SANTARUS INC - FORM 10-Q - November 7, 2013

SANTARUS INC - FORM 10-Q - November 7, 2013

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Attached files

SANTARUS INC Reports

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EXCEL - IDEA: XBRL DOCUMENT - SANTARUS INC	Financial_Report.xls
EX-32 - EX-32 - SANTARUS INC	d586116dex32.htm
EX-31.1 - EX-31.1 - SANTARUS INC	d586116dex311.htm
EX-31.2 - EX-31.2 - SANTARUS INC	d586116dex312.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2013

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

For the transition period from to

Commission File Number: 000-50651

SANTARUS, INC.

(Exact name of registrant as specified in its charter)

Delaware

33-0734433

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)


3611 Valley Centre Drive, Suite 400, San Diego, CA		92130
(Address of principal executive offices)		(Zip Code)

(858) 314-5700

(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes 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.

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

The number of outstanding shares of the registrant’s common stock, par value $0.0001 per share, as of October 31, 2013 was 67,128,949.

SANTARUS, INC.

FORM 10-Q — QUARTERLY REPORT

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2013

TABLE OF CONTENTS


	Page
	No.
PART I – FINANCIAL INFORMATION

Item 1. Financial Statements		1

Consolidated Balance Sheets as of September 30, 2013 (unaudited) and December 31, 2012		1

Consolidated Statements of Operations and Comprehensive Income (unaudited) for the three and nine months ended September 30, 2013 and 2012		2

Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2013 and 2012		3

Notes to Unaudited Consolidated Financial Statements		4

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		15

Item 3. Quantitative and Qualitative Disclosures about Market Risk		31

Item 4. Controls and Procedures		31

PART II – OTHER INFORMATION

Item 1. Legal Proceedings		32

Item 1A. Risk Factors		35

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		57

Item 3. Defaults Upon Senior Securities		57

Item 4. Mine Safety Disclosures		57

Item 5. Other Information		57

Item 6. Exhibits		57

SIGNATURES		60

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

Santarus, Inc.

Consolidated Balance Sheets

(in thousands, except share and per share amounts)

(unaudited)


	September 30,			December 31,
	2013			2012
Assets
Current assets:
Cash and cash equivalents	$	121,138		$	49,772
Short-term investments		47,581			44,964
Accounts receivable, net		43,576			31,024
Inventories, net		11,882			9,897
Deferred tax assets		35,899			—
Prepaid expenses and other current assets		7,821			6,678

Total current assets		267,897			142,335
Long-term restricted cash		750			950
Property and equipment, net		1,197			945
Intangible assets, net		18,502			16,254
Goodwill		2,913			2,913
Long-term deferred tax assets		19,556			—
Other assets		861			352

Total assets	$	311,676		$	163,749

Liabilities and stockholders’ equity
Current liabilities:
Accounts payable and accrued liabilities	$	52,662		$	45,824
Allowance for product returns		24,165			20,574

Total current liabilities		76,827			66,398
Deferred revenue		1,103			1,639
Long-term debt		—			9,876
Other long-term liabilities		4,764			2,884
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.0001 par value; 10,000,000 shares authorized at September 30, 2013 and December 31, 2012; no shares issued and outstanding at September 30, 2013 and December 31, 2012		—			—
Common stock, $0.0001 par value; 200,000,000 and 100,000,000 shares authorized at September 30, 2013 and December 31, 2012, respectively; 66,984,705 and 63,583,492 shares issued and outstanding at September 30, 2013 and December 31, 2012, respectively		7			6
Additional paid-in capital		392,054			368,594
Accumulated other comprehensive income		4			3
Accumulated deficit		(163,083	)		(285,651	)

Total stockholders’ equity		228,982			82,952

Total liabilities and stockholders’ equity	$	311,676		$	163,749

See accompanying notes.

Santarus, Inc.

Consolidated Statements of Operations and Comprehensive Income

(in thousands, except share and per share amounts)

(unaudited)


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2013			2012			2013			2012
Revenues:
Product sales, net	$	98,073		$	53,687		$	265,086		$	145,124
Royalty revenue		721			983			2,510			2,618

Total revenues		98,794			54,670			267,596			147,742
Costs and expenses:
Cost of product sales		6,032			3,276			16,145			10,463
License fees and royalties		20,918			14,849			63,701			43,544
Research and development		6,824			6,177			19,978			18,089
Selling, general and administrative		35,487			21,133			99,692			61,567

Total costs and expenses		69,261			45,435			199,516			133,663

Income from operations		29,533			9,235			68,080			14,079
Other income (expense):
Interest income		9			11			34			13
Interest expense		(61	)		(81	)		(214	)		(259	)

Total other income (expense)		(52	)		(70	)		(180	)		(246	)

Income before income taxes		29,481			9,165			67,900			13,833
Income tax (benefit) expense		(838	)		181			(54,668	)		774

Net income	$	30,319		$	8,984		$	122,568		$	13,059

Net income per share:
Basic	$	0.46		$	0.14		$	1.88		$	0.21

Diluted	$	0.38		$	0.13		$	1.57		$	0.19

Weighted average shares outstanding used to calculate net income per share:
Basic		66,567,180			62,992,473			65,321,156			62,496,446
Diluted		79,388,362			69,723,094			77,954,236			67,906,620

Comprehensive income	$	30,325		$	8,987		$	122,569		$	13,056

See accompanying notes.

Santarus, Inc.

Consolidated Statements of Cash Flows

(in thousands)

(unaudited)


	Nine Months Ended
	September 30,
	2013			2012
Operating activities
Net income	$	122,568		$	13,059
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		5,099			4,605
(Gain) loss on contingent consideration		561			(25	)
Stock-based compensation		10,099			4,897
Excess tax benefit from stock-based compensation		(758	)		—
Issuance of common stock for technology license agreement		—			3,698
Deferred income taxes		(55,455	)		—
Changes in operating assets and liabilities:
Accounts receivable, net		(12,552	)		(3,065	)
Inventories, net		(1,985	)		(2,499	)
Prepaid expenses and other current assets		(366	)		(3,069	)
Other assets		(509	)		—
Accounts payable and accrued liabilities		8,216			2,993
Allowance for product returns		3,591			3,585
Deferred revenue		(536	)		(396	)

Net cash provided by operating activities		77,973			23,783

Investing activities
Purchases of short-term investments		(66,961	)		(41,925	)
Sales and maturities of short-term investments		64,365			5,414
Long-term restricted cash		200			(950	)
Purchases of property and equipment		(573	)		(187	)
Acquisition of intangible assets		(7,000	)		—
Net cash paid for business combination		—			(2,519	)

Net cash used in investing activities		(9,969	)		(40,167	)

Financing activities
Payment on credit facility		(10,000	)		—
Payment of commitment fee on credit facility		—			(175	)
Exercise of stock options		11,910			2,041
Issuance of common stock, net		694			393
Excess tax benefit from stock-based compensation		758			—

Net cash provided by financing activities		3,362			2,259

Increase (decrease) in cash and cash equivalents		71,366			(14,125	)
Cash and cash equivalents at beginning of the period		49,772			54,244

Cash and cash equivalents at end of the period	$	121,138		$	40,119

See accompanying notes.

Santarus, Inc.

Notes to Consolidated Financial Statements

(unaudited)

1. Organization and Business

Santarus, Inc. (“Santarus” or the “Company”) is a specialty biopharmaceutical company focused on acquiring, developing and commercializing proprietary products that address the needs of patients treated by physician specialists. Santarus was incorporated on December 6, 1996 as a California corporation and did not commence significant business activities until late 1998. On July 9, 2002, the Company reincorporated in the State of Delaware.

2. Basis of Presentation

The accompanying unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) related to the preparation of interim financial statements and the rules and regulations of the U.S. Securities and Exchange Commission related to a quarterly report on Form 10-Q. Accordingly, they do not include all of the information and disclosures required by GAAP for complete financial statements. The consolidated balance sheet at December 31, 2012 has been derived from the audited consolidated financial statements at that date but does not include all information and disclosures required by GAAP for complete financial statements. The interim consolidated financial statements reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the financial condition and results of operations for the periods presented. Except as otherwise disclosed, all such adjustments are of a normal recurring nature.

Operating results for the three and nine months ended September 30, 2013 are not necessarily indicative of the results that may be expected for any future periods. For further information, please see the consolidated financial statements and related disclosures included in the Company’s annual report on Form 10-K for the year ended December 31, 2012.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as well as disclosures of contingent assets and liabilities at the date of the financial statements. Estimates also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

3. Principles of Consolidation

The unaudited interim consolidated financial statements of the Company include the accounts of Santarus, Inc. and its wholly owned subsidiary, Covella Pharmaceuticals, Inc. (“Covella”). The Company does not have any interest in variable interest entities. All material intercompany transactions and balances have been eliminated in consolidation.

4. Revenue Recognition

The Company recognizes revenue when there is persuasive evidence that an arrangement exists, title has passed, the price is fixed or determinable, and collectability is reasonably assured.

Product Sales, Net. The Company sells its commercial products primarily to pharmaceutical wholesale distributors. The Company is obligated to accept from customers products that are returned within six months of their expiration date or up to 12 months beyond their expiration date. The shelf life of the Company’s products from the date of manufacture is as follows: Uceris^® (budesonide) extended release tablets (36 months); Zegerid^® (omeprazole/sodium bicarbonate) capsules and powder for oral suspension (36 months); Glumetza^® (metformin hydrochloride extended release tablets) (36 to 48 months); Cycloset^® (bromocriptine mesylate) tablets (18 months); and Fenoglide^® (fenofibrate) tablets (36 months). The Company authorizes returns for expired or damaged products in accordance with its return goods policy and procedures. The Company issues credit to the customer for expired or damaged returned product. The Company rarely exchanges product from inventory for returned product. At the time of sale, the Company records its estimates for product returns as a reduction to revenue at full sales value with a corresponding increase in the allowance for product returns liability. Actual returns are recorded as a reduction to the allowance for product returns liability at sales value with a corresponding decrease in accounts receivable for credit issued to the customer.

The Company recognizes product sales net of estimated allowances for product returns, estimated rebates in connection with contracts relating to managed care, Medicare, patient coupons and voucher programs, and estimated chargebacks from distributors, wholesaler fees and prompt payment and other discounts. The Company establishes allowances for estimated product returns, rebates and chargebacks based primarily on the following qualitative and quantitative factors:

•

the number of and specific contractual terms of agreements with customers;

•

estimated levels of inventory in the distribution channel;

•

estimated remaining shelf life of products;

•

analysis of prescription data gathered by a third-party prescription data provider;

•

direct communication with customers;

•

historical product returns, rebates and chargebacks;

•

anticipated introduction of competitive products or generics;

•

anticipated pricing strategy changes by the Company and/or its competitors; and

•

the impact of state and federal regulations.

In its analyses, the Company utilizes prescription data purchased from a third-party data provider to develop estimates of historical inventory channel pull-through. The Company utilizes a separate analysis which compares historical product shipments less returns to estimated historical prescriptions written. Based on that analysis, the Company develops an estimate of the quantity of product in the distribution channel which may be subject to various product return, rebate and chargeback exposures.

The Company’s estimates of product returns, rebates and chargebacks require its most subjective and complex judgment due to the need to make estimates about matters that are inherently uncertain. If actual future payments for returns, rebates, chargebacks and other discounts vary from the estimates the Company made at the time of sale, its financial position, results of operations and cash flows would be impacted.

The Company’s allowance for product returns was $24.2 million as of September 30, 2013 and $20.6 million as of December 31, 2012. The Company recognizes product sales at the time title passes to its customers, and the Company provides for an estimate of future product returns at that time based upon historical product returns trends, analysis of product expiration dating and estimated inventory levels in the distribution channel, review of returns trends for similar products, if available, and the other factors discussed above. Due to the lengthy shelf life of the Company’s products and the terms of the Company’s returns policy, there may be a significant time lag between the date the Company determines the estimated allowance and when the Company receives the product return and issues credit to a customer. Therefore, the amount of returns processed against the allowance in a particular year generally has no direct correlation to the product sales in the same year, and the Company may record adjustments to its estimated allowance over several periods, which can result in a net increase or a net decrease in its operating results in those periods.

The Company has been tracking its Zegerid product returns history by individual production batches from the time of its first commercial product launch of Zegerid powder for oral suspension 20 mg in late 2004. The Company launched Cycloset in November 2010 and began distributing Fenoglide in December 2011. Under a commercialization agreement with Depomed, Inc. (“Depomed”), the Company began distributing and recording product sales for Glumetza in September 2011. The Company has provided for an estimate of product returns based upon a review of the Company’s product returns history and returns trends for similar products, taking into consideration the effect of a product’s shelf life on its returns history. The Company launched Uceris in February 2013 and recognizes product sales when title has passed to customers. Based on the Company’s historical experience with its Zegerid and Glumetza products, the Company has the ability to develop a reasonable estimate of Uceris product returns, taking into consideration the similar shelf lives and distribution channels of these products.

The Company’s allowance for rebates, chargebacks and other discounts was $23.0 million as of September 30, 2013 and $17.2 million as of December 31, 2012. These allowances reflect an estimate of the Company’s liability for rebates due to managed care organizations under specific contracts, rebates due to various organizations in connection with Medicare contracts, patient coupons and voucher programs, chargebacks due to various organizations purchasing the Company’s products through federal contracts and/or group purchasing agreements, and other rebates and customer discounts due in connection with wholesaler fees and prompt payment and other discounts. The Company estimates its liability for rebates and chargebacks at each reporting period based on a combination of the qualitative and quantitative assumptions listed above. In each reporting period, the Company evaluates its outstanding contracts and applies the contractual discounts to the invoiced

price of wholesaler shipments recognized. Although the total invoiced price of shipments to wholesalers for the reporting period and the contractual terms are known during the reporting period, the Company projects the ultimate disposition of the sale (e.g. future utilization rates of cash payors, managed care, Medicare or other contracted organizations). This estimate is based on historical trends adjusted for anticipated changes based on specific contractual terms of new agreements with customers, anticipated pricing strategy changes by the Company and/or its competitors and the other qualitative and quantitative factors described above. There may be a significant time lag between the date the Company determines the estimated allowance and when the Company makes the contractual payment or issues credit to a customer. Due to this time lag, the Company records adjustments to its estimated allowance over several periods, which can result in a net increase or a net decrease in its operating results in those periods.

In late June 2010, the Company began selling an authorized generic version of its prescription Zegerid capsules under a distribution and supply agreement with Prasco, LLC (“Prasco”). Prasco has agreed to purchase all of its authorized generic product requirements from the Company and pays a specified invoice supply price for such products. The Company recognizes revenue from shipments to Prasco at the invoice supply price and the related cost of product sales when title transfers, which is generally at the time of shipment. The Company is also entitled to receive a significant percentage of the gross margin on sales of the authorized generic products by Prasco, which the Company recognizes as an addition to product sales, net when Prasco reports to the Company the gross margin from the ultimate sale of the products. Any adjustments to the gross margin related to Prasco’s estimated sales discounts and other deductions are recognized in the period Prasco reports the amounts to the Company.

Promotion, Royalty and Other License Revenue. The Company analyzes each element of its promotion and licensing agreements to determine the appropriate revenue recognition. Prior to January 1, 2011, the Company recognized revenue on upfront payments over the period of significant involvement under the related agreements unless the fee was in exchange for products delivered or services rendered that represent the culmination of a separate earnings process and no further performance obligation existed under the contract. The Company follows the authoritative guidance for revenue arrangements with multiple deliverables materially modified or entered into after December 31, 2010. Under this guidance, the Company identifies the deliverables included within the agreement and evaluates which deliverables represent separate units of accounting. Upfront license fees are generally recognized upon delivery of the license if the facts and circumstances dictate that the license has standalone value from any undelivered items, the relative selling price allocation of the license is equal to or exceeds the upfront license fees, persuasive evidence of an arrangement exists, the Company’s price to the partner is fixed or determinable and collectability is reasonably assured. Upfront license fees are deferred if facts and circumstances dictate that the license does not have standalone value. The determination of the length of the period over which to defer revenue is subject to judgment and estimation and can have an impact on the amount of revenue recognized in a given period.

Effective January 1, 2011, the Company adopted prospectively, the authoritative guidance that offers an alternative method of revenue recognition for milestone payments. Under the milestone method guidance, the Company recognizes payment that is contingent upon the achievement of a substantive milestone, as defined in the guidance, in its entirety in the period in which the milestone is achieved. Other milestones that do not fall under the definition of a milestone under the milestone method are recognized under the authoritative guidance concerning revenue recognition. Sales milestones, royalties and promotion fees are based on sales and/or gross margin information, which may include estimates of sales discounts and other deductions, received from the relevant alliance agreement partner. Sales milestones, royalties and promotion fees are recognized as revenue when earned under the agreements, and any adjustments related to estimated sales discounts and other deductions are recognized in the period the alliance agreement partner reports the amounts to the Company.

5. Stock-Based Compensation

For the three months ended September 30, 2013 and 2012 and the nine months ended September 30, 2013 and 2012, the Company recognized approximately $4.2 million, $1.8 million, $10.1 million and $4.9 million of total stock-based compensation, respectively. In March 2013, the Company granted options to purchase an aggregate of 2,591,870 shares of its common stock in connection with annual option grants to all eligible employees. These stock options vest over a four-year period from the date of grant. As of September 30, 2013, total unrecognized compensation cost related to stock options and employee stock purchase plan rights was approximately $35.0 million, and the weighted average period over which it was expected to be recognized was 2.9 years.

6. Income Taxes

The Company provides for income taxes under the liability method. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of differences between the tax basis of assets or liabilities and their carrying amounts in the financial statements. The Company provides a valuation allowance for deferred tax assets if it is more likely than not that these items will expire before the Company is able to realize their benefit. The Company calculates the valuation allowance in accordance with the authoritative guidance relating to income taxes, which requires an assessment of both positive and negative evidence regarding the realizability of these deferred tax assets, when measuring the need for a valuation allowance. Significant judgment is required in determining any valuation allowance against deferred tax assets. As of December 31, 2012, due to a history of operating losses and other key operating factors, including uncertainty regarding the pending U.S. Food and Drug Administration (“FDA”) approval to market and commercialize Uceris, the Company concluded that a full valuation allowance was necessary to offset all of its deferred tax assets. As of June 30, 2013, the Company concluded that it was more likely than not that its deferred tax assets would be realized through future taxable income. This conclusion was based on the Company’s sustained profitability for 2011, 2012 and the six months ended June 30, 2013, assessment of sales trends for each of the Company’s products including Uceris, which the Company commercially launched in February 2013, and projections of positive future earnings. The release of the valuation allowance resulted in an income tax benefit of $54.9 million, which was recorded as a discrete item in the three months ended June 30, 2013. The release of the valuation allowance will not affect the amount of cash paid for income taxes. The Company reassesses its ability to realize the deferred tax benefits on a quarterly basis. If it is more likely than not that the Company will not realize the deferred tax benefits, then all or a portion of the valuation allowance may need to be re-established, which would result in a charge to tax expense.

The Company follows the authoritative guidance relating to accounting for uncertainty in income taxes. This guidance clarifies the recognition threshold and measurement attributes for financial statement disclosure of tax positions taken or expected to be taken on a tax return. The impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more likely than not to be sustained upon audit by the relevant taxing authority. An uncertain tax position will not be recognized if it has less than a 50% likelihood of being sustained.

7. Net Income Per Share

Basic income per share is calculated by dividing the net income by the weighted average number of common shares outstanding for the period, without consideration for common stock equivalents. Diluted income per share is computed by dividing the net income by the weighted average number of common share equivalents outstanding for the period determined using the treasury-stock method. For purposes of this calculation, common stock subject to repurchase by the Company, contingently issuable shares, options and warrants are considered to be common stock equivalents and are only included in the calculation of diluted income per share when their effect is dilutive. Potentially dilutive securities totaling approximately 3.0 million shares and 3.1 million shares for the three months ended September 30, 2013 and 2012 and 2.2 million shares and 6.8 million shares for the nine months ended September 30, 2013 and 2012, respectively, were excluded from the calculation of diluted income per share because of their anti-dilutive effect.


	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
Numerator:
Net income (in thousands)	$	30,319	$	8,984	$	122,568	$	13,059
Denominator:
Weighted average common shares outstanding for basic net income per share		66,567,180		62,992,473		65,321,156		62,496,446
Net effect of dilutive common stock equivalents		12,821,182		6,730,621		12,633,080		5,410,174

Denominator for diluted net income per share		79,388,362		69,723,094		77,954,236		67,906,620

Net income per share
Basic	$	0.46	$	0.14	$	1.88	$	0.21

Diluted	$	0.38	$	0.13	$	1.57	$	0.19

8. Segment Reporting

Management has determined that the Company operates in one business segment which is the acquisition, development and commercialization of pharmaceutical products.

9. Available-for-Sale Securities

The Company has classified its debt securities as available-for-sale and, accordingly, carries these investments at fair value, and unrealized holding gains or losses on these securities are carried as a separate component of stockholders’ equity. The cost of debt securities is adjusted for amortization of premiums or accretion of discounts to maturity, and such amortization or accretion is included in interest income. Realized gains and losses and declines in value judged to be other-than-temporary on available-for-sale securities are included in interest income. The cost of securities sold is based on the specific identification method.

All available-for-sale securities held as of September 30, 2013 and December 31, 2012 have contractual maturities within one year and are included in short-term investments in the Company’s consolidated balance sheets. There were no material gross realized gains or losses on sales of available-for-sale securities for the three and nine months ended September 30, 2013 and 2012. The following is a summary of the Company’s available-for-sale investment securities as of September 30, 2013 and December 31, 2012 (in thousands):


	Amortized Cost		Market Value		Unrealized Gain
September 30, 2013:
U.S. government sponsored enterprise securities	$	47,577	$	47,581	$	4

December 31, 2012:
U.S. government sponsored enterprise securities	$	44,961	$	44,964	$	3

10. Fair Value Measurements

The carrying values of the Company’s financial instruments, including cash, cash equivalents, accounts receivable, accounts payable and accrued liabilities and the Company’s revolving credit facility approximate fair value due to the relative short-term nature of these instruments.

The authoritative guidance for fair value measurements establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

The Company obtains the fair value of its Level 2 financial instruments from its investment managers, who obtain these fair values from professional pricing sources. The professional pricing sources determine fair value using pricing models whereby all significant observable inputs, including maturity dates, issue dates, settlement dates, reported trades, broker-dealer quotes, issue spreads, benchmark securities or other market related data, are observable or can be derived from or corroborated by observable market data for substantially the full term of the financial instrument. The Company validates the fair values of its Level 2 financial instruments provided by its investment managers by comparing these fair values to a third-party data source.

The Company’s assets and liabilities measured at fair value on a recurring basis at September 30, 2013 and December 31, 2012 are as follows (in thousands):


	Fair Value Measurements at Reporting Date Using
	Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total
September 30, 2013:
Assets
Money market funds	$	121,063	$	—	$	—	$	121,063
U.S. government sponsored enterprise securities		—		48,406		—		48,406
Deferred compensation plan assets		947		—		—		947

	$	122,010	$	48,406	$	—	$	170,416

Liabilities
Contingent consideration	$	—	$	—	$	2,761	$	2,761
Deferred compensation plan liabilities		947		—		—		947

	$	947	$	—	$	2,761	$	3,708

December 31, 2012:
Assets
Money market funds	$	48,522	$	—	$	—	$	48,522
U.S. government sponsored enterprise securities		—		47,164		—		47,164
Deferred compensation plan assets		169		—		—		169

	$	48,691	$	47,164	$	—	$	95,855

Liabilities
Contingent consideration	$	—	$	—	$	2,200	$	2,200
Deferred compensation plan liabilities		169		—		—		169

	$	169	$	—	$	2,200	$	2,369

The following table provides a summary of changes in fair value of the Company’s Level 3 liabilities for the three and nine months ended September 30, 2013 and 2012 (in thousands):


	Three Months Ended September 30,					Nine Months Ended September 30,
	2013		2012			2013		2012
Contingent Consideration:
Beginning balance	$	2,642	$	2,342		$	2,200	$	2,054
Change in fair value recorded in operating expenses		119		(313	)		561		(25	)

Ending balance	$	2,761	$	2,029		$	2,761	$	2,029

Level 3 liabilities include contingent milestone and royalty obligations the Company may pay related to the acquisition of Covella in September 2010. The fair value of the contingent consideration has been determined using a probability-weighted discounted cash flow model. The key assumptions in applying this approach are the discount rate and the probability assigned to the milestone or royalty being achieved. Management remeasures the fair value of the contingent consideration at each reporting period, with any change in its fair value resulting from either the passage of time or events occurring after the acquisition date, such as changes in the estimated probability or timing of achieving the milestone or royalty, being recorded in the current period’s statement of operations.

11. Balance Sheet Details

Inventories, net consist of the following (in thousands):


	September 30, 2013			December 31, 2012
Raw materials	$	2,239		$	1,533
Finished goods		10,748			9,968

		12,987			11,501
Allowance for excess and obsolete inventory		(1,105	)		(1,604	)

	$	11,882		$	9,897

Inventories are stated at the lower of cost or market (net realizable value). Cost is determined by the first-in, first-out method. Inventories consist of finished goods and raw materials used in the manufacture of the Company’s commercial products. The Company provides reserves for potentially excess, dated or obsolete inventories based on an analysis of inventory on hand and on firm purchase commitments, compared to forecasts of future sales.

