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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 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 March 31, 2013

or

 

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

For the transition period from              to             

Commission File Number: 001-35614

 

 

HYPERION THERAPEUTICS, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware		61-1512713
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

601 Gateway Boulevard, Suite 200

South San Francisco, California 94080

(650) 745-7802

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

 

 

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

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

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

 

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 Exchange Act Rule 12b-2)    Yes  ¨    No  x

As of May 1, 2013, the number of outstanding shares of the registrant’s common stock was 20,042,022.

 

 

 

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TABLE OF CONTENTS

 

						Page
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS							i
PART I. FINANCIAL INFORMATION							1
		Item 1.           Condensed Consolidated Financial Statements (Unaudited)					1
		Condensed   Consolidated Balance Sheets					1
		Condensed   Consolidated Statements of Operations					2
		Condensed   Consolidated Statements of Cash Flows					3
		Notes to Condensed Consolidated Financial Statements					5-14
		Item 2.           Management’s Discussion and Analysis of Financial Condition and Results of Operations					15
		Item 3.           Quantitative and Qualitative Disclosures About Market Risk					23
		Item 4.           Controls and Procedures					23
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					46
		Item 3.           Defaults Upon Senior Securities					46
		Item 4.           Mine Safety Disclosures					47
		Item 5.          Other Information					47
		Item 6.          Exhibits					47

In this report, unless otherwise stated or the context otherwise indicates, references to “Hyperion,” “we,” “us,” “our” and similar references refer to Hyperion Therapeutics, Inc. and our wholly owned subsidiary. The names Hyperion Therapeutics, Inc.^TM and Ravicti^TM are our trademarks. BUPHENYL^® and AMMONUL^® are registered trademarks of Ucyclyd Pharma, Inc., a subsidiary of Valeant Pharmaceuticals International, Inc. All other trademarks, trade names and service marks appearing in this report are the property of their respective owners.

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements. In some cases you can identify these statements by forward-looking words such as “believe,” “may,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “could,” “would,” “project,” “plan,” “expect,” or similar expressions, or the negative or plural of these words or expressions. These forward-looking statements include, but are not limited to, statements concerning the following:

 

•

the commercial launch and future sales of or any other future products or product candidates;

 

•

our expectations regarding the commercial supply of our UCD products;

 

•

third-party payor reimbursement for Ravicti, BUPHENYL and AMMONUL;

 

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our estimates regarding anticipated capital requirements and our needs for additional financing;

 

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the UCD or HE patient market size and market adoption of Ravicti by physicians and patients;

 

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the timing or cost of a Phase III trial in HE;

 

•

the development and approval of the use of Ravicti for additional indications or in combination therapy;

 

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our expectations regarding licensing, acquisitions and strategic operations;

 

•

Ucyclyd’s plans with respect to its retention of the worldwide rights to AMMONUL;

 

•

impact of accounting standards; and

 

•

repayment of notes payable.

These statements are only current predictions and are subject to known and unknown risks, uncertainties, and other factors that may cause our or our industry’s actual results, levels of activity, performance or achievements to be materially different from those anticipated by the forward-looking statements. We discuss many of these risks in this report in greater detail under the heading “Risk Factors” and elsewhere in this report. You should not rely upon forward-looking statements as predictions of future events.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, or achievements. Except as required by law, we are under no duty to update or revise any of the forward-looking statements, whether as a result of new information, future events or otherwise, after the date of this report.

 

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Hyperion Therapeutics, Inc.

(A development stage company)

Condensed Consolidated Balance Sheets

(In thousands, except share and per share amounts)

 

		March  31, 2013 (unaudited)				December 31, 2012
Assets
Current assets
Cash and cash equivalents		$	102,666			$	49,853
Accounts receivable, net			819				—
Inventories			473				—
Prepaid expenses and other current assets			1,080				1,155
Total current assets			105,038				51,008
Property and equipment, net			345				49
Other non-current assets			140				147
Total assets		$	105,523			$	51,204
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable		$	1,343			$	2,177
Accrued liabilities			2,897				2,540
Notes payable, current portion			5,039				4,348
Total current liabilities			9,279				9,065
Notes payable, net of current portion			6,513				7,750
Total liabilities			15,792				16,815
Commitments and contingencies (Note 8)
Stockholders’ equity
Preferred stock, par value $0.0001 — 10,000,000 shares authorized; none issued and outstanding			—				—
Common stock, par value $0.0001 — 100,000,000 shares authorized at March 31, 2013 and December 31, 2012; 20,010,416 and 16,646,269 shares issued and outstanding at March 31, 2013 and December 31, 2012, respectively			2				2
Additional paid-in capital			237,701				173,384
Deficit accumulated during the development stage			(147,972	)			(138,997	)
Total stockholders’ equity			89,731				34,389
Total liabilities and stockholders’ equity		$	105,523			$	51,204

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

 

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Hyperion Therapeutics, Inc.

(A development stage company)

Condensed Consolidated Statements of Operations

(In thousands, except share and per share amounts)

(Unaudited)

 

		Three Months Ended March 31,								Cumulative Period From November 1, 2006 (Date of Inception) to
		2013				2012				March 31, 2013
Revenues:
Product revenue, net		$	783			$	—			$	783
Contract and other revenue			—				—				286
Total revenues			783				—				1,069
Costs and expenses:
Cost of sales			68				—				78
Research and development			1,849				8,902				89,130
Selling, general and administrative			7,934				2,323				45,624
Impairment of development and promotion rights acquisition cost			—				—				7,059
Total costs and expenses			9,851				11,225				141,891
Loss from operations			(9,068	)			(11,225	)			(140,822	)
Interest income			1				4				455
Interest expense			(408	)			(1,040	)			(9,353	)
Other income (expense), net			500				375				1,748
Net loss			(8,975	)			(11,886	)			(147,972	)
Accretion of Series B preferred stock to redemption value			—				—				(114	)
Net loss attributable to common stockholders		$	(8,975	)		$	(11,886	)		$	(148,086	)
Net loss per share attributable to common stockholders:
Basic and diluted		$	(0.52	)		$	(25.33	)
Weighted average number of shares used to compute net loss per share of common stock:
Basic and diluted			17,366,848				469,319

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

 

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Hyperion Therapeutics, Inc.

(A development stage company)

Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

 

		Three Months Ended March 31,								Cumulative Period From November 1, 2006 (Date of Inception) to
		2013				2012				March 31, 2013
Cash flows from operating activities
Net loss		$	(8,975	)		$	(11,886	)		$	(147,972	)
Adjustments to reconcile net loss to net cash used in operating activities
Depreciation and amortization			19				5				524
Amortization of debt discount			130				368				2,957
Conversion of accrued interest to convertible preferred stock			—				—				514
Re-measurement of warrants liability			—				343				1,448
Re-measurement of call option liability and preferred stock liability			—				(737	)			(2,818	)
Stock-based compensation expense			505				78				2,482
Issuance of common stock in connection with collaboration agreement			—				—				564
Acquisition of development and promotion rights			—				—				(10,000	)
Amortization of debt issuance costs			7				20				529
Amortization of development and promotion rights acquisition cost			—				—				2,941
Impairment of development and promotion rights acquisition cost			—				—				7,059
Other			—				—				4
Changes in assets and liabilities
Accounts receivable			(819	)			—				(819	)
Inventories			(464	)			—				(464	)
Prepaid expenses and other current assets			75				408				(815	)
Other non-current assets			—				(39	)			(147	)
Accounts payable			(834	)			326				1,343
Accrued liabilities and other non-current liabilities			(396	)			408				4,787
Net cash used in operating activities			(10,752	)			(10,706	)			(137,883	)
Cash flows from investing activities
Acquisition of property and equipment			(315	)			—				(678	)
Option to purchase BUPHENYL and AMMONUL (Note 3)			—				(283	)			(283	)
Change in restricted cash			—				155				—
Net cash used in investing activities			(315	)			(128	)			(961	)
Cash flows from financing activities
Proceeds from issuance of common stock in initial public offering, net of underwriting discounts			—				—				53,475
Proceeds from issuance of common stock in follow-on offering, net of underwriting discounts			64,488				—				64,488
Proceeds from issuance of common stock, net of repurchases			91				48				353
Proceeds from issuance of convertible preferred stock, net			—				—				66,074
Proceeds from issuance of convertible notes payable			—				7,504				47,774
Proceeds from issuance of notes payable			—				—				22,401
Payments of offering costs			(23	)			—				(2,186	)
Principal payments under notes payable			(676	)			—				(10,676	)
Principal payments under capital lease obligations			—				—				(193	)
Net cash provided by financing activities			63,880				7,552				241,510
Net increase (decrease) in cash and cash equivalents			52,813				(3,282	)			102,666
Cash and cash equivalents, beginning of period			49,853				7,018				—
Cash and cash equivalents, end of period		$	102,666			$	3,736			$	102,666
Supplemental cash flow information
Cash paid for interest		$	275			$	—			$	2,656

 

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		Three Months Ended March  31,								Cumulative Period From November 1, 2006 (Date of Inception) to
		2013				2012				March 31, 2013
Supplemental disclosure of noncash investing and financing activities
Stock-based compensation capitalized into inventories			9				—				9
Warrants issued in connection with notes payable			—				547				3,210
Issuance of call option related to convertible notes payable			—				—				1,707
Gain on extinguishment of debt			—				—				1,143
Conversion of promissory notes to Series B redeemable convertible preferred stock			—				—				301
Accretion to redemption value of Series B redeemable convertible preferred stock			—				—				114
Purchase of property and equipment under capital leases			—				—				193
Conversion of notes payable and accrued interest to Series C-1 convertible preferred stock			—				—				15,501
Conversion of Series A and Series B redeemable convertible preferred stock to common stock			—				—				21,934
Preferred stock liability related to the second tranche of Series C-2 preferred stock			—				—				361
Deferred offering costs in accounts payable and accrued liabilities			753				419				753
Issuance of common stock upon automatic net exercise of warrants			—				—				3,901
Conversion of convertible notes payable and accrued interest to common stock			—				—				33,322
Conversion of Series C-1 and C-2 preferred stock to common stock			—				—				58,326

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

 

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Hyperion Therapeutics, Inc.

(A development stage company)

Notes to Condensed Consolidated Financial Statements (Unaudited)

1. Formation and Business of the Company

Hyperion Therapeutics, Inc. (the “Company”) was incorporated in the state of Delaware on November 1, 2006. The Company’s activities since inception have consisted primarily of raising capital, negotiating a promotion and drug development collaboration agreement, establishing a management team and performing drug development activities. Accordingly, the Company is considered to be in the development stage. The Company has launched Ravicti into the market and expects to exit development stage designation when the Company has sufficient revenue from principal operations.

The Company is a biopharmaceutical company focused on the development and commercialization of novel therapeutics to treat disorders in the areas of orphan diseases and hepatology. The Company has developed Ravicti™ (glycerol phenylbutyrate) Oral Liquid to treat the most prevalent urea cycle disorders (“UCD”) and is developing hepatic encephalopathy (“HE”). UCD and HE are generally characterized by elevated levels of ammonia in the bloodstream. Elevated levels of ammonia are potentially toxic and can lead to severe medical complications which may include death. The Company’s product, Ravicti, is designed to lower ammonia in the blood. UCD are inherited rare genetic diseases caused by a deficiency of one or more enzymes or transporters that constitute the urea cycle, which in a healthy individual removes ammonia through conversion of ammonia to urea. HE is a serious but potentially reversible neurological disorder that can occur in patients with liver scarring, known as cirrhosis, or acute liver failure. On February 1, 2013, the U.S. food and drug administration, administration (“FDA”), granted approval of Ravicti for the use as a nitrogen-binding agent for chronic management of adult and pediatric UCD patients greater than two years of age who cannot be managed by dietary protein restriction and/or amino acid supplementation alone.

Hyperion Therapeutics Limited was formed in January 2008 as a private limited company under the Companies Act 1985 for England and Wales and is wholly owned by the Company. There has been no activity in Hyperion Therapeutics Limited for the last five fiscal years.

On July 31, 2012, the Company completed its initial public offering (“IPO”) and the shares began trading on the NASDAQ Global Market on July 26, 2012. The Company received net proceeds from the IPO of $51.3 million, after deducting underwriting discounts and commissions of $4.0 million and expenses of $2.2 million.

On March 13, 2013, the Company completed its follow-on offering and issued 2,875,000 shares of its common stock at an offering price of $20.75 per share. In addition, the Company sold an additional 431,250 shares of common stock directly to its underwriters when they exercised their over-allotment option in full at the initial offering price of $20.75 per share. The Company received net proceeds from the offering of $63.7 million, after deducting underwriting discounts and commissions of $4.1 million and expenses of $0.8 million.

Since inception, the Company has incurred recurring net operating losses and negative cash flows from operations. During the three months ended March 31, 2013, the Company incurred a net loss of $9.0 million and the Company used $10.8 million of cash in operations during the three months ended March 31, 2013. At March 31, 2013, the Company had a deficit accumulated during the development stage of $148.0 million. The Company expects to incur increased research and development expenses when the Company initiates a Phase III trial of Ravicti for the treatment of patients with episodic HE. In addition, the Company expects to incur increased sales and marketing expenses for Ravicti in UCD. Management’s plans with respect to these matters include utilization of a substantial portion of the Company’s capital resources and efforts in completing the development of Ravicti in HE, expanding the Company’s organization, and commercialization of Ravicti.

 

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2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and on a basis consistent with the annual consolidated financial statements, and in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary for a fair presentation of the periods presented. These interim financial results are not necessarily indicative of the results to be expected for the year ending December 31, 2013, or for any other future annual or interim period. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the related notes thereto included in the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2012.

Use of Estimates

The preparation of the interim condensed consolidated financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. On an ongoing basis, the Company evaluates its estimates, including those related to fair value of assets, preclinical and clinical trial accruals, research and development expenses, stock-based compensation expense and revenue recognition. Management bases its estimates on historical experience or on various other assumptions, including information received from its service providers, which it believes to be reasonable under the circumstances. Actual results could differ from those estimates.

Reclassifications

Certain prior year amounts in the interim condensed consolidated financial statements have been reclassified to conform to the current year’s presentation. In particular, certain sales and marketing expenses have been combined with general and administrative expenses in the condensed consolidated statement of operations. The result of this reclassification had no impact on previously reported net loss or balance sheet.

Segment Reporting

The Company operates as one operating segment and uses one measurement of profitability to manage its business. All long-lived assets are maintained in the United States.

Fair Value of Financial Instruments

The Company measures certain financial assets and liabilities at fair value based on the exchange price that would be received for an asset or paid for to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants. The carrying amounts of the Company’s financial instruments, including cash equivalents, the option to purchase BUPHENYL and AMMONUL, accounts payable, and accrued liabilities, approximate fair value due to their short maturities. See Note 4, Fair Value Measurements, regarding the fair value of the Company’s notes payable.

Accounts Receivable

Trade accounts receivable are recorded net of product sales allowances for prompt-payment discounts, chargebacks, and doubtful accounts. Estimates for chargebacks and prompt-payment discounts are based on contractual terms, historical trends and our expectations regarding the utilization rates for these programs.

Inventories

Inventories are stated at the lower of cost or market value with cost determined under the first-in-first-out (FIFO) cost method and consist of raw materials and supplies, work in process and finished goods. Costs to be capitalized as inventories include third party manufacturing costs, associated compensation related costs of personnel indirectly involved in the manufacturing process and other overhead costs such as ancillary supplies. The Company began capitalizing inventories post FDA approval of Ravicti on February 1, 2013 as the related costs were expected to be recoverable through the commercialization of the product. Costs incurred prior to the FDA approval of Ravicti have been recorded as research and development expense in the condensed consolidated statements of operations. If information becomes available that suggest that inventories may not be realizable, the Company may be required to expense a portion or all of the previously capitalized inventories. The costs of inventories during the quarter ended March 31, 2013 consists mainly of packaging and labeling costs, indirect costs including compensation cost of personnel and supplies. As of March 31, 2013, inventories include $0.3 million of work in process and $0.2 million of finished goods.

 

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Products that have been approved by the U.S. Food and Drug Administration (FDA) or other regulatory authorities, such as Ravicti, are also used in clinical programs to assess the safety and efficacy of the products for usage in diseases that have not been approved by the FDA or other regulatory authorities. The form of Ravicti utilized for both commercial and clinical programs is identical and, as a result, the inventory has an “alternative future use” as defined in authoritative guidance. Raw materials and purchased drug product associated with clinical development programs are included in inventory and charged to research and development expense when the product enters the research and development process and no longer can be used for commercial purposes and, therefore, does not have an “alternative future use”.

The Company evaluates for potential excess inventory by analyzing current and future product demand relative to the remaining product shelf life. The Company builds demand forecasts by considering factors such as, but not limited to, overall market potential, market share, market acceptance and patient usage.

Revenue Recognition

The Company recognizes revenue in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 605, Revenue Recognition, when the following criteria have been met: persuasive evidence of an arrangement exists; delivery has occurred and risk of loss has passed; the seller’s price to the buyer is fixed or determinable and collectability is reasonably assured. The Company determines that persuasive evidence of an arrangement exists based on written contracts that defined the terms of the arrangements. In addition, the Company determines that services have been delivered in accordance with the arrangement. The Company assesses whether the fee is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. The Company assesses collectability based primarily on the customer’s payment history and on the creditworthiness of the customer.

Product Revenue, net: The Company’s product revenue represents U.S. sales of Ravicti which is recognized once all four revenue recognition criteria described above are met. During the first quarter of 2013, the Company began distributing Ravicti to two specialty pharmacies through a specialty distributor. The specialty pharmacies then in turn dispensed Ravicti to patients in fulfillment of prescriptions. As Ravicti is a new product, and the Company’s first commercial product, the Company could not reasonably assess potential product sales allowances at the time of sale to the specialty distributor. As a result of the Company’s inability to estimate product sales allowance at the time of sale to the specialty distributor, the price of Ravicti was not deemed fixed or determinable. The Company deferred the recognition of revenues on product shipments to the specialty distributor of Ravicti until the product was shipped to patients by the specialty pharmacies at which time the related product sales allowances could be reasonably estimated.

The Company recognizes revenue net of product sales allowances. Product shipping and handling costs are included in cost of sales.

Product Sales Allowances: The Company establishes reserves for prompt-payment discounts, government and commercial rebates, product returns and chargebacks. Allowances relate to prompt-payment discounts and are recorded at the time of revenue recognition, resulting in a reduction in product sales revenue and a decrease in trade accounts receivables. Accruals related to government rebates, product returns and other applicable allowances such as distributor fees are recognized at the time of revenue recognition, resulting in a reduction in product sales and an increase in accrued expenses or a reduction in the related accounts receivable.

Prompt-payment discounts: The specialty distributor and specialty pharmacies are offered prompt payment discounts. The Company expects the specialty distributor and specialty pharmacies will earn prompt payment discounts and, therefore deduct the full amount of these discounts from total product sales when revenues are recognized. The Company records prompt-payment discounts as allowances against accounts receivable on the condensed consolidated balance sheet.

Rebates: Allowances for rebates include mandated discounts under the Medicaid Drug Rebate Program. Rebate amounts are based upon contractual agreements or legal requirements with public sector (e.g. Medicaid) benefit providers. Rebates are amounts owed after the final dispensing of the product to a benefit plan participant and are based upon contractual agreements or legal requirements with public sector benefit providers. The allowance for rebates is based on statutory discount rates and expected utilization. The Company estimates for expected utilization of rebates based on data received from the specialty pharmacies. Rebates are generally invoiced and paid in arrears so that the accrual balance consists of an estimate of the amount expected to be incurred for the current quarter’s activity, plus an accrual balance for known prior quarter’s unpaid rebates. If actual future rebates vary from estimates, the Company may need to adjust prior period accruals, which would affect revenue in the period of adjustment. Allowance for rebates are recorded in accrued liabilities on the condensed consolidated balance sheet.

 

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Chargebacks: Chargebacks are discounts that occur when contracted customers purchase directly from a specialty distributor. Contracted customers, which primarily consist of Public Health Service institutions, non-profit clinics, and Federal government entities purchasing via the Federal Supply Schedule, generally purchase the product at a discounted price. The specialty distributor, in turn, charges back to the Company the difference between the price initially paid by the specialty distributor and the discounted price paid to the specialty distributor by the customer. The allowance for chargebacks is based on known sales to contracted customers. For qualified programs that can purchase the Company’s products through distributors at a lower contractual government price, the distributors charge back to the Company the difference between their acquisition cost and the lower contractual government price.

