Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 


 

x

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

 

 

For The Quarterly Period Ended March 31, 2009

 

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o   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 April 30, 2009, 69,721,583 shares of common stock, par value $.001 per share, were outstanding.

 

 

 



Table of Contents

 

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

 

54

Item 4:

Controls and Procedures

 

54

 

 

 

 

 

PART II — OTHER INFORMATION

 

55

 

 

 

 

Item 1:

Legal Proceedings

 

55

Item 1A:

Risk Factors

 

56

Item 2:

Unregistered Sales of Equity Securities and Use of Proceeds

 

80

Item 3:

Defaults Upon Senior Securities

 

80

Item 4:

Submission of Matters to Vote of Security Holders

 

80

Item 5:

Other Information

 

80

Item 6:

Exhibits

 

80

 

Signatures

 

82

 

 

 

 

 

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

 

 

 

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Table of Contents

 

PART I: FINANCIAL INFORMATION

 

ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

 

VIVUS, INC.

 

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value)

 

 

 

March 31
2009

 

December 31
2008*

 

 

 

(unaudited)

 

 

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

42,723

 

$

66,121

 

Available-for-sale securities

 

122,482

 

121,789

 

Accounts receivable, (net of allowance for doubtful accounts of $53 and $23 at March 31, 2009 and December 31, 2008, respectively)

 

912

 

4,157

 

Inventories, net

 

3,324

 

3,041

 

Prepaid expenses and other assets

 

4,227

 

3,744

 

Total current assets

 

173,668

 

198,852

 

Property, plant and equipment, net

 

6,480

 

6,726

 

Restricted cash

 

700

 

700

 

Available-for-sale securities

 

631

 

1,344

 

Total assets

 

$

181,479

 

$

207,622

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

14,395

 

$

17,205

 

Accrued product returns

 

2,781

 

2,865

 

Accrued research and clinical expenses

 

7,216

 

6,435

 

Accrued chargeback reserve

 

1,482

 

1,379

 

Accrued employee compensation and benefits

 

2,170

 

2,394

 

Accrued and other liabilities

 

1,951

 

1,836

 

Deferred revenue

 

10,928

 

31,858

 

Total current liabilities

 

40,923

 

63,972

 

 

 

 

 

 

 

Notes payable-net of current portion

 

13,514

 

11,177

 

Deferred revenue

 

1,145

 

1,260

 

Total liabilities

 

55,582

 

76,409

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock; $1.00 par value; 5,000 shares authorized; no shares issued and outstanding

 

 

 

Common stock; $.001 par value; 200,000 shares authorized; 69,722 and 69,677 shares issued and outstanding at March 31, 2009 and December 31, 2008, respectively

 

70

 

70

 

Additional paid-in capital

 

312,077

 

310,558

 

Accumulated other comprehensive income

 

328

 

354

 

Accumulated deficit

 

(186,578

)

(179,769

)

Total stockholders’ equity

 

125,897

 

131,213

 

Total liabilities and stockholders’ equity

 

$

181,479

 

$

207,622

 

 


*     Derived from audited consolidated financial statements filed in the Company’s 2008 Annual Report on Form 10-K.

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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VIVUS, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

AND OTHER COMPREHENSIVE INCOME (LOSS)

(In thousands, except per share data)

(UNAUDITED)

 

 

 

Three Months Ended

 

 

 

March 31

 

 

 

2009

 

2008

 

 

 

 

 

 

 

Revenue:

 

 

 

 

 

United States product, net

 

$

893

 

$

1,088

 

International product

 

293

 

554

 

License and other revenue

 

21,046

 

21,046

 

Total revenue

 

22,232

 

22,688

 

Operating expenses:

 

 

 

 

 

Cost of goods sold and manufacturing expense

 

2,603

 

2,787

 

Research and development

 

20,069

 

23,371

 

Selling, general and administrative

 

5,411

 

4,252

 

Total operating expenses

 

28,083

 

30,410

 

 

 

 

 

 

 

Loss from operations

 

(5,851

)

(7,722

)

 

 

 

 

 

 

Interest (expense) income:

 

 

 

 

 

Interest income, net

 

208

 

2,109

 

Interest expense

 

(716

)

(122

)

Other-than-temporary loss on impaired securities

 

(444

)

(1,352

)

Total interest (expense) income

 

(952

)

635

 

Loss before provision for income taxes

 

(6,803

)

(7,087

)

 

 

 

 

 

 

Provision for income taxes

 

(6

)

(5

)

Net loss

 

$

(6,809

)

$

(7,092

)

Other comprehensive loss:

 

 

 

 

 

Unrealized loss on securities

 

(26

)

(305

)

Comprehensive loss

 

$

(6,835

)

$

(7,397

)

 

 

 

 

 

 

Net loss per share:

 

 

 

 

 

Basic and diluted

 

$

(0.10

)

$

(0.12

)

Shares used in per share computation:

 

 

 

 

 

Basic and diluted

 

69,687

 

58,882

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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VIVUS, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

 

 

 

Three Months Ended
March 31

 

 

 

2009

 

2008

 

 

 

(unaudited)

 

(unaudited)

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net loss

 

$

(6,809

)

$

(7,092

)

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

 

 

 

 

 

Provision for doubtful accounts

 

30

 

(12

)

Depreciation

 

283

 

278

 

Net realized loss on investments

 

257

 

12

 

Other-than-temporary loss on impaired securities

 

444

 

1,352

 

Share-based compensation expense

 

1,334

 

1,406

 

Changes in assets and liabilities:

 

 

 

 

 

Accounts receivable

 

3,215

 

2,802

 

Inventories

 

(283

)

(540

)

Prepaid expenses and other assets

 

(483

)

1,481

 

Accounts payable

 

(2,810

)

6,146

 

Accrued product returns

 

(84

)

(74

)

Accrued research and clinical expenses

 

781

 

3,331

 

Accrued chargeback reserve

 

103

 

(229

)

Accrued employee compensation and benefits

 

(224

)

(698

)

Deferred revenue

 

(21,045

)

(21,046

)

Accrued and other liabilities

 

112

 

(464

)

Net cash used for operating activities

 

(25,179

)

(13,347

)

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Property and equipment purchases

 

(37

)

(83

)

Investment purchases

 

(31,406

)

 

Proceeds from sale/maturity of securities

 

30,699

 

29,220

 

Net cash provided by (used for) investing activities

 

(744

)

29,137

 

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Proceeds from notes payable

 

3,333

 

 

Payments of notes payable

 

(993

)

(29

)

Exercise of common stock options

 

185

 

114

 

Net cash provided by financing activities

 

2,525

 

85

 

 

 

 

 

 

 

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

 

(23,398

)

15,875

 

CASH AND CASH EQUIVALENTS:

 

 

 

 

 

Beginning of period

 

66,121

 

37,838

 

End of period

 

$

42,723

 

$

53,713

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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VIVUS, INC.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

MARCH 31, 2009

 

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, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009. The unaudited condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2008, as filed on March 11, 2009 with the Securities and Exchange Commission, or SEC. 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.

 

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International

 

The Company has supply agreements with Meda AB, or Meda, to market and distribute MUSE internationally in some Member States of the European Union. In Canada, the Company entered into a license and supply agreement with Paladin Labs, Inc., or Paladin, for the marketing and distribution of MUSE. Sales to Meda, who supplies MUSE in the European marketplace, for 2008, 2007 and 2006 were 93%, 95.8% and 91.7% 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 received a $1.5 million upfront payment in connection with the international supply agreement signed with Meda in September 2002. In January 2006, the Company also received a milestone payment from Meda of $2 million. The milestone payment provides Meda with the right to continue to sell and distribute MUSE in its European Union territories. These amounts were recorded as deferred revenue and are being recognized ratably over the term of the supply agreement. Through March 31, 2009, $2 million has been recognized as revenue.

 

License and Other Revenue

 

The Company recognizes license revenue in accordance with the SEC’s Staff Accounting Bulletin No. 104, Revenue Recognition, and Emerging Issues Task Force, or 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, or K-V, 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 Food and Drug Administration, or FDA, for marketing. The sale transaction contained multiple deliverables, including: the delivery at closing of the Evamist assets, a grant of a sublicense of the Company’s rights under a license agreement 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, or 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. In August 2008, the Company assigned all of its rights and obligations under the Evamist license agreement to K-V.

 

Upon FDA Approval, the two remaining deliverables are the transition services to be performed under the Transition Services Agreement, or 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 million, is being 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 million paid at closing and the $140 million paid upon FDA Approval have been recorded as deferred revenue and is being 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, 2009, $140 million has been recognized as revenue.

 

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The Company is also eligible to receive milestone payments of up to $30 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.

 

In February 2009, K-V and certain of its subsidiaries announced a voluntary recall of most of its prescription products. Subsequent to the recall, K-V announced plans to reduce its workforce by 700 employees. In January 2009, K-V voluntarily suspended the manufacturing and shipping of all of its products. Evamist is not manufactured by K-V and was not subject to the recall. Given the uncertainties with K-V, it is difficult to determine the extent of the adverse impact on Evamist. Although the Company is entitled to additional milestone payments from future sales of Evamist by K-V, at the present time the Company does not anticipate receiving any additional milestones for the sales of Evamist.

 

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 three months ended March 31, 2009 and 2008 was comprised as follows (in thousands, except per share data):

 

 

 

Three Months Ended

 

 

 

March 31,

 

 

 

2009

 

2008

 

 

 

 

 

 

 

Cost of goods sold and manufacturing expense

 

$

172

 

$

137

 

Research and development

 

292

 

483

 

Selling, general and administrative

 

870

 

786

 

Share-based compensation expense before taxes

 

1,334

 

1,406

 

Related income tax benefits

 

 

 

Share-based compensation expense, net of taxes

 

$

1,334

 

$

1,406

 

Basic and diluted per common share

 

$

0.02

 

$

0.02

 

 

4. CASH, CASH EQUIVALENTS AND AVAILABLE-FOR-SALE SECURITIES

 

The fair value and the amortized cost of cash, cash equivalents, and available-for-sale securities by major security type at March 31, 2009 and December 31, 2008 are presented in the tables that follow:

 

As of March 31, 2009 (in thousands) (unaudited):

 

Cash and cash equivalents

 

Amortized
Cost

 

Estimated
Fair Value

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Cash and money market funds

 

$

42,723

 

$

42,723

 

$

 

$

 

Total cash and cash equivalents

 

$

42,723

 

$

42,723

 

$

 

$

 

 

Available-for-sale securities

 

Amortized
Cost

 

Estimated
Fair Value

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

U.S. Treasury securities and debt securities of U.S. government agencies

 

$

113,643

 

$

113,795

 

$

159

 

$

(7

)

Corporate bonds

 

688

 

688

 

 

 

Asset backed and other securities

 

7,823

 

7,999

 

176

 

 

Total available-for-sale securities

 

$

122,154

 

$

122,482

 

$

335

 

$

(7

)

 

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Available-for-sale securities, non-current

 

Amortized
Cost

 

Estimated
Fair Value

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Corporate bonds

 

$

562

 

$

562

 

$

 

$

 

Asset backed and other securities

 

69

 

69

 

 

 

Total available-for-sale securities, non current

 

$

631

 

$

631

 

$

 

$

 

 

As of December 31, 2008 (in thousands):

 

Cash and cash equivalents

 

Amortized
Cost

 

Estimated
Fair Value

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Cash and money market funds

 

$

66,121

 

$

66,121

 

$

 

$

 

Total cash and cash equivalents

 

$

66,121

 

$

66,121

 

$

 

$

 

 

Available-for-sale securities

 

Amortized
Cost

 

Estimated
Fair Value

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

U.S. Treasury securities and debt securities of U.S. government agencies

 

$

100,061

 

$

100,412

 

$

351

 

$

 

Corporate bonds

 

8,393

 

8,387

 

 

(6

)

Asset backed and other securities

 

12,981

 

12,990

 

10

 

(1

)

Total available-for-sale securities

 

$

121,435

 

$

121,789

 

$

361

 

$

(7

)

 

Available-for-sale securities, non-current

 

Amortized
Cost

 

Estimated
Fair Value

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Corporate bonds

 

$

1,067

 

$

1,067

 

$

 

$

 

Asset backed and other securities

 

277

 

277

 

 

 

Total available-for-sale securities, non current

 

$

1,344

 

$

1,344

 

$

 

$

 

 

The following table summarizes the Company’s available-for-sale securities by the contractual maturity date as of March 31, 2009 (in thousands) (unaudited):

 

 

 

Amortized
Cost

 

Estimated
Fair Value

 

Due within one year

 

$

114,804

 

$

114,955

 

Due within one year to two years

 

89

 

89

 

*No single maturity date

 

7,892

 

8,069

 

 

 

$

122,785

 

$

123,113

 

 


*                                         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 may 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.

 

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The following table summarizes the net realized gains (losses) on available-for-sale securities for the periods presented (in thousands):

 

 

 

Three Months Ended

 

 

 

March 31, 2009

 

March 31, 2008

 

 

 

(unaudited)

 

(unaudited)

 

Realized gains

 

$

151

 

$

37

 

Realized losses

 

(408

)

(49

)

Net realized gains/(losses)

 

$

(257

)

$

(12

)

 

During the three months ended March 31, 2009, we sold and received paydowns totaling $11.8 million of fixed income securities which resulted in net realized losses of $257,000. In the ordinary course of business, we may sell securities at a loss for a number of reasons, including, but not limited to: (i) changes in the investment environment; (ii) expectation that the fair value could deteriorate further; (iii) desire to reduce exposure to an issuer or an industry; (iv) changes in credit quality; or (v) changes in expected cash flow.