Accounts payable and accrued liabilities consist of the following (in thousands):


	September 30, 2013		December 31, 2012
Accounts payable	$	7,019	$	6,873
Accrued compensation and benefits		8,580		9,183
Accrued rebates		15,083		11,693
Accrued license fees and royalties		11,949		7,181
Accrued research and development expenses		3,875		3,441
Accrued legal fees		1,625		1,953
Income taxes payable		—		950
Other accrued liabilities		4,531		4,550

	$	52,662	$	45,824

12. Long-Term Debt

In July 2006, the Company entered into a loan agreement with Comerica Bank (“Comerica”), which was most recently amended in February 2012, pursuant to which the Company may request advances in an aggregate outstanding amount not to exceed $35.0 million. Pursuant to the February 2012 amendment, the revolving loan bears interest, as selected by the Company, at either the variable rate of interest, per annum, most recently announced by Comerica as its “prime rate” or the LIBOR rate plus 2.25%. In December 2008, the Company drew down $10.0 million under the loan agreement. In August

2013, the Company repaid the $10.0 million and as of September 30, 2013, the Company had no outstanding balance under the loan agreement. Interest payments on advances made under the amended loan agreement are due and payable in arrears on a monthly basis during the term of the amended loan agreement. Amounts borrowed under the loan agreement may be repaid and re-borrowed at any time prior to February 13, 2015, and any outstanding principal drawn during the term of the loan facility is due and payable on February 13, 2015. In conjunction with the execution of the February 2012 amendment to the loan agreement, the Company paid a one-time commitment fee of $175,000. The commitment fee has been capitalized as a debt discount and is being amortized to interest expense over the remaining term of the loan agreement. The amended loan agreement will remain in full force and effect for so long as any obligations remain outstanding or Comerica has any obligation to make credit extensions under the amended loan agreement.

Amounts borrowed under the amended loan agreement are secured by substantially all of the Company’s personal property, excluding intellectual property. Under the amended loan agreement, the Company is subject to certain affirmative and negative covenants, including limitations on the Company’s ability to: undergo certain change of control events; convey, sell, lease, license, transfer or otherwise dispose of assets; create, incur, assume, guarantee or be liable with respect to certain indebtedness; grant liens; pay dividends and make certain other restricted payments; and make investments. In addition, under the amended loan agreement, the Company is required to maintain its cash balances with either Comerica or another financial institution covered by a control agreement for the benefit of Comerica. The Company is also subject to specified financial covenants with respect to a minimum liquidity ratio and, in specified limited circumstances, minimum EBITDA requirements as defined in the amended loan agreement. The Company believes it has currently met all of its obligations under the amended loan agreement.

13. Strategic Collaboration with Cosmo

In December 2008, the Company entered into a strategic collaboration with Cosmo Technologies Limited (“Cosmo”), an affiliate of Cosmo Pharmaceuticals S.p.A., including a license agreement, stock issuance agreement and registration rights agreement, under which the Company was granted exclusive rights to develop and commercialize Uceris and rifamycin SV MMX^® in the U.S. Following the first commercial sale of Uceris which occurred in February 2013, Cosmo elected, in April 2013, to receive payment of a $7.0 million commercial milestone in cash. The Company accrued the $7.0 million commercial milestone in February 2013 and made the cash payment to Cosmo in April 2013. The commercial milestone has been capitalized in intangible assets and is being amortized to license fees and royalties over the estimated useful life of the asset on a straight-line basis through mid-2020.

14. License Agreement and Supply Agreement with Pharming

In September 2010, the Company entered into a license agreement and a supply agreement with Pharming Group NV (“Pharming”) under which the Company was granted certain non-exclusive rights to develop and manufacture, and certain exclusive rights to commercialize Ruconest^® (recombinant human C1 esterase inhibitor) in the U.S., Canada and Mexico for the treatment of hereditary angioedema (“HAE”) and other future indications. Under the terms of the license agreement, as a result of the FDA acceptance for review of the biologics license application (“BLA”) for Ruconest in June 2013, the Company paid Pharming a $5.0 million milestone in July 2013. The $5.0 million milestone is included in license fees and royalties in the nine months ended September 30, 2013.

15. Recent Accounting Pronouncements

In June and December 2011, the Financial Accounting Standards Board (“FASB”) issued authoritative guidance on the presentation of comprehensive income. Under this newly issued authoritative guidance, an entity has the option to present comprehensive income and net income either in a single continuous statement or in two separate but consecutive statements. This guidance, therefore, eliminated the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. The Company adopted the requirements of this guidance effective for its fiscal year beginning January 1, 2012. Upon adoption, the guidance did not have a material impact on the Company’s consolidated financial statements. In February 2013, the FASB amended its guidance on reporting reclassifications out of accumulated other comprehensive income. For significant items reclassified out of accumulated other comprehensive income to net income in their entirety in the same reporting period, this amendment requires reporting about the effect of the reclassifications on the respective line items in the statement where net income is presented. For items that are not reclassified to net income in their entirety in the same reporting period, a cross reference to other disclosures currently required under GAAP is required in the notes to the financial statements. This amendment is effective for interim periods beginning after December 15, 2012. Upon adoption, the guidance did not have a material impact on the Company’s consolidated financial statements.

16. Contingencies

Zegerid Rx Litigation

In April 2010, the U.S. District Court for the District of Delaware ruled that five patents covering Zegerid capsules and Zegerid powder for oral suspension (U.S. Patent Nos. 6,489,346; 6,645,988; 6,699,885; 6,780,882; and 7,399,772) were invalid due to obviousness. These patents were the subject of lawsuits the Company filed in 2007 against Par Pharmaceutical, Inc. (“Par”) in response to abbreviated new drug applications (“ANDAs”) filed by Par with the FDA. The University of Missouri, licensor of the patents, is joined in the litigation as a co-plaintiff. In May 2010, the Company filed an appeal of the District Court’s ruling to the U.S. Court of Appeals for the Federal Circuit. Following the District Court’s decision, Par launched its generic version of Zegerid capsules in late June 2010.

In September 2012, the U.S. Court of Appeals for the Federal Circuit reversed in part the April 2010 decision of the District Court. The Federal Circuit found that certain claims of asserted U.S. Patent Nos. 6,780,882 and 7,399,772, which Par had been found to infringe, were not invalid due to obviousness. These patents represent two of the five patents that were found to be invalid by the District Court, and the Federal Circuit affirmed the District Court’s finding of invalidity for the asserted claims from the remaining three patents. The Federal Circuit also upheld the District Court’s finding that there was no inequitable conduct. Following the Federal Circuit’s decision, Par announced that it had ceased distribution of its generic Zegerid capsules product in September 2012. In December 2012, the Federal Circuit issued an order denying a combined petition for panel and en banc rehearing filed by Par and issued its mandate, remanding the case to the District Court for further proceedings pertaining to damages. In February 2013, the Company filed an amended complaint with the District Court for infringement of U.S. Patent Nos. 6,780,882 and 7,399,772 and requested a jury trial with respect to the issue of damages in connection with Par’s launch of its generic version of Zegerid capsules in June 2010. The trial has been scheduled in November 2014. In March 2013, Par filed its amended answer, which alleges, among other things, failure to state a claim upon which relief can be granted and non-infringement based on purported invalidity of the two asserted patents. In addition, Par filed a motion for a judgment on the pleadings, alleging, among other things, that the two asserted patents are invalid because the Federal Circuit purportedly did not expressly address certain prior art references considered by the District Court, and the Company is waiting for a ruling from the District Court on Par’s motion. Although the Company does not believe that Par has a meritorious basis upon which to further challenge validity of the asserted patents in this proceeding, the Company cannot be certain of the timing or outcome of this or any other proceedings. If the District Court rules in favor of Par on its pending motion or otherwise, the Company cannot be certain of the impact to the Company, including if or when Par might re-launch its generic product. In addition, in April 2013, Par received approval from the FDA of its generic version of Zegerid powder for oral suspension.

In December 2011, the Company filed a lawsuit in the U.S. District Court for the District of New Jersey against Zydus Pharmaceuticals USA, Inc. (“Zydus”) for infringement of the patents listed in the Orange Book for Zegerid capsules. The University of Missouri, licensor of the patents, is joined in the litigation as a co-plaintiff. Zydus had filed an ANDA with the FDA regarding its intent to market a generic version of Zegerid capsules prior to the expiration of the listed patents. In September 2012, the Company amended its complaint to be limited to U.S. Patent No. 7,399,772, which patent was found not to be invalid in the September 2012 Federal Circuit decision. In October 2012, Zydus filed its answer, which alleges, among other things, failure to state a claim upon which relief can be granted. The lawsuit was commenced within the requisite 45-day time period, resulting in an FDA stay on the approval of Zydus’ proposed product for 30 months or until a decision is rendered by the District Court, which is adverse to the asserted patent. The trial for this matter has been scheduled in January 2014. Absent a court decision, the 30-month stay is expected to expire in May 2014. The Company is not able to predict the timing or outcome of this lawsuit.

In August 2012, the Company filed a lawsuit in the U.S. District Court for the District of New Jersey against Dr. Reddy’s Laboratories, Ltd. and Dr. Reddy’s Laboratories, Inc. (collectively “Dr. Reddy’s”) for infringement of the patents listed in the Orange Book for Zegerid capsules. The Company and the University of Missouri, licensor of the patents, were joined in the litigation as co-plaintiffs. Dr. Reddy’s had filed an ANDA with the FDA regarding its intent to market a generic version of Zegerid capsules prior to the expiration of the listed patents. In June 2013, this case was settled allowing Dr. Reddy’s to begin selling a generic version of prescription Zegerid capsules upon expiration of the applicable patent (or earlier under certain circumstances), and the District Court entered an order dismissing the case with prejudice.

Zegerid OTC Litigation

In September 2010, MSD Consumer Products, Inc. (“Merck”), a subsidiary of Merck & Co., Inc., filed a lawsuit in the U.S. District Court for the District of New Jersey against Par for infringement of the patents listed in the Orange Book for Zegerid OTC^®. The Company and the University of Missouri, licensors of the listed patents, are joined in the lawsuit as co-plaintiffs. Par had filed an ANDA with the FDA regarding its intent to market a generic version of Zegerid OTC prior to the expiration of the listed patents. In October 2012, Merck amended its complaint to be limited to U.S. Patent No. 7,399,772, which patent was found not to be invalid in the September 2012 Federal Circuit decision. Also in October 2012, Par filed its answer, which alleges, among other things, failure to state a claim upon which relief can be granted, non-infringement and invalidity. Par has received tentative approval of its proposed generic Zegerid OTC product. The lawsuit was commenced within the requisite 45-day time period, resulting in an FDA stay on the approval of Par’s proposed product for 30 months or until a decision is rendered by the District Court, which is adverse to the asserted patent. Although the 30-month stay expired in February 2013, the parties have agreed that Par will not launch its generic Zegerid OTC product unless there is a District Court judgment favorable to Par or in certain other specified circumstances. The District Court issued a Markman order in October 2013 in which the District Court adopted Merck’s proposed construction of several claim terms that were consistent with those adopted by the U.S. District Court for the District of Delaware. A trial has been scheduled in January 2015. The Company is not able to predict the timing or outcome of this lawsuit.

In September 2010, Merck filed a lawsuit in the U.S. District Court for the District of New Jersey against Perrigo Research and Development Company (“Perrigo”) for infringement of the patents listed in the Orange Book for Zegerid OTC. The Company and the University of Missouri, licensors of the listed patents, were joined in the lawsuits as co-plaintiffs. Perrigo had filed an ANDA with the FDA regarding its intent to market a generic version of Zegerid OTC prior to the expiration of the listed patents. In January 2013, this case was settled allowing Perrigo to market a generic version of Zegerid OTC upon expiration of the applicable patents (or earlier under certain circumstances), and the District Court entered an order dismissing the case with prejudice.

In December 2011, Merck filed a lawsuit in the U.S. District Court for the District of New Jersey against Zydus for infringement of the patents listed in the Orange Book for Zegerid OTC. The Company and the University of Missouri, licensors of the listed patents, are joined in the litigation as co-plaintiffs. Zydus had filed an ANDA with the FDA regarding its intent to market a generic version of Zegerid OTC prior to the expiration of the listed patents. In September 2012, Merck amended its complaint to be limited to U.S. Patent No. 7,399,772, which patent was found not to be invalid in the September 2012 Federal Circuit decision. In October 2012, Zydus filed its answer, which alleges, among other things, failure to state a claim upon which relief can be granted. The lawsuit was commenced within the requisite 45-day time period, resulting in an FDA stay on the approval of Zydus’ proposed product for 30 months or until a decision is rendered by the District Court, which is adverse to the asserted patent. Absent a court decision, the 30-month stay is expected to expire in May 2014. The trial for this matter has been scheduled in January 2014. The Company is not able to predict the timing or outcome of this lawsuit.

Any adverse outcome in the Zegerid Rx and Zegerid OTC litigation described above would adversely impact the Company, including the amount of revenues the Company receives from sales of Zegerid brand and authorized generic prescription products and the Company’s ability to receive, milestone payments and royalties under its agreement with Merck. For example, the royalties payable to the Company under its license agreement with Merck are subject to reduction in the event it is ultimately determined by the courts (with the decision being unappealable or unappealed within the time allowed for appeal) that there is no valid claim of the licensed patents covering the manufacture, use or sale of the Zegerid OTC product and third parties have received marketing approval for, and are conducting bona fide ongoing commercial sales of, generic versions of the licensed products. Any negative outcome may also negatively impact the patent protection for the products being commercialized pursuant to the Company’s ex-US license with Glaxo Group Limited (“GSK”), an affiliate of GlaxoSmithKline, plc. Although a U.S. ruling is not binding in countries outside the U.S., similar challenges to those raised in the U.S. litigation may be raised in territories outside the U.S. At this time the Company is unable to estimate possible losses or ranges of losses for ongoing actions.

Regardless of how these litigation matters are ultimately resolved, the litigation has been and will continue to be costly, time-consuming and distracting to management, which could have a material adverse effect on the Company.

Glumetza Patent Litigation

In November 2009, Depomed filed a lawsuit in the U.S. District Court for the Northern District of California against Lupin Limited and its wholly owned subsidiary, Lupin Pharmaceuticals, Inc. (collectively “Lupin”) for infringement of certain patents listed in the Orange Book for Glumetza. The lawsuit was filed in response to an ANDA filed with the FDA by Lupin regarding Lupin’s intent to market generic versions of Glumetza 500 mg and 1000 mg tablets prior to the expiration of the listed patents. In February 2012, the case was settled allowing Lupin to begin selling a generic version of Glumetza in February 2016, or earlier under certain circumstances, and the District Court entered an order dismissing the case without prejudice.

In June 2011, Depomed filed a lawsuit in the U.S. District Court for the District of New Jersey against Sun Pharma Global FZE, Sun Pharmaceutical Industries Ltd. and Sun Pharmaceutical Industries Inc. (collectively “Sun”) for infringement of the patents listed in the Orange Book for Glumetza. Valeant International Bermuda (“Valeant”) was joined in the lawsuit as a co-plaintiff. The lawsuit was filed in response to an ANDA filed with the FDA by Sun regarding Sun’s intent to market generic versions of Glumetza 500 mg and 1000 mg tablets prior to the expiration of the listed patents. In January 2013, the case was settled allowing Sun to begin selling a generic version of Glumetza in August 2016, or earlier under certain circumstances, and the District Court dismissed the case without prejudice.

In April 2012, Depomed filed a lawsuit in the U.S. District Court for the District of Delaware against Watson Laboratories, Inc. — Florida, Actavis, Inc. and Watson Pharma, Inc., collectively referred to herein as Watson, for infringement of the patents listed in the Orange Book for Glumetza 1000 mg at the time the lawsuit was filed (U.S. Patent Nos. 6,488,962 and 7,780,987). Valeant is joined in the lawsuit as a co-plaintiff. The lawsuit was filed in response to an ANDA filed with the FDA by Watson regarding Watson’s intent to market a generic version of Glumetza 1000 mg tablets prior to the expiration of the listed patents. Depomed and Valeant commenced the lawsuit within the requisite 45-day time period, resulting in an FDA stay on the approval of Watson’s proposed product for 30 months or until a decision is rendered by the District Court, which is adverse to the asserted patents. Absent a court decision, the 30-month stay is expected to expire in September 2014. In June 2012, Watson filed its answer, which alleges, among other things, non-infringement and invalidity of the asserted patents, failure to state a claim, lack of subject matter jurisdiction, and has also filed counterclaims. In February 2013, Depomed amended its complaint to add infringement of a newly listed Orange Book patent (U.S. Patent No. 8,323,692), as well as two non-Orange Book listed patents (U.S. Patent Nos. 7,736,667 and 8,329,215). The Markman hearing for this matter has been scheduled in April 2014, and the trial has been scheduled in May 2014. In August 2013, the District Court ordered that the case be stayed. The Company is not able to predict the timing or outcome of this lawsuit.

In February 2013, Depomed filed a lawsuit in the U.S. District Court for the District of Delaware against Watson for infringement of the patents listed in the Orange Book for Glumetza 500 mg (U.S. Patent Nos. 6,340,475; 6,488,962; 6,635,280 and 6,723,340). The lawsuit was filed in response to an ANDA filed with the FDA by Watson regarding Watson’s intent to market a generic version of Glumetza 500 mg tablets prior to the expiration of the listed patents. Depomed commenced the lawsuit within the requisite 45-day time period, resulting in an FDA stay on the approval of Watson’s proposed product for 30 months or until a decision is rendered by the District Court, which is adverse to the asserted patents. Absent a court decision, the 30-month stay is expected to expire in July 2015. In March 2013, Watson filed its answer, which alleges, among other things, non-infringement and invalidity of the asserted patents, failure to state a claim, and lack of subject matter jurisdiction, and has also filed counterclaims. The Markman hearing for this matter has been scheduled in December 2014, and a trial has been scheduled in January 2015. In August 2013, the District Court ordered that the case be stayed. The Company is not able to predict the timing or outcome of this lawsuit.

Under the terms of the Company’s commercialization agreement with Depomed, Depomed will manage any ongoing patent infringement litigation relating to Glumetza, subject to certain consent rights in favor of the Company, including with regard to any proposed settlements. The Company is responsible for 70% of the future out-of-pocket costs, and Depomed is responsible for 30% of the future out-of-pocket costs, related to patent infringement cases. Although Depomed has indicated that it intends to vigorously defend and enforce its patent rights, the Company is not able to predict the timing or outcome of ongoing or future actions. At this time the Company is unable to estimate possible losses or ranges of losses for ongoing actions.

Any adverse outcome in the litigation described above would adversely impact the Company and its revenues. Regardless of how these litigation matters are ultimately resolved, the litigation will continue to be costly, time-consuming and distracting to management, which could have a material adverse effect on the Company.

In addition, certain of the patents that provide coverage for Glumetza are utilized in other products developed by Depomed or Depomed licensees and are subject to ongoing patent infringement litigation and may be subject to patent infringement litigation in the future. Any adverse outcome in such patent infringement litigation could negatively impact the value of the patent coverage for Glumetza.

Fenoglide Patent Litigation

Prior to the execution of the license agreement, Shore Therapeutics, Inc. (“Shore”) entered into a settlement arrangement with Impax Laboratories, Inc. (“Impax”) in connection with patent infringement litigation associated with Impax’s ANDA for a generic version of Fenoglide and a related paragraph IV challenge. The settlement terms grant Impax a sublicense to begin selling a generic version of Fenoglide on October 1, 2015, or earlier under certain circumstances. In February 2012, the U.S. District Court for the District of Delaware entered an order dismissing the litigation, and the Company assumed Shore’s obligations associated with the sublicense to Impax.

In January 2013, the Company filed a lawsuit in the U.S. District Court for the District of Delaware against Mylan Inc. and Mylan Pharmaceuticals Inc. (collectively “Mylan”) for infringement of the patents listed in the Orange Book for Fenoglide 120 mg and 40 mg at the time the lawsuit was filed (U.S. Patent Nos. 7,658,944, and 8,124,125). Veloxis Pharmaceuticals A/S (“Veloxis”) is joined in the lawsuit as a co-plaintiff. The lawsuit was filed in response to an ANDA filed with the FDA by Mylan regarding Mylan’s intent to market a generic version of Fenoglide 120 mg and 40 mg tablets prior to the expiration of the listed patents. The Company commenced the lawsuit within the requisite 45-day time period, resulting in an FDA stay on the approval of Mylan’s proposed product for 30 months or until a decision is rendered by the District Court, which is adverse to the asserted patents, whichever may occur earlier. Absent a court decision, the 30-month stay is expected to expire in June 2015. In February 2013, Mylan filed its answer, which alleges, among other things, non-infringement, invalidity, and failure to state a claim, and has also filed counterclaims. In August 2013, the Company filed an amended complaint to add infringement of a newly listed Orange Book patent (U.S. Patent No. 8,481,078). In September 2013, Mylan filed its answer to the amended complaint, which alleges, among other things, non-infringement, invalidity, and failure to state a claim, and has also filed counterclaims. The Markman hearing for this matter has been scheduled in June 2014, and a trial has been scheduled in March 2015. The Company is not able to predict the timing or outcome of this lawsuit.

Trademark Litigation

In October 2013, Endochoice, Inc. (“Endochoice”) filed a lawsuit in the U.S. District Court for the Southern District of New York against the Company for trademark infringement, false designation of origin, and unfair competition under the Trademark Act, unfair trade practices under the New York Unfair Trade Practices Act, and trademark infringement and unfair competition under the common law of the State of New York, all in connection with the Company’s use of a graphical logo in connection with some materials related to Uceris. Endochoice’s requested relief includes a permanent injunction preventing the Company from continued use of the graphical logo, that the Company surrender for destruction all products, web pages, labels, advertisements, promotional and other materials that use the graphical logo, an award of damages, and payment of Endochoice’s costs and expenses, including reasonable attorney’s fees. The Company is not able to predict the timing or outcome of this lawsuit.

17. Subsequent Event

On November 7, 2013, the Company entered into an agreement and plan of merger (“Merger Agreement”) with Salix Pharmaceuticals, Ltd. (“Parent”), Salix Pharmaceuticals, Inc., a wholly-owned subsidiary of Parent, and Willow Acquisition Sub Corporation, a wholly-owned indirect subsidiary of Parent (“Merger Sub”), pursuant to which, and on the terms and subject to the conditions thereof, among other things, Merger Sub will commence a tender offer (“Offer”), no later than December 3, 2013, to acquire all of the outstanding shares of common stock of the Company at a purchase price of $32.00 per share in cash, without interest (the “Offer Price”). Following the completion of the Offer and subject to the satisfaction or waiver of certain conditions set forth in the Merger Agreement, Merger Sub will merge with and into the Company, with the Company surviving as an indirect wholly-owned subsidiary of Parent, pursuant to the procedure provided for under Section 251(h) of the Delaware General Corporation Law without any additional stockholder approvals (the “Merger”).

At the effective time of the Merger (the “Effective Time”), by virtue of the Merger and without any action on the part of the holders of any shares of common stock of the Company, each outstanding share of common stock of the Company, other than any shares owned by the Company, Parent, Merger Sub or any wholly-owned subsidiary of the Company or of Parent, or any stockholders who are entitled to and who properly exercise appraisal rights under Delaware law, will be canceled and converted into the right to receive an amount in cash equal to the Offer Price. In addition, upon the closing of the Offer each outstanding Company stock option will fully vest and, at the Effective Time, the holder thereof will be entitled to receive an amount in cash, without interest and less the amount of any tax withholding, equal to the product of the excess, if any, of the Offer Price over the exercise price of such option and the number of shares of Company common stock underlying such option.

The obligation of Merger Sub to purchase the shares of common stock of the Company tendered in the Offer is subject to the satisfaction or waiver of a number of conditions set forth in the Merger Agreement, including (i) that there shall have been validly tendered and not validly withdrawn a number of shares of common stock of the Company that represent one more than 50% of the total number of shares of common stock of the Company outstanding at the time of the expiration of the Offer (calculated on a fully-diluted basis), and (ii) the expiration or termination of applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended. The consummation of the Offer is not subject to any financing condition.

The Merger Agreement contains customary representations, warranties and covenants, including covenants obligating the Company to continue to conduct its business in the ordinary course and to cooperate in seeking regulatory approvals. The Company has also agreed (1) to cease all existing, and agreed not to solicit or initiate any additional, discussions with third parties regarding other proposals to acquire the Company and (2) to certain restrictions on its ability to respond to such proposals, subject to fulfillment of certain fiduciary requirements of the board of directors of the Company.

The Merger Agreement includes a remedy of specific performance for the Company, Parent and Merger Sub. The Merger Agreement also contains certain termination rights in favor of each the Company and Parent, including under certain circumstances, the requirement for the Company to pay to Parent a termination fee of $80 million. The board of directors of the Company has unanimously (i) determined that the Merger Agreement and the transactions contemplated thereby are fair to, advisable and in the best interests of the Company’s stockholders, (ii) approved and declared advisable the Merger Agreement and the transactions contemplated thereby and (iii) resolved to recommend acceptance of the Offer by the Company’s stockholders. The board of directors of Parent also has unanimously approved the transaction. The Company expects to complete the Merger in the first quarter of 2014, subject to the satisfaction of the closing conditions.

Concurrently with the execution and delivery of the Merger Agreement, on November 7, 2013, the Company and Parent entered into an agreement (the “License Amendment”) with Cosmo, which License Amendment modifies certain terms of the License Agreement by and between the Company and Cosmo dated December 10, 2008 (the “Original License Agreement”). Under the terms of the License Amendment, among other things, effective and conditioned upon the consummation of the Merger, (1) the Company agreed to return to Cosmo all rights to rifamycin SV MMX acquired by the Company under the Original License Agreement, (2) Cosmo consented to the development, promotion and marketing in the United States by the Company, Parent and any of their subsidiaries of budesonide products; provided, that the Company, Parent and their subsidiaries are prohibited from developing, promoting or marketing an oral formulation budesonide product other than the product licensed by the Company under the Original License Agreement, and (3) milestone obligations payable to Cosmo are only payable in cash, and the Stock Issuance Agreement between the Company and Cosmo, effective as of December 10, 2008, and the Registration Rights Agreement between the Company and Cosmo, dated as of December 10, 2008 and amended on April 23, 2009, were terminated. The License Amendment shall automatically terminate upon any termination of the Merger Agreement or if the Merger is not consummated by June 30, 2014.

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

The following discussion contains forward-looking statements, which involve risks and uncertainties. As used herein, the terms “we,” “us,” “our” or the “Company” refer to Santarus, Inc., a Delaware corporation, and its wholly owned subsidiary Covella. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth below under the caption “Risk Factors.” The interim consolidated financial statements and this Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the consolidated financial statements and notes thereto for the year ended December 31, 2012 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K for the year ended December 31, 2012.

Overview

We are a specialty biopharmaceutical company focused on acquiring, developing and commercializing proprietary products that address the needs of patients treated by physician specialists.