Medicare Part D Coverage Gap: Medicare Part D prescription drug benefit mandates manufacturers to fund 50% of the Medicare Part D insurance coverage gap for prescription drugs sold to eligible patients. The Company estimates for the expected Medicare Part D coverage gap are based on historical invoices received and in part from data received from the specialty pharmacies. Funding of the coverage gap is generally invoiced and paid in arrears so that the accrual balance consists of an estimate of the amount expected to be incurred for the current quarter’s activity, plus an accrual balance for known prior quarters. If actual future funding varies from estimates, the Company may need to adjust prior period accruals, which would affect revenue in the period of adjustment. Estimates of the Medicare Part D coverage Gap are recorded in accrued liabilities on the condensed consolidated balance sheet.

Distribution Service Fees: The Company has written contract with the distributor that include terms for distribution-related fees. Distributor fees are calculated at percentage of gross sales based upon agreed contracted rate. The Company accrues distributor fees at the time of the revenue recognition, resulting in reduction of product sales revenue and the recording of accrued liabilities on the condensed consolidated balance sheet. The Company records distribution and other fees paid to its customers as a reduction of revenue, unless it receives an identifiable and separate benefit for the consideration and it can reasonably estimate the fair value of the benefit received. If both conditions are met, the Company records the consideration paid to the customer as an operating expense. These costs are typically known at the time of sale, resulting in minimal adjustments subsequent to the period of sale.

Product Returns: Consistent with industry practice, the Company generally offers customer a limited right to return. The Company accepts returns of products from patients resulting from breakage as defined within the Company’s returns policy. Additionally, the Company considers several other factors in the estimation process including the expiration dates of product shipped, third party data in monitoring channel inventory levels, shelf life of the product, prescription trends and other relevant factors. Provisions for estimated product returns are recorded at the patient level and recorded as accrued liabilities on the condensed consolidated balance sheet.

Contract and other revenues: The Company’s commissions for promotion services in 2007 and 2008 were generated through the collaboration agreement with Ucyclyd related to the sales of BUPHENYL and AMMONUL for UCD. These promotion services were terminated effective June 2008. The Company considered the guidance in ASC 605-50, Revenue Recognition, Customer Payments and Incentives, to determine the appropriate classification of the promotion commission.

Cost of sales

Cost of sales includes third-party manufacturing cost of products sold, royalty fees, shipping, supplies and other indirect related costs including compensation cost of personnel. Costs incurred prior to FDA approval have been recorded as research and development expenses in the Company’s condensed statement of operations. The Company expects that cost of sales as a percentage of revenue will increase in future periods as product manufactured prior to FDA approval, and therefore fully expensed, is utilized.

Cost of sales in 2007 and 2008 were related to royalty payments to a third party in connection with the commissions received from Ucyclyd related to sales of BUPHENYL and AMMONUL under the prior collaboration agreement with Ucyclyd.

Comprehensive Loss

For all periods presented the comprehensive loss was equal to the net loss; therefore, a separate statement of comprehensive loss is not included in the accompanying interim condensed consolidated financial statements.

Net Loss per Share of Common Stock

Basic net loss per common share is calculated by dividing the net loss attributable to common stockholders by the weighted-average number of common shares outstanding during the period, without consideration for potentially dilutive securities. Diluted

 

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net loss per share is computed by dividing the net loss attributable to common stockholders by the weighted-average number of common shares and potentially dilutive securities outstanding for the period determined using the treasury-stock and if-converted methods. For purposes of the diluted net loss per share calculation, convertible preferred stock, convertible notes payable, stock options and common and preferred stock warrants are considered to be potentially dilutive securities but are excluded from the calculation of diluted net loss per share because their effect would be anti-dilutive and therefore, basic and diluted net loss per share were the same for all periods presented.

Recent Accounting Pronouncements

In February 2013, FASB issued an update on the reporting of amounts reclassified from accumulated other comprehensive income. An entity is required to present either parenthetically on the face of the financial statements or in the notes, significant amounts reclassified from each component of accumulated other comprehensive income and the income statement line items affected by the reclassification. However, an entity would not need to show the income statement line item affected for certain components that are not required to be reclassified in their entirety to net income, such as amounts amortized into net periodic pension cost. The standard is effective prospectively for public entities for fiscal years, and interim periods with those years, beginning after December 15, 2012. Early adoption is permitted. The Company adopted this guidance on January 1, 2013; however, the implementation did not to have an impact on the Company’s financial statements.

3. Collaboration Agreement with Ucyclyd Pharma, Inc.

In March 2012, the Company entered into the purchase agreement with Ucyclyd Pharma Inc. (“Ucyclyd”), (a subsidiary of Valeant Pharmaceuticals International, Inc. (“Valeant”),) under which the Company purchased the worldwide rights to Ravicti and the amended and restated collaboration agreement (the “restated collaboration agreement”) under which Ucyclyd granted the Company an option to purchase all of Ucyclyd’s worldwide rights in BUPHENYL and AMMONUL at a fixed price at a future defined date, plus subsequent milestone and royalty payments, subject to Ucyclyd’s right to retain AMMONUL for a predefined price. The restated collaboration agreement superseded the collaboration agreement with Ucyclyd, dated August 23, 2007, as amended. The entry into the purchase agreement and the restated collaboration agreement resolved a dispute that the two parties had with respect to their rights under the prior collaboration agreement.

Under the purchase agreement, the Company made a payment of $6.0 million of which (i) $5.7 million was allocated to the worldwide rights to Ravicti and (ii) $0.3 million was allocated to the option to purchase rights to BUPHENYL and AMMONUL, based on their relative fair values. The allocated amount to the rights to Ravicti of $5.7 million was recorded to research and development expense in the consolidated statements of operations for the period ended March 31, 2012 due to the uncertainty of an alternative future use. The allocated amount to the option to purchase rights to BUPHENYL and AMMONUL in the amount of $0.3 million is included within other non-current assets and will be evaluated for potential impairment until exercised, at which time it will be added to the option exercise price.

The Company will also pay tiered mid to high single digit royalties on global net sales of Ravicti and may owe regulatory milestones of up to $15.8 million related to approval of Ravicti in HE, regulatory milestones of up to $7.3 million per indication for approval of Ravicti in indications other than UCD or HE, and net sales milestones of up to $38.8 million if Ravicti is approved for use in indications other than UCD (such as HE) and all annual sales targets are reached.

In addition, the intellectual property license agreements executed between Ucyclyd and Dr. Marshall L. Summar, (“Summar”) and Ucyclyd and Brusilow Enterprises, LLC, (“Brusilow”) were assigned to the Company, and the Company has assumed the royalty and milestone obligations under the Brusilow agreement for sales of Ravicti in any indication and the royalty obligations under the Summar agreement on sales of Ravicti to treat HE. The Company will also pay Brusilow an annual license extension fee to keep the Brusilow license in effect, which extension fee is payable until the Company’s first commercial sale of Ravicti following FDA approval. The Brusilow and Summar agreements provide that royalty obligations will continue, without adjustment, even if generic versions of the licensed products are introduced and sold in the relevant country.

Under the terms of the restated collaboration agreement, the Company has an option to purchase all of Ucyclyd’s worldwide rights in BUPHENYL and AMMONUL, subject to Ucyclyd’s option to retain rights to AMMONUL. The Company will be permitted to exercise this option for 90 days beginning on the earlier of the date of the approval of Ravicti for the treatment of UCD and June 30, 2013, but in no event earlier than January 1, 2013. The upfront purchase price for AMMONUL and BUPHENYL is $22.0 million, which the Company may fund by drawing on a loan commitment from Ucyclyd. The loan would be payable in eight quarterly payments and would bear interest at a rate of 9% per year, and would be secured by the BUPHENYL and AMMONUL assets. If the Ravicti NDA for UCD is not approved by January 1, 2013, then Ucyclyd is obligated to make monthly payments of $0.5 million to the Company until the earliest of (1) FDA approval of the Ravicti NDA for UCD, (2) June 30, 2013 and (3) the Company’s written notification of the decision not to purchase Ucyclyd’s worldwide rights to BUPHENYL and AMMONUL.

 

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If the Company exercises its option to purchase Ucyclyd’s worldwide rights to BUPHENYL and AMMONUL, then Ucyclyd has the time-limited right to elect to retain all rights to AMMONUL for a purchase price of $32.0 million. If Ucyclyd exercises this option, Ucyclyd will pay the Company a net payment of $13.0 million on closing of the purchase transaction, which reflects the purchase price for Ucyclyd’s worldwide rights to BUPHENYL being set-off against Ucyclyd’s retention payment for AMMONUL. If Ucyclyd retains rights to AMMONUL, subject to certain terms and conditions, the Company retains a right of first negotiation should Ucyclyd later decide to sell, exclusively license, or otherwise transfer the AMMONUL assets to a third party.

On February 1, 2013, the FDA approved Ravicti for the treatment of UCD in adult and pediatric patients two years of age and older. In accordance with the restated collaboration agreement terms, Ucyclyd made the payment of $0.5 million during the quarter ended March 31, 2013.

As discussed in Note. 13, Subsequent Event, on April 29, 2013, the Company exercised its option to acquire BUPHENYL and AMMONUL.

4. Fair Value Measurements

The Company follows ASC 820-10, “Fair Value Measurements and Disclosures,” which among other things, defines fair value, establishes a consistent framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring or nonrecurring basis. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, a three-tier fair value hierarchy has been established, which prioritizes the inputs used in measuring fair value as follows:

 

•

Level 1 — Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.

 

•

Level 2 — Inputs (other than quoted prices included in Level 1) are either directly or indirectly observable for the asset or liability through correlation with market data at the measurement date and for the duration of the instrument’s anticipated life.

 

•

Level 3 — Inputs reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date. Consideration is given to the risk inherent in the valuation technique and the risk inherent in the inputs to the model.

The following table presents the Company’s fair value hierarchy for assets and liabilities measured at fair value on a recurring basis as of March 31, 2013 and December 31, 2012 (in thousands):

		March 31, 2013
		Quoted prices in Active Markets for Identical Items (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets:
Money market funds		$	38,004			$	—			$	—
		$	38,004			$	—			$	—
		December 31, 2012
		Quoted prices in Active Markets for Identical Items (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets:
Money market funds		$	45,003			$	—			$	—
		$	45,003			$	—			$	—

 

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The following table presents the carrying value and estimated fair value of the Company’s notes payable as of March 31, 2013 (in thousands):

 

		March 31, 2013
		Carrying Value				Estimated Fair  Value
April and September 2012 Notes		$	11,552			$	12,255

The fair value of the April and September 2012 Notes is based on the present value of expected future cash flows and assumptions about current interest rates and the credit worthiness of the Company. The notes payable are classified within Level 3 of the hierarchy of fair value measurements.

5. Accrued Liabilities

The following table represents the components of accrued liabilities (in thousands):

 

		March 31, 2013				December 31, 2012
Preclinical and clinical trial expenses		$	518			$	583
Payroll and related expenses			1,001				1,457
Interest payable			89				93
Other			1,289				407
		$	2,897			$	2,540

6. Notes Payable

In April 2012, the Company borrowed $10.0 million (the “April 2012 Notes”) pursuant to a loan and security agreement (the “Loan Agreement”) with Silicon Valley Bank and Leader Lending, LLC—Series B (the “Lenders”). The loan carries an interest rate of 8.88%, with interest only payments for the period of 9 months from May 1, 2012. The loan is then payable in equal monthly principal payments plus interest over a period of 27 months from February 1, 2013. In connection with the Loan Agreement, the Company granted a security interest in all of its assets, except intellectual property. The Company’s obligations to the Lenders include restrictions on borrowing, asset transfers, placing liens or security interest on its assets including the Company’s intellectual property, mergers and acquisitions and distributions to stockholders. The Loan Agreement also requires the Company to provide the Lenders monthly financials and compliance certificate within 30 days of each month end, annual audited financials within 180 days of each fiscal year-end and annual approved financial projections. The Company issued warrants to the Lenders to purchase a total of 75,974 shares of common stock with an exercise price of $4.08 per share. The Loan Agreement requires immediate repayment of amounts outstanding upon an event of default, as defined in the Loan Agreement, which includes events such as a payment default, a covenant default or the occurrence of a material adverse change, as defined in the Loan Agreement. In addition, a final payment equal to 6.5% of the principal loan amount is due on the earlier of (i) maturity date, (ii) prepayment of the loan or (iii) an event of default.

Pursuant to the terms of the Loan Agreement, once the Company raises at least $30.0 million from the sale of equity securities or subordinated debt, the Lenders also agreed to lend the Company a one-time single loan in the amount of $2.5 million (the “Bank Term Loan”). In September 2012, the Company borrowed an additional $2.5 million (the “September 2012 Note”) from Silicon Valley Bank pursuant to the terms of the Bank Term Loan. In addition, the Company issued warrants to Silicon Valley Bank to purchase a total of 8,408 shares of common stock with an exercise price of $5.05 per share. A final payment equal to 6.5% of the principal loan amount is due on the earlier of (i) maturity date, (ii) prepayment of the loan or (iii) an event of default. The principal amount outstanding under the Bank Term Loan accrues interest at a per annum rate equal to the greater of (i) 8.88% and (ii) the Treasury Rate, as defined in the Loan Agreement, on the date the loan is funded plus 8.50%, with interest only payments for the period of 9 months from the date the loan is funded. The loan is then payable in equal monthly principal payments plus interest over a period of 27 months from the date the loan is funded.

Through March 31, 2013 and for three months ended, the Company recorded amortization of debt discount of $0.5 million and $0.1 million, respectively, related to the April 2012 Notes and September 2012 Note.

 

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7. Warrants

October 2007 Common Stock Warrants

In connection with a Loan and Security Agreement entered into in October 2007, the Company issued warrants to purchase 274 shares of Series B convertible preferred stock. In June 2009, as part of the recapitalization, these warrants were converted into warrants to purchase shares of common stock. The warrants are exercisable at $1,913.05 per share and will expire in October 2017 (the “October 2007 common stock warrants”).

April 2012 Common Stock Warrants

In connection with the Loan Agreement entered into in April 2012 (Note 6), the Company issued warrants to the Lenders to purchase a total of 75,974 shares of common stock. The warrants are exercisable at $4.08 per share and expire in April 2022 (the “April 2012 common stock warrants”). During the quarter ended March 31, 2013, warrants to purchase 37,987 shares of common stock were net exercised by Silicon Valley Bank. The remaining April 2012 common stock warrants to purchase 37,987 shares of common stock held by Leader Lending, LLC—Series B remain outstanding at March 31, 2013.

September 2012 Common Stock Warrants

In connection with the September 2012 Note, the Company issued warrants to the Lender to purchase a total of 8,408 shares of common stock. The warrants are exercisable at $5.05 per share and expire in September 2022 (the “September 2012 common stock warrants”). As of March 31, 2013, the September 2012 common stock warrants had been fully exercised.

The following table summarizes the outstanding warrants and the corresponding exercise price as of March 31, 2013 and December 31, 2012:

 

		Number of Shares Outstanding
		March 31, 2013				December 31, 2012				Per Share Exercise Price
October 2007 common stock warrants			274				274			$	1,913.05
April 2012 common stock warrants			37,987				75,974				4.08
September 2012 common stock warrants			—				8,408				5.05
Total			38,261				84,656

8. Commitments and Contingencies

Contingencies

In the normal course of business, the Company enters into contracts and agreements that contain a variety of representations and warranties and provide for general indemnifications. The Company’s exposure under these agreements is unknown because it involves claims that may be made against the Company in the future, but have not yet been made. Further, the Company may be subject to certain contingent liabilities that arise in the ordinary course of its business activities. The Company accrues a liability for such matters when it is probable that future expenditures will be made and such expenditures can be reasonably estimated.

In accordance with the Company’s amended and restated certificate of incorporation and amended and restated bylaws, the Company has indemnification obligations to its officers and directors for certain events or occurrences, subject to certain limits, while they are serving at the Company’s request in such capacity. There have been no claims to date and the Company has a director and officer insurance policy that may enable it to recover a portion of any amounts paid for future claims.

The Company is contingently committed for development milestone payments as well as sales-related milestone payments and royalties relating to potential future product sales under the restated collaboration agreement and purchase agreement with Ucyclyd (Note 3). The amount, timing and likelihood of these payments are unknown as they are dependent on the occurrence of future events that may or may not occur, including approval by the FDA of Ravicti for HE and the closing of the purchase of Ucyclyd’s worldwide rights to BUPHENYL and AMMONUL under the purchase agreement and the restated collaboration agreement.

9. Stockholders’ Equity

On March 13, 2013, the Company completed its follow-on offering and issued 2,875,000 shares of its common stock at an offering price of $20.75 per share. In addition, the Company sold an additional 431,250 shares of common stock directly to its underwriters when they exercised their over-allotment option in full at an offering price of $20.75 per share. The Company received net proceeds from the offering of $63.7 million, after deducting underwriting discounts and commissions of $4.1 million and expenses of $0.8 million. As a result of these transactions, the Company issued a total of 3,306,250 shares of its common stock during the three months ended March 31, 2013, which resulted in an increase to additional paid-in capital of $63.7 million.

 

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10. Stock Option Plan

In April 2012, the board of directors of the Company adopted the 2012 Omnibus Incentive Plan (the “2012 Plan”). The Company’s stockholders approved the 2012 Plan in July 2012. The 2012 Plan provides for the grant of stock options, stock appreciation rights, restricted stock, unrestricted stock, stock units, dividend equivalent rights, other equity-based awards and cash bonus awards. The 2012 Plan became effective on July 25, 2012

As of March 31, 2013, the Company had 1,347,058 shares of common stock available for issuance and 472,932 options outstanding under the 2012 Plan. During the three months ended March 31, 2013, the board of directors approved the grants of 226,700 stock options under the 2012 Plan at exercise prices in the range of $18.24 - $25.82. In addition, pursuant to the provisions of the 2012 Plan providing for an annual automatic increase in the number of shares of common stock reserved for issuance under the plan, the shares available for issuance under the 2012 Plan increased by 665,850 shares.

On July 25, 2012, the effective date of the 2012 Plan, the 2006 Plan was frozen and no additional awards will be made under the 2006 Plan. Any shares remaining available for future grant were allocated to the 2012 Plan and any shares underlying outstanding options that terminate by expiration, forfeiture, cancellation, or otherwise without issuance of such shares, will be allocated to the 2012 Plan. As of March 31, 2013, there were 1,639,523 options outstanding under the 2006 Plan.

Stock-Based Compensation

The Company estimates the fair value of stock options using the Black-Scholes option valuation model. The fair value of employee stock options is being amortized on a straight-line basis over the requisite service period of the awards.

Total stock-based compensation expense related to options granted was allocated as follows (in thousands):

 

		Three Months Ended March 31,								Cumulative Period From November 1, 2006 (Date of Inception) to March 31,
		2013				2012				2013
Cost of sales		$	1			$	—			$	1
Research and development		$	91			$	37			$	795
Selling, general and administrative			413				41				1,686
Total		$	505			$	78			$	2,482

Stock-based compensation of $9,000 was capitalized into inventories for the three months ended March 31, 2013. Capitalized stock-based compensation is recognized as cost of sales when the related product is sold. Allocations to research and development, selling, general and administrative expenses are based upon the department to which the associated employee reported. No related tax benefits of the stock-based compensation expense have been recognized.

11. Income Taxes

The Company was granted orphan drug designation in 2009 by the FDA for its products currently under development. The orphan drug designation allows the Company to claim increased federal tax credits for its research and development activities. The Company had $16.4 million of federal credit carryforwards of which $15.9 million relates to Orphan Drug Credit claims for 2009 through 2012. These federal credit carryforwards were fully provided with 100% valuation allowance.

There was no interest or penalties accrued through March 31, 2013. The Company’s policy is to recognize any related interest or penalties in income tax expense. The material jurisdiction in which the Company is subject to potential examination by tax authorities for tax years ended 2006 through the current period include the U.S. and California. The Company is not currently under income tax examinations by any tax authorities.

