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EX-32.1 - EXHIBIT 32.1 - ACELRX PHARMACEUTICALS INCex32-1.htm
EX-31.2 - EXHIBIT 31.2 - ACELRX PHARMACEUTICALS INCex31-2.htm
EX-31.1 - EXHIBIT 31.1 - ACELRX PHARMACEUTICALS INCex31-1.htm
EX-10.3 - EXHIBIT 10.3 - ACELRX PHARMACEUTICALS INCex10-3.htm

 



UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 


 

FORM 10-Q

 


 

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

 

For the quarterly period ended June 30, 2016

 

or

 

TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

 

For the transition period from              to             

 

Commission File Number: 001-35068

 


 

ACELRX PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

 


 

Delaware

41-2193603

(State or other jurisdiction of
incorporation or organization)

(IRS Employer
Identification No.)

 

351 Galveston Drive

Redwood City, CA 94063

(650) 216-3500

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 


 

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  ☒    No  ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    No  ☐

 

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

 

Large accelerated filer

Accelerated filer

       

Non-accelerated filer

 (Do not check if a smaller reporting company)

Smaller reporting company

 

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

 

As of July 21, 2016, the number of outstanding shares of the registrant’s common stock was 45,312,242.

 

 
 

 

 

ACELRX PHARMACEUTICALS, INC.

 

QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2016

 

Table of Contents

 

       

 

 

 

Page

Part I. Financial Information

3

       

 

Item 1.    

Financial Statements

3

       

 

 

Condensed Consolidated Balance Sheets as of June 30, 2016 (unaudited) and December 31, 2015

3

       

 

 

Condensed Consolidated Statements of Comprehensive Loss for the three and six months ended June 30, 2016 and 2015 (unaudited)

4

       

 

 

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2016 and 2015 (unaudited)

5

       

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

6

       

 

Item 2.    

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

21

       

 

Item 3.    

Quantitative and Qualitative Disclosures About Market Risk

33

       

 

Item 4.    

Controls and Procedures

34

   

Part II. OTHER Information

34

       

 

Item 1.    

Legal Proceedings

34

       

 

Item 1A.

Risk Factors

34

       

 

Item 2.    

Unregistered Sales of Equity Securities and Use of Proceeds

63

       

 

Item 3.    

Defaults Upon Senior Securities

63

       

 

Item 4.    

Mine Safety Disclosures

63

       

 

Item 5.    

Other Information

63

       

 

Item 6.    

Exhibits

64

 

Unless the context indicates otherwise, the terms “AcelRx,” “AcelRx Pharmaceuticals,” “we,” “us” and “our” refer to AcelRx Pharmaceuticals, Inc. “ACELRX,” “ZALVISO,” and “ACCELERATE, INNOVATE, ALLEVIATE” are U.S registered trademarks owned by AcelRx Pharmaceuticals, Inc. This report also contains other trademarks and trade names that are the property of their respective owners.

 

 
2

 

 

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

AcelRx Pharmaceuticals, Inc.

 

Condensed Consolidated Balance Sheets

(In thousands, except share data)

 

   

June 30,
2016
(Unaudited)

   

December 31,
2015
(1)

 

Assets

               

Current Assets:

               

Cash and cash equivalents

  $ 97,800     $ 107,922  

Short-term investments

    1,000       5,542  

Accounts receivable, net

    4,185       3,286  

Inventories

    1,328       466  

Prepaid expenses and other current assets

    1,237       1,731  
                 

Total current assets

    105,550       118,947  

Property and equipment, net

    7,794       8,610  

Restricted cash

    178       178  

Other assets

    50       50  
                 

Total Assets

  $ 113,572     $ 127,785  
                 

Liabilities and Stockholders’ Equity

               

Current Liabilities:

               

Accounts payable

  $ 2,857     $ 1,561  

Accrued liabilities

    2,914       3,956  

Long-term debt, current portion

    13,942       4,541  

Deferred revenue, current portion

    957       2,604  

Liability related to the sale of future royalties, current portion

    357       118  
                 

Total current liabilities

    21,027       12,780  

Deferred rent, net of current portion

    148       245  

Long-term debt, net of current portion

    7,406       16,381  

Deferred revenue, net of current portion

    3,113       593  

Liability related to the sale of future royalties, net of current portion

    67,775       63,494  

Contingent put option liability

    165       266  

Warrant liability

    440       913  
                 

Total liabilities

    100,074       94,672  
                 

Commitments and Contingencies

               

Stockholders’ Equity:

               

Common stock, $0.001 par value—100,000,000 shares authorized as of June 30, 2016 and December 31, 2015; 45,312,242 and 45,273,772 shares issued and outstanding as of June 30, 2016 and December 31, 2015

    45       45  

Additional paid-in capital

    238,725       236,274  

Accumulated deficit

    (225,278 )     (203,205 )

Accumulated other comprehensive income (loss)

    6       (1 )
                 

Total stockholders’ equity

    13,498       33,113  
                 

Total Liabilities and Stockholders’ Equity

  $ 113,572     $ 127,785  

 

(1)

The condensed consolidated balance sheet as of December 31, 2015 has been derived from the audited financial statements as of that date included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.

 

See notes to condensed consolidated financial statements.

 

 
3

 

 

AcelRx Pharmaceuticals, Inc.

 

Condensed Consolidated Statements of Comprehensive Loss

(Unaudited)

(In thousands, except share and per share data)

 

   

Three Months Ended
June 30,

   

Six Months Ended
June 30,

 
   

2016

   

2015

   

2016

   

2015

 

Revenue:

                               

Collaboration agreement

  $ 1,314     $ 486     $ 3,107     $ 667  

Contract and other

    3,217       1,438       4,449       1,438  

Total revenue

    4,531       1,924       7,556       2,105  

Operating costs and expenses:

                               

Cost of goods sold

    2,976             6,575        

Research and development

    6,280       7,310       10,451       13,616  

General and administrative

    3,597       2,735       7,374       7,256  

Restructuring costs

          2             756  
                                 

Total operating costs and expenses

    12,853       10,047       24,400       21,628  
                                 

Loss from operations

    (8,322 )     (8,123 )     (16,844 )     (19,523 )

Other (expense) income:

                               

Interest expense

    (687 )     (777 )     (1,367 )     (1,583 )

Interest income and other income, net

    241       4       660       2,184  

Non-cash interest expense on liability related to future sale of royalties

    (2,324 )           (4,520 )      
                                 

Total other (expense) income

    (2,770 )     (773 )     (5,227 )     601  
                                 

Net loss before income taxes

    (11,092 )     (8,896 )     (22,071 )     (18,922 )

Provision for income taxes

                (2 )      
                                 

Net loss

    (11,092 )     (8,896 )     (22,073 )     (18,922 )
                                 

Other comprehensive loss:

                               

Unrealized gains on available-for-sale securities

    2       1       7       5  
                                 

Comprehensive loss

  $ (11,090 )   $ (8,895 )   $ (22,066 )   $ (18,917 )
                                 

Net loss per share of common stock, basic

  $ (0.24 )   $ (0.20 )   $ (0.49 )   $ (0.43 )
                                 

Net loss per share of common stock, diluted

  $ (0.24 )   $ (0.20 )   $ (0.49 )   $ (0.47 )
                                 

Shares used in computing net loss per share of common stock, basic

    45,312,242       44,343,270       45,299,560       44,109,488  
                                 

Shares used in computing net loss per share of common stock, diluted – see Note 11

    45,312,242       44,343,270       45,299,560       44,397,471  

 

See notes to condensed consolidated financial statements.

 

 
4

 

 

AcelRx Pharmaceuticals, Inc.

 

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

 

   

Six Months
Ended June 30,

 
   

2016

   

2015

 

Cash flows from operating activities:

               

Net loss

  $ (22,073 )   $ (18,922 )

Adjustments to reconcile net loss to net cash used in operating activities:

               

Non-cash interest expense on liability related to royalty monetization

    4,520        

Depreciation and amortization

    1,029       997  

Amortization of premium/discount on investments, net

    17       47  

Interest expense related to debt financing

    426       472  

Restructuring costs

          (756 )

Stock-based compensation

    2,330       2,649  

Revaluation of put option and PIPE warrant liabilities

    (574 )     (2,148 )

Changes in operating assets and liabilities:

               

Accounts receivable

    (899 )      

Inventories

    (862 )      

Prepaid expenses and other assets

    494       (1,376 )

Accounts payable

    1,391       (834 )

Accrued liabilities

    (1,042 )     (850 )

Deferred revenue

    873       (667 )

Deferred rent

    (97 )     (50 )
                 

Net cash used in operating activities

    (14,467 )     (21,438 )
                 

Cash flows from investing activities:

               

Purchase of property and equipment

    (308 )     (894 )

Purchase of investments

    (993 )     (5,543 )

Proceeds from maturities of investments

    5,525       5,460  
                 

Net cash provided by (used in) investing activities

    4,224       (977 )
                 

Cash flows from financing activities:

               

Payment of long-term debt

          (2,240 )

Net proceeds from issuance of common stock through equity plans and exercise of warrants

    121       459  
                 

Net cash provided by (used in) financing activities

    121       (1,781 )
                 

Net decrease in cash and cash equivalents

    (10,122 )     (24,196 )

Cash and cash equivalents—Beginning of period

    107,922       60,038  
                 

Cash and cash equivalents—End of period

  $ 97,800     $ 35,842  

 

See notes to condensed consolidated financial statements.

 

 
5

 

 

AcelRx Pharmaceuticals, Inc.

 

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1. Organization and Summary of Significant Accounting Policies

 

AcelRx Pharmaceuticals, Inc., or the Company or AcelRx, was incorporated in Delaware on July 13, 2005 as SuRx, Inc., and in January 2006, the Company changed its name to AcelRx Pharmaceuticals, Inc. The Company’s operations are based in Redwood City, California.

 

AcelRx is a specialty pharmaceutical company focused on the development and commercialization of innovative therapies for the treatment of acute pain. AcelRx intends to commercialize its product candidates in the United States and license the development and commercialization rights to its product candidates for sale outside of the United States through strategic partnerships and collaborations. AcelRx may also consider the option to enter into strategic partnerships for its product candidates in the United States.

 

The Company has two late-stage development candidates based on sublingual sufentanil. The first, ARX-04, is a 30 mcg sufentanil sublingual tablet in a single-dose applicator intended for the treatment of moderate-to-severe acute pain administered by a healthcare professional. ARX-04 was initially developed at the request of the U.S. Department of Defense as a replacement for injections of morphine on the battlefield. In addition to the military application, AcelRx is developing ARX-04 as an investigational product for the treatment of patients suffering from moderate-to-severe acute pain in multiple settings, such as emergency room patients; patients who are recovering from short-stay or ambulatory surgery and do not require more long-term patient-controlled analgesia; post-operative patients who are transitioning from the operating room to the recovery floor; and patients being transported by paramedics. AcelRx has completed two placebo-controlled clinical studies (one Phase 2 and one Phase 3) demonstrating safety and efficacy of ARX-04. In October 2015, the Company initiated SAP302, an open-label Phase 3 study of ARX-04 for the treatment of adult patients who present in the emergency room with moderate-to-severe acute pain associated with trauma or injury, which treated 40 patients in the initial phase. In March 2016, the Company initiated the extension phase of the SAP302 study of ARX-04, which treated an additional 36 patients. Also in March 2016, the Company initiated SAP303, an open-label, single-arm study of ARX-04 in post-operative patients which treated 140 patients 40 years of age and older who had moderate-to-severe acute pain following a surgical procedure. The SAP303 study allowed for administration of ARX-04 for up to 12 hours. Both the SAP302 and SAP303 trials have had their last patient visits and data are currently being analyzed. The Company anticipates the top-line results for both studies will be available in the third quarter of 2016. Pending successful results of these two Phase 3 open-label studies, the Company intends to submit to the U.S. Food and Drug Administration, or FDA, a New Drug Application, or NDA, for ARX-04 for the treatment of moderate-to-severe acute pain to be administered by a healthcare professional in medically-supervised settings by the end of 2016.

 

The Company’s other late-stage investigational product candidate, Zalviso®, delivers 15 mcg sufentanil sublingually through a non-invasive delivery route via a pre-programmed, patient-controlled analgesia device. Zalviso is approved in the EU as well as Norway, Iceland and Liechtenstein and is in late-stage development in the U.S. In response to the NDA the Company submitted to the FDA seeking approval for Zalviso, the Company received a Complete Response Letter, or CRL, on July 25, 2014. Subsequently, the FDA requested an additional clinical study, IAP312, and the Company estimates that it may be able to begin IAP312 in September 2016. The Company does not intend to initiate the study until final supplies have been received and tested and clinical sites are ready. These activities may or may not occur in time to initiate the trial in September 2016. Timing of the completion of the IAP312 study will be dependent on the actual initiation date and other timing including, but not limited to, study enrollment.

 

On December 16, 2013, AcelRx and Grünenthal GmbH, or Grünenthal, entered into a Collaboration and License Agreement, or the License Agreement, which was amended effective July 17, 2015, or the Amended License Agreement, which grants Grünenthal rights to commercialize Zalviso, the Company’s novel sublingual patient-controlled analgesia, or PCA, system, or the Product, in the countries of the European Union, Switzerland, Liechtenstein, Iceland, Norway and Australia, or the Territory, for human use in pain treatment within, or dispensed by, hospitals, hospices, nursing homes and other medically-supervised settings, or the Field. In September 2015, the European Commission approved the Marketing Authorization Application, or MAA, previously submitted to the European Medicines Agency, or EMA, for Zalviso for the management of acute moderate-to-severe post-operative pain in adult patients. The approval allows Grünenthal to market Zalviso in the 28 European Union member states as well as for the European Economic Area countries, Norway, Iceland and Liechtenstein, or EEA. Also on December 16, 2013, AcelRx and Grünenthal, entered into a related Manufacture and Supply Agreement, or the MSA, and together with the License Agreement, the Agreements. Under the MSA, the Company will exclusively manufacture and supply the Product to Grünenthal for the Field in the Territory. On July 22, 2015, the Company entered into an amendment to the MSA, or the MSA Amendment, and together with the MSA, the Amended MSA, between the Company and Grünenthal, each effective as of July 17, 2015, and together, with the Amended License Agreement, the Amended Agreements.

 

 
6

 

 

In April 2016, Grünenthal completed the first commercial sale of Zalviso. Grünenthal continues to sell Zalviso initially in a limited number of hospitals in Germany under a pilot program, whereby the hospital will use Zalviso in a small number of post-operative patients. The pilot program, which is expected to last approximately two months at each institution, is being made available to additional hospitals in Germany over the next several months. Pending success with the pilot program, Grünenthal expects to make the product widely available in Germany. With similar methodology, Grünenthal has also initiated the sale of Zalviso in France, the United Kingdom, Italy and Belgium, and intends to launch Zalviso in the Netherlands, Ireland and Portugal by the end of 2016.

