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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended September 30, 2012

 

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

For the transition period from              to             

Commission File No. 000 – 51967

 

 

TRANSCEPT PHARMACEUTICALS, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Delaware   33-0960223

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification Number)

1003 W. Cutting Blvd., Suite #110

Pt. Richmond, California

  94804
(Address of principal executive offices)   (Zip Code)

(510) 215-3500

Registrant’s telephone number, including area code

 

 

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

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

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

 

Large accelerated filer    ¨    Accelerated filer    ¨
Non-accelerated filer    x  (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 November 9, 2012, 18,618,623 shares of our common stock, $0.001 par value, were outstanding.

 

 

 


Table of Contents

Index to Financial Statements

Transcept Pharmaceuticals, Inc.

 

Item No.

        Page No.  

PART I FINANCIAL INFORMATION

  

Item 1.

  

Financial Statements (unaudited)

     1   
  

Condensed Consolidated Balance Sheets—September 30, 2012 and December 31, 2011

     1   
  

Condensed Consolidated Statements of Operations and Comprehensive Loss—Three and Nine Months Ended September 30, 2012 and 2011

     2   
  

Condensed Consolidated Statements of Cash Flows—Nine Months Ended September 30, 2012 and 2011

     3   
  

Notes to Condensed Consolidated Financial Statements

     4   

Item 2.

  

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

     14   

Item 3.

  

Quantitative and Qualitative Disclosures About Market Risk

     24   

Item 4.

  

Controls and Procedures

     24   

PART II OTHER INFORMATION

     25   

Item 1.

   Legal Proceedings      25   

Item 1A.

   Risk Factors      25   

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds      50   

Item 3.

   Defaults Upon Senior Securities      50   

Item 4.

   Mine Safety Disclosures      50   

Item 5.

   Other Information      50   

Item 6.

   Exhibits      51   
   SIGNATURES      52   


Table of Contents

PART I

FINANCIAL INFORMATION

 

Item 1. Financial Statements

Transcept Pharmaceuticals, Inc.

Condensed Consolidated Balance Sheets

(in thousands)

 

     September 30,     December 31,  
     2012     2011  
     (Unaudited)     (Note 1)  

Assets

    

Current assets:

    

Cash and cash equivalents

   $ 70,037      $ 10,659   

Marketable securities

     28,634        51,703   

Prepaid and other current assets

     2,348        3,275   

Restricted cash

     200        200   
  

 

 

   

 

 

 

Total current assets

     101,219        65,837   

Property and equipment, net

     166        314   

Goodwill

     2,962        2,962   

Other assets

     —          38   
  

 

 

   

 

 

 

Total assets

   $ 104,347      $ 69,151   
  

 

 

   

 

 

 

Liabilities and stockholders’ equity

    

Current liabilities:

    

Accounts payable

   $ 1,100      $ 987   

Accrued liabilities

     2,227        2,108   

Other liabilities, current portion

     42        244   
  

 

 

   

 

 

 

Total current liabilities

     3,369        3,339   

Other liabilities, non-current portion

     —          60   
  

 

 

   

 

 

 

Total liabilities

     3,369        3,399   

Stockholders’ equity:

    

Common stock

     19        14   

Additional paid-in capital

     206,509        165,803   

Accumulated deficit

     (105,556     (100,094

Accumulated other comprehensive income

     6        29   
  

 

 

   

 

 

 

Total stockholders’ equity

     100,978        65,752   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 104,347      $ 69,151   
  

 

 

   

 

 

 

See accompanying notes.

 

1


Table of Contents

Transcept Pharmaceuticals, Inc.

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)

(in thousands, except per share amounts)

(Unaudited)

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2012     2011     2012     2011  

Revenue:

        

Royalty revenue

   $ 190      $ —        $ 683      $ —     

License fee revenue

     —          625        —          6,875   

Milestone revenue

     10,000        —          10,000        —     

Other revenue

     250        —          250        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenue

     10,440        625        10,933        6,875   

Operating expense:

        

Research and development

     3,057        2,668        8,273        7,922   

General and administrative

     2,483        2,919        7,998        8,045   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expense

     5,540        5,587        16,271        15,967   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

     4,900        (4,962     (5,338     (9,092

Interest and other income (expense), net

     (45     (29     (124     (84
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ 4,855      $ (4,991   $ (5,462   $ (9,176
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per share:

        

Basic

   $ 0.26      $ (0.37   $ (0.33   $ (0.68
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ 0.25      $ (0.37   $ (0.33   $ (0.68
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding

        

Basic

     18,568        13,522        16,523        13,491   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     19,232        13,522        16,523        13,491   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

   $ 4,862      $ (4,996   $ (5,485   $ (9,142
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes.

 

2


Table of Contents

Transcept Pharmaceuticals, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)

(Unaudited)

 

     Nine Months Ended  
     September 30,  
     2012     2011  

Operating activities

    

Net loss

   $ (5,462   $ (9,176

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

    

Depreciation and amortization

     182        290   

Stock-based compensation

     2,199        2,037   

Amortization of lease liability

     (186     (254

Loss on disposals of fixed assets

     —          1   

Amortization of premium on available for sale securities

     466        1,044   

Changes in operating assets and liabilities:

    

Prepaid and other current assets

     927        216   

Other assets

     38        —     

Accounts payable

     113        49   

Accrued and other liabilities

     44        (470

Deferred revenue

     —          (6,875
  

 

 

   

 

 

 

Net cash used in operating activities

     (1,679     (13,138

Investing activities

    

Purchases of property and equipment, net

     (34     (42

Purchases of marketable securities

     (12,421     (38,276

Maturities of marketable securities

     35,000        41,500   
  

 

 

   

 

 

 

Net cash provided by investing activities

     22,545        3,182   

Financing activities

    

Proceeds from issuance of common stock, net

     38,512        292   
  

 

 

   

 

 

 

Net cash provided by financing activities

     38,512        292   

Net increase (decrease) in cash and cash equivalents

     59,378        (9,664

Cash and cash equivalents at beginning of period

     10,659        13,720   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 70,037      $ 4,056   
  

 

 

   

 

 

 

See accompanying notes.

 

3


Table of Contents

Transcept Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1. Organization and Summary of Significant Accounting Policies

Transcept Pharmaceuticals, Inc. (the “Company”) is a specialty pharmaceutical company focused on the development and commercialization of proprietary products that address important therapeutic needs in the field of neuroscience. Intermezzo® (zolpidem tartrate) sublingual tablet C-IV is the first U.S. Food and Drug Administration (“FDA”) approved Transcept product. Purdue Pharmaceutical Products L.P. (“Purdue Pharma”) holds commercialization and development rights for Intermezzo in the United States. Transcept is currently conducting a Phase 2 study of an investigational product, TO-2061, in patients with obsessive-compulsive disorder. The Company operates in one business segment.

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not contain all of the information and footnotes required for complete consolidated financial statements. In the opinion of management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly the Company’s interim financial information. The accompanying condensed consolidated balance sheet at December 31, 2011 has been derived from our audited financial statements at that date. The results for the three and nine months ended September 30, 2012 are not necessarily indicative of the results to be expected for the full year ending December 31, 2012 or for any other interim period or any other future year.

The accompanying unaudited condensed consolidated financial statements and notes to condensed consolidated financial statements should be read in conjunction with the Company’s audited financial statements in its Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the United States Securities and Exchange Commission on March 30, 2012.

Need to Raise Additional Capital

As of September 30, 2012, the Company had cash, cash equivalents and marketable securities of $98.7 million, working capital of $97.9 million, and an accumulated deficit of approximately $105.6 million. Management expects to continue to incur additional losses in the foreseeable future as the Company continues its research and development activities. Management believes that cash, cash equivalents and marketable securities balances on hand at September 30, 2012 will be sufficient to fund planned expenditures for at least the next twelve months. Management recognizes the potential need to raise additional funds in the future. There can be no assurance that the Company will be successful in consummating any such financing transaction, or if the Company does consummate such a transaction, that the terms and conditions of such transaction will be favorable. Any failure to obtain additional funding may have a material negative effect on the Company and will likely result in a substantial reduction in the scope of the Company’s operations.

Use of Estimates

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Management bases its estimates on historical experience and on assumptions believed to be reasonable under the circumstances. Actual results could differ materially from those estimates. Management makes estimates when preparing the financial statements including those relating to revenue recognition, clinical trials expense, and stock-based compensation.

 

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Table of Contents

Transcept Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Concentration of Risk

The Company is dependent on Purdue Pharma to market and sell Intermezzo in the United States, from which all of its royalty and milestone revenue to date has been derived.

Significant Accounting Policies

Principles of Consolidation

The accompanying condensed consolidated financial statements include the results of operations of Transcept Pharmaceuticals, Inc. and its wholly-owned subsidiary, Transcept Pharma, Inc. All significant intercompany accounts and transactions have been eliminated in the consolidation.

Revenue Recognition

The Company applies the revenue recognition criteria outlined in Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements, and Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 605 Revenue Recognition, sub-topic 25 Multiple-Element Arrangements.

Revenue arrangements with multiple components are divided into separate units of accounting if certain criteria are met, including whether the delivered component has stand-alone value to the customer. Consideration received is allocated among the separate units of accounting based on their relative fair values or if fair value is not determinable, based on the Company’s best estimate of selling price. Applicable revenue recognition criteria are then applied to each of the units.

Revenue is recognized when the four basic criteria of revenue recognition are met: (1) persuasive evidence of an arrangement exists; (2) transfer of technology has been completed or services have been rendered; (3) the fee is fixed or determinable; and (4) collectability is reasonably assured.

For each source of revenue, the Company complies with the above revenue recognition criteria in the following manner:

 

   

Up-front license payments are assessed to determine whether or not the licensee is able to obtain any stand-alone value from the license. Where this is not the case, the Company does not consider the license deliverable to be a separate unit of accounting, and the revenue is deferred with revenue recognition for the license fee assessed in conjunction with the other deliverables that constitute the combined unit of accounting. When the period of deferral cannot be specifically identified from the agreement, management estimates the period based upon provisions contained within the related agreements and other relevant facts. The Company periodically reviews the estimated involvement period, which could impact the deferral period and, therefore, the timing and the amount of revenue recognized. It is possible that future adjustments will be made if actual conditions differ from the Company’s current plan and involvement assumptions;

 

   

Payments received that are related to substantive, performance-based “at-risk” milestones are recognized as revenue upon achievement of the milestone or event specified in the underlying contracts, which represents the culmination of the earnings process. Amounts received in advance, if any, are recorded as deferred revenue until the milestone is reached; and

 

   

Royalty revenue from sales of the Company’s licensed products is recognized as earned in accordance with the underlying contract terms and when royalties from licensees can be reasonably estimated and collectability is reasonably assured.

 

5


Table of Contents

Transcept Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

Stock-Based Compensation

The Company records stock-based compensation in accordance with ASC Topic 718 Compensation – Stock Compensation (“ASC Topic 718”) (formerly Statement of Financial Accounting Standards (“SFAS”) No. 123(R), Share-Based Payment). ASC Topic 718 requires an entity to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award on the date of grant and to recognize the cost over the period during which the employee is required to provide service in exchange for the award. Additionally, the Company is required to include an estimate of the number of awards that will be forfeited in calculating compensation costs, which are recognized over the requisite service period of the awards on a straight-line basis.

The Company recognized employee stock-based compensation costs of $707,000 and $2,005,000 during the three and nine months ended September 30, 2012, respectively, and $465,000 and $1,594,000 during the three and nine months ended September 30, 2011, respectively, in accordance with the provisions of ASC Topic 718. No related tax benefits of stock-based compensation costs have been recognized since the Company’s inception. The Company issued 26,233 and 171,212 shares of common stock for the three and nine months ended September 30, 2012, respectively, upon stock option exercises.

During the nine months ended September 30, 2012, the Company modified the terms of stock options previously granted to an employee upon retirement to extend the exercise period of the options upon the end of service to the Company in May 2012. Additionally, the Company modified the terms of stock options previously granted to a member of its Board of Directors to accelerate vesting of the option upon the director’s anticipated end of service to the Company in April 2012. These modifications resulted in additional compensation expense of $28,000 during the nine months ended September 30, 2012. During the three and nine months ended September 30, 2011, the Company modified the terms of stock options previously granted to thirteen of its employees in connection with a reduction in force. The modifications included accelerated vesting of certain options and extension of the exercise period after termination with respect to certain of the options. These modifications resulted in additional compensation expense of $197,000 that was recognized in the third quarter of 2011. Additionally, during the nine months ended September 30, 2011, the Company modified the terms of certain stock options previously granted to two members of its Board of Directors to align and extend the exercise period of the options after the directors’ end of service to the Company in June 2011. These modifications resulted in additional compensation expense of $154,000 during the nine months ended September 30, 2011. The Company accounted for the modification of these stock option awards in accordance with the provisions of ASC Topic 718.

The Company accounts for equity instruments issued to non-employees in accordance with the provisions of ASC Topic 505, subtopic 50, Equity-Based Payments to Non-Employees (formerly Emerging Issues Task Force No. 96-18, Accounting for Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services), using a fair-value approach. The equity instruments, consisting of stock options and warrants granted to lenders and consultants, are valued using the Black-Scholes valuation model. The measurement of stock-based compensation is subject to periodic adjustments as the underlying equity instruments vest and is recognized as an expense over the term of the related financing or the period over which services are received. The Company recorded non-employee stock-based compensation costs of $33,000 and $166,000 during the three and nine months ended September 30, 2012, respectively, and $16,000 and $92,000 during the three and nine months ended September 30, 2011, respectively.

Clinical Trials

The Company accrues and expenses costs for clinical trial activities performed by third parties, including clinical research organizations and clinical investigators, based upon estimates made of the work completed as of the reporting date, in accordance with agreements established with contract research organizations and clinical trial sites and the agreed upon fee to be paid for the services. The Company determines these

 

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Table of Contents

Transcept Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

estimates through discussion with internal personnel and outside service providers as to the progress or stage of completion of the trials or services. Costs of setting up clinical trial sites for participation in the trials are expensed immediately as research and development expenses. Clinical trial site costs related to patient enrollment are accrued as patients are entered into the trial and reduced by any initial payment made to the clinical trial site when the first patient is enrolled.

Recently Adopted Accounting Standards

Effective January 1, 2012, the Company adopted the Accounting Standards Update (“ASU”) No. 2011-05, Presentation of Comprehensive Income on a retrospective basis. ASU No. 2011-05 was issued to enhance comparability between entities that report under U.S. GAAP and International Financial Reporting Standards (“IFRS”), and to provide a more consistent method of presenting non-owner transactions that affect an entity’s equity. ASU 2011-05 eliminates the option to solely report other comprehensive income and its components in the statement of changes in stockholders’ equity and requires an entity to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement or in two separate but consecutive statements. The adoption of this ASU did not have any impact on the Company’s results of operations or financial position, but did require modifying the format of the former “Statements of Operations” to include total comprehensive income (loss) and changing the title of the statements to “Statements of Operations and Comprehensive Income (Loss).”

Effective January 1, 2012, the Company adopted ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and International Financial Reporting Standards (“IFRS”) on a prospective basis. This pronouncement was issued to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between U.S. GAAP and IFRS. ASU 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements particularly for Level 3 fair value measurements. The adoption of ASU No. 2011-04 did not have a material impact on the Company’s consolidated results of operations or financial condition.

2. Results of Operations

Net Income (Loss) Per Share

Basic net income (loss) per share is computed by dividing net income (loss) by the weighted average number of vested shares outstanding during the period. Diluted net income (loss) per share is computed by giving effect to all potential dilutive common securities, including options, warrants and common stock subject to repurchase.

Potential dilutive common shares includes the dilutive effect of the common stock underlying in-the-money stock options and was calculated based on the average share price for each period using the treasury stock method. Under the treasury stock method, the exercise price of an option and the average amount of compensation cost, if any, for future service that the Company has not yet recognized when the option is exercised, are assumed to be used to repurchase shares in the current period.

For the nine months ended September 30, 2012 and the three and nine months ended September 30, 2011, diluted net loss per share was identical to basic earnings per share (“EPS”) since potential common shares were excluded from the calculation, as their effect was anti-dilutive.

 

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Table of Contents

Transcept Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The computations for basic and diluted net income (loss) per share were as follows (in thousands):

 

     Three months ended September 30,     Nine months ended September 30,  
     2012      2011     2012     2011  

Numerator:

         

Net income (loss)

   $ 4,855       $ (4,991   $ (5,462   $ (9,176
  

 

 

    

 

 

   

 

 

   

 

 

 

Denominator:

         

Weighted average shares outstanding

     18,568         13,522        16,523        13,492   

Less: Weighted average shares subject to repurchase

     —           —          —          (1
  

 

 

    

 

 

   

 

 

   

 

 

 

Weighted average common shares outstanding - basic

     18,568         13,522        16,523        13,491   

Effect of dilutive equity incentive plans

     664         —          —          —     
  

 

 

    

 

 

   

 

 

   

 

 

 

Weighted average common shares outstanding - diluted

     19,232         13,522        16,523        13,491   
  

 

 

    

 

 

   

 

 

   

 

 

 

Weighted average anti-dilutive securities

The following common equivalent shares were not included in the computation of diluted net income (loss) per share because their effect was anti-dilutive.