 

At March 31, 2009 and December 31, 2008, we had the following available-for-sale securities that were in an unrealized loss position but were not deemed to be other-than-temporarily impaired (in thousands):

 

 

 

Less Than 12 Months

 

12 Months or Greater

 

 

 

Gross

 

Estimated

 

Gross

 

Estimated

 

 

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

March 31, 2009 (unaudited)

 

Losses

 

Value

 

Losses

 

Value

 

 

 

 

 

 

 

 

 

 

 

U.S. Treasury securities and debt securities of U.S. government agencies

 

$

(7

)

$

26,703

 

$

 

$

 

Total

 

$

(7

)

$

26,703

 

$

 

$

 

 

 

 

Less Than 12 Months

 

12 Months or Greater

 

 

 

Gross

 

Estimated

 

Gross

 

Estimated

 

 

 

Unrealized

 

Fair

 

Unrealized

 

Fair

 

December 31, 2008

 

Losses

 

Value

 

Losses

 

Value

 

 

 

 

 

 

 

 

 

 

 

Corporate bonds

 

$

(6

)

$

231

 

$

 

$

 

Asset backed and other securities

 

(1

)

1,144

 

 

 

Total

 

$

(7

)

$

1,375

 

$

 

$

 

 

The gross unrealized losses reported above for March 31, 2009 and December 31, 2008 were primarily caused by general fluctuations in market interest rates from the respective purchase date of these securities through the end of those periods. No significant facts or circumstances have occurred to indicate that these unrealized losses are related to any deterioration in the creditworthiness of the issuers of the marketable securities the Company owns. Based on the Company’s review of these securities, including its assessment of the duration and severity of the related unrealized losses, the Company has not recorded any other-than-temporary impairment losses on these investments.

 

As of March 31, 2009 and December 31, 2008, the temporary unrealized gains on available-for-sale securities, net of tax, of $328,000 and $354,000, respectively, were included in accumulated other comprehensive income in the accompanying unaudited condensed consolidated balance sheets. As of March 31, 2009, a significant portion of the available-for-sale securities that the Company held were investment grade.

 

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. A significant judgment in the valuation of investments is the determination of when an other-than-temporary decline in value has occurred. We follow a consistent and systematic process for recognizing impairments on securities that sustain other-than-temporary declines in value. We have established a policy for the impairment review process. The decision to impair a security incorporates both quantitative criteria and qualitative information. The impairment review process considers a number of factors including, but not limited to: (i) the length of time and the extent to which the fair value has been less than book value, (ii) the financial condition and near term prospects of the issuer, (iii) our intent and ability to retain impaired investments for a period of time sufficient to allow for any anticipated recovery in value, (iv) whether the debtor is current on interest and principal payments and (v) general market conditions and industry or sector specific

 

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factors. For securities that are deemed to be other-than-temporarily impaired, the security is adjusted to fair value and the resulting losses are recognized in other-than-temporary loss on impaired securities in the condensed consolidated statements of operations. The new cost basis of the impaired securities is not increased for future recoveries in fair value.

 

During the Company’s quarterly impairment assessment, the Company determined that a decline in value of certain securities was other-than-temporary. Accordingly, the Company recorded other-than-temporary impairment adjustments of $444,000 in the three months ended March 31, 2009. The Company included this non-cash impairment charge in other-than-temporary loss on impaired securities in the condensed consolidated statements of operations and other comprehensive income (loss). Other-than-temporary impairment losses recognized in 2009 included impairments on investments for which the Company determined that the impairment was other-than-temporary due to credit downgrades and/or the Company’s intent and ability to hold the investment to maturity. These securities covered a number of industries. If market, industry, and/or investee conditions deteriorate, the Company may incur further impairments. In addition, due to the current lack of a readily available market for certain of the Company’s available-for-sale securities totaling $631,000 and the continued uncertainty in the capital markets, the Company expects to recover the carrying values of these securities beyond the next 12 months. Consequently, the Company has classified those available-for-sale securities as non-current in the condensed consolidated balance sheets.

 

In December 2007, our enhanced money market fund investment, Columbia Strategic Cash Portfolio Fund, or Columbia fund, ceased accepting cash redemption requests and changed to a floating net asset value. In light of the restricted liquidity, the Company elected to receive a pro-rata allocation of the underlying securities in a separately managed account. At March 31, 2009, the market value of securities received in-kind from the Columbia fund investment included in available-for-sale securities was $9.3 million.

 

Fair Value Measurements

 

Effective January 1, 2008, the Company 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.

 

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 (cash and cash equivalents, available-for-sale securities) measured at fair value on a recurring basis as of March 31, 2009 (in thousands):

 

 

 

Basis of Fair Value Measurements

 

 

 

Balance at
March 31, 2009

 

Level 1

 

Level 2

 

Level 3

 

Cash and cash equivalents and available-for-sale securities:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

42,723

 

$

42,723

 

$

 

$

 

U.S. Treasury securities

 

109,073

 

109,073

 

 

 

Debt securities of U.S. government agencies

 

4,722

 

 

4,722

 

 

Corporate bonds

 

1,249

 

 

884

 

365

 

Asset backed and other securities

 

8,069

 

 

6,376

 

1,693

 

Total

 

$

165,836

 

$

151,796

 

$

11,982

 

$

2,058

 

Reported as:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

42,723

 

 

 

 

 

 

 

Available-for-sale securities

 

122,482

 

 

 

 

 

 

 

Available-for-sale securities, non-current

 

631

 

 

 

 

 

 

 

Total

 

$

165,836

 

 

 

 

 

 

 

 

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Fair values are based on quoted market prices, where available. These fair values are obtained primarily from third party pricing services, which generally use Level I or Level II inputs for the determination of fair value in accordance with SFAS 157. Third party pricing services normally derive the security prices through recently reported trades for identical or similar securities making adjustments through the reporting date based upon available market observable information. For securities not actively traded, the third party pricing services may use quoted market prices of comparable instruments or discounted cash flow analyses, incorporating inputs that are currently observable in the markets for similar securities. Inputs that are often used in the valuation methodologies include, but are not limited to, benchmark yields, broker quotes, credit spreads, default rates and prepayment speeds. The Company performs a review of the prices received from third parties to determine whether the prices are reasonable estimates of fair value. The Company’s analyses include, as needed, a comparison of pricing services’ valuations to other pricing services’ valuations for the identical security.

 

The Company generally obtains one price for each investment security. The Company performs a review to assess if the evaluated prices represent a reasonable estimate of their fair value. This process involves quantitative and qualitative analysis by the Company. Examples of procedures performed include, but are not limited to, initial and ongoing review of pricing service methodologies, review of the prices received from the pricing service, and comparison of prices for certain securities with two different appropriate price sources for reasonableness. As a result of this analysis, if the Company determines there is a more appropriate fair value based upon available market data, which happens infrequently, the price of a security is adjusted accordingly. The pricing service provides information to indicate which securities were priced using market observable inputs so that the Company can properly categorize its financial assets in the fair value hierarchy.

 

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 States, United Kingdom and Australian markets, a prime auto loan asset-backed security and five structured investment vehicles (SIVs).

 

These Level 3 securities were valued using a number of different sources, namely the use of independent pricing sources which used their proprietary models. The Company reviewed the inputs and assumptions used in these fair value models for reasonableness, and believes that the fair values are consistent with the principles of SFAS 157.

 

The changes in Level 3 assets measured at fair value on a recurring basis for the three months ended March 31, 2009 were (in thousands):

 

Activity for the Three Months Ended March 31, 2009 (unaudited)

 

Fair Value
Measurements
Using Significant
Unobservable
Inputs (Level 3)

 

Balance at December 31, 2008

 

$

 2,314

 

Total unrealized gains included in other comprehensive income/loss

 

31

 

Total (realized/unrealized) losses included in net loss

 

(207

)

Purchases, sales, issuances and settlements, net

 

(539

)

Transfers out of Level 3 securities(a)

 

 

Transfers into Level 3 securities(a)

 

459

 

Balance at March 31, 2009

 

$

 2,058

 

 


(a)               Transfers out of Level 3 are considered to occur at the beginning of the period. Transfers into Level 3 are considered to occur at the end of the period. Transfers into Level 3 were a result of increased use of input data that could not be validated with other market data, resulting from continued deterioration in the credit markets.

 

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The following table presents the amounts of other-than-temporary losses and change in unrealized losses for the three months ended March 31, 2009 relating to those available-for-sale securities for which the Company utilized significant Level 3 inputs to determine fair value and that were still held by the Company at March 31, 2009 (in thousands):

 

For the Three Months Ended March 31, 2009 (unaudited)

 

 

 

Total other-than-temporary loss on impaired securities for the period

 

$

 (268

)

 

 

 

 

Increase in unrealized gains on securities still held at reporting date

 

$

 31

 

 

As of March 31, 2009, the Company does not have any liabilities that are measured at fair value on a recurring basis.

 

Certain assets and liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on an ongoing basis but are subject to fair value adjustments only in certain circumstances (for example, when there is evidence of impairment). There were no assets or liabilities measured at fair value on a nonrecurring basis during the three months ended March 31, 2009.

 

5. INVENTORIES

 

Inventories are recorded net of reserves of $1.5 million and $1.4 million as of March 31, 2009 and December 31, 2008, respectively. Inventory balances, net of reserves, consist of (in thousands):

 

 

 

March 31, 2009

 

December 31, 2008

 

 

 

(unaudited)

 

 

 

Raw materials and component parts

 

$

2,787

 

$

2,719

 

Work in process

 

58

 

40

 

Finished goods

 

479

 

282

 

Inventory, net

 

$

3,324

 

$

3,041

 

 

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 inventories that the Company estimated would have no future use. The Company determined that it likely would continue to use some portion of the fully reserved component parts in production. The Company used $18,000 and $15,000 of its fully reserved component parts inventory during the first three months of 2009 and 2008, 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 three months of 2009 and 2008, 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 $593,000 as of March 31, 2009, and the Company intends 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, 2009 and December 31, 2008, respectively, consist of (in thousands):

 

 

 

March 31, 2009

 

December 31, 2008

 

 

 

(unaudited)

 

 

 

Receivable from Food and Drug Administration

 

$

1,877

 

$

1,877

 

Refundable federal income taxes

 

 

156

 

Prepaid clinical studies

 

873

 

200

 

Interest receivable

 

324

 

368

 

Prepaid insurance

 

466

 

448

 

Other prepaid expenses and assets

 

687

 

695

 

Total

 

$

4,227

 

$

3,744

 

 

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), for the fiscal year 2008 of $653,000 (which was paid to the FDA in October 2007) and for the fiscal year 2009 of $712,000 (which was paid to the FDA in September 2008). The Company believes it is due a refund pursuant to Section 736(d)(1)(C) of the Federal Food, Drug and Cosmetic Act, or 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 the Company’s 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.

 

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7. DEERFIELD FINANCING

 

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). Certain of the agreements were amended and restated on March 16, 2009. 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, or FARA, entered into with a newly incorporated subsidiary of Deerfield, or the Deerfield Sub, and $10 million from the sale of the Company’s common stock under a securities purchase agreement. Under the FARA, the Deerfield Sub made $3.3 million payments to the Company in April, September and December 2008 and February 2009 and will make two quarterly payments of approximately $3.3 million, thereafter. The Company will pay royalties on the current net sales of MUSE and if approved, on future sales of avanafil, an investigational product candidate, to the Deerfield Sub. The term of the FARA is 10 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.

 

The agreements also provide the Company with an option to purchase, and the Deerfield Affiliates with an option to compel the Company to purchase, or put right, 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 before April 3, 2011, or $26 million if exercised after April 3, 2011 but before April 3, 2012 (the purchase prices are subject to other adjustments as defined in the agreement). After April 3, 2011, the Deerfield Affiliates may exercise the right to compel the Company to purchase the Deerfield Sub at a price of $17 million. This price could increase up to $26 million, and the timing of the sale of the shares could be accelerated under certain conditions including a change-in-control, sale of MUSE or avanafil, sale of major assets and the sale of securities in a transaction or a series of related transactions by the Company that exceed 20% of the Company’s outstanding common stock at the date the Option and Put Agreement was signed if at the time of the sale the Company’s market capitalization is below $300 million or each, a Major Transaction. Under these conditions, the cost of the shares of the Deerfield Sub would be $23 million on or before April 3, 2011 and $26 million from April 3, 2011 through April 3, 2018. The sale of the shares of the Deerfield Sub could also accelerate if the Company’s cash, cash equivalents and available for sale securities falls below $15 million or the Company’s market capitalization falls below $50 million. The purchase prices under the put right are subject to other adjustments as defined in the agreements. 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. The Company’s intellectual property and all of the accounts receivable, inventory and machinery and equipment arising out of or relating to MUSE and avanafil are collateral for this transaction. At March 31, 2009, substantially all of the accounts receivable, inventory and machinery and equipment on the Company’s condensed consolidated balance sheet relates to MUSE and serves as collateral for this transaction.

 

The Company has evaluated the Deerfield financing in accordance with FASB Financial Interpretation No., or FIN, 46(R), Consolidation of Variable Interest Entities, or FIN 46R, and determined that the Deerfield Sub may constitute a Variable Interest Entity, or VIE; however, the Company has also determined that it is not the primary beneficiary of this VIE at this time and has therefore concluded that the Company is not required to consolidate the Deerfield Sub (see Note 8: “Notes Payable”).

 

8. NOTES PAYABLE

 

Deerfield Financing

 

In accordance with Emerging Issues Task Force (EITF) Issue 88-18, Sale of Future Revenues, the FARA transaction is in substance a financing arrangement, or loan, that will be repaid by the Company. The minimum repayment amount would be $17 million, the amount of the unconditional put option held by the Deerfield Affiliates, plus royalties paid during the term of the agreement on sales of MUSE and, if approved, avanafil. Accordingly, the Company has recorded the advances from the Deerfield Affiliates, net of the $2 million option right payment and related fees and expenses, as a loan. The loan balance will increase as additional advances are received. The loan balance will increase quarterly up to the minimum amount owed of $17 million. The minimum amount to be recorded is lower than the contractual amounts owed if the Company exercises its call option of $23 million to $26 million, or if the Deerfield Affiliates require the Company to purchase the shares as a result of a “Major Transaction” (see Note 7: “Deerfield Financing”). Using the interest method under APB Opinion No. 21, Interest on Receivables and Payables, interest expense on the loan will be calculated and recognized over three years, which is the estimated term of the loan based on the earliest date that the Deerfield Affiliates could require the Company to repay the amounts advanced. The Deerfield Affiliates will receive a quarterly payment based on net sales of MUSE. The initial imputed effective annual interest rate on the financing was approximately 32% as calculated based upon quarterly advances under the FARA, up to a loan balance of $17 million, offset by the estimated quarterly royalty payments to the Deerfield Affiliates. The imputed interest rate was revised to 33% at December 31, 2008 based on the actual royalty payments made and the timing of payments and advances in 2008. The imputed effective interest rate is utilized for purposes of calculating the interest expense only and does not reflect the amount of royalty paid to the Deerfield Affiliates on a quarterly basis. Quarterly royalty payments are based on a percentage of net MUSE sales at a rate substantially lower than the imputed effective interest rate used to calculate interest expense.

