Paratek Pharmaceuticals, Inc. - FORM 10-Q - August 6, 2014

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________
Form 10-Q
____________________________
x
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended: June 30, 2014
or
o
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: 000-51967
____________________________
TRANSCEPT PHARMACEUTICALS, INC.
(Exact name of registrant as specified in its charter)
____________________________
Delaware
 
33-0960223
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
____________________________
1003 W. Cutting Blvd., Suite #110
Point Richmond, California 94804
(510) 215-3500
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive office)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o
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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o.
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  o
 
Accelerated filer   o
 
Non-accelerated filer  o
 
Smaller reporting company  x
 
 
 
 
(Do not check if a smaller
reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  o    No  x
As of August 4, 2014 there were 19,160,435 shares of the registrant’s common stock outstanding.
 


TABLE OF CONTENTS
 
 
Item No.
 
Page No.
 
 
 
 
Condensed Consolidated Balance Sheets - June 30, 2014 and December 31, 2013
 
 
Condensed Consolidated Statements of Operations and Comprehensive Loss - Three and Six Months Ended June 30, 2014 and 2013
 
 
Condensed Consolidated Statements of Cash Flows - Six Months Ended June 30, 2014 and 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


PART I
FINANCIAL INFORMATION
 
Item 1.
Financial Statements
Transcept Pharmaceuticals, Inc.
Condensed Consolidated Balance Sheets
(in thousands)
 
 
June 30,
2014
 
December 31,
2013
 
(Unaudited)
 
(Note 1)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
16,845

 
$
9,935

Marketable securities
26,557

 
60,110

Prepaid and other current assets
902

 
3,382

Restricted cash
35

 
200

Total current assets
44,339

 
73,627

Property and equipment, net
20

 
43

Total assets
$
44,359

 
$
73,670

Liabilities and stockholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
1,044

 
$
413

Accrued liabilities
1,448

 
1,515

Total current liabilities
2,492

 
1,928

Commitments and contingencies


 


Stockholders’ equity:
 
 
 
Common stock
19

 
19

Additional paid-in capital
187,525

 
211,257

Accumulated deficit
(145,686
)
 
(139,556
)
Accumulated other comprehensive income
9

 
22

Total stockholders’ equity
41,867

 
71,742

Total liabilities and stockholders’ equity
$
44,359

 
$
73,670

See accompanying notes.


1

Transcept Pharmaceuticals, Inc.
Condensed Consolidated Statements of Operations and Comprehensive Loss
(in thousands, except per share amounts)
(Unaudited)
 
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Revenue:
 
 
 
 
 
 
 
Gross royalty revenue
$
362

 
$
481

 
$
780

 
$
963

Advertising expense - Purdue Pharma
—

 
(283
)
 
—

 
(6,595
)
Net revenue
362

 
198

 
780

 
(5,632
)
Operating expenses:
 
 
 
 
 
 
 
Research and development
585

 
898

 
1,293

 
2,741

General and administrative
3,079

 
3,030

 
5,575

 
5,832

Goodwill impairment
—

 
2,962

 
—

 
2,962

Total operating expenses
3,664

 
6,890

 
6,868

 
11,535

Loss from operations
(3,302
)
 
(6,692
)
 
(6,088
)
 
(17,167
)
Interest and other income (expense), net
(24
)
 
(16
)
 
(42
)
 
(41
)
Net loss
$
(3,326
)
 
$
(6,708
)
 
$
(6,130
)
 
$
(17,208
)
Net loss per share:
 
 
 
 
 
 
 
Basic and diluted
$
(0.18
)
 
$
(0.36
)
 
$
(0.32
)
 
$
(0.92
)
Cash distribution declared per common share
$
1.33

 
$
—

 
$
1.33

 
$
—

Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic and diluted
18,982

 
18,757

 
18,913

 
18,731

 
 
 
 
 
 
 
 
Other comprehensive loss:
 
 
 
 
 
 
 
Changes in unrealized gain (loss) on marketable securities
(11
)
 
(16
)
 
(13
)
 
(16
)
Comprehensive loss
$
(3,337
)
 
$
(6,724
)
 
$
(6,143
)
 
$
(17,224
)
See accompanying notes.


2

Transcept Pharmaceuticals, Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
 
 
Six Months Ended June 30,
 
2014
 
2013
Operating activities
 
 
 
Net loss
$
(6,130
)
 
$
(17,208
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
11

 
72

Stock-based compensation
1,047

 
1,548

Gain on disposals of fixed assets
(101
)
 
(17
)
Amortization of premium on available for sale securities
349

 
366

Impairment of goodwill
—

 
2,962

Changes in operating assets and liabilities:
 
 
 
Prepaid and other current assets
2,480

 
6,039

Accounts payable
631

 
(625
)
Accrued liabilities
(68
)
 
(687
)
Net cash used in operating activities
(1,781
)
 
(7,550
)
Investing activities
 
 
 
Purchases of property and equipment
—

 
(2
)
Proceeds from the sale of property and equipment
115

 
23

Purchases of marketable securities
(35
)
 
(53,745
)
Maturities of marketable securities
33,391

 
39,530

Net cash provided by (used in) investing activities
33,471

 
(14,194
)
Financing activities
 
 
 
Cash distributions paid to common stockholders
(25,408
)
 
—

Proceeds from issuance of common stock, net
628

 
223

Net cash (used in) provided by financing activities
(24,780
)
 
223

Net increase (decrease) in cash and cash equivalents
6,910

 
(21,521
)
Cash and cash equivalents at beginning of period
9,935

 
39,368

Cash and cash equivalents at end of period
$
16,845

 
$
17,847

See accompanying notes.

3

Transcept Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Organization and Summary of Significant Accounting Policies
Transcept Pharmaceuticals, Inc. (the “Company”) is a specialty pharmaceutical company focused on the development and commercialization of proprietary products that address important therapeutic needs in the field of neuroscience. The Company's remaining development candidate is TO-2070, a novel, rapidly absorbed treatment for acute migraine incorporating dihydroergotamine (DHE) as the active drug, which Transcept has developed through the completion of preclinical safety studies, but has not initiated a Phase 1 human pharmacokinetic study. Intermezzo® (zolpidem tartrate) sublingual tablet C-IV is the first FDA approved Transcept product. Purdue Pharmaceutical Products L.P. (“Purdue Pharma”) holds commercialization and development rights for Intermezzo in the United States. The Company operates in one business segment.
In 2013, the Company engaged a financial and strategic advisor to explore a range of alternatives to enhance stockholder value, including but not limited to business combination and/or partnership opportunities, as well as a distribution of a significant amount of cash to stockholders, and dissolution of the Company. In June 2014, the Company distributed $1.33 in cash for each outstanding share of common stock, equal to approximately $25.4 million in the aggregate, to Transcept stockholders by way of a special distribution.
Subsequently, in June 2014, the Company entered into a definitive agreement for a merger with Paratek Pharmaceuticals, Inc. See Note 2 regarding this transaction.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required for complete consolidated financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly the Company's interim financial information. The accompanying condensed consolidated balance sheet at December 31, 2013 has been derived from our audited financial statements at that date, but does not include all the disclosures required for complete financial statements. The results for the three and six months ended June 30, 2014 are not necessarily indicative of the results to be expected for the full year ending December 31, 2014 or for any other interim period or any other future year.
The accompanying unaudited condensed consolidated financial statements and notes to condensed consolidated financial statements should be read in conjunction with the Company's audited financial statements in its Annual Report on Form 10-K for the year ended December 31, 2013, as filed with the United States Securities and Exchange Commission on March 14, 2014.
Use of Estimates
The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Management bases its estimates on historical experience and on assumptions believed to be reasonable under the circumstances. Actual results could differ materially from those estimates. Management makes estimates when preparing the financial statements including those relating to revenue recognition, clinical trials expense, advertising expense, and stock-based compensation.
Concentration of Risk
The Company is dependent on Purdue Pharma to market and sell Intermezzo in the United States from which all of its royalty and milestone revenue to date has been derived.
Significant Accounting Policies
Principles of Consolidation
The accompanying condensed consolidated financial statements include the results of operations of Transcept Pharmaceuticals, Inc. and its wholly-owned subsidiaries, Transcept Pharma, Inc. and Tigris Merger Sub. Inc. All significant intercompany accounts and transactions have been eliminated in consolidation.

4
Transcept Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements (continued) (Unaudited)

Goodwill
Goodwill is not subject to amortization, but is tested for impairment on an annual basis during the third quarter or whenever events or changes in circumstances indicate the carrying amount of these assets may not be recoverable. Goodwill impairment testing is a two-step process and performed on a reporting unit level. In the first step, the Company conducts an assessment of qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the Company determines that it is more likely than not that the fair value of its reporting unit is less than its carrying amount, it then conducts the second step, a two-part test for impairment of goodwill. The Company first compares the fair value of its reporting unit to its carrying value. If the fair value of the reporting unit exceeds the carrying value of the reporting unit's net assets, goodwill is not considered impaired and no further analysis is required. If the carrying value of the net assets exceeds the fair value of the reporting unit, then the second part of the impairment test must be performed in order to determine the implied fair value of the goodwill. If the carrying value of the goodwill exceeds the implied fair value, then an impairment loss equal to the difference would be recorded. The Company operates in one reporting unit and believes that its market capitalization is indicative of the fair value of the Company.
During the second quarter of 2013, several events occurred that indicated that the carrying amount of goodwill exceeded the fair value of the reporting unit, including:
•
the approximately 30% decline in Intermezzo prescriptions at June 30, 2013 from the peak of the direct to consumer ("DTC") advertising campaign, which was substantially completed in April 2013; and
•
the May 2013 termination by Purdue of 90 contract sales representatives dedicated exclusively to promoting Intermezzo, resulting in reliance solely on Purdue's existing analgesics sales force of approximately 525 sales representatives.
As a result of these factors, the Company experienced a 37% decline in its stock price during the quarter ended June 30, 2013. The decline in stock price resulted in a market capitalization of approximately $56.7 million at June 30, 2013 which, when compared to the Company's stockholders' equity of $79.9 million, and in consideration of the early nature of ongoing internal research and development, the progress of new product search and evaluation efforts and the declining sales of Intermezzo, was an indication of impairment under step one of the goodwill impairment testing accounting guidance.
Step two of the goodwill test consisted of comparing the fair value of the Company to its carrying value at June 30, 2013. If the carrying value exceeds fair value, then a hypothetical purchase price exercise is to be performed to determine the amount, if any, of goodwill impairment. In determining the fair value of the Company, management considered the Company's market capitalization, including any premium that would be necessary for an acquirer to obtain control of the Company, as well as net cash and investments on hand at June 30, 2013. In each of these scenarios, the carrying value of the Company exceeded its fair value in excess of the carrying value of goodwill.
The impairment analysis indicated that the entire goodwill balance of $3.0 million was impaired, which was recognized during the three-months ended June 30, 2013. No previous impairments of goodwill had been recognized by the Company.
Revenue Recognition
The Company applies the revenue recognition criteria outlined in Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements, and Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 605 Revenue Recognition, sub-topic 25 Multiple-Element Arrangements.
Revenue arrangements with multiple components are divided into separate units of accounting if certain criteria are met, including whether the delivered component has stand-alone value to the customer. Consideration received is allocated among the separate units of accounting based on their relative fair values or if fair value is not determinable, based on the Company’s best estimate of selling price. Applicable revenue recognition criteria are then applied to each of the units.
Revenue is recognized when the four basic criteria of revenue recognition are met: (1) persuasive evidence of an arrangement exists; (2) transfer of technology has been completed or services have been rendered; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured.
For each source of revenue, the Company complies with the above revenue recognition criteria in the following manner:
•
Up-front license payments are assessed to determine whether or not the licensee is able to obtain any stand-alone value from the license. Where this is not the case, the Company does not consider the license deliverable to be a separate unit of accounting, and the revenue is deferred with revenue recognition for the license fee assessed in conjunction with the other deliverables that constitute the combined unit of accounting. When the period of

