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EX-31.2 - SECTION 302 CFO CERTIFICATION - INSPIRE PHARMACEUTICALS INCdex312.htm
EX-32.2 - SECTION 906 CFO CERTIFICATION - INSPIRE PHARMACEUTICALS INCdex322.htm
EX-10.1 - AMENDED AND RESTATED LICENSE, DEVELOPMENT AND MARKETING AGREEMENT - INSPIRE PHARMACEUTICALS INCdex101.htm
EX-10.2 - STOCK OPTION AGREEMENT BETWEEN INSPIRE PHARMACEUTICALS, INC. - INSPIRE PHARMACEUTICALS INCdex102.htm
EX-10.3 - RESTRICTED STOCK UNIT AGREEMENT BETWEEN INSPIRE PHARMACEUTICALS, INC. - INSPIRE PHARMACEUTICALS INCdex103.htm
EX-31.1 - SECTION 302 CEO CERTIFICATION - INSPIRE PHARMACEUTICALS INCdex311.htm
EX-32.1 - SECTION 906 CEO CERTIFICATION - INSPIRE PHARMACEUTICALS INCdex321.htm
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

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

For the quarterly period ended September 30, 2010

OR

 

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

For the transition period from              to             

Commission File Number: 000-31135

 

 

INSPIRE PHARMACEUTICALS, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

 

Delaware

(State or Other Jurisdiction of

Incorporation or Organization)

 

04-3209022

(I.R.S. Employer

Identification No.)

4222 Emperor Boulevard, Suite 200

Durham, North Carolina

(Address of Principal Executive Offices)

 

27703

(Zip Code)

Registrant’s Telephone Number, Including Area Code: (919) 941-9777

 

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES  x    NO  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES  ¨    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   x
Non-accelerated filer   ¨  (do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES  ¨    NO  x

As of September 30, 2010, there were 82,840,320 shares of Inspire Pharmaceuticals, Inc. common stock outstanding.

 

 

 


Table of Contents

 

TABLE OF CONTENTS

 

     Page  

PART I: FINANCIAL INFORMATION

  

Item 1. Financial Statements (unaudited)

     3   

Condensed Balance Sheets – September 30, 2010 and December 31, 2009

     3   

Condensed Statements of Operations – Three and Nine months ended September 30, 2010 and 2009

     4   

Condensed Statements of Cash Flows – Nine months ended September 30, 2010 and 2009

     5   

Notes to Condensed Financial Statements

     6   

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

     22   

Item 3. Quantitative and Qualitative Disclosures about Market Risk

     47   

Item 4. Controls and Procedures

     48   

PART II: OTHER INFORMATION

  

Item 1A. Risk Factors.

     49   

Item 6. Exhibits

     70   

SIGNATURES

     71   

We own or have rights to various trademarks, copyrights and trade names used in our business. AzaSite® is a trademark owned by InSite Vision Incorporated. Restasis®, Elestat® and ProlacriaTM are trademarks owned by Allergan, Inc. DiquasTM is a trademark owned by Santen Pharmaceutical Co., Ltd. This report also includes trademarks, service marks and trade names of other companies.

 

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Table of Contents

 

PART I: FINANCIAL INFORMATION

 

Item 1. Financial Statements

INSPIRE PHARMACEUTICALS, INC.

Condensed Balance Sheets

(in thousands, except per share amounts)

(Unaudited)

 

     September 30,
2010
    December 31,
2009
 

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 39,699      $ 52,256   

Investments

     58,951        54,367   

Trade receivables, net

     23,111        22,682   

Prepaid expenses and other receivables

     3,790        5,479   

Inventories, net

     747        1,717   

Other assets

     23        153   
                

Total current assets

     126,321        136,654   

Property and equipment, net

     5,243        4,429   

Assets held-for-sale

     152        402   

Investments

     200        21,861   

Restricted deposits

     615        615   

Intangibles, net

     13,552        14,748   

Other assets

     199        61   
                

Total assets

   $ 146,282      $ 178,770   
                

Liabilities and Stockholders’ Equity

    

Current liabilities:

    

Accounts payable

   $ 8,761      $ 10,056   

Accrued expenses

     28,447        21,246   

Short-term debt

     10,369        19,940   
                

Total current liabilities

     47,577        51,242   

Long-term debt

     —          5,235   

Other long-term liabilities

     1,915        3,125   
                

Total liabilities

     49,492        59,602   

Stockholders’ equity:

    

Preferred stock, $0.001 par value, 1,860 shares authorized; no shares issued and outstanding

     —          —     

Common stock, $0.001 par value, 200,000 shares authorized; 82,840 and 82,346 shares issued and outstanding, respectively

     83        82   

Additional paid-in capital

     528,217        519,462   

Accumulated other comprehensive income

     127        68   

Accumulated deficit

     (431,637     (400,444
                

Total stockholders’ equity

     96,790        119,168   
          

Total liabilities and stockholders’ equity

   $ 146,282      $ 178,770   
                

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

 

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INSPIRE PHARMACEUTICALS, INC.

Condensed Statements of Operations

(in thousands, except per share amounts)

(Unaudited)

 

     Three Months Ended     Nine Months Ended  
     September 30,
2010
    September 30,
2009
    September 30,
2010
    September 30,
2009
 

Revenues:

        

Product sales, net

   $ 11,131      $ 9,041      $ 29,448      $ 22,814   

Product co-promotion and royalty

     15,601        16,127        46,624        39,736   
                                

Total revenue

     26,732        25,168        76,072        62,550   

Operating expenses:

        

Cost of sales

     3,689        3,032        10,398        7,277   

Research and development

     11,937        15,300        33,329        41,124   

Selling and marketing

     12,363        11,323        38,399        36,132   

General and administrative

     6,174        3,410        24,474        11,463   

Restructuring

     —          35        —          2,014   
                                

Total operating expenses

     34,163        33,100        106,600        98,010   
                                

Loss from operations

     (7,431     (7,932     (30,528     (35,460

Other income/(expense):

        

Interest income

     147        151        472        470   

Interest expense

     (274     (712     (1,142     (2,421

Gain on investments

     —          —          5        —     
                                

Other expense, net

     (127     (561     (665     (1,951
                                

Net loss

   $ (7,558   $ (8,493   $ (31,193   $ (37,411
                                

Basic and diluted net loss per common share

   $ (0.09   $ (0.12   $ (0.38   $ (0.61
                                

Weighted average common shares used in computing basic and diluted net loss per common share

     82,825        71,168        82,655        61,564   
                                

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

 

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INSPIRE PHARMACEUTICALS, INC.

Condensed Statements of Cash Flows

(in thousands)

(Unaudited)

 

     Nine Months Ended  
     September 30,
2010
    September 30,
2009
 

Cash flows from operating activities:

    

Net loss

   $ (31,193   $ (37,411

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

    

Amortization expense

     1,331        1,481   

Depreciation of property and equipment

     788        571   

Asset impairment

     219        484   

Loss/(gain) on disposal of property and equipment, net

     72        (1

Gain on investments

     (5     —     

Allowance for doubtful accounts

     18        3   

Inventory reserve

     421        —     

Stock-based compensation expense

     9,050        3,738   

Changes in operating assets and liabilities:

    

Trade receivables

     (447     (3,817

Prepaid expenses and other receivables

     1,597        (632

Inventories

     549        (728

Other assets

     (143     —     

Accounts payable

     (113     2,136   

Accrued expenses and other liabilities

     5,469        5,665   

Deferred revenue

     —          1,219   
                

Net cash used in operating activities

     (12,387     (27,292
                

Cash flows from investing activities:

    

Purchase of investments

     (22,645     (60,776

Proceeds from sale of investments

     39,786        19,526   

Purchase of property and equipment

     (2,391     (1,158

Proceeds from sales of property and equipment

     180        —     
                

Net cash provided by/(used in) investing activities

     14,930        (42,408
                

Cash flows from financing activities:

    

Proceeds from the sale of common stock, net

     —          109,000   

Proceeds from exercise of common stock options

     560        261   

Payments related to net settlement of employee stock-based awards

     (854     —     

Payments on notes payable and capital lease obligations

     (14,806     (13,685
                

Net cash provided by/(used in) financing activities

     (15,100     95,576   
                

Increase/(decrease) in cash and cash equivalents

     (12,557     25,876   

Cash and cash equivalents, beginning of period

     52,256        58,488   
                

Cash and cash equivalents, end of period

   $ 39,699      $ 84,364   
                

Supplemental disclosure of non-cash investing activities:

    

Capitalized equipment acquired, not paid

   $ —        $ 555   

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

 

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INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

 

1. Organization

Inspire Pharmaceuticals, Inc. (the “Company” or “Inspire”) was incorporated in October 1993 and commenced operations in March 1995. Inspire is located in Durham, North Carolina, adjacent to the Research Triangle Park.

Inspire has incurred losses and negative cash flows from operations since inception. Based on current operating plans, the Company expects it has sufficient liquidity to continue its planned operations beyond 2011. The Company’s liquidity needs will largely be determined by the commercial success of its products and key development and regulatory events. In order to continue its operations substantially beyond 2011 it will need to: (1) successfully increase revenues; (2) obtain additional product candidate approvals; (3) out-license rights to certain of its product candidates; (4) raise additional capital through equity or debt financings or from other sources; (5) reduce spending on one or more research and development programs; and/or (6) further restructure its operations. The Company currently receives revenue from sales of AzaSite (azithromycin ophthalmic solution) 1% and its co-promotion of Elestat (epinastine HCl ophthalmic solution) 0.05%, and royalties on Restasis (cyclosporine ophthalmic emulsion) 0.05%. The Company will continue to incur operating losses until revenues reach a level sufficient to support ongoing operations.

 

2. Basis of Presentation

The accompanying unaudited Condensed Financial Statements have been prepared in accordance with generally accepted accounting principles in the United States of America and applicable Securities and Exchange Commission (“SEC”) regulations for interim financial information. These financial statements do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. It is presumed that users of this interim financial information have read or have access to the audited financial statements from the preceding fiscal year contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair statement of the Company’s financial position and operations for the interim periods presented herein have been made.

Revenue, expenses, assets and liabilities vary during each quarter of the year. Therefore, the results and trends in the unaudited Condensed Financial Statements and accompanying notes may not be indicative of the results for the full year or any future period.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates and assumptions.

Fair Value of Financial Instruments

The Company discloses the fair value of financial instruments for assets and liabilities for which it is practicable to estimate that value. The carrying amounts of all cash equivalents, available-for-sale securities and restricted deposits approximate fair value based upon quoted market prices. The carrying value of trade accounts receivable, accounts payable and short-term debt approximates their fair value due to their short-term nature.

 

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INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

 

 

Other long-term assets include the Company’s common stock investment of $200 in a non-public entity for which fair value is not readily determinable. The investment is carried at cost and is subject to potential write-down for impairment whenever events or changes in circumstances indicate that the carrying value is not recoverable. Other long-term liabilities typically represent deferred fees, credits and cost reimbursement arrangements. The carrying value of these long-term assets and liabilities approximate their fair values.

Net Loss Per Common Share

Basic net loss per common share is computed by dividing net loss attributable to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net loss per common share is computed by dividing net loss attributable to common stockholders by the weighted average number of common shares outstanding and dilutive potential common shares then outstanding. Dilutive potential common shares consist of shares issuable upon the exercise of stock options and restricted stock units that are paid in shares of the Company’s stock upon conversion. The calculation of diluted earnings per share for the three months ended September 30, 2010 and 2009 does not include 606 and 535, respectively, and for the nine months ended September 30, 2010 and 2009 does not include 1,010 and 219, respectively, of potential common shares, as their impact would be antidilutive.

Assets Held-For-Sale

In the fourth quarter of 2009, the Company began disposing of its laboratory equipment in connection with the corporate restructuring that occurred in the first quarter of 2009. The assets held-for-sale are reported at the lower of the carrying value or fair value, less costs to sell, and are no longer being depreciated. See Note 7 “Restructuring” and Note 8 “Fair Value Measurements” for additional information.

Intangible Assets

Costs associated with obtaining patents on the Company’s product candidates and license initiation and preservation fees, including milestone payments by the Company to its licensors, are evaluated based on the stage of development of the related product candidate and whether the underlying product candidate has an alternative use. Costs of these types incurred for product candidates not yet approved by the U.S. Food and Drug Administration (“FDA”) and for which no alternative future use exists are recorded as an expense. In the event a product candidate has been approved by the FDA or an alternative future use exists for a product candidate, patent and license costs are capitalized and amortized over the expected life of the related product candidate. Milestone payments to the Company’s collaborators are recognized when the underlying requirement is met.

Upon FDA approval of AzaSite in April 2007, the Company paid a $19,000 milestone payment to InSite Vision Incorporated (“InSite Vision”). The $19,000 is being amortized ratably on a straight-line basis through the term of the underlying patent coverage for AzaSite, or March 2019, which represents the expected period of commercial exclusivity. As of September 30, 2010 and December 31, 2009, the Company had $5,448 and $4,252, respectively, in accumulated amortization related to this milestone payment.

The carrying values of intangible assets are periodically reviewed to determine if the facts and circumstances suggest that a potential impairment may have occurred. The review includes a determination of the carrying values of intangible assets based on an analysis of undiscounted cash flows over the remaining amortization period. If the review indicates that carrying values may not be recoverable, the Company would record an impairment charge to reduce the carrying values to the estimated fair value. The Company had no impairments of its intangible assets for the nine months ended September 30, 2010 and 2009.

 

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INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

 

 

Debt

In December 2006, the Company entered into a loan and security agreement with two financial institutions, which provided a term loan facility to the Company in an aggregate amount of $40,000. In June 2007, the Company amended the loan and security agreement to enable the Company to draw upon a new supplemental term loan facility in the amount of $20,000, which effectively increased the total term loan facility to $60,000. The Company borrowed the full $60,000 available under the term loan facility. The interest rates associated with the individual borrowings under the facility range from approximately 7.6% to 8.0%. As of September 30, 2010, the Company had net borrowings under the term loan facility of $10,369. The final maturity date for all loan advances under the original term loan facility and the supplemental term loan facility is March 2011. In addition, the Company is obligated to make a final payment of $1,200 equal to 2% of the original principal amount borrowed.

The loan and security agreement contains a financial covenant that requires the Company to maintain certain levels of liquidity based on its cash, investment and accounts receivable balances, as well as negative covenants that may limit the Company from assuming additional indebtedness and entering into other transactions as defined in the agreement. In addition to other financial and non-financial covenants within the agreement, the agreement contains a subjective acceleration clause such that repayment could be accelerated upon a material adverse change to the business, properties, assets, financial condition or results of operations of the Company. At September 30, 2010, the Company was in compliance with all of the covenants under its loan and security agreement.

Revenue Recognition

The Company records all of its revenue from: (1) sales of AzaSite; (2) product co-promotion activities and earned royalties; and (3) collaborative research agreements, when realized or realizable and earned. Revenue is realized or realizable and earned when all of the following criteria are met: (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred or services have been rendered; (iii) the seller’s price to the buyer is fixed or determinable; and (iv) collectibility is reasonably assured.

Product Revenues

The Company recognizes revenue for sales of AzaSite when title and substantially all the risks and rewards of ownership have transferred to the customer, which generally occurs on the date of shipment to wholesalers and distributors. In the United States, the Company sells AzaSite to wholesalers and distributors, who, in turn, sell to pharmacies and federal, state and commercial health care organizations.

Sales deductions consist of statutory rebates to state Medicaid, Medicare and other government agencies, contractual rebates with commercial managed care organizations, wholesaler chargebacks, sales discounts (including trade discounts and distribution service fees), allowances for coupon and voucher programs and product returns. These deductions are recorded as reductions to revenue from AzaSite in the same period as the related sales with estimates of future utilization derived from historical experience adjusted to reflect known changes in the factors that impact such reserves.

The Company utilizes data from external sources to help it estimate gross-to-net sales adjustments as they relate to the recognition of revenue for AzaSite sold. External sourced data includes, but is not limited to, information obtained from certain wholesalers with respect to their inventory levels and sell-through to customers, targeted surveys as well as data from IMS Health, a third-party supplier of market research data to the pharmaceutical industry. The Company also utilizes this data to help estimate and identify prescription trends and patient demand, as well as product levels in the supply chain.

 

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INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

 

 

The Company accounts for these sales deductions in accordance with the Financial Accounting Standards Board (“FASB”) authoritative guidance on revenue recognition when consideration is given by a vendor to a customer as well as when the right of return exists.

The Company has categorized and described more fully the following significant sales deductions, all of which involve estimates and judgments, which the Company considers to be critical accounting estimates, and requires it to use information from external sources.

Rebates and Chargebacks

Statutory rebates to state Medicaid agencies and Medicare and contractual rebates to commercial managed care organizations are based on statutory or negotiated discounts to AzaSite’s selling price. As it can take up to nine months or more for information to be received on actual usage of AzaSite in managed care and Medicaid and other governmental programs as well as on the total discounts to be reimbursed, the Company maintains reserves for amounts payable under these programs relating to AzaSite sales.

Chargebacks claimed by wholesalers are based on the differentials between product acquisition prices paid by wholesalers and lower government contract pricing paid by eligible customers covered under federally qualified programs.

The amount of the reserve for rebates and chargebacks is based on multiple qualitative and quantitative factors, including the historical and projected utilization levels, historical payment experience, changes in statutory laws and interpretations as well as contractual terms, product pricing (both normal selling prices and statutory or negotiated prices), changes in prescription demand patterns and utilization of our product through private or public benefit plans, and the levels of AzaSite inventory in both the wholesale and retail distribution channel. Other factors that the Company may consider, if determined relevant, would include price changes from competitors and introductions of generics and/or competitive new products. The Company acquires prescription utilization data from IMS Health, a third-party supplier of market research data to the pharmaceutical industry. The Company applies these multiple factors, the quantitative historical data along with other qualitative aspects, such as management’s judgment regarding future utilization trends, to the respective period’s sales of AzaSite to determine the rebate accrual and related expense. The Company updates its estimates and assumptions each period and records any necessary adjustments to its reserves. Settlements of rebates and chargebacks typically occur within nine months from point of sale. To the extent actual rebates and chargebacks differ from the Company’s estimates, additional reserves may be required or reserves may need to be reversed, either of which would impact current period product revenue. As of September 30, 2010 and December 31, 2009, reserves for rebates and chargebacks were $7,518 and $3,488, respectively.

Discounts and Other Sales Incentives

Discounts and other sales incentives consist of the following:

 

   

Prompt pay discounts — Prompt payment discounts are offered to all wholesalers in return for payment within 30 days following the invoice date. The Company records sales of AzaSite net of the discount amount based on historical experience. The Company adjusts the reserve at the end of each reporting period to approximate the percentage discount applicable to the outstanding gross accounts receivable balances.

 

   

Inventory Management Agreement (“IMA”) Fees — Per contractual agreements with the Company’s largest wholesalers, the Company provides an IMA fee based on a percentage of their purchases of AzaSite. The IMA fee rates are set forth in the individual contracts. The Company tracks sales to these wholesalers

 

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INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

 

 

each period and accrues a liability relating to the unpaid portion of these fees by applying the contractual rates to such sales.

 

   

Product coupons and vouchers — Product coupons and vouchers, made available by us online or through pharmacies and prescribing physicians, offer patients the ability to receive free or discounted product. The Company uses a third-party administrator who coordinates program activities and invoices on a periodic basis for the cost of coupons and vouchers redeemed in the period. The Company bases its estimates on the historical coupon and voucher redemption rate of similar programs.

As of September 30, 2010 and December 31, 2009, the Company’s reserves for discounts and other sales incentives were $1,283 and $889, respectively.

Product Returns

At the time of sale of AzaSite, the Company records product return allowances based on its estimate of the portion of sales that will be returned by its customers in the future. The return allowances are established in accordance with the Company’s returned goods policy. The Company’s returned goods policy generally allows for returns of AzaSite within an 18-month period, from six months prior to the expiration date and up to 12 months following the expiration date, but may differ from customer to customer, depending on certain factors. Future estimated returns of AzaSite are based primarily on the return data for comparative products and the Company’s own historical experience with AzaSite. Historical return data on AzaSite is analyzed on a specific production lot basis. In determining the Company’s return allowance, the Company also considers other relevant factors, including:

 

   

Levels of inventory in the distribution channel and any significant changes to these levels;

 

   

Estimated expiration date or remaining shelf life of inventory in the distribution channel;

 

   

Current and projected demand of AzaSite that could be impacted by introductions of generic products and/or introductions of competitive new products; and

 

   

Competitive product shortages, recalls and/or discontinuances.

The Company’s estimates of the level of AzaSite inventory in the distribution channel is based on inventory data provided by wholesalers and third-party prescription data. As of September 30, 2010 and December 31, 2009, reserves for returns of AzaSite were $2,189 and $1,523, respectively.

Product Co-promotion and Royalty Revenues

The Company recognizes co-promotion revenue based on net sales of Elestat and royalty revenue based on net sales of Restasis, as defined in the applicable agreements, and as reported to Inspire by Allergan, Inc. (“Allergan”). The Company’s co-promotion and royalty revenues are based upon Allergan’s revenue recognition policy and other accounting policies over which the Company has limited or no control and on the underlying terms of the agreements. Allergan recognizes revenue from product sales when goods are shipped and title and risk of loss transfers to the customer. The agreements provide for gross sales to be reduced by estimates of sales returns, credits and allowances, normal trade and cash discounts, managed care sales rebates and other allocated costs as defined in the agreements, all of which are determined by Allergan and are outside the Company’s control. The Company records a percentage of Allergan’s reported net sales to Inspire for Elestat and Restasis, as co-promotion revenue and royalty revenue, respectively. The Company receives monthly sales information from Allergan and performs analytical reviews and trend analyses using prescription information that it receives from IMS Health. In addition, the Company exercises its audit rights under the contractual agreements with Allergan to annually perform an examination of Allergan’s sales records of both Restasis and Elestat. The Company makes no adjustments to the amounts reported to it by Allergan other than reductions in net sales to reflect the incentive programs managed by the Company. The Company offers

 

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INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

 

and manages certain incentive programs associated with Elestat, which are utilized by it in addition to those programs managed by Allergan. The Company reduces co-promotion revenue from net sales of Elestat by estimating the portion of sales that are subject to these incentive programs based on information reported to it by a third-party administrator of the incentive program. The rebates associated with the programs that the Company manages represent an insignificant amount, as compared to the rebate and discount programs administered by Allergan and as compared to the Company’s aggregate co-promotion and royalty revenue. Prior to January 1, 2010, under the co-promotion agreement for Elestat, the Company was obligated to meet predetermined minimum calendar year net sales target levels. If the annual minimum was not achieved, the Company recorded revenues using a reduced percentage of net sales based upon its level of achievement of the predetermined calendar year net sales target levels. Amounts receivable from Allergan in excess of recorded co-promotion revenue were recorded as deferred revenue. Calendar year 2009 was the last year in which there was a minimum annual net sales target level for Elestat under the co-promotion agreement. Accordingly, effective January 1, 2010, all co-promotion revenue from net sales of Elestat is recognized in the same period in which the sales occur.

Collaborative Research and Development Revenues

The Company recognizes revenue under its collaborative research and development agreements when it has performed services under such agreements or when the Company or its collaborative partner have met a contractual milestone triggering a payment to the Company. The Company recognizes revenue from research and development service agreements ratably over the estimated service period as related research and development costs are incurred and the services are substantially performed. Upfront non-refundable fees and milestone payments received at the initiation of collaborative agreements for which the Company has an ongoing research and development commitment are deferred and recognized ratably over the period in which the services are substantially performed. This period, if not defined in the collaborative agreement, is based on estimates by the Company’s management and the progress towards agreed upon development events as set forth in the collaborative agreements. These estimates are subject to revision as the Company’s development efforts progress and it gains knowledge regarding required additional development. Revisions in the commitment period are made in the period that the facts related to the change first become known. If the estimated service period is subsequently modified, the period over which the upfront fee or revenue related to ongoing research and development services is modified on a prospective basis. The Company is also entitled to receive milestone payments under its collaborative research and development agreements based upon the achievement of agreed upon development events that are substantively at-risk by its collaborative partners or the Company. This collaborative research and development revenue is recognized upon the achievement and acknowledgement of the Company’s collaborative partner of a development event, which is generally at the date payment is received from the collaborative partner or is reasonably assured. Accordingly, the Company’s revenue recognized under its collaborative research and development agreements may fluctuate significantly from period to period.