Our commercial organization currently promotes the following products in the U.S. prescription pharmaceutical market:

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Uceris^® (budesonide) extended release tablets is available in 9 mg tablets and is a locally acting corticosteroid in an oral tablet formulation that utilizes proprietary multi-matrix system, or MMX, colonic delivery technology. Uceris is indicated for the induction of remission in patients with active, mild to moderate ulcerative colitis.

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Zegerid^® (omeprazole/sodium bicarbonate) capsules and powder for oral suspension is available in 20 mg and 40 mg dosage strengths and is a proprietary immediate-release formulation of the proton pump inhibitor, or PPI, omeprazole. Zegerid is indicated for short-term treatment of active duodenal ulcer, short-term treatment of active benign gastric ulcer, treatment of gastroesophageal reflux disease, or GERD, maintenance of healing of erosive esophagitis and reduction of risk of upper gastrointestinal, or GI, bleeding in critically ill patients. In addition, we receive a significant percentage of the gross margin on sales of an authorized generic version of Zegerid capsules.

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Glumetza^® (metformin hydrochloride extended release tablets) is available in 500 mg and 1000 mg tablets and is a once-daily, extended-release formulation of metformin that incorporates patented drug delivery technology. Glumetza is indicated as an adjunct to diet and exercise to improve glycemic control in adult patients with type 2 diabetes.

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Cycloset^® (bromocriptine mesylate) tablets is available in 0.8 mg tablets and is a novel formulation of bromocriptine, a dopamine receptor agonist that acts on the central nervous system. Cycloset is indicated as an adjunct to diet and exercise to improve glycemic control in adult patients with type 2 diabetes.

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Fenoglide^® (fenofibrate) tablets is available in 40 mg and 120 mg tablets and is a proprietary formulation of fenofibrate that incorporates patented drug delivery technology. Fenoglide is indicated as an adjunct to diet to reduce elevated low-density lipoprotein-cholesterol, or LDL-C, total cholesterol, triglycerides and apolipoprotein B, or Apo B, and to increase high-density lipoprotein-cholesterol, or HDL-C, in adult patients with primary hyperlipidemia or mixed dyslipidemia. Fenoglide also is indicated as an adjunct to diet for treatment of adult patients with hypertriglyceridemia.

In addition to our commercial products, we are focused on advancing the following investigational drugs to commercialization:

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Ruconest^® (recombinant human C1 esterase inhibitor) is a recombinant version of the human protein C1 esterase inhibitor, which is produced using proprietary transgenic technology. In November 2012, we announced positive top-line results from the phase III clinical study to evaluate the safety and efficacy of Ruconest for the treatment of acute attacks of angioedema in patients with hereditary angioedema, or HAE. In June 2013, our biologics license application, or BLA, seeking approval to market Ruconest for this indication was accepted for review by the U.S. Food and Drug Administration, or FDA.

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Rifamycin SV MMX^® is a broad spectrum, non-systemic antibiotic in a novel oral tablet formulation, which utilizes proprietary MMX colonic delivery technology. In September 2012, we announced positive top-line results from the first phase III clinical study to evaluate the safety and efficacy of rifamycin SV MMX for the treatment of patients with travelers’ diarrhea. Dr. Falk Pharma GmbH, or Dr. Falk, is currently conducting a second phase III clinical study evaluating rifamycin SV MMX for the treatment of travelers’ diarrhea.

•

SAN-300 (anti-VLA-1 antibody) is a novel early stage anti-VLA-1 monoclonal antibody, or mAb, investigational drug that we initially expect to develop for the treatment of rheumatoid arthritis. In December 2012, we completed a phase I dose-escalation clinical study in healthy volunteers to determine the safety, tolerability, pharmacokinetics and pharmacodynamics of single doses of SAN-300. We plan to begin a phase IIa clinical study evaluating SAN-300 for treatment of rheumatoid arthritis during the fourth quarter of 2013.

To leverage our PPI technology and diversify our sources of revenue, we have licensed certain exclusive rights to MSD Consumer Products, Inc., a subsidiary of Merck & Co., Inc., or Merck, to develop, manufacture and sell over-the-counter, or OTC, Zegerid products in the U.S. and Canada. We have also licensed certain exclusive rights to our PPI technology to Glaxo Group Limited, an affiliate of GlaxoSmithKline, plc, or GSK, to develop, manufacture and commercialize prescription and OTC immediate-release omeprazole products in more than 100 specified countries (including markets within Africa, Asia, the Middle-East, and Latin America).

Recent Development

On November 7, 2013, we entered into an agreement and plan of merger, or Merger Agreement, with Salix Pharmaceuticals, Ltd., or Parent, Salix Pharmaceuticals, Inc., a wholly-owned subsidiary of Parent, and Willow Acquisition Sub Corporation, a wholly-owned indirect subsidiary of Parent, or Merger Sub, pursuant to which, and on the terms and subject to the conditions thereof, among other things, Merger Sub will commence a tender offer, or Offer, no later than December 3, 2013, to acquire all of our outstanding shares of common stock at a purchase price of $32.00 per share in cash, without interest, or the Offer Price. Following the completion of the Offer and subject to the satisfaction or waiver of certain conditions set forth in the Merger Agreement, Merger Sub will merge with and into Santarus, with Santarus surviving as an indirect wholly-owned subsidiary of Parent, pursuant to the procedure provided for under Section 251(h) of the Delaware General Corporation Law without any additional stockholder approvals, such merger being referred to herein as the Merger.

At the effective time of the Merger, or the Effective Time, by virtue of the Merger and without any action on the part of the holders of any shares of our common stock, each outstanding share of our common stock, other than any shares owned by us, Parent, Merger Sub or any wholly-owned subsidiary of Santarus or of Parent, or any stockholders who are entitled to and who properly exercise appraisal rights under Delaware law, will be canceled and converted into the right to receive an amount in cash equal to the Offer Price. In addition, upon the closing of the Offer each of our outstanding stock options will fully vest and, at the Effective Time, the holder thereof will be entitled to receive an amount in cash, without interest and less the amount of any tax withholding, equal to the product of the excess, if any, of the Offer Price over the exercise price of such option and the number of shares of our common stock underlying such option.

The obligation of Merger Sub to purchase the shares of our common stock tendered in the Offer is subject to the satisfaction or waiver of a number of conditions set forth in the Merger Agreement, including (i) that there shall have been validly tendered and not validly withdrawn a number of shares of our common stock that represent one more than 50% of the total number of shares of our common stock outstanding at the time of the expiration of the Offer (calculated on a fully-diluted basis), and (ii) the expiration or termination of applicable waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended. The consummation of the Offer is not subject to any financing condition.

The Merger Agreement contains customary representations, warranties and covenants, including covenants obligating us to continue to conduct our business in the ordinary course and to cooperate in seeking regulatory approvals. We have also agreed (1) to cease all existing, and agreed not to solicit or initiate any additional, discussions with third parties regarding other proposals to acquire us and (2) to certain restrictions on our ability to respond to such proposals, subject to fulfillment of certain fiduciary requirements of our board of directors.

The Merger Agreement includes a remedy of specific performance for us, Parent and Merger Sub. The Merger Agreement also contains certain termination rights in favor of each us and Parent, including under certain circumstances, the requirement for us to pay to Parent a termination fee of $80 million. Our board of directors has unanimously (i) determined that the Merger Agreement and the transactions contemplated thereby are fair to, advisable and in the best interests of our stockholders, (ii) approved and declared advisable the Merger Agreement and the transactions contemplated thereby and (iii) resolved to recommend acceptance of the Offer by our stockholders. The board of directors of Parent also has unanimously approved the transaction. We expect to complete the Merger in the first quarter of 2014, subject to the satisfaction of the closing conditions.

Concurrently with the execution and delivery of the Merger Agreement, on November 7, 2013, we and Parent entered into an agreement, or the License Amendment, with Cosmo Technologies Limited, an affiliate of Cosmo Pharmaceuticals S.p.A., or Cosmo, which License Amendment modifies certain terms of the License Agreement by and between us and Cosmo dated December 10, 2008, or the Original License Agreement. Under the terms of the License Amendment, among other things, effective and conditioned upon the consummation of the Merger, (1) we agreed to return to Cosmo all rights to rifamycin SV MMX acquired by us under the Original License Agreement, (2) Cosmo consented to the development, promotion and marketing in the United States by us, Parent and any of their subsidiaries of budesonide products; provided, that we, Parent and their subsidiaries are prohibited from developing, promoting or marketing an oral formulation budesonide product other than the product licensed by us under the Original License Agreement, and (3) milestone obligations payable to Cosmo are only payable in cash, and the Stock Issuance Agreement between us and Cosmo, effective as of December 10, 2008, and the Registration Rights Agreement between us and Cosmo, dated as of December 10, 2008 and amended on April 23, 2009, were terminated. The License Amendment shall automatically terminate upon any termination of the Merger Agreement or if the Merger is not consummated by June 30, 2014.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. We review our estimates on an on-going basis. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. We believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our financial statements.

Principles of Consolidation

Our consolidated financial statements include the accounts of Santarus and its wholly owned subsidiary, Covella Pharmaceuticals, Inc., or Covella. We do not have any interest in variable interest entities. All material intercompany transactions and balances have been eliminated in consolidation.

Inventories and Related Reserves

Inventories are stated at the lower of cost or market (net realizable value). Cost is determined by the first-in, first-out method. Inventories consist of finished goods and raw materials used in the manufacture of our commercial products. We provide reserves for potentially excess, dated or obsolete inventories based on an analysis of inventory on hand and on firm purchase commitments compared to forecasts of future sales.

Business Combinations

The authoritative guidance for business combinations establishes principles and requirements for recognizing and measuring the total consideration transferred to and the assets acquired and liabilities assumed in the acquired target in a business combination.

We accounted for the acquisition of Covella in September 2010 in accordance with the authoritative guidance for business combinations. The consideration paid to acquire Covella was required to be measured at fair value and included cash consideration, the issuance of our common stock and contingent consideration, which includes our obligation to make clinical and regulatory milestone payments based on success in developing product candidates in addition to a royalty on net sales of any commercial products resulting from the anti-VLA-1 mAb technology. After the total consideration transferred was calculated by determining the fair value of the contingent consideration plus the upfront cash and stock consideration, we assigned the purchase price of Covella to the fair value of the assets acquired and liabilities assumed. This allocation of the purchase price resulted in recognition of intangible assets related to in-process research and development, or IPR&D, and goodwill.

We accounted for the commercialization agreement with Depomed, Inc., or Depomed, entered into in August 2011 in accordance with the authoritative guidance for business combinations. The purchase consideration was comprised of cash payments for the purchase of existing inventory, and the entire purchase price was allocated to inventory, as cost approximated fair value, and no other assets were acquired and no liabilities were assumed in the transaction. Under the commercialization agreement, we have an obligation to pay royalties to Depomed based on Glumetza net product sales. These royalties are being expensed as incurred as we determined that the royalty rates reflect reasonable market rates for the manufacturing and commercialization rights we were granted under the commercialization agreement.

We accounted for the license agreement with Healthcare Royalty Partners, L.P., or HRP, and Shore Therapeutics, Inc., or Shore, entered into in December 2011 in accordance with the authoritative guidance for business combinations. The purchase consideration was comprised of an upfront cash payment, and the purchase price was allocated to prepaid royalty expense and intangible assets related to the license agreement. There were no other assets acquired or liabilities assumed under the license agreement. Under the license agreement, we have an obligation to pay royalties to Shore based on Fenoglide net product sales

and certain one-time success-based milestones contingent on sales achievement. These royalties and sales milestones will be expensed as incurred as we determined that the royalty rates and sales milestone amounts reflect reasonable market rates for the manufacturing and commercialization rights granted under the license agreement.

The determination and allocation of consideration transferred in a business combination requires us to make significant estimates and assumptions, especially at the acquisition date with respect to the fair value of the contingent consideration. The key assumptions in determining the fair value are the discount rate and the probability assigned to the potential milestone or royalty being achieved. We remeasure the fair value of the contingent consideration at each reporting period, with any change in fair value being recorded in the current period’s operating expenses. Changes in the fair value may result from either the passage of time or events occurring after the acquisition date, such as changes in the estimated probability or timing of achieving the milestone or royalty.

Intangible Assets and Goodwill

Our intangible assets are comprised primarily of acquired IPR&D and license agreements. Goodwill represents the excess of the cost over the fair value of net assets acquired from business combinations. We periodically assess the carrying value of our intangible assets and goodwill, which requires us to make assumptions and judgments regarding the future cash flows of these assets. The assets are considered to be impaired if we determine that the carrying value may not be recoverable based upon our assessment of the following events or changes in circumstances:

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the asset’s ability to generate income from operations and positive cash flow in future periods;

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loss of legal ownership or title to the asset;

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significant changes in our strategic business objectives and utilization of the asset(s); and

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the impact of significant negative industry, regulatory or economic trends.

IPR&D will not be amortized until the related development process is complete, and goodwill is not amortized. License agreements and other intangible assets are amortized over their estimated useful lives. If the assets are considered to be impaired, the impairment we recognize is the amount by which the carrying value of the assets exceeds the fair value of the assets. Fair value is determined by a combination of third-party sources and forecasted discounted cash flows. In addition, we base the useful lives and related amortization expense on our estimate of the period that the assets will generate revenues or otherwise be used. We also periodically review the lives assigned to our intangible assets to ensure that our initial estimates do not exceed any revised estimated periods from which we expect to realize cash flows from the technologies. A change in any of the above-mentioned factors or estimates could result in an impairment charge which could negatively impact our results of operations. We have not recognized any impairment charges on our intangible assets or goodwill through September 30, 2013.

Revenue Recognition

We recognize revenue when there is persuasive evidence that an arrangement exists, title has passed, the price is fixed or determinable, and collectability is reasonably assured.

Product Sales, Net. We sell our commercial products primarily to pharmaceutical wholesale distributors. We are obligated to accept from customers products that are returned within six months of their expiration date or up to 12 months beyond their expiration date. The shelf life of our products from the date of manufacture is as follows: Uceris (36 months); Zegerid (36 months); Glumetza (36 to 48 months); Cycloset (18 months); and Fenoglide (36 months). We authorize returns for expired or damaged products in accordance with our return goods policy and procedures. We issue credit to the customer for expired or damaged returned product. We rarely exchange product from inventory for returned product. At the time of sale, we record our estimates for product returns as a reduction to revenue at full sales value with a corresponding increase in the allowance for product returns liability. Actual returns are recorded as a reduction to the allowance for product returns liability at sales value with a corresponding decrease in accounts receivable for credit issued to the customer.

We recognize product sales net of estimated allowances for product returns, estimated rebates in connection with contracts relating to managed care, Medicare, patient coupons and voucher programs, and estimated chargebacks from distributors, wholesaler fees and prompt payment and other discounts. We establish allowances for estimated product returns, rebates and chargebacks based primarily on the following qualitative and quantitative factors:

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the number of and specific contractual terms of agreements with customers;

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estimated levels of inventory in the distribution channel;

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estimated remaining shelf life of products;

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analysis of prescription data gathered by a third-party prescription data provider;

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direct communication with customers;

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historical product returns, rebates and chargebacks;

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anticipated introduction of competitive products or generics;

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anticipated pricing strategy changes by us and/or our competitors; and

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the impact of state and federal regulations.

In our analyses, we utilize prescription data purchased from a third-party data provider to develop estimates of historical inventory channel pull-through. We utilize a separate analysis which compares historical product shipments less returns to estimated historical prescriptions written. Based on that analysis, we develop an estimate of the quantity of product in the distribution channel which may be subject to various product return, rebate and chargeback exposures.

Our estimates of product returns, rebates and chargebacks require our most subjective and complex judgment due to the need to make estimates about matters that are inherently uncertain. If actual future payments for returns, rebates, chargebacks and other discounts vary from the estimates we made at the time of sale, our financial position, results of operations and cash flows would be impacted.

Our allowance for product returns was $24.2 million as of September 30, 2013 and $20.6 million as of December 31, 2012. We recognize product sales at the time title passes to our customers, and we provide for an estimate of future product returns at that time based upon historical product returns trends, analysis of product expiration dating and estimated inventory levels in the distribution channel, review of returns trends for similar products, if available, and the other factors discussed above. Due to the lengthy shelf life of our products and the terms of our returns policy, there may be a significant time lag between the date we determine the estimated allowance and when we receive the product return and issue credit to a customer. Therefore, the amount of returns processed against the allowance in a particular year generally has no direct correlation to the product sales in the same year, and we may record adjustments to our estimated allowance over several periods, which can result in a net increase or a net decrease in our operating results in those periods.

We have been tracking our Zegerid product returns history by individual production batches from the time of our first commercial product launch of Zegerid powder for oral suspension 20 mg in late 2004. We launched Cycloset in November 2010 and began distributing Fenoglide in December 2011. Under a commercialization agreement with Depomed, we began distributing and recording product sales for Glumetza in September 2011. We have provided for an estimate of product returns based upon a review of our product returns history and returns trends for similar products, taking into consideration the effect of a product’s shelf life on its returns history. We launched Uceris in February 2013 and recognize product sales when title has passed to customers. Based on our historical experience with our Zegerid and Glumetza products, we have the ability to develop a reasonable estimate of Uceris product returns, taking into consideration the similar shelf lives and distribution channels of these products.

In the nine months ended September 30, 2012, based upon our analysis of product expiration dating and actual product returns history through September 30, 2012, we increased our estimate for Cycloset product returns to reflect actual experience accordingly. The increase in our estimate for Cycloset product returns reflected higher than expected actual returns, as well as an increase in the sales price of Cycloset, during the second quarter of 2012. Contributing to the higher than expected actual product returns was our receipt of regulatory approval during the second quarter of 2012 for an improved process for the manufacturing of Cycloset product. We began shipping Cycloset product manufactured under the new process in the second quarter of 2012. As a result of the availability of this new product that has the standard 18 months shelf life from the date of manufacture, we experienced higher than expected product returns of short-dated Cycloset product in accordance with our returns policy in the second quarter of 2012. For the nine months ended September 30, 2012, we recorded an increase in our estimated allowance for Cycloset product returns associated with product sales in prior periods of approximately $1.8 million. This change in estimate was based on our assessment of actual returns of Cycloset product during the nine months ended September 30, 2012. Prior to 2012, we had not experienced significant returns activity.

Our allowance for rebates, chargebacks and other discounts was $23.0 million as of September 30, 2013 and $17.2 million as of December 31, 2012. These allowances reflect an estimate of our liability for rebates due to managed care organizations under specific contracts, rebates due to various organizations in connection with Medicare contracts, patient coupons and voucher programs, chargebacks due to various organizations purchasing our products through federal contracts and/or group purchasing agreements, and other rebates and customer discounts due in connection with wholesaler fees and prompt payment and other discounts. We estimate our liability for rebates and chargebacks at each reporting period based on a combination of the qualitative and quantitative assumptions listed above. In each reporting period, we evaluate our outstanding contracts and apply the contractual discounts to the invoiced price of wholesaler shipments recognized. Although the total invoiced price of shipments to wholesalers for the reporting period and the contractual terms are known during the reporting period, we project the ultimate disposition of the sale (e.g. future utilization rates of cash payors, managed care, Medicare or other contracted organizations). This estimate is based on historical trends adjusted for anticipated changes based on specific contractual terms of new agreements with customers, anticipated pricing strategy changes by us and/or our competitors and the other qualitative and quantitative factors described above. There may be a significant time lag between the date we determine the estimated allowance and when we make the contractual payment or issue credit to a customer. Due to this time lag, we record adjustments to our estimated allowance over several periods, which can result in a net increase or a net decrease in our operating results in those periods. For the nine months ended September 30, 2013 and 2012, actual results were not materially different from our estimates.

In late June 2010, we began selling an authorized generic version of our prescription Zegerid capsules under a distribution and supply agreement with Prasco LLC, or Prasco. Prasco has agreed to purchase all of its authorized generic product requirements from us and pays a specified invoice supply price for such products. We recognize revenue from shipments to Prasco at the invoice supply price and the related cost of product sales when title transfers, which is generally at the time of shipment. We are also entitled to receive a significant percentage of the gross margin on sales of the authorized generic products by Prasco, which we recognize as an addition to product sales, net when Prasco reports to us the gross margin from the ultimate sale of the products. Any adjustments to the gross margin related to Prasco’s estimated sales discounts and other deductions are recognized in the period Prasco reports the amounts to us.

Promotion, Royalty and Other License Revenue. We analyze each element of our promotion and licensing agreements to determine the appropriate revenue recognition. Prior to January 1, 2011, we recognized revenue on upfront payments over the period of significant involvement under the related agreements unless the fee was in exchange for products delivered or services rendered that represent the culmination of a separate earnings process and no further performance obligation existed under the contract. We follow the authoritative guidance for revenue arrangements with multiple deliverables materially modified or entered into after December 31, 2010. Under this guidance, we identify the deliverables included within the agreement and evaluate which deliverables represent separate units of accounting. Upfront license fees are generally recognized upon delivery of the license if the facts and circumstances dictate that the license has standalone value from any undelivered items, the relative selling price allocation of the license is equal to or exceeds the upfront license fees, persuasive evidence of an arrangement exists, our price to the partner is fixed or determinable and collectability is reasonably assured. Upfront license fees are deferred if facts and circumstances dictate that the license does not have standalone value. The determination of the length of the period over which to defer revenue is subject to judgment and estimation and can have an impact on the amount of revenue recognized in a given period.

Effective January 1, 2011, we adopted prospectively, the authoritative guidance that offers an alternative method of revenue recognition for milestone payments. Under the milestone method guidance, we recognize payment that is contingent upon the achievement of a substantive milestone, as defined in the guidance, in its entirety in the period in which the milestone is achieved. Other milestones that do not fall under the definition of a milestone under the milestone method are recognized under the authoritative guidance concerning revenue recognition. Sales milestones, royalties and promotion fees are based on sales and/or gross margin information, which may include estimates of sales discounts and other deductions, received from the relevant alliance agreement partner. Sales milestones, royalties and promotion fees are recognized as revenue when earned under the agreements, and any adjustments related to estimated sales discounts and other deductions are recognized in the period the alliance agreement partner reports the amounts to us.

Stock-Based Compensation

We estimate the fair value of stock options and employee stock purchase plan rights granted using the Black-Scholes valuation model. This estimate is affected by our stock price, as well as assumptions regarding a number of complex and subjective variables. These variables include the expected volatility of our stock price, the expected life of the stock option, the risk-free interest rate and expected dividends. In determining our volatility factor, we perform an analysis of the historical volatility of our common stock for a period corresponding to the expected life of the options. In addition, we consider the

expected volatility of similar entities. In evaluating similar entities, we consider factors such as industry, stage of development, size and financial leverage. In determining the expected life of the options, we use the “simplified” method. Under this method, the expected life is presumed to be the mid-point between the vesting date and the end of the contractual term. We will continue to use the “simplified” method until we have sufficient historical exercise data to estimate the expected life of the options.

The fair value of options granted is amortized on a straight-line basis over the requisite service period of the awards, which is generally the vesting period ranging from one to four years. Pre-vesting forfeitures were estimated to be approximately 0% for the three and nine months ended September 30, 2013 and 2012 as the majority of options granted contain monthly vesting terms.

The following table includes stock-based compensation recognized in our consolidated statements of operations (in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
Cost of product sales	$	137	$	58	$	318	$	162
Research and development		794		317		1,980		885
Selling, general and administrative		3,279		1,428		7,801		3,850

Total	$	4,210	$	1,803	$	10,099	$	4,897

As of September 30, 2013, total unrecognized compensation cost related to stock options and employee stock purchase plan rights was approximately $35.0 million, and the weighted average period over which it was expected to be recognized was 2.9 years.

Income Taxes

We provide for income taxes under the liability method. This approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of differences between the tax basis of assets or liabilities and their carrying amounts in the financial statements. We provide a valuation allowance for deferred tax assets if it is more likely than not that these items will expire before we are able to realize their benefit. We calculate the valuation allowance in accordance with the authoritative guidance relating to income taxes, which requires an assessment of both positive and negative evidence regarding the realizability of these deferred tax assets, when measuring the need for a valuation allowance. Significant judgment is required in determining any valuation allowance against deferred tax assets. At December 31, 2012, due to a history of operating losses and other key operating factors, including uncertainty regarding the pending FDA approval to market and commercialize Uceris, we concluded that a full valuation allowance was necessary to offset all of our deferred tax assets. At June 30, 2013, we concluded that it was more likely than not that our deferred tax assets would be realized through future taxable income. This conclusion was based on our sustained profitability for 2011, 2012 and the six months ended June 30, 2013, assessment of sales trends for each of our products including Uceris, which we commercially launched in February 2013, and projections of positive future earnings. The release of the valuation allowance resulted in an income tax benefit of $54.9 million, which was recorded as a discrete item in the three months ended June 30, 2013. The release of the valuation allowance will not affect the amount of cash paid for income taxes. We reassess our ability to realize the deferred tax benefits on a quarterly basis. If it is more likely than not that we will not realize the deferred tax benefits, then all or a portion of the valuation allowance may need to be re-established, which would result in a charge to tax expense.

We follow the authoritative guidance relating to accounting for uncertainty in income taxes. This guidance clarifies the recognition threshold and measurement attributes for financial statement disclosure of tax positions taken or expected to be taken on a tax return. The impact of an uncertain income tax position on the income tax return must be recognized at the largest amount that is more likely than not to be sustained upon audit by the relevant taxing authority. An uncertain tax position will not be recognized if it has less than a 50% likelihood of being sustained.

The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP. There are also areas in which our management’s judgment in selecting any available alternative would not produce a materially different result. Please see our audited consolidated financial statements and notes thereto included in our annual report on Form 10-K, which contain accounting policies and other disclosures required by GAAP.

Recent Accounting Pronouncements

In June and December 2011, the Financial Accounting Standards Board, or FASB, issued authoritative guidance on the presentation of comprehensive income. Under this newly issued authoritative guidance, an entity has the option to present comprehensive income and net income either in a single continuous statement or in two separate but consecutive statements. This guidance, therefore, eliminated the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. We adopted the requirements of this guidance effective for our fiscal year beginning January 1, 2012. Upon adoption, the guidance did not have a material impact on our consolidated financial statements. In February 2013, the FASB amended its guidance on reporting reclassifications out of accumulated other comprehensive income. For significant items reclassified out of accumulated other comprehensive income to net income in their entirety in the same reporting period, this amendment requires reporting about the effect of the reclassifications on the respective line items in the statement where net income is presented. For items that are not reclassified to net income in their entirety in the same reporting period, a cross reference to other disclosures currently required under GAAP is required in the notes to the financial statements. This amendment is effective for interim periods beginning after December 15, 2012. Upon adoption, the guidance did not have a material impact on our consolidated financial statements.

