UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

x

 

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

 

 

 

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2008

 

 

 

OR

 

 

 

o

 

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 001-33389

 

VIVUS, INC.

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

 

Delaware

 

94-3136179

(STATE OR OTHER JURISDICTION OF

 

(IRS EMPLOYER

INCORPORATION OR ORGANIZATION)

 

IDENTIFICATION NUMBER)

 

 

 

1172 Castro Street

 

 

Mountain View, California

 

94040

(Address of principal executive office)

 

(Zip Code)

 

(650) 934-5200

(REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE)

 

N/A

(FORMER NAME, FORMER ADDRESS AND FORMER FISCAL YEAR, IF CHANGED SINCE LAST REPORT)

 

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

 

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

 

Large accelerated filer o

 

Accelerated filer x

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

At May 5, 2008, 60,592,210 shares of common stock, par value $.001 per share, were outstanding.

 

 



 

VIVUS, INC.

 

Quarterly Report on Form 10-Q

 

INDEX

 

 

PART I — FINANCIAL INFORMATION

3

 

 

 

Item 1:

Condensed Consolidated Financial Statements (Unaudited)

3

Item 2:

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

21

Item 3:

Quantitative and Qualitative Disclosures about Market Risk

51

Item 4:

Controls and Procedures

52

 

 

 

 

PART II — OTHER INFORMATION

53

 

 

 

Item 1:

Legal Proceedings

53

Item 1A:

Risk Factors

53

Item 2:

Unregistered Sales of Equity Securities and Use of Proceeds

78

Item 3:

Defaults Upon Senior Securities

78

Item 4:

Submission of Matters to Vote of Security Holders

78

Item 5:

Other Information

78

Item 6:

Exhibits

78

 

Signatures

80

 

 

 

 

CERTIFICATIONS

 

 

 

 

31.1-Certification of Chief Executive Officer

 

31.2-Certification of Chief Financial Officer

 

32.0-Certification of Chief Executive Officer and Chief Financial Officer

 

 

2



 

PART I: FINANCIAL INFORMATION

 

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

VIVUS, INC.

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value)

 

 

 

MARCH 31,
2008

 

DECEMBER 31
2007*

 

 

 

(UNAUDITED)

 

 

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

53,713

 

$

37,838

 

Available-for-sale securities

 

107,792

 

141,672

 

Accounts receivable, (net of allowance for doubtful accounts of $17 and $29 at March 31, 2008 and December 31, 2007, respectively)

 

1,412

 

4,202

 

Inventories, net

 

3,107

 

2,567

 

Prepaid expenses and other assets

 

3,832

 

5,313

 

Total current assets

 

169,856

 

191,592

 

Property, plant and equipment, net

 

7,222

 

7,417

 

Restricted cash

 

700

 

700

 

Available-for-sale securities, non-current

 

2,991

 

 

Total assets

 

$

 180,769

 

$

 199,709

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

13,914

 

$

7,768

 

Accrued product returns

 

2,424

 

2,498

 

Accrued research and clinical expenses

 

5,233

 

1,902

 

Accrued chargeback reserve

 

1,085

 

1,314

 

Accrued employee compensation and benefits

 

1,301

 

1,999

 

Deferred revenue-short term

 

84,183

 

84,183

 

Accrued and other liabilities

 

1,259

 

1,698

 

Total current liabilities

 

109,399

 

101,362

 

 

 

 

 

 

 

Notes payable-long term

 

5,008

 

5,062

 

Deferred revenue-long term

 

12,072

 

33,118

 

Total liabilities

 

126,479

 

139,542

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock; $1.00 par value; 5,000 shares authorized; no shares issued and outstanding at March 31, 2008 and December 31, 2007

 

 

 

Common stock; $.001 par value; 200,000 shares authorized; 58,905 shares issued and outstanding at March 31, 2008 and 58,873 at December 31, 2007

 

59

 

59

 

Additional paid-in capital

 

231,525

 

230,005

 

Accumulated other comprehensive loss

 

(373

)

(68

)

Accumulated deficit

 

(176,921

)

(169,829

)

Total stockholders’ equity

 

54,290

 

60,167

 

Total liabilities and stockholders’ equity

 

$

180,769

 

$

199,709

 

 


*     Derived from audited consolidated financial statements filed in the Company’s 2007 Annual Report on Form 10-K.

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

3



 

VIVUS, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND OTHER COMPREHENSIVE INCOME (LOSS)

(In thousands, except per share data)

 

 

 

THREE MONTHS ENDED

 

 

 

MARCH 31

 

 

 

2008

 

2007

 

 

 

(UNAUDITED)

 

(UNAUDITED)

 

 

 

 

 

 

 

Revenue:

 

 

 

 

 

United States product, net

 

$

1,088

 

$

460

 

International product

 

554

 

1,113

 

License and other revenue

 

21,046

 

116

 

Total revenue

 

22,688

 

1,689

 

Operating expenses:

 

 

 

 

 

Cost of goods sold and manufacturing expense

 

2,787

 

2,571

 

Research and development

 

23,371

 

3,011

 

Selling, general and administrative

 

4,252

 

4,105

 

Total operating expenses

 

30,410

 

9,687

 

 

 

 

 

 

 

Loss from operations

 

(7,722

)

(7,998

)

 

 

 

 

 

 

Interest income (expense):

 

 

 

 

 

Interest income

 

757

 

767

 

Interest expense

 

(122

)

(154

)

 

 

635

 

613

 

Loss before provision for income taxes

 

(7,087

)

(7,385

)

Provision for income taxes

 

(5

)

(6

)

Net loss

 

$

(7,092

)

$

(7,391

)

Other comprehensive loss:

 

 

 

 

 

Unrealized (loss) gain on securities

 

(305

)

4

 

Comprehensive loss

 

$

(7,397

)

$

(7,387

)

 

 

 

 

 

 

Net loss per share:

 

 

 

 

 

Basic and diluted

 

$

(0.12

)

$

(0.13

)

Shares used in per share computation:

 

 

 

 

 

Basic and diluted

 

58,882

 

58,242

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

4



 

VIVUS, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

 

 

THREE MONTHS ENDED 
MARCH 31

 

 

 

2008

 

2007

 

 

 

(UNAUDITED)

 

(UNAUDITED)

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net loss

 

$

(7,092

)

$

(7,391

)

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

 

 

 

 

 

Provision for doubtful accounts

 

(12

)

7

 

Provision for excess inventory

 

 

(1

)

Depreciation

 

278

 

266

 

Net realized loss on investments

 

12

 

 

Other-than-temporary loss on investments

 

1,352

 

 

Share-based compensation expense

 

1,406

 

906

 

Loss on disposal of property and equipment

 

 

2

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

2,802

 

3,311

 

Inventories

 

(540

)

(178

)

Prepaid expenses and other assets

 

1,481

 

206

 

Accounts payable

 

6,146

 

(249

)

Accrued product returns

 

(74

)

(207

)

Accrued research and clinical expenses

 

3,331

 

187

 

Accrued chargeback reserve

 

(229

)

(100

)

Accrued employee compensation and benefits

 

(698

)

(538

)

Deferred revenue

 

(21,046

)

18

 

Income taxes payable

 

 

116

 

Accrued and other liabilities

 

(464

)

(534

)

Net cash used for operating activities

 

(13,347

)

(4,179

)

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Property and equipment purchases

 

(83

)

(155

)

Proceeds from sale of property and equipment

 

 

3

 

Investment purchases

 

 

(2,464

)

Proceeds from sale/maturity of securities

 

29,220

 

4,925

 

Net cash provided by investing activities

 

29,137

 

2,309

 

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Borrowing under note agreements

 

 

379

 

Principal payments under note agreements

 

(29

)

(29

)

Exercise of common stock options

 

114

 

730

 

Net cash provided by financing activities

 

85

 

1,080

 

 

 

 

 

 

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

 

15,875

 

(790

)

CASH AND CASH EQUIVALENTS:

 

 

 

 

 

Beginning of period

 

37,838

 

44,628

 

End of period

 

$

 53,713

 

$

43,838

 

 

 

 

 

 

 

SUPPLEMENTAL CASH FLOW DISCLOSURE:

 

 

 

 

 

Reclassification of income taxes payable to accumulated deficit

 

$

 

$

1,206

 

Reclassification of assets held for sale

 

$

 

$

543

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

5



 

VIVUS, INC.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

MARCH 31, 2008

 

1. BASIS OF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. The year-end condensed consolidated balance sheet data was derived from audited financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. Accordingly, they do not include all of the information and footnotes required by United States generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included. Operating results for the quarter ended March 31, 2008 are not necessarily indicative of the results that may be expected for the year ending December 31, 2008. The unaudited financial statements should be read in conjunction with the audited financial statements and notes thereto included in our annual report on Form 10-K for the year ended December 31, 2007, as filed on March 7, 2008 with the Securities and Exchange Commission. The condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated.

 

Reclassifications

 

Certain prior year amounts in the condensed consolidated financial statements have been reclassified to conform to the current year presentation.

 

Use of Estimates

 

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

 

2. REVENUE RECOGNITION

 

The Company recognizes product revenue when the following four criteria are met:

 

·  persuasive evidence of an arrangement exists;

 

·  shipment has occurred;

 

·  the sales price is fixed or determinable; and

 

·  collectibility is reasonably assured.

 

The Company recognizes revenue upon shipment when title passes to the customer and risk of loss is transferred to the customer. The Company does not have any post shipment obligations.

 

United States

 

The Company primarily sells its products through wholesalers in the United States. The Company provides for government chargebacks, rebates, returns and other adjustments in the same period the related product sales are recorded. Reserves for government chargebacks, rebates, returns and other adjustments are based upon analysis of historical data. Each period the Company reviews its reserves for government chargebacks, rebates, returns and other adjustments based on data available at that time. Any adjustment to these reserves results in charges to the amount of product sales revenue recognized in the period.

 

International

 

The Company has supply agreements with Meda AB (“Meda”) to market and distribute MUSE internationally in some Member States of the European Union. In Canada, the Company has entered into a license and supply agreement with Paladin Labs, Inc. (“Paladin”) for the marketing and distribution of MUSE. Sales to Meda, who supplies MUSE in the European

 

6



 

marketplace, for 2007, 2006 and 2005 were 95.8%, 91.7% and 93.4% of international sales, respectively. The balance of international sales was made to Paladin.

 

The Company invoices its international distributors based on an agreed transfer price per unit, which is subject to revision upon quarterly reconciliations based on contractual formulas. Final pricing for product shipments to international distributors is subject to contractual formulas based on the distributor’s net realized price to its customers. The Company recognizes additional revenue, if any, upon finalization of pricing with its international distributors. International distributors generally do not have the right to return products unless the products are damaged or defective.

 

The Company initially recorded $1.5 million of unearned revenue related to an upfront payment in accordance with the international supply agreement signed with Meda in September 2002. In January 2006, the Company received a milestone payment from Meda of $2.0 million. The milestone payment provides Meda with the right to continue to sell and distribute MUSE in its European territories. These amounts are being recognized as income ratably over the term of the supply agreement. Through March 31, 2008, $1.5 million has been recognized as revenue.

 

License and Other Revenue

 

The Company recognizes license revenue in accordance with the Securities and Exchange Commission’s Staff Accounting Bulletin No. 104, Revenue Recognition, and Emerging Issues Task Force (“EITF”) Issue 00-21, Revenue Arrangements with Multiple Deliverables. Revenue arrangements with multiple deliverables are divided into separate units of accounting if certain criteria are met, including whether the delivered item has standalone value to the customer, and whether there is objective, reliable evidence of the fair value of the undelivered items. Consideration received is allocated among the separate units of accounting based on their relative fair values, and the applicable revenue recognition criteria are identified and applied to each of the units.

 

Revenue from non-refundable, upfront license fees where the Company has continuing involvement is recognized ratably over the development or agreement period. Revenue associated with performance milestones is recognized based upon the achievement of the milestones, as defined in the respective agreements.

 

Sale of Evamist product

 

On May 15, 2007, the Company closed its transaction with K-V Pharmaceutical Company for the sale of its product candidate, Evamist. At the time of the sale, Evamist was an investigational product and was not yet approved by the FDA for marketing. The sale transaction contained multiple deliverables, including: the delivery at closing of the Evamist assets, a grant of a sublicense of our rights under a license related to Evamist, and a license to the metered-dose transdermal spray, or MDTS, applicator; the delivery upon receipt of regulatory approval of the approved drug along with all regulatory submissions; and, lastly, the delivery after FDA approval of certain transition services and a license to improvements to the MDTS applicator. The Company received approval from the FDA to market Evamist on July 27, 2007 (“FDA Approval”), and on August 1, 2007, the Company transferred and assigned the Evamist FDA submissions, and all files related thereto, to K-V. The Company received an upfront payment of $10 million upon the closing and received an additional $140 million milestone payment in August 2007 upon FDA Approval. These payments are non-refundable.

 

Upon FDA Approval, the two remaining deliverables are the transition services to be performed under the Transition Services Agreement (“TSA”) and a license to improvements to the MDTS applicator during the two-year period commencing with the closing, or May 15, 2007, and ending on May 15, 2009. The Company has been able to establish fair value for the TSA. Given the unique nature of the license to improvements, the Company is unable to obtain objective, reliable evidence of its fair value.

 

Accordingly, the delivered items, together with the undelivered items, are treated as one unit of accounting. Since the deliverables are treated as a single unit of accounting, the total cash received, $150.0 million, will be recognized as revenue on a pro-rata basis over the term of the last deliverable, which in this case is the license to improvements that expires on May 15, 2009. As a result, the initial $10.0 million paid at closing and the $140.0 million paid upon FDA Approval have been recorded as deferred revenue and will be recognized as revenue together with the future billings, if any, under the TSA, ratably over the remaining 21.5-month term of the license to improvements, from August 1, 2007 to May 15, 2009. Through March 31, 2008, $55.8 million has been recognized as revenue.

 

The Company may also receive milestone payments of up to $30.0 million based upon sales of Evamist through the term of the agreements. Revenue associated with performance milestones will be recognized based upon the achievement of the milestones, as defined in the respective agreements.

 

7



 

3. SHARE-BASED COMPENSATION

 

The Company accounts for share-based compensation in accordance with SFAS No. 123R, Share-Based Payment, which was adopted January 1, 2006, utilizing the modified prospective transition method.

 

Total estimated share-based compensation expense, related to all of the Company’s share-based awards, recognized for the quarters ended March 31, 2008 and 2007 was comprised as follows (in thousands, except per share data):

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2008

 

2007

 

 

 

 

 

 

 

Cost of goods sold and manufacturing expense

 

$

137

 

$

123

 

Research and development

 

483

 

228

 

Selling, general and administrative

 

786

 

555

 

Share-based compensation expense before taxes

 

1,406

 

906

 

Related income tax benefits

 

 

 

Share-based compensation expense, net of taxes

 

$

1,406

 

$

906

 

Basic and diluted per common share

 

$

0.02

 

$

0.02

 

 

At March 31, 2008, a total of 6,753,010 stock options and restricted stock units were outstanding under our stock option plans. Stock-based compensation expense recognized for the quarters ended March 31, 2008 and 2007 included compensation expense for stock options granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the pro forma provisions of SFAS 123. Included in stock-based compensation expense was $1.4 million and $859,000 related to stock options, $30,000 and $33,000 related to the employee stock purchase plan, and $8,000 and $14,000 related to restricted stock units, net of the estimated forfeitures for the first quarter of 2008 and 2007, respectively.

 

As of March 31, 2008, unrecognized estimated compensation expense totaled $6.0 million related to non-vested stock options, $14,000 related to the employee stock purchase plan, and $52,000 related to restricted stock units. The weighted average remaining requisite service period of the non-vested options was 1.6 years, of the employee stock purchase plan was 1.5 months, and of the restricted stock units was 3.3 years.

 

A summary of stock option award activity under these plans is as follows:

 

 

 

Three Months Ended 
March 31, 2008

 

 

 

Shares

 

Weighted Average 
Exercise Price

 

Outstanding at January 1, 2008

 

5,348,501

 

$

4.25

 

Granted

 

1,396,881

 

$

6.04

 

Exercised

 

(31,905

)

$

3.58

 

Cancelled

 

(22,967

)

$

5.15

 

Outstanding at March 31, 2008

 

6,690,510

 

$

4.62

 

Options exercisable at March 31, 2008

 

3,735,672

 

 

 

Weighted average fair value of options granted

 

 

 

$

3.33

 

 

8



 

A summary of restricted stock units award activity under the 2001 Plan as of March 31, 2008 and changes during the three month period then ended are presented below:

 

 

 

Three Months Ended March 31, 2008

 

 

 

Number 
of 
Restricted 
Stock 
Units

 

Weighted 
Average 
Grant Date 
Fair Value

 

Weighted 
Average 
Remaining 
Contractual
Term (Years)

 

Aggregate 
Intrinsic 
Value

 

Restricted stock units outstanding January 1, 2008

 

62,500

 

$

2.04

 

3.7

 

$

255,000

 

Granted

 

 

 

 

 

Vested

 

 

 

 

 

Forfeited

 

 

 

 

 

Restricted stock units outstanding, March 31, 2008

 

62,500

 

$

2.04

 

3.3

 

$

255,000

 

 

At March 31, 2008, stock options were outstanding and exercisable as follows:

 

 

 

Options Outstanding

 

Options Exercisable

 

Range of 
Exercise Prices

 

Number 
Outstanding at 
March 31, 2008

 

Weighted-
Average 
Remaining
Contractual Life

 

Weighted-Average
Exercise Price

 

Number
Exercisable
March 31, 2008

 

Weighted-
Average
Exercise Price

 

$

2.00  -  $4.03

 

2,230,874

 

5.52 years

 

$

3.42

 

1,764,088

 

$

3.43

 

$

4.03  -  $4.84

 

2,370,987

 

7.41 years

 

$

4.33

 

1,285,926

 

$

4.39

 

$

5.00  -  $8.08

 

2,088,649

 

8.25 years

 

$

6.24

 

685,658

 

$

6.72

 

$

2.00  -  $8.08

 

6,690,510

 

7.04 years

 

$

4.62

 

3,735,672

 

$

4.36

 

 

The aggregate intrinsic value of outstanding options as of March 31, 2008 was $10.1 million, of which $6.8 million related to exercisable options.

 

At March 31, 2008, 1,091,212 options remain available for grant. 1,000,000 of these shares were registered on a Form S-8 filed with the SEC on May 5, 2008. In the first quarter of 2008, in accordance with the terms of the 2001 Plan, the Company transferred a net total of 5,000 expired plan shares to the 2001 Plan. Options under these plans generally vest over four years, and all options expire after ten years.

 

As of March 31, 2008, 1,116,255 shares have been issued to employees and there are 283,745 available for issuance under the Stock Purchase Plan.

 

Valuation Assumptions

 

The fair value of each option award is estimated on the grant date using a Black-Scholes option-pricing model that uses the weighted average assumptions noted in the following table. Prior to January 1, 2008, we calculated the estimated life of stock options granted using a “simplified” method, which is based on the average of the vesting term and the term of the option, as a result of guidance from the SEC, as contained in Staff Accounting Bulletin No. 107 permitting the initial use of this method. Effective January 1, 2008, the expected term, which represents the period of time that options granted are expected to be outstanding, is derived by analyzing the historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior. Expected volatilities are estimated using the historical share price performance over the expected term of the option. The Company also considers other factors such as its planned clinical trials and other company activities that may affect the volatility of VIVUS’ stock in the future but determined that at this time, the historical volatility was more indicative of expected future stock price volatility. The risk-free interest rate for the period matching the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of the grant. The Black-Scholes Model also requires a single expected dividend yield as an input. The Company does not anticipate paying any dividends in the near future.

 

The following table sets forth information about the weighted-average assumptions used for options granted in the quarters ended March 31, 2008 and 2007:

 

 

 

Three Months Ended 
March 31,

 

 

 

2008

 

2007

 

 

 

 

 

 

 

Expected life (in years)

 

5.60

 

6.18

 

Volatility

 

59.93

%

67.75

%

Risk-free interest rate

 

2.67

%

4.58

%

Dividend yield

 

 

 

 

9



 

4. CASH AND CASH EQUIVALENTS AND MARKETABLE SECURITIES

 

The fair value and the amortized cost of cash, cash equivalents, and available-for-sale securities by major security type at March 31, 2008 and December 31, 2007 are presented in the tables that follow. Fair values are based on market prices obtained from our investment advisor who uses a number of pricing methods to derive the fair value of the securities on a recurring basis, one of which is the use of  independent pricing services.  For each category of investment securities, the table presents gross unrealized holding gains and losses.

 

As of March 31, 2008 (in thousands) (unaudited):

 

 

 

Amortized
Cost

 

Estimated
Fair Value

 

Unrealized
Holding
Gains

 

Unrealized
Holding
Losses

 

Cash and money market

 

$

53,713

 

$

53,713

 

$

 

$

 

Commercial paper

 

249

 

249

 

 

 

Asset backed and other securities

 

57,557

 

57,694

 

137

 

 

 

Corporate bonds

 

53,350

 

52,840

 

 

(510

)

Total cash, cash equivalents and available-for-sale securities

 

$

164,869

 

$

164,496

 

$

137

 

$

(510

)

 

As of December 31, 2007 (in thousands):

 

 

 

Amortized 
Cost

 

Estimated
Fair Value

 

Unrealized 
Holding 
Gains

 

Unrealized 
Holding 
Losses

 

Cash and money market

 

$

19,358

 

$

19,358

 

$

 

$

 

Commercial paper

 

17,199

 

17,200

 

1

 

 

Asset backed and other securities

 

82,031

 

82,059

 

28

 

 

Corporate bonds

 

60,990

 

60,893

 

 

(97

)

Total cash, cash equivalents and available-for-sale securities

 

$

179,578

 

$

179,510

 

$

29

 

$

(97

)

 

The following table summarizes our available-for-sale securities by the contractual maturity date as of March 31, 2008 (in thousands) (unaudited):

 

 

 

Amortized
Cost

 

Estimated
Fair Value

 

Due within one year

 

$

35,655

 

$

35,513

 

Due within one year to two years

 

17,945

 

17,577

 

*No single maturity date

 

57,556

 

57,693

 

 

 

$

111,156

 

$

110,783

 

 


*              Securities with no single maturity date include mortgage and asset backed securities that consist of several payment streams.  For certain of these securities, principal and interest payments are received monthly or quarterly.  In addition, a certain portion of these investments will be repaid prior to their legal maturity.

 

Actual maturities may differ from the contractual maturities because borrowers may have the right to call or prepay certain obligations.

 

10



 

The following table summarizes the net realized gains (losses) on short-term and long term investments for the periods presented (in thousands):

 

 

 

Three Months Ended

 

 

 

March 31, 2008

 

March 31, 2007

 

 

 

(unaudited)

 

(unaudited)

 

Realized gains

 

$

37

 

$

 

Realized losses

 

(49

)

 

Net realized gains/(losses)

 

$

(12

)

$

 

 

The Company does not have any securities that have been in a continuous unrealized loss position for 12 months or longer.  As of March 31, 2008 and December 31, 2007, the temporary unrealized loss on available-for-sale securities, net of tax, of $373,000 and $68,000, respectively, were included in accumulated other comprehensive income in the accompanying unaudited condensed consolidated balance sheets. As of March 31, 2008, substantially all of the investments that the Company held were high investment grade. The unrealized losses on the Company’s investments were due primarily to changes in interest rates and market and credit conditions of the underlying securities. Because the Company has the ability to hold these investments until a recovery of principal, which may be at maturity, the Company does not consider these investments to be other-than-temporarily impaired as of March 31, 2008.

 

SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, and SAB Topic 5M, Accounting for Non-current Marketable Equity Securities, provide guidance on determining when an investment is other-than-temporarily impaired. Investments are reviewed quarterly for indicators of other-than-temporary impairment. This determination requires significant judgment. In making this judgment, the Company employs a systematic methodology quarterly that considers available quantitative and qualitative evidence in evaluating potential impairment of its investments. If the cost of an investment exceeds its fair value, the Company evaluates, among other factors, general market conditions, the duration and extent to which the fair value is less than cost, and its intent and ability to hold the investment. The Company also considers specific adverse conditions related to the financial health of and business outlook for the investee, including industry and sector performance, operational and financing cash flow factors, and rating agency actions. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded and a new cost basis in the investment is established. During the Company’s quarter end assessment, we determined that a decline in value of certain securities was other-than-temporary. Accordingly, the Company recorded an impairment adjustment of approximately $1.4 million in the first quarter of fiscal year 2008. The Company included this non-cash impairment charge in interest income in the condensed consolidated statements of operations and other comprehensive income (loss). If market, industry, and/or investee conditions deteriorate, we may incur future impairments.
 