 

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INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

 

 

Comprehensive Loss

Accumulated other comprehensive loss is comprised of unrealized gains and losses on marketable securities and is disclosed as a component of stockholders’ equity. The Company had $127 and $68 of unrealized gains on its investments that are classified as accumulated other comprehensive income at September 30, 2010 and December 31, 2009, respectively. Comprehensive loss consists of the following components:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Net loss

   $ (7,558   $ (8,493   $ (31,193   $ (37,411

Adjustment for realized gain in net loss

     —          —          (5     —     

Change in unrealized gain on investments

     31        (14     64        176   
                                

Total comprehensive loss

   $ (7,527   $ (8,507   $ (31,134   $ (37,235
                                

Risks from Third Party Manufacturing and Distribution Concentration

The Company relies on single source manufacturers for its commercial products and product candidates. Allergan is responsible for the manufacturing of both Restasis and Elestat and relies on single source manufacturers for the active pharmaceutical ingredients (“API”) in both products. The Company relies on InSite Vision for the supply of the API for AzaSite, which InSite Vision obtains from a single source manufacturer. The Company is responsible for the remaining finished product manufacturing of AzaSite, for which it relies on a single source manufacturer. Additionally, the Company relies upon a single third party to provide warehousing and distribution services for AzaSite.

The Company relies upon one vendor as the sole manufacturer of the supply of API for both Prolacria and denufosol; however, in March 2010, the Company and Finorga S.A.S. (“Novasep”) entered into a Technical Transfer & Development Services Agreement for the purpose of enabling Novasep to become a qualified manufacturer of the API for denufosol. Pursuant to the terms of the agreement, the Company transferred to Novasep certain technology relating to the manufacture and production of denufosol and granted Novasep a non-exclusive, royalty-free, non-transferable, non-sublicensable license to use certain intellectual property to perform its obligations under the agreement.

Novasep is responsible for procuring, installing at one of its facilities, qualifying and maintaining certain equipment to be used for the manufacture of denufosol API. The manufacturing equipment is owned by the Company and will be used by Novasep for the manufacture of denufosol API. The Company has capitalized the equipment in accordance with US GAAP authoritative guidance. Novasep is responsible for various services relating to process development, process-improvement and scale-up of the manufacturing process for denufosol API, as well as the manufacture of various development, demonstration and validation batches of denufosol API in accordance with current Good Manufacturing Practices and certain legal requirements. The Company was initially obligated to pay an aggregate amount of up to 5,101 Euros. In July 2010, the Company amended the agreement to provide for additional services, increasing the contract obligation by 938 Euros for a total revised contract amount of 6,039 Euros. As of September 30, 2010, the Company had paid 4,522 Euros, or approximately $6,345, to Novasep under the agreement for services provided.

Effective September 25, 2009, the Company and Yamasa Corporation entered into a Technology License Agreement for the Manufacture of Denufosol. The purpose of the agreement is to facilitate the transfer of the current

 

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INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

 

denufosol manufacturing technology, including intellectual property, to an additional and/or alternative manufacturer. In consideration of the grant of rights under the agreement, in October 2009, the Company paid Yamasa three hundred million Japanese Yen, which was approximately $3,302 at the then prevailing exchange rate. Additionally, the Company is obligated to pay Yamasa additional amounts upon the satisfaction of the following conditions: (i) three hundred million Yen within thirty (30) days after the receipt of a process validation report by December 31, 2010 following the successful completion of three validation batches; and (ii) four hundred million Yen within thirty (30) days after both (a) the acceptance of a pre-approval inspection of denufosol at Yamasa by the FDA, and (b) the approval of a New Drug Application of a formulated denufosol drug product at Inspire by the FDA.

Delays in the manufacture or distribution of any product or manufacture of any product candidate could adversely impact the marketing of the Company’s products or the development of the Company’s product candidates. Furthermore, the Company has no control over the manufacturing or the overall product supply chain of Restasis and Elestat.

Significant Customers and Risk

The Company relies primarily on three pharmaceutical wholesalers to purchase and supply the majority of AzaSite at the retail level. These three pharmaceutical wholesalers accounted for greater than 85% of all AzaSite product sales in the nine months ended September 30, 2010 and the year ended December 31, 2009, respectively, and accounted for 31% and 27% of the Company’s outstanding trade receivables as of September 30, 2010 and December 31, 2009, respectively. The loss of one or more of these wholesalers as a customer could negatively impact the commercialization of AzaSite. All co-promotion and royalty revenues recognized and recorded were from one collaborative partner, Allergan. The Company is entitled to receive co-promotion revenue from net sales of Elestat and royalty revenue from net sales of Restasis under the terms of its collaborative agreements with Allergan, and accordingly, all trade receivables for these two products are solely due from Allergan and accounted for 67% and 72% of the Company’s outstanding trade receivables as of September 30, 2010 and December 31, 2009, respectively. Due to the nature of these agreements, Allergan has significant influence over the commercial success of Restasis and Elestat.

Risk from Generic Competition

The Company’s revenues are subject to risk due to generic product entrants. The Elestat co-promotion agreement provides that unless earlier terminated, the term of such agreement will be in effect until the earlier of (i) the approval and launch of the first generic epinastine product after expiration of the FDA exclusivity period covering Elestat in the United States, or (ii) the approval and launch of the first over-the-counter epinastine product after expiration of the listing of Elestat in the FDA’s Orange Book. Following the termination of such co-promotion agreement, the Company will no longer have rights to co-promote Elestat. The Company will be entitled to receive post-termination payments from Allergan, based on any remaining net sales of Elestat for a period of 36 months.

The Company is aware that the following companies have filed an Abbreviated New Drug Application (“ANDA”) for a generic version of Elestat: Apotex, Inc., Cypress Pharmaceutical, Inc., Paddock Laboratories, Inc., PharmaForce, Inc. and Sandoz Inc. The date of submission of the first ANDA filing to the FDA Office of Generic Drugs was October 14, 2008, according to the FDA’s website (www.fda.gov). Also, according to the FDA’s website, in June 2010, PharmaForce, Inc. received tentative approval for its epinastine hydrochloride ophthalmic solution. The Company does not know when the FDA will complete its review of these ANDAs, but it expects that a generic form of epinastine could be launched at any time.

The manufacture and sale of Restasis is protected in the United States by a formulation patent that expires in May 2014. While a formulation patent may afford certain limited protection, a competitor may attempt to gain FDA approval for a cyclosporine product using a different formulation. Furthermore, following the expiration of the

 

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INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

 

formulation patent in 2014, a generic form of Restasis could be introduced into the market. If and when Restasis experiences competition from a cyclosporine product, including a generic cyclosporine product, the Company’s revenues attributable to Restasis may be significantly impacted.

 

3. Stockholders’ Equity – Common Stock Sale

In August 2009, the Company completed a public offering of 25,556 shares of its common stock at a price of $4.50 per share, which included the underwriter’s over-allotment allocation of an additional 3,333 shares, for gross proceeds of $115,000. Net proceeds were $109,000, after deducting underwriting discounts and estimated offering expenses, including reimbursing Warburg Pincus Private Equity IX, L.P. (“Warburg”), a related party, for $500 of expenses incurred. Warburg purchased $40,000, or 8,889 shares, of the common stock offering for total holdings of 22,907 shares of the Company’s common stock.

Standstill Agreement

In connection with its initial investment in Inspire, on July 20, 2007, the Company and Warburg entered into a Standstill Agreement pursuant to which Warburg and certain of its affiliates agreed for three years not to increase their holdings of Inspire’s voting securities beyond the lesser of: (x) 32.5% of Inspire’s voting securities on a fully diluted basis and (y) 34.9% of Inspire’s then outstanding voting securities. On August 4, 2009, the Company and Warburg entered into Amendment No. 1 to the Standstill Agreement extending its term until August 4, 2012.

 

4. Recent Accounting Pronouncements

In April 2010, the FASB issued authoritative guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. Consideration that is contingent on achievement of a milestone in its entirety may be recognized as revenue in the period in which the milestone is achieved only if the milestone is judged to meet certain criteria to be considered substantive. Milestones should be considered substantive in their entirety and may not be bifurcated. An arrangement may contain both substantive and nonsubstantive milestones, and each milestone should be evaluated individually to determine if it is substantive. The guidance is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010, with early adoption permitted. The Company does not expect the adoption of this guidance to have a material impact on its condensed consolidated financial statements.

 

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INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

 

 

 

5. Inventories

The Company’s inventories are related to AzaSite and are valued at the lower of cost or market using the first-in, first-out (i.e., FIFO) method. Cost includes materials, labor, overhead, shipping and handling costs. The Company’s inventories are subject to expiration dating and the Company has reserved for potential overstocking. The Company’s inventories consisted of the following:

 

     As of  
     September 30,
2010
    December 31,
2009
 

Finished Goods

   $ 434      $ 808   

Work-in-Process

     138        96   

Raw Materials

     425        838   
                

Total Inventories

   $ 997      $ 1,742   

Less Valuation Reserve

     (250     (25
                

Total Inventories, net

   $ 747      $ 1,717   
                

During the three months ended June 30, 2010, the Company experienced spoilage of a portion of its azithromycin inventory, which is the API used to manufacture AzaSite. As a result, for the three months ended June 30, 2010, the Company recorded a valuation reserve of approximately $449 to reflect the loss of API and associated manufacturing costs.

 

6. Investments

The following is a summary of the Company’s marketable debt securities which are classified as available-for-sale as of September 30, 2010 and December 31, 2009:

 

     Cost      Gross
Unrealized
Gain
     Gross
Unrealized
Loss
    Fair Value  

As of September 30, 2010:

          

Corporate bonds and commercial paper

   $ 33,773       $ 95       $ (1   $ 33,867   

U.S. Government agencies

     21,551         32         —          21,583   

Negotiated certificates of deposit

     3,500         1         —          3,501   
                                  

Total

   $ 58,824       $ 128       $ (1   $ 58,951   
                                  

As of December 31, 2009:

          

Corporate bonds and commercial paper

   $ 44,702       $ 88       $ (12   $ 44,778   

U.S. Treasury

     5,981         —           (1     5,980   

U.S. Government agencies

     12,664         —           (6     12,658   

Negotiated certificates of deposit

     12,612         —           —          12,612   
                                  

Total

   $ 75,959       $ 88       $ (19   $ 76,028   
                                  

 

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INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

 

 

The following table shows the gross unrealized losses and fair value of the Company’s investment in marketable debt securities with unrealized losses that are deemed to be temporarily impaired, aggregated by length of time that the individual securities have been in a continuous unrealized loss position as of September 30, 2010 and December 31, 2009:

 

     Less than 12 months  
     Fair Value      Unrealized
Loss
 

As of September 30, 2010:

     

Corporate bonds

   $ 2,484       $ (1
                 

Total

   $ 2,484       $ (1
                 

As of December 31, 2009:

     

Corporate bonds

   $ 20,586       $ (12

U.S. Treasury

     5,980         (1

U.S. Government agencies

     9,158         (6
                 

Total

   $ 35,724       $ (19
                 

The contractual terms of these investments do not permit the issuer to settle the securities at a price less than the amortized cost of the investment. Because the Company has the ability and intent to hold its investments until a recovery of fair value, which may be at maturity, the Company does not consider its investments to be other-than-temporarily impaired at September 30, 2010. The Company did not have any investments in marketable debt securities that have been in a continuous unrealized loss position for 12 months or greater as of September 30, 2010 and December 31, 2009. The Company recognized a gain of $5 on the sale of a debt security during the three months ended June 30, 2010. There were no realized gains or losses on the Company’s available-for-sale securities for the year ended December 31, 2009 or any other period in 2010.

As of September 30, 2010 and December 31, 2009, the Company had available-for-sale marketable debt securities with maturities of one year or less of $58,951 and $54,367, respectively. As of September 30, 2010 and December 31, 2009, the Company had available-for-sale marketable debt securities with maturities after one year through five years of $0 and $21,661, respectively.

 

7. Restructuring

The Company restructured its operations during the first quarter of 2009, eliminating preclinical and drug discovery activities and refocusing its resources on the development of existing later-stage clinical programs and commercially available products. In connection with the restructuring, the Company recorded restructuring charges of $2,014 for both the nine months ended September 30, 2009 and year ended December 31, 2009. The Company recorded its restructuring activities in accordance with FASB authoritative guidance regarding the accounting for the impairment and disposal of long-lived assets and the accounting for costs associated with exit or disposal activities.

For the year ended December 31, 2009, the Company incurred the following restructuring charges:

 

   

Employee separation costs of $1,072 consisted of one-time termination benefits, primarily severance costs, associated with the reduction in the Company’s workforce.

 

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INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

 

 

 

   

Asset impairments of $484 consisted of property and equipment, primarily lab equipment, that was used for discovery and preclinical research activities. The Company performed an impairment analysis and determined that the carrying value of the idle assets exceeded their fair value and recorded an impairment charge of $484. Fair value was based on internally established estimates and the selling prices of similar assets.

 

   

Contract charges of $203 consisted of costs associated with contractual commitments and work performed subsequent to the restructuring related to programs the Company no longer supports as part of its planned ongoing research and development activities.

 

   

Facility related charges of $255 consisted of estimated losses associated with leased lab space at the Company’s Durham, North Carolina headquarters that the Company no longer uses in its operations. The unoccupied leased space is approximately 14,000 square feet and the lease term is through January 2011. The Company used a discounted cash-flow analysis to calculate the amount of this liability. The probability-weighted discounted cash-flow analysis is based on management’s assumptions and estimates of its ongoing lease obligations, including contractual rental commitments, build-out commitments and building operating costs, estimates of income from subleases, and market conditions for similar rental properties in its geographic area. The estimated cash flows were discounted using a credit-adjusted risk free rate of approximately 15%.

The Company expects to incur approximately $45 of accretion expense over the term of the lease. As of September 30, 2010 and December 31, 2009, the liability associated with facilities was $37 and $115, respectively, and will be reduced as monthly rental payments are made through the lease term, which ends in January 2011.

As of December 31, 2009, the activities associated with the restructuring were substantially complete and the liabilities associated with employee separation costs and contractual commitments were fully paid.

 

8. Fair Value Measurements

The Company’s financial assets recorded at fair value on a recurring basis have been categorized based upon a fair value hierarchy. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. Specifically, Level 1 fair values are defined as observable inputs such as quoted prices in active markets; Level 2 fair values are defined as inputs other than quoted prices in active markets that are either directly or indirectly observable. These include quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and inputs to valuation models or other pricing methodologies that do not require significant judgment; Level 3 fair values are defined as inputs for which little or no market data exists, therefore requiring an entity to develop its own assumptions.

 

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INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

 

 

The following fair value hierarchy tables present information about the Company’s financial assets measured at fair value on a recurring basis as of September 30, 2010 and December 31, 2009:

 

    Total Balance     Quoted Prices in  Active
Markets for Identical
Assets
(Level 1)
    Significant Other
Observable Inputs
(Level 2)
 

As of September 30, 2010:

     

Cash equivalents

  $ 23,119      $ 20,120      $ 2,999   

Investments - Available-for-sale securities:

     

U.S. Government agencies

    21,583        —          21,583   

Corporate bonds and commercial paper

    33,867        —          33,867   

Negotiated certificates of deposit

    3,501        —          3,501   
                       

Total

  $ 82,070      $ 20,120      $ 61,950   
                       

As of December 31, 2009:

     

Cash equivalents

  $ 41,052      $ 36,053      $ 4,999   

Investments - Available-for-sale securities:

     

U.S. Treasury

    5,980        5,980        —     

U.S. Government agencies

    12,658        —          12,658   

Corporate bonds and commercial paper

    44,778        —          44,778   

Negotiated certificates of deposit

    12,612        —          12,612   
                       

Total

  $ 117,080      $ 42,033      $ 75,047   
                       

Level 1 cash equivalents consist of investments concentrated in money market funds which are primarily invested in U.S. Treasury securities. Level 2 cash equivalents and available-for-sale securities consist of investments in U.S. government agency securities, corporate bonds and commercial paper and negotiated certificates of deposit. The fair value of these securities is derived using a market approach—i.e., from pricing models that rely on relevant observable market data including interest rates, yield curves, recently reported trades of comparable securities, and benchmark securities.

The Company’s investment policy dictates that investments in money market instruments are limited to those that have a rating of at least A-1 and P-1 according to Standard & Poor’s and Moody’s Investor Services, respectively. Likewise, for investments made in corporate obligations, the Company’s investment policy requires ratings of at least A and A-2 according to Standard & Poor’s and Moody’s Investor Services. The Company does not have any direct investments in auction-rate securities or securities that are collateralized by assets that include mortgages or subprime debt.

Level 3 Fair Valued Assets

As of September 30, 2010 and December 31, 2009, the Company had laboratory equipment and related assets classified as held-for-sale that are fair valued on a non-recurring basis and are considered Level 3 valuations. During the third quarter of 2010, the Company recorded a final impairment charge of $118 to reduce the value of the laboratory equipment and related assets held-for-sale associated with the restructuring that occurred in 2009 to $0. The Company had previously recorded an impairment charge of $484 in the first quarter of 2009 to reflect the estimated fair value of the idle assets, based on internally established estimates and the selling prices of similar assets and subsequently recorded an additional impairment charge of $100 in the second quarter of 2010. The Company began marketing and disposing of all its laboratory equipment in the fourth quarter of 2009.

In addition, during the third quarter of 2010, the Company began marketing for sale additional lab equipment and related assets. This newly marketed lab equipment and related assets are classified as assets held-for-sale and the Company has not recorded any impairment charges related to this newly marketed lab equipment and related assets.

As of September 30, 2010 and December 31, 2009, the non-recurring fair value amount for the assets held-for-sale was $152 and $402, respectively, which reflect the lower of the carrying value or fair value less costs to sell.

 

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INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

 

 

 

9. Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with FASB authoritative guidance regarding share-based payments. Total stock-based compensation was allocated as follows:

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2010      2009      2010      2009  

Research and development

   $ 391       $ 317       $ 1,004       $ 960   

Selling and marketing

     506         476         1,506         1,360   

General and administrative

     416         502         6,540         1,418   
                                   

Total stock-based compensation expense

   $ 1,313       $ 1,295       $ 9,050       $ 3,738   
                                   

Equity Compensation Plans

The Company’s stock-based compensation plan, the Amended and Restated 2010 Equity Compensation Plan (the “2010 Plan”), allows for the granting of both incentive and non-qualified stock options, stock appreciation rights, restricted stock and restricted stock units to directors, officers, employees and consultants. At September 30, 2010, there were 7,895 shares available for grant as options or other forms of share-based payments under the 2010 Plan.

CEO Transition

In February 2010, the Company’s CEO, Christy Shaffer, resigned from the Company and Adrian Adams was hired as CEO. As part of this transition, certain existing stock options and restricted stock units previously granted to Dr. Shaffer were modified. In addition, Dr. Shaffer was also granted 100 stock options which vested immediately and a stock award for 100 shares of our common stock. The modification of the existing options and the granting of the new awards to Dr. Shaffer resulted in stock-based compensation expense of $0 and $2,230 during the three and nine months ended September 30, 2010, respectively.

As part of his hiring, Mr. Adams was granted 350 stock options. On the date of grant, 25% of these options vested immediately and the remaining 75% will vest ratably over the 36 months following the first anniversary of the effective date of Mr. Adams’ employment. In addition, Mr. Adams was granted an award of 650 restricted stock units. On the date of grant, 25% of these restricted stock units became non-forfeitable or vested and the remaining 75% will become non-forfeitable ratably over the 36 months following the first anniversary of the effective date of his employment. The total value of these awards to Mr. Adams was $5,199, of which $0 and $1,300 was expensed during the three and nine months ended September 30, 2010, respectively.

Additional Sign-On Grants

On May 10, 2010, the Company hired Andrew I. Koven as Executive Vice President and Chief Administrative and Legal Officer. As part of his hiring, Mr. Koven was granted 200 stock options. On the date of grant, 25% of these options vested immediately and the remaining 75% will vest ratably over the 36 months following the first anniversary of the effective date of Mr. Koven’s employment. In addition, Mr. Koven was granted an award of 500 restricted stock units. On the date of grant, 50% of these restricted stock units became non-forfeitable or vested and the remaining 50% will become non-forfeitable ratably over the 36 months following the first anniversary

 

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INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

 

of the effective date of his employment. The total value of these awards to Mr. Koven was $3,725, of which $0 and $1,686 was expensed during the three and nine months ended September 30, 2010, respectively.

Basis for Fair Value Estimate of Share-Based Payments

Stock Options

The Company uses its own historical volatility to estimate its future volatility. Actual volatility, and future changes in estimated volatility, may differ substantially from the Company’s current estimates.

The Company utilizes the simplified method of calculating the expected life of options for grants made to its employees under the 2010 Plan in accordance with authoritative guidance due to the lack of adequate historical data with regard to exercise activity on options. For options granted to directors under the 2010 Plan, the Company uses the contractual term of seven years as the expected life of options. The Company will continue with these assumptions in determining the expected life of options under the 2010 Plan until such time that adequate historical data is available. The Company estimates the forfeiture rate based on its historical experience. These estimates will be revised in future periods if actual forfeitures differ from the estimate. Changes in forfeiture estimates impact compensation cost in the period in which the change in estimate occurs.

The table below presents the weighted average expected life of options granted during the period indicated. The risk-free rate of the stock options is based on the U.S. Treasury yield curve in effect at the time of grant, which corresponds with the expected term of the option granted. The fair value of share-based payments, granted during the period indicated, was estimated using the Black-Scholes option pricing model with the following assumptions and weighted average fair values as follows:

 

     Stock Options for  
     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Risk-free interest rate

     1.03     1.94     1.61     1.78

Dividend yield

     0     0     0     0

Expected volatility

     70     71     69     71

Expected life of options (years)

     3.8        3.6        4.0        4.0   

Weighted average fair value of grants

   $ 2.56      $ 2.35      $ 3.04      $ 2.25   

 

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INSPIRE PHARMACEUTICALS, INC.

Notes to Condensed Financial Statements

(Unaudited)

(in thousands, except per share amounts)

 

 

The following table summarizes the stock option activity for the nine months ended September 30, 2010:

 

     Number of
Shares
    Weighted
Average
Exercise Price
(per share)
    Weighted Average
Remaining
Contractual Term

(in Years)
   Aggregate
Intrinsic
Value
 

Outstanding at December 31, 2009

     11,001      $ 7.47      3.5    $ 6,503   

Granted

     2,728        5.82        

Exercised

     (121     (4.64     

Forfeited/cancelled/expired

     (703     (11.77     
                     

Outstanding at September 30, 2010

     12,905      $ 6.91      3.3    $ 9,690   
                     

Vested and exercisable at September 30, 2010

     8,741      $ 7.73      2.6    $ 6,084   

Expected to vest at September 30, 2010

     12,722      $ 6.93      3.3    $ 9,571   

Total intrinsic value of stock options exercised for the nine months ended September 30, 2010 was $216. Cash received from stock option exercises for the nine months ended September 30, 2010 was $560. Due to the Company’s net loss position, no windfall tax benefits have been realized during the nine months ended September 30, 2010. As of September 30, 2010, approximately $9,780 of total unrecognized compensation cost related to unvested stock options is expected to be recognized over a weighted-average period of 2.4 years.

Restricted Stock Units and Stock Awards

The following table summarizes the restricted stock unit activity for the nine months ended September 30, 2010:

 

     Number of
Shares
    Weighted Average
Grant Date
Fair Value
(per share)
 

Nonvested Awards at December 31, 2009

     70      $ 4.16   

Granted

     1,408        5.94   

Vested

     (459     (5.93

Forfeited

     —          —     
                

Nonvested Awards at September 30, 2010

     1,019      $ 5.85   
                

Vested and deferred awards at September 30, 2010

     150      $ 4.16   
                

During the nine months ended September 30, 2010, approximately 459 restricted stock units with an aggregate fair value of $2,721 became vested. Restricted stock units outstanding at September 30, 2010 had a weighted-average remaining contractual life of 1.9 years and a total aggregate intrinsic value of $6,952. Restricted stock units outstanding and expected to vest at September 30, 2010 had a weighted-average remaining contractual life of 1.9 years and a total aggregate intrinsic value of $5,722.