Results of Operations

Comparison of Three Months Ended September 30, 2013 and 2012 and Nine Months Ended September 30, 2013 and 2012

Product Sales, Net. Product sales, net were $98.1 million for the three months ended September 30, 2013 and $53.7 million for the three months ended September 30, 2012. Product sales, net were $265.1 million for the nine months ended September 30, 2013 and $145.1 million for the nine months ended September 30, 2012. The following table summarizes the components of our product sales, net (in thousands):


	Three Months Ended September 30,				Nine Months Ended September 30,
	2013		2012		2013		2012
Product sales, net
Glumetza	$	45,558	$	39,236	$	131,438	$	102,404
Zegerid (brand and authorized generic)		27,152		8,407		73,396		27,216
Uceris		19,584		—		42,365		—
Cycloset		4,161		4,323		12,347		9,869
Fenoglide		1,618		1,721		5,540		5,635

Total product sales, net	$	98,073	$	53,687	$	265,086	$	145,124

The $44.4 million increase in product sales, net for the three months ended September 30, 2013 as compared to the three months ended September 30, 2012 included an increase in sales of our Zegerid products of $18.7 million primarily driven by sales of the authorized generic products. The increase in product sales, net also included approximately $3.1 million related to increased average selling prices and approximately $3.2 million related to increased sales volume of our Glumetza products. Product sales, net for the three months ended September 30, 2013 included $19.6 million in sales of Uceris which we launched in February 2013.

The $120.0 million increase in product sales, net for the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012 included an increase in sales of our Zegerid products of $46.2 million primarily driven by sales of the authorized generic products. The increase in product sales, net also included approximately $21.8 million related to increased average selling prices and approximately $7.2 million related to increased sales volume of our Glumetza products. Product sales, net for the nine months ended September 30, 2013 included $42.4 million in sales of Uceris.

Royalty Revenue. Royalty revenue was $721,000 for the three months ended September 30, 2013 and $983,000 for the three months ended September 30, 2012. Royalty revenue was $2.5 million for the nine months ended September 30, 2013 and $2.6 million for the nine months ended September 30, 2012. Royalty revenue was comprised of royalty revenue earned under our license agreement with Merck for Zegerid OTC and our license agreement with GSK for prescription and OTC immediate-release omeprazole products in specified countries outside the U.S.

Cost of Product Sales. Cost of product sales was $6.0 million for the three months ended September 30, 2013 and $3.3 million for the three months ended September 30, 2012, or approximately 6% of net product sales in each period. Cost of product sales was $16.1 million for the nine months ended September 30, 2013 and $10.5 million for the nine months ended September 30, 2012, or approximately 6% and 7% of net product sales, respectively. Cost of product sales consists primarily of raw materials, third-party manufacturing costs, freight and indirect personnel and other overhead costs associated with the sales of our commercial prescription products as well as shipments to Prasco of the authorized generic version of Zegerid capsules. Cost of product sales also includes reserves for excess, dated or obsolete commercial inventories based on an analysis of inventory on hand and on firm purchase commitments compared to forecasts of future sales. The decrease in our cost of product sales as a percentage of net product sales for the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012 was primarily attributable to increased average selling prices.

License Fees and Royalties. License fees and royalties were $20.9 million for the three months ended September 30, 2013 and $14.8 million for the three months ended September 30, 2012. License fees and royalties were $63.7 million for the nine months ended September 30, 2013 and $43.5 million for the nine months ended September 30, 2012. License fees and royalties consist of royalties due to Depomed under our commercialization agreement based on net product sales of Glumetza, royalties due to Cosmo under our license agreement based on net product sales of Uceris, royalties earned by HRP and Shore under our license agreement based on net product sales of Fenoglide and royalties due to the University of Missouri based on net product sales of our Zegerid prescription products, sales of Zegerid OTC by Merck under our license agreement and products sold by GSK under our license agreement. In addition, license fees and royalties include milestone payments and upfront fees expensed or amortized under license agreements, as well as amounts payable to S2 Therapeutics, Inc., or S2, and VeroScience, LLC, or VeroScience, based on a percentage of the gross margin associated with net sales of Cycloset. License fees and royalties also include changes in the fair value of contingent consideration related to business combinations.

The $6.1 million increase in license fees and royalties for the three months ended September 30, 2013 as compared to the three months ended September 30, 2012 and the $20.2 million increase in license fees and royalties for the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012 were primarily attributable to an increase in royalties due to Depomed based on net product sales of Glumetza, as well as royalties due to Cosmo based on net product sales of Uceris which we launched in February 2013. In addition, following first commercial sale of Uceris which occurred in February 2013, Cosmo elected, in April 2013, to receive payment of a $7.0 million commercial milestone in cash. The commercial milestone has been capitalized in intangible assets and is being amortized to license fee expense over the estimated useful life of the asset on a straight-line basis through mid-2020. License fees and royalties for the nine months ended September 30, 2013 also included a $5.0 million milestone we paid Pharming Group NV, or Pharming, in July 2013 as a result of the FDA acceptance for review of our BLA for Ruconest in June 2013. For the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012, these increases were offset in part by a milestone payment to Cosmo expensed in the nine months ended September 30, 2012 based on the achievement of a regulatory milestone under our license agreement. Cosmo elected to receive payment through the issuance of 906,412 shares of our common stock. The fair value of the shares issued to Cosmo was approximately $3.7 million.

Research and Development. Research and development expenses were $6.8 million for the three months ended September 30, 2013 and $6.2 million for the three months ended September 30, 2012. Research and development expenses were $20.0 million for the nine months ended September 30, 2013 and $18.1 million for the nine months ended September 30, 2012. The $1.9 million increase in our research and development expenses for the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012 was primarily attributable to increased compensation costs associated with an increase in the number of research and development personnel and annual merit increases to existing employees, and an increase in stock-based compensation resulting from an increase in the price of our common stock. These increases were offset in part by a decrease in costs associated with our rifamycin SV MMX phase III clinical program.

Our research and development efforts are currently focused on Uceris and our Ruconest, rifamycin SV MMX and SAN-300 investigational drugs.

In connection with our strategic collaboration with Cosmo entered into in December 2008, we were granted exclusive rights in the U.S. to develop and commercialize Uceris and rifamycin SV MMX. Uceris is a locally acting corticosteroid in an oral tablet formulation that utilizes proprietary MMX colonic delivery technology. Uceris (budesonide) extended release tablets 9 mg is indicated for the induction of remission in patients with active, mild to moderate ulcerative colitis. In connection with receipt of FDA approval of Uceris, we committed to a post-marketing requirement to conduct an 8-week randomized clinical study in children 5 to 16 years of age with active, mild to moderate ulcerative colitis. We are currently discussing protocol design for the pediatric study with the FDA and expect to initiate the study once we have reached agreement with the FDA on the study design.

In addition, in July 2013, we completed patient enrollment in a multicenter, randomized, double-blind placebo-controlled CONTRIBUTE phase IIIb clinical study to evaluate Uceris 9 mg as an add-on therapy to current oral aminosalicylate, or 5-ASA, drugs for induction of remission of active ulcerative colitis. We enrolled 509 patients at clinical sites in the U.S., Canada and Europe. We expect to report top-line data from the study by the end of 2013 or in early 2014.

Rifamycin SV MMX is a broad spectrum, non-systemic antibiotic in a novel oral tablet formulation, which utilizes proprietary MMX colonic delivery technology and is being developed for the treatment of patients with travelers’ diarrhea and potentially for other diseases that have a bacterial component in the intestine. In September 2012, we announced that rifamycin SV MMX met the primary endpoint in a phase III clinical study in patients with travelers’ diarrhea. Dr. Falk Pharma GmbH, Cosmo’s European development partner, is conducting a second phase III clinical study to evaluate the efficacy of rifamycin SV MMX in patients with travelers’ diarrhea. Assuming positive results in the second phase III clinical study, we and Dr. Falk plan to share the clinical data from our respective phase III studies for inclusion in each company’s regulatory submissions.

We have acquired rights to Ruconest under license and supply agreements with Pharming. Ruconest is a recombinant version of the human protein C1 esterase inhibitor, which is produced using proprietary transgenic technology. In November 2012, we announced positive top-line results from the phase III clinical study to evaluate the safety and efficacy of Ruconest for the treatment of acute attacks of angioedema in patients with HAE. In June 2013, our BLA seeking approval to market Ruconest for this indication was accepted for review by the FDA. Pursuant to the Prescription Drug User Fee Act guidelines, or PDUFA, we expect that the FDA will complete its review or otherwise respond to the BLA by April 16, 2014.

We currently are exploring clinical and regulatory strategies to evaluate Ruconest for the treatment of acute pancreatitis and for HAE prophylaxis. For HAE prophylaxis, Pharming submitted under its investigational new drug application a protocol to the FDA with a request for a special protocol assessment, or SPA. The FDA has indicated that modifications to the protocol are needed before proceeding with the study and further discussions will be required in order for the protocol to be approved pursuant to the SPA process. We and Pharming are evaluating next steps to move the program forward. For acute pancreatitis, we have a meeting scheduled with the FDA later in November 2013 to discuss the study design.

We have acquired the exclusive worldwide rights to SAN-300 through the acquisition of Covella and a related license agreement with Biogen Idec MA, or Biogen. SAN-300 is a humanized anti-VLA-1 mAb that we believe may offer a novel approach to the treatment of inflammatory and autoimmune diseases. In December 2012, we completed a phase I dose-escalation clinical study in healthy volunteers to determine the safety, tolerability, pharmacokinetics and pharmacodynamics of single doses of SAN-300 in both intravenous, or IV, and subcutaneous formulations. The phase I study was conducted in Australia and enrolled a total of 66 healthy volunteers. We plan to begin a phase IIa clinical study evaluating SAN-300 for treatment of rheumatoid arthritis during the fourth quarter of 2013.

Research and development expenses have historically consisted primarily of costs associated with clinical studies of our investigational drugs as well as clinical studies designed to further differentiate our products from those of our competitors, development of and preparation for commercial manufacturing of our products, compensation and other expenses related to research and development personnel and facilities expenses.

A substantial portion of our external research and development costs is tracked on a direct project basis. However, because our internal research and development resources are used in several projects, the related indirect costs are not attributable to a specific marketed product or investigational drug. For example, personnel and facility related costs are not tracked on a project basis. We have summarized the costs associated with our development programs in the following table (in thousands). Costs that are not attributable to a specific marketed product or investigational drug, including salaries and related personnel and facilities costs, are included in the “indirect costs” category.


	Three Months Ended September 30,				Nine Months Ended September 30,				Project to Date Through September 30,
	2013		2012		2013		2012		2013⁽¹⁾
Direct costs:
Uceris	$	2,247	$	3,064	$	8,123	$	7,910	$	42,650
Rifamycin SV MMX		24		211		59		931		5,584
Ruconest		243		19		372		60		916
SAN-300		861		418		1,872		1,567		7,439
Zegerid and other projects		—		56		16		459		N/A

Total direct costs		3,375		3,768		10,442		10,927
Indirect costs		3,449		2,409		9,536		7,162		N/A

Total research and development	$	6,824	$	6,177	$	19,978	$	18,089

(1)	Project to date amounts are included for projects on which we are primarily focused.

In the future, we may conduct additional clinical studies to further differentiate our marketed products and investigational drugs, as well as conduct research and development related to any future products that we may in-license or otherwise acquire. Although we are currently focused primarily on the Uceris CONTRIBUTE phase IIIb program and the rifamycin SV MMX, Ruconest and SAN-300 investigational drugs, we anticipate that we will make determinations as to which development projects to pursue and how much funding to direct to each project on an ongoing basis in response to the scientific, clinical and commercial merits of each project. We are unable to estimate with any certainty the research and development costs that we may incur in the future. In addition, in connection with the approval of Zegerid powder for oral suspension, we committed to commence clinical studies to evaluate the product in pediatric populations. We have not yet commenced any of the studies and have requested a waiver of this requirement from the FDA.

Selling, General and Administrative. Selling, general and administrative expenses were $35.5 million for the three months ended September 30, 2013 and $21.1 million for the three months ended September 30, 2012. Selling, general and administrative expenses were $99.7 million for the nine months ended September 30, 2013 and $61.6 million for the nine months ended September 30, 2012. The $14.4 million increase in our selling, general and administrative expenses for the three months ended September 30, 2013 as compared to the three months ended September 30, 2012 and the $38.1 million increase in our selling, general and administrative expenses for the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012 was primarily attributable to the expansion of our commercial presence, including the addition of 85 new sales representatives (both employee and contract), advertising and promotional spending in connection with the launch of Uceris in February 2013, increased legal expenses and an increase in stock-based compensation resulting from an increase in the price of our common stock.

Interest Income. Interest income was $9,000 for the three months ended September 30, 2013 and $11,000 for the three months ended September 30, 2012. Interest income was $34,000 for the nine months ended September 30, 2013 and $13,000 for the nine months ended September 30, 2012.

Interest Expense. Interest expense was $61,000 for the three months ended September 30, 2013 and $81,000 for the three months ended September 30, 2012. Interest expense was $214,000 for the nine months ended September 30, 2013 and $259,000 for the nine months ended September 30, 2012. Interest expense was comprised primarily of interest due in connection with our revolving credit facility with Comerica Bank, or Comerica.

Income Tax (Benefit) Expense. Income tax (benefit) expense was $(838,000) for the three months ended September 30, 2013 and $181,000 for the three months ended September 30, 2012. Income tax (benefit) expense was $(54.7) million for the nine months ended September 30, 2013 and $774,000 for the nine months ended September 30, 2012. At June 30, 2013, we determined that it was more likely than not that our deferred tax assets would be realized through future taxable income. Therefore, we released our valuation allowance on our deferred tax assets in the second quarter of 2013. The release of the valuation allowance resulted in an income tax benefit of $54.9 million, which was recorded as a discrete item in the three months ended June 30, 2013.

Liquidity and Capital Resources

As of September 30, 2013, cash, cash equivalents and short-term investments were $168.7 million, compared to $94.7 million as of December 31, 2012, an increase of $74.0 million. This net increase resulted primarily from our net income for the nine months ended September 30, 2013, adjusted for non-cash charges and changes in working capital and proceeds from the exercise of stock options.

Net cash provided by operating activities was $78.0 million for the nine months ended September 30, 2013 and $23.8 million for the nine months ended September 30, 2012. The primary source of cash for the nine months ended September 30, 2013 resulted from our net income for the period, adjusted for non-cash charges of $5.1 million in depreciation and amortization and $10.1 million in stock-based compensation and the non-cash income tax benefit of $55.5 million resulting from the reversal of our valuation allowance on our deferred tax assets. Significant working capital uses of cash for the nine months ended September 30, 2013 included an increase in accounts receivable, resulting from our increase in product sales and the launch of Uceris, offset in part by increases in accounts payable and accrued liabilities. The primary source of cash for the nine months ended September 30, 2012 resulted from our net income for the period, adjusted for non-cash charges, including $4.6 million in depreciation and amortization, $4.9 million in stock-based compensation and $3.7 million related to the issuance of common stock under a technology license agreement.

Net cash used in investing activities was $10.0 million for the nine months ended September 30, 2013 and $40.2 million for the nine months ended September 30, 2012. These activities included purchases and maturities of short-term investments and purchases of property and equipment. For the nine months ended September 30, 2013, net cash used in investing activities also included a $7.0 million commercial milestone we paid to Cosmo in cash under our license agreement. For the nine months ended September 30, 2012, net cash used in investing activities also included approximately $2.5 million we paid to Depomed for the purchase of Glumetza inventories in connection with the commercialization agreement we entered into in August 2011.

Net cash provided by financing activities was $3.4 million for the nine months ended September 30, 2013 and $2.3 million for the nine months ended September 30, 2012. Net cash provided by financing activities was comprised primarily of proceeds received from the exercise of stock options and through the issuance of common stock under our employee stock purchase plan. For the nine months ended September 30, 2013, net cash provided by financing activities was offset in part by our repayment of the $10.0 million outstanding balance under our credit facility with Comerica.

Contractual Obligations and Commitments

We rely on Patheon, Inc. as our sole third-party manufacturer of Glumetza 500 mg, Cycloset and Zegerid powder for oral suspension, and we currently rely on Depomed to oversee the manufacturing of Glumetza 1000 mg. We rely on Cosmo as our sole third-party manufacturer of Uceris, Norwich Pharmaceuticals, Inc. as our sole third-party manufacturer of Zegerid capsules and the related authorized generic product, and we rely on Catalent Pharma Solutions, LLC as our sole third-party manufacturer of Fenoglide. We also are required to purchase commercial quantities of certain active ingredients in our commercial products. At September 30, 2013, we had finished goods and raw materials inventory purchase commitments of approximately $4.7 million.

License Agreement and Manufacturing and Supply Agreement with Cosmo

Under our license agreement, stock issuance agreement and registration rights agreement with Cosmo entered into in December 2008, following the first commercial sale of Uceris which occurred in February 2013, Cosmo elected, in April 2013, to receive payment of a $7.0 million commercial milestone in cash. We may also be required to pay Cosmo the following additional commercial milestones for Uceris: a one-time $5.0 million milestone payment upon initial achievement of $75.0 million in annual calendar year net product sales; and a one-time $17.5 million milestone payment upon initial achievement of $150.0 million in annual calendar year net product sales. In addition, we may also be required to pay Cosmo commercial milestones of up to $28.0 million for rifamycin SV MMX, an additional $2.0 million regulatory milestone for the initial indication for rifamycin SV MMX and up to $6.0 million in clinical and regulatory milestones for a second indication for rifamycin SV MMX. The milestones may be paid in cash or through issuance of additional shares of our common stock, at Cosmo’s option, subject to certain limitations. We pay tiered royalties to Cosmo equal to 12% (on annual net sales of each licensed product up to $120.0 million) and 14% (on annual net sales of each licensed product in excess of $120.0 million). Such royalties are subject to reduction in certain circumstances, including in the event of market launch in the U.S. of a

generic version of a licensed product. We are also responsible for all of the out-of-pocket costs for the Uceris CONTRIBUTE phase IIIb clinical study. In the event that additional clinical work is required to obtain U.S. regulatory approval for rifamycin SV MMX, the parties will agree on cost sharing. Under our manufacturing and supply agreement with Cosmo entered into in May 2012, we are obligated to purchase all of our commercial supply of Uceris from Cosmo. We pay Cosmo a supply price equal to 10% of net sales, and Cosmo reimburses us for costs associated with packaging, which is contracted separately by us.

License Agreement with University of Missouri

Under our exclusive worldwide license agreement with the University of Missouri entered into in January 2001 relating to specific formulations of PPIs with antacids and other buffering agents, we are required to make milestone payments to the University of Missouri upon initial commercial sale in specified territories outside the U.S., which may total up to $3.5 million in the aggregate. We are also required to make milestone payments, up to a maximum of $83.8 million remaining under the agreement, based on first-time achievement of significant sales thresholds, which includes sales by us, Prasco, Merck and GSK, the next of which is a one-time $7.5 million milestone payment upon initial achievement of $250.0 million in annual calendar year net product sales. We are also obligated to pay royalties on net sales of our Zegerid prescription products and any products sold by Prasco, Merck and GSK under our existing license and distribution agreements.

Agreements with Depomed

Under our commercialization agreement with Depomed entered into in August 2011, we are required to pay to Depomed royalties on Glumetza net product sales in the U.S. of 32.0% in 2013 and 2014; and 34.5% in 2015 and beyond prior to generic entry of a Glumetza product. We have the exclusive right to commercialize authorized generic versions of the Glumetza products. In the event of generic entry of a Glumetza product in the U.S., the parties will equally share proceeds based on a gross margin split. Under the commercialization agreement, we have certain minimum marketing expenditures and sales force promotion obligations during the term of the agreement until such time as a generic to Glumetza enters the market. Under the terms of the commercialization agreement, Depomed will continue to manage the ongoing patent infringement litigation related to Glumetza, subject to certain consent rights in favor of us, including with regard to any proposed settlements. We are responsible for 70% of the future out-of-pocket costs, and Depomed is responsible for 30% of the future out-of-pocket costs, related to patent infringement cases.

Distribution and License Agreement with S2 and VeroScience

Under the terms of our distribution and license agreement with S2 and VeroScience entered into in September 2010, we are responsible for paying a product royalty to S2 and VeroScience of 35% of the gross margin associated with net sales of Cycloset up to $100.0 million of cumulative total gross margin, increasing to 40% thereafter. Gross margin is defined as net sales less cost of goods sold. In the event net sales of Cycloset exceed $100.0 million in a calendar year, we will pay an additional 3% of the gross margin to S2 and VeroScience on incremental net sales over $100.0 million.

License Agreement with HRP and Shore

Under the terms of our license agreement with HRP and Shore, we are responsible for paying Shore tiered royalties on net sales of Fenoglide. The royalties are 5% on net sales of up to $10.0 million (commencing in 2013), a 20% royalty on net sales between $10.0 million and $20.0 million, and a 25% royalty on net sales above $20.0 million. We will also be obligated to pay Shore one-time, success-based milestones contingent on sales achievement: $2.0 million if calendar year net sales equal or exceed $20.0 million and $3.0 million if calendar year net sales equal or exceed $30.0 million. We have agreed to use commercially reasonable efforts to commercialize Fenoglide within the U.S. In addition, prior to the entry of any generic version of Fenoglide, we are required to provide certain minimum detailing efforts and sales and marketing expenditures.

License Agreement and Supply Agreement with Pharming

Under our license agreement with Pharming entered into in September 2010, we paid Pharming a $5.0 million milestone in July 2013 as a result of the FDA acceptance for review of the BLA seeking approval of Ruconest for the treatment of acute attacks of angioedema in patients with HAE. We may be required to pay Pharming a $20.0 million milestone upon the earlier of first commercial sale of Ruconest in the U.S. or 90 days following receipt of FDA approval. In addition, we will be required to pay certain one-time performance milestones if we achieve certain aggregate net sales levels of Ruconest. The

amount of each such milestone payment varies upon the level of net sales of Ruconest: a $20.0 million milestone if calendar year net sales exceed $300.0 million and a $25.0 million milestone if calendar year net sales exceed $500.0 million. As consideration for the licenses and rights granted under the license agreement, and as compensation for the commercial supply of Ruconest by Pharming pursuant to our supply agreement, we will pay Pharming a tiered supply price, based on a percentage of net sales of Ruconest, subject to reduction in certain events, as follows: 30% of net sales less than or equal to $100.0 million, 32% of net sales greater than $100.0 million but less than or equal to $250.0 million, 34% of net sales greater than $250.0 million but less than or equal to $500.0 million, 37% of net sales greater than $500.0 million but less than or equal to $750.0 million, and 40% of net sales greater than $750.0 million.

Acquisition of Covella

We have acquired the exclusive worldwide rights to SAN-300 through the acquisition of Covella and a related license agreement with Biogen. In connection with our acquisition of Covella, under the terms of the merger agreement, we may be required to make clinical and regulatory milestone payments totaling up to an aggregate of $37.7 million (consisting of a combination of cash and our common stock) based on success in developing product candidates (with the first such milestone being payable upon successful completion of the first Phase IIb clinical study). We may also be required to pay a royalty equal to a low single digit percentage rate of net sales of any commercial products resulting from the anti-VLA-1 mAb technology.

Amended License and Amended Services and Supply Agreement with Biogen

Under our amended license agreement with Biogen, we may be obligated to make various clinical, regulatory and sales milestone payments based upon our success in developing and commercializing development-stage products (with the first such milestone being payable upon successful completion of the first Phase IIb clinical study). The amounts of the clinical and regulatory milestone payments vary depending on the type of product, the number of indications, and other specifically negotiated milestones. If SAN-300 is the first to achieve all applicable milestones for all three indications, we will be required to pay Biogen maximum aggregate clinical and regulatory milestone payments of $97.2 million. The amount of the commercial milestone payments we will be required to pay Biogen will depend on the level of net sales of a particular product in a calendar year. The maximum aggregate commercial milestone payments to Biogen total $105.5 million for SAN-300, assuming cumulative net sales of at least $5 billion of such product, and total $60.25 million for products containing certain other compositions as described in the license, assuming cumulative net sales of at least $5 billion of such products. In addition, we will be required to pay tiered royalties ranging from low single digit to low double digit percentage rates, subject to reduction in certain limited circumstances, on net sales of products developed under the amended license.

Under our services and supply agreement, Biogen agreed to supply to us materials manufactured by Biogen for use in the anti-VLA-1 mAb development program. The amendment to the agreement provides for a revised payment structure for such material. Under the terms of our amended services and supply agreement, upon the achievement of the first regulatory approval as set forth in our amended license agreement, Biogen is entitled to receive a one-time milestone payment of approximately $11.7 million, which is equivalent to the cost of the materials supplied under the services and supply agreement. In the event the amended license agreement is terminated by us or Biogen prior to the achievement of the first regulatory approval as set forth in the amended license agreement, we will be required to pay Biogen a one-time termination fee of $3.0 million.

The following summarizes our long-term contractual obligations as of September 30, 2013, excluding potential clinical, regulatory and commercial milestones and royalty obligations under our agreements which are described above:


	Payments Due by Period
Contractual Obligations	Total		Less than One Year		One to Three Years		Four to Five Years		Thereafter
	(in thousands)
Operating leases	$	16,799	$	717	$	8,248	$	4,604	$	3,230
Other long-term contractual obligations		589		90		329		70		100

Total	$	17,388	$	807	$	8,577	$	4,674	$	3,330

The amount and timing of cash requirements will depend on our ability to generate revenues from our currently promoted commercial prescription products, including our ability to maintain commercial supply. In addition, our cash requirements will depend on market acceptance of any other products that we may market in the future, the success of our strategic alliances, the resources we devote to researching, developing, formulating, manufacturing, commercializing and supporting our products, and our ability to enter into third-party collaborations.