5
Transcept Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements (continued) (Unaudited)

deferral cannot be specifically identified from the agreement, management estimates the period based upon provisions contained within the related agreements and other relevant facts. The Company periodically reviews the estimated involvement period, which could impact the deferral period and, therefore, the timing and the amount of revenue recognized. It is possible that future adjustments will be made if actual conditions differ from the Company’s current plan and involvement assumptions;
•
Payments received that are related to substantive, performance-based “at-risk” milestones are recognized as revenue upon achievement of the milestone or event specified in the underlying contracts, which represents the culmination of the earnings process. Amounts received in advance, if any, are recorded as deferred revenue until the milestone is reached; and
•
Royalty revenue from sales of the Company’s licensed product is recognized as earned in accordance with the contract terms when royalties from licensees can be estimated and collectability is reasonably assured.
Advertising
The Company expenses non-direct response advertising as incurred. Advertising expense consisted of the Company's December 2012 $10.0 million contribution to Purdue Pharma's national direct-to-consumer ("DTC") advertising campaign, including digital, print and television advertising to support Intermezzo commercialization. The Company initially recorded the $10.0 million payment to Purdue Pharma as a prepaid expense. This payment was recognized as the advertising costs were incurred. As this payment was made directly to Purdue Pharma, recognition of the expense was recorded as an offset to revenue. At December 31, 2013, Purdue Pharma estimated that approximately $1.8 million of the Company's original contribution would be returned due to reduced overall DTC campaign spending. Accordingly, $1.8 million was recorded as a receivable and included in prepaid and other current assets at December 31, 2013.
For the three and six months ended June 30, 2013, the offset to revenue totaled $0.3 million and $6.6 million, respectively. As the DTC advertising campaign was completed during 2013, there is no advertising offset to revenue in 2014.
Stock-Based Compensation
The Company records stock-based compensation of stock options granted to employees and directors and of employee stock purchase plan shares by estimating the fair value of stock-based awards using the Black-Scholes option pricing model and amortizing the fair value of the stock-based awards granted over the applicable vesting period. Additionally, the Company is required to include an estimate of the number of awards that will be forfeited in calculating compensation costs, which are recognized over the requisite service period of the awards on a straight-line basis.
The Company recognized employee stock-based compensation costs of $0.5 million and $1.0 million during the three and six months ended June 30, 2014, respectively, and $0.7 million and $1.5 million during the three and six months ended June 30, 2013, respectively. No related tax benefits of stock-based compensation costs have been recognized since the Company's inception. The Company issued 280,324 and 280,824 shares of common stock for the three and six months ended June 30, 2014, respectively, upon stock option exercises.
During the six months ended June 30, 2013, the Company modified the terms of stock options previously granted to six of its employees in connection with a reduction in force. The modifications included accelerated vesting of certain options and extension of the exercise period after termination with respect to certain of the options. These modifications resulted in additional compensation expense of $23,000. During the six months ended June 30, 2014, the Company modified the terms of stock options previously granted to two former employee to extend the exercise period with respect to certain of the remaining outstanding options resulting in additional compensation of $39,000.
Equity instruments, consisting of stock options granted to consultants, are valued using the Black-Scholes valuation model. The measurement of stock-based compensation is subject to periodic adjustments as the underlying equity instruments vest and is recognized as an expense over the term of the related financing or the period over which services are received. The Company recorded non-employee stock-based compensation costs of $8,000 and $19,000 during the three and six months ended June 30, 2014, respectively and $13,000 and $57,000 during the three and six months ended June 30, 2013, respectively.
Clinical Trials
The Company accrues and expenses costs for clinical trial activities performed by third parties, including clinical research organizations and clinical investigators, based upon estimates made of the work completed as of each reporting date, in accordance with agreements established with contract research organizations and clinical trial sites and the agreed upon fee to be paid for the services. The Company determines these estimates through discussion with internal personnel and outside service providers as to the progress or stage of completion of the trials or services. Costs of setting up clinical trial sites for

6
Transcept Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements (continued) (Unaudited)

participation in the trials are expensed immediately as research and development expenses. Clinical trial site costs related to patient enrollment are accrued as patients are entered into the trial and reduced by any initial payment made to the clinical trial site when the first patient is enrolled.
2. Merger Agreement
On June 30, 2014, the Company, Tigris Merger Sub, Inc., a Delaware corporation and a wholly owned subsidiary of the Company (“Merger Sub”), Tigris Acquisition Sub, LLC, a Delaware limited liability company and a wholly owned subsidiary of the Company (“Merger LLC”), and Paratek Pharmaceuticals, Inc., a Delaware corporation (“Paratek”), entered into an Agreement and Plan of Merger and Reorganization (the “Merger Agreement”), pursuant to which, among other things, subject to the satisfaction or waiver of the conditions set forth in the Merger Agreement, (i) Merger Sub will merge with and into Paratek, with Paratek becoming a wholly-owned subsidiary of the Company and the surviving corporation of the merger (the “Merger”) and (ii) immediately following the Merger, the surviving corporation will merge with and into Merger LLC with Merger LLC surviving as the surviving company in such merger (the “Second Merger”).
Subject to the terms and conditions of the Merger Agreement, at the closing of the Merger, each outstanding share of Paratek common stock will be converted into the right to receive 0.810 shares of common stock of the Company, subject to the payment of cash in lieu of fractional shares. Immediately following the effective time of the Merger, Paratek stockholders are expected to own approximately 89.6% of the outstanding capital stock of the Company.
Consummation of the Merger is subject to certain closing conditions, including, among other things, approval by the stockholders of the Company and Paratek. The Merger Agreement contains certain termination rights for both the Company and Paratek, and further provides that, upon termination of the Merger Agreement under specified circumstances, either party may be required to pay the other party a termination fee of $6.3 million.
At the effective time of the Merger, the Board of Directors of the Company is expected to consist of a total of seven members, two of whom will be designated by Transcept and five of whom will be designated by Paratek.
Pursuant to the terms of the Merger Agreement, prior to the closing of the Merger, the Company is expected to make a dividend to its stockholders of certain assets, including excess cash (as calculated in accordance with the Merger Agreement), the right to receive certain royalty income received by the Company pursuant to the Collaboration Agreement with Purdue Pharma and the right to receive the proceeds (net of certain fees, expenses) of any sale of Intermezzo or TO-2070 which are received prior to the two-year anniversary of the closing of the Merger or which are received pursuant to a definitive agreement relating to such sale which is entered into during such period, as well as the amount, if any, of the $3 million Intermezzo expense reserve deposited at closing which is remaining following the second anniversary of the closing date.
Concurrent with the execution of the Merger Agreement, on July 1, 2014, the Company made a bridge loan to Paratek in the principal amount of $3.5 million. In the event that the transaction does not close by September 15, 2014, the Company has committed to make available further funding of up to $800,000 per month, until December 31, 2014, provided the Merger continues to be pending and the Merger Agreement has not been terminated.

3. Results of Operations
Net Loss Per Share
Basic net loss per share is computed by dividing net loss by the weighted average number of shares outstanding during the period. Diluted net loss per share is computed by giving effect to all potential dilutive common securities, including options, warrants and common stock subject to repurchase.
Potentially dilutive common shares include the dilutive effect of the common stock underlying in-the-money stock options and is calculated based on the average share price for each period using the treasury stock method. Under the treasury stock method, the exercise price of an option and the average amount of compensation cost, if any, for future service that the Company has not yet recognized when the option is exercised, are assumed to be used to repurchase shares in the current period.
For the three and six months ended June 30, 2014 and 2013, diluted net loss per share was identical to basic earnings per share ("EPS") since potential common shares were excluded from the calculation, as their effect was anti-dilutive.

7
Transcept Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements (continued) (Unaudited)

The following table presents the calculation of basic and diluted net loss per share (in thousands):
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Numerator:
 
 
 
 
 
 
 
Net loss
$
(3,326
)
 
$
(6,708
)
 
$
(6,130
)
 
$
(17,208
)
Denominator for basic and diluted net loss per share:
 
 
 
 
 
 
 
Weighted average common shares outstanding
18,982

 
18,757

 
18,913

 
18,731

The following outstanding shares subject to options and warrants to purchase common stock were antidilutive due to a net loss in the periods presented and, therefore, were excluded from the dilutive securities computation as of the dates indicated below (in thousands):
 
Six Months Ended
 
2014
 
2013
Excluded potentially dilutive securities (1):
 
 
 
Shares subject to options to purchase common stock
3,910

 
3,788

Shares subject to warrants to purchase common stock
61

 
61

Total
3,971

 
3,849


(1)
The number of shares is based on the maximum number of shares issuable on exercise or conversion of the related securities as of the period end. Such amounts have not been adjusted for the treasury stock method or weighted average outstanding calculations as required if the securities were dilutive.


8
Transcept Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements (continued) (Unaudited)

4. Available-for-sale Securities

The following is a summary of available-for-sale debt securities recognized as cash and cash equivalents, marketable securities, or restricted cash in the Company's condensed consolidated balance sheets. Estimated fair values of available-for-sale securities are generally based on prices obtained from commercial pricing services (in thousands):
 
June 30, 2014
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Estimated
Fair Value
Money market funds
$
4,009

 
$
—

 
$
—

 
$
4,009

Commercial paper
11,800

 
—

 
—

 
11,800

Corporate notes
2,501

 
—

 
—

 
2,501

Government sponsored enterprise issues
20,875

 
5

 
—

 
20,880

U.S. Treasury securities
3,172

 
4

 
—

 
3,176

 
$
42,357

 
$
9

 
$
—

 
$
42,366

 
December 31, 2013
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Estimated
Fair Value
Certificates of deposit
$
200

 
$
—

 
$
—

 
$
200

Money market funds
769

 
—

 
—

 
769

Commercial paper
12,910

 
—

 
—

 
12,910

Corporate notes
16,704

 
9

 
—

 
16,713

Government sponsored enterprise issues
36,157

 
10

 
—

 
36,167

U.S. Treasury securities
3,228

 
3

 
—

 
3,231

 
$
69,968

 
$
22

 
$
—

 
$
69,990

The following table summarizes the classification of the available-for-sale securities on the Company's condensed consolidated balance sheets (in thousands):
 
 
June 30,
 
December 31,
 
 
2014
 
2013
Cash and cash equivalents
 
$
15,774

 
$
9,680

Marketable securities
 
26,557

 
60,110

Restricted cash
 
35

 
200

 
 
$
42,366

 
$
69,990

 
 
 
 
 
There were no sales of available-for-sale marketable securities during 2014 or 2013.
The Company's marketable securities at June 30, 2014 of $26.6 million had maturities of one year or less.
5. Fair Value
The Company defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.
The Company's valuation techniques are based on observable and unobservable inputs. Observable inputs reflect readily obtainable data from independent sources, while unobservable inputs reflect the Company's market assumptions. The Company classifies these inputs into the following hierarchy:
•
Level 1—Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs;

9
Transcept Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements (continued) (Unaudited)

•
Level 2—Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities; and
•
Level 3—Unobservable inputs (i.e. inputs that reflect the reporting entity’s own assumptions about the assumptions that market participants would use in estimating the fair value of an asset or liability) are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.
A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Where quoted prices are available in an active market, securities are classified as Level 1 of the valuation hierarchy. Level 1 securities include highly liquid money market funds. If quoted market prices are not available for the specific security, then the Company estimates fair value by using pricing models, quoted prices of securities with similar characteristics or discounted cash flows. Level 2 instruments include commercial paper, U.S. corporate debt, and U.S. government sponsored enterprise issues. There are no Level 3 assets in the periods presented.
The estimated fair values of the Company's financial assets (cash equivalents and marketable securities) as of June 30, 2014 (in thousands) are as follows:
 
 
 
Fair Value Measurements at Reporting Date Using
 
June 30,
2014
Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets
 
 
 
 
 
 
 
Money market funds
$
4,009

 
$
4,009

 
$
—

 
$
—

Commercial paper
11,800

 
—

 
11,800

 
—

Corporate notes
2,501

 
—

 
2,501

 
—

Government sponsored enterprise issues
20,880

 
—

 
20,880

 
—

U.S. Treasury securities
3,176

 
—

 
3,176

 
—

 
$
42,366

 
$
4,009

 
$
38,357

 
$
—

The estimated fair values of the Company's financial assets (cash equivalents and marketable securities) as of December 31, 2013 (in thousands) are as follows:
 
 
 
Fair Value Measurements at Reporting Date Using
 
December 31,
2013
 
Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Assets
 
 
 
 
 
 
 
Certificates of deposit
$
200

 
$
200

 
$
—

 
$
—

Money market funds
769

 
769

 
—

 
—

Commercial paper
12,910

 
—

 
12,910

 
—

Corporate notes
16,713

 
—

 
16,713

 
—

Government sponsored enterprise issues
36,167

 
—

 
36,167

 
—

U.S. Treasury securities
3,231

 
—

 
3,231

 
—

 
$
69,990

 
$
969

 
$
69,021

 
$
—

During the six months ended June 30, 2014 and the year ended December 31, 2013, there were no significant changes to the valuation models used for purposes of determining the fair value of Level 2 assets. No other assets and liabilities were carried at fair value as of June 30, 2014 and December 31, 2013.