Additionally, during the nine months ended September 30, 2010, 100 stock awards were granted. The 100 stock awards were issued, fully vested upon grant, with an aggregate fair value of $627.

 

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

CAUTIONARY STATEMENT

The discussion herein contains forward-looking statements regarding our financial condition and our results of operations that are based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted within the United States, as well as projections for the future. The preparation of these financial statements requires our management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. We evaluate our estimates on an ongoing basis. Our estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. The results of our estimates form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.

We operate in a highly competitive environment that involves a number of risks, some of which are beyond our control. We are subject to risks common to biopharmaceutical companies, including risks inherent in our research, development and commercialization efforts, clinical trials, uncertainty of regulatory actions and marketing approvals, reliance on collaborative partners, enforcement of patent and proprietary rights, the need for future capital, competition associated with products, potential competition associated with our product candidates and retention of key employees. In order for any of our product candidates to be commercialized, it will be necessary for us, or our collaborative partners, to conduct clinical trials, demonstrate efficacy and safety of the product candidate to the satisfaction of regulatory authorities, obtain marketing approval, enter into manufacturing, distribution and marketing arrangements; and obtain market acceptance and adequate reimbursement from government and private insurers. We cannot provide assurance that we will generate significant revenues or achieve and sustain profitability in the future. In addition, we can provide no assurance that we will have sufficient funding to meet our future capital requirements. Statements contained in Management’s Discussion and Analysis of Financial Condition and Results of Operations and elsewhere in this report which are not historical facts are, or may constitute, forward-looking statements. Forward-looking statements involve known and unknown risks that could cause our actual results to differ materially from expected results. The most significant known risks are discussed in the section entitled “Risk Factors”. Although we believe the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.

Our revenues are difficult to predict and depend on numerous factors. The effectiveness of our ability and the ability of third parties on which we rely to help us manufacture, distribute and market AzaSite; physician and patient acceptance of AzaSite; competitor response to AzaSite; as well as discounts, pricing and coverage on governmental and commercial formularies, and the recently passed healthcare reform legislation are all factors, among others, that will impact the level of revenue recorded for AzaSite in subsequent periods. Our co-promotion and royalty revenues are based upon Allergan’s revenue recognition policy and other accounting policies, over which we have limited or no control, and on the underlying terms of our agreements. Our co-promotion and royalty revenues are impacted by the number of governmental and commercial formularies upon which Restasis and Elestat are listed, the discounts and pricing under such formularies, as well as the estimated and actual amount of rebates, all of which are managed by Allergan. Other factors that are difficult to predict and that impact our co-promotion and royalty revenues are the extent and effectiveness of Allergan’s sales and marketing efforts, our sales and marketing efforts, coverage and reimbursement under Medicare Part D and Medicaid programs, the recently passed healthcare reform legislation and the sales and marketing activities of competitors. Additionally, our ability to receive revenues on future sales of AzaSite, Restasis and Elestat are dependent upon the duration of market exclusivity and the strength of patent protection. Revenues related to development activities are dependent upon the progress toward and the achievement of developmental milestones by us or our collaborative partners.

Our operating expenses are also difficult to predict and depend on several factors. Cost of sales related to AzaSite contain variable and fixed cost components. Research and development expenses, including expenses for development milestones, drug manufacturing, and clinical research activities, depend on the ongoing requirements of our development programs, completion of business development transactions, availability of capital and direction from regulatory agencies, which are difficult to predict. In addition, we have incurred and expect to continue to incur

 

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significant selling and marketing expenses to commercialize our products. Management may be able to control the timing and level of research and development, selling and marketing and general and administrative expenses, but many of these expenditures will occur irrespective of our actions due to contractually committed activities and/or payments.

As a result of these factors, we believe that period to period comparisons are not necessarily meaningful and you should not rely on them as an indication of future performance. Due to all of the foregoing factors, it is possible that our operating results will be below the expectations of market analysts and investors. In such event, the prevailing market price of our common stock could be materially adversely affected.

 

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OVERVIEW

We are a biopharmaceutical company focused on researching, developing and commercializing prescription pharmaceutical products for ophthalmic and pulmonary diseases. Our goal is to build and commercialize a sustainable portfolio of innovative new products based on our technical, scientific and commercial expertise. Our clinical pipeline includes denufosol tetrasodium for cystic fibrosis in Phase 3 development and AzaSite for blepharitis in Phase 2 development. We receive revenues related to the sale of AzaSite for bacterial conjunctivitis, the co-promotion of Elestat for allergic conjunctivitis and royalties based on net sales of Restasis for dry eye. Our portfolio of products and product candidates include:

 

PRODUCTS AND

PRODUCT CANDIDATES

  

THERAPEUTIC AREA/

INDICATION

  

COLLABORATIVE

PARTNER (1)

  

CURRENT STATUS

Products

        
AzaSite    Bacterial conjunctivitis    InSite Vision    Promoting
Elestat    Allergic conjunctivitis    Allergan    Co-promoting
Restasis    Dry eye disease    Allergan    Receiving royalty
Diquas    Dry eye disease    Santen Pharmaceutical    Japanese approval (2)

Product Candidates in

Clinical Development

        
Denufosol tetrasodium    Cystic fibrosis    None    Phase 3

Prolacria

(diquafosol tetrasodium)

   Dry eye disease    None    Phase 3 (3)

DE-089

(diquafosol tetrasodium)

   Dry eye disease    Santen Pharmaceutical    Phase 3 (4)
AzaSite    Blepharitis    InSite Vision    Phase 2
INS115644, INS117548    Glaucoma    Wisconsin Alumni Research Foundation    Phase 1

 

(1) See Item 1.01 of our Current Report on Form 8-K filed with the Securities and Exchange Commission on August 25, 2010 for a description of the Amended and Restated License, Development and Marketing Agreement, dated August 19, 2010, relating to diquafosol and Restasis rights and obligations. See Item 1.01 of our Current Report on Form 8-K filed with the Securities and Exchange Commission on June 10, 2010 for a description of the First Amendment to the Development, License and Supply Agreement, dated as of June 3, 2010 related to diquafosol and Diquas rights and obligations. See “Collaborative Agreements” in Item 1 of our Annual Report on Form 10-K for the year ended December 31, 2009 for descriptions of our other agreements with these collaborative partners.
(2) Santen Pharmaceutical Co., Ltd. has developed a different formulation of diquafosol tetrasodium, which it refers to as Diquas in Japan. In April 2010, Santen announced that the Japanese Ministry of Health, Labor, and Welfare (the Japanese equivalent of the FDA) granted approval for Diquas Ophthalmic Solution 3%. The launch date for Diquas in Japan is subject to, among other things, the Japanese pricing approval process.
(3) In January 2010, we announced that our Phase 3 clinical trial (Trial 03-113) did not meet its primary or secondary endpoints. We are not currently proceeding with the clinical development of Prolacria.
(4) In November 2010, Santen stated that Phase 3 clinical trials with DE-089 are being conducted in China.

 

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We were incorporated as a Delaware corporation in October 1993 and commenced operations in March 1995. We are currently located in Durham, North Carolina, adjacent to the Research Triangle Park. However, on June 28, 2010, we entered into a lease for approximately 42,850 square feet in Raleigh, North Carolina, which we intend to use as our corporate headquarters. We intend to occupy our new corporate headquarters in January 2011.

PRODUCTS

AzaSite

AzaSite (azithromycin ophthalmic solution) 1% is a topical anti-infective, in which azithromycin is formulated into an ophthalmic solution utilizing DuraSite®, a novel ocular drug delivery system. Azithromycin is a semi-synthetic antibiotic that is derived from erythromycin and, since 1992, has been available via oral administration by Pfizer Inc. under the trade name Zithromax®. In April 2007, AzaSite was approved by the U.S. Food and Drug Administration, or FDA, for the treatment of bacterial conjunctivitis in adults and children one year of age and older.

In February 2007, we entered into a license agreement with InSite Vision Incorporated, or InSite Vision, pursuant to which we acquired exclusive rights to commercialize AzaSite for use in the treatment of human ocular or ophthalmic indications. The license agreement grants us exclusive rights to develop, make, use, market, commercialize and sell AzaSite in the United States and Canada. We are obligated to pay InSite Vision royalties on net sales of AzaSite in the United States and Canada.

In August 2007, we launched AzaSite in the United States and are promoting it to eye care specialists. The manufacture and sale of AzaSite is protected in the United States under use and formulation patents, the latest of which expires in March 2019. In addition, the sale of AzaSite is also protected in the United States under a use patent that we sub-licensed from Pfizer that expires in November 2018.

Elestat

Elestat (epinastine HCl ophthalmic solution) 0.05% is a topical antihistamine developed by Allergan, Inc., or Allergan, for the prevention of ocular itching associated with allergic conjunctivitis. Elestat was approved by the FDA in October 2003 and is indicated for adults and children at least three years old.

We receive co-promotion revenue from Allergan on its U.S. net sales of Elestat. When a generic form of Elestat or an over-the-counter form of epinastine ophthalmic solution is introduced into the market, our agreement with Allergan to co-promote Elestat will no longer be in effect, and our revenues from sales of Elestat will be minimal.

Subject to applicable law, competitors are permitted to submit to the FDA an Abbreviated New Drug Application, or ANDA, for a generic version of Elestat, due to the expiration of the marketing exclusivity period for Elestat provided under the Hatch-Waxman Act on October 15, 2008. We are aware that the following companies have filed an ANDA for a generic version of Elestat: Apotex, Inc., Cypress Pharmaceutical, Inc., Paddock Laboratories, Inc., PharmaForce, Inc. and Sandoz Inc. The date of submission of the first ANDA filing to the FDA Office of Generic Drugs was October 14, 2008, according to the FDA’s website (www.fda.gov). Also, according to the FDA’s website, in June 2010, PharmaForce, Inc. received tentative approval for its epinastine hydrochloride ophthalmic solution.

We plan to continue co-promoting and receiving co-promotion revenues on Elestat sales during the FDA’s review period of these ANDAs. According to an Office of Generic Drugs Update presentation made by Gary Buehler, Director, Office of Generic Drugs, on February 16, 2010, at the GPhA Annual Meeting, the ANDA median approval time for the fiscal period ending September 30, 2009 was approximately 26.7 months. We do not know when the FDA will complete its review of the ANDAs relating to a generic version of Elestat and we do not expect to be notified by any party prior to any approval. However, based upon our assessment, we believe it is likely that a generic form of epinastine may be launched at any time. See the risk factor entitled - “When a generic form of Elestat or an over-the-counter form of epinastine ophthalmic solution is introduced into the market, our agreement with Allergan to

 

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co-promote Elestat will no longer be in effect, and our revenues from sales of Elestat will be minimal” - for further discussion of the risk related to the ANDA filings.

Restasis

Restasis (cyclosporine ophthalmic emulsion) 0.05% is the first approved prescription product in the United States for the treatment of dry eye disease. It is indicated to increase tear production in adults and children at least 16 years old whose tear production is presumed to be suppressed due to ocular inflammation associated with keratoconjunctivitis sicca, or dry eye disease. Restasis was approved by the FDA in December 2002, and Allergan launched the product in the United States in April 2003.

In June 2001, we entered into an agreement with Allergan to develop and commercialize our product candidate, Prolacria (diquafosol tetrasodium), for the treatment of dry eye disease. The agreement also provided that Allergan pay us royalties on net sales of Restasis.

In August 2010, we amended and restated our agreement with Allergan. Under the amended and restated agreement, which runs through December 31, 2020, we are entitled to receive revenues at one global rate based on net sales of Restasis and any other human ophthalmic formulation of cyclosporine owned or controlled by Allergan, with no requirement to co-promote Restasis.

The manufacture and sale of Restasis is protected in the United States by a formulation patent that expires in May 2014.

Diquas

Diquas ophthalmic solution 3% (diquafosol tetrasodium) has been developed by Santen Pharmaceutical Co., Ltd., or Santen, as a treatment for dry eye.

In December 1998, we entered into an agreement with Santen that allows Santen to develop diquafosol tetrasodium for the therapeutic treatment of ocular surface diseases, such as dry eye disease, in Japan and nine other Asian countries, and provides for certain milestone payments to be paid to us upon achievement of development milestones by Santen. We are eligible to receive royalties on net sales of Diquas if it is approved for commercialization and launched in Santen’s licensed territories. In April 2010, Santen announced that the Japanese Ministry of Health, Labor, and Welfare (the Japanese equivalent of the FDA) granted approval for Diquas Ophthalmic Solution 3%. The launch date for Diquas in Japan is subject to, among other things, the Japanese pricing approval process.

The manufacture and sale of Diquas is protected in Japan under patents that have claims to the drug substance, the formulation, and method of use that expire in February 2018, subject to any applicable patent restoration that may extend protection up to an additional five years from the date of expiration of the applicable patent, if any, for which restoration is sought.

For a more detailed discussion of the risks associated with these products, please see the Risk Factors located under Part II of this report.

PRODUCT CANDIDATES IN CLINICAL DEVELOPMENT

Denufosol tetrasodium for the treatment of cystic fibrosis

Overview. We are developing denufosol tetrasodium as an inhaled product candidate for the treatment of cystic fibrosis. Denufosol is a novel ion channel regulator targeted as an early disease state intervention that potentially corrects ion transport in patients independent of the class of CFTR defect. Denufosol is designed to enhance airway

 

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hydration and mucociliary clearance by increasing chloride secretion, inhibiting sodium absorption and increasing ciliary beat frequency. These integrated pharmacological actions and the potential to reach the small airways are key to maintaining lung function and potentially delaying the progression of lung disease. We believe that our product candidate could be the first FDA-approved product that mitigates the underlying defect in the airways of patients with cystic fibrosis. This product candidate has been granted orphan drug status and fast-track review status by the FDA, and orphan drug status by the European Medicines Agency.

The manufacture and sale of denufosol tetrasodium is protected in the United States under patents that have claims to the drug substance, the formulation, and method of use that expire in February 2017, subject to any applicable patent restoration that may extend protection up to an additional five years from the date of expiration of the applicable patent, if any, for which restoration is sought.

Development Status

TIGER 1: Our first Phase 3 clinical trial, TIGER-1 (Trial 08-108), with denufosol tetrasodium inhalation solution for the treatment of cystic fibrosis was a 24-week, double-blind, placebo-controlled, randomized clinical trial comparing 60 mg of denufosol to placebo, administered three-times daily by jet nebulizer, in 352 patients with mild cystic fibrosis lung disease (FEV1 (Forced Expiratory Volume in One Second) (in liters) ³ 75% predicted normal) at clinical centers across North America. This portion of the clinical trial was followed by a 24-week denufosol-only open-label extension, or OLE.

In June 2008, we announced top-line results from the 24-week placebo-controlled portion of the clinical trial. The clinical trial demonstrated statistical significance for its primary efficacy endpoint, which was the change in FEV1 from baseline at the clinical trial endpoint (at 24 weeks or last observation carried forward). Patients treated with denufosol had a statistically significant improvement in FEV1 compared to placebo (45 milliliter treatment group difference in adjusted means, p = 0.047). On average, patients on denufosol improved in FEV1 relative to baseline whereas patients on placebo remained essentially unchanged. Secondary endpoints were also evaluated during the placebo-controlled portion of TIGER-1. There was a trend in differences in FEF25%-75% (Forced Expiratory Flow 25%-75%), a measure of small airway function, favoring denufosol over placebo (87.5 milliliters/second treatment group difference, p = 0.072).

In October 2008, we presented data at the North American Cystic Fibrosis Conference which indicated that patients who continued to receive denufosol for an additional 24 weeks during the OLE experienced a progressive improvement in FEV1. Those patients who received denufosol for 48 weeks during TIGER-1 experienced a mean change from baseline in FEV1 of 115 ml at the end of the OLE, almost a two-and-a-half fold increase compared to the initial 48 ml increase at the end of the 24-week placebo-controlled portion of the trial.

The patients who crossed over from placebo to denufosol at week 24 also experienced improvements in FEV1 when receiving denufosol during the OLE. In terms of observed means, these patients had a 78 ml increase from baseline, compared to a 16 ml increase at the end of the 24-week placebo-controlled portion of the trial. This differs from the 3 ml adjusted mean for placebo at the 24-week study endpoint which also accounted for discontinuations.

A total of 315 out of 352 (89%) patients completed the 24-week placebo-controlled phase of TIGER-1 and had the option to participate in the OLE phase in which all patients received denufosol for an additional 24 weeks. All of the patients but one (n=314) entered the OLE extension. The objective of the OLE phase was to evaluate the long-term safety of denufosol treatment among cystic fibrosis patients with FEV1 ³ 75% predicted normal. In the TIGER-1 trial, there was no evidence of adverse effects on growth, clinical laboratory values or vital sign assessments with long-term denufosol treatment. Denufosol was well-tolerated over 48 weeks of dosing in the TIGER-1 trial.

The retention rate during the OLE phase was approximately 96%, with 302 patients completing the full 48 weeks. Twelve patients withdrew during the OLE phase, with only four withdrawals related to Adverse Events, or AEs. In the OLE phase, the most commonly reported AEs, which included cough, condition aggravated and productive

 

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cough, were similar to those reported during the placebo-controlled phase. The incidence of Serious Adverse Events, or SAEs, in the OLE phase was under 20% and the majority of SAEs were pulmonary exacerbations.

In TIGER-1, there were two definitions of pulmonary exacerbations in the protocol. Based on the primary protocol definition of an exacerbation as a patient experiencing at least four out of 12 defined signs and symptoms regardless of treatment, the frequency of pulmonary exacerbations was 23% in both the placebo-controlled phase and the OLE phase. Based on the secondary protocol definition of an exacerbation as a patient requiring treatment with IV antibiotics for a respiratory sign or symptom, the frequency of pulmonary exacerbations was 8% in the placebo-controlled phase and 13% in the OLE phase.

TIGER 2: We initiated patient enrollment in TIGER-2 (Trial 08-110), our second planned pivotal Phase 3 clinical trial in February 2008, announced modifications to the clinical protocol in July 2008, and completed patient enrollment in November 2009. We have approximately 100 participating clinical trial sites across the United States, Canada, Australia and New Zealand. Top-line results from this clinical trial are expected in the first quarter of 2011.

The TIGER-2 clinical trial is a 48-week, double-blind, placebo-controlled, randomized clinical trial comparing 60 mg of denufosol to placebo, administered three-times daily by jet nebulizer, in approximately 450 patients with FEV1 greater than or equal to 75% and less than or equal to 110% of predicted normal. The primary efficacy endpoint is the change from baseline in FEV1 (in liters) at the 48-week trial endpoint. Secondary endpoints include other lung function parameters, pulmonary exacerbations, requirements for concomitant cystic fibrosis medications and health related quality of life. Patients aged five years and older were eligible for enrollment. The use of standard cystic fibrosis maintenance therapies is permitted during the trial. Hypertonic saline is not permitted to be used by those patients enrolled in the clinical trial.

Additionally, we are conducting DEFY (08-114), a denufosol open-label clinical trial open to eligible patients that complete the year-long TIGER-2 trial. This three year trial will evaluate the potential disease-modifying impact of denufosol on rate of lung function decline. To date, approximately 80% of the patients who were eligible have elected to enroll in DEFY.

We are targeting a potential U.S. commercial launch for denufosol in the 2012 timeframe, assuming (i) the results of TIGER-2 are positive; (ii) we subsequently file a New Drug Application, or NDA, for denufosol with the FDA in the second half of 2011; and (iii) the FDA approves such NDA under a priority review timeline.

Additionally, in connection with our denufosol franchise development activities, in August 2010, we initiated REACH (08-116), the first clinical trial aimed at studying expanded patient populations with denufosol. This clinical trial is a small safety and tolerability clinical trial dosing denufosol tetrasodium in cystic fibrosis patients ages 2-4 years old for seven days. We have completed enrollment in REACH and top-line results are expected in the first quarter of 2011.

Other: In 2006, we completed a 52-week inhalation toxicology study in one animal species, and have submitted the final study report to the FDA. There were no signs of pulmonary or systemic toxicity at doses well above the Phase 3 clinical dose. In 2009, we completed the required two-year inhalation carcinogenicity study in rats and the final study report confirms that there was no evidence of a carcinogenic effect with denufosol.

Estimated subsequent costs necessary to submit an NDA for denufosol for the treatment of cystic fibrosis are projected to be in the range of $8 million to $13 million. This estimate includes completing TIGER-2 as well as conducting any additionally required toxicology studies and other ancillary studies, manufacturing denufosol for clinical trials, producing qualification lots consistent with current Good Manufacturing Practices, or cGMP, standards, salaries for development personnel, other unallocated development costs and regulatory preparation and filing costs. These costs do not include the costs of pre-launch inventory and any product approval milestones payable to Cystic Fibrosis Foundation Therapeutics, Inc. These costs are difficult to project and actual costs could be materially different from our estimate. For example, clinical trials and any other required studies may not proceed as planned, results from ongoing or future clinical trials may change our planned development program, additional Phase 3 clinical trials may be necessary and an anticipated NDA filing could be delayed.

 

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In addition to the activities and costs necessary to submit an NDA for denufosol, we are initiating commercial planning and franchise development activities, including conducting market research, developing manufacturing plans, and expanding our clinical and scientific database on denufosol beyond the TIGER-1 and TIGER-2 pivotal trials. More specifically, these activities would include the DEFY trial discussed above, development of an additional and/or alternative supplier of denufosol, evaluating options for a second generation delivery device and designing potential clinical trials to study a broader patient population, including patients less than 5 years old and/or patients with more impaired lung function (less than 75% predicted normal). The costs of these activities are expected to be significant and could include approximately $8 million in remaining milestone payments due under our technology license agreement with Yamasa Corporation.

We currently plan to retain commercial rights for denufosol for the treatment of cystic fibrosis in North America. We continue to assess the best strategy for developing and commercializing this product candidate outside of North America.

Prolacria (diquafosol tetrasodium) for the treatment of dry eye disease

Overview. Diquafosol tetrasodium is a dinucleotide which functions as an agonist at the P2Y2 receptor and was being developed for the treatment of dry eye disease. Prolacria, the proposed U.S. tradename for diquafosol tetrasodium ophthalmic solution 2%, is designed to stimulate the release of three components of natural tears – mucin, lipids and fluid. The manufacture and sale of Prolacria is protected in the United States under drug substance and formulation patents that expire in July 2016, as well as under use patents that expire in February 2017, subject to any applicable patent restoration that may extend protection up to an additional five years from the date of expiration of the applicable patent, if any, for which restoration is sought.

Under our amended and restated agreement with Allergan, we have sole control over any future Prolacria development and commercialization. We are not currently proceeding with the clinical development of Prolacria. In the event we resume the Prolacria clinical development program and receive regulatory approval for a Prolacria product in a particular country, we will have the option to offer Prolacria commercialization rights to Allergan for such country upon the original commercial terms previously agreed to between us and Allergan. If we choose not to offer Allergan Prolacria commercialization rights with respect to a country, we will receive all the commercialization revenues related to Prolacria in such country and our rights to receive royalties from Allergan based on net sales of Restasis products in such country will terminate.

Development Status. In June 2003, we filed an NDA with the FDA for Prolacria for the treatment of dry eye disease. We received approvable letters from the FDA in December 2003 and December 2005. In September 2008, we submitted a clinical protocol and request for Special Protocol Assessment to the FDA for a pivotal Phase 3 environmental trial with Prolacria. During 2009, we reached agreement with the FDA on the design of a Phase 3 clinical trial for Prolacria, and completed the trial.

In January 2010, we announced that this Phase 3 clinical trial (Trial 03-113) did not meet its primary endpoint (p = 0.526) or its secondary endpoint (p = 0.368). Given the complexity of this program and the large database of information we have, we are continuing to evaluate potential next steps for the program, but are not currently proceeding with the clinical development of Prolacria.