From 2005 and until December 2007 the Company had an investment in Columbia Strategic Cash Portfolio (“Strategic Cash”) offered by the Company’s investment advisor, Columbia Management LLC (“Columbia”), an affiliate of Bank of America. Strategic Cash is an enhanced money market fund in which the fund sought to maintain a $1 per share net asset value. The Company used Strategic Cash for the investment of excess cash, and periodic transfers were made from Strategic Cash to the operating cash account to fund current operations.

 

In early December 2007, VIVUS was notified by Columbia that the Strategic Cash fund was closed and that the fund was to be liquidated. The fund no longer supported the $1 per share net asset value and switched to a market value fund in which all investments were marked to market. VIVUS was given the option of staying in the fund and receiving cash proceeds from the fund as its holdings were liquidated or receiving a pro-rata share of the investments held by the fund. Upon advice from the investment advisor, the Company took a redemption-in-kind consisting of cash, interest receivable and a pro-rata distribution of the underlying securities, consisting principally of high quality corporate debt and asset-backed securities. Prior to the redemption the Company’s investment in Strategic Cash was $84.4 million. On December 20, 2007 and December 21, 2007, the Company received its redemption-in-kind consisting of securities with a market value of $68.7 million, interest receivable of $300,000 and cash of $14.4 million. The difference between the Company’s investment in Strategic Cash of $84.4 million and the fair value of the securities, cash and interest receivable totaling $83.4 million received in-kind resulted in a loss of $1 million. This loss of $1 million was reflected in interest income in the consolidated statements of operations and other comprehensive income (loss) for the year ended December 31, 2007.

 

Effective January 1, 2008, we adopted SFAS No. 157, Fair Value Measurements, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements.  Broadly, the SFAS 157 framework clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability.

 

11



 

As a basis for considering such assumptions, SFAS No. 157 establishes a three-tier value hierarchy, which prioritizes the inputs used in measuring fair value as follows: (Level 1) observable inputs such as quoted prices in active markets; (Level 2) inputs other than the quoted prices in active markets that are observable either directly or indirectly; and (Level 3) unobservable inputs in which there is little or no market data, which require the Company  to develop its own assumptions. This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. On a recurring basis, VIVUS  measures its  marketable securities at fair value.

 

The following fair value hierarchy tables present information about the Company’s assets (available-for-sale securities current and non-current) measured at fair value on a recurring basis as of March 31, 2008 (in thousands):

 

 

 

Basis of Fair Value Measurements

 

 

 

Balance at
March 31, 2008

 

Quoted Prices in
Active Markets for
Identical Items

 

Significant Other
Observable Inputs

 

Significant
Unobservable
Inputs

 

 

 

(unaudited)

 

Level 1

 

Level 2

 

Level 3

 

Assets:

 

 

 

 

 

 

 

 

 

Commercial Paper

 

$

249

 

$

 

$

 

$

249

 

Asset Backed and Other Securities

 

57,694

 

 

52,105

 

5,589

 

Corporate Bonds

 

52,840

 

 

44,748

 

8,092

 

Total

 

$

110,783

 

$

 

$

96,853

 

$

13,930

 

 

 

 

 

 

 

 

 

 

 

Balance Sheet Presentation

 

 

 

 

 

 

 

 

 

Available-for-sale securities

 

$

107,792

 

 

 

 

 

 

 

Available-for-sale securities, non-current

 

2,991

 

 

 

 

 

 

 

Total

 

$

110,783

 

 

 

 

 

 

 

 

The following table presents additional information about Level 3 assets measured at fair value on a recurring basis. Unobservable inputs are used to determine the fair value of positions that the Company has classified within the Level 3 category.  The types of instruments valued based on Level 3 inputs include some corporate bonds, residential mortgage asset backed securities in the United Kingdom and Australian markets and several structured investment vehicles (SIVs). The changes in Level 3 assets measured at fair value on a recurring basis for the three months ended March 31, 2008 were (in thousands):

 

Activity for the Three Months Ended March 31, 2008 (unaudited)

 

Fair Value 
Measurements 
Using Significant 
Unobservable 
Inputs (Level 3)

 

Balance at December 31, 2007

 

$

1,332

 

Total unrealized losses included in other comprehensive loss

 

(12

)

Total unrealized losses included in net loss

 

(598

)

Principal payments

 

(8

)

Net transfers of Level 3 securities

 

13,216

 

Balance at March 31, 2008

 

$

13,930

 

 

 

 

 

The amount of total losses for the period included in net loss attributable to the change in unrealized losses relating to securities still held at the reporting date

 

$

(598

)

 

12



 

The following table presents the amounts of unrealized losses for the three months ended March 31, 2008  relating to those assets for which the Company utilized significant Level 3 inputs to determine fair value and that were still held by the Company at March 31, 2008 (in thousands):

 

Activity for the Three Months Ended March 31, 2008 (unaudited)

 

Available-for-sale
securities

 

Total losses included in net loss for the period

 

$

(598

)

 

 

 

 

Change in unrealized losses to securities still held at reporting date

 

$

(12

)

 

In the quarter ended March 31, 2008, the Company recorded an other-than-temporary impairment in the value of its available-for-sale securities of $1.4 million and this non-cash charge is included in interest income in the condensed consolidated statement of operations and other comprehensive income (loss). In addition, the Company classified $3.0 million of the available-for-sale securities deemed to be non-current due to current market conditions from current assets to non-current assets, as the Company expects these securities to recover their full or substantial values beyond the next 12 months due to the continued uncertainty in the capital markets.

 

5. INVENTORIES

 

Inventories are recorded net of reserves of $1.9 million and $1.7 million as of March 31, 2008 and December 31, 2007, respectively. Inventory balances, net of reserves, consist of (in thousands):

 

 

 

MARCH 31, 2008

 

DECEMBER 31, 2007

 

 

 

(unaudited)

 

 

 

 

Raw materials and component parts

 

$

2,714

 

$

2,224

 

Work in process

 

45

 

38

 

Finished goods

 

348

 

305

 

Inventory, net

 

$

3,107

 

$

2,567

 

 

As noted above, the Company has recorded significant reserves against the carrying value of its inventory of raw material and certain component parts. The reserves relate primarily to inventory that the Company previously estimated would not be used. In 2007, we disposed of $2.8 million of fully reserved alprostadil, which had no impact on cost of goods sold. As of March 31, 2008, the Company does not intend to use any of the reserved raw materials in future production. In the first quarter of 2005, the Company determined that it likely would continue to use some portion of the fully reserved component parts in production. The Company used $15,000 and $17,000 of its fully reserved component parts inventory during the first three months of 2008 and 2007, respectively.  When the Company records inventory reserves, it establishes a new, lower cost basis for the inventory for accounting purposes. Accordingly, to the extent that this fully reserved inventory was used in production in the first quarters of 2008 and 2007, it was charged to cost of goods sold at a zero basis, which had a favorable impact on cost of goods sold. The original cost of the fully reserved inventory related to component parts is $717,000 as of March 31, 2008, and we intend to continue to use this reserved component parts inventory in production when appropriate.

 

6. PREPAID EXPENSES AND OTHER ASSETS

 

Prepaid expenses and other assets as of March 31, 2008 and December 31, 2007, respectively, consist of (in thousands):

 

 

 

MARCH 31, 2008

 

DECEMBER 31, 2007

 

 

 

(unaudited)

 

 

 

Receivable from Food and Drug Administration

 

$

1,932

 

$

1,932

 

Refundable federal income taxes

 

178

 

919

 

Prepaid clinical studies

 

327

 

1,277

 

Interest receivable

 

714

 

825

 

Other prepaid expenses and assets

 

681

 

360

 

Total

 

$

3,832

 

$

5,313

 

 

The Company has paid product and establishment fees for its marketed product, MUSE, for the fiscal year 2007 of $512,000 (which was paid to the FDA in October 2006) and for the fiscal year 2008 of $653,000 (which was paid to the FDA in October 2007). The Company is due a refund pursuant to Section 736(d)(1)(C) of the Federal Food, Drug and Cosmetic Act

 

13



 

(“FDC Act”) on the basis that the fees paid by the Company exceed the anticipated present and future costs incurred by the FDA in conducting the process for the review of human drug applications for VIVUS, Inc. The Company also paid an application fee to the FDA in September 2006 for the NDA for Evamist of $767,000 for which it received a refund in April 2008, on this same basis.

 

7. NOTES PAYABLE

 

Tanabe Line of Credit

 

In the first quarter of 2004, the Company signed an agreement for a secured line of credit with Tanabe Holding America, Inc., a subsidiary of Tanabe Seiyaku Co., Ltd., or Tanabe, allowing it to borrow up to $8.5 million to be used for the development of avanafil, an erectile dysfunction compound that has completed Phase 2 clinical trials. On April 24, 2007, in connection with the Company’s sale of Evamist to K-V (see Note 10: “Sale of Evamist Product”), the Company paid off the outstanding balance of $6.7 million, including all accrued interest. All the assets of the Company, except the land and buildings, served as collateral for this line of credit. On May 1, 2007, Tanabe signed a Termination and Release acknowledging payment in full of the principal and interest due under the line of credit and releasing the lien on the Company’s assets, and thereby terminating the line of credit. In September 2007, Tanabe Seiyaku Co., Ltd., following its merger with Mitsubishi Pharma Corporation, announced its name change to Mitsubishi Tanabe Pharma Corporation.

 

Crown Bank N.A. Loan

 

On January 4, 2006, VIVUS, Inc. and Vivus Real Estate LLC, a wholly owned subsidiary of VIVUS, Inc. (jointly, “the Company”) entered into a Term Loan Agreement and a Commercial Mortgage Note (the “Agreements”) with Crown Bank N. A. (“Crown”) secured by the land and buildings, among other assets, located at 735 Airport Road and 745 Airport Road in Lakewood, New Jersey (the “Facility”). The Facility is the Company’s principal manufacturing facility, which the Company purchased on December 22, 2005. Under the Agreements, the Company borrowed $5,375,000 on January 4, 2006 from Crown payable over a 10-year term. The interest rate is adjusted annually to a fixed rate for the year equal to the prime rate plus 1%, with a floor of 7.5%. Principal and interest are payable monthly based upon a 20-year amortization schedule and are adjusted annually at the time of the interest rate reset. All remaining principal is due on February 1, 2016. The interest rate was 7.5% and 9.25% for the quarter ended March 31, 2008 and 2007, respectively. Because the interest rate is variable, and based on a market rate, the carrying value of the debt approximates fair value. The Agreements contain prepayment penalties, and a requirement to maintain a depository account at Crown with a minimum collected balance of $100,000 which, if not maintained, will result in an automatic increase in the interest rate on the note of one-half (0.5%) percent. The Facility, assignment of rents and leases on the Facility, and a $700,000 Certificate of Deposit held by Crown, classified as restricted cash, serve as collateral for these Agreements.

 

Total long-term notes payable consist of the following (in thousands):

 

 

 

March 31, 
2008

 

December 31, 
2007

 

 

 

(unaudited)

 

 

 

 

Total notes payable

 

$

5,145

 

$

5,175

 

Less current portion

 

(137

)

(113

)

Total long-term notes payable

 

$

5,008

 

$

5,062

 

 

Current portion of notes payable is included under the heading “Accrued and other liabilities”.

 

Future minimum principal payments of the long-term notes payable as of March 31, 2008 are as follows (in thousands):

 

As of March 31, 2008

 

Crown Bank N.A. 
Loan

 

2008 (remainder of)

 

$

101

 

2009

 

145

 

2010

 

157

 

2011

 

169

 

2012

 

181

 

Thereafter

 

4,392

 

Total

 

$

5,145

 

 

14



 

8. AGREEMENTS

 

In 2001, VIVUS entered into a Development, Licensing and Supply Agreement with Tanabe for the development of avanafil, an oral PDE5 inhibitor product candidate for the treatment of erectile dysfunction. Under the terms of the 2001 Development, Licensing and Supply Agreement with Tanabe, the Company paid a $2 million license fee obligation to Tanabe in the year ended December 31, 2006, which was previously accrued in the year ended December 31, 2004. The Company expects to make other substantial payments to Tanabe in accordance with its agreements with them. These payments are based on certain development, regulatory and sales milestones. In addition, VIVUS is required to make royalty payments on any future product sales.

 

In February 2004, the Company entered into exclusive licensing agreements with Acrux Limited (“Acrux”) and a subsidiary of Acrux under which it agreed to develop and, if approved, commercialize Testosterone MDTS (“Luramist”) and Evamist in the United States for various female health applications. Under the terms of the agreements, the Company agreed to pay to Acrux for Luramist licensing fees of $2 million, up to $3.3 million for the achievement of certain clinical development milestones, up to $3 million for achieving product approval milestones, and royalties on net sales in the United States following approval and commercialization. For Evamist, the Company agreed to pay to Acrux licensing fees of $1 million, up to $1 million for the achievement of certain clinical development milestones, up to $3 million for achieving product approval milestones, and royalties on net sales in the United States following approval and commercialization. The Company made a $1 million milestone payment to Acrux in October 2006 related to the submission of an NDA to the FDA for Evamist. Upon approval of the NDA for Evamist, a $3 million product approval milestone became due and was paid to Acrux in August 2007. Per the terms of the Asset Purchase Agreement with K-V for the sale of Evamist, K-V paid $1.5 million of this $3 million obligation. Although the Company has sublicensed its rights under the Acrux Agreement related to Evamist to K-V, the Company will continue to have certain obligations under this license in the event that K-V does not satisfy the requirements under the sublicense agreement. See Note 10: “Sale of Evamist Product” below for additional information concerning the terms of this agreement and Note 17: “Legal Matters” for further information regarding Acrux.

 

The Company has entered into several agreements to license patented technologies that are essential to the development and production of the Company’s transurethral product for the treatment of erectile dysfunction. In connection with these agreements, the Company is obligated to pay royalties on product sales of MUSE (4% of United States and Canadian product sales and 3% of sales elsewhere in the world). In the first three months of 2008 and 2007, the Company recorded royalty expenses, in thousands, of $68, and $70, respectively, as cost of goods sold and manufacturing expense.

 

International sales are transacted through distributors. The distribution agreements include certain milestone payments from the distributors to the Company including upon achieving established sales thresholds. To date, we have collected $3.6 million in milestone payments from our current international distributors.

 

9. INCOME TAXES

 

The Company makes certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes.

 

As part of the process of preparing its condensed consolidated financial statements, the Company is required to estimate its income taxes in each of the jurisdictions in which it operates. This process involves the Company estimating its current tax exposure under the most recent tax laws and assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Company’s condensed consolidated balance sheets.

 

The Company assesses the likelihood that it will be able to recover its deferred tax assets. The Company considers all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. If it is not more likely than not that the Company will recover its deferred tax assets, the Company will increase its provision for taxes by recording a valuation allowance against the deferred tax assets that the Company estimates will not ultimately be recoverable. As a result of the Company’s analysis of all available evidence, both positive and negative, as of March 31, 2008, it was not considered more likely than not that the Company’s deferred tax assets would be realized.

 

However, should there be a change in the Company’s ability to recover its deferred tax assets, the Company would recognize a benefit to its tax provision in the period in which the Company determines that it is more likely than not that it cannot recover its deferred tax assets.

 

15



 

10. SALE OF EVAMIST PRODUCT

 

On March 30, 2007, the Company entered into a definitive agreement with K-V to transfer the assets and grant a sublicense of its rights under the Company’s agreement with Acrux related to Evamist, a metered dose transdermal spray for the treatment of menopause symptoms, to K-V (the “Transaction”). At the time of the sale, Evamist was an investigational product not yet approved by the FDA for marketing. Under the Transaction, the Company received an upfront payment of $10.0 million at the closing and, upon approval of the NDA for Evamist on July 27, 2007 and the transfer and assignment of the NDA submissions to K-V on August 1, 2007 received an additional $140.0 million.

 

The Company may also receive certain one-time payments of up to $30.0 million based on K-V achieving certain annual net sales thresholds for Evamist. In addition, per the terms of the Transaction, K-V reimbursed VIVUS for $1.5 million of the $3.0 million milestone payment paid by VIVUS to Acrux upon FDA Approval of the NDA. In connection with the Transaction, in order to obtain Tanabe’s release of liens against all assets including the Evamist assets and intellectual property, the Company repaid the Tanabe line of credit (see Note 7: “Notes Payable”).

 

11. NET INCOME (LOSS) PER SHARE

 

Net income (loss) per share is calculated in accordance with SFAS No. 128, Earnings per Share, which requires a dual presentation of basic and diluted earnings per share, or EPS. Basic net income (loss) per share is based on the weighted average number of common shares outstanding during the period. Diluted net income (loss) per share is based on the weighted average number of common and common equivalent shares, which represent shares that may be issued in the future upon the exercise of outstanding options. When there is a net loss, potentially dilutive common equivalent shares are not included in the calculation of net loss per share since their inclusion would be anti-dilutive.

 

As the Company recognized a net loss for the three months ended March 31, 2008 and 2007, all potential common equivalent shares were excluded as they were anti-dilutive. For the three months ended March 31, 2008 and 2007, 2,814,600 and 3,772,116 options outstanding, respectively, were not included in the computation of diluted net loss per share for the Company because the effect would be anti-dilutive.

 

12. COMMITMENTS AND CONTINGENCIES

 

Lease Commitments

 

In November 2006, the Company entered into a new 30-month lease for the existing Mountain View corporate headquarters location with its existing landlord. The new lease commenced on February 1, 2007. The base monthly rent is set at $1.85 per square foot or $26,000 per month. The lease expires on July 31, 2009 and allows the Company one option to extend the term of the lease for a period of one year from the expiration of the lease.

 

16



 

Future minimum lease payments under operating leases are as follows (in thousands):

 

2008 (remainder)

 

$

416

 

2009

 

324

 

 

 

$

740

 

 

Manufacturing Agreements

 

In November 2002, the Company entered into a manufacturing agreement to purchase raw materials from a supplier beginning in 2003 and ending in 2008. In May 2007, the terms of the agreement were amended and the Company’s remaining commitment is to purchase a minimum total of $2.3 million of product from 2007 through 2011. The Company’s remaining commitment under this agreement is $1.5 million.

 

In January 2004, the Company entered into a manufacturing agreement to purchase raw materials from an additional supplier beginning in 2004 and ending in 2006. In February 2006, the terms of this agreement were amended to require the purchase of a minimum total of $1.5 million of product from 2006 through 2008. The Company’s remaining commitment under this agreement is $765,000.

 

Other Agreements

 

The Company has entered into various agreements with clinical consultants and clinical research organizations to perform clinical studies on its behalf and, at March 31, 2008, its remaining commitment under these agreements totaled $39.2 million. The Company has remaining commitments under various general and administrative services agreements totaling $1.8 million at March 31, 2008, including $1.2 million related to Mr. Wilson’s Employment Agreement (see below). The Company has also entered into various agreements with research consultants and other contractors to perform regulatory services, drug research, testing and manufacturing including animal studies and, at March 31, 2008, its remaining commitment under these agreements totaled $6.1 million. In addition, the Company has entered into marketing promotion agreements for its erectile dysfunction product, MUSE. At March 31, 2008, its remaining commitment under the MUSE agreements totaled $866,000.

 

On December 19, 2007, the Compensation Committee of the Board of Directors of the Company approved an employment agreement (the “Employment Agreement”) with Leland F. Wilson, the Company’s President and Chief Executive Officer. The Employment Agreement includes salary, incentive compensation, retirement benefits and length of employment, among other items, as agreed to with Mr. Wilson. The Employment Agreement has an initial term of two years commencing on the effective date, June 1, 2007 (the “Effective Date”). On the second anniversary of the Effective Date, the Employment Agreement will automatically renew for an additional one-year term unless either party provides the other party with a notice of non-renewal.

 

Indemnifications

 

In the normal course of business, the Company provides indemnifications of varying scope to customers against claims of intellectual property infringement made by third parties arising from the use of its products and to certain of our clinical research organizations and investigator sites. Historically, costs related to these indemnification provisions have not been significant and the Company is unable to estimate the maximum potential impact of these indemnification provisions on our future results of operations.

 

Pursuant to the terms of the Asset Purchase Agreement for the sale of the Evamist product to K-V, the Company made certain representations and warranties concerning its rights and assets related to Evamist and the Company’s authority to enter into and consummate the transaction. The Company also made certain covenants which survive the closing date of the transaction, including a covenant not to operate a business that competes, in the United States, and its territories and protectorates, with the Evamist product. See Note 17: “Legal Matters” for further information regarding Acrux.

 

To the extent permitted under Delaware law, the Company has agreements whereby it indemnifies its officers and directors for certain events or occurrences while the officer or director is, or was, serving at the Company’s request in such capacity. The indemnification period covers all pertinent events and occurrences during the officer’s or director’s lifetime. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, VIVUS has director and officer insurance coverage that reduces its exposure and enables the Company to recover a portion of any future amounts paid. The Company believes the estimated fair value of these indemnification agreements in excess of applicable insurance coverage is minimal.

 

17



 

13. CONCENTRATION OF CUSTOMERS AND SUPPLIERS

 

During the first three months of 2008 and 2007, sales to significant customers as a percentage of total revenues were as follows:

 

 

 

2008

 

2007

 

Customer A

 

5

%

19

%

Customer B

 

42

%

1

%

Customer C

 

19

%

12

%

Customer D

 

23

%

56

%

 

The Company relies on third party sole-source manufacturers to produce its clinical trial materials, components and raw materials. Third party manufacturers may not be able to meet the Company’s needs with respect to timing, quantity or quality. Several of the Company’s manufacturers are sole-source manufacturers where no alternative suppliers exist. In the three months ended March 31, 2008, we spent $17.3 million for services  provided by one clinical research organization on the  Qnexa Phase 3 studies, which  represented 74% of the Company’s total research and development expenses.

 

14. RESEARCH AND DEVELOPMENT

 

Research and development expenses including advertising for clinical trials and patient recruitment costs are expensed as incurred.

 

15. EQUITY TRANSACTIONS

 

On July 14, 2006, VIVUS, Inc. filed with the SEC a shelf Registration Statement on Form S-3. The shelf Registration Statement (File Number 333-135793) was declared effective by the SEC on August 16, 2006, providing the Company with the ability to offer and sell up to an aggregate of $80.0 million of common stock from time to time in one or more offerings. The terms of any such future offering would be established at the time of such offering. This shelf Registration Statement (File Number 333-135793) replaces shelf Registration Statement (File Number 333-12159).

 

On November 17, 2006, the Company raised $33.6 million in a registered direct offering of VIVUS common stock pursuant to this shelf Registration Statement. Under the terms of this financing, the Company sold and issued a total of 6,750,000 shares of its common stock at a price of $3.50 per share in an initial closing and an additional 2,850,000 shares at $3.50 per share in a second closing on December 8, 2006. All of the shares of common stock were offered pursuant to the effective shelf Registration Statement on Form S-3 filed with the SEC on July 14, 2006.

 

See Note 19: “Subsequent Events” for additional equity transactions filed with the SEC in May 2008.

 

16. RELATED PARTY TRANSACTIONS

 

Mario M. Rosati, one of our directors, is also a member of Wilson Sonsini Goodrich & Rosati, Professional Corporation, which has served as our outside corporate counsel since our formation and has received compensation at normal commercial rates for these services. In the first three months of 2008 and 2007, we paid $95,000 and $190,000, respectively, to Wilson Sonsini Goodrich & Rosati.

 

17. LEGAL MATTERS

 

In the normal course of business, the Company receives claims and makes inquiries regarding patent infringement and other legal matters. The Company believes that it has meritorious claims and defenses and intends to pursue any such matters vigorously.