Although we do not believe that we will need to raise additional funds to finance our current operations through at least the next twelve months, we may pursue raising additional funds for various reasons, including to expand our commercial presence, in connection with licensing or acquisition of new marketed products or investigational drugs, to continue development of investigational drugs in our pipeline, or for other general corporate purposes. Sources of additional funds may include funds generated through equity and/or debt financing or through strategic collaborations or licensing agreements.

Our existing universal shelf registration statement, which was declared effective in December 2011, may permit us, from time to time, to offer and sell up to approximately $75.0 million of equity or debt securities. However, there can be no assurance that we will be able to complete any such offerings of securities. Factors influencing the availability of additional financing include the progress of our commercial and development activities, investor perception of our prospects and the general condition of the financial markets, among others.

In July 2006, we entered into our loan agreement with Comerica, which was most recently amended in February 2012, pursuant to which we may request advances in an aggregate outstanding amount not to exceed $35.0 million. The revolving loan bears interest, as selected by us, at a variable rate of interest, per annum, most recently announced by Comerica as its “prime rate” or the LIBOR rate plus 2.25%. In December 2008, we drew down $10.0 million under the loan agreement. In August 2013, we repaid the $10.0 million and as of September 30, 2013, we had no outstanding balance under the loan agreement. Interest payments on advances made under the loan agreement are due and payable in arrears on a monthly basis during the term of the loan agreement. Amounts borrowed under the loan agreement may be repaid and re-borrowed at any time prior to February 13, 2015, and any outstanding principal drawn during the term of the loan facility is due and payable on February 13, 2015. The loan agreement will remain in full force and effect for so long as any obligations remain outstanding or Comerica has any obligation to make credit extensions under the loan agreement.

Amounts borrowed under the loan agreement are secured by substantially all of our personal property, excluding intellectual property. Under the loan agreement, we are subject to certain affirmative and negative covenants, including limitations on our ability to: undergo certain change of control events; convey, sell, lease, license, transfer or otherwise dispose of assets; create, incur, assume, guarantee or be liable with respect to certain indebtedness; grant liens; pay dividends and make certain other restricted payments; and make investments. In addition, under the loan agreement, we are required to maintain our cash balances with either Comerica or another financial institution covered by a control agreement for the benefit of Comerica. We are also subject to specified financial covenants with respect to a minimum liquidity ratio and, in specified limited circumstances, minimum EBITDA requirements. We believe we have currently met all of our obligations under the loan agreement.

We cannot be certain that our existing cash, cash equivalents and short-term investments and use of our line of credit will be adequate to sustain our current operations. To the extent we require additional funding, we cannot be certain that such funding will be available to us on acceptable terms, or at all. To the extent that we raise additional capital by issuing equity or convertible securities, our stockholders’ ownership will be diluted. Any debt financing we enter into may involve covenants that restrict our operations. If adequate funds are not available on terms acceptable to us at that time, our ability to continue our current operations or pursue new product opportunities would be significantly limited.

In addition, our results of operations could be materially affected by economic conditions generally, both in the U.S. and elsewhere around the world. Continuing concerns over U.S. spending and deficits, inflation, energy costs, geopolitical issues, the availability and cost of credit, the U.S. mortgage market and a difficult residential real estate market in the U.S. have contributed to increased volatility and diminished expectations for the economy and the markets going forward. Domestic and international equity markets have experienced and may continue to experience heightened volatility and turmoil based on domestic and international economic conditions and concern, including concerns over U.S. spending and deficits. In the event these economic conditions and concerns continue and the markets continue to remain volatile, our results of operations

could be adversely affected by those factors in many ways, including making it more difficult for us to raise funds if necessary, and our stock price may decline. In addition, we maintain significant amounts of cash and cash equivalents at one or more financial institutions that are in excess of federally insured limits. If economic instability continues, we cannot be assured that we will not experience losses on these deposits.

In March 2010, the President signed the Patient Protection and Affordable Care Act, or PPACA, which makes extensive changes to the delivery of healthcare in the U.S. This act includes numerous provisions that affect pharmaceutical companies, some of which were effective immediately and others of which will be taking effect over the next several years.

For example, the act seeks to expand healthcare coverage to the uninsured through private health insurance reforms and an expansion of Medicaid. The act also imposes substantial costs on pharmaceutical manufacturers, such as an increase in liability for rebates paid to Medicaid, new drug discounts that must be offered to certain enrollees in the Medicare prescription drug benefit, an annual fee imposed on all manufacturers of brand prescription drugs in the U.S., and an expansion of an existing program requiring pharmaceutical discounts to certain types of hospitals and federally subsidized clinics. The act also contains cost-containment measures that could reduce reimbursement levels for healthcare items and services generally, including pharmaceuticals. It also will require reporting and public disclosure of payments and other transfers of value provided by pharmaceutical companies to physicians and teaching hospitals. These measures could result in decreased net revenues from our pharmaceutical products and decreased potential returns from our development efforts. In addition, although the PPACA was recently upheld by the U.S. Supreme Court, it is also possible that the PPACA may be modified or repealed in the future.

As of September 30, 2013, we did not have 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. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.

Caution on Forward-Looking Statements

Any statements in this report and the information incorporated herein by reference about our expectations, beliefs, plans, objectives, assumptions or future events or performance that are not historical facts are forward-looking statements. You can identify these forward-looking statements by the use of words or phrases such as “believe,” “may,” “could,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “seek,” “plan,” “expect,” “should,” or “would.” Among the factors that could cause actual results to differ materially from those indicated in the forward-looking statements are risks and uncertainties inherent in our business including, without limitation: our ability to generate revenues from our currently promoted commercial products and our authorized generic Zegerid^® products; risks related to the Ruconest biologics license application, or BLA, including whether the U.S. Food and Drug Administration ultimately approves the BLA in a timely matter or at all; our ability to timely and successfully complete ongoing and planned clinical studies and otherwise advance the development of our product pipeline; our ability to maintain patent protection for our products, including the difficulty in predicting the timing and outcome of ongoing and any future patent litigation; our dependence on our strategic partners for certain aspects of our development programs, including risks related to their financial stability; adverse side effects, inadequate therapeutic efficacy or other issues related to our products that could result in product recalls, market withdrawals or product liability claims; competition from other pharmaceutical or biotechnology companies and evolving market dynamics; other difficulties or delays relating to the development, testing, manufacturing and marketing of, and obtaining and maintaining regulatory approvals for, our products; fluctuations in quarterly and annual results; our ability to obtain additional financing as needed to support our operations or future product acquisitions; the impact of healthcare reform legislation and any instability in the financial markets; and other risks detailed below under Part II — Item 1A — Risk Factors.

Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee future results, events, levels of activity, performance or achievement. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Under the terms of our loan agreement with Comerica Bank, or Comerica, the interest rate applicable to any amounts borrowed by us under the credit facility will be, at our election, indexed to either Comerica’s prime rate or the LIBOR rate. If we elect Comerica’s prime rate for all or any portion of our borrowings, the interest rate will be variable, which would expose us to the risk of increased interest expense if interest rates rise. If we elect the LIBOR rate for all or any portion of our borrowings, such LIBOR rate will remain fixed only for a specified, limited period of time after the date of our election, after which we will be required to repay the borrowed amount, or elect a new interest rate indexed to either Comerica’s prime rate or the LIBOR rate. The new rate may be higher than the earlier interest rate applicable under the loan agreement. Under our current policies, we do not use interest rate derivative instruments to manage our exposure to interest rate changes. A hypothetical 10% increase or decrease in the interest rate under the loan agreement would not materially affect our interest expense at our current level of borrowing.

In addition to market risk related to our loan agreement with Comerica, we are exposed to market risk primarily in the area of changes in U.S. interest rates and conditions in the credit markets, particularly because the majority of our investments are in short-term marketable securities. We do not have any material foreign currency or other derivative financial instruments. Our short-term investment securities have consisted of corporate debt securities, government agency securities and U.S. Treasury securities which are classified as available-for-sale and therefore reported on the consolidated balance sheets at estimated market value.

Our results of operations could be materially affected by economic conditions generally, both in the U.S. and elsewhere around the world. Continuing concerns over U.S. spending and deficits, inflation, energy costs, geopolitical issues, the availability and cost of credit, the U.S. mortgage market and a difficult residential real estate market in the U.S. have contributed to increased volatility and diminished expectations for the economy and the markets going forward. Domestic and international equity markets have experienced and may continue to experience heightened volatility and turmoil based on domestic and international economic conditions and concern, including concerns over U.S. spending and deficits. In the event these economic conditions and concerns continue and the markets continue to remain volatile, our results of operations could be adversely affected by those factors in many ways, including making it more difficult for us to raise funds if necessary, and our stock price may decline. In addition, we maintain significant amounts of cash and cash equivalents at one or more financial institutions that are in excess of federally insured limits. If economic instability continues, we cannot be assured that we will not experience losses on these deposits.

Item 4. Controls and Procedures

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

As required by Securities and Exchange Commission Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

There has been no change 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.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

Zegerid Rx and Zegerid OTC Patent Litigation

Zegerid Rx Litigation

In April 2010, the U.S. District Court for the District of Delaware ruled that five patents covering Zegerid capsules and Zegerid powder for oral suspension (U.S. Patent Nos. 6,489,346; 6,645,988; 6,699,885; 6,780,882; and 7,399,772) were invalid due to obviousness. These patents were the subject of lawsuits we filed in 2007 against Par Pharmaceutical, Inc., or Par, in response to abbreviated new drug applications, or ANDAs, filed by Par with the FDA. The University of Missouri, licensor of the patents, is joined in the litigation as a co-plaintiff. In May 2010, we filed an appeal of the District Court’s ruling to the U.S. Court of Appeals for the Federal Circuit. Following the District Court’s decision, Par launched its generic version of Zegerid capsules in late June 2010.

In September 2012, the U.S. Court of Appeals for the Federal Circuit reversed in part the April 2010 decision of the District Court. The Federal Circuit found that certain claims of asserted U.S. Patent Nos. 6,780,882 and 7,399,772, which Par had been found to infringe, were not invalid due to obviousness. These patents represent two of the five patents that were found to be invalid by the District Court, and the Federal Circuit affirmed the District Court’s finding of invalidity for the asserted claims from the remaining three patents. The Federal Circuit also upheld the District Court’s finding that there was no inequitable conduct. Following the Federal Circuit’s decision, Par announced that it had ceased distribution of its generic Zegerid capsules product in September 2012. In December 2012, the Federal Circuit issued an order denying a combined petition for panel and en banc rehearing filed by Par and issued its mandate, remanding the case to the District Court for further proceedings pertaining to damages. In February 2013, we filed an amended complaint with the District Court for infringement of U.S. Patent Nos. 6,780,882 and 7,399,772 and requested a jury trial with respect to the issue of damages in connection with Par’s launch of its generic version of Zegerid capsules in June 2010. The trial has been scheduled in November 2014. In March 2013, Par filed its amended answer, which alleges, among other things, failure to state a claim upon which relief can be granted and non-infringement based on purported invalidity of the two asserted patents. In addition, Par filed a motion for a judgment on the pleadings, alleging, among other things, that the two asserted patents are invalid because the Federal Circuit purportedly did not expressly address certain prior art references considered by the District Court, and we are waiting for a ruling from the District Court on Par’s motion. Although we do not believe that Par has a meritorious basis upon which to further challenge validity of the asserted patents in this proceeding, we cannot be certain of the timing or outcome of this or any other proceedings. If the District Court rules in favor of Par on its pending motion or otherwise, we cannot be certain of the impact to us, including if or when Par might re-launch its generic product. In addition, in April 2013, Par received approval from the FDA of its generic version of Zegerid powder for oral suspension.

In December 2011, we filed a lawsuit in the U.S. District Court for the District of New Jersey against Zydus Pharmaceuticals USA, Inc., or Zydus, for infringement of the patents listed in the Orange Book for Zegerid capsules. The University of Missouri, licensor of the patents, is joined in the litigation as a co-plaintiff. Zydus had filed an ANDA with the FDA regarding its intent to market a generic version of Zegerid capsules prior to the expiration of the listed patents. In September 2012, we amended our complaint to be limited to U.S. Patent No. 7,399,772, which patent was found not to be invalid in the September 2012 Federal Circuit decision. In October 2012, Zydus filed its answer, which alleges, among other things, failure to state a claim upon which relief can be granted. The lawsuit was commenced within the requisite 45 day time period, resulting in an FDA stay on the approval of Zydus’ proposed product for 30 months or until a decision is rendered by the District Court, which is adverse to the asserted patent. The trial for this matter has been scheduled in January 2014. Absent a court decision, the 30-month stay is expected to expire in May 2014. We are not able to predict the timing or outcome of this lawsuit.

In August 2012, we filed a lawsuit in the U.S. District Court for the District of New Jersey against Dr. Reddy’s Laboratories, Ltd. and Dr. Reddy’s Laboratories, Inc., collectively referred to herein as Dr. Reddy’s, for infringement of the patents listed in the Orange Book for Zegerid capsules. We and the University of Missouri, licensor of the patents, were joined in the litigation as co-plaintiffs. Dr. Reddy’s had filed an ANDA with the FDA regarding its intent to market a generic version of Zegerid capsules prior to the expiration of the listed patents. In June 2013, this case was settled allowing Dr. Reddy’s to begin selling a generic version of prescription Zegerid capsules upon expiration of the applicable patent (or earlier under certain circumstances), and the District Court entered an order dismissing the case with prejudice.

Zegerid OTC Litigation

In September 2010, Merck filed a lawsuit in the U.S. District Court for the District of New Jersey against Par for infringement of the patents listed in the Orange Book for Zegerid OTC. We and the University of Missouri, licensors of the listed patents, are joined in the lawsuit as co-plaintiffs. Par had filed an ANDA with the FDA regarding its intent to market a generic version of Zegerid OTC prior to the expiration of the listed patents. In October 2012, Merck amended its complaint to be limited to U.S. Patent No. 7,399,772, which patent was found not to be invalid in the September 2012 Federal Circuit decision. Also in October 2012, Par filed its answer, which alleges, among other things, failure to state a claim upon which relief can be granted, non-infringement and invalidity. Par has received tentative approval of its proposed generic Zegerid OTC product. The lawsuit was commenced within the requisite 45-day time period, resulting in an FDA stay on the approval of Par’s proposed product for 30 months or until a decision is rendered by the District Court, which is adverse to the asserted patent. Although the 30-month stay expired in February 2013, the parties have agreed that Par will not launch its generic Zegerid OTC product unless there is a District Court judgment favorable to Par or in certain other specified circumstances. The District Court issued a Markman order in October 2013 in which the District Court adopted Merck’s proposed construction of several claim terms that were consistent with those adopted by the U.S. District Court for the District of Delaware. A trial has been scheduled in January 2015. We are not able to predict the timing or outcome of this lawsuit.

In September 2010, Merck filed a lawsuit in the U.S. District Court for the District of New Jersey against Perrigo Research and Development Company, or Perrigo, for infringement of the patents listed in the Orange Book for Zegerid OTC. We and the University of Missouri, licensors of the listed patents, were joined in the lawsuits as co-plaintiffs. Perrigo had filed an ANDA with the FDA regarding its intent to market a generic version of Zegerid OTC prior to the expiration of the listed patents. In January 2013, this case was settled allowing Perrigo to market a generic version of Zegerid OTC upon expiration of the applicable patents (or earlier under certain circumstances), and the District Court entered an order dismissing the case with prejudice.

In December 2011, Merck filed a lawsuit in the U.S. District Court for the District of New Jersey against Zydus for infringement of the patents listed in the Orange Book for Zegerid OTC. We and the University of Missouri, licensors of the listed patents, are joined in the litigation as co-plaintiffs. Zydus had filed an ANDA with the FDA regarding its intent to market a generic version of Zegerid OTC prior to the expiration of the listed patents. In September 2012, Merck amended its complaint to be limited to U.S. Patent No. 7,399,772, which patent was found not to be invalid in the September 2012 Federal Circuit decision. In October 2012, Zydus filed its answer, which alleges, among other things, failure to state a claim upon which relief can be granted. The lawsuit was commenced within the requisite 45-day time period, resulting in an FDA stay on the approval of Zydus’ proposed product for 30 months or until a decision is rendered by the District Court, which is adverse to the asserted patent. Absent a court decision, the 30-month stay is expected to expire in May 2014. The trial for this matter has been scheduled in January 2014. We are not able to predict the timing or outcome of this lawsuit.

Any adverse outcome in the Zegerid Rx and Zegerid OTC litigation described above would adversely impact our business, including the amount of revenues we receive from sales of Zegerid brand and authorized generic prescription products and our ability to receive, milestone payments and royalties under our agreement with Merck. For example, the royalties payable to us under our license agreement with Merck are subject to reduction in the event it is ultimately determined by the courts (with the decision being unappealable or unappealed within the time allowed for appeal) that there is no valid claim of the licensed patents covering the manufacture, use or sale of the Zegerid OTC product and third parties have received marketing approval for, and are conducting bona fide ongoing commercial sales of, generic versions of the licensed products. Any negative outcome may also negatively impact the patent protection for the products being commercialized pursuant to our ex-US license with GSK. Although a U.S. ruling is not binding in countries outside the U.S., similar challenges to those raised in the U.S. litigation may be raised in territories outside the U.S. At this time we are unable to estimate possible losses or ranges of losses for ongoing actions.

Glumetza^® Patent Litigation

In November 2009, Depomed filed a lawsuit in the U.S. District Court for the Northern District of California against Lupin Limited and its wholly owned subsidiary, Lupin Pharmaceuticals, Inc., collectively referred to herein as Lupin, for infringement of certain patents listed in the Orange Book for Glumetza. The lawsuit was filed in response to an ANDA filed with the FDA by Lupin regarding Lupin’s intent to market generic versions of Glumetza 500 mg and 1000 mg tablets prior to the expiration of the listed patents. In February 2012, the case was settled allowing Lupin to begin selling a generic version of Glumetza in February 2016, or earlier under certain circumstances, and the District Court entered an order dismissing the case without prejudice.

In June 2011, Depomed filed a lawsuit in the U.S. District Court for the District of New Jersey against Sun Pharma Global FZE, Sun Pharmaceutical Industries Ltd. and Sun Pharmaceutical Industries Inc., collectively referred to herein as Sun, for infringement of the patents listed in the Orange Book for Glumetza. Valeant International Bermuda, or Valeant, was joined in the lawsuit as a co-plaintiff. The lawsuit was filed in response to an ANDA filed with the FDA by Sun regarding Sun’s intent to market generic versions of Glumetza 500 mg and 1000 mg tablets prior to the expiration of the listed patents. In January 2013, the case was settled allowing Sun to begin selling a generic version of Glumetza in August 2016, or earlier under certain circumstances, and the District Court entered an order dismissing the case without prejudice.

In April 2012, Depomed filed a lawsuit in the U.S. District Court for the District of Delaware against Watson Laboratories, Inc. — Florida, Actavis, Inc. and Watson Pharma, Inc., collectively referred to herein as Watson, for infringement of the patents listed in the Orange Book for Glumetza 1000 mg at the time the lawsuit was filed (U.S. Patent Nos. 6,488,962 and 7,780,987). Valeant is joined in the lawsuit as a co-plaintiff. The lawsuit was filed in response to an ANDA filed with the FDA by Watson regarding Watson’s intent to market a generic version of Glumetza 1000 mg tablets prior to the expiration of the listed patents. Depomed and Valeant commenced the lawsuit within the requisite 45-day time period, resulting in an FDA stay on the approval of Watson’s proposed product for 30 months or until a decision is rendered by the District Court, which is adverse to the asserted patents. Absent a court decision, the 30-month stay is expected to expire in September 2014. In June 2012, Watson filed its answer, which alleges, among other things, non-infringement and invalidity of the asserted patents, failure to state a claim, lack of subject matter jurisdiction, and has also filed counterclaims. In February 2013, Depomed amended its complaint to add infringement of a newly listed Orange Book patent (U.S. Patent No. 8,323,692), as well as two non-Orange Book listed patents (U.S. Patent Nos. 7,736,667 and 8,329,215). The Markman hearing for this matter has been scheduled in April 2014, and the trial has been scheduled in May 2014. In August 2013, the District Court ordered that the case be stayed. We are not able to predict the timing or outcome of this lawsuit.

In February 2013, Depomed filed a lawsuit in the U.S. District Court for the District of Delaware against Watson for infringement of the patents listed in the Orange Book for Glumetza 500 mg (U.S. Patent Nos. 6,340,475; 6,488,962; 6,635,280 and 6,723,340). The lawsuit was filed in response to an ANDA filed with the FDA by Watson regarding Watson’s intent to market a generic version of Glumetza 500 mg tablets prior to the expiration of the listed patents. Depomed commenced the lawsuit within the requisite 45-day time period, resulting in an FDA stay on the approval of Watson’s proposed product for 30 months or until a decision is rendered by the District Court, which is adverse to the asserted patents. Absent a court decision, the 30-month stay is expected to expire in July 2015. In March 2013, Watson filed its answer, which alleges, among other things, non-infringement and invalidity of the asserted patents, failure to state a claim, and lack of subject matter jurisdiction, and has also filed counterclaims. The Markman hearing for this matter has been scheduled in December 2014, and a trial has been scheduled in January 2015. In August 2013, the District Court ordered that the case be stayed. We are not able to predict the timing or outcome of this lawsuit.

Under the terms of our commercialization agreement with Depomed, Depomed will manage any ongoing patent infringement litigation relating to Glumetza, subject to certain consent rights in favor of us, including with regard to any proposed settlements. We are responsible for 70% of the future out-of-pocket costs, and Depomed is responsible for 30% of the future out-of-pocket costs, related to patent infringement cases. Although Depomed has indicated that it intends to vigorously defend and enforce its patent rights, we are not able to predict the timing or outcome of ongoing or future actions. At this time we are unable to estimate possible losses or ranges of losses for ongoing actions.

Any adverse outcome in the litigation described above would adversely impact our business and revenues. Regardless of how these litigation matters are ultimately resolved, the litigation will continue to be costly, time-consuming and distracting to management, which could have a material adverse effect on our business.

Fenoglide Patent Litigation

Prior to the execution of the license agreement, Shore entered into a settlement arrangement with Impax Laboratories, Inc., or Impax, in connection with patent infringement litigation associated with Impax’s ANDA for a generic version of Fenoglide and a related paragraph IV challenge. The settlement terms grant Impax a sublicense to begin selling a generic version of Fenoglide on October 1, 2015, or earlier under certain circumstances. In February 2012, the U.S. District Court for the District of Delaware entered an order dismissing the litigation, and we assumed Shore’s obligations associated with the sublicense to Impax.

In January 2013, we filed a lawsuit in the U.S. District Court for the District of Delaware against Mylan Inc. and Mylan Pharmaceuticals Inc., collectively referred to herein as Mylan, for infringement of the patents listed in the Orange Book for Fenoglide 120 mg and 40 mg at the time the lawsuit was filed (U.S. Patent Nos. 7,658,944, and 8,124,125). Veloxis Pharmaceuticals A/S, or Veloxis, is joined in the lawsuit as a co-plaintiff. The lawsuit was filed in response to an ANDA filed with the FDA by Mylan regarding Mylan’s intent to market a generic version of Fenoglide 120 mg and 40 mg tablets prior to the expiration of the listed patents. We commenced the lawsuit within the requisite 45-day time period, resulting in an FDA stay on the approval of Mylan’s proposed product for 30 months or until a decision is rendered by the District Court, which is adverse to the asserted patents, whichever may occur earlier. Absent a court decision, the 30-month stay is expected to expire in June 2015. In February 2013, Mylan filed its answer, which alleges, among other things, non-infringement, invalidity, and failure to state a claim, and has also filed counterclaims. In August 2013, we filed an amended complaint to add infringement of a newly listed Orange Book patent (U.S. Patent No. 8,481,078). In September 2013, Mylan filed its answer to the amended complaint, which alleges, among other things, non-infringement, invalidity, and failure to state a claim, and has also filed counterclaims. The Markman hearing for this matter has been scheduled in June 2014, and a trial has been scheduled in March 2015. We are not able to predict the timing or outcome of this lawsuit.

Trademark Litigation

In October 2013, Endochoice, Inc., or Endochoice, filed a lawsuit in the U.S. District Court for the Southern District of New York against us for trademark infringement, false designation of origin, and unfair competition under the Trademark Act, unfair trade practices under the New York Unfair Trade Practices Act, and trademark infringement and unfair competition under the common law of the State of New York, all in connection with our use of a graphical logo in connection with some materials related to Uceris. Endochoice’s requested relief includes a permanent injunction preventing us from continued use of the graphical logo, that we surrender for destruction all products, web pages, labels, advertisements, promotional and other materials that use the graphical logo, an award of damages, and payment of Endochoice’s costs and expenses, including reasonable attorney’s fees. We are not able to predict the timing or outcome of this lawsuit.

Item 1A. Risk Factors

Certain factors may have a material adverse effect on our business, financial condition and results of operations, and you should carefully consider them. Accordingly, in evaluating our business, we encourage you to consider the following discussion of risk factors in its entirety, in addition to other information contained in this report as well as our other public filings with the Securities and Exchange Commission, or SEC.

In the near-term, the success of our business will depend on many factors, including:

•

our ability to generate revenues from our marketed products: Uceris^® (budesonide) extended release tablets, Zegerid^® (omeprazole/sodium bicarbonate) capsules and powder for oral suspension, Glumetza^® (metformin hydrochloride extended release tablets), Cycloset^® (bromocriptine mesylate) tablets, and Fenoglide^® (fenofibrate) tablets;

•

our ability to continue to generate revenues from our authorized generic Zegerid (omeprazole/sodium bicarbonate) capsules prescription product;

•

our ability to maintain patent coverage for our promoted commercial products, including whether favorable outcomes are obtained in pending and any future patent infringement lawsuits;

•

our ability to successfully advance the development of, obtain regulatory approval for and ultimately commercialize, our investigational drugs: Ruconest^® (recombinant human C1 esterase inhibitor), rifamycin SV MMX^® and SAN-300; and

•

our ability to further expand our product portfolio through co-promotion, in-licensing or acquisition of products that would be complementary to our existing products or that otherwise have attractive commercial potential.