DE-089 (diquafosol tetrasodium) for the treatment of dry eye disease

Our agreement with Santen allows Santen to develop diquafosol tetrasodium for the therapeutic treatment of ocular surface diseases, such as dry eye disease, in Japan, the People’s Republic of China and eight other Asian countries, and provides for certain milestone payments to be paid to us upon achievement of development milestones by Santen. In November 2010, Santen stated that Phase 3 clinical trials with DE-089 are being conducted in China.

 

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AzaSite for the treatment of blepharitis

Overview. Blepharitis is an ocular disease characterized by inflammation of the lid margin that is common, complex, and has a multi-factorial etiology. Blepharitis coexists with other common ocular surface conditions and we believe is often under-diagnosed and misdiagnosed in general clinical practice. Blepharitis can be subdivided into two categories: anterior and posterior blepharitis. Although they are distinct diseases, they can overlap. Anterior blepharitis is generally associated with the presence of bacteria, lid debris and/or sebaceous gland activity and is most often an acute disease. Posterior blepharitis is almost always associated with dysfunctional meibomian glands or altered meibomian gland secretions and is generally considered a chronic disease.

Our market research and input from eye care specialists suggests that blepharitis is an under-diagnosed and under-treated disease. Survey data published in The Ocular Surface and funded by Inspire indicated that 15% of adults reported having at least one of the three symptoms that clinicians associate with anterior blepharitis at least half of the time in the previous 12 months. Based on the overall U.S. adult population of 232 million, this implies potentially as many as 34 million adults might have suffered from some form of blepharitis over such time frame. Currently, there are no FDA-approved prescription pharmaceutical products indicated for the treatment of this disease. Patients currently manage the acute and often chronic effects of blepharitis with the use of warm compresses, lid hygiene, topical antibiotic ointments and, when exacerbated, with topical steroids or oral antibiotics.

Development Status. During 2008, we conducted a series of Phase 4 clinical trials with AzaSite evaluating the safety and efficacy of AzaSite in ocular conditions, such as blepharitis. In late 2008, we sought input from numerous medical experts and evaluated our Phase 4 data along with market research on the prevalence and awareness of the disease to evaluate AzaSite’s potential opportunity as it relates to the treatment of blepharitis. In addition, we had preliminary discussions with the FDA on potential regulatory pathways. Based on preliminary information gathered, we decided to pursue a Phase 2 program to study AzaSite for the treatment of blepharitis.

In May 2009, we initiated Phase 2 work which consisted of two randomized, vehicle-controlled clinical trials that enrolled approximately 600 patients with anterior blepharitis. Trial 044-101 included a two-week treatment period with a two-week follow-up period and Trial 044-102 included a four-week treatment period with a four-week follow-up period. Patients were randomized to AzaSite or the DuraSite vehicle and received one drop in each eye twice-a-day for the first two days, then one drop in each eye daily for the remainder of the treatment period. All patients in the trials performed lid hygiene using commercially available lid scrubs once daily for the duration of the trials.

In March 2010, we announced the results of these two trials. In the four-week trial, improvements for AzaSite compared to vehicle were achieved for a number of blepharitis signs and symptoms at various time points with p-values £ 0.05, but statistical significance was not achieved for the primary endpoint of mean lid margin hyperemia. In the two-week trial, there were no statistically significant improvements for AzaSite compared to vehicle, including for the primary endpoint of clearing of lid debris. In both trials, the AzaSite treatment group and the vehicle treatment group showed statistically significant improvements relative to baseline for all measured signs and symptoms of blepharitis. Additionally, AzaSite was well-tolerated in both trials.

We plan to initiate an exploratory Phase 2 trial with AzaSite for blepharitis by the end of 2010. This trial plans to enroll up to 300 blepharitis patients with various levels of severity of clinically relevant eyelid margin erythema (or redness) and lid debris. This multi-center trial will be set up to evaluate AzaSite compared to vehicle over four weeks of treatment with an eight-week follow-up period with the goal of informing future trial design. We will be assessing the patient population, length of dosing and measurements of multiple signs and symptoms of blepharitis, including utilizing photographic methods and a centralized reading center. Information from this trial is expected in the second half of 2011.

Given the limited data available and the early stage of development of this program, we are currently unable to reasonably project the future dates and costs associated with clinical trials or a prospective NDA filing for this program.

 

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Glaucoma product candidates

Overview. In November 2004, we licensed technology for use in developing and commercializing new treatments for glaucoma from Wisconsin Alumni Research Foundation. In relation to this technology, we are evaluating new and existing compounds that are active in disrupting the acto-cytoskeleton of the trabecular meshwork as potential treatments for glaucoma. Our scientific hypothesis is that the mechanism of action may result in reduction of intraocular pressure, or IOP, by affecting the primary outflow pathway for aqueous humor.

Development Status. In 2007, we initiated a Phase 1 proof-of-concept placebo-controlled, dose-ranging clinical trial (Trial 032-101) for INS115644, the first compound in a series of compounds, in glaucoma patients to evaluate the safety and tolerability of INS115644, as well as changes in IOP. In 2008, we initiated a Phase 1 proof-of-concept placebo-controlled, dose-ranging clinical trial (Trial 037-101) for a second compound, referred to as INS117548, to evaluate the safety, tolerability and IOP-lowering effects of INS117548 in approximately 80 subjects with early stage glaucoma or ocular hypertension.

In September 2009, we announced top-line results of these trials. In Trial 032-101 with INS115644, a Latrunculin B formulation, we observed dose-dependent IOP-lowering effects and the compound was well-tolerated. Trial 037-101 with INS117548, which is one of a series of Rho kinase molecules we have developed, showed mild IOP-lowering effects but had some dose-related tolerability issues, specifically with ocular discomfort such as burning and stinging. We are in the process of evaluating next steps for the overall glaucoma program, based on our clinical and preclinical data, expert opinions and resource availability.

Due to the uncertainty of the future of this program, and given the limited data available and the early stage of development of this program, we are currently unable to reasonably project the future dates and costs associated with clinical trials or a prospective NDA filing for either of these product candidates.

For a discussion of the risks associated with our development programs, please see the Risk Factors located elsewhere in this report.

 

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RESULTS OF OPERATIONS

Three Months Ended September 30, 2010 and 2009

Revenues

Total revenues were approximately $26.7 million for the three months ended September 30, 2010, as compared to approximately $25.2 million for the same period in 2009. The increase in 2010 revenue of approximately $1.5 million, or 6%, as compared to the same period in 2009, was due to an increase in product revenue from net sales of AzaSite and an increase in royalty revenue from net sales of Restasis, partially offset by a reduction in co-promotion revenue from net sales of Elestat.

Product Sales, net

Product sales of AzaSite, net of sales deductions, for the three months ended September 30, 2010 were approximately $11.1 million, as compared to approximately $9.0 million for the same period in 2009. The increase in revenue for AzaSite of approximately $2.1 million, or 23%, for the three months ended September 30, 2010, as compared to the same period in 2009, was primarily due to increased patient usage of AzaSite and an increase in prescribers of AzaSite, as evidenced by an increase of prescriptions year-over-year, as well as a price increase effective in February 2010. Additionally, approximately $1.0 million to $1.5 million of revenue from sales of AzaSite for the three months ended September 30, 2009 was associated with hospital usage of AzaSite as a substitute therapy during a temporary supply shortage of erythromycin ophthalmic ointment (0.5%) that was resolved in the first quarter of 2010. For the three months ended September 30, 2010, the average monthly prescriptions per sales force associate and the average monthly prescriptions per targeted physician increased 17% and 10%, respectively, as compared to the same period in 2009.

The increase in AzaSite revenues for the three months ended September 30, 2010, as compared to the same period in 2009, was partially offset by an increase in gross-to-net sales deductions. Total sales deductions as a percentage of gross revenues increased approximately 13%. The impact of the net rate increase as a percentage of gross revenues was approximately $2.2 million in additional provisions for the three months ended September 30, 2010. The increase was primarily attributable to an approximate 10% increase in rebates and discounts due to (1) an increase in the number of formularies that now list AzaSite and (2) the price concessions required to secure this coverage under Medicare and commercial managed care organizations. In addition, we initiated several mail-in rebate and voucher programs. These increases were partially offset by a slight decline in accrual rates for product return allowances. Our reserves related to rebates and discounts for the three months ended September 30, 2010 were not significantly impacted by the new U.S. healthcare reform legislation passed in March 2010 and those provisions of the legislation that became effective during the first quarter of 2010.

For the three months ended September 30, 2010, based on prescription data from IMS Health, there were approximately 182,000 prescriptions written for AzaSite, representing approximately 5% of all prescriptions in the single agent ocular anti-infective market, defined as both branded and generic single-entity ocular antibiotics. In comparison, approximately 125,000 prescriptions were written for AzaSite for the three months ended September 30, 2009, representing approximately 4% of all prescriptions in the single agent ocular anti-infective market. Since launch, actual units of AzaSite dispensed have been higher than the number of prescriptions as reported by IMS Health due to the issuance of multiple unit prescriptions by some physicians. For the three months ended September 30, 2010, the single agent ocular anti-infective market, in terms of prescriptions, increased approximately 3%, as compared to the same period in 2009.

Our market share in eye care specialists was approximately 11% for the three months ended September 30, 2010, as compared to approximately 8% for the same period in 2009. In addition, our market share in our target call audience of eye care specialists was approximately 21% for the three months ended September 30, 2010, as compared to approximately 13% for the same period in 2009.

 

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Product Co-Promotion and Royalty

Total co-promotion and royalty revenue for the three months ended September 30, 2010 was approximately $15.6 million, as compared to approximately $16.1 million for the same period in 2009, representing a decrease of approximately $526,000, or 3%.

Our royalty revenue from net sales of Restasis for the three months ended September 30, 2010 was approximately $11.7 million, as compared to approximately $9.4 million for the same period in 2009. The increase in royalty revenue for Restasis for the three months ended September 30, 2010, as compared to the same period in 2009, was primarily due to increased patient usage of Restasis, as evidenced by an increase in prescriptions year-over-year, as well as a price increase effective in January 2010. For the three months ended September 30, 2010 and 2009, Allergan recorded revenue from net sales of Restasis of approximately $159 million and $129 million, respectively.

Co-promotion revenue from net sales of Elestat for the three months ended September 30, 2010 was approximately $3.9 million, as compared to approximately $6.7 million for the same period in 2009, or a decrease of approximately 41%. As of January 1, 2010, all co-promotion revenue on Elestat is recorded as the product is sold as we no longer are under contractual minimums requiring revenue deferral. Excluding the impact of recognizing approximately $2.1 million of previously deferred revenue in the third quarter of 2009, Elestat revenue decreased approximately 14% for the three months ended September 30, 2010, as compared to the same period in 2009, primarily due to a lower share of the total U.S. allergic conjunctivitis market, partially offset by a price increase effective in January 2010.

Elestat is a seasonal product with product demand mirroring seasonal trends for topical allergic conjunctivitis products. Typically, demand is highest during the Spring months followed by moderate demand in the Summer and Fall months. The lowest demand is during the Winter months. Based upon national prescription data from IMS Health, for the three months ended September 30, 2010 and 2009, Elestat prescriptions, as a percentage of the total U.S. allergic conjunctivitis market, represented approximately 6% and 7%, respectively, of the total U.S. allergic conjunctivitis market. Based upon monthly data from IMS Health, for the three months ended September 30, 2010, the total U.S. allergic conjunctivitis market, in terms of prescriptions, increased approximately 3%, as compared to the same period in 2009.

Cost of Sales

Cost of sales related to the sales of AzaSite were approximately $3.7 million for the three months ended September 30, 2010, as compared to approximately $3.0 million for the same period in 2009. The increase in cost of sales of approximately $657,000, or 22%, as compared to the same period in 2009, was primarily due to increased sales volume of AzaSite, which has resulted in increased royalties due to InSite Vision.

Cost of sales expense consists of variable and fixed cost components. Variable cost components include royalties to InSite Vision on net sales of AzaSite, the cost of AzaSite inventory sold, distribution, shipping and logistic service charges from our third-party logistics provider, and changes to our inventory reserve for overstocking, short-dated or otherwise unmarketable product or unusable materials. Fixed cost components are primarily the amortization of the $19.0 million approval milestone that we paid InSite Vision as part of our licensing agreement. This approval milestone is being amortized ratably on a straight-line basis through the term of the underlying patent coverage for AzaSite, which expires in March 2019.

 

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Research and Development Expenses

Research and development expenses were approximately $11.9 million for the three months ended September 30, 2010, as compared to approximately $15.3 million for the same period in 2009.

The decrease in research and development expenses of approximately $3.4 million, or 22%, for the three months ended September 30, 2010, as compared to the same period in 2009, was primarily due to the substantial completion of both our Phase 3 trial activities associated with our product candidate, Prolacria, for the treatment of dry eye and our Phase 2 trials researching AzaSite for the treatment of blepharitis in the first quarter of 2010, as well as completion of Phase 1 trial activities related to our glaucoma program in the third quarter of 2009.

Research and development expenses include all direct and indirect costs, including salaries for our research and development personnel, consulting fees, clinical trial costs, including the development and manufacture of drug product for clinical trials, sponsored research costs, clinical trial insurance, upfront license fees, milestone and royalty payments relating to research and development, and other fees and costs related to the development of product candidates. Research and development expenses vary according to the number of programs in clinical development and the stage of development of our clinical programs. Later stage clinical programs tend to cost more than earlier stage programs due to the length of the clinical trials and the number of patients enrolled in later stage clinical trials.

Selling and Marketing Expenses

Selling and marketing expenses were approximately $12.4 million for the three months ended September 30, 2010, as compared to approximately $11.3 million for the same period in 2009.

The increase in selling and marketing expenses of approximately $1.1 million, or 9%, for the three months ended September 30, 2010, as compared to the same period in 2009, was primarily due to a general increase in personnel related expenses, as well as the timing of certain marketing activities.

Our commercial organization currently focuses its promotional efforts on approximately 10,000 eye care specialists. Our selling and marketing expenses include all direct costs associated with the commercial organization, which include our sales force and marketing programs. Our sales force expenses include salaries, training and educational program costs, product sample costs, fleet management and travel. Our marketing and promotion expenses include product management, promotion, advertising, public relations, Phase 4 clinical trial costs, physician training and continuing medical education and administrative expenses. We adjust the timing, magnitude and targeting of our advertising, promotional, Phase 4 clinical trials and other commercial activities for our products based on seasonal trends and other factors, and accordingly, these costs can fluctuate from period to period.

General and Administrative Expenses

General and administrative expenses were approximately $6.2 million for the three months ended September 30, 2010, as compared to approximately $3.4 million for the same period in 2009.

The increase in general and administrative expenses of approximately $2.8 million, or 81%, for the three months ended September 30, 2010, as compared to the same period in 2009, was primarily due to an increase in (i) executive compensation expense associated with recent changes in management; (ii) consulting expenses, primarily associated with business development activities and; (iii) legal expenses associated with amending and restating our license, development and marketing agreement with Allergan. Furthermore, general and administrative expenses for the prior year period were reduced by a reimbursement of legal expenses of approximately $875,000 from our insurance carrier.

Our general and administrative expenses consist primarily of personnel, facility and related costs for general corporate functions, including business development, finance, accounting, legal, human resources, quality/compliance, facilities and information systems.

 

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Other Income/(Expense)

For the three months ended September 30, 2010, we incurred other expense, net of approximately $127,000, as compared to approximately $561,000 in other expense, net for the same period in 2009.

The decrease in other expense, net of approximately $434,000 for the three months ended September 30, 2010, as compared to the same period in 2009, was due to a decrease in interest expense. The decrease in interest expense is the result of a lower average outstanding principal balance of our term loan facility during the three months ended September 30, 2010, as compared to the same period in 2009.

Nine Months Ended September 30, 2010 and 2009

Revenues

Total revenues were approximately $76.1 million for the nine months ended September 30, 2010, as compared to approximately $62.5 million for the same period in 2009. The increase in 2010 revenue of approximately $13.6 million, or 22%, as compared to the same period in 2009, was due to an increase in product revenue from net sales of AzaSite, an increase in royalty revenue from net sales of Restasis and the full recognition of all co-promotion revenue from net sales of Elestat.

Product sales of AzaSite, net of sales deductions, for the nine months ended September 30, 2010 were approximately $29.5 million, as compared to approximately $22.8 million for the same period in 2009. The increase in revenue for AzaSite of approximately $6.7 million, or 29%, for the nine months ended September 30, 2010, as compared to the same period in 2009, was primarily due to increased patient usage of AzaSite and an increase in prescribers of AzaSite, as evidenced by an increase in prescriptions year-over-year, as well as price increases for the product between the periods. Additionally, approximately $1.0 million of revenue from net sales of AzaSite in the first quarter of 2010 was associated with hospital usage of AzaSite during a temporary supply shortage of erythromycin ophthalmic ointment. This compares to approximately $1.0 million to $1.5 million of revenue recognized in the third quarter of 2009 associated with hospital usage of AzaSite. The erythromycin ophthalmic ointment supply shortage began in the third quarter of 2009 and was resolved in the first quarter of 2010.

Our reserves related to rebates and discounts for the nine months ended September 30, 2010 were not significantly impacted by the new U.S. healthcare reform legislation passed in March 2010 and those provisions of the legislation that became effective during the first quarter of 2010. We do not expect our 2010 AzaSite revenues to be significantly impacted by the new legislation, however we do expect future sales of AzaSite to be impacted by the provisions of the new legislation that become effective in 2011.

Total co-promotion and royalty revenue for the nine months ended September 30, 2010 was approximately $46.6 million, comprised of approximately $32.7 million in royalty revenue from net sales of Restasis and approximately $13.9 million in co-promotion revenue from net sales of Elestat. This compares to approximately $39.7 million for the same period in 2009, comprised of approximately $26.4 million in royalty revenue from net sales of Restasis and approximately $13.3 million in co-promotion revenue from net sales of Elestat.

In August 2010, we amended and restated our agreement with Allergan. Under the amended and restated agreement, which runs through December 31, 2020, we are entitled to receive revenues at one global rate based on net sales of Restasis and any other human ophthalmic formulation of cyclosporine owned or controlled by Allergan, with no requirement to co-promote Restasis. The royalty rate for Restasis in the United States remains unchanged for 2010. The annual global rate steps down from the 2010 U.S. rate by three percentage points in 2011, a further 0.25 percentage point in 2013 and a final 0.50 percentage point in 2014, remaining at this level through the end of the term in 2020.

 

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For the nine months ended September 30, 2010 and 2009, Allergan recorded revenue from net sales of Restasis of approximately $446 million and $360 million, respectively.

For the nine months ended September 30, 2009, we deferred approximately $1.2 million of co-promotion revenue associated with net sales of Elestat as the minimum annual target level had not been achieved. Under our agreement with Allergan related to our co-promotion of Elestat, prior to 2010, we were obligated to meet predetermined minimum calendar year net sales target levels, which increased annually through 2009. We were entitled to an escalating percentage of net sales of Elestat based upon predetermined calendar year net sales target levels. Prior to January 1, 2010, we recognized product co-promotion revenue associated with targeted net sales levels for Elestat achieved during that time period and deferred revenue in excess of the sales level achieved. Under the co-promotion agreement with Allergan, calendar year 2009 was the last year that our co-promotion revenues of Elestat were subject to annual minimum target levels. Accordingly, beginning January 1, 2010, all co-promotion revenue from net sales of Elestat is recognized in the same period in which the sales occur.

During the third quarter of 2009, ISTA Pharmaceuticals, Inc. received FDA approval for BepreveTM (bepotastine besilate ophthalmic solution) 1.5% as a twice-daily prescription eye drop treatment for ocular itching associated with allergic conjunctivitis, and began marketing this product in October 2009.

Subject to applicable law, competitors are permitted to submit to the FDA an ANDA for a generic version of Elestat, due to the expiration of the marketing exclusivity period for Elestat provided under the Hatch-Waxman Act on October 15, 2008. We are aware that the following companies have filed an ANDA for a generic version of Elestat: Apotex, Inc., Cypress Pharmaceutical, Inc., Paddock Laboratories, Inc., PharmaForce, Inc. and Sandoz Inc. The date of submission of the first ANDA filing to the FDA Office of Generic Drugs was October 14, 2008, according to the FDA’s website (www.fda.gov).

The Elestat co-promotion agreement provides that unless earlier terminated, the term of such agreement will be in effect until the earlier of (i) the approval and launch of the first generic epinastine product after expiration of the FDA exclusivity period covering Elestat in the United States, or (ii) the approval and launch of the first over-the-counter epinastine product after expiration of the listing of Elestat in the FDA’s Orange Book. Following the termination of such co-promotion agreement, we will no longer have the right to co-promote Elestat. We will be entitled to receive post-termination payments from Allergan, based on any remaining net sales of Elestat for a period of 36 months. During the three successive 12-month periods immediately following the termination of the agreement, Allergan will be obligated to pay to us 20%, 15% and 10%, respectively, on any net sales of Elestat in the United States. We expect any revenue from net sales of Elestat received during this 36-month post-termination period to be minimal. We plan to continue co-promoting and receiving co-promotion revenues on Elestat sales during the FDA’s review period of these ANDAs. We do not know when the FDA will complete its review but we expect that a generic form of epinastine could be launched at any time. Loss of our co-promotion revenue from Elestat will significantly impact our results of operations and cash flows.

Our future revenue will depend on various factors including the effectiveness of our commercialization of AzaSite and continued commercial success and duration of commercial exclusivity of Restasis and Elestat. In addition to the foregoing, pricing, rebates, discounts and returns for all products; seasonality of sales of Elestat; the effect of competing products; coverage and reimbursement under commercial or government plans; and the recently passed healthcare reform legislation will impact future revenues. If Allergan significantly under-estimates or over-estimates rebate amounts, there could be a material effect on our revenue. In addition to the continuing sales of AzaSite, Restasis and Elestat, our future revenue will also depend on our ability to enter into additional collaboration agreements, and to achieve milestones under existing or future collaboration agreements, as well as whether we obtain regulatory approvals for our product candidates.

 

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Cost of Sales

Cost of sales related to the sales of AzaSite were approximately $10.4 million for the nine months ended September 30, 2010, as compared to approximately $7.3 million for the same period in 2009. The increase in cost of sales of approximately $3.1 million, or 43%, as compared to the same period in 2009, was primarily due to increased sales volume of AzaSite, which has resulted in increased royalties, as well as an increase in the royalty rate paid to InSite Vision. In July 2009, our royalty rate to InSite Vision on net sales of AzaSite increased from 20% to 25% in accordance with the terms of our licensing agreement, and will remain at 25% for the remaining term of the licensing agreement. Additionally, the increase in cost of sales during the nine months ended September 30, 2010 was due to recording a valuation reserve of approximately $449,000 to inventory, as a result of spoilage of API used to manufacture AzaSite.

Certain costs included in cost of sales are subject to annual increases for which we have limited control. We expect that cost of sales will increase in relation to, but not proportionately to, the increases in revenue from sales of AzaSite.

Research and Development Expenses

Research and development expenses were approximately $33.3 million for the nine months ended September 30, 2010, as compared to approximately $41.1 million for the same period in 2009.

The decrease in research and development expenses of approximately $7.8 million, or 19%, for the nine months ended September 30, 2010, as compared to the same period in 2009, was primarily due to the substantial completion of both our Phase 3 trial activities associated with our product candidate, Prolacria, for the treatment of dry eye and our Phase 2 trials researching AzaSite for the treatment of blepharitis in the first quarter of 2010, as well as completion of Phase 1 trial activities related to our glaucoma program in the third quarter of 2009. Additionally, we experienced cost savings due to our elimination of preclinical and drug discovery activities as a result of the restructuring that occurred in the first quarter of 2009. These decreases in expenses were partially offset by increased costs associated with our cystic fibrosis development program, including pre-launch development activities with Novasep associated with developing an additional and/or alternative commercial supplier of denufosol.

Our future research and development expenses will depend on the results and magnitude or scope of our clinical activities and requirements imposed by regulatory agencies. Year over year spending on active development programs can vary due to the differing levels and stages of development activity, the timing of certain expenses and other factors. Accordingly, our research and development expenses may fluctuate significantly from period to period. In addition, if we in-license or out-license rights to product candidates, our research and development expenses may fluctuate significantly from prior periods.