 

The Company has incurred recurring operating losses and negative cash flows from operating activities since inception and expects to continue to incur negative cash flows. Although Zalviso has been approved for sale in the European Union, the Company sold the majority of the royalty rights and certain commercial sales milestones it is entitled to receive under the Amended License Agreement with Grünenthal to PDL BioPharma, Inc., or PDL. As a result, the Company expects to continue to incur negative cash flows.

 

When we refer to "we," "our," "us," the "Company" or "AcelRx" in this document, we mean the current Delaware corporation, or AcelRx Pharmaceuticals, Inc., and its predecessor, as well as its consolidated subsidiary.

 

Principles of Consolidation

 

The condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, ARPI LLC, which was formed in September 2015 for the sole purpose of facilitating the monetization transaction with PDL of the expected royalty stream and milestone payments due from the sales of Zalviso in the European Union by its commercial partner, Grünenthal, pursuant to the Amended License Agreement, or the Royalty Monetization. All intercompany accounts and transactions have been eliminated in consolidation. Refer to Note 7 “Liability Related to Sale of Future Royalties” for additional information.

 

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 the rules and regulations of the U.S. Securities and Exchange Commission, or SEC. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.

 

Operating results for the three and six months ended June 30, 2016, are not necessarily indicative of the results that may be expected for the year ending December 31, 2016. The condensed consolidated balance sheet as of December 31, 2015, was derived from the Company’s audited financial statements as of December 31, 2015, included in the Company’s Annual Report on Form 10-K filed with the SEC. These financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2015, which includes a broader discussion of the Company’s business and the risks inherent therein.

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. Management evaluates its estimates on an ongoing basis including critical accounting policies. Estimates are based on historical experience and on various other market-specific and other relevant assumptions that the Company believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates.

 

Significant Accounting Policies 

 

The Company’s significant accounting policies are detailed in its Annual Report on Form 10-K for the year ended December 31, 2015. During the six months ended June 30, 2016, there have been no significant changes to the Company’s significant accounting policies from those previously disclosed in its Annual Report on Form 10-K.

 

Recently Issued Accounting Standards 

 

In March 2016, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, No. 2016-09, Compensation - Stock Compensation (Topic 718), which is part of the FASB's Simplification Initiative. The updated guidance simplifies the accounting for share-based payment transactions. The amended guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, with early adoption permitted. The Company is currently evaluating the impact of the adoption of this standard on its consolidated financial statements.

 

 
7

 

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which establishes a new lease accounting model for lessees. The updated guidance requires an entity to recognize assets and liabilities arising from a lease for both financing and operating leases, along with additional qualitative and quantitative disclosures. The amended guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the impact of the adoption of this standard on its consolidated financial statements.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, to provide guidance on revenue recognition. ASU No. 2014-09 requires a company to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under today’s guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which provided for the adoption of the new standard for fiscal years beginning after December 15, 2017. Accordingly, ASU No. 2014-09 is effective for the Company in the first quarter of 2018. Early adoption up to the first quarter of 2017 is permitted. Upon adoption, ASU No. 2014-09 can be applied retrospectively to all periods presented or only to the most current period presented with the cumulative effect of changes reflected in the opening balance of retained earnings in the most current period presented. The FASB has also issued the following standards which clarify ASU No. 2014-09 and have the same effective date as the original standard:

 

 

ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net);

 

 

ASU No. 2016-10, Identifying Performance Obligations and Licensing (Topic 606);

 

 

ASU No. 2016-11, Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815): Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting; and

 

 

ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients.

 

The Company is currently evaluating the method of adoption and the impact of adopting ASU No. 2014-09 on its results of operations, cash flows and financial position. 

 

2. Investments and Fair Value Measurement

 

Investments

 

The Company classifies its marketable securities as available-for-sale and records its investments at fair value. Available-for-sale securities are carried at estimated fair value based on quoted market prices or observable market inputs of almost identical assets, with the unrealized holding gains and losses included in accumulated other comprehensive income. Marketable securities which have maturities beyond one year as of the end of the reporting period are classified as non-current.

 

The table below summarizes the Company’s cash, cash equivalents and investments (in thousands):

 

   

As of June 30, 2016

 
   

Amortized Cost

   

Gross Unrealized
Gains

   

Gross Unrealized
Losses

   

Fair
Value

 

Cash and cash equivalents:

                               

Cash

  $ 68,360     $     $     $ 68,360  

U.S. government agency securities

    29,434       6             29,440  
                                 

Total cash and cash equivalents

    97,794       6             97,800  

Marketable securities:

                               

U.S. government agency securities

    1,000                   1,000  
                                 

Total marketable securities

    1,000                   1,000  
                                 

Total cash, cash equivalents and investments

  $ 98,794     $ 6     $     $ 98,800  

 

 
8

 

 

   

As of December 31, 2015

 
   

Amortized Cost

   

Gross Unrealized
Gains

   

Gross Unrealized
Losses

   

Fair
Value

 

Cash and cash equivalents:

                               

Cash

  $ 83,112     $     $     $ 83,112  

U.S. government agency securities

    24,809       1             24,810  
                                 

Total cash and cash equivalents

    107,921       1             107,922  

Marketable securities:

                               

U.S. government agency securities

    5,544             (2 )     5,542  
                                 

Total marketable securities

    5,544             (2 )     5,542  
                                 

Total cash, cash equivalents and investments

  $ 113,465     $ 1     $ (2 )   $ 113,464  

 

As of June 30, 2016 and December 31, 2015, none of the available-for-sale securities held by the Company had material unrealized losses. There were no other-than-temporary impairments for these securities at June 30, 2016 or December 31, 2015. No gross realized gains or losses were recognized on the available-for-sale securities and, accordingly, there were no amounts reclassified out of accumulated other comprehensive income to earnings during the three and six months ended June 30, 2016 and 2015.

 

As of June 30, 2016 and December 31, 2015, the contractual maturity of all investments held was less than one year.

 

 
9

 

 

Fair Value Measurement

 

The Company’s financial instruments consist of Level I and Level II assets and Level III liabilities. Level I securities include highly liquid money market funds and are valued based on quoted market prices. For Level II instruments, the Company estimates fair value by utilizing third party pricing services in developing fair value measurements where fair value is based on valuation methodologies such as models using observable market inputs, including benchmark yields, reported trades, broker/dealer quotes, bids, offers and other reference data. Such Level II instruments typically include U.S. treasury and U.S. government agency obligations. As of June 30, 2016 and December 31, 2015, the Company held, in addition to Level I and Level II assets, a contingent put option liability associated with the Company’s Amended and Restated Loan and Security Agreement, or the Amended Loan Agreement, with Hercules Technology II, L.P. and Hercules Technology Growth Capital, Inc., collectively referred to as Hercules, which amends and restates the loan and security agreement with Hercules dated as of June 29, 2011, or the Original Loan Agreement, and which was classified as a Level III liability. See Note 6 “Long-Term Debt” for further description. The Company’s estimate of fair value of the contingent put option liability was determined by using a risk-neutral valuation model, wherein the fair value of the underlying debt facility is estimated both with and without the presence of the default provisions, holding all other assumptions constant. The resulting difference between the two estimated fair values is the estimated fair value of the default provisions, or the contingent put option. Changes to the estimated fair value of these liabilities are recorded in interest income and other income, net in the condensed consolidated statements of comprehensive loss. The fair value of the underlying debt facility is estimated by calculating the expected cash flows in consideration of an estimated probability of default and expected recovery rate in default, and discounting such cash flows back to the reporting date using a risk-free rate. As of June 30, 2016 and December 31, 2015, the Company also held a Level III liability associated with warrants, or PIPE warrants, issued in connection with the Company’s private placement equity offering, completed in June 2012. For a detailed description, see Note 8 “Warrants.” The PIPE warrants are considered a liability and are valued using the Black-Scholes option-pricing model, the inputs for which include exercise price of the PIPE warrants, market price of the underlying common shares, expected term, volatility based on a group of the Company’s peers and the risk-free rate corresponding to the expected term of the PIPE warrants. Changes to any of these inputs can have a significant impact to the estimated fair value of the PIPE warrants. The following table sets forth the fair value of the Company’s financial assets and liabilities by level within the fair value hierarchy (in thousands):

 

   

As of June 30, 2016

 
   

Fair Value

   

Level I

   

Level II

   

Level III

 

Assets

                               

Money market funds

  $ 26     $ 26     $     $  

U.S. government agency obligations

    30,414             30,414        
                                 

Total assets measured at fair value

  $ 30,440     $ 26     $ 30,414     $  
                                 

Liabilities

                               

PIPE warrants

  $ 440                 $ 440  

Contingent put option liability

    165                   165  
                                 

Total liabilities measured at fair value

  $ 605     $     $     $ 605  

 

 

   

As of December 31, 2015

 
   

Fair Value

   

Level I

   

Level II

   

Level III

 

Assets

                               

Money market funds

  $ 2     $ 2     $     $  

U.S. government agency obligations

    30,352             30,352        
                                 

Total assets measured at fair value

  $ 30,354     $ 2     $ 30,352     $  
                                 

Liabilities

                               

PIPE warrants

  $ 913                 $ 913  

Contingent put option liability

    266                   266  
                                 

Total liabilities measured at fair value

  $ 1,179     $     $     $ 1,179  

 

The following table sets forth the assumptions used in the Black-Scholes option-pricing model to estimate the fair value of the PIPE warrants as of June 30, 2016:

 

Market price

  $ 2.69  

Exercise price

  $ 3.40  

Risk-free interest rate

    0.45 %

Expected volatility

    85.0 %

Expected life (in years)

    1.42  

Expected dividend yield

    0.0 %

 

The following table sets forth the assumptions used in the Black-Scholes option-pricing model to estimate the fair value of the PIPE warrants as of December 31, 2015:

 

Market price

  $ 3.85  

Exercise price

  $ 3.40  

Risk-free interest rate

    1.06 %

Expected volatility

    80.0 %

Expected life (in years)

    1.92  

Expected dividend yield

    0.0 %

 

 
10

 

 

The following tables set forth a summary of the changes in the fair value of the Company’s Level III financial liabilities for the three and six months ended June 30, 2016 and 2015 (in thousands):

 

   

Three Months
Ended
June 30,
2016

   

Six Months
Ended
June 30,
2016

 

Fair value—beginning of period

  $ 804     $ 1,179  

Change in fair value of PIPE warrants

    (142 )     (473 )

Change in fair value of contingent put option associated with Original Loan Agreement with Hercules

    (57 )     (101 )
                 

Fair value—end of period

  $ 605     $ 605  

 

 

   

Three Months
Ended
June 30,
2015

   

Six Months
Ended
June 30,
2015

 

Fair value—beginning of period

  $ 1,155     $ 5,859  

Change in fair value of PIPE warrants

    68       (4,661 )

Change in fair value of contingent put option associated with Original Loan Agreement with Hercules

    (56 )     (31 )
                 

Fair value—end of period

  $ 1,167     $ 1,167  

 

 

3. Inventories

 

Inventories consist of finished goods, raw materials and work in process and are stated at the lower of cost or market and consist of the following (in thousands):

 

   

Balance as of

 
   

June 30, 2016

   

December 31, 2015

 

Raw materials

  $ 675     $ 140  

Work-in-process

    278       181  

Finished goods

    375       145  

Total

  $ 1,328     $ 466  

 

 

4. U.S. Department of Defense Contract

 

On May 11, 2015, the Company entered into an award contract supported by the Clinical and Rehabilitative Medicine Research Program, or CRMRP, of the United States Army Medical Research and Materiel Command, or USAMRMC, within the U.S. Department of Defense, or the DoD, in which the DoD agreed to provide up to $17.0 million to the Company in order to support the development of the Company’s product candidate, ARX-04 (sufentanil sublingual tablet, 30 mcg), a proprietary, non-invasive, single-use tablet in a disposable, pre-filled single-dose applicator, or SDA, for the treatment of moderate-to-severe acute pain. The DoD Contract supports development of ARX-04 to perform Phase 3 clinical trials and manufacturing activities in order to submit an NDA to the FDA. Under the terms of the contract, the DoD will reimburse the Company for costs incurred for development, manufacturing and clinical costs outlined in the contract, including reimbursement for certain personnel and overhead expenses. The period of performance under the contract began on May 11, 2015. The contract gives the DoD the option to extend the term of the contract and provide additional funding for the research. On March 2, 2016, the Company entered into an amendment to the award contract with the DoD in which the DoD agreed to approve enrollment of additional patients in the SAP302 study, approve the addition of the SAP303 study, and extend the contract period of performance by four months from November 10, 2016 to March 9, 2017, to accommodate the increased SAP302 patient enrollment and the SAP303 study. The costs for these changes will be absorbed within the current contract value. All other terms and conditions remain unchanged. If ARX-04 is approved by the FDA, the DoD has the option to purchase a certain number of units of commercial product pursuant to the terms of the contract.

 

Revenue is recognized based on expenses incurred by the Company in conducting research and development activities, including overhead, as set forth in the agreement. Revenue attributable to the research and development services performed under the DoD Contract, recorded as contract and other revenue in the condensed consolidated statements of comprehensive loss, was $3.2 million and $4.4 million for the three and six months ended June 30, 2016, respectively, and $1.4 million for the three and six months ended June 30, 2015.

 

5. Collaboration Agreement

 

On December 16, 2013, AcelRx and Grünenthal, entered into a Collaboration and License Agreement, or the License Agreement, and related Manufacture and Supply Agreement, or the MSA, and together with the License Agreement, the Agreements. The License Agreement grants Grünenthal rights to commercialize Zalviso in the Territory, for human use in the Field. The Company retains rights with respect to the Product in countries outside the Territory, including the United States, Asia and Latin America. Under the MSA, the Company will exclusively manufacture and supply the Product to Grünenthal for the Field in the Territory. On July 22, 2015, the Company entered into amendments to the License Agreement, or the License Amendment, and together with the License Agreement, the Amended License Agreement, and the MSA, or the MSA Amendment, and together with the MSA, the Amended MSA, between the Company and Grünenthal, each effective as of July 17, 2015, and together, the Amended Agreements.

 

 
11

 

 

In the Amended Agreements, the parties amended the Product supply configurations and packaging of Product components and accessories, and associated pricing therefor, which the Company will manufacture and supply to Grünenthal for the Territory. The parties agreed to increase the pricing of the Product components and accessories in exchange for a reduction of $5.5 million in the total milestone payments due from Grünenthal contingent upon achieving specified net sales targets from a total of $171.5 million to $166.0 million. The parties also updated the development plan for the Product in the Territory, providing for additional near-term development services to be rendered by AcelRx in exchange for payments by Grünenthal of $0.7 million. In accordance with the terms of the Amended MSA, AcelRx also received a binding Product forecast from Grünenthal for approximately $3.7 million.