 

     Three months ended September 30,      Nine months ended September 30,  
     2012      2011      2012      2011  

Shares subject to options to purchase common stock

     1,958         2,968         3,147         2,617   

Shares subject to warrants to purchase common stock

     156         156         156         156   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     2,114         3,124         3,303         2,773   
  

 

 

    

 

 

    

 

 

    

 

 

 

At September 30, 2012, there were 3,158,000 shares subject to options to purchase common stock outstanding and 156,000 shares subject to warrants to purchase common stock outstanding.

Comprehensive Income (Loss)

Comprehensive loss is comprised of net income (loss) and unrealized gains (losses) on available-for-sale securities. Total comprehensive income (loss) for the three and nine months ended September 30, 2012 and 2011 is as follows (in thousands):

 

     Three months ended September 30,     Nine months ended September 30,  
     2012      2011     2012     2011  

Net income (loss)

   $ 4,855       $ (4,991   $ (5,462   $ (9,176

Changes in unrealized gain (loss) on marketable securities

     7         (5     (23     34   
  

 

 

    

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

   $ 4,862       $ (4,996   $ (5,485   $ (9,142
  

 

 

    

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Transcept Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

3. Fair Value

On January 1, 2008, the Company adopted ASC Topic 820, Fair Value Measurements and Disclosures (formerly SFAS No. 157) as it applies to financial assets and financial liabilities. ASC Topic 820 defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. Fair value is defined as the estimated exit price received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date rather than on an entry price which represents the purchase price of an asset or liability. ASC Topic 820 establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value into three broad levels, which are described below:

 

   

Level 1 - Quoted prices (unadjusted) in active markets that are accessible at the measurement date for assets or liabilities. The fair value hierarchy gives the highest priority to Level 1 inputs.

 

   

Level 2 - Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

   

Level 3 - Unobservable inputs (i.e., inputs that reflect the reporting entity’s own assumptions about the assumptions that market participants would use in estimating the fair value of an asset or liability) are used when little or no market data is available. The fair value hierarchy gives the lowest priority to Level 3 inputs.

In accordance with ASC Topic 820, the following table represents the Company’s fair value hierarchy for its financial assets (cash equivalents and marketable securities) measured at fair value on a recurring basis as of September 30, 2012 (in thousands):

 

            Fair Value Measurements at Reporting Date Using  
     September 30,
2012
     Quoted
Prices in
Active
Markets for

Identical
Assets

(Level 1)
     Significant
Other
Observable
Inputs

(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

Assets

           

Certificates of deposit

   $ 200       $ 200       $ —         $ —     

Money market funds

     27,517         27,517         —           —     

U.S. Treasury securities

     70,680         —           70,680         —     
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 98,397       $ 27,717       $ 70,680       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Transcept Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The following table represents the Company’s fair value hierarchy for its financial assets (cash equivalents and marketable securities) measured at fair value on a recurring basis as of December 31, 2011 (in thousands):

 

            Fair Value Measurements at Reporting Date Using  
     December 31,
2011
     Quoted
Prices in
Active
Markets for
Identical
Assets
(Level 1)
     Significant
Other
Observable
Inputs

(Level 2)
     Significant
Unobservable
Inputs

(Level 3)
 

Assets

           

Certificates of deposit

   $ 200       $ 200       $ —         $ —     

Money market funds

     9,238         9,238         —           —     

U.S. Treasury securities

     51,703         —           51,703         —     
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 61,141       $ 9,438       $ 51,703       $ —     
  

 

 

    

 

 

    

 

 

    

 

 

 

No other assets or liabilities were carried at fair value as of September 30, 2012 and December 31, 2011.

Level 2 securities are priced using quoted market prices for similar instruments, nonbinding market prices that are corroborated by observable market data, or discounted cash flow techniques. There were no transfers of assets between different fair-value levels during the periods presented.

4. Available-for-sale Securities

The following is a summary of available-for-sale debt securities recognized as cash and cash equivalents, marketable securities, or restricted cash in the Company’s condensed consolidated balance sheets. Estimated fair values of available-for-sale securities are generally based on prices obtained from commercial pricing services (in thousands):

 

     September 30, 2012  
     Amortized      Unrealized      Unrealized      Estimated  
     Cost      Gains      Losses      Fair Value  

Certificates of deposit

   $ 200       $ —         $ —         $ 200   

Money market funds

     27,517         —           —           27,517   

U.S. Treasury securities

     70,674         6         —           70,680   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 98,391       $ 6       $ —         $ 98,397   
  

 

 

    

 

 

    

 

 

    

 

 

 
     December 31, 2011  
     Amortized      Unrealized      Unrealized      Estimated  
     Cost      Gains      Losses      Fair Value  

Certificates of deposit

   $ 200       $ —         $ —         $ 200   

Money market funds

     9,238         —           —           9,238   

U.S. Treasury securities

     51,674         29         —           51,703   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 61,112       $ 29       $ —         $ 61,141   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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Transcept Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

The following table summarizes the classification of the available-for-sale securities on the Company’s condensed consolidated balance sheets (in thousands):

 

     September 30, 2012      December 31, 2011  

Cash and cash equivalents

   $ 69,563       $ 9,238   

Marketable securities

     28,634         51,703   

Restricted cash

     200         200   
  

 

 

    

 

 

 
   $ 98,397       $ 61,141   
  

 

 

    

 

 

 

There were no sales of available-for-sale marketable securities during the first nine months of 2012 or 2011.

At September 30, 2012, all of the Company’s marketable securities had a maturity of one year or less.

5. Collaboration Agreement

In July 2009, the Company entered into the Collaboration Agreement with Purdue Pharma that grants an exclusive license to Purdue Pharma to commercialize Intermezzo in the United States and pursuant to which:

 

   

Purdue Pharma paid a $25.0 million non-refundable license fee in August 2009;

 

   

Purdue Pharma paid a $10.0 million non-refundable intellectual property milestone in December 2011 when the first of two issued formulation patents was listed in the FDA’s Approved Drug Products with Therapeutic Equivalence Evaluations, or Orange Book;

 

   

Purdue Pharma paid a $10.0 million non-refundable intellectual property milestone in August 2012 when the first of two issued method of use patents was listed in the FDA’s Orange Book;

 

   

The Company transferred the Intermezzo New Drug Application (“NDA”) to Purdue Pharma, and Purdue Pharma is obligated to assume the expense associated with maintaining the NDA and further development of Intermezzo in the United States, including any expense associated with post-approval studies;

 

   

Purdue Pharma is obligated to commercialize Intermezzo in the United States at its expense using commercially reasonable efforts;

 

   

Purdue Pharma is obligated to pay the Company tiered base royalties on net sales of Intermezzo in the United States ranging from the mid-teens up to the mid-20% level. The base royalty is tiered depending upon the achievement of certain fixed net sales thresholds by Purdue Pharma, which net sales levels reset each year for the purpose of calculating the royalty; and

 

   

Purdue Pharma is obligated to pay the Company up to an additional $70.0 million upon the achievement of certain net sales targets for Intermezzo in the United States.

The Company has retained an option to co-promote Intermezzo to psychiatrists in the United States. The option can be exercised as late as August 2015. The Company may begin promotion to psychiatrists 8 to 15 months after option exercise. The exact timing of when the Company begins promoting to psychiatrists is determined by the calendar month in which the option exercise notice is delivered to Purdue Pharma. If the Company exercises the co-promote option and enters the marketplace, it is entitled to receive an additional co-promote royalty from Purdue Pharma on net sales that are generated by psychiatrist prescriptions. Had the Company chosen to exercise the option as soon as it was eligible, it could have begun promoting to psychiatrists in May 2013 and received a co-promote royalty of 40%. The co-promote royalty rate declines on a straight-line basis to approximately 22% if it does not begin promoting to psychiatrists until November

 

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Transcept Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

2016, at which time the right to co-promote expires. Net sales qualifying for this additional co-promote royalty are limited by an annual cap of 15% of total Intermezzo annual net sales in the United States. The co-promote option cannot be transferred to a third party, except under a limited circumstance at the discretion of Purdue Pharma.

Purdue Pharma has the right to terminate the Collaboration Agreement at any time upon advance notice of 180 days. The Company’s co-promote option may also be terminated by Purdue Pharma upon the Company’s acquisition by a third party or in the event of entry of generic competition to Intermezzo. The royalty payments discussed above are subject to reduction in connection with, among other things, the entry of generic competition to Intermezzo. The Collaboration Agreement expires on the later of 15 years from the date of first commercial sale in the United States or the expiration of patent claims related to Intermezzo. The Collaboration Agreement is also subject to termination by Purdue Pharma in the event of FDA or governmental action that materially impairs Purdue Pharma’s ability to commercialize Intermezzo or the occurrence of a serious event with respect to the safety of Intermezzo. The Collaboration Agreement may also be terminated by the Company upon Purdue Pharma commencing an action that challenges the validity of Intermezzo related patents. The Company also has the right to terminate the Collaboration Agreement immediately if Purdue Pharma is excluded from participation in federal healthcare programs. The Collaboration Agreement may also be terminated by either party in the event of a material breach by or insolvency of the other party.

The Company began earning royalty revenue during the nine months ended September 30, 2012, upon commercial launch of Intermezzo in April 2012. Royalty revenue earned during the three and nine months ended September 30, 2012 was $0.2 million and $0.7 million, respectively.

The Company recorded as revenue the $10.0 million milestone payment received in August 2012. The patent-related milestone was substantive and at-risk given the inherent uncertainty and risks associated with obtaining patent approval from the U.S. Patent and Trademark Office and subsequent listing in the FDA’s Orange Book. The Company has no additional performance obligations under the Collaboration Agreement related to this milestone.

The Company also granted Purdue Pharma and an associated company the right to negotiate for the commercialization of Intermezzo in Mexico and Canada and retained rights to commercialize Intermezzo in the rest of the world. During the third quarter of 2012, the Company recorded revenue of $0.2 million in Other Revenue associated with these rights.

Through June 30, 2011, the Company recognized revenue from the $25.0 million non-refundable license fee ratably over an estimated 24-month period beginning in August 2009 and ending in July 2011 as this represented the estimated period during which the Company had significant participatory obligations under the Collaboration Agreement. During the quarter ended September 30, 2011, the Company re-assessed the time period over which the remaining $1.04 million of deferred revenue at June 30, 2011 was recognized, and the Company recorded the remaining revenue through November 30, 2011 based on FDA approval of Intermezzo and the completion of the Company’s participatory obligations under the Collaboration Agreement. Revenue recognized in connection with the license fee during the three and nine months ended September 30, 2011 was $0.6 million and $6.9 million, respectively.

6. Commitments and Contingencies

Legal proceedings

From time to time, the Company may be involved in litigation relating to claims arising out of its operations. The Company is not currently involved in any material legal proceedings.

 

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Transcept Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

In July 2012, the Company received notifications that each of Actavis Elizabeth LLC (Actavis), Watson Laboratories, Inc. – Florida (Watson), and Novel Laboratories, Inc. (Novel), and in September 2012, that each of Par Pharmaceutical, Inc. and Par Formulations Private Ltd. (together, the Par Entities), has filed with the FDA an abbreviated new drug application, or ANDA, including Paragraph IV certifications, for generic versions of Intermezzo. In August 2012, September 2012 and October, 2012, we joined Purdue Pharma in filing actions against Actavis, Watson, Novel, the Par Entities, and certain of their affiliates, alleging patent infringement and seeking injunctive and other relief.

7. Common Stock

On May 1, 2012, the Company completed a public offering of 4,500,000 shares of its common stock at a public offering price of $9.00 per share. Net proceeds to the Company from the public offering were approximately $37.7 million after deducting underwriting discounts and commissions and offering expenses.

 

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

This Quarterly Report on Form 10-Q contains forward-looking statements that are based upon current expectations within the meaning of the Private Securities Litigation Reform Act of 1995. Transcept Pharmaceuticals, Inc., or Transcept, intends that such statements be protected by the safe harbor created thereby. Forward-looking statements involve risks and uncertainties and actual Transcept results and the timing of events may differ significantly from those results discussed in the forward-looking statements. Examples of such forward-looking statements include, but are not limited to, statements about or relating to:

 

   

expected activities and responsibilities of us and Purdue Pharmaceuticals L.P., or Purdue Pharma, under our United States License and Collaboration Agreement, or the Collaboration Agreement;

 

   

the future satisfaction of conditions required for continued commercialization of Intermezzo under the Collaboration Agreement, and the fulfillment of Purdue Pharma’s obligations under the Collaboration Agreement;

 

   

our potential receipt of revenue under the Collaboration Agreement, including milestone and royalty revenue;

 

   

expectations for the commercial potential of Intermezzo and Purdue Pharma’s continued commitment to collaborate with us;

 

   

our expectations regarding suits that Purdue Pharma or we have filed or may file in regards to Abbreviated New Drug Application, or ANDA, proceedings, and the timing, costs and results of such actions and ANDA proceedings;

 

   

expectations regarding reimbursement for Intermezzo in the United States;

 

   

expectations with respect to our intent and ability to successfully and profitably carry out plans to co-promote Intermezzo to psychiatrists in the United States through our co-promotion option under the Collaboration Agreement;

 

   

the potential benefits of, and markets for, Intermezzo and other product candidates;

 

   

expectations regarding our TO-2061 development program;

 

   

plans for the manufacturing of Intermezzo and TO-2061;

 

   

potential competitors and competitive products, including generic manufacturers;

 

   

expectations with respect to our intent and ability to successfully enter into other collaboration or co-promotion arrangements;

 

   

expectations regarding our ability to obtain regulatory approval of Intermezzo outside of the United States;

 

   

the adequacy of our current cash, cash equivalents and marketable securities to fund our operations for at least the next twelve months;

 

   

capital requirements and our need for additional financing;

 

   

expectations regarding future losses, costs, expenses, expenditures and cash flows;

 

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the ability and degree to which we may obtain and maintain market exclusivity from the U.S. Food and Drug Administration, or FDA, for Intermezzo, TO-2061 and any future product candidates under Section 505(b)(2) of the Federal Food, Drug, and Cosmetic Act, or FFDCA;

 

   

our ability to maintain and obtain additional patent protection for Intermezzo and obtain patent protection for our TO-2061 development program without violating the intellectual property rights of others;

 

   

our expectations regarding issuances of patents from any currently pending or future patent applications;

 

   

expected future sources of revenue and capital; and

 

   

our expectations regarding the use of proceeds from our recent public offering of common stock.

Forward-looking statements do not reflect the potential impact of any future in-licensing, collaborations, acquisitions, mergers, dispositions, joint ventures, or investments we may enter into or make. Except as required by law, we undertake no obligation to, and expressly disclaim any obligation to, revise or update the forward-looking statements made herein or the risk factors whether as a result of new information, future events or otherwise. Forward-looking statements involve risks and uncertainties, which are more fully discussed in the “Risk Factors” section and elsewhere in this Quarterly Report on Form 10-Q, including, but not limited to, those risks and uncertainties relating to:

 

   

potential termination of the Collaboration Agreement by Purdue Pharma;

 

   

physician or patient reluctance to use Intermezzo;

 

   

the potential for delays in or the inability to complete commercial partnership relationships, including additional marketing alliances for Intermezzo outside the United States;

 

   

unexpected results from and/ or additional costs related to ANDA proceedings;

 

   

changing standards of care and the introduction of products by competitors that could reduce our royalty rates under the Collaboration Agreement, or alternative therapies for the treatment of indications we target;

 

   

generic equivalents to Intermezzo whose introduction would reduce royalty rates under the Collaboration Agreement;

 

   

our inability to obtain additional financing, if available, under favorable terms, if necessary;

 

   

difficulties or delays in building a sales and marketing organization in connection with any exercise of our co-promote option to psychiatrists under the Collaboration Agreement;

 

   

our inability to operate any sales and marketing organization profitably in connection with any exercise of our co-promote option to psychiatrists under the Collaboration Agreement;

 

   

our ability to identify and finance additional products for in-licensing or acquisition, and the ability of those products to be accretive to our earnings;

 

   

unexpected adverse side effects or inadequate therapeutic efficacy of our product candidates that could slow or prevent product approval or approval for particular indications;

 

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other difficulties or delays in development, testing, obtaining regulatory approvals for, and undertaking production and marketing of Intermezzo, TO-2061 and our other product candidates;

 

   

the uncertainty of protection for our intellectual property, through patents, trade secrets or otherwise; and

 

   

potential infringement of the intellectual property rights or trade secrets of third parties.

Transcept Pharmaceuticals, Inc.TM is a registered and unregistered trademark of ours in the United States and other jurisdictions. Intermezzo® is a registered and unregistered trademark of Purdue Pharma and associated companies in the United States and other jurisdictions and is a registered and unregistered trademark of ours in certain other jurisdictions. Other trademarks and trade names referred to in this Quarterly Report on Form 10-Q are the property of their respective owners.

Company Overview

We are a specialty pharmaceutical company focused on the development and commercialization of proprietary products that address important therapeutic needs in the field of neuroscience.