 

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Our research and development expenses for the nine months ended September 30, 2010 and 2009, and from the respective project’s inception are shown below and includes the percentage of overall research and development expenditures for the periods listed.

 

     (In thousands)  
     Nine Months Ended
September 30,
    

Cumulative from

Inception

        
     2010      %      2009      %      to September 30, 2010      %  

Denufosol tetrasodium for cystic fibrosis

   $ 26,363         79       $ 24,306         59       $ 120,733         30   

AzaSite for blepharitis

     1,802         5         4,519         11         8,182         2   

AzaSite (1)

     1,620         5         1,643         4         20,150         5   

Prolacria (diquafosol tetrasodium) for dry eye disease

     819         2         5,420         13         58,391         15   

INS115644 and INS117548 for glaucoma and related research and development

     198         1         1,461         4         16,645         4   

Other research, preclinical and development costs (2)

     2,527         8         3,775         9         173,203         44   
                                                     

Total

   $ 33,329         100       $ 41,124         100       $ 397,304         100   
                                                     

 

(1) Expenses in 2010 include costs associated with new bottle design and development activities.
(2) Prior to February 2009, other research, preclinical and development costs represent all unallocated research and development costs or those costs allocated to preclinical programs as well as costs of discontinued and/or inactive programs. These unallocated costs included personnel costs of our research, preclinical programs, internal and external general research costs and other internal and external costs of other research, preclinical and development programs. In February 2009, we restructured our operations eliminating our preclinical and molecule discovery activities.

Selling and Marketing Expenses

Selling and marketing expenses were approximately $38.4 million for the nine months ended September 30, 2010, as compared to approximately $36.1 million for the same period in 2009.

The increase in selling and marketing expenses of approximately $2.3 million, or 6%, for the nine months ended September 30, 2010, as compared to the same period in 2009, was primarily due to a general increase in personnel related expenses, as well as the timing of certain marketing activities.

Future selling and marketing expenses will depend on the level of our future commercialization activities. We expect selling and marketing expenses will increase in periods that immediately precede and follow product launches. In addition, if we in-license or out-license rights to products, our selling and marketing expenses may fluctuate significantly from prior periods.

General and Administrative Expenses

General and administrative expenses were approximately $24.5 million for the nine months ended September 30, 2010, as compared to approximately $11.5 million for the same period in 2009.

The increase in general and administrative expenses of approximately $13.0 million, or 114%, for the nine months ended September 30, 2010, as compared to the same period in 2009, was primarily due to an increase in executive compensation expense, the majority of which consisted of non-cash stock based compensation expense, associated with recent changes in management. Non-cash stock based compensation expense increased by

 

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approximately $5.1 million for the nine months ended September 30, 2010, as compared to the same period in 2009. In addition, there was an increase in consulting expenses, primarily associated with business and corporate development activities and the CEO transition, for the nine months ended September 30, 2010, as compared to the same period in 2009. Furthermore, general and administrative expenses for the prior year period were reduced by a reimbursement of legal expenses of approximately $875,000 from our insurance carrier.

Future general and administrative expenses will depend on the level and extent of support required to conduct our future research and development, commercialization, business development, and corporate activities.

Restructuring

In March 2009, we announced that we had restructured our operations, eliminating preclinical and drug discovery activities and refocusing our resources on the development of existing later-stage clinical programs and commercially available products. Significant components of the restructuring charge were one-time termination benefits for employees impacted by the restructuring, estimated costs to write-down idle lab equipment to net realizable value, losses associated with leased lab space that is now vacant, and costs to satisfy contract commitments related to activities and programs no longer associated with our supported programs and on-going operations. In connection with the restructuring, we recorded restructuring charges of approximately $2.0 million for the nine months ended September 30, 2009. As of December 31, 2009, all activities associated with the restructuring were substantially completed.

Other Income/(Expense)

For the nine months ended September 30, 2010, we incurred other expense, net of approximately $665,000, as compared to approximately $1.9 million in other expense, net for the same period in 2009.

The decrease in other expense, net of approximately $1.3 million for the nine months ended September 30, 2010, as compared to the same period in 2009, was due to a decrease in interest expense. The decrease in interest expense is the result of a lower average outstanding principal balance of our term loan facility during the nine months ended September 30, 2010, as compared to the same period in 2009.

Other income/(expense) fluctuates from year to year depending on the level of interest income earned on variable cash and investment balances, realized gains and losses on investments due to changes in fair market value and interest expense on debt. Future other income/(expense) will depend on our future cash and investment balances, the return and change in fair market value on these investments, as well as levels of debt and the associated interest rates.

LIQUIDITY AND CAPITAL RESOURCES

We have financed our operations primarily through the sale of equity securities, including private sales of preferred stock and public offerings of common stock and, to a lesser extent, through our term loan facility. We also currently receive product revenue from net sales of AzaSite, royalty revenue from net sales of Restasis, and co-promotion revenue from net sales of Elestat. We do not expect our revenue to exceed our operating expenses in 2010.

As of September 30, 2010, we had net working capital of approximately $78.7 million, a decrease of approximately $6.7 million from approximately $85.4 million at December 31, 2009. The decrease in working capital was principally due to the funding of normal operating expenses associated with commercialization activities and the development of our product candidates, as well as principal and interest payments on our term loan facility. Our principal sources of liquidity at September 30, 2010 were approximately $39.7 million in cash and cash equivalents, approximately $59.0 million in investments, which are considered available-for-sale, and approximately $23.1 million in trade receivables.

 

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In August 2009, we completed a public offering of 25,555,555 shares of our common stock at a price of $4.50 per share for gross proceeds of $115 million. Net proceeds were $109 million, after deducting underwriting discounts and offering expenses.

In December 2006, we entered into a loan and security agreement in order to obtain debt financing of up to $40.0 million to fund in-licensing opportunities and related development. In June 2007, we amended the loan and security agreement to enable us to draw upon a new supplemental term loan facility in the amount of $20.0 million. We have borrowed the full $60.0 million under the term loan facility of which $10.4 million remained outstanding as of September 30, 2010. We make scheduled principal and interest payments on a monthly basis and all loan advances made under the agreement have a final maturity date in March 2011. In addition, we are obligated to make a final payment of $1.2 million, equal to 2% of the original principal amount borrowed.

Our working capital requirements may fluctuate in future periods depending on many factors, including: the number, magnitude, scope and timing of our development programs; the commercial potential and success of our products; the potential loss of commercial exclusivity of any of our products; the loss of revenue from our products due to competition or loss of market share; the level of ongoing costs related to the commercialization of AzaSite and Elestat; the costs related to the potential FDA approval of our other product candidates; the cost, timing and outcome of regulatory reviews, regulatory investigations, and changes in regulatory requirements; the costs of obtaining patent protection for our product candidates; the timing and terms of business development activities; the rate of technological advances relevant to our operations; the timing, method and cost of the commercialization of our product candidates; the efficiency of manufacturing processes developed on our behalf by third parties; the level of required administrative support for our daily operations; the availability of capital to support product candidate development programs we pursue; and the commercial potential of our product candidates.

2010 Financial Guidance

Based upon current trends and assumptions, we expect to record 2010 aggregate revenue in the range of $100-$111 million. Co-promotion revenue from net sales of Elestat will be dependent upon the timing of a launch of a generic form of epinastine which could occur at any time. Total 2010 operating expenses are expected to be in the range of $145-$159 million. Cost of sales, which includes the amortization of the AzaSite approval milestone and royalty obligations to InSite Vision, is expected to be in the range of $13-$18 million. Total estimated selling and marketing and general and administrative expenses are estimated to be in the range of $48-$53 million and $27-$32 million, respectively. Research and development expenses are estimated to be in the range of $48-$60 million. Included within this operating expense guidance are projected stock-based compensation costs of approximately $8-$12 million.

Our ability to remain within our operating expense target range is subject to multiple factors, including unanticipated cost overruns, the need to expand or reduce the magnitude or scope of existing development programs, the need to change the number or timing of clinical trials, unanticipated regulatory requirements, unanticipated costs to successfully commercialize our products and product candidates, the commercial success of our current products and other factors described under the Risk Factors located elsewhere in this report.

Operating cash utilization in 2010 is expected to be in the range of $43-$53 million, revised from the prior guidance of $53-$65 million, which incorporates $20 million of principal repayment on our outstanding debt. Our need for additional working capital will largely be determined by the commercial success of our products and the successful and timely completion of our development programs. In order for us to continue operations substantially beyond 2011 we will need to: (1) successfully increase revenues, (2) obtain additional product candidate approvals, (3) out-license rights to certain of our product candidates, (4) raise additional capital through equity or debt financings or from other sources, (5) reduce spending on one or more research and development programs and/or (6) further restructure our operations.

 

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We currently have the ability to sell $150 million of securities, including common stock, preferred stock, debt securities, depositary shares and securities warrants from an effective shelf registration statement that we filed with the SEC on October 6, 2010.

The loan and security agreement that we entered into in December 2006, as amended in June 2007, contains a financial covenant that requires us to maintain certain levels of liquidity based on our cash, investment and account receivables balances, as well as negative covenants that may limit us from assuming additional indebtedness and entering into other transactions as defined in the agreement. The agreement also includes a subjective acceleration clause which provides our lenders with the ability to accelerate repayment, even if we are in compliance with all conditions of the agreement, upon a material adverse change to our business, properties, assets, financial condition or results of operations. At September 30, 2010, we were in compliance with all of the covenants under our loan and security agreement and project that we will be throughout 2010.

Off Balance Sheet Arrangements

On June 28, 2010, we entered into a lease for approximately 42,850 square feet in Raleigh, North Carolina, which we intend to use as our corporate headquarters. The term of the new lease commences on January 1, 2011 and ends on December 31, 2017.

CRITICAL ACCOUNTING POLICIES AND 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 generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. We evaluate our estimates, judgments and the policies underlying these estimates on a periodic basis, as situations change and regularly discuss financial events, policies, and issues with members of our audit committee and our independent registered public accounting firm. In addition, recognition of revenue from product co-promotion and earned royalties is affected by certain estimates and judgments made by Allergan on which we rely when recording this revenue. We routinely evaluate our estimates and policies regarding revenue recognition, product returns, rebates and incentives, inventory and manufacturing, taxes, stock-based compensation, research and development, marketing and other expenses and any associated liabilities.

We believe the following policies to be the most critical to an understanding of our financial condition and results of operations because they require us to make estimates and judgments about matters that are inherently uncertain.

Revenue Recognition

We record all of our revenue from: (1) sales of AzaSite; (2) product co-promotion activities and earned royalties; and (3) collaborative research agreements, when realized or realizable and earned. Revenue is realized or realizable and earned when all of the following criteria are met: (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred or services have been rendered; (iii) the seller’s price to the buyer is fixed or determinable; and (iv) collectibility is reasonably assured.

Product Revenues

We recognize revenue for sales of AzaSite when title and substantially all the risks and rewards of ownership have transferred to the customer, which generally occurs on the date of shipment to wholesalers and distributors. In the United States, we sell AzaSite to wholesalers and distributors, who, in turn, sell to pharmacies and federal, state and commercial health care organizations.

 

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Sales deductions consist of statutory rebates to state Medicaid, Medicare and other government agencies, contractual rebates with commercial managed care organizations, wholesaler chargebacks, sales discounts (including trade discounts and distribution service fees), allowances for coupon and voucher programs and product returns. These deductions are recorded as reductions to revenue from AzaSite in the same period as the related sales with estimates of future utilization derived from historical experience adjusted to reflect known changes in the factors that impact such reserves.

We utilize data from external sources to help us estimate our gross-to-net sales adjustments as they relate to the recognition of revenue for AzaSite sold. External sourced data includes, but is not limited to, information obtained from certain wholesalers with respect to their inventory levels and sell-through to customers, targeted surveys as well as data from IMS Health, a third-party supplier of market research data to the pharmaceutical industry. We also utilize this data to help estimate and identify prescription trends and patient demand, as well as product levels in the supply chain.

We account for these sales deductions in accordance with the Financial Accounting Standards Board, or FASB, authoritative guidance on revenue recognition when consideration is given by a vendor to a customer as well as when the right of return exists.

We have categorized and described more fully, the following significant sales deductions, all of which involve estimates and judgments which we consider to be critical accounting estimates, and require us to use information from external sources.

Rebates and Chargebacks

Statutory rebates to state Medicaid agencies and Medicare and contractual rebates to commercial managed care organizations are based on statutory or negotiated discounts to AzaSite’s selling price. As it can take up to nine months or more for information to be received on actual usage of AzaSite in managed care and Medicaid and other governmental programs as well as on the total discounts to be reimbursed, we maintain reserves for amounts payable under these programs relating to AzaSite sales.

Chargebacks claimed by wholesalers are based on the differentials between product acquisition prices paid by wholesalers and lower government contract pricing paid by eligible customers covered under federally qualified programs.

The amount of the reserve for rebates and chargebacks is based on multiple qualitative and quantitative factors, including the historical and projected utilization levels, historical payment experience, changes in statutory laws and interpretations as well as contractual terms, product pricing (both normal selling prices and statutory or negotiated prices), changes in prescription demand patterns and utilization of our product through private or public benefit plans, and the levels of AzaSite inventory in both the wholesale and retail distribution channel. Other factors that we may consider, if determined relevant, would include price changes from competitors and introductions of generics and/or competitive new products. We acquire prescription utilization data from IMS Health, a third-party supplier of market research data to the pharmaceutical industry. We apply these multiple factors, the quantitative historical data along with other qualitative aspects, such as management’s judgment regarding future utilization trends, to the respective period’s sales of AzaSite to determine the rebate accrual and related expense. We update our estimates and assumptions each period and record any necessary adjustments to our reserves. Settlements of rebates and chargebacks typically occur within nine months from point of sale. To the extent actual rebates and chargebacks differ from our estimates, additional reserves may be required or reserves may need to be reversed, either of which would impact current period product revenue. As of September 30, 2010 and December 31, 2009, reserves for rebates and chargebacks were $7.5 million and $3.5 million, respectively.

 

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Discounts and Other Sales Incentives

Discounts and other sales incentives consist of the following:

 

   

Prompt pay discounts — Prompt payment discounts are offered to all wholesalers in return for payment within 30 days following the invoice date. We record sales of AzaSite net of the discount amount based on historical experience. We adjust the reserve at the end of each reporting period to approximate the percentage discount applicable to the outstanding gross accounts receivable balances.

 

   

Inventory Management Agreement (“IMA”) Fees — Per contractual agreements with our largest wholesalers, we provide an IMA fee based on a percentage of their purchases of AzaSite. The IMA fee rates are set forth in the individual contracts. We track sales to these wholesalers each period and accrue a liability relating to the unpaid portion of these fees by applying the contractual rates to such sales.

 

   

Product coupons and vouchers — Product coupons and vouchers, made available by us online or through pharmacies and prescribing physicians, offer patients the ability to receive free or discounted product. We use a third-party administrator to coordinate program activities and who invoices us on a periodic basis for the cost of coupons and vouchers redeemed in the period. We base our estimates on the historical coupon and voucher redemption rate of similar programs.

As of September 30, 2010 and December 31, 2009, reserves for discounts and other sales incentives were $1.3 million and $889,000, respectively.

Product Returns

At the time of sale of AzaSite, we record product return allowances based on our estimate of the portion of sales that will be returned by our customers in the future. The return allowances are established in accordance with our returned goods policy. Our returned goods policy generally allows for returns of AzaSite within an 18-month period, from six months prior to the expiration date and up to 12 months following the expiration date, but may differ from customer to customer, depending on certain factors. Future estimated returns of AzaSite are based primarily on the return data for comparative products and our own historical experience with AzaSite. Historical return data on AzaSite is analyzed on a specific production lot basis. In determining our return allowance we also consider other relevant factors, including:

 

   

Levels of inventory in the distribution channel and any significant changes to these levels;

 

   

Estimated expiration date or remaining shelf life of inventory in the distribution channel;

 

   

Current and projected demand of AzaSite that could be impacted by introductions of generic products and/or introductions of competitive new products; and

 

   

Competitive product shortages, recalls and/or discontinuances.

Our estimates of the level of AzaSite inventory in the distribution channel is based on inventory data provided by wholesalers and third-party prescription data. As of September 30, 2010 and December 31, 2009, reserves for returns of AzaSite were $2.2 million and $1.5 million, respectively.

Product Co-promotion and Royalty Revenues

We recognize co-promotion revenue based on net sales of Elestat and royalty revenue based on net sales of Restasis, as defined in the applicable agreements, and as reported to us by Allergan. Our co-promotion and royalty revenues are based upon Allergan’s revenue recognition policy and other accounting policies over which we have limited or no control and on the underlying terms of our agreements. Allergan recognizes revenue from product sales when goods are shipped and title and risk of loss transfers to the customer. The agreements provide for gross sales to be reduced by estimates of sales returns, credits and allowances, normal trade and cash discounts, managed care sales

 

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rebates and other allocated costs as defined in the agreements, all of which are determined by Allergan and are outside our control. We record a percentage of Allergan’s reported net sales to us for Elestat and Restasis, as co-promotion revenue and royalty revenue, respectively. We receive monthly net sales information from Allergan and perform analytical reviews and trend analyses using prescription information that we receive from IMS Health. In addition, we exercise our audit rights under the contractual agreements with Allergan to annually perform an examination of Allergan’s sales records of both Restasis and Elestat. We make no adjustments to the amounts reported to us by Allergan other than reductions in net sales to reflect the incentive programs managed by us. We offer and manage certain incentive programs associated with Elestat, which are utilized by us in addition to those programs managed by Allergan. We reduce co-promotion revenue from net sales of Elestat by estimating the portion of sales that are subject to these incentive programs based on information reported to us by our third-party administrator of the incentive programs. The rebates associated with the programs we manage represent an insignificant amount, as compared to the rebate and discount programs administered by Allergan and as compared to our aggregate co-promotion and royalty revenue. Prior to January 1, 2010, under the co-promotion agreement for Elestat, we were obligated to meet predetermined minimum calendar year net sales target levels. If the annual minimum was not achieved, we recorded revenues using a reduced percentage of net sales based upon our level of achievement of the predetermined calendar year net sales target levels. Amounts receivable from Allergan in excess of recorded co-promotion revenue were recorded as deferred revenue. Calendar year 2009 was the last year in which there was a minimum annual net sales target level for Elestat under the co-promotion agreement. Accordingly, effective January 1, 2010, all co-promotion revenue from net sales of Elestat is recognized in the same period in which the sales occur.

Collaborative Research and Development Revenues

We recognize revenue under our collaborative research and development agreements when we have performed services under such agreements or when we or our collaborative partner have met a contractual milestone triggering a payment to us. We recognize revenue from research and development service agreements ratably over the estimated service period as related research and development costs are incurred and the services are substantially performed. Upfront non-refundable fees and milestone payments received at the initiation of collaborative agreements for which we have an ongoing research and development commitment are deferred and recognized ratably over the period in which the services are substantially performed. This period, if not defined in the collaborative agreement, is based on estimates by management and the progress towards agreed upon development events as set forth in our collaborative agreements. These estimates are subject to revision as our development efforts progress and we gain knowledge regarding required additional development. Revisions in the commitment period are made in the period that the facts related to the change first become known. If the estimated service period is subsequently modified, the period over which the upfront fee or revenue related to ongoing research and development services is modified on a prospective basis. We are also entitled to receive milestone payments under our collaborative research and development agreements based upon the achievement of agreed upon development events that are substantively at-risk by our collaborative partners or us. This collaborative research and development revenue is recognized upon the achievement and acknowledgement of our collaborative partner of a development event, which is generally at the date payment is received from the collaborative partner or is reasonably assured. Accordingly, our revenue recognized under our collaborative research and development agreements may fluctuate significantly from period to period. No collaborative research and development revenue was recognized for the nine months ended September 30, 2010 and 2009.

Inventories

Our inventories are related to AzaSite and are valued at the lower of cost or market using the first-in, first-out (i.e., FIFO) method. Cost includes materials, labor, overhead, shipping and handling costs. Our inventories are subject to expiration dating. We regularly evaluate the carrying value of our inventories and provide valuation reserves for any estimated obsolete, short-dated or unmarketable inventories. In addition, we may experience spoilage of our raw materials, which primarily consist of API. Our determination that a valuation reserve might be required, in addition to the quantification of such reserve, requires us to utilize significant judgment. We base our analysis, in part, on the level of inventories on hand in relation to our estimated forecast of product demand, production requirements for forecasted product demand, expected market conditions and the expiration dates or remaining shelf life of inventories. As of September 30, 2010 and December 31, 2009, we had net reserves of $250,000 and $25,000, respectively.

 

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Taxes

We account for uncertain tax positions in accordance with FASB authoritative guidance regarding the accounting for taxes. Significant management judgment is required in determining our provision for income taxes, deferred tax assets and liabilities and any valuation allowance recorded against net deferred tax assets. We have recorded a valuation allowance against all potential tax assets due to uncertainties in our ability to utilize deferred tax assets, primarily consisting of certain net operating losses carried forward, before they expire. The valuation allowance is based on estimates of taxable income in each of the jurisdictions in which we operate and the period over which our deferred tax assets will be recoverable.

Liabilities

We generally enter into contractual agreements with third-party vendors who provide research and development, manufacturing, and other services in the ordinary course of business. Many of these contracts are subject to milestone-based invoicing and services are completed over an extended period of time. We record liabilities under these contractual commitments when we determine an obligation has been incurred, regardless of the timing of the invoice. We monitor all significant research and development, manufacturing, sales and marketing and other service activities and the progression of work related to these activities. We estimate the underlying obligation for each activity based upon our estimate of the amount of work performed and compare the estimated obligation against the amount that has been invoiced. Because of the nature of certain contracts and related delay in the contract’s invoicing, the obligation to these vendors may be based upon management’s estimate of the underlying obligation. We record the larger of our estimated obligation or invoiced amounts for completed service. In all cases, actual results may differ from our estimate.

Stock-Based Compensation Expense

We recognize stock-based compensation expense in accordance with FASB authoritative guidance regarding the accounting for share-based payments, which requires us to measure compensation cost for share-based payment awards at fair value and recognize compensation expense over the service period for awards expected to vest. We utilize the Black-Scholes option-pricing model to value our awards and recognize compensation expense on a straight-line basis over the vesting periods of our awards. We consider many factors when estimating expected forfeitures, including types of awards, employee class, and historical experience. Our expected volatility is determined based on our own historical volatility. The estimation of share-based payment awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, such amounts will be recorded as a cumulative adjustment in the period estimates are revised. Significant management judgment is also required in determining estimates of future stock price volatility, forfeitures and expected life to be used in the valuation of the options. Actual results, and future changes in estimates, may differ substantially from our current estimates.

Impact of Inflation

We do not believe that our operating results have been materially impacted by inflation during the past three years. However, we cannot be assured that our operating results will not be adversely affected by inflation in the future. We will continually seek to mitigate the adverse effects of inflation on the costs of goods and services that we use through improved operating efficiencies and cost containment and periodic price increases for our product.

 

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Impact of Recently Issued Accounting Pronouncements

In April 2010, the FASB issued authoritative guidance on defining a milestone and determining when it may be appropriate to apply the milestone method of revenue recognition for research or development transactions. Consideration that is contingent on achievement of a milestone in its entirety may be recognized as revenue in the period in which the milestone is achieved only if the milestone is judged to meet certain criteria to be considered substantive. Milestones should be considered substantive in their entirety and may not be bifurcated. An arrangement may contain both substantive and nonsubstantive milestones, and each milestone should be evaluated individually to determine if it is substantive. The guidance is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those years, beginning on or after June 15, 2010, with early adoption permitted. We do not expect the adoption of this guidance to have a material impact on our condensed consolidated financial statements.

Healthcare Reform

In March 2010, Congress passed significant health reform legislation, the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act (collectively, “Affordable Care Act” or “ACA”). The legislation is designed to expand access to affordable health insurance through subsidies, Medicaid expansion, and insurance market reforms (including the development of new health benefit exchanges), financed in part through reduced federal health care spending. Among many other things, the ACA makes a number of significant changes affecting pharmaceutical manufacturers.