 

The Company and Acrux Limited, or Acrux, are parties to the Testosterone Development and Commercialization Agreement and the Estradiol Development and Commercialization Agreement, each dated February 12, 2004, or the Acrux Agreements.  The Acrux Agreements cover the Company’s Evamist and Luramist investigational products, both of which are licensed from Acrux under the Acrux Agreements.  The Company received a letter dated November 13, 2006 from legal counsel for Acrux containing various claims of breach under the Acrux Agreements.  The Company has responded that it believes there is no merit to those claims and that it has meritorious defenses to such claims.  The claims with respect to Evamist have not progressed further, but, to date, the claims have not been withdrawn. On November 5, 2007, Acrux made a demand for arbitration under the Acrux Agreements regarding its claims related to Luramist.  Acrux’s demand seeks a reversion of all rights assigned to the Company related to Luramist, monetary damages, a portion of a milestone payment for Luramist under the Acrux Agreements and declaratory relief.  The Company believes that is in compliance with all material aspects of the Acrux Agreements, including those relating to Luramist and that it currently does not owe monetary damages or any milestone payment under the Acrux Agreements.  The arbitration process is proceeding, with the parties selecting and

 

18



 

qualifying potential arbitrators. However, in the event that Acrux should prevail in this matter, it could have a material adverse effect on our business, financial condition and results of operations and cash flow.

 

The Company is not aware of any other asserted or unasserted claims against it where an unfavorable resolution would have an adverse material impact on the operations or financial position of the Company.

 

18. STOCKHOLDER RIGHTS PLAN

 

On March 26, 2007, the Board of Directors of the Company adopted a Stockholder Rights Plan (the “Rights Plan”) and amended its bylaws. Under the Rights Plan, the Company will issue a dividend of one right for each share of its common stock held by stockholders of record as of the close of business on April 13, 2007.

 

The Rights Plan is designed to guard against partial tender offers and other coercive tactics to gain control of the Company without offering a fair and adequate price and terms to all of the Company’s stockholders. The Rights Plan is intended to provide the Board of Directors with sufficient time to consider any and all alternatives to such an action and is similar to plans adopted by many other publicly traded companies. The Rights Plan was not adopted in response to any efforts to acquire the Company, and the Company is not aware of any such efforts.

 

Each right will initially entitle stockholders to purchase a fractional share of the Company’s preferred stock for $26.00. However, the rights are not immediately exercisable and will become exercisable only upon the occurrence of certain events. If a person or group acquires, or announces a tender or exchange offer that would result in the acquisition of 15% or more of the Company’s common stock while the Stockholder Rights Plan remains in place, then, unless the rights are redeemed by the Company for $.001 per right, the rights will become exercisable by all rights holders except the acquiring person or group for the Company’s shares or shares of the third party acquirer having a value of twice the right’s then-current exercise price.

 

The Board of Directors also amended provisions of the Company’s bylaws concerning procedures for the calling of special stockholder meetings and establishing the agenda and board nominees at annual stockholders meetings. The Company filed these bylaw amendments with the SEC on Form 8-K on March 28, 2007.

 

19. SUBSEQUENT EVENTS

 

On April 3, 2008, the Company entered into several agreements with Deerfield Management Company, L.P., or Deerfield, a healthcare investment fund, and its affiliates, Deerfield Private Design Fund L.P. and Deerfield Private Design International, L.P. (collectively, the Deerfield Affiliates).  Under the agreements, Deerfield and its affiliates agreed to provide $30 million in funding to the Company.  The $30 million in funding consists of $20 million from a Funding and Royalty Agreement (“FARA”) entered into with a newly incorporated subsidiary of Deerfield (“Deerfield Sub”) and $10 million from the sale of the Company’s common stock under a securities purchase agreement.  Under the FARA, the Deerfield Affiliates will make six payments of approximately $3.3 million, beginning in April 2008 and quarterly thereafter.  The Company will pay royalties on the current net sales of MUSE and if approved, future sales of avanafil, an investigational product candidate, to the Deerfield Sub.  The term of the FARA is ten years.  The FARA includes covenants requiring the Company to use commercially reasonable efforts to preserve its intellectual property, manufacture, promote and sell MUSE, and develop avanafil.  At the closing on April 15, 2008, under the securities purchase agreement, the Deerfield Affiliates purchased 1,626,017 shares of the Company’s common stock for an aggregate purchase price of $10 million and the Company paid to the Deerfield Affiliates a $500,000 fee and reimbursed certain expenses incurred in this transaction, registered under the shelf Registration Statement (File Number 333-135793) filed with the SEC, on July 16, 2006, approximately $200,000. The agreements also provided the Company with an option to purchase, and the Deerfield Affiliates with an option to compel the Company to purchase, the Deerfield Sub holding the royalty rights. If the Company exercises its right to purchase the Deerfield Sub, the net price will be $23 million if exercised within three years, or $26 million if exercised after three years but before four years (the purchase prices are subject to other adjustments as defined in the agreement).  After three years from the closing, the Deerfield affiliates may exercise the right to compel the Company to purchase the Deerfield Sub at a price ranging from $17 million to $26 million based upon various circumstances. If either party exercises its option, any further royalty payments would be effectively terminated.  In exchange for the option right, the Company paid $2 million to the Deerfield Affiliates.  Also at closing, the initial $3.3 million under the FARA was paid to VIVUS. The Company’s intellectual property and all of the accounts receivable, inventory and equipment arising out of or relating to MUSE and avanafil are collateral for this transaction.

 

On May 5, 2008, VIVUS, Inc. filed with the Securities and Exchange Commission (SEC) a shelf Registration Statement on Form S-3.  Once the shelf Registration Statement (File Number 333-150649) has been reviewed and declared effective by the SEC, the Company will have the ability to offer and sell up to an aggregate of $150 million of common stock from time to time in one or more offerings.  The terms of any such future offering would be established at the time of such offering.

 

19



 

On May 5, 2008, the Company filed a Form S-8 with the SEC registering 1,000,000 shares of common stock, par value $0.001 per share, under the 2001 Stock Option Plan, as amended.

 

On May 6, 2008, the Company filed with the SEC a Post-Effective Amendment No. 1 to Form S-3 (File No. 333-135793) (the “Registration Statement”), which was filed with the SEC on July 14, 2006, to amend the Registration Statement to deregister any securities registered pursuant to the Registration Statement and not otherwise sold thereunder.

 

20



 

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

This Management’s Discussion and Analysis of Financial Conditions and Results of Operations and other parts of this Form 10-Q contain “forward-looking” statements that involve risks and uncertainties. These statements typically may be identified by the use of forward-looking words or phrases such as “believe,” “expect,” “intend,” “anticipate,” “should,” “planned,” “estimated,” and “potential,” among others. All forward-looking statements included in this document are based on our current expectations, and we assume no obligation to update any such forward-looking statements. The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for such forward-looking statements. In order to comply with the terms of the safe harbor, we note that a variety of factors could cause actual results and experiences to differ materially from the anticipated results or other expectations expressed in such forward-looking statements. The risks and uncertainties that may affect the operations, performance, development, and results of our business include but are not limited to: (1) our history of losses and variable quarterly results; (2) substantial competition; (3) risks related to the failure to protect our intellectual property and litigation in which we may become involved; (4) our reliance on sole source suppliers; (5) our limited sales and marketing efforts and our reliance on third parties; (6) failure to continue to develop innovative products; (7) risks related to noncompliance with United States Food and Drug Administration (“FDA”) regulations; (8) our ability to demonstrate through clinical testing the safety and effectiveness of our clinical candidates; (9) the timing of initiation and completion of clinical trials and submissions to the FDA; (10) the volatility and liquidity of the financial markets; and (11) other factors that are described from time to time in our periodic filings with the Securities and Exchange Commission (the “SEC”), including those set forth in this filing as “Risk Factors Affecting Operations and Future Results.”

 

All percentage amounts and ratios were calculated using the underlying data in thousands. Operating results for the quarter ended March 31, 2008 are not necessarily indicative of the results that may be expected for the full fiscal year or any future period.

 

BUSINESS OVERVIEW

 

VIVUS, Inc. is a pharmaceutical company, incorporated in 1991, dedicated to the development and commercialization of therapeutic products for large underserved markets. The investigational products currently under development could serve the obesity, diabetes and sexual health markets. Our current and investigational product candidates in development will encompass patented proprietary formulations and novel delivery systems and investigational products may be developed by seeking new indications for previously approved pharmaceutical products. To date, through employment of this strategy, we have one commercial product and several investigational product candidates in late stages of development that address these markets. In these sectors patients seek more effective treatment options with fewer negative side effects. With respect to obesity, analysts estimate that this potential market could exceed $5 billion annually. Sales of approved drugs for diabetes exceed $10 billion. The indications targeted by VIVUS’ investigational sexual health products each represent a projected market greater than $1 billion annually.

 

The current investigational product pipeline includes three late-stage clinical products, each addressing specific components of the obesity, diabetes and sexual health markets. One of these investigational products, Qnexa™, is in Phase 3 clinical trials for obesity and in Phase 2 clinical trials for diabetes.

 

All of the pivotal Phase 3 studies for Qnexa were initiated in the fourth quarter of 2007 and are now fully enrolled. The co-primary endpoints for these studies will evaluate the differences between treatments from baseline to the end of the treatment period, in mean percent weight loss and in the percentage of subjects achieving weight loss of 5% or more. All Phase 3 studies will utilize our novel once-a-day formulation of Qnexa, which at full strength contains 15 mg phentermine immediate release and 92 mg topiramate controlled release. Pharmacokinetic-Pharmacodynamic (PK/PD) studies indicated that the once-a-day formulation is comparable to the twice-a-day formulation used in the Phase 2 study.

 

Our late-stage investigational product pipeline includes:

 

·      Qnexa, being developed to treat obesity, for which the pivotal Phase 3 studies have been initiated;

 

·      Qnexa, being developed to treat diabetes, for which Phase 2 studies have been initiated;

 

·      Luramist (Testosterone MDTS®),being developed to treat hypoactive sexual desire disorder in women, for which a Phase 2 study has been completed; and

 

·      Avanafil, being developed to treat erectile dysfunction for which Phase 2 studies have been completed.

 

21



 

Our former investigational product, Evamist™, a metered dose transdermal estradiol spray approved for the treatment of vasomotor symptoms associated with menopause, was sold to K-V Pharmaceutical Company (“K-V”) on May 15, 2007. We had completed Phase 3 studies for Evamist in May 2006 and a New Drug Application (“NDA”) was approved by the United States Food and Drug Administration (the “FDA”) on July 27, 2007.

 

On March 30, 2007, we announced that we had entered into a definitive agreement with K-V to transfer certain of our assets and grant a sublicense under our exclusive rights to certain patents and know-how related to Evamist pursuant to our Estradiol Development and Commercialization Agreement with FemPharm Pty Ltd. and Acrux DDS Pty Ltd. (together, “Acrux”), dated February 12, 2004, as amended (the “Acrux Agreement”) to K-V (the “Transaction”).

 

On May 15, 2007, the Transaction with K-V closed. Under the terms of the Transaction, we received an upfront payment of $10 million upon the closing. On August 1, 2007, we transferred and assigned the Evamist FDA submissions, and all files related thereto to K-V, and on August 8, 2007, we received a $140 million milestone payment from K-V. K-V also paid $1.5 million of the $3 million product approval milestone payment due to Acrux upon approval of Evamist. We are also eligible to receive certain one-time milestone payments from K-V totaling up to $30 million based on the achievement of certain annual net sales thresholds for Evamist.

 

On April 3, 2008, we entered into several agreements with Deerfield Management Company, L.P., or Deerfield, a healthcare investment fund, and its affiliates, Deerfield Private Design Fund L.P. and Deerfield Private Design International, L.P. (collectively, the Deerfield Affiliates). Under the agreements, Deerfield and its affiliates agreed to provide $30 million in funding to the Company. The $30 million in funding consists of $20 million from a Funding and Royalty Agreement (“FARA”) entered into with a newly incorporated subsidiary of Deerfield (“Deerfield Sub”) and $10 million from the sale of our common stock under a securities purchase agreement. Under the FARA, the Deerfield Affiliates will make six payments of approximately $3.3 million, beginning in April 2008 and quarterly thereafter. We will pay royalties on the current net sales of MUSE and if approved, future sales of avanafil, an investigational product candidate, to the Deerfield Sub. The term of the FARA is ten years. The FARA includes covenants requiring us to use commercially reasonable efforts to preserve our intellectual property, manufacture, promote and sell MUSE, and develop avanafil. At the closing on April 15, 2008, under the securities purchase agreement, the Deerfield Affiliates purchased 1,626,017 shares of our common stock for an aggregate purchase price of $10 million and we paid to the Deerfield Affiliates a $500,000 fee and reimbursed certain expenses incurred in this transaction of approximately $200,000. The agreements also provided us with an option to purchase, and the Deerfield Affiliates with an option to compel us to purchase, the Deerfield Sub holding the royalty rights. If we exercise our right to purchase the Deerfield Sub, the net price will be $23 million if exercised within three years, or $26 million if exercised after three years but before four years (the purchase prices are subject to other adjustments as defined in the agreement). After three years from the closing, the Deerfield affiliates may exercise the right to compel us to purchase the Deerfield Sub at a price ranging from $17 million to $26 million based upon various circumstances. If either party exercises its option, any further royalty payments would be effectively terminated. In exchange for the option right, we paid $2 million to the Deerfield Affiliates. Also at closing, the initial $3.3 million under the FARA was paid to us. Our intellectual property and all of the accounts receivable, inventory and equipment arising out of or relating to MUSE and avanafil are collateral for this transaction.

 

In 1997, we launched MUSE (alprostadil) in the United States and, together with our partners, internationally. We market MUSE as a prescription product for the treatment of erectile dysfunction.

 

Our Future

 

Our goal is to build a successful pharmaceutical company through the development and commercialization of innovative proprietary products. We intend to achieve this by:

 

·

 

capitalizing on our clinical and regulatory expertise and experience to advance the development of investigational product candidates in our pipeline;

 

 

 

·

 

establishing strategic relationships with marketing partners to maximize sales potential for our products that require significant commercial support;

 

 

 

·

 

licensing complementary clinical stage investigational product candidates or technologies with competitive advantages from third parties for new and established markets; and

 

 

 

·

 

partnering our late-stage investigational product candidates with third parties.

 

22



 

It is our objective to become a leader in the development and commercialization of products for large underserved markets. We believe that we have strong intellectual property supporting several opportunities in obesity, diabetes and sexual health. Our future growth will depend on our ability to further develop and obtain regulatory approval of our investigational product candidates as well as in-licensing and product line extensions.

 

We have funded operations primarily through private and public offerings of our common stock, the sale of the rights to Evamist and through product sales of MUSE. We expect to generate future net losses due to increases in operating expenses as investigational product candidates are advanced through the various stages of clinical development. In connection with the sale of Evamist, we received $150 million. The sale of Evamist was a unique transaction. As discussed in Note 10: “Sale of Evamist Product”, an initial $10 million was paid at closing and $140 million was paid upon the FDA’s approval of the Evamist NDA. These payments are non-refundable and have been recorded as deferred revenue and will be recognized as license and other revenue ratably over a 21.5-month period, from August 1, 2007 to May 15, 2009, which is the remaining term of a license to improvements to the MDTS applicator. As compared to revenues from product sales, license and other revenue will be significant on a quarterly basis until all of the revenue from the sale of Evamist is recognized which is currently expected to be May 2009. Since the $150 million has been received and we have no related contingencies, the future recognition of revenue and the corresponding reduction of deferred revenue related to the Evamist sale will have no impact on our cash flows from operations in future periods through May 2009. As of March 31, 2008, we have incurred a cumulative deficit of $176.9 million and expect to incur operating losses in future years.

 

Year-to-Date 2008

 

Highlights year to date include:

 

·      Completion of Enrollment of the Phase 3 Qnexa for Obesity Studies – Through April 2008, we completed enrollment of all of the pivotal studies.  The co-primary endpoints for these studies will evaluate the differences between treatments from baseline to the end of the treatment period, in mean percent weight loss and in the percentage of subjects achieving weight loss of 5% or more. Specifically, the Phase 3 studies include:

 

·      EQUATE (OB-301), a 28-week study in which 700 patients with Body Mass Index (“BMI”) ranging from 30 to 45 have been enrolled.

 

·      EQUIP (OB-302), a 56-week study in which 1,250 morbidly obese patients with BMI that equals or exceeds 35 have been enrolled.

 

·      CONQUER (OB-303), a 56-week study in which 2,500 patients with a BMI ranging from 27 to 45 and two related co-morbidities including hypertension, dyslipidemia and type 2 diabetes have been enrolled.

 

·      Initiation of Extension Study with Qnexa for Diabetes — In January 2008, we announced the initiation of a six-month extension study for patients currently enrolled in the OB-202 diabetes study.

 

·      Special Protocol Assessment Completed and Agreement Reached with the FDA on Safety Study for Luramist—In the first quarter of 2008, we completed the Special Protocol Assessment, or SPA, process and reached agreement with the FDA on the safety requirements for Luramist (testosterone MDTS). The pivotal Phase 3 studies will include two six-month studies in menopausal women with hypoactive sexual desire disorder. The safety outcomes study will enroll 5,200 postmenopausal women aged 50 or over with at least one cardiovascular risk factor.

 

·      Entered into Funding Collaboration for the Phase 3 Studies of Avanafil for Erectile Dysfunction—In April 2008, we entered into agreements with Deerfield Management (“Deerfield”). Under the terms of the agreements, Deerfield will provide funds for the Phase 3 program for avanafil. The $30 million in funding will be provided by Deerfield from two sources:  $20 million under a Funding and Royalty Agreement and $10 million from the sale of our common stock. We have granted Deerfield a royalty interest on sales of MUSE®, our product currently marketed for the treatment of ED as part of the funding collaboration.

 

23



 

Our Product Pipeline

 

We currently have the following research and development programs targeting obesity, diabetes and sexual health:

 

Product

 

Indication

 

Status

 

Patent Expiry
and Number

Qnexa (phentermine and topiramate)

 

Obesity

 

Phase 3 initiated

 

2019 (US 7,056,890 B2)

 

 

 

 

 

 

 

Qnexa (phentermine and topiramate)

 

Diabetes

 

Phase 2 initiated

 

2019 (US 7,056,890 B2)

 

 

 

 

 

 

 

Luramist (Testosterone MDTS)

 

Hypoactive sexual desire disorder (HSDD)

 

Phase 2 completed

 

2017 (US 6,818,226)

 

 

 

 

 

 

 

Avanafil (PDE5 inhibitor)

 

Erectile dysfunction (ED)

 

Phase 2 completed

 

2020 (US 6,656,935)

 

Obesity and Diabetes

 

In 2004, the U.S. Centers for Disease Control and Prevention (the “CDC”) ranked obesity as one of the top health threats in America. Obesity is a chronic condition that affects millions of people and often requires long-term or invasive treatment to promote and sustain weight loss. Obesity is the second leading cause of preventable death in the United States. The American Obesity Association estimates that approximately 127 million, or 64.5%, of adults in the United States are overweight, and an estimated 60 million, or 30.5%, are obese. According to a study performed by the CDC, as reported in the Journal of the American Medical Association, an estimated 112,000 excess deaths a year in the United States are attributable to obesity. The total direct and indirect costs attributed to overweight and obesity amounted to approximately $117 billion in 2000. Additionally, Americans spend more than $30 billion annually on weight-loss products and services.

 

Diabetes

 

Diabetes is a significant worldwide disease. Based on 2003 data, the International Diabetes Federation estimated that in 2005 there were 194 million adults with diabetes worldwide, an increase of over 40% since 1995. These figures included approximately 23 million in the United States and approximately 48 million in the European region. Approximately 90%, or 175 million, of diabetics worldwide suffer from type 2 diabetes, which is characterized by inadequate response to insulin and/or inadequate secretion of insulin as blood glucose levels rise. Therapies for type 2 diabetes are directed toward correcting the body’s inadequate response with oral or injectable medications, or directly modifying insulin levels through injection of insulin or insulin analogs.

 

The currently approved oral medications for type 2 diabetes include insulin releasers such as glyburide, insulin sensitizers such as Actos and Avandia, inhibitors of glucose production by the liver such as metformin, DPP-IV inhibitors like Januvia, as well as Precose and Glyset, which slow the uptake of glucose from the intestine. The worldwide market for diabetes medications exceeded $10 billion in 2004, of which oral drugs exceeded $6 billion. However, a significant portion of type 2 diabetics fail oral medications and require injected insulin therapy. Current oral medications for type 2 diabetes have a number of side effects, including hypoglycemia, weight gain and edema. Numerous pharmaceutical and biotechnology companies are seeking to develop insulin sensitizers, novel insulin formulations and other therapeutics to improve the treatment of diabetes. Previous clinical studies of topiramate in type 2 diabetics resulted in a reduction of hemoglobin A1c, a measure used to determine treatment efficacy of anti-diabetic agents. We are currently studying the impact of treating type 2 diabetics with Qnexa in an initial six-month Phase 2 study.

 

Qnexa for Obesity

 

Qnexa is our proprietary oral investigational product candidate for the treatment of obesity, incorporating low doses of active ingredients from two previously approved products, topiramate and phentermine. By combining each of these compounds, we believe Qnexa can simultaneously address excessive appetite and high threshold for satiety, or the feeling of being full, the two main mechanisms that impact eating behavior. Qnexa is a once-a-day capsule containing a proprietary formulation of controlled release topiramate and phentermine.

 

Previously, we reported results from a Phase 2 double-blind, randomized, and placebo-controlled clinical trial in which patients on Qnexa lost, on average, 25.1 pounds as compared to patients in the placebo group, who lost 4.8 pounds. This trial involved 200 subjects, 159 women and 41 men with an average approximate age of 40 and a mean BMI of 38.6. (A BMI of >

 

24



 

30 is classified as obese per guidelines from the U.S. Department of Health and Human Services.) Patients completing the 24-week treatment period lost on average approximately 11% of baseline body weight, as compared to an average 2.8% in the placebo group. The difference between the Qnexa arm and the placebo arm was statistically significant. Qnexa was well-tolerated in this trial. The study completion rate for patients on Qnexa over the 24-week treatment period was 92%, as compared to 62% for patients in the placebo group. Adverse events occurring in greater than 10% in the Qnexa arm as compared to placebo included paresthesia (mild tingling of the extremities), altered taste, increased urinary frequency and headache. There were no dropouts in the Qnexa arm due to serious or severe adverse events.

 

The Phase 2 study also demonstrated significant improvements in patients’ quality of life, such as self-esteem, public distress and physical function when treated with Qnexa. Treatment with topiramate alone showed no improvement in any aspects of quality of life despite significant weight loss. These results suggest that the component of phentermine increases the tolerability of topiramate, which was the scientific rationale for combining these two agents at low doses for the treatment of obesity and related co-morbidities.

 

In addition, Qnexa-treated subjects had a significant reduction of waist circumference, triglycerides, systolic blood pressure, C-reactive protein and total cholesterol compared to patients in the placebo group. These secondary findings suggest that Qnexa may improve several important metabolic disease risk factors in obese patients. According to the American Heart Association, “The metabolic syndrome is characterized by a group of metabolic risk factors in one person.” Such factors include but are not limited to abdominal obesity and blood fat disorders that foster plaque buildup in artery walls including: high triglycerides, low HDL cholesterol, high LDL cholesterol, and elevated blood pressure. People with metabolic syndrome have an increased risk of coronary heart disease and other conditions that result from the buildup of plaque in artery walls (e.g., stroke and peripheral vascular disease) and type 2 diabetes. The current FDA guidelines state that on its own, metabolic syndrome represents a cluster of laboratory and clinical findings that serve as markers for increased risk for cardiovascular disease and type 2 diabetes, and is prevalent in as much as 25% of the adult American population. The FDA does not consider the metabolic syndrome to represent a distinct disease entity or treatment indication. Nonetheless, in addition to lifestyle modification, a host of approved drug therapies now exist to address individual or multiple components of the syndrome (e.g., lipid altering agents, antihypertensives, insulin sensitizers). An initial Phase 2 clinical trial (OB-202) is currently underway in patients with type 2 diabetes. We may, in the future, conduct additional studies of Qnexa on these components of metabolic syndrome.

