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 June 30, 2011

 

 

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 x  No o

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

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 July 28, 2011, 81,976,086 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

 

16

Item 3:

Quantitative and Qualitative Disclosures about Market Risk

 

46

Item 4:

Controls and Procedures

 

47

 

 

 

 

 

PART II — OTHER INFORMATION

 

47

 

 

 

 

Item 1:

Legal Proceedings

 

47

Item 1A:

Risk Factors

 

48

Item 2:

Unregistered Sales of Equity Securities and Use of Proceeds

 

86

Item 3:

Defaults Upon Senior Securities

 

86

Item 4:

Removed and Reserved

 

86

Item 5:

Other Information

 

86

Item 6:

Exhibits

 

86

 

Signatures

 

88

 

2



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)

 

 

 

June 30,
2011

 

December 31,
2010*

 

 

 

(unaudited)

 

 

 

ASSETS

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

28,312

 

$

37,216

 

Available-for-sale securities

 

93,304

 

101,970

 

Inventories

 

3,107

 

3,225

 

Prepaid expenses and other assets

 

1,198

 

1,648

 

Current assets of discontinued operations

 

 

6

 

Total current assets

 

125,921

 

144,065

 

Property and equipment, net

 

280

 

221

 

Total assets

 

$

126,201

 

$

144,286

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

6,224

 

$

2,395

 

Accrued research and clinical expenses

 

1,920

 

2,625

 

Accrued employee compensation and benefits

 

2,705

 

2,820

 

Accrued and other liabilities

 

657

 

932

 

Current liabilities of discontinued operations

 

2,662

 

3,512

 

Total current liabilities

 

14,168

 

12,284

 

 

 

 

 

 

 

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; 81,971 and 81,568 shares issued and outstanding at June 30, 2011 and December 31, 2010, respectively

 

82

 

82

 

Additional paid-in capital

 

438,077

 

432,041

 

Accumulated other comprehensive income

 

49

 

4

 

Accumulated deficit

 

(326,175

)

(300,125

)

Total stockholders’ equity

 

112,033

 

132,002

 

Total liabilities and stockholders’ equity

 

$

126,201

 

$

144,286

 

 


*                    Derived from audited consolidated financial statements filed in the Company’s 2010 Annual Report on Form 10-K.

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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Table of Contents

 

VIVUS, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)

 

 

 

THREE MONTHS ENDED
JUNE 30

 

SIX MONTHS ENDED
JUNE 30

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Research and development

 

$

11,035

 

$

13,576

 

$

15,515

 

$

23,787

 

General and administrative

 

5,303

 

6,750

 

10,731

 

11,914

 

Total operating expenses

 

16,338

 

20,326

 

26,246

 

35,701

 

 

 

 

 

 

 

 

 

 

 

Loss from operations

 

(16,338

)

(20,326

)

(26,246

)

(35,701

)

 

 

 

 

 

 

 

 

 

 

Interest income (expense):

 

 

 

 

 

 

 

 

 

Interest income

 

38

 

52

 

81

 

114

 

Interest expense

 

(2

)

(1,297

)

(3

)

(2,592

)

Total interest income (expense)

 

36

 

(1,245

)

78

 

(2,478

)

Loss from continuing operations before income taxes

 

(16,302

)

(21,571

)

(26,168

)

(38,179

)

Provision for income taxes

 

(2

)

 

(3

)

(1

)

Net loss from continuing operations

 

(16,304

)

(21,571

)

(26,171

)

(38,180

)

Discontinued operations:

 

 

 

 

 

 

 

 

 

Income (loss) from discontinued operations, net of tax

 

107

 

(1,186

)

121

 

(3,395

)

Net loss

 

(16,197

)

(22,757

)

(26,050

)

(41,575

)

Other comprehensive income:

 

 

 

 

 

 

 

 

 

Unrealized gain on securities

 

20

 

14

 

45

 

25

 

Comprehensive loss

 

$

(16,177

)

$

(22,743

)

$

(26,005

)

$

(41,550

)

 

 

 

 

 

 

 

 

 

 

Basic and diluted net loss per share:

 

 

 

 

 

 

 

 

 

Continuing operations

 

$

(0.20

)

$

(0.27

)

$

(0.32

)

$

(0.47

)

Discontinued operations

 

0.00

 

(0.01

)

0.00

 

(0.04

)

Net loss per share

 

$

(0.20

)

$

(0.28

)

$

(0.32

)

$

(0.51

)

Shares used in per share computation:

 

 

 

 

 

 

 

 

 

Basic

 

81,928

 

80,903

 

81,874

 

80,801

 

Diluted

 

84,133

 

80,903

 

84,120

 

80,801

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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Table of Contents

 

VIVUS, INC.