 

Amended License Agreement

 

Under the terms of the Amended License Agreement, Grünenthal has the exclusive right to commercialize the Product in the Field in the Territory. The Company retains control of clinical development, while Grünenthal and the Company will be responsible for certain development activities pursuant to a development plan as agreed between the parties. The Company will not receive separate payment for such development activities, apart from the $0.7 million included under the Amended Agreements. Grünenthal is exclusively responsible for marketing approval applications and other regulatory filings relating to the sufentanil sublingual tablet drug cartridge for the Product in the Field in the Territory, while the Company is responsible for the CE Mark and other regulatory filings relating to device portions of the Product. In July 2014, Grünenthal submitted an MAA to the European Medicines Agency, or EMA, for Zalviso (15 micrograms sufentanil sublingual tablets) for the management of acute moderate-to-severe post-operative pain in adult patients. A CE Mark for Zalviso was obtained in the fourth quarter of 2014 which specifies AcelRx as the device design authority and manufacturer. In September 2015, the European Commission approved the MAA for Zalviso for the 28 European Union member states as well as for the EEA. In April 2016, Grünenthal completed the first commercial sale of Zalviso.

 

The Company received an upfront non-refundable cash payment of $30.0 million in December 2013, and a milestone payment of $5.0 million related to the MAA submission in the third quarter of 2014, and an additional $15.0 million milestone payment upon the European Commission, or EC, approval of the MAA for Zalviso, which was approved in September 2015. Under the Amended License Agreement, the Company is eligible to receive approximately $194.5 million in additional milestone payments, based upon successful regulatory and product development efforts ($28.5 million) and net sales target achievements ($166.0 million). Grünenthal will also make tiered royalty and supply and trademark fee payments in the mid-teens up to the mid-twenties percent range, depending on the level of sales achieved, on net sales of Zalviso. A portion of the tiered royalty payment, exclusive of the supply and trademark fee payments, will be paid to PDL in connection with the Royalty Monetization. For additional information on the Royalty Monetization with PDL, see Note 7 “Liability Related to Sale of Future Royalties.” Unless earlier terminated, the Amended License Agreement continues in effect until the expiration of the obligation of Grünenthal to make royalty and supply and trademark fee payments, which supply and trademark fee continues for so long as the Company continues to supply the Product to Grünenthal. The Amended License Agreement is subject to earlier termination in the event the parties mutually agree, by a party in the event of an uncured material breach by the other party, upon the bankruptcy or insolvency of either party, or by Grünenthal for convenience.

 

Amended MSA

 

Under the terms of the Amended MSA, the Company will manufacture and supply the Product for use in the Field for the Territory exclusively for Grünenthal. Grünenthal shall purchase from AcelRx, during the first five years after the effective date of the MSA, 100% and thereafter 80% of Grünenthal’s and its sublicensees’ and distributors’ requirements of Product for use in the Field for the Territory. The Product will be supplied at prices approximating the Company’s manufacturing cost, subject to certain caps, as defined in the MSA Amendment. The MSA Amendment requires the Company to use commercially reasonable efforts to enter stand-by contracts with third parties providing significant supply and manufacturing services and, under certain specified conditions, permits Grünenthal to use a third party back-up manufacturer to manufacture the Product for Grünenthal’s commercial sale in the Territory.

 

Unless earlier terminated, the Amended MSA continues in effect until the later of the expiration of the obligation of Grünenthal to make royalty and supply and trademark fee payments or the end of any transition period for manufacturing obligations due to the expiration or termination of the Amended License Agreement. The Amended MSA is subject to earlier termination in connection with certain termination events in the Amended License Agreement, in the event the parties mutually agree, by a party in the event of an uncured material breach by the other party or upon the bankruptcy or insolvency of either party.

 

 
12

 

 

The Company identified the following four significant non-contingent performance deliverables under the original Agreements: 1) intellectual property (license), 2) the obligation to provide research and development services, 3) the significant and incremental discount on the manufacturing of Zalviso for commercial purposes, and 4) the obligation to participate on the joint steering committee.

 

At the time the Amended Agreements were executed, with the exception of the intellectual property license, these obligations remained partially undelivered. Additionally, the Company identified the following three performance deliverables under the License Amendment and the MSA Amendment: 1) the obligation to provide additional research and development services, 2) the obligation to provide Zalviso demonstration device systems, and 3) the obligation to manufacture and deliver Product under the binding forecast. The Company determined that the License Amendment and MSA Amendment are modifications to the original Agreements.

 

The Company considered the provisions of the multiple-element arrangement guidance in determining whether the deliverables outlined above have standalone value and thus should be treated as separate units of accounting. The Company’s management determined that the license under the original License Agreement had standalone value and represented a separate unit of accounting because the rights conveyed permitted Grünenthal to perform all efforts necessary to commercialize and begin selling the product upon regulatory approval. In addition, Grünenthal has the appropriate development, regulatory and commercial expertise with products similar to the product licensed under the agreement and has the ability to engage third parties to manufacture the product allowing Grünenthal to realize the value of the license without receiving any of the remaining deliverables. Grünenthal can also sublicense its license rights to third parties. Also, the Company’s management determined that the research and development services, Zalviso demonstration device systems, joint steering committee participation, the significant and incremental discount on the manufacturing of Zalviso, and the obligation to manufacture and deliver Products each represent individual units of accounting, as Grünenthal could perform such services and/or could acquire these on a separate basis.

 

The Company believes that none of the deliverables have vendor-specific objective evidence, or VSOE, or sufficient third-party evidence, or TPE, of selling price, as none of them have been sold separately by the Company, and as there is only limited information about third party pricing for similar deliverables. Accordingly, the Company developed best estimates of selling prices, or ESP, for each deliverable in order to allocate the noncontingent arrangement consideration to the units of accounting, based on current information available as of the modification date.

 

The Company’s management determined the best estimate of selling price for the license based on Grünenthal’s estimated future cash flows arising from the arrangement. Embedded in the estimate were significant assumptions regarding regulatory expenses, revenue, including potential customer market for the product and product price, costs to manufacture the product and the discount rate. The Company’s management determined the best estimate of selling price of the research and development services and committee participation based on the nature and timing of the services to be performed and in consideration of personnel and other costs incurred in the delivery of the services. For the discount on manufacturing services, the Company’s management estimated the selling price based on the market level of contract manufacturing margin it could have received if it were engaged to supply products to a customer in a separate transaction, the estimated cost of manufacturing, and the anticipated volume of Grünenthal’s orders over the course of the agreement, to which the discount would apply. For the Zalviso demonstration devices and the obligation to manufacture and deliver Product, the Company’s management estimated the selling price based on the binding volume of such devices and Products, the estimated cost of manufacturing, and the market level of contract manufacturing margin. ESP of the license, research and development and committee participation services and the discount on manufacturing services were updated at the time the Amended Agreements were executed for purposes of allocating the amended arrangement consideration.

 

The Amended Agreements entitle the Company to receive additional payments upon the achievement of certain development and sales milestones. Based on ASC Topic 605-28, Revenue Recognition — Milestone Method, the Company evaluates contingent milestones at inception or modification of the agreement, and recognizes consideration that is contingent upon the achievement of a milestone in its entirety as revenue in the period in which the milestone is achieved only if the milestone is considered substantive in its entirety. Milestones are events which have the following characteristics: (i) they can be achieved based in whole or in part on either the Company’s performance or on the occurrence of a specific outcome resulting from the Company’s performance, (ii) there was substantive uncertainty at the date the agreement was entered into that the event would be achieved and, (iii) they would result in additional payments due to the Company. A milestone is considered substantive if the following criteria are met: (i) the consideration is commensurate with either (1) the entity’s performance to achieve the milestone, or (2) the enhancement of the value of the delivered item (s) as a result of a specific outcome resulting from the entity’s performance to achieve the milestone, (ii) the consideration relates solely to past performance and, (iii) the consideration is reasonable relative to all of the other deliverables and payment terms, including other potential milestone consideration, within the arrangement.

 

The substantive milestone payments will be recognized as revenue in their entirety upon the achievement of each substantive milestone. Based on the criteria noted above, the identified substantive milestones in the original Agreements pertain to post approval product enhancements, expanded market opportunities and manufacturing efficiencies for Zalviso. Each of these potential achievements is based primarily on the Company’s performance and involves substantive uncertainty as achievement of these milestones requires future research, development and regulatory activities, which are inherently uncertain in nature. The Company determined that the consideration for each milestone was commensurate with the Company’s performance to achieve the milestone, including future research, development, manufacturing and regulatory activities and that the consideration is reasonable relative to all of the other deliverables and payments within the arrangement. Aggregate potential payments for these milestones total $28.5 million.

 

 
13

 

 

In addition to substantive milestones, two milestones associated with the original Agreements were deemed not to be substantive. These milestones pertain to regulatory developments for Zalviso in Europe, which the Company’s management deemed to be not substantive due to the high likelihood of achievement, both at inception of the original Agreements and at the time the Amended Agreements were executed. Aggregate potential payments for these milestones totaled $20.0 million. In July 2014, Grünenthal submitted an MAA to the EMA for Zalviso for the management of acute moderate-to-severe post-operative pain in adult patients, triggering the first of these two milestones, a cash payment of $5.0 million. In September of 2015, the MAA was approved by the European Commission, triggering the second of these two milestones, a cash payment of $15.0 million. Amounts received under these non-substantive milestones were allocated to performance deliverables based on the relative selling price method and recognized as appropriate for such deliverables.

 

The Amended Agreements also include milestone payments related to specified net sales targets, totaling $166.0 million. These milestones do not meet the definition of a milestone under ASU 2010-17 because the achievement of these milestones is solely dependent on counter-party performance and not on any performance obligations of the Company.

 

At the time the Amended Agreements were executed, approximately $33.3 million of revenue had been recognized, and $1.7 million remained unrecognized from the aggregate to-date consideration of $35.0 million received under the original Agreements. Upon execution of the Amended Agreements, the Company updated the allocation of this arrangement consideration, along with the consideration owed under the Amended Agreements totaling $54.4 million, consisting of $0.7 million related to research and development services and the demonstration device systems, and $3.7 million related to the Product binding purchase forecast, to all of the identified deliverables in the arrangement (both delivered and undelivered) using their relative selling prices. Further, the $15.0 million non-substantive milestone achieved in September of 2015 was also allocated to the deliverables in the same manner. As a result of such allocations, additional amounts of $13.2 million and $0.5 million were allocated to the previously delivered license and research and development and committee participation services, respectively. A total of $4.4 million was allocated to the significant and incremental discount on manufacturing services, and is expected to be recognized over the period such discount is made available to Grünenthal, beginning in February 2016, on a straight-line basis over the estimated period through 2029. An additional $0.2 million has been allocated to committee participation services and is recognized on a straight-line basis over the performance obligation period extending through 2018. A total of $2.3 million was allocated to manufacturing services for the binding forecast of Products. The remaining $0.5 million was allocated to the additional research and development services under the Amended License Agreement and demonstration device systems, and manufacturing and delivery of the Products, and will be recognized as those services are performed or as the devices are delivered, as applicable.

 

Below is a summary of revenue recognized under the Amended Agreements during the three and six months ended June 30, 2016 and 2015 (in thousands):

 

   

Three Months Ended
June 30,

   

Six Months Ended
June 30,

 
   

2016

   

2015

   

2016

   

2015

 

Product sales

  $ 1,302     $     $ 2,702     $  

Joint steering committee and research and development services

    12       486       405       667  

Total

  $ 1,314     $ 486     $ 3,107     $ 667  

 

 

As of June 30, 2016, the Company had current and noncurrent portions of the deferred revenue balance under the Amended Agreements of $1.0 million and $3.1 million, respectively.

 

6. Long-Term Debt

 

Hercules Loan and Security Agreements

 

In June 2011, AcelRx entered into the Loan and Security Agreement, or the Loan Agreement, between the Company and with Hercules Technology II, L.P. and Hercules Technology Growth Capital, Inc., together, the Lenders, under which AcelRx borrowed $20.0 million in two tranches of $10.0 million each, represented by secured convertible term promissory notes. The Company’s obligations associated with the agreement are secured by a security interest in substantially all of its assets, other than its intellectual property and those assets sold under the Royalty Monetization.

 

 
14

 

 

The Company borrowed the first tranche of $10.0 million upon the closing of the transaction on June 29, 2011 and borrowed the second tranche of $10.0 million in December 2011. The Company used a portion of the proceeds from the first tranche to repay the remaining obligations under that certain loan and security agreement between the Company and Pinnacle Ventures, L.L.C., or Pinnacle Ventures, dated September 16, 2008. The interest rate for each tranche was 8.50%. In connection with the loan, the Company issued Hercules seven-year warrants to purchase an aggregate of 274,508 shares of common stock at a price of $3.06 per share. See Note 8 “Warrants,” for further description.

 

On December 16, 2013, AcelRx entered into an Amended and Restated Loan and Security Agreement with the Lenders, or the Amended Loan Agreement, under which the Company may borrow up to $40.0 million in three tranches. The loans are represented by secured convertible term promissory notes, collectively, the Notes. The Amended Loan Agreement amends and restates the Loan Agreement between the Company and the Lenders dated as of June 29, 2011. The Company borrowed the first tranche of $15.0 million upon closing of the transaction on December 16, 2013, and the second tranche of $10.0 million on June 16, 2014. The Company used approximately $8.6 million of the proceeds from the first tranche to repay its obligations under the Loan and Security Agreement with the Lenders. The Company recorded the new debt at an estimated fair value of $24.9 million as of December 31, 2014.

 

On September 24, 2014, the Company entered into Amendment No. 1 to the Amended Loan Agreement with Hercules. Amendment No. 1 extended the time period under which the Company could draw down the third tranche, of up to $15.0 million, from March 15, 2015 to August 1, 2015, subject to the Company obtaining approval for Zalviso from the FDA. The Company did not receive FDA approval of Zalviso by August 1, 2015 and as such, did not have access to the third tranche.

 

On September 18, 2015, concurrently with the closing of the Royalty Monetization, the Company entered into a Consent and Amendment No. 2, or Amendment No. 2, to the Amended Loan Agreement with the Lenders. Amendment No. 2 includes an interest only period from October 1, 2015 through March 31, 2016, with further extension to September 30, 2016 upon satisfaction of certain conditions. These conditions were satisfied in the third quarter of 2015 and the interest only period was extended through September 30, 2016. Loans under the Amended Loan Agreement mature on October 31, 2017. In connection with Amendment No. 2, the Company reduced the exercise price of the warrants already held by the Lenders, which are exercisable for an aggregate of 176,730 shares of Common Stock, from the previous exercise price of $6.79 per share to $3.88 per share, or the Warrant Amendments.