Although many provisions of the ACA do not take effect immediately, several provisions became effective in the first quarter of 2010. For instance, the ACA provides for increases to the minimum Medicaid rebate percentages from 15.1% to 23.1%, increased “additional rebates” for new formulations of brand name drugs, the establishment of a maximum rebate amount, and the extension of Medicaid rebates to Medicaid managed care organization utilization. In addition, the ACA broadens the definition of “average manufacturer price” effective October 1, 2010, which in turn may have the effect of increasing Medicaid rebate and Public Health Service section 340B drug discount program payment obligations.

Beginning in 2011, the ACA requires that drug manufacturers provide a 50% discount to Medicare beneficiaries whose prescription drug costs cause them to be subject to the Medicare Part D coverage gap. Also, beginning in 2011, we will be assessed our share of a new fee assessed on all branded prescription drug and biologics manufacturers and importers. This fee will be calculated based upon each organization’s percentage share of total branded prescription drug sales to U.S. government programs (such as Medicare, Medicaid and VA and PHS discount programs) made during the previous year.

The Obama Administration has issued guidance on certain aspects of implementation, including the manufacturer discount program for certain Medicare Part D drugs, which we are assessing. However, details on many other ACA policies have yet to be finalized, including how the annual fee on branded prescription drugs will be calculated and allocated in 2011. We do not expect the provisions that became effective in the first quarter of 2010 to have a significant financial impact on our 2010 revenues from AzaSite sales. We expect future AzaSite revenues to be impacted beginning in 2011 but are unable to adequately assess at this time the extent of the impact of provisions that have not yet gone into effect until additional operational details are available. There can be no assurance that the prescription drug user fees and other ACA provisions yet to be implemented will not impact our financial position.

 

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

We are subject to interest rate risk on our investment portfolio and borrowings under our term loan facility.

We invest in marketable securities in accordance with our investment policy. The primary objectives of our investment policy are to preserve capital, maintain proper liquidity to meet operating needs and maximize yields. Our investment policy specifies credit quality standards for our investments and limits the amount of credit exposure to any single issue, issuer or type of investment. Our investment portfolio may consist of a variety of securities, including U.S. government and agency obligations, money market and mutual fund investments, municipal and corporate notes and bonds and asset or mortgage-backed securities. As of September 30, 2010, cash equivalents consisted of $12.7 million in a money market account and $20.1 million in money market funds and $3.0 million in a U.S. agency security. Our investment portfolio as of September 30, 2010 consisted of corporate notes and bonds, commercial paper, U.S. Government and agency securities, and negotiated certificates of deposit and had an average maturity of less than 12 months, using the stated maturity. All of our cash, cash equivalents and investments are maintained at two banking institutions.

Our investment exposure to market risk for changes in interest rates relates to the increase or decrease in the amount of interest income we can earn on our portfolio, changes in the market value due to changes in interest rates and other market factors as well as the increase or decrease in any realized gains and losses. Our investment portfolio includes only marketable securities and instruments with active secondary or resale markets to help ensure portfolio liquidity and we have implemented guidelines limiting the duration of investments. At September 30, 2010, our portfolio of available-for-sale investments consisted of approximately $59.0 million of investments maturing within one year. In general, securities with longer maturities are subject to greater interest-rate risk than those with shorter maturities. A hypothetical 100 basis point drop in interest rates along the entire interest rate yield curve would not significantly affect the fair value of our interest sensitive financial instruments. We generally have the ability to hold our fixed-income investments to maturity and therefore do not expect that our operating results, financial position or cash flows will be materially impacted due to a sudden change in interest rates. However, our future investment income may fall short of expectations due to changes in interest rates, or we may suffer losses in principal if forced to sell securities which have declined in market value due to changes in interest rates or other factors, such as changes in credit risk related to the securities’ issuers.

We do not use interest rate derivative instruments to manage exposure to interest rate changes. We ensure the safety and preservation of invested principal funds by limiting default risk, market risk and reinvestment risk. We reduce default risk by investing in investment grade securities.

Our risk associated with fluctuating interest expense is limited to future capital leases and other short-term debt obligations we may incur in our normal operations. The interest rates on our debt borrowings under the term loan facility are fixed and as a result, interest due on borrowings are not impacted by changes in market-based interest rates.

Investment Risk

In addition to our normal investment portfolio, we have an investment in Parion Sciences, Inc. of $200,000 as of September 30, 2010. This investment is in the form of unregistered common stock and is subject to higher investment risk than our normal investment portfolio due to the lack of an active resale market for the Parion Sciences, Inc. securities.

Foreign Currency Exchange Risk

The majority of our transactions occur in U.S. dollars and we do not have subsidiaries or investments in foreign countries. Therefore, we are not subject to significant foreign currency exchange risk. We do, however, have foreign currency exposure with regard to the purchase of active pharmaceutical ingredients as they relate to AzaSite,

 

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which is manufactured by a foreign-based company, and activities currently ongoing at Novasep as part of developing an additional and/or alternative supplier for denufosol, both of which are payable in Euros. Additionally, future milestone payments due under the technology license agreement with Yamasa Corporation are payable in Japanese Yen. We have established policies and procedures for assessing market and foreign exchange risk. As of September 30, 2010, we did not have any foreign currency hedges.

 

Item 4. Controls and Procedures

Our management is responsible for establishing and maintaining an adequate system of internal control over our financial reporting. The design, monitoring and revision of the system of internal accounting controls involves, among other items, management’s judgments with respect to the relative cost and expected benefits of specific control measures. The effectiveness of the control system is supported by the selection, retention and training of qualified personnel and an organizational structure that provides an appropriate division of responsibility and formalized procedures. The system of internal accounting controls is periodically reviewed and modified in response to changing conditions. Internal audit consultants regularly monitor the adequacy and effectiveness of internal accounting controls. In addition to the system of internal accounting controls, management maintains corporate policy guidelines that help monitor proper overall business conduct, possible conflicts of interest, compliance with laws and confidentiality of proprietary information. Our Chief Executive Officer and Chief Financial Officer have reviewed and evaluated the effectiveness of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our current disclosure controls and procedures are effective.

No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the fiscal quarter ended September 30, 2010 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II: OTHER INFORMATION

 

Item 1A. Risk Factors.

RISK FACTORS

An investment in our common stock involves a substantial risk of loss. You should carefully read this entire report and should give particular attention to the following risk factors. You should recognize that other significant risks may arise in the future, which we cannot foresee at this time. Also, the risks that we now foresee might affect us to a greater or different degree than expected. There are a number of important factors that could cause our actual results to differ materially from those indicated by any forward-looking statements in this report. These factors include, without limitation, the risk factors listed below and other factors presented throughout this report and any other reports filed by us with the SEC.

Risks Related to Product Commercialization

Failure to adequately market and commercialize AzaSite will negatively impact our revenues.

The commercial success of AzaSite will depend on a number of factors, including:

 

   

Acceptance by patients and physicians;

 

   

Effectiveness of our sales and marketing efforts;

 

   

Ability to differentiate AzaSite relative to our competitors’ products;

 

   

Ability to further develop clinical information to support AzaSite;

 

   

Market satisfaction with existing alternative therapies;

 

   

Perceived efficacy relative to other available therapies;

 

   

Disease prevalence;

 

   

Cost of treatment;

 

   

Pricing and availability of alternative products, including generic or over-the-counter products;

 

   

Marketing and sales activities of competitors;

 

   

Shifts in the medical community to new treatment paradigms or standards of care;

 

   

Relative convenience and ease of administration;

 

   

The manufacturer’s successful sustaining of manufacturing capability; and

 

   

Our ability to enter into managed care and governmental agreements on favorable terms.

We are responsible for all aspects of the commercialization of this product, including the determination of formularies upon which AzaSite is listed, manufacturing, distribution, marketing and sales. The determination of formularies upon which AzaSite is listed, the discounts and pricing under such formularies, as well as the amount of time it takes for us to obtain favorable formulary status under various plans, will impact our commercialization efforts. Additionally, inclusion on certain formularies requires significant price concessions through rebate programs that impact the level of revenue that we receive. The need to give price concessions can be particularly acute where competing products are listed on the same formulary, such as the area of bacterial conjunctivitis. If AzaSite is not successfully commercialized, our revenues will be limited.

Under our agreement with InSite Vision, we are obligated to make pre-determined minimum annual royalty payments to InSite Vision. To the extent annual royalty payments actually paid to InSite Vision on our sales of AzaSite are less than the minimum annual royalty amounts established under our agreement with InSite Vision, we are obligated to pay the difference. In the event we are required to make annual minimum royalty payments, our profits with respect

 

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to AzaSite, if any, will be decreased or any losses with respect to the product will be increased. Such circumstances may result in us ceasing our commercialization of AzaSite and terminating our agreement with InSite Vision.

Under our agreement with the manufacturer of AzaSite, we are required to purchase a minimum number of units of AzaSite annually, regardless of our ability to sell AzaSite. If we are unable to sell the quantities of AzaSite that we are required to purchase, our inventory of the product will increase and the shelf life of the inventory will be adversely impacted. In such circumstances, we may be required to make price concessions to sell short-dated product or write-off and dispose of expired product, which may have an adverse affect on our AzaSite profitability.

If Restasis is not successfully commercialized by Allergan, our revenues will be negatively impacted.

Allergan is responsible for commercializing Restasis. Accordingly, our revenues on the net sales of Restasis are dependent on the actions and success of Allergan, over whom we have no control.

The manufacture and sale of Restasis is protected in the United States by a formulation patent that expires in May 2014. While a formulation patent may afford certain limited protection, a competitor may attempt to gain FDA approval for a cyclosporine product using a different formulation. Furthermore, following the expiration of the formulation patent in 2014, a generic form of Restasis could be introduced into the market. If and when Restasis experiences competition from a cyclosporine product, including generics, our revenues attributable to Restasis may be significantly impacted.

Other factors that could affect the commercialization of Restasis include:

 

   

Extent and effectiveness of Allergan’s sales and marketing efforts;

 

   

Satisfaction with existing alternative therapies, including generic or over-the-counter products;

 

   

Perceived efficacy relative to other available therapies;

 

   

Changes in, or the levels of, third-party reimbursement of product costs;

 

   

Coverage and reimbursement under Medicare Part D, state government sponsored plans and commercial plans;

 

   

Cost of treatment;

 

   

Development and FDA approval of competing dry eye products; and

 

   

Shifts in the medical community to new treatment paradigms or standards of care.

When a generic form of Elestat or an over-the-counter form of epinastine ophthalmic solution is introduced into the market, our agreement with Allergan to co-promote Elestat will no longer be in effect, and our revenues from sales of Elestat will be minimal.

Our Elestat co-promotion agreement with Allergan provides that unless earlier terminated, the term of such agreement will be in effect until the earlier of (i) the approval and launch of the first generic epinastine product after expiration of the FDA exclusivity period covering Elestat in the United States, or (ii) the approval and launch of the first over-the-counter epinastine product after expiration of the listing of Elestat in the FDA publication Approved Drug Products with Therapeutic Equivalence (commonly called the “Orange Book”). Following the termination of the co-promotion agreement, we will no longer have the right to co-promote Elestat. We will be entitled to receive post-termination payments from Allergan, based on any remaining net sales of Elestat for a period of 36 months. During the three successive 12-month periods immediately following the termination of the agreement, Allergan will be obligated to pay to us 20%, 15% and 10%, respectively, on any net sales of Elestat in the United States.

Subject to applicable law, competitors are permitted to submit to the FDA an ANDA for a generic version of Elestat, due to the expiration of the marketing exclusivity period for Elestat provided under the Hatch-Waxman Act on October 15, 2008. We are aware that the following companies have filed an ANDA for a generic version of Elestat: Apotex, Inc., Cypress Pharmaceutical, Inc., Paddock Laboratories, Inc., PharmaForce, Inc. and Sandoz Inc. The date of submission of the first ANDA filing to the FDA Office of Generic Drugs was October 14, 2008, according to the

 

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FDA’s website (www.fda.gov). Also, according to the FDA’s website, in June 2010, PharmaForce, Inc. received tentative approval for its epinastine hydrochloride ophthalmic solution.

The FDA’s review of an ANDA is a confidential process between the FDA and the applicable ANDA filer. We do not expect to be informed by the FDA, any ANDA filer or any other party regarding the status or timing of the review relating to any of the ANDA filings pertaining to a generic form of Elestat. The FDA may complete its review of the filed ANDAs at any time. As a result, we expect to be required to stop the co-promotion of Elestat with little, if any, advance notice. We believe it is likely that a generic form of epinastine may be launched at any time. The loss of co-promotion revenue from Elestat will significantly impact our results of operations and cash flows.

If we do not successfully market and promote Elestat, our revenues will be negatively impacted.

Notwithstanding the expected termination of the Elestat agreement upon the launch of a generic form of Elestat, our present revenues depend, in part, upon the continued acceptance of Elestat by eye care professionals, allergists and patients. Other factors that could affect the commercialization of Elestat include:

 

   

Satisfaction with existing alternative therapies, including therapies requiring only one dose per day;

 

   

Decreases in the size of the market for topical allergic conjunctivitis products;

 

   

Extent and effectiveness of our sales and marketing efforts;

 

   

Changes in, or the levels of, third-party reimbursement of product costs;

 

   

Coverage and reimbursement under Medicare Part D, state government sponsored plans and commercial plans;

 

   

Pricing and availability of alternative products, including generic or over-the-counter products; and

 

   

Marketing and sales activities of competitors.

We rely on third parties to distribute and sell our products and those third parties may not perform.

We are dependent on third parties to perform or assist us in the distribution or sale of AzaSite, and are dependent on third parties, primarily Allergan, to perform or assist us in the distribution and sale of Elestat. We rely on the services of a single source, third-party distributor to deliver AzaSite to our customers. In addition to the physical storage and distribution of AzaSite, this third-party distributor maintains and provides us with information and data with regard to our inventory, AzaSite orders, billings and receivables, chargebacks and returns, among others, on which our accounting estimates are based. If third parties do not successfully carry out their contractual duties in maximizing the commercial potential of our products, we may be required to hire or expand our own staff and sales force to compete successfully, which may not be possible. If third parties or Allergan do not perform, or assist us in performing these functions, or if there is a delay or interruption in the distribution of our products, it could have an adverse effect on product revenue, accounting estimates and our overall operations.

We depend on three pharmaceutical wholesalers for the vast majority of our AzaSite sales in the United States, and the loss of any of these wholesalers could negatively impact our revenues.

The prescription drug wholesaling industry in the United States is highly concentrated, with a vast majority of all sales made by three major full-line companies: Cardinal Health, McKesson Corporation and AmerisourceBergen. Greater than 85% of our AzaSite revenues come from sales to these three companies. The loss of any of these wholesalers could have a negative impact on our commercialization of AzaSite.

It is also possible that these wholesalers, or others, could decide to change their policies and fees in the future. This could result in or cause us to incur higher product distribution costs, lower margins or the need to find alternative methods of distributing our products. Such alternative methods may not be economically or administratively feasible.

If Diquas is not successfully launched and commercialized by Santen in Japan, we may not receive any royalty revenues with respect to the sales of such product.

 

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On April 16, 2010, the Japanese Ministry of Health, Labor and Welfare granted approval of Santen’s application for marketing of Diquas. Santen is solely responsible for commercializing Diquas in Japan. Accordingly, royalty revenues on the net sales of Diquas are dependent on the successful launch and commercialization efforts of Santen, over whom we have no control. Factors that could affect the launch and commercialization of Diquas include:

 

   

The receipt of pricing approval from the Japanese regulatory authorities;

 

   

The production of sufficient quantities of the product in order to facilitate the launch of the product and continuously supply the market;

 

   

The extent and effectiveness of Santen’s sales and marketing efforts; and

 

   

Satisfaction with existing alternative therapies, including generic or over-the-counter products.

Risks Related to Manufacture and Supply

If we are unable to contract with third parties for the manufacture of active pharmaceutical ingredients required for preclinical testing, for the manufacture of drug products for clinical trials, for the large-scale manufacture of any approved products, or for the manufacture of related devices, we may be unable to develop or commercialize our drug products.

The manufacturing of sufficient quantities of new products or product candidates is a time-consuming and complex process. We have no experience or capabilities to conduct the manufacture of any of our product candidates. In order to successfully commercialize AzaSite and continue to develop our product candidates, we need to contract or otherwise arrange for the necessary manufacturing services. There are a limited number of manufacturers that operate under the FDA’s cGMP regulations capable of manufacturing for us or our collaborators. We depend upon third parties for the manufacture of active pharmaceutical ingredients, or API, finished drug products for clinical trials, and for the manufacture of AzaSite. We expect to depend upon third parties for the large-scale manufacture of commercial quantities of any other approved product. This dependence may adversely affect our ability to develop and deliver such products on a timely and competitive basis. Similarly, our dependence on our partners to arrange for their own supplies of finished drug products may adversely affect our operations and revenues. If we, or our partners, are unable to engage or retain third-party manufacturers on a long-term basis or on commercially acceptable terms, our products may not be commercialized as planned, and the development of our product candidates could be delayed.

The manufacturing processes for our product candidates have not been validated at the scale required for commercial sales. Delays in scale-up to commercial quantities and any change at the site of manufacture could delay clinical trials, regulatory submissions and ultimately the commercialization of our products. In addition, manufacturing facilities are subject to an FDA inspection to confirm cGMP compliance prior to a product candidate’s potential NDA approval as well as ongoing post-approval FDA inspections to ensure continued compliance with cGMP regulations, over which we have no control.

We depend upon a third-party vendor to manufacture the nebulizer used with denufosol with whom we have no supply agreement. This vendor is responsible for managing the manufacturing process of the nebulizer in accordance with all applicable regulatory requirements. Any manufacture or regulatory compliance problems related to the manufacture of this device or any failure on the part of the manufacturer to supply the device (including discontinuation of the nebulizer) could delay product development or adversely affect regulatory approvals of denufosol.

 

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Reliance on a single party to manufacture and supply either finished product or the bulk active pharmaceutical ingredients for a product or product candidates could adversely affect us.

Under our agreements with Allergan, Allergan is responsible for the manufacture and supply of Restasis and Elestat. Allergan relies upon an arrangement with a single third party for the manufacture and supply of APIs for each of Restasis and Elestat. Allergan then completes the manufacturing process to yield finished product.

Under our supply agreement with InSite Vision, InSite Vision is responsible for supplying us with azithromycin, the API used in AzaSite. InSite Vision, in turn, relies upon an arrangement with a single third party for the manufacture and supply of such API. We are responsible for producing the finished product form of AzaSite, which is currently manufactured by a single party. There can be no assurance that such manufacturer will be able to continue to produce sufficient quantities of finished product in a timely manner to support the commercialization of AzaSite.

In the event a third-party manufacturer is unable to supply Allergan or InSite Vision (as the case may be), if such supply is unreasonably delayed, or if Allergan or our finished product contract partner are unable to complete the manufacturing cycle, sales of the applicable product could be adversely impacted, which would result in a reduction in any applicable product revenue. In addition, if Allergan or the third-party manufacturers do not maintain cGMP compliance, the FDA could require corrective actions or take enforcement actions that could affect production and availability of the applicable product, thus adversely affecting sales.

In addition, we rely upon supply agreements with third parties for the manufacture and supply of the bulk APIs for our product candidates for purposes of preclinical testing and clinical trials. We presently depend upon one vendor as the sole manufacturer of our clinical supply of API for denufosol. Delays in any aspect of implementing the manufacturing process could cause significant development delays and increased costs.

It would be time consuming and costly to identify and qualify new sources for manufacture of APIs or finished products. If our vendors were to terminate our arrangement or fail to meet our supply needs we might be forced to delay our development programs and/or be unable to supply products to the market, which could delay or reduce revenues and result in loss of market share.

We do not have a commercial supply agreement with a vendor for the manufacture of denufosol.

Yamasa Corporation is the manufacturer of the clinical supplies of denufosol. In addition, we have entered into a technical transfer and development agreement with Finorga S.A.S., acting in its own name and on behalf of Novasep Process, for the purpose of establishing and validating an additional and/or alternative source of supply for denufosol. We are in the process of negotiating arrangements with each of these vendors relating to the commercial supply of denufosol. We may not be able to enter into such arrangements with either of such parties on commercially acceptable terms, if at all.

A failure to negotiate commercial supply agreements on acceptable terms and in a timely manner could result in a delay in the launch of denufosol and adversely affect product sales.

Risks Related to Product Development

If the FDA does not conclude that our product candidates meet statutory requirements for safety and efficacy, we will be unable to obtain regulatory approval for marketing in the United States.

We have to conduct significant development activities, non-clinical and clinical tests and obtain regulatory approval before our product candidates can be commercialized. Product candidates that may appear to be promising at early stages of development may not successfully reach the market for a number of reasons. The results of preclinical and clinical testing of our product candidates under development may not necessarily indicate the results that will be

 

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obtained from later or more extensive testing. Additionally, companies in the pharmaceutical and biotechnology industries, including us, have suffered significant setbacks in advanced clinical trials, even after obtaining promising results in earlier clinical trials. Our ongoing clinical trials might be delayed or halted for various reasons, including:

 

   

The measure of efficacy of the drug is not statistically significant compared to placebo;

 

   

Patients experience severe side effects or serious adverse events during treatment;

 

   

Patients die during the clinical trial because their disease is too advanced or because they experience medical problems that may or may not relate to the drug being studied;

 

   

Patients do not enroll in the clinical trials at the rate we expect;

 

   

We decide to modify the drug or the clinical trial protocol during testing;

 

   

Our commercial partners, or future commercial partners, delay, amend or change our development plan or strategy; and

 

   

We allocate our limited financial and other resources to other clinical and preclinical programs.

Changes in regulatory policy or new regulations as well as clinical investigator misconduct could also result in delays or rejection of our applications for approval of our product candidates. Clinical investigator misconduct that raises questions about the integrity of data in one or more applications (e.g., fraud, bribery, omission of a material fact, gross negligence) could be used by the FDA as grounds to suspend substantive scientific review of all pending marketing applications until the data in question have successfully undergone a validity assessment. Product candidates that fail validity assessments must be withdrawn from FDA review or, if the drug is an approved, marketed product, such product must be removed from the market.

Additionally, the introduction of our products in foreign markets will subject us to foreign regulatory clearances, the receipt of which may be unpredictable, uncertain and may impose substantial additional costs and burdens which we or our partners in such foreign markets may be unwilling or unable to fund. As with the FDA, foreign regulatory authorities must be satisfied that adequate evidence of safety and efficacy of the product has been presented before marketing authorization is granted. The foreign regulatory approval process includes all of the risks associated with obtaining FDA marketing approval. Approval by the FDA does not ensure approval by other regulatory authorities, nor does approval by any foreign regulatory authority ensure approval by the FDA.

Since some of our clinical candidates utilize new or different mechanisms of action and in some cases there may be no regulatory precedents, conducting clinical trials and obtaining regulatory approval may be difficult, expensive and prolonged, which would delay any commercialization of our products.

To complete successful clinical trials, our product candidates must demonstrate safety and provide substantial evidence of efficacy. The FDA generally evaluates efficacy based on the statistical significance of a product candidate meeting predetermined clinical endpoints. The design of clinical trials to establish meaningful endpoints is done in collaboration with the FDA prior to the commencement of clinical trials. We establish these endpoints based on guidance from the FDA, including FDA guidance documents applicable to establishing the efficacy, safety and tolerability measures required for approval of products. However, since some of our product candidates utilize new or different mechanisms of action, the FDA may not have established guidelines for the design of our clinical trials and may take longer than average to consider our product candidates for approval. The FDA could change its view on clinical trial design and establishment of appropriate standards for efficacy, safety and tolerability and require a change in clinical trial design, additional data or even further clinical trials before granting approval of our product candidates. We could encounter delays and increased expenses in our clinical trials if the FDA concludes that the endpoints established for a clinical trial do not adequately predict a clinical benefit.

We are developing denufosol, a novel ion channel regulator, as an inhaled product candidate for the treatment of cystic fibrosis. The FDA has not published guidance on the drug approval process associated with such a product candidate. Furthermore, we are not aware of any FDA-approved product that addresses the underlying ion transport defect in the lungs of patients with cystic fibrosis. We cannot predict or guarantee the outcome or timing of our Phase 3 program for denufosol for cystic fibrosis. A significant amount of work will be required to advance denufosol

 

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through clinical testing, including satisfactory completion of additional clinical trials and other studies. We may later decide to change the focus or timing of our Phase 3 program. Our TIGER-2 clinical trial for denufosol for cystic fibrosis may not be successful or unexpected safety concerns may emerge that would negatively change the risk/benefit profile for this product candidate.