 

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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, or the Agreements, with Crown Bank N. A., or Crown, secured by the land and buildings, among other assets, located at 735 Airport Road and 745 Airport Road in Lakewood, New Jersey, or 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% for the quarters ended March 31, 2009 and 2008, 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, 2009

 

December 31,
2008

 

 

 

(unaudited)

 

 

 

Deerfield loan

 

$

8,653

 

$

6,277

 

Crown Bank N.A. loan

 

5,009

 

5,045

 

Total notes payable

 

13,662

 

11,322

 

Less current portion

 

(148

)

(145

)

Total long-term notes payable

 

$

13,514

 

$

11,177

 

 

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, 2009 are as follows (in thousands):

 

As of March 31, 2009

 

Deerfield Loan

 

Crown Bank N.A.
Loan

 

Total

 

Remainder of 2009

 

$

 

$

145

 

$

145

 

2010

 

 

157

 

157

 

2011

 

8,653

 

169

 

8,822

 

2012

 

 

181

 

181

 

2013

 

 

197

 

197

 

Thereafter

 

 

4,160

 

4,160

 

Total

 

$

8,653

 

$

5,009

 

$

13,662

 

 

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. In October 2007, Tanabe and Mitsubishi Pharma Corporation completed their merger and announced their name change to Mitsubishi Tanabe Pharma Corporation, or Mitsubishi Tanabe. On April 24, 2007, in connection with the Company’s sale of Evamist to K-V (see Note 11: “Sale of Evamist Product”), the Company paid off the outstanding balance of $6.7 million, including all accrued interest, in order to obtain Mitsubishi Tanabe’s release of liens against all assets including the Evamist assets and intellectual property.

 

9. 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. In October 2007, Tanabe and Mitsubishi Pharma Corporation completed their merger and announced their name change to Mitsubishi Tanabe Pharma Corporation, or Mitsubishi Tanabe. 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. No payments were made under this agreement with Mitsubishi Tanabe in the years ended December 31, 2007 and 2008; however, the Company paid Mitsubishi Tanabe $4 million in January 2009 following the enrollment in December 2008 of the first patient in the first Phase 3 clinical study. The Company expects to make other

 

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substantial payments to Mitsubishi Tanabe in accordance with its agreements with Mitsubishi Tanabe as the Company continues to develop and, if approved for sale, commercialize avanafil for the oral treatment of male sexual dysfunction.  Such potential future milestone payments total $15 million in the aggregate and include payments upon: the first submission of an NDA; obtainment of the first regulatory approval in the United States and any major European country; and achievement of $250 million or more in calendar year sales.

 

The term of the Mitsubishi Tanabe agreement is based on a country-by-country and on a product-by-product basis.  The term shall continue until the later of (i) ten years after the date of the first sale for a particular product, or (ii) the expiration of the last to expire patents within the Mitsubishi Tanabe patents covering such product in such country. In the event that the Company’s product is deemed to be (i) insufficiently effective or insufficiently safe relative to other PDE5 inhibitor compounds based on published information, or (ii) not economically feasible to develop due to unforeseen regulatory hurdles or costs as measured by standards common in the pharmaceutical industry for this type of product, the Company has the right to terminate the agreement with Mitsubishi Tanabe with respect to such product.

 

In February 2004, the Company entered into exclusive licensing agreements with Acrux Limited, or Acrux, and a subsidiary of Acrux under which it agreed to develop and, if approved, commercialize Testosterone MDTS, or 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. Under 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. In August 2008, the Company assigned all of its rights and obligations under the Evamist license agreement to K-V. See Note 11: “Sale of Evamist Product” below for additional information concerning the terms of this agreement.

 

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 2009 and 2008, the Company recorded royalty expenses of $9,000 and $68,000, 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, the Company has collected $3.6 million in milestone payments from its current international distributors.

 

10. 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, 2009, it was considered more likely than not that the Company’s deferred tax assets would not be realized.

 

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As of March 31, 2009, the Company believes that the amount of the deferred tax assets recorded on its condensed consolidated balance sheet would not ultimately be recovered.  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 can recover its deferred tax assets.

 

11. 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 licensing agreement with Acrux related to Evamist, a metered dose transdermal spray for the treatment of menopause symptoms, to K-V, or the Transaction. In August 2008, the Company assigned all of its rights and obligations under the Evamist license agreement to K-V. 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 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 million.

 

The Company is also eligible to receive certain one-time payments of up to $30 million based on K-V achieving certain annual net sales thresholds for Evamist. In February 2009, K-V and certain of its subsidiaries announced a voluntary recall of most of its prescription products. Subsequent to the recall, K-V announced plans to reduce its workforce by 700 employees. In January 2009, K-V voluntarily suspended the manufacturing and shipping of all of its products. Evamist is not manufactured by K-V and was not subject to the recall. Given the uncertainties with K-V, it is difficult to determine the extent of the adverse impact on Evamist. Although the Company is entitled to additional milestone payments from future sales of Evamist by K-V, at the present time the Company does not anticipate receiving any additional milestones for the sales of Evamist.

 

In addition, under the terms of the Transaction, K-V reimbursed VIVUS for $1.5 million of the $3 million milestone payment paid by VIVUS to Acrux upon FDA Approval of the NDA. In connection with the Transaction, in order to obtain Mitsubishi Tanabe’s release of liens against all assets including the Evamist assets and intellectual property, the Company repaid the Mitsubishi Tanabe line of credit (see Note 8: “Notes Payable”).

 

12. 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 stock options. Common share equivalents are excluded from the computation in periods in which they have an anti-dilutive effect. Stock options for which the price exceeds the average market price over the period have an anti-dilutive effect on net income per share and, accordingly, are excluded from the calculation. When there is a net loss, other 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, 2009 and 2008, all potential common equivalent shares were excluded as they were anti-dilutive. For the three months ended March 31, 2009 and 2008, 5,760,918 and 2,814,600 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.

 

13. COMMITMENTS AND CONTINGENCIES

 

Lease Commitments

 

In November 2006, the Company entered into a 30-month lease for its Mountain View corporate headquarters location with its existing landlord. The 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.  On December 16, 2008, we entered into an amendment to this lease. Under the terms of the amended lease, we will continue to lease the office space for our corporate headquarters for a two year period commencing on August 1, 2009 and expiring on July 31, 2011. The base monthly rent is set at $1.64 per square foot or $23,000 per month. The amended lease allows us one option to extend the term of the lease for one year from the expiration of the lease.

 

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

 

Remainder of 2009

 

$

397

 

2010

 

513

 

2011

 

299

 

 

 

$

1,209

 

 

Manufacturing Agreements

 

In November 2002, the Company entered into a manufacturing agreement to purchase alprostadil from a supplier beginning in 2003 and ending in 2008. In May 2007, the terms of the agreement were amended to require the purchase of 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.

 

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, 2009, its remaining commitment under these agreements totaled $41.3 million. The Company has remaining commitments under various general and administrative services agreements totaling $2 million at March 31, 2009, including $1.3 million related to Leland F. Wilson’s Employment Agreement (see paragraph 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, 2009, its remaining commitment under these agreements totaled $8.3 million. In addition, the Company has entered into marketing promotion and related agreements for its erectile dysfunction product, MUSE. At March 31, 2009, its remaining commitment under these marketing agreements totaled $695,000.

 

On December 19, 2007, the Compensation Committee of the Board of Directors of the Company approved an employment agreement, or 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, or 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. On January 23, 2009, the Compensation Committee approved an amendment to the Employment Agreement, or the Amendment, which amends the Employment Agreement. Pursuant to the Amendment, the initial term of the Employment Agreement was increased from two to three years commencing on June 1, 2007 and other relevant dates were also extended to reflect the three year initial term.

 

Indemnifications

 

In the normal course of business, the Company provides indemnifications of varying scope to certain customers against claims of intellectual property infringement made by third parties arising from the use of its products and to its clinical research organizations and investigator sites against liabilities incurred in connection with any third-party claim arising from the work performed on behalf of the Company. 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 its 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.

 

Pursuant to the terms of the Funding and Royalty Agreement with Deerfield, the Company made certain representations, warranties and covenants related to MUSE and avanafil. Covenants include that it will maintain all registrations and regulatory rights to sell and promote MUSE in the United States, it will continue to manufacture and promote MUSE and will continue the development of avanafil. The Company also entered into a covenant that it will not manufacture, promote or sell any product that competes with avanafil in the United States other than MUSE.

 

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, the Company maintains 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.

 

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14. CONCENTRATION OF CUSTOMERS AND SUPPLIERS

 

During the first three months of 2009 and 2008, sales to significant customers as a percentage of total revenues were as follows:

 

 

 

2009

 

2008

 

Customer A

 

2

%

5

%

Customer B

 

58

%

42

%

Customer C

 

11

%

19

%

Customer D

 

21

%

23

%

 

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, 2009, the Company spent $7.2 million for services provided by one clinical research organization on the Qnexa Phase 3 studies, which represented 36% of the Company’s total research and development expenses for the quarter. Separately, the Company spent another $5.2 million for services provided by another clinical research organization on the avanafil Phase 3 studies, which represented 26% of the Company’s total research and development expenses for the quarter. In the three months ended March 31, 2008, the Company 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 for the quarter.

 

15. INTEREST INCOME, NET

 

The components of interest income, net were as follows (in thousands):

 

 

 

Three Months Ended
March 31,

 

 

 

2009

 

2008

 

Interest income

 

$

465

 

$

2,121

 

Realized losses on marketable securities, net

 

(257

)

(12

)

Interest income, net

 

$

208

 

$

2,109

 

 

16. EQUITY TRANSACTIONS

 

On April 3, 2008, the Company entered into several agreements with the Deerfield Affiliates (see Note 7: “Deerfield Financing”). Certain of these agreements were amended and restated on March 16, 2009. 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 FARA and $10 million from the sale of the Company’s common stock under a securities purchase agreement. 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 approximately $200,000 in certain expenses incurred in this transaction, registered under the shelf Registration Statement (File Number 333-135793) filed with the SEC on July 14, 2006. The number of shares was determined based on the volume weighted average price on the Nasdaq Global Market of the Company’s common stock on the three days prior to the execution of the securities purchase agreement dated as of April 3, 2008.

 

On May 5, 2008, the Company filed with the SEC a shelf Registration Statement on Form S-3 (File Number 333-150649) which was declared effective by the SEC on May 29, 2008, providing the Company with 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 5, 2008, the Company filed a Form S-8 (File Number 333-150647) 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), or 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.

 

On August 6, 2008, the Company sold $65 million of its common stock in a registered direct offering. Under the terms of the financing, the Company sold 8,365,508 shares of its common stock at a price of $7.77 per share. On August 5, 2008, the Company filed a prospectus supplement with the SEC relating to this registered direct offering under the existing shelf Registration Statement (File Number 333-150649).

 

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On March 9, 2009, the Company filed a Form S-8 (File Number 333-157787) 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.

 

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 through its wholly owned subsidiary FemPharm Pty Ltd., or Acrux, are parties to the Testosterone Development and Commercialization Agreement dated February 12, 2004, or the Testosterone Agreement. The Testosterone Agreement covers the Company’s investigational product candidate, Luramist, which is licensed from Acrux under the Testosterone Agreement. On November 5, 2007, Acrux made a demand for arbitration under the Testosterone Agreement regarding certain claims related to Luramist. Acrux’s demand sought a reversion of all rights assigned to the Company related to Luramist, monetary damages and the payment of a milestone payment for Luramist under the Testosterone Agreement and declaratory relief.  The Company asserted counterclaims against Acrux in the arbitration and sought the enforcement of the Company’s rights under the Testosterone Agreement. The arbitration hearing concluded on January 23, 2009,and on April 6, 2009 the panel of arbitrators, or the Panel, issued its Interim Arbitration Award finding in favor of the Company that it was in compliance with the Testosterone Agreement and denying all of the relief sought by Acrux in its demand. The Panel found that the Company had used diligent, commercially reasonable efforts to develop Luramist and that the Company has satisfied its obligations to keep Acrux informed on the status of the development efforts. The Panel also ruled in favor of the Company on certain of its counterclaims. The Interim Arbitration Award requires the parties to meet and confer on a number of contractual obligations and to report back to the Panel within 35 days on the results of these efforts. See Note 18: “Subsequent Event”.

 

In January 2009, a former employee filed a U.S. Equal Employment Opportunity Commission Claim. The Notice of Charge of Discrimination was vague as to the nature and scope of the claim, merely indicating that sex discrimination and retaliation under Title VII of the Civil Rights Act is alleged. Additionally, the Company received a letter from a former employee claiming California labor code violations in connection with the former employee’s recruitment and wrongful termination. The Company has fully investigated the charges by these former employees and believes that there is no merit to these charges and that it has meritorious defenses to such charges. The Company believes the employees have no claim to additional compensation or benefits. Due to the current economic downturn, employees may be more likely to file employment-related claims, especially those that have received poor performance reviews. Although there may be no merit to such claims, the Company may be required to allocate additional monetary and personnel resources to defend against these types of allegations in the future.

 

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. SUBSEQUENT EVENT

 

As mentioned in Note 17: “Legal Matters”, the arbitration hearing between the Company and Acrux concluded on January 23, 2009, and on April 6, 2009 the Panel issued its Interim Arbitration Award finding in favor of the Company that it was in compliance with the Testosterone Agreement and denying all of the relief sought by Acrux in its demand. The Interim Arbitration Award requires the parties to meet and confer on a number of contractual obligations and to report back to the Panel within 35 days on the results of these efforts.