 

The interest rate for each tranche will be calculated at a rate equal to the greater of either (i) 9.10% plus the prime rate as reported from time to time in The Wall Street Journal minus 5.25%, and (ii) 9.10%. Payments under the Amended Loan Agreement were interest only until April 1, 2015, followed by equal monthly payments of principal and interest through September 30, 2015, to be followed by an interest only period from October 1, 2015 through September 30, 2016, and by equal monthly payments of principal and interest from October 1, 2016 through the scheduled maturity date on October 1, 2017, or the Loan Maturity Date. In addition, a final payment equal to $1.7 million will be due on the Loan Maturity Date, or such earlier date specified in the Amended Loan Agreement. The Company’s obligations under the Amended Loan Agreement are secured by a security interest in substantially all of its assets, other than its intellectual property and those assets sold under the Royalty Monetization.

 

If the Company prepays the Amended Loan Agreement prior to maturity, it will pay Hercules a prepayment charge, based on a percentage of the then outstanding principal balance, or 1% if the prepayment occurs after December 16, 2015.

 

Subject to certain conditions and limitations set forth in the Amended Loan Agreement, the Company has the right to convert up to $5.0 million of scheduled principal installments under the Notes into freely tradeable shares of the Company’s common stock, or Common Stock. The number of shares of Common Stock that would be issued upon conversion of the Amended Notes would be equal to the number determined by dividing (x) the product of (A) the principal amount to be paid in shares of Common Stock and (B) 103%, by (y) $9.30 (subject to certain proportional adjustments as provided for in the Amended Loan Agreement).

 

The Amended Loan Agreement includes customary affirmative and restrictive covenants, but does not include any financial maintenance covenants, and also includes standard events of default, including payment defaults, breaches of covenants following any applicable cure period, a material impairment in the perfection or priority of Hercules’ security interest or in the value of the collateral, and events relating to bankruptcy or insolvency. Upon the occurrence of an event of default, a default interest rate of an additional 5% may be applied to the outstanding loan balances, and Hercules may declare all outstanding obligations immediately due and payable and take such other actions as set forth in the Amended Loan Agreement.

 

In connection with the Amended Loan Agreement, the Company issued a warrant to each Lender which, collectively, are exercisable for an aggregate of 176,730 shares of common stock and each carried an exercise price of $6.79 per share. As mentioned above, in connection with Amendment No. 2, the Company reduced the exercise price of these warrants from the previous exercise price of $6.79 per share to $3.88 per share. See Note 8 “Warrants,” for further description.

 

 
15

 

 

Upon an event of default, including a change of control, Hercules has the option to accelerate repayment of the Amended Loan Agreement, including payment of any applicable prepayment charges, which range from 1%-3% of the outstanding loan balance and accrued interest, as well as a final payment fee of $1.7 million. This option is considered a contingent put option liability, as the holder of the loan may exercise the option in the event of default, and is considered an embedded derivative, which must be valued and separately accounted for in the Company’s financial statements. As the Amended Loan Agreement entered into on December 16, 2013 was considered an extinguishment, the contingent put option liability associated with the Loan Agreement, which had an estimated fair value of $32,000 at the time of the amendment, was written off as a part of the loss on extinguishment, and a new contingent put option liability was established. As of June 30, 2016 and December 31, 2015, the estimated fair value of the contingent put option liability was $165,000 and $266,000, respectively, which was determined by using a risk-neutral valuation model, wherein the fair value of the underlying debt facility is estimated both with and without the presence of the default provisions, holding all other assumptions constant. The resulting difference between the two estimated fair values is the estimated fair value of the default provisions, or the contingent put option. The fair value of the underlying debt facility is estimated by calculating the expected cash flows in consideration of an estimated probability of default and expected recovery rate in default, and discounting such cash flows back to the reporting date using a risk-free rate. The contingent put option liability was recorded as a debt discount to the loan and consequently a reduction to the carrying value of the loan. The contingent put option liability is revalued at the end of each reporting period and any change in the fair value is recognized in interest income and other income (expense), net in the condensed consolidated statements of comprehensive loss.

 

The Company performed an analysis of Amendment No. 2 to determine if it was a modification or extinguishment of the debt under the Amended Loan Agreement. The Company assumed immediate prepayment of both the pre-modification debt and post-modification debt, including the change in the fair value due to the Warrant Amendments, and concluded that Amendment No. 2 was a modification rather than an extinguishment of the debt.

 

The balance due under the Amended Loan Agreement was $21.3 million at June 30, 2016 and $20.9 million at December 31, 2015. Interest expense related to the Amended Loan Agreement was $0.7 million and $1.4 million for the three and six months ended June 30, 2016, respectively, and $0.8 million and $1.6 million for the three and six months June 30, 2015, respectively.

 

7. Liability Related to Sale of Future Royalties

 

On September 18, 2015, the Company consummated the Royalty Monetization, in which it sold certain royalty and milestone payment rights to its newly formed wholly owned subsidiary, ARPI LLC, pursuant to a Purchase and Sale Agreement, or PSA. Subsequently, ARPI LLC sold the royalty and milestone payment rights to PDL for an upfront cash purchase price of $65.0 million, subject to a capped amount of $195.0 million pursuant to the Subsequent Purchase and Sale Agreement, or SPSA. Under the SPSA, PDL will receive 75% of the European royalties under the Amended License Agreement as well as 80% of the first four commercial milestones, worth $35.6 million (or 80% of $44.5 million), subject to the capped amount. The Company is entitled to receive 25% of the royalties, 20% of the first four commercial milestones, 100% of the remaining commercial milestones and all remaining development milestones of $43.5 million, including the $15.0 million payment for the approval of the Zalviso MAA.

 

The Company and ARPI LLC continue to retain certain duties and obligations under the Amended License Agreement. These include the collection of the royalty and milestones amounts due and enforcement of related provisions under the Amended License Agreement, among others. In addition, the Company must prepare a quarterly distribution report relating to the Amended License Agreement, containing among other items, the amount of royalty and milestone payments received, reimbursable expenses and set-offs. The Company and ARPI LLC must also provide PDL with notice of certain communications, events or actions with respect to the Amended License Agreement and infringement of any underlying intellectual property.

 

The Company has significant continuing involvement in the Royalty Monetization primarily due to an obligation to act as the intermediary for the supply of Zalviso to Grünenthal. Under the relevant accounting guidance, because of its significant continuing involvement, the Royalty Monetization has been accounted for as a liability that will be amortized using the interest method over the life of the arrangement. In order to determine the amortization of the liability, the Company is required to estimate the total amount of future royalty and milestone payments to be received by PDL and payments the Company is required to make to PDL, up to a capped amount of $195.0 million, over the life of the arrangement. The sum of the capped amount of $195.0 million, less the $61.2 million of net proceeds the Company received will be recorded as interest expense over the life of the liability. Consequently, the Company imputes interest on the unamortized portion of the liability and records interest expense. The Company’s estimate of the interest rate under the arrangement is based on the amount of royalty and milestone payments expected to be received by PDL over the life of the arrangement. The Company’s estimate of this total interest expense resulted in an effective annual interest rate of approximately 14%.

 

The Company will periodically assess the expected royalty and milestone payments using a combination of historical results, internal projections and forecasts from external sources. To the extent such payments are greater or less than our initial estimates or the timing of such payments is materially different than our original estimates, the Company will prospectively adjust the amortization of the liability and the interest rate.

 

 
16

 

 

The following table shows the activity within the liability account during the six months ended June 30, 2016 (in thousands):

 

Liability related to sale of future royalties—beginning balance as of December 31, 2015

  $ 63,612  

Non-cash interest expense recognized

    4,520  

Payments from AcelRx to PDL

     

Total liability related to sale of future royalties as of June 30, 2016

    68,132  

Less: current portion

    (357

)

Liability related to sale of future royalties, less current portion

  $ 67,775  

 

As royalties are remitted to PDL from ARPI LLC as described in Note 1 “Organization and Summary of Significant Accounting Policies,” the balance of the liability will be effectively repaid over the life of the agreement. The Company will record non-cash royalty revenues and non-cash interest expense within its condensed consolidated statements of comprehensive loss over the term of the Royalty Monetization.

 

8. Warrants

 

Series A Warrants

 

As of June 30, 2016, warrants to purchase 3,425 shares of common stock had not been exercised and were still outstanding. These warrants expire in March 2017.

 

Hercules Warrants

 

In connection with the Amended Loan Agreement, executed in December 2013, the Company issued warrants to Hercules which were exercisable for an aggregate of 176,730 shares of common stock with an exercise price of $6.79 per share, or the Warrants. In connection with Amendment No. 2 to the Amended Loan Agreement, the Company reduced the exercise price of the warrants already held by the Lenders from the previous exercise price of $6.79 per share to $3.88 per share, or the Warrant Amendments. Each Warrant may be exercised on a cashless basis. The Warrants are exercisable for a term beginning on the date of issuance and ending on the earlier to occur of five years from the date of issuance or the consummation of certain acquisitions of the Company as set forth in the Warrants. The number of shares for which the Warrants are exercisable and the associated exercise price are subject to certain proportional adjustments as set forth in the Warrants. The Company estimated the fair value of these Warrants as of the issuance date to be $1.1 million, which was used in the estimating the fair value of the amended debt instrument and was recorded as equity. The fair value of the Warrants was calculated using the Black-Scholes option-valuation model, and was based on the original strike price of $6.79, the stock price at issuance of $9.67, the five-year contractual term of the warrants, a risk-free interest rate of 1.55%, expected volatility of 71% and 0% expected dividend yield. The Company estimated the fair value of the modification of the Warrants, or the Warrant Amendments, as of the issuance date to be $0.1 million, which was used in estimating the fair value of the amended debt instrument and was recorded as equity.

 

As of June 30, 2016, warrants to purchase 176,730 shares of common stock issued to Hercules had not been exercised and were still outstanding. These warrants expire in December 2018.

 

2012 Private Placement Warrants

 

In connection with the Private Placement, completed in June 2012, the Company issued PIPE warrants to purchase up to 2,630,103 shares of common stock. The per share exercise price of the PIPE warrants was $3.40 which equals the closing consolidated bid price of the Company’s common stock on May 29, 2012, the effective date of the Purchase Agreement. The PIPE warrants issued in the Private Placement became exercisable six months after the issuance date, and expire on the five year anniversary of the initial exercisability date. Under the terms of the PIPE warrants, upon certain transactions, including a merger, tender offer, sale of all or substantially all of the assets of the Company or if a person or group shall become the owner of 50% of the Company’s issued and outstanding common stock, which is outside of the Company’s control, each PIPE warrant holder may elect to receive a cash payment in exchange for the warrant, in an amount determined by application of the Black-Scholes option-pricing model. Accordingly, the PIPE warrants were recorded as a liability at fair value, as determined by the Black-Scholes option-pricing model, and then marked to fair value each reporting period, with changes in estimated fair value recorded through the Consolidated Statements of Comprehensive Loss in interest income and other income (expense), net. The Black-Scholes assumptions used to value the PIPE warrants are disclosed in Note 2 “Investments and Fair Value Measurement.”

 

 
17

 

 

Upon execution of the Purchase Agreement, the fair value of the PIPE warrants was estimated to be $5.8 million, which was recorded as a liability. As of June 30, 2016, the fair value of the PIPE warrants was estimated to be $0.4 million. The change in fair value for the three months ended June 30, 2016, which was recorded as other income, was $0.2 million, while the change in fair value for the three months ended June 30, 2015, which was recorded as other expense, was $0.1 million. The change in fair value for the six months ended June 30, 2016 and 2015, which was recorded as other income, was $0.5 million, and $2.1 million, respectively.

 

During the three months ended March 31, 2015, PIPE warrants to purchase 847,058 shares were net exercised for 527,101 shares of common stock. As of June 30, 2016, PIPE warrants to purchase 512,456 shares of common stock issued in connection with the Private Placement had not been exercised and were outstanding. These warrants expire in November 2017.

 

9. Stockholders’ Equity

 

Common Stock

 

Public Offerings

 

On July 23, 2013, AcelRx completed an underwritten public offering of 4,370,000 shares of common stock, at a price of $11.65 per share to the public. The total gross proceeds of this offering were $50.9 million with net proceeds to AcelRx of $47.9 million after deducting underwriting discounts and commissions and other expenses payable by AcelRx.

 

Private Placement Offering

 

On June 1, 2012, or the Issuance Date, the Company issued an aggregate of 2,922,337 shares of common stock and warrants to purchase up to 2,630,103 shares of common stock, or the PIPE warrants, for aggregate gross proceeds of $10.0 million, or the Private Placement. Costs related to the offering were $0.9 million. The shares of common stock and PIPE warrants issued in the Private Placement were sold pursuant to a Securities Purchase Agreement, or Purchase Agreement, dated May 29, 2012, between the Company and certain purchasers, including certain entities affiliated with Mark Wan and Stephen J. Hoffman, members of the Company’s Board of Directors. Pursuant to the Purchase Agreement, AcelRx sold shares of common stock and PIPE warrants to purchase common stock in immediately separable “Units,” with each Unit consisting of (i) one share of common stock and (ii) a PIPE warrant to purchase 0.9 of a share of common stock. The per share exercise price of the PIPE warrants was $3.40. The offering price per Unit was $3.40 for non-affiliated investors, and $3.5125 for affiliated investors, which equals the sum of (i) $3.40, the closing consolidated bid price of the Company’s common stock on May 29, 2012, plus (ii) $0.1125 (which is equal to $0.125 per PIPE warrant share, multiplied by 0.9), for an aggregate amount of $10.0 million. The PIPE warrants issued in the Private Placement became exercisable six months after the Issuance Date, and expire on the five year anniversary of the initial exercisability date.

 

In connection with the Private Placement, the Company filed a registration statement with the U.S. Securities and Exchange Commission, or SEC, registering for resale the shares of common stock and shares of common stock issuable upon exercise of the warrants sold in the Private Placement. The registration statement was declared effective by the SEC in July 2012.

 

2016 ATM Agreement

 

On June 21, 2016, the Company entered into a Controlled Equity OfferingSM Sales Agreement, or the Sales Agreement, or 2016 ATM Agreement, with Cantor Fitzgerald & Co., or Cantor, as agent, pursuant to which the Company may offer and sell, from time to time through Cantor, shares of the Company’s common stock, or the Common Stock having an aggregate offering price of up to $40.0 million, or the Shares. The Company is not obligated to make any sales of common stock under the Sales Agreement. The offering of Shares pursuant to the Sales Agreement will terminate upon the earlier of (a) the sale of all of the Shares subject to the Sales Agreement or (b) the termination of the Sales Agreement by Cantor or the Company, as permitted therein. The Company will pay Cantor a commission rate in the low single digits on the aggregate gross proceeds from each sale of Shares and have agreed to provide Cantor with customary indemnification and contribution rights. As of June 30, 2016, the Company has not sold any shares of common stock pursuant to the 2016 ATM Agreement.