Each of these factors, as well as other factors that may impact our business, are described in more detail in the following discussion. Although the factors highlighted above are among the most significant, any of the following factors could materially adversely affect our business or cause our actual results to differ materially from those contained in forward-looking statements we have made in this report and those we may make from time to time, and you should consider all of the factors described when evaluating our business.

Risks Related to Our Pending Acquisition by Salix Pharmaceuticals, Ltd.

The announcement and pendency of the acquisition by Salix Pharmaceuticals, Ltd., or Salix, of us pursuant to a tender offer, or the Offer, and subsequent merger of us with a wholly-owned indirect subsidiary of Salix, or the Merger, could have an adverse effect on our stock price and/or our business, financial condition, results of operations or business prospects.

The announcement and pendency of the Offer and Merger could disrupt our business in the following ways, among others:

•

third parties may determine to delay or defer purchase decisions with regards to our products or terminate and/or renegotiate their relationships with us as a result of the Offer and the Merger, whether pursuant to the terms of their existing agreements with us or otherwise;

•

the attention of our management may be directed toward the completion of the Offer and the Merger and related matters and may be diverted from the day-to-day business operations of our company, including from other opportunities that might otherwise be beneficial to us; and

•

current and prospective employees may experience uncertainty regarding their future roles with Salix, which might adversely affect our ability to retain, recruit and motivate key personnel and may adversely affect the focus of our employees on sales of our products.

Should they occur, any of these matters could adversely affect our stock price or harm our financial condition, results of operations or business prospects.

Our executive officers and directors may have interests that are different from, or in addition to, those of our stockholders generally.

Our executive officers and directors may have interests in the Offer and the Merger that are different from, or are in addition to, those of our stockholders generally. These interests include direct or indirect ownership of our common stock and stock options and the potential receipt of change in control payments in connection with the proposed Offer and Merger.

The Merger Agreement contains provisions that could discourage or make it difficult for a third party to acquire us prior to the completion of the Offer and the Merger.

The Merger Agreement contains provisions that make it difficult for us to entertain a third-party proposal for an acquisition of our company. These provisions include the general prohibition on our soliciting, initiating or participating in discussions with third parties regarding any alternative acquisition proposal, and the requirement that we pay a termination fee of $80.0 million to Salix if the Merger Agreement is terminated in specified circumstances.

These provisions might discourage an otherwise-interested third party from considering or proposing an acquisition of our company, even one that may be deemed of greater value than the Offer and the Merger to our stockholders. Furthermore, even if a third party elects to propose an acquisition, the concept of a termination fee may result in that third party’s offering of a lower value to our stockholders than such third party might otherwise have offered.

Litigation may be filed against us and the members of our board of directors challenging the Offer and the Merger and an adverse judgment in any such lawsuit may prevent the Offer and the Merger from becoming effective or from becoming effective within the expected timeframe.

Historically, following the announcement of a proposed merger, securities class action litigation has often been brought against a company and its board of directors. Any adverse judgment in any such litigation may prevent the Offer and the Merger from becoming effective or from becoming effective within the expected timeframe.

Failure to complete the Offer and the Merger could negatively impact our business, financial condition, results of operations or our stock price.

The completion of the Offer and the Merger are subject to a number of conditions, including the tender of a sufficient number of shares held by our current stockholders pursuant to the Offer and clearance under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, or the HSR Act, and there can be no assurance that the conditions to the completion of the Offer and the Merger will be satisfied. The Merger Agreement may also be terminated by us and Salix in certain specified circumstances, including, subject to compliance with the terms of the Merger Agreement, by us in order to accept a third-party acquisition proposal that our board of directors determines constitutes a superior proposal upon payment of a $80.0 million termination fee to Salix. If the Offer and the Merger are not completed, we will be subject to several risks, including:

•

the current trading price of our common stock may reflect a market assumption that the Merger will occur, meaning that a failure to complete the Merger could result in a decline in the price of our common stock;

•

certain of our executive officers, employees and/or directors may seek other opportunities;

•

we expect to incur substantial transaction costs in connection with the Offer and the Merger whether or not the Offer and the Merger is completed; and

•

under the Merger Agreement, we are subject to certain restrictions on the conduct of our business prior to the completion of the Merger, which restrictions could adversely affect our ability to realize certain of our business strategies or take advantage of certain business opportunities.

If the Merger is not completed, these risks may materialize and materially and adversely affect our business, financial condition, results of operations or our stock price.

Obtaining required approvals necessary to satisfy the conditions to the completion of the Offer and the Merger may delay or prevent completion of the proposed acquisition.

The completion of the Offer and the Merger is conditioned upon the expiration or termination of the waiting period under the HSR Act. We and Salix intend to pursue all required approvals in accordance with the Merger Agreement. However, no assurance can be given that the required approvals will be obtained and, even if all such approvals are obtained, no assurance can be given as to the terms, conditions and timing of the approvals or that they will satisfy the terms of the Merger Agreement.

Risks Related to Our Business and Industry

We are dependent upon our ability to generate revenues from our promoted commercial products, and we cannot be certain that we will be successful.

Our ability to generate product revenue in the near term will depend in part on the success of our promoted commercial products, which in turn will depend on several factors, including:

•

our ability to generate and increase market demand for, and sales of, our promoted commercial products;

•

our ability to maintain patent coverage for our promoted commercial products, including whether favorable outcomes are obtained in pending and any future patent infringement lawsuits;

•

the performance of third-party manufacturers and their ability to maintain commercial manufacturing operations in accordance with regulatory and quality requirements and as necessary to meet commercial demand for the products and avoid supply interruptions;

•

the occurrence of adverse side effects, inadequate therapeutic efficacy or other issues relating to the products, and any resulting product liability claims or product recalls;

•

the availability of adequate levels of reimbursement coverage for the products from third-party payors, particularly in light of the availability of other branded and generic competitive products; and

•

our ability to effectively market our promoted commercial products in accordance with the requirements of the U.S. Food and Drug Administration, or FDA, and other governmental and regulatory authorities.

We promote Uceris under a strategic collaboration with Cosmo Technologies Limited, or Cosmo. We promote Zegerid under a license agreement with the University of Missouri. We promote Glumetza under a commercialization agreement with Depomed, Inc., or Depomed. We promote Cycloset under a distribution and license agreement with S2 Therapeutics, Inc., or S2, and VeroScience, LLC, or VeroScience. We promote Fenoglide under a license agreement with Healthcare Royalty Partners, L.P., or HRP, and Shore Therapeutics, Inc., or Shore. Our ability to successfully commercialize our marketed products is also subject to risks associated with these agreements, including the financial condition of our partners, the potential for termination of the agreements, and our reliance on our partners for certain key activities. We cannot be certain that our marketing of our promoted commercial products will result in increased demand for, and sales of, those products.

We are also dependent on our ability to generate and increase revenues from sales of our authorized generic Zegerid prescription products.

Under the terms of our distribution and supply agreement with Prasco LLC, or Prasco, Prasco distributes and sells an authorized generic of prescription Zegerid capsules in the U.S. Prasco pays us a specified invoice supply price and a percentage of the gross margin on sales of the authorized generic products.

We are dependent on Prasco and cannot be certain that Prasco will be able to maintain or increase revenues related to the authorized generic product. Even if physicians prescribe Zegerid products, third-party payors and pharmacists may encourage patients to use generic versions of other proton pump inhibitor, or PPI, products. In many cases, insurers and other healthcare payment organizations encourage the use of generic brands through their prescription benefits coverage and payment or reimbursement policies. Any inability to generate and increase sales of our authorized generic Zegerid prescription products would have a negative impact on our financial condition and results of operations.

Our investigational drugs will require significant development activities and ultimately may not be approved by the FDA, and any failure or delays associated with these activities or the FDA’s approval of such products would increase our costs and time to market.

We will not be permitted to market Ruconest, rifamycin SV MMX and SAN-300 or any other investigational drugs for which we may acquire rights in the U.S. until we complete all necessary development activities and obtain regulatory approval from the FDA.

To market a new drug in the U.S., we must submit to the FDA and obtain FDA approval of a new drug application, or NDA, or a biologics license application, or BLA. An NDA or BLA must be supported by extensive clinical and preclinical data, as well as extensive information regarding chemistry, manufacturing and controls, or CMC, to demonstrate the safety and effectiveness of the applicable investigational drug. The FDA’s regulatory review of NDAs and BLAs is becoming increasingly focused on product safety attributes, and even if approved, investigational drugs may not be approved for all indications requested and such approval may be subject to limitations on the indicated uses for which the drug may be marketed, restricted distribution methods or other limitations.

Failure can occur at any stage of clinical testing. The clinical study process may fail to demonstrate that our products are safe for humans or effective for their intended uses. Our clinical tests must comply with FDA and other applicable U.S. and foreign regulations, including a requirement that they be conducted in accordance with good clinical practices. We may encounter delays based on our inability to timely enroll enough patients to complete our clinical studies. We may suffer significant setbacks in advanced clinical studies, even after showing promising results in earlier studies. Based on results at any stage of clinical studies, we may decide to discontinue development of an investigational drug. We or the FDA may suspend clinical studies at any time if the patients participating in the studies are exposed to unacceptable health risks or if the FDA finds deficiencies in our applications to conduct the clinical studies or in the conduct of our studies.

Regulatory approval of an NDA or a BLA is difficult, time-consuming and expensive to obtain. The number and types of preclinical studies and clinical trials that will be required for NDA or BLA approval varies depending on the investigational drug, the disease or the condition that the investigational drug is designed to target and the regulations applicable to any particular investigational drug. Despite the time and expense associated with preclinical and clinical studies, failure can occur at any stage, and we could encounter problems that cause us to repeat or perform additional preclinical studies, CMC studies or clinical studies. The FDA and similar foreign authorities could delay, limit or deny approval of an investigational drug for many reasons, including because they:

•

may not deem an investigational drug to be adequately safe and effective;

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may not find the data from preclinical studies, CMC studies and clinical studies to be sufficient to support a claim of safety and efficacy;

•

may interpret data from preclinical studies, CMC studies and clinical studies significantly differently than we do;

•

may not approve the manufacturing processes or facilities utilized for our development activities or our proposed commercial manufacturing operations;

•

may conclude that we have not sufficiently demonstrated long-term stability of the formulation for which we are seeking marketing approval;

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may change approval policies (including with respect to our investigational drugs’ class of drugs) or adopt new regulations; or

•

may not accept a submission due to, among other reasons, the content or formatting of the submission.

Even if we believe that data collected from our preclinical studies, CMC development program and clinical studies of our investigational drugs are promising and that our information and procedures regarding CMC are sufficient, our data may not be sufficient to support marketing approval by the FDA or any other U.S. or foreign regulatory authority, or regulatory interpretation of these data and procedures may be unfavorable. In addition, before the FDA approves one of our investigational drugs, the FDA may choose to conduct an inspection of one or more clinical or manufacturing sites. These inspections may be conducted by the FDA both at U.S. sites as well as overseas. Any restrictions on the ability of FDA investigators to travel overseas to conduct such inspections, either because of financial or other reasons including political unrest, disease outbreaks or terrorism, could delay the inspection of overseas sites and consequently delay FDA approval of our investigational drugs.

Our product development costs will increase and our product revenues will be delayed if we experience delays or setbacks for any reason. In addition, such failures could cause us to abandon an investigational drug entirely. If we fail to take any current or future investigational drug from the development stage to market, we will have incurred significant expenses without the possibility of generating revenues, and our business will be adversely affected.

To market any drugs outside of the U.S., we and current or future collaborators must comply with numerous and varying regulatory requirements of other countries. Approval procedures vary among countries and can involve additional product testing and additional administrative review periods, including obtaining reimbursement approval in select markets. Regulatory approval in one country does not ensure regulatory approval in another, but a failure or delay in obtaining regulatory approval in one country may negatively impact the regulatory process in others.

We may also pursue additional development programs for our currently marketed products. For example, in July 2013, we completed patient enrollment in a multicenter, randomized, double-blind placebo-controlled CONTRIBUTE phase IIIb clinical study to evaluate Uceris 9 mg as an add-on therapy to current oral aminosalicylate, or 5-ASA, drugs, such as Asacol^® or Lialda^®, for induction of remission of active ulcerative colitis. We enrolled 509 patients at clinical sites in the U.S., Canada and Europe. We expect to report top-line data from the study by the end of 2013 or in early 2014. We may not be able to complete the remainder of the trial activities as expected, and we cannot be certain that the results of the trial will be positive.

In addition to the general development and regulatory risks described above, each of our investigational drugs is subject to the following additional risks:

Ruconest (recombinant human C1 esterase inhibitor)

Ruconest is a recombinant version of the human protein C1 esterase inhibitor, which is produced using proprietary transgenic technology. We have rights to commercialize Ruconest in North America under a license agreement with Pharming Group NV, or Pharming.

In November 2012, we announced that when compared with placebo, Ruconest demonstrated a significantly shorter time to beginning of relief of symptoms, the primary endpoint, in a pivotal phase III clinical study that was conducted to evaluate the safety and efficacy of Ruconest 50 IU/kg for the treatment of acute attacks of angioedema in patients with hereditary angioedema, or HAE. In April 2013, we and Pharming submitted a BLA to the FDA, seeking approval to market Ruconest for the treatment of acute attacks of angioedema in patients with HAE, and the FDA accepted the BLA for review in June 2013. Pursuant to the Prescription Drug User Fee Act guidelines, or PDUFA, we expect that the FDA will complete its review or otherwise respond to the BLA by April 16, 2014.

We cannot be certain as to whether the FDA will ultimately approve the BLA in a timely manner or at all. Although the top-line results from the phase III study were positive, we cannot be sure that the FDA will concur with our clinical interpretation of the results or the conduct of the study or that the FDA will satisfactorily complete its review of manufacturing and supply matters, including inspections of facilities. Ultimately, the FDA may provide us with a complete response letter or take other action that could delay or prevent approval. The FDA may ultimately conclude that we have not demonstrated sufficient safety or efficacy to approve a BLA filing for this investigational drug or may require additional clinical studies or other development programs before approving Ruconest. The costs of any additional clinical studies and development programs could be significant, and we and Pharming may not have sufficient resources to complete any additional development requirements in a prompt manner or at all.

In addition, we currently are exploring clinical and regulatory strategies to evaluate Ruconest for the treatment of acute pancreatitis and for HAE prophylaxis. For HAE prophylaxis, Pharming submitted under its investigational new drug application a protocol to the FDA with a request for a special protocol assessment, or SPA. The FDA has indicated that modifications to the protocol are needed before proceeding with the study and further discussions will be required in order for the protocol to be approved pursuant to the SPA process. We and Pharming are evaluating next steps to move the program forward. For acute pancreatitis, we have a meeting scheduled with the FDA later in November 2013 to discuss the study design. These programs are early stage, and we cannot be certain that we will be able to receive regulatory feedback, design and commence initial studies or otherwise pursue development for one or both of these indications in a timely manner or at all.

We are dependent on Pharming for many activities related to the Ruconest development program, including manufacturing and supply, and there are significant risks concerning Pharming’s ability to continue to perform these functions based on its limited financial resources. Any inability of Pharming to continue to fund its operations would have a material adverse effect on the Ruconest development program.

Moreover, Ruconest utilizes Pharming’s transgenic technology platform for the production of recombinant human proteins, and to date there has been only one other prescription product approved by the FDA that utilizes transgenic technology. As a result, Ruconest is subject to risks related to the novelty of its technology platform as well as other general development risks, any of which may result in additional costs and delays prior to our ability to obtain U.S. regulatory approval for, and commercialize, Ruconest.

In addition, in March 2013 a Citizen Petition was submitted to the FDA with regard to two currently marketed plasma-derived C1 esterase inhibitor products (Cinryze^® and Berinert^®). The petition requests, among other things, that the FDA add additional warnings to the labeling for these products relating to risks associated with systemic venous, septic and arterial thromboembolic complications and that the FDA require the product sponsors to conduct additional studies to evaluate the risks. In August 2013, FDA issued an interim response to the petitioner stating that FDA has been unable to reach a decision on the petition because it raises complex issues requiring extensive review and analysis by FDA officials. We cannot predict when or if the FDA will issue a final response to, or otherwise take any other action with respect to, the Citizen Petition.

Rifamycin SV MMX

In September 2012, we announced positive top-line results from a phase III clinical study to evaluate the safety and efficacy of rifamycin SV MMX for the treatment of patients with travelers’ diarrhea. The study results showed that rifamycin SV MMX, when compared with placebo, demonstrated a statistically significant reduction in the time to last unformed stool, or TLUS, the primary endpoint of the study. We have licensed rights to develop and commercialize rifamycin SV MMX in the U.S. from Cosmo.

Dr. Falk Pharma GmbH, or Dr. Falk, Cosmo's European development partner, is conducting a second phase III clinical study to evaluate the efficacy of rifamycin SV MMX versus ciprofloxacin with a primary endpoint of TLUS in patients with travelers’ diarrhea. Based on a prespecified interim analysis, an independent data monitoring committee has recommended that approximately 250 patients be added to the study, which originally targeted enrolling approximately 780 patients. Dr. Falk recently received approval from the Indian regulatory authorities to begin enrolling the additional patients in the clinical study. We believe Dr. Falk will complete patient enrollment in 2014. In recent months, clinical trial sponsors have experienced significant delays in obtaining approvals to proceed with certain clinical trials in India following changes in the Indian regulatory system intended to provide additional protection for the safety of clinical trial subjects. The Dr. Falk study has taken longer than originally anticipated and we cannot be certain that it will be completed in a timely manner or at all. Assuming positive results in the second phase III clinical study, we and Dr. Falk plan to share the clinical data from our respective phase III studies for inclusion in each company’s regulatory submissions. We cannot be certain that Dr. Falk will be able to complete its study in a timely manner or that results from Dr. Falk’s study will be positive or provide a sufficient basis for planned regulatory submissions.

SAN-300 (anti-VLA-1 antibody)

We have acquired the exclusive worldwide rights to a humanized anti-VLA-1 monoclonal antibody, or mAb, development program, through the acquisition of Covella Pharmaceuticals, Inc., or Covella, and a related license agreement with Biogen Idec MA Inc., or Biogen. SAN-300, our anti-VLA-1 mAb, is an inhibitor of VLA-1, also known as a₁ß₁ integrin, and has shown activity in multiple preclinical models of inflammatory and autoimmune diseases. We initially expect to develop SAN-300 for the treatment of rheumatoid arthritis.

In December 2012, we completed a phase I dose-escalation clinical study in healthy volunteers to determine the safety, tolerability, pharmacokinetics and pharmacodynamics of single doses of SAN-300 in both intraveneous, or IV, and subcutaneous formulations. The phase I study was conducted in Australia and enrolled a total of 66 healthy volunteers. We plan to begin a phase IIa clinical study evaluating SAN-300 for treatment of rheumatoid arthritis during the fourth quarter of 2013.

Although SAN-300 has shown activity in pre-clinical models, it is at a very early stage of development, and has only recently completed the initial phase of human clinical testing. As a result, we cannot be certain that further clinical testing and any necessary additional pre-clinical testing will be timely or successful, and there are many significant risks for this early-stage development program.

Our reliance on our strategic partners, third-party clinical investigators and clinical research organizations, or CROs, may result in delays in completing, or a failure to complete, clinical studies or we may be unable to use the clinical data gathered if they fail to comply with our patient enrollment criteria, our clinical protocols or regulatory requirements, or otherwise fail to perform under our agreements with them.

As an integral component of our clinical development programs, we engage clinical investigators and CROs to enroll patients and conduct and manage our clinical studies, including CROs located both within and outside the U.S. In addition, it is anticipated that U.S. regulatory approval for many of our investigational drugs will be supported in part by clinical studies that have been or are being conducted by our strategic partners in connection with CROs or other third parties. Accordingly, our ability to successfully commercialize these products is subject to risks associated with our agreements with these partners, including the potential for early termination of the agreements and the financial condition of our partners. As a result, many key aspects of this process have been and will be out of our direct control and are impacted by general conditions both within and outside the U.S. If the CROs and other third parties that we rely on for patient enrollment and other portions of our clinical studies fail to perform the clinical studies in a timely and satisfactory manner and in compliance with applicable U.S. and foreign regulations, including the FDA’s regulations relating to good clinical practices, we could face significant delays in completing our clinical studies or we may be unable to rely in the future on the clinical data generated. If these CROs or other third parties do not carry out their contractual duties or obligations or fail to meet expected deadlines, or if the quality or accuracy of the clinical data they obtain is compromised due to their failure to adhere to our patient enrollment criteria, our clinical protocols, regulatory requirements or for other reasons, our clinical studies may be extended, delayed or terminated, we may be required to repeat one or more of our clinical studies and we may be unable to obtain or maintain regulatory approval for or successfully commercialize our products.

The markets in which we compete are intensely competitive and many of our competitors have significantly more resources and experience, which may limit our commercial opportunity.

The pharmaceutical and biotechnology industries are intensely competitive in the markets in which our commercial products compete and our investigational drugs may compete, and there are many other currently marketed products that are well-established and successful, as well as development programs underway. In addition, many of our competitors are large, well-established companies in the pharmaceutical and biotechnology fields with significantly greater financial resources, sales and marketing capabilities, manufacturing capabilities, experience in obtaining regulatory approvals for product candidates, and other resources than we do. Larger pharmaceutical and biotechnology companies typically have significantly larger field sales force organizations and invest significant amounts in advertising and marketing their products. As a result, these larger companies are able to reach a greater number of physicians and consumers than we can with our smaller sales organization.

If we are unable to compete successfully, our business, financial condition and results of operations will be materially adversely affected.

Our marketed prescription products currently compete with many other drug products.

Uceris competes with many other products, including:

•

branded 5-aminosalicylate prescription products (such as Asacol^®, Lialda^®, Pentasa^® and Apriso^®);

•

generic 5-aminosalicylate prescription products (such as sulfasalazine, mesalamine, and balsalazide);

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generic prescription corticosteroids (such as prednisone and hydrocortisone);

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branded and generic prescription immunosuppressive products (such as azathioprine and 6-mercaptopurine); and

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branded anti-TNF-a prescription products (such as Remicade^® and Humira^®).

Zegerid (branded and authorized generic) competes with many other products, including:

•

branded PPI prescription products (such as Nexium^®, Aciphex^® and Dexilant^®);

•

generic PPI prescription products (such as delayed-release omeprazole, delayed-release lansoprazole and delayed-release pantoprazole);

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OTC PPI products (such as Prilosec OTC^®, Prevacid^® 24HR and store-brand versions); and

•

other prescription and/or OTC acid-reducing agents (such as histamine-2 receptor antagonists and antacids).

Glumetza competes with many other products, including:

•

other branded immediate-release and extended-release metformin products (such as Fortamet^®, Glucophage^® and Glucophage XR^®);

•

branded extended-release metformin combination products (such as Janumet^®XR and Kombiglyze^®XR);

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generic immediate-release and extended-release metformin products; and

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other prescription diabetes treatments.

In addition, various companies are developing new products that may compete with the Glumetza products in the future. For example, Depomed has licensed rights to use its extended-release patents in combination with canagliflozin, a sodium-glucose transporter-2, or SGLT2, compound being developed by Janssen. Depomed has also licensed rights to use its extended-release metformin patents to Boehringer Ingelheim for use with certain fixed dose combination products that include proprietary Boehringer Ingelheim compounds.

Like Glumetza, Cycloset competes with many other products, including:

•

dipeptidyl peptidase IV inhibitors, or DPP-4, products (such as Januvia^® and Onglyza^®);

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glucagon-like peptide 1, or GLP-1, receptor agonist products (such as Byetta^®, Victoza^® and Bydureon^®);

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thiazolidinedione, or TZD, products (such as Avandia^® and Actos^®);

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sulfonylureas products (such as Amaryl^® and Glynase^®);

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sodium-glucose co-transporter 2 inhibitors, or SGLT2, products (such as Invokana™); and

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branded and generic metformin products.

In addition, various companies are developing new products that may compete with the Cycloset product in the future. For example, new SGLT2 and new DPP-4 inhibitor products in development could compete with Cycloset in treating type 2 diabetes patients in the future. In addition, companies could develop combination products that include bromocriptine mesylate as one of the active ingredients for the treatment of type 2 diabetes.

Fenoglide competes with many other products, including:

•

other branded and generic formulations of fenofibrate (such as Tricor^®, Antara^® and Lipofen^®), gemfibrozil (such as Lopid^®), and fenofibric acid (such as Trilipix^®); and

•

other prescription treatments for primary hyperlipidemia, mixed dyslipidemia, and hypertriglyceridemia (such as statins and niacin).

In addition, various companies are developing new products that may compete with Fenoglide in the future. For example, monoclonal antibodies targeting PCSK9 for reducing LDL-C could compete with Fenoglide in the future. In addition, companies could develop combination products with fenofibrate as one of the active ingredients for the treatment of primary hyperlipidemia, mixed lipidemia, or hypertriglyceridemia. For example, rosuvastatin calcium and fenofibric acid are being studied in combination for the treatment of mixed dyslipidemia.

We or our strategic partners may also face competition for our products from lower-priced products from foreign countries that have placed price controls on pharmaceutical products. Proposed federal legislative changes may expand consumers’ ability to import lower-priced versions of our products and competing products from Canada and other developed countries. Further, several states and local governments have implemented importation schemes for their citizens and, in the absence of federal action to curtail such activities, we expect other states and local governments to launch importation efforts. The importation of foreign products that compete with our own products could negatively impact our business and prospects.

The existence of numerous competitive products may put downward pressure on pricing and market share, which in turn may adversely affect our business, financial condition and results of operations.

In addition, if approved, our investigational drugs will compete with many other drug and biologic products that are already entrenched in the marketplace, as well as face competition from other product candidates currently under development.

We do not currently have any manufacturing facilities and instead rely on third-party manufacturers and our strategic partners for supply.

We rely on third-party manufacturers and our strategic partners to provide us with an adequate and reliable supply of our products on a timely basis, and we do not currently have any of our own manufacturing or distribution facilities. Our manufacturers must comply with U.S. regulations, including the FDA’s current good manufacturing practices, applicable to the manufacturing processes related to pharmaceutical products, and their facilities must be inspected and approved by the FDA and other regulatory agencies on an ongoing basis as part of their business. In addition, because several of our key manufacturers are located outside of the U.S., they must also comply with applicable foreign laws and regulations.