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

 

 

 

Six Months Ended
June 30

 

 

 

2011

 

2010

 

 

 

 

 

 

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net loss from continuing operations

 

$

(26,171

)

$

(38,180

)

Adjustments to reconcile net loss to net cash used for operating activities from continuing operations:

 

 

 

 

 

Depreciation

 

63

 

65

 

Share-based compensation expense

 

4,105

 

3,154

 

Changes in assets and liabilities:

 

 

 

 

 

Inventories

 

118

 

(208

)

Prepaid expenses and other assets

 

450

 

593

 

Accounts payable

 

3,828

 

(3,643

)

Accrued research and clinical expenses

 

(705

)

2,640

 

Accrued employee compensation and benefits

 

(115

)

143

 

Accrued and other liabilities

 

(275

)

1,227

 

Net cash used for operating activities from continuing operations

 

(18,702

)

(34,209

)

Net cash (used for) provided by operating activities from discontinued operations

 

(722

)

779

 

Net cash used for operating activities

 

(19,424

)

(33,430

)

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Property and equipment purchases

 

(122

)

(51

)

Investment purchases

 

(56,289

)

(108,886

)

Proceeds from sale/maturity of securities

 

65,000

 

111,895

 

Net cash provided by investing activities from continuing operations

 

8,589

 

2,958

 

Net cash used for investing activities from discontinued operations

 

 

(33

)

Net cash provided by investing activities

 

8,589

 

2,925

 

 

 

 

 

 

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Net proceeds from exercise of common stock options

 

1,799

 

1,082

 

Sale of common stock through employee stock purchase plan

 

132

 

215

 

Net cash provided by financing activities from continuing operations

 

1,931

 

1,297

 

Net cash used for financing activities from discontinued operations

 

 

(78

)

Net cash provided by financing activities

 

1,931

 

1,219

 

 

 

 

 

 

 

NET DECREASE IN CASH AND CASH EQUIVALENTS

 

(8,904

)

(29,286

)

CASH AND CASH EQUIVALENTS:

 

 

 

 

 

Beginning of period

 

37,216

 

40,533

 

End of period

 

$

28,312

 

$

11,247

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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VIVUS, INC.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

JUNE 30, 2011

 

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 and six months ended June 30, 2011 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011. Management has evaluated all events and transactions that occurred after June 30, 2011 up through the date these condensed consolidated financial statements were filed. There were no events or transactions occurring during this subsequent event reporting period which require recognition in these condensed consolidated financial statements except as presented in Note 15: “Subsequent Events”. 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, 2010, as filed on March 1, 2011 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 quarter presentation. On November 5, 2010, the Company completed the sale of MUSE®. As discussed in Note 2: “Discontinued Operations,” the results of operations, the assets and the liabilities related to MUSE have been reported as discontinued operations in accordance with FASB ASC topic 205, Discontinued Operations, or ASC 205. Accordingly, the assets, liabilities and results of operations related to MUSE from prior periods have been reclassified to discontinued operations.

 

Use of Estimates

 

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the 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. DISCONTINUED OPERATIONS

 

On October 1, 2010, the Company entered into a definitive Asset Purchase Agreement with Meda AB, or Meda, to sell certain rights and assets related to MUSE, transurethral alprostadil, for the treatment of erectile dysfunction, or the MUSE Transaction. Meda has been the Company’s European distributor of MUSE since 2002. The assets sold in the MUSE Transaction include the U.S. and foreign MUSE patents, existing inventory, and the manufacturing facility located in Lakewood, New Jersey. The Company retained all of the liabilities associated with the pre-closing operations and products of the MUSE business and the accounts receivable for pre-closing MUSE sales. The transaction closed on November 5, 2010. Prior to the closing of the MUSE Transaction, the Company terminated all of the rights to MUSE and avanafil held by Deerfield Management Company, L.P. and affiliates and by Crown Bank, N. A. as collateral to the Company’s notes payable. Under the terms of the MUSE Transaction, the Company received an upfront payment of $22 million upon the closing and is eligible to receive an additional $1.5 million based on future sales of MUSE, provided that certain sales milestones are reached. Meda is now responsible for the manufacturing, selling and marketing of MUSE. Meda also assumed all post-closing expenses and liabilities associated with MUSE. The Company has agreed not to develop, manufacture or sell any transurethral erectile dysfunction drugs for a period of three years following the closing of the MUSE Transaction.

 

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Table of Contents

 

The sale of the MUSE product and certain related assets has been reported as discontinued operations in the condensed consolidated statements of operations for all periods presented, since (i) the MUSE product and related assets have identifiable cash flows that are largely independent of the cash flows of other groups of assets and liabilities, (ii) the Company does not have any significant continuing involvement with the product after the close of the transaction, and (iii) the cash milestone payment to be received upon achievement of certain sales levels is considered an indirect cash flow. The assets and liabilities related to the MUSE operations are reported as assets and liabilities of discontinued operations in the condensed consolidated balance sheets for all periods presented. The extinguishment of the largest liability of the discontinued operations, accrued product returns, will be settled in accordance with the returns policy and by cash payments made to former customers for the return of expired MUSE product sold by VIVUS. The return window for expired MUSE product will end in 2013.