 

Stock Plans

 

2006 Stock Plan

 

In August 2006, the Company established the 2006 Plan in which 342,000 shares of common stock were originally reserved for the issuance of incentive stock options, or ISOs, and nonstatutory stock options, or NSOs, to employees, directors or consultants of the Company. In February 2008, an additional 375,000 shares of common stock were reserved for issuance under the 2006 Plan and, in November 2009, an additional 1,376,059 shares of common stock were reserved for issuance under the 2006 Plan. Per the 2006 Plan, the exercise price of ISOs and NSOs granted to a stockholder who at the time of grant owns stock representing more than 10% of the voting power of all classes of the stock of the Company could not be less than 110% of the fair value per share of the underlying common stock on the date of grant. Effective upon the execution and delivery of the underwriting agreement for the Company’s IPO, no additional stock options or other stock awards may be granted under the 2006 Plan.

 

 
18

 

 

2011 Equity Incentive Plan

 

In January 2011, the Board of Directors adopted, and the Company’s stockholders approved, the 2011 Equity Incentive Plan, or 2011 Incentive Plan, as a successor to the 2006 Plan. The 2011 Incentive Plan became effective immediately upon the execution and delivery of the underwriting agreement for the IPO on February 10, 2011. As of February 10, 2011, no more awards may be granted under the 2006 Plan, although all outstanding stock options and other stock awards previously granted under the 2006 Plan will continue to remain subject to the terms of the 2006 Plan. The 51,693 shares reserved under the 2006 Plan that remained available for future grant at the time of the IPO were transferred to the share reserve of the 2011 Incentive Plan.

 

The initial aggregate number of shares of the Company’s common stock that may be issued pursuant to stock awards under the 2011 Incentive Plan is 1,875,000 shares, which number was the sum of (i) 51,693 shares remaining available for future grant under the 2006 Plan at the time of the execution and delivery of the underwriting agreement for the Company’s IPO, and (ii) an additional 1,823,307 new shares. The number of shares of common stock reserved for issuance under the 2011 Incentive Plan will automatically increase on January 1st each year, starting on January 1, 2012 and continuing through January 1, 2020, by 4% of the total number of shares of the Company’s common stock outstanding on December 31 of the preceding calendar year, or such lesser number of shares of common stock as determined by the Board of Directors. The term of the option is determined by the Board of Directors on the date of grant but shall not be longer than 10 years. Options under the 2011 Equity Incentive Plan generally vest over four years, and all options expire after 10 years. The Company issues new shares for settlement of vested restricted stock units and exercises of stock options. The Company does not have a policy of purchasing its shares relating to its share-based programs.

 

2011 Employee Stock Purchase Plan

 

Additionally, in January 2011, the Board of Directors adopted, and the Company’s stockholders approved, the 2011 Employee Stock Purchase Plan, or the ESPP, which also became effective immediately upon the execution and delivery of the underwriting agreement for the IPO.

 

Initially, 250,000 shares of the Company’s common stock were authorized for issuance under the ESPP pursuant to purchase rights granted to the Company’s employees or to employees of any of its designated affiliates. The number of shares of the Company’s common stock reserved for issuance will automatically increase on January 1st each year, starting January 1, 2012 and continuing through January 1, 2020, in an amount equal to the lower of (1) 2% of the total number of shares of the Company’s common stock outstanding on December 31 of the preceding calendar year, or (2) a number of shares of common stock as determined by the Board of Directors. If a purchase right granted under the ESPP terminates without having been exercised, the shares of the Company’s common stock not purchased under such purchase right will be available for issuance under the ESPP.

 

10. Stock-Based Compensation

 

The Company recorded total stock-based compensation expense for stock options, stock awards and the ESPP, as follows (in thousands):

 

   

Three Months Ended
June 30,

   

Six Months Ended
June 30,

 
   

2016

   

2015

   

2016

   

2015

 

Cost of goods sold

  $ 77     $     $ 148     $  

Research and development

    586       629       1,186       1,331  

General and administrative

    482       482       996       1,318  
                                 

Total

  $ 1,145     $ 1,111     $ 2,330     $ 2,649  

 

As of June 30, 2016, there were 2,677,349 shares available for grant, 6,405,808 options outstanding and no restricted stock units outstanding under the Company’s 2011 Equity Incentive Plan and 1,157,690 shares available for grant under the ESPP.

 

11. Net Loss per Share of Common Stock

 

The Company’s basic net loss per share of common stock is calculated by dividing the net loss by the weighted average number of shares of common stock outstanding for the period. The diluted net loss per share of common stock is computed by giving effect to all potential common stock equivalents outstanding for the period determined using the treasury stock method. For purposes of this calculation, options to purchase common stock and warrants to purchase common stock were considered to be common stock equivalents. In periods with a reported net loss, common stock equivalents are excluded from the calculation of diluted net loss per share of common stock if their effect is antidilutive.

 

 
19

 

 

During the three months ended June 30, 2016 and the six months ended June 30, 2016, the PIPE warrants were out-of-the-money, and therefore antidilutive. During the three months ended June 30, 2015, the PIPE warrants were also antidilutive due to an increasing average market share price during the period; however, during the six months ended June 30, 2015, the PIPE warrants had a dilutive impact to net loss per share due to a lower average share price during the period as compared to the closing share price at December 31, 2014. The decrease in share price created a lower Black-Scholes value and lower liability for the PIPE warrants, which resulted in other income during the three months ended June 30, 2016 and the six months ended June 30, 2016 and 2015, respectively. The calculation of diluted net loss per share requires that, to the extent the average market price of the underlying shares for the reporting period exceeds the exercise price of the PIPE warrants and the presumed exercise of such securities are dilutive to loss per share for the period, adjustments to net loss used in the calculation are required to remove the change in fair value of the PIPE warrants for the period. Likewise, adjustments to the denominator are required to reflect the related dilutive shares. As the average market prices during the three and six months ended June 30, 2016, respectively, did not exceed the exercise price of the PIPE warrants, no such adjustments were made.

 

The following table sets forth the computation of the Company’s basic and diluted net loss per share of common stock during the three and six months ended June 30, 2016 and 2015 (in thousands, except for share and per share amounts):

 

 

   

Three Months Ended
June 30,

   

Six Months Ended
June 30,

 
   

2016

   

2015

   

2016

   

2015

 
   

(in thousands, except share and per share amounts)

 

Numerator

                               

Net loss used to compute net loss per share:

                               

Basic

  $ (11,092

)

  $ (8,896

)

  $ (22,073

)

  $ (18,922

)

Adjustments for change in fair value of warrant liability

                      (2,117

)

                                 

Diluted

  $ (11,092

)

  $ (8,896

)

  $ (22,073

)

  $ (21,039

)

                                 

Denominator

                               

Weighted average shares outstanding used to compute net loss per share:

                               

Basic

    45,312,242       44,343,270       45,299,560       44,109,488  

Dilutive effect of warrants

                      287,983  
                                 

Diluted

    45,312,242       44,343,270       45,299,560       44,397,471  
                                 

Net loss per share — basic

  $ (0.24

)

  $ (0.20

)

  $ (0.49

)

  $ (0.43

)

                                 

Net loss per share — diluted

  $ (0.24

)

  $ (0.20

)

  $ (0.49

)

  $ (0.47

)

 

The following outstanding shares of common stock equivalents were excluded from the computation of diluted net loss per share of common stock for the periods presented because including them would have been antidilutive:

 

   

June 30,

 
   

2016

   

2015

 

ESPP and stock options to purchase common stock

    6,537,180       5,907,881  

Restricted stock units

           

Convertible debt into common stock

    553,763       553,763  

Common stock warrants

    180,155       692,611  

 

 
20

 

 

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

 

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, which are subject to the “safe harbor” created by those sections. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to them. In some cases you can identify forward-looking statements by words such as “may,” “will,” “should,” “could,” “would,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “projects,” “predicts,” “potential” and similar expressions intended to identify forward-looking statements. Examples of these statements include, but are not limited to, statements related to the process and timing of anticipated future development of AcelRx's product candidates, ARX-04 (sufentanil sublingual tablet, 30 mcg) and Zalviso® (sufentanil sublingual tablet system), including the ARX-04 clinical trial results; ability to fund ARX-04 development from the contract with the Department of Defense; anticipated submission of the New Drug Application, or NDA, for ARX-04 to the U.S. Food and Drug Administration, or FDA; AcelRx’s pathway forward towards gaining approval of Zalviso in the U.S.; the anticipated timing, design and results of the IAP312 clinical trial for Zalviso; anticipated resubmission of the Zalviso NDA to the FDA including the scope of the resubmission and the timing of the resubmission, and FDA review time; the status of the Collaboration and License Agreement with Grünenthal GmbH, a company organized under the laws of Germany, or Grünenthal, or any other future potential collaborations, including potential milestones and royalty payments under the Grünenthal agreement; and the therapeutic and commercial potential of AcelRx’s product candidates, including potential market opportunities for ARX-04 and Zalviso. These forward-looking statements are based on AcelRx Pharmaceuticals’ current expectations and inherently involve significant risks and uncertainties. AcelRx Pharmaceuticals’ actual results and timing of events could differ materially from those anticipated in such forward-looking statements, and as a result of these risks and uncertainties, which include, without limitation, risks related to AcelRx Pharmaceuticals’ ability to complete Phase 3 clinical development of ARX-04 and support ARX-04 development under the contract with the Department of Defense; AcelRx’s ability to successfully execute the pathway towards a resubmission of the Zalviso NDA to the FDA, including the initiation and completion of the IAP312 clinical study for Zalviso; any delays or inability to obtain and maintain regulatory approval of its product candidates, including ARX-04 in the United States and Europe, and Zalviso in the United States; AcelRx’s ability to receive any milestones or royalty payments under the Grünenthal agreement and the timing thereof; ability to manufacture and supply sufficient quantities of Zalviso to Grünenthal on a timely basis; the commercial success of Grünenthal’s launch of Zalviso in the European Union, or EU; the uncertain clinical development process, including adverse events; the risk that planned clinical trials may not begin on time, have an effective clinical design, enroll a sufficient number of patients, or be initiated or completed on schedule, if at all; the success, cost and timing of all development activities and clinical trials, including the Phase 3 ARX-04 SAP302 and SAP303 trials, and the additional clinical trial for Zalviso, IAP312; the fact that the FDA may dispute or interpret differently clinical results obtained to date from the Phase 3 SAP301 study of ARX-04; the market potential for AcelRx’s product candidates; the accuracy of AcelRx’s estimates regarding expenses, capital requirements and the need for financing. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us and described in Part II, Item 1A of this Quarterly Report on Form 10-Q and our other filings with the SEC. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report on Form 10-Q. You should read this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from those we expect. Except as required by law, we assume no obligation to update these forward-looking statements, whether as a result of new information, future events or otherwise.

 

The following discussion and analysis should be read in conjunction with the unaudited financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q and with the audited consolidated financial statements and related notes thereto included as part of our Annual Report on Form 10-K for the year ended December 31, 2015.

 

About AcelRx Pharmaceuticals 

 

We are a specialty pharmaceutical company focused on the development and commercialization of innovative therapies for the treatment of acute pain. Our lead product candidates, ARX-04 and Zalviso®, utilize sublingual sufentanil, delivered via a non-invasive route of administration. We intend to commercialize our product candidates in the United States and license the development and commercialization rights to our product candidates for sale outside of the United States through strategic partnerships and collaborations. We may also consider the option to enter into strategic partnerships for our product candidates in the United States.

 

ARX-04 (sufentanil sublingual tablet, 30 mcg)

 

ARX-04 is an investigational product candidate consisting of a single tablet delivered via a disposable, pre-filled, single-dose applicator, or SDA. We are developing ARX-04 for the treatment of moderate-to-severe acute pain to be administered by a healthcare professional to a patient in medically supervised settings of acute pain. If approved, examples of potential patient populations and settings in which ARX-04 could be used include: emergency room patients; patients who are recovering from short-stay or ambulatory surgery and do not require more long-term patient-controlled analgesia; post-operative patients who are transitioning from the operating room to the recovery floor; patients being treated and transported by paramedics; and for battlefield casualties.

 

 
21

 

 

In October 2015, we initiated an open-label Phase 3 study, SAP302, of ARX-04 for the treatment of adult patients who present in the emergency room with moderate-to-severe acute pain associated with trauma or injury. The primary efficacy endpoint is the summed pain intensity difference, or SPID, over 1-hour, or SPID-1. Safety endpoints, such as adverse events and vital signs will also be assessed, as will the patients’ and healthcare providers’ satisfaction with the method of pain control. The initial phase of SAP302 treated 40 patients, who each received a single dose of ARX-04. Patients treated with one dose of ARX-04 experienced a mean decrease from baseline pain intensity difference, or PID-1, of 2.7 points on a 0 – 10 point numeric rating scale for pain intensity one hour after dosing. Based on published literature, a PID-1 of 1.3 points has been shown to be the minimal clinically significant difference in pain. The most frequently reported adverse events, nausea and somnolence, were each reported in two of the 40 patients. Based on discussions with the FDA, we initiated the extension phase of the SAP302 study of ARX-04 in March 2016. In the extension phase, an additional 36 patients have been treated, each of whom may have received multiple doses of ARX-04, given hourly as needed for pain, for up to four doses.

 

We held a pre-NDA meeting with the FDA in December 2015 to review plans for an NDA for ARX-04. Based on discussions with the FDA, we expanded the clinical program for ARX-04 by 176 additional patients to include individuals from specific populations and settings, in order to increase the ARX-04 safety database. Enrollment in the SAP302 open-label study in the emergency room was increased as described above, and a new study, known as SAP303, was initiated in March 2016 in post-operative patients with moderate-to-severe acute pain. SAP303 treated 140 patients 40 years of age and older who had moderate-to-severe acute pain following a surgical procedure with general anesthesia or spinal anesthesia (except those who received intrathecal opioids). SAP303 allowed for administration of ARX-04 for up to 12 hours.

 

Both the SAP302 and SAP303 trials have had their last patient visits and data are currently being analyzed. Top-line results for both studies are expected to be available in the third quarter of 2016, and pending successful results of these two open-label studies, we anticipate submitting the NDA for ARX-04 by the end of 2016.

 

On May 11, 2015, we entered into an award contract supported by the Clinical and Rehabilitative Medicine Research Program, or CRMRP, of the United States Army Medical Research and Materiel Command, or USAMRMC, within the U.S. Department of Defense, or the DoD, in which the DoD agreed to provide up to $17.0 million to support the development of ARX-04, referred to as the DoD Contract. Under the terms of the contract, the DoD will reimburse us for costs incurred for development, manufacturing, regulatory and clinical costs outlined in the contract in order to submit an NDA to the FDA, including reimbursement for certain personnel and overhead expenses. The period of performance under the DoD Contract began on May 11, 2015. The contract gives the DoD the option to extend the term of the contract and provide additional funding. On March 2, 2016, the DoD Contract was amended to approve enrollment of additional patients in the SAP302 study, approve the addition of the SAP303 study, and extend the contract period of performance by four months from November 10, 2016 to March 9, 2017, to accommodate the increased SAP302 patient enrollment and the SAP303 study. The costs for these changes will be absorbed within the current contract value. If ARX-04 is approved by the FDA, the DoD has the option to purchase a certain number of units of commercial product pursuant to the terms of the contract.