 

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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 drug candidates and products; (7) risks related to noncompliance with United States Food and Drug Administration, or the FDA, regulations; (8) our ability to demonstrate through clinical testing the safety and effectiveness of our clinical investigational drug 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, or 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, 2009 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 biopharmaceutical company, incorporated in 1991, dedicated to the development and commercialization of therapeutic products for large underserved markets. Our investigational drugs currently under development could serve the obesity, diabetes and sexual health markets. Our current and investigational drug candidates in development encompass patented proprietary formulations and novel delivery systems. To date, through employment of this strategy, we have one FDA approved drug and several investigational drug candidates in late stages of clinical development. With respect to obesity, analysts estimate that this potential worldwide market could exceed $5 billion annually. Sales of approved drugs for diabetes exceed $10 billion. The indications targeted by our investigational sexual health product candidates each represent a projected market greater than $1 billion annually.

 

The current investigational drug pipeline includes three late-stage clinical drug candidates, 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 has completed a Phase 2 clinical trial for diabetes. Another of our investigational drug candidates, avanafil, is in Phase 3 trials for erectile dysfunction.

 

All of the pivotal Phase 3 studies for Qnexa for obesity were initiated in the fourth quarter of 2007 and are fully enrolled. The first Phase 3 study, EQUATE (OB-301), was completed in late 2008. The co-primary endpoints for the ongoing 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 utilize our novel once-a-day formulation of Qnexa, which at full strength contains 15 mg phentermine and 92 mg of a proprietary controlled release formulation of topiramate.

 

Our late-stage investigational product candidate pipeline includes:

 

·                  Qnexa, being developed to treat obesity, for which two of the Phase 3 studies are ongoing and one Phase 3 study has been completed;

 

·                  Qnexa, being developed to treat diabetes, for which a Phase 2 study has been completed;

 

·                  Avanafil, being developed to treat erectile dysfunction (ED), for which Phase 3 studies are ongoing; and

 

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

 

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In April 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, and $10 million from the sale of our common stock under a securities purchase agreement. We pay royalties on the current net sales of MUSE (alprostadil) and if approved, future sales of avanafil, an investigational product candidate, to the Deerfield Affiliates.

 

Evamist™, a metered dose transdermal estradiol spray approved for the treatment of vasomotor symptoms associated with menopause, was sold to K-V Pharmaceutical Company, or K-V, on May 15, 2007 for $150 million in cash, which has all been received.

 

In 1997, we launched MUSE 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 drug candidates in our pipeline;

 

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

 

·                  licensing complementary clinical stage investigational drug candidates or technologies with competitive advantages from third parties for new and established markets.

 

It is our objective to become a leader in the development and commercialization of products for large underserved markets. We believe we have strong intellectual property supporting several opportunities in obesity, diabetes and sexual health. Our future growth depends on our ability to further develop and obtain regulatory approval of our investigational drug candidates for indications in which we are studying 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 our various investigational drug candidates are advanced through the various stages of clinical development. In connection with the sale of Evamist, we received to date an aggregate of $150 million. The sale of Evamist was a unique transaction. As discussed in Note 11: “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 are 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 metered dose transdermal spray, or MDTS, applicator. As compared to revenues from sales of MUSE, 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, 2009, we have incurred a cumulative deficit of $186.6 million and expect to incur operating losses in future years.

 

Year-to-Date 2009

 

Year-to-date highlights include:

 

·                 Issuance of Key European Patent for Qnexa – In January 2009, we announced that the European Patent Office had granted a patent for Qnexa. The European patent, No. 1,187,603, broadly covers Qnexa and its use as a weight loss treatment and extends the intellectual property protection of Qnexa beyond the already issued patents in the United States and abroad.

 

·                 Qnexa Treatment Resulted in Improved Glucose Control in Obese Non-Diabetic Subjects– In January 2009, we announced additional results from the EQUATE study (OB-301), which found that EQUATE study subjects treated with Qnexa had a significant reduction in HbA1c compared to placebo treated subjects. The EQUATE study was designed as a weight loss trial; however, additional analysis of the results showed a significant control of blood sugar in these non-diabetic subjects treated with Qnexa as compared to the placebo group.

 

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·                 Senior Management Promotions – In January 2009, we announced that Peter Tam had been promoted to chief operating officer (COO). In his capacity as COO, Mr. Tam will continue to have overall responsibility for business development, clinical and preclinical development, regulatory affairs and chemistry, manufacturing and controls. In addition, Charles Bowden, M.D., was promoted to senior director, clinical development. Dr. Bowden has assumed responsibility for the avanafil Phase 3 clinical studies and continues to lead our efforts in experimental medicine.

 

·                  Initiated Second Pivotal Phase 3 Trial of Avanafil for Treatment of Erectile Dysfunction – In February 2009, we announced that we had initiated the REVIVE-Diabetes (TA-302) study to evaluate avanafil for treatment of ED in men with diabetes, one of the most common causes of erectile dysfunction.

 

Our Product Pipeline

 

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

 

Product

 

Indication

 

Status

 

Patent Expiry and Number

Qnexa (phentermine and topiramate CR)

 

Obesity

 

Phase 3 ongoing. One Phase 3 study completed

 

2019 (US 7,056,890 B2)

Qnexa (phentermine and topiramate CR)

 

Diabetes

 

Phase 2 study completed

 

2019 (US 7,056,890 B2)

Avanafil (PDE5 inhibitor)

 

Erectile dysfunction

 

Phase 3 ongoing

 

2020 (US 6,656,935)

Luramist (Testosterone MDTS)

 

Hypoactive sexual desire disorder

 

Phase 2 completed

 

2017 (US 6,818,226)

 

Obesity

 

In 2004, the U.S. Centers for Disease Control and Prevention, or the CDC, ranked obesity as one of the top health threats in the United States. 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.

 

In December 2008, we announced the results from the EQUATE (OB-301) study. The EQUATE study included 756 obese subjects (599 females and 157 males) across 32 centers in the United States. The average baseline body mass index, or BMI, of the study population was 36.3 kg/m(2) and baseline weight was 223 pounds. Subjects treated with full-dose and mid-dose Qnexa lost 9.2% and 8.5% of their starting body weight in 28-weeks, respectively, as compared to 1.7% for those in the placebo group (ITT-LOCF p<0000.1%). On an observed basis, patients on full-dose Qnexa lost 11.6% of their body weight in 28-weeks. The protocol for the EQUATE study was designed to meet current FDA guidelines for combination drug development.

 

Diabetes

 

Diabetes is a significant worldwide disease. Based on the third edition of the Diabetes Atlas published in 2006, the International Diabetes Federation estimated that in 2007 there were 246 million people with diabetes worldwide, with 46% of those affected in the 40 to 59 age group. Diabetes, mostly type 2 diabetes, now affects 5.9% of the world’s adult population, with almost 80% of the total in developing countries. The CDC estimates, based on 2007 data, that nearly 24 million people in the United States have diabetes, mostly type 2 diabetes, and that 57 million people have pre-diabetes, a condition that puts people at increased risk of diabetes. Type 2 diabetes 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 global market for diabetes medications was estimated at $24 billion in 2007, according to IMS Health. However, it is estimated that 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

 

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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 clinically meaningful reduction of hemoglobin A1c, a measure used to determine treatment efficacy of anti-diabetic agents.

 

In December 2008, we announced the results of our DM-230 diabetes study, a 56-week, Phase 2 clinical trial in 130 type 2 diabetics conducted at 10 sites in the United States. Subjects treated with Qnexa had a reduction in hemoglobin A1c of 1.6%, from 8.8% to 7.2%, as compared to 1.1% from 8.5% to 7.4% in the placebo group (ITT LOCF p=0.0381) at 56 weeks. Subjects treated with Qnexa for 56-weeks also had a reduction in body weight of 9.4%.

 

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. We believe that by combining these compounds, 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. 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. FDA draft guidelines for obesity products set forth a primary efficacy benchmark in Phase 3 trials of at least 35% of patients achieving 5% or more weight loss. In Europe, the Committee for Medicinal Products for Human Use of the European Medicines Agency 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. The FDA and foreign authorities require obesity studies to be conducted for at least one year. Although the results for both of our Phase 2 studies and our first Phase 3 obesity trial met these current guidelines for efficacy, there can be no assurance that these results can be replicated in a one-year Phase 3 trial.

 

We have successfully completed the Special Protocol Assessment, or SPA, process and have reached agreement with the FDA regarding key elements of the pivotal Phase 3 protocols (OB-301 and OB-303) of Qnexa for the treatment of obesity and weight-related co-morbidities. The key elements of the SPA and suggestions from the FDA were also incorporated into the OB-302 protocol. 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.

 

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 by the sponsor or the FDA 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 obesity development program also includes a six-month Phase 3 pivotal factorial-design study, known as EQUATE (OB-301). The EQUATE study included 756 obese subjects (599 females and 157 males) across 32 centers in the United States. The average baseline BMI of the study population was 36.3 kg/m2 and baseline weight was 223 pounds. The proportion of patients losing 5% or more of their initial body weight was 66% for full-dose, 62% for mid-dose and 15% for placebo (p<0.0001). The proportion of patients losing 10% or more of their initial body weight was 41% for full-dose, 39% for mid-dose and 7% for the placebo group (p<0.0001).

 

The EQUATE study met the primary endpoint by demonstrating superior weight loss with both the full-dose and mid-dose of Qnexa, as compared to the individual components and placebo. Subjects treated with full-dose and mid-dose Qnexa had an average weight loss of 9.2% and 8.5% respectively, as compared to weight loss of 1.7% reported in the placebo group (ITT LOCF p<0.0001). Average weight loss was 19.8 pounds and 18.2 pounds in the treatment arms as compared to 3.3 pounds in the placebo group. Qnexa was well-tolerated, with no drug-related serious adverse events in the study.

 

The most common drug-related adverse events reported for the full-dose, mid-dose and placebo group were paresthesia (tingling of the extremities) (23%, 16%, 3%), dry mouth (18%, 13%, 0%), altered taste (15%, 8%, 0%), headache (16%, 15%, 13%) and constipation (15%, 7%, 8%). Reported drug-related adverse events for depression and altered mood were minimal (1.9%, 0.9% and 1.8%, respectively). Moreover, individual depression assessments for each subject, as measured by PHQ-9, demonstrated statistically significant improvements (p<0.05) from baseline for both Qnexa treatment groups. Overall average completion rate for the Qnexa treatment group was 70%.

 

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Subjects in the EQUATE study had a 4-week dose titration period followed by 24 weeks of treatment. The study was a randomized, double-blind, placebo-controlled, 7-arm, prospective trial with subjects randomized to receive once-a-day treatment with mid-dose Qnexa (7.5 mg phentermine/46 mg topiramate CR), full-dose Qnexa (15 mg phentermine/92 mg topiramate CR), the respective phentermine and topiramate constituents, or placebo. Subjects were asked to follow a hypocaloric diet representing a 500-calorie/day deficit and were advised to implement a simple lifestyle modification program.

 

The EQUATE study was designed as a weight loss trial; however, additional analysis of the results showed a significant control of blood sugar in these non-diabetic subjects treated with Qnexa as compared to the placebo group. Subjects treated with Qnexa had a significant improvement in glycemic control as measured by a reduction in hemoglobin A1c (HbA1c) compared to placebo. The overall placebo subtracted reduction in HbA1c was 0.11% and 0.10% for Qnexa full and mid-dose, respectively, over the 28-week treatment period (p < 0.0001). Baseline HbA1c levels were 5.48% and 5.42% for the full-dose and mid-dose groups.

 

In November 2007, we initiated two Phase 3 double-blind, placebo-controlled, multi-center studies comparing Qnexa to placebo over a 56-week treatment period. All Phase 3 studies are utilizing our once-a-day formulation of Qnexa, which at full dose contains 15 mg phentermine and 92 mg of a proprietary controlled release formulation of topiramate. The studies are designed to prospectively demonstrate the safety and efficacy of Qnexa in obese and overweight patients with different baseline characteristics. The first year-long 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 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. Top-line results from the EQUIP and CONQUER studies are expected in the third quarter of 2009.

 

We have initiated a one-year extension study for subjects who complete the CONQUER study. The extension study is known as SEQUEL (OB-305). Subjects will continue in a blinded fashion in their respective treatment groups. This extension study is not required by the FDA nor does it need to be completed prior to submission of an NDA. We expect to enroll up to 1,000 subjects in this study. The purpose of this study is to provide long-term safety and efficacy data for commercial purposes.

 

Safety and tolerability of Qnexa will be determined in the Phase 3 studies that include approximately 4,500 subjects by assessment of serious and non-serious adverse events, physical exam, findings and clinical laboratory data. In addition to these standard methods, there are specialized tools for cognitive function, mood and suicidality assessments.

 

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 > 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 primary 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.

 

Our first patent covering Qnexa was issued on June 6, 2006. In January 2009, we announced that the European Patent Office granted a patent for Qnexa. The European patent, No. 1,187,603, broadly covers Qnexa and its use as a weight loss treatment. The patent extends the intellectual property protection of Qnexa beyond the already issued patents in the United States and abroad. In addition, Qnexa is the subject of multiple U.S. and international patent applications.

 

Qnexa for Diabetes

 

In December 2008, we announced the results of the DM-230 study, a one-year study in type 2 diabetics. The study met its primary endpoint of demonstrating glycemic control as measured by a reduction of hemoglobin A1c of 1.6% from 8.8% to 7.2% for subjects treated with Qnexa, as compared to 1.1% from 8.5% to 7.4% in the placebo group (ITT LOCF p=0.0381) at 56 weeks. Subjects in the

 

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study were actively managed according to American Diabetes Association, or ADA, standards of care with respect to diabetes medications and lifestyle. For subjects treated with placebo, significant increases in the number and doses of concurrent anti-diabetic medications were required to bring about the observed reduction in HbA1c. By contrast, concurrent anti-diabetic medications were actually reduced over the course of the trial in subjects treated with Qnexa (p<0.05).

 

Fasting plasma glucose levels were reduced in subjects treated with Qnexa from 176 mg/dL to 133 mg/dL, as compared to a decrease from 171 mg/dL to 145 mg/dL for the placebo group (p=0.02). Over 56 weeks, subjects treated with Qnexa also lost 9.4% of their baseline body weight, or 20.5 pounds, as compared to 2.7%, or 6.1 pounds, for the placebo group (p<0.0001). Subjects treated with Qnexa had reductions in blood pressure, triglycerides and waist circumference. Both treatment groups had a study completion rate greater than 90%.