 

The following table presents the major classes of assets and liabilities that have been presented as assets and liabilities of discontinued operations in the condensed consolidated balance sheets (in thousands):

 

 

 

June 30, 2011
(unaudited)

 

December 31, 2010

 

ASSETS

 

 

 

 

 

Trade accounts receivable, net

 

$

 

$

6

 

Total current assets of discontinued operations

 

$

 

$

6

 

 

 

 

June 30, 2011
(unaudited)

 

December 31, 2010

 

LIABILITIES

 

 

 

 

 

Accounts payable

 

$

 7

 

$

 211

 

Accrued product returns

 

2,380

 

2,598

 

Accrued chargeback reserve

 

275

 

472

 

Accrued employee compensation and benefits

 

 

47

 

Accrued and other liabilities

 

 

184

 

Total current liabilities of discontinued operations

 

$

 2,662

 

$

 3,512

 

 

The following table presents summarized results of operations for the discontinued operations presented in the condensed consolidated statements of operations (in thousands)(unaudited):

 

 

 

For the Three Months
Ended

 

For the Six Months
Ended

 

 

 

June 30,
2011

 

June 30,
2010

 

June 30,
2011

 

June 30,
2010

 

 

 

(unaudited)

 

(unaudited)

 

Operating income (loss)

 

$

107

 

$

(1,087

)

$

121

 

$

(3,199

)

Income (loss) before provision for income taxes

 

107

 

(1,178

)

121

 

(3,380

)

Net income (loss) from discontinued operations

 

$

107

 

$

(1,186

)

$

121

 

$

(3,395

)

 

3. SHARE-BASED COMPENSATION

 

The Company accounts for share-based compensation arrangements in accordance with SFAS 123R, Share-Based Payment, as codified in FASB ASC topic 718, Compensation—Stock Compensation, or ASC 718.

 

Total estimated share-based compensation expense, related to all of the Company’s share-based awards, recognized for the three and six months ended June 30, 2011 and 2010 was comprised as follows (in thousands, except per share data)(unaudited):

 

 

 

Three Months Ended
June 30

 

Six Months Ended
June 30

 

 

 

2011

 

2010

 

2011

 

2010

 

 

 

 

 

 

 

 

 

 

 

Research and development

 

$

529

 

$

229

 

$

1,068

 

$

561

 

General and administrative

 

1,455

 

1,311

 

3,037

 

2,593

 

Share-based compensation expense before taxes

 

1,984

 

1,540

 

4,105

 

3,154

 

Related income tax benefits

 

 

 

 

 

Share-based compensation expense, net of taxes

 

$

1,984

 

$

1,540

 

$

4,105

 

$

3,154

 

Basic and diluted per common share

 

$

0.02

 

$

0.02

 

$

0.05

 

$

0.04

 

 

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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 June 30, 2011 and December 31, 2010 are presented in the tables that follow:

 

As of June 30, 2011 (in thousands)(unaudited):

 

Cash and cash equivalents

 

Amortized
Cost

 

Estimated
Fair Value

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Cash and money market funds

 

$

28,312

 

$

28,312

 

$

 

$

 

Total cash and cash equivalents

 

$

28,312

 

$

28,312

 

$

 

$

 

 

Available-for-sale securities

 

Amortized
Cost

 

Estimated
Fair Value

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

U.S. Treasury securities

 

$

93,255

 

$

93,304

 

$

49

 

$

 

Total available-for-sale securities

 

$

93,255

 

$

93,304

 

$

49

 

$

 

 

As of December 31, 2010 (in thousands):

 

Cash and cash equivalents

 

Amortized
Cost

 

Estimated
Fair Value

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

Cash and money market funds

 

$

37,216

 

$

37,216

 

$

 

$

 

Total cash and cash equivalents

 

$

37,216

 

$

37,216

 

$

 

$

 

 

Available-for-sale securities

 

Amortized
Cost

 

Estimated
Fair Value

 

Gross
Unrealized
Gains

 

Gross
Unrealized
Losses

 

U.S. Treasury securities

 

$

101,966

 

$

101,970

 

$

12

 

$

(8

)

Total available-for-sale securities

 

$

101,966

 

$

101,970

 

$

12

 

$

(8

)

 

The following table summarizes the Company’s available-for-sale securities by the contractual maturity date as of June 30, 2011 (in thousands)(unaudited):

 

 

 

Amortized
Cost

 

Estimated
Fair Value

 

Due within one year

 

$

93,255

 

$

93,304

 

 

 

$

93,255

 

$

93,304

 

 

There were no net realized gains or losses on available-for-sale securities for the periods ended June 30, 2011 and 2010.

 

During the three and six months ended June 30, 2011, the Company had no sales of available-for-sale securities. In the ordinary course of business, the Company 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 June 30, 2011, the Company did not have any cash equivalent or available-for-sale securities that were in an unrealized loss position.

 

At December 31, 2010, the Company had the following cash equivalent and available-for-sale securities that were in an unrealized loss position (in thousands):

 

 

 

Less Than 12 Months

 

December 31, 2010

 

Gross
Unrealized
Losses

 

Estimated
Fair
Value

 

U.S. Treasury securities

 

$

(8

)

$

42,822

 

Total

 

$

(8

)

$

42,822

 

 

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The gross unrealized losses reported above for December 31, 2010 were primarily caused by general fluctuations in market interest rates from the respective purchase date of these securities through the end of those periods.

 

As the Company presently does not intend to sell its debt securities and believes it will not likely be required to sell the securities that are in an unrealized loss position before recovery of their amortized cost, the Company does not consider these securities to be other-than-temporarily impaired.

 

As of June 30, 2011 and December 31, 2010, the temporary unrealized gains on cash, cash equivalents and available-for-sale securities, net of tax, of $49,000 and $4,000, respectively, were included in accumulated other comprehensive income in the accompanying condensed consolidated balance sheets.