Recent Events

Our U.S. marketing partner, Purdue Pharma, launched Intermezzo in April 2012.

On May 1, 2012, we completed a public offering of 4,500,000 shares of our common stock at a public offering price of $9.00 per share. Net proceeds to us from the public offering were approximately $37.7 million after deducting underwriting discounts and commissions and offering expenses.

Intermezzo® (zolpidem tartrate sublingual tablet)

Our first approved product, Intermezzo (zolpidem tartrate) sublingual tablet C-IV, is a sublingual formulation of zolpidem approved for use as needed for the treatment of insomnia when a middle-of-the-night awakening is followed by difficulty returning to sleep. Intermezzo is the first and only sleep aid approved by the FDA for this indication. On April 4, 2012, Purdue Pharma began promotion of Intermezzo to high prescribers of insomnia products.

According to IMS Health, an independent market research firm, the number of prescriptions filled in the United States to treat insomnia grew to approximately 79 million for the twelve months ended September 30, 2011. Data from a major study conducted by the Stanford Sleep Epidemiology Center and published in 2009 indicate that middle-of-the-night awakening is the most common form of insomnia in the United States and affects approximately one-third of the population at least three times each week. Data from a study published in Population Health Management in 2010, based on information from the United States National Health and Wellness Survey to evaluate the economic and humanistic burden of chronic insomnia characterized by nighttime awakenings, indicate that this condition was associated with a significant negative impact in health care utilization, health-related quality of life and work productivity.

In July 2009, we entered into the Collaboration Agreement with Purdue Pharma that grants an exclusive license to Purdue Pharma to commercialize Intermezzo in the United States and pursuant to which:

 

   

Purdue Pharma paid us a $25.0 million non-refundable license fee in August 2009;

 

   

Purdue Pharma paid us a $10.0 million non-refundable intellectual property milestone in December 2011 when the first of two issued formulation patents was listed in the FDA’s Approved Drug Products with Therapeutic Equivalence Evaluations, or Orange Book;

 

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Purdue Pharma paid us a $10.0 million non-refundable intellectual property milestone in August 2012 when the first of two issued method of use patents was listed in the FDA’s Orange Book;

 

   

We transferred the Intermezzo NDA to Purdue Pharma, and Purdue Pharma is obligated to assume the expense associated with maintaining the NDA and further development of Intermezzo in the United States, including any expense associated with post-approval studies;

 

   

Purdue Pharma is obligated to commercialize Intermezzo in the United States at its expense using commercially reasonable efforts;

 

   

Purdue Pharma is obligated to pay us tiered base royalties on net sales of Intermezzo in the United States ranging from the mid-teens up to the mid-20% level. The base royalty is tiered depending upon the achievement of certain fixed net sales thresholds by Purdue Pharma, which net sales levels reset each year for the purpose of calculating the royalty; and

 

   

Purdue Pharma is obligated to pay us up to an additional $70.0 million upon the achievement of certain net sales targets for Intermezzo in the United States.

In August 2012, our U.S. Patent No. 8,242,131 was issued by the United States Patent and Trademark Office, or USPTO, and listed in the FDA’s Orange Book. This patent, titled “Methods of Treating Middle-of-the-Night Insomnia,” includes claims related to methods of treating middle-of-the-night insomnia with low doses of zolpidem, and will expire no earlier than 2029. Pursuant to the Collaboration Agreement, in August 2012 we received from Purdue Pharma the remaining $10.0 million payment related to achievement of intellectual property milestones in connection with such Orange Book listing. Also in August 2012, the USPTO issued our U.S. Patent No. 8,252,809, which includes claims directed to compositions for treating middle-of-the-night insomnia and which will expire no earlier than 2025.

We have retained an option to co-promote Intermezzo to psychiatrists in the United States. The option can be exercised as late as August 2015. We may begin promotion to psychiatrists 8 to 15 months after we exercise the option. The exact timing of when we begin promoting to psychiatrists is determined by the calendar month in which the option exercise notice is delivered to Purdue Pharma. If we exercise the co-promote option and enter the marketplace, we are entitled to receive an additional co-promote royalty from Purdue Pharma on net sales that are generated by psychiatrist prescriptions. Had we chosen to exercise the option as soon as we were eligible, we could have begun promoting to psychiatrists in May 2013 and received a co-promote royalty of 40%. The co-promote royalty rate declines on a straight-line basis to approximately 22% if we do not begin promoting to psychiatrists until November 2016, at which time our right to co-promote expires. Net sales qualifying for this additional co-promote royalty are limited by an annual cap of 15% of total Intermezzo annual net sales in the United States. The co-promote option cannot be transferred to a third party, except under a limited circumstance at the discretion of Purdue Pharma.

We also granted Purdue Pharma and an associated company the right to negotiate for the commercialization of Intermezzo in Mexico and Canada, respectively, and retained rights to commercialize Intermezzo in the rest of the world. During the third quarter of 2012, we recorded revenue of $0.2 million in Other Revenue associated with these rights.

We plan to enter into one or more development and marketing alliances to develop and commercialize Intermezzo with established pharmaceutical companies in major markets outside the United States.

TO-2061: Low Dose Ondansetron as Adjunctive Therapy in Patients with Obsessive Compulsive Disorder

We are developing TO-2061, a low dose of ondansetron, to be used as adjunctive therapy in patients with obsessive compulsive disorder, or OCD, who have not adequately responded to first-line treatment with currently approved OCD medications, such as selective serotonin re-uptake inhibitors, or SSRIs. Our strategy is to augment the therapeutic effects of first-line pharmacotherapy in OCD patients with ondansetron to provide more effective treatments to control OCD in patients who do not respond adequately to conventional therapies. Ondansetron is currently marketed in higher doses as Zofran® by

 

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GlaxoSmithKline, and is available in generic form, for the prevention of nausea and vomiting caused by radiation therapy and chemotherapy and for the prevention of postsurgical nausea and vomiting. Typical daily doses of ondansetron for these indications are 16 mg to 24 mg. We are studying ondansetron at total daily doses of 1 mg to 1.5 mg.

In March 2011, we began a Phase 2 double-blind, multi-center, placebo-controlled study of TO-2061 to evaluate its effectiveness and safety when used as an adjunctive treatment for patients with OCD who have not adequately responded to standard first-line therapy with currently approved OCD medications, such as SSRIs. The decision to conduct the Phase 2 study was based in part on two single-blind exploratory clinical studies that examined the use of a range of low doses of ondansetron in the treatment of OCD. These studies yielded initial results that we and our advisors believe to be encouraging.

OCD is characterized by a pattern of unwanted and intrusive thoughts that cause distress and consequent repetitive behaviors aimed at reducing this distress. OCD has been known to significantly impact everyday life activities of both patients and their families. It has been estimated by the U.S. Department of Health and Human Services that OCD affects 1% to 2% of the United States adult population. Approximately 40% to 50% of OCD sufferers seek treatment from a physician and approximately 40% to 60% of OCD patients do not respond adequately to first-line pharmacotherapy. There is currently no FDA approved treatment for this group of patients. Atypical antipsychotics are often used off-label to augment first-line treatment of OCD, but approximately 68% of treatment resistant OCD patients do not respond adequately. Frequently reported adverse events associated with atypical antipsychotics include weight gain and metabolic disorders.

Net Loss and Profitability

We have incurred net losses since inception as we have devoted substantially all of our resources to research and development, including contract manufacturing and clinical trials. As of September 30, 2012, we had an accumulated deficit of $105.6 million. While we had net income of $4.9 million for the three months ended September 30, 2012, our net loss for the nine months ended September 30, 2012 was $5.5 million. Our net loss for the years ended December 31, 2011, 2010, and 2009 was $3.9 million, $9.3 million, and $21.8 million, respectively. As of September 30, 2012, we had cash, cash equivalents, and marketable securities of $98.7 million and working capital of $97.9 million.

We began earning royalty revenue upon commercial launch of Intermezzo in April 2012. Royalty revenue earned during the three and nine months ended September 30, 2012 was $0.2 million and $0.7 million, respectively.

Prior to the fourth quarter of 2011, our only source of revenue had been the receipt in August 2009 of a $25.0 million non-refundable license fee received pursuant to our Collaboration Agreement with Purdue Pharma. Through June 30, 2011, we recognized revenue from the license fee ratably over an estimated 24-month period beginning in August 2009 and ending in July 2011 as this represented the estimated period during which we had significant participatory obligations under the Collaboration Agreement. During the quarter ended September 30, 2011, we re-assessed the time period over which the remaining $1.04 million of deferred revenue at June 30, 2011 was recognized, and we recorded the remaining revenue through November 30, 2011, based on FDA approval of Intermezzo and the completion of our participatory obligations under the Collaboration Agreement.

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

Financial Operations Overview

Revenue

We began earning royalty revenue upon commercial launch of Intermezzo in April 2012. Royalty revenue earned during the three and nine months ended September 30, 2012 was $0.2 million and $0.7 million, respectively. Royalty revenue is derived from Net Sales of Intermezzo generated by Purdue Pharma to the wholesalers.

 

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During the third quarter of 2012, we received a $10.0 million milestone payment under our Collaboration Agreement with Purdue Pharma for the listing of our method of use patent in the FDA’s Orange Book. Revenue during the third quarter of 2012 also included a non-refundable payment from Purdue Pharma and an associated company for the right to negotiate for the commercialization of Intermezzo in Mexico and Canada of $0.2 million.

Through June 30, 2011, we recognized revenue from the $25.0 million non-refundable license fee ratably over an estimated 24-month period beginning in August 2009 and ending in July 2011 as this represented the estimated period during which we had significant participatory obligations under the Collaboration Agreement. During the quarter ended September 30, 2011, we re-assessed the time period over which the remaining $1.04 million of deferred revenue at June 30, 2011 was recognized, and we recorded the remaining revenue through November 30, 2011, based on FDA approval of Intermezzo and the completion of our participatory obligations under the Collaboration Agreement. The revenue recognized in connection with the license fee during the three and nine months ended September 30, 2011 was $0.6 million and $6.9 million, respectively.

Research and Development Expense

Research and development expense has represented approximately 55% and 48% of total operating expense for the three months ended September 30, 2012 and 2011, respectively, and 51% and 50% of total operating expense for the nine months ended September 30, 2012 and 2011, respectively. Research and development costs are expensed as incurred. Research and development expense consists of expense incurred in identifying, researching, developing and testing product candidates. This expense primarily consists of the following:

 

   

salaries, benefits, travel and related expense for personnel associated with research and development activities;

 

   

fees paid to professional service providers for services related to the conduct and analysis of clinical trials;

 

   

contract manufacturing costs for formulations used in clinical trials and pre-commercial manufacturing and packaging costs;

 

   

fees paid to consultants related to continued development of Intermezzo and TO-2061;

 

   

laboratory supplies and materials;

 

   

depreciation of equipment; and

 

   

allocated costs of facilities and infrastructure.

General and Administrative Expense

General and administrative expense consists primarily of salaries and related expense for personnel in executive, market research, finance and accounting, information technology and human resource functions. Other costs include facility costs not otherwise included in research and development expense and professional fees for legal, consulting and accounting services.

 

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Interest and other income (expense), net:

Interest and other income (expense), net consists of interest income received from cash, cash equivalents, restricted cash and marketable securities held with certain financial institutions, and is offset by interest expense incurred on a $0.3 million loan for tenant improvements, payable to the landlord of our corporate facility in Point Richmond, California, and other income (expense), net, primarily relating to Delaware franchise tax.

Results of Operations

Comparison of the Three Months Ended September 30, 2012 and 2011

The following table summarizes results of operations with respect to the items set forth below for the three months ended September 30, 2012 and 2011, together with the percentage change in those items (in thousands).

 

     For the Three Months Ended September 30,  
                   Favorable     %  
   2012      2011      (Unfavorable)     Change  

Revenue

   $ 10,440       $ 625       $ 9,815        1570

Research and development expense

     3,057         2,668         (389     (15 %) 

General and administrative expense

     2,483         2,919         436        15

Revenue

Revenue recorded for the quarter ended September 30, 2012 consisted of the following:

 

   

$10.0 million milestone payment under our Collaboration Agreement with Purdue Pharma for the listing of our method of use patent in the FDA’s Orange Book; and

 

   

$0.2 million of royalty revenue recorded in connection with the April 2012 commercial launch of Intermezzo; and

 

   

$0.2 million non-refundable payment from Purdue Pharma and an associated company for the right to negotiate for the commercialization of Intermezzo in Mexico and Canada.

We recorded $0.6 million of license fee revenue for the quarter in September 30, 2011. All revenue from the license fee received from Purdue Pharma in connection with the Collaboration Agreement was recognized by December 31, 2011.

Research and Development Expense

Research and development expense increased 15% to $3.1 million for the three months ended September 30, 2012 from $2.7 million for the comparable period in 2011. The increase of approximately $0.4 million for the three months ended September 30, 2012 is primarily attributable to increased clinical expense associated with our TO-2061 development program, specifically related to our ongoing Phase 2 clinical trial. This increase is partially offset by severance and benefit continuation expense of $0.5 million incurred in the third quarter 2011 related to our July 2011 reduction-in-force.

 

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General and Administrative Expense

General and administrative expense decreased 15% to $2.5 million for the three months ended September 30, 2012 from $2.9 million for the comparable period in 2011. The approximately $0.4 million decrease for the three months ended September 30, 2012 as compared to September 30, 2011 is primarily attributable to $0.5 million of severance and benefit continuation expense incurred in the third quarter 2011 related to our July 2011 reduction-in-force. This decrease was partially offset by increased external professional fees, including fees due to third-party consulting and market research in 2012.

Comparison of the Nine Months Ended September 30, 2012 and 2011

The following table summarizes results of operations with respect to the items set forth below for the nine months ended September 30, 2012 and 2011, together with the percentage change in those items (in thousands).

 

     For the Nine Months Ended September 30,  
                   Favorable     %  
     2012      2011      (Unfavorable)     Change  

Revenue

   $ 10,933       $ 6,875       $ 4,058        59

Research and development expense

     8,273         7,922         (351     (4 %) 

General and administrative expense

     7,998         8,045         47        1

Revenue

Revenue recorded for the nine months ended September 30, 2012 consisted of the following:

 

   

$10.0 million milestone payment under our Collaboration Agreement with Purdue Pharma for the listing of our method of use patent in the FDA’s Orange Book; and

 

   

$0.7 million of royalty revenue recorded in connection with the April 2012 commercial launch of Intermezzo; and

 

   

$0.2 million non-refundable payment from Purdue Pharma and an associated company for the right to negotiate for the commercialization of Intermezzo in Mexico and Canada.

We recorded $6.9 million of license fee revenue for the comparable period in 2011. All revenue from the license fee received from Purdue Pharma in connection with the Collaboration Agreement was recognized by December 31, 2011.

Research and Development Expense

Research and development expense increased 4% to $8.3 million for the nine months ended September 30, 2012 from $7.9 million for the comparable period in 2011. The increase for the nine months ended September 30, 2012 is primarily attributable to increased clinical expense associated with our TO-2061 development program, specifically related to our ongoing Phase 2 clinical trial, significantly offset by severance and benefit continuation expense of $0.5 million incurred in the third quarter 2011 related to our July 2011 reduction-in-force.

General and Administrative Expense

General and administrative expense was slightly lower during the nine months ended September 30, 2012 versus the comparable period in 2011. The 2011 period included $0.5 million of severance and benefit continuation expense related to our July 2011 reduction-in-force as well as non cash stock compensation expense of $0.2 million for stock option modifications to two members of our Board of Directors. During the nine months ended September 30, 2012, we incurred increased external professional fees, including fees due to third-party consulting and market research.

 

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Liquidity and Capital Resources

At September 30, 2012, we had cash, cash equivalents and marketable securities of $98.7 million.

Sources of Liquidity

From our inception through the completion of our January 2009 merger with Novacea, Inc., or the Merger, we financed our operations primarily through private placements of preferred stock, debt financing and interest income. We received net proceeds of $71.0 million from the sale of preferred stock, all of which was converted to common stock upon completion of the Merger. Through the Merger in January 2009, we acquired an additional $80.9 million in cash, cash equivalents and marketable securities. On August 4, 2009, we received a $25 million non-refundable license fee from Purdue Pharma in connection with our entry into the Collaboration Agreement. In December 2011, we received a $10.0 million milestone payment from Purdue Pharma in accordance with the Collaboration Agreement.

On May 1, 2012, we completed a public offering of 4,500,000 shares of our common stock at a public offering price of $9.00 per share. Net proceeds to us from the public offering were approximately $37.7 million after deducting underwriting discounts and commissions and offering expenses.

In August 2012, we received an additional $10.0 million milestone payment from Purdue Pharma in connection with the Collaboration Agreement.

Purdue Pharma launched Intermezzo in April 2012 and we began recognizing royalty revenue during the second quarter of 2012.