 

The primary efficacy endpoint for Phase 3 weight loss trials as recommended by the FDA is an assessment of the mean percent reduction in baseline body weight compared to placebo and the proportion of subjects who lose 5% or more of their baseline body weight over a one-year period. New FDA draft guidelines for obesity products set forth a primary efficacy benchmark in Phase 3 trials of at least 35% of patients achieving 5% weight loss. The weight loss in patients taking the obesity product should also be twice the weight loss of the placebo group. In our Phase 2 trial after 24 weeks, 82% of patients lost 5% of their baseline weight as compared to 14% in the placebo group. In Europe, the Committee for Medicinal Products for Human Use (“CHMP”) of the European Medicines Agency (“EMEA”) has recommended that demonstration of significant weight loss of at least 10% of baseline weight is considered to be a valid primary endpoint for anti-obesity drugs. In the Phase 2 study after 24 weeks, 50% of the patients on Qnexa lost 10% of their baseline weight as compared to 8% of the patients in the placebo group. The FDA and the Medicines and Healthcare products Regulatory Agency, the regulatory authority in the United Kingdom, require obesity studies to be conducted for at least one year. While the results from our single center Phase 2 trial for six months of treatment meet these guidelines, there can be no assurance that these results can be replicated in a multi-center, one-year, Phase 3 trial, or with a once-a-day controlled release formulation of the product. We completed the development of our once-a-day controlled release formulation of Qnexa prior to the initiation of our Phase 3 clinical trials.

 

In June 2007, we announced the formation of our Qnexa Scientific Advisory Board (the “Qnexa SAB”), consisting of well-known experts in the areas of obesity, clinical trial design, psychology and diabetes. We appointed Dr. David Allison, Dr. Nancy Bohannon, Dr. Arthur Frank, Dr. Donna Ryan, Dr. Xavier Pi-Sunyer and Dr. Tom Wadden to the Qnexa SAB. These experts have provided guidance concerning Qnexa Phase 3 clinical trials and are available for continuing consultations.

 

We have successfully completed the Special Protocol Assessment (“SPA”) process and have reached agreement with the FDA regarding key elements of the pivotal Phase 3 clinical trials of Qnexa for the treatment of obesity and weight-related co-morbidities. We have reached agreement with the FDA on study design features that will be employed throughout the entire Phase 3 program including the co-primary endpoints of the study, scope and size of the patient population, specific safety assessments, inclusion/exclusion criteria, duration of the trials and the statistical method for analyzing the co-primary study endpoints.

 

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Under the SPA process, a sponsor may seek the FDA’s agreement on the design and analysis of a clinical trial intended to form the primary basis of an efficacy claim. If the FDA agrees in writing, its agreement may not be changed after the trial begins except in limited circumstances, such as the FDA determining that a substantial scientific issue essential to determining the safety or effectiveness of the product was identified after the trial had begun. If the outcome of the trial is successful, the sponsor will ordinarily be able to rely on it as the basis for approval with respect to effectiveness.

 

The Phase 3 Qnexa program will include two pivotal, double-blind, placebo-controlled, multi-center studies comparing Qnexa to placebo over a 56-week treatment period. In November 2007, we initiated both of these two pivotal Phase 3 studies of Qnexa. All Phase 3 studies are utilizing our novel once-a-day formulation of Qnexa, which at full strength contains 15 mg phentermine immediate release and 92 mg topiramate controlled release. The studies are designed to prospectively demonstrate the safety and efficacy of Qnexa in obese and overweight patients with different baseline characteristics. The first study, known as EQUIP (OB-302), enrolled over 1,250 morbidly obese patients with a BMI that equals or exceeds 35 with or without controlled co-morbidities. The EQUIP study completed enrollment in March 2008. The second trial, known as CONQUER (OB-303), enrolled overweight and obese adult subjects with BMI’s from 27 to 45 and at least two co-morbid conditions, such as hypertension, dyslipidemia and type 2 diabetes. The co-primary endpoints for these studies will evaluate the differences between treatments in mean percent weight loss from baseline to the end of the treatment period and the differences between treatments in the percentage of subjects achieving weight loss of 5% or more. Patient enrollment for both pivotal Phase 3 trials, OB-302 and OB-303, are complete.

 

A pharmacokinetic-pharmacodynamic (PK/PD) study has confirmed that the once-a-day formulation is comparable to the twice-a-day formulation used in the Phase 2 study.

 

The Phase 3 program also includes a six-month confirmatory factorial-design study, known as EQUATE (OB-301), including obese subjects with BMI’s from 30 to 45. This trial was initiated in December 2007 and completed enrollment in March 2008. The EQUATE study will evaluate two dose levels of Qnexa, compared to both placebo and the individual constituents of the combination. The primary endpoints at six months are similar to those evaluated in the pivotal studies.

 

Safety and tolerability of Qnexa will be determined by reporting adverse events, physical exam, clinical laboratory data, electrocardiogram, cognitive function tests, psychological assessments, and clinical assessment of clinical laboratory variables. The Phase 3 studies are fully enrolled and include approximately 4,500 subjects.

 

Qnexa for Diabetes

 

We are currently studying the effect of Qnexa on type 2 diabetics.  This study, known as OB-202, is a 28-week, randomized, double-blind, placebo-controlled, efficacy and safety study of Qnexa in the glycemic management of obese Type 2 diabetics.  In January 2008, we announced that we had initiated a six-month extension study for patients currently enrolled in the OB-202 diabetes study.  The newly initiated study, DM-230, will allow subjects to continue, in a blinded fashion as randomized, in the study for an additional 28 weeks.

 

The primary endpoint of the diabetes studies will be improvement of glycemic control as measured by a reduction of glycosylated hemoglobin (HbA1c) levels. The randomized, double-blind, parallel-designed study will also measure the effects of Qnexa on associated metabolic and cardiovascular risk factors as well as changes in total body weight, percent of baseline body weight lost, and a change in waist circumference. The OB-202 study will measure endpoints at the end of 28 weeks. The DM-230 study will measure endpoints after an additional 28 weeks, for a total time on treatment of one year.

 

OB-302 with the extension is intended to assess both safety and efficacy of Qnexa in subjects with type 2 diabetes controlled with diet or oral medications. Subjects have aBMI between 27 to 42 kg/m2. Patients on antidepressants such as SSRI’s or SNRI’s are allowed to participate in the study. The trials involve 10 centers nationwide. VIVUS enrolled 208 subjects in the OB-202 study. Data from the OB-202 study is expected to be available in the second quarter of 2008.

 

Our first patent covering Qnexa was issued on June 6, 2006. In addition, Qnexa is the subject of multiple U.S. and international patent applications.

 

Female Sexual Health

 

We believe that the market for the treatment of sexual disorders in women is large and underserved. A paper published in the Journal of the American Medical Association in 1999 noted 43% of women between the ages of 18 and 59 identified themselves as afflicted with a sexual disorder, reporting hypoactive sexual desire disorder as one of the most common

 

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conditions of female sexual dysfunction, or FSD. Currently, there are no pharmaceutical treatments on the market that have been approved by the FDA for the treatment of this sexual disorder in women.

 

Testosterone MDTS

 

Hypoactive Sexual Desire Disorder

 

Hypoactive Sexual Desire Disorder (“HSDD”), the persistent or recurrent lack of interest in sexual activity resulting in personal distress, is reported to be the most common type of female sexual dysfunction, affecting as many as 30% of women in the United States. Several studies over the last several decades have demonstrated that testosterone is an important component of female sexual desire. As a woman ages, there is a decline in testosterone production. The administration of testosterone has been associated with an increase in sexual desire in both pre- and post-menopausal women. In addition to the gradual decline in testosterone that accompanies aging and natural menopause, the surgical removal of a woman’s ovaries rapidly results in a decrease of approximately one half of the woman’s testosterone production capability. Hence, HSDD can occur much faster, and at a younger age, in women who have undergone this type of surgically induced menopause. Furthermore, HSDD has been observed in pre-menopausal women with naturally occurring low levels of testosterone.

 

There are no FDA-approved medical treatments for HSDD; however, OB/GYNs have been prescribing Androgel®, an approved testosterone treatment for hypogonadism in males. In addition, Intrinsa™, a transdermal testosterone patch, is currently approved and available for sale in Europe.

 

Double-blind, multi-center, placebo-controlled clinical trials conducted by The Procter & Gamble Company to assess the effects of Intrinsa (a twice-weekly testosterone patch) demonstrated a statistically significant increase in the number of satisfying sexual events in surgically induced menopausal women. In addition, an independent clinical study, conducted by Acrux in 261 patients, demonstrated that testosterone transdermally applied with a spray has the ability to increase the number of sexually satisfying events in pre-menopausal women with HSDD.

 

Our Clinical Candidate

 

Luramist™ (Testosterone MDTS) is our patent protected, transdermal investigational product candidate being developed for the treatment of HSDD in women. The active ingredient in Luramist is the synthetic version of the testosterone that is present naturally in humans.

 

Luramist utilizes a proprietary, metered-dose transdermal spray, (“MDTS”), applicator that delivers a precise amount of testosterone to the skin. We licensed the U.S. rights for this product from Acrux in 2004. The metered spray enables patients to apply a precise dose of testosterone for transdermal delivery. The applied dose dries in approximately 60 seconds and becomes invisible. Acrux’s independent studies have demonstrated that the Luramist system delivers sustained levels of testosterone in women over a 24-hour period and achieves an increasing number of satisfying sexual events.

 

We believe that our Luramist product candidate has significant advantages over patches and other transdermal gels that are being developed for this indication. The Luramist spray allows for discreet application, unlike patches that are visible and topical gels that can be messy. We believe that the patented MDTS delivery technology should prevent others from commercializing competitive therapies utilizing a spray delivery technology.

 

Clinical Status

 

Previously, we announced positive Phase 2 results for Luramist, which showed a statistically significant improvement in the number of satisfying sexual events in pre-menopausal patients with HSDD. We met with the FDA to share results from our Phase 2 clinical study and to discuss the Phase 3 study requirements. We submitted a Phase 3 safety and efficacy protocol under the SPA process and met with the FDA in March 2007 to resolve the issues they raised regarding the details of the protocol. In April 2008, we successfully completed and reached agreement with the FDA regarding the SPA for the Phase 3 efficacy trials for Luramist. In addition, we reached agreement with the FDA on the safety requirements necessary for approval.

 

Under the SPA, we have agreed with the FDA to design features for the pivotal Phase 3 efficacy studies including the primary endpoints, the scope and size of the patient population to be studied, inclusion/exclusion criteria, duration of the trials

 

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and elements of the statistical analysis plan. The pivotal Phase 3 program will include two double-blind, placebo-controlled trials that will enroll menopausal women for six months of treatment. The primary endpoints in the clinical trials are an increase in sexual desire and the number of satisfying sexual events, with a secondary endpoint of a decrease in sexual distress.

 

In addition to the two pivotal Phase 3 efficacy trials, we have reached agreement with the FDA on the safety study. The safety study will be a randomized, double-blind, placebo-controlled, multi-center, cardiovascular event-based outcomes study. Subjects will be required to have an average exposure of 12 months. The study will enroll approximately 5,200 postmenopausal women, aged 50 years or older, who have at least one cardiovascular risk factor. As an event-driven study, analysis of outcomes may occur when there is an average exposure of 12 months and a sufficient number of cardiovascular events have occurred. Subjects enrolled in the safety study will remain in the study for up to five years to allow longer term assessments of cardiovascular and breast cancer risks. These longer term assessments are not required for NDA submission.

 

With the successful completion of the two pivotal Phase 3 efficacy studies along with achieving the primary endpoint of the safety study, we expect to submit an NDA seeking approval of Luramist within two years from initiation of the safety study.

 

Male Sexual Health

 

Erectile dysfunction (“ED”), or the inability to attain or maintain an erection sufficient for intercourse, was reported by 35% of men between the ages of 40 to 70 in the United States, according to an independent study, with the incidence increasing with age. ED, frequently associated with vascular problems, is particularly common in men with diabetes and in those who have had a radical prostatectomy for prostate cancer. PDE5 inhibitors such as sildenafil citrate (Viagra®), vardenafil (Levitra®) and tadalafil (Cialis®), which inhibit the breakdown of cyclic guanosine monophosphate, have been shown to be effective treatments for ED.

 

The worldwide sales in 2007 of PDE5 inhibitor products for ED were in excess of $3.5 billion, including approximately $1.8 billion in sales of Viagra, approximately $1.2 billion in sales of Cialis and approximately $495 million in sales of Levitra. Based on the aging baby boomer population and the desire to maintain an active sexual lifestyle, we believe the market for PDE5 inhibitors will continue to grow.

 

Avanafil

 

Our Clinical Candidate

 

Avanafil is our orally administered, PDE5 inhibitor investigational product candidate, which we licensed from Tanabe Seiyaku Co., Ltd., or Tanabe, in 2001. We have exclusive worldwide development and commercialization rights for avanafil with the exception of certain Asian markets.

 

Pre-clinical and clinical data suggests that avanafil:

 

·  is highly selective to PDE5, which we believe may result in a favorable side effect profile;

 

·  has a shorter plasma half-life than the current commercially available PDE5 inhibitors; and

 

·  is fast-acting.

 

Avanafil possesses a shorter plasma half-life than other PDE5 inhibitors currently on the market. The plasma half-life of a drug is the amount of time required for 50% of the drug to be removed from the bloodstream. We believe avanafil’s short half-life and fast onset of action are ideal characteristics for the treatment of ED.

 

Clinical Status

 

We have conducted a number of clinical trials with avanafil, including pharmacokinetic and in-clinic studies as well as at-home efficacy trials in men with ED.

 

We previously announced positive results from a Phase 2, multi-center, double-blind, randomized, parallel-design study conducted to assess the safety and efficacy of different doses of avanafil for the treatment of ED. Patients in this study were instructed to attempt sexual intercourse 30 minutes after taking avanafil, with no restrictions on food or alcohol consumption. Results showed that up to 84% of avanafil doses resulted in erections sufficient for vaginal penetration, as compared to those who received a dosage of placebo. No serious adverse events were reported during this study.

 

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We previously released the results from an open-label, pharmacokinetic study designed to evaluate the feasibility of allowing avanafil to be taken twice in a 24-hour period. This study compared blood levels of avanafil in healthy volunteer subjects after taking a single dose of avanafil and after taking avanafil every 12 hours for seven days. The results showed no significant plasma accumulation of avanafil after the twice-a-day treatment regimen when compared to the single dose.

 

We also previously announced the results of a clinical pharmacology study conducted to evaluate the hemodynamic responses (blood pressure and heart rate) to glyceryl trinitrate (“GTN”) in subjects pretreated with placebo, avanafil, and sildenafil citrate (Viagra). Results revealed that avanafil had less impact on blood pressure and heart rate than Viagra. The clinical significance of this data is unknown.

 

An End-of-Phase 2 meeting with the FDA for avanafil took place in November 2005. We discussed the Phase 2 results and the proposed protocol for the Phase 3 trials. Based on feedback from the FDA at this meeting, we anticipate completing several non-clinical studies prior to the initiation of the Phase 3 trials. The Phase 3 protocol and the SPA process for avanafil have been completed.

 

Our Marketed Product

 

MUSE

 

In 1997, we commercially launched MUSE in the United States. MUSE was the first minimally invasive therapy for erectile dysfunction approved by the FDA. With MUSE, an erection is typically produced within 15 minutes of administration and lasts approximately 30 to 60 minutes. Alprostadil is the active pharmacologic agent used in MUSE. Alprostadil is the generic name for the synthetic version of prostaglandin E1, a naturally-occurring vasodilator present in the human body and at high levels in seminal fluid.

 

Because therapeutic levels of drug are delivered locally to the erectile tissues with minimal systemic drug exposure, MUSE is a relatively safe, local treatment that minimizes the chances of systemic interactions with other drugs or diseases. Over 13 million units of MUSE have been sold since we introduced MUSE to the market.

 

In May 2005, results were reported from an independent study conducted by the Cleveland Clinic, which focused on an individual’s ability to restore sexual function following radical prostatectomy, a common treatment for prostate cancer. The study showed that 74% of patients who completed six months of MUSE treatment were able to resume sexual activity and 39% were able to achieve natural erections sufficient for intercourse.

 

Other Programs

 

We have licensed and intend to continue to license from third parties the rights to other products to treat various diseases and medical conditions. We also sponsor early stage clinical trials at various research institutions and intend to conduct early stage proof of concept studies on our own. We expect to continue to use our expertise in designing clinical trials, formulation and product development to commercialize pharmaceuticals for unmet medical needs or for disease states that are underserved by currently approved products. We intend to develop products with a proprietary position or that complement our other products currently under development.

 

Sale of Evamist to K-V Pharmaceutical Company

 

On March 30, 2007, we entered into a definitive agreement with K-V, to transfer our assets and grant a sublicense of our rights under the Acrux Agreement related to Evamist to K-V (the “Transaction”). The closing of the Transaction occurred on May 15, 2007. Under the terms of the Transaction, we received an upfront payment of $10.0 million upon the closing. On July 27, 2007, we received FDA approval of the NDA for Evamist. On August 1, 2007, we transferred and assigned the Evamist FDA submissions, and all files related thereto to K-V and on August 8, 2007, K-V paid us the additional $140.0 million milestone payment due upon FDA approval of the Evamist NDA. We may also receive certain one-time payments of up to $30.0 million based on achieving certain annual net sales thresholds for Evamist. In connection with the Transaction, in order to obtain Tanabe’s blanket release of liens against our assets including the Evamist assets and intellectual property, we repaid the Tanabe line of credit.

 

In May 2006, we announced positive results from the pivotal Phase 3 clinical trial of Evamist. The study showed a statistically significant reduction in the number and severity of moderate and severe hot flashes. We submitted the NDA for Evamist to the FDA in the third quarter of 2006 and made a $1.0 million clinical development milestone payment to Acrux in October 2006 under the terms of our licensing agreement, related to this submission. Upon approval of the NDA for Evamist, a $3.0 million product approval milestone became due and was paid to Acrux in August 2007. Per the terms of the Transaction, K-V paid $1.5 million of this $3.0 million milestone.

 

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Deerfield Financing

 

On April 3, 2008, we entered into several agreements with Deerfield Management Company, L.P., or Deerfield, a healthcare investment fund, and its affiliates, Deerfield Private Design Fund L.P. and Deerfield Private Design International, L.P. (collectively, the Deerfield Affiliates).  Under the agreements, Deerfield and its affiliates agreed to provide us with $30 million in funding.  The $30 million in funding consists of $20 million from a Funding and Royalty Agreement (“FARA”) entered into with a newly incorporated subsidiary of Deerfield (“Deerfield Sub”) and $10 million from the sale of our common stock.  Under the FARA, the Deerfield Affiliates will make six payments of approximately $3.3 million, beginning in April 2008 and quarterly thereafter.  Such payments are referred to as the “Funding Payments”. We will pay royalties on the current net sales of MUSE and if approved, future sales of avanafil, an investigational product candidate to Deerfield Sub. The term of the FARA is ten years.  The FARA includes covenants requiring us to use commercially reasonable efforts to preserve our intellectual property, manufacture, promote and sell MUSE, and develop avanafil.  At the closing on April 15, 2008, under the securities purchase agreement, the Deerfield Affiliates purchased 1,626,017 shares of our common stock for an aggregate purchase price of $10 million and we paid to the Deerfield Affiliates a $500,000 fee and reimbursed certain expenses incurred in this transaction of approximately $200,000. The agreements also provided us with an option to purchase, and the Deerfield Affiliates with an option to compel us to purchase, the Deerfield Sub holding the royalty rights.  If either party exercises its option, any further royalty payments would be effectively terminated.  Collectively, these transactions are referred to as the Deerfield Transactions.

 

Also in connection with the Deerfield Transactions, VIVUS, the Deerfield Affiliates and Deerfield Sub entered into the Option and Put Agreement, dated April 3, 2008, or the OPA.  Pursuant to the OPA, the Deerfield Affiliates have granted us an option to purchase all of the outstanding shares of common stock of Deerfield Sub, or the Shares, from the Deerfield Affiliates, referred to as the Option, and we have agreed to grant the Deerfield Affiliates an option to require us to purchase all of the outstanding shares of common stock of Deerfield Sub from the Deerfield Affiliates, referred to as the Put Right.

 

If we exercise the Option, base consideration for the Option exercise, or Base Option Price, will be:

 

·      $25 million, if the Option is exercised on or prior to the third anniversary of the execution of the OPA; or

 

·      $28 million, if the Option is exercised subsequent to the third anniversary but prior to the fourth anniversary of the execution of the OPA.

 

The aggregate consideration payable by VIVUS upon exercise of the Option, or the Option Purchase Price, would be equal to the sum of the Base Option Price, plus: (i) the cash and cash equivalents held by Deerfield Sub at the date of the closing of the resulting sale of the common stock of Deerfield Sub; (ii) accrued and unpaid royalties; and minus (i) the option premium of $2 million which was paid at the closing of the transaction (referred to as the Option Premium); (ii) accrued but unpaid taxes; (iii) unpaid Funding Payments; and (iv) any other outstanding liabilities of Deerfield Sub.  The Option terminates on the fourth anniversary of the execution of the OPA.

 

In consideration of the grant of the Option, at closing we paid $2 million to the Deerfield Affiliates. As indicated in the calculation of the Option Purchase Price, if the Option is exercised by us the Option Premium will be applied to reduce the Option Purchase Price.

 

The Put Right terminates on the tenth anniversary of the execution of the OPA and will become exercisable on the earliest of:

 

·      the third anniversary of the execution of the OPA;

 

·      any date on which:

 

(1)   the market capitalization of the Company falls below $50,000,000; or

 

(2)   the amount of cash and cash equivalents as defined, held by the Company falls below $15,000,000; or

 

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(3)   the fifteenth day following the delivery of written notice to VIVUS that we have failed to make Royalty Payments in accordance with the provisions of the FARA unless we make such Royalty Payments prior to such fifteenth day; or

 

(4)   a Major Transaction, as defined below, closes.

 

If the Deerfield Affiliates exercise the Put Right, base consideration for the put exercise, or the Base Put Price, will be:

 

·      $23 million, if the Put Right is exercised on or prior to the third anniversary of the execution of the OPA and we have notified the Deerfield Affiliates of our intent to enter into a Major Transaction (such notice is referred to as a Major Transaction Notice); or

 

·      $26 million, if the Put Right is exercised subsequent to the third anniversary of the execution of the OPA and we have provided the Deerfield Affiliates a Major Transaction Notice; or

 

·      $17 million, in all other cases.

 

The aggregate consideration payable by VIVUS upon exercise of the Put Right, or the Put Purchase Price, would be equal to the sum of the Base Put Price, plus: (i) the cash and cash equivalents held by Deerfield Sub at the date of the closing of the resulting sale of the common stock of Deerfield Sub; (ii) accrued and unpaid royalties; and minus (i) accrued but unpaid taxes; (ii) unpaid Funding Payments; and (iii) any other outstanding liabilities of Deerfield Sub.

 

Pursuant to the OPA, the following events would qualify as Major Transactions:

 

·      a consolidation, merger, exchange of shares, recapitalization, reorganization, business combination or similar event:

 

(1)    following which the holders of common stock of VIVUS immediately preceding such event either:

 

(a)           no longer hold a majority of the shares of the common stock of VIVUS; or

 

(b)           no longer have the ability to elect a majority of the board of directors of VIVUS;

 

(2)   as a result of which shares of common stock of VIVUS are changed into (or the shares of common stock become entitled to receive) the same or a different number of shares of the same or another class or classes of stock or securities of VIVUS or another entity, collectively referred to as Change in Control Transactions;

 

·                  a sale or transfer of assets of VIVUS in one transaction or a series of related transactions for a purchase price of more than $350 million where the consideration to be payable at or within thirty days of closing of such transaction or transactions has a value of more than $350 million, or a sale, transfer or license of all or substantially all assets or proprietary rights of VIVUS that relate specifically to MUSE or avanafil; or

 

·                  a purchase, tender or exchange offer made to the holders of outstanding shares of VIVUS’ common stock, such that following such purchase, tender or exchange offer a Change in Control Transaction shall have occurred; or

 

·                  an issuance or series of issuances in a series of related transactions by VIVUS of an aggregate number of shares of common stock in excess of 20% of our outstanding common stock on the date hereof if, immediately prior to such issuance, the market capitalization of VIVUS is less than $300 million.

 

In connection with the FARA, Deerfield Sub and VIVUS have entered into a Royalty Security Agreement, whereby we have granted Deerfield Sub a security interest in certain collateral related to MUSE and avanafil including: all of our drug applications; all existing and future licenses relating to the development, manufacture, warehousing, distribution, promotion, sale, importing or pricing of MUSE and avanafil; our intellectual property and all of the accounts, inventory and equipment arising out of or relating to Muse and avanafil. In connection with the OPA, the Deerfield Affiliates and VIVUS have entered into a security agreement, whereby we have granted the Deerfield Affiliates a security interest in the same Collateral as defined by the Royalty Security

 

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Agreement.  The security interest granted to the Deerfield Affiliates has priority to that granted to Deerfield Sub by the Royalty Security Agreement.