10
Transcept Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements (continued) (Unaudited)

Level 2 securities are priced using quoted market prices for similar instruments, nonbinding market prices that are corroborated by observable market data, or discounted cash flow techniques. There were no transfers of assets between different fair-value levels during the periods presented.
6. Collaboration Agreements
Intermezzo
In July 2009, the Company entered into a collaboration agreement with Purdue Pharmaceuticals L.P., ("Purdue Pharma")(the "Collaboration Agreement") that grants an exclusive license to Purdue Pharma to commercialize Intermezzo in the United States and pursuant to which:
◦
Purdue Pharma paid a $25.0 million non-refundable license fee in August 2009;
◦
Purdue Pharma paid a $10.0 million non-refundable intellectual property milestone in December 2011 when the first of two issued formulation patents was listed in the FDA's Approved Drug Products with Therapeutic Equivalence Evaluations, or Orange Book;
◦
Purdue Pharma paid a $10.0 million non-refundable intellectual property milestone in August 2012 when the first of two issued method of use patents was listed in the FDA's Orange Book;
◦
The Company transferred the Intermezzo New Drug Application (NDA) to Purdue Pharma, and Purdue Pharma is obligated to assume the expense associated with maintaining the NDA and further development of Intermezzo in the United States, including any expense associated with post-approval studies;
◦
Purdue Pharma is obligated to commercialize Intermezzo in the United States at its expense using commercially reasonable efforts;
◦
Purdue Pharma is obligated to pay the Company tiered base royalties on net sales of Intermezzo in the United States ranging from the mid-teens up to the mid-20% level. The base royalty is tiered depending upon the achievement of certain fixed net sales thresholds by Purdue Pharma, which net sales levels reset each year for the purpose of calculating the royalty; and
◦
Purdue Pharma is obligated to pay the Company up to an additional $70.0 million upon the achievement of certain net sales targets for Intermezzo in the United States.
The Company has retained an option to co-promote Intermezzo to psychiatrists in the United States. The option can be exercised as late as August 2015. The Company may begin promotion to psychiatrists 8 to 15 months after option exercise. The exact timing of when the Company begins promoting to psychiatrists is determined by the calendar month in which the option exercise notice is delivered to Purdue Pharma. If the Company exercises the co-promote option and enters the marketplace, it is entitled to receive an additional co-promote royalty from Purdue Pharma on net sales that are generated by psychiatrist prescriptions. Had the Company chosen to exercise the option as soon as it was eligible, it could have begun promoting to psychiatrists in May 2013 and received a co-promote royalty of 40%. The co-promote royalty rate declines on a straight-line basis to approximately 22% if the Company does not begin promoting to psychiatrists until November 2016, at which time the right to co-promote expires. Net sales qualifying for this additional co-promote royalty are limited by an annual cap of 15% of total Intermezzo annual net sales in the United States. The co-promote option cannot be transferred to a third party, except under a limited circumstance at the discretion of Purdue Pharma.
Purdue Pharma has the right to terminate the Collaboration Agreement at any time upon advance notice of 180 days. The Company's co-promote option may also be terminated by Purdue Pharma upon the Company's acquisition by a third party or in the event of entry of generic competition to Intermezzo. The royalty payments discussed above are subject to reduction in connection with, among other things, the entry of generic competition to Intermezzo. The Collaboration Agreement expires on the later of 15 years from the date of first commercial sale in the United States or the expiration of patent claims related to Intermezzo. The Collaboration Agreement is also subject to termination by Purdue Pharma in the event of FDA or governmental action that materially impairs Purdue Pharma's ability to commercialize Intermezzo or the occurrence of a serious event with respect to the safety of Intermezzo. The Collaboration Agreement may also be terminated by the Company upon Purdue Pharma commencing an action that challenges the validity of Intermezzo related patents. The Company also has the right to terminate the Collaboration Agreement immediately if Purdue Pharma is excluded from participation in federal healthcare programs. The Collaboration Agreement may also be terminated by either party in the event of a material breach by or insolvency of the other party.
The Company also granted Purdue Pharma and an associated company the right to negotiate for the commercialization of Intermezzo in Mexico in 2013 and retained the rights to commercialize Intermezzo in the rest of the world.

11
Transcept Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements (continued) (Unaudited)

The Company began earning royalty revenue upon commercial launch of Intermezzo in April 2012. Royalty revenue earned during the three and six months ended June 30, 2014 was $0.4 million and $0.8 million, respectively. Royalty revenue earned during the three and six months ended June 30, 2013 was $0.5 million and $1.0 million, respectively.
Royalty revenue during 2013 was offset by the Company's contribution to Purdue Pharma's 2013 national DTC advertising campaign, including digital, print and television advertising to support Intermezzo commercialization. For the three and six months ended June 30, 2013, the offset to revenue totaled $0.3 million and $6.6 million, respectively. As the DTC advertising campaign was completed during 2013, there is no advertising offset to revenue during 2014.
TO-2070: a developmental product candidate for migraine treatment
In September 2013, the Company entered into the License Agreement with Shin Nippon Biomedical Laboratories Ltd. ("SNBL") pursuant to which SNBL granted the Company an exclusive worldwide license to commercialize SNBL's proprietary nasal drug delivery technology to develop TO-2070. The Company is developing TO-2070 as a treatment for acute migraine using SNBL’s proprietary nasal powder drug delivery system. Under the License Agreement, the Company is required to fund, lead and be responsible for product development, preparing and submitting regulatory filings and obtaining and maintaining regulatory approval with respect to TO-2070. Pursuant to the License Agreement, the Company has incurred an upfront nonrefundable technology license fee of $1.0 million, and is also obligated to pay:
•
up to $6.5 million upon the occurrence of certain development milestones, including NDA approval of TO-2070 by the FDA,
•
up to $35.0 million in commercialization milestone payments tied to the achievement of specified annual sales levels of TO-2070, and
•
tiered, low double-digit royalties on annual net sales of TO-2070.
Under the License Agreement, the Company is responsible for the clinical and commercial manufacture, supply, and distribution of TO-2070 products. SNBL has agreed to supply its nasal drug delivery device to the Company to conduct development activities for non-registration studies, and has the right of first negotiation to be the Company's exclusive supplier for devices for any registration studies and for incorporation into commercial TO-2070 products under the License Agreement thereafter.
The License Agreement terminates on a country-by-country basis upon the later of (i) the expiration of the last patent licensed under the License Agreement in such country and (ii) 15 years from the first commercial sale in such country. The License Agreement may also be terminated (i) by either party upon 90 days' written notice in connection with an uncured material breach of the License Agreement, (ii) by either party upon insolvency of the other party, (iii) immediately by SNBL if the Company challenges the validity of the patents licensed under the License Agreement, or (iv) by the Company at its convenience upon 90 days' prior notice.
The $1.0 million license fee was recorded as research and development expense in September 2013 because the licensed technology was incomplete and has no alternative future use. Payments to SNBL that relate to pre-approval development milestones will be recognized as research and development expense when incurred.
7. Commitments and Contingencies
Leases
On March 6, 2013, the Company extended its lease agreement for 11,600 square feet of space in its current facility in Point Richmond, California by one year through May 31, 2014. On February 18, 2014, the lease was extended to August 31, 2014. On July 1, 2014, the term of the lease was amended to continue on a month-to-month basis, terminable by either party with sixty days notice; with the soonest any such notice may be given is October 2, 2014 (which, if delivered, would cause the term to expire as of November 30, 2014).
Legal Proceedings
ANDA Litigation - Intermezzo
In July 2012, the Company received notifications from three companies, Actavis Elizabeth LLC (Actavis), Watson Laboratories, Inc. - Florida (Watson), and Novel Laboratories, Inc. (Novel), in September 2012, from each of Par Pharmaceutical, Inc. and Par Formulations Private Ltd. (together, the Par Entities), in February 2013 from Dr. Reddy's

12
Transcept Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements (continued) (Unaudited)

Laboratories, Inc. and Dr. Reddy's Laboratories, Ltd. (together, Dr. Reddy's), and in July 2013 from TWi Pharmaceuticals, Inc. (TWi) stating that each has filed with the FDA an Abbreviated New Drug Application, or ANDA, that references Intermezzo.
•
Actavis & Watson: In the July 2012 notifications, Actavis and Watson indicated that each company's ANDA includes Paragraph IV patent certifications to our U.S. Patent Nos. 7,658,945 (expiring April 15, 2027) and 7,682,628 (expiring February 16, 2025) (together, the “'945 and '628 Patents”). On November 28, 2012, Watson withdrew its ANDA, and, as a result of such withdrawal, on December 18, 2012, the Company and Purdue agreed to voluntarily dismiss the action without prejudice and on December 20, 2012 a court order was entered to such effect. The dismissal of Watson's ANDA had no effect on the ANDA filed by Actavis, a wholly owned subsidiary of Watson Pharmaceuticals, Inc. On January 24, 2013, Actavis notified the Company that it has included Paragraph IV patent certifications to Transcept's U.S. Patent Nos. 8,242,131 (expiring August 20, 2029) and 8,252,809 (expiring February 16, 2025) (together, the “'131 and '809 Patents”).
•
Novel: In the July 2012 notifications, Novel indicated that its ANDA includes Paragraph IV patent certifications to the '945 and '628 Patents. On December 10, 2012, Novel notified the Company that it has included Paragraph IV patent certifications to the '131 and '809 Patents.
•
Par Entities: The ANDAs submitted by the Par Entities each include Paragraph IV patent certifications to the '945, '628, '131 and '809 Patents.
•
Dr. Reddy's: The ANDA submitted by Dr. Reddy's includes Paragraph IV patent certifications to the '945, '628, '131 and '809 Patents.
•
TWi: The ANDA submitted by TWi includes Paragraph IV patent certifications to the '945, '628, '131 and '809 Patents.

In August 2012, August 2012, September 2012, and October 2012, respectively, the Company joined Purdue Pharma in filing actions against Actavis, Watson and certain of their affiliates, Novel, and the Par Entities, in the U.S. District Court for the District of New Jersey, in each action alleging patent infringement and seeking injunctive and other relief. In December 2012, the Company and Purdue Pharma agreed to voluntarily dismiss the action against Watson following its withdrawal of its ANDA. After receiving the supplemental notifications referenced above, the Company and Purdue Pharma amended their pending complaints against Actavis and Novel to also allege infringement of the '131 and '809 patents, as well as the '628 patent previously asserted against those companies.

The actions against the Par Entities alleged infringement of the '131 and '809 patents. In September 2013, the Company and Purdue Pharma agreed to voluntarily dismiss the action against one of the two Par Entities, Par Formulations Private Ltd., following that Par Entity’s withdrawal of its ANDA. The action against the other Par Entity, Par Pharmaceutical, Inc., remains pending and continues to allege infringement of the ‘131 and ‘809 patents.

In April 2013, the Company joined Purdue Pharma in filing an action in the U.S. District Court for the District of New Jersey against Dr. Reddy's, alleging patent infringement of the '628, '131 and '809 patents, and seeking injunctive and other relief.

In August 2013, the Company joined Purdue Pharma in filing two actions against TWi. The first action against TWi was filed on August 20, 2013 in the U.S. District Court for the District of New Jersey, and the second action against TWi was filed on August 22, 2013 in the U.S. District Court for the Northern District of Illinois. Each action alleges patent infringement of the ‘131 and ‘809 patents, and seeks injunctive and other relief. On October 17, 2013, TWi filed answers and counterclaims in both New Jersey and Illinois, in both cases seeking declarations of non-infringement and invalidity as to the ‘945, ‘628, ‘131, and ‘809 patents, as well as other relief. On January 13, 2014, the Illinois action against TWi was stayed pending dismissal of the New Jersey action against TWi, or further order of the Illinois court. On January 24, 2014, the Company and Purdue provided TWi with a covenant not to sue TWi based on its current ANDA formulation under the '945 or '628 patents, and on February 28, 2014, the Company and Purdue filed a motion in the New Jersey action to dismiss TWi's counterclaims pertaining to the '945 or '628 patents based on the tendering of that covenant not to sue. On April 9, 2014, the New Jersey court denied the motion of the Company and Purdue. On July 22, 2014, the New Jersey court entered a consent decree and partial final judgment of non-infringement in TWi's favor on the '945, '628, and '809 patents. The action against TWi remains pending as to the '131 patent.

On February 26, 2014, the New Jersey court consolidated the action of the Company and Purdue against TWi with the existing consolidated action referenced above against Actavis, Novel, Par Pharmaceutical, and Dr. Reddy's.


13
Transcept Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements (continued) (Unaudited)

On July 22, 2014, the New Jersey court ordered that the trail of the consolidated action will commence on December 1, 2014.
Patent Term Adjustment Suit
    
In January 2013, the Company and Purdue Pharma filed suit in the Eastern District of Virginia against the United States Patent and Trademark Office, or USPTO, in connection with certain changes to the Leahy-Smith America Invents Act. The Company and Purdue Pharma are seeking a recalculation of the patent term adjustment of the '131 Patent. Purdue Pharma has agreed to bear the costs and expenses associated with this litigation. In June of 2013, the judge granted a joint motion to stay the proceedings pending a final decision on appeal by the Federal Circuit in Exelixis, Inc. v. Rea, No. 2013-11 75 (Fed. Cir.), and Exelixis, Inc. v. Rea, No. 20 13-11 98 (Fed. Cir.).
    
From time to time the Company is involved in legal proceedings arising in the ordinary course of business. The Company believes there is no other litigation pending that could have, individually or in the aggregate, a material adverse effect on its results of operations or financial condition.
8. Restructuring
On January 2, 2013, the Company implemented a reduction of 29% of its workforce, which resulted in $0.3 million of expenses which primarily consisted of severance charges. The severance was paid during the quarter ended March 31, 2013 and no additional charges were incurred under this reduction in force.
9. Cash distribution
On June 3, 2014, the Company distributed $1.33 in cash for each outstanding share of the Company's common stock, equal to approximately $25.4 million in the aggregate.

Additionally, on June 3, 2014, in accordance with the Company's equity plans and warrant terms, all of the Company's outstanding stock options and warrants were adjusted by reducing the exercise price and/or increasing the number of shares to preserve the intrinsic value of such awards after the decline in the Company's stock price directly resulting from the cash dividend. The award adjustments resulted in no incremental stock compensation expense for the three and six month periods ending June 30, 2014.

14

Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains certain statements that are not strictly historical and are “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995 and involve a high degree of risk and uncertainty. Actual results may differ materially from those projected in the forward-looking statements due to other risks and uncertainties. All forward-looking statements included in this section are based on information available to us as of the date hereof, and we assume no obligation to update any such forward-looking statement, except as required by law.