 

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12. Net Loss per Share of Common Stock

The following table sets forth the computation of basic and diluted net loss per share of common stock for the periods indicated (in thousands, except share and per share amounts):

 

		Three Months Ended March 31,
		2013				2012
Net loss per share
Numerator:
Net loss attributable to common stockholders		$	(8,975	)		$	(11,886	)
Denominator:
Weighted-average number of common shares used in calculating net loss per share — basic and diluted outstanding			17,366,848				469,319
Net loss per share attributable to common stockholders — basic and diluted		$	(0.52	)		$	(25.33	)

As the Company incurred net losses for all of the periods presented, the following outstanding potentially dilutive securities were excluded from the computation of diluted net loss per share, as the effect of including them would have been antidilutive:

 

		Three Months Ended March 31,
		2013				2012
Convertible preferred stock			—				6,575,637
Stock options			2,112,455				1,267,385
October 2007, April 2008, April 2011, April 2012 and September 2012 common stock warrants			38,261				296
Total			2,150,716				7,843,318

13. Subsequent Event

On April 29, 2013, the Company exercised its option to acquire BUPHENYL and AMMONUL from Valeant pursuant to the restated collaboration agreement, as discussed in Note 3. Pursuant to the restated collaboration agreement, Valeant has 20 days from the date of exercise to formally notify the Company whether it intends to retain rights to AMMONUL. If Valeant elects not to retain AMMONUL, the Company is obligated to pay $22.0 million, plus subsequent milestone and royalty payments, to Valeant. To fund this upfront payment, the Company may choose to draw on a loan commitment from Valeant, which would be payable over eight quarters. If Valeant elects to retain AMMONUL, Valeant must pay the Company $13.0 million upon close of the transaction, and the Company is obligated to pay subsequent milestone and royalty payments to Valeant.

 

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

You should read the following management’s discussion and analysis of our financial condition and results of operations in conjunction with our unaudited condensed consolidated financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q and with our audited consolidated financial statements and related notes thereto for the year ended December 31, 2012, included in our Annual Report on Form 10-K/A, filed with the U.S. Securities and Exchange Commission (“SEC”).

Overview

We are a biopharmaceutical company focused on the development and commercialization of novel therapeutics to treat disorders in the areas of orphan diseases and hepatology. We have developed our product, Ravicti™ (glycerol phenylbutyrate) Oral Liquid (“Ravicti”), to treat the most prevalent urea cycle disorders (“UCD”) and are developing Ravicti to treat hepatic encephalopathy (“HE”), two different diseases in which blood ammonia is elevated. UCD are inherited rare genetic diseases caused by a deficiency of one or more enzymes or protein transporters that constitute the urea cycle, which in a healthy individual removes ammonia through the conversion of ammonia to urea. HE may develop in some patients with liver scarring, known as cirrhosis, or acute liver failure and is a chronic disease which fluctuates in severity and may lead to serious neurological damage. On February 1, 2013, the U.S. Food and Drug Administration (“FDA”), granted approval of Ravicti for use as a nitrogen-binding agent for chronic management of UCD in adult and pediatric patients greater than two years of age who cannot be managed by dietary protein restriction and/or amino acid supplementation alone. Limitations of use for Ravicti include treatment of patients with acute hyperammonemia (“HA”) crises for whom urgent intervention is typically necessary, patients with N-acetylglutamate synthetase deficiency for whom the safety and efficacy of Ravicti has not been established, and UCD patients under two months of age for whom Ravicti is contraindicated due to uncertainty as to whether newborns, who may have immature pancreatic function, can effectively digest Ravicti. We commercially launched Ravicti during the first quarter of 2013. On May 1, 2013, we received notification from the FDA that Ravicti qualified for orphan drug exclusivity.

We originally obtained rights to develop Ravicti in 2007 pursuant to a collaboration agreement with Ucyclyd Pharma, Inc. (“Ucyclyd”), a wholly owned subsidiary of Medicis Pharmaceutical Corporation, which became a wholly owned subsidiary of Valeant Pharmaceuticals International, Inc. (‘Valient”) on December 11, 2012. In March 2012, we purchased the worldwide rights to Ravicti for an upfront payment of $6.0 million, future payments based upon the achievement of regulatory milestones in indications other than UCD, sales milestones, and mid to high single digit royalties on global net sales of Ravicti. Pursuant to an amended and restated collaboration agreement (the “restated collaboration agreement”), with Ucyclyd entered into in March 2012, we have an option to purchase all of Ucyclyd’s worldwide rights in BUPHENYL and AMMONUL^® (sodium phenylacetate and sodium benzoate) injection 10%/10%, the only adjunctive therapy currently FDA-approved for the treatment of HA crises in UCD patients, for an upfront payment of $22.0 million, plus subsequent milestone and royalty payments. To fund this upfront payment, we may draw on a loan commitment from Ucyclyd, which loan would be payable over eight quarters. On April 29, 2013, we exercised our option to acquire BUPHENYL and AMMONUL from Ucyclyd. Ucyclyd has until May 19, 2013, to exercise its option to retain AMMONUL at a purchase price of $32.0 million. If Ucyclyd exercises its option and retains AMMONUL, the upfront purchase price for Ucyclyd’s worldwide rights to BUPHENYL will be $19.0 million plus subsequent payments and milestones resulting in a net payment from Ucyclyd to us of $13.0 million upon close of the transaction.

We are a development stage company and have incurred net losses since our inception. As of March 31, 2013, we have a deficit accumulated during the development stage of $148.0 million. We recorded net losses of $9.0 million and $11.9 million for the three months ended March 31, 2013 and 2012, respectively. We expect to exit development stage designation when we have sufficient revenue from our principal operations. We anticipate that a substantial portion of our capital resources and efforts in the foreseeable future will be focused on completing the development and obtaining regulatory approval of Ravicti in HE and preparing for the commercialization of BUPHENYL and AMMONUL, if purchased from Ucyclyd. In addition, any future acquisitions of products or product candidates may require additional capital and personnel.

In April 2012, our Phase II HE trial data was unblinded and the trial met its primary endpoint, which was to demonstrate that the proportion of patients experiencing an HE event was significantly lower on Ravicti versus placebo, both administered in addition to a standard of care, including lactulose and/or rifaximin. We expect our research and development expenses to increase when we initiate a Phase III trial of Ravicti in HE. We will likely continue to incur significant commercial, sales, marketing and outsourced manufacturing expenses in connection with the commercialization of Ravicti in UCD. These increased expenses include payroll related expenses as we add employees in the commercial and regulatory departments, costs related to the initiation and operation of our distribution network, and marketing costs and general infrastructure expenses as we expand our organization. Accordingly, we expect to continue to incur significant and increasing operating losses for the foreseeable future.

On July 31, 2012, we completed our initial public offering (“IPO”) and issued 5,000,000 shares of our common stock at an initial offering price of $10.00 per share. We sold an additional 750,000 shares of common stock directly to our underwriters when they exercised their over-allotment option in full at the initial offering price of $10.00 per share. Our shares began trading on the NASDAQ Global Market on July 26, 2012. We received net proceeds from the IPO of $51.3 million, after deducting underwriting discounts and commissions of $4.0 million and expenses of $2.2 million.

 

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Prior to our IPO, substantially all of our operations were funded through the private placement of equity securities and convertible debt. Through December 31, 2011, we have raised net cash proceeds of approximately $66.1 million from the sale of convertible preferred stock and $15.3 million from the issuance of convertible notes, which subsequently converted into shares of convertible preferred stock. Additionally, during 2011 and the first quarter of 2012, we issued approximately $32.5 million of convertible notes.

On March 13, 2013, we completed a follow-on offering and issued 2,875,000 shares of our common stock at an offering price of $20.75 per share. In addition, we sold an additional 431,250 shares of common stock directly to our underwriters when they exercised their over-allotment option in full at an offering price of $20.75 per share. We received net proceeds from the offering of $63.7 million, after deducting underwriting discounts and commissions of $4.1 million and expenses of $0.8 million.

Financial Overview

Net Revenue

For the period from inception to March 31, 2013, we have generated no revenue from the sale of any products other than product revenue generated during the first quarter of 2013 following FDA approval and the commercial launch of Ravicti. We have only generated limited revenue from the promotion of BUPHENYL and AMMONUL during 2007 and 2008.

Cost of sales

The manufacturing costs we incurred prior to FDA approval of Ravitcti have been recorded as research and development expenses in our condensed consolidated statement of operations. Our cost of sales during the quarter ended March 31, 2013 consists mainly of, royalty fees payable under our restated collaboration agreement with Ucyclyd, and other indirect costs including compensation cost of personnel, shipping and supplies. We expect that cost of sales as a percentage of sales will increase in future periods as product manufactured prior to FDA approval, and therefore fully expensed, is utilized.

Cost of sales in 2007 and 2008 were related to royalty payments to a third party in connection with the commissions received from Ucyclyd related to sales of BUPHENYL and AMMONUL under our prior collaboration agreement with Ucyclyd.

Research and Development Expenses

Since our inception, we have focused on our clinical development programs. We recognize research and development expenses as they are incurred. Our research and development expenses consist primarily of:

 

•

salaries and related expenses for personnel, including expenses related to stock options or other stock-based compensation granted to personnel in development functions;

 

•

fees paid to clinical consultants, clinical trial sites and vendors, including clinical research organizations, or CROs, in conjunction with implementing and monitoring our clinical trials and acquiring and evaluating clinical trial data, including all related fees, such as for investigator grants, patient screening fees, laboratory work and statistical compilation and analysis;

 

•

other consulting fees paid to third parties;

 

•

expenses related to production of clinical supplies, including fees paid to contract manufacturers;

 

•

expenses related to license fees and milestone payments under in-licensing agreements;

 

•

expenses related to compliance with drug development regulatory requirements in the United States, the European Union and other foreign jurisdictions; and

 

•

depreciation and other allocated expenses;

 

•

expenses incurred to manufacture Ravicti prior to FDA approval.

 

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We expense both internal and external research and development expenses as they are incurred. We did not begin tracking our research and development expenses on a program-by-program basis until January 1, 2010. We have been developing Ravicti in both UCD and HE in parallel, and we typically use our employees, consultants and infrastructure resources across our two programs. Thus, some of our research and development expenses are not attributable to an individual program, but rather are allocated across our two clinical stage programs and these costs are included in unallocated costs as detailed below. In 2012, unallocated costs included $5.7 million incurred in connection with the purchase agreement with Ucyclyd. Allocated expenses include salaries, stock-based compensation and related benefit expenses for our employees, consulting fees and fees paid to clinical suppliers. The following table shows our research and development expenses for the three months ended March 31, 2013 and 2012:

 

		Three Months Ended March 31,
(in thousands)		2013				2012
		(unaudited)
UCD Program		$	926			$	1,104
HE Program			314				873
Unallocated			609				6,925
Total		$	1,849			$	8,902

We expect our research and development expenses to increase when we initiate our Phase III trial of Ravicti for the treatment of patients with episodic HE. Due to the inherently unpredictable nature of product development, we are currently unable to estimate the expenses we will incur in the continued development of Ravicti.

Our research and development expenditures are subject to numerous uncertainties in timing and cost to completion. Development timelines, the probability of success and development expenses can differ materially from expectations. Clinical trials in orphan diseases, such as UCD and HE, may be difficult to enroll given the small number of patients with these diseases. Completion of clinical trials may take several years or more, but the length of time generally varies according to the type, complexity, novelty and intended use of a product candidate. The cost of clinical trials may vary significantly over the life of a project as a result of differences arising during clinical development, including, among others:

 

•

the number of trials required for approval;

 

•

the number of sites included in the trials;

 

•

the length of time required to enroll suitable patients;

 

•

the number of patients that participate in the trials;

 

•

the drop-out or discontinuation rates of patients;

 

•

the duration of patient follow-up;

 

•

the number and complexity of analyses and tests performed during the trial;

 

•

the phase of development of the product candidate; and

 

•

the efficacy and safety profile of the product candidate.

Our expenses related to clinical trials are based on estimates of patient enrollment and related expenses at clinical investigator sites as well as estimates for the services received and efforts expended pursuant to contracts with multiple research institutions and contract research organizations that conduct and manage clinical trials on our behalf. We generally accrue expenses related to clinical trials based on contracted amounts applied to the level of patient enrollment and activity according to the protocol. If timelines or contracts are modified based upon changes in the clinical trial protocol or scope of work to be performed, we modify our estimates of accrued expenses accordingly on a prospective basis.

As a result of the uncertainties discussed above, we are unable to determine with certainty the duration and completion costs of our Ravicti development programs.

Selling, General and Administrative Expenses

Selling general and administrative expenses consist primarily of salaries, benefits and stock-based compensation for employees in administration, finance and business development, marketing, commercial and sales functions, including fees to third party vendors providing customer support services. Other significant expenses include consulting fees, allocated facilities expenses and professional fees for accounting and legal services, including legal services associated with obtaining and maintaining patents. We expect that our selling, general and administrative expenses will increase with the continued commercialization of Ravicti, and BUPHENYL and AMMONUL, if purchased from Ucyclyd. We expect these increases will likely include increased expenses for insurance, expenses related to the hiring of additional personnel and payments to outside consultants, lawyers and accountants.

Interest Income

Interest income consists of interest earned on our cash and cash equivalents.

 

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Interest Expense

Interest expense consists primarily of non-cash and cash interest costs related to our borrowings.

Other Income (Expense), net

In the three months ended March 31, 2013 other income (expense), net consists of a $0.5 million payment from Ucyclyd in accordance with the restated collaboration agreement. During the three months ended March 31, 2012, other income (expense), net consists primarily of the changes in the fair value of the common and preferred stock warrants liability and call option liability associated with the issuance of approximately $32.5 million of convertible notes. Under ASC 815, Derivatives and Hedging and ASC 480, Distinguishing Liabilities from Equity, we account for the common stock warrants issued in 2011 and preferred stock warrants issued in 2012 and 2011, at fair value and recorded as liabilities on the date of each issuance. The fair value was determined and subsequently re-measured using the Black-Scholes option-pricing model on each reporting date. On July 31, 2012, upon closing of the IPO, we performed a final re-measurement of the common stock warrants issued in 2011 and preferred stock warrants issued in 2012 and 2011, and recorded the impact of the re-measurement to other income (expense), net. These warrants automatically net exercised into shares of common stock on July 31, 2012. As a result, these warrants will no longer be re-measured after July 31, 2012.

Income Taxes

Since inception, we have only generated revenues in the U.S. and have not generated revenues outside the U.S. The only revenues generated in the U.S. prior to the product sales of Ravicti in the three months ended March 31, 2013, have been from commissions for promotion services in 2007 and 2008 through the Ucyclyd collaboration agreement related to the sales of BUPHENYL and AMMONUL for UCD. We have incurred net losses and have not recorded any U.S. federal or state income tax benefits for the losses as they have been offset by valuation allowances.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with U.S. GAAP. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Actual results could differ from those estimates.

Critical accounting estimates are necessary in the application of certain accounting policies and procedures, and are particularly susceptible to significant change. Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and could potentially result in materially different results under different assumptions and conditions. For additional information on our critical accounting policies, please refer to the information contained in Note 2 of the accompanying unaudited condensed consolidated financial statements and the Critical Accounting Policies and Estimates section of our Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Annual Report on Form 10-K/A for the year ended December 31, 2012.

In relation to our commercial launch of Ravicti during the quarter ended March 31, 2013, we implemented the following new critical accounting policies:

Accounts Receivable

Our trade accounts receivable are recorded net of product sales allowances for prompt-payment discounts, chargebacks and doubtful accounts. We estimates chargebacks and prompt-payment discounts based on contractual terms, historical trends and our expectations regarding the utilization rates for these programs.

Inventories

Our inventories are stated at the lower of cost or market value with cost determined under the first-in-first-out (FIFO) cost method. Our inventories consist of raw materials, supplies, and work in process and finished goods. We began capitalizing inventories post FDA approval of Ravicti on February 1, 2013 as the related costs were expected to be recoverable through the commercialization of the product. Our costs incurred prior to the FDA approval of Ravicti have been recorded as research and development expense in the

 

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condensed statements of operations. The costs of our inventories during the quarter ended March 31, 2013 consists mainly of packaging and labeling costs from our third party vendor, indirect costs including compensation cost of personnel and supplies. As of March 31, 2013, our inventories include $0.3 million of work in process and $0.2 million of finished goods. In the future, our capitalizable inventories will include third party manufacturing costs, associated compensation related costs of personnel indirectly involved in the manufacturing process and other overhead costs attributable to the manufacture of inventories. If information becomes available that suggest that our inventories may not be realizable, we may be required to expense a portion or all of the previously capitalized inventories.

We evaluate for potential excess inventory by analyzing current and future product demand relative to the remaining product shelf life. We build demand forecasts by considering factors such as, but not limited to, overall market potential, market share, market acceptance and patient usage. We classified inventory as current on the consolidated balance sheets when we expect inventory to be consumed for commercial use within the next 12 months.

Revenue Recognition

We recognize revenue in accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 605, Revenue Recognition, when the following criteria have been met: persuasive evidence of an arrangement exists; delivery has occurred and risk of loss has passed; and the seller’s price to the buyer is fixed or determinable and collectability is reasonably assured. We determine that persuasive evidence of an arrangement exists based on written contracts that define the terms of our arrangements. In addition, we determine that services have been delivered in accordance with the arrangement. We assesses whether the fee is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment. We assess collectability based primarily on the customer’s payment history and on the creditworthiness of the customer.

Product Revenue

Our product revenue represents U.S. sales of Ravicti and we recognized revenue once all four revenue recognition criteria described above are met. During the first quarter of 2013, we began distributing Ravicti to two specialty pharmacies through a specialty distributor. The specialty pharmacies, then in turn dispensed Ravicti to patients in fulfillment of prescriptions. As Ravicti is a new product, and our first commercial product, we could not reasonably assess potential product sales allowances at the time of sale to the specialty distributor. As a result of our inability to estimate product sales allowance at the time of sale to the specialty distributor, the price of Ravicti was not deemed fixed or determinable. We deferred the recognition of revenues on product shipments of Ravicti to the specialty distributor until the product was shipped to patients by the specialty pharmacies at which time our related product sales allowances could be reasonably estimated. We recognize revenue net of product sales allowances, including estimated rebates, chargebacks, prompt-payment discounts, returns, distribution service fees and Medicare Part D coverage gap reimbursements. Product shipping and handling costs are included in cost of sales.

Product Sales Allowances

We establish reserves for prompt-payment discounts, government and commercial rebates, product returns and chargebacks. Allowances relate to prompt-payment discounts and, are recorded at the time of revenue recognition, resulting in a reduction in product sales revenue and a decrease in trade accounts receivables. Accruals related to government rebates, product returns and other applicable allowances such as distributor fees are recognized at the time of revenue recognition, resulting in a reduction in product sales and an increase in accrued expenses or a reduction in the related accounts receivable depending on the nature of the sales deduction.

Cost of Sales

Costs incurred prior to FDA approval have been recorded as research and development expenses in our condensed consolidated statement of operations. Cost of sales during the quarter ended March 31, 2013 consists mainly of, royalty fees, and other indirect costs including compensation cost of personnel, shipping and supplies. We expect that cost of sales as a percentage of revenue will increase in future periods as product manufactured prior to FDA approval, and therefore fully expensed, is utilized.

 

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Results of Operations

Comparison of the Three Months Ended March 31, 2013 and 2012

 

		Three Months Ended March 31,								Increase/ (Decrease)				% Increase/ (Decrease)
(in thousands, except for percentages)		2013				2012
Product revenue, net		$	783			$	—			$	783				100	%
Cost of sales			68				—				68				100
Research and development			1,849				8,902				(7,053	)			(79	)
Selling, general and administrative			7,934				2,323				5,611				242
Interest income			1				4				(3	)			(75	)
Interest expense			(408	)			(1,040	)			(632	)			(61	)
Other income (expense), net			500				375				125				33

Revenues

During the three months ended March 31, 2013, $0.8 million of net product sales of Ravicti were recognized. Product revenues from the sale of Ravicti are recorded net of estimated product sales allowances including rebates offered pursuant to mandatory federal and state government programs and chargebacks, prompt pay discounts, sales returns and distribution fees.