 

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

 

The discussion and analysis of our financial condition and results of operations are based upon our condensed consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to product returns, rebates and sales reserves, research and development expenses, doubtful accounts, income taxes, inventories, contingencies and litigation and stock-based compensation. We base our estimates on historical experience, information received from third parties and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

 

We believe the following critical accounting policies affect our more significant judgments and estimates used in the preparation of our condensed consolidated financial statements:

 

Revenue Recognition

 

Product Revenue:  Product sales are recognized as revenues when persuasive evidence of an arrangement exists, shipment has occurred, the sales price is fixed or determinable and collectibility is reasonably assured.

 

Sales Allowances and Reserves:  Revenues from product sales are recorded net of product sales allowances for expected returns of expired product, government chargebacks, other rebates, and cash discounts for prompt payment. These sales allowances are deducted from gross product revenues at the time such revenues are recognized along with the recording of a corresponding reserve, or liability. In making these estimates we take into consideration our historical information, current contractual and statutory requirements, shelf life of our products, estimated customer inventory levels and information received from outside parties. Significant judgments and estimates must be made and used in estimating the reserve balances in any accounting period. Our product sales allowances and reserves include:

 

·      Product Returns:  We have estimated reserves for product returns from wholesalers, hospitals and pharmacies in the United States in accordance with our product returns policy. Our returns policy allows product returns within the period beginning six months prior to and twelve months following product expiration. As of March 31, 2008, the shipments of MUSE in the United States made in 2008, 2007, 2006 and a portion of the shipments in 2005 remain subject to future returns.

 

We record reserves for anticipated returns of expired product in the United States. We follow this method since reasonably dependable estimates of product returns can be made based on historical experience. There is no right-of-return on expired product sold internationally subsequent to shipment; thus, no returns reserve is needed.

 

We estimate our returns reserve by utilizing historical information and data obtained from external sources, along with the shelf life of the product. We track the actual returns on a lot-by-lot basis along with date of production and date of expiration. We review the actual returns experience for trends. We calculate our returns reserve by applying an estimated return rate to the quantity of units sold that is subject to future return. We routinely assess our experience with product returns and adjust the reserves accordingly. Revisions in returns estimates are charged to income in the period in which the information that gives rise to the revision becomes known.

 

·      Government Chargebacks:  Government chargebacks are contractual commitments by us to provide MUSE to federal government organizations including the Veterans Administration at specified prices. Government chargeback allowances are recorded at the time of sale and accrued as a reserve. In estimating the government chargeback reserve, we analyze actual chargeback amounts and apply chargeback rates to estimates of the quantity of units subject to chargeback. We routinely reassess the chargeback estimates and adjust the reserves accordingly.

 

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·      Other Rebates:  We estimate amounts payable by us for rebate programs, primarily with managed care organizations, for the reimbursement of portions of the prescriptions filled that are covered by these programs. Rebate allowances are estimated and reserved at the time of sale. We estimate this reserve by utilizing historical information, contractual and statutory requirements, estimated quantities sold to these organizations and estimated customer inventory levels. Effective January 1, 2006, MUSE no longer qualifies for Medicaid reimbursement and effective January 1, 2007, MUSE no longer qualifies for Medicare Part D.

 

·      Cash Discounts:  We offer cash discounts to wholesaler distributors, generally 2% of the sales price as an incentive for prompt payment. The estimate of cash discounts is recorded at the time of sale. We account for the cash discounts by reducing accounts receivable by the full amount of the discounts we expect wholesaler distributors to take.

 

All of the aforementioned categories of sales allowances are evaluated each reporting period and adjusted when trends or significant events indicate that a change in estimate is appropriate. Changes in actual experience or changes in other qualitative factors could cause our sales allowance adjustments to fluctuate. If actual returns, government chargebacks, rebates and cash discounts are greater than our estimates, additional reserves may be required which could have an adverse effect on financial results in the period of adjustment. Revisions to estimates are charged to income in the period in which the facts that give rise to the revision become known.

 

License and Other Revenue:  We recognize license revenue in accordance with the Securities and Exchange Commission’s Staff Accounting Bulletin No. 104, Revenue Recognition. When evaluating multiple element arrangements, we consider whether the components of the arrangement represent separate units of accounting as defined in Emerging Issues Task Force (“EITF”) Issue No. 00-21, Revenue Arrangements with Multiple Deliverables (“EITF 00-21”). In accordance with EITF 00-21, we recognize revenue for delivered elements only when the delivered element has stand-alone value and we have objective and reliable evidence of fair value for each undelivered element. If the fair value of any undelivered element included in a multiple element arrangement cannot be objectively determined, revenue is deferred until all elements are delivered and services have been performed, or until fair value can objectively be determined for any remaining undelivered elements, or such elements are insignificant. Application of this standard requires subjective determinations and requires management to make judgments about the fair value of the individual elements and whether such elements are separable from the other aspects of the contractual relationship.

 

Revenue from non-refundable, upfront license fees where we have continuing involvement is recognized ratably over the development or agreement period. Revenue associated with performance milestones is recognized based upon the achievement of the milestones, as defined in the respective agreements.

 

On May 15, 2007, we closed our transaction with K-V Pharmaceutical Company (“K-V”) for the sale of our product candidate, Evamist, a metered dose transdermal spray for the treatment of menopause symptoms. At the time of the sale, Evamist was an investigational product and was not yet approved by the FDA for marketing. The sale transaction contained multiple deliverables, including: the delivery at closing of the Evamist assets (mainly raw material inventory and certain fixed assets), a grant of a sublicense of our rights under a license related to Evamist, and a license to the MDTS applicator; the delivery upon receipt of regulatory approval of Evamist, along with all regulatory submissions; and, lastly, the delivery after FDA approval of certain transition services and a license to improvements to the MDTS applicator. We received approval from the FDA to market Evamist on July 27, 2007 (“FDA Approval”), and on August 1, 2007, we transferred and assigned the Evamist FDA submissions, and all files related thereto to K-V.

 

We received an upfront payment of $10 million in May 2007 upon the closing and received an additional $140 million milestone payment in August 2007 upon FDA Approval. These payments are non-refundable.

 

We evaluated this multiple deliverable arrangement under EITF 00-21 to determine whether the deliverables are divided into separate units of accounting.

 

Upon FDA Approval, the two remaining deliverables are the transition services to be performed under the Transition Services Agreement (“TSA”) and a license to improvements to the MDTS applicator (“Improvement License”) during the two-year period commencing with the closing, or May 15, 2007, and ending on May 15, 2009. We are able to establish fair value for the TSA.

 

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As it relates to the Improvement License, no specific value was assigned in the agreement. We have no obligation to develop improvements to the MDTS applicator and have no plans to expend significant resources in this endeavor. However, as required under EITF 00-21, we do not have objective, reliable evidence of fair value or evidence of inconsequential value to the customer of the Improvement License. Accordingly, the delivered items, together with the undelivered items, are bundled together and are treated as one unit of accounting.

 

As a result, the initial $10 million paid at closing and the $140 million paid upon FDA Approval have been recorded as deferred revenue and will be recognized as license revenue, together with the future billings under the TSA, if any, ratably over the remaining 21.5-month term of the Improvement License, from August 1, 2007 to May 15, 2009. The revenue related to the transaction recognized in the year ended December 31, 2007 was $34.9 million and for the quarter ended March 31, 2008 was $20.9 million. Such revenue in future quarters is expected to be recognized as follows (in thousands):

 

Quarter ending

 

License revenue

 

June 30, 2008

 

$

20,930

 

September 30, 2008

 

$

20,930

 

December 31, 2008

 

$

20,930

 

March 31, 2009

 

$

20,930

 

June 30, 2009

 

$

10,465

 

 

We may also receive milestone payments of up to $30 million based upon sales of Evamist through the term of the agreements. Revenues associated with these performance milestones will be recognized when they are earned and collectability is reasonably assured.

 

Research and Development Expenses

 

Research and development (“R&D”) expenses include license fees, related compensation, consultants fees, facilities costs, administrative expenses related to R&D activities and clinical trial costs at other companies and research institutions under agreements which are generally cancelable, among other related R&D costs. We also record accruals for estimated ongoing clinical trial costs. Clinical trial costs represent costs incurred by clinical research organizations, (“CROs”), and clinical sites. These costs are recorded as a component of R&D expenses. Under our agreements, progress payments are typically made to investigators, clinical sites and CROs. We analyze the progress of the clinical trials, including levels of patient enrollment, invoices received and contracted costs when evaluating the adequacy of accrued liabilities. Significant judgments and estimates must be made and used in determining the accrued balance in any accounting period. Actual results could differ from those estimates under different assumptions. Revisions are charged to expense in the period in which the facts that give rise to the revision become known.

 

Accounts Receivable and Allowance for Doubtful Accounts

 

We extend credit to our customers for product sales resulting in accounts receivable. Customer accounts are monitored for past due amounts. Past due accounts receivable, determined to be uncollectible, are written off against the allowance for doubtful accounts. Allowances for doubtful accounts are estimated based upon past due amounts, historical losses and existing economic factors, and are adjusted periodically. The accounts receivable are reported on the balance sheet, net of the allowance for doubtful accounts.

 

Income Taxes

 

We make certain estimates and judgments in determining income tax expense for financial statement purposes. These estimates and judgments occur in the calculation of certain tax assets and liabilities, which arise from differences in the timing of recognition of revenue and expense for tax and financial statement purposes.

 

As part of the process of preparing our condensed consolidated financial statements, we are required to estimate our income taxes in each of the jurisdictions in which we operate. This process involves us estimating our current tax exposure under the most recent tax laws and assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our condensed consolidated balance sheets.

 

We assess the likelihood that we will be able to recover our deferred tax assets. We consider all available evidence, both positive and negative, including historical levels of income, expectations and risks associated with estimates of future taxable

 

34



 

income and ongoing prudent and feasible tax planning strategies in assessing the need for a valuation allowance. If it is not more likely than not that we will recover our deferred tax assets, we will increase our provision for taxes by recording a valuation allowance against the deferred tax assets that we estimate will not ultimately be recoverable. As a result of our analysis of all available evidence, both positive and negative, as of March 31, 2008, it was not considered more likely than not that our deferred tax assets would be realized.

 

As of March 31, 2008, we believed that the amount of the deferred tax assets recorded on our condensed consolidated balance sheet would not ultimately be recovered. However, should there be a change in our ability to recover our deferred tax assets; we would recognize a benefit to our tax provision in the period in which we determine that it is more likely than not that we will recover our deferred tax assets.

 

In July 2006, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 48 (“FIN No. 48”) Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109, to clarify certain aspects of accounting for uncertain tax positions, including issues related to the recognition and measurement of those tax positions. FIN No. 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN No. 48 also provides guidance on derecognizing, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. This interpretation is effective for fiscal years beginning after December 15, 2006. The cumulative effect of adopting FIN No. 48 on January 1, 2007 was recognized as a change in accounting principle, recorded as an adjustment to the opening balance of accumulated deficit on the adoption date. As a result of the implementation of FIN No. 48, we recognized a decrease of approximately $1.2 million in our income tax liability, which resulted in a decrease of $1.2 million in accumulated deficit on January 1, 2007.

 

Inventories

 

We record inventory reserves for estimated obsolescence, unmarketable or excess inventory equal to the difference between the cost of inventory and the estimated market value based upon assumptions about future demand and market conditions. If actual market conditions are less favorable than those projected by management, additional inventory write-downs may be required. In 2006, we recorded a $764,000 inventory write-down related to the purchase of alprostadil, considered to be in excess of projected production needs. During the quarter ended September 30, 1998, we established significant reserves against our inventory to align with new estimates of expected future demand for MUSE. In 2007, we disposed of $2.8 million of fully reserved alprostadil which had no impact on cost of goods sold. As of March 31, 2008, the remaining inventory reserve balance is $1.9 million relating to raw materials and components. In the first quarter of 2005, we determined that we likely would continue to use some portion of the fully reserved component parts inventory in production. When we record inventory reserves, we establish a new, lower cost basis for the inventory for accounting purposes. Accordingly, to the extent that this fully reserved inventory was used in production in the first quarters of 2008 and 2007, it was charged to cost of goods sold at a zero basis, which had a favorable impact on cost of goods sold.

 

Cash and Cash Equivalents

 

The Company considers highly liquid investments with maturities from the date of purchase of three months or less to be cash equivalents. All cash equivalents are in money market funds, certificate of deposit and commercial paper. These amounts are recorded at cost, which approximates fair value.

 

Cash with restrictions for a period of greater than twelve months is classified as restricted cash, a non-current asset.

 

Available-for-Sale Securities

 

We focus on liquidity and capital preservation in our investments in available-for-sale securities. Through February 28, 2008, we restricted our investments to:

 

·      Direct obligations of the United States Treasury;

 

·      Federal agency securities which carry the direct or implied guarantee of the United States government; and

 

·      Corporate and asset-backed securities, including commercial paper, rated A1/P1/F1 or better.

 

The weighted average maturity of our portfolio was not to exceed 18 months.

 

35



 

On February 29, 2008, the Audit Committee of the Board of Directors approved a change to the investment policy to be more restrictive in the focus on liquidity and capital preservation in our investments in available-for-sale securities. Future cash investments are restricted to:

 

·      Direct obligations of the United States Treasury;

 

·      Federal agency securities which carry the direct or implied guarantee of the United States government; and

 

·      Corporate debt obligations rated AA3/AA- or A-1+/P-1 or better or asset-backed commercial paper rated A-1+/P-1 or better.

 

The weighted average maturity of our portfolio for new investments is not to exceed 9 months.

 

We invest our excess cash balances in money market and marketable securities, primarily corporate debt securities and asset-backed securities in accordance with our investment policy. The investment policy has the primary investment objectives of preservation of principal while at the same time maximizing yields without significantly increasing risk; however, there may be times when certain of the securities in our portfolio will fall below the credit ratings required in the policy. If those securities are downgraded or impaired we would experience losses in the value of our portfolio which would have an adverse effect on our results of operations, liquidity and financial condition. Certain of these securities are subject to general credit, liquidity, market and interest rate risks, which may be exacerbated by U.S. sub-prime mortgage defaults that have affected various sectors of the financial markets and caused credit and liquidity issues.

 

We determine the appropriate classification of marketable securities at the time of purchase and reevaluate such designation at each balance sheet date. Our marketable securities have been classified and accounted for as available-for-sale. These securities are carried at fair value, as provided by our investment advisor. We hold certain securities with stated maturities greater than 12 months until maturity. In response to changes in the availability of and the yield on alternative investments as well as liquidity requirements, we will occasionally sell these securities prior to their stated maturities. As these securities are viewed by us as available to support current operations, based on the provisions of Accounting Research Bulletin No. 43, Chapter 3A, Working Capital—Current Assets and Liabilities, securities with maturities beyond 12 months are classified as current assets, expect for certain securities that the Company expects to recover their full or substantial value beyond the next 12 months due to continued uncertainty in the capital markets, classified as non-current, under the captions available-for-sale securities in our condensed consolidated balance sheets.

 

Our policy is to record investments in marketable securities as available-for-sale because the sale of such securities may be required prior to maturity. Any gains and losses on the sale of marketable securities are determined on a specific identification basis and are included in interest income in the accompanying condensed consolidated statements of operations and other comprehensive income (loss).

 

The difference between amortized cost (cost adjusted for amortization of premiums and accretion of discounts which are recognized as adjustments to interest income) and fair value, representing unrealized holding gains or losses, are recorded in accumulated other comprehensive income (loss), a separate component of stockholders’ equity until realized. We recognize all realized gains and losses on our available-for-sale securities in income before provision for income taxes.

 

From 2005 and until December 2007 we had an investment in Columbia Strategic Cash Portfolio (“Strategic Cash”) offered by our investment advisor, Columbia Management LLC (“Columbia”). Strategic Cash is an enhanced money market fund in which the fund sought to maintain a $1 per share net asset value. We used Strategic Cash for the investment of excess cash, and periodic transfers were made from Strategic Cash to the operating cash account to fund our current operations.

 

In early December 2007, we were notified by Columbia that the Strategic Cash fund was closed and that the fund was to be liquidated. The fund no longer supported the $1 per share net asset value and switched to a market value fund in which all investments were marked to market. We were given the option of staying in the fund and receiving cash proceeds from the fund as its holdings were liquidated or receiving a pro-rata share of the investments held by the fund. Upon advice from our investment advisor, we took redemption-in-kind consisting of cash, interest receivable and a pro-rata distribution of the underlying securities, consisting principally of high quality corporate debt and asset-backed securities. Prior to the redemption our investment in Strategic Cash was $84.4 million. On December 20, 2007 and December 21, 2007, we received our redemption-in-kind consisting of securities with a market value of $68.7 million, interest receivable of $300,000 and cash of $14.4 million. The difference between our investment in Strategic Cash of $84.4 million and the fair value of the securities, cash and interest receivable totaling $83.4 million received in-kind resulted in a loss of $1 million. This loss of $1 million was

 

36



 

reflected in interest income in the condensed consolidated statement of operations and other comprehensive income (loss) for the year ended December 31, 2007.

 

The securities distributed to us from Strategic Cash included corporate bonds, commercial paper, asset-backed securities and other securities. Certain of the securities transferred to us from Strategic Cash, totaling $3.9 million in fair value at transfer, did not comply with our investment policy in effect at that time due to either credit ratings, length of maturities or sectors not allowed under the policy. These securities were approved by the Audit Committee of the Board of Directors for acceptance into our portfolio. The securities received on redemption will be subject to changes in value depending on market conditions.

 

We monitor our investment portfolio for impairment on a periodic basis. In the event that the carrying value of an investment exceeds its fair value and the decline in value is determined to be other-than-temporary, an impairment charge is recorded and a new cost basis for the investment is established. In order to determine whether a decline in value is other-than-temporary, we evaluate, among other factors: the duration and extent to which the fair value has been less than the carrying value; our financial condition and business outlook, including key operational and cash flow metrics, current market conditions and future trends in our industry; our relative competitive position within the industry; and our intent and ability to retain the investment for a period of time sufficient to allow for any anticipated recovery in fair value.

 

Contingencies and Litigation

 

We are periodically involved in disputes and litigation related to a variety of matters. When it is probable that we will experience a loss, and that loss is quantifiable, we record appropriate reserves.

 

Share-Based Payments

 

We follow the fair value method of accounting for share-based compensation arrangements in accordance with the Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standards (“SFAS”) 123R, Share-Based Payment (“SFAS 123R”). We adopted SFAS 123R effective January 1, 2006 using the modified prospective method of transition. Under SFAS 123R, the estimated fair value of share-based-compensation, including stock options and restricted stock units granted under our Stock Option Plan and purchases of common stock by employees at a discount to market price under the Employee Stock Purchase Plan (“the ESPP”), is recognized as compensation expense. Compensation expense for purchases under the ESPP is recognized based on the estimated fair value of the common stock purchase rights during each offering period and the percentage of the purchase discount.

 

We recorded $1.4 million of share-based compensation expense for the quarter ended March 31, 2008, and $906,000 of share-based compensation expense for the quarter ended March 31, 2007. Share-based compensation expense is allocated among cost of goods sold and manufacturing, research and development and selling, general and administrative expenses based on the function of the related employee. This charge had no impact on our cash flows for the periods presented.

 

We use the Black-Scholes option pricing model to estimate the fair value of the share-based awards as of the grant date. The Black-Scholes model, by its design, is highly complex, and dependent upon key data inputs estimated by management. The primary data inputs with the greatest degree of judgment are the estimated lives of the share-based awards and the estimated volatility of our stock price. The Black-Scholes model is highly sensitive to changes in these two data inputs. The expected term of the options represents the period of time that options granted are expected to be outstanding and is derived by analyzing the historical experience of similar awards, giving consideration to the contractual terms of the stock-based awards, vesting schedules and expectations of future employee behavior. We determine expected volatility using the historical method, which is based on the daily historical trading data of our common stock over the expected term of the option. Management selected the historical method primarily because we have not identified a more reliable or appropriate method to predict future volatility. For more information about SFAS 123R, see Note 3: “Share-Based Compensation” to the notes to condensed consolidated financial statements included in this Form 10-Q.

 

Fair Value Measurements

 

On January 1, 2008, we partially adopted SFAS No. 157 “Fair Value Measurements.” Adoption of the provisions of this standard did not have a material effect on our financial position. For assets that are measured using quoted prices in active markets, total fair value is the published market price per unit multiplied by the number of units held without consideration of transaction costs.

 

37



 

Financial Instruments Measured at Fair Value.  Our available-for-sale financial instruments are carried at fair value and we make estimates regarding valuation of these assets measured at fair value in preparing the condensed consolidated financial statements.

 

Fair Value Measurement—Definition and Hierarchy.  SFAS No. 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (i.e., the “exit price”) in an orderly transaction between market participants at the measurement date.

 

Valuation Technique.  SFAS No. 157 establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of VIVUS. Unobservable inputs are inputs that reflect our assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The hierarchy is broken down into three levels based on the reliability of inputs as follows:

 

·      Level 1—Valuations based on quoted prices in active markets for identical assets. Valuation adjustments and block discounts are not applied to Level 1 instruments. Since valuations are based on quoted prices that are readily and regularly available in an active market, valuation of these products does not entail a significant degree of judgment.

 

Assets utilizing Level 1 inputs include exchange-traded equity securities that are actively traded, most U.S. Government securities and certain other sovereign government obligations.

 

·      Level 2—Valuations based on quoted prices in markets that are not active or for which all significant inputs are observable, directly or indirectly. Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

Assets utilizing Level 2 inputs include: corporate bonds; asset-backed securities (“ABS”), and collateralized mortgage obligations (“CMO”).

 

·      Level 3—Valuations based on inputs that are unobservable and significant to the overall fair value measurement.

 

Assets utilizing Level 3 inputs include: corporate bonds, including structured investment vehicles, commercial paper, ABS’ and CMOs.

 

The availability of observable inputs can vary from product to product and is affected by a wide variety of factors, including, for example, the type of product, whether the product is new and not yet established in the marketplace, and other characteristics particular to the transaction. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment. Accordingly, the degree of judgment exercised by us in determining fair value is greatest for instruments categorized in Level 3. In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, for disclosure purposes the level in the fair value hierarchy within which the fair value measurement in its entirety falls is determined based on the lowest level input that is significant to the fair value measurement in its entirety.  Investment securities priced using non-binding broker quotes and retained interests are included in Level 3.

 

Fair value is a market-based measure considered from the perspective of a market participant who holds the asset or owes the liability rather than an entity-specific measure. Therefore, even when market assumptions are not readily available, our own assumptions are set to reflect those that market participants would use in pricing the asset or liability at the measurement date. We use prices and inputs that are current as of the measurement date, including during periods of market dislocation. In periods of market dislocation, the observability of prices and inputs may be reduced for many instruments. This condition could cause an instrument to be reclassified from Level 1 to Level 2 or Level 2 to Level 3.

 

38



 

Valuation Techniques.

 

Corporate Bonds.    The fair value of corporate bonds is estimated using recently executed transactions, market price quotations (where observable), bond spreads or credit default swap spreads. The spread data used are for the same maturity as the bond. If the spread data do not reference the issuer, then data that reference a comparable issuer is used. When observable price quotations are not available, fair value is determined based on cash flow models with yield curves, bond or single name credit default swap spreads and recovery rates based on collateral values as key inputs. Corporate bonds are generally categorized in Level 2 of the fair value hierarchy; in instances where significant inputs are unobservable, they are categorized in Level 3 of the hierarchy.

 

Collateralized Mortgage Obligations (“CMO”) and Asset-Backed Securities (“ABS”).    CMO and ABS may be valued based on external price/spread data. When position-specific external price data are not observable, the valuation is based on prices of comparable securities. Included in this category are certain interest-only securities, which, in the absence of market prices, are valued as a function of observable securities prices and cash flow values of principal-only securities using current market assumptions at the measurement date. CMO and ABS are categorized in Level 3 if external prices are unobservable; otherwise they are categorized in Level 2 of the fair value hierarchy.