 

We have also held various meetings with Health Authorities in Europe to discuss the submission of a Marketing Authorization Application, or MAA, for ARX-04. Based on feedback from these discussions, we intend to submit for a label indication for ARX-04 in the EU for acute moderate-to-severe pain following surgery, or as a result of trauma. At the time of the anticipated submission of the MAA, we will have only completed one study in the emergency room for acute pain patients, in addition to three Phase 3 post-operative pain studies. We may need an additional controlled study in the emergency department with ARX-04 to obtain a label that includes both post-operative pain and trauma-related pain. In addition, we anticipate that we may need comparator studies in the EU to ensure premium reimbursement in certain countries. Assuming successful completion of the studies, we anticipate submitting the MAA for ARX-04 in the first half of 2017.

 

The Market Opportunity for ARX-04

 

United States

According to the Nationwide Emergency Department Sample, or NEDS, there were more than 104 million adult emergency room visits in the United States during 2011, of which we estimate more than 48 million were associated with moderate-to-severe acute pain.  Based on the National Survey of Ambulatory Surgery, in 2006, an estimated 27 million adult patients underwent outpatient surgical procedures in the United States, of which we estimate more than 11 million patients experienced moderate-to-severe acute pain. According to the National Inpatient Sample, in 2013, more than 15 million adult patients in the United States underwent surgical procedures in an inpatient setting, of which we estimate more than 7 million resulted in moderate-to-severe acute pain. At peak sales, assuming a 2016 price of $20 per unit, taking into account standard price increases, we believe the market opportunity for ARX-04 to be approximately $1.3 billion in the United States.

 

 
22

 

 

Europe

According to recent EU5 (France, Germany, Italy, Spain, and the United Kingdom) national health statistics, 142 million patients are represented across the ARX-04 target segments annually. Each year, there are an estimated 110 million emergency attendances and 32 million surgical procedures performed each year. It is anticipated that there are 51 million patients in emergency medicine with moderate-to-severe acute pain and 16 million with moderate-to-severe acute pain following surgery each year. Using the published priced benchmarks of Penthrox (methoxyflurane) and branded fentanyl products, £17.89 (UK) and €8.04 (Germany), respectively, we believe that ARX-04 could achieve a €15 price per unit. A micro-costing literature review is in process to determine the total cost per patient necessary to administer IV opioids in the emergency department as further support for premium pricing. Based on this information, we believe peak year sales in emergency medicine and post-operative pain across Europe are expected to be approximately €700 million, assuming ARX-04 achieves a €15 price point; however, there can be no assurance that ARX-04 will be able to achieve a €15 price per unit. Oligo-analgesia or under-treatment of pain is a recognized issue throughout Europe, and supports growth in treatment of acute pain with the introduction of ARX-04.

 

Zalviso (sufentanil sublingual tablet system)

 

Our product candidate, Zalviso, is intended for the management of moderate-to-severe acute pain in hospitalized adult patients. Zalviso consists of sufentanil sublingual tablets, 15 mcg, delivered by the Zalviso System, a needle-free, handheld, patient-administered, pain management system, or together, Zalviso.

 

Zalviso is a pre-programmed, non-invasive, system to allow hospital patients with moderate-to-severe acute pain to self-dose with sufentanil sublingual tablets, 15 mcg, to manage their pain. Zalviso is designed to help address certain problems associated with post-operative intravenous patient-controlled analgesia. Zalviso allows patients to self-administer sufentanil sublingual tablets via a pre-programmed, secure system designed to eliminate the risk of programming errors.

 

On December 16, 2013, AcelRx and Grünenthal GmbH, a company organized under the laws of Germany, or Grünenthal, entered into a Collaboration and License Agreement, or the License Agreement, and related Manufacture and Supply Agreement, or the MSA, and together with the License Agreement, the Agreements. The License Agreement grants Grünenthal rights to commercialize Zalviso, the Company’s novel sublingual patient-controlled analgesia, or PCA, system, or the Product, in the countries of the European Union, Switzerland, Liechtenstein, Iceland, Norway and Australia, or the Territory, for human use in pain treatment within, or dispensed by, hospitals, hospices, nursing homes and other medically-supervised settings, or the Field. The Company retains rights with respect to the Product in countries outside the Territory, including the United States, Asia and Latin America. Under the MSA, the Company will exclusively manufacture and supply the Product to Grünenthal for the Field in the Territory. On July 22, 2015, the Company entered into amendments to the License Agreement, or the License Amendment, and together with the License Agreement, the Amended License Agreement, and the MSA, or the MSA Amendment, and together with the MSA, the Amended MSA, between the Company and Grünenthal, each effective as of July 17, 2015, and together, the Amended Agreements. For additional information on the Amended Agreements, see Note 5 “Collaboration Agreement” in the accompanying notes to the condensed consolidated financial statements.

 

Grünenthal will be responsible for all commercial activities for Zalviso, including obtaining and maintaining pharmaceutical product regulatory approval in the Territory. We will be responsible for obtaining and maintaining device regulatory approval in the Territory and the manufacturing and supply of Zalviso to Grünenthal for commercial sales.

 

In April 2016, Grünenthal completed the first commercial sale of Zalviso. Grünenthal continues to sell Zalviso initially in a limited number of hospitals in Germany under a pilot program, whereby the hospital will use Zalviso in a small number of post-operative patients. The pilot program, which is expected to last approximately two months at each institution, is being made available to additional hospitals in Germany over the next several months. Pending success with the pilot program, Grünenthal expects to make the product widely available in Germany. With similar methodology, Grünenthal has also initiated the sale of Zalviso in France, the United Kingdom, Italy and Belgium, and intends to launch Zalviso in the Netherlands, Ireland and Portugal by the end of 2016.

 

On September 18, 2015, we sold a portion of the expected royalty stream and commercial milestones from the sales of Zalviso in the EU by Grünenthal to PDL, or the Royalty Monetization. AcelRx received gross proceeds of $65.0 million in the Royalty Monetization. PDL will receive 75% of the European royalties under the Amended License Agreement with Grünenthal, as well as 80% of the first four commercial milestones worth $35.6 million (or 80% of $44.5 million), subject to the capped amount of $195.0 million. For additional information on the Royalty Monetization with PDL, see Note 7 “Liability Related to Sale of Future Royalties” in the accompanying notes to the condensed consolidated financial statements.

 

 
23

 

 

We submitted an NDA for Zalviso in September 2013, which the FDA accepted for filing in December 2013. On July 25, 2014, the FDA issued a Complete Response Letter, or CRL, for the Zalviso NDA. The CRL contains requests for additional information on the Zalviso System to ensure proper use of the device. The requests include submission of data demonstrating a reduction in the incidence of optical system errors, changes to address inadvertent dosing, among other items, and submission of additional data to support the shelf life of the product. Although there were no requests for additional clinical studies in the CRL, in March 2015, we received correspondence from the FDA stating that, in addition to the work we had performed to address the items in the CRL, a clinical study would be required to test modifications to the Zalviso device.

 

Our IAP312 study is designed to evaluate the effectiveness of changes made to enhance performance of the Zalviso device and takes into account comments from the FDA on the protocol. The IAP312 study is expected to include approximately 315 post-operative patients and collect information requested by the Division of Anesthesia, Analgesia, and Addiction Products, or the Division, of the FDA to supplement the three positive Phase 3 trials already completed. While the Company estimates that it may be able to begin the IAP312 study in September 2016, it does not intend to initiate the study until final supplies have been received and tested and clinical sites are ready. These activities may or may not occur in time to initiate the trial in September 2016. Timing of the completion of the IAP312 study will be dependent on the actual initiation date and other timing including, but not limited to, study enrollment.

 

The Market Opportunity for Zalviso

 

According to the 2014 Decision Resources Acute Pain Report, or 2014 DR Report, the acute pain market (represented by treatments for post-operative pain, acute musculoskeletal pain and cancer breakthrough pain) in the United States, Europe and Japan realized 2013 revenues of $12.7 billion, and is expected to reach approximately $13.3 billion by 2023.  Opioid analgesic use remains a standard in the management of acute pain, representing 44% of the 2013 market, and is projected to grow to 46% of the 2023 market.  Post-operative acute pain treatment in the United States is projected to grow significantly in the 2013 to 2023 period, from management of 8.9 million procedures in 2013 to 10.3 million procedures in 2023, a 1.5% Compound Annual Growth Rate. 

 

 

Financial Overview

 

We have incurred net losses and generated negative cash flows from operations since inception and expect to incur losses in the future as we continue our research and development activities and pre-commercialization activities. As a result, we expect to continue to incur negative cash flows. Although Zalviso has been approved for sale in the European Union, we sold the majority of the royalty rights and certain commercial sales milestones we are entitled to receive under the Grünenthal Agreements to PDL in September 2015. As we pursue development of our product candidates, including regulatory review and potential commercial development, subject to FDA approval, of our product candidates, we expect the business aspects of our company to become more complex. In the future, we plan to add personnel and incur additional costs related to the maturation of our business and the potential commercialization of ARX-04 and Zalviso in the United States. In addition, we believe that continued investment in research and development is critical to attaining our strategic objectives. In order to develop our product candidates as commercially viable therapeutics, we expect to expend significant resources for expertise in manufacturing, regulatory affairs, clinical research and other aspects of pharmaceutical development.

 

To date, we have funded our operations primarily through the issuance of equity securities, borrowings, payments from our commercial partner, Grünenthal, monetization of certain future royalties and commercial sales milestones from the sales of Zalviso by Grünenthal, and funding from the DoD.

 

Our revenues since inception have consisted primarily of revenues from our Amended License Agreement with Grünenthal and our research contracts with the DoD. As mentioned above, in May 2015, the DoD agreed to provide us up to $17.0 million to support the development of ARX-04. Under the terms of the contract, the DoD will reimburse us for costs incurred for development, manufacturing, regulatory and clinical costs outlined in the contract in order to submit an NDA to the FDA, including reimbursement for certain personnel and overhead expenses.

 

There can be no assurance that we will enter into other collaborative agreements or receive research-related contract awards in the future. We expect revenues to continue to fluctuate from period-to-period. There can be no assurance that our relationship with our existing commercial partner, Grünenthal, will continue beyond the initial term, or that we will be able to meet the milestones specified in the Amended License Agreement, or that the funding provided by the DoD Contract will be sufficient for an NDA submission for ARX-04, or that we will obtain marketing approval for any of our product candidates outside of Zalviso in the EU and EEA and subsequently generate revenue from those product candidates in excess of our operating expenses.

 

 
24

 

 

Our net loss for the three months and six months ended June 30, 2016 was $11.1 million and $22.1 million, respectively, compared to net losses of $8.9 million and $18.9 million for the three and six months ended June 30, 2015, respectively. As of June 30, 2016, we had an accumulated deficit of $225.3 million. As of June 30, 2016, we had cash, cash equivalents and investments totaling $98.8 million compared to $113.5 million as of December 31, 2015.

 

Critical Accounting Estimates

 

The accompanying discussion and analysis of our financial condition and results of operations are based upon our financial statements and the related disclosures, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates, assumptions and judgments that affect the reported amounts in our financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected. Our critical accounting policies and estimates are detailed in our Annual Report on Form 10-K for the year ended December 31, 2015. There have been no significant changes in our critical accounting policies and estimates during the three and six months ended June 30, 2016 from those previously disclosed in our Annual Report on Form 10-K.

 

Recently Issued Accounting Standards

 

In March 2016, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, No. 2016-09, Compensation - Stock Compensation (Topic 718), which is part of the FASB's Simplification Initiative. The updated guidance simplifies the accounting for share-based payment transactions. The amended guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, with early adoption permitted. We are currently evaluating the impact of the adoption of this standard on our consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842), which establishes a new lease accounting model for lessees. The updated guidance requires an entity to recognize assets and liabilities arising from a lease for both financing and operating leases, along with additional qualitative and quantitative disclosures. The amended guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018, with early adoption permitted. We are currently evaluating the impact of the adoption of this standard on our consolidated financial statements.

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, to provide guidance on revenue recognition. ASU No. 2014-09 requires a company to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under today’s guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. In August 2015, the FASB issued ASU No. 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, which provided for the adoption of the new standard for fiscal years beginning after December 15, 2017. Accordingly, ASU No. 2014-09 is effective for the Company in the first quarter of 2018. Early adoption up to the first quarter of 2017 is permitted. Upon adoption, ASU No. 2014-09 can be applied retrospectively to all periods presented or only to the most current period presented with the cumulative effect of changes reflected in the opening balance of retained earnings in the most current period presented. The FASB has also issued the following standards which clarify ASU No. 2014-09 and have the same effective date as the original standard:

 

 

ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net);

 

 

ASU No. 2016-10, Identifying Performance Obligations and Licensing (Topic 606);

 

 

and ASU No. 2016-11, Revenue Recognition (Topic 605) and Derivatives and Hedging (Topic 815): Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 EITF Meeting; and

 

 

ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients.

 

We are currently evaluating the method of adoption and the impact of adopting ASU No. 2014-09 on our consolidated financial statements. 

 

 
25

 

 

Results of Operations

 

Three and Six Months Ended June 30, 2016 and 2015

 

Revenue

 

In September 2015, the European Commission, or EC, granted marketing approval for Zalviso in the European Union to our commercial partner, Grünenthal. In April 2016, Grünenthal completed the first commercial sale of Zalviso. Grünenthal continues to sell Zalviso initially in a limited number of hospitals in Germany under a pilot program, whereby the hospital will use Zalviso in a small number of post-operative patients. The pilot program, which is expected to last approximately two months at each institution, is being made available to additional hospitals in Germany over the next several months. Pending success with the pilot program, Grünenthal expects to make the product widely available in Germany. With similar methodology, Grünenthal has also initiated the sale of Zalviso in France, the United Kingdom, Italy and Belgium, and intends to launch Zalviso in the Netherlands, Ireland and Portugal by the end of 2016. We anticipate that royalty revenues and non-cash royalty revenues from the commercial sale of Zalviso in 2016 will be minimal. Revenue during the three months ended June 30, 2016, was $4.5 million, including $1.3 million in collaboration agreement revenue recognized under our Amended Agreements with Grünenthal, plus $3.2 million in revenue for services performed under the DoD Contract.

 

Revenue for the three and six months ended June 30, 2015, was $1.9 million and $2.1 million, respectively, the majority of which was generated from our contract for ARX-04 with the DoD.