Special Note Regarding Forward-Looking Statements
This Quarterly Report on Form 10-Q contains forward-looking statements that are based upon current expectations within the meaning of the Private Securities Litigation Reform Act of 1995. Transcept Pharmaceuticals, Inc., or Transcept, intends that such statements be protected by the safe harbor created thereby. Forward-looking statements involve risks and uncertainties and actual Transcept results and the timing of events may differ significantly from those results discussed in the forward-looking statements. Examples of such forward-looking statements include, but are not limited to, statements about or relating to:
•
the timing, and completion of our merger with Paratek, including any dividend in connection therewith;
•
our continued listing on NASDAQ after the merger with Paratek;
•
our expectations regarding the capitalization, resources and ownership structure of the combined organization after our merger with Paratek;
•
the timing and nature of the planned equity investment and bridge loan in connection with the merger with Paratek;
•
the possibility of a dissolution of the Company if we are not successful in completing the merger with Paratek;
•
possible future royalties on Intermezzo sales and potential proceeds from any sale of assets relating to Intermezzo and TO-2070;
•
the nature, strategy and focus of the combined organization after our merger with Paratek;
•
the development and commercial potential of any product candidates after our merger with Paratek, including Omadacycline;
•
the executive and board structure of the combined organization after our merger with Paratek;
•
expectations regarding voting by Transcept and Paratek stockholders in connection with the proposed merger;
•
expected activities and responsibilities of us and Purdue Pharmaceuticals L.P., or Purdue Pharma, under our United States License and Collaboration Agreement, or the Collaboration Agreement;
•
expectations for the commercial potential of Intermezzo and our collaboration partner's commitment to collaborate with us;
•
the future satisfaction of conditions required for continued commercialization of Intermezzo under the Collaboration Agreement, and the fulfillment of Purdue Pharma's obligations under the Collaboration Agreement;
•
our expectations regarding suits that Purdue Pharma or we have filed or may file in regards to Abbreviated New Drug Application, or ANDA, proceedings, and the timing, costs and results of such actions and ANDA proceedings;
•
our potential receipt of revenue under the Collaboration Agreement, including milestone and royalty revenue;
•
expectations regarding our TO-2070 development program, including the nature of our relationship with Shin Nippon Biomedical Laboratories Ltd., or SNBL, under our License Agreement regarding TO-2070, or the License Agreement;
•
expectations regarding potential payments by us to SNBL under the License Agreement, including milestone and royalty payments;
•
expectations regarding reimbursement for Intermezzo in the United States;
•
expectations with respect to our ability to successfully and profitably carry out plans to co-promote Intermezzo to psychiatrists in the United States through our co-promotion option under the Collaboration Agreement;
•
the potential benefits of, and markets for, Intermezzo and TO-2070;

15

•
potential competitors and competitive products, including generic manufacturers;
•
expectations with respect to our intent and ability to successfully enter into other collaboration or co-promotion arrangements;
•
expectations regarding our ability to obtain regulatory approval of Intermezzo outside of the United States and TO-2070;
•
the adequacy of our current cash, cash equivalents and marketable securities to fund our operations for at least the next twelve months;
•
our beliefs regarding the merits of pending litigation and our expectations regarding our response to such litigation;
•
expectations regarding the value of our net operating loss carry forwards, or NOLs, and the preservation of such NOLs by our tax benefit preservation plan adopted in September 2013, or Tax Benefit Preservation Plan;
•
expectations regarding future losses, costs, expenses, expenditures and cash flows;
•
the ability and degree to which we may obtain and maintain market exclusivity from the U.S. Food and Drug Administration, or FDA, for Intermezzo and TO-2070 under Section 505(b)(2) of the Federal Food, Drug, and Cosmetic Act, or FFDCA; and
•
our ability to maintain and obtain additional patent protection for Intermezzo and TO-2070 without violating the intellectual property rights of others.
Forward-looking statements do not reflect the potential impact of any future in-licensing, collaborations, acquisitions, mergers, dispositions, joint ventures, or investments we may enter into or make. Except as required by law, we undertake no obligation to, and expressly disclaim any obligation to, revise or update the forward‑looking statements made herein or the risk factors whether as a result of new information, future events or otherwise. Forward‑looking statements involve risks and uncertainties, which are more fully discussed in the “Risk Factors” section and elsewhere in this Quarterly Report on Form 10-Q, including, but not limited to, those risks and uncertainties relating to:
•
our inability to successfully complete the proposed merger with Paratek and subsequent difficulties we may face as a stand-alone company;
•
the inability of the combined organization after our merger with Paratek to successfully develop and commercialize products and/or product candidates, or to sell our Intermezzo and/or TO-2070 assets;
•
potential termination of the Collaboration Agreement by Purdue Pharma;
•
actual and potential decreases in Purdue Pharma's commercialization efforts with respect to Intermezzo;
•
physician or patient reluctance to use Intermezzo;
•
unexpected results from and/or additional costs related to ANDA proceedings;
•
changing standards of care and the introduction of products by competitors that could reduce our royalty rates under the Collaboration Agreement, or alternative therapies for the treatment of indications we target;
•
generic equivalents to Intermezzo whose introduction would reduce royalty rates under the Collaboration Agreement;
•
our inability to obtain additional financing, if available, under favorable terms, if necessary;
•
the ability of our Tax Benefit Preservation Plan adopted in September 2013 to protect the value of our net operating loss carryforwards;
•
unexpected adverse side effects or inadequate therapeutic efficacy of our product candidates that could slow or prevent product approval or approval for particular indications;
•
the uncertainty of protection for our intellectual property, through patents, trade secrets or otherwise; and
•
potential infringement of the intellectual property rights or trade secrets of third parties.
Transcept Pharmaceuticals, Inc.TM is a registered and unregistered trademark of ours in the United States and other jurisdictions. Intermezzo® is a registered and unregistered trademark of Purdue Pharma and associated companies in the United States and other jurisdictions and is a registered and unregistered trademark of ours in certain other jurisdictions. Other trademarks and trade names referred to in this Quarterly Report on Form 10-Q are the property of their respective owners.


16

Company Overview

We are a specialty pharmaceutical company focused on the development and commercialization of proprietary products that address important therapeutic needs in the field of neuroscience. We have one commercial product, Intermezzo® (zolpidem tartrate) sublingual tablet C-IV for the treatment of insomnia related to middle-of-the-night awakenings, and our remaining product candidate is TO-2070, a novel, rapidly absorbed treatment for acute migraine incorporating dihydroergotamine (DHE) as the active drug.
Recent Events
On June 30, 2014, we, Tigris Merger Sub, Inc., a Delaware corporation and a wholly owned subsidiary of Transcept (“Merger Sub”), Tigris Acquisition Sub, LLC, a Delaware limited liability company and a wholly owned subsidiary of Transcept (“Merger LLC”), and Paratek Pharmaceuticals, Inc., a Delaware corporation (“Paratek”), entered into an Agreement and Plan of Merger and Reorganization (the “Merger Agreement”), pursuant to which, among other things, subject to the satisfaction or waiver of the conditions set forth in the Merger Agreement, (i) Merger Sub will merge with and into Paratek, with Paratek becoming a wholly-owned subsidiary of Transcept and the surviving corporation of the merger (the “Merger”) and (ii) immediately following the Merger, the surviving corporation will merge with and into Merger LLC with Merger LLC surviving as the surviving company in such merger (the “Second Merger”). The Merger and the Second Merger are intended to qualify for federal income tax purposes as a tax-free reorganization under the provisions of Section 368(a) of the Internal Revenue Code of 1986, as amended.
Subject to the terms and conditions of the Merger Agreement, at the closing of the Merger, each outstanding share of Paratek common stock will be converted into the right to receive 0.810 shares of our common stock, subject to the payment of cash in lieu of fractional shares. Immediately following the effective time of the Merger, Paratek stockholders are expected to own approximately 89.6% of the outstanding capital stock of Transcept.
Consummation of the Merger is subject to certain closing conditions, including, among other things, approval by our stockholders and Paratek stockholders. The Merger Agreement contains certain termination rights for both us and Paratek, and further provides that, upon termination of the Merger Agreement under specified circumstances, either party may be required to pay the other party a termination fee of $6.3 million.
At the effective time of the Merger, the Board of Directors of Transcept is expected to consist of a total of seven members, two of whom will be designated by us and five of whom will be designated by Paratek.
Pursuant to the terms of the Merger Agreement, prior to the closing of the Merger, we are expected to make a dividend to our stockholders of certain assets, including excess cash (as calculated in accordance with the Merger Agreement), the right to receive certain royalty income received by us pursuant to the Collaboration Agreement with Purdue Pharma, and the right to receive the proceeds (net of certain fees and expenses) of any sale of Intermezzo or TO-2070 which are received prior to the two-year anniversary of the closing of the Merger or which are received pursuant to a definitive agreement relating to such sale which is entered into during such period, as well as the amount, if any, of the $3 million Intermezzo expense reserve deposited at closing which is remaining following the second anniversary of the closing date.
Concurrent with the execution of the Merger Agreement, on July 1, 2014 we made a bridge loan to Paratek in the principal amount of $3.5 million. In the event that the transaction does not close by September 15, 2014, we have committed to make available further funding of up to $800,000 per month, until December 31, 2014, provided the Merger continues to be pending and the Merger Agreement has not been terminated.
In accordance with the terms of the Merger Agreement, (i) our officers, directors and certain stockholders of Transcept holding approximately 43% of our outstanding capital stock have each entered into a support agreement with Paratek (the “Paratek Support Agreements”), and (ii) the officers, directors and certain stockholders of Paratek holding sufficient shares of Paratek have each entered into a support agreement with us (the “Transcept Support Agreements,” together with the Paratek Support Agreements, the “Support Agreements”). The Support Agreements place certain restrictions on the transfer of the shares of Transcept and Paratek held by the respective signatories thereto and covenants on the voting of such shares in favor of approving the transactions contemplated by the Merger Agreement and against any actions that could adversely affect the consummation of the Merger.
Prior to Paratek’s entry into the Merger Agreement, certain third parties, including existing stockholders of Paratek, entered into agreements with Paratek pursuant to which such parties have agreed, subject to the terms and conditions of such agreements, to purchase shares of Paratek’s capital stock for an aggregate purchase price of approximately $93 million prior to the consummation of the Merger. The consummation of the transactions contemplated by such agreements are conditioned upon the satisfaction or waiver of the conditions set forth in the Merger Agreement.

17

Strategic Initiatives and Process
In 2013, we engaged a financial and strategic advisor to explore a range of alternatives to enhance stockholder value, including but not limited to business combination and/or partnership opportunities as well as a distribution of a significant amount of cash to stockholders, and dissolution of the Company. After identifying and evaluating several opportunities together with our strategic advisor, in June 2014, prior to the execution of the Merger Agreement, we distributed $1.33 in cash for each outstanding share of our common stock, equal to approximately $25.4 million in the aggregate, to our stockholders by way of a special distribution. Subsequently, in June 2014, we entered into the Merger Agreement with Paratek Pharmaceuticals, Inc. as discussed above.
In connection with our strategic process, we have implemented operating cost reductions and organizational restructuring, including a reduction in our workforce, to reduce overall cash burn and facilitate our pursuit of strategic initiatives. We continue to work with Purdue Pharmaceuticals L.P., or Purdue Pharma, our U.S. marketing partner for Intermezzo, to develop and implement strategies to maximize the value of Intermezzo. We may pursue opportunities to sell Intermezzo and TO-2070 assets.

Intermezzo® (zolpidem tartrate) sublingual tablet C-IV

Our first approved product, Intermezzo (zolpidem tartrate) sublingual tablet, is a sublingual formulation of zolpidem approved for use as needed for the treatment of insomnia when a middle-of-the-night awakening is followed by difficulty returning to sleep. Intermezzo is the first and only sleep aid approved by the FDA for this indication.

In July 2009, we entered into the Collaboration Agreement with Purdue Pharma that grants an exclusive license to Purdue Pharma to commercialize Intermezzo in the United States and pursuant to which:
◦
Purdue Pharma paid us a $25.0 million non-refundable license fee in August 2009;
◦
Purdue Pharma paid us a $10.0 million non-refundable intellectual property milestone in December 2011 when the first of two issued formulation patents was listed in the FDA's Approved Drug Products with Therapeutic Equivalence Evaluations, or Orange Book;
◦
Purdue Pharma paid us a $10.0 million non-refundable intellectual property milestone in August 2012 when the first of two issued method-of-use patents was listed in the FDA's Orange Book;
◦
We transferred the Intermezzo New Drug Application (“NDA”) to Purdue Pharma, and Purdue Pharma is obligated to assume the expense associated with maintaining the NDA and further development of Intermezzo in the United States, including any expense associated with post-approval studies;
◦
Purdue Pharma is obligated to commercialize Intermezzo in the United States at its expense using commercially reasonable efforts;
◦
Purdue Pharma is obligated to pay us tiered base royalties on net sales of Intermezzo in the United States ranging from the mid-teens up to the mid-20% level. The base royalty is tiered depending upon the achievement of certain fixed net sales thresholds by Purdue Pharma, which net sales levels reset each year for the purpose of calculating the royalty; and
◦
Purdue Pharma is obligated to pay us up to an additional $70.0 million upon the achievement of certain net sales targets for Intermezzo in the United States.
We have retained an option to co-promote Intermezzo to psychiatrists in the United States. The option can be exercised as late as August 2015. We may begin promotion to psychiatrists 8 to 15 months after option exercise. The exact timing of when we begin promoting to psychiatrists is determined by the calendar month in which the option exercise notice is delivered to Purdue Pharma. If we exercise the co-promote option and enter the marketplace, we are entitled to receive an additional co-promote royalty from Purdue Pharma on net sales that are generated by psychiatrist prescriptions. Had we chosen to exercise the option as soon as we were eligible, we could have begun promoting to psychiatrists in May 2013 and received a co-promote royalty of 40%. The co-promote royalty rate declines on a straight-line basis to approximately 22% if we do not begin promoting to psychiatrists until November 2016, at which time the right to co-promote expires. Net sales qualifying for this additional co-promote royalty are limited by an annual cap of 15% of total Intermezzo annual net sales in the United States. The co-promote option cannot be transferred to a third party, except under a limited circumstance at the discretion of Purdue Pharma.