The following table summarizes our cash flow activities (in thousands):

 

     Nine Months Ended  
   September 30,  
     2012     2011  

Net cash used in operating activities

   $ (1,679   $ (13,138

Net cash provided by investing activities

     22,545        3,182   

Net cash provided by financing activities

     38,512        292   

Operating Activities

Net cash used in operating activities was $1.7 million for the nine months ended September 30, 2012, compared to $13.1 million for the nine months ended September 30, 2011. Net cash used in operating activities for both periods consisted primarily of our net loss adjusted for noncash items such as depreciation, amortization, stock-based compensation charges and noncash interest expense, as well as net changes in working capital. The net change in working capital during 2011 included $6.9 million of revenue recognition resulting from a decrease in deferred revenue.

Investing Activities

Net cash provided by investing activities for the nine months ended September 30, 2012 and 2011 of $22.5 million and $3.2 million, respectively, was primarily attributable to maturities of marketable securities, net of purchases. Uses of cash in investing activities for both periods also included net purchases of property and equipment.

Financing Activities

Net cash provided by financing activities during the nine months ended September 30, 2012 was $38.5 million, compared to $0.3 million for the nine months ended September 30, 2011. Net cash provided during both periods related to common stock issuances, including net proceeds of $37.7 million from our public offering completed on May 1, 2012.

 

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Capital Resources

We expect that our cash, cash equivalents, and marketable securities of $98.7 million at September 30, 2012, will be sufficient to satisfy our liquidity requirements for at least the next twelve months. On May 1, 2012, we completed a public offering of 4,500,000 shares of our common stock at a public offering price of $9.00 per share. Net proceeds to us from the public offering were approximately $37.7 million after deducting underwriting discounts and commissions and offering expenses. We believe our investments in cash equivalents and marketable securities are highly rated and highly liquid.

Our future capital requirements will depend on, and could increase significantly as a result of, numerous factors, including:

 

   

the ability of Purdue Pharma to successfully commercialize Intermezzo in the United States;

 

   

whether we choose to share the cost of advertising or other marketing efforts with Purdue Pharma related to the commercialization of Intermezzo in the United States;

 

   

the cost of establishing or contracting for sales and marketing capabilities if we exercise our option to co-promote Intermezzo to psychiatrists in the United States, and potential costs of being required to engage in contracting to replace Purdue Pharma’s primary care sales and marketing capabilities if our existing Collaboration Agreement with Purdue Pharma is terminated;

 

   

the extent to which we develop internally, acquire or in-license new products, technologies or businesses;

 

   

the rate of progress and cost of our ongoing TO-2061 clinical trial, the need to conduct additional clinical trials and other development activities;

 

   

the receipt of additional milestone and royalty payments, if any, from Purdue Pharma under the Collaboration Agreement;

 

   

the prospect, cost and timing for the development of Intermezzo to obtain regulatory approval for Intermezzo outside the United States;

 

   

the ability to license Intermezzo outside the United States and the terms and timing of any such licensing arrangements;

 

   

the cost of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; and

 

   

the effect of competing technological and market developments.

In addition, we may seek to raise additional funds to:

 

   

further develop Intermezzo to meet the requirements for regulatory approval of Intermezzo outside the United States;

 

   

establish or contract for sales and marketing capabilities if we exercise our option to co-promote Intermezzo, or to build our own sales force if Purdue Pharma does not continue with our collaboration to commercialize Intermezzo in the United States;

 

   

support the ongoing promotion of Intermezzo by Purdue Pharma;

 

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continue to develop TO-2061 through clinical trials and other development activities; and

 

   

develop internally, acquire or in-license new products, technologies or businesses or to otherwise fund our operations.

If our Collaboration Agreement with Purdue Pharma is terminated or other factors arise, we may decide to reduce operating expenses by limiting research and development efforts with respect to TO-2061 or other potential product candidates or otherwise reduce our expenses. Alternatively, we may decide to raise funds through public or private financings, collaboration relationships or other arrangements. There can be no assurance that funding, if needed, will be available on attractive terms, or at all. Furthermore, any additional equity financing may be dilutive to stockholders and any debt financing, if available, may involve restrictive covenants. Similarly, financing obtained through future collaborations may require us to forego certain commercialization and other rights to our drug candidates. Our failure to raise capital as and when needed could have a negative impact on our financial condition and our ability to successfully pursue our business strategy.

Critical Accounting Policies

There were no changes to our critical accounting policies since we filed our 2011 Annual Report on Form 10-K for the year ended December 31, 2011 with the Securities and Exchange Commission, or SEC. For a description of our critical accounting policies, please refer to our 2011 Annual Report.

Off-Balance Sheet Arrangements

Since inception, we have not engaged in any off-balance sheet financing activities, including the use of structured finance, special purpose entities or variable interest entities.

Inflation

We do not believe that inflation has had a significant impact on our results of operations since inception.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Our exposure to market risk is confined to cash, cash equivalents and marketable securities which have contractual maturities of eighteen months or less, bear interest rates at fixed rates and are denominated in, and pay interest in, U.S. dollars. The goals of our investment policy are preservation of capital, fulfillment of liquidity needs, and fiduciary control of cash and investments. We also seek to achieve income from investments consistent with our investment policy. Investments are classified as available-for-sale. We do not use derivative financial instruments in our investment portfolio. To achieve our goals, we invest excess cash in securities with different maturities to match projected cash needs and limit concentration of credit risk by limiting investments to U.S. Treasury debt or SEC registered money market funds. A hypothetical 100 basis point increase in interest rates would result in an approximate $138,000 decrease in the fair value of our marketable securities at September 30, 2012.

 

Item 4. Controls and Procedures

(a) Evaluation of disclosure controls and procedures

Our management evaluated, with the participation and under the supervision of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded, subject to the limitations described below, that our disclosure controls and procedures were effective at the reasonable assurance level to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosures.

 

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(b) Changes in internal control over financial reporting

There were no changes in our internal controls over financial reporting during the three months ended September 30, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II.

OTHER INFORMATION

 

Item 1. Legal Proceedings

From time to time, we may be involved in litigation relating to claims arising out of our operations. We are not currently involved in any material legal proceedings.

We received notifications in July 2012 that each of Actavis Elizabeth LLC (Actavis), Watson Laboratories, Inc. – Florida (Watson), and Novel Laboratories, Inc. (Novel), and, in September 2012, that each of Par Pharmaceutical, Inc. and Par Formulations Private Ltd. (together, the Par Entities), had filed with the FDA an abbreviated new drug application, or ANDA, including Paragraph IV certifications, for generic versions of Intermezzo. In August 2012, September 2012 and October 2012, we joined Purdue Pharma in filing actions against Actavis, Watson, Novel, the Par Entities, and certain of their affiliates, alleging patent infringement and seeking injunctive and other relief.

 

Item 1A. Risk Factors

Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below and all information contained in this report before you decide to purchase our common stock. If any of these risks actually occur, it may materially harm our business, financial condition, operating results or cash flow. As a result, the market price of our common stock could decline, and you may lose all or part of your investment.

We have had a limited operating history that may make it difficult for you to evaluate the potential success of our business and we have a history of incurring losses.

We were founded in January 2001 under our former name, Novacea, Inc., and in January 2009 underwent a merger with Transcept Pharmaceuticals, Inc., a privately held company, or TPI, founded in 2002, which is the primary business we currently conduct. Our operations to date have been limited to organizing and staffing, acquiring, developing and securing technology and undertaking preclinical studies and clinical trials. Furthermore, our business is not profitable and has incurred losses in each year since the inception of TPI in 2002. Our net loss for the years ended December 31, 2011, 2010 and 2009 was $3.9 million, $9.3 million and $21.8 million, respectively. Our net loss for the nine months ended September 30, 2012 was $5.5 million and we had an accumulated deficit at September 30, 2012 of $105.6 million.

In November 2011, we obtained regulatory approval for the commercial sale of our lead product candidate, Intermezzo, from the FDA. In April 2012, our U.S. marketing partner, Purdue Pharma, launched Intermezzo. We have not demonstrated over a substantial period of time the ability to meet and adhere to other regulatory standards applicable to an FDA approved product, to conduct sales and marketing activities or to co-promote a product with a collaboration partner, including Purdue Pharma. Consequently, any predictions you make about our future success or viability may not be as accurate as they would be if we had a longer operating history.

In addition, we expect to continue to incur losses for the foreseeable future until such time, if ever, that Intermezzo is successfully commercialized by Purdue Pharma and we receive milestone and royalty revenue from our collaboration that exceeds our expenses. For the foreseeable future, we expect our accumulated deficit to increase as we continue our research, development, regulatory, and collaboration

 

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efforts with respect to Intermezzo both in support of Purdue Pharma and potential collaboration partners outside North America, and with respect to our other product candidate, TO-2061. If Purdue Pharma does not successfully commercialize Intermezzo, or if TO-2061 or future product candidates, if any, do not gain regulatory approval and are not commercialized or do not achieve market acceptance, we may not be able to generate any revenue. We cannot assure you that we will ever be profitable or that we can sustain profitability, even if achieved. If we fail to achieve and maintain profitability, or if we are unable to fund our continuing losses, you could lose all or part of your investment.

We are dependent on the commercial success of Intermezzo in the United States for the treatment of middle-of-the-night awakening, which only recently received FDA approval.

In November 2011, the FDA granted marketing approval for the commercial sale of Intermezzo in the United States for use as-needed for the treatment of insomnia when a middle-of-the-night awakening is followed by difficulty returning to sleep.

In July 2009, we entered into a Collaboration Agreement with Purdue Pharma, which provided Purdue Pharma with the option to commercialize Intermezzo in the United States at its expense. On November 30, 2011, Purdue Pharma notified us that it exercised its option to commercialize Intermezzo and subsequently launched commercial sales of Intermezzo in the United States in April 2012. If Purdue Pharma does not successfully commercialize Intermezzo in the United States, our ability to generate revenue will be jeopardized and, consequently, our business will be seriously harmed.

We currently have one other product candidate in clinical development, TO-2061, which is being evaluated as a potential adjunctive therapy for patients with OCD who have not adequately responded to standard first-line treatment with currently approved OCD medications and which is currently undergoing a Phase 2 clinical study.

Because we do not have another product candidate that has received regulatory approval for commercial sale, our future success is currently dependent on the successful commercialization of Intermezzo in the United States by Purdue Pharma.

We are substantially dependent upon the efforts of Purdue Pharma to commercialize Intermezzo in the United States and will be dependent on the efforts of other collaboration partners if we enter into future strategic collaborations.

The success of sales of Intermezzo in the United States is dependent on the ability of Purdue Pharma to successfully commercialize Intermezzo pursuant to the Collaboration Agreement. The terms of the Collaboration Agreement provide that Purdue Pharma can terminate the agreement for any reason at any time upon advance notice of 180 days. For example, Purdue Pharma may find that the commercial potential of Intermezzo is not sufficient to continue pursuing. If the Collaboration Agreement is terminated, our business and our ability to generate revenue from sales of Intermezzo will be substantially harmed and we will be required to develop our own sales and marketing organization or enter into another strategic collaboration in order to commercialize Intermezzo in the United States. We do not currently have the infrastructure in place or adequate resources to launch a commercial product and implementing such infrastructure would require substantial time and resources and such efforts may not be successful.

The manner in which Purdue Pharma commercializes Intermezzo, including the amount and timing of Purdue Pharma’s investment in commercial activities and pricing of Intermezzo, will have a significant impact on the ultimate success of Intermezzo in the United States, and the success of the overall commercial arrangement with Purdue Pharma. If the launch and resulting sales of Intermezzo are not deemed successful, our stock price may decline. The outcome of Purdue Pharma’s commercialization efforts could also have an effect on investors’ perception of potential sales of Intermezzo outside the United States, which could also cause a decline in our stock price and may make it more difficult for us to enter into strategic collaborations outside the United States.

Under the Collaboration Agreement, Purdue Pharma is responsible for conducting post-approval studies of Intermezzo and bears the cost associated with such studies. The planning and execution of these

 

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studies, if any, will be primarily the responsibility of Purdue Pharma, and may not be carried out in accordance with our preferences, or could yield results that are detrimental to Purdue Pharma’s sales of Intermezzo in the United States or detrimental to our efforts to develop or commercialize Intermezzo outside the United States.

We plan to enter into one or more additional strategic collaborations for the development and commercialization of Intermezzo outside the United States. We may not be able to enter into additional collaborations on acceptable terms, if at all. Our collaboration with Purdue Pharma as our commercial partner for Intermezzo in the United States could also limit the potential collaboration options we have outside the United States or could render potential collaborators less inclined to enter into an agreement with us because of such relationship. Further, we have granted Purdue Pharma and an associated company an option to negotiate with us for a license to commercialize Intermezzo in Mexico and Canada. While these options and subsequent negotiation periods continue, we are prevented from negotiating with and being able to enter into commercialization agreements with other potential strategic partners for the development or commercialization of Intermezzo in such countries.

If we decide to enter into a strategic collaboration covering TO-2061 or any future product candidates, our ability to receive any significant revenue under such arrangements will be dependent on the efforts of the collaboration partner and may result in lower levels of income than if we marketed or developed our product candidates entirely on our own. Our collaboration partner may not fulfill its obligations or carry out marketing activities for the product candidates as diligently as we would like. We could also become involved in disputes with our collaboration partner, which could lead to delays in or termination of commercialization programs and time-consuming and expensive litigation or arbitration. If a collaboration partner terminates or breaches its agreement, or otherwise fails to complete its obligations in a timely manner, the chances of successfully developing or marketing our product candidates would be materially and adversely affected.

Intermezzo, despite obtaining FDA approval, may never achieve market acceptance, nor may TO-2061 or future product candidates, if any, even if regulatory approval for such product candidates is obtained.

Despite obtaining FDA regulatory approval for the commercial sale of Intermezzo, the commercial success of Intermezzo, TO-2061 and/or future product candidates, if any, even if regulatory approval is obtained for such candidates, will depend upon, among other things, acceptance by physicians and patients. Market acceptance of, and demand for, any products that we develop and that are commercialized by us or our collaboration partner will depend on many factors, including:

 

   

the effectiveness of our or Purdue Pharma’s sales, marketing and distribution strategies;

 

   

the availability, relative cost and relative efficacy and safety of alternative and competing treatments including the existence of generic or branded competition;

 

   

further expanding managed care access for Intermezzo, including the ability to establish adequate pricing and reimbursement;

 

   

motivating physicians to identify middle-of-the-night awakenings as an important manifestation of insomnia;

 

   

building awareness among physicians and patients of Intermezzo as the appropriate treatment option for middle of the night awakenings with difficulty returning to sleep;

 

   

the ability to obtain adequate pricing and sufficient insurance coverage and reimbursement;

 

   

the ability to provide acceptable evidence of safety and efficacy of Intermezzo or future products for their respective indications;

 

   

the ease of use of Intermezzo; and

 

   

the ability to produce commercial quantities sufficient to meet demand.

 

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If Intermezzo, TO-2061 and/or future product candidates fail to gain market acceptance, we may be unable to earn sufficient revenue to continue our business.

Intermezzo faces substantial competition from companies with established products.

Intermezzo has been approved for use as-needed for the treatment of insomnia when a middle-of-the-night awakening is followed by difficulty returning to sleep, an indication that we believe represents an opportunity within the broader insomnia therapeutic market. The insomnia market is large, deeply commercialized and characterized by intense competition among generic products and large, established pharmaceutical companies with well-funded, well-staffed and experienced sales and marketing organizations, as well as far greater name recognition than we or Purdue Pharma have.

Intermezzo competes in this large market against well-established branded products with a history of deep market penetration and significant advertising support, as well as with new market entrants and generic competitors selling zolpidem and other sleep aids at a fraction of the price at which Purdue Pharma sells Intermezzo.

Intermezzo is the first sleep aid approved by the FDA specifically for use as needed for the treatment of insomnia when a middle-of-the-night awakening is followed by difficulty returning to sleep. We are not aware of any product candidate that has successfully completed the clinical trials required for approval for such indication. However, currently approved and marketed seven- to eight-hour therapeutics may be prescribed by doctors and used by patients to treat this condition when used to deliver a prophylactic dose of a sleep aid at the beginning of the night.

In 2010, we sponsored an epidemiology study conducted by Dr. Ronald Kessler that sought to quantify the extent of the off-label middle-of-the-night use of seven- to eight-hour sleep aids. The study suggested that approximately 11% of all hypnotic users sometimes take their sleep aid in the middle of the night in order to return to sleep, and that approximately 50% of those hypnotic users who reported middle-of-the-night awakening as their most bothersome insomnia symptom sometimes take their bedtime sleep aid in the middle of the night. Despite the fact that currently available sleep aids are not approved to be taken in the middle of the night, these findings suggest the possibility that some patients may use, or continue to use, these products, or their low cost generic versions, rather than Intermezzo. In addition, anecdotal evidence suggests that some patients currently split low cost generic tablets for off-label use in the middle of the night, despite the fact that these patients have no instruction as to the proper dose or how long they should stay in bed and refrain from driving.

The most directly competitive approved products in the United States are generic forms of Ambien® and Ambien CR®, which were originally developed by sanofi-aventis, and are available from multiple generic manufacturers. EdluarTM, a sublingual tablet containing zolpidem, was launched in the U.S. market by Meda Pharmaceuticals, Inc. in September 2009. ZolpimistTM, an orally administered spray containing zolpidem, was launched by ECR Pharmaceuticals Company, Inc., a wholly-owned subsidiary of Hi-Tech Pharmacal Co., Inc., in February 2011. EdluarTM and ZolpimistTM employ the same 10 mg and 5 mg zolpidem doses as generic Ambien® and are designed to be used in the same manner at bedtime to promote sleep onset.