 

SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, FSP SFAS 115-2 and SFAS 124-4, Recognition and Presentation of Other-than-Temporary Impairments (“FSP 115-2/SFAS 124-2”) and SAB Topic 5M, Accounting for Non-current Marketable Equity Securities, as codified in FASB ASC topic 320-10, Investments—Debt and Equity Securities, or ASC 320-10, provides guidance on determining when an investment is other-than-temporarily impaired. Investments are reviewed quarterly for indicators of other-than-temporary impairment. Effective for all periods ending after June 15, 2009, it provides additional guidance designed to create greater clarity and consistency in accounting for and presenting impairment losses on securities. At June 30, 2011 and December 31, 2010, all available-for-sale securities were invested in U.S. Treasuries.

 

Fair Value Measurements

 

Effective January 1, 2008, the Company adopted SFAS No. 157, Fair Value Measurements, as codified in FASB ASC 820, Fair Value Measurements and Disclosures, or ASC 820, 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 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, this statement 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, the Company 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 June 30, 2011 (in thousands)(unaudited):

 

 

 

Basis of Fair Value Measurements

 

 

 

Balance at
June 30, 2011

 

Level 1

 

Level 2

 

Level 3

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

Cash and money market funds

 

$

28,312

 

$

28,312

 

$

 

$

 

Total cash and cash equivalents

 

$

28,312

 

$

28,312

 

$

 

$

 

 

 

 

Basis of Fair Value Measurements

 

 

 

Balance at
June 30, 2011

 

Level 1

 

Level 2

 

Level 3

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

$

93,304

 

$

93,304

 

$

 

$

 

Total available-for-sale securities

 

$

93,304

 

$

93,304

 

$

 

$

 

Reported as:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

28,312

 

 

 

 

 

 

 

Available-for-sale securities

 

93,304

 

 

 

 

 

 

 

Total

 

$

121,616

 

 

 

 

 

 

 

 

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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 December 31, 2010 (in thousands):

 

 

 

Basis of Fair Value Measurements

 

 

 

Balance at
December 31, 2010

 

Level 1

 

Level 2

 

Level 3

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

Cash and money market funds

 

$

37,216

 

$

37,216

 

$

 

$

 

Total cash and cash equivalents

 

$

37,216

 

$

37,216

 

$

 

$

 

 

 

 

Basis of Fair Value Measurements

 

 

 

Balance at
December 31, 2010

 

Level 1

 

Level 2

 

Level 3

 

Available-for-sale securities:

 

 

 

 

 

 

 

 

 

U.S. Treasury securities

 

$

101,970

 

$

101,970

 

$

 

$

 

Total available-for-sale securities

 

$

101,970

 

$

101,970

 

$

 

$

 

Reported as:

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

37,216

 

 

 

 

 

 

 

Available-for-sale securities

 

101,970

 

 

 

 

 

 

 

Total

 

$

139,186

 

 

 

 

 

 

 

 

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 1 or Level 2 inputs for the determination of fair value in accordance with ASC 820. 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 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 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.

 

As of June 30, 2011, 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 six months ended June 30, 2011.

 

5. INVENTORIES

 

Inventory balances consist of (in thousands):

 

 

 

June 30, 2011

 

 

 

 

 

(unaudited)

 

December 31, 2010

 

Raw materials

 

$

3,107

 

$

3,225

 

 

The raw materials balance at June 30, 2011 consists of the active pharmaceutical ingredients for QNEXA.

 

The Company has made and anticipates in future periods that it will scale-up and make commercial quantities of certain of its product candidates prior to the date it anticipates that such products will receive final FDA approval in the U.S. or European Medicines Agency approval in the European Union (i.e., pre-launch inventories). Pre-launch inventories are included on the condensed consolidated balance sheets once the product under review has attained a stage in the development process of having been subject to a Phase 3 clinical trial or its equivalent, or if a regulatory filing has been made for licensure for marketing the product and the product has a well characterized manufacturing process.

 

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6. PREPAID EXPENSES AND OTHER ASSETS

 

Prepaid expenses and other assets as of June 30, 2011 and December 31, 2010, respectively, consist of (in thousands):

 

 

 

June 30, 2011
(unaudited)

 

December 31, 2010

 

Refundable federal income taxes

 

$

 

$

141

 

Interest receivable

 

600

 

553

 

Prepaid insurance

 

355

 

594

 

Other prepaid expenses and assets

 

243

 

360

 

Prepaid expenses and other assets

 

$

1,198

 

$

1,648

 

 

7. NOTES PAYABLE

 

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, which included the addition of Deerfield PDI Financing L.P. as a Deerfield Affiliate. Under the agreements, Deerfield and its affiliates agreed to provide $30 million in funding to the Company. The $30 million in funding consisted 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, June and September 2009, constituting all of the required payments under the FARA. The Company paid royalties on the net sales of MUSE and if approved, on future sales of avanafil, an investigational drug candidate, to the Deerfield Sub. The term of the FARA was 10 years. The FARA included 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 provided 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 exercised its right to purchase the Deerfield Sub, the net price would 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 were subject to other adjustments as defined in the agreement). After April 3, 2011, the Deerfield Affiliates could have exercised the right to compel the Company to purchase the Deerfield Sub at a price of $17 million. The purchase prices under the put right were subject to other adjustments as defined in the agreements. If either party exercised 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 were collateral for this transaction.