Purdue Pharma has the right to terminate the Collaboration Agreement at any time upon advance notice of 180 days. Our co-promote option may also be terminated by Purdue Pharma upon our acquisition by a third party or in the event of entry of generic competition to Intermezzo. The royalty payments discussed above are subject to reduction in connection with, among other things,

18

the entry of generic competition to Intermezzo. The Collaboration Agreement expires on the later of 15 years from the date of first commercial sale in the United States or the expiration of patent claims related to Intermezzo. The Collaboration Agreement is also subject to termination by Purdue Pharma in the event of FDA or governmental action that materially impairs Purdue Pharma's ability to commercialize Intermezzo or the occurrence of a serious event with respect to the safety of Intermezzo. The Collaboration Agreement may also be terminated by us upon Purdue Pharma commencing an action that challenges the validity of Intermezzo related patents. We also have the right to terminate the Collaboration Agreement immediately if Purdue Pharma is excluded from participation in federal healthcare programs. The Collaboration Agreement may also be terminated by either party in the event of a material breach by or insolvency of the other party.
Purdue Pharma holds the right to negotiate for the commercialization of Intermezzo in Mexico and we have retained rights to commercialize Intermezzo in the rest of the world.
Royalty revenue during 2013 was offset by the Company's contribution to Purdue Pharma's 2013 national DTC advertising campaign, including digital, print and television advertising to support Intermezzo commercialization. For the three and six months ended June 30, 2013, the offset to revenue totaled $0.3 million and $6.6 million, respectively. As the DTC advertising campaign was completed during 2013, there is no advertising offset to revenue during 2014.
TO-2070: a developmental product candidate for migraine treatment
In September 2013, we entered into the License Agreement with SNBL, pursuant to which SNBL granted us an exclusive worldwide license to commercialize SNBL's proprietary nasal drug delivery technology to develop TO-2070. We are developing TO-2070 as a treatment for acute migraine using SNBL’s proprietary nasal powder drug delivery system. Under the License Agreement, we are required to fund, lead and be responsible for product development, preparing and submitting regulatory filings and obtaining and maintaining regulatory approval with respect to TO-2070. Pursuant to the License Agreement, we have incurred an upfront nonrefundable technology license fee of $1.0 million, and we are also obligated to pay:
•
up to $6.5 million upon the occurrence of certain development milestones, including NDA approval of TO-2070 by the FDA,
•
up to $35.0 million in commercialization milestone payments tied to the achievement of specified annual sales levels of TO-2070, and
•
tiered, low double-digit royalties on annual net sales of TO-2070.
Under the License Agreement, we are responsible for the clinical and commercial manufacture, supply, and distribution of TO-2070 products. SNBL has agreed to supply its nasal drug delivery device to us to conduct development activities for non-registration studies, and has the right of first negotiation to be our exclusive supplier for devices for any registration studies and for incorporation into commercial TO-2070 products under the License Agreement thereafter.
The License Agreement terminates on a country-by-country basis upon the later of (i) the expiration of the last patent licensed under the License Agreement in such country and (ii) 15 years from the first commercial sale in such country. The License Agreement may also be terminated (i) by either party upon 90 days' written notice in connection with an uncured material breach of the License Agreement, (ii) by either party upon insolvency of the other party, (iii) immediately by SNBL if we challenge the validity of the patents licensed under the License Agreement, or (iv) by us at our convenience upon 90 days' prior notice. The License Agreement is assignable with prior written consent of the other party, which consent may not be unreasonably withheld, conditioned or delayed.
We have developed TO-2070 through the completion of preclinical safety studies, but have not initiated a Phase 1 human pharmacokinetic study.
Net Loss and Profitability

We have incurred net losses since inception as we have devoted substantially all of our resources to research and development, including contract manufacturing and clinical trials. As of June 30, 2014, we had an accumulated deficit of $145.7 million. Our net loss for the six months ended June 30, 2014 and 2013 was $6.1 million and $17.2 million, respectively. Our net loss for the years ended December 31, 2013, 2012, and 2011 was $27.4 million, $12.0 million, and $3.9 million, respectively. As of June 30, 2014, we had cash, cash equivalents, and marketable securities of $43.4 million and working capital of $41.8 million.

Prior to the fourth quarter of 2011, our only source of revenue has been the receipt in August 2009 of a $25.0 million non-refundable license fee received pursuant to our Collaboration Agreement with Purdue Pharma. During each of 2011 and 2012, we received $10.0 million in intellectual property milestone payments and during 2012, we began receiving royalty revenue pursuant to our Collaboration Agreement with Purdue Pharma.


19

Our ability to generate additional near term revenue is dependent upon our ability to license the development and commercialization of Intermezzo outside the United States and the receipt of milestone and royalty payments under our Collaboration Agreement with Purdue Pharma.

Intermezzo and any other product candidates, if approved for commercial use, may never achieve market acceptance and may face competition from both generic and branded pharmaceutical products.

Financial Operations Overview
Net revenue
We began earning royalty revenue upon commercial launch of Intermezzo in April 2012. Royalty revenue earned during the three and six months ended June 30, 2014 was $0.4 million and $0.8 million, respectively. Royalty revenue earned during the three and six months ended June 30, 2013 was $0.5 million and $1.0 million, respectively. Royalty revenue is derived from net sales of Intermezzo generated by Purdue Pharma to wholesalers. Royalty revenue during the three and six months ended June 30, 2013 was offset by $0.3 million and $6.6 million, respectively, related to a $10.0 million contribution by Transcept in December 2012 to the Intermezzo DTC advertising campaign. As the DTC advertising campaign was completed during 2013, there is no advertising offset to revenue during 2014.

Research and Development Expense

Research and development expense represented approximately 16% and 13% of total operating costs for the three months ended June 30, 2014 and 2013, respectively, and 19% and 24% of total operating expenses for the six months ended June 30, 2014 and 2013, respectively. Research and development costs are expensed as incurred. Research and development expense consists of expenses incurred in identifying, researching, developing and testing product candidates. These expenses primarily consist of the following:
•
salaries, benefits, travel and related expense for personnel associated with research and development activities;
•
fees paid to professional service providers for services related to the conduct and analysis of pre-clinical and clinical trials;
•
contract manufacturing costs for formulations used in clinical trials and pre-commercial manufacturing and packaging costs;
•
fees paid to consultants to evaluate product in-licensing or acquisition opportunities, to advise us on the development of internally generated new product concepts, to development of TO-2070 and the wind down of TO-2061;
•
laboratory supplies and materials;
•
depreciation of equipment; and
•
allocated costs of facilities and infrastructure.
General and Administrative Expense
General and administrative expense consists primarily of salaries and related expense for personnel in executive, marketing, finance and accounting, information technology and human resource functions. Other costs include facility costs not otherwise included in research and development expense and professional fees for legal and accounting services.


20

Results of Operations

Comparison of the Three Months Ended June 30, 2014 and 2013
The following table summarizes results of operations with respect to the items set forth below for the three months ended June 30, 2014 and 2013, in thousands, together with the percentage change in those items.
 
 
Three months ended June 30,
 
 
 
 
 
 
Favorable
 
%
 
 
2014
 
2013
 
(Unfavorable)
 
Change
Net revenue
 
$
362

 
$
198

 
$
164

 
83
%
Research and development expense
 
585

 
898

 
313

 
35
%
General and administrative expense
 
3,079

 
3,030

 
(49
)
 
2
%
Goodwill impairment
 
—

 
2,962

 
2,962

 
100
%
Net revenue
Royalty revenue was $0.4 million and $0.5 million for the three months ended June 30, 2014 and June 30, 2013, respectively. Royalty revenue during 2013 was offset by the Company's contribution to Purdue Pharma's 2013 national DTC advertising campaign to support Intermezzo commercialization. For the three months ended June 30, 2013, the offset to revenue totaled $0.3 million. As the DTC advertising campaign was completed during 2013, there is no advertising offset to revenue during 2014.
Research and Development Expense
Research and development expense decreased 35% to $0.6 million for the three months ended June 30, 2014 from $0.9 million for the comparable period in 2013. The decrease of approximately $0.3 million is primarily attributable to reductions in our research and development operations, including significant reductions in headcount.
General and Administrative Expense
General and administrative expense increased slightly between periods due to increased professional fees, primarily associated with Intermezzo ANDA litigation and merger-related expenses, partially offset by significant reductions in headcount.
Goodwill Impairment
We recorded a goodwill impairment charge of $3.0 million during the three months ended June 30, 2013. During the second quarter of 2013, several events occurred which indicated that the carrying amount of goodwill exceeded the fair value of the reporting unit, including:
•
the approximately 30% decline in Intermezzo prescriptions at June 30, 2013 from the peak of the direct to consumer ("DTC") advertising campaign, which was substantially completed in April 2013; and
•
the May 2013 termination by Purdue of 90 contract sales representatives dedicated exclusively to promoting Intermezzo, resulting in reliance solely on Purdue's existing analgesics sales force of approximately 525 sales representatives.
As a result of these factors, we experienced a 37% decline in our stock price during the quarter ended June 30, 2013. The decline in stock price resulted in a market capitalization of approximately $56.7 million at June 30, 2013 which, when compared to our stockholders' equity of $79.9 million, and in consideration of the early nature of ongoing internal research and development, the progress of new product search and evaluation efforts and the declining sales of Intermezzo, was an indication of impairment under step one of the goodwill impairment testing accounting guidance.
The impairment analysis indicated that the entire goodwill balance of $3.0 million was impaired, which was recognized during the three-months ended June 30, 2013. We have not previously recognized any impairment of goodwill.


21


Comparison of the Six Months Ended June 30, 2014 and 2013
The following table summarizes results of operations with respect to the items set forth below for the six months ended June 30, 2014 and 2013, in thousands, together with the percentage change in those items.
 
 
Six months ended June 30,
 
 
 
 
 
 
Favorable
 
%
 
 
2014
 
2013
 
(Unfavorable)
 
Change
Net revenue
 
$
780

 
$
(5,632
)
 
$
6,412

 
114
%
Research and development expense
 
1,293

 
2,741

 
1,448

 
53
%
General and administrative expense
 
5,575

 
5,832

 
257

 
4
%
Goodwill impairment
 
—

 
2,962

 
2,962

 
100
%
Net revenue
Royalty revenue was $0.8 million and $1.0 million for the six months ended June 30, 2014 and June 30, 2013, respectively. Royalty revenue during 2013 was offset by the Company's contribution to Purdue Pharma's 2013 national DTC advertising campaign to support Intermezzo commercialization. For the six months ended June 30, 2013, the offset to revenue totaled $6.6 million. As the DTC advertising campaign was completed during 2013, there is no advertising offset to revenue during 2014.
Research and Development Expense
Research and development expense decreased 53% to $1.3 million for the six months ended June 30, 2014 from $2.7 million for the comparable period in 2013. The decrease of approximately $1.4 million is primarily attributable to reductions in our research and development operations, including significant reductions in headcount.
General and Administrative Expense
General and administrative expense decreased $0.3 million between periods due to significant reductions in staffing significantly offset by increased professional fees, primarily associated with Intermezzo ANDA litigation and merger-related expenses.
Goodwill Impairment
We recorded a goodwill impairment charge of $3.0 million during the six months ended June 30, 2013. During the second quarter of 2013, several events occurred which indicated that the carrying amount of goodwill exceeded the fair value of the reporting unit, including:
•
the approximately 30% decline in Intermezzo prescriptions at June 30, 2013 from the peak of the direct to consumer ("DTC") advertising campaign, which was substantially completed in April 2013; and
•
the May 2013 termination by Purdue of 90 contract sales representatives dedicated exclusively to promoting Intermezzo, resulting in reliance solely on Purdue's existing analgesics sales force of approximately 525 sales representatives.
As a result of these factors, we experienced a 37% decline in our stock price during the quarter ended June 30, 2013. The decline in stock price resulted in a market capitalization of approximately $56.7 million at June 30, 2013 which, when compared to our stockholders' equity of $79.9 million, and in consideration of the early nature of ongoing internal research and development, the progress of new product search and evaluation efforts and the declining sales of Intermezzo, was an indication of impairment under step one of the goodwill impairment testing accounting guidance.
The impairment analysis indicated that the entire goodwill balance of $3.0 million was impaired, which was recognized during the three-months ended June 30, 2013. We have not previously recognized any impairment of goodwill.
Liquidity and Capital Resources
At June 30, 2014, we had cash, cash equivalents and marketable securities of $43.4 million.
Sources of Liquidity

On April 26, 2013, we entered into a Controlled Equity OfferingSM sales agreement with Cantor Fitzgerald & Co. The sales agreement provides us with the ability to conduct an at-the-market (ATM) public offering for up to a total of $20.0 million of shares of our common stock at prices to be determined at the time or times of sale. As of the date of filing of this report, we have not sold any shares of common stock pursuant to the ATM facility.