We have initiated a Phase 2 development program to evaluate the use of AzaSite for the treatment of blepharitis. The FDA has not published guidelines on the approval of a product for the treatment of blepharitis. Furthermore, to date, no prescription product has been approved by the FDA for the treatment of blepharitis. The FDA may require that we evaluate the product in relation to different primary and/or secondary clinical endpoints than those being used presently. This may require us to undertake additional Phase 2 clinical trials, which could lead to increased costs and program delays.

The FDA has not published guidelines on the approval of a product for the treatment of dry eye disease. In order to gain approval, it will be necessary to undertake at least one additional Phase 3 clinical trial in support of our NDA for Prolacria. There can be no guarantee that any such additional clinical trial would be successful or that the FDA would approve Prolacria even if such additional clinical trial was successful.

We may need to develop alternate dosing regimens for our product candidates.

In order to achieve broad market acceptance of our product candidates, we may need to develop, alone or with others, alternate dosing regimens and methods for administering our products. For example, in our current clinical trials, denufosol for the treatment of cystic fibrosis is administered by a standard nebulizer three times per day, but clinical data from our TIGER-1 clinical trial indicated that patients in that study administered the drug only 2.7 times per day, on average. Patients may prefer a smaller, more portable device or less frequent dose administration. Development of a smaller more portable device for denufosol would require compliance with regulations that differ from drug regulations, including the need for a new full clinical development program and the submission of a new NDA, if we believe that the new clinical program supports authorization for the drug and the related device. Compliance with such requirements would increase the cost of development.

Similar challenges may exist in identifying and developing appropriate and convenient dosing and methods of administration for our other product candidates. If the number of doses, or the method of dosing, is not convenient, patients may not use our product. Furthermore, if patients use our products at a dosing level that is less than the dosing level tested in our clinical trials, the drug may not be efficacious or may be less efficacious. In such cases, the patient may look for alternative therapies.

Estimated development costs are difficult to project and may change frequently prior to regulatory approval.

The number and type of studies that may be required by the FDA, or other regulatory authorities, for a particular compound are based on the compound’s clinical profile compared to existing therapies for the targeted patient population. While all new compounds require standard regulated phases of testing, the actual type and scope of testing can vary significantly among different product candidates and as a result, creates additional complexity when estimating program costs. Factors that affect the costs of a clinical trial include:

 

   

The number of patients required to participate in clinical trials to demonstrate statistical significance for a drug’s safety and efficacy and the number and geographical location of clinical trial sites necessary to enroll such patients;

 

   

The time required to enroll the targeted number of patients in clinical trials, which may vary depending on the size and availability of the targeted patient population and the perceived benefit to the clinical trial participants; and

 

   

The number and type of required laboratory tests supporting clinical trials.

 

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Additionally, ongoing development programs and associated costs are subject to frequent, significant and unpredictable changes due to a number of factors, including:

 

   

Data collected in preclinical or clinical trials may prompt significant changes, delays or enhancements to an ongoing development program;

 

   

Commercial partners and the underlying contractual agreements may require additional or more involved clinical or preclinical activities;

 

   

The FDA or other regulatory authorities may direct the sponsor to change or enhance its ongoing development program based on developments in the testing of similar compounds or related compounds;

 

   

Unexpected regulatory requirements, changes in regulatory policy or review standards, or interim reviews by regulatory agencies may cause delays or changes to development programs; and

 

   

Anticipated manufacturing costs may change significantly due to necessary changes in manufacturing processes, variances from anticipated manufacturing process yields or changes in the cost and/or availability of starting materials, and other costs to ensure the manufacturing facility is in compliance with cGMP requirements and is capable of consistently producing the product candidate in accordance with established specifications submitted to the FDA.

The occurrence of any of these factors may result in significant disparities in total costs required to complete the respective development programs.

Clinical trials may take longer to complete and cost more than we expect, which would adversely affect our ability to commercialize product candidates and achieve profitability.

Clinical trials are expensive and are often lengthy. They require appropriate identification of optimal treatment regimens and relevant patient population, adequate supplies of drug product, monitoring and auditing, and sufficient patient enrollment. Patient enrollment is a function of many factors, including:

 

   

The size and availability of the relevant patient population;

 

   

The nature of the protocol;

 

   

The proximity of patients to clinical sites;

 

   

The eligibility criteria for the clinical trial;

 

   

The perceived benefit of participating in a clinical trial; and

 

   

Approval of the Institutional Review Board.

Delays in patient enrollment can result in increased costs and longer development times. Even if we successfully complete clinical trials, we may not receive regulatory approval for the product candidate. In addition, if the FDA or foreign regulatory authorities require additional clinical trials, we could face increased costs and significant development delays.

We are conducting portions of our TIGER-2 clinical trial in Canada, Australia and New Zealand and are therefore subject to the risks and uncertainties of doing business internationally. Disruptions in communication and transportation, changes in governmental policies, and currency exchange rates, among other factors, may affect the time and costs required to complete these clinical trials.

Clinical trials and clinical trial results must be posted on a public, government run database, which provides competitors with information about our commercial plans to our disadvantage.

The FDA Amendments Act of 2007 requires drug and device companies to list all clinical trials to inform patients of the existence and eligibility requirements for clinical trials. Prior to the enactment of this law, such information was considered confidential and exempt from public disclosure. In addition, this law requires companies

 

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to post on a government run public database, www.clinicaltrials.gov, the results of all clinical trials. Clinical trial results, including results that were not required to be submitted to the FDA, also had been considered confidential. Such material could provide our competitors with information about drug development very early in the development process, thus giving competitors a possible advantage in developing their own marketing strategy.

If we fail to reach milestones or to make annual minimum payments or otherwise breach our obligations under our license agreements, our licensors may terminate our agreements with them and seek additional remedies.

If we fail to meet payment obligations, performance milestones relating to the timing of regulatory filings, development and commercial diligence obligations, fail to make milestone payments in accordance with applicable provisions, or fail to pay the minimum annual payments under our respective licenses, our licensors may terminate the applicable license. As a result, our development of the respective product candidate or commercialization of the product would cease.

Risks Related to Governmental Regulation

Failure to comply with all applicable regulations, including those that require us to obtain and maintain governmental approvals for our product candidates, may result in fines, corrective actions, administrative sanctions and restrictions, including the withdrawal of a product from the market.

Pharmaceutical companies are subject to significant regulation by a number of local, state, and federal governmental agencies, including the FDA. Such regulations and their authorizing statutes are amended from time to time. There are laws and regulations that govern areas including financial controls, clinical trials, testing, manufacturing, labeling, safety, packaging, shipping, distribution, post-approval safety surveillance, marketing, and promotion of pharmaceuticals, including those governing interactions with prescribers and health care professionals in a position to prescribe, recommend, or arrange for the provision of our products. Failure to comply with applicable regulatory requirements could, among other things, result in warning letters, fines, corrective actions, administrative sanctions, suspensions or delays of product manufacture or distribution or both, product recalls, delays in marketing activities and sales, withdrawal of marketing approvals, and civil or criminal sanctions including seizure of product, court-ordered injunction, and possible exclusion from eligibility for federal government contracts payment of our products by Medicare, Medicaid, and other third-party payors.

After initial regulatory approval, the manufacturing and marketing of drugs, including our products, are subject to continuing FDA and foreign regulatory review. The FDA requires drug manufacturers and distributors to monitor the safety of a drug after it is approved and marketed. We are required to document and investigate reports of adverse events and report serious adverse events to the FDA. Additionally, the FDA encourages health professionals to report significant adverse events associated with products. The FDA may require additional clinical studies, known as Phase 4 studies, to evaluate product safety effects. In addition to studies required by the FDA after approval, we may conduct our own Phase 4 studies to explore the use of the approved drug product for treatment of new indications or to broaden our knowledge of the product. The subsequent discovery of previously unknown problems with a product’s safety or efficacy as a result of these studies or as reported in their prescribed use may result in the implementation of an FDA-required risk evaluation and mitigation strategy known as REMS, restrictions through labeling changes, or withdrawal of the product from the market.

The FDA periodically inspects drug manufacturing facilities to ensure compliance with applicable cGMP regulations. Failure to comply with statutory and regulatory requirements subjects the manufacturer to possible legal or regulatory action, such as suspension of manufacturing, seizure of product or court-ordered injunction, which could include mandatory recall of a product. Before taking such actions, the FDA may first issue one or more notices of compliance deficiencies. Such notices include inspectional observations on Form FDA-483, warning letters, and other untitled written correspondence; however, the FDA may also take action without such notice in situations of egregious noncompliance or where public safety is at risk. The FDA may also request us to take actions voluntarily or we may initiate actions ourselves such as recalls or suspension of manufacturing to ensure compliance with cGMP regulations.

 

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Additional authority to take post-approval actions was given to the FDA under the FDA Amendments Act of 2007. The FDA is authorized to revisit and change its prior determinations if new information raises questions about our product’s safety profile. The FDA is authorized to impose additional post-marketing requirements, such as development of a risk evaluation and mitigation strategy which could include additional monitoring of post-approval adverse events, providing additional patient safety information, and adding warnings, precautions, and other safety information to the labeling. Failure to implement such requirements could result in corrective actions, fines, withdrawal of marketing approval, or any combination of such actions.

In its regulation of drug product advertising and promotional activities, the FDA may issue correspondence to pharmaceutical companies alleging that its advertising, promotional materials or activities are false or misleading and requesting corrective actions to remove and mitigate claims made in such materials. Pharmaceutical advertising and promotional activity must be true, fairly balanced between benefits and risks, provide adequate risk information, and be within the labeled indications. Drug manufacturers are prohibited from promoting unapproved, investigational drug products, and any approved and marketed drug product for a use that is not on the approved labeling; however, healthcare professionals are free to use the product for any use that, in the judgment of the healthcare professional, may be appropriate for any individual patient. The FDA and the Office of the Inspector General (“OIG”) in the Department of Health and Human Services (“HHS”) have the power to impose a wide array of sanctions on companies for advertising practices that are found to be false or misleading, do not include adequate risk information, or promote an unapproved or off-label use and, if we were to receive correspondence from the FDA or the OIG alleging such practices, it may be necessary for us to:

 

   

Incur substantial expenses, including fines, penalties, legal fees and costs to conform to the FDA’s limits on such promotion;

 

   

Change our methods of marketing, promoting and selling products;

 

   

Take corrective action, which could include placing advertisements or sending letters to physicians correcting statements made in previous advertisements or promotions; or

 

   

Disrupt the distribution of products and stop sales until we are in compliance with the FDA’s interpretation of applicable laws and regulations.

Medicare prescription drug coverage legislation and legislative or regulatory reform of the health care system may affect our or our partners’ ability to sell products profitably.

In both the United States and some foreign jurisdictions, there have been a number of legislative and regulatory changes to the health care system that could affect our ability to sell our products profitably. In the United States, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 established a voluntary Medicare outpatient prescription drug benefit under Part D of the Social Security Act. The program, which went into effect January 1, 2006, is administered by the Centers for Medicare & Medicaid Services within HHS and is implemented and operated by private sector Part D plan sponsors. Each participating drug plan is permitted by regulation to develop and establish its own unique drug formulary that may exclude certain drugs from coverage and impose prior authorization and other coverage restrictions, and negotiate payment levels with drug manufacturers that may be lower than reimbursement levels available through private health plans or other payers. Moreover, beneficiary co-insurance requirements can vary, which could influence which products are recommended by physicians and selected by patients. The federal government can be expected to continue to issue guidance and regulations regarding the obligations of Part D sponsors under the program, and as discussed below, Congress recently enacted specific Part D changes to be implemented in the future.

Allergan is responsible for the implementation of the Medicare Part D program as it relates to Restasis and Elestat and has contracted with Part D plan sponsors to cover such drugs under the Part D benefit. We are responsible for contracting with Part D plan sponsors with respect to AzaSite. There is no assurance that any drug that we co-promote or sell will be covered by drug plans participating under the Medicare Part D program or, if covered, what the terms of any such coverage will be, or that the drugs will be reimbursed at amounts that reflect current or historical payment levels. Our results of operations could be materially adversely affected by the reimbursement changes

 

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associated with the Medicare prescription drug program or by changes in the formularies or price negotiations with Part D drug plans. To the extent that private insurers or managed care programs follow Medicare coverage and payment developments, the adverse effects of lower Medicare payment may be magnified by private insurers adopting similar lower payment.

Our products also can be impacted by state and federal legislative and regulatory changes in Medicaid reimbursement policy and in mandated levels of Medicaid drug rebates paid by pharmaceutical manufacturers. In March 2010, Congress passed significant health reform legislation, the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act (collectively, “ACA”). The legislation is designed to expand access to affordable health insurance through subsidies, Medicaid expansion, and insurance market reforms (including the development of new health benefit exchanges), financed in part through reduced federal health care spending.

Among many other things, the ACA makes a number of significant changes affecting pharmaceutical manufacturers. For instance, the ACA provides for increases to the minimum Medicaid rebate percentages from 15.1% to 23.1%, increased “additional rebates” for new formulations of brand name drugs, the establishment of a maximum rebate amount, and the extension of Medicaid rebates to Medicaid managed care organization utilization. In addition, the ACA broadens the definition of “average manufacturer price”, which in turn may have the effect of increasing Medicaid rebate and Public Health Service section 340B drug discount program payment obligations. Likewise, many states are facing serious budgetary pressures that could lead to adoption of additional cost-containment measures, including provisions aimed at reducing Medicaid drug prices. There can be no assurances that new state policies will not lower Medicaid reimbursement levels for our products.

The ACA also requires drug manufacturers to provide a 50% discount on brand-name prescriptions filled in the Medicare Part D “coverage gap”. The legislation also provides a $250 payment to Part D beneficiaries who reach the coverage gap during 2010, and mandates the gradual elimination of the coverage gap, beginning in 2011 and finishing in 2020. Moreover, the ACA reduces Part D premium subsidies for higher-income beneficiaries, expands medication therapy management requirements, and makes a number of other revisions to Part D program requirements. In addition, the ACA: extends the 340B program to additional entities, expands oversight of the 340B program, and increases manufacturer reporting requirements; creates an Independent Payment Advisory Board to develop recommendations to reduce Medicare spending under certain circumstances, with such recommendations to go into effect automatically unless Congress adopts alternative savings; expands public disclosure requirements regarding drug manufacturer financial arrangements with physicians; and establishes a licensure pathway for generic versions of biologics. Further, beginning in 2011, manufacturers and importers of branded prescription drugs and biologics will be assessed an annual “fee” ($2.5 billion in 2011 and increasing amounts in subsequent years up to $4.2 billion in 2018 and $2.8 billion annually thereafter), with individual company allocations to be determined by the Secretary of the Treasury, based generally on market share. There can be no assurances that implementation of the new health reform legislation will not have an adverse impact on revenues, as well as reimbursement and/or coverage of our products. Likewise, the potential for adoption of health care reform or other cost-control proposals on a state-by-state basis could impact our reimbursement levels and require us to develop state-specific marketing and sales approaches. Further, a number of states require disclosure of financial arrangements with physicians, marketing expenditures, and the like, and other states may do so in the future; our failure to comply with these as well as the federal disclosure requirements could have an adverse impact.

Congress also has enacted the American Recovery and Reinvestment Act, which included a major expansion of federal efforts to compare the effectiveness of different medical treatments, including pharmaceuticals, which eventually could impact Medicare and private payer coverage and payment policies. This comparative effectiveness initiative was expanded by the ACA, and can include studies regarding the comparative clinical effectiveness of drugs. The federal government may consider additional proposals that could lead to coverage or reimbursement constraints and restrictions on access to certain products. We cannot predict the outcome of such initiatives, and it is difficult to predict the impact on our business of future legislative and regulatory changes.

 

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We are subject to “fraud and abuse” and similar government laws and regulations, and a failure to comply with such laws and regulations, or an investigation into our compliance with such laws and regulations, or a failure to prevail in any litigation related to noncompliance, could harm our business.

We are subject to multiple state and federal laws pertaining to health care fraud and abuse. Pharmaceutical pricing, sales, and marketing programs and arrangements, and related business practices in the health care industry generally are under increasing scrutiny from federal and state regulatory, investigative, prosecutorial, and administrative entities. Many health care laws, including the federal and state anti-kickback laws and federal and state statutory and common law false claims laws, have been construed broadly by the courts and permit government entities to exercise considerable discretion. Further, ACA contains a number of provisions strengthening the scope of the federal laws, including making a violation under the federal anti-kickback law a predicate action for violation of the federal False Claims Act, and expanding the authority for Medicaid exclusions. Further, ACA provides that a person need not have actual knowledge of the anti-kickback law, among others, or a specific intent to commit a violation of the law, to be found in violation of it. The ACA also applies the False Claims Act to payments made through new health benefits exchanges if the payments include any federal funds. In the event that government entities believed that wrongdoing had occurred, such entities could institute civil, administrative, or criminal proceedings which, if instituted and resolved unfavorably, could subject us to substantial fines, penalties, and injunctive and administrative remedies, including exclusion from government reimbursement programs. We cannot predict whether investigations or enforcement actions would affect our marketing or sales practices. Any such result could have a material adverse impact on our results of operations, cash flows, financial condition, and our business. Such investigations and enforcement actions could be costly, divert management’s attention from our business, and result in damage to our reputation. We cannot guarantee that measures that we have taken to prevent violations, including our corporate compliance program, will protect us from future violations, lawsuits or investigations by governmental entities or private whistleblowers. If any such actions are instituted against us, and we are not successful in defending ourselves or asserting our rights, those actions could have a significant negative impact on our business, including the imposition of significant fines or other sanctions.

Failure to adequately ensure compliance with applicable laws and regulations may subject us to whistleblower and government actions.

In recent years, pharmaceutical companies have been the targets of extensive whistleblower actions in which the person bringing the action alleges violations of the federal civil False Claims Act or its state equivalent, including allegations that manufacturers aided and abetted in the submission of false claims. These actions have focused on such areas as pricing practices, off-label product promotion, sales and marketing practices, and improper relationships with physicians and other health care professionals, among others. The ACA eliminates a number of jurisdictional bars to bringing a false claims action, and therefore may make it easier for whistleblowers to bring successful actions. If our relationships with health care professionals and/or our promotional or other activities fail to comply with applicable laws, regulations or guidelines, we may be subject to warnings from, or investigative or enforcement action by, regulatory and other federal or state governmental authorities. The potential ramifications are far-reaching if there are areas identified as out of compliance by regulatory agencies and governmental authorities including, but not limited to, significant financial penalties, manufacturing and clinical trial consent decrees, commercialization restrictions, exclusion from government programs, product recalls or seizures, the imposition of corporate integrity agreements and deferred prosecution agreements, or other restrictions and litigation. Furthermore, there can be no assurance that we will not be subject to a whistleblower or other state or federal investigative or enforcement action at some time in the future. Even an unsuccessful challenge to our operations or activities could prove costly and divert management’s attention.

 

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Risks Associated with Our Business and Industry

If we do not receive timely regulatory approvals of our product candidates and successfully launch such products, we may need substantial additional funds to support our expanding capital requirements.

We have used substantial amounts of cash to fund our research and development and commercial activities. Our operating expenses were approximately $106.6 million for the nine months ended September 30, 2010 and approximately $129.8 million for the year ended December 31, 2009, respectively. Our cash, cash equivalents and investments totaled approximately $99.5 million on September 30, 2010. Based on current operating plans, we expect our cash and investments to provide liquidity beyond 2011.

We expect that our capital and operating expenditures will continue to exceed our revenue over the next several years as we conduct our research and development and commercial activities. Many factors will influence our future capital requirements, including:

 

   

The number, breadth and progress of our research and development programs;

 

   

The level of activities relating to commercialization of our products;

 

   

The ability to attract collaborators for our products and establish and maintain those relationships;

 

   

Achievement of milestones under our existing or future collaborations and licensing agreements;

 

   

Progress by our collaborators with respect to the development of product candidates;

 

   

Competing technological and market developments;

 

   

The timing and terms of any business development activities;

 

   

The timing and amount of debt repayment requirements;

 

   

The costs involved in defending any litigation claims against us;

 

   

The costs involved in responding to government, the Financial Industry Regulatory Authority, Inc., or other applicable investigations against us; and

 

   

The costs involved in enforcing patent claims and other intellectual property rights.

In addition, our capital requirements will depend upon:

 

   

The level of sales generated for AzaSite;

 

   

The receipt of revenue from Allergan on net sales of Restasis;

 

   

The timing of the introduction of a generic form of Elestat;

 

   

The receipt of revenue from wholesalers and other customers on net sales of AzaSite;

 

   

The receipt or payment of milestone payments under our current collaborative agreements and any future collaborations;

 

   

The ability to obtain approval from the FDA for our product candidates; and

 

   

Payments from existing and future collaborators.

In the event that we do not receive timely regulatory approvals, we may need substantial additional funds to fully develop, manufacture, market and sell all of our other potential products and support our on-going product commercialization and co-promotion efforts. We may seek such additional funding through public or private equity offerings and debt financings. Additional financing may not be available when needed. If available, such financing may not be on terms favorable to us or our stockholders. Our stockholders’ ownership will be diluted if we raise additional capital by issuing equity securities. If we are required to raise funds through future collaborations and licensing arrangements, we may have to give up rights to our technologies or product candidates or grant licenses on unfavorable terms. If adequate funds are not available, we would have to scale back or terminate research programs and product development and we may not be able to successfully commercialize any product candidate.

 

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Our co-promotion and royalty revenues are based, in part, upon Allergan’s revenue recognition policy and other accounting policies over which we have limited or no control.

We recognize co-promotion revenue based on Allergan’s net sales of Elestat and royalty revenue based on Allergan’s net sales of Restasis, as defined in the agreements and as reported to us by Allergan. Accordingly, our co-promotion and royalty revenues are based upon Allergan’s revenue recognition policy and other accounting policies over which we have limited or no control and the underlying terms of our agreements. Allergan’s filings with the SEC indicate that Allergan maintains disclosure controls and procedures in accordance with applicable laws, which are designed to provide reasonable assurance that the information required to be reported by Allergan in its Exchange Act filings is reported timely and in accordance with applicable laws, rules and regulations. We are not entitled to review Allergan’s disclosure controls and procedures. All of our co-promotion and royalty revenues are currently derived from Allergan’s net sales of Restasis and Elestat as reported to us by Allergan. We are unable to provide complete assurance that Allergan will not revise reported revenue amounts in the future. If Allergan’s reported revenue amounts were inaccurate, it could have a material impact on our financial statements, including financial statements for previous periods.

Revenues in future periods could vary significantly and may not cover our operating expenses.

Our revenues may fluctuate from period to period due in part to:

 

   

The timing of the introduction of a generic form of Elestat;

 

   

Fluctuations in future sales of AzaSite, Restasis and Elestat due to competition, the intensity of an allergy season, disease prevalence, manufacturing difficulties, reimbursement and pricing under commercial or government plans, seasonality, or other factors that affect the sales of a product;

 

   

Deductions from gross sales relating to estimates of sales returns, credits and allowances, normal trade and cash discounts, managed care sales rebates and other allocated costs;

 

   

The duration of market exclusivity of AzaSite and Restasis;

 

   

The timing of approvals, if any, for other possible future products;

 

   

The progress toward and the achievement of developmental milestones by us or our partners;

 

   

The initiation of new contractual arrangements with other companies; and

 

   

The failure or refusal of a collaborative partner to pay royalties or milestone payments.

Inventory levels of AzaSite held by wholesalers can also cause our operating results to fluctuate unexpectedly. Although we attempt to monitor wholesaler inventory of our products, we rely upon information provided by third parties to quantify the inventory levels maintained by wholesalers. In addition, we and the wholesalers may not be effective in matching inventory levels to end-user demand. Significant differences between actual and estimated inventory levels and product demand may result in (1) inadequate or excessive (i) inventory production, (ii) product supply in distribution channels, or (iii) product availability at the retail level, and (2) unexpected increases or decreases in orders from our major customers. Any of these events may cause our revenues to fluctuate significantly from quarter to quarter, and in some cases may cause our operating results for a particular quarter to be below expectations.