 

In preparation for the closing of the MUSE Transaction and in accordance with the terms of the Option Premium Adjustment, or OPA, the Company exercised the option right and on October 21, 2010, it paid $27.1 million in satisfaction of all of its financial obligations under the FARA and OPA. The gross amount paid consisted of the Base Option Price of $25 million less the $2 million Option Premium Adjustment, or $23 million, plus the Cash Adjustment of $2.8 million and the Royalty Adjustment of $1.3 million. The Royalty Adjustment was calculated based upon royalties on MUSE sales not yet paid to the Deerfield Sub at the time of Option Closing. The Cash Adjustment was the total amount of cash remaining in the Deerfield Sub at time of Option Closing. As a result, all of the outstanding shares of the Deerfield Sub were acquired by the Company, the royalty rights to MUSE and avanafil were terminated and the notes payable of the Deerfield Sub were cancelled. In addition, the $2.8 million of cash held by the Deerfield Sub is now owned by the Company. All the security interests in the collateral related to MUSE and avanafil held by the Deerfield Sub and the Deerfield Affiliates as part of the FARA and OPA were terminated. The payoff of the Deerfield loan resulted in a loss on the early extinguishment of debt of $6 million which was recognized in the fourth quarter of 2010.

 

The Company evaluated the Deerfield financing in accordance with FASB Financial Interpretation No., or FIN, 46(R), Consolidation of Variable Interest Entities, or FIN 46R, as codified in FASB ASC topic 810, Consolidation, or ASC 810, and determined that the Deerfield Sub may constitute a Variable Interest Entity, or VIE; however, the Company also determined that it was not the primary beneficiary of this VIE and therefore concluded that the Company was not required to consolidate the Deerfield Sub. In December 2010, the Deerfield Sub was dissolved.

 

In accordance with Emerging Issues Task Force (EITF) Issue 88-18, Sale of Future Revenues, as codified in FASB ASC 605, the FARA transaction was in substance a financing arrangement, or loan, that was repaid by the Company. The minimum repayment

 

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amount was $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 recorded the advances from the Deerfield Affiliates, net of the $2 million option right payment and related fees and expenses, as a loan. The Company received all of the required advances under the financing arrangement. Per the agreement, the loan amount would be lower than the contractual amounts owed if the Company exercised its call option of $23 million to $26 million, or if the Deerfield Affiliates required the Company to purchase the shares as a result of a “Major Transaction”. Using the interest method under APB Opinion No. 21, Interest on Receivables and Payables, as codified in FASB ASC topic 835, Interest, subtopic 30, Imputation of Interest or ASC 835-30, interest expense on the loan was calculated and recognized over three years, which was 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 received quarterly payments 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 31% at December 31, 2009 and 33% at December 31, 2008 based on the actual royalty payments made and the timing of payments and advances in 2009 and 2008, respectively. The imputed effective interest rate was utilized for purposes of calculating the interest expense only and did not reflect the amount of royalty paid to the Deerfield Affiliates on a quarterly basis. Quarterly royalty payments were based on a percentage of net MUSE sales at a rate substantially lower than the imputed effective interest rate used to calculate interest expense.

 

8. AGREEMENTS

 

In 2001, VIVUS entered into a Development, Licensing and Supply Agreement with Tanabe for the development of avanafil, an oral PDE5 inhibitor investigational drug 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 MTPC. 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 MTPC in the year ended December 31, 2008; however, the Company paid MTPC $4 million in January 2009 following the enrollment in December 2008 of the first patient in the first Phase 3 clinical study. In June 2011, the Company submitted an NDA to the FDA for avanafil and accrued a $4 million milestone due to MTPC under this agreement. The Company expects to make other substantial payments to MTPC in accordance with its agreements with MTPC 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 $11 million in the aggregate and include payments upon: the obtainment of the first regulatory approval in the U.S. and any major European country; and achievement of $250 million or more in calendar year sales.

 

The term of the MTPC agreement is based on a country-by-country and on a product-by-product basis. The term shall continue until the later of (i) 10 years after the date of the first sale for a particular product, or (ii) the expiration of the last-to-expire patents within the MTPC 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 MTPC with respect to such product.

 

On October 16, 2001, the Company entered into an assignment agreement, or the Assignment Agreement, with Thomas Najarian, M.D. for a combination of pharmaceutical agents for the treatment of obesity and other disorders, or the Combination Therapy, that has since been the focus of our investigational drug candidate development program for QNEXA for the treatment of obesity, obstructive sleep apnea and diabetes. The Combination Therapy and all related patent applications, or the Patents, were transferred to the Company with worldwide rights to develop and commercialize the Combination Therapy and exploit the Patents. Pursuant to the Assignment Agreement, the Company has paid a total of $220,000 to Dr. Najarian through June 30, 2011 and has issued him options to purchase 40,000 shares of our common stock. The Company is obligated under the terms of the Assignment Agreement to make a milestone payment of $1 million and issue an option to purchase 20,000 shares of VIVUS’ common stock to Dr. Najarian upon marketing approval by the FDA of a product for the treatment of obesity that is based upon the Combination Therapy and Patents. The Assignment Agreement will require the Company to pay royalties on worldwide net sales of a product for the treatment of obesity that is based upon the Combination Therapy and Patents until the last-to-expire of the assigned Patents. To the extent that the Company decides not to commercially exploit the Patents, the Assignment Agreement will terminate and the Combination Therapy and Patents will be assigned back to Dr. Najarian. In 2006, Dr. Najarian joined the Company as a part-time employee and currently serves as a Principal Scientist.