 

Collaboration Agreement Revenue

 

Below is a summary of revenue recognized under the Amended Agreements during the three and six months ended June 30, 2016 and 2015 (in thousands):

 

   

Three Months Ended
June 30,

   

Six Months Ended
June 30,

 
   

2016

   

2015

   

2016

   

2015

 

Product sales

  $ 1,302     $     $ 2,702     $  

Joint steering committee, research and development services and demonstration devices

    12       486       405       667  

Collaboration agreement revenue

  $ 1,314     $ 486     $ 3,107     $ 667  

 

In support of the launch of Zalviso in Europe by our licensee, Grünenthal, we recognized $1.3 million and $2.7 million in product sales in the three and six months ended June 30, 2016, respectively, consisting of Zalviso devices, drug product and accessories. Delivery of the Zalviso cartridges ordered by Grünenthal is behind schedule at Patheon. The inability to deliver cartridges to the schedule ordered by Grünenthal may have a negative impact on their future sales including the timing of their launch in certain countries. We are working with Patheon to resolve these issues; however, there can be no assurance that the issues will be resolved in a timely fashion, or that we will be able to meet Grünenthal’s needs in such a way as to not impact their future sales.

 

The first commercial sale of Zalviso occurred in April 2016; however, we did not recognize any royalty revenue or non-cash royalty revenue in the second quarter of 2016 from the sales in the EU by Grünenthal. Beginning in the third quarter of 2016, we will receive quarterly royalty reports from Grünenthal for the prior quarter. As the royalty amounts are not currently reasonably estimable without the royalty reports, we will recognize royalty revenue and non-cash royalty revenue on a quarterly basis, one quarter in arrears beginning in the third quarter of 2016.

 

As of June 30, 2016, we had current and non-current portions of the deferred revenue balance under the Amended Agreements of $1.0 million and $3.1 million, respectively. Our long-term deferred revenue balance increased during the six months ended June 30, 2016 from $0.6 million to $3.1 million. The estimated margin we expect to receive on transfer prices under the Amended Agreements, was deemed to be a significant and incremental discount on manufacturing services, as compared to market rates for contract manufacturing margin. The value assigned to this portion of the total allocated consideration was $4.4 million. We anticipate that the long-term deferred revenue balance will peak at approximately $4.0 million, as we complete invoicing Grünenthal in connection with the Amended Agreements in 2016, and decline on a straight-line basis through 2029, as we recognize collaboration revenue under the Amended Agreements.   

 

Contract and Other Revenue

 

During the three and six months ended June 30, 2016, AcelRx recognized revenue of $3.2 million and $4.4 million, respectively, for services performed under the DoD contract for ARX-04.

 

 
26

 

 

Cost of goods sold

 

Total cost of goods sold was $3.0 million and $6.6 million for the three and six months ended June 30, 2016, respectively. As mentioned above, the EC approved Zalviso in late September 2015. Under the Amended Agreements with Grünenthal, we will sell Zalviso at a predetermined transfer price that approximates the direct cost of manufacture at our contract manufacturers. We will not recover internal indirect costs as part of the transfer price. In addition, the Amended Agreements include declining maximum transfer prices over the term of the contract with Grünenthal. We may not be able to achieve the manufacturing cost reductions required in order to accommodate these declining transfer prices without a corresponding decrease in our gross margin. Cost of goods sold for Zalviso delivered to Grünenthal includes the inventory costs of the active pharmaceutical ingredient, or API, third-party contract manufacturing costs, estimated warranty costs, packaging and distribution costs, shipping, handling and storage costs. The indirect costs to manufacture include internal personnel and related costs for purchasing, supply chain, quality assurance, depreciation and related expenses. Prior to the initiation of commercial production in October 2015, these costs were included in research and development expenses as period costs.

 

Research and Development Expenses

 

Conducting research and development is central to our business model. The majority of our operating expenses to date have been for research and development activities related to Zalviso; however, in 2016 we anticipate that research and development expenses for ARX-04 will be greater than those for Zalviso. Research and development expenses included the following:

 

 

expenses incurred under agreements with contract research organizations and clinical trial sites;

 

 

employee-related expenses, which include salaries, benefits and stock-based compensation;

 

 

payments to third party pharmaceutical and engineering development contractors;

 

 

payments to third party manufacturers;

 

 

depreciation and other allocated expenses, which include direct and allocated expenses for rent and maintenance of facilities and equipment, and equipment and laboratory and other supply costs; and

 

 

costs for equipment and laboratory and other supplies. 

 

Product candidates in late stages of clinical development generally have higher development costs than those in earlier stages of clinical development, primarily due to the increased size and duration of late stage clinical trials. We will incur substantial future research and development expenditures as we seek to continue development of ARX-04 and Zalviso, including the expenses associated with the anticipated submission of the NDA for ARX-04, in addition to preparing for and conducting IAP312, the additional clinical trial for Zalviso.

 

We track external development expenses on a program-by-program basis. Our development resources are shared among all of our programs. Compensation and benefits, facilities, depreciation, stock-based compensation, and development support services are not allocated specifically to projects and are considered research and development overhead. Below is a summary of our research and development expenses during the three and six months ended June 30, 2016 and 2015:

 

   

Three Months Ended
June 30,

   

Six Months Ended
June 30,

 

Drug Indication/Description

 

2016

   

2015

   

2016 vs.
2015

Increase/
(Decrease)

   

2016

   

2015

   

2016 vs.
2015

Increase/
(Decrease)

 
   

(In thousands, except percentages)

 

ARX-04

  $ 3,365     $ 2,996       12

%

  $ 4,520     $ 4,157       9

%

Zalviso

    777       1,082       (28

)%

    1,687       2,752       (39

)%

Overhead

    2,138       3,232       (34

)%

    4,244       6,707       (37

)%

Total research and development expenses

  $ 6,280     $ 7,310       (14

)%

  $ 10,451     $ 13,616       (23

)%

 

 
27

 

 

Due to the inherently unpredictable nature of product development, development timelines and the probability of success, development costs can differ materially from expectations. While we are currently focused on advancing ARX-04 and the continued development of Zalviso, our future research and development expenses will depend on the clinical success of each product candidate as well as ongoing assessments of the commercial potential of our product candidates. In addition, we cannot predict which product candidates may be subject to future collaborations, when these arrangements will be secured, if at all, and to what degree these arrangements would affect our development plans and capital requirements.

 

Research and development expenses during the three months ended June 30, 2016, as compared to the three months ended June 30, 2015, decreased by $1.0 million primarily due to a $1.1 million reduction in overhead costs, predominantly as a result of the cost reduction plan implemented in March 2015 and the allocation of certain personnel and related expenses to cost of goods sold. In addition, Zalviso-related expenses decreased by $0.3 million due to the slowing of development activities as we clarified the development path forward with the FDA, while ARX-04-related spending increased incrementally by $0.4 million due to increased spending on the SAP302 and SAP303 studies, partially offset by the completion of the SAP301 study in 2015.

 

The $3.2 million decrease in research and development expenses during the six months ended June 30, 2016, as compared to the six months ended June 30, 2015, was primarily attributable to a $2.5 million reduction in overhead costs, predominantly as a result of the cost reduction plan implemented in March 2015 and the allocation of certain personnel and related expenses to cost of goods sold. In addition, during the first half of 2016, Zalviso-related expenses decreased by $1.1 million while ARX-04-related spending increased by a $0.4 million, as compared to the first half of 2015.

 

General and Administrative Expenses

 

General and administrative expenses consisted primarily of salaries, benefits and stock-based compensation for personnel in administration, finance, pre-commercialization and business development activities. Other significant expenses included legal expenses related to litigation and patent protection of our intellectual property, allocated facility costs and professional fees for general legal, audit and consulting services. We expect general and administrative expenses for the remainder of 2016 to remain comparable to 2015 expenses, as we focus our efforts on further development and seeking marketing approval for ARX-04, and the continued development of Zalviso.

 

Total general and administrative expenses for the three and six months ended June 30, 2016 and 2015 were as follows:

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2016

   

2015

   

Change

   

%

   

2016

   

2015

   

Change

   

%

 
   

(In thousands, except percentages)

 

General and administrative expenses

  $ 3,597     $ 2,735     $ 862       32 %   $ 7,374     $ 7,256     $ 118       2 %

 

The $0.9 million increase in general and administrative expenses during the three months ended June 30, 2016, as compared to the three months ended June 30, 2015, was primarily due to $0.5 million in ARX-04-related market research activities, and an incremental increase of $0.4 million in other general and administrative expenses.

 

The $0.1 million increase in general and administrative expenses during the six months ended June 30, 2016, as compared to the six months ended June 30, 2015, was primarily due to $0.9 million in ARX-04-related market research activities, partially offset by decreases of $0.5 million in headcount-related expenses, including a $0.3 million decrease in stock-based compensation expense, and net decreases in other general and administrative expenses of $0.3 million.

 

 
28

 

 

Restructuring Costs

 

In March 2015, we received correspondence from the FDA stating that in addition to the bench testing and two Human Factors studies we had performed in response to the issues identified in the CRL, a clinical trial would be needed to assess the risk of inadvertent dispensing and overall risk of dispensing failures. On March 19, 2015, our Board of Directors, in connection with our efforts to reduce operating costs, conserve capital, focus the Company's financial and development resources on working with the FDA to seek marketing approval for Zalviso, and continuing development of ARX-04, implemented a cost reduction plan. The cost reduction plan reduced our workforce by 19 employees, approximately 36% of total headcount, in the first quarter of 2015.

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2016

   

2015

   

Change

   

%

   

2016

   

2015

   

Change

   

%

 
   

(In thousands, except percentages)

 

Restructuring costs

  $     $ 2     $ (2 )     %   $     $ 756     $ (756 )     %

 

Restructuring costs in the three and six months ended June 30, 2015 consisted of employee termination benefit costs of $0.8 million which has been fully disbursed.

 

Other (Expense) Income

 

Total other (expense) income for the three and six months ended June 30, 2016 and 2015 was as follows:

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 

(In thousands)

 

2016

   

2015

   

2016

   

2015

 
                                 

Interest expense

  $ (687

)

  $ (777

)

  $ (1,367

)

  $ (1,583 )

Interest income and other income (expense), net

    241       4       660       2,184  

Non-cash interest expense on liability related to sale of future royalties

    (2,324

)

          (4,520

)

     

Total other (expense) income

  $ (2,770

)

  $ (773

)

  $ (5,227

)

  $ 601  

 

Interest expense consisted primarily of interest accrued or paid on our debt obligation agreements and amortization of debt discounts. Interest expense for all periods pertains to interest on our Loan and Security Agreement with Hercules. In December 2013, we entered into the Amended Loan Agreement with Hercules, which amends and restates the Loan and Security Agreement. The overall debt facility was increased to $40.0 million, and the maturity was extended to October 1, 2017. On June 16, 2014, we borrowed the second tranche of $10.0 million. We did not have access to the third tranche, of up to $15.0 million, as we did not receive FDA approval of Zalviso by August 1, 2015. As a result of the lower principal balance in the three and six months ended June 30, 2016 as compared to the three and six months ended June 30, 2015, the amount of interest expense incurred decreased. As of June 30, 2016, the balance due to Hercules was $21.3 million.

 

On September 18, 2015, concurrently with the closing of the Royalty Monetization, the Company entered into a Consent and Amendment No. 2, or Amendment No. 2, to the Amended Loan Agreement. Amendment No. 2 provided for an interest only period from October 1, 2015 through March 31, 2016, with further extension to September 30, 2016 upon satisfaction of certain conditions, which have since been satisfied.

 

Interest income and other income (expense), net, during the three and six months ended June 30, 2016 and 2015, consisted primarily of the change in the fair value of our warrants, or PIPE warrants, issued in connection with our private placement of our common stock, which was completed in June 2012.

 

The decrease in interest income and other income (expense), net, during the three and six months ended June 30, 2016 as compared to the three and six months ended June 30, 2015, was primarily attributable to fewer PIPE warrants outstanding at June 30, 2016, as compared to June 30, 2015. During the three months ended June 30, 2016, our stock price decreased resulting in other income for the revaluation of the PIPE warrants, while during the three months ended June 30, 2015, our stock price increased, resulting in other expense during the second quarter of 2015. In the six months ended June 30, 2016 as compared to the six months ended June 30, 2015, there was a smaller decrease in our stock price, which is a primary driver in the Black-Scholes valuation model used to estimate the fair value of the PIPE warrants.

 

The increase in non-cash interest expense on liability related to the Royalty Monetization during the three and six months ended June 30, 2016 as compared to the three and six months ended June 30, 2015, is attributable to the royalty sale transaction that we completed in September 2015. As described above, the Royalty Monetization has been recorded as debt under the applicable accounting guidance. We impute interest on the liability and record interest expense based on the amount and timing of royalty and milestone payments expected to be received by PDL over the life of the arrangement. There are a number of factors that could materially affect the estimated interest rate and we will assess this estimate on a periodic basis. As a result, future interest rates could differ significantly and any such change in interest rate will be adjusted prospectively. We anticipate that we will incur an additional $4.9 million in non-cash interest expense related to the Royalty Monetization in the year ended December 31, 2016, for a total of $9.4 million in 2016.

 

 
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Liquidity and Capital Resources

 

Liquidity

 

We have incurred losses and generated negative cash flows from operations since inception. We expect to continue to incur significant losses in 2016 and may incur significant losses and negative cash flows from operations for the foreseeable future. We have funded our operations primarily through issuance of equity securities, borrowings, payments from our commercial partner, Grünenthal, monetization of certain future royalties and commercial sales milestones from the sales of Zalviso by Grünenthal, and our contracts with the DoD.

 

On June 21, 2016, we entered into a Controlled Equity OfferingSM Sales Agreement, or the Sales Agreement, with Cantor Fitzgerald & Co., or Cantor, as agent, pursuant to which AcelRx may offer and sell, from time to time through Cantor, shares of the Company’s common stock, or the Common Stock, having an aggregate offering price of up to $40.0 million, or the Shares. For a detailed description, see Note 9 “Stockholders’ Equity.”

 

As of June 30, 2016, we had cash, cash equivalents and investments totaling $98.8 million compared to $113.5 million as of December 31, 2015. The decrease was primarily due to cash required to fund our continuing operations, as we continue our research and development activities. We anticipate that our existing capital resources will permit us to meet our capital and operational requirements through at least the first half of 2017. While we believe we have sufficient capital to meet our operational requirements through at least the first half of 2017, our expectations may change depending on a number of factors. For example, based on their review of the protocol we have submitted for the requested clinical trial for Zalviso, the FDA may in the future, require a scope or design change that is beyond what our current and estimated future capital resources can support. We believe that together with the support from the DoD Contract, we have sufficient resources to complete the Phase 3 development program for ARX-04 through submission of the NDA to the FDA. However, our existing capital resources will not be sufficient to fund our operations until such time as we may be able to generate sufficient revenues to sustain our operations.   

 

On September 18, 2015, we sold a portion of the expected royalty stream and commercial milestone payments from the sales of Zalviso in the EU by Grünenthal to PDL. As mentioned above, we received net proceeds of $61.2 million in the Royalty Monetization. PDL will receive 75% of the European royalties under the Amended License Agreement with Grünenthal, as well as 80% of the first four commercial milestones worth $35.6 million (or 80% of $44.5 million), subject to the capped amount of $195.0 million. We are entitled to receive all remaining amounts under the Amended License Agreement which include 25% of the European royalties, 20% of the first four commercial milestones, 100% of the remaining commercial milestones and all development milestones of $43.5 million, including the $15.0 million payment for the EC approval of the MAA for Zalviso, which we received in the fourth quarter of 2015. The total liability related to sale of future royalties to PDL as of June 30, 2016 was $68.1 million.