Cost of Sales

We began capitalizing inventory costs after FDA approval of Ravicti as the related costs were expected to be recoverable through the commercialization of the product. Costs incurred prior to FDA approval have been recorded as research and development expenses in our 2012 consolidated statement of operations. As a result, cost of sales for the next several quarters will reflect a lower average per unit cost of materials. Cost of sales for the quarter ended March 31, 2013 of $68,000, includes royalty costs based on our restated collaboration agreement with Ucyclyd and other indirect costs including compensation cost of personnel indirectly involved in the manufacturing process, cost of shipping and supplies.

Research and Development Expenses

Research and development expenses decreased by $7.1 million, or 79%, to $1.9 million for the three months ended March 31, 2013, from $8.9 million for the three months ended March 31, 2012. This decrease was primarily due to decreases of $0.8 million in clinical development costs due to completion of our HE Phase II trial in 2012 and due to a $5.7 million expense recognized pertaining to purchase of Ravicti which occurred in first quarter of fiscal 2012.

For the period from inception to March 31, 2013, research and development expenses amounted to $89.1 million. Research and development expenses comprise primarily clinical and pre-clinical development costs of $46.4 million, payroll related costs of $15.9 million, professional and consulting costs of $8.3 million, the expenses incurred for the purchase of Ravicti of $5.7 million, regulatory related costs of $3.9 million and amortization of development and promotion rights acquisition cost of $3.1 million.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased by $5.6 million, or 242%, to $7.9 million for the three months ended March 31, 2013, from $2.3 million for the three months ended March 31, 2012. This increase was primarily due to increases of $2.3 million in compensation expense as a result of hiring additional employees in the sales and marketing departments and $0.6 million in insurance and other office and administrative related expenses, $1.3 million in selling and marketing expenses pertaining to the Ravicti product launch and $0.4 million increase in consulting costs.

For the period from inception to March 31, 2013, selling, general and administrative expenses amounted to $45.6 million. Selling, general and administrative expenses comprise primarily of payroll related expenses of $17.4 million, professional and consulting costs of $18.3 million, office and rent related costs of $3.3 million and $4.5 million of selling and marketing related costs.

 

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Interest Income

Interest income consists of interest earned on our cash and cash equivalents. The changes in interest income were not significant for the three ended March 31, 2013 and 2012.

Interest Expense

We recognized $0.4 million in interest expense for the three months ended March 31, 2013, compared to $1.0 million for the three months ended March 31, 2012. Interest expense decreased for the three months ended March 31, 2013, compared to the same period in 2012, due primarily to the conversion of our April 2011 Notes and October 2011 Notes to common stock upon the closing of our IPO in July 2012.

For the period from inception to March 31, 2013, interest expense amounted to $9.4 million primarily related to our interest expense on our convertible notes payable and our loan and security agreements entered into in 2007 and April 2012.

Other Income (Expense), net

Other income (expense), net, primarily relates to the change in fair values of our common and preferred stock warrants and call option liability associated with our convertible notes.

During the three months ended March 31, 2013, we recorded $0.5 million in income related to Ucyclyd’s payment to us in relation to restated collaboration agreement as discussed in Note 3 of the unaudited condensed consolidated statements.

During the three months ended March 31, 2012, we recorded a change in fair value of $0.5 million of expense and $0.2 million of income related to the common stock warrants and the preferred stock warrants, respectively. Additionally, we recorded $0.7 million to other income relating to the change in the fair value of call option liability upon issuance of convertible notes in February 2012.

For the period from inception to March 31, 2013, other income amounted to $1.7 million, consisting primarily of the change in fair value of our preferred stock liability associated with our Series C-2 convertible preferred stock, and the change in fair values of our common and preferred stock warrants and call option liability associated with our convertible notes. In addition $0.5 million relates to other income for the quarter ended March 31, 2013 as discussed in the preceding paragraph.

Liquidity and Capital Resources

Since our inception in November 2006, we have funded our operations primarily through proceeds from the sale of convertible preferred stock, bank debt, sales of our common stock and the issuance of convertible debt. During the three months ended March 31, 2013, we raised net proceeds of $63.7 from our follow-on offering. From inception through March 31, 2013, we have not generated any product revenue other than net product revenue of $0.8 million generated during the first quarter of 2013.

We have incurred losses and generated negative cash flows from operations since inception. As of March 31, 2013 and December 31, 2012, our principal sources of liquidity were our cash and cash equivalents, which totaled $102.7 million and $49.9 million, respectively.

From inception through March 31, 2013, we have received net cash proceeds of $66.1 million from the sale of convertible preferred stock, $15.3 million from the issuance of convertible notes which subsequently converted into shares of convertible preferred stock and $32.5 million from the issuance of convertible debt that was subsequently converted into common stock in July 2012 in connection with the closing of our IPO. In July 2012, we raised $51.3 million in net proceeds in our IPO. On March 13, 2013, we completed our follow-on offering and issued 2,875,000 shares of our common stock at an offering price of $20.75 per share. In addition, we sold an additional 431,250 shares of common stock directly to our underwriters when they exercised their over-allotment option in full at an offering price of $20.75 per share. We received net proceeds from the offering of $63.7 million, after deducting underwriting discounts and commissions of $4.1 million and expenses of $0.8 million.

We currently have limited revenues as we recently began the commercialization of Ravicti during the quarter ended March 31, 2013. We believe that our existing cash and cash equivalents as of March 31, 2013, and our future expected product revenues will be sufficient to fund our operations for at least the next 12 months.

 

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Cash Flows

The following table sets forth the major sources and uses of cash for the periods set forth below (in thousands):

 

		Three Months Ended March 31,
(In thousands)		2013				2012
		(unaudited)
Net cash (used in) provided by:
Operating activities		$	(10,752	)		$	(10,706	)
Investing activities			(315	)			(128	)
Financing activities			63,880				7,552
Net increase (decrease) in cash and cash equivalents		$	52,813			$	(3,282	)

The primary use of cash in operating activities for the three months ended March 31, 2013 and 2012 was to fund our operations related to the development and commercialization of Ravicti in UCD and HE, respectively. Cash used in operating activities of $10.8 million for the three months ended March 31, 2013 primarily related to our net loss of $9.0 million, adjusted for non-cash items such as $0.1 million of amortization of debt discount, $0.5 million of stock-based compensation expense and net cash outflow of $2.4 million related to changes in operating assets and liabilities. Cash used in operating activities of $10.7 million for the three months ended March 31, 2012 primarily related to our net loss of $11.9 million, adjusted for $0.4 million of amortization of debt discount and $1.1 million of net cash inflow related to changes in operating assets and liabilities. In addition, for the first three months of 2012, cash used in operating activities included the $5.7 million of expense incurred for the purchase of Ravicti.

Net cash used in investing activities was $0.3 million for the three months ended March 31, 2013 and $0.1 million for the three months ended March 31, 2012. Net cash used in investing activities for the three months ended March 31, 2013 consisted of property and equipment purchases of $0.3 million. For the three months ended March 31, 2012, net cash provided by investing activities consisted of an increase in restricted cash of $0.2 million, partially offset by the purchase of the option to purchase rights to BUPHENYL and AMMONUL of $0.3 million.

Net cash provided by financing activities amounted to $63.9 million and $7.6 million for the three months ended March 31, 2013 and 2012, respectively. Net cash provided by financing activities for the three months ended March 31, 2013 related primarily to the proceeds from our follow-on offering of $64.5 million (net of underwriting discounts and commissions), partially offset by our payments of notes payable in the amount of $0.7 million and proceeds from issuance of common stock in the amount of $ 0.1 million.

Future Funding Requirements

We will likely need to obtain additional financing to fund our future operations, supporting sales and marketing activities related to BUPHENYL and AMMONUL (if purchased from Ucyclyd), a Phase III trial in HE, as well as the development of any additional product candidates we might acquire or develop on our own. Our future funding requirements will depend on many factors, including, but not limited to

 

•

our ability to successfully commercialize BUPHENYL and AMMONUL if purchased from Ucyclyd;

 

•

the amount of sales and other revenues from products that we may commercialize, if any, including the selling prices for such products and the availability of adequate third-party reimbursement;

 

•

selling and marketing costs associated with our UCD products, including the cost and timing of expanding our marketing and sales capabilities and establishing a network of specialty pharmacies;

 

•

the progress, timing, scope and costs of our nonclinical studies and clinical trials, including the ability to timely enroll patients in our planned and potential future clinical trials;

 

•

the time and cost necessary to obtain regulatory approvals and the costs of post-marketing studies that may be required by regulatory authorities;

 

•

the costs of obtaining clinical and commercial supplies of Ravicti and, if purchased from Ucyclyd, BUPHENYL and AMMONUL;

 

•

payments of milestones and royalties to third parties, including Ucyclyd;

 

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•

cash requirements of any future acquisitions of product candidates;

 

•

the time and cost necessary to respond to technological and market developments:

 

•

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

 

•

any changes made to, or new developments in, our restated collaboration agreement with Ucyclyd or any new collaborative, licensing and other commercial relationships that we may establish.

We only started to generate product revenue during the quarter ended March 31, 2013 and otherwise had not generated revenue from the sale of products in the last three years. We expect our continuing operating losses to result in increases in cash used in operations over the next several years.

We believe that our current cash and cash equivalents, which include the net proceeds from our IPO and follow-on offering will be sufficient to fund our operations for at least the next twelve months.

We have based these estimates on a number of assumptions that may prove to be wrong, and changing circumstances beyond our control may cause us to consume capital more rapidly than we currently anticipate. For example, we may not achieve the revenues we anticipated and our HE Phase III clinical trial may cost more than we expect. Because of the numerous risks and uncertainties associated with the development and commercialization of our product candidates, we are unable to estimate the amounts of increased capital outlays and operating expenditures associated with our current and anticipated clinical trials.

Additional financing may not be available when we need it or may not be available on terms that are favorable to us. We may seek to raise additional capital through a combination of private and public equity offerings and debt financings. To the extent that we raise additional capital through the sale of equity or convertible debt securities, the ownership interest of existing stockholders will be diluted, and the terms may include liquidation or other preferences that adversely affect the rights of existing stockholders. Debt financing, if available, would result in increased fixed payment obligations and may involve agreements that include covenants limiting or restricting our ability to take specific actions such as incurring debt, making capital expenditures or declaring dividends.

If adequate funds are not available to us on a timely basis, or at all, we may be required to terminate or delay clinical trials or other development activities for Ravicti, or delay our establishment of sales and marketing capabilities or other activities that may be necessary to commercialize BUPHENYL and AMMONUL (if purchased from Ucyclyd). We may elect to raise additional funds even before we need them if the conditions for raising capital are favorable.

Off-Balance Sheet Arrangements

We do not currently have, nor have we ever had, any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts.

Jumpstart Our Business Startups Act of 2012

The Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”) permits an “emerging growth company” such as us to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. We are choosing to “opt out” of this provision and, as a result, we will comply with new or revised accounting standards as required when they are adopted. This decision to opt out of the extended transition period under the JOBS Act is irrevocable.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risks in the ordinary course of our business. These risks primarily include risk related to interest rate sensitivities. During the three months ended March 31, 2013, our market risks have not changed materially from those discussed in Item 7A of our Form 10-K/A for the year ended December 31, 2012.

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures. Management, including our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)), as of the end of the period covered by this report. Based upon the evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports we file and submit under the Securities Exchange Act of 1934, as amended, is (i) recorded, processed, summarized and reported as and when required and (ii) accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely discussion regarding required disclosure.

 

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Changes in internal control over financial reporting. There have been no changes in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. On April 1, 2013, we completed the first of two phases of the implementation of our corporate-wide Enterprise Resource Planning (“ERP”) system. Our new ERP system is expected to standardize and automate business processes, to improve operational and financial performance, and to enhance internal controls.

 

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings

We are not currently a party to any material legal proceedings.

Item 1A. Risk Factors

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

Risks Related to Commercialization of Ravicti and Our Development Programs

We depend substantially on the commercial success of our only product, Ravicti, and we may not be able to successfully commercialize it.

We have invested a significant portion of our efforts and financial resources in the development of Ravicti, which is currently our only product. As a result, our business is substantially dependent on our ability to successfully commercialize Ravicti. We launched Ravicti in March 2013. As a result, we may be unable to commercialize Ravicti successfully.

Our ability to commercialize Ravicti successfully will depend on our ability to:

 

•

achieve market acceptance and generate product sales through execution of agreements with a third-party logistics company and specialty pharmacies on commercially reasonable terms;

 

•

obtain adequate levels of reimbursement for Ravicti;

 

•

hire, train, deploy and support a qualified commercial organization and field force;

 

•

create market demand for Ravicti through education, marketing and sales activities;

 

•

comply with requirements established by the FDA, including post-marketing requirements and label restrictions; and

 

•

comply with other healthcare regulatory requirements.

If we are unable to enter into agreements with third parties to distribute any of our UCD products to patients, our results of operations and business could be adversely affected.

We rely on third parties to distribute Ravicti to patients. We have contracted with a third-party logistics company to warehouse Ravicti and two specialty pharmacies to sell and distribute it to patients. A specialty pharmacy is a pharmacy that specializes in the dispensing of medications for complex or chronic conditions which require a high level of patient education and ongoing management. We have also contracted with a third-party call center to coordinate prescription intake and distribution, reimbursement adjudication, patient financial support, and ongoing compliance support. This distribution network requires significant coordination with our sales and marketing and finance organizations. In addition, failure to coordinate financial systems could negatively impact our ability to accurately report product revenue from sales of Ravicti, and BUPHENYL and AMMONUL if we purchase these products from Ucyclyd. If we are unable to effectively manage the distribution process, the commercial launch and sales of our UCD products, as well as any future products we may commercialize, will be delayed or severely compromised and our results of operations may be harmed.

In addition, the use of specialty pharmacies and a call center involves certain risks, including, but not limited to, risks that these organizations will:

 

•

not provide us with accurate or timely information regarding their inventories, the number of patients who are using our UCD products, or complaints regarding those drugs;

 

•

not effectively sell or support our UCD products;

 

•

reduce or discontinue their efforts to sell or support our UCD products;

 

•

not devote the resources necessary to sell our UCD products in the volumes and within the time frames that we expect;

 

•

be unable to satisfy financial obligations to us or others; or

 

•

cease operations.

Any such events may result in decreased product sales and lower product revenue, which would harm our results of operations and business.

 

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If we are unable to successfully develop internal commercialization capabilities, we will be unable to successfully commercialize our UCD products.

We currently have limited internal capabilities for the commercialization of our UCD products. We will need to commit significant time and financial and managerial resources to develop and maintain a marketing and sales force with technical expertise and with supporting distribution capabilities. Factors that may inhibit our efforts to develop our commercialization capabilities include:

 

•

our inability to retain adequate numbers of effective commercial personnel;

 

•

our inability to train sales personnel, who may have limited experience with our company or Ravicti, to deliver a consistent message regarding Ravicti and be effective in convincing physicians to prescribe Ravicti;

 

•

our inability to equip sales personnel with effective materials, including medical and sales literature to help them educate physicians and other healthcare providers regarding Ravicti and its proper administration;

 

•

our inability to manage an increase in our number of full-time employees in a matter of months; and

 

•

Unforeseen costs and expenses associated with creating and sustaining an independent sales and marketing organization.

If we are not successful in maintaining ang effective sales and marketing infrastructure, we will have difficulty commercializing Ravicti, which would adversely affect our business and financial condition.

The commercial success of Ravicti will depend upon the degree of market acceptance among physicians, patients, patient advocacy groups, health care payors and the medical community.

Ravicti may not gain market acceptance among physicians, patients, patient advocacy groups, health care payors and the medical community. The degree of market acceptance of Ravicti will depend on a number of factors, including:

 

•

the effectiveness, or perceived effectiveness, of Ravicti as compared with any branded or generic forms of sodium phenylbutyrate;

 

•

the prevalence and severity of any side effects;

 

•

potential advantages over BUPHENYL or any generic versions of BUPHENYL;

 

•

the market price and patient out-of-pocket costs of Ravicti relative to BUPHENYL and other UCD treatment options, including any generics;

 

•

sufficient third-party coverage or reimbursement;

 

•

relative convenience and ease of administration;

 

•

willingness by patients to stop using sodium phenylbutyrate or any other UCD treatment options and to adopt Ravicti;

 

•

the strength of our sales and marketing organizations and our third-party distributors; and

 

•

the quality of our relationship with patient advocacy groups.

If we fail to achieve market acceptance of Ravicti, our revenue will be limited and it will be more difficult to achieve profitability, or profitability may not occur at all.

If we are unable to maintain orphan drug exclusivity for Ravicti in the United States, we may face increased competition.

Under the Orphan Drug Act of 1983, the FDA may designate a product as an orphan drug if it is a drug intended to treat a rare disease or condition affecting fewer than 200,000 people in the United States. A company that first obtains FDA approval for a designated orphan drug for the specified rare disease or condition receives orphan drug marketing exclusivity for that drug for a period of seven years from the date of its approval. This orphan drug exclusivity prevents the approval of another drug containing the same active ingredient and used for the same orphan indication except in very limited circumstances, based upon the FDA’s determination that a subsequent drug is safer, more effective or makes a major contribution to patient care, or if the orphan drug manufacturer is unable to assure that a sufficient quantity of the orphan drug is available to meet the needs of patients with the rare disease or condition. Orphan drug exclusivity may also be lost if the FDA later determines that the initial request for designation was materially defective. Ravicti was granted orphan drug designation by the FDA in May 2013, which we expect will provide the drug with orphan drug marketing exclusivity in the United States until February 2020, seven years from the date of its approval. However, such exclusivity may not effectively protect the product from competition if the FDA determines that a subsequent drug for the same indication is safer, more effective or makes a major contribution to patient care, or if we are unable to assure the FDA that sufficient quantities of Ravicti are available to meet patient demand. In addition, orphan drug exclusivity does not prevent the FDA from approving competing drugs for the same or similar indication containing a different active ingredient. If a subsequent drug is approved for marketing for the same or similar indication we may face increased competition, and our revenues from the sale of Ravicti will be adversely affected. Ravicti does not have orphan drug status in the EU or other regions of the world.

 

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We have a history of net losses and may not achieve or maintain profitability.

We have a limited operating history and only recently received FDA approval for Ravicti, which we initiated commercial sales of during the first quarter of 2013. We have funded our operations primarily from sales of our equity and debt securities. We have incurred losses in each year since our inception and through March 31, 2013, had an accumulated deficit totaling $148.0 million. Our net losses were $9.0 million and $11.9 million for the quarter ended March 31, 2013 and 2012, respectively, $32.3 million for the year ended December 31, 2012, $29.4 million for the year ended December 31, 2011 and $25.5 million for the year ended December 31, 2010. These losses, among other things, have had and will continue to have an adverse effect on our cash flow, stockholders’ equity and working capital. We may not generate sufficient sales of Ravicti for us to achieve or maintain profitability on a timely basis, or at all.

We expect to incur increased selling, general and administrative expenses during the remainder of this year versus comparable periods last year due to higher sales and marketing expenses related to the commercialization of Ravicti, as well as additional full-year expenses related to operating as a public company. In addition, we expect increased research and development expenses related to our expected HE Phase III trial and for required post-marketing studies for UCD. We also expect to continue to incur significant losses for the foreseeable future. Additionally, our operating expenses may increase significantly if we in-license other products or product candidates. Further, because of the numerous risks and uncertainties associated with developing and commercializing therapeutic drugs, we may experience larger than expected future losses and may not become profitable.

If we fail to obtain and sustain an adequate level of reimbursement for our products by third-party payors, sales would be adversely affected.

The course of treatment for UCD patients is and will continue to be expensive. We currently expect that the average price per patient year for Ravicti will be between $250,000 and $290,000. We expect UCD patients to need treatment throughout their lifetimes. We expect that most families of patients will not be capable of paying for this treatment themselves. There will be no commercially viable market for Ravicti without reimbursement from third-party payors. Even if there is a commercially viable market, if the level of reimbursement is below our expectations, our revenue and gross margins will be adversely affected. In addition, we expect to provide Ravicti at no cost to qualified patients without insurance or without coverage for Ravicti. If the numbers of patients that qualify for these programs is higher than our current estimates, our revenues and gross margins will be adversely affected.