 

9. COMMITMENTS AND CONTINGENCIES

 

Lease Commitments

 

In November 2006, the Company entered into a 30-month lease for its corporate headquarters located in Mountain View, California. The lease commenced on February 1, 2007. The base monthly rent was set at $1.85 per square foot or $26,000 per month.

 

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The lease expired on July 31, 2009. On December 16, 2008, the Company entered into a first amendment to this lease. Under the terms of the amended lease, it continues to lease the office space for its corporate headquarters for a two-year period commencing on August 1, 2009 and expiring on July 31, 2011. The base monthly rent was set at $1.64 per square foot or $23,000 per month. The amended lease allowed the Company one option to extend the term of the lease for one year from the expiration of the lease. On November 12, 2009, the Company entered into a second amendment to this lease. The second amendment commenced on January 1, 2010, expires on July 31, 2011 and expands the leased space. The base rent for the expansion space was set at $2.25 per square foot or $8,500 per month. The option to extend the term of the amended lease for one year from the expiration of the lease applies to this expansion space as well. In December 2010, the Company entered into a third amendment to this lease. The third amendment extended the lease term for the original premises and the expansion space for a period of twelve months commencing August 1, 2011 and terminating July 31, 2012. Under the third amendment, the base rent for the original space will be set at $1.69 per square foot or $24,000 per month and the base rent for the expansion space will be set at $2.31 per square foot or $8,700 per month. The amended lease allows the Company one additional option to extend the term of the lease for one year from the expiration of the lease. The option to extend the term of the amended lease for one year from the expiration of the lease applies to this expansion space as well.

 

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

 

2011

 

$

346

 

2012

 

406

 

Total

 

$

752

 

 

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 June 30, 2011, its remaining commitments under these agreements totaled $5.6 million.

 

The Company has remaining commitments under various general and administrative services agreements totaling $3.8 million at June 30, 2011, including $1.5 million related to Leland F. Wilson’s Employment Agreement. 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 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 had an initial term of two years commencing on the effective date, June 1, 2007, or the Effective Date. 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. On January 21, 2011, the Compensation Committee approved the second amendment to Mr. Wilson’s Employment Agreement. Pursuant to the second amendment, the initial term of the Employment Agreement is increased to four years commencing on June 1, 2007. As neither party provided notice of termination, the Employment Agreement was automatically extended for an additional one-year term commencing on June 1, 2011.

 

The Company has also entered into various agreements with research consultants and other contractors to perform regulatory services, drug research and testing and, at June 30, 2011, its remaining commitments under these agreements totaled $3.9 million. The Company has placed orders with MTPC for avanafil finished goods and its remaining commitment under these purchase obligations at June 30, 2011 totaled $6.4 million.

 

Indemnifications

 

In the normal course of business, the Company provides indemnifications of varying scope to certain customers, third party service providers and business partners 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, among others. 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.

 

On May 15, 2007, the Company closed its transaction with K-V Pharmaceutical Company, or K-V, for the sale of its investigational drug candidate, Evamist. At the time of the sale, Evamist was an investigational drug candidate and was not yet approved by the Food and Drug Administration, or FDA, for marketing. 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 that survive the closing date of the transaction, including a covenant not to operate a business that competes, in the U.S., and its territories and protectorates, with the Evamist product.

 

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Pursuant to the terms of the Asset Purchase Agreement, (see Note 2: “Discontinued Operations”), the Company entered into with Meda AB, or Meda, to sell certain of the assets related to the MUSE business to Meda, or the MUSE Transaction, the Company agreed to indemnify Meda in connection with the representations and warranties that it made concerning its rights, liabilities and assets related to the MUSE business and its authority to enter into and consummate the MUSE Transaction. The Company also made certain covenants in the Asset Purchase Agreement which survive the closing of the MUSE Transaction, including a three year covenant not to develop, manufacture, promote or commercialize a trans-urethral erectile dysfunction drug.

 

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.

 

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 June 30, 2011, it was considered more likely than not that the Company’s deferred tax assets would not be realized. However, should there be a change in the Company’s ability to recover its deferred tax assets, the Company would recognize a benefit to its tax provision in the period in which the Company determines that it is more likely than not that it can recover its deferred tax assets.

 

The total gross unrecognized tax benefits as of June 30, 2011 are $1.2 million and relate to state tax exposures, of which $7,000 would affect the effective tax rate if recognized. The total unrecognized tax benefits as of June 30, 2011 include approximately $1.2 million of unrecognized tax benefits that have been netted against the related deferred tax assets.

 

The Company recognizes interest and penalties accrued on any unrecognized tax benefits as a component of its provision for income taxes. As of June 30, 2011, the Company has accrued $1,000 of interest and penalties related to unrecognized tax benefits.

 

The Company’s income tax return for the year ended December 31, 2007 is currently under examination by the California Franchise Tax Board. The Company’s income tax return for the years ended December 31, 2007 and 2008 are currently under examination by the Internal Revenue Service. Because the Company used net operating loss carryforwards and other tax attributes to offset its taxable income on its 2007 income tax returns for U.S. Federal and California, such attributes can be adjusted by these taxing authorities until the statute closes on the year in which such attributes were utilized. Tax years 1991 to 2009 remain subject to examination by the appropriate governmental agencies due to tax loss carryovers from those years.