We have limited control over our third-party manufacturers and strategic partners, including with respect to regulatory compliance and quality assurance matters. Any delay or interruption of supply related to a failure to comply with regulatory or other requirements, or in connection with transfer of manufacturing activities to alternate facilities, would limit our ability to sell our products. Any manufacturing defect or error discovered after products have been produced and distributed could result in even more significant consequences, including costly recall procedures, re-stocking costs, damage to our reputation and potential for product liability claims. With respect to our investigational drugs, if the FDA finds significant issues with any of our manufacturers during the pre-approval inspection process, the approval of those drugs could be delayed while the manufacturer addresses the FDA’s concerns, or we may be required to identify and obtain the FDA’s approval of a new supplier. This could result in significant delays before manufacturing of our products can begin, which in turn would delay commercialization of our products. In addition, the importation of pharmaceutical materials into the U.S. is subject to regulation by the FDA, and the FDA can refuse to allow an imported item into the U.S. if it is not satisfied that the product complies with applicable laws or regulations.

For Uceris, we rely on Cosmo, located in Italy, to manufacture and supply all of our bulk drug product requirements and we rely on a third party packager for supply of the finished product.

For Zegerid, we currently rely on Norwich Pharmaceuticals, Inc., located in New York, as the sole third-party manufacturer of Zegerid capsules and related authorized generic product. In addition, we rely on a Patheon Inc., or Patheon, facility located in Canada as the sole third-party manufacturer of Zegerid powder for oral suspension.

For Glumetza 500 mg, we assumed from Depomed a commercial manufacturing agreement with Patheon, and, accordingly, we rely on a Patheon facility located in Puerto Rico as the sole third-party manufacturer of Glumetza 500 mg. We currently rely on Depomed to oversee product manufacturing and supply of Glumetza 1000 mg. In turn, Depomed relies on a Valeant Pharmaceuticals International, Inc. facility located in Canada as the sole third-party manufacturer of Glumetza 1000 mg.

In connection with the license of rights to Cycloset, we assumed a manufacturing services agreement with Patheon, and, accordingly, we rely on a Patheon facility located in Ohio as the sole third-party manufacturer for Cycloset.

In connection with the license of rights to Fenoglide, we assumed a commercial supply agreement with Catalent Pharma Solutions, LLC, or Catalent, and accordingly, we rely on a Catalent facility located in Kentucky as the sole third-party manufacturer for Fenoglide.

For our Ruconest investigational drug, we rely on Pharming to oversee product manufacturing and supply. In turn, Pharming utilizes certain of its own facilities as well as third-party manufacturing facilities for supply, all of which are located in Europe.

For our rifamycin SV MMX investigational drug, we will rely on Cosmo, located in Italy, to manufacture and supply all of our drug product requirements. We plan to enter into a manufacturing and supply agreement with Cosmo relating to the commercial supply of rifamycin SV MMX.

For our SAN-300 investigational drug, we are utilizing materials previously manufactured by Biogen for the production of clinical trial materials and also rely on a separate fill/finish manufacturer. In the future, Biogen has a right of first offer to supply our product requirements. We plan to contract with a third-party manufacturer in the event Biogen elects not to supply our product requirements.

We and our strategic partners also rely in many cases on sole source suppliers for active ingredients and other product materials and components. Any significant problem that our strategic partners or the third-party manufacturers or suppliers experience could result in a delay or interruption in the supply until the problem is cured or until we or our partners locate an alternative source of supply. In addition, because these sole source manufacturers and suppliers in many cases provide services to a number of other pharmaceutical companies, they may experience capacity constraints or choose to prioritize one or more of their other customers.

Although alternative sources of supply exist, the number of third-party manufacturers with the manufacturing and regulatory expertise and facilities necessary to manufacture the finished forms of our pharmaceutical products or the key ingredients in our products is limited, and it would take a significant amount of time to arrange for alternative manufacturers. Any new supplier of products or key ingredients would be required to qualify under applicable regulatory requirements and would need to have sufficient rights under applicable intellectual property laws to the method of manufacturing such products or ingredients. The FDA may require us to conduct additional clinical studies, collect stability data and provide additional information concerning any new supplier before we could distribute products from that supplier. Obtaining the necessary FDA approvals or other qualifications under applicable regulatory requirements and ensuring non-infringement of third-party intellectual property rights could result in a significant interruption of supply and could require the new supplier to bear significant additional costs which may be passed on to us.

Any delay, interruption or cessation of production by our third-party manufacturers or strategic partners of our commercial products or investigational drugs or their respective materials and components, as a result of any of the above factors or otherwise, may limit our ability to meet demand for our commercial products resulting in lost potential revenue or, with respect to investigational drugs, delay any ongoing clinical trials, which could have a material adverse impact on our business, results of operations and financial condition.

Our future growth may depend in part on our ability to identify and in-license or acquire additional products, and if we do not successfully do so, or otherwise fail to integrate any new products into our operations, we may have limited growth opportunities.

We are continuing to seek to acquire or in-license products, businesses or technologies that we believe are a strategic fit with our business strategy. Future in-licenses or acquisitions, however, may entail numerous operational and financial risks, including:

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exposure to unknown liabilities;

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disruption of our business and diversion of our management’s time and attention to develop acquired products or technologies;

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a reduction of our current financial resources;

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difficulty or inability to secure financing to fund development activities for such acquired or in-licensed technologies;

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incurrence of substantial debt or dilutive issuances of securities to pay for acquisitions; and

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higher than expected acquisition and integration costs.

We may not have sufficient resources to identify and execute the acquisition or in-licensing of third-party products, businesses and technologies and integrate them into our current infrastructure. In particular, we may compete with larger pharmaceutical companies and other competitors in our efforts to establish new collaborations and in-licensing opportunities. These competitors likely will have access to greater financial resources than us and may have greater expertise in identifying and evaluating new opportunities. In addition, we may devote resources to potential acquisitions or in-licensing opportunities that are never completed, or we may fail to realize the anticipated benefits of such efforts.

Our reporting and payment obligations under governmental purchasing and rebate programs are complex and may involve subjective decisions, and any failure to comply with those obligations could subject us to penalties and sanctions, which in turn could have a material adverse effect on our business and financial condition.

As a condition of reimbursement by various federal and state healthcare programs, we must calculate and report certain pricing information to federal and state healthcare agencies. The regulations regarding reporting and payment obligations with respect to governmental programs are complex. Our calculations and methodologies are subject to review and challenge by the applicable governmental agencies, and it is possible that such reviews could result in material changes. In addition,

because our processes for these calculations and the judgments involved in making these calculations involve subjective decisions and complex methodologies, these calculations are subject to the risk of errors. Any failure to comply with the government reporting and payment obligations could result in civil and/or criminal sanctions.

Regulatory approval for our currently marketed products is limited by the FDA to those specific indications and conditions for which clinical safety and efficacy have been demonstrated.

Any regulatory approval is limited to those specific diseases and indications for which our products are deemed to be safe and effective by the FDA. In addition to the FDA approval required for new formulations, any new indication for an approved product also requires FDA approval. If we are not able to obtain FDA approval for any desired future indications for our products, our ability to effectively market and sell our products may be reduced and our business may be adversely affected.

While physicians may choose to prescribe drugs for uses that are not described in the product’s labeling and for uses that differ from those tested in clinical studies and approved by the regulatory authorities, our ability to promote the products is limited to those indications that are specifically approved by the FDA. These “off-label” uses are common across medical specialties and may constitute an appropriate treatment for many patients in varied circumstances. Regulatory authorities in the U.S. generally do not regulate the behavior of physicians in their choice of treatments. Regulatory authorities do, however, restrict communications by pharmaceutical companies on the subject of off-label use. If our promotional activities fail to comply with these regulations or guidelines, we may be subject to warnings from, or enforcement action by, these authorities. In addition, our failure to follow FDA rules and guidelines relating to promotion and advertising may cause the FDA to delay its approval or refuse to approve a product, the suspension or withdrawal of an approved product from the market, recalls, fines, disgorgement of money, operating restrictions, injunctions or criminal prosecution, any of which could harm our business.

We are subject to ongoing regulatory review of our currently marketed products.

Following receipt of regulatory approval, any products that we market continue to be subject to extensive regulation. These regulations impact many aspects of our operations, including the manufacture, labeling, packaging, adverse event reporting, storage, distribution, advertising, promotion and record keeping related to the products. The FDA also frequently requires post-marketing testing and surveillance to monitor the effects of approved products or place conditions on any approvals that could restrict the commercial applications of these products. For example, in connection with the approval of Zegerid powder for oral suspension, we committed to commence clinical studies to evaluate the product in pediatric populations. We have not yet commenced any of the studies and have requested a waiver of this requirement from the FDA. Similarly, in connection with the approval of Uceris, we committed to a post-marketing requirement to conduct an 8-week randomized clinical study in children 5 to 16 years of age with active, mild to moderate ulcerative colitis. We are currently discussing protocol design for the pediatric study with the FDA and expect to initiate the study once we have reached agreement with the FDA on the study design. If we fail to comply with applicable regulatory requirements, we may be subject to fines, suspension or withdrawal of regulatory approvals, product recalls, seizure of products, disgorgement of money, operating restrictions and criminal prosecution.

In addition to FDA restrictions on marketing of pharmaceutical products, several other types of state and federal laws have been applied to restrict certain marketing practices in the pharmaceutical industry in recent years. These laws include anti-kickback statutes and false claims statutes. The federal healthcare program anti-kickback statute prohibits, among other things, knowingly and willfully offering, paying, soliciting or receiving remuneration to induce or in return for purchasing, leasing, ordering or arranging for the purchase, lease or order of any healthcare item or service reimbursable under Medicare, Medicaid or other federally financed healthcare programs. This statute has been interpreted to apply to arrangements between pharmaceutical manufacturers on the one hand and prescribers, purchasers and formulary managers on the other. Violations of the anti-kickback statute are punishable by imprisonment, criminal fines, civil monetary penalties and exclusion from participation in federal healthcare programs. Although there are a number of statutory exemptions and regulatory safe harbors protecting certain common activities from prosecution or other regulatory sanctions, the exemptions and safe harbors are drawn narrowly, and practices that involve remuneration intended to induce prescribing, purchases or recommendations may be subject to scrutiny if they do not qualify for an exemption or safe harbor. Our practices may not in all cases meet all of the criteria for safe harbor protection from anti-kickback liability.

Federal false claims laws prohibit any person from knowingly presenting, or causing to be presented, a false claim for payment to the federal government, or knowingly making, or causing to be made, a false statement to have a false claim paid. Recently, several pharmaceutical and other healthcare companies have been prosecuted under these laws for allegedly inflating drug prices they report to pricing services, which in turn are used by the government to set Medicare and Medicaid reimbursement rates, and for allegedly providing free product to customers with the expectation that the customers would bill federal programs for the product. In addition, certain marketing practices, including off-label promotion, may also violate false claims laws. The majority of states also have statutes or regulations similar to the federal anti-kickback law and false claims laws, which apply to items and services reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payor. Sanctions under these federal and state laws may include civil monetary penalties, exclusion of a manufacturer’s products from reimbursement under government programs, criminal fines and imprisonment.

The Patient Protection and Affordable Care Act, or PPACA, enacted in 2010, imposes new reporting and disclosure requirements for pharmaceutical and device manufacturers with regard to payments or other transfers of value made to physicians and teaching hospitals. In addition, pharmaceutical and device manufacturers will also be required to report and disclose investment interests held by physicians and their immediate family members during the preceding calendar year. Failure to submit required information may result in civil monetary penalties for payments, transfers of value or ownership or investment interests not reported in an annual submission. The reforms imposed by the PPACA will significantly impact the pharmaceutical industry; however, the full effects of the new law cannot be known until these provisions are implemented. In addition, although the PPACA was recently upheld by the U.S. Supreme Court, it is possible that the PPACA may be modified or repealed in the future.

If not preempted by this federal law, several states require pharmaceutical companies to report expenses relating to the marketing and promotion of pharmaceutical products and to report gifts and payments to individual physicians in the states. Other states prohibit providing various other marketing related activities. Still other states require the posting of information relating to clinical studies and their outcomes. In addition, certain states require pharmaceutical companies to implement compliance programs or marketing codes. Currently, several additional states are considering similar proposals. Compliance with these laws is difficult and time consuming, and companies that do not comply with these state laws face civil penalties. Because of the breadth of these laws and the narrowness of the safe harbors, it is possible that some of our business activities could be subject to challenge under one or more of such laws. Such a challenge could have a material adverse effect on our business, financial condition, results of operations and growth prospects.

In addition, as part of the sales and marketing process, pharmaceutical companies frequently provide samples of approved drugs to physicians. This practice is regulated by the FDA and other governmental authorities, including, in particular, requirements concerning record keeping and control procedures. Any failure to comply with the regulations may result in significant criminal and civil penalties as well as damage to our credibility in the marketplace.

We are subject to new legislation, regulatory proposals, managed care initiatives and other legal developments that may increase our costs and adversely affect our ability to market our products.

In March 2010, the President signed the PPACA, which makes extensive changes to the delivery of healthcare in the U.S. This act includes numerous provisions that affect pharmaceutical companies, some of which were effective immediately and others of which will be taking effect over the next several years. For example, the act seeks to expand healthcare coverage to the uninsured through private health insurance reforms and an expansion of Medicaid. The act also imposes substantial costs on pharmaceutical manufacturers, such as an increase in liability for rebates paid to Medicaid, new drug discounts that must be offered to certain enrollees in the Medicare prescription drug benefit, an annual fee imposed on all manufacturers of brand prescription drugs in the U.S., increased disclosure obligations and an expansion of an existing program requiring pharmaceutical discounts to certain types of hospitals and federally subsidized clinics. The act also contains cost-containment measures that could reduce reimbursement levels for healthcare items and services generally, including pharmaceuticals. It also will require reporting and public disclosure of payments and other transfers of value provided by pharmaceutical companies to physicians and teaching hospitals. These measures could result in decreased net revenues from our pharmaceutical products and decreased potential returns from our development efforts. Although the PPACA was recently upheld by the U.S. Supreme Court, it is possible that the PPACA may be modified or repealed in the future.

In addition, there have been a number of other legislative and regulatory proposals aimed at changing the pharmaceutical industry. These include proposals to permit reimportation of pharmaceutical products from other countries and proposals concerning safety matters. For example, in an attempt to protect against counterfeiting and diversion of drugs, a bill was introduced in a previous Congress that would establish an electronic drug pedigree and track-and-trace system capable of electronically recording and authenticating every sale of a drug unit throughout the distribution chain. This bill or a similar

bill may be introduced in Congress in the future. California has already enacted legislation that requires development of an electronic pedigree to track and trace each prescription drug at the saleable unit level through the distribution system. California’s electronic pedigree requirement is scheduled to take effect beginning in January 2015. Compliance with California and any future federal or state electronic pedigree requirements will likely require an increase in our operational expenses and will likely be administratively burdensome. As a result of these and other new proposals, we may determine to change our current manner of operation, provide additional benefits or change our contract arrangements, any of which could have a material adverse effect on our business, financial condition and results of operations.

We, as well as many other pharmaceutical companies, sponsor prescription drug coupons and other cost-savings programs to help reduce the burden of co-payments and co-insurance. Since 2012, lawsuits have been filed against several pharmaceutical companies alleging, among other things, that the drug-makers violated anti-trust laws and the Racketeer Influenced and Corrupt Organizations Act, or RICO, when they provided coupon programs to privately-insured consumers that subsidize all or part of the cost-sharing obligation (co-pay or co-insurance) for a branded prescription drug or drugs. We cannot be certain as to whether we will be named in any future similar lawsuit or concerning the potential outcome of the ongoing litigation.

We face a risk of product liability claims and may not be able to obtain adequate insurance.

Our business exposes us to potential liability risks that may arise from the clinical testing, manufacture and sale of our marketed products and investigational drugs. These risks exist even if a product is approved for commercial sale by the FDA and manufactured in facilities licensed and regulated by the FDA. Any product liability claim or series of claims brought against us could significantly harm our business by, among other things, reducing demand for our products, injuring our reputation and creating significant adverse media attention and costly litigation. Plaintiffs have received substantial damage awards in some jurisdictions against pharmaceutical companies based upon claims for injuries allegedly caused by the use of their products. Any judgment against us that is in excess of our insurance policy limits would have to be paid from our cash reserves, which would reduce our capital resources. Although we have product and clinical study liability insurance with a coverage limit of $15.0 million, this coverage may prove to be inadequate. Furthermore, we cannot be certain that our current insurance coverage will continue to be available for our commercial or clinical study activities on reasonable terms, if at all. Further, we may not have sufficient capital resources to pay a judgment, in which case our creditors could levy against our assets, including our intellectual property.

If we are unable to retain key personnel, our business will suffer.

Our success depends on our continued ability to retain and motivate highly qualified management, clinical, regulatory, manufacturing, product development, business development and sales and marketing personnel. We may not be able to recruit and retain qualified personnel in the future, due to competition for personnel among pharmaceutical businesses, and the failure to do so could have a significant negative impact on our future product revenues and business results.

Our success also depends on a number of key senior management personnel, particularly Gerald T. Proehl, our President and Chief Executive Officer. Although we have employment agreements with our executive officers, these agreements are terminable at will at any time with or without notice and, therefore, we cannot be certain that we will be able to retain their services. In addition, although we have a “key person” insurance policy on Mr. Proehl, we do not have “key person” insurance policies on any of our other employees that would compensate us for the loss of their services. If we lose the services of one or more of these individuals, replacement could be difficult and may take an extended period of time and could impede significantly the achievement of our business objectives.

If we become subject to unsolicited public proposals from activist stockholders due to our shifting strategic focus or otherwise, we may experience significant uncertainty that would likely be disruptive to our business and increase volatility in our stock price.

Even if we are successful in future in-licenses or acquisitions, other companies who have shifted focus to new products and additional development programs have been the target of unsolicited public proposals from activist stockholders. The unsolicited and often hostile nature of these public proposals can result in significant uncertainty for current and potential licensors, suppliers, patients, physicians and other constituents, and can cause these parties to change or terminate their business relationships with the targeted company. Companies targeted by these unsolicited proposals from activist stockholders may not be able to attract and retain key personnel as a result of the related uncertainty. In addition, unsolicited proposals can result in stockholder class action lawsuits. The review and consideration of an unsolicited proposal as well as any resulting lawsuits can be a significant distraction for management and employees, and may require the expenditure of significant time, costs and other resources.

If we were to receive unsolicited public proposals from activist stockholders, we may encounter all of these risks and, as a result, may be delayed in executing our core strategy. We could be required to spend substantial resources on the evaluation of the proposal as well as the review of other opportunities that never come to fruition. If we were to receive any of these unsolicited public proposals, the future trading price of our common stock is likely to be even more volatile than in the past, and could be subject to wide price fluctuations based on many factors, including uncertainty associated with the proposals.

Risks Related to Our Intellectual Property

The protection of our intellectual property rights is critical to our success and any failure on our part to adequately maintain such rights would materially affect our business.

We regard the protection of patents, trademarks and other proprietary rights that we own or license as critical to our success and competitive position. Laws and contractual restrictions, however, may not be sufficient to prevent unauthorized use or misappropriation of our technology or deter others from independently developing products that are substantially equivalent or superior to our products.

Patents

Our commercial success will depend in part on the patent rights we have licensed or will license and on patent protection for our own inventions related to the products that we market and intend to market. Our success also depends on maintaining these patent rights against third-party challenges to their validity, scope or enforceability. Our patent position is subject to uncertainties similar to other biotechnology and pharmaceutical companies. For example, the U.S. Patent and Trademark Office, or PTO, or the courts may deny, narrow or invalidate patent claims, particularly those that concern biotechnology and pharmaceutical inventions.

We may not be successful in securing or maintaining proprietary or patent protection for our products, and protection that we have and do secure may be challenged and possibly lost. In addition, our competitors may develop products similar to ours using methods and technologies that are beyond the scope of our intellectual property rights. Other drug companies may challenge the scope, validity and enforceability of our patent claims and may be able to develop generic versions of our products if we are unable to maintain our proprietary rights. We also may not be able to protect our intellectual property rights against third-party infringement, which may be difficult to detect.

We have licensed the primary patent rights for each of our products and investigational drugs. Although we consult with our strategic partners and licensors concerning our licensed patent rights, in most cases those partners remain primarily responsible for prosecution activities. We cannot control the amount or timing of resources that our strategic partners and licensors devote to these activities. As a result of this lack of control and general uncertainties in the patent prosecution process, we cannot be sure that any additional patents will ever be issued or that the issued patents will be properly maintained. In addition, we are subject to the risk that one or more of our licenses could be terminated and any loss of our license rights would negatively impact our ability to develop, manufacture and commercialize our products and investigational drugs.

If generic manufacturers use litigation and regulatory means to obtain approval for generic versions of our products, our business will suffer. Under the Federal Food, Drug and Cosmetics Act, or FDCA, the FDA can approve an Abbreviated New Drug Application, or ANDA, for a generic version of a branded drug without the ANDA applicant undertaking the clinical testing necessary to obtain approval to market a new drug. In place of such clinical studies, an ANDA applicant usually needs only to submit data demonstrating that its product has the same active ingredient(s) and is bioequivalent to the branded product, in addition to any data necessary to establish that any difference in strength, dosage form, inactive ingredients, or delivery mechanism does not result in different safety or efficacy profiles, as compared to the reference drug.

The FDCA requires an applicant for a drug that relies, at least in part, on the patent of one of our branded drugs to notify us of their application and potential infringement of our patent rights. Upon receipt of this notice we have 45 days to bring a patent infringement suit in federal district court against the company seeking approval of a product covered by one of our

patents. The discovery, trial and appeals process in such suits can take several years. If such a suit is commenced, the FDCA provides a 30-month stay on the FDA's approval of the competitor's application. Such litigation is often time-consuming and quite costly and may result in generic competition if the patents at issue are not upheld or if the generic competitor is found not to infringe such patents. If the litigation is resolved in favor of the applicant or the challenged patent expires during the 30-month stay period, the stay is lifted and the FDA may thereafter approve the application based on the standards for approval of ANDAs.

In addition, any patent litigation settlement agreements we enter with regard to our products could be subject to further review by the U.S. Department of Justice and the Federal Trade Commission. Any legal or regulatory challenge to one or more of our settlement agreements by the U.S. Department of Justice and/or the Federal Trade Commission could adversely impact our business and revenues. A recent Supreme Court case expanded the scope for government agencies and private litigants to challenge such settlement agreements under the federal antitrust laws, which could make it more difficult to settle patent litigation involving our products, which could adversely impact our business and revenues. Pending proposals for federal legislation would further limit our ability to enter into such settlement agreements, which could increase the adverse impact on our business and revenues.

Uceris

We have exclusive rights to develop and commercialize Uceris in the U.S. under our strategic collaboration with Cosmo. Currently, there are four issued U.S. patents that are owned by Cosmo and licensed to us that we believe provide coverage for Uceris (U.S. Patent Nos. 7,431,943, 7,410,651; RE43,799 and 8,293,273), each of which expires in 2020.

Although the patents that provide coverage for Uceris are not currently subject to patent litigation, Cosmo has licensed rights to a different patent covering related MMX^® technology that is utilized in Lialda^®(mesalamine) delayed-release tablets that is subject to ongoing patent infringement litigation. Because the patents are different, it is unclear whether an adverse outcome in the Lialda patent infringement litigation would negatively impact the value of the patent coverage for Uceris.

In February 2013, we submitted a citizen petition to the FDA requesting that the FDA (1) develop and publish an individual bioequivalence recommendation for budesonide extended release tablets and (2) refrain from approving any ANDA that identifies Uceris as the reference listed drug unless the generic product is shown to be bioequivalent based on appropriate data from a clinical efficacy endpoint study, alternative comparative pharmacokinetic testing, in vitro dissolution testing, and pharmacoscintigraphy studies. In July 2013, we received an interim response from the FDA stating that the FDA has been unable to reach a decision on our petition because it raises complex issues requiring extensive review and analysis by FDA officials. We cannot predict when or if the FDA will issue a final response to, or otherwise take any other action with respect to, the citizen petition.

Zegerid and Pending Patent Litigation

We have entered into an exclusive, worldwide license agreement with the University of Missouri for patents and pending patent applications relating to specific formulations of PPIs with antacids and other buffering agents and methods of using these formulations. Currently, there are three U.S. patents that we believe provide coverage for our Zegerid products (U.S. Patent Nos. 5,840,737; 6,780,882; and 7,399,772), each of which expires in 2016. In addition to the issued U.S. patent coverage described above, several international patents have been issued.

Zegerid Rx and Zegerid OTC Patent Litigation

Zegerid Rx Litigation

In April 2010, the U.S. District Court for the District of Delaware ruled that five patents covering Zegerid capsules and Zegerid powder for oral suspension (U.S. Patent Nos. 6,489,346; 6,645,988; 6,699,885; 6,780,882; and 7,399,772) were invalid due to obviousness. These patents were the subject of lawsuits we filed in 2007 against Par Pharmaceutical, Inc., or Par, in response to ANDAs filed by Par with the FDA. The University of Missouri, licensor of the patents, is joined in the litigation as a co-plaintiff. In May 2010, we filed an appeal of the District Court’s ruling to the U.S. Court of Appeals for the Federal Circuit. Following the District Court’s decision, Par launched its generic version of Zegerid capsules in late June 2010.