 

The most common drug-related adverse events reported over the year for the treatment and placebo groups, respectively, were tingling (19%, 0%), constipation (13%, 4%) and nausea (12%, 6%). Patients on antidepressants such as SSRI’s or SNRI’s were allowed to participate in the studies. Subjects were monitored for depression and suicidality using the PHQ-9 questionnaire, a validated mental health assessment tool agreed to by the FDA for use in our studies. Subjects treated with Qnexa demonstrated greater improvements in PHQ-9 scores from baseline to the end of the study than the placebo group.

 

Despite a mean baseline HbA1c level of 8.8%, 53% of the subjects treated with Qnexa were able to achieve the ADA recommended goal of 7% or lower, versus 40% of the subjects in the placebo arm (p<0.05). The incidence of hypoglycemia in the treatment and placebo arms were similar (12% and 9%, respectively). Qnexa was well-tolerated, with no treatment-related serious adverse events.

 

The DM-230 study enrolled 130 subjects, who completed OB-202, at 10 study sites to continue in a blinded fashion as previously randomized for an additional 28 weeks. The results of the DM-230 study included assessments from the start of the OB-202 study through the end of the DM-230 study in this population, for a total treatment period of 56 weeks.

 

Male Sexual Health

 

Erectile dysfunction, or ED, is defined as the inability to attain or maintain an erection sufficient for intercourse. ED 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 2008 of PDE5 inhibitor products for ED were in excess of $3.7 billion, including approximately $1.9 billion in sales of Viagra, approximately $1.5 billion in sales of Cialis and approximately $300 million in estimated 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. In October 2007, Tanabe and Mitsubishi Pharma Corporation completed their merger and announced their name change to Mitsubishi Tanabe Pharma Corporation, or Mitsubishi Tanabe. We have exclusive worldwide development and commercialization rights for avanafil with the exception of certain Asian markets.

 

Pre-clinical and clinical data suggest 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.

 

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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.

 

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 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.

 

In December 2008, we initiated the first of several pivotal Phase 3 studies of avanafil. The first study, REVIVE (TA-301), is a randomized, double-blind, placebo-controlled, efficacy and safety study of avanafil in men with a history of ED. In April 2009, we completed enrollment in this study. Subjects will undergo a four-week run-in period followed by 12 weeks of treatment. Subjects will be randomized to placebo or one of three dose levels of active drug. The primary endpoints of the study will be improvement in erectile function as measured by the Sexual Encounter Profile and improvements in the International Index of Erectile Function score, or IIEF.

 

The REVIVE study (TA-301) is being conducted pursuant to an SPA agreement with the FDA. TA-301 has enrolled over 600 patients at approximately 40 sites in the United States. Subjects are instructed to attempt sexual intercourse 30 minutes after taking avanafil, with no restrictions on food or alcohol consumption. TA-301 will study three doses of avanafil: 50mg, 100 mg and 200mg.

 

The Phase 3 program will include two additional studies. It is expected that REVIVE-Diabetes (TA-302) will enroll 300 subjects with ED caused by diabetes; REVIVE-RP (TA-303) will enroll 375 subjects with ED who have undergone a radical prostatectomy. REVIVE-Diabetes and REVIVE-RP have commenced enrollment. Subjects will undergo a four-week run-in period followed by 12 weeks of treatment. Subjects will be randomized to placebo or one of three dose levels of active drug. The primary endpoints of the study will be improvement in erectile function as measured by the Sexual Encounter Profile and improvements in the IIEF score. Subjects are instructed to attempt sexual intercourse 30 minutes after taking avanafil, with no restrictions on food or alcohol consumption. TA-302 and TA-303 will study two doses of avanafil: 100 mg and 200mg.

 

The Phase 3 program will also include an open-label safety study, TA-314. Enrollment in TA-314 has begun. The open label study will follow subjects for up to one year with the objective of providing data on at least 300 subjects for six months and 100 subjects for 12 months.

 

VIVUS has entered into a $30 million funding collaboration with Deerfield to provide funding for the Phase 3 studies of avanafil.

 

Female Sexual Health

 

We believe that the market for the treatment of sexual disorders in women is large and underserved. A paper published in 1999 in the Journal of the American Medical Association noted that 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 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.

 

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Testosterone MDTS

 

Hypoactive Sexual Desire Disorder

 

Hypoactive Sexual Desire Disorder, or 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 applied transdermally 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, or 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 January 2008, we successfully completed and reached agreement with the FDA regarding the SPA for the Phase 3 efficacy trial for Luramist. We plan to conduct two identically designed efficacy trials. 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 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.

 

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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 out to five years are not required for NDA submission.

 

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 14 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 Evamist Agreement to K-V, or the Transaction. The closing of the Transaction occurred on May 15, 2007. Under the terms of the Transaction, upon the closing, we received an upfront payment of $10 million. 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 million milestone payment due upon FDA approval of the Evamist NDA. In August 2008, the Company assigned all of its rights and obligations under the Evamist license agreement to K-V. We are also eligible to receive certain one-time payments of up to $30 million based on achieving certain annual net sales thresholds for Evamist. In connection with the Transaction, in order to obtain Mitsubishi Tanabe’s blanket release of liens against our assets including the Evamist assets and intellectual property, we repaid the Mitsubishi 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 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 million product approval milestone became due and was paid to Acrux in August 2007. Under the terms of the Transaction, K-V paid $1.5 million of this $3 million milestone.

 

In February 2009, K-V and certain of its subsidiaries announced a voluntary recall of most of its prescription products. Subsequent to the recall, K-V announced plans to reduce its workforce by 700 employees. In January 2009, K-V voluntarily suspended the manufacturing and shipping of all of its products. Evamist is not manufactured by K-V and was not subject to the recall. Given the uncertainties with K-V, it is difficult to determine the extent of the adverse impact on Evamist. Although we are entitled to additional milestone payments from future sales of Evamist by K-V, at the present time we do not anticipate receiving any additional milestones for the sales of Evamist.

 

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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). Certain of the agreements were amended and restated on March 16, 2009. 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 the Funding and Royalty Agreement, or FARA, entered into with a newly incorporated subsidiary of Deerfield, or the Deerfield Sub, and $10 million from the sale of our common stock. Under the FARA, the Deerfield Sub made $3.3 million payments to us in April, September and December 2008 and February 2009 and will make two quarterly payments of approximately $3.3 million thereafter. Such payments are referred to as the Funding Payments. We will pay royalties on the current net sales of MUSE and, if approved, on future sales of avanafil, an investigational product candidate to the Deerfield Sub. The term of the FARA is 10 years. The FARA includes covenants requiring us to use commercially reasonable efforts to preserve our intellectual property, to manufacture, promote and sell MUSE, and to 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 approximately $200,000 in certain expenses incurred in this transaction. The number of shares was determined based on the volume weighted average price on the NASDAQ Global Market of the Company’s common stock on the three days prior to the execution of the securities purchase agreement dated as of April 3, 2008. 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, each as described in greater detail below. 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, the Company, the Deerfield Affiliates and the Deerfield Sub entered into the Option and Put Agreement, dated April 3, 2008, and an Amended and Restated Option and Put Agreement dated March 16, 2009, 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 the Deerfield Sub 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 the 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, less $2 million we paid on closing, if the Option is exercised on or prior to the third anniversary of the execution of the OPA; or

 

·                  $28 million, less $2 million we paid on closing, 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 the Deerfield Sub at the date of the closing of the resulting sale of the common stock of the Deerfield Sub; (ii) accrued and unpaid royalties; and minus (i) the option premium of $2 million that was paid at the closing of the transaction (referred to as the Option Premium); (ii) accrued but unpaid taxes; (iii) unpaid Funding Payments; (iv) loans payable by the Deerfield Sub; and (v) any other outstanding liabilities of the 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 million; or

 

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

 

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(3)   the fifteenth day following the delivery of written notice to the Company 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, or April 3, 2011, 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, or April 3, 2011, and we have provided the Deerfield Affiliates a Major Transaction Notice; or

 

·                  $17 million, in all other cases.

 

The aggregate consideration payable by the Company 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 the Deerfield Sub at the date of the closing of the resulting sale of the common stock of the Deerfield Sub; (ii) accrued and unpaid royalties; and minus (i) accrued but unpaid taxes; (ii) unpaid Funding Payments; (iii) loans payable by the Deerfield Sub, and (iv) any other outstanding liabilities of the 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 the Company’s common stock immediately preceding such event either:

 

(a)          no longer hold a majority of the shares of the Company’s common stock; or

 

(b)         no longer have the ability to elect a majority of the Company’s Board of Directors;

 

(2)          as a result of which shares of the Company’s common stock 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 the Company or another entity, collectively referred to as Change in Control Transactions;

 

·                  a sale or transfer of the Company’s assets 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 30 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 the Company’s assets or proprietary rights that relate specifically to MUSE or avanafil; or

 

·                  a purchase, tender or exchange offer made to the holders of outstanding shares of the Company’s 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 the Company of an aggregate number of shares of common stock in excess of 20% of the Company’s outstanding common stock on April 3, 2008 if, immediately prior to such issuance, the market capitalization of the Company is less than $300 million.

 

In connection with the FARA, the Deerfield Sub and the Company have entered into a Royalty Security Agreement, whereby we have granted the 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 the Company 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 over that granted to the Deerfield Sub by the Royalty Security Agreement.

 

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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 available-for-sale securities, 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 and other rebate programs, 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. We sell one pharmaceutical product, MUSE, which is sold in four dosages and has a 24-month shelf-life. As of March 31, 2009, the shipments of MUSE in the United States made in 2009, 2008, 2007, and a portion of the shipments in 2006 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 returns data obtained from external sources, along with the shelf life of the product. We believe that the information obtained from external sources is reliable, but we are unable to independently verify the accuracy of such data. 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.

 

At March 31, 2009, we continued to use an estimated product returns rate of 6.5%. We have used this rate since December 31, 2007, based on our product returns experience. Actual product returns can fluctuate between years due to both the timing of expiration and timing of when customers apply the credit memos that have been issued for returned product. The product returns reserve at March 31, 2009, covering the estimated returns exposure for product shipped in 2009, 2008, 2007 and a portion of 2006, was $2.8 million. This product returns reserve calculation is based upon the most recent information available, and we believe is reasonable and adequate to cover the estimated future credit memos to be issued for the return of prior sales of MUSE. Quarterly, we will continue to monitor the product returns experience and make adjustments to the product returns reserve, as appropriate.

 

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·      Chargebacks:  Chargebacks include government chargebacks which are contractual commitments by us to provide MUSE to federal government organizations including the Veterans Administration at specified prices and other rebate programs, including those with managed care organizations, for the reimbursement of portions of the prescriptions filled that are covered by these programs. Allowances for chargebacks are recorded at the time of sale to the wholesaler distributors and accrued as a reserve. In estimating the chargeback reserve, we analyze actual government chargeback and rebate amounts paid and apply chargeback rates to estimates of the quantity of units subject to chargeback. We estimate this reserve by utilizing historical information, contractual and statutory requirements, end-customer prescription demand data, estimated quantities sold to these organizations and estimated wholesaler inventory levels based upon data obtained from our larger wholesaler customers which we began receiving in 2007. We believe that the information received from the wholesaler customers regarding inventory levels and information received from external sources regarding end-customer prescription demand are reliable, but we are unable to independently verify the accuracy of such data. We routinely reassess the chargeback estimates and adjust the reserves accordingly.

 

·      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 SEC’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, or EITF, Issue No. 00-21, Revenue Arrangements with Multiple Deliverables, or 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, 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, or FDA Approval, and on August 1, 2007, we transferred and assigned the Evamist FDA submissions, and all files related thereto to K-V. In August 2008, the Company assigned all of its rights and obligations under the Evamist license agreement 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, or TSA, and a license to improvements to the MDTS applicator, or 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 are 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, 2008 was $83.7 million and for the three months ended March 31, 2009 was $20.9 million. Such revenue in future quarters is expected to be recognized as follows (in thousands):

 

Quarter ending

 

License revenue

 

June 30, 2009

 

$

10,465

 

 

We are also eligible to 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.

 

In February 2009, K-V and certain of its subsidiaries announced a voluntary recall of most of its prescription products. Subsequent to the recall, K-V announced plans to reduce its workforce by 700 employees. In January 2009, K-V voluntarily suspended the manufacturing and shipping of all of its products. Evamist is not manufactured by K-V and was not subject to the recall. Given the uncertainties with K-V, it is difficult to determine the extent of the adverse impact on Evamist. Although we are entitled to additional milestone payments from future sales of Evamist by K-V, at the present time we do not anticipate receiving any additional milestones for the sales of Evamist.

 

Research and Development Expenses

 

Research and development, or 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, or CROs, and clinical sites and include advertising for clinical trials and patient recruitment costs. These costs are recorded as a component of R&D expenses and are expensed as incurred. 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 condensed consolidated 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 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

 

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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, 2009, it was considered more likely than not that the Company’s deferred tax assets would not be realized.

 

As of March 31, 2009, 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.

 

Inventories

 

Inventories are valued at the lower of cost or market. 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. During the quarter ended September 30, 1998, we established significant reserves against our inventory to align with the then new estimates of expected future demand for MUSE. As of March 31, 2009, the remaining inventory reserve balance is $1.5 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 three months of 2009 and 2008, 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 invested in money market funds, U.S. Treasury securities and debt securities of U.S. government agencies, certificates of deposit, corporate bonds and commercial paper. These accounts are recorded at cost, which approximates fair value.

 

Cash with restrictions for a period of greater than 12 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.

 

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 capital preservation and liquidity 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 nine months.

 

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We invest our excess cash balances in money market and marketable securities, primarily U.S. Treasury securities and debt securities of U.S. government agencies, 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. Also, if the banking system or the financial markets do not improve, continue to deteriorate or remain volatile, our investment portfolio may be impacted and the values and liquidity of our investments could be adversely affected.