 

The Company is in various stages of the examination process in connection with all of its tax audits and it is difficult to determine when these examinations will be settled. It is reasonably possible that over the next twelve-month period the Company may experience an increase or decrease in its unrecognized tax benefits. It is not possible to determine either the magnitude or range of any increase or decrease at this time.

 

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11. NET INCOME (LOSS) PER SHARE

 

The Company computes basic net income (loss) per share applicable to common shareholders 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 and six months ended June 30, 2011 and 2010 all potential common equivalent shares were excluded for these periods as they were anti-dilutive. For the three months ended June 30, 2011and 2010, 5,412,766 and 5,168,457 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. For the six months ended June 30, 2011, and 2010, respectively, 5,321,330 and 4,753,501 options outstanding, respectively, were not included in the computation of diluted net loss per share for the Company because the effect would be anti-dilutive.

 

12. EQUITY TRANSACTIONS

 

On February 16, 2010, the Company filed a Form S-8 (File Number 333-164921) 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 July 14, 2010, the Company filed a Form S-8 (File Number 333-168106) with the SEC registering 16,615,199 shares of common stock, par value $0.001 per share, to be issued pursuant to the 2010 Equity Incentive Plan, and registering 400,000 shares of common stock, par value $0.001 per share, to be issued pursuant to the Stand-Alone Stock Option Agreement with Michael P. Miller.

 

On August 1, 2011, the Company filed a Form S-8 with the SEC registering 600,000 shares of common stock, par value $0.001 per share, under the 1994 Employee Stock Purchase Plan, as amended, or 1994 ESPP.

 

13. LEGAL MATTERS

 

Securities Related Class Action Lawsuits

 

The Company and two of its officers are defendants in a putative class action lawsuit captioned Kovtun v. Vivus, Inc., et al., Case No. CV10-4957 PJH, pending in the U.S. District Court, Northern District of California. The action, filed in November 2010, alleges violations of Section 10(b) and 20(a) of the federal Securities Exchange Act of 1934 based on allegedly false or misleading statements made by defendants in connection with the Company’s clinical trials and New Drug Application, or NDA, for QNEXA as a treatment for obesity. In his Amended Class Action Complaint filed April 4, 2011, plaintiff alleges generally that defendants misled investors regarding the prospects for QNEXA’s NDA approval, and the drug’s efficacy and safety. On June 3, 2011, defendants filed a motion to dismiss, which is currently scheduled for hearing on October 5, 2011. Discovery is stayed pending resolution of the motion.

 

Additionally, the Company’s directors are defendants in a shareholder derivative lawsuit captioned Turberg v. Logan, et al., Case No. CV 10-05271 PJH, also pending in the same federal court. In her Verified Amended Shareholder Derivative Complaint filed June 3, 2011, plaintiff largely restates the allegations of the Kovtun action and alleges that the directors breached fiduciary duties to the Company by purportedly permitting the Company to violate the federal securities laws as alleged in Kovtun. The matter is stayed pending resolution of defendants’ motion to dismiss in Kovtun. The Company’s directors are also named defendants in consolidated shareholder derivative suits pending in the California Superior Court, Santa Clara County under the caption In re VIVUS, Inc. Derivative Litigation, Master File No. 11 0 CV188439. The allegations in the state court derivative suits are substantially similar to the other lawsuits. As with the federal derivative litigation, these consolidated actions are stayed pending resolution of the motion to dismiss in Kovtun.

 

The Company and its directors believe that the various shareholder lawsuits are without merit, and they intend to vigorously defend the various actions.

 

Other Matters

 

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

 

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subject to various claims from current and former employees including wrongful termination, sexual discrimination and employment matters. Due to the current economic downturn, employees may be more likely to file employment-related claims following termination of their employment. Employment-related claims also may be more likely following a poor performance review. Although there may be no merit to such claims or legal matters, the Company may be required to allocate additional monetary and personnel resources to defend against these type of allegations. The Company believes the disposition of the current lawsuit and claims is not likely to have a material effect on its financial condition or liquidity.

 

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

 

14. STOCK OPTION AND PURCHASE PLANS

 

On March 29, 2010, the Company’s Board of Directors terminated the Company’s 2001 Stock Option Plan, or the 2001 Plan. In addition, the Board of Directors adopted and approved a new 2010 Equity Incentive Plan, or the 2010 Plan, with 32,000 shares remaining reserved and unissued under the 2001 Plan. In addition, the Board of Directors adopted and approved a new 2010 Equity Incentive Plan, or the 2010 Plan, subject to the approval of the Company’s stockholders. The 2001 Plan, however, will continue to govern awards previously granted under it. On June 25, 2010, the Company’s stockholders approved the 2010 Plan at the Company’s 2010 Annual Meeting of Stockholders. The 2010 Plan provides for the grant of stock options, stock appreciation rights, restricted stock, restricted stock units, performance shares and performance units to employees, directors and consultants, to be granted from time to time as determined by the Board of Directors, the Compensation Committee of the Board of Directors, or its designees. The 2010 Plan’s share reserve which the stockholders approved is 8,400,000 shares, plus any shares reserved but not issued pursuant to awards under the 2001 Plan as of the date of stockholder approval, plus any shares subject to outstanding awards under the 2001 Plan that expire or otherwise terminate without having been exercised in full, or are forfeited to or repurchased by the Company, up to a maximum of 8,111,273 shares (which is the number of shares subject to outstanding options under the 2001 Plan as of March 11, 2010). Awards exercisable for 1,563,790 shares have been granted pursuant to the 2010 Plan.