Lunesta® (eszopiclone), marketed by Sunovion Pharmaceuticals Inc., a subsidiary of Dainippon-Sumitomo Pharma Co. Ltd., and Rozerem® (ramelteon), marketed by Takeda Pharmaceuticals Company Limited, can similarly treat middle-of-the-night awakenings by providing a prophylactic dose at bedtime in order to avoid a middle-of-the-night awakening. Also, short duration products such as Sonata®, which uses the active ingredient zaleplon and is marketed by King Pharmaceuticals, Inc., have been used off-label for the as-needed treatment of middle-of-the-night awakenings. In September 2010, Somaxon Pharmaceuticals, Inc. announced that its product, Silenor®, became commercially available in the United States. Silenor® is a

 

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low dose doxepin formulation intended for use at bedtime for the treatment of both transient (short term) and chronic (long term) insomnia characterized by difficulty with sleep maintenance in both adults and elderly patients. Other drugs, such as the antidepressant generic trazodone, are also widely prescribed off-label for the treatment of insomnia.

We may need to engage in costly, and potentially unsuccessful, litigation to protect our intellectual property from potential generic manufacturers of Intermezzo.

We received notifications in July 2012 from three companies, Actavis Elizabeth LLC (Actavis), Watson Laboratories, Inc. – Florida (Watson), and Novel Laboratories, Inc. (Novel), and, in September 2012, from each of Par Pharmaceutical, Inc. and Par Formulations Private Ltd. (together, the Par Entities), stating that each has filed with the FDA an abbreviated new drug application, or ANDA, that references Intermezzo. Each company’s ANDA also includes a Paragraph IV patent certification to our U.S. Patent Nos. 7,658,945 (expiring April 15, 2027) and 7,682,628 (expiring February 16, 2025). Additionally, the Par Entities’ ANDAs each include Paragraph IV patent certifications to our U.S. Patent Nos. 8,242,131 (expiring August 20, 2029) and 8,252,809 (expiring February 16, 2025). The Hatch-Waxman Act permits the FDA to approve ANDAs for generic versions of brand name drugs like Intermezzo. We refer to this process as the “ANDA process.” The ANDA process permits competitor companies to obtain marketing approval for a drug product with the same active ingredient, dosage form, strength, route of administration, and labeling as the approved brand name drug, but without having to conduct and submit clinical studies to establish the safety and efficacy of the proposed generic product. In place of such clinical studies, an ANDA applicant usually needs only to submit data demonstrating that its product is bioequivalent to the brand name product based on pharmacokinetic studies. Following the commercial launch of Intermezzo in April 2012, companies are able to submit an ANDA application for a generic version of Intermezzo at any time pursuant to the Hatch-Waxman Act.

The Hatch-Waxman Act requires an applicant for a drug product that relies, in whole or in part, on the FDA’s prior approval of Intermezzo, to notify us of its application if the applicant is seeking to market its product prior to the expiration of the patents that claim Intermezzo. This notice is required to contain a detailed factual and legal statement explaining the basis for the applicant’s opinion that the proposed product does not infringe our patents, that our patents are invalid, or both. Purdue Pharma has the option of bringing a patent infringement suit in federal district court against each company seeking approval for its product within 45 days from the date of receipt of each notice. Pursuant to the Collaboration Agreement, if Purdue Pharma chooses to file a patent infringement suit, we may decide whether to join Purdue Pharma as a named party in such lawsuit, or if Purdue Pharma chooses not to file patent infringement claims within the required 45 days, we may choose to do so on our own behalf. If such a suit is commenced within this 45 day period, we will be entitled to receive a 30 month stay on FDA’s ability to give final approval to any of the proposed products that reference Intermezzo. The stay may be shortened or lengthened if either party fails to cooperate in the litigation and it may be terminated if the court decides the case in less than 30 months. If the litigation is resolved in favor of the applicant before the expiration of the 30 month period, the stay will be immediately lifted and the FDA’s review of the application may be completed. Such litigation is often time-consuming and costly, and may result in generic competition if such patent(s) are not upheld or if the generic competitor is found not to infringe such patent(s).

In August 2012, September 2012, and October 2012, we joined Purdue Pharma in filing actions against Actavis, Watson, Novel, the Par Entities, and certain of their affiliates, alleging patent infringement and seeking injunctive and other relief. The filing of the Actavis, Watson, Novel and each of the Par Entities’ and any future ANDA applications referencing Intermezzo could have an adverse impact on our stock price, and litigation, if any, to enforce our patents is likely to require significant management attention and may require substantial capital resources. If the patents covering Intermezzo are not upheld in litigation or if the generic competitor is found to not infringe these patents, the resulting generic competition for Intermezzo would have a material adverse effect on our revenue and results of operations.

 

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Other companies may develop new products to compete with Intermezzo.

We are aware of several new products currently in development that are seeking indication statements from the FDA for the treatment of middle-of-the-night awakenings. NovaDel Pharma, Inc. has indicated that it has commenced development of a low-dose version of Zolpimist™ for the treatment of middle-of-the-night awakenings with the intent to enter such product candidate into clinical trials, and Somnus Therapeutics Inc. has indicated that it is similarly targeting treatment of middle-of-the-night awakenings with development of its controlled-release zaleplon formulation that would be dosed at bedtime, SKP-1041. Additionally, Alexza Pharmaceuticals, Inc. is developing AZ-007, immediate release zaleplon, for its ability to treat middle-of-the-night awakenings.

There are many other companies working to develop new products and other therapies to treat insomnia. Several of these products are in late stage clinical trials. In June 2012, Merck and Co., Inc. announced positive Phase 3 data from two pivotal trials of an investigational new drug. Merck plans to file a New Drug Application with the U.S. Food and Drug Administration in 2012. In January 2010, Vanda Pharmaceuticals Inc. received an orphan drug designation from the FDA for VEC-162 (tasimelteon), a melatonin agonist similar to ramelteon, for treatment of non-24 hour sleep/wake disorder in blind individuals without light perception. Vanda may seek approval for additional, broader insomnia indications for this product candidate, or such product candidate, if approved by the FDA, may be prescribed and used off-label to treat other insomnia indications.

Furthermore, new developments, including the development of other drug technologies and methods of treating conditions, occur in the biopharmaceutical industry at a rapid pace, and may negatively affect the commercial prospects of Intermezzo.

Many potential competitors, either alone or together with their partners, have substantially greater financial resources, research and development programs, clinical trial and regulatory experience, expertise in prosecution of intellectual property rights, and manufacturing, distribution and sales and marketing capabilities than us and our collaboration partner. As a result of such factors, our competitors may:

 

   

develop product candidates and market products that are less expensive, safer, more effective or easier to use than Intermezzo;

 

   

commercialize competing products, including generic versions of Intermezzo;

 

   

initiate or withstand substantial price competition more successfully than we can;

 

   

have greater success in recruiting skilled scientific workers and experienced sales and marketing personnel from the limited pool of available talent;

 

   

more effectively negotiate third party licenses and strategic collaborations; and

 

   

take advantage of acquisition or other opportunities more readily than us or our collaboration partner.

We may require substantial additional funding and may need to curtail operations if we are unable to raise capital when needed.

We had cash, cash equivalents and marketable securities of $98.7 million at September 30, 2012. We expect our negative cash flows from operations to continue for the foreseeable future as Purdue Pharma attempts to establish Intermezzo as a successful brand in the insomnia category, and as we develop TO-2061, seek regulatory approval for Intermezzo in other countries and seek additional products and product candidates through business development efforts. We do not know how long it will take to obtain

 

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regulatory approval of TO-2061 or any future product candidates, if any, or if such approval is obtainable. We also expect continuing negative cash flows. As a result, we will need to generate significant revenue to pay these costs and achieve profitability. We do not know whether or when we will become profitable because of the significant uncertainties with respect to Purdue Pharma’s ability to successfully commercialize Intermezzo and, as a result, our ability to generate revenue from sales of Intermezzo and from our existing and potential future collaborations, if any.

If our Collaboration Agreement with Purdue Pharma is terminated or other factors arise, our cash, cash equivalents and marketable securities may prove insufficient to fund our operations through the successful commercialization of Intermezzo. Also, the development and potential regulatory approval of additional product candidates will likely require additional funding, which may not be available at the time needed on commercially reasonable terms, if at all.

We currently believe that our available cash, cash equivalents and marketable securities and interest income will be sufficient to fund our anticipated levels of operations for at least the next twelve months. However, our future capital requirements will depend on many factors, including:

 

   

the ability of Purdue Pharma to successfully commercialize Intermezzo in the United States;

 

   

whether we choose to share the cost of advertising or other marketing efforts with Purdue Pharma related to the commercialization of Intermezzo in the United States;

 

   

the cost of establishing or contracting for sales and marketing capabilities if we exercise our option to co-promote Intermezzo to psychiatrists in the United States, and potential costs of being required to engage in contracting to replace Purdue Pharma’s primary care sales and marketing capabilities if our existing Collaboration Agreement with Purdue Pharma is terminated;

 

   

the extent to which we develop internally, acquire or in-license new products, technologies or businesses;

 

   

the rate of progress and cost of our ongoing TO-2061 clinical trial, the need to conduct additional clinical trials and other development activities;

 

   

the receipt of milestone and other payments, if any, from Purdue Pharma under the Collaboration Agreement;

 

   

the prospect, cost and timing for the development of Intermezzo to obtain regulatory approval for Intermezzo outside the United States;

 

   

the ability to license Intermezzo outside the United States and the terms and timing of any such licensing arrangements;

 

   

the cost of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights, including in connection with ANDA proceedings relating to Intermezzo; and

 

   

the effect of competing technological and market developments.

 

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In addition, we may seek to raise additional funds to:

 

   

further develop Intermezzo to meet the requirements for regulatory approval of Intermezzo outside the United States;

 

   

establish or contract for sales and marketing capabilities if we exercise our option to co-promote Intermezzo, or to build our own sales force if Purdue Pharma does not continue with our collaboration to commercialize Intermezzo in the United States;

 

   

support the ongoing promotion of Intermezzo by Purdue Pharma;

 

   

continue to develop TO-2061 through clinical trials and other development activities; and

 

   

develop internally, acquire or in-license new products, technologies or businesses or to otherwise fund our operations.

There can be no assurance that additional funding, if needed, will be available on attractive terms, or at all. Our failure to raise capital as and when needed may require us to significantly curtail one or more of our development, licensing or acquisition programs, which could have a negative impact on our financial condition and our ability to successfully pursue our business strategy.

If we choose to exercise our co-promotion option and are unable to establish an effective and profitable sales and marketing infrastructure in the United States, our financial performance could be substantially harmed.

In order to commercialize Intermezzo or any other product candidates successfully, we must enter into and maintain strategic collaborations to perform, and/or acquire or internally develop a sales and marketing infrastructure. We have entered into a strategic collaboration for commercialization of Intermezzo in the United States with Purdue Pharma and may develop our own sales force and marketing infrastructure to co-promote Intermezzo to psychiatrists in the United States. If we exercise our co-promotion option and are unable to develop a sales and marketing infrastructure to effectively commercialize Intermezzo, our ability to generate additional revenue from potential sales of Intermezzo to psychiatrists would be substantially harmed. Even if we develop an effective sales and marketing organization, we may not be able to generate sufficient revenue from our additional co-promotion royalties from Purdue Pharma to make that operation profitable during the first several years of operation, or at all.

The development of sales and marketing infrastructure is difficult and time consuming, and requires substantial financial and other resources. Factors that may hinder our efforts to develop an internal sales and marketing infrastructure include:

 

   

the inability to recruit, retain and effectively manage adequate numbers of effective sales and marketing personnel;

 

   

the inability of sales personnel to obtain access to or convince adequate numbers of physicians to prescribe Intermezzo or future products, if approved;

 

   

the abundance of well branded, competing products sold and distributed by large established organizations;

 

   

the lack of complementary products to be offered by sales personnel, which may put us at a competitive disadvantage relative to companies with more extensive product lines; and

 

   

unforeseen delays, costs and expenses associated with creating a sales and marketing organization.

 

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We cannot transfer or assign to a third party our option to co-promote Intermezzo to psychiatrists in the United States, except in a limited circumstance at the discretion of Purdue Pharma.

The Collaboration Agreement prohibits the transfer or assignment of our co-promotion option to third parties, except in a limited circumstance at the discretion of Purdue Pharma. The Collaboration Agreement provides that if we have not exercised the co-promote option prior to an acquisition of us or a change in control, the co-promote option will terminate. In the event that we have exercised our co-promote option and have met certain sales criteria, Purdue Pharma maintains full discretion over our ability to transfer or assign the co-promote option to a third party in the event of an acquisition of us or change in control. The Collaboration Agreement also prohibits any transfer or assignment of our co-promote option to a third party, except in the limited circumstance described in the foregoing sentence. The inability to transfer or assign our co-promote option to a third party reduces our flexibility in monetizing the option and may decrease the value of Transcept to potential acquirors.

If we delay exercising our co-promotion option for Intermezzo or commencing co-promotion activities after exercise, the royalties for net sales of Intermezzo that we may receive under the co-promotion option are reduced.

The Collaboration Agreement provides that we can exercise our co-promotion option at any point before or on the last day of the fortieth calendar month (e.g. on or before August 31, 2015) after commercial launch of Intermezzo in the United States, which occurred in early April 2012. The Collaboration Agreement also provides that we cannot begin co-promoting Intermezzo until at least 12 months following the commercial launch of Intermezzo in the United States. In the event that we exercise our co-promotion option in the first four months of a calendar year, we cannot commence co-promotion activities until the first month of the next calendar year. In the event that we exercise our option after the fourth calendar month of the year, we cannot commence co-promotion activities until 15 months from the date we exercise our option. Had we chosen to exercise the option as soon as we were eligible, we could have begun promoting to psychiatrists in May 2013 and received a co-promote royalty of 40%. The co-promote royalty rate declines on a straight-line basis to approximately 22% if we do not begin promoting to psychiatrists until November 2016, at which point our right to co-promote expires. A delay in the exercise of our co-promote option or the commencement of co-promotion activities following exercise of our option will adversely affect the revenue we can generate pursuant to our co-promotion right.

Governmental and third party payors may impose restrictions on reimbursement or pricing controls that could limit product revenue.

The continuing efforts of government and third party payors to contain or reduce the costs of health care through various means may reduce potential revenue we may receive from sales of Intermezzo. In particular, third party insurance coverage may not be available to patients for Intermezzo or other future products, if any, especially in light of the availability of low-cost generic zolpidem therapeutics, regardless of the fact that such products are not specifically designed or indicated to specifically treat middle-of-the-night awakening. Government and third party payors could also impose conditions on reimbursement, price controls and other conditions that must be met by patients prior to providing coverage for use of our products. For example, insurers may establish a “step-edit” system that requires a patient to utilize a lower price alternative product prior to becoming eligible for reimbursement of a higher price product. If government and third party payors do not provide adequate coverage and reimbursement levels for our products, or if price controls, prior authorization or step-edit systems are enacted, our royalties and/or product revenue will suffer. Also, potential revenue based on sales to Federal government customers, including the Departments of Veterans Affairs and Defense, will be limited given that Intermezzo will be subject to statutory price constraints that apply to innovator products (those approved by the FDA under NDAs). In addition, the Affordable Care Act requires manufacturers of branded prescription drugs to pay an annual fee to the Federal government. Each manufacturer’s fee is calculated based on the dollar value of its sales to certain federal programs and the aggregate dollar value of all branded prescription drug sales by covered manufacturers. A manufacturer’s fee will be its prorated share of the industry’s total fee obligation (approximately $2.8 billion in 2012 and 2013 and set to increase in following years), based on the ratio of its sales to the total sales by manufacturers to these same programs. We cannot predict our share of this fee because it will be determined in part on other entities’ sales to the relevant programs.

 

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Negative publicity and documented side effects concerning products used to treat patients in the insomnia market may harm commercialization of Intermezzo.

Products containing zolpidem, the active ingredient in Intermezzo, are widely marketed. Zolpidem use has been linked to negative effects, such as sleepwalking and amnesia, and has the potential to cause physical or psychological dependence. Furthermore, zolpidem is classified as a Schedule IV controlled substance under the Controlled Substances Act, and is subject to certain packaging, prescription and purchase volume limitations. There can be no assurance that additional negative publicity or increased governmental controls on the use of zolpidem or other compounds used in products for the insomnia market would not inhibit or prevent commercialization of Intermezzo. Furthermore, negative information arising out of clinical trials, post-market adverse event reporting or publicity concerning zolpidem and other hypnotic pharmaceuticals could cause the FDA to make approval or marketing of new products for the insomnia market more difficult, by requiring additional pre- or post-market studies or different non-clinical or clinical studies or taking other actions, out of safety or other concerns, or could lead to reduced consumer usage of sleep aids, including zolpidem products and Intermezzo. For example, the FDA has taken steps to ensure that we warn patients that the use of other zolpidem products may negatively affect patient driving ability the morning after dosing.