In September 2012, the U.S. Court of Appeals for the Federal Circuit reversed in part the April 2010 decision of the District Court. The Federal Circuit found that certain claims of asserted U.S. Patent Nos. 6,780,882 and 7,399,772, which Par had been found to infringe, were not invalid due to obviousness. These patents represent two of the five patents that were found to be invalid by the District Court, and the Federal Circuit affirmed the District Court’s finding of invalidity for the asserted claims from the remaining three patents. The Federal Circuit also upheld the District Court’s finding that there was no inequitable conduct. Following the Federal Circuit’s decision, Par announced that it had ceased distribution of its generic Zegerid capsules product in September 2012. In December 2012, the Federal Circuit issued an order denying a combined petition for panel and en banc rehearing filed by Par and issued its mandate, remanding the case to the District Court for further proceedings pertaining to damages. In February 2013, we filed an amended complaint with the District Court for infringement of U.S. Patent Nos. 6,780,882 and 7,399,772 and requested a jury trial with respect to the issue of damages in connection with Par’s launch of its generic version of Zegerid capsules in June 2010. The trial has been scheduled in November 2014. In March 2013, Par filed its amended answer, which alleges, among other things, failure to state a claim upon which relief can be granted and non-infringement based on purported invalidity of the two asserted patents. In addition, Par filed a motion for a judgment on the pleadings, alleging, among other things, that the two asserted patents are invalid because the Federal Circuit purportedly did not expressly address certain prior art references considered by the District Court, and we are waiting for a ruling from the District Court on Par’s motion. Although we do not believe that Par has a meritorious basis upon which to further challenge validity of the asserted patents in this proceeding, we cannot be certain of the timing or outcome of this or any other proceedings. If the District Court rules in favor of Par on its pending motion or otherwise, we cannot be certain of the impact to us, including if or when Par might re-launch its generic product. In addition, in April 2013, Par received approval from the FDA of its generic version of Zegerid powder for oral suspension.

Zegerid OTC Litigation

In December 2011, Merck filed a lawsuit in the U.S. District Court for the District of New Jersey against Zydus for infringement of the patents listed in the Orange Book for Zegerid OTC. We and the University of Missouri, licensors of the listed patents, are joined in the litigation as co-plaintiffs. Zydus had filed an ANDA with the FDA regarding its intent to market a generic version of Zegerid OTC prior to the expiration of the listed patents. In September 2012, Merck amended its complaint to be limited to U.S. Patent No. 7,399,772, which patent was found not to be invalid in the September 2012 Federal Circuit decision. In October 2012, Zydus filed its answer, which alleges, among other things, failure to state a claim upon which relief can be granted. The lawsuit was commenced within the requisite 45-day time period, resulting in an FDA stay on the approval of Zydus’ proposed product for 30 months or until a decision is rendered by the District Court, which is adverse to the asserted patent. Absent a court decision, the 30-month stay is expected to expire in May 2014. The trial for this matter has been scheduled in January 2014. We are not able to predict the timing or outcome of this lawsuit.

Glumetza and Pending Patent Litigation

We have exclusive rights to manufacture and commercialize the Glumetza products in the U.S., including its territories and possessions and Puerto Rico, under our commercialization agreement with Depomed. Currently, there are four issued U.S. patents that are owned or licensed by Depomed that we believe provide coverage for the Glumetza 500 mg dose product (U.S. Patent Nos. 6,340,475; 6,635,280; 6,488,962; and 6,723,340), with expiration dates in 2016, 2020 and 2021. There are three issued U.S. patents that are owned or licensed by Depomed that we believe provide coverage for the Glumetza 1000 mg dose product (U.S. Patent Nos. 6,488,962; 7,780,987; and 8,323,692), with expiration dates in 2020 and 2025.

In November 2009, Depomed filed a lawsuit in the U.S. District Court for the Northern District of California against Lupin Limited and its wholly owned subsidiary, Lupin Pharmaceuticals, Inc., collectively referred to herein as Lupin, for infringement of certain patents listed in the Orange Book for Glumetza. The lawsuit was filed in response to an ANDA filed with the FDA by Lupin regarding Lupin’s intent to market generic versions of Glumetza 500 mg and 1000 mg tablets prior to the expiration of the listed patents. In February 2012, the case was settled allowing Lupin to begin selling a generic version of Glumetza in February 2016, or earlier under certain circumstances, and the District Court entered an order dismissing the case without prejudice.

In June 2011, Depomed filed a lawsuit in the U.S. District Court for the District of New Jersey against Sun Pharma Global FZE, Sun Pharmaceutical Industries Ltd. and Sun Pharmaceutical Industries Inc., collectively referred to herein as Sun, for infringement of the patents listed in the Orange Book for Glumetza. Valeant International Bermuda, or Valeant, was joined in the lawsuit as a co-plaintiff. The lawsuit was filed in response to an ANDA filed with the FDA by Sun regarding Sun’s intent to market generic versions of Glumetza 500 mg and 1000 mg tablets prior to the expiration of the listed patents. In January 2013, the case was settled allowing Sun to begin selling a generic version of Glumetza in August 2016, or earlier under certain circumstances, and the District Court entered an order dismissing the case without prejudice.

In April 2012, Depomed filed a lawsuit in the U.S. District Court for the District of Delaware against Watson Laboratories, Inc. — Florida, Actavis, Inc. and Watson Pharma, Inc., collectively referred to herein as Watson, for infringement of the patents listed in the Orange Book for Glumetza 1000 mg at the time the lawsuit was filed (U.S. Patent Nos. 6,488,962 and 7,780,987). Valeant is joined in the lawsuit as a co-plaintiff. The lawsuit was filed in response to an ANDA filed with the FDA by Watson regarding Watson’s intent to market a generic version of Glumetza 1000 mg tablets prior to the expiration of the listed patents. Depomed and Valeant commenced the lawsuit within the requisite 45-day time period, resulting in an FDA stay on the approval of Watson’s proposed product for 30 months or until a decision is rendered by the District Court, which is adverse to the asserted patents. Absent a court decision, the 30-month stay is expected to expire in September 2014. In June 2012, Watson filed its answer, which alleges, among other things, non-infringement and invalidity of the asserted patents, failure to state a claim, lack of subject matter jurisdiction, and has also filed counterclaims. In February 2013, Depomed amended its complaint to add infringement of a newly listed Orange Book patent (U.S. Patent No. 8,323,692), as well as two non-Orange Book listed patents (U.S. Patent Nos. 7,736,667 and 8,329,215). The Markman hearing for this matter has been scheduled in April 2014, and the trial has been scheduled in May 2014. In August 2013, the District Court ordered that the case be stayed. We are not able to predict the timing or outcome of this lawsuit.

In February 2013, Depomed filed a lawsuit in the U.S. District Court for the District of Delaware against Watson for infringement of the patents listed in the Orange Book for Glumetza 500 mg (U.S. Patent Nos. 6,340,475; 6,488,962; 6,635,280 and 6,723,340). The lawsuit was filed in response to an ANDA filed with the FDA by Watson regarding Watson’s intent to market a generic version of Glumetza 500 mg tablets prior to the expiration of the listed patents. Depomed commenced the lawsuit within the requisite 45-day time period, resulting in an FDA stay on the approval of Watson’s proposed product for 30 months or until a decision is rendered by the District Court, which is adverse to the asserted patents. Absent a court decision, the 30-month stay is expected to expire in July 2015. In March 2013, Watson filed its answer, which alleges, among other things, non-infringement and invalidity of the asserted patents, failure to state a claim, and lack of subject matter jurisdiction, and has also filed counterclaims. The Markman hearing for this matter has been scheduled in December 2014, and a trial has been scheduled in January 2015. In August 2013, the District Court ordered that the case be stayed. We are not able to predict the timing or outcome of this lawsuit.

Cycloset

We have exclusive rights to manufacture and commercialize Cycloset in the U.S. under our distribution and license agreement with S2 and VeroScience. Currently, there are seven issued U.S. patents that we have licensed from S2 and VeroScience that we believe provide coverage for Cycloset (U.S. Patent Nos. 5,679,685; 5,716,957; 7,888,310; 8,137,992; 8,137,993; 8,137,994; and 8,431,155), with expiration dates in 2014, 2015, 2023 and 2032.

Fenoglide and Pending Patent Litigation

We have exclusive rights to manufacture and commercialize Fenoglide in the U.S. under the terms of a license agreement with HRP and Shore. Currently, there are three issued U.S. patents that we believe provide coverage for the Fenoglide products (U.S. Patent Nos. 7,658,944; 8,124,125; and 8,481,078), with expiration dates in 2024.

Ruconest

We have exclusive rights to develop and commercialize the Ruconest investigational drug in the U.S., Canada and Mexico under our license and supply agreements with Pharming. Currently, there are two issued U.S. patents that are owned by Pharming and licensed to us that we believe provide coverage for Ruconest (U.S. Patent Nos. 7,067,713 and RE43,691), which expire in 2022 and 2024. In addition, we believe Ruconest, as a biological product, is entitled under the PPACA to a period of 12 years of regulatory exclusivity in the U.S.

Rifamycin SV MMX

We have exclusive rights to develop and commercialize the rifamycin SV MMX investigational drug in the U.S. under our strategic collaboration with Cosmo. Currently, there are four issued U.S. patents that are owned by Cosmo and licensed to us that we believe provide coverage for rifamycin SV MMX (U.S. Patent Nos. 7,431,943; 8,263,120; 8,486,446; and 8,529,945), which expire in 2020 and 2025. In addition, we believe rifamycin SV MMX, as a new chemical entity, is entitled to a period of five years of data exclusivity.

SAN-300

We acquired worldwide rights to develop and commercialize the SAN-300 investigational drug in connection with our acquisition of Covella. Currently, there are eight issued U.S. patents that are owned by Biogen and licensed to us that we believe provide coverage for SAN-300 (U.S. Patent Nos. 7,358,054; 7,462,353; 6,955,810; 7,723,073; 7,910,099; 8,084,031; 8,084,028; and 8,557,240), which expire in 2020 and 2022. In addition, we believe SAN-300, as a biological product, is entitled under the PPACA to a period of 12 years of regulatory exclusivity in the U.S.

Trademarks

We own, or have licensed the rights to use, the trademarks for each of our brand pharmaceutical products, as well as for our corporate name and logo. We have applied for trademark registration for various other names and logos. Over time, we intend to maintain registrations on trademarks that remain valuable to our business.

The trademarks and trademark applications we own and license are important to our success and competitive position. Any objections we receive from the PTO, foreign trademark authorities or third parties relating to our registered trademarks and pending applications could require us to incur significant expense in defending the objections or establishing alternative names. There is no guarantee we will be able to secure any of our pending trademark applications with the PTO or comparable foreign authorities.

If we do not adequately protect our rights in our various trademarks from infringement, any goodwill that has been developed in those marks would be lost or impaired. We could also be forced to cease using any of our trademarks that are found to infringe upon or otherwise violate the trademark or service mark rights of another company, and, as a result, we could lose all the goodwill which has been developed in those marks and could be liable for damages caused by any such infringement or violation.

Third parties may choose to file patent infringement claims against us, which litigation would be costly, time-consuming and distracting to management and could be materially adverse to our business.

The products we currently market, and those we may market in the future, may infringe patent and other rights of third parties. In addition, our competitors, many of which have substantially greater resources than us and have made significant investments in competing technologies or products, may seek to apply for and obtain patents that will prevent, limit or interfere with our ability to make, use and sell products either in the U.S. or international markets. Intellectual property litigation in the pharmaceutical industry is common, and we expect this to continue. Any third party patent infringement litigation may result in a loss of rights and would be time-consuming and costly. In addition, we may be required to negotiate licenses with one or more third parties with terms that may or may not be favorable to us.

Risks Related to Our Financial Results and Need for Financing

Our quarterly financial results are likely to fluctuate significantly due to uncertainties about future sales levels for our marketed products and future costs associated with our investigational drugs.

Our quarterly operating results are difficult to predict and may fluctuate significantly from period to period, particularly because the commercial success of, and demand for, marketed products, as well as the success and costs of our development programs are uncertain and therefore our future prospects are uncertain. The level of our revenues and results of operations at any given time will be based primarily on the following factors:

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commercial success of our marketed prescription products;

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potential to receive revenue from Zegerid authorized generic products;

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results of clinical studies and other development programs;

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our ability to obtain regulatory approval for our investigational drugs and any future investigational drugs we develop or in-license;

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whether we are able to maintain patent protection for our products, including whether favorable outcomes are obtained in the pending litigation;

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interruption in the manufacturing or distribution of our products;

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progress under our strategic alliances with Merck and GSK, including the impact on these alliances from generic competition and the potential for early termination of, or reduced payments under, the related agreements;

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timing of new product offerings, acquisitions, licenses or other significant events by us, our strategic partners or our competitors; and

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legislative changes, including healthcare reform, affecting the products we may offer or those of our competitors.

Because of these factors, our operating results in one or more future quarters may fail to meet the expectations of securities analysts or investors, which could cause our stock price to decline significantly.

To the extent we need to raise additional funds in connection with the licensing or acquisition of new products or to continue our operations, we may be unable to raise capital when needed.

We believe that our current cash, cash equivalents and short-term investments and use of our line of credit will be sufficient to fund our current operations through at least the next twelve months; however, our projected revenue may decrease or our expenses may increase and that would lead to our cash resources being consumed earlier than we expect. Although we do not believe that we will need to raise additional funds to finance our current operations through at least the next twelve months, we may pursue raising additional funds for various reasons, including to expand our commercial presence, in connection with licensing or acquisition of new marketed products or investigational drugs, to continue development of investigational drugs in our pipeline, or for other general corporate purposes. Sources of additional funds may include funds generated through equity and/or debt financing or through strategic collaborations or licensing agreements.

In addition, our ability to borrow additional amounts under our loan agreement with Comerica Bank, or Comerica, depends upon a number of conditions and restrictions, and we cannot be certain that we will satisfy all borrowing conditions at a time when we desire to borrow such amounts under the loan agreement. For example, we are subject to a number of affirmative and negative covenants, each of which must be satisfied at the time of any proposed borrowing. If we have not satisfied these various conditions, or an event of default otherwise has occurred, we may be unable to borrow additional amounts under the loan agreement, and may be required to repay any amounts previously borrowed.

Our ability to use our net operating losses to offset taxes that would otherwise be due could be limited or lost entirely if we trigger an “ownership change” pursuant to Section 382 of the Internal Revenue Code which, if we continue to generate taxable income, could materially and adversely affect our business, financial condition, and results of operations.

As of December 31, 2012, we had Federal and state income tax net operating loss carryforwards, or NOLs, of approximately $118.1 million and $129.7 million, respectively. Our ability to use our NOLs to offset taxes that would otherwise be due could be restricted by annual limitations on use of NOLs triggered by an “ownership change” under Section 382 of the Internal Revenue Code and similar state provisions. An “ownership change” may occur when there is a 50% or greater change in total ownership of our company by one or more 5% shareholders within a three-year period. The loss of some or all of our NOLs could materially and adversely affect our business, financial condition and results of operations. In addition, California and certain states have suspended use of NOLs for certain taxable years, and other states may consider similar measures. As a result, we may incur higher state income tax expense in the future. Depending on our future tax position, continued suspension of our ability to use NOLs in states in which we are subject to income tax could have an adverse impact on our operating results and financial condition.

Our results of operations and liquidity needs could be materially negatively affected by market fluctuations and economic downturn.

Our results of operations could be materially negatively affected by economic conditions generally, both in the U.S. and elsewhere around the world. Continuing concerns over U.S. spending and deficits, inflation, energy costs, geopolitical issues, the availability and cost of credit, the U.S. mortgage market and a difficult residential real estate market in the U.S. have contributed to increased volatility and diminished expectations for the economy and the markets going forward. Domestic and international equity markets have experienced and may continue to experience heightened volatility and turmoil based on domestic and international economic conditions and concern, including concerns over U.S. spending and deficits. In the event these economic conditions and concerns continue and the markets continue to remain volatile, our results of operations

In connection with the reporting of our financial condition and results of operations, we are required to make estimates and judgments which involve uncertainties, and any significant differences between our estimates and actual results could have an adverse impact on our financial position, results of operations and cash flows.

Our discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. In particular, as part of our revenue recognition policy, our estimates of product returns, rebates and chargebacks require our most subjective and complex judgment due to the need to make estimates about matters that are inherently uncertain. Any significant differences between our actual results and our estimates under different assumptions or conditions could negatively impact our financial position, results of operations and cash flows.

Risks Related to the Securities Markets and Ownership of Our Common Stock

Our stock price has been and may continue to be volatile, and our stockholders may not be able to sell their shares at attractive prices.

The market prices for securities of specialty biopharmaceutical companies in general have been highly volatile and may continue to be highly volatile in the future. In addition, we have not paid cash dividends since our inception and do not intend to pay cash dividends in the foreseeable future. Furthermore, our loan agreement with Comerica prohibits us from paying dividends. Therefore, investors will have to rely on appreciation in our stock price and a liquid trading market in order to achieve a gain on their investment.

The trading price of our common stock may continue to fluctuate substantially as a result of one or more of the following factors:

•

announcements concerning our commercial progress and activities, including sales and revenue trends for the we promote and the status of the patent litigation relating to such products;

•

the sales and revenue trends for authorized generic Zegerid prescription products;

•

announcements concerning our products or competitive products, including progress under development programs, results of clinical studies or status of regulatory submissions;

•

announcements concerning any recalls or supply interruptions caused by manufacturing issues or otherwise;

•

announcements made by our strategic partners concerning their business or the products they develop or promote;

•

developments, including announcements concerning progress, delays or terminations, pursuant to our strategic alliances with Merck and GSK;

•

other disputes or developments concerning proprietary rights, including patents and trade secrets, litigation matters, and our ability to patent or otherwise protect our products and technologies;

•

acquisition of products or businesses by us or our competitors;

•

conditions or trends in the pharmaceutical and biotechnology industries, including the impact and possible repeal of healthcare reform;

•

fluctuations in stock market prices and trading volumes of similar companies or of the markets generally;

•

changes in, or our failure to meet or exceed, investors’ and securities analysts’ expectations;

•

announcements concerning borrowings under our loan agreement, takedowns under our existing universal shelf registration statement or other developments relating to the loan agreement, universal shelf registration statement or our other financing activities;

•

litigation and government inquiries; or

•

economic and political factors, including election results, sovereign debt uncertainty, wars, terrorism and political unrest.

Our stock price could decline and our stockholders may suffer dilution in connection with future issuances of equity or debt securities.

Although we believe that our current cash, cash equivalents and short-term investments and use of our line of credit will be sufficient to fund our current operations through at least the next twelve months, we may pursue raising additional funds for various reasons, including to expand our commercial presence, in connection with licensing or acquisition of new marketed products or investigational drugs, to continue development of investigational drugs in our pipeline, or for other general corporate purposes. Sources of additional funds may include funds generated through equity and/or debt financing, or through strategic collaborations or licensing agreements. To the extent we conduct substantial future offerings of equity or debt securities, such offerings could cause our stock price to decline. For example, we may issue securities under our existing universal shelf registration statement or we may pursue alternative financing arrangements.

The exercise of outstanding options and warrants and future equity issuances, including future public offerings or future private placements of equity securities and any additional shares issued in connection with licenses or acquisitions, will also result in dilution to investors. The market price of our common stock could fall as a result of resales of any of these shares of common stock due to an increased number of shares available for sale in the market.

Future sales of our common stock by our stockholders may depress our stock price.

A concentrated number of stockholders hold significant blocks of our outstanding common stock. Sales by our current stockholders of a substantial number of shares, or the expectation that such sales may occur, could significantly reduce the market price of our common stock. In addition, certain of our executive officers have from time to time established programmed selling plans under Rule 10b5-1 of the Securities Exchange Act of 1934, as amended, for the purpose of effecting sales of common stock, and other employees and affiliates, including our directors and executive officers, may choose to establish similar plans in the future. If any of our stockholders cause securities to be sold in the public market, the sales could reduce the trading price of our common stock. These sales also could impede our ability to raise future capital.

We may become involved in securities or other class action litigation that could divert management’s attention and harm our business.

The stock market has from time to time experienced significant price and volume fluctuations that have affected the market prices for the common stock of pharmaceutical and biotechnology companies. These broad market fluctuations may cause the market price of our common stock to decline. In the past, following periods of volatility in the market price of a particular company’s securities, securities class action litigation has often been brought against that company. Any securities or other class action litigation asserted against us could have a material adverse effect on our business.

Anti-takeover provisions in our organizational documents and Delaware law may discourage or prevent a change in control, even if an acquisition would be beneficial to our stockholders, which could adversely affect our stock price and prevent attempts by our stockholders to replace or remove our current management.

Our certificate of incorporation and bylaws contain provisions that may delay or prevent a change in control, discourage bids at a premium over the market price of our common stock and adversely affect the market price of our common stock and the voting and other rights of the holders of our common stock.

These provisions include:

•

dividing our board of directors into three classes serving staggered three-year terms;

•

prohibiting our stockholders from calling a special meeting of stockholders;

•

permitting the issuance of additional shares of our common stock or preferred stock without stockholder approval;

•

prohibiting our stockholders from making certain changes to our certificate of incorporation or bylaws except with 66 2/3% stockholder approval; and

•

requiring advance notice for raising business matters or nominating directors at stockholders’ meetings.

We are also subject to provisions of the Delaware corporation law that, in general, prohibit any business combination with a beneficial owner of 15% or more of our common stock for five years unless the holder’s acquisition of our stock was approved in advance by our board of directors. Together, these charter and statutory provisions could make the removal of management more difficult and may discourage transactions that otherwise could involve payment of a premium over prevailing market prices for our common stock.

In addition, we have adopted a stockholder rights plan. Although the rights plan will not prevent a takeover, it is intended to encourage anyone seeking to acquire our company to negotiate with our board prior to attempting a takeover by potentially significantly diluting an acquirer’s ownership interest in our outstanding capital stock. The existence of the rights plan may also discourage transactions that otherwise could involve payment of a premium over prevailing market prices for our common stock.

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

Unregistered Sales of Equity Securities

Not applicable.

Issuer Purchases of Equity Securities

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Mine Safety Disclosures

Not applicable.

Item 5. Other Information

Not applicable.

Item 6. Exhibits


Exhibit
Number		Description

2.1(1)*		Agreement and Plan of Merger, dated September 10, 2010, among us, SAN Acquisition Corp., Covella Pharmaceuticals, Inc. and Lawrence C. Fritz, as the Stockholder Representative

3.1(2)		Amended and Restated Certificate of Incorporation

3.2(3)		Amendment to the Amended and Restated Certificate of Incorporation

3.2(4)		Amended and Restated Bylaws

3.3(5)		Certificate of Designations for Series A Junior Participating Preferred Stock

4.1(5)		Form of Common Stock Certificate

4.2(6)		Amended and Restated Investors’ Rights Agreement, dated April 30, 2003, among us and the parties named therein

4.3(6)		Amendment No. 1 to Amended and Restated Investors’ Rights Agreement, dated May 19, 2003, among us and the parties named therein



4.4(6)*		Stock Restriction and Registration Rights Agreement, dated January 26, 2001, between us and The Curators of the University of Missouri

4.5(6)		Form of Common Stock Purchase Warrant

4.6(5)		Rights Agreement, dated as of November 12, 2004, between us and American Stock Transfer & Trust Company, which includes the form of Certificate of Designations of the Series A Junior Participating Preferred Stock of Santarus, Inc. as Exhibit A, the form of Right Certificate as Exhibit B and the Summary of Rights to Purchase Preferred Shares as Exhibit C

4.7(7)		First Amendment to Rights Agreement, dated as of April 19, 2006, between us and American Stock Transfer & Trust Company

4.8(8)		Second Amendment to Rights Agreement, dated December 10, 2008, between us and American Stock Transfer & Trust Company

4.9(9)		Warrant to Purchase Shares of Common Stock, dated February 3, 2006, issued by us to Kingsbridge Capital Limited

4.10(9)		Registration Rights Agreement, dated February 3, 2006, between us and Kingsbridge Capital Limited

4.11(10)		Registration Rights Agreement, dated December 10, 2008, between us and Cosmo Technologies Limited

4.12(10)		Amendment No. 1 to Registration Rights Agreement, dated April 23, 2009, between us and Cosmo Technologies Limited

31.1		Certification of Chief Executive Officer pursuant to Rules 13a-14 and 15d-14 promulgated under the Securities Exchange Act of 1934

31.2		Certification of Chief Financial Officer pursuant to Rules 13a-14 and 15d-14 promulgated under the Securities Exchange Act of 1934

32‡		Certifications of Chief Executive Officer and 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.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema Document

101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF		XBRL Taxonomy Extension Definition Linkbase Document

101.LAB		XBRL Taxonomy Extension Label Linkbase Document

101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

(1)	Incorporated by reference to the Quarterly Report on Form 10-Q of Santarus, Inc. for the quarter ended September 30, 2010, filed with the Securities and Exchange Commission on November 9, 2010.

(2)	Incorporated by reference to the Quarterly Report on Form 10-Q of Santarus, Inc. for the quarter ended March 31, 2004, filed with the Securities and Exchange Commission on May 13, 2004.

(3)	Incorporated by reference to our Registration Statement on Form S-8, filed with the Securities and Exchange Commission on June 12, 2013.

(4)	Incorporated by reference to the Current Report on Form 8-K of Santarus, Inc., filed with the Securities and Exchange Commission on December 5, 2008.

(5)	Incorporated by reference to the Current Report on Form 8-K of Santarus, Inc., filed with the Securities and Exchange Commission on November 17, 2004.

(6)	Incorporated by reference to the Registration Statement on Form S-1 of Santarus, Inc. (Registration No. 333-111515), filed with the Securities and Exchange Commission on December 23, 2003, as amended.

(7)	Incorporated by reference to the Current Report on Form 8-K of Santarus, Inc., filed with the Securities and Exchange Commission on April 21, 2006.

(8)	Incorporated by reference to our Current Report on Form 8-K, filed with the Securities and Exchange Commission on December 15, 2008.

(9)	Incorporated by reference to the Current Report on Form 8-K of Santarus, Inc., filed with the Securities and Exchange Commission on February 3, 2006.

(10)	Incorporated by reference to the Registration Statement on Form S-3 of Santarus, Inc. (Registration No. 333-156806), filed with the Securities and Exchange Commission on January 20, 2009, as amended.

*	Santarus, Inc. has been granted confidential treatment with respect to certain portions of this exhibit (indicated by asterisks), which portions have been omitted and filed separately with the Securities and Exchange Commission.

+	Application has been made to the Securities and Exchange Commission to seek confidential treatment of certain provisions. Omitted material for which confidential treatment has been requested has been filed separately with the Securities and Exchange Commission.

‡

These certifications are being furnished solely to accompany this quarterly report pursuant to 18 U.S.C. Section 1350, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934 and are not to be incorporated by reference into any filing of Santarus, Inc., whether made before or after the date hereof, regardless of any general incorporation language in such filing.

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.

Dated: November 7, 2013

/s/ Debra P. Crawford

Debra P. Crawford,

Senior Vice President and Chief Financial Officer

(Duly Authorized Officer and Principal Financial Officer)

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