Third-party payors, such as government or private health care insurers, carefully review and increasingly question the coverage of, and challenge the prices charged for, drugs. Reimbursement rates from private health insurance companies vary depending on the company, the insurance plan and other factors. A current trend in the United States health care industry is toward cost containment. Large public and private payors, managed care organizations, group purchasing organizations and similar organizations are exerting increasing influence on decisions regarding the use of, and reimbursement levels for, particular treatments. Such third-party payors, including Medicare, are questioning the coverage of, and challenging the prices charged for, medical products and services, and many third-party payors limit coverage of or reimbursement for newly approved health care products. In particular, third-party payors may limit the covered indications. Cost-control initiatives could decrease the price we might establish for products, which could result in product revenues being lower than anticipated. If the prices for our products decrease or if governmental and other third-party payors do not provide adequate coverage and reimbursement levels, our revenue and prospects for profitability will suffer. Additionally, there may be delays in obtaining appropriate documentation and securing reimbursement coverage from third-party payors, which may also have a significant impact on our revenue and profitability. Reimbursement systems in international markets, including the European Union, vary significantly by country and by region, and reimbursement approvals must be obtained on a country-by-country basis. In many countries the product cannot be commercially launched until reimbursement is approved. The negotiation process in some countries can exceed 12 months.

We are required to complete post-marketing studies mandated by the FDA and such studies may be costly and time consuming. If the results of these studies reveal unacceptable safety risks, we may be required to withdraw Ravicti from the market.

As part of the FDA approval of Ravicti to treat UCD, we made a Phase IV commitment to conduct a long-term (approximately 10 years) outcomes study (or Registry), which is noted on the FDA-approved label; and the FDA imposed several post-marketing requirements. These include obligations to conduct:

 

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two separate studies in UCD patients during the first two months of life and from 2 months to 2 years of age, including a study of the pharmacokinetics in both age groups;

 

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a study to determine whether metabolites are present in human breast milk;

 

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a study to determine whether the metabolites of Ravicti affect the metabolism of other drugs that these patients might be given concurrently; and

 

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a randomized study to determine the safety and efficacy in UCD patients who are naïve to phenylbutyrate treatment being treated with sodium phenylbutyrate.

 

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If we are unable to complete these studies or the results of the studies reveal unacceptable safety risks, we could be required to perform additional studies, which may be costly, and even lose marketing approval of Ravicti. In addition to these studies, the FDA may also require us to commit to perform other lengthy post-marketing studies, for which we would have to expend significant additional resources, which could have an adverse effect on our operating results, financial condition and stock price.

The patient population suffering from UCD is small and has not been established with precision. If the actual number of patients is smaller than we estimate or if we are unable to convert patients from BUPHENYL to Ravicti, our revenue and ability to achieve profitability may be adversely affected.

We estimate that the number of individuals in the United States with UCD is approximately 2,100, of which approximately 1,100 are currently diagnosed and approximately 500 are treated with BUPHENYL. As of Ravicti’s FDA approval on February 1, 2013, 75 UCD patients greater than two years of age were being treated with Ravicti in our ongoing long-term safety clinical trials in the United States. Of these, we estimate that approximately 60% are children and 40% are adults. Our estimate of the size of the patient population is based on published studies as well as internal analyses. If the results of these studies or our analysis of them do not accurately reflect the number of patients with UCD, our assessment of the market may be inaccurate, making it difficult or impossible for us to meet our revenue goals, or to obtain and maintain profitability. In addition, if we are unable to successfully convert patients from BUPHENYL to Ravicti, it will be more difficult to achieve profitability, or profitability may not occur at all.

The number of patients in the United States who might be prescribed Ravicti could be significantly less than the 575 currently estimated to be on either Ravicti or BUPHENYL. Since Ravicti, BUPHENYL and AMMONUL target diseases with small patient populations, the per-patient drug pricing must be high in order to recover our development and manufacturing costs, fund adequate patient support programs and achieve profitability. We may be unable to maintain or obtain sufficient sales volume at a price high enough to justify our product development efforts and our sales and marketing and manufacturing expenses.

To obtain regulatory approval to market Ravicti in indications other than UCD, including HE, costly and lengthy clinical trials may be required, and the results of the studies and trials are highly uncertain.

As part of the regulatory approval process, we must conduct, at our own expense, clinical trials on humans for each indication that we intend to pursue. We expect the number of nonclinical studies and clinical trials that the regulatory authorities will require will vary depending on the disease or condition the drug is being developed to address and regulations applicable to the particular drug. Generally, the number and size of clinical trials required for approval varies based on the nature of the disease and size of the expected patient population that may be treated with a drug, and we are still in discussions with the FDA as to the design of any HE clinical trials. We must demonstrate that our drug products are safe and efficacious for use in the targeted human patients in order to receive regulatory approval for commercial sale.

Serious adverse events or other safety risks could require us to abandon development and preclude or limit approval of Ravicti to treat HE.

We may voluntarily suspend or terminate our clinical trials if at any time we believe that they present an unacceptable risk to participants or if preliminary data demonstrate that the product is unlikely to receive regulatory approval or unlikely to be successfully commercialized. In addition, regulatory agencies, institutional review boards and data safety monitoring boards may at any time order the temporary or permanent discontinuation of our clinical trials or request that we cease using investigators in the clinical trials if they believe that the clinical trials are not being conducted in accordance with applicable regulatory requirements, or that they present an unacceptable safety risk to participants. If we elect or are forced to suspend or terminate a clinical trial of Ravicti to treat HE, the commercial prospects for Ravicti will be harmed and our ability to generate product revenues from Ravicti may be delayed or eliminated.

Our potential purchase of Ucyclyd’s worldwide rights to BUPHENYL and AMMONUL could be hampered or prevented by regulatory action as well as by government or private litigation.

We are subject to antitrust review due to our exercise of our option to purchase Ucyclyd’s worldwide rights for BUPHENYL and AMMONUL on April 29, 2013, including, if the necessary jurisdictional thresholds are met at that time, review under the HSR Act. Even if the planned purchase is approved, the terms and conditions of the approval that is granted, if accepted by the parties, may impose requirements, limitations and additional costs and place restrictions on the conduct of our business. There is no assurance that we will receive the necessary approvals under the HSR Act or that any other conditions, terms, obligations, or restrictions sought to be imposed, if accepted, would not have a material adverse effect on us. If the government challenges the purchase under the HSR Act and the challenge cannot be resolved by consent decree, our restated collaboration agreement with Ucyclyd will automatically terminate and we would not have any rights to BUPHENYL or AMMONUL. In addition, whether or not HSR filings are required to purchase Ucyclyd’s worldwide rights for BUPHENYL and AMMONUL, federal antitrust regulators could, before or after the purchase, take any action under the antitrust laws that they consider necessary or desirable in the public interest, including seeking to

 

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enjoin the purchase or to seek the divestiture of assets or the imposition of licensing obligations on us. Private parties as well as State Attorneys General and foreign antitrust regulators may also bring legal actions under the antitrust laws under some circumstances, the outcome of which could have a material adverse effect on us.

We may never obtain approval for or commercialize Ravicti outside of the United States, which would limit our ability to realize its full market potential.

We only have approval to market Ravicti in the United States at this time. In order to market Ravicti outside of the United States, we must comply with regulatory requirements of and obtain required regulatory approvals in, other countries. Clinical trials conducted in one country may not be accepted by regulatory authorities in other countries, and obtaining regulatory approval in one country does not mean that regulatory approval will be obtained in any other country. Approval processes vary among countries and can involve additional product testing and validation and additional administrative review periods. Seeking foreign regulatory approval could require additional nonclinical studies or clinical trials, which could be costly and time consuming. Regulatory requirements can vary widely from country to country and could delay or prevent the introduction of Ravicti in those countries. We do not have any products approved for sale in any jurisdiction, including international markets, and we do not have experience in obtaining regulatory approval in international markets. If we fail to comply with regulatory requirements in international markets or to obtain and maintain required approvals or if regulatory approvals in international markets are delayed, our target market will be reduced and our ability to realize the full market potential of our products will be harmed.

If we obtain approval to commercialize Ravicti outside of the United States and continue to maintain the existing Ucyclyd distribution agreements for BUPHENYL and AMMONUL outside of the United States, a variety of risks associated with international operations could materially adversely affect our business.

If Ravicti is approved for commercialization outside the United States, we will likely enter into agreements with third parties to market Ravicti outside the United States. In addition, if we purchase Ucyclyd’s worldwide rights to BUPHENYL and AMMONUL, we will assume Ucyclyd’s rights and obligations under its existing agreements for distribution of these drugs outside the United States, including Ucyclyd’s obligation to provide Swedish Orphan AB with a right of first refusal for the distribution of Ravicti and other newly developed products for urea cycle disorders on terms and conditions reasonably satisfactory to us. We expect that we will be subject to additional risks related to entering into or maintaining these international business relationships, including:

 

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different regulatory requirements for drug approvals in foreign countries;

 

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differing United States and foreign drug import and export rules;

 

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reduced protection for intellectual property rights in foreign countries;

 

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unexpected changes in tariffs, trade barriers and regulatory requirements;

 

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different reimbursement systems;

 

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economic weakness, including inflation, or political instability in particular foreign economies and markets;

 

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compliance with tax, employment, immigration and labor laws for employees living or traveling abroad;

 

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foreign taxes, including withholding of payroll taxes;

 

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foreign currency fluctuations, which could result in increased operating expenses and reduced revenues, and other obligations incident to doing business in another country;

 

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workforce uncertainty in countries where labor unrest is more common than in the United States;

 

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production shortages resulting from any events affecting raw material supply or manufacturing capabilities abroad;

 

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potential liability resulting from development work conducted by these distributors; and

 

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business interruptions resulting from geopolitical actions, including war and terrorism, or natural disasters.

Even if we successfully commercialize Ravicti and purchase Ucyclyd’s worldwide rights to BUPHENYL and AMMONUL, we will continue to face extensive development and regulatory requirements.

Even after a drug is FDA-approved, regulatory authorities may still impose significant restrictions on a product’s indicated uses or marketing or impose ongoing requirements for potentially costly post-marketing studies. Furthermore, any new legislation addressing drug safety issues could result in delays or increased costs to assure compliance.

BUPHENYL, AMMONUL and Ravicti are subject to ongoing regulatory requirements for labeling, packaging, storage, advertising, promotion, sampling, record-keeping and submission of safety and other post-market information, including both federal and state requirements in the United States. In addition, manufacturers and manufacturers’ facilities are required to comply with extensive FDA requirements, including ensuring that quality control and manufacturing procedures conform to cGMP. As such, we and our contract manufacturers are subject to continual review and periodic inspections to assess compliance with cGMP. Accordingly, we and others with whom we work must continue to expend time, money and effort in all areas of regulatory compliance, including manufacturing, production and quality control. We will also be required to report certain adverse reactions and production problems, if any, to the FDA, and to comply with requirements concerning advertising and promotion for our products.

 

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Promotional communications with respect to prescription drugs are subject to a variety of legal and regulatory restrictions and must be consistent with the information in the product’s approved label. As such, we may not promote our products for indications or uses for which they do not have FDA approval.

If a regulatory agency discovers previously unknown problems with a product, such as adverse events of unanticipated severity or frequency, or problems with the facility where the product is manufactured, or disagrees with the promotion, marketing, or labeling of a product, a regulatory agency may impose restrictions on that product or us, including requiring withdrawal of the product from the market. If we fail to comply with applicable regulatory requirements, a regulatory agency or enforcement authority may:

 

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issue warning letters;

 

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impose civil or criminal penalties;

 

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suspend regulatory approval;

 

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suspend any of our ongoing clinical trials;

 

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refuse to approve pending applications or supplements to approved applications submitted by us;

 

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impose restrictions on our operations, including closing our contract manufacturers’ facilities; or

 

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seize or detain products or require a product recall.

Any government investigation of alleged violations of law could require us to expend significant time and resources in response and could generate negative publicity. Any failure to comply with ongoing regulatory requirements may significantly and adversely affect our ability to commercialize and generate revenues from Ravicti, and BUPHENYL and AMMONUL if purchased from Ucyclyd. If regulatory sanctions are applied or if regulatory approval is withdrawn, the value of our company and our operating results will be adversely affected. Additionally, if we are unable to generate revenues from the sale of Ravicti, and BUPHENYL and AMMONUL if purchased from Ucyclyd, our potential for achieving profitability will be diminished and the capital necessary to fund our operations will be increased.

If third-party manufacturers fail to comply with manufacturing regulations, our financial results and financial condition will be adversely affected.

Contract manufacturers must obtain and maintain regulatory approval of their manufacturing facilities, processes and quality systems. In addition, pharmaceutical manufacturing facilities are continuously subject to inspection by the FDA and foreign regulatory authorities, before and after product approval. Due to the complexity of the processes used to manufacture pharmaceutical products and product candidates, any potential third-party manufacturer may be unable to continue to pass or initially pass federal, state or international regulatory inspections in a cost effective manner.

If a third-party manufacturer with whom we contract is unable to comply with manufacturing regulations, we may be subject to fines, unanticipated compliance expenses, recall or seizure of our products, total or partial suspension of production and/or enforcement actions, including injunctions, and criminal or civil prosecution. These possible sanctions would adversely affect our financial results and financial condition.

If our competitors are able to develop and market products that are preferred over Ravicti, BUPHENYL or AMMONUL, our commercial opportunity will be reduced or eliminated.

We face competition from established pharmaceutical and biotechnology companies, as well as from academic institutions, government agencies and private and public research institutions, which may in the future develop products to treat UCD or HE. During the lifetime of the United States patents covering Ravicti, and for any longer period of market exclusivity granted by the FDA for Ravicti, Ucyclyd and its affiliates are contractually prohibited from developing or commercializing new products, anywhere in the world, for the treatment of UCD or HE that are chemically similar to Ravicti, except for products delivered parenterally for the treatment of HE. In countries outside the United States, this contractual restriction will continue, on a country-by-basis, for the lifetime of patents covering Ravicti in each such country and for any longer period of regulatory exclusivity granted for Ravicti in each such country. Since this restriction only applies to specific indications and products that are chemically similar to Ravicti, it may not prevent Ucyclyd or its affiliates from developing and commercializing products that compete with Ravicti. Moreover, products approved for indications other than UCD and HE may compete with Ravicti if physicians prescribe such products off-label for UCD or HE. Ucyclyd may develop and commercialize such products and, under the purchase agreement, has a time-limited option to acquire the right to use and reference certain Ravicti data for the development and commercialization of products (other than Ravicti) for the treatment of a specific indication that we are not pursuing. Furthermore, unless and until we purchase Ucyclyd’s worldwide rights to BUPHENYL, Ucyclyd is allowed to continue to market and sell BUPHENYL, and its sales of BUPHENYL will continue to compete with our sales of Ravicti for UCD.

In addition to competition from BUPHENYL, in November 2011, Ampolgen Pharmaceuticals, LLC received FDA approval for a generic version of sodium phenylbutyrate tablets and in March 2013, Sigmapharm Laboratories, LLC received FDA approval for a generic version of sodium phenylbutyrate power both of which may compete with Ravicti and BUPHENYL in treating UCD.

 

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We are aware that Lucane Pharma has requested market authorization from the European Medicines Agency for taste-masked sodium phenylbutyrate and we believe they are also seeking approval via an ANDA in the United States. If this ANDA is approved, this formulation may compete with Ravicti and BUPHENYL in treating UCD. We are also aware that Orphan Europe is conducting a clinical trial of carglumic acid to treat some of the UCD enzyme deficiencies for which Ravicti was approved. Carglumic acid is approved for maintenance therapy for chronic hyperammonemia and to treat HA crises in NAGS deficiency, a rare UCD subtype, and is sold under the name Carbaglu. If the results of this trial are successful and Orphan Europe is able to complete development and obtain approval of Carbaglu to treat additional UCD enzyme deficiencies, we would face competition from this compound. In addition, if we complete development, obtain regulatory approval and commercialize Ravicti to treat HE, we will face competition from Salix Pharmaceuticals, Inc., the manufacturer of rifaximin, as well as generic manufacturers of lactulose. In addition to currently marketed treatments for HE, Ocera has conducted two Phase II trials of one of their compounds to treat mild HE and is conducting a Phase II trial of a second compound delivered intravenously to patients with cirrhosis in which they are assessing ammonia control versus placebo. In addition, researchers are continually learning more about UCD and HE and new discoveries may lead to new therapies. As a result, Ravicti, BUPHENYL and AMMONUL may be rendered less competitive, or even obsolete, at any time. Other early-stage companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies.

Our commercial opportunity will be reduced or eliminated if our competitors develop and commercialize products that are safer, more effective, have fewer side effects, are more convenient or are less expensive than Ravicti and, if acquired, BUPHENYL and AMMONUL. We expect that our ability to compete effectively will depend upon, among other things, our ability to:

 

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successfully and rapidly complete clinical trials and obtain all requisite regulatory approvals in a timely and cost-effective manner;

 

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maintain patent protection for Ravicti and otherwise prevent the introduction of generics of Ravicti and, if acquired, BUPHENYL and AMMONUL;

 

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attract and retain key personnel;

 

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build an adequate sales and marketing infrastructure;

 

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obtain adequate reimbursement from third-party payors; and

 

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maintain positive relationships with patient advocacy groups.

If Ravicti is approved to treat HE in the future, the cost of Ravicti to treat UCD may decline significantly, which could materially affect our UCD revenues.

Given the relative differences in the size of the affected patient populations, the number of requests third-party payors receive to reimburse drugs for the treatment of HE is significantly greater than the number of requests for UCD. As a result, we will likely experience greater pricing pressure if Ravicti is approved by the FDA to treat HE than if it is only approved to treat UCD. We do not currently have a plan to differentiate the formulations for UCD and HE, nor can we guarantee success if we attempt to differentiate the formulation. We expect the required dosing volume to be similar for UCD and HE if Ravicti is approved for both indications. If Ravicti is approved by the FDA for HE after FDA approval and launch of the drug for UCD, we may need to significantly decrease the price for Ravicti from that established with respect to UCD in order to gain third-party reimbursement for broad use in HE patients. This would result in a significant decrease in revenues generated by the UCD patient population. We believe the Ravicti revenue potential for HE is much larger than for UCD; however, if the market for Ravicti in HE is significantly smaller than we anticipate, or if we are unsuccessful in any commercial launch of Ravicti for the treatment of HE, total Ravicti revenues may decrease significantly and we may be unable to achieve or maintain profitability. If the Ravicti price is decreased with the introduction of the drug for HE, we may need to decrease our UCD specialty pharmacy and patient support service offerings. This may result in lower UCD revenues due to fewer UCD patients electing to begin use of Ravicti and/or remain compliant.

If we are unable to maintain an effective direct sales force in the United States, our business may be harmed.

We market Ravicti directly to physicians in the United States through our own sales force. We will need to incur significant additional expenses and commit significant additional management resources to train our sales force to market and sell Ravicti, and BUPHENYL and AMMONUL if we purchase Ucyclyd’s worldwide rights to those products. We may not be able to successfully establish these capabilities despite these additional expenditures. We will also have to compete with other pharmaceutical and life sciences companies to recruit, hire, train and retain sales and marketing personnel. In the event we are unable to successfully market and promote Ravicti, and BUPHENYL and AMMONUL if purchased from Ucyclyd, our business may be harmed.

 

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If we are found to be in violation of federal or state “fraud and abuse” laws, we may be required to pay a penalty and/or be suspended from participation in federal or state health care programs, which may adversely affect our business, financial condition and results of operation.

In the United States, we are subject to various federal and state health care “fraud and abuse” laws, including anti-kickback laws, false claims laws and other laws intended to reduce fraud and abuse in federal and state health care programs. The federal Medicare-Medicaid Anti-Fraud and Abuse Act, as amended (the “Anti-Kickback Statute”), makes it illegal for any person, including a prescription drug manufacturer (or a party acting on its behalf), to knowingly and willfully solicit, receive, offer or pay any remuneration that is intended to induce the referral of business, including the purchase, order or prescription of a particular drug for which payment may be made under a federal health care program, such as Medicare or Medicaid. Under federal government regulations, some arrangements, known as safe harbors, are deemed not to violate the federal Anti-Kickback Statute. Although we seek to structure our business arrangements in compliance with all applicable requirements, these laws are broadly written, and it is often difficult to determine precisely how the law will be applied in specific circumstances. Accordingly, it is possible that our practices may be challenged under the federal Anti-Kickback Statute. False claims laws prohibit anyone from knowingly and willfully presenting or causing to be presented for payment to third-party payors, including government payors, claims for reimbursed drugs or services that are false or fraudulent, claims for items or services that were not provided as claimed, or claims for medically unnecessary items or services. Cases have been brought under false claims laws alleging that off-label promotion of pharmaceutical products or the provision of kickbacks has resulted in the submission of false claims to governmental health care programs. Under the Health Insurance Portability and Accountability Act of 1996, we are prohibited from knowingly and willfully executing a scheme to defraud any health care benefit program, including private payors, or knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement in connection with the delivery of or payment for health care benefits, items or services. Violations of fraud and abuse laws may be punishable by criminal and/or civil sanctions, including fines and/or exclusion or suspension from federal and state health care programs such as Medicare and Medicaid and debarment from contracting with the U.S. government. In addition, private individuals have the ability to bring actions on behalf of the government under the federal False Claims Act as well as under the false claims laws of several states.