22

On June 3, 2014, we made a special cash distribution of $1.33 for each outstanding share of our common stock, equal to approximately $25.4 million in the aggregate. For U.S. Federal income tax purposes, the distribution will be a dividend to the extent it is paid out of our current or accumulated earnings and profits, as determined under U.S. Federal income tax principles. We expect the payment to be treated as a return of capital. Stockholders will receive a Form 1099-DIV in early 2015 notifying them of the portion of the special cash distribution that is treated as a dividend for U.S. Federal income tax purposes.
The following table summarizes our cash provided by (used in) operating, investing and financing activities (in thousands):
 
 
Six months ended June 30,
 
 
2014
 
2013
 
 
 
 
 
Net cash used in operating activities
 
$
(1,781
)
 
$
(7,550
)
Net cash provided by (used in) investing activities
 
33,471

 
(14,194
)
Net cash (used in) provided by financing activities
 
(24,780
)
 
223

Net Cash Used in Operating Activities
Net cash used in operating activities for the six months ended June 30, 2014 and 2013 was $1.8 million and $7.6 million, respectively. Net cash used in operating activities during each of these years consisted primarily of our net loss adjusted for noncash items such as depreciation, amortization, stock-based compensation charges and noncash interest expense, as well as net changes in working capital.
Net Cash Provided by (Used in) Investing Activities
Net cash provided by investing activities was $33.5 million for the six months ended June 30, 2014. Net cash used in investing activities was $14.2 million for the six months ended June 30, 2013. Net cash provided by investing activities during 2014 was primarily attributable to the maturity of marketable securities, net of purchases. Net cash used by investing activities during 2013 was primarily attributable to the purchase of marketable securities, net of maturities. Cash provided by investing activities in both periods included proceeds from the sale of fixed assets, net of purchases.
Net Cash (Used in) Provided by Financing Activities
Net cash used in financing activities during the six months ended June 30, 2014 was $24.8 million, compared to $0.2 million provided by financing activities during the six months ended June 30, 2013. Net cash used in financing activities during 2014 was primarily due to the $1.33 per share cash distribution paid in June 2014, partially offset by common stock issuances in connection with stock option exercises. Net cash provided by financing activities during 2013 consisted of common stock issuances in connection with stock option exercises.
Capital Resources
We expect our cash, cash equivalents, and marketable securities of $43.4 million at June 30, 2014, will be sufficient to satisfy our liquidity requirements for at least the next twelve months. We believe our investments in cash equivalents and marketable securities are highly rated and highly liquid.
While we are pursuing the completion of the merger with Paratek, our operating plan may change or ability to consummate a transaction or dissolution may be delayed. However, if our current operating plans change, we will require substantial additional funding to operate. As such, our future capital requirements will depend on many factors, including:
•
our ability to complete the merger with Paratek;
•
the timing and nature of any strategic transactions that we undertake including, but not limited to, potential partnerships;
•
the level of Purdue Pharma's commercialization efforts with respect to Intermezzo;
•
whether, as a result of our strategic and financial review with Leerink Swann LLC, we enter into a partnership or business combination, or return capital to our stockholders;
•
the cost of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights, including in connection with ANDA proceedings relating to Intermezzo;
•
the timing and amount of milestone and royalty payments to SNBL under the License Agreement for TO-2070;
•
the potential costs associated with Intermezzo if our existing Collaboration Agreement with Purdue is terminated, including the increased costs to us of litigation expense in connection with ANDA proceedings related to Intermezzo;

23

•
the receipt of milestone and other payments, if any, from Purdue Pharma under the Collaboration Agreement;
•
the effect of competing technological and market developments; and
•
the cost incurred in responding to disruptive actions by activist stockholders.
Additional funding may not be available at the time needed on commercially reasonable terms, if at all.
Critical Accounting Policies
There were no changes to our critical accounting policies since we filed our 2013 Annual Report on Form 10-K for the year ended December 31, 2013 with the Securities and Exchange Commission, or SEC. For a description of our critical accounting policies, please refer to our 2013 Annual Report.
Off-Balance Sheet Arrangements
Since inception, we have not engaged in any off-balance sheet financing activities, including the use of structured finance, special purpose entities or variable interest entities.
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
Our exposure to market risk is confined to cash, cash equivalents and marketable securities which have contractual maturities of eighteen months or less, bear interest rates at fixed rates and are denominated in, and pay interest in, U.S. dollars. The goals of our investment policy are preservation of capital, fulfillment of liquidity needs, maximization of investment performance and fiduciary control of cash and investments. Investments are classified as available-for-sale. We do not use derivative financial instruments in our investment portfolio. To achieve our goals, we invest excess cash in securities with different maturities to match projected cash needs and limit concentration of credit risk by diversifying investments among a variety of high credit-quality issuers, including U.S. government agencies, corporate debt obligations, taxable and tax-exempt pre-refunded municipal debt obligations and money market funds. There is no limit to the percentage of investments that may be maintained in U.S. Treasury debt obligations, U.S. agency debt obligations, or SEC-registered money market funds. The portfolio includes marketable securities with active secondary or resale markets to ensure portfolio liquidity, and we regularly review our portfolio against our policy. A hypothetical 100 basis point increase in interest rates would result in a decrease of approximately $86,400 in the fair value of our marketable securities at June 30, 2014.
Item 4.
Controls and Procedures
Disclosure Controls and Procedures
Our management evaluated, with the participation and under the supervision of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that our disclosure controls and procedures are effective at the reasonable assurance level to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission, or SEC, rules and forms, and that such information is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosures.
Changes in Internal Control over Financial Reporting
There have not been any changes in our internal controls over financial reporting (as such item is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the period covered by this Quarterly Report on Form 10-Q that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.
Inherent Limitations on the Effectiveness of Controls
A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the controls are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected. Accordingly, our controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of our control system are met.

24

PART II
 
Item 1.
Legal Proceedings
ANDA Litigation - Intermezzo
In July 2012, we received notifications from three companies, Actavis Elizabeth LLC (Actavis), Watson Laboratories, Inc. - Florida (Watson), and Novel Laboratories, Inc. (Novel), in September 2012 from each of Par Pharmaceutical, Inc. and Par Formulations Private Ltd. (together, the Par Entities), in February 2013 from Dr. Reddy's Laboratories, Inc. and Dr. Reddy's Laboratories, Ltd. (together, Dr. Reddy's), and in July 2013 from TWi Pharmaceuticals, Inc. (TWi) stating that each has filed with the FDA an Abbreviated New Drug Application, or ANDA, that references Intermezzo.
•
Actavis & Watson: In the July 2012 notifications, Actavis and Watson indicated that each company's ANDA includes Paragraph IV patent certifications to our U.S. Patent Nos. 7,658,945 (expiring April 15, 2027) and 7,682,628 (expiring February 16, 2025) (together, the “'945 and '628 Patents”). On November 28, 2012, Watson withdrew its ANDA, and, as a result of such withdrawal, on December 18, 2012, we and Purdue agreed to voluntarily dismiss the action without prejudice and on December 20, 2012 a court order was entered to such effect. The dismissal of Watson's ANDA had no effect on the ANDA filed by Actavis, a wholly owned subsidiary of Watson Pharmaceuticals, Inc. On January 24, 2013, Actavis notified us that it has included Paragraph IV patent certifications to our U.S. Patent Nos. 8,242,131 (expiring August 20, 2029) and 8,252,809 (expiring February 16, 2025) (together, the “'131 and '809 Patents”).
•
Novel: In the July 2012 notifications, Novel indicated that its ANDA includes Paragraph IV patent certifications to the '945 and '628 Patents. On December 10, 2012, Novel notified us that it has included Paragraph IV patent certifications to the '131 and '809 Patents.
•
Par Entities: The ANDAs submitted by the Par Entities each include Paragraph IV patent certifications to the '945, '628, '131 and '809 Patents.
•
Dr. Reddy's: The ANDA submitted by Dr. Reddy's includes Paragraph IV patent certifications to the '945, '628, '131 and '809 Patents.
•
TWi: The ANDA submitted by TWi includes Paragraph IV patent certifications to the '945, '628, '131 and '809 Patents.

In August 2012, August 2012, September 2012, and October 2012, respectively, we joined Purdue Pharma in filing actions against Actavis, Watson and certain of their affiliates, Novel, and the Par Entities, in each action alleging patent infringement and seeking injunctive and other relief. In December 2012, we and Purdue Pharma agreed to voluntarily dismiss the action against Watson without prejudice following its withdrawal of its ANDA application on November 28, 2012. On December 20, 2012, a court order was entered to such effect. The dismissal of Watson's ANDA had no effect on the ANDA filed by Actavis, a wholly owned subsidiary of Watson Pharmaceuticals, Inc. After receiving the supplemental notifications referenced above, we and Purdue Pharma amended our pending complaints against Actavis and Novel to also allege infringement of the '131 and '809 patents, as well as the '628 patent previously asserted against those companies.

The actions against the Par Entities alleged infringement of the '131 and '809 patents. In September 2013, we and Purdue Pharma agreed to voluntarily dismiss the action against one of the two Par Entities, Par Formulations Private Ltd., following that Par Entity’s withdrawal of its ANDA. The action against the other Par Entity, Par Pharmaceutical, Inc., remains pending and continues to allege infringement of the ‘131 and ‘809 patents. In April 2013, we joined Purdue Pharma in filing an action against Dr. Reddy's, alleging patent infringement of the '628, '131, and '809 patents, and seeking injunctive and other relief. The New Jersey court has consolidated our actions against each of the above-referenced generic companies into a single action.
In August 2013, we joined Purdue Pharma in filing two actions against TWi. The first action against TWi was filed on August 20, 2013 in the U.S. District Court for the District of New Jersey, and the second action against TWi was filed on August 22, 2013 in the U.S. District Court for the Northern District of Illinois. Each action alleges patent infringement of the ‘131 and ‘809 patents, and seeks injunctive and other relief. On October 17, 2013, TWi filed answers and counterclaims in both New Jersey and Illinois, in both cases seeking declarations of non-infringement and invalidity as to the ‘945, ‘628, ‘131, and ‘809 patents, as well as other relief. On January 13, 2014, the Illinois action against TWi was stayed pending dismissal of the New Jersey action against TWi, or further order of the Illinois court. On January 24, 2014, we and Purdue provided TWi with a covenant not to sue TWi based on its current ANDA formulation under the ’945 or ’628 patents, and on February 28, 2014, we and Purdue filed a motionin the New Jersey action to dismiss TWi’s counterclaims pertaining to the ’945 or ’628 patents based on the tendering of that covenant not to sue. On April 9, 2014, the New Jersey court denied our motion. On July 22, 2014, the New Jersey court entered a consent decree and partial final judgment of non-infringement in TWi's favor on the '945, '628, and '809 patents. The action against TWi remains pending as to the '131 patent.

25

On February 26, 2014, the New Jersey court consolidated our action against TWi with the existing consolidated action referenced above against Actavis, Novel, Par Pharmaceutical, and Dr. Reddy’s.

On July 22, 2014, the New Jersey court ordered that the trail of the consolidated action will commence on December 1, 2014.
Patent Term Adjustment Suit
In January 2013, we and Purdue Pharma filed suit in the Eastern District of Virginia against the USPTO in connection with certain changes to the Leahy-Smith America Invents Act. We and Purdue Pharma are seeking recalculation of the patent term adjustment of the '131 Patent. Purdue Pharma has agreed to bear the costs and expenses associated with this litigation. In June of 2013, the judge granted a joint motion to stay the proceedings pending a final decision on appeal by the Federal Circuit in Exelixis, Inc. v. Rea, No. 2013-11 75 (Fed. Cir.), and Exelixis, Inc. v. Rea, No. 2013-11 98 (Fed. Cir.).
Item 1A.
Risk Factors
Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below and all information contained in this report before you decide to purchase our common stock. If any of the possible adverse events described below actually occurs, we may be unable to conduct our business as currently planned and our financial condition and operating results could be harmed. In addition, the trading price of our common stock could decline due to the occurrence of any of the events described below, and you may lose all or part of your investment.
We may not be able to complete the merger with Paratek and may elect to pursue another strategic transaction similar to such merger, which may not occur on commercially reasonably terms or at all.
We cannot assure you that we will complete the pending merger with Paratek in a timely manner or at all. The merger agreement is subject to many closing conditions and termination rights. In addition to our product candidates, for which we have stopped all development, our assets currently consist primarily of our cash, cash equivalents and marketable securities, our listing on The NASDAQ Global Market and the merger agreement with Paratek. If we do not close the pending merger with Paratek, our Board of Directors may elect to attempt to complete another strategic transaction similar to this merger. Attempting to complete another strategic transaction similar to the merger will prove to be costly and time consuming, and we cannot make any assurances that a future strategic transaction will occur on commercially reasonable terms or at all. Even if we do complete the merger with Paratek, such merger ultimately may not deliver the anticipated benefits or enhance stockholder value.
If the merger with Paratek is not completed, in light of the challenges of rebuilding an operating business, we may elect to liquidate our remaining assets, and there can be no assurances as to the amount of cash available to distribute to stockholders after paying our debts and other obligations.
If we do not close the pending merger with Paratek, in light of the risks of reestablishing an operating business, as set forth herein, our Board of Directors may elect to take the steps necessary to liquidate all remaining assets of Transcept. The process of liquidation may be lengthy and we cannot make any assurances regarding timing of completion. In addition, we would be required to pay all of our debts and contractual obligations, and to set aside certain reserves for potential future claims. There can be no assurance as to the amount or timing of available cash remaining to distribute to stockholders after paying our debts and other obligations and setting aside funds for reserves.
If the merger with Paratek is not completed, and we fail to acquire and develop other products or product candidates at all or on commercially reasonable terms, we may be unable to reestablish a viable operating business.
Given the discontinuation of development of TO-2070 and the additional capital and resources required to resume and pursue such development, if the merger is not completed, we could be required to rely on in-licensing as the source of any of future product candidates for development and commercialization. Due to our history, our limited operational and management capabilities, and the intense competition for pharmaceutical product candidates, even if we find promising product candidates, and generate interest in a collaborative or strategic arrangement to acquire such product candidates, we may not be able to acquire rights to additional product candidates or approved products on commercially reasonable terms that we find acceptable, or at all. Proposing, negotiating and implementing an economically viable product acquisition or license is a lengthy and complex process. We compete for collaborative arrangements and license agreements with pharmaceutical and biotechnology companies and academic research institutions. Our competitors may have stronger relationships with third parties with whom it