Intermezzo, and any other future product candidate for which we may receive regulatory approval from the FDA, will be subject to ongoing regulatory requirements and may face regulatory or enforcement action.

Intermezzo, as well as any other product candidate for which we receive regulatory approval, together with related third party manufacturing facilities and processes, post-approval clinical data, and advertising and promotional activities for the product, will be subject to significant review, oversight and ongoing and changing regulation by the FDA. Failure to comply with regulatory requirements may subject us, or Purdue Pharma, to administrative and judicially-imposed sanctions. These may include warning letters, adverse publicity, civil and criminal penalties, injunctions, product seizures or detention, product recalls, total or partial suspension of production, refusal to approve pending product marketing applications, import alerts placing a hold on the importation of drug products and drug substances, and withdrawal of product approvals. Even if we receive regulatory approval to market a particular product candidate, the approval could be conditioned on our conducting additional costly post-approval studies or could limit the indicated uses included in our labeling. The FDA now has the authority to require certain post-market studies, including post-market studies to further evaluate the safety of the drug and the use of the drug in certain patient populations, including pediatric and geriatric populations. For example, as part of the approval of Intermezzo, the FDA has required us to conduct a post-market study of the ability of patients to comply with our dosing instructions in an actual-use setting. Moreover, the product may later cause adverse effects that limit or prevent its widespread use, force us or our marketing partner to withdraw it from the market or impede or delay the ability to obtain regulatory approvals in additional countries. The FDA has also requested that all manufacturers of sedative-hypnotic pharmaceutical products modify their product labeling to include strong language concerning potential risks. These risks include severe allergic reactions and complex sleep-related behaviors, which include sleep-driving. The FDA also recommended that pharmaceutical manufacturers of sedative-hypnotics conduct clinical studies to investigate the frequency with which sleep-driving and other complex behaviors occur in association with individual drug products, and to deliver to the FDA information related to the effect, if any, their drug products may have on next day driving safety.

 

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If manufacturers supplying Intermezzo or any other product candidate fail to produce in the volumes and quality that are required on a timely basis, or to comply with stringent regulations applicable to pharmaceutical manufacturers, there may be delays in the commercialization of or an inability to meet demand for Intermezzo or delays in the development of future product candidates, if any, and we may lose potential revenue.

Neither we nor Purdue Pharma manufacture Intermezzo, nor do we manufacture TO-2061, and we do not currently have plans to develop the capacity to manufacture either product. We have a primary manufacturing and supply agreement with Patheon, Inc. to manufacture a supply of Intermezzo for use outside the United States, and Purdue Pharma has entered into an agreement with Patheon to manufacture and supply Intermezzo for use in the United States. We and Purdue Pharma currently have arrangements to use Sharp Corporation as a primary packager of Intermezzo. Purdue Pharma relies upon SPI Pharma, Inc. as a supplier for certain key excipients contained within Intermezzo and as the sole supplier for one such excipient, Pharmaburst®. If we obtain approval to sell Intermezzo outside the U.S. territory, we would likely also rely on SPI Pharma as a supplier for the same excipients. In addition, Purdue Pharma relies upon Teva Pharmaceutical Industries Ltd., API Division (formerly Plantex USA, Inc.) as the sole source for a special form of zolpidem tartrate, which is the active pharmaceutical ingredient of Intermezzo.

Purdue Pharma is dependent upon these manufacturers for the commercial supply of Intermezzo in the United States. The realization of any of the risks described here would have a significant impact on Purdue Pharma’s commercialization efforts for Intermezzo and our ability to generate revenue under the Collaboration Agreement. In the event we commercialize Intermezzo outside the U.S. territory, we would likely also rely on the same key manufacturers and suppliers as Purdue Pharma intends to use to commercialize Intermezzo in the U.S. territory.

The manufacture of pharmaceutical products requires significant expertise and capital investment, including the development of advanced manufacturing techniques and process controls. Manufacturers of pharmaceutical products often encounter difficulties in production, particularly in scaling up initial production. These problems include difficulties with production costs and yields, quality control, including stability of the product candidate and quality assurance testing, shortages of qualified personnel, and compliance with strictly enforced federal, state and foreign regulations. Third-party manufacturers and key suppliers may not perform as agreed, may terminate their agreements, or may experience manufacturing difficulties due to resource constraints or as a result of labor disputes, unstable political environments at foreign facilities or financial difficulties. For example, Purdue Pharma’s supplier of zolpidem tartrate with its manufacturing facility in Israel may face geopolitical risk that could prevent it from providing supplies from such facility. Additionally, third-party manufacturers and key suppliers may become subject to claims of infringement of intellectual property rights of others, which could cause them to incur substantial expenses, and, if such claims were successful, could cause them to incur substantial damages or cease production of our products or product components. In addition, several of the suppliers of Intermezzo have only one facility qualified to supply key components of Intermezzo, and transferring such supply to an alternate site could take substantial time and resources. Any interruption of supply from such facilities could materially impair the ability to manufacture Intermezzo, which may harm Purdue Pharma’s ability to commercialize Intermezzo in the United States and impair our ability to generate revenue from Intermezzo through our collaboration with Purdue Pharma. Furthermore, as noted above, in the event we commercialize Intermezzo outside the U.S. territory, we would likely also rely on the same key manufacturers and suppliers as Purdue Pharma intends to use to commercialize Intermezzo in the U.S. territory. These manufacturers and suppliers may also choose, or be required, to seek licenses from the claimant, which may not be available on acceptable terms or at all. If these manufacturers or key suppliers were to encounter any of these difficulties, or otherwise fail to comply with their contractual obligations, our ability to launch Intermezzo in the United States through our collaboration with Purdue Pharma or, if we choose to commercialize Intermezzo accordingly, outside of the United States, or any other product candidate, if approved, would be jeopardized. Even if we were able to launch a product, these difficulties could cause increases in the prices we or our collaborators pay for supply of such product and its components which could substantially hinder or prevent commercialization efforts.

 

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In addition, all manufacturers and suppliers of pharmaceutical products must comply with current good manufacturing practice, or cGMP, requirements enforced by the FDA through its facilities inspection program. The FDA is likely to conduct inspections of third-party manufacturer and key supplier facilities as part of its review of any of our NDAs. If third-party manufacturers and key suppliers are not in compliance with cGMP requirements, it may result in a delay of approval, particularly if these sites are supplying single source ingredients required for the manufacture of Intermezzo. These cGMP requirements include quality control, quality assurance and the maintenance of records and documentation. Furthermore, regulatory qualifications of manufacturing facilities are applied on the basis of the specific facility being used to produce supplies. As a result, if one of these manufacturers shifts production from one facility to another, the new facility must go through a complete regulatory qualification process and be approved by regulatory authorities prior to being used for commercial supply. Manufacturers may be unable to comply with these cGMP requirements and with other FDA, state and foreign regulatory requirements. A failure to comply with these requirements may result in fines and civil penalties, suspension of production, suspension or delay in product approval, product seizure or recall, or withdrawal of product approval. If the safety of any quantities supplied is compromised due to a third-party manufacturer or key supplier failure to adhere to applicable laws or for other reasons, we may not be able to obtain regulatory approval for our product candidates and, even if such approval is obtained, any resulting products may not be successfully commercialized.

There are no alternate manufacturers qualified at this time with respect to the commercial supply of Intermezzo, nor are there alternate manufacturers identified or qualified with respect to the commercial supply of several of the key ingredients and packaging materials used in Intermezzo. If manufacturers are required to be changed, prior approval by the FDA and comparable foreign regulators would be required and Purdue Pharma would likely incur significant costs and expend significant efforts to educate the new manufacturer with respect to, or to help the new manufacturer independently develop, the processes necessary for production. If we exercise our right to co-promote Intermezzo to psychiatrists, we may also incur such costs and expend such efforts to ensure commercial supply of Intermezzo. Manufacturing and supply switching costs in the pharmaceutical industry can be very high, and switching manufacturers or key suppliers can frequently take 12 to 18 months to complete, although in certain circumstances such a switch may be significantly delayed or prevented by regulatory and other factors.

Any of these factors could cause the delay or suspension of commercialization of Intermezzo, TO-2061 or any other product candidate that we may develop, hinder or delay future regulatory submissions and/or required regulatory approvals, or entail higher costs or result in an inability to effectively commercialize our products. Furthermore, if manufacturers fail to deliver the required commercial quantities of raw materials, including the active pharmaceutical ingredient, key excipients or finished product on a timely basis and at commercially reasonable prices, we or our strategic partners, including Purdue Pharma, would be unable to meet demand for our products and we would lose potential revenue.

Our future clinical trials may fail to demonstrate adequately the safety and efficacy of TO-2061 or any future product candidates, which could prevent or delay regulatory approval and commercialization.

Before obtaining regulatory approvals for the commercial sale of TO-2061 or any future product candidates, we must demonstrate through lengthy, complex and expensive preclinical testing and clinical trials that the product candidate is both safe and effective for use in each target indication. Our trial results may be negatively affected by factors that had not been fully anticipated prior to commencement of the trial. Such trials may fail to demonstrate efficacy in the treatment of the intended disorder or may fail to demonstrate that a product candidate is safe when used as directed or even when misused. The results obtained in completed clinical trials and non-clinical studies may not be predictive of results from ongoing or future trials. Actual results of any future studies may differ materially from past studies due to various risks and uncertainties, including, but not limited to, the following:

 

   

identical study designs evaluating identical endpoints may produce different study results;

 

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different study designs intended to measure the same or similar endpoints may produce different results;

 

   

different studies in different or progressively larger patient populations could reveal more frequent, more severe or additional side effects that were not seen in earlier studies; and

 

   

the unpredictable nature of clinical trials generally.

Although we seek to design our clinical trial protocols to address known factors that may negatively affect results, there can be no assurance that protocol designs will be adequate or that factors that we may or may not be aware of or anticipate will not have a negative effect on the results of our clinical trials. Once a study has commenced, we may voluntarily suspend or terminate the study if at any time we believe that there is an unacceptable safety risk to patients.

Further, side effects could interrupt, delay or halt clinical trials of our product candidates and could result in the FDA or other regulatory authorities stopping further development of or denying approval of our product candidates. Based on results at any stage of clinical trials, we may decide to repeat or redesign a trial, modify our regulatory strategy or even discontinue development of one or more of our product candidates. For example, ondansetron is approved for episodic use. It has not been clinically determined what risks could be associated with the long term or chronic use of ondansetron in treatment resistant OCD. In addition, from time to time the FDA will review the safety of an approved product, molecule or therapeutic class. In a recent review of ondansetron the FDA revised the Important Safety Information related to ondansetron and cited a risk of QT prolongation, or irregular heart rhythm. These types of safety reviews by the FDA, or new clinical findings generated by the scientific community, could cause us to modify our clinical study plans for ondansetron and other programs, or abandon such programs altogether.

If our product candidates are not shown to be both safe and effective in clinical trials, the resulting delays in developing other compounds and conducting associated non-clinical testing and clinical trials, as well as the potential need for additional financing, would have a material adverse effect on our business, financial condition and results of operations.

Delays in the commencement or completion of clinical testing could result in increased costs to us and delay our ability to generate revenue.

We do not know whether future clinical trials will begin on time or be completed on schedule, if at all. The commencement and completion of clinical trials can be disrupted for a variety of reasons, including difficulties in:

 

   

recruiting and enrolling patients to participate in a clinical trial,

 

   

addressing issues raised by the FDA or other regulatory authorities regarding safety, design, scope and objectives of clinical studies;

 

   

obtaining regulatory approval to commence a clinical trial;

 

   

reaching agreement on acceptable terms with prospective clinical research organizations and trial sites;

 

   

manufacturing sufficient quantities of a product candidate; and

 

   

obtaining institutional review board approval to conduct a clinical trial at a prospective site.

 

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A clinical trial may also be suspended or terminated by us or the FDA or other regulatory authorities due to a number of factors, including:

 

   

failure to conduct the clinical trial in accordance with regulatory requirements or in accordance with our clinical protocols;

 

   

inspection of the clinical trial operations or trial site by the FDA or other regulatory authorities resulting in the imposition of a clinical hold;

 

   

unforeseen safety issues; and

 

   

inadequate patient enrollment or lack of adequate funding to continue the clinical trial.

In addition, changes in regulatory requirements and guidance may occur and we may need to amend clinical trial protocols to reflect these changes, which could impact the cost, timing or successful completion of a clinical trial. Further, conducting clinical trials in foreign countries, as we are currently doing with respect to TO-2061, presents additional risks that may delay completion of our clinical trials. These risks include the failure of enrolled patients in foreign countries to adhere to clinical protocol as a result of differences in healthcare services or cultural customs, managing additional administrative burdens associated with foreign regulatory schemes, as well as political and economic risks relevant to such foreign countries. If we experience delays in the commencement or completion of our clinical trials, the commercial prospects for our product candidates and our ability to generate product revenue will be harmed. Many of the factors that cause, or lead to, a delay in the commencement or completion of clinical trials may also lead to the denial of regulatory approval of a product candidate.

The commercial success of Intermezzo, as well as TO-2061, depends, in part, on meeting the conditions for market exclusivity under Section 505 of the Federal Food, Drug and Cosmetic Act, or FFDCA.

We have been granted approval of a new drug application (NDA) for Intermezzo submitted under Section 505(b)(2) of the FFDCA, enacted as part of the Drug Price Competition and Patent Term Restoration Act of 1984, otherwise known as the Hatch-Waxman Act. Section 505(b)(2) permits applicants to rely in part on clinical and non-clinical studies conducted by third parties. Specifically, with respect to Intermezzo, we relied in part on third party data concerning zolpidem, which is the active ingredient in Intermezzo and in the previously approved insomnia products Ambien® and Ambien CR®. We also plan to seek approval of TO-2061, which is at an earlier stage of development, under a Section 505(b)(2) application.

In connection with the approval of the Intermezzo NDA, the FDA has granted three years of Hatch-Waxman marketing exclusivity for Intermezzo. Under this form of exclusivity, the FDA is precluded from approving an abbreviated new drug application (ANDA) for a generic of Intermezzo, i.e., a product candidate that the FDA views as a therapeutically equivalent drug product having the same conditions of use as Intermezzo (for example, the same labeling, the same dosage form and route of administration, the same strength and the same bioavailability as Intermezzo). Marketing exclusivity for Intermezzo also precludes the FDA from approving 505(b)(2) applications for proposed drug products having the same or similar conditions of use as Intermezzo, including applications that rely on Intermezzo as the reference product. The exclusivity lasts for a period of three years from the date of Intermezzo approval, or until November 2014, though the FDA may accept and commence review of ANDAs and 505(b)(2) NDAs during the three-year period. However, the three-year exclusivity period may not prevent FDA from approving an original NDA that relies only on its own data to support the approval. In addition, we received notifications in July 2012 that each of Actavis, Watson, and Novel and, in September 2012, that each of the Par Entities, has filed with the FDA an ANDA, including Paragraph IV certifications, for generic versions of Intermezzo.

 

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We rely on third parties to conduct our non-clinical and clinical trials. If these third parties do not perform as contractually required or as otherwise expected, we may not be able to obtain regulatory approval for our current and future product candidates, if any.

We do not currently conduct non-clinical and clinical trials on our own and instead rely on third parties, such as contract research organizations, medical institutions, clinical investigators and contract laboratories, to assist us with our non-clinical and clinical trials. We, and our third parties, are also required to comply with regulations and standards, commonly referred to as Good Clinical Practice, for conducting, recording and reporting the results of clinical trials to assure that data and reported results are credible and accurate and that the trial participants are adequately protected. If these third parties do not successfully carry out their duties with regard to our products in development or fail to successfully carry out their duties to us as they relate to meeting future regulatory obligations or expected deadlines, if the third parties need to be replaced, or if the quality or accuracy of the data these third parties obtained during the development of a product candidate is compromised due to the failure to adhere to our clinical protocols or regulatory requirements or for other reasons, our non-clinical development activities or clinical trials may be extended, delayed, suspended or terminated, and we may not be able to obtain regulatory approval for a product candidate.

We or any future partners may never receive regulatory approval to market or commercialize Intermezzo outside of the United States.

In order to market and commercialize Intermezzo outside of the United States, we and any future partners must establish and comply with numerous and varying regulatory requirements of other countries regarding safety and efficacy. Approval procedures vary among countries and can involve additional pre-clinical studies and clinical trials and additional administrative review periods. For example, European regulatory authorities generally require clinical testing comparing the efficacy of the new drug to an existing drug prior to granting approval. The time required to obtain approval in other countries might differ from that required to obtain FDA approval. The regulatory approval process in other countries may include all of the risks detailed in this “Risk Factor” section regarding FDA approval in the United States, as well as other risks. Regulatory approval in one country does not ensure regulatory approval in another, but a failure or delay in obtaining regulatory approval in one country may have a negative effect on the regulatory process in other countries.

We may face potential product liability exposure, and if successful claims are brought against us, we may incur substantial liability for a product candidate and may have to limit such candidate’s commercialization.