If we are unable to make the scheduled principal and interest payments on our term loan facility or maintain minimum liquidity levels or compliance with other debt covenants as defined in the loan and security agreement, we may default on our debt.

As of September 30, 2010, we had net borrowings under our term loan facility of approximately $10.4 million. Our term loan facility is collateralized by substantially all of our assets, except for our intellectual property, but including all accounts, license and royalty fees and other revenues and proceeds arising from our intellectual property. Under the agreement, we are required to maintain minimum liquidity levels based on the balance of the outstanding advances. The agreement also includes a subjective acceleration clause that provides our lenders with the ability to accelerate repayment, even if we are in compliance with all conditions of the agreement, upon a material adverse

 

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change to our business, properties, assets, financial condition or results of operations. The agreement may affect our operations in several ways, including the following:

 

   

A portion of our cash flow from operations will be dedicated to the payment of the principal and interest on our indebtedness;

 

   

Our future cash flow may be insufficient to meet our required principal and interest payments;

 

   

We may need to raise additional capital in order to remain in compliance with the loan covenants;

 

   

Our ability to enter into certain transactions (including incurrences of indebtedness) may be limited; and

 

   

We may need to delay or reduce planned expenditures for clinical trials as well as other development and commercial activities if our current operations are not sufficient enough to service our debt.

Events of default under the loan and security agreement are not limited to, but include the following:

 

   

Payment default;

 

   

Covenant default;

 

   

A material adverse change in our business operations;

 

   

Breach of our agreements with Allergan; and

 

   

Judgments against us over a specified dollar amount.

In case of an uncured default, the following actions may be taken against us by the lending institutions:

 

   

All outstanding obligations associated with the term loan facility would be immediately due and payable;

 

   

Any of our balances and deposits held by the lending institutions would be applied to the obligation;

 

   

Balances and accounts at other financial institutions could be “held” or exclusive control could be transferred to the lending institutions; and

 

   

All collateral, as defined in the agreement, could be seized and disposed of.

If we continue to incur operating losses for a period longer than anticipated, or in an amount greater than anticipated, we may be unable to continue our operations.

We have experienced significant losses since inception. We incurred net losses of approximately $31.2 million for the nine months ended September 30, 2010 and approximately $40.0 million for the year ended December 31, 2009. As of September 30, 2010, our accumulated deficit was approximately $431.6 million. We currently expect to incur operating losses over the next several years. We expect that losses will fluctuate from quarter to quarter and that such fluctuations may be substantial. Such fluctuations will be affected by the timing and level of the following:

 

   

Commercialization activities to support AzaSite and Elestat;

 

   

Revenues from Restasis;

 

   

Regulatory approvals of our product candidates;

 

   

Patient demand for our products and any licensed products;

 

   

Payments to and from licensors and corporate partners;

 

   

Research and development activities;

 

   

Investments in new technologies and product candidates; and

 

   

The costs involved in defending any litigation claims against, or government investigations of, us.

To achieve and sustain profitable operations, we must, alone or with others, develop successfully, obtain regulatory approval for, manufacture, introduce, market and sell our products. The time frame necessary to achieve market success is long and uncertain. We may not generate sufficient product revenues to become profitable or to

 

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sustain profitability. If the time required to achieve profitability is longer than we anticipate, we may not be able to continue our operations.

The current stock market and credit market conditions are extremely volatile and unpredictable. It is difficult to predict whether these conditions will continue or worsen, and, if so, whether the conditions would impact us and whether such impact could be material.

We have exposure to many different industries and counterparties, including commercial banks, investment banks and customers (which include wholesalers, managed care organizations and governments) that may be unstable or may become unstable in the current economic environment. Any such instability may impact these parties’ ability to fulfill contractual obligations to us or they might limit or place burdensome conditions upon future transactions with us. Customers may also reduce spending during times of economic uncertainty. Also, it is possible that suppliers may be negatively impacted. If such events were to occur, there could be a resulting material and adverse impact on our operations and results of operations.

We may decide to access the equity or debt markets to meet capital or liquidity needs. However, the constriction and volatility in these markets may restrict our future flexibility to do so when such needs arise. Further, recent economic conditions have resulted in severe downward pressure on the stock and credit markets, which could reduce the return available on invested corporate cash, which if severe and sustained could have a material and adverse impact on our results of operations and cash flows.

Our dependence on collaborative relationships may lead to delays in product development, lost revenues and disputes over rights to technology.

Our business strategy depends to some extent upon the formation of research collaborations, licensing and/or marketing arrangements. We currently have collaboration agreements with several collaborators, including Allergan, InSite Vision and Santen. The termination of any collaboration will result in the loss of any unmet development or commercial milestone payments, may lead to delays in product development and disputes over technology rights, and may reduce our ability to enter into collaborations with other potential partners. In the event we breach an agreement with a collaborator, the collaborator is entitled to terminate our agreement with them in the event we do not cure the breach within a specified period of time, which is typically 60 or 90 days from the notice date. With respect to the Allergan collaboration, in the event we become an affiliate of a third party that manufactures, markets or sells any then currently promoted prescription ophthalmic product, Allergan will have the right to terminate our Elestat co-promotion agreement, which right must be exercised within 3 months of the occurrence of such event. If we do not maintain our current collaborations, or establish additional research and development collaborations or licensing arrangements, it will be difficult to develop and commercialize potential products. Any future collaborations or licensing arrangements may not be on terms favorable to us.

Our current or any future collaborations or licensing arrangements ultimately may not be successful. Under our current strategy, and for the foreseeable future, we do not expect to develop or market products outside North America without a collaborative partner or outside our therapeutic areas of focus. We are currently considering the out-licensing of certain rights related to our cystic fibrosis program. We may be unsuccessful in out-licensing this program or we may be forced to out-license this program on terms that are not favorable to us.

It may be necessary in the future for us to obtain additional licenses to avoid infringement of third-party patents. Additionally, we may enter into license arrangements with other third parties as we build our product portfolio. We do not know the terms on which such licenses may be available, if at all.

We will continue to depend on collaborators and contractors for the preclinical study and clinical development of therapeutic products and for manufacturing and marketing of potential products. Our agreements with collaborators typically allow them some discretion in electing whether to pursue such activities. If any collaborator were to breach or terminate its agreement with us or otherwise fail to conduct collaborative activities in a timely and successful manner, the clinical development or commercialization of product candidates or research programs would be delayed or

 

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terminated. Any delay or termination in clinical development or commercialization would delay or eliminate potential product revenues relating to our product candidates.

Disputes may arise in the future over the ownership of rights to any technology developed with collaborators. These and other possible disagreements between us and our collaborators could lead to delays in the collaborative development or commercialization of products. Such disagreements could also result in litigation or require arbitration to resolve.

Failure to hire and retain key personnel may hinder our product development programs and our business efforts.

We depend on the principal members of our management and scientific staff, including Adrian Adams, our President and Chief Executive Officer and a director, and Thomas R. Staab, II, our Chief Financial Officer and Treasurer. If these people leave us, we may have difficulty conducting our operations. Our future success will depend in part on our ability to attract, hire or appoint, and retain additional personnel skilled or experienced in the pharmaceutical industry. There is significant competition for such qualified personnel and we may not be able to attract and retain such personnel.

We may not be able to successfully compete with other biotechnology companies and established pharmaceutical companies.

The biotechnology and pharmaceutical industries are intensely competitive and subject to rapid and significant technological change. There are many companies seeking to develop products for the same indications that we are working on. Our competitors in the United States and elsewhere are numerous and include, among others, major multinational pharmaceutical and chemical companies and specialized biotechnology firms.

Most of these competitors have greater resources than we do, including greater financial resources, larger research and development staffs and more experienced marketing and manufacturing organizations. In addition, most of our competitors have greater experience than we do in conducting clinical trials and obtaining FDA and other regulatory approvals. Accordingly, our competitors may succeed in obtaining FDA or other regulatory approvals for product candidates more rapidly than we do. Companies that complete clinical trials, obtain required regulatory approvals, and commence commercial sale of their drugs before we do may achieve a significant competitive advantage, including patent and FDA marketing exclusivity rights that would delay our ability to market products. Drugs resulting from our research and development efforts, or from our joint efforts with our collaborative partners, may not compete successfully with competitors’ existing products or products under development.

Our competitors may also develop technologies and drugs that are safer, more effective, or less costly than any we are developing or which would render our technology and future drugs obsolete and non-competitive. In addition, alternative approaches, such as gene therapy, in treating diseases that we have targeted, such as cystic fibrosis, may make our product candidates obsolete.

If our intellectual property protection is inadequate, the development and any possible sales of our product candidates could suffer or competitors could force our products completely out of the market.

Our business and competitive position depends on our ability to continue to develop and protect our products and processes, proprietary methods and technology and to prevent others from infringing on our patents, trademarks and other intellectual property rights. Upon the expiration or loss of patent protection for a product, we or our applicable collaborative partners may lose a significant portion of sales of that product in a short period of time as other companies manufacture generic forms of the previously protected product or manufacture similar products at lower cost, without having had to incur significant research and development costs in formulating the product. Therefore, our future financial success may depend in part on our and our partners obtaining patent protection for technologies incorporated into our products. We cannot be assured that such patents will be issued, or that any existing or future patents will be of commercial benefit. In addition, it is impossible to anticipate the breadth or degree of protection that

 

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any such patents will afford, and we cannot be assured that any such patents will not be successfully challenged in the future. If we are unsuccessful in obtaining or preserving patent protection, or if any of our products rely on unpatented proprietary technology, we cannot be assured that others will not commercialize products substantially identical to those products. We also believe that the protection of our trademarks is an important factor in product recognition and in our ability to maintain or increase market share. If we do not adequately protect our rights in our various trademarks from infringement, their value to us could be lost or diminished, seriously impairing our competitive position. Moreover, the laws of certain foreign countries do not protect our intellectual property rights to the same extent as the laws of the United States.

Certain of our patents are use patents containing claims covering methods of treating disorders and diseases by administering therapeutic chemical compounds. Use patents may provide limited protection for commercial efforts in the United States, but may afford a lesser degree of protection, if any, in other countries due to their patent laws. Besides our use patents, we have patents and patent applications covering compositions (new chemical compounds), pharmaceutical formulations and processes for manufacturing our new chemical compounds. Many of the chemical compounds included in the claims of our use patents and process applications were known in the scientific community prior to our patent applications. None of our composition patents or patent applications covers these previously known chemical compounds, which are in the public domain. As a result, competitors may be able to commercialize products that use the same previously known chemical compounds used by us for the treatment of disorders and diseases not covered by our use patents. Such competitors’ activities may reduce our revenues.

Third parties may challenge, invalidate or circumvent our patents and patent applications relating to our products, product candidates or technologies at any time. If we must defend a patent suit, or if we choose to initiate a suit to have a third-party patent declared invalid, or allege infringement of our patents, we may need to make considerable expenditures of money and expend considerable management time in litigation. We believe that there is significant litigation in the pharmaceutical and biotechnology industry regarding patent and other intellectual property rights. A patent does not provide the patent holder with freedom to operate in a way that infringes the patent rights of others. We may be accused of patent infringement at any time. A judgment against us in a patent infringement action could cause us to pay monetary damages, require us to obtain licenses, or prevent us from manufacturing or marketing the affected products. In addition, we may need to initiate litigation to enforce our proprietary rights against others. Initiation of litigation may result in considerable expenditures of money and management time and may result in our patents being declared invalid. Further, we may need to participate in interference proceedings in the U.S. Patent and Trademark Office, or USPTO, to determine the priority of invention of any of our technologies.

Our ability to develop sufficient patent rights in our pharmaceutical, biopharmaceutical and biotechnology products to support commercialization efforts is uncertain and involves complex legal and factual questions. For instance, the USPTO examiners may not allow our claims in examining our patent applications. If we have to appeal a decision to the USPTO’s Appeals Board for a final determination of patentability, we could incur significant legal fees. Lengthy and uncertain patent prosecutions, including the utilization of the appeals process, can add uncertainty, delay and expense to the process of obtaining intellectual property rights for our products, and as such may add delay and uncertainty to the development program for any such product.

Use of our products may result in product liability claims for which we may not have adequate insurance coverage.

Manufacturing, marketing and sale of our products or conducting clinical trials of our product candidates may expose us to liability claims from the use of those products and product candidates. Product liability claims could result in the imposition of substantial liability on us, a recall of products, or a change in the indications for which they may be used. Although we carry product liability insurance and clinical trial liability insurance, we, or our collaborators, may not maintain sufficient insurance to cover these potential claims. We do not have the financial resources to self-insure and it is unlikely that we will have these financial resources in the foreseeable future. If we are unable to protect against potential product liability claims adequately, we may find it difficult or impossible to continue to commercialize our products or the product candidates we develop. If claims or losses exceed our liability insurance coverage, there could be a resulting material adverse effect on our business.

 

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Insurance coverage is increasingly more costly and difficult to obtain or maintain.

While we currently have insurance for our business, property, directors and officers, and our products, insurance is increasingly more costly and narrower in scope, and we may be required to assume more risk in the future. If we are subject to claims or suffer a loss or damage in excess of our insurance coverage, we will be required to share that risk in excess of our insurance limits. If we are subject to claims or suffer a loss or damage that is outside of our insurance coverage, we may incur significant uninsured costs associated with loss or damage that could have an adverse effect on our operations and financial position. Furthermore, any claims made on our insurance policies may impact our ability to obtain or maintain insurance coverage at reasonable costs or at all.

Risks Related to Our Stock

Our common stock price has been volatile and your investment in our stock may decline in value.

The market price of our common stock has been volatile. These fluctuations create a greater risk of capital losses for our stockholders as compared to less volatile stocks. Factors that have caused volatility and could cause additional volatility in the market price of our common stock include among others:

 

   

Announcements made by us concerning results of clinical trials with our product candidates;

 

   

Announcements regarding the commercialization of AzaSite;

 

   

Announcements regarding potential FDA approval (or lack thereof) of denufosol or any of our product candidates;

 

   

Market acceptance and market share of AzaSite, Restasis and Elestat;

 

   

The timing of the introduction of a generic form of Elestat;

 

   

Duration of market exclusivity of AzaSite and Restasis;

 

   

Volatility in other securities including pharmaceutical and biotechnology securities;

 

   

Changes in government regulations;

 

   

Regulatory actions and/or investigations;

 

   

Changes in the development priorities of our collaborators that result in changes to, or termination of, our agreements with such collaborators;

 

   

Developments concerning proprietary rights including patents by us or our competitors;

 

   

Variations in our operating results;

 

   

FDA approval of other treatments for the same indication as any one of our product candidates;

 

   

Business development activities; and

 

   

Litigation.

Extreme price and volume fluctuations occur in the stock market from time to time that can particularly affect the prices of biotechnology companies. These extreme fluctuations are sometimes unrelated to the actual performance of the affected companies.

Warburg is able to exercise substantial control over our business.

Warburg Pincus Private Equity IX, L.P., or Warburg, holds 22,907,488 shares of our common stock, which represented approximately 28% of our outstanding common stock as of September 30, 2010. Warburg and its affiliates may acquire the lesser of: (x) 32.5% of our voting securities on a fully diluted basis and (y) 34.9% of our then outstanding voting securities, without triggering the provisions of our stockholder rights plan. Warburg has the right to designate one person for election to our Board of Directors for so long as Warburg owns a significant percentage of our securities. Pursuant to this right, Jonathan S. Leff serves as a Class C member of the Board of Directors. Pursuant to a Securities Purchase Agreement, dated July 17, 2007, for so long as Warburg owns at least 10% of the shares of

 

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common stock issued upon the exchange of Exchangeable Preferred Stock it acquired in July 2007, it will have subscription rights to acquire a pro rata amount of future issuances of equity securities by us, subject to certain exceptions. As a result of the foregoing, Warburg is able to exercise substantial influence over our business, policies and practices.

Our existing principal stockholders hold a substantial amount of our common stock and may be able to influence significant corporate decisions, which may conflict with the interest of other stockholders.

As of September 30, 2010, our current 5% and greater stockholders (which includes Warburg) and their affiliates beneficially owned approximately 43% of our outstanding common stock. These stockholders, if they act together, may be able to influence the outcome of matters requiring approval of the stockholders, including the election of our directors and other corporate actions such as:

 

   

a merger or corporate combination with or into another company;

 

   

a sale of substantially all of our assets; and

 

   

amendments to our certificate of incorporation.

The decisions of these individual stockholders may conflict with our interests or those of our other stockholders.

Future sales and issuances of securities may dilute the ownership interests of our current stockholders and cause our stock price to decline.

Future sales of our common stock by current stockholders into the public market could cause the market price of our stock to fall. As of September 30, 2010, there were 82,840,320 shares of our common stock outstanding. We may from time to time issue securities in relation to a license arrangement, collaboration, merger or acquisition.

In addition, on October 6, 2010, we filed with the SEC a shelf registration statement on Form S-3. This shelf registration statement has been declared effective and allows us to sell up to $150 million of securities, including common stock, preferred stock, debt securities, depositary shares and securities warrants, from time to time at prices and on terms to be determined at the time of sale.

As of September 30, 2010, there were 14,073,122 stock options and restricted stock units outstanding and 7,894,810 shares available for issuance under our Amended and Restated 2010 Equity Compensation Plan and equity compensation grants outside such plan. The shares underlying existing stock options and restricted stock units and possible future stock options, stock appreciation rights and stock awards have been registered pursuant to registration statements on Form S-8.

If some or all of such shares are sold or otherwise issued into the public market over a short period of time, our current stockholders’ ownership interests may be diluted and the value of all publicly traded shares is likely to decline, as the market may not be able to absorb those shares at then-current market prices. Additionally, such sales and issuances may make it more difficult for us to sell equity securities or equity-related securities in the future at a time and price that our management deems acceptable, or at all.

Our Rights Agreement, the provisions of our Change in Control Severance Benefit Plans, the anti-takeover provisions in our Amended and Restated Certificate of Incorporation, as amended, and Amended and Restated Bylaws, standstill agreements, and our right to issue preferred stock, may discourage a third party from making a take-over offer that could be beneficial to us and our stockholders and may make it difficult for stockholders to replace our Board of Directors and effect a change in our management if they desire to do so.

In October 2002, we entered into a Rights Agreement with Computershare Trust Company. The Rights Agreement could discourage, delay or prevent a person or group from acquiring 15% or more of our common stock. The Rights Agreement provides that if a person acquires 15% or more of our common stock without the approval of

 

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our Board of Directors, all other stockholders will have the right to purchase securities from us at a price that is less than its fair market value, which would substantially reduce the value of our common stock owned by the acquiring person. As a result, our Board of Directors has significant discretion to approve or disapprove a person’s efforts to acquire 15% or more of our common stock. In connection with the transaction with Warburg, we and Computershare entered into a First Amendment to Rights Agreement which provides that Warburg and its affiliates will be exempt from the definition of an “Acquiring Person” under the Rights Agreement, unless Warburg or certain of its affiliates becomes the beneficial owner of the lesser of: (x) 32.5% of our voting securities on a fully diluted basis and (y) 34.9% of our then outstanding voting securities. In addition to Warburg’s ability to exercise substantial control over our business, the First Amendment to Rights Agreement could further discourage, delay or prevent a person or group from acquiring 15% or more of our common stock. As part of the same transaction with Warburg, we entered into a standstill agreement, dated July 20, 2007, pursuant to which Warburg and certain of its affiliates agreed for three years not to increase their holdings of our common stock beyond the levels described above in the First Amendment to Rights Agreement. On August 4, 2009, we amended the standstill agreement to extend its term until August 4, 2012.

Our employees are covered under Change in Control Severance Benefit Plans which provide severance benefits in the event they are terminated after a change in control. In addition, the Company’s Executive Employment Agreements with Mr. Adams, our President and Chief Executive Officer, and Mr. Koven, our Executive Vice President and Chief Administrative and Legal Officer, provide for severance benefits in the event of a change of control. These arrangements would increase the acquisition costs to a purchasing company that triggers the change in control provisions and as a result, may discourage, delay or prevent a change in control.

Our Amended and Restated Certificate of Incorporation and Amended and Restated Bylaws contain provisions which could discourage, delay or prevent a third party from acquiring shares of our common stock or replacing members of our Board of Directors. Our Amended and Restated Certificate of Incorporation allows our Board of Directors to issue shares of preferred stock. Our Board of Directors can determine the price, rights, preferences and privileges of those shares without any further vote or action by the stockholders. As a result, our Board of Directors could make it difficult for a third party to acquire a majority of our outstanding voting stock. Since management is appointed by the Board of Directors, any inability to effect a change in the Board of Directors may result in the entrenchment of management.

Our Amended and Restated Certificate of Incorporation also provides that the members of the Board will be divided into three classes. Each year, the terms of approximately one-third of the directors will expire. Our Amended and Restated Bylaws include director nomination procedures and do not permit our stockholders to call a special meeting of stockholders. The staggering of directors’ terms of office, the director nomination procedures and the inability of stockholders to call a special meeting may make it difficult for stockholders to remove or replace the Board of Directors should they desire to do so. The director nomination requirements include a provision that requires stockholders give advance notice to our Secretary of any nominations for director or other business to be brought by stockholders at any stockholders’ meeting. Our directors may be removed from our Board of Directors only for cause. These provisions may discourage, delay or prevent changes of control or management, either by third parties or by stockholders seeking to change control or management.

In the ordinary course of our business, from time to time we discuss possible collaborations, licenses and other transactions with various third parties, including pharmaceutical companies and biotechnology companies. When we deem it appropriate, we enter into standstill agreements with such third parties in relation to the discussions. These standstill agreements, several of which may be in force from time-to-time, typically prohibit such parties from acquiring our securities for a period of time.

We are also subject to the anti-takeover provisions of Section 203 of the Delaware General Corporation Law. Under these provisions, if anyone becomes an “interested stockholder,” we may not enter a “business combination” with that person for three years without special approval, which could discourage a third party from making a take-over offer and could delay or prevent a change of control. For purposes of Section 203, “interested stockholder” means, generally, someone owning 15% or more of our outstanding voting stock or an affiliate of ours that owned 15% or more of our outstanding voting stock during the past three years, subject to certain exceptions as described in Section

 

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203. In connection with our prior sale of stock to Warburg, we agreed to waive Warburg’s acquisition of securities from the provisions of Section 203 of the Delaware General Corporation Law.

 

Item 6. Exhibits

See the Exhibit Index located at the end of this Quarterly Report on Form 10-Q.

 

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SIGNATURES

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

 

  Inspire Pharmaceuticals, Inc.
Date: November 5, 2010   By:  

/s/ Adrian Adams

    Adrian Adams
    President & Chief Executive Officer
    (principal executive officer)
Date: November 5, 2010   By:  

/s/ Thomas R. Staab, II

    Thomas R. Staab, II
    Chief Financial Officer & Treasurer
    (principal financial and
    chief accounting officer)

 

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EXHIBIT INDEX

 

Exhibit
No.

  

Description of Exhibit

  3.1    Amended and Restated Certificate of Incorporation (Incorporated by reference to Exhibit 99.2 to the Company’s Current Report on Form 8-K filed on June 8, 2010).
  3.2    Amended and Restated Bylaws (Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on December 18, 2007).
10.1*    Amended and Restated License, Development and Marketing Agreement, dated August 19, 2010, between Inspire Pharmaceuticals, Inc. and Allergan, Inc., Allergan Sales, LLC and Allergan Pharmaceuticals Holdings (Ireland) Ltd.
10.2    Stock Option Agreement between Inspire Pharmaceuticals, Inc. and Charles A. Johnson, dated September 15, 2010.
10.3    Restricted Stock Unit Agreement between Inspire Pharmaceuticals, Inc. and Charles A. Johnson, dated September 15, 2010.
31.1    Certification of the President & Chief Executive Officer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
31.2    Certification of the Chief Financial Officer & Treasurer pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934.
32.1    Certification of the President & Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2    Certification of the Chief Financial Officer & Treasurer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

* Confidential treatment has been requested with respect to a portion of this Exhibit.