Many states have adopted laws similar to the federal anti-kickback statute, some of which apply to the referral of patients for health care services reimbursed by any source, not just governmental payors. In addition, California and a few other states have passed laws that require pharmaceutical companies to comply with the April 2003 Office of Inspector General Compliance Program Guidance for Pharmaceutical Manufacturers and/or the Pharmaceutical Research and Manufacturers of America Code on Interactions with Healthcare Professionals. In addition, several states impose other marketing restrictions or require pharmaceutical companies to make marketing or price disclosures to the state. There are ambiguities as to what is required to comply with these state requirements and if we fail to comply with an applicable state law requirement we could be subject to penalties.

Neither the government nor the courts have provided definitive guidance on the application of fraud and abuse laws to our business. Law enforcement authorities are increasingly focused on enforcing these laws, and it is possible that some of our practices may be challenged under these laws. While we believe we have structured our business arrangements to comply with these laws, it is possible that the government could allege violations of or convict us of violating, these laws. If we are found in violation of one of these laws, we could be required to pay a penalty and could be suspended or excluded from participation in federal or state health care programs, and our business, financial condition and results of operations may be adversely affected.

Recently enacted and future legislation may increase the difficulty and cost for us to obtain marketing approval of and commercialize our product candidates and may affect the prices we may obtain.

In the United States and some foreign jurisdictions, there have been a number of legislative and regulatory changes and proposed changes regarding the healthcare system that could prevent or delay marketing approval of our product candidates, restrict or regulate post-marketing activities and affect our ability to profitably sell our products for which we obtain marketing approval.

In March 2010, President Obama signed into law the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, “PPACA”), a sweeping law intended to broaden access to health insurance, reduce or constrain the growth of healthcare spending, enhance remedies against healthcare fraud and abuse, add new transparency requirements for healthcare and health insurance industries, impose new taxes and fees on the health industry and impose additional health policy reforms. PPACA increased manufacturers’ rebate liability under the Medicaid Drug Rebate Program by increasing the minimum rebate from 15.1% to 23.1% of the AMP for most innovator products and from 11% to 13% for non-innovator products and capped the total rebate amount for innovator drugs at 100% of AMP. In addition, the PPACA and subsequent legislation revised the definition of AMP, which may also increase the amount of Medicaid drug rebates manufacturers are required to pay to states. The legislation also expanded Medicaid drug rebates, which previously had been payable only on fee-for-service utilization, to Medicaid managed care utilization, and created an alternative rebate formula for certain innovator products that qualify as line extensions of certain existing products that is intended to increase the rebates due on those drugs. CMS, which administers the Medicaid Drug Rebate Program, has issued proposed regulations to implement the changes to the Medicaid Drug Rebate program under PPACA and subsequent legislation but has not yet issued final regulations. CMS has proposed to expand Medicaid rebates to the utilization that occurs in the territories of the United States, such as Puerto Rico and the Virgin Islands. Federal law requires that any company that participates in the Medicaid rebate program also participate in the Public Health Service’s 340B drug pricing discount program in order for federal funds to be available for the manufacturer’s drugs under Medicaid and Medicare Part B. Also

 

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effective in 2010, PPACA expanded the types of entities eligible to receive discounted 340B pricing, although, with the exception of children’s hospitals, these newly eligible entities will not be eligible to receive discounted 340B pricing on orphan drugs. In addition, as 340B drug pricing is determined based on AMP and Medicaid rebate data, the revisions to the Medicaid rebate formula and AMP definition described above could cause the required 340B discount to increase. Further, beginning in 2011, PPACA imposed a significant annual branded prescription drug fee on companies that manufacture or import branded prescription drug products and requires manufacturers to provide a 50% discount off the negotiated price of prescriptions filled by beneficiaries in the Medicare Part D coverage gap, referred to as the “donut hole.” Substantial new provisions affecting compliance have also been enacted, which may require us to modify our business practices with healthcare practitioners. For example, beginning in 2013, pharmaceutical companies will be required to track and report to the federal government certain payments made to physicians and teaching hospitals in the preceding year. We will not know the full effects of PPACA until applicable federal and state agencies issue regulations or guidance under the new law. Although it is too early to determine the effect of PPACA, the new law appears likely to continue the downward pressure on pharmaceutical pricing, especially under the Medicaid program, and may also increase our regulatory burdens and operating costs.

Legislative and regulatory proposals have been introduced at both the state and federal level to expand post-approval requirements and restrict sales and promotional activities for pharmaceutical products. We are not sure whether additional legislative changes will be enacted, or whether the FDA regulations, guidance or interpretations will be changed, or what the impact of such changes on the marketing approvals of our product candidates, if any, may be. In addition, increased scrutiny by the United States Congress of the FDA’s approval process may significantly delay or prevent marketing approval, as well as subject us to more stringent product labeling and post-marketing testing and other requirements. Furthermore, the concerns raised by patients, patient advocacy groups and congressional representatives about the recent pricing of orphan drugs, could result in changes to the Orphan Drug Act or limitations in the approval pathway or pricing and reimbursement of orphan drugs.

Risks Related to Our Financial Position and Need for Additional Capital

We currently have a limited source of revenue and may never become profitable.

We are a development stage biopharmaceutical company with a limited operating history. We have generated no revenue in the last three years; however, we have generated product revenue during the first quarter of 2013 due to the FDA approval and commercialization of Ravicti. Our ability to generate product revenue depends on a number of factors, including our ability to:

 

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set an acceptable price for our products;

 

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obtain commercial quantities of our UCD products at acceptable cost levels;

 

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obtain adequate reimbursement from third-party payors;

 

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successfully market and sell our UCD products in the United States;

 

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delay the introduction and impact of generic versions of our UCD products;

 

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maintain our licenses or sublicenses to intellectual property rights to Ravicti; and

 

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maintain existing distribution agreements for BUPHENYL and AMMONUL, if we purchase these products, outside the United States.

In addition, because of the numerous risks and uncertainties associated with product development, we are unable to predict the timing or amount of increased expenses, or when, or if, we will be able to achieve or maintain profitability. We anticipate incurring significant costs associated with the commercial launch of Ravicti, and the acquisition of BUPHENYL and AMMONUL if such acquisition occurs.

Even if we are able to generate revenues from the sale of our products, we may not become profitable and may need to obtain additional funding to continue operations. If we fail to become profitable or are unable to sustain profitability on a continuing basis, then we may be unable to continue our operations at planned levels and be forced to reduce our operations.

We have incurred net losses since inception and anticipate that we will continue to incur net losses for the foreseeable future.

We have incurred losses in each year since our inception on November 1, 2006. Our losses were $9.0 million and $11.9 million during the first quarter of 2013 and 2012, respectively and $32.3 million in fiscal 2012, $29.4 million in fiscal 2011 and $25.5 million in fiscal 2010. As of March 31, 2013, we had a deficit accumulated during the development stage of $148.0 million. We have devoted most of our financial resources to research and development, including our nonclinical development activities and clinical trials. To date, we have financed our operations primarily through the sale of equity securities and debt. Ravicti will require significant marketing efforts and substantial investment before it can provide us with any revenue. We expect our research and development expenses to continue to be significant in connection with our ongoing and planned clinical trials for Ravicti and any other clinical trials or nonclinical testing that we may initiate. In addition, we expect to incur increased sales and marketing expenses. As a result, we expect to continue to incur significant and increasing operating losses and negative cash flows for the foreseeable future. These losses have had and will continue to have an adverse effect on our stockholders’ deficit and working capital.

 

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We may need to obtain additional financing to fund our operations.

We may need to obtain additional financing to fund the Phase III HE trial if the design is materially different from what we currently expect and for the commercial launch of Ravicti in HE if we are approved in this indication. We will likely need to obtain additional financing for development of any additional product candidates we might acquire. Our future funding requirements will depend on many factors, including, but not limited to:

 

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our ability to successfully commercialize Ravicti for the treatment of UCD, and BUPHENYL and AMMONUL if purchased from Ucyclyd;

 

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the amount of sales and other revenues from products that we may commercialize, if any, including the selling prices for such products and the availability of adequate third-party reimbursement;

 

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selling and marketing costs associated with our UCD products, including the cost and timing of expanding our marketing and sales capabilities and establishing a network of specialty pharmacies;

 

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the progress, timing, scope and costs of our nonclinical studies and clinical trials, including the ability to timely enroll patients in our planned and potential future clinical trials;

 

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the time and cost necessary to obtain regulatory approvals and the costs of post-marketing studies that may be required by regulatory authorities;

 

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the costs of obtaining clinical and commercial supplies of Ravicti and BUPHENYL, and AMMONUL if purchased from Ucyclyd;

 

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payments of milestones and royalties to third parties, including Ucyclyd;

 

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cash requirements of any future acquisitions of product candidates;

 

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the time and cost necessary to respond to technological and market developments;

 

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

 

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changes to the design of our clinical trials; and

 

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any changes made to, or new developments in, our restated collaboration agreement with Ucyclyd or any new collaborative, licensing and other commercial relationships that we may establish.

Until we can generate a sufficient amount of revenue, we expect to finance future cash needs through public or private equity offerings or debt financings. Additional funds may not be available when we need them on terms that are acceptable to us, or at all. If adequate funds are not available, we may be required to delay or reduce the scope of or eliminate one or more of our research or development programs or our commercialization efforts. We may seek to access the public or private capital markets whenever conditions are favorable, even if we do not have an immediate need for additional capital at that time. Our inability to obtain additional funding when we need it could seriously harm our business.

We may sell additional equity or debt securities to fund our operations, which may result in dilution to our stockholders and impose restrictions on our business.

In order to raise additional funds to support our operations, we may sell additional equity or debt securities, which would result in dilution to all of our stockholders or impose restrictive covenants that adversely impact our business. The incurrence of indebtedness would result in increased fixed payment obligations and could also result in restrictive covenants, such as limitations on our ability to incur additional debt, limitations on our ability to acquire, sell or license intellectual property rights and other operating restrictions that could adversely impact our ability to conduct our business. If we are unable to expand our operations or otherwise capitalize on our business opportunities, our business, financial condition and results of operations could be materially adversely affected.

Risks Related to Our Reliance on Third Parties

We have no control over Ucyclyd’s conduct of the BUPHENYL and AMMONUL business in the intervening time period.

On April 29, 2013, we exercised our option to acquire BUPHENYL and AMMONUL from Ucyclyd. Until we close the transaction, Ucyclyd has full control over the commercialization of BUPHENYL and AMMONUL and we are entirely dependent on Ucyclyd to preserve the value of the businesses related to these products.

We have no manufacturing capacity and anticipate continued reliance on third-party manufacturers for the development and commercialization of our products.

We do not currently operate manufacturing facilities for clinical or commercial production of Ravicti, BUPHENYL or AMMONUL. We have no experience in drug formulation and we lack the resources and the capabilities to manufacture Ravicti, BUPHENYL or AMMONUL on a clinical or commercial scale. We do not intend to develop facilities for the manufacture of products

 

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for clinical trials or commercial purposes in the foreseeable future. We rely on third-party manufacturers to produce bulk drug substance and drug products required for our clinical trials. We plan to continue to rely upon contract manufacturers and, potentially, collaboration partners, to manufacture commercial quantities of Ravicti, and BUPHENYL and AMMONUL if we purchase these products from Ucyclyd. We have clinical and commercial supplies of Ravicti manufactured for us by two alternate drug substance suppliers, Helsinn and DSM on a purchase order basis. We believe our commercial requirements of drug substance can be satisfied without significant delay or material additional costs. Lyne provides fill/finish services on a purchase order basis under a clinical supply agreement. We have an agreement in place to initiate process transfer and development at HALO, an identified secondary fill/finish supplier. We do not have a long-term commercial supply arrangement in place with any of our contract manufacturers. If we need to identify an additional fill/finish manufacturer, we would not be able to do so without significant delay and likely significant additional cost. We have not secured commercial supply agreements with any contract manufacturers and can give no assurance that we will enter commercial supply agreements with any contract manufacturers on favorable terms or at all.

Our contract manufacturers’ failure to achieve and maintain high manufacturing standards, in accordance with applicable regulatory requirements, or the incidence of manufacturing errors, could result in patient injury or death, product shortages, product recalls or withdrawals, delays or failures in product testing or delivery, cost overruns or other problems that could seriously harm our business. Contract manufacturers often encounter difficulties involving production yields, quality control and quality assurance, as well as shortages of qualified personnel. For example, in the fourth quarter of 2011, we discovered a contaminated lot of Ravicti, which we believe was caused by a failure in a filtration step by one of our third-party drug substance manufacturers. Our existing manufacturers and any future contract manufacturers may not perform as agreed or may not remain in the contract manufacturing business. In the event of a natural disaster, business failure, strike or other difficulty, we may be unable to replace a third-party manufacturer in a timely manner and the production of our UCD products would be interrupted, resulting in delays and additional costs.

In addition, because our contract manufacturers of the bulk drug substance are located outside of the United States, we may face difficulties in importing our UCD products into the United States as a result of, among other things, FDA import inspections, incomplete or inaccurate import documentation or defective packaging.

Some of the intellectual property necessary for the commercialization of our UCD products is or will be licensed from third parties, which will require us to pay milestones and royalties.

Ucyclyd has granted us a license to use some of the technology developed by Ucyclyd in connection with the manufacturing of Ravicti. The purchase agreement under which we purchased the worldwide rights to Ravicti further obligates us to pay Ucyclyd regulatory and sales milestone payments relating to Ravicti, as well as royalties on the net sales of Ravicti. If we purchase BUPHENYL and AMMONUL under the restated collaboration agreement with Ucyclyd, we will also receive a license to use some of the manufacturing technology developed by Ucyclyd in connection with the manufacturing of these products. The restated collaboration agreement will obligate us to pay Ucyclyd regulatory and sales milestone payments, as well as royalties on net sales of these products.

We may become obligated to make a milestone or royalty payments when we do not have the cash on hand to make these payments, or have budgeted cash for our development efforts. This could cause us to delay our development efforts, curtail our operations, scale back our commercialization and marketing efforts or seek additional capital to meet these obligations, which could be on terms unfavorable to us. Additionally, if we fail to make a required payment to Ucyclyd and do not cure the failure with the required time period, Ucyclyd may be able to terminate our license to use its manufacturing technology for our UCD products.

We also license intellectual property necessary for commercialization of Ravicti from Brusilow Enterprises, LLC (“Brusilow”). Brusilow may be entitled to terminate our license if we breach that agreement or do not meet specified diligence obligations in our development and commercialization of Ravicti and do not cure the failure within the required time period. If our license from Brusilow is terminated, it may be difficult or impossible for us to commercialize Ravicti.

Termination of the restated collaboration agreement prior to our purchase of Ucyclyd’s worldwide rights to BUPHENYL and AMMONUL would result in our losing rights to these products.

If the restated collaboration agreement terminates before the closing of our potential purchase of Ucyclyd’s worldwide rights to BUPHENYL and AMMONUL, we would lose our rights to these products and would be unable to generate any revenue from these products. The restated collaboration agreement will automatically terminate if any of the following events occur:

 

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we fail to exercise the option to purchase Ucyclyd’s worldwide rights to BUPHENYL and AMMONUL during the required time period;

 

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after we exercise our option to purchase Ucyclyd’s worldwide rights to BUPHENYL and AMMONUL, we are unable to resolve a challenge to our purchase of Ucyclyd’s worldwide rights to BUPHENYL and AMMONUL from the Federal Trade Commission or Antitrust Division of the Department of Justice; or

 

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after we exercise the option to purchase Ucyclyd’s worldwide rights to BUPHENYL and AMMONUL, we do not consummate the purchase within the required time period.

Any collaboration arrangements that we may enter into in the future may not be successful, which could adversely affect our ability to develop and commercialize our current and potential future product candidates.

We may seek collaboration arrangements with pharmaceutical or biotechnology companies for the development or commercialization of our current and potential future product candidates. We may enter into these arrangements on a selective basis depending on the merits of retaining commercialization rights for ourselves as compared to entering into selective collaboration arrangements with leading pharmaceutical or biotechnology companies for each product candidate, both in the United States and internationally. We will face, to the extent that we decide to enter into collaboration agreements, significant competition in seeking appropriate collaborators. Moreover, collaboration arrangements are complex and time consuming to negotiate, document and implement. We may not be successful in our efforts to establish and implement collaborations or other alternative arrangements should we so chose to enter into such arrangements. The terms of any collaboration or other arrangements that we may establish may not be favorable to us.

Any future collaboration that we enter into may not be successful. The success of our collaboration arrangements will depend heavily on the efforts and activities of our collaborators. Collaborators generally have significant discretion in determining the efforts and resources that they will apply to these collaborations.

Disagreements between parties to a collaboration arrangement regarding clinical development and commercialization matters, can lead to delays in the development process or commercializing the applicable product candidate and, in some cases, termination of the collaboration arrangement. These disagreements can be difficult to resolve if neither of the parties has final decision making authority.

Collaborations with pharmaceutical or biotechnology companies and other third parties often are terminated or allowed to expire by the other party. Any such termination or expiration would adversely affect us financially and could harm our business reputation.

We currently depend on third parties to conduct some of the operations of our clinical trials.

We rely on third parties, such as contract research organizations, medical institutions, clinical investigators and contract laboratories to oversee some of the operations of our clinical trials and to perform data collection and analysis. As a result, we may face additional delays outside of our control if these parties do not perform their obligations in a timely fashion or in accordance with regulatory requirements. If these third parties do not successfully carry out their contractual duties or obligations and meet expected deadlines, if they need to be replaced, or if the quality or accuracy of the clinical data they obtain is compromised due to the failure to adhere to our clinical protocols or for other reasons, our financial results and the commercial prospects for Ravicti or our potential future product candidates could be harmed, our costs could increase and our ability to obtain regulatory approval and commence product sales could be delayed.

Risks Related to Our Intellectual Property

We may not be able to protect our proprietary technology in the marketplace.

Where appropriate, we seek patent protection for certain aspects of our technology. Patent protection may not be available for some of the products or technology we are developing. If we must spend significant time and money protecting or enforcing our patents, designing around patents held by others or licensing, potentially for large fees, patents or other proprietary rights held by others, our business and financial prospects may be harmed. We may not develop additional proprietary products which are patentable.

The patent positions of pharmaceutical products are complex and uncertain. The scope and extent of patent protection for Ravicti and our future products and product candidates are particularly uncertain. Publication of information related to Ravicti and our future products and product candidates may prevent us from obtaining or enforcing patents relating to these products and product candidates, including without limitation composition-of-matter patents, which are generally believed to offer the strongest patent protection.

 

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We have licensed patents in the United States and in certain foreign jurisdictions related to Ravicti, including U.S. Patent 5,968,979, which covers the composition of matter of Ravicti, which we license from Brusilow. Our Brusilow license may be terminated if we do not comply with the terms of the applicable license. Patents that we own or license do not ensure the protection of our intellectual property for a number of reasons, including without limitation the following:

 

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our patents may not be broad or strong enough to prevent competition from other products including identical or similar products;

 

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U.S. Patent 5,968,979 covering Ravicti composition of matter expires February 7, 2015, unless its term is successfully extended;

 

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upon expiration of U.S. Patent 5,968,979, we do not at this time own or control a granted U.S. Patent that prevents generic entry into the United States market for Ravicti;

 

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we may be required to disclaim part of the term of one or more patents;

 

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there may be prior art of which we are not aware that may affect the validity or enforceability of a patent claim;

 

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there may be prior art of which we are aware, which we do not believe affects the validity or enforceability of a patent claim, but which, nonetheless ultimately may be found to affect the validity or enforceability of a patent claim;

 

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there may be other patents existing in the patent landscape for Ravicti that will affect our freedom to operate;

 

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if our patents are challenged, a court could determine that they are not valid or enforceable;

 

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a court could determine that a competitor’s technology or product does not infringe our patents; and

 

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our patents could irretrievably lapse due to failure to pay fees or otherwise comply with regulations, or could be subject to compulsory licensing.