The use of a product candidate in clinical trials and the sale of any products for which we obtain marketing approval, including Intermezzo, exposes us to the risk of product liability claims. Product liability claims might be brought against us by consumers, health care providers, pharmaceutical companies or others selling our products. If we cannot successfully defend ourselves against these claims, we will incur substantial liabilities. We are also obligated under certain circumstances to indemnify suppliers and others with whom we have contractual relationships for product liability claims such entities might incur with respect to our products and product candidates. Regardless of merit or eventual outcome, liability claims may result in:

 

   

decreased demand for Intermezzo or future products, if any;

 

   

impairment of our business reputation;

 

   

withdrawal of clinical trial participants;

 

   

costs of related litigation;

 

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substantial monetary awards to patients or other claimants;

 

   

loss of revenue; and

 

   

the inability to commercialize future product candidates.

Under our Collaboration Agreement with Purdue Pharma, we remain liable for 50% of the cost of defending against any product liability or personal or economic injury claims. In addition, we and Purdue Pharma have agreed to allocate any losses for such claims on a comparative fault basis but in the absence of such determination have agreed to split such losses equally. Although we currently have product liability insurance coverage for our clinical trials with limits that we believe are customary and adequate to provide us with coverage for foreseeable risks associated with our development efforts, this insurance coverage may not reimburse us or may be insufficient to reimburse us for the actual expenses or losses we may suffer. Moreover, insurance coverage is becoming increasingly expensive and, in the future, we may not be able to maintain insurance coverage at a reasonable cost or in sufficient amounts to protect us against losses due to liability. We have product liability insurance covering the sale of Intermezzo in the United States.

We depend on key personnel and if we are not able to retain them, our business will suffer.

We are highly dependent on the principal members of our management and scientific staff, including but not limited to Glenn A. Oclassen, our President and Chief Executive Officer, Thomas P. Soloway, our Executive Vice President and Chief Operating Officer and Nikhilesh N. Singh, Ph.D., our Senior Vice President and Chief Scientific Officer. The competition for skilled personnel among biopharmaceutical companies in the San Francisco Bay Area is intense and the employment services of our scientific, management and other executive officers may be terminated at-will. If we lose one or more of these key employees, our ability to implement and execute our business strategy successfully could be seriously harmed. Replacing key employees may be difficult and may take an extended period of time because of the limited number of individuals in the biopharmaceutical industry with the breadth of skills and experience required to develop, gain regulatory approval of and commercialize products successfully. We do not carry key man life insurance on any of our key personnel other than Dr. Singh.

The commercial success, if any, of Intermezzo and TO-2061 depends, in part, on certain patent rights and rights we are seeking through certain patent applications.

The potential commercial success of Intermezzo depends in part on patents that have been issued to us from the U.S. Patent and Trademark Office, or USPTO, covering the formulation and use of Intermezzo that expire no earlier than February 2025. In addition, we have pending certain foreign equivalent patent applications. We also have pending applications covering methods of treating OCD with TO-2061 in combination with first-line pharmacotherapy, and optionally atypical antipsychotic drugs.

The active, and many of the inactive, ingredients in Intermezzo and TO-2061, including generically manufactured zolpidem and ondansetron, respectively, have been known and used for many years. The zolpidem and ondansetron compositions of matter are no longer subject to patent protection. Accordingly, certain of our patents for Intermezzo are directed to the particular formulations of its ingredients. Also, for both Intermezzo and TO-2061, we are seeking or have received patent protection for new uses of such compounds. Although we believe our formulations and the use of Intermezzo and TO-2061 are patentable, and patents covering or arising from such product candidates have the potential to provide a competitive advantage, such patents may not prevent others from marketing formulations using the same active and inactive ingredients in similar but different formulations. Moreover, if our patents are successfully challenged and ruled to be invalid and/or unenforceable, we would be exposed to direct competition from low-priced generic products.

There can be no assurance that our pending patent applications and applications we may file in the future, or those applications we may license from third parties, will result in patents being issued in a

 

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timely manner, or at all. Even if patents issue, the claims in such patents may not issue in a form that will be advantageous to us, may not cover Intermezzo or TO-2061 and their unique features, and may not provide us with proprietary protection or competitive advantages. For instance, with Intermezzo, competitors may be able to engineer around our formulation patents and applications with alternate formulations that deliver therapeutic effects sufficiently similar to Intermezzo to warrant approval under existing FDA standards for generic product approvals. Accordingly, other drug companies may be able to develop generic versions of our products even if we are able to maintain our current proprietary rights. Similarly, our patents, and any patents that result from currently pending or future patent applications, covering the use of ondansetron may be insufficient to provide effective protection for TO-2061 in light of existing generic availability of ondansetron. Although such generic versions are offered in higher doses than currently contemplated for TO-2061, physicians may instruct their patients to split generic tablets of ondansetron into a dose similar or equal to our contemplated dose for TO-2061, or simply prescribe higher doses of generic ondansetron if they believe that such higher doses do not create a safety liability for the patient.

Alternatively, other drug companies can challenge the validity of our patents and seek to gain marketing approval for generic versions of our products. For example, drug makers may attempt to introduce low-dose zolpidem or ondansetron products similar to our products immediately after the expiration of Hatch-Waxman marketing exclusivity and prior to the expiration of patents that may be issued relating to our respective products by challenging the validity of our patents or certifying that their competitive products do not infringe our patents.

Generic drug manufacturers routinely initiate challenges during the Hatch-Waxman marketing exclusivity period. We received notifications in July 2012 that each of Actavis, Watson, and Novel, and in September 2012 that each of the Par Entities, has filed with the FDA an ANDA, including Paragraph IV certifications, for generic versions of Intermezzo. If we or Purdue Pharma initiate timely patent litigation against a generic or 505(b)(2) sponsor who seeks to challenge one or more of the patents that claim Intermezzo, we would be entitled to a regulatory stay that prohibits final approval of the generic or 505(b)(2) product for 30 months from the date we receive notice of the challenge to our patents. That stay may be terminated if we or Purdue Pharma do not succeed in maintaining litigation against the generic or 505(b)(2) applicant. In addition, if a generic or 505(b)(2) applicant formulates around our patents, we may not be able to initiate Hatch-Waxman patent litigation and, as a result, there would be no 30 month regulatory stay on FDA’s ability to give final approval to the generic or 505(b)(2) application. In August 2012, September 2012, and October 2012, we joined Purdue Pharma in filing actions against Actavis, Watson, Novel, the Par Entities, and certain of their affiliates, alleging patent infringement and seeking injunctive and other relief.

In addition, among other limitations, certain of our patents that protect Intermezzo are limited in scope to certain uses and formulations of zolpidem, so potential competitors could develop similar products using active pharmaceutical ingredients other than zolpidem. Any patents that have been allowed, we have obtained or do obtain may be challenged by re-examination, opposition, or other administrative proceeding, or may be challenged in litigation, and such challenges could result in a determination that the patent is invalid and/or unenforceable.

Failure to obtain effective patent protection for Intermezzo or TO-2061, or future product candidates, if any, would allow for products to be marketed by competitors that would undermine sales, marketing and collaboration efforts for our product candidates, and reduce or eliminate our revenue. In addition, both the patent application process and the process of managing patent disputes can be time consuming and expensive.

If we are unable to maintain and enforce our proprietary rights, we may not be able to compete effectively or operate profitably.

Our commercial success will depend, in part, on obtaining and maintaining patent protection, trade secret protection and regulatory protection of our proprietary technology and information as well as

 

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successfully defending against third party challenges to our proprietary technology and information. We will be able to protect our proprietary technology and information from use by third parties only to the extent that we have valid and enforceable patents, trade secrets or regulatory protection to cover them and we have exclusive rights to utilize them.

Our commercial success will continue to depend in part on the patent rights we own, the patent rights we have licensed, the patent rights of our suppliers and the patent rights we plan to obtain related to future products we may market. Our success also depends on our and our licensors’ and suppliers’ ability to maintain these patent rights against third party challenges to their validity, scope or enforceability. Further, if we were to in-license intellectual property, we may not fully control the patent prosecution of the patents and patent applications we have licensed. There is a risk that licensors to us will not devote the same resources or attention to the prosecution of the licensed patent applications as we would if we controlled the prosecution of the patent applications, and the resulting patent protection, if any, may not be as strong or comprehensive as if we had prosecuted the applications ourselves. The patent positions of biopharmaceutical companies can be highly uncertain and involve complex legal and factual questions for which important legal principles remain unresolved. No consistent policy regarding the breadth of claims allowed in such companies’ patents has emerged to date in the United States. The patent situation outside the United States is even more uncertain. Changes in either the patent laws or in interpretations of patent laws in the United States or other countries may diminish the value of our intellectual property. Accordingly, we cannot predict the breadth of claims that may be allowed or enforced in our patents or in third party patents. For example:

 

   

we or our licensors might not have been the first to make the inventions covered by pending patent applications and issued patents;

 

   

we or our licensors might not have been the first to file patent applications for these inventions;

 

   

others may independently develop similar or alternative technologies or duplicate any of our technologies;

 

   

it is possible that none of our pending patent applications or any pending patent applications of our licensors will result in issued patents;

 

   

our patents, if issued, and the issued patents of our licensors may not provide a basis for commercially viable products, or may not provide us with any competitive advantages, or may be challenged and invalidated by third parties;

 

   

we may not develop additional proprietary technologies or product candidates that are patentable; or

 

   

the patents of others may have an adverse effect on our business.

We also rely on trade secrets to protect our technology, especially where we do not believe patent protection is appropriate or obtainable. However, trade secrets are difficult to protect. While we seek to protect confidential information, in part, by confidentiality agreements with our employees, consultants, contractors, or scientific and other advisors, they may unintentionally or willfully disclose our information to competitors. If we were to enforce a claim that a third party had illegally obtained and was using our trade secrets, it would be expensive and time consuming, and the outcome would be unpredictable. In addition, courts outside the United States are sometimes less willing to protect trade secrets.

If we are not able to defend the patent or trade secret protection position of our technologies and product candidates, then we will not be able to exclude competitors from developing or marketing competing products, and we may not generate enough revenue from product sales, if any, to justify the cost of development of our product candidates and to achieve or maintain profitability.

 

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If we are sued for infringing intellectual property rights of other parties, such litigation will be costly and time consuming, and an unfavorable outcome would have a significant adverse effect on our business.

Although we believe that we would have valid defenses to allegations that our current product candidates, production methods and other activities infringe the valid and enforceable intellectual property rights of any third parties of which we are aware, we cannot be certain that a third party will not challenge our position in the future. Other parties may own patent rights that might be infringed by our products or other activities, or other parties may claim that their patent rights are infringed by excipients manufactured by others and contained in our products. There has been, and we believe that there will continue to be, significant litigation and demands for licenses in the life sciences industry regarding patent and other intellectual property rights. Competitors or other patent holders may assert that our products and the methods we employ are covered by their patents. These parties could bring claims against us that would cause us to incur substantial expenses and, if successful against us, could cause us to pay substantial damages or possibly prevent us from commercializing our product candidates. Further, if a patent infringement suit were brought against us, we could be forced to stop or delay research, development, manufacturing or sales of the product or product candidate that is the subject of the suit.

As a result of patent infringement claims, or in order to avoid potential claims, we may choose to seek, or be required to seek, a license from the third party and would most likely be required to pay license fees or royalties or both. These licenses may not be available on acceptable terms, or at all. Even if we were able to obtain a license, the rights may be non-exclusive, which would give competitors access to the same intellectual property. Ultimately, we could be prevented from commercializing a product, or be forced to cease some aspect of our business operations if, as a result of actual or threatened patent infringement claims, we or our collaborators are unable to enter into licenses on acceptable terms. This could harm our business significantly.

These risks of intellectual property infringement are similarly faced by our suppliers and collaborators, which could hinder or prevent them from manufacturing or commercializing our products.

We may incur substantial costs as a result of litigation or other proceedings relating to patent and other intellectual property rights.

In the event a competitor infringes upon one of our patents or other intellectual property rights, litigation to enforce our intellectual property rights or to defend our patents against challenge, even if successful, could be expensive and time consuming and could require significant time and attention from management. Under the Collaboration Agreement, Purdue Pharma has the right, but not the obligation, to bring action against a party engaged in infringement of our patents covering Intermezzo, and we are required to share 40% of the costs related to all such actions up to an aggregate cap of $1.0 million per calendar year and $4.0 million over the term of the agreement. Additionally, in August 2012, September 2012 and October 2012, we joined Purdue Pharma in filing actions against Actavis, Watson, Novel, the Par Entities, and certain of their affiliates, alleging patent infringement and seeking injunctive and other relief. We may not have sufficient resources to enforce our intellectual property rights or to defend our patents against challenges from others.

The pharmaceutical industry is characterized by extensive litigation and administrative proceedings over patent and other intellectual property rights. We could therefore become subject to litigation that could be costly, result in the diversion of management’s time and efforts, and require us to pay damages. Whether a product infringes a patent involves complex legal and factual issues, the determination of which is often uncertain. Our competitors may assert that they own U.S. or foreign patents containing claims that cover our products, components of our products, or the methods we employ in making or using our products. In addition, we may become a party to an interference proceeding declared

 

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by the USPTO to determine the priority of inventions. Because patent applications can take many years to issue, there may be applications now pending of which we are unaware, which may later result in issued patents that contain claims that cover our products. There could also be existing patents, of which we are unaware, that contain claims that cover one or more components of our products. As the number of participants in our industry increases, the possibility of patent infringement claims against us also increases.

Any interference proceeding, litigation, or other assertion of claims against us may cause us to incur substantial costs, place a significant strain on our financial resources, divert the attention of management from our core business and harm our reputation. If the relevant patents were upheld as valid and enforceable and we were found to infringe, we could be required to pay substantial damages and/or royalties and could be prevented from selling our products unless we could obtain a license or were able to redesign our products to avoid infringement. Any such license may not be available on reasonable terms, if at all. If we fail to obtain any required licenses or make any necessary changes to our products or technologies, we may be unable to make, use, sell, or otherwise commercialize one or more of our products. In addition, if we were found to willfully infringe, we could be required to pay treble damages, among other penalties.

If we fail to acquire, develop and commercialize additional product candidates or approved products, we may be unable to grow our business.

As part of our growth strategy we intend to seek to expand our product pipeline by exploring the in-licensing, acquisition, development and commercialization of product candidates and approved products in the field of neuroscience. Because our internal research and development capabilities are limited, and because new product approvals can take several years, we may be dependent upon pharmaceutical and biotechnology companies, academic scientists and other researchers to sell or license products or technology to us. The success of this strategy depends partly upon our ability to identify and select promising product candidates and approved products, negotiate licensing or acquisition agreements with their current owners and finance these arrangements, including via collaboration and development arrangements with third parties.

The process of proposing, negotiating and implementing a license or acquisition of a product candidate or approved product is lengthy and complex. We compete for acquisition and license agreements with pharmaceutical and biotechnology companies and academic research institutions, including those with substantially greater financial, marketing, sales and other resources. We have limited resources to identify and execute the acquisition or in-licensing of third party products, businesses and technologies and integrate them into our current infrastructure. Moreover, we may devote resources to potential acquisitions or licensing opportunities that are never completed, or we may fail to realize the anticipated benefits of such efforts. We may not be able to acquire the rights to additional product candidates or approved products on terms that we find acceptable, or at all. In addition, even if we generate interest in an acquisition or in-license of a product candidate or approved product, other companies may have stronger relationships with third parties with whom we are interested in collaborating and/or may have more established histories of developing and commercializing products. As a result, they may have a competitive advantage in entering into collaboration and development arrangements with such third parties.

Further, any product candidate that we acquire may require additional development efforts prior to commercial sale, including pre-clinical or clinical testing and approval by the FDA and applicable foreign regulatory authorities. All product candidates are prone to risks of failure typical of pharmaceutical product development, including the possibility that a product candidate will not be shown to be sufficiently safe and effective for approval by regulatory authorities. In addition, we cannot provide assurance that any products that we develop or approved products that we acquire will be manufactured or sold profitably or achieve market acceptance.

If we are unable to acquire or in-license additional product candidates or approved products and successfully develop and commercialize them, it would likely have a material adverse effect on our business, results of operations, financial condition and prospects.

 

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If we fail to comply with our obligations in the agreements under which we license rights to products or technology from third parties, we could lose license rights that are important to our business.

We are a party to a number of agreements that include technology licenses that are important to our business and expect to enter into additional licenses in the future. For example, we hold licenses from SPI relating to key excipients used in the manufacture of Intermezzo. If we fail to comply with these agreements, the licensor may have the right to terminate the license, in which event we and our collaboration partners would not be able to market products covered by the license, including Intermezzo.

We may be subject to damages resulting from claims that we or our employees have wrongfully used or disclosed alleged trade secrets of former employers.

Certain of our employees were previously employed at universities or other biotechnology or pharmaceutical companies, including competitors or potential competitors. Although no claims against us are currently pending, we may be subject to claims that these employees or we ourselves have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of former employers. Litigation may be necessary to defend against these claims. If we fail in defending such claims, in addition to paying monetary damages, we may lose valuable intellectual property rights or personnel. A loss of key research personnel or their work product could hamper or prevent our or a collaboration partner’s ability to develop or commercialize certain potential products, which could severely harm our business. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management.