 

Reclasses from Level 2 to Level 3.    During the first quarter of fiscal 2008, the Company reclassified approximately $13.2 million of securities, net, from Level 2 to Level 3 because certain significant inputs for the fair value measurement became unobservable. These reclasses were primarily related to the continued market and liquidity deterioration in the financial markets. Most of the transfers to Level 3 during the quarter ended March 31, 2008 were in CMO’s, ABS’ and Corporate Bonds.

 

Recent Accounting Pronouncements

 

In December 2007, the FASB issued SFAS No. 141(R) “Business Combinations” (“SFAS 141(R)”). SFAS 141(R) changes several underlying principles in applying the purchase method of accounting. Among the significant changes, SFAS 141(R) requires a redefining of the measurement date of a business combination, expensing direct transaction costs as incurred, capitalizing in-process research and development costs as an intangible asset and recording a liability for contingent consideration at the measurement date with subsequent re-measurements recorded in the results of operations. SFAS 141(R) also requires that costs for business restructuring and exit activities related to the acquired company will be included in the post-combination financial results of operations and also provides new guidance for the recognition and measurement of contingent assets and liabilities in a business combination. In addition, SFAS 141(R) requires several new disclosures, including the reasons for the business combination, the factors that contribute to the recognition of goodwill, the amount of acquisition related third-party expenses incurred, the nature and amount of contingent consideration, and a discussion of pre-existing relationships between the parties. SFAS 141(R) is effective for the Company as of January 1, 2009. Management is currently evaluating the impact of adopting this Statement, but we do not expect it to have a material impact on our condensed consolidated financial position or results of operations.

 

In December 2007, the FASB issued SFAS No. 160 “Noncontrolling Interests in Consolidated Financial Statements, an Amendment of ARB No. 51,” (“SFAS 160”). SFAS 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. SFAS 160 requires noncontrolling interests in subsidiaries initially to be measured at fair value and classified as a separate component of equity. SFAS 160 also requires a new presentation on the face of the condensed consolidated financial statements to separately report the amounts attributable to controlling and noncontrolling interests. SFAS 160 is effective for the Company as of January 1, 2009. Management is currently evaluating the impact of adopting this Statement, but we do not expect it to have a material impact on our condensed consolidated financial position or results of operations.

 

In September 2007, the FASB ratified Emerging Issues Task Force Issue No. 07-1 “Accounting for Collaborative Agreements,” (“EITF 07-1”). EITF 07-1 defines collaborative agreements as contractual arrangements that involve a joint operating activity. These arrangements involve two (or more) parties who are both active participants in the activity and that are exposed to significant risks and rewards dependent on the commercial success of the activity. EITF 07-1 provides that a company should report the effects of adoption as a change in accounting principle through retrospective application to all periods and requires additional disclosures about a company’s collaborative arrangements. EITF 07-1 is effective for the Company as of January 1, 2009. The adoption of EITF 07-1 is not expected to have a material impact on our condensed consolidated financial position or results of operations.

 

In June 2007, the FASB ratified EITF 07-03, “Accounting for Nonrefundable Advance Payments for Goods or Services to

 

39



 

Be Used in Future Research and Development Activities,” which requires nonrefundable advance payments for future R&D activities to be capitalized and recognized as an expense as the goods are delivered or services are performed. Earlier application is not permitted. EITF 07-03 is effective for fiscal years beginning after December 15, 2007, and interim periods within those fiscal years. On January 1, 2008, we adopted this Statement which did not have a material impact on our condensed consolidated financial position or results of operations.

 

In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115.” SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value. This statement provides entities the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. This Statement is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. We did not elect to measure any additional assets or liabilities at fair value that are not already measured at fair value under existing standards.  Therefore, the adoption of this standard had no impact on our condensed consolidated financial statements.

 

In September 2006, the FASB issued SFAS 157, “Fair Value Measurements.” SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles (GAAP) and expands disclosures about fair value measurements. SFAS 157 is effective for VIVUS as of January 1, 2008 for financial assets and financial liabilities within its scope. In February 2008, the FASB issued FASB Staff Position No. FAS 157-2 “Effective Date of FASB Statement No. 157” (“FSP FAS 157-2”), which defers the effective date of SFAS 157 for all non-financial assets and non-financial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), for fiscal years beginning after November 15, 2008 and interim periods within those fiscal years for items within the scope of FSP FAS 157-2. On January 1, 2008, the Company partially adopted  SFAS No. 157 for financial assets and financial liabilities. This did not have a material impact on our condensed consolidated financial position and results of operations. The Company is currently assessing the impact of SFAS No. 157 for non-financial assets and non-financial liabilities on its condensed consolidated financial position and results of operations.

 

RESULTS OF OPERATIONS

 

Executive Overview

 

For the three months ended March 31, 2008, we reported a net loss of $7.1 million, or $0.12 net loss per share, as compared to a net loss of $7.4 million, or $0.13 net loss per share, during the same period in 2007.The lower net loss in the first quarter of 2008 as compared to the net loss in the first quarter of 2007 is primarily due to the recognition of the K-V deferred license revenue offset by an increase in operating expenses in the first quarter of 2008 as compared to the same period in 2007. The increase in operating expenses was primarily attributable to spending related to our development program for Qnexa, our investigational product candidate currently in Phase 3 clinical trials for obesity.

 

On April 3, 2008, we entered into several agreements with Deerfield Management Company, L.P., or Deerfield, a healthcare investment fund, and its affiliates. Under the agreements Deerfield and its affiliates agreed to provide $30 million in funding to us. The $30 million in funding consists of $20 million from a Funding and Royalty Agreement (“FARA”), and $10 million from the sale of VIVUS’ common stock at the closing on April 15, 2008 in connection with the registered direct offering mentioned above under a securities purchase agreement. Under the FARA, the Deerfield Affiliates will make six payments to us of $3.3 million, beginning in April 2008 and quarterly thereafter.  We are currently in the process of evaluating the accounting treatment for the Deerfield Transaction.

 

In connection with the sale of Evamist, we received $150.0 million. The sale of Evamist was a unique transaction. As discussed in Note 10: “Sale of Evamist Product”, an initial $10.0 million was paid at closing and $140.0 million was paid upon FDA approval of Evamist. These payments are non-refundable and have been recorded as deferred revenue and will be recognized as license and other revenue ratably over a 21.5-month period, from August 1, 2007 to May 15, 2009, which is the remaining term of a license to improvements to the MDTS applicator. As compared to revenues from product sales, license and other revenue will be significant on a quarterly basis until all of the revenue from the sale of Evamist is recognized, currently expected to be May 2009. Since the $150.0 million has been received and we have no related contingencies, the future recognition of revenue and the corresponding reduction of deferred revenue related to the Evamist sale will have no impact on our cash flows from operations in future periods through May 2009.

 

40



 

The revenue related to the transaction recognized in the first quarter of 2008 is $20.9 million and the revenue in future quarters is expected to be recognized as follows (in thousands):

 

Quarter ending

 

License revenue

 

June 30, 2008

 

$

20,930

 

September 30, 2008

 

$

20,930

 

December 31, 2008

 

$

20,930

 

March 31, 2009

 

$

20,930

 

June 30, 2009

 

$

10,465

 

 

With the exception of income generated from the revenue recognition of the $150.0 million received from K-V, we may have continued losses in future years, depending on the timing of our research and development expenditures, because we expect MUSE sales to remain steady and we plan to continue to invest in clinical development of our current research and development product candidates to bring those potential products to market.

 

Revenue.

 

 

 

Three Months Ended 
March 31,

 

Increase/

 

%

 

 

 

2008

 

2007

 

(Decrease)

 

Change

 

 

 

(In thousands, except percentages)

 

United States product, net

 

$

1,088

 

$

460

 

$

628

 

137

%

International product

 

554

 

1,113

 

(559

)

(50

)%

License and other revenue

 

21,046

 

116

 

20,930

 

18,043

%

Total revenues

 

$

22,688

 

$

1,689

 

$

20,999

 

1,243

%

 

Product revenues for the quarters ended March 31, 2008 and March 31, 2007, remained constant at $1.6 million. The increase in U.S. product revenues in the quarter ended March 31, 2008 as compared to the same period in 2007 is primarily due to increased domestic shipments of MUSE and a price increase in 2008. The decrease in international revenue in the quarter ended March 31, 2008 as compared to the same period in 2007 was due to the timing of orders from our international partners. The increase in MUSE domestic shipments is a result of fluctuations in inventory levels at the wholesale level and is not indicative of any trend.

 

Although the demand for MUSE has stabilized, given the loss of coverage under Medicare Part D, we are not able to anticipate if wholesalers will continue their historical pattern of making purchases in the fourth quarter that exceed expected quarterly demands. If wholesalers do not repeat this pattern of purchasing quantities of MUSE that exceed quarterly demands, revenues from the sale of MUSE in 2008 may be lower as compared to 2007.

 

On March 30, 2007, we announced that we had entered into a definitive agreement with K-V, to transfer our assets and grant a sublicense of our rights under the Acrux Agreement related to Evamist to K-V (the “Transaction”). The closing of the Transaction occurred on May 15, 2007 and on July 27, 2007, we received FDA approval of the Evamist NDA. An initial $10.0 million was paid at closing and $140.0 million was paid upon FDA Approval. These payments have been recorded as deferred revenue and will be recognized as revenue ratably over the remaining 21.5-month term of the Improvement License, from August 1, 2007 to May 15, 2009.

 

Cost of goods sold and manufacturing.

 

 

 

Three Months Ended
March 31,

 

 

 

%

 

 

 

2008

 

2007

 

Increase

 

Change

 

 

 

(In thousands, except percentages)

 

Cost of goods sold and manufacturing

 

$

2,787

 

$

2,571

 

$

216

 

8

%

 

Cost of goods sold and manufacturing (“cost of goods sold”) in the first quarter of 2008 increased $216,000, or 8%, to $2.8 million, as compared to $2.6 million for the first quarter of 2007. Cost of goods sold increased in the three months ended March 31, 2008 as compared to the same period of 2007 primarily due to an increase in inventory reserves and the disposal of inventory due to the non-conformance of certain raw materials.

 

We anticipate cost of goods sold and manufacturing in 2008 will be similar to costs incurred in 2007.

 

41



 

Research and development.

 

 

 

Three Months Ended
March 31,

 

 

 

%

 

 

 

2008

 

2007

 

Increase

 

Change

 

 

 

(In thousands, except percentages)

 

Research and development

 

$

23,371

 

$

3,011

 

$

20,360

 

676

%

 

Research and development expenses in the first quarter of 2008 increased $20.4 million, or 676%, to $23.4 million, as compared to $3.0 million for the first quarter of 2007. In the first quarter of 2008, increased Qnexa obesity and diabetes spending of $20.2 million and non-project related spending of $600,000 (primarily due to increases in non-cash stock based compensation expense of $255,000, compensation and related expense of $195,000 due to an increase in headcount and increased consulting expense of $65,000) were partially offset by decreases in other clinical trial and project activity of $460,000 (primarily a $513,000 decrease in avanafil project related spending), as compared to the first quarter of 2007. In the three months ended March 31, 2008, we spent $17.3 million on Qnexa Phase 3 trials performed by our primary contract research organization which represented 74% of our total research and development expenses.

 

We anticipate that our research and development expenses will continue to increase significantly in 2008 over the expenses in 2007, as we continue to advance the clinical program for Qnexa for the treatment of obesity and our other programs. The current remaining contractual obligation with our primary contract research organization for the Phase 3 Qnexa trials totals $32.2 million which will be recorded as research and development expense in the next two years. There are likely to be additional research and development expenses related to Qnexa and our other programs under development. Our research and development expenses may fluctuate from period to period due to the timing and scope of our development activities and the results of clinical and preclinical studies. If we are successful in obtaining FDA regulatory approval for any new investigational product candidates being developed through our research and development efforts, we do not expect to recognize revenue from sales of such new products, if any, for several years.

 

Selling, general and administrative.

 

 

 

Three Months Ended
March 31,

 

 

 

%

 

 

 

2008

 

2007

 

Increase

 

Change

 

 

 

(In thousands, except percentages)

 

Selling, general and administrative

 

$

4,252

 

$

4,105

 

$

147

 

4

%

 

Selling, general and administrative expenses in the three months ended March 31, 2008 of $4.3 million increased $147,000, or 4% as compared to the three months ended March 31, 2007. In the quarter ended March 31, 2008, this increase is primarily due to $230,000 in additional non-cash stock based compensation expense and an incremental increase in compensation expense of $225,000, partially offset by decreased direct to consumer MUSE marketing expense of $278,000, as compared to the quarter ended March 31, 2007.

 

We anticipate that our selling, general and administrative expenses in 2008 will be similar to 2007.

 

Interest income and expense.

 

Interest income for the quarter ended March 31, 2008 was $757,000, as compared to $767,000 for the quarter ended March 31, 2007. The decrease in interest income is primarily due to an other-than-temporary impairment loss on our available-for-sale securities of $1.4 million partially offset by the increase in our average investment cash balance (due to the receipt of the $140.0 million payment from K-V in August 2007) from the three months ended March 31, 2008 as compared to the same period in 2007.

 

Interest expense for the quarter ended March 31, 2008 was $122,000 as compared to $154,000 during the same period last year. On April 24, 2007, in connection with the sale of Evamist to K-V, we paid off the $6.7 million outstanding balance on the Tanabe line of credit, including all accrued interest and terminated the line of credit.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Cash. Unrestricted cash, cash equivalents and available-for-sale securities totaled $164.5 million at March 31, 2008, as compared to $179.5 million at December 31, 2007. The decrease in cash, cash equivalents and available-for-sale securities of

 

42



 

$15.0 million is the net result of cash used by operating activities, partially offset by cash provided by investing and financing activities for the first three months of 2008. Included in these amounts are cash receipts from the collection of amounts owed at December 31, 2007 from customers as measured by a decrease of $2.8 million in accounts receivable and $114,000 from exercises of stock options.

 

Since inception, we have financed operations primarily from the issuance of equity securities. Through March 31, 2008, we raised $224.2 million from financing activities, received $150 million from the sale of Evamist and had an accumulated deficit of $176.9 million at March 31, 2008.

 

Available-for-sale securities. We focus on liquidity and capital preservation in our investments in available-for-sale securities. Through February 28, 2008, we restricted our investments to:

 

·      Direct obligations of the United States Treasury;

 

·      Federal Agency securities which carry the direct or implied guarantee of the United States government; and

 

·      Corporate securities, including commercial paper, rated A1/P1/F1 or better.

 

The weighted average maturity of our portfolio was not to exceed 18 months.

 

On February 29, 2008, the Audit Committee of the Board of Directors approved a change to the investment policy to be more restrictive in the focus on liquidity and capital preservation in our investments in available-for-sale securities. Future investments are restricted to:

 

·      Direct obligations of the United States Treasury;

 

·      Federal agency securities which carry the direct or implied guarantee of the United States government; and

 

·      Corporate debt obligations rated AA3/AA- or A-1+/P-1 or better or asset-backed commercial paper rated A-1+/P-1 or better.

 

The weighted average maturity of our portfolio for new investments is not to exceed 9 months.

 

At March 31, 2008, we had $53.7 million in cash and cash equivalents and $110.8 million in available-for-sale securities. We invest our excess cash balances in money market and marketable securities, primarily high quality corporate debt securities and asset-backed securities, in accordance with our investment policy. The investment policy has the primary investment objectives of preservation of principal while at the same time maximizing yields without significantly increasing risk; however, there may be times when certain of the securities in our portfolio will fall below the credit ratings required in the policy. If those securities are downgraded or impaired we would experience losses in the value of our portfolio which would have an adverse effect on our results of operations, liquidity and financial condition. Certain of these securities are subject to general credit, liquidity, market and interest rate risks, which may be exacerbated by U.S. sub-prime mortgage defaults that have affected various sectors of the financial markets and caused credit and liquidity issues.

 

We currently believe we will be able to realize the par value of our investments without significant loss; however, it could take until the final maturity of the underlying securities or an improvement in the liquidity of the financial markets to realize the par value. Based on our expected operating cash flows, and our other sources of cash, we do not anticipate the potential lack of liquidity on certain of these investments will affect our ability to execute our current business plan; however, these market risks associated with our investment portfolio could cause the loss of a significant portion of our investments which would have an adverse effect on our results of operations, liquidity and financial condition.

 

Accounts Receivable. Accounts receivable (net of allowance for doubtful accounts) at March 31, 2008 was $1.4 million, as compared to $4.2 million at December 31, 2007. The 66% decrease in the accounts receivable balance at March 31, 2008 is primarily due to the collection of accounts receivable outstanding at December 31, 2007. Currently, we do not have any significant concerns related to accounts receivable or collections.

 

Liabilities. Total liabilities were $126.5 million at March 31, 2008, $13.1 million lower than at December 31, 2007. The change in total liabilities includes a $21 million net decrease in deferred revenue primarily due to the amortization of the $150 million in deferred license revenue received from K-V on the sale of Evamist, a $6.1 million increase in accounts payable due to the timing of payments for goods and services supporting the development effort for Qnexa and a $3.3 million increase in

 

43



 

accrued research and clinical expenses, also due to the Qnexa development effort. The deferred revenue balance primarily results from the K-V transaction and the related amortization over time of the revenue based on the receipt of the cash in 2007. Deferred revenue is a non-cash liability and does not represent any future obligations on our part.

 

We have entered into manufacturing agreements with suppliers to purchase raw materials. As of March 31, 2008, our remaining commitment under these agreements is to purchase a minimum of $2.3 million of product from 2008 through 2011. In the first quarter of 2006, we recorded a $764,000 inventory write-down related to the purchase of alprostadil considered to be in excess of projected production needs. Should our inventory of raw materials exceed our future production needs, it may be necessary to write-off additional excess inventory.

 

In February 2004, we entered into exclusive licensing agreements with Acrux Limited and a subsidiary of Acrux under which we have agreed to develop and commercialize Luramist and Evamist in the United States for various female health applications. Under the terms of the agreements, we agreed to pay to Acrux combined licensing fees of $3 million, up to $4.3 million for the achievement of certain clinical development milestones, up to $6 million for achieving product approval milestones, and royalties on net sales in the United States upon commercialization of each product. We made a $1 million clinical development milestone payment to Acrux in October 2006 related to the submission of an NDA to the FDA for Evamist and we made an additional $3 million product approval milestone payment for the approval of this NDA in August 2007. Per the terms of our Asset Purchase Agreement with K-V for the sale of our Evamist product, K-V paid $1.5 million of this milestone obligation.

 

Operating Activities. Our operating activities used $13.3 million of cash and $4.2 million of cash during the three months ended March 31, 2008 and 2007, respectively. During the first three months of 2008, our net operating loss of $7.1 million was offset by a $6.1 million increase in accounts payable due to the timing of payments, a $2.8 million reduction in our accounts receivable, due to the collection of monies owed to us, $1.4 million in non-cash stock based compensation expense, a $1.4 million other-than-temporary loss on investments, a $3.3 million increase in accrued research and clinical expenses due to the Qnexa development effort and a $1.5 million decrease in prepaid and other assets. These offsets to our net operating loss were in turn offset by the recognition of $21 million of deferred revenue primarily due to the amortization of license revenue due to the receipt of $150 million from K-V for the sale of Evamist.  During the first three months of 2007, our net operating loss of $7.4 million was partially offset by a $3.3 million reduction in our accounts receivable, due to the collection of monies owed to us, which in turn was offset by use of cash to pay accrued employee compensation and benefits of $538,000.

 

Investing Activities. Our investing activities provided $29.1 million and $2.3 million in cash during the three months ended March 31, 2008 and 2007, respectively. The fluctuations from period to period are due primarily to the timing of purchases, sales and maturity of investment securities.

 

Financing Activities. Financing activities provided $85,000 and $1.1 million during the three months ended March 31, 2008 and 2007, respectively. In the first three months of 2008, the cash provided by financing activities included $114,000 in proceeds from the exercise of stock options partially offset by $29,000 in principal payments under our note with Crown Bank, N.A. In the first three months of 2007, the cash provided by financing activities was primarily due to increased borrowings under our Tanabe Holding America, Inc. line of credit of $379,000 and $730,000 in proceeds from the exercise of stock options.

 

In the first quarter of 2004, we signed an agreement for a line of credit with Tanabe Holding America, Inc., a subsidiary of Tanabe Seiyaku Co., Ltd., or Tanabe, allowing us to borrow up to $8.5 million to be used for the development of avanafil. The secured line of credit could be drawn upon quarterly and each quarterly borrowing had a 48-month term and bore interest at the annual rate of 2%. On April 24, 2007, in connection with the sale of Evamist to K-V, we paid off the $6.7 million outstanding balance on the Tanabe line of credit, including all accrued interest and terminated the line of credit. All of the assets of the Company, except the land and buildings, served as collateral for this line of credit. On May 1, 2007, Tanabe signed a Termination and Release acknowledging payment in full of the principal and interest due under the line of credit and releasing the lien on the Company’s assets.

 

On December 22, 2005, we purchased from our landlord our principal manufacturing facility, which was previously leased, for $7.1 million. The purchase price was funded in part by $3.3 million, which was being held by the landlord as cash collateral for renovations to the facility upon the termination of the lease and the remainder with cash. On January 4, 2006, we obtained a $5.4 million loan from Crown Bank, N.A. (“Crown”). The land and buildings, among other assets, located at our principal manufacturing facility and a $700,000 Certificate of Deposit held by Crown serve as collateral for these Agreements. The loan is payable over a 10-year term. The interest rate is adjusted annually to a fixed rate for the year equal to the prime rate plus 1%, with a floor of 7.5%. Principal and interest are payable monthly based upon a 20-year amortization schedule and are adjusted annually at the time of the interest rate reset. All remaining principal is due on February 1, 2016. The interest rate was 7.5% and 9.25% for the first three months of 2008 and 2007, respectively.

 

44



 

On July 14, 2006, VIVUS, Inc. filed with the Securities and Exchange Commission, or SEC, a shelf Registration Statement on Form S-3. The shelf Registration Statement (File Number 333-135793) was declared effective by the SEC on August 16, 2006, providing us with the ability to offer and sell up to an aggregate of $80.0 million of common stock from time to time in one or more offerings. The terms of any such future offering would be established at the time of such offering. This shelf Registration Statement (File Number 333-135793) replaces shelf Registration Statement (File Number 333-12159).

 

On November 17, 2006, we raised $33.6 million in a registered direct offering of our common stock pursuant to this shelf Registration Statement. Under the terms of this financing, we sold and issued a total of 6,750,000 shares of our common stock at a price of $3.50 per share in an initial closing and an additional 2,850,000 shares in a second closing on December 8, 2006. All of the shares of Common Stock were offered pursuant to an effective Registration Statement on Form S-3 filed with the SEC on July 14, 2006.

 

On April 15, 2008, we closed the Deerfield Transaction in which Deerfield and its affiliates agreed to provide us with $30 million in funding.  The $30 million in funding consists of $20 million from a Funding and Royalty Agreement (“FARA”) entered into with a newly incorporated subsidiary of Deerfield (“Deerfield Sub”), and $10 million from the sale of VIVUS’ common stock under a securities purchase agreement.  Under the FARA, at closing the Deerfield Affiliates made the first of six payments of $3.3 million, beginning in April 2008 and quarterly thereafter. We will pay royalties on the current net sales of MUSE and if approved, future sales of avanafil, an investigational product candidate, to Deerfield Sub. The term of the FARA is ten years. The FARA includes covenants requiring us to use commercially reasonable efforts to preserve our intellectual property, manufacture, promote and sell MUSE, and develop avanafil. At the closing on April 15, 2008, in connection with the registered direct offering mentioned above under the securities purchase agreement, the Deerfield Affiliates purchased 1,626,017 shares of our common stock for an aggregate purchase price of $10 million and we paid to the Deerfield Affiliates a $500,000 fee and reimbursed certain expenses incurred in this transaction of approximately $200,000. The agreements also provided us with an option to purchase, and the Deerfield Affiliates with an option to compel us to purchase, the Deerfield Sub holding the royalty rights. If we exercise our right to purchase the Deerfield Sub, the net price will be $23 million, if exercised within three years or $26 million if exercised after three years but before four years (the purchase price is subject to other adjustments, as defined in the agreement).  After three years from the closing the Deerfield affiliates may exercise the right to compel us to purchase the Deerfield Sub at a price ranging from $17 million to $26 million based upon various circumstances. If either party exercises its option, any further royalty payments would be effectively terminated.  In exchange for the option right, we paid $2 million to the Deerfield Affiliates.  Our intellectual property and all of the accounts receivable, inventory and equipment arising out of or relating to MUSE and avanafil are collateral for this transaction.