26

is interested in collaborating, greater financial, development and commercialization resources and/or may have more established histories of developing and commercializing products than us. As a result, our competitors may have a competitive advantage in entering into collaborative arrangements with such third parties. In addition, even if we find promising product candidates, and generate interest in a collaborative or strategic arrangement to acquire such product candidates, we may not be able to acquire rights to additional product candidates or approved products on commercially reasonable terms that we find acceptable, or at all.
We expect that any product candidate to which we acquire rights will require additional development and regulatory efforts prior to commercial sale, including extensive clinical testing and approval by the FDA and other non-U.S. regulatory authorities. All product candidates are subject to the risks of failure inherent in pharmaceutical product development, including the possibility that the product candidate will not be shown to be sufficiently safe and effective for approval by regulatory authorities and the possibility that, due to strategic considerations, we will discontinue research or development with respect to a product candidate for which we have already incurred significant expense. Even if the product candidates are approved, we cannot be sure that they would be capable of economically feasible production or commercial success.
We may be unable to sell Intermezzo or TO-2070, or otherwise derive revenue from these assets.
The success of sales of Intermezzo in the United States is dependent on the ability of Purdue Pharma to successfully commercialize Intermezzo pursuant to the Collaboration Agreement. The terms of the Collaboration Agreement provide that Purdue Pharma can terminate the agreement for any reason at any time upon advance notice of 180 days. If the Collaboration Agreement is terminated, our business and our ability to generate revenue from sales of Intermezzo will be substantially harmed. If the Collaboration Agreement is terminated and we determine to commercialize Intermezzo, we will be required to develop our own sales and marketing organization, fund any future clinical studies and other required regulatory activities (including any post-approval studies), and bear increased litigation expenses due to ANDA proceedings. Alternatively, we may enter into another strategic collaboration in order to commercialize Intermezzo in the United States. We do not currently have the infrastructure in place or adequate resources to launch a commercial product and implementing such infrastructure would require substantial time and resources and such efforts may not be successful. In addition, the value of Intermezzo, including the royalty stream, could be significantly impaired by current or future ANDA litigation.
The manner in which Purdue Pharma commercializes Intermezzo, including the amount and timing of Purdue Pharma's investment in commercial activities and pricing of Intermezzo, will have a significant impact on the ultimate success of Intermezzo in the United States, and the success of the overall commercial arrangement with Purdue Pharma. If Purdue Pharma deems Intermezzo to have insufficient market potential, they may continue to decrease their commercialization efforts, which would likely result in decreased sales of Intermezzo and negatively impact our business and operating results. For example, in December 2013, Purdue Pharma notified us that it intended to discontinue use of the Purdue sales force to actively market Intermezzo to healthcare professionals during the first quarter of 2014.
In addition, before regulatory approvals for the commercial sale of TO-2070 is obtained, TO-2070 must be demonstrated through lengthy, complex and expensive clinical trials to be both safe and effective for use in each target indication. Although we have developed TO-2070 through the completion of preclinical safety studies, our clinical trial results may be negatively affected by factors that had not been fully anticipated prior to commencement of the clinical trials. Such trials may fail to demonstrate that TO-2070 is safe when used as directed or even when misused. Further, based on results at any stage of these trials, we may decide to repeat or redesign a trial, or even discontinue development of TO-2070.
If Purdue Pharma is not successful in increasing sales of Intermezzo or if TO-2070 is not shown to be safe in our preclinical trials, we may be unable to sell these assets or otherwise derive revenue from them, which may harm the value of your investment.
We have had a limited operating history that may make it difficult for you to evaluate the potential success of our business and we have a history of incurring losses.
We were founded in January 2001 under our former name, Novacea, Inc., and in January 2009 underwent a merger with Transcept Pharmaceuticals, Inc., a privately held company, or TPI, founded in 2002, which is the primary business we currently conduct. Our operations to date have been limited to organizing and staffing, acquiring, developing and securing technology and undertaking preclinical studies and clinical trials. Furthermore, our business is not profitable and has incurred losses in each year since the inception of TPI in 2002. Our net loss for the years ended December 31, 2013, 2012 and 2011 was $27.4 million, $12.0 million and $3.9 million, respectively. Our net loss for the six months ended June 30, 2014 was $6.1 million. We had an accumulated deficit at June 30, 2014 of $145.7 million.
In November 2011, we obtained regulatory approval for the commercial sale of our lead product, Intermezzo, from the FDA. In April 2012, our U.S. marketing partner, Purdue Pharma, launched Intermezzo. We have not demonstrated over a substantial period of time the ability to meet and adhere to other regulatory standards applicable to an FDA approved product,

27

to conduct sales and marketing activities or to co-promote a product with a collaboration partner, including Purdue Pharma. In September 2013, we licensed our remaining product candidate, TO-2070 for the treatment of acute migraines, which is currently in the early stages of development. Furthermore, we have developed TO-2070 through the completion of preclinical safety studies, but have not initiated a Phase 1 human pharmacokinetic study, and therefore may not subsequently develop or commercialize TO-2070.
We expect to continue to incur losses for the foreseeable future and we expect our accumulated deficit to increase as we continue our strategic process and continue the development, regulatory, and collaboration efforts with respect to Intermezzo and TO-2070. Consequently, any predictions you make about our future value or viability may not be as accurate as they would be if we had a longer operating history and you could lose all or part of your investment.
We are engaged in litigation to protect our intellectual property from potential generic manufacturers of Intermezzo and any future products, and an unsuccessful outcome could harm our business and/or dissuade a potential acquiror of the asset.
The Hatch-Waxman Act permits the FDA to approve Abbreviated New Drug Applications, or ANDAs, for generic versions of brand name drugs like Intermezzo. We refer to this process as the “ANDA process.” The ANDA process permits competitor companies to obtain marketing approval for a drug product with the same active ingredient, dosage form, strength, route of administration, and labeling as the approved brand name drug, but without having to conduct and submit clinical studies to establish the safety and efficacy of the proposed generic product. In place of such clinical studies, an ANDA applicant usually needs only to submit data demonstrating that its product is bioequivalent to the brand name product, usually based on pharmacokinetic studies. Following the commercial launch of Intermezzo in April 2012, companies are able to submit an ANDA application for a generic version of Intermezzo at any time pursuant to the Hatch-Waxman Act.
The Hatch-Waxman Act requires an applicant for a drug product that relies, in whole or in part, on the FDA's prior approval of Intermezzo, to notify us of its application if the applicant is seeking to market its product prior to the expiration of the patents that claim Intermezzo. This notice is required to contain a detailed factual and legal statement explaining the basis for the applicant's opinion that the proposed product does not infringe our patents, that our patents are invalid, or both. Pursuant to the Collaboration Agreement, Purdue Pharma then has the option of bringing a patent infringement suit in federal district court against each company seeking approval for its product within 45 days from the date of receipt of each notice. Pursuant to the Collaboration Agreement, if Purdue Pharma chooses to file a patent infringement suit, we may decide whether to join Purdue Pharma as a named party in such lawsuit, or if Purdue Pharma chooses not to file patent infringement claims within the required 45 days, we may choose to do so on our own behalf. If such a suit is commenced within this 45 day period, we will be entitled to receive a 30 month stay on FDA's ability to give final approval to any of the proposed products that reference Intermezzo. The stay may be shortened or lengthened if either party fails to cooperate in the litigation and it may be terminated if the court decides the case in less than 30 months. If the litigation is resolved in favor of the applicant before the expiration of the 30 month period, the stay will be immediately lifted and the FDA's review of the application may be completed. Such litigation is often time-consuming and costly, and may result in generic competition if such patent(s) are not upheld or if the generic competitor is found not to infringe such patent(s).
We have received multiple notifications of ANDA filings referencing Intermezzo. See "Legal Proceedings." The filing of these and any future ANDA applications referencing Intermezzo could have an adverse impact on our stock price, and litigation, if any, to enforce our patents is likely to require significant management attention and may require substantial capital resources. If the patents covering Intermezzo are not upheld in litigation or if the generic competitor is found to not infringe these patents, the resulting generic competition for Intermezzo would have a material adverse effect on our revenue and results of operations. Moreover, the existence of these ANDA filings and/or potential litigation may dissuade a potential acquiror of Intermezzo or prevent the consummation of a strategic transaction.
If we do not successfully complete the merger with Paratek, we will require substantial additional funding in the event we resume our operations, and may need to curtail operations if we have insufficient capital.
We had cash, cash equivalents and marketable securities of $43.4 million at June 30, 2014. We expect our negative cash flows from operations to continue for the foreseeable future. While we are exploring a range of alternatives to enhance stockholder value, including business combination and/or partnership opportunities, and distribution of a significant amount of cash to our stockholders, our operating plan may change or ability to consummate a transaction or dissolution may be delayed.
We currently believe that our available cash, cash equivalents and marketable securities and interest income will be sufficient to fund our anticipated levels of operations for at least the next twelve months. However, if we do not successfully complete the merger with Paratek, we will require substantial additional funding in the event we resume our operations. As such, our future capital requirements will depend on many factors, including:
•
our ability to complete the merger with Paratek;

28

•
the timing and nature of any future strategic transactions that we undertake, including, but not limited to selling Intermezzo and/or TO-2070 and potential partnerships;
•
the level of Purdue Pharma's commercialization efforts with respect to Intermezzo;
•
the cost of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights, including in connection with ANDA proceedings relating to Intermezzo;
•
the timing and amount of milestone and royalty payments to SNBL under the License Agreement for TO-2070;
•
the potential costs associated with Intermezzo if our existing Collaboration Agreement with Purdue is terminated, including the increased costs to us of litigation expense in connection with ANDA proceedings related to Intermezzo;
•
the receipt of milestone and other payments, if any, from Purdue Pharma under the Collaboration Agreement;
•
the effect of competing technological and market developments; and
•
the cost incurred in responding to disruptive actions by activist stockholders.
Having an insufficient level of capital to resume our operations may require us to significantly curtail one or more of our development, licensing or acquisition programs, which could have a negative impact on our financial condition and our ability to successfully pursue our business strategy.
We may be subject to damages resulting from claims that we or our employees have wrongfully used or disclosed alleged trade secrets of former employers.
Certain of our employees were previously employed at universities or other biotechnology or pharmaceutical companies, including competitors or potential competitors. Although no claims against us are currently pending, we may be subject to claims that these employees or we ourselves have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of former employers. Litigation may be necessary to defend against these claims. If we fail in defending such claims, in addition to paying monetary damages, we may lose valuable intellectual property rights or personnel. A loss of key research personnel or their work product could hamper or prevent our or a collaboration partner's ability to develop or commercialize certain potential products, which could severely harm our business. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management.
If our agreements with employees, consultants, advisors and corporate partners fail to protect our intellectual property, proprietary information or trade secrets, it could have a significant adverse effect on us.
We have taken steps to protect our intellectual property and proprietary technology by entering into confidentiality agreements and intellectual property assignment agreements with our employees, consultants, advisors and corporate partners. However, such agreements may not be enforceable or may not provide meaningful protection for all of our trade secrets or other proprietary information in the event of unauthorized use or disclosure or other breaches of the agreements, and we may not be able to prevent such unauthorized disclosure. Monitoring unauthorized disclosure is difficult, and we do not know whether the steps we have taken to prevent such disclosure are, or will be, adequate. Furthermore, the laws of some foreign countries may not protect our intellectual property rights to the same extent as do the laws of the United States.
We may fail to meet publicly announced financial guidance or other expectations about our business, which would cause our stock to decline in value.
There are a number of reasons why we might fail to meet financial guidance or other expectations about our business, including, but not limited to, the following:
•
the failure of our strategic initiatives to enhance stockholder value or delay in the completion of our merger with Paratek, including with respect to the amount and timing of any pre-closing and post-closing dividends;
•
our inability to sell Intermezzo and/or TO-2070;
•
the effectiveness of the sales, marketing and distribution efforts by Purdue Pharma in the United States and overall success of Purdue Pharma's commercialization efforts in the United States;
•
delays or unexpected changes in Purdue Pharma's plan to invest in and support the sales and marketing of Intermezzo;
•
unexpected difficulties in Purdue Pharma's efforts to commercialize Intermezzo in the United States;  

29

•
lower than expected pricing and reimbursement levels, or no reimbursement at all, for Intermezzo in the United States;
•
the use of currently available sleep aids that are not approved to be taken in the middle of the night;
•
negative developments or setbacks in our efforts to seek marketing approval for Intermezzo outside of the United States;
•
FDA approval of generic versions of Intermezzo or negative developments in any ongoing ANDA proceedings;
•
current and future competitive products that have or obtain greater acceptance in the market than Intermezzo;
•
if only a subset of or no affected patients respond to therapy with Intermezzo or future products, if any;
•
negative publicity about the results of our clinical studies, or those of others with similar or related products may reduce demand for Intermezzo or future products, if any;
•
the inability to sell a product at the price we expect; or
•
the inability to supply enough product to meet demand.
If we fail to meet our revenue and/or expense projections and/or other financial guidance for any reason, our stock could decline in value.