 

On December 16, 2013, AcelRx and Grünenthal entered into the License Agreement, and related Manufacture and Supply Agreement, or the MSA, and together with the License Agreement, the Agreements. The License Agreement grants Grünenthal rights to commercialize Zalviso, or the Product, in the Territory for human use in the Field. We retain rights with respect to the Product in countries outside the Territory, including the United States, Asia and Latin America. On July 22, 2015, the Company entered into amendments to the License Agreement, or the License Amendment, and together with the License Agreement, the Amended License Agreement, and the MSA, or the MSA Amendment, and together with the MSA, the Amended MSA, between the Company and Grünenthal, each effective as of July 17, 2015, and together, the Amended Agreements.

 

 
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Under the terms of the Amended Agreements, we received an upfront cash payment of $30.0 million, a milestone payment of $5.0 million related to the MAA submission in the third quarter of 2014 and an additional $15.0 million milestone payment related to the EC approval of the MAA for Zalviso in September 2015. In addition, under the terms of the Amended Agreements, we are eligible to receive approximately $194.5 million in additional milestone payments, based upon successful regulatory and product development efforts ($28.5 million) and net sales target achievements ($166.0 million).  Grünenthal will also make tiered royalty, supply and trademark fee payments in the mid-teens up to the mid-twenties percent range, depending on the level of sales achieved, on net sales of Zalviso in the Territory. A portion of the tiered royalty payment, exclusive of the supply and trademark fee payments, will be paid to PDL in connection with the Royalty Monetization, as discussed above.

 

On December 16, 2013, AcelRx entered into an Amended and Restated Loan and Security Agreement with Hercules Technology II, L.P. and Hercules Technology Growth Capital, Inc., together, the Lenders, or the Amended Loan Agreement, under which AcelRx may borrow up to $40.0 million in three tranches. The loans are represented by secured convertible term promissory notes, collectively, the Notes. The Amended Loan Agreement amends and restates the Loan and Security Agreement between AcelRx and the Lenders dated as of June 29, 2011. We borrowed the first tranche of $15.0 million upon closing of the transaction on December 16, 2013, and the second tranche of $10.0 million on June 16, 2014. We used approximately $8.6 million of the proceeds from the first tranche to repay our obligations under the Loan and Security Agreement with the Lenders. We recorded the new debt at an estimated fair value of $24.9 million as of December 31, 2014.

 

On September 24, 2014, we entered into Amendment No. 1 to the Amended Loan Agreement with Hercules. Amendment No. 1 extended the time period under which we could draw down the third tranche, of up to $15.0 million, from March 15, 2015 to August 1, 2015, subject to AcelRx obtaining approval for Zalviso from the FDA. We did not receive FDA approval of Zalviso by August 1, 2015 and as such, did not have access to the third tranche.

 

On September 18, 2015, concurrently with the closing of the Royalty Monetization, we entered into a Consent and Amendment No. 2, or Amendment No. 2, to the Amended Loan Agreement with the Lenders. Amendment No. 2 includes an interest only period from October 1, 2015 through March 31, 2016, with further extension to September 30, 2016 upon satisfaction of certain conditions, which have since been satisfied. Loans under the Amended Loan Agreement mature on October 31, 2017. As of June 30, 2016, the balance due to Hercules was $21.3 million.

 

Our cash and investment balances are held in a variety of interest bearing instruments, including obligations of U.S. government agencies, money market funds and time deposits. Cash in excess of immediate requirements is invested with a view toward capital preservation and liquidity.

 

Cash Flows

 

The following is a summary of our cash flows for the periods indicated and has been derived from our condensed consolidated financial statements which are included elsewhere in this Form 10-Q (in thousands):

 

   

Six Months Ended March 31,

 
   

2016

   

2015

 

Net cash used in operating activities

  $ (14,467 )   $ (21,438 )

Net cash provided by (used in) investing activities

    4,224       (977 )

Net cash provided by (used in) financing activities

    121       (1,781 )

 

 

 

Cash Flows from Operating Activities

 

The primary use of cash for our operating activities during these periods was to fund the development of our product candidates, including commercial readiness activities for our product candidates, ARX-04 and Zalviso. Our cash used for operating activities also reflected changes in our working capital, net of adjustments for non-cash charges, such as depreciation and amortization of our fixed assets, stock-based compensation, non-cash interest expense related to the sale of future royalties, interest expense related to our debt financings and the revaluation of our PIPE warrant liability and the contingent put option liability.

 

Cash used in operating activities of $14.5 million during the six months ended June 30, 2016, reflected a net loss of $22.1 million, partially offset by aggregate non-cash charges of $7.7 million, and a net change of $0.1 million in our net operating assets and liabilities. Non-cash charges included $4.5 million in non-cash interest expense on the liability related to the royalty monetization and $2.3 million for stock-based compensation, and $1.0 million in depreciation expense, partially offset by $0.6 million for the change in fair value of our PIPE warrant liability and contingent put liability. The net change in our operating assets and liabilities included an increase in accounts payable of $1.4 million, primarily due to the timing of payments, partially offset by a decrease in accrued liabilities of $1.0 million, largely due to the payment of compensation-related expenses.

 

Cash used in operating activities of $21.4 million during the six months ended June 30, 2015, reflected a net loss of $18.9 million, partially offset by aggregate non-cash charges of $1.3 million, and a net change of $3.8 million in our net operating assets and liabilities. Non-cash charges included $2.6 million for stock-based compensation, and $1.0 million for depreciation and amortization of our fixed assets, partially offset by $2.1 million for the change in fair value of our PIPE warrant liability and contingent put liability. The net change in our operating assets and liabilities included a $1.4 million increase in prepaid expenses and other assets, primarily due to the timing of payments, and a decrease in accrued liabilities of $0.9 million, largely due to payment of compensation-related expenses.

 

Cash Flows from Investing Activities

 

Our investing activities have consisted primarily of our capital expenditures and purchases and sales and maturities of our available-for-sale investments.

 

During the six months ended June 30, 2016, cash provided by investing activities of $4.2 million was primarily a result of $5.5 million in proceeds from maturity of investments, offset by $1.0 million for purchases of investments and $0.3 million for purchases of property and equipment.

 

During the six months ended June 30, 2015, cash used in investing activities of $1.0 million was primarily as a result of $5.5 million for purchases of investments and $0.9 million for purchases of property and equipment, partially offset by $5.4 million in proceeds from maturity of investments.

 

 
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Cash Flows from Financing Activities

 

During the six months ended June 30, 2016, cash provided by financing activities of $0.1 million as a result of stock purchases made under our 2011 Employee Stock Purchase Plan.

 

During the six months ended June 30, 2015, cash used in financing activities of $1.8 million was primarily due to payments on our Loan and Security Agreement with Hercules.

 

Operating Capital and Capital Expenditure Requirements

 

We expect our rate of cash usage to increase in the future, in particular to support our product development activities, including continued development of ARX-04, Zalviso and the potential commercialization of our product candidates, if approved outside of the Grünenthal Territory. Our future cash needs anticipate the receipt of reimbursement for qualified expenses under the DoD Contract. We anticipate that our existing capital resources will permit us to meet our capital and operational requirements through at least the first half of 2017. Our current operating plan includes the continued development of ARX-04, specifically the filing of the NDA by the end of 2016. These assumptions may change as a result of many factors. For example, based on feedback from the FDA, we expanded the planned clinical program for ARX-04 by 176 additional patients to include individuals from specific populations and settings. As a result, the completion of the Phase 3 clinical program for ARX-04 was extended and our clinical trial expenses have increased. In addition, although the FDA has provided feedback on both the ARX-04 clinical program and reviewed the protocol for IAP312, the additional clinical trial for Zalviso, pending the results of these clinical trials, the FDA may in the future require us to complete additional work to submit the NDA for ARX-04 and/or to resubmit the NDA for Zalviso. We have delayed the initiation of the IAP312, originally planned for the first quarter of 2016. If we are unable to initiate the IAP312 study before the end of 2016, we may not have sufficient resources to complete the study and resubmit the Zalviso NDA. We will continue to evaluate the work necessary to gain approval of ARX-04 and Zalviso in the U.S. and intend to update our cash forecasts accordingly. Our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement that involves risks and uncertainties, and actual results could vary materially. Additional capital may not be available on terms acceptable to us, or at all. If adequate funds are not available, or if the terms underlying potential funding sources are unfavorable, our business and our ability to develop our product candidates would be harmed.

 

Our future capital requirements may vary materially from our expectations based on numerous forward looking factors, including but not limited to the following:

 

 

the outcome, timing and cost of regulatory approvals for ARX-04 and Zalviso;

 

 

the initiation, progress, timing and completion of clinical trials for our product candidates, including ARX-04 and Zalviso;

 

 

expenditures related to the activities required in support of the anticipated NDA submission for ARX-04;

 

 

expenditures related to the activities required in support of our resubmission of the Zalviso NDA, including an additional clinical trial for Zalviso, as requested by the FDA;

 

 

expenditures related to our commercialization preparation of ARX-04;

 

 

future manufacturing, selling and marketing costs related to ARX-04 and Zalviso, including our contractual obligations to Grünenthal for Zalviso;

 

 

changes in the focus and direction of our business strategy and/or research and development programs;

 

 

milestone and royalty revenue we receive under our collaborative development and commercialization arrangements;

 

 

delays that may be caused by changing regulatory requirements;

 

 

the number of product candidates that we pursue;

 

 

the costs involved in filing and prosecuting patent applications and enforcing and defending patent claims;

 

 

the timing and terms of future in-licensing and out-licensing transactions;

 

 

the cost and timing of establishing sales, marketing, manufacturing and distribution capabilities;

 

 

the cost of procuring clinical and commercial supplies of our product candidates;

 

 

the extent to which we acquire or invest in businesses, products or technologies, and;

 

 

the expenses associated with any possible litigation.

 

 
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We will need substantial funds to:

 

 

commercialize any products we market, including ARX-04 and Zalviso, if approved outside of the Grünenthal Territory;

 

 

manufacture and market our product candidates;

 

 

conduct preclinical and clinical testing of our product candidates, and;

 

 

conduct research and development programs.

 

Our existing capital resources may not be sufficient to fund our operations until such time as we may be able to generate sufficient revenues to sustain our operations. To the extent that our capital resources are insufficient to meet our future capital requirements, we will have to raise additional funds through the sale of our equity securities, monetization of current and future assets, issuance of debt or debt-like securities or from development and licensing arrangements to continue our development programs. We may be unable to raise such additional capital on favorable terms, or at all. If we raise additional capital by selling our equity or convertible debt securities, the issuance of such securities could result in dilution of our shareholders’ equity positions. If adequate funds are not available we may have to:

 

 

significantly curtail or put on hold commercialization or development efforts of our product candidates or other operations;

 

 

obtain funds through entering into collaboration agreements on unattractive terms, and/or;

 

 

delay, postpone or terminate planned clinical trials.

 

Contractual Obligations 

 

During the six months ended June 30, 2016, there were no material changes to our contractual obligations, other than the fulfillment of existing obligations in the ordinary course of business, described under Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for our fiscal year ended December 31, 2015.

 

Off-Balance Sheet Arrangements

 

Through June 30, 2016, we have not entered into any off-balance sheet arrangements and do not have any holdings in variable interest entities.

 

 Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

Our cash, cash equivalents and short-term investments as of June 30, 2016, consisted primarily of money market funds and U.S. government agency securities. We do not have any auction rate securities on our Consolidated Balance Sheet, as they are not permitted by our investment policy. Our cash is invested in accordance with an investment policy approved by our Board of Directors which specifies the categories, allocations, and ratings of securities we may consider for investment. We do not believe our cash, cash equivalents and short-term investments have significant risk of default or illiquidity.

 

Our primary exposure to market risk is interest income sensitivity, which is affected by changes in the general level of U.S. interest rates, particularly because the majority of our investments are in short-term marketable debt securities. The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. In an attempt to limit interest rate risk, we follow guidelines to limit the average and longest single maturity dates, place our investments with high quality issuers and follow internally developed guidelines to limit the amount of credit exposure to any one issuer. Some of the securities that we invest in may be subject to market risk. This means that a change in prevailing interest rates may cause the value of the investment to fluctuate. For example, if we purchase a security that was issued with a fixed interest rate and the prevailing interest rate later rises, the value of our investment may decline. If a 10 percent change in interest rates were to have occurred on June 30, 2016, this change would not have had a material effect on the fair value of our investment portfolio as of that date. In general, money market funds are not subject to market risk because the interest paid on such funds fluctuates with the prevailing interest rate.

 

In addition, domestic and international equity markets have experienced and may continue to experience heightened volatility and turmoil based on domestic and international economic conditions and concerns. In the event these economic conditions and concerns continue and the markets continue to remain volatile, our results of operations could be adversely affected by those factors in many ways, including making it more difficult for us to raise funds if necessary and our stock price may further decline. In addition, we maintain significant amounts of cash and cash equivalents that are not federally insured. If economic instability continues, we cannot provide assurance that we will not experience losses on these investments.

 

 
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Item 4. Controls and Procedures

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended, or the Exchange Act, and the rules and regulations thereunder, is recorded, processed, summarized and reported within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

Evaluation of disclosure controls and procedures. As required by Rule 13a-15(b) under the Exchange Act, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

 

Changes in internal control over financial reporting. There have been no changes in our internal control over financial reporting during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

Part II. Other Information

 

Item 1. Legal Proceedings

 

From time to time we may be involved in legal proceedings arising in the ordinary course of business.

 

Item 1A. Risk Factors

 

This Quarterly Report on Form 10-Q contains forward-looking information based on our current expectations. Because our actual results may differ materially from any forward-looking statements made by or on behalf of us, this section includes a discussion of important factors that could affect our actual future results, including, but not limited to, our revenues, expenses, net loss and loss per share. You should carefully consider these risk factors, together with all of the other information included in this Quarterly Report on Form 10-Q as well as our other publicly available filings with the U.S. Securities and Exchange Commission, or SEC.

 

We have marked with an asterisk (*) those risks described below that reflect substantive changes from, or additions to, the risks described in our Annual Report on Form 10-K for the year ended December 31, 2015.

 

Risks Related to Clinical Development and Regulatory Approval

 

We depend substantially on the success of ARX-04, which may not receive regulatory approval in the United States or in Europe.*

 

Since our inception in 2005, we have focused primarily on development of our product candidate, Zalviso®; however, given the delay in the potential approval of Zalviso in the United States, we believe the importance of ARX-04 (sufentanil sublingual tablet, 30