 

On May 5, 2008, VIVUS, Inc. filed with the SEC a shelf Registration Statement on Form S-3.  Once the shelf Registration Statement (File Number 333-150649) has been reviewed and declared effective by the SEC, we will have the ability to offer and sell up to an aggregate of $150 million of common stock from time to time in one or more offerings.  The terms of any such future offering would be established at the time of such offering.

 

On May 6, 2008, we filed with the SEC a Post-Effective Amendment No. 1 to Form S-3 (File No. 333-135793) (the “Registration Statement”), which was filed with the SEC on July 14, 2006, to amend the Registration Statement to deregister any securities registered pursuant to the Registration Statement and not otherwise sold thereunder.

 

The funding necessary to execute our business strategies is subject to numerous uncertainties, which may adversely affect our liquidity and capital resources. Completion of clinical trials may take several years or more, but the length of time generally varies substantially according to the type, complexity, novelty and intended use of an investigational product candidate. It is also important to note that if a clinical candidate is identified, the further development of that candidate can be halted or abandoned at any time due to a number of factors. These factors include, but are not limited to, funding constraints, lack of efficacy or safety or change in market demand.

 

The nature and efforts required to develop our investigational product candidates into commercially viable products include research to identify a clinical candidate, preclinical development, clinical testing, FDA approval and commercialization. This process is very costly and can take in excess of 10 years to complete for each investigational product candidate. The duration and the cost of clinical trials may vary significantly over the life of a project as a result of matters arising during the clinical studies, including, among others, the following:

 

·      we or the FDA may suspend trials;

 

·      we may discover that an investigational product candidate may cause harmful side effects or is not effective;

 

·      patient recruitment may be slower than expected; and

 

·      patients may drop out of the trials.

 

45



 

For each of our programs, we periodically assess the scientific progress and the merits of the programs to determine if continued research and development is economically viable. Certain of our programs have been terminated due to the lack of scientific progress and lack of prospects for ultimate commercialization. As such, the ultimate timeline and costs to commercialize a product cannot be accurately estimated.

 

Our investigational product candidates have not yet achieved FDA regulatory approval, which is required before we can market them as therapeutic products. In order to achieve regulatory approval, the FDA must conclude that our clinical data establish substantial evidence of safety and efficacy. The results from preclinical testing and early clinical trials may not be predictive of results in later clinical trials. It is possible for a candidate to show promising results in early clinical trials, but subsequently fail to establish safety and efficacy data necessary to obtain regulatory approvals.

 

As a result of the uncertainties discussed above, among others, the duration and completion of our research and development projects are difficult to estimate and are subject to considerable variation. Our inability to complete our research and development projects in a timely manner or our failure to enter into collaborative agreements, when appropriate, could significantly increase our capital requirements and could adversely impact our liquidity. These uncertainties could force us to seek additional, external sources of financing from time to time in order to continue with our business strategy. Our inability to raise capital, or to do so on terms reasonably acceptable to us, would jeopardize the future success of our business.

 

We may also be required to make further substantial expenditures if unforeseen difficulties arise in other areas of our business. In particular our future capital and additional funding requirements will depend upon numerous factors, including:

 

·      the progress and costs of our research and development programs;

 

·      the scope, timing and results of pre-clinical testing and clinical trials;

 

·      patient recruitment and enrollment in current and future clinical trials;

 

·      the costs involved in seeking regulatory approvals for our investigational product candidates;

 

·      the costs involved in filing and pursuing patent applications and enforcing patent claims;

 

·      the establishment of collaborations, sublicenses and strategic alliances;

 

·      the cost of manufacturing and commercialization activities and arrangements;

 

·      the results of operations;

 

·      demand for MUSE;

 

·      the potential forced purchase of the royalty streams we previously sold to Deerfield;

 

·      the cost, timing and outcome of regulatory reviews;

 

·      the rate of technological advances;

 

·      ongoing determinations of the potential commercial success of our products under development;

 

·      the level of resources devoted to sales and marketing capabilities; and

 

·      the activities of competitors.

 

We anticipate that our existing capital resources combined with anticipated future cash flows will be sufficient to support our operating needs at least through the end of 2009. However, we anticipate that we may require additional funding to continue our research and product development programs, to conduct preclinical studies and trials, for operating expenses, to pursue regulatory approvals for our investigational product candidates, for the costs involved in filing and prosecuting patent applications and enforcing or defending our patent claims, if any, and we may require additional funding to establish additional manufacturing and marketing capabilities in the future. In particular, we expect to make other substantial payments to Acrux

 

46



 

and Tanabe, in accordance with our agreements with them in connection with the licensing of certain compounds. These payments are based on certain development, regulatory and sales milestones. In addition, we are required to make royalty payments on any future product sales. Similar to the transaction with Evamist, we may consider divesting any of our products in development or our commercial product in order to raise additional funding. We may seek to access the public or private equity markets whenever conditions are favorable. The sale of additional equity securities would result in additional dilution to our stockholders. We may also seek additional funding through strategic alliances and other financing mechanisms. We cannot assure you that adequate funding will be available on terms acceptable to us, if at all. If adequate funds are not available, we may be required to curtail significantly one or more of our research or development programs or obtain funds through arrangements with collaborators or others. This may require us to relinquish rights to certain of our technologies or investigational product candidates. To the extent that we are unable to obtain third party funding for such expenses, we expect that increased expenses may result in future losses from operations. We are continually evaluating our existing portfolio and we may choose to divest or spin-off one or more of our products or investigational product candidates at any time. We cannot assure you that we will successfully develop our products under development or that our products, if successfully developed, will generate revenues sufficient to enable us to earn a profit.

 

Contractual Obligations

 

The following table summarizes our contractual obligations at March 31, 2008 and the effect such obligations are expected to have on our liquidity and cash flow in future fiscal years. These do not include milestones or future interest expense and assume non-termination of agreements. These obligations, commitments and supporting arrangements represent payments based on current operating forecasts, which are subject to change:

 

 

 

Payments Due by Period

 

Contractual obligations

 

Total

 

2008
(9 months)

 

2009-2011

 

2012-2013

 

Thereafter

 

 

 

(in thousands)

 

Operating leases

 

$

740

 

$

416

 

$

324

 

 

 

Manufacturing and other agreements

 

11,058

 

8,326

 

2,732

 

 

 

Clinical trials

 

39,240

 

27,976

 

11,264

 

 

 

Notes payable

 

5,145

 

101

 

471

 

$

378

 

$

4,195

 

Total contractual obligations

 

$

56,183

 

$

36,819

 

$

14,791

 

$

378

 

$

4,195

 

 

Operating Leases

 

We purchased our previously leased manufacturing facilities in Lakewood, New Jersey on December 22, 2005. In November 2006, we entered into a new 30-month lease for our existing Mountain View corporate headquarters location with our existing landlord. The new lease commenced on February 1, 2007. The lease expires on July 31, 2009 and allows us one option to extend the term of the lease for a period of one year from the expiration of the lease.

 

Manufacturing and Other Purchases

 

Purchase obligations consist of agreements to purchase goods or services that are enforceable and legally binding on us and that specify all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction. These include obligations for minimum inventory purchase contracts, research and development, general and administrative services, and media/market research contracts.

 

Manufacturing Agreements

 

In November 2002, we entered into a manufacturing agreement to purchase raw materials from a supplier beginning in 2003 and ending in 2008. In May 2007, we amended the terms of this agreement and our remaining commitment is to purchase a minimum total of $1.5 million of product from 2008 through 2011.

 

In January 2004, we entered into a manufacturing agreement to purchase raw materials from an additional supplier beginning in 2004 and ending in 2006. In February 2006, we amended the terms of this agreement to require the purchase of a minimum total of $1.5 million of product from 2006 through 2008. Our remaining commitment under this agreement is $765,000.

 

Other Agreements

 

We have remaining commitments under various general and administrative services agreements totaling $1.8 million at March 31, 2008, including $1.2 million related to Mr. Wilson’s Employment Agreement (see below). We have also entered

 

47



 

into various agreements with research consultants and other contractors to perform regulatory services, drug research, testing and manufacturing including animal studies and, at March 31, 2008, our remaining commitment under these agreements totaled $6.1 million. In addition, we have entered into marketing promotion agreements for our erectile dysfunction product, MUSE. At March 31, 2008, our remaining commitment under the MUSE agreements totaled $866,000.

 

On December 19, 2007, the Compensation Committee of the Board of Directors of the Company approved an employment agreement (the “Employment Agreement”) with Leland F. Wilson, the Company’s President and Chief Executive Officer. The Employment Agreement includes salary, incentive compensation, retirement benefits and length of employment, among other items, as agreed to with Mr. Wilson. The Employment Agreement has an initial term of two years commencing on the effective date, June 1, 2007 (the “Effective Date”). On the second anniversary of the Effective Date, the Employment Agreement will automatically renew for an additional one-year term unless either party provides the other party with a notice of non-renewal.

 

Clinical Trials

 

We have entered into various agreements with clinical consultants, investigators, clinical suppliers and clinical research organizations to perform clinical trial management and clinical studies on our behalf and, at March 31, 2008, our remaining commitment under these agreements totaled $39.2 million. We make payments to these providers based upon the number of patients enrolled and the length of their participation in the trials. These obligations, however, are contingent on future events, e.g. the rate of patient accrual in our clinical trials. This amount represents the remaining contractual amounts due under various contracts, although all of these contracts could be cancelled by us, in which case we would only be liable to the vendors for work performed to the date of cancellation.

 

Notes Payable

 

On January 4, 2006, we obtained a $5.4 million loan from Crown. The land and buildings, among other assets, located at our principal manufacturing facility and a $700,000 Certificate of Deposit held by Crown serve as collateral for these Agreements. The loan is payable over a 10-year term. The interest rate is adjusted annually to a fixed rate for the year equal to the prime rate plus 1%, with a floor of 7.5%. Principal and interest are payable monthly based upon a 20-year amortization schedule and are adjusted annually at the time of the interest rate reset. All remaining principal is due on February 1, 2016. The interest rate was 7.5% and 9.25% for the three months ended March 31, 2008 and 2007, respectively. As of March 31, 2008, we have a principal balance of $5.1 million remaining on the Crown loan.

 

Additional Payments

 

We have entered into development, license and supply agreements which contain provisions for payments upon completion of certain development, regulatory and sales milestones and possible payments arising from the Deerfield Transaction. Due to the uncertainty concerning when and if these milestones may be completed or other payments are due, we have not included these potential future obligations in the above table.

 

Tanabe

 

In January 2001, we entered into an exclusive development, license and supply agreement with Tanabe for the development and commercialization of avanafil, a PDE5 inhibitor compound for the oral and local treatment of male and female sexual dysfunction. Under the terms of the agreement, Tanabe agreed to grant an exclusive license to us for products containing avanafil outside of Japan, North Korea, South Korea, China, Taiwan, Singapore, Indonesia, Malaysia, Thailand, Vietnam and the Philippines. We agreed to grant Tanabe an exclusive, royalty-free license within those countries for oral products that we develop containing avanafil. In addition, we agreed to grant Tanabe an exclusive option to obtain an exclusive, royalty-bearing license within those countries for non-oral products that we develop containing avanafil. Further, we granted Tanabe the option to obtain co-promotional rights for oral products that we develop under our license for up to 25% of the promotional activity in our territory. Tanabe agreed to manufacture and supply us with avanafil for use in clinical trials, which will be our primary responsibility.

 

We have paid upfront licensing fees of $5 million to Tanabe and have agreed to make additional payments upon the completion of certain development, regulatory and sales milestones. During the first quarter of 2004, we initiated a Phase 2 clinical trial with avanafil, which meets one of the clinical development milestone criteria above. We paid Tanabe $2 million in connection with this milestone in 2006. We have further agreed to pay royalties on net sales of products containing avanafil. No payments were made under this agreement with Tanabe in the three months ended March 31, 2008.

 

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Acrux

 

In February 2004, we entered into exclusive licensing agreements with Acrux Limited (“Acrux”) and its subsidiary under which we have agreed to develop and, if approved, commercialize Luramist and Evamist in the United States for various female health applications. Acrux’s metered-dose transdermal spray, or MDTS, technology is a patented, simple to use spray that is being developed to deliver testosterone and estradiol effectively to women when applied to the skin. We agreed to grant Acrux’s subsidiary a non-exclusive, royalty-free license outside the United States for any MDTS products containing improvements we have made to the licensed intellectual property and the option to obtain a non-exclusive, worldwide license for our intellectual property related to MDTS products. We have paid $3 million in upfront licensing fees to Acrux and have agreed to make additional payments upon the completion of certain development, regulatory and sales milestones. Under the terms of the agreements, we agreed to pay to Acrux combined licensing fees up to $4.3 million for the achievement of certain clinical development milestones, up to $6 million for achieving product approval milestones, and royalties on net sales in the United States following approval and commercialization of each product. We have paid $4.8 million in clinical development milestones payments to date, including the $1 million milestone payment we made to Acrux in October 2006 related to the submission of an NDA to the FDA for Evamist and the $3 million product approval milestone payment for approval of this NDA, which was paid in August 2007. Per the terms of our Asset Purchase Agreement with K-V for the sale of our Evamist product, we granted a sublicense of our rights under the Acrux Agreement related to Evamist to K-V and K-V paid $1.5 million of this $3 million obligation. Although we have sublicensed our rights under the Acrux Agreement related to Evamist to K-V, we will continue to have certain obligations under this license in the event that K-V does not satisfy the requirements under the sublicense agreement. See Note 10: “Sale of Evamist Product” to the unaudited notes to condensed consolidated financial statements included in this Form 10-Q for additional information concerning the terms of this agreement and Note 17: “Legal Matters” for further information regarding Acrux.

 

Deerfield Financing

 

On April 3, 2008, we entered into several agreements with Deerfield Management Company, L.P., or Deerfield, a healthcare investment fund, and its affiliates, Deerfield Private Design Fund L.P. and Deerfield Private Design International, L.P. (collectively, the Deerfield Affiliates).  Under the agreements Deerfield and its affiliates agreed to provide us with $30 million in funding.  The $30 million in funding consists of $20 million from a Funding and Royalty Agreement (“FARA”) entered into with a newly incorporated subsidiary of Deerfield (“Deerfield Sub”) and $10 million from the sale of our common stock.  Under the FARA, the Deerfield Affiliates will make six payments of approximately $3.3 million, beginning in April 2008 and quarterly thereafter.  Such payments are referred to as the “Funding Payments”. We will pay royalties on the current net sales of MUSE and if approved, future sales of avanafil, an investigational product candidate to Deerfield Sub. The term of the FARA is ten years.  The FARA includes covenants requiring us to use commercially reasonable efforts to preserve our intellectual property, manufacture, promote and sell MUSE, and develop avanafil.  At the closing on April 15, 2008, under the securities purchase agreement, the Deerfield Affiliates purchased 1,626,017 shares of our common stock for an aggregate purchase price of $10 million and we paid to the Deerfield Affiliates a $500,000 fee and reimbursed certain expenses incurred in this transaction of approximately $200,000. The agreements also provided us with an option to purchase, and the Deerfield Affiliates with an option to compel us to purchase, the Deerfield Sub holding the royalty rights.  If either party exercises its option, any further royalty payments would be effectively terminated.  Collectively, these transactions are referred to as the Deerfield Transactions.

 

Also in connection with the Deerfield Transactions, VIVUS, the Deerfield Affiliates and Deerfield Sub entered into the Option and Put Agreement, dated April 3, 2008, or the OPA.  Pursuant to the OPA, the Deerfield Affiliates have granted us an option to purchase all of the outstanding shares of common stock of Deerfield Sub, or the Shares, from the Deerfield Affiliates, referred to as the Option, and we have agreed to grant the Deerfield Affiliates an option to require us to purchase all of the outstanding shares of common stock of Deerfield Sub from the Deerfield Affiliates, referred to as the Put Right.

 

If we exercise the Option, base consideration for the Option exercise, or Base Option Price, will be:

 

·      $25 million, if the Option is exercised on or prior to the third anniversary of the execution of the OPA; or

 

·                  $28 million, if the Option is exercised subsequent to the third anniversary but prior to the fourth anniversary of the execution of the OPA.

 

The aggregate consideration payable by VIVUS upon exercise of the Option, or the Option Purchase Price, would be equal to the sum of the Base Option Price, plus: (i) the cash and cash equivalents held by Deerfield Sub at the date of the closing of the resulting sale of the common stock of Deerfield Sub; (ii) accrued and unpaid royalties; and minus (i) the option premium of

 

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$2 million which was paid at the closing of the transaction (referred to as the Option Premium); (ii) accrued but unpaid taxes; (iii) unpaid Funding Payments; and (iv) any other outstanding liabilities of Deerfield Sub.  The Option terminates on the fourth anniversary of the execution of the OPA.

 

In consideration of the grant of the Option, at closing we paid $2 million to the Deerfield Affiliates. As indicated in the calculation of the Option Purchase Price, if the Option is exercised by us the Option Premium will be applied to reduce the Option Purchase Price.

 

The Put Right terminates on the tenth anniversary of the execution of the OPA and will become exercisable on the earliest of:

 

·      the third anniversary of the execution of the OPA;

 

·      any date on which:

 

(1)     the market capitalization of the Company falls below $50,000,000; or

 

(2)     the amount of cash and cash equivalents as defined, held by the Company falls below $15,000,000; or

 

(3)     the fifteenth day following the delivery of written notice to VIVUS that we have failed to make Royalty Payments in accordance with the provisions of the FARA unless we make such Royalty Payments prior to such fifteenth day; or

 

(4)     a Major Transaction, as defined below, closes.

 

If the Deerfield Affiliates exercise the Put Right, base consideration for the put exercise, or the Base Put Price, will be:

 

·                  $23 million, if the Put Right is exercised on or prior to the third anniversary of the execution of the OPA and we have notified the Deerfield Affiliates of our intent to enter into a Major Transaction (such notice is referred to as a Major Transaction Notice); or

 

·                  $26 million, if the Put Right is exercised subsequent to the third anniversary of the execution of the OPA and we have provided the Deerfield Affiliates a Major Transaction Notice; or

 

·                  $17 million, in all other cases.

 

The aggregate consideration payable by VIVUS upon exercise of the Put Right, or the Put Purchase Price, would be equal to the sum of the Base Put Price, plus: (i) the cash and cash equivalents held by Deerfield Sub at the date of the closing of the resulting sale of the common stock of Deerfield Sub; (ii) accrued and unpaid royalties; and minus (i) accrued but unpaid taxes; (ii) unpaid Funding Payments; and (iii) any other outstanding liabilities of Deerfield Sub.

 

Pursuant to the OPA, the following events would qualify as Major Transactions:

 

·                  a consolidation, merger, exchange of shares, recapitalization, reorganization, business combination or similar event:

 

(1)               following which the holders of common stock of VIVUS immediately preceding such event either:

 

(a)               no longer hold a majority of the shares of the common stock of VIVUS; or

 

(b)              no longer have the ability to elect a majority of the board of directors of VIVUS;

 

(2)               as a result of which shares of common stock of VIVUS are changed into (or the shares of common stock become entitled to receive) the same or a different number of shares of the same or another class or classes of stock or securities of VIVUS or another entity, collectively referred to as Change in Control Transactions;

 

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·                       a sale or transfer of assets of VIVUS in one transaction or a series of related transactions for a purchase price of more than $350 million where the consideration to be payable at or within thirty days of closing of such transaction or transactions has a value of more than $350 million, or a sale, transfer or license of all or substantially all assets or proprietary rights of VIVUS that relate specifically to MUSE or avanafil; or

 

·                       a purchase, tender or exchange offer made to the holders of outstanding shares of VIVUS’ common stock, such that following such purchase, tender or exchange offer a Change in Control Transaction shall have occurred; or

 

·                       an issuance or series of issuances in a series of related transactions by VIVUS of an aggregate number of shares of common stock in excess of 20% of the our outstanding common stock on the date hereof if, immediately prior to such issuance, the market capitalization of VIVUS is less than $300 million.

 

In connection with the FARA, Deerfield Sub and VIVUS have entered into a Royalty Security Agreement, whereby we have granted Deerfield Sub a security interest in certain collateral related to MUSE and avanafil including: all of our drug applications; all existing and future licenses relating to the development, manufacture, warehousing, distribution, promotion, sale, importing or pricing of MUSE and avanafil; our intellectual property and all of the accounts, inventory and equipment arising out of or relating to Muse and avanafil. In connection with the OPA, the Deerfield Affiliates and VIVUS have entered into a security agreement, whereby we have granted the Deerfield Affiliates a security interest in the same Collateral as defined by the Royalty Security Agreement.  The security interest granted to the Deerfield Affiliates has priority to that granted to Deerfield Sub by the Royalty Security Agreement.

 

Off-Balance Sheet Arrangements

 

We have not entered into any off-balance sheet financing arrangements and have not established any special purpose entities. We have not guaranteed any debt or commitments of other entities or entered into any options on non-financial assets.

 

Indemnifications

 

In the normal course of business, we provide indemnifications of varying scope to customers against claims of intellectual property infringement made by third parties arising from the use of our products and to certain of our clinical research organizations and investigators sites. Historically, costs related to these indemnification provisions have not been significant and we are unable to estimate the maximum potential impact of these indemnification provisions on our future results of operations.

 

Pursuant to the terms of the K-V transaction for the sale of Evamist, we made certain representations and warranties concerning our rights and assets related to Evamist and our authority to enter into and consummate the transaction. We also made certain covenants which survive the closing date of the transaction, including a covenant not to operate a business that competes, in the United States, and its territories and protectorates, with the Evamist product.

 

To the extent permitted under Delaware law, we have agreements whereby we indemnify our officers and directors for certain events or occurrences while the officer or director is, or was, serving at our request in such capacity. The indemnification period covers all pertinent events and occurrences during the officer’s or director’s lifetime. The maximum potential amount of future payments we could be required to make under these indemnification agreements is unlimited; however, we have director and officer insurance coverage that reduces our exposure and enables us to recover a portion of any future amounts paid. We believe the estimated fair value of these indemnification agreements in excess of applicable insurance coverage is minimal.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Securities and Exchange Commission’s rule related to market risk disclosure requires that we describe and quantify our potential losses from market risk sensitive instruments attributable to reasonably possible market changes. Market risk sensitive instruments include all financial or commodity instruments and other financial instruments that are sensitive to future changes in interest rates, currency exchange rates, commodity prices or other market factors.

 

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Market Risk

 

Market risk represents the risk of loss that may impact our financial position, results of operations or cash flows due to adverse changes in financial and commodity market prices and rates. We are exposed to market risk in the area of changes in United States interest rates. We do not have any material foreign currency or other derivative financial instruments. Under our current policies, we do not use interest rate derivative instruments to manage exposure to interest rate changes. We attempt to increase the safety and preservation of our invested principal funds by limiting default risk, market risk and reinvestment risk. We mitigate default risk by investing in investment grade securities.

 

Interest Rate Risk

 

The primary objective of our investment activities is to preserve principal while at the same time maximizing yields without significantly increasing risk. To achieve this objective, we invest in widely diversified investments consisting of investment grade securities. This means that a change in prevailing interest rates may cause the principal amount of the investment to fluctuate. For example, if we hold a security that was issued with a fixed interest rate at the then-prevailing rate and the interest rate later rises, the principal amount of our investment will probably decline. Based on information provided by our investment advisor, Columbia Management LLC, a hypothetical 100 basis point increase in interest rates reduces the fair value of our available-for-sale securities at March 31, 2008 by approximately $233,000. To minimize this risk in the future, we intend to maintain our portfolio of cash equivalents and marketable securities in a variety of securities.

 

We hold investments in both fixed rate and floating rate interest earning instruments, and both carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fall short of expectations due to changes in market conditions and in interest rates or we may suffer losses in principal if forced to sell securities which may have declined in market value due to changes in interest rates.

 

We have investments in commercial paper, corporate bonds, asset-backed securities, and other securities. While we now earn a premium interest rate on these investments, some of these investments are not liquid. We presently do not need to access these funds for operating purposes. We have the ability to generally hold our investments until maturity and therefore we would not expect our operating results or cash flows to be affected to any significant degree by the effect of a sudden change in market interest rates on our securities portfolio. In the event we need to access these funds, we may not be able to do so without a loss of principal.