 

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 based on market prices obtained from a number of pricing methods used to derive the fair value of the securities on a recurring basis. These fair values are obtained primarily from multiple third-party pricing services. We may or may not hold 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 may 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, except for certain securities that we expect to recover their full or substantial values beyond the next 12 months due to the current lack of a readily available market, and the continued uncertainty in the capital markets. Consequently, we have classified those available-for-sale securities as non-current in our condensed consolidated balance sheet at March 31, 2009.

 

Securities are carried at fair value, with the unrealized gains and losses, net of taxes, reported as a component of stockholders’ equity, unless the decline in value is deemed to be other-than-temporary and we do not have the intent and ability to hold such securities until their full cost can be recovered, in which case such securities are written down to fair value and the loss is charged to other-than-temporary loss on impaired securities. We evaluate our investment securities for other-than-temporary declines based on quantitative and qualitative factors. Any realized gains or losses on the sale of marketable securities are determined on a specific identification method, and such gains and losses are reflected as a component of interest income.

 

Financial Accounting Standards Board, or FASB, Statement of Financial Accounting Standards, or SFAS, No. 115, Accounting for Certain Investments in Debt and Equity Securities, and Staff Accounting Bulletin, or 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. A significant judgment in the valuation of investments is the determination of when an other-than-temporary decline in value has occurred. We follow a consistent and systematic process for recognizing impairments on securities that sustain other-than-temporary declines in value. We have established a policy for the impairment review process. The decision to impair a security incorporates both quantitative criteria and qualitative information. The impairment review process considers a number of factors including, but not limited to: (i) the length of time and the extent to which the fair value has been less than book value, (ii) the financial condition and near term prospects of the issuer, (iii) our intent and ability to retain impaired investments for a period of time sufficient to allow for any anticipated recovery in value, (iv) whether the debtor is current on interest and principal payments and (v) general market conditions and industry or sector specific factors. For securities that are deemed to be other-than-temporarily impaired, the security is adjusted to fair value and the resulting losses are recognized in other-than-temporary loss on impaired securities in the condensed consolidated statements of operations. The new cost basis of the impaired securities is not increased for future recoveries in fair value.

 

During our quarterly impairment assessment, we determined that a decline in value of certain securities was other-than-temporary. Accordingly, we recorded other-than-temporary impairment adjustments of $444,000 in the three months ended March 31, 2009. We included this non-cash impairment charge in other-than-temporary loss on impaired securities in the condensed consolidated statements of operations and other comprehensive income (loss). Other-than-temporary impairment losses recognized in 2009 included impairments on investments for which we determined that the impairment was other-than-temporary due to credit downgrades and/or our intent and ability to hold the investment to maturity. These securities covered a number of industries. If market, industry, and/or investee conditions deteriorate, we may incur further impairments. In addition, due to the current lack of a readily available market for certain of our available-for-sale securities totaling $631,000, and the continued uncertainty in the capital markets, we expect to recover the carrying values of these securities beyond the next 12 months. Consequently, we have classified those available-for-sale securities as non-current in the condensed consolidated balance sheets.

 

In December 2007, our enhanced money market fund investment, Columbia Strategic Cash Portfolio Fund, or Columbia fund, ceased accepting cash redemption requests and changed to a floating net asset value. In light of the restricted liquidity, we elected to receive a pro-rata allocation of the underlying securities in a separately managed account. At March 31, 2009, the market value of securities received in-kind from the Columbia fund investment included in available-for-sale securities was $9.3 million.

 

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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. We record legal fees and costs as an expense when incurred.

 

Share-Based Payments

 

We follow the fair value method of accounting for share-based compensation arrangements in accordance with SFAS 123R, Share-Based Payment, or  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, or 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 $1.3 million and $1.4 million of share-based compensation expense for the quarters ended March 31, 2009 and 2008, respectively. 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.

 

Fair Value

 

On January 1, 2008, we adopted SFAS No. 157 Fair Value Measurements and effective October 10, 2008, we adopted FSP No. SFAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active, except as it applies to the nonfinancial assets and nonfinancial liabilities subject to FSP 157-2. Adoption of the provisions of this standard did not have a material effect on our financial position.

 

Financial Instruments Measured at Fair Value.  Our cash and cash equivalents and 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. SFAS No. 157 prescribes three valuation techniques that shall be used to measure fair value as follows:

 

1.  Market Approach—uses prices or other relevant information generated by market transactions involving identical or comparable assets or liabilities.

 

2.  Income Approach—uses valuation techniques to convert future cash flow amounts to a single present value amount (discounted).

 

3.  Cost Approach—the amount that currently would be required to replace the service capacity of an asset (i.e., current replacement cost).

 

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One or a combination of the approaches above can be used to calculate fair value, whichever results in the most representative fair value.

 

In addition to the three valuation techniques, SFAS No. 157 prescribes a fair value hierarchy in order to increase consistency and comparability in fair value measurements and related disclosures. 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. 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.

 

These types of instruments primarily consist of financial instruments whose value is based on quoted market prices such as cash, money market funds and U.S. Treasury securities that are actively traded. Management judgment was required to determine our policy that defines the levels at which sufficient volume and frequency of transactions is met for a market to be considered active.

 

·      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.

 

The types of instruments valued based on other observable inputs include debt securities of U.S. government agencies, corporate bonds, mortgage-backed and asset-backed products. Substantially all of these assumptions are observable in the marketplace, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace.

 

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

 

These types of instruments include certain corporate bonds, mortgage-backed securities and asset-backed securities. Level 3 is comprised of unobservable inputs that are supported by little or no market activity. These instruments are considered Level 3 when their fair values are determined using pricing models, discounted cash flows or similar techniques and at least one significant model assumption or input is unobservable. Level 3 may still include some observable inputs such as yield spreads derived from markets with limited activity. Level 3 financial assets include securities for which there is limited market activity such that the determination of fair value requires significant judgment or estimation. At March 31, 2009, these securities were valued primarily using valuation models that incorporate transaction details such as contractual terms, maturity, timing and amount of future cash inflows, as well as assumptions, including but not limited to, about prepayment speeds, credit spreads, default rates and benchmark yields and liquidity.

 

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.

 

Fair Value Measurements

 

As of March 31, 2009, our cash and cash equivalents and available-for-sale securities measured at fair value on a recurring basis totaled $165.8 million. Of these, approximately $151.8 million were classified as Level 1, $12 million were classified as Level 2, and approximately $2 million as Level 3.

 

Approximately 92% of our cash and cash equivalents and available-for-sale securities are cash, money market instruments and U.S. Treasury securities and these are classified as Level 1. The valuation techniques used to measure the fair values of these financial instruments were derived from quoted market prices, as substantially all of these instruments have maturity dates, if any, within one year from the date of purchase and active markets for these instruments exists.

 

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Approximately 7% of the balance of our cash and cash equivalents and available-for-sale securities that are measured at fair value on a recurring basis and classified as Level 2 were classified as such due to the usage of observable market prices for identical securities that are traded in less active markets. When observable market prices for identical securities are not available, we price our marketable debt instruments using: quoted market prices for similar instruments, or pricing models, such as a discounted cash flow model, with all significant inputs derived from or corroborated with observable market data. Securities classified as Level 2 generally include debt securities of U.S. government agencies, corporate bonds, mortgage-backed securities and asset-backed securities.

 

When values are determined using inputs that are both unobservable and significant to the values of the instruments being measured, we classify those instruments as Level 3 under the SFAS No. 157 hierarchy. As of March 31, 2009, our investment securities classified as Level 3 totaled $2 million or 1% of cash, cash equivalents and available-for-sale securities. For the three months ended March 31, 2009, we experienced $268,000 in impairment losses related to the Level 3 assets in our portfolio.

 

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). Certain of these agreements were amended and restated on March 16, 2009. Please refer to Note 7: “Deerfield Financing” and Note 8: “Notes Payable” to the notes to condensed consolidated financial statements included in this Form 10-Q for additional information on these agreements. 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 the Funding and Royalty Agreement, or FARA, and $10 million from the sale of the Company’s common stock. Under the FARA, the Deerfield Affiliates made $3.3 million payments to us in April, September, and December 2008 and February 2009 and will make two quarterly payments of approximately $3.3 million, thereafter. We have agreed to pay royalties on the current net sales of MUSE and if approved, on future sales of avanafil, an investigational product candidate, to the Deerfield Sub. The agreements also provide 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. In exchange for the option right, we paid $2 million to the Deerfield Affiliates.

 

We have evaluated the Deerfield financing in accordance with FASB Financial Interpretation No., or FIN, 46(R), Consolidation of Variable Interest Entities, or FIN 46R, and determined that the Deerfield Sub may constitute a Variable Interest Entity, or VIE; however, we have also determined that the Company is not the primary beneficiary of this VIE at this time and we therefore have concluded that we are not required to consolidate the Deerfield Sub.

 

In accordance with Emerging Issues Task Force (EITF) Issue 88-18, Sale of Future Revenues, the transaction is in substance a financing arrangement, or loan that will be repaid by us. The minimum repayment amount would be $17 million, the amount of the unconditional put option held by Deerfield Affiliates, plus royalties paid on MUSE sales, and avanafil sales if approved, during the term of the agreement. Accordingly, we will record the advances from the Deerfield Affiliates, net of the $2 million option right payment and related fees and expenses, as a loan. Using the interest method under APB Opinion No. 21, Interest on Receivables and Payables, interest on the loan will be recognized over three years, which is the estimated term of the loan based on the earliest date that the Deerfield Affiliates could require us to repay the amounts advanced.

 

Recent Accounting Pronouncements

 

In October 2008, the FASB issued FASB Staff Position, or FSP, SFAS 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. FSP SFAS 157-3 clarifies the application of SFAS No. 157 in a market that is not active and addresses application issues such as the use of internal assumptions when relevant observable data does not exist, the use of observable market information when the market is not active and the use of market quotes when assessing the relevance of observable and unobservable data. FSP SFAS 157-3 is effective for all periods presented in accordance with SFAS No. 157. The guidance in FSP SFAS 157-3 is effective immediately and did not have a significant impact on our condensed consolidated financial position or results of operations upon adoption. See Note 4: “Cash, Cash Equivalents and Available-for-Sale Securities” to the notes to condensed consolidated financial statements in this Form 10-Q for information and related disclosures regarding our fair value measurements.

 

In February 2008, the FASB issued FSP SFAS 157-2, which delays the effective date of SFAS 157 for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value on a recurring basis (items that are remeasured at least annually). The FSP deferred the effective date of SFAS 157 for non-financial assets and non-financial liabilities until our fiscal year beginning on January 1, 2009. We do not expect the adoption of SFAS 157 for non-financial assets and non-financial liabilities to have a material effect on our condensed consolidated financial statements.

 

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In December 2007, the FASB issued SFAS No. 141(R), Business Combinations, or 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. On January 1, 2009, we adopted this Statement, which did not 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. 07-01, Accounting for Collaborative Agreements, or EITF 07-01. EITF 07-01 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 07-01 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. On January 1, 2009, we adopted this Statement, which did not 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 Be Used in Future Research and Development Activities, or EITF 07-03, 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, or SFAS 159. 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 April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments. This FSP amends SFAS No. 107, Disclosures About Fair Value of Financial Instruments, to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This FSP also amends APB Opinion No. 28, Interim Financial Reporting, to require those disclosures in summarized financial information at interim reporting periods. This FSP is effective for interim reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The FSP does not require disclosures for earlier periods presented for comparative purposes at initial adoption. In periods after initial adoption, this FSP requires comparative disclosures only for periods ending after initial adoption. We are currently evaluating this FSP and we do not expect the changes associated with adoption of this FSP will have a material effect on the determination or reporting of our financial results.

 

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments. This FSP amends the other-than-temporary impairment guidance for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. This FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. This FSP modifies the requirements for recognizing other-than-temporarily impaired debt securities and revises the existing impairment model for such securities, by modifying the current intent and ability indicator in determining whether a debt security is other-than-temporarily impaired. This FSP is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The FSP does not require disclosures for earlier periods presented for comparative purposes at initial adoption. In periods after initial adoption, this FSP requires comparative disclosures only for periods ending after initial adoption. We are currently evaluating this FSP and we do not expect the changes associated with adoption of this FSP will have a material effect on the determination or reporting of our financial results.

 

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In April 2009, the FASB issued FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. This FSP provides additional guidance for estimating fair value in accordance with SFAS No. 157, Fair Value Measurements, when the volume and level of activity for the asset or liability have significantly decreased. This FSP also includes guidance on identifying circumstances that indicate a transaction is not orderly. FSP 157-4 provides guidance on how to determine the fair value of assets and liabilities under SFAS 157 in the current economic environment and reemphasizes that the objective of a fair value measurement remains an exit price. If we were to conclude that there has been a significant decrease in the volume and level of activity of the asset or liability in relation to normal market activities, quoted market values may not be representative of fair value and we may conclude that a change in valuation technique or the use of multiple valuation techniques may be appropriate. This FSP is effective for interim and annual reporting periods ending after June 15, 2009, with early adoption permitted for periods ending after March 15, 2009. The FSP does not require disclosures for earlier periods presented for comparative purposes at initial adoption. In periods after initial adoption, this FSP requires comparative disclosures only for periods ending after initial adoption. We are currently evaluating this FSP and we do not expect the changes associated with adoption of this FSP will have a material effect on the determination or reporting of our financial results.

 

RESULTS OF OPERATIONS

 

Executive Overview

 

For the three months ended March 31, 2009, we reported a net loss of $6.8 million, or $0.10 net loss per share, as compared to a net loss of $7.1 million, or $0.12 net loss per share, during the same period in 2008. The lower net loss in the first quarter of 2009 as compared to the first quarter of 2008 is primarily due to reduced operating expenses, a decrease in losses on other-than-temporarily impaired securities, partially offset by lower U.S. and international revenue, a decrease in interest income and an increase in interest expense. The decrease in operating expenses was primarily attributable to decreased spending related to our Phase 3 clinical trials of Qnexa for the treatment of obesity in the first quarter of 2009 as compared to the first quarter of 2008.

 

On April 3, 2008, we entered into several agreements with Deerfield Management Company, L.P., or Deerfield, a healthcare investment fund, and its affiliates. Certain of these agreements were amended and restated on March 16, 2009. 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 the FARA, and $10 million from the sale of the Company’s 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 made $3.3 million payments to us in April, September and December 2008 and February 2009 and will make two quarterly payments of approximately $3.3 million thereafter. The amounts of funding provided under the FARA, net of certain amounts, represent a financial obligation, a loan payable by the Company in which the principal and interest will be repaid through royalty payments and the exercise of the option or put rights.