Our stock price is volatile.
The market price of our common stock is subject to significant fluctuations. During the 12-month period ended June 30, 2014, the sales price of our common stock on The NASDAQ Global Market ranged from a high of $3.90 in September and October 2013 to a low of $1.85 in June 2014 (the latter of which is adjusted for our special cash dividend in June 2014 of $1.33 per share). Market prices for securities of early-stage pharmaceutical, biotechnology and other life sciences companies have historically been particularly volatile. The volatility of the market price of our common stock is exacerbated by the low trading volume of our common stock and the high proportion of our shares held by insiders. Some of the factors that may cause the market price of our common stock to fluctuate include:
•
announcements related to our merger with Paratek, and any pre-closing and post-closing dividends;
•
the initiation of, material developments in, or conclusion of litigation to enforce or defend our intellectual property rights or defend against the intellectual property rights of others;
•
the perception of our prospects for successful commercialization or a sale of Intermezzo by Purdue Pharma, and a sale of TO-2070;
•
announcements by us or Purdue Pharma regarding the commercialization and/or marketing efforts of Intermezzo or by us regarding the development efforts of TO-2070;
•
the termination by Purdue Pharma of the Collaboration Agreement, the termination by SNBL of the License Agreement, or the termination of other future collaboration, partnering or license agreements;
•
the failure of our products to achieve commercial success, including due to competition from generic versions, or the perception by investors that commercial success may not be achieved;
•
issues in manufacturing our products;
•
the entry into any in-licensing agreements securing licenses, patents or development rights;
•
the entry into, or termination of, key agreements, including additional commercial partner agreements;
•
announcements by commercial partners or competitors of new commercial products, clinical progress or the lack thereof, significant contracts, commercial relationships or capital commitments;
•
adverse publicity relating to the insomnia or migraine market, including with respect to other products and potential products in such markets;
•
the introduction of technological innovations or new therapies that compete with our potential products;
•
the loss of key employees;
•
changes in estimates or recommendations by securities analysts, if any, who cover our common stock;
•
future sales of our common stock;
•
general and industry-specific economic conditions that may affect our research and development expenditures;

30

•
changes in the structure of health care payment systems, including changes to prescription drug reimbursement levels; and
•
period-to-period fluctuations in financial results.

Moreover, the stock markets in general have experienced substantial volatility that has often been unrelated to the operating performance of individual companies. These broad market fluctuations may also adversely affect the trading price of our common stock.
 
In the past, following periods of volatility in the market price of a company's securities, stockholders have often instituted class action securities litigation against those companies. Such litigation, if instituted, could result in substantial costs and diversion of management attention and resources, which could significantly harm our profitability and reputation.

If we fail to continue to meet all applicable NASDAQ Global Market requirements and NASDAQ determines to delist our common stock, the delisting could adversely affect the market liquidity of our common stock and the market price of our common stock could decrease.

Our common stock is listed on The NASDAQ Global Market. In order to maintain our listing, we must meet minimum financial and other requirements, including requirements for a minimum amount of capital and a minimum price per share. If we are unable to comply with NASDAQ's listing standards, NASDAQ may determine to delist our common stock from The NASDAQ Global Market. If our common stock is delisted for any reason, it could reduce the value of our common stock and its liquidity. Delisting could also adversely affect our ability to obtain financing for the continuation of our operations, if we choose to reestablish our business, or to use our common stock in acquisitions, including the proposed merger with Paratek. Delisting could result in the loss of confidence by suppliers, customers and employees. Delisting would prevent us from satisfying a closing condition for the merger with Paratek, and, in such event, Paratek may elect not to consummate the merger. In addition, the combined organization must submit a new application for listing on The NASDAQ Global Market after the merger pursuant to the reverse merger rules, and the combined company will need to meet the NASDAQ minimum requirements.

If securities or industry analysts do not publish research or reports or publish inaccurate or unfavorable research about us, our business or our stock, our stock price and trading volume could decline.
The trading market for our common stock is influenced by the research and reports that securities or industry analysts publish about us, our business and our stock. As of June 30, 2014, we had research coverage by three securities analysts. If any of the analysts who cover us downgrades our stock or publishes inaccurate or unfavorable research regarding us or our business model, technology or stock performance, our stock price would likely decline. If one or more of these analysts ceases coverage of us or fails to publish reports on us regularly, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline. Moreover, the unpredictability of our financial results likely reduces the certainty, and therefore reliability, of the forecasts by securities or industry analysts of our future financial results, adding to the potential volatility of our stock price.
Raising additional funds by issuing securities or through licensing arrangements may cause dilution to existing stockholders, restrict our operations or require us to relinquish proprietary rights.
Additional financing may not be available to us when we need it or may not be available on favorable terms. To the extent that we raise additional capital by issuing equity securities, our existing stockholders' ownership will be diluted and the terms of any new equity securities may have preferences over our common stock. Any debt financing we enter into may involve covenants that restrict our operations. These restrictive covenants may include limitations on additional borrowing and specific restrictions on the use of our assets, as well as prohibitions on our ability to create liens, pay dividends, redeem our stock or make investments. In addition, if we raise additional funds through licensing arrangements, it may be necessary to relinquish potentially valuable rights to potential products or proprietary technologies, or grant licenses on terms that are not favorable to us.
Failure to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 could have a material adverse effect on our stock price.
Section 404 of the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the SEC require an annual management assessment of the effectiveness of our internal control over financial reporting and, depending on our public float, a report by our independent registered public accounting firm attesting to the effectiveness of our internal control over financial reporting at the end of the fiscal year. If we fail to maintain the adequacy of our internal control over financial reporting, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404 of the

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Sarbanes-Oxley Act of 2002 and the related rules and regulations of the SEC. If we cannot in the future favorably assess, or, if required, our independent registered public accounting firm is unable to provide an unqualified attestation report on, the effectiveness of our internal control over financial reporting, investor confidence in the reliability of our financial reports may be adversely affected, which could have a material adverse effect on our stock price.
Anti-takeover provisions in the Collaboration Agreement with Purdue Pharma, in our charter documents and under Delaware law could make an acquisition of us more difficult and may prevent attempts by stockholders to replace or remove management.
Provisions in the Collaboration Agreement with Purdue Pharma, our certificate of incorporation and our bylaws may delay or prevent an acquisition or a change in management. The provisions in the Collaboration Agreement include an agreement with Purdue Pharma that prevents Purdue Pharma from acquiring above a certain percentage of our stock and engaging in certain other activities for a limited period of time following the commercial launch of Intermezzo that may lead to an acquisition of our company without our consent. In addition, our co-promote option pursuant to the Collaboration Agreement cannot be transferred to a third party, except under a limited circumstance at the discretion of Purdue Pharma, which may significantly reduce the value of our shares to a potential acquirer. Such provisions in our charter documents include a classified board of directors, a prohibition on actions by written consent of stockholders and the ability of our board of directors to issue preferred stock without stockholder approval. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which prohibits stockholders owning in excess of 15% of our outstanding voting stock from merging or combining with us unless certain conditions are met. Although we believe most of these provisions collectively will provide for an opportunity to receive higher bids by requiring potential acquirers to negotiate with our board of directors, they would apply even if the offer may be considered beneficial by some stockholders. In addition, these provisions may frustrate or prevent any attempts by stockholders to replace or remove the then-current management by making it more difficult for stockholders to replace members of the board of directors, which is responsible for appointing the members of management.
Furthermore, in September 2013, our board of directors adopted the Tax Benefit Preservation Plan to help preserve the value of our net operating losses and other deferred tax benefits. At December 31, 2013, we had cumulative NOLs of approximately $97 million, which NOLs can be utilized in certain circumstances to offset future U.S. taxable income. The Tax Benefit Preservation Plan is intended to act as a deterrent to any person acquiring sufficient shares of our common stock to jeopardize the value of the NOLs.
While we do not expect that these provisions will delay or prevent the completion of our merger with Paratek, they may hinder or prevent us from considering competing offers for a business combination, which may harm the value of your investment.
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
None.

Item 3.
Defaults Upon Senior Securities
Not applicable.

Item 4.
Mine Safety Disclosures
Not applicable.
Item 5.
Other Information
None.
Item 6.
Exhibits
(a) Exhibits:
Reference is made to the Exhibit Index attached to this Report.

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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, on the 6th day of August, 2014.
 
 
Transcept Pharmaceuticals, Inc.
 
 
 
 
 
By:
 
/s/    Leone D. Patterson   
 
 
 
Leone D. Patterson
Vice President, Chief Financial Officer
(Principal Financial and Accounting Officer)


33

Exhibit Index

Exhibit No.
 
Description of Exhibit
 
 
 
2.1(6)*
 
Agreement and Plan of Merger and Reorganization, dated as of June 30, 2014, by and among Transcept Pharmaceuticals, Inc., Tigris Merger Sub., Inc. and Paratek Pharmaceuticals, Inc.
 
 
 
2.2 (6)
 
Form of Support Agreement, by and between Transcept Pharmaceuticals, Inc. and certain stockholders of Paratek Pharmaceuticals, Inc.
 
 
 
2.3 (6)
 
Form of Support Agreement, by and between Paratek Pharmaceuticals, Inc. and certain stockholders of Transcept Pharmaceuticals, Inc.
 
 
 
3.1(1)
 
Amended and Restated Certificate of Incorporation of Transcept Pharmaceuticals, Inc.
 
 
 
3.2(1)
 
Bylaws of Transcept Pharmaceuticals, Inc., as amended.
 
 
 
3.3(2)
 
Certificate of Designations of Series A Junior Participating Preferred Stock of Transcept Pharmaceuticals, Inc.
 
 
 
4.1(3)
 
Specimen Common Stock certificate of Transcept Pharmaceuticals, Inc.
 
 
 
4.2(3)
 
Form of Preferred Stock Purchase Warrant issued to certain TPI investors as of March 21, 2005.
 
 
 
4.3(3)
 
Preferred Stock Purchase Warrant issued by TPI to Hercules Technology Growth Capital, Inc., dated as of April 13, 2006.
 
 
 
4.4(4)
 
2005 Amended and Restated Investor Rights Agreement, dated as of December 21, 2005, by and between Novacea and purchasers of Novacea Series A, Series B and Series C Preferred Stock.
 
 
 
4.5(5)
 
Amended and Restated Investor Rights Agreement, dated as of February 27, 2007, by and between TPI and purchasers of TPI Series A, Series B, Series C and Series D Preferred Stock.
 
 
 
4.6(5)
 
Termination Agreement, dated as of January 26, 2009, by and between TPI and purchasers of TPI Series A, Series B, Series C and Series D Preferred Stock.
 
 
 
4.7(2)
 
Tax Benefit Preservation Plan, dated as of September 13, 2013, between Transcept Pharmaceuticals, Inc. and American Stock Transfer & Trust Company, LLC, which includes the Form of Certificate of Designations of Series A Junior Participating Preferred Stock as Exhibit A, the Form of Right Certificate as Exhibit B and the Summary of Rights to Purchase Preferred Shares as Exhibit C
 
 
 
10.1
 
Fifth Amendment to Lease, by and between Transcept Pharmaceuticals, Inc. and Point Richmond R&D Associates, L.P., dated as of July 1, 2014.
 
 
 
31.1
 
Certification of the Company’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
31.2
 
Certification of the Company’s Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
 
 
32.1**
 
Certification of the Company’s Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
 
101
 
The following materials from Registrant’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2014, formatted in Extensible Business Reporting Language (XBRL) includes: (i) Condensed Consolidated Balance Sheets at June 30, 2014 and December 31, 2013, (ii)  Condensed Consolidated Statements of Operations and Comprehensive Loss for the Three and Six Months Ended June 30, 2014 and 2013, (iii) Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2014 and 2013 and (iv) Notes to Condensed Consolidated Financial Statements.
 
 
 
 _____________________________
(1)
Incorporated by reference from the Current Report on Form 8-K filed with the Securities and Exchange Commission on February 5, 2009.
(2)
Incorporated by reference from the Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 9, 2013.
(3)
Incorporated by reference from the Current Report on Form 8-K filed with the Securities and Exchange Commission on February 5, 2009.
(4)
Incorporated by reference from the Registration Statement on Form S-1, Securities and Exchange Commission file number 333-131741, filed on February 10, 2006.

34

(5)
Incorporated by reference from the Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 14, 2010.
(6)
Incorporated by reference from the Current Report on Form 8-K filed with the Securities and Exchange Commission on July 1, 2014.

*
All schedules and exhibits to the Merger Agreement have been omitted pursuant to Item 601(b)(2) of Regulation S-K. A copy of any omitted schedule and/or exhibit will be furnished to the Securities and Exchange Commission upon request.
 
 
**
The certification attached as Exhibit 32.1 that accompanies this Quarterly Report on Form 10-Q is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Transcept Pharmaceuticals, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Form 10-Q, irrespective of any general incorporation language contained in such filing.



35

Paratek Pharmaceuticals, Inc. Reports