We also own several pending patent applications in the United States and in foreign jurisdictions relating to methods of using, administering, and adjusting the dosage of Ravicti. These applications do not ensure the protection of our intellectual property. Additionally, these pending applications may not issue or may issue with claims significantly narrower than we currently seek. Similarly, our patent for which claims have been allowed may be successfully challenged and invalidated. Unless and until our pending applications issue, their protective scope is impossible to determine, and even after issuance their protective scope may be limited. For example, we may not have developed a method for determining dosing for Ravicti before others developed identical, similar methods or distinct methods, in which case we may not receive a granted patent or any granted patent may not cover potential competition.

If we encounter delays in our development or clinical trials, the period of time during which we could market our products under patent protection would be reduced.

Additional competitors could enter the market, including with generic versions of our products, and sales of affected products may decline materially.

The Ravicti composition of matter patent expires in the United States in 2015. Based on current projections, we expect to receive an extension of this patent under the Drug Price Competition and Patent Term Restoration Act, or Hatch-Waxman Amendments, which we expect to extend this patent coverage for approximately an additional three years.

We own a first set of pending patent applications in the United States, Europe, Japan, and Canada, and a second set of pending patent applications in the United States and internationally pursuant to the Patent Cooperation Treaty (“PCT”). These applications are directed to methods of using, administering, and adjusting the effective dosage of Ravicti. If granted, these applications could extend patent protection until 2029 to 2032; however, there is a significant risk that these applications will not issue timely, or that they may not issue at all. In particular, claims directed to dosing and dose adjustment may be substantially less likely to issue in light of the recent Supreme Court decision in Mayo Collaborative Services v. Prometheus Laboratories, Inc. Further, any patents issuing from these applications could be vulnerable to future validity challenges based on Mayo and subsequent court decisions that further clarify the scope of Mayo. In Mayo, the Court held that claims directed to methods of determining whether to adjust drug dosing levels based on drug metabolite levels in the blood were not patent eligible because they were directed to a law of nature. This decision may have wide-ranging implications on the validity and scope of pharmaceutical method claims, although its full impact will not be known for many years. We own one patent application for which it has been advised by the USPTO that claims are allowed. Assuming that these patent issues, it may be subject to challenge by competitors and invalidated.

Ravicti holds orphan drug exclusivity for UCD until February 2020.

Under the Hatch-Waxman Act, a pharmaceutical manufacturer may file an abbreviated new drug application, (“ANDA”), seeking approval of a generic copy of an approved innovator product. Under the Hatch-Waxman Act, a manufacturer may also submit an NDA under section 505(b)(2) that references the FDA’s prior approval of the innovator product. A 505(b)(2) NDA product may be for a new or improved version of the original innovator product. Hatch-Waxman also provides for certain periods of regulatory exclusivity, which preclude FDA approval (or in some circumstances, FDA filing and reviewing) of an ANDA or 505(b)(2) NDA. These include, subject to certain exceptions, the period during which an FDA-approved drug is subject to orphan drug exclusivity. In addition to the benefits of regulatory exclusivity, an innovator NDA holder may have patents claiming the active ingredient, product formulation or an approved use of the drug, which would be listed with the product in the FDA publication, “Approved Drug Products with Therapeutic Equivalence Evaluations,” known as the “Orange Book.” If there are patents listed in the Orange Book, a generic or

 

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505(b)(2) applicant that seeks to market its product before expiration of the patents must include in the ANDA what is known as a “Paragraph IV certification,” challenging the validity or enforceability of, or claiming non-infringement of, the listed patent or patents. Notice of the certification must be given to the innovator, too, and if within 45 days of receiving notice the innovator sues to protect its patents, approval of the ANDA is stayed for 30 months, or as lengthened or shortened by the court.

We anticipate that Ravicti will qualify for a three-year period of exclusivity, based on the fact that data from clinical trials with the product will be necessary to obtain approval. That exclusivity would mean that, even in the absence of any patent protection, FDA could not grant final approval to an ANDA for a generic version of Ravicti until three years after approval of Ravicti. It would not delay a generic competitor submitting an ANDA, or the FDA reviewing it, or granting it “tentative approval.” The exclusivity would also prohibit FDA from approving a 505(b)(2) NDA that references FDA’s approval of Ravicti or includes the same active ingredient and uses as Ravicti.

Accordingly, competitors could file ANDAs for generic versions of Ravicti, or 505(b)(2) NDAs that reference Ravicti, immediately after approval of an NDA for Ravicti, and if there are patents listed for Ravicti in the Orange Book, those ANDAs and 505(b)(2) NDAs would be required to include a certification as to each listed patent indicating whether the ANDA applicant does or does not intend to challenge the patent. We cannot predict whether Ravicti will be granted any regulatory exclusivity, or the scope of that exclusivity. We also cannot predict whether any patents issuing from our pending patent applications will be eligible for listing in the Orange Book, how any generic competitor would address such patents, whether we would sue on any such patents, or the outcome of any such suit.

The composition of matter patent and orphan drug exclusivity for BUPHENYL have expired. Because BUPHENYL has no regulatory exclusivity or listed patents, a competitor could at any time submit an ANDA for a generic version of BUPHENYL and request immediate approval. We are aware of one ANDA for sodium phenylbutyrate tablets, which was approved in the fourth quarter of 2011 and one for sodium phenylbutyrate powder which was approved in the first quarter of 2013. The ANDA process is a confidential one, so there may be other BUPHENYL ANDAs pending.

We own a first set of patent applications in the United States, Europe, Japan, and Canada and a second set of patent applications in the United States and internationally pursuant to the PCT. The applications are directed to methods of using, administering, and adjusting the dosage of Ravicti or BUPHENYL. If granted, these applications could extend patent protection until 2029 to 2032; however, there is a significant risk that these applications will not issue timely, or that they may not issue at all. In particular, claims directed to dosing and dose adjustment may be substantially less likely to issue in light of the recent Supreme Court decision in Mayo. Further, any patents issuing from these applications could be vulnerable to future validity challenges based on Mayo and subsequent court decisions that further clarify the scope of Mayo. This decision may have wide-ranging implications on the validity and scope of pharmaceutical method claims, although its full impact will not be known for many years. Moreover, even if granted these applications may not provide protection sufficient to protect against the use of generic forms of BUPHENYL.

In the absence of any additional patent protection or even if U.S. Patents issued from our pending patent applications, a competitor may seek and obtain FDA approval for, and subsequently sell, a generic version of BUPHENYL. For example, in November 2011, FDA approved a generic version of BUPHENYL tablets. Such a generic product may be priced at a discount to BUPHENYL and Ravicti, and physicians, patients, or payors may decide that this less expensive alternative is preferable to either of our drugs. If this occurs, our UCD product sales could be materially reduced, but we would nevertheless be required to make royalty payments to Ucyclyd and Brusilow at the same royalty rates.

Although AMMONUL also has no patents listed in the Orange Book, it was the subject of orphan drug exclusivity that expired in February 2012, which means that the FDA can approve a generic version of AMMONUL at any time.

We may not be successful in securing or maintaining proprietary patent protection for products we currently market or for products and technologies we develop or license. Moreover, if any patents that are granted and listed in the Orange Book are successfully challenged by way of a Paragraph IV certification and subsequent litigation, the affected product could more immediately face generic competition and its sales would likely decline materially. Should sales decline, we may have to write off a portion or all of the intangible assets associated with the affected product and our results of operations and cash flows could be materially and adversely affected.

We may not be able to enforce our intellectual property rights throughout the world.

The laws of some foreign countries do not protect intellectual property rights to the same extent as the laws of the United States. Many companies have encountered significant problems in protecting and defending intellectual property rights in certain foreign jurisdictions. The legal systems of some countries, particularly developing countries, do not favor the enforcement of patents and other intellectual property protection, especially those relating to life sciences. This could make it difficult for us to stop the infringement of our in-licensed patents or the misappropriation of our other intellectual property rights. For example, many foreign countries have compulsory licensing laws under which a patent owner must grant licenses to third parties. In addition, many countries limit the enforceability of patents against third parties, including government agencies or government contractors. In these countries, patents may provide limited or no benefit.

 

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Proceedings to enforce our patent rights in foreign jurisdictions could result in substantial costs and divert our efforts and attention from other aspects of our business. Accordingly, our efforts to protect our intellectual property rights in such countries may be inadequate. In addition, changes in the law and legal decisions by courts in the United States and foreign countries may affect our ability to obtain adequate protection for our technology and the enforcement of intellectual property.

We may infringe the intellectual property rights of others, which may prevent or delay our product development efforts and stop us from commercializing or increase the costs of commercializing our products.

Our commercial success depends significantly on our ability to operate without infringing the patents and other intellectual property rights of third parties. For example, there could be issued patents of which we are not aware that our products infringe. There also could be patents that we believe we do not infringe, but that we may ultimately be found to infringe. Moreover, patent applications are in some cases maintained in secrecy until patents are issued. The publication of discoveries in the scientific or patent literature frequently occurs substantially later than the date on which the underlying discoveries were made and patent applications were filed. Because patents can take many years to issue, there may be currently pending applications of which we are unaware that may later result in issued patents that our products infringe. For example, pending applications may exist that provide support or can be amended to provide support for a claim that results in an issued patent that our product infringes.

Third parties may assert that we are employing their proprietary technology without authorization. If a court held that any third-party patents are valid, enforceable and cover our products or their use, the holders of any of these patents may be able to block our ability to commercialize our products unless we obtained a license under the applicable patents, or until the patents expire. We may not be able to enter into licensing arrangements or make other arrangements at a reasonable cost or on reasonable terms. Any inability to secure licenses or alternative technology could result in delays in the introduction of our products or lead to prohibition of the manufacture or sale of products by us.

We may be unable to adequately prevent disclosure of trade secrets and other proprietary information.

We rely on trade secrets to protect our proprietary know-how and technological advances, especially where we do not believe patent protection is appropriate or obtainable. However, trade secrets are difficult to protect. We rely in part on confidentiality agreements with our employees, consultants, outside scientific collaborators, sponsored researchers and other advisors to protect our trade secrets and other proprietary information. These agreements may not effectively prevent disclosure of confidential information and may not provide an adequate remedy in the event of unauthorized disclosure of confidential information. In addition, others may independently discover our trade secrets and proprietary information. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights. Failure to obtain or maintain trade secret protection could enable competitors to use our proprietary information to develop products that compete with our products or cause additional, material adverse effects upon our competitive business position.

Any lawsuits relating to infringement of intellectual property rights necessary to defend ourselves or enforce our rights will be costly and time consuming.

Our ability to defend our intellectual property may require us to initiate litigation to enforce our rights or defend our activities in response to alleged infringement of a third party. In addition, we may be sued by others who hold intellectual property rights who claim that their issued patents are infringed by Ravicti or any future products, including BUPHENYL or AMMONUL, or product candidates. These lawsuits can be very time consuming and costly. There is a substantial amount of litigation involving patent and other intellectual property rights in the biotechnology and pharmaceutical industries generally.

In addition, our patents and patent applications, or those of our licensors, could face other challenges, such as interference proceedings, opposition proceedings, and re-examination proceedings. Any of these challenges, if successful, could result in the invalidation of, or in a narrowing of the scope of, any of our patents and patent applications subject to challenge. Any of these challenges, regardless of their success, would likely be time consuming and expensive to defend and resolve and would divert our management’s time and attention.

Recent patent reform legislation could increase the uncertainties and costs surrounding the prosecution of our patent applications and the enforcement or defense of our issued patents.

On September 16, 2011, the Leahy-Smith America Invents Act (the “Leahy-Smith Act”), was signed into law. The Leahy-Smith Act includes a number of significant changes to United States patent law. These include provisions that affect the way patent applications will be prosecuted and may also affect patent litigation. The USPTO is currently developing regulations and procedures

 

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to govern administration of the Leahy-Smith Act, and many of the substantive changes to patent law associated with the Leahy-Smith Act, and in particular, the first to file provisions, will not become effective until 18 months after its enactment. Accordingly, it is not clear what, if any, impact the Leahy-Smith Act will have on the operation of our business. However, the Leahy-Smith Act and its implementation could increase the uncertainties and costs surrounding the prosecution of our patent applications and the enforcement or defense of our issued patents, all of which could have a material adverse effect on our business and financial condition.

Risks Related to Our Business Operations and Industry

We depend upon our key personnel and our ability to attract and retain employees.

Our future growth and success depend on our ability to recruit, retain, manage and motivate our employees. The loss of the services of any member of our senior management or the inability to hire or retain experienced management personnel could adversely affect our ability to execute our business plan and harm our operating results.

Because of the specialized scientific and managerial nature of our business, we rely heavily on our ability to attract and retain qualified scientific, technical and managerial personnel. In particular, the loss of one or more of our senior executive officers could be detrimental to us if we cannot recruit suitable replacements in a timely manner. We do not currently carry “key person” insurance on the lives of members of senior management. The competition for qualified personnel in the pharmaceutical field is intense. Due to this intense competition, we may be unable to continue to attract and retain qualified personnel necessary for the development of our business or to recruit suitable replacement personnel.

Failure to build our financial infrastructure and improve our accounting systems and controls could impair our ability to comply with the financial reporting and internal controls requirements for publicly traded companies.

As a public company, we operate in an increasingly challenging regulatory environment which requires us to comply with the Sarbanes-Oxley Act of 2002, as amended (the “Sarbanes-Oxley Act”), and the related rules and regulations of the SEC expanded disclosures, accelerated reporting requirements and more complex accounting rules. Company responsibilities required by the Sarbanes-Oxley Act include establishing corporate oversight and adequate internal control over financial reporting and disclosure controls and procedures. Effective internal controls are necessary for us to produce reliable financial reports and are important to help prevent financial fraud. We are required to disclose material changes made in our internal controls and procedures on a quarterly basis. However, our independent registered public accounting firm will not be required to attest to the effectiveness of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act until the later of the year following our first annual report required to be filed with the SEC or the date we are no longer an “emerging growth company” as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), because we are taking advantage of the exemptions contained in the JOBS Act.

To build this infrastructure, we will need to hire additional accounting personnel and improve our accounting systems, disclosure policies, procedures and controls. We are currently in the process of:

 

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initiating our plans to upgrade our computer systems, including hardware and software;

 

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establishing written policies and procedures; and

 

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enhancing internal controls and our financial statement review process.

If we are unsuccessful in building an appropriate financial infrastructure, we may not be able to prepare and disclose, in a timely manner, our financial statements and other required disclosures, or comply with existing or new reporting requirements. If we cannot provide reliable financial reports or prevent fraud, our business and results of operations could be harmed and investors could lose confidence in our reported financial information.

Forecasting sales of Ravicti, and BUPHENYL or AMMONUL if purchased from Ucyclyd, may be difficult and revenue recognition may be deferred. If our revenue projections are inaccurate or revenue is deferred and our business forecasting and planning decisions are not reflected in our actual results, our business may be harmed and our future prospects may be adversely affected.

Our management must make forecasting decisions regarding future revenue in the course of business planning despite this uncertainty, and actual results of operations may deviate materially from projected results. This may lead to inefficiencies and increased difficulties in operational planning. If our revenues from Ravicti sales are lower than we anticipate or revenue is deferred, we will incur costs in the short term that will result in losses that are unavoidable. A shortfall in our revenue would have a direct impact on our cash flow and on our business generally. In addition, fluctuations in our quarterly results can adversely and significantly affect the market price of our common stock.

 

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There are inherent uncertainties involved in the estimates, judgments and assumptions used in the preparation of our financial statements, and any changes in those estimates, judgments and assumptions could have a material adverse effect on our financial condition and results of operations.

The consolidated financial statements that we file with the SEC are prepared in accordance with U.S. GAAP. The preparation of financial statements in accordance with U.S. GAAP involves making estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent assets and liabilities. A summary of our significant accounting practices is included in Note 2—“Summary of Significant Accounting Policies” of the notes to unaudited condensed consolidated financial statements included in this report. We periodically evaluate estimates used in the preparation of the consolidated financial statements for reasonableness, including estimates provided by third parties. Appropriate adjustments to the estimates will be made prospectively, as necessary, based on such periodic evaluations. We base our estimates on, among other things, currently available information, market conditions, historical experience and various assumptions, which together form the basis of making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Although we believe that our assumptions are reasonable under the circumstances, estimates would differ if different assumptions were utilized and these estimates may prove in the future to have been inaccurate.

Our financial results depend on management’s selection of accounting methods and certain assumptions and estimates.

Our accounting policies and methods are fundamental to how we record and report our financial condition and results of operations. Our management must exercise judgment in selecting and applying many of these accounting policies and methods so they comply with generally accepted accounting principles and reflect management’s judgment of the most appropriate manner to report our financial condition and results. In some cases, management must select the accounting policy or method to apply from two or more alternatives, any of which may be reasonable under the circumstances, yet may result in our reporting materially different results than would have been reported under a different alternative.

Certain accounting policies are critical to presenting our financial condition and results. The preparation of our financial statements require us to make significant estimates, assumptions and judgments that affect the amounts of assets, liabilities, revenues and expenses and related disclosures. Significant estimates made by us include assumptions used in the determination of revenue recognition and the calculation of reserves, the fair value of marketable securities, revenue from the collaboration agreement, multiple element arrangements, fair value measurement of tangible and intangible assets and liabilities, goodwill and other intangible assets, fair value of convertible senior notes, research and development expenses, stock-based compensation and the provision for income taxes. Although we base our estimates and judgments on historical experience, our interpretation of existing accounting literature and on various other assumptions that we believe to be reasonable under the circumstances, if our interpretation or application of existing accounting literature is deemed to be materially incorrect, actual results may differ materially from these estimates.

A failure to maintain optimal inventory levels to meet commercial demand for our products could harm our reputation and subject us to financial losses.

Because accurate product planning is necessary to ensure that we maintain optimal inventory levels, significant differences between our current estimates and judgments and future estimated demand for our products and the useful life of inventory may result in significant charges for excess inventory or purchase commitments in the future. If we are required to recognize charges for excess inventories, such charges could have a material adverse effect on our financial condition and results of operations. Our ability to maintain optimal inventory levels also depends on the performance of third-party contract manufacturers. If our manufacturers are unsuccessful in obtaining raw materials and manufacture, if we are unable to release inventory on a timely and consistent basis, if we fail to maintain an adequate level of product inventory, if inventory is destroyed or damaged, or if our inventory reaches its expiration date, patients might not have access to our products, our reputation and brands could be harmed, and physicians may be less likely to recommend our products in the future, each of which could have a material adverse effect on our business, financial condition, results of operations, and cash flows.

 

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We will need to significantly increase the size of our organization, and we may experience difficulties in managing growth.

We are a small company with 38 employees as of March 31, 2013. In order to commercialize our products, we will need to substantially increase our operations, including expanding our employee base of managerial, operational and financial personnel. Future growth will impose significant added responsibilities on members of management, including the need to identify, recruit, maintain and integrate additional employees. Our future financial performance and our ability to commercialize our products and to compete effectively will depend, in part, on our ability to manage any future growth effectively. To that end, we must be able to:

 

•

manage our clinical trials and the regulatory process effectively;

 

•

manage the manufacturing of products for commercial and clinical use;

 

•

integrate current and additional management, administrative, financial and sales and marketing personnel;

 

•

hire new personnel necessary to effectively commercialize product candidates we license;

 

•

develop our administrative, accounting and management information systems and controls; and

 

•

hire and train additional qualified personnel.

Product candidates that we may acquire in the future may be intended for patient populations that are significantly larger than those for UCD and HE. In order to continue development and marketing of these products, if approved, we would need to significantly expand our operations. Our staff, financial resources, systems, procedures or controls may be inadequate to support our operations and our management may be unable to manage successfully future market opportunities or our relationships with customers and other third parties.

If we engage in acquisitions, we will incur a variety of costs and we may never realize the anticipated benefits of such acquisitions.