If our agreements with employees, consultants, advisors and corporate partners fail to protect our intellectual property, proprietary information or trade secrets, it could have a significant adverse effect on us.

We have taken steps to protect our intellectual property and proprietary technology by entering into confidentiality agreements and intellectual property assignment agreements with our employees, consultants, advisors and corporate partners. However, such agreements may not be enforceable or may not provide meaningful protection for all of our trade secrets or other proprietary information in the event of unauthorized use or disclosure or other breaches of the agreements, and we may not be able to prevent such unauthorized disclosure. Monitoring unauthorized disclosure is difficult, and we do not know whether the steps we have taken to prevent such disclosure are, or will be, adequate. Furthermore, the laws of some foreign countries may not protect our intellectual property rights to the same extent as do the laws of the United States.

Our operations involve hazardous materials, which could subject us to significant liabilities.

Our research and development processes involve the controlled use of hazardous materials, including chemicals. Our operations produce hazardous waste products. We cannot eliminate the risk of accidental contamination or discharge or injury from these materials. Federal, state and local laws and regulations govern the use, manufacture, storage, handling and disposal of these materials. We could be subject to civil damages in the event of an improper or unauthorized release of, or exposure of individuals, including employees, to hazardous materials. In addition, claimants may sue us for injury or contamination that results from our use of these materials and our liability may exceed our total assets. We maintain limited insurance for the use of hazardous materials which may not be adequate to cover any claims. Compliance with environmental and other laws and regulations may be expensive and current or future regulations may impair our research, development or production efforts.

 

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Risks Related to Our Common Stock

We may fail to meet publicly announced financial guidance or other expectations about our business, which would cause our stock to decline in value.

There are a number of reasons why we might fail to meet financial guidance or other expectations about our business, including, but not limited to, the following:

 

   

unexpected difficulties in Purdue Pharma’s efforts to commercialize Intermezzo in the United States;

 

   

delays or unexpected changes in Purdue Pharma’s plan to invest approximately $100 million to support sales and marketing during the first year of Intermezzo commercialization;

 

   

the effectiveness of the sales, marketing and distribution efforts by Purdue Pharma in the United States and overall success of Purdue Pharma’s commercialization efforts in the United States;

 

   

whether we choose to share the cost of advertising or other marketing efforts with Purdue Pharma related to the commercialization of Intermezzo in the United States;

 

   

lower than expected pricing and reimbursement levels, or no reimbursement at all, for Intermezzo in the United States;

 

   

the use of currently available sleep aids that are not approved to be taken in the middle of the night;

 

   

negative developments or setbacks in our efforts to seek marketing approval for Intermezzo outside of the United States;

 

   

FDA approval of generic versions of Intermezzo or negative developments in any ongoing ANDA proceedings;

 

   

current and future competitive products that have or obtain greater acceptance in the market than Intermezzo;

 

   

if only a subset of or no affected patients respond to therapy with Intermezzo or future products, if any;

 

   

negative publicity about the results of our clinical studies, or those of others with similar or related products may reduce demand for Intermezzo or future products, if any;

 

   

the inability to sell a product at the price we expect; or

 

   

the inability to supply enough product to meet demand.

If we fail to meet our revenue and/or expense projections and/or other financial guidance for any reason, our stock could decline in value.

Our stock price is volatile.

The market price of our common stock is subject to significant fluctuations. During the 12-month period ended September 30, 2012, the sales price of our common stock on The NASDAQ Global Market ranged from a high of $12.99 in April 2012 to a low of $5.09 in August 2012. Market prices for securities of early-stage pharmaceutical, biotechnology and other life sciences companies have historically been particularly volatile. The volatility of the market price of our common stock is exacerbated by the low trading volume of our common stock and the high proportion of our shares held by insiders. Some of the factors that may cause the market price of our common stock to fluctuate include:

 

   

the perception of our prospects for successful commercialization of Intermezzo by Purdue Pharma, including the costs associated with the launch;

 

   

announcements by us or Purdue Pharma regarding the commercialization and/or marketing efforts of Intermezzo;

 

   

the termination by Purdue Pharma of the Collaboration Agreement, or the termination of other future collaboration or partnering agreements;

 

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the failure of any product candidates, if approved, to achieve commercial success, including due to competition from generic versions of Intermezzo, or the perception by investors that commercial success may not be achieved;

 

   

issues in manufacturing Intermezzo, or other approved products, if any, or product candidates;

 

   

the results of current and any future clinical trials of our product candidates, such as our ongoing Phase 2 trial of TO-2061;

 

   

the entry into, or termination of, key agreements, including additional commercial partner agreements;

 

   

the initiation of, material developments in, or conclusion of litigation to enforce or defend our intellectual property rights or defend against the intellectual property rights of others;

 

   

announcements by commercial partners or competitors of new commercial products, clinical progress or the lack thereof, significant contracts, commercial relationships or capital commitments;

 

   

adverse publicity relating to the insomnia market, including with respect to other products and potential products in such market;

 

   

the introduction of technological innovations or new therapies that compete with our potential products;

 

   

the loss of key employees;

 

   

changes in estimates or recommendations by securities analysts, if any, who cover our common stock;

 

   

future sales of our common stock;

 

   

general and industry-specific economic conditions that may affect our research and development expenditures;

 

   

changes in the structure of health care payment systems, including changes to prescription drug reimbursement levels; and

 

   

period-to-period fluctuations in financial results.

Moreover, the stock markets in general have experienced substantial volatility that has often been unrelated to the operating performance of individual companies. These broad market fluctuations may also adversely affect the trading price of our common stock.

In the past, following periods of volatility in the market price of a company’s securities, stockholders have often instituted class action securities litigation against those companies. Such litigation, if instituted, could result in substantial costs and diversion of management attention and resources, which could significantly harm our profitability and reputation.

If securities or industry analysts do not publish research or reports or publish inaccurate or unfavorable research about us, our business or our stock, our stock price and trading volume could decline.

 

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The trading market for our common stock is influenced by the research and reports that securities or industry analysts publish about us, our business and our stock. As of September 30, 2012, we had research coverage by five securities analysts. If any of the analysts who cover us downgrades our stock or publishes inaccurate or unfavorable research regarding us or our business model, technology or stock performance, our stock price would likely decline. If one or more of these analysts ceases coverage of us or fails to publish reports on us regularly, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline. Moreover, the unpredictability of our financial results likely reduces the certainty, and therefore reliability, of the forecasts by securities or industry analysts of our future financial results, adding to the potential volatility of our stock price.

Future sales of our common stock may cause our stock price to decline and impede our ability to raise capital.

Our common stock is closely held. Our executive officers and directors beneficially own or control approximately 20.6% of our approximately 18.6 million outstanding shares of common stock as of September 30, 2012 and an additional 11.2% is beneficially owned by a venture capital firm in which one of our directors is a partner. Significant portions of these shares are held by a small number of stockholders. In addition, other investors not otherwise affiliated with us beneficially own a significant number of shares of our common stock based on filings made with the SEC.

All of our outstanding shares of common stock are freely tradable without restriction or further registration under the federal securities laws, unless held or purchased by our “affiliates” as that term is defined in Rule 144 under the Securities Act of 1933, as amended, or the Securities Act. Also, some stockholders affiliated with our directors maintain rights with respect to the registration of the sale of their shares of common stock with the SEC. The shares authorized for issuance under our stock option plans and employee stock purchase plan are registered under the Securities Act and can be freely sold in the public market upon issuance, subject to restrictions imposed on our affiliates under Rule 144.

Sales into the public market by our officers, directors and their affiliates, or other major stockholders, of a substantial number of shares, or the expectation that such sales may occur, could significantly reduce the market price of our common stock.

In addition, certain of our executive officers may establish predetermined selling plans under Rule 10b5-1 of the Securities Exchange Act of 1934, or the Exchange Act, for the purpose of effecting sales of common stock.

If any such sales occur, are expected to occur or a large number of our shares are sold in the public market, the trading price of our common stock could decline. Further, any such decline or expectation could impede our ability to raise capital in the future through the sale of equity securities under terms that are favorable to us.

Raising additional funds by issuing securities or through licensing arrangements may cause dilution to existing stockholders, restrict our operations or require us to relinquish proprietary rights.

Additional financing may not be available to us when we need it or may not be available on favorable terms. To the extent that we raise additional capital by issuing equity securities, our existing stockholders’ ownership will be diluted and the terms of any new equity securities may have preferences over our common stock. Any debt financing we enter into may involve covenants that restrict our operations. These restrictive covenants may include limitations on additional borrowing and specific restrictions on the use of our assets, as well as prohibitions on our ability to create liens, pay dividends, redeem our stock or make investments. In addition, if we raise additional funds through licensing arrangements, it may be necessary to relinquish potentially valuable rights to potential products or proprietary technologies, or grant licenses on terms that are not favorable to us.

 

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Failure to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 could have a material adverse effect on our stock price.

Section 404 of the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the SEC require an annual management assessment of the effectiveness of our internal control over financial reporting and, based on our public float, a report by our independent registered public accounting firm attesting to the effectiveness of our internal control over financial reporting at the end of the fiscal year. If we fail to maintain the adequacy of our internal control over financial reporting, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the SEC. If we cannot in the future favorably assess, or, if required, our independent registered public accounting firm is unable to provide an unqualified attestation report on, the effectiveness of our internal control over financial reporting, investor confidence in the reliability of our financial reports may be adversely affected, which could have a material adverse effect on our stock price.

Anti-takeover provisions in the Collaboration Agreement with Purdue Pharma, in our charter documents and under Delaware law could make an acquisition of us more difficult and may prevent attempts by stockholders to replace or remove management.

Provisions in the Collaboration Agreement with Purdue Pharma, our certificate of incorporation and our bylaws may delay or prevent an acquisition or a change in management. The provisions in the Collaboration Agreement include an agreement with Purdue Pharma that prevents Purdue Pharma from acquiring above a certain percentage of our stock and engaging in certain other activities for a limited period of time following the commercial launch of Intermezzo that may lead to an acquisition of our company without our consent. In addition, our co-promote option pursuant to the Collaboration Agreement cannot be transferred to a third party, except under a limited circumstance at the discretion of Purdue Pharma, which may significantly reduce the value of our shares to a potential acquirer. Such provisions in our charter documents include a classified board of directors, a prohibition on actions by written consent of stockholders and the ability of our board of directors to issue preferred stock without stockholder approval. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which prohibits stockholders owning in excess of 15% of our outstanding voting stock from merging or combining with us unless certain conditions are met. Although we believe most of these provisions collectively will provide for an opportunity to receive higher bids by requiring potential acquirers to negotiate with our board of directors, they would apply even if the offer may be considered beneficial by some stockholders. In addition, these provisions may frustrate or prevent any attempts by stockholders to replace or remove the then-current management by making it more difficult for stockholders to replace members of the board of directors, which is responsible for appointing the members of management.

We have never paid dividends on our capital stock, and do not anticipate that we will pay any cash dividends in the foreseeable future.

We have not paid cash dividends on any of our classes of capital stock to date, and our current expectation is that we will retain our future earnings to fund the development and growth of our business. As a result, capital appreciation, if any, of our common stock will be the sole source of gain, if any, as a result of holding shares of our common stock, for the foreseeable future.

The highly concentrated ownership of our common stock may prevent stockholders from influencing significant corporate decisions and may result in conflicts of interest that could cause our stock price to decline.

Our executive officers and directors beneficially own or control approximately 20.6% of the outstanding shares of our common stock as of September 30, 2012 and an additional 11.2% is beneficially owned by a venture capital firm in which one of our directors is a partner. Accordingly, these executive officers, directors and their affiliates, acting as a group, will have substantial influence over the outcome of

 

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corporate actions requiring stockholder approval, including the election of directors, any merger, consolidation or sale of all or substantially all of our assets or any other significant corporate transactions. These stockholders may also delay or prevent a change of control of us, even if such a change of control would benefit our other stockholders. The significant concentration of stock ownership may adversely affect the trading price of our common stock due to investors’ perception that conflicts of interest may exist or arise.

 

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

None.

 

Item 3. Defaults Upon Senior Securities

Not applicable.

 

Item 4. Mine Safety Disclosures

Not applicable.

 

Item 5. Other Information

Not applicable.

 

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Item 6. Exhibits

(a) Exhibits:

 

Exhibit

No.

 

Description of Exhibit

    3.1(1)   Amended and Restated Certificate of Incorporation of Transcept Pharmaceuticals, Inc.
    3.2(1)   Bylaws of Transcept Pharmaceuticals, Inc., as amended.
    4.1(2)   Specimen Common Stock certificate of Transcept Pharmaceuticals, Inc.
    4.2(2)   Form of Preferred Stock Purchase Warrant issued to certain TPI investors as of March 21, 2005.
    4.3(2)   Preferred Stock Purchase Warrant issued by TPI to Hercules Technology Growth Capital, Inc., dated as of April 13, 2006.
    4.4(3)   2005 Amended and Restated Investor Rights Agreement, dated as of December 21, 2005, by and between Novacea and purchasers of Novacea Series A, Series B and Series C Preferred Stock.
    4.5(4)   Amended and Restated Investor Rights Agreement, dated as of February 27, 2007, by and between TPI and purchasers of TPI Series A, Series B, Series C and Series D Preferred Stock.
    4.6(4)   Termination Agreement, dated as of January 26, 2009, by and between TPI and purchasers of TPI Series A, Series B, Series C and Series D Preferred Stock.
  31.1   Certification of the Company’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.2   Certification of the Company’s Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32.1*   Certification of the Company’s Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101**   The following materials from Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2012, formatted in Extensible Business Reporting Language (XBRL) includes: (i) Condensed Consolidated Balance Sheets at September 30, 2012 and December 31, 2011, (ii) Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2012 and 2011, (iii) Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2012 and 2011, and (iv) Notes to Condensed Consolidated Financial Statements.

 

(1) Incorporated by reference from the first Current Report on Form 8-K filed with the Securities and Exchange Commission on February 5, 2009.
(2) Incorporated by reference from the second Current Report on Form 8-K filed with the Securities and Exchange Commission on February 5, 2009.
(3) Incorporated by reference from the Registration Statement on Form S-1, Securities and Exchange Commission file number 333-131741, filed on February 10, 2006.
(4) Incorporated by reference from the Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 14, 2010.
* The certification attached as Exhibit 32.1 that accompanies this Quarterly Report on Form 10-Q is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Transcept Pharmaceuticals, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Form 10-Q, irrespective of any general incorporation language contained in such filing.
** XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

 

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SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized as of the 13th day of November 2012.

 

Transcept Pharmaceuticals, Inc.

/s/ Leone D. Patterson

Leone D. Patterson

Vice President, Chief Financial Officer

(Principal Financial and Accounting Officer)

 

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Table of Contents

Exhibits:

 

Exhibit

No.

 

Description of Exhibit

    3.1(1)   Amended and Restated Certificate of Incorporation of Transcept Pharmaceuticals, Inc.
    3.2(1)   Bylaws of Transcept Pharmaceuticals, Inc., as amended.
    4.1(2)   Specimen Common Stock certificate of Transcept Pharmaceuticals, Inc.
    4.2(2)   Form of Preferred Stock Purchase Warrant issued to certain TPI investors as of March 21, 2005.
    4.3(2)   Preferred Stock Purchase Warrant issued by TPI to Hercules Technology Growth Capital, Inc., dated as of April 13, 2006.
    4.4(3)   2005 Amended and Restated Investor Rights Agreement, dated as of December 21, 2005, by and between Novacea and purchasers of Novacea Series A, Series B and Series C Preferred Stock.
    4.5(4)   Amended and Restated Investor Rights Agreement, dated as of February 27, 2007, by and between TPI and purchasers of TPI Series A, Series B, Series C and Series D Preferred Stock.
    4.6(4)   Termination Agreement, dated as of January 26, 2009, by and between TPI and purchasers of TPI Series A, Series B, Series C and Series D Preferred Stock.
  31.1   Certification of the Company’s Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  31.2   Certification of the Company’s Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
  32.1*   Certification of the Company’s Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101**   The following materials from Registrant’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2012, formatted in Extensible Business Reporting Language (XBRL) includes: (i) Condensed Consolidated Balance Sheets at September 30, 2012 and December 31, 2011, (ii) Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2012 and 2011, (iii) Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2012 and 2011, and (iv) Notes to Condensed Consolidated Financial Statements.

 

(1) Incorporated by reference from the first Current Report on Form 8-K filed with the Securities and Exchange Commission on February 5, 2009.
(2) Incorporated by reference from the second Current Report on Form 8-K filed with the Securities and Exchange Commission on February 5, 2009.
(3) Incorporated by reference from the Registration Statement on Form S-1, Securities and Exchange Commission file number 333-131741, filed on February 10, 2006.
(4) Incorporated by reference from the Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on May 14, 2010.
* The certification attached as Exhibit 32.1 that accompanies this Quarterly Report on Form 10-Q is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of Transcept Pharmaceuticals, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Form 10-Q, irrespective of any general incorporation language contained in such filing.
** XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

 

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