 

We are also exposed to interest rate risk on the $5.1 million loan payable to Crown Bank, N.A. as of March 31, 2008. The loan is payable over a 10-year term. The interest rate is adjusted annually to a fixed rate for the year equal to the prime rate plus 1%, with a floor of 7.5%. The interest rate was 7.5% and 9.25% for the first three months of 2008 and 2007, respectively.

 

ITEM 4. CONTROLS AND PROCEDURES

 

(a.) Evaluation of disclosure 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 timelines 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 timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can only provide reasonable assurance of achieving the desired control objectives, and in reaching a reasonable level of assurance, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

As required by SEC 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 our Chief Financial Officer, of the effectiveness of the design and operation of VIVUS’ disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

 

(b.) Changes in internal controls. There was no change in our internal control over financial reporting that occurred during the period covered by this Quarterly Report on Form 10-Q that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II: OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

In the normal course of business, VIVUS receives and makes inquiries regarding patent infringement and other legal matters.

 

The Company and Acrux Limited, or Acrux, are parties to the Testosterone Development and Commercialization Agreement and the Estradiol Development and Commercialization Agreement, each dated February 12, 2004, or the Acrux Agreements. The Acrux Agreements cover the Company’s Evamist and Luramist investigational products, both of which are licensed from Acrux under the Acrux Agreements. The Company received a letter dated November 13, 2006 from legal counsel for Acrux containing various claims of breach under the Acrux Agreements. The Company has responded that it believes there is no merit to those claims and that it has meritorious defenses to such claims. The claims with respect to Evamist have not progressed further, but, to date, the claims have not been withdrawn. On November 5, 2007, Acrux made a demand for arbitration under the Acrux Agreements regarding its claims related to Luramist. Acrux’s demand seeks a reversion of all rights assigned to the Company related to Luramist, monetary damages, a portion of a milestone payment for Luramist under the Acrux Agreements and declaratory relief. The Company believes that is in compliance with all material aspects of the Acrux Agreements, including those relating to Luramist and that it currently does not owe monetary damages or any milestone payment under the Acrux Agreements. The arbitration process is proceeding, with the parties selecting and qualifying potential arbitrators. However, in the event that Acrux should prevail in this matter, it could have a material adverse effect on our business, financial condition and results of operations and cash flow.

 

The Company is not aware of any other asserted or unasserted claims against it where the resolution would have an adverse material impact on the operations or financial position of the Company.

 

ITEM 1A. RISK FACTORS AFFECTING OPERATIONS AND FUTURE RESULTS

 

Set forth below and elsewhere in this Form 10-Q and in other documents we file with the Securities and Exchange Commission (the “SEC”) are risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements contained in this Quarterly Report on Form 10-Q. These are not the only risks and uncertainties facing VIVUS. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations.

 

Risks Relating to our Product Development Efforts

 

We face significant risks in our product development efforts.

 

The process of developing new drugs and/or therapeutic products is inherently complex, time-consuming, expensive and uncertain. We must make long-term investments and commit significant resources before knowing whether our development programs will result in products that will receive regulatory approval and achieve market acceptance. Investigational product candidates that may appear to be promising at all stages of development may not reach the market for a number of reasons. Investigational product candidates may be found ineffective or may cause harmful side effects during clinical trials, may take longer to progress through clinical trials than had been anticipated, may not be able to achieve the pre-defined clinical endpoint due to statistical anomalies even though clinical benefit may have been achieved, may fail to receive necessary regulatory approvals, may prove impracticable to manufacture in commercial quantities at reasonable cost and with acceptable quality, or may fail to achieve market acceptance. Historically, our development efforts have been focused on products for sexual and postmenopausal health. While we have experience in managing Phase 1 through 3 clinical trials in support of various indications, we do not have any experience in managing Phase 3 clinical trials for obesity or Phase 2 clinical trials for diabetes. There can be no assurance that we will be successful with the limited experience and resources we have available at the present time relating to obesity or diabetes.

 

The results of pre-clinical studies and completed clinical trials are not necessarily predictive of future results, and our current investigational product candidates may not have favorable results in later studies or trials.

 

Pre-clinical studies and Phase 1 and Phase 2 clinical trials are not primarily designed to test the efficacy of an investigational product candidate in the general population, but rather to test initial safety, to study pharmacokinetics and pharmacodynamics, to study limited efficacy in a selected disease population, and to identify and attempt to understand the investigational product candidate’s side effects at various doses and schedules. Success in pre-clinical studies or completed clinical trials does not ensure that later studies or trials, including continuing pre-clinical studies and large-scale clinical trials, will be successful nor does it necessarily predict future results. Favorable results in early studies or trials may not be repeated in later studies or trials, and investigational product candidates in later stage trials may fail to show acceptable safety and efficacy despite having progressed through initial-stage trials. In addition, the placebo rate in larger studies may be higher than expected.

 

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Our investigational product candidates, Qnexa, Luramist and avanafil, have not completed the large, pivotal Phase 3 trials for efficacy and safety that are required for approval by the FDA and other worldwide regulatory authorities. Pre-clinical data and the limited clinical results that we have obtained for these investigational products may not predict results from studies in larger numbers of subjects in multiple sites drawn from more diverse populations treated for longer periods of time. The smaller clinical trials also may not predict the ability of these investigational products to achieve or sustain the desired effects in the broad intended population or to do so safely. We may also decide to not conduct additional Phase 2 studies prior to the initiation of pivotal Phase 3 studies. In addition, we may elect to enter into pivotal Phase 3 studies with a new formulation, delivery system or choose to study different populations than had been used or studied in previous clinical trials.

 

Qnexa is our proprietary capsule formulation investigational product candidate containing the active ingredients phentermine and topiramate. Phentermine was approved for the short-term treatment of obesity by the FDA in 1959. Topiramate is approved for seizures and migraine prevention. Topiramate has been reported in published studies to produce weight loss. By combining the activity of each of these compounds, Qnexa attempts to simultaneously address excessive appetite and a high threshold for satiety, the two main mechanisms believed to impact eating behavior. Although we believe Qnexa affects both of the two major causes of overeating, excessive hunger and the inability to feel satisfied, we may not be correct in our assessment of the impact the combination of these two ingredients may have on weight loss or their mechanism of action. Our Phase 2 study was a single center trial conducted at Duke University in only 200 patients. The twice-a-day dose and timing of the administration of the active ingredients was determined by the inventor through the treatment of patients in his private practice. We have completed the formulation development of Qnexa and have initiated Phase 3 studies of Qnexa with a once-a-day formulation. We have completed various pharmacokinetic studies of the once-a-day formulations to characterize the pharmacokinetic profile of the once-a-day formulation of Qnexa; however, there can be no assurance that we will be able to achieve any weight loss effects with the once-a-day formulation or that we will be able to duplicate the weight loss seen in the Phase 2 study. The FDA has also asked us to study the effects of a lower dose of Qnexa, which we plan to do in the Phase 3 trials. We are unable to predict the effect of the inclusion of a lower dose group in the Phase 3 trials on the overall development program of Qnexa.

 

We will be required to demonstrate through larger-scale clinical trials that these investigational product candidates are safe and effective for use in a broad population before we can seek regulatory approvals for their commercial sale. There is typically a high rate of attrition from the failure of investigational product candidates proceeding through clinical trials. To date, long-term safety and efficacy have not yet been demonstrated in clinical trials for any of our investigational product candidates. If any of our investigational products fails to demonstrate sufficient safety and efficacy in any clinical trial, we will experience potentially significant delays in, or decide to abandon development of, that investigational product candidate. If we abandon or are delayed in our development efforts related to any of our investigational products we may not be able to generate sufficient revenues to continue our operations and clinical studies at the current level or become profitable, our reputation in the industry and in the investment community would likely be significantly damaged, it may not be possible for us to complete financings, and our stock price would likely decrease significantly.

 

If the results of current or future pre-clinical studies, clinical testing and/or clinical trials indicate that our proposed products are not safe or effective for human use, our business will suffer.

 

Unfavorable results from ongoing pre-clinical studies, clinical testing and/or clinical trials could result in delays, modifications or abandonment of ongoing or future clinical trials. A number of companies in the pharmaceutical industry have suffered significant setbacks in late stage clinical trials, even after promising results in initial-stage trials. Clinical results are frequently susceptible to varying interpretations that may delay, limit or prevent regulatory approvals. Negative or inconclusive results or adverse medical events during a clinical trial could cause a clinical trial to be delayed, repeated, modified or terminated. In addition, failure to design appropriate clinical trial protocols could result in the test or control group experiencing a disproportionate number of adverse events and could cause a clinical trial to be delayed, repeated, modified or terminated.

 

All of the investigational product candidates that we are currently developing require extensive pre-clinical and/or clinical testing before we can submit any application for regulatory approval. Before obtaining regulatory approvals for the commercial sale of any of our investigational product candidates, we must demonstrate through pre-clinical testing and/or clinical trials that

 

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our investigational product candidates are safe and effective in humans. Conducting clinical trials is a lengthy, expensive and uncertain process. Completion of clinical trials may take several years or more. Our ability to complete clinical trials may be delayed by many factors, including, but not limited to:

 

·      inability to obtain or manufacture sufficient quantities of drugs for use in clinical trials;

 

·      failure to receive approval by the FDA of our clinical trial protocols;

 

·      changes in clinical trial protocols made by us or imposed by the FDA;

 

·      the effectiveness of our investigational product candidates;

 

·      slower than expected rate of and higher than expected cost of patient recruitment;

 

·      inability to adequately follow patients after treatment;

 

·      unforeseen safety issues;

 

·      government or regulatory delays; or

 

·      our ability to raise the necessary cash to start or complete the trials.

 

Many of these factors may also ultimately lead to denial of regulatory approval of a current or investigational drug candidate. If we experience delays, suspensions or terminations in our clinical trials for a particular investigational product candidate, the commercial prospects for that investigational candidate will be harmed, and we may be unable to raise additional funds, or generate product revenues from that investigational candidate or revenues would be delayed.

 

One of the active ingredients in Qnexa, phentermine, had previously been used in combination with fenfluramine and dexfenfluramine. Phentermine is the most commonly prescribed anti-obesity product. As phentermine is an older drug, no new efficacy trials have been conducted with the exception of several trials on the combination of phentermine and fenfluramine in the early and mid 1990s. The combination of fenfluramine or PONDIMIN (“fen”) and phentermine (“phen”) was known as “fen-phen.” Fenfluramine received FDA approval in 1973 for the short-term treatment of obesity. Together, phentermine and fenfluramine were used by doctors to treat obesity. The FDA never approved the fen-phen combination; however, since the FDA approved fenfluramine, doctors were able to prescribe it as needed. The use of these drugs together for treatment of obesity was considered an off-label and unapproved use. In 1992, a published study cited fen-phen as a more effective method than dieting or exercise in reducing the weight of the chronically obese. The fen-phen combination was successful and in 1996, 6.6 million prescriptions of fen-phen were written. In the U.S. Dexfen-phen refers to the combination of dexfenfluramine or Redux (“dexfen”) and phentermine. Dexfenfluramine received FDA approval in 1996 for use as an appetite suppressant in the management of obesity.

 

Neither combination, however, was ever tested for safety. By the summer of 1997, the Mayo Clinic reported 24 cases of heart valve disease in patients that had taken the fen-phen combination. The cluster of unusual cases of heart valve disease in fen-phen users suggested a co-relation between fen-phen use and heart valve disease. On July 8, 1997, the FDA issued a Public Health Advisory to report the Mayo findings. The FDA continued to receive additional reports of heart disease, including reports from patients who had taken only fenfluramine or dexfenfluramine. Further evaluations of patients taking fenfluramine or dexfenfluramine showed that approximately 30% had abnormal valve findings. This figure was much higher than expected for abnormal test results and suggests fenfluramine and dexfenfluramine as the likely causes of Primary Pulmonary Hypertension (“PPH”) and valvular heart disease.

 

In September 1997, the FDA requested drug manufacturers to voluntarily withdraw fenfluramine and dexfenfluramine. At the same time, the FDA recommended that patients using either fenfluramine or dexfenfluramine stop taking them. The FDA did not, however, request the withdrawal of phentermine. Although studies to date have shown that phentermine does not cause PPH and valvular heart disease, there can be no assurance that Qnexa will not have any significant cardiovascular or other detrimental side effects. In the Phase 2 study, echocardiograms and cardiovascular monitoring were performed and no abnormalities were noted. Moreover, the adverse clinical history of fen-phen and dexfen-phen combinations for obesity may result in increased FDA regulatory scrutiny of the safety or the risk/benefit profile of Qnexa and may raise potential adverse publicity in the marketplace, which could affect clinical enrollment or ultimately market acceptance if Qnexa is approved for sale.

 

Previous published studies suggest that the administration of topiramate alone, in conjunction with diet and a behavioral modification program, results in weight reduction in obese patients. The most prominent side effect seen in the published

 

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studies was paresthesia, (tingling of the extremities) experienced by 42% to 59% of patients. Drop outs due to paresthesia were 5% or less. In the Phase 2 Duke study, paresthesia was experienced in 38% of the patients on Qnexa. There were no drop outs in the Qnexa group due to paresthesia. The other common adverse events experienced in the topiramate monotherapy studies were also central nervous system (“CNS”) related including fatigue, difficulty with attention, memory and concentration and depression. In the Phase 2 study, these CNS related side effects were also experienced but the difference was not significant when compared to placebo. The pharmaceutical company performing research of topiramate alone announced they had discontinued development of a time-release formulation due to side effects at high doses.

 

The FDA has also recently issued an alert on the use of antiepileptic drugs and a potential risk of increased suicidal ideation. The agency has requested that as part of our Phase 3 trials for Qnexa, a standard analysis of patients’ suicidal tendencies be performed. While we do not expect a negative impact from the completion of this analysis, any approved labeled use of Qnexa may exclude patients with suicidal tendencies.

 

To date, the clinical results we have obtained do not necessarily predict that the results of further testing, including larger, late-stage controlled human clinical testing, will be successful. If our trials are not successful or are perceived as not successful by the FDA or physicians, our business, financial condition and results of operations will be materially harmed.

 

Our investigational product candidate, Qnexa, is a combination of drugs approved individually by the FDA that are commercially available and marketed by other companies. As a result, our product may be subject to substitution and competition.

 

We anticipate that each of the approved drugs that are combined to produce our investigational product candidate, Qnexa, will be commercially available at prices lower than the price at which we would seek to market our investigational product candidate. We cannot be sure that physicians will view our products as sufficiently superior to a treatment regime of the individual active pharmaceutical ingredients as to justify the significantly higher cost we expect to seek for Qnexa, and they may prescribe the individual drugs already approved and marketed by other companies instead of our combination product. Even though our U.S. patent contains composition, product formulation and method-of-use claims that should protect Qnexa, that patent may be ineffective as a practical matter to protect against physicians prescribing the individual drugs marketed by other companies instead of our combination product. To the extent that the price of our product is significantly higher than the prices of the individual components as marketed by other companies, physicians may have a greater incentive to write prescriptions for the individual components instead of for our combination product, and this may limit how we price Qnexa. Similar concerns could also limit the reimbursement amounts private health insurers or government agencies in the United States are prepared to pay for Qnexa, which could also limit market and patient acceptance of our product, and could negatively impact our revenues and net income, if any. A physician could seek to prescribe off-label generics in place of Qnexa. Off-label use occurs when a drug that is approved by the FDA for one indication is legally prescribed by physicians for a different, unapproved indication. Topiramate, one of the ingredients in Qnexa, is not approved for obesity treatment. With regard to off-label substitution at the pharmacy level, we expect to rely on the novel dose ratios and novel pharmacokinetic properties of our investigational product candidate, to provide sufficient distinction such that generic preparations are not considered therapeutic equivalents by the FDA. State pharmacy laws in many instances preclude pharmacists from substituting with generic preparations if the products are not therapeutic equivalents. We believe there will be no commercially available doses of the active ingredients in Qnexa, when and if approved. Therefore, the lack of therapeutic equivalency restricts generic substitution by pharmacies and/or pharmacy benefit managers. However, we cannot be certain that pharmacists and/or pharmacy benefit managers will not substitute generics in place of Qnexa, which could significantly diminish its market potential. Physicians might also prescribe the individual components of an investigational product candidate prior to Qnexa’s approval, which could adversely affect our development of the investigational product candidate due to our lack of control over the administration to patients of the combination of active pharmaceutical ingredients in our investigational product candidate, the occurrence of adverse effects, and other reasons. Such pre-approval use could also adversely affect our ability to market and commercialize Qnexa.

 

In many countries where we may plan to market Qnexa, including Europe, Japan and Canada, the pricing of prescription drugs is controlled by the government or regulatory agencies. Regulatory agencies in these countries could determine that the pricing for Qnexa should be based on prices for its active pharmaceutical ingredients when sold separately, rather than allowing us to market Qnexa at a premium as a new drug.

 

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The FDA and other regulatory agencies will likely require more extensive or expensive trials for our combination investigational product candidate, Qnexa, than may be required for single agent pharmaceuticals.

 

To obtain regulatory approval for Qnexa, we will be required to show that each active pharmaceutical ingredient in the investigational product candidate makes a contribution to the combined investigational product candidate’s claimed effects and that the dosage of each component, including amount, frequency and duration, is such that the combination is safe and effective. As a result, we will be required to include in our clinical trials an evaluation of each component drug as well as for the component drug in combination. This would likely require us to conduct more extensive and more expensive clinical trials than would be the case for many single agent pharmaceuticals. The need to conduct such trials could make it more difficult and costly to obtain regulatory approval of Qnexa than of a new drug containing only a single active pharmaceutical ingredient. The OB-301, or EQUIP trial, is designed to meet the combination guidelines set by the FDA. This trial was fully enrolled in March 2008. Data from this study is expected to be available late in 2008.

 

We are exposed to risks related to collaborative arrangements, licenses or strategic alliances.

 

We have and will continue to in-license investigational product candidates from third parties. The United States rights to Evamist and Luramist were licensed from Acrux and its related affiliates. The rights to avanafil were licensed from Tanabe. The rights to Evamist, under the Acrux Agreement, were sublicensed to K-V upon closing of the sale of Evamist to K-V. Each of these agreements contains certain obligations. Failure to comply with the terms of the agreements could result in the early termination of these agreements. We believe we are in compliance with all the material terms of these agreements; however, there can be no assurance that this compliance will continue or that the licensors would not have a differing interpretation of the material terms of the agreements. If the license or sublicense agreements were terminated early or if the terms of the license or sublicense were contested for any reason, it would have a material adverse impact on our ability to commercialize products subject to these agreements, our ability to raise funds to finance the company, our stock price and our overall financial condition. In the event that the Acrux license was terminated, and at such time K-V was not in material breach of the sublicense, then we may be required to pay as liquidated damages an amount equal to the amounts paid by K-V for Evamist under our Asset Purchase Agreement with K-V.

 

VIVUS and Acrux Limited, or Acrux, are parties to the Testosterone Development and Commercialization Agreement and the Estradiol Development and Commercialization Agreement, each dated February 12, 2004, or the Acrux Agreements. The Acrux Agreements cover our Evamist and Luramist investigational products, both of which are licensed from Acrux under the Acrux Agreements. We received a letter dated November 13, 2006 from legal counsel for Acrux containing various claims of breach under the Acrux Agreements. We have responded that we believe there is no merit to those claims and that we have meritorious defenses to such claims. The claims with respect to Evamist have not progressed further, but, to date, the claims have not been withdrawn. On November 5, 2007, Acrux made a demand for arbitration under the Acrux Agreements regarding its claims related to Luramist. Acrux’s demand seeks a reversion of all rights assigned to VIVUS related to Luramist, monetary damages, a portion of a milestone payment for Luramist under the Acrux Agreements and declaratory relief. We believe that we are in compliance with all material aspects of the Acrux Agreements, including those relating to Luramist and that we currently do not owe monetary damages or any milestone payment under the Acrux Agreements. The arbitration process is proceeding, with the parties selecting and qualifying potential arbitrators. However, in the event that Acrux should prevail in this matter, it could have a material adverse effect on our business, financial condition and results of operations and cash flow.

 

We are, and in the future expect to be, dependent upon collaborative arrangements or strategic alliances to complete the development and commercialization of some of our investigational product candidates, particularly after the Phase 2 stage of clinical testing. These arrangements may place the development of our investigational product candidates outside of our control, may require us to relinquish important rights, or may otherwise be on terms unfavorable to us.

 

In October 2007, Tanabe and Mitsubishi Pharma Corporation completed their merger and announced their name change to Mitsubishi Tanabe Pharma Corporation (“Mitsubishi Tanabe”). It is unclear at this time what effect, if any, the merger will have on our agreement with Tanabe. There can be no guarantee that the merger of Tanabe and Mitsubishi will not have an adverse material effect on our agreement with Tanabe, which in turn could lead to a material adverse effect on our business, financial condition and results of operations.

 

We may be unable to locate and enter into favorable agreements with third parties, which could delay or impair our ability to develop and commercialize our investigational product candidates and could increase our costs of development and commercialization. Dependence on collaborative arrangements or strategic alliances will subject us to a number of risks, including the risk that:

 

·                  we may not be able to control the amount and timing of resources that our collaborators may devote to the investigational product candidates;

 

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·                  our collaborators may experience financial difficulties;

 

·                  we may be required to relinquish important rights such as marketing and distribution rights;

 

·                  business combinations or significant changes in a collaborator’s business strategy may also adversely affect a collaborator’s willingness or ability to complete its obligations under any arrangement;

 

·                  a collaborator could independently move forward with a competing investigational product candidate developed either independently or in collaboration with others, including our competitors; and

 

·                  collaborative arrangements are often terminated or allowed to expire, which would delay the development and may increase the cost of developing our investigational product candidates.

 

We face significant governmental regulation during our product development activities.

 

The research, testing, manufacturing, selling and marketing of investigational product candidates are subject to extensive regulations by the FDA and other regulatory agencies in the United States and other countries. We cannot predict with certainty if or when we might submit for regulatory review those investigational product candidates currently under development. The FDA can suspend clinical studies at any time if the agency believes that the subjects participating in such studies are being exposed to unacceptable health risks.

 

Regulatory approval is never guaranteed, and the approval process typically takes several years and is extremely expensive. The FDA has substantial discretion in the drug approval process. Despite the time and expense involved, failure can occur at any stage.

 

In June 2007, an FDA advisory panel recommended against approval of rimonabant, an oral obesity treatment targeting the CB1 receptor system being developed by another sponsor. Rimonabant is a centrally acting drug that reduces patients’ desire to eat. The advisory panel expressed concerns about the impact of the drug on depressed patients and also expressed concerns about patients having thoughts about suicide. In addition, concerns about rimonabant’s mechanism of action and interference with the CB1 receptor pathway were also voiced. The sponsor of rimonabant withdrew its NDA shortly after the advisory panel meeting.

 

In December 2004, an FDA advisory panel recommended against approval of a testosterone patch under development by another company to address female sexual dysfunction, specifically hypoactive sexual desire disorder. The FDA indicated that more safety data would be required before it would be in a position to recommend approval. Subsequently, this company withdrew its New Drug Application. We are developing an investigational transdermal testosterone product candidate, Luramist, which is designed to address hypoactive sexual desire disorder. We recently reached agreement with the FDA regarding the long-term cardiovascular event study that we must complete prior to submitting Luramist for approval.  We estimate we will have to enroll a minimum of 5,200 patients, over the age of 50, with one cardiovascular risk factor.  The average minimum exposure to Luramist in the safety study is 12 months.  The safety study is an events driven study and patients will be followed until the minimum number of pre-defined cardiovascular events has occurred. Despite the agreement with the FDA on the size and scope of the safety study, we may be required to undertake additional or expanded clinical trials, which could be expensive and the cause of significant delays in our ability to submit our investigational product candidate to the FDA for consideration. In the end, we may be unsuccessful in obtaining FDA approval of Luramist or any of our investigational product candidates.

 

We are not permitted to market any of our investigational product candidates in the United States until we receive approval from the FDA. As a consequence, any failure to obtain or delay in obtaining FDA approval for our investigational product candidates would delay or prevent our ability to generate revenue from our investigational product candidates, which would adversely affect our financial results and our business.</