We may attempt to acquire businesses, technologies, services, products or product candidates that we believe are a strategic fit with our business. We have no present agreement regarding any material acquisitions other than the restated collaboration agreement, under which we have an option to purchase Ucyclyd’s worldwide rights to BUPHENYL and AMMONUL. However, if we do undertake any acquisitions, the process of integrating an acquired business, technology, service, products or product candidates into our business may result in unforeseen operating difficulties and expenditures, including diversion of resources and management’s attention from our core business. In addition, we may fail to retain key executives and employees of the companies we acquire, which may reduce the value of the acquisition or give rise to additional integration costs. Future acquisitions could result in additional issuances of equity securities that would dilute the ownership of existing stockholders. Future acquisitions could also result in the incurrence of debt, contingent liabilities or the amortization of expenses related to other intangible assets, any of which could adversely affect our operating results. In addition, we may fail to realize the anticipated benefits of any acquisition.

If we acquire additional products, including BUPHENYL and AMMONUL, or technologies, we will incur a variety of costs, may have integration difficulties and may experience numerous other risks that could adversely affect our business.

To remain competitive, we may decide to acquire additional products or technologies. On April 29, 2013, we exercised our option to acquire BUPHENYL and AMMONUL from Ucyclyd. Unless Ucyclyd elects to retain AMMONUL, we will owe Ucyclyd $22.0 million for these two products. We have no experience in successfully acquiring and integrating products into our current infrastructure. We may not be able to successfully integrate BUPHENYL and AMMONUL, if Ucyclyd does not elect to retain it, without a significant expenditure of operating, financial and management resources, if at all. Furthermore, sales of BUPHENYL and AMMONUL may not generate sufficient revenue to offset the costs of acquisition. In addition, other acquisitions of products or technologies could require significant capital infusions and could involve many risks, including, but not limited to the following:

 

•

an acquisition may negatively impact our results of operations because it may require us to incur large one-time charges to earnings, amortize or write down amounts related to goodwill and other intangible assets, or incur or assume substantial debt or liabilities, or it may cause adverse tax consequences or substantial depreciation;

 

•

we may encounter difficulties in assimilating and integrating the technologies or products that we acquire;

 

•

acquisitions may require significant capital infusions and the acquired products or technologies may not generate sufficient revenue to offset acquisition costs;

 

•

an acquisition may disrupt our ongoing business, divert resources, increase our expenses and distract our management; and

 

•

acquisitions may involve the entry into a geographic or business market in which we have little or no prior experience.

Any of the foregoing risks could have a significant adverse effect on our business, financial condition and results of operations

Our business is affected by macroeconomic conditions.

Various macroeconomic factors could adversely affect our business and the results of our operations and financial condition, including changes in inflation, interest rates and foreign currency exchange rates and overall economic conditions and uncertainties, including those resulting from the current and future conditions in the global financial markets. For instance, if inflation or other factors were to significantly increase our business costs, it may not be feasible to pass through price increases to patients. Interest rates, the liquidity of the credit markets and the volatility of the capital markets could also affect the value of our investments and our ability to liquidate our investments in order to fund our operations.

Interest rates and the ability to access credit markets could also adversely affect the ability of patients and distributors to purchase, pay for and effectively distribute our products. Similarly, these macroeconomic factors could affect the ability of our contract manufacturers, sole-source or single-source suppliers to remain in business or otherwise manufacture or supply product. Failure by any of them to remain a going concern could affect our ability to manufacture products.

 

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If product liability lawsuits are successfully brought against us, we will incur substantial liabilities and may be required to limit the commercialization of Ravicti or other products.

We face potential product liability exposure related to marketing and distributing our products commercially as well as testing of our product candidates in human clinical trials. An individual may bring a liability claim against us alleging that one of our products or product candidates caused an injury. If we cannot successfully defend ourselves against product liability claims, we will incur substantial liabilities. Regardless of merit or eventual outcome, liability claims may result in:

 

•

decreased demand for our products;

 

•

injury to our reputation;

 

•

withdrawal of clinical trial participants;

 

•

costs of related litigation;

 

•

substantial monetary awards to patients and others;

 

•

loss of revenues; and

 

•

the inability to commercialize our products.

In addition, while we continue to take what we believe are appropriate precautions, we may be unable to avoid significant liability if any product liability lawsuit is brought against us.

If product liability lawsuits are successfully brought against us, our insurance may be inadequate.

We are exposed to the potential product liability risks inherent in the testing, manufacturing and marketing of human pharmaceuticals. We plan to maintain insurance against product liability lawsuits for commercial sale of Ravicti, and for BUPHENYL and AMMONUL if we purchase Ucyclyd’s worldwide rights to those products. We currently maintain insurance for the clinical trials and commercial sale of Ravicti. Biopharmaceutical companies must balance the cost of insurance with the level of coverage based on estimates of potential liability. Historically, the potential liability associated with product liability lawsuits for pharmaceutical products has been unpredictable. Although we believe that our current insurance is a reasonable estimate of our potential liability and represents a commercially reasonable balancing of the level of coverage as compared to the cost of the insurance, we may be subject to claims for which our insurance coverage may not be adequate. If we are the subject of a successful product liability claim that exceeds the limits of any insurance coverage we obtain, we may incur substantial charges that would adversely affect our earnings and require the commitment of capital resources that might otherwise be available for the development and commercial launch of our product programs.

Business interruptions could delay us in the process of developing our products and could disrupt our sales.

Our headquarters is located in the San Francisco Bay Area, near known earthquake fault zones and is vulnerable to significant damage from earthquakes. We are also vulnerable to other types of natural disasters and other events that could disrupt our operations. We do not carry insurance for earthquakes or other natural disasters and we may not carry sufficient business interruption insurance to compensate us for losses that may occur. Any losses or damages we incur could have a material adverse effect on our business operations.

Risks Related to Ownership of Our Common Stock

The market price of our common stock has been and will likely continue to be highly volatile.

The trading price of our common stock has been and is likely to continue to be volatile. Our closing stock price as reported on the NASDAQ Global Stock Market has ranged from $10.04 to $26.26, through May 8, 2013. The following factors, in addition to other risk factors described in this section, may have a significant impact on the market price of our common stock:

 

•

any associated delays or difficulties in completing the purchase of Ucyclyd’s worldwide rights to BUPHENYL and AMMONUL or otherwise acquiring such rights, including as a result of antitrust review of the transaction;

 

•

announcements of therapeutic innovations or new products by us or our competitors;

 

•

adverse actions taken by regulatory agencies with respect to our clinical trials, manufacturing supply chain or sales and marketing activities;

 

•

changes or developments in laws or regulations applicable to Ravicti and the products that we may acquire under our restated collaboration agreement with Ucyclyd;

 

•

any adverse changes to our relationship with Ucyclyd or other licensors, manufacturers or suppliers;

 

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•

the success of our testing and clinical trials;

 

•

the success of our efforts to acquire or license additional product candidates;

 

•

any intellectual property infringement actions in which we may become involved;

 

•

announcements concerning our competitors or the pharmaceutical industry in general;

 

•

achievement of expected product sales and profitability;

 

•

manufacture, supply or distribution shortages;

 

•

actual or anticipated fluctuations in our operating results;

 

•

changes in financial estimates or recommendations by securities analysts;

 

•

trading volume of our common stock;

 

•

sales of our common stock by us, our executive officers and directors or our stockholders in the future;

 

•

general economic and market conditions and overall fluctuations in the United States equity markets;

 

•

changes in accounting principles; and

 

•

the loss of any of our key scientific or management personnel.

In addition, the stock market in general, and The NASDAQ Stock Market in particular, have experienced extreme price and volume fluctuations that have often been unrelated or disproportionate to the operating performance of these companies. Broad market and industry factors may negatively affect the market price of our common stock, regardless of our actual operating performance. Further, the current decline in the financial markets and related factors beyond our control, including the credit and mortgage crisis in the United States and worldwide, may cause our stock price to decline rapidly and unexpectedly.

We may be subject to securities litigation, which is expensive and could divert management attention.

Our share price may be volatile, and in the past companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation. We may be the target of this type of litigation in the future. Litigation of this type could result in substantial costs and diversion of management’s attention and resources, which could seriously hurt our business. Any adverse determination in litigation could also subject us to significant liabilities.

Our principal stockholders, executive officers and directors own a significant percentage of our common stock and will be able to exert a significant control over matters submitted to our stockholders for approval.

Our officers and directors, and stockholders who own more than 5% of our outstanding common stock, own approximately 60.2% of our common stock. This significant concentration of share ownership may adversely affect the trading price for our common stock because investors often perceive disadvantages in owning stock in companies with controlling stockholders. As a result, these stockholders, if they acted together, could significantly influence all matters requiring approval by our stockholders, including the election of directors and the approval of mergers or other business combination transactions. The interests of these stockholders may not always coincide with our interests or the interests of other stockholders.

Sales of a substantial number of shares of our common stock in the public market by our existing stockholders could cause our stock price to fall.

Sales of a substantial number of shares of our common stock in the public market or the perception that these sales might occur, could depress the market price of our common stock. We are unable to predict the effect that sales may have on the prevailing market price of our common stock.

Some of the holders of our securities are entitled to rights with respect to the registration of their shares under the Securities Act of 1933, as amended (the “Securities Act”). Registration of these shares under the Securities Act would result in the shares becoming freely tradable without restriction under the Securities Act, except for shares held by our affiliates as defined in Rule 144 under the Securities Act. Any sales of securities by these stockholders could have a material adverse effect on the trading price of our common stock.

If securities or industry analysts do not publish or cease publishing research or reports about us, our business or our market, or if they adversely change their recommendations or publish negative reports regarding our business or our stock, our stock price and trading volume could decline.

The trading market for our common stock will be influenced by the research and reports that industry or securities analysts may publish about us, our business, our market or our competitors. We do not have any control over these analysts and we cannot provide any assurance that analysts will cover us or provide favorable coverage. If any of the analysts who may cover us adversely change their recommendation regarding our stock, or provide more favorable relative recommendations about our competitors, our stock price would likely decline. If any analyst who may cover us were to cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.

 

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Because we do not intend to declare cash dividends on our shares of common stock in the foreseeable future, stockholders must rely on appreciation of the value of our common stock for any return on their investment.

We have never declared or paid cash dividends on our common stock. We currently anticipate that we will retain future earnings for the development, operation and expansion of our business and do not anticipate declaring or paying any cash dividends in the foreseeable future. As a result, only appreciation of the price of our common stock, if any, will provide a return to investors.

Our ability to use our net operating loss carryforwards may be limited.

As of December 31, 2012, we had net operating losses of approximately $96.4 million and $117.5 million for both U.S. federal and California income tax purposes, respectively, which begin to expire in 2026 for U.S. federal income tax purposes and 2016 for California income tax purposes. If we experience an “ownership change” for purposes Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”), we may be subject to annual limits on our ability to utilize net operating loss carryforwards. An ownership change is, as a general matter, triggered by sales or acquisitions of our stock in excess of 50% on a cumulative basis during a three-year period by persons owning 5% or more of our total equity value. We are not currently subject to any annual limits on our ability to utilize net operating loss carryforwards. Our deferred tax assets have been fully offset by a valuation allowance as of December 31, 2012.

The requirements associated with being a public company require significant company resources and management attention.

We are subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act, the listing requirements of the securities exchange on which our common stock is traded, and other applicable securities rules and regulations. The Exchange Act requires that we file annual, quarterly and current reports with respect to our business and financial condition and maintain effective disclosure controls and procedures and internal control over financial reporting. In addition, subsequent rules implemented by the SEC, and The NASDAQ Stock Market may also impose various additional requirements on public companies. As a result, we will incur additional legal, accounting and other expenses that we did not incur as a nonpublic company, particularly after we are no longer an “emerging growth company” as defined in the JOBS Act. Further, the need to establish the corporate infrastructure demanded of a public company may divert management’s attention from implementing our growth strategy. We have made, and will continue to make, changes to our corporate governance standards, disclosure controls and financial reporting and accounting systems to meet our reporting obligations. However, the measures we take may not be sufficient to satisfy our obligations as a public company, which could subject us to delisting of our common stock, fines, sanctions and other regulatory action and potentially civil litigation.

The JOBS Act allows us to postpone the date by which we must comply with some of the laws and regulations intended to protect investors and to reduce the amount of information we provide in our reports filed with the SEC, which could undermine investor confidence in our company and adversely affect the market price of our common stock.

For so long as we remain an “emerging growth company” as defined in the JOBS Act, we may take advantage of certain exemptions from various requirements that are applicable to public companies that are not “emerging growth companies” including:

 

•

the provisions of Section 404(b) of the Sarbanes-Oxley Act requiring that our independent registered public accounting firm provide an attestation report on the effectiveness of our internal control over financial reporting;

 

•

the “say on pay” provisions (requiring a non-binding shareholder vote to approve compensation of certain executive officers) and the “say on golden parachute” provisions (requiring a non-binding shareholder vote to approve golden parachute arrangements for certain executive officers in connection with mergers and certain other business combinations) of the Dodd-Frank Act and some of the disclosure requirements of the Dodd-Frank Act relating to compensation of its chief executive officer;

 

•

the requirement to provide detailed compensation discussion and analysis in proxy statements and reports filed under the Exchange Act, and instead provide a reduced level of disclosure concerning executive compensation; and

 

•

any rules that may be adopted by the Public Company Accounting Oversight Board requiring mandatory audit firm rotation or a supplement to the auditor’s report on the financial statements.

We may take advantage of these exemptions until we are no longer an “emerging growth company.” We would cease to be an “emerging growth company” upon the earliest of: (i) the first fiscal year following the fifth anniversary of our IPO; (ii) the first fiscal year after our annual gross revenues are $1 billion or more; (iii) the date on which we have, during the previous three-year period, issued more than $1 billion in non-convertible debt securities; or (iv) as of the end of any fiscal year in which the market value of our common stock held by non-affiliates exceeded $700 million as of the end of the second quarter of that fiscal year.

We currently take advantage of some, but not all, of the reduced regulatory and reporting requirements that are available to us so long as we qualify as an “emerging growth company.” For example, we have irrevocably elected not to take advantage of the extension of time to comply with new or revised financial accounting standards available under Section 102(b) of the JOBS Act. Our

 

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independent registered public accounting firm will not be required to provide an attestation report on the effectiveness of our internal control over financial reporting so long as we qualify as an “emerging growth company,” which may increase the risk that weaknesses or deficiencies in our internal control over financial reporting go undetected. Likewise, so long as we qualify as an “emerging growth company,” we may elect not to provide you with certain information, including certain financial information and certain information regarding compensation of our executive officers, that we would otherwise have been required to provide in filings we make with the SEC, which may make it more difficult for investors and securities analysts to evaluate our company. We cannot predict if investors will find our common stock less attractive because we may rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock, and our stock price may be more volatile and may decline.

Some provisions of our charter documents and Delaware law may have anti-takeover effects that could discourage an acquisition of us by others, even if an acquisition would be beneficial to our stockholders, and may prevent attempts by our stockholders to replace or remove our current management.

Provisions in our restated certificate of incorporation and our bylaws, as well as provisions of the Delaware General Corporation Law (“DGCL”), could make it more difficult for a third party to acquire us or increase the cost of acquiring us, even if doing so would benefit our stockholders, including transactions in which stockholders might otherwise receive a premium for their shares. These provisions include:

 

•

authorizing the issuance of “blank check” preferred stock, the terms of which may be established and shares of which may be issued without stockholder approval;

 

•

prohibiting stockholder action by written consent, thereby requiring all stockholder actions to be taken at a meeting of our stockholders;

 

•

limiting the removal of directors by the stockholders;

 

•

eliminating the ability of stockholders to call a special meeting of stockholders; and

 

•

establishing advance notice requirements for nominations for election to the board of directors or for proposing matters that can be acted upon at stockholder meetings.

These provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management. In addition, we are subject to Section 203 of the DGCL, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with an interested stockholder for a period of three years following the date on which the stockholder became an interested stockholder, unless such transactions are approved by our board of directors. This provision could have the effect of delaying or preventing a change of control, whether or not it is desired by or beneficial to our stockholders.

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

On July 31, 2012, we completed our IPO and issued 5,000,000 shares of our common stock at an initial offering price of $10.00 per share. We sold an additional 750,000 shares of common stock directly to our underwriters when they exercised their over-allotment option in full at the initial offering price of $10.00 per share. We received net proceeds from the IPO of $51.3 million, after deducting underwriting discounts and commissions of $4.0 million and expenses of $2.2 million. None of the expenses associated with the IPO were paid to directors, officers, persons owning 10% or more of any class of equity securities, or to their associates, or to our affiliates. Leerink Swann LLC and Cowen and Company, LLC acted as joint book-running managers and Needham & Company, LLC acted as co-manager for the offering.

The shares were registered under the Securities Act on a Registration Statement on Form S-1 (Registration No. 333-180694). The SEC declared the registration statement effective on July 25, 2012. Shares of our common stock began trading on the NASDAQ Global Market on July 26, 2012. On July 31, 2012, following the sale of 5,750,000 shares of common stock, the offering terminated.

As of March 31, 2013, we have used a portion of the proceeds from the sale of these securities to fund operations, capital expenditures, working capital and other general corporate purposes.

Item 3. Defaults Upon Senior Securities

None.

 

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Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

None.

Item 6. Exhibits

The exhibits filed as part of this Quarterly Report on Form 10-Q are set forth on the Exhibit Index, which are incorporated herein by reference.

 

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SIGNATURES

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

 

		Hyperion Therapeutics, Inc.
Date: May 10, 2013		/s/ Donald J. Santel
		Donald J. Santel Chief Executive Officer and President (Principal Executive Officer)
Date: May 10, 2013		/s/ Jeffrey S. Farrow
		Jeffrey S. Farrow Chief Financial Officer (Principal Financial and Accounting Officer)

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EXHIBIT INDEX

 

Exhibit No.		Description
3.1		Amended and Restated Certificate of Incorporation of the Company (incorporated herein by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, as filed with the SEC on July 31, 2012).
3.2		Amended and Restated Bylaws of the Company (incorporated herein by reference to Exhibit 3.4 to the Company’s Registration Statement on Form S-1/A (File No. 333-180694), as filed with the SEC on May 24, 2012).
4.1		Specimen Common Stock Certificate of the Company (incorporated herein by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-1/A (File No. 333-180694), as filed with the SEC on July 5, 2012).
4.2		Amended and Restated Warrant issued pursuant to the Loan and Security Agreement by and between the Company and Comerica Bank, dated October 2, 2007, and as amended on July 6, 2012 (incorporated herein by reference to Exhibit 4.2 to the Company’s Registration Statement on Form S-1/A (File No. 333-180694), as filed with the SEC on July 13, 2012).
4.3		Form of Secured Promissory Note issued pursuant to the Loan and Security Agreement by and among the Company, Silicon Valley Bank and the Lenders listed therein, dated April 19, 2012 (the “SVB Loan and Security Agreement”) (incorporated herein by reference to Exhibit 4.8 to the Company’s Registration Statement on Form S-1/A (File No. 333-180694), as filed with the SEC on May 24, 2012).
4.4		Form of Warrant to Purchase Stock issued pursuant to the SVB Loan and Security Agreement (incorporated herein by reference to Exhibit 4.9 to the Company’s Registration Statement on Form S-1/A (File No. 333-180694), as filed with the SEC on May 24, 2012).
10.1†		Distribution Services Agreement by and between the Company and ASD Healthcare, a division of ASD Specialty Healthcare, Inc., dated February 14, 2013 (incorporated by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K, File No. 001-35614, as filed with the SEC on February 20, 2013.)
31.1*		Certification of Principal Executive Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended.
31.2*		Certification of Principal Financial Officer pursuant to Rules 13a-14(a) and 15d-14(a) promulgated under the Securities Exchange Act of 1934, as amended.
32.1*		Certifications of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2*		Certifications of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
101**		Financial statements from the Quarterly Report on Form 10-Q of Hyperion Therapeutics, Inc. for the quarter ended March 31, 2013, formatted in XBRL (eXtensible Business Reporting Language): (i) the Condensed Consolidated Balance Sheets, ii) the Condensed Consolidated Statements of Operations, (iii) the Condensed Consolidated Statements of Cash Flows and (iv) Notes to Condensed Consolidated Financial Statements.

 

*	Filed herewith.

**

Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Section 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

†	Registrant has received confidential treatment for certain portions of this agreement. This exhibit omits the information subject to this confidentiality treatment. The omitted portions have been filed separately with the SEC.