 

In connection with the sale of Evamist, we received $150 million. The sale of Evamist was a unique transaction. As discussed in Note 11: “Sale of Evamist Product,” an initial $10 million was paid at closing and $140 million was paid upon FDA approval of Evamist. These payments are non-refundable and have been recorded as deferred revenue and are 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 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.

 

The revenue related to the transaction recognized in the first quarter of 2009 was $20.9 million and the revenue in future quarters is expected to be recognized as follows (in thousands):

 

Quarter ending

 

License revenue

 

June 30, 2009

 

$

10,465

 

 

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 consistent with prior years and we plan to continue to invest in clinical development of our current research and investigational product candidates to bring those potential products to market.

 

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Revenue. (Unaudited)

 

 

 

Three Months Ended
March 31,

 

 

 

%

 

 

 

2009

 

2008

 

(Decrease)

 

Change

 

 

 

(In thousands, except percentages)

 

United States product, net

 

$

893

 

$

1,088

 

$

(195

)

(18

)%

International product

 

293

 

554

 

(261

)

(47

)%

License and other revenue

 

21,046

 

21,046

 

0

 

0

%

Total revenues

 

$

22,232

 

$

22,688

 

$

(456

)

(2

)%

 

Product revenues for the quarters ended March 31, 2009 and 2008 were $1.2 million and $1.6 million, respectively. U.S. product revenues in the quarter ended March 31, 2009 decreased as compared to the same period in 2008. While the U.S. units shipped and the price of MUSE increased in the first quarter of 2009, revenues decreased partially due to an increase in the sales allowance for pricing discounts for certain government customers of $136,000. The decrease in international revenue in the quarter ended March 31, 2009 as compared to the same period in 2008 was partially due to a reduction in transfer prices resulting from the difference in currency exchange rates. We anticipate that these exchange rate differences and the resulting lower transfer prices are likely to continue. Also contributing to the decrease in both U.S. and international product revenues in the first quarter 2009 as compared with the same period of 2008 were sales allowances of $212,000 and $208,000, respectively, for certain production lots of the 125 mg and 250 mg strength MUSE shipped that do not meet certain specifications applied toward the end of the 24 month shelf life. This out-of-specification condition appears to arise in the last six months of the 24 month shelf life. This condition does not pose any safety risk to the patient. We have recorded these sales allowances based upon the best estimate at this time of the quantity of 125 mg and 250 mg MUSE that may be on hand at the wholesale level. This matter remains under investigation and revisions to our estimates will be charged to income in the period in which the information that gives rise to the revision becomes known. 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, we are not able to anticipate if our largest wholesaler customer will continue its historical pattern of making purchases in the fourth quarter that exceed expected quarterly demand. If our largest wholesaler customer does not repeat this pattern of purchasing quantities of MUSE that exceed quarterly demands, revenues from the sale of MUSE in 2009 may be lower as compared to 2008.

 

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 Evamist Agreement to K-V, or the Transaction. In August 2008, the Company assigned all of its rights and obligations under the Evamist license agreement to K-V. 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 million was paid at closing and $140 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. (Unaudited)

 

 

 

Three Months Ended
March 31,

 

 

 

%

 

 

 

2009

 

2008

 

(Decrease)

 

Change

 

 

 

(In thousands, except percentages)

 

 

 

 

 

Cost of goods sold and manufacturing

 

$

2,603

 

$

2,787

 

$

(184

)

(7

)%

 

Cost of goods sold and manufacturing, or cost of goods sold, in the first quarter of 2009 decreased $184,000, or 7%, to $2.6 million, as compared to $2.8 million for the first quarter of 2008. Cost of goods sold decreased in the three months ended March 31, 2009 as compared to the same period in 2008 primarily due to the disposal of inventory due to the non-conformance of certain raw materials in 2008.

 

We anticipate cost of goods sold for the year 2009 will be similar to costs incurred in 2008.

 

Research and development. (Unaudited)

 

 

 

Three Months Ended
March 31,

 

 

 

%

 

 

 

2009

 

2008

 

(Decrease)

 

Change

 

 

 

(In thousands, except percentages)

 

Research and development

 

$

20,069

 

$

23,371

 

$

(3,302

)

(14

)%

 

Research and development expenses in the first quarter of 2009 decreased $3.3 million, or 14%, to $20.1 million, as compared to $23.4 million for the first quarter of 2008. In the first quarter of 2009, this decrease in spending was primarily due to lower Qnexa for obesity spending of $8.3 million and other net project spending decreases of $515,000, partially offset by increased spending for avanafil of $5.3 million and a net increase in non-project related spending of $205,000 (primarily due to increases in compensation

 

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and related expense of $412,000 due to an increase in headcount partially offset by a decrease in non-cash stock based compensation expense of $191,000), as compared to the first quarter of 2008. In the three months ended March 31, 2009, we spent $7.2 million for services provided by one clinical research organization on the Qnexa Phase 3 studies, which represented 36% of our research and development expenses for the quarter. Separately, we spent another $5.2 million for services provided by another clinical research organization on the avanafil Phase 3 studies, which represented 26% of our research and development expenses for the first quarter of 2009.

 

We anticipate that our research and development expenses in 2009 will be similar to costs incurred in 2008, as we continue to advance the clinical program for Qnexa for the treatment of obesity, avanafil for erectile dysfunction and our other investigational products. The current remaining contractual obligation for payments to our primary contract research organization, or CRO, for the Phase 3 Qnexa trials totals $18.1 million and for payments to our primary CRO for the Phase 3 avanafil trials totals $13.4 million. There are likely to be additional research and development expenses related to Qnexa and our other investigational products 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. Regardless, 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 at least several years due to the length of time required to develop investigational product candidates into commercially viable products.

 

Selling, general and administrative.(Unaudited)

 

 

 

Three Months Ended
March 31,

 

 

 

%

 

 

 

2009

 

2008

 

Increase

 

Change

 

 

 

(In thousands, except percentages)

 

Selling, general and administrative

 

$

5,411

 

$

4,252

 

$

1,159

 

27

%

 

Selling, general and administrative expenses in the three months ended March 31, 2009 of $5.4 million increased $1.2 million, or 27% as compared to the three months ended March 31, 2008. In the quarter ended March 31, 2009, this increase is primarily due to an incremental increase of $234,000 in investor relations expense, $732,000 in corporate legal fees and other net increases in selling, general and administrative expenses totaling $193,000, as compared to the quarter ended March 31, 2008.

 

We anticipate that our selling, general and administrative expenses in 2009 will increase slightly compared to those in 2008 due to higher legal expenses relating to the Acrux arbitration matter.

 

Interest income and expense.

 

Interest income for the quarter ended March 31, 2009 was $208,000, as compared to $2.1 million for the quarter ended March 31, 2008. The decrease in interest income in the quarter ended March 31, 2009 as compared to the same period last year is primarily due to lower investment yields in the three months ended March 31, 2009 as compared to the same period in 2008.

 

Interest expense for the quarter ended March 31, 2009 was $716,000 as compared to $122,000 during the same period last year. The net increase in interest expense in the three months ended March 31, 2009 as compared to the same period in 2008 is primarily due to interest expense on the Deerfield financing in 2009.

 

The other-than-temporary loss on impaired securities was $444,000 in the three months ended March 31, 2009 as compared to $1.4 million during the same period in 2008. The $444,000 other-than-temporary loss primarily represents unrealized impairment losses recorded on securities that are classified as available-for-sale securities on our condensed consolidated balance sheet as of March 31, 2009. The majority of the other-than-temporary losses on impaired securities were recorded on securities obtained in late 2007 through the redemption-in-kind distribution from the Bank of America Columbia Strategic Cash Portfolio Fund. With the current volatility and turmoil in the economy and financial markets there can be no assurance that additional impairment losses will not be recognized in future periods.

 

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LIQUIDITY AND CAPITAL RESOURCES

 

Cash. Unrestricted cash, cash equivalents and available-for-sale securities totaled $165.8 million at March 31, 2009, as compared to $189.2 million at December 31, 2008. The decrease in cash, cash equivalents and available-for-sale securities of $23.4 million is the net result of cash used for operating and investing activities partially offset by cash provided by financing activities for the first three months of 2009. Included in these amounts are $3.3 million in cash receipts from the Deerfield financing, and $185,000 from stock option exercises.

 

Since inception, we have financed operations primarily from the issuance of equity securities. Through March 31, 2009, we raised $300.1 million from financing activities, received $150 million from the sale of Evamist and had an accumulated deficit of $186.6 million at March 31, 2009.

 

Available-for-sale securities. We focus on capital preservation and liquidity 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 capital preservation and on liquidity 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 nine months.

 

At March 31, 2009, we had $42.7 million in cash and cash equivalents and $123.1 million in available-for-sale securities. We invest our excess cash balances in money market and marketable securities, primarily U.S. Treasury securities and debt securities of U.S. government agencies, 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 realized or unrealized losses in the value of our portfolio which would have an adverse effect on our results of operations, liquidity and financial condition. Also, if the banking system or the financial markets do not improve, continue to deteriorate or remain volatile, our investment portfolio may be impacted and the values and liquidity of our investments could be adversely affected.

 

The current economic environment and recent volatility of securities markets increase the difficulty of assessing investment impairment and the same influences tend to increase the risk of potential impairment of these assets. During the three months ended March 31, 2009, we recorded unrealized charges for other-than-temporary impairment of securities of $444,000. We believe we have adequately reviewed our investment securities for impairment and that our investment securities are carried at fair value. However, over time, the economic and market environment may provide additional insight regarding the fair value of certain securities, which could change our judgment regarding impairment. This could result in realized losses relating to other-than-temporary declines being charged against future income. Given the current market conditions and the significant judgments involved, there is continuing risk that further declines in fair value may occur and additional material other-than-temporary impairments may be charged to income in future periods.

 

Investment securities are exposed to various risks, such as interest rate, market and credit. Due to the level of risk associated with certain investment securities and the level of uncertainty related to changes in the value of investment securities, it is possible that changes in these risk factors in the near term could have an adverse material impact on our results of operations or shareholders’ equity.

 

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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, 2009 was $912,000, as compared to $4.2 million at December 31, 2008. The 79% decrease in the accounts receivable balance at March 31, 2009 is primarily due to the collection of the accounts receivable outstanding at December 31, 2008. Currently, we do not have any significant concerns related to accounts receivable or collections.

 

Liabilities. Total liabilities were $55.6 million at March 31, 2009, or $20.8 million lower than at December 31, 2008. 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.

 

We have entered into a manufacturing agreement with a supplier to purchase alprostadil. As of March 31, 2009, our remaining commitment under this agreement is to purchase a minimum of $1.5 million of product from 2009 through 2011. Should our inventory of alprostadil 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. Under 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 $25.2 million of cash and $13.3 million of cash during the three months ended March 31, 2009 and 2008, respectively. During the first three months of 2009, our net operating loss of $6.8 million was offset by a $444,000 other-than-temporary loss on impaired securities, $1.3 million in non-cash stock based compensation expense, a $781,000 increase in accrued research and clinical expenses primarily due to the Qnexa for obesity development effort, and a $3.2 million reduction in our accounts receivable, due to the collection of monies owed to us. These positive cash flows to our net operating loss were in turn offset by the recognition of $21 million in revenue primarily due to the amortization of deferred license revenue from the receipt of $150 million from K-V for the sale of Evamist and a $2.8 million decrease in accounts payable due to the timing of payments.

 

Investing Activities. Our investing activities used and provided $744,000 and $29.1 million in cash during the three months ended March 31, 2009 and 2008, 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 $2.5 million and $85,000 during the three months ended March 31, 2009 and 2008, respectively. In the first three months of 2009, the cash provided by financing activities included $3.3 million in cash receipts from the Deerfield financing and $185,000 in proceeds from the exercise of stock options and partially offset by $993,000 in principal payments under our notes payable.

 

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., or 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 the Crown loan. 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% for the first three months of 2009 and 2008, respectively.

 

On April 15, 2008, we closed the Deerfield Transaction in which Deerfield and its affiliates agreed to provide us with $30 million in funding. Certain of the agreements with Deerfield were amended and restated on March 16, 2009. The $30 million in funding consists of $20 million from the FARA entered into with the Deerfield Sub, and $10 million from the sale of our common stock under

 

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a securities purchase agreement. Under the FARA, the Deerfield Sub made $3.3 million payments to us in April, September and December 2008 and February 2009 and will make two quarterly payments of approximately $3.3 million, 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 10 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 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 number of shares was determined based on the volume weighted average price on the NASDAQ Global Market of the Company’s common stock on the three days prior to the execution of the securities purchase agreement dated as of April 3, 2008.

 

The agreements also provided us with an option to purchase, and the Deerfield Affiliates with an option to compel us to purchase, or put right, the Deerfield Sub holding the royalty rights through a purchase and sale of all the shares of the Deerfield Sub. If we exercise our right to purchase the Deerfield Sub, the net price will be $23 million if exercised before April 3, 2011 or $26 million if exercised after April 3, 2011 but before April 3, 2012 (the purchase price is subject to other adjustments, as defined in the agreement). After April 3, 2011, the Deerfield Affiliates may exercise the right to compel us to purchase the Deerfield Sub at a price of $17 million. This price could increase up to $26 million, and the timing of the sale of the shares could be accelerated under certain conditions including a change-in-control, sale of MUSE or avanafil, sale of major assets and the sale of securities in a transaction or a series of related transactions by the Company that exceed 20% of our outstanding common stock at the date the Option and Put Agreement was signed if at the time of the sale the Company’s market capitalization is below $300 million (each, a Major Transaction). Under these conditions, the cost of the shares of the Deerfield Sub would be $23 million on or before April 3, 2011 and $26 million from April 3, 2011 through April 3, 2018. The sale of the shares of the Deerfield Sub could also accelerate if the Company’s cash, cash equivalents and available for sale securities falls below $15 million or the Company’s market capitalization falls below $50 million. The purchase prices under the put right are subject to other adjustments as defined in the agreements. 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, we filed with the SEC a shelf Registration Statement on Form S-3 (File Number 333-150649) which was declared effective by the SEC on May 29, 2008, providing the us with the ability to offer and sell up to an aggregate of $150 million of our 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), or 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.

 

On August 6, 2008, we sold $65 million of our common stock in a registered direct offering. Under the terms of the financing, we sold 8,365,508 shares of our common stock at a price of $7.77 per share. On August 5, 2008, the Company filed a prospectus supplement with the SEC relating to this registered direct offering under the existing shelf Registration Statement (File Number 333-150649).

 

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 and approval by the FDA 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 an investigational product 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;

 

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·      patient recruitment may be slower than expected; and

 

·      patients may drop out of the trials.

 

For each of our investigational product 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 investigational product programs are difficult to estimate and are subject to considerable variation. Our inability to complete our research and investigational product programs 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 costs involved in establishing a commercial operation and in launching a product without a partner;

 

·      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 state of the economy and financing environment;

 

·                  the regulatory approval environment and regulatory hurdles for safety assessment for new products;

 

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·                  the health care reimbursement system or the impact of healthcare reform, if any, imposed by the U.S. federal government;

 

·      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 investigational product development programs, to conduct preclinical studies and trials, to fund operating expenses, to pursue regulatory approvals for our investigational product candidates, to finance 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 or new manufacturing and marketing capabilities in the future, or to launch a product. In particular, we expect to make other substantial payments to Acrux and Mitsubishi 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 selling or licensing 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 at any time. The sale of additional equity securities would result in additional dilution to our stockholders. We may also seek additional funding through strategic alliances, acquisitions of companies with cash balances 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 investigational product 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 approved for sale, will generate revenues sufficient to enable us to earn a profit.

 

Contractual Obligations

 

The following table summarizes our contractual obligations at March 31, 2009, excluding amounts already recorded on our condensed consolidated balance sheet as accounts payable, and the effect such obligations are expected to have on our liquidity and cash flow in future fiscal years. This table includes our enforceable and legally binding obligations and future commitments, as well as obligations related to all contracts that we are likely to continue, regardless of the fact that they were cancelable as of March 31, 2009. These do not include milestones and assumes 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

 

2009
(9 months)

 

2010-2012

 

2013-2014

 

Thereafter

 

 

 

(in thousands)

 

Operating leases

 

$

1,209

 

$

397

 

$

812

 

$

 

$

 

Manufacturing and other agreements

 

12,570

 

9,712

 

2,825

 

10

 

23

 

Clinical trials

 

41,295

 

37,238

 

4,057

 

 

 

Notes payable

 

13,662

 

145

 

9,160

 

409

 

3,948

 

Interest payable

 

9,855

 

2,504

 

4,726

 

639

 

1,986

 

Total contractual obligations

 

$

78,591

 

$

49,996

 

$

21,580

 

$

1,058

 

$

5,957

 

 

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. This 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. On December 16, 2008, we entered into an amendment to this lease. Under the terms of the amended lease, we will continue to lease the office space for our corporate headquarters for a two year period commencing on August 1, 2009 and expiring on July 31, 2011. The base monthly rent is set at $1.64 per square foot or $23,000 per month. The amended lease allows us one option to extend the term of the lease for one year from the expiration of the lease.

 

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Manufacturing and Other Agreements

 

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 alprostadil 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 2009 through 2011.

 

Other Agreements

 

We have remaining commitments under various general and administrative services agreements totaling $2 million at March 31, 2009, including $1.3 million related to Leland F. Wilson’s Employment Agreement (see paragraph below). We have 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, 2009, our remaining commitment under these agreements totaled $8.3 million. In addition, we have entered into marketing promotion and related agreements for our erectile dysfunction product, MUSE. At March 31, 2009, our remaining commitment under the MUSE agreements totaled $695,000.

 

On December 19, 2007, the Compensation Committee of the Board of Directors of the Company approved an employment agreement, or 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, or 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. On January 23, 2009, the Compensation Committee approved an amendment to the Employment Agreement, or the Amendment, which amends the Employment Agreement. Pursuant to the Amendment, the initial term of the Employment Agreement was increased from two to three years commencing on June 1, 2007 and other relevant dates were also extended to reflect the three year initial term.

 

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, 2009, our remaining commitment under these agreements totaled $41.3 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 and Interest Payable

 

Crown Loan

 

On January 4, 2006, we obtained a $5.4 million mortgage loan from Crown. The land and buildings, among other assets, located at our principal MUSE 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% for the three months ended March 31, 2009 and 2008, respectively. As of March 31, 2009, we have a principal balance of $5 million remaining on the Crown loan.

 

We have included in the above table the estimated interest payments based upon current interest rates that we expect to make in accordance with the terms of the loan agreement. However, should we decide to prepay the loan, there would be a prepayment premium, in lieu of the interest payable in the above table, which would have been 2% at March 31, 2009 (the fourth year of the loan term). If prepayment occurs in the fifth year or thereafter, the premium would be 1%.

 

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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). Certain of the agreements were amended and restated on March 16, 2009. 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 the Funding and Royalty Agreement, or FARA, entered into with a newly incorporated subsidiary of Deerfield, or the Deerfield Sub, and $10 million from the sale of our common stock. Under the FARA, the Deerfield Sub made $3.3 million payments to us in April, September and December 2008 and February 2009 and will make two quarterly payments of approximately $3.3 million thereafter. Such payments are referred to as the Funding Payments. We will pay royalties on the current net sales of MUSE and, if approved, on future sales of avanafil, an investigational product candidate to the Deerfield Sub. The term of the FARA is 10 years. The FARA includes covenants requiring us to use commercially reasonable efforts to preserve our intellectual property, to manufacture, promote and sell MUSE, and to 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 approximately $200,000 in certain expenses incurred in this transaction. The number of shares was determined based on the volume weighted average price on the NASDAQ Global Market of the Company’s common stock on the three days prior to the execution of the securities purchase agreement dated as of April 3, 2008. 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, each as described in greater detail below. 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, the Company, the Deerfield Affiliates and the Deerfield Sub entered into the Option and Put Agreement, dated April 3, 2008, and an Amended and Restated Option and Put Agreement dated March 16, 2009, 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 the Deerfield Sub 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 the 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, less $2 million we paid on closing, if the Option is exercised on or prior to the third anniversary of the execution of the OPA; or

 

·      $28 million, less $2 million we paid on closing, 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 the Deerfield Sub at the date of the closing of the resulting sale of the common stock of the Deerfield Sub; (ii) accrued and unpaid royalties; and minus (i) the option premium of $2 million that was paid at the closing of the transaction (referred to as the Option Premium); (ii) accrued but unpaid taxes; (iii) unpaid Funding Payments; (iv) loans payable by the Deerfield Sub, and (v) any other outstanding liabilities of the 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 million; or

 

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

 

(3)   the fifteenth day following the delivery of written notice to the Company 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.

 

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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, or April 3, 2011, 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, or April 3, 2011, and we have provided the Deerfield Affiliates a Major Transaction Notice; or

 

·      $17 million, in all other cases.

 

The aggregate consideration payable by the Company 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 the Deerfield Sub at the date of the closing of the resulting sale of the common stock of the Deerfield Sub; (ii) accrued and unpaid royalties; and minus (i) accrued but unpaid taxes; (ii) unpaid Funding Payments; (iii) loans payable by the Deerfield Sub, and (iv) any other outstanding liabilities of the 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 the Company’s common stock immediately preceding such event either:

 

(a)   no longer hold a majority of the shares of the Company’s common stock; or

 

(b)   no longer have the ability to elect a majority of the Company’s Board of Directors;

 

(2)   as a result of which shares of the Company’s common stock 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 the Company or another entity, collectively referred to as Change in Control Transactions;

 

·      a sale or transfer of the Company’s assets 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 30 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 the Company’s assets or proprietary rights that relate specifically to MUSE or avanafil; or

 

·      a purchase, tender or exchange offer made to the holders of outstanding shares of the Company’s 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 the Company of an aggregate number of shares of common stock in excess of 20% of the Company’s outstanding common stock on April 3, 2008 if, immediately prior to such issuance, the market capitalization of the Company is less than $300 million.

 

In connection with the FARA, the Deerfield Sub and the Company have entered into a Royalty Security Agreement, whereby we have granted the 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 the Company 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 over that granted to the Deerfield Sub by the Royalty Security Agreement.

 

In accordance with Emerging Issues Task Force (EITF) Issue 88-18, Sale of Future Revenues, the FARA transaction is in substance a financing arrangement, or loan that will be repaid by us. The minimum repayment amount would be $17 million, the amount of the unconditional put option held by Deerfield Affiliates, plus royalties paid on MUSE sales, and avanafil sales if approved, during the term of the agreement. Accordingly, we will record the advances from the Deerfield Affiliates, net of the $2 million option right payment and related fees and expenses, as a loan. The loan balance will increase as the advances are received. The loan balance will increase quarterly up to the minimum amount owed of $17 million. The minimum amount to be recorded is lower than the contractual amounts owed if we exercise our call option of $23 million to $26 million, or if the Deerfield Affiliates require us to purchase the shares as a result of a Major Transaction (see Note 7: “Deerfield Financing”). Using the interest method under APB Opinion No. 21, Interest on Receivables and Payables, interest on the loan will be calculated and recognized over three years, which is the estimated term of the loan based on the earliest date that the Deerfield Affiliates could require us to repay the amounts advanced. The Deerfield Affiliates will receive a quarterly payment based on net sales of MUSE. The above Contractual Obligations table includes estimated interest payable on the principal owing at March 31, 2009 from the Deerfield Financing based upon a 33% imputed effective interest rate whereas actual quarterly royalty payments are based upon a percentage of net MUSE sales at a rate substantially lower than the imputed effective interest rate used to calculate interest expense.

 

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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. 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.

 

Mitsubishi Tanabe

 

In January 2001, we entered into an exclusive development, license and supply agreement with Tanabe Seiyaku Co., Ltd., or Tanabe, now Mitsubishi Tanabe, and hereinafter referred to as Mitsubishi 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, Mitsubishi 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 Mitsubishi Tanabe an exclusive, royalty-free license within those countries for oral products that we develop containing avanafil. In addition, we agreed to grant Mitsubishi Tanabe an exclusive option to obtain an exclusive, royalty-bearing license within those countries for non-oral products that we develop containing avanafil. Mitsubishi 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 Mitsubishi 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 triggered one of the clinical development milestone criteria noted above. We paid Mitsubishi 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 Mitsubishi Tanabe in the years ended December 31, 2007 and 2008; however, we paid Mitsubishi Tanabe $4 million in January 2009 following the enrollment in December 2008 of the first patient in the first Phase 3 clinical studies. We expect to make other substantial payments to Mitsubishi Tanabe in accordance with our agreements with Mitsubishi Tanabe as we continue to develop and, if approved for sale, commercialize avanafil for the oral treatment of male sexual dysfunction. Such potential future milestone payments total $15 million in the aggregate and include payments upon: the first submission of an NDA; obtainment of the first regulatory approval in the United States and any major European country; and achievement of $250 million or more in calendar year sales.

 

The term of the Mitsubishi Tanabe agreement is based on a country-by-country and on a product-by-product basis. The term shall continue until the later of (i) ten years after the date of the first sale for a particular product, or (ii) the expiration of the last to expire patents within the Mitsubishi Tanabe patents covering such product in such country. In the event that our product is deemed to be (i) insufficiently effective or insufficiently safe relative to other PDE5 inhibitor compounds based on published information, or (ii) not economically feasible to develop due to unforeseen regulatory hurdles or costs as measured by standards common in the pharmaceutical industry for this type of product, we have the right to terminate the agreement with Mitsubishi Tanabe with respect to such product.

 

Acrux

 

In February 2004, we entered into exclusive licensing agreements with Acrux Limited, or 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. Future potential milestone payments to Acrux for Luramist total $5.5 million and are payable upon (1) the dosage of the first patient in the Phase 3 clinical studies, (2) the first submission of an NDA, and (3) obtainment of the first regulatory approval in the United States. We have paid $4.8 million in clinical development milestone 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. Under 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 Evamist Agreement to K-V and K-V paid $1.5 million of this $3 million obligation. In August 2008, the Company assigned all of its rights and obligations under the Evamist license agreement to K-V. See Note 11: “Sale of Evamist Product” to the notes to condensed consolidated financial statements included in this Form 10-Q for additional information concerning the terms of this agreement.

 

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In November 2006, we were notified of certain claims by Acrux regarding the Luramist agreements. On November 5, 2007, Acrux made a demand for arbitration under the Testosterone Agreement regarding certain claims related to Luramist. Acrux’s demand sought a reversion of all rights assigned to us related to Luramist, monetary damages and the payment of a milestone payment for Luramist under the Testosterone Agreement and declaratory relief. We asserted counterclaims against Acrux in the arbitration and sought the enforcement of our rights under the Testosterone Agreement. The arbitration hearing concluded on January 23, 2009, and on April 6, 2009 the panel of arbitrators, or the Panel, issued its Interim Arbitration Award finding in favor of VIVUS that we were in compliance with the Testosterone Agreement and denying all of the relief sought by Acrux in its demand. The Panel found that we had used diligent, commercially reasonable efforts to develop Luramist and that we had satisfied our obligations to keep Acrux informed on the status of the development efforts. The Panel also ruled in favor of VIVUS on certain of its counterclaims. The Interim Arbitration Award requires the parties to meet and confer on a number of contractual obligations and to report back to the Panel within 35 days on the results of these efforts.

 

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, 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 its clinical research organizations and investigators sites against liabilities incurred in connection with any third-party claim arising from the work performed on behalf of the Company. 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 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.

 

Pursuant to the terms of the Funding and Royalty Agreement with Deerfield, we made certain representations, warranties and covenants related to MUSE and avanafil. Covenants include that we will maintain all registrations and regulatory rights to sell and promote MUSE in the United States, we will continue to manufacture and promote MUSE and will continue the development of avanafil. We also entered into a covenant that we will not manufacture, promote or sell any product that competes with avanafil in the United States other than MUSE.

 

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.

 

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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.

 

Market Risk

 

Market risk represents the risk of loss that may impact our financial position, results of op