 

On April 30, 2010, the Company’s Board of Directors granted an option to purchase 400,000 shares of the Company’s common stock, or the Inducement Grant, to Michael P. Miller, the Company’s new Senior Vice President and Chief Commercial Officer. The Inducement Grant was granted outside of the Company’s 2010 Plan and without stockholder approval pursuant to NASDAQ Listing Rule 5635(c)(4) and is subject to the terms and conditions of the Stand-Alone Stock Option Agreement between the Company and Michael P. Miller.

 

As of June 30, 2011, there were 8,769,511 shares subject to all options outstanding under all stock plans and 7,282,044 shares reserved for issuance under the 2010 Plan. Additionally, the average weighted exercise price of all outstanding options under all stock plans was $6.19 per share and the average weighted remaining term was 6.81 years.

 

On June 17, 2011, the Company’s stockholders approved amendments to the Company’s 1994 ESPP to increase the number of shares reserved for issuance under the 1994 ESPP by 600,000 shares to a new total of 2,000,000, to remove the Plan’s 20-year term, and to include certain changes consistent with Treasury Regulations relating to employee stock purchase plans under Section 423 of the Internal Revenue Code of 1986, as amended, and other applicable law.

 

As of June 30, 2011, 1,351,550 shares have been issued to employees and there are 48,450 shares available for issuance under the 1994 ESPP.

 

15. SUBSEQUENT EVENTS

 

On August 1, 2011, the Company filed a Form S-8 with the SEC registering 600,000 shares of common stock, par value $0.001 per share, under the 1994 Employee Stock Purchase Plan, as amended.

 

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 “may,” “will,” “believe,” “expect,” “intend,” “anticipate,” “predict,” “should,” “planned,” “continue,” “likely,” “opportunity,” “estimated,” and “potential,” the negative use of these words or other similar words. 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

 

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statements. The risks and uncertainties that may affect the operations, performance, development, and results of our business include but are not limited to: (1) the timing and substance of our response to the FDA’s requests from the End-of-Review meeting; (2) our response to, and continued dialogue with, the FDA relating to matters raised in the FDA’s Complete Response Letter, or CRL; (3) the timing and results of the retrospective observational study of fetal outcomes in infants born to mothers exposed to topiramate during pregnancy; (4) the reliability of the electronic medical claims healthcare databases used in the FORTRESS study; (5) the FDA’s interpretation of and agreement with the information VIVUS submitted relating to teratogenicity and cardiovascular safety; (6) the FDA’s interpretation of the data from our SEQUEL study (OB-305) and Sleep Apnea study (OB-204); (7) that we may be required to conduct additional prospective studies or retrospective observational studies or to provide further analysis of clinical trial data; (8) our response to questions and requests for additional information including additional pre-clinical or clinical studies from the European Medicines Agency, or EMA, and the Committee for Medicinal Products for Human Use, or CHMP, of the Marketing Authorization Application, or MAA, for QNEXA; (9) the results of external studies to assess the teratogenic risk of topiramate; (10) results of the REMS or cardiovascular outcomes for obesity advisory meetings; (11) the outcome of the second advisory committee meeting for QNEXA; (12) impact on future sales based on specific indication and contraindications contained in the label and extent of the REMS, distribution and patient access program; (13) our history of losses and variable quarterly results; (14) substantial competition; (15) risks related to the failure to protect our intellectual property and litigation in which we may become involved; (16) uncertainties of government or third party payer reimbursement; (17) our reliance on sole source suppliers; (18) our limited sales and marketing efforts and our reliance on third parties; (19) failure to continue to develop innovative investigational drug candidates and drugs; (20) risks related to the failure to obtain United States Food and Drug Administration, or FDA, or foreign authority clearances or approvals and noncompliance with FDA regulations; (21) our ability to demonstrate through clinical testing the safety and effectiveness of our investigational drug candidates; (22) our dependence on the performance of our collaborative partners; (23) the timing of initiation and completion of clinical trials and submissions to the FDA; (24) the volatility and liquidity of the financial markets; (25) our liquidity and capital resources; (26) our expected future revenues, operations and expenditures; and (27) 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 “Item 1A. Risk Factors.”

 

All percentage amounts and ratios were calculated using the underlying data in thousands. Operating results for the quarter and six months ended June 30, 2011, 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 as a California corporation and reincorporated in 1996 as a Delaware corporation, dedicated to the development and commercialization of therapeutic drugs for large underserved markets, including obesity and related morbidities, such as sleep apnea and diabetes and men’s sexual health. With respect to obesity, historical estimates are that the potential worldwide pharmaceutical market for obesity could approach $5 billion annually. The recent withdrawal of sibutramine from the market and failure of new therapies, including QNEXA, to gain approval from the FDA or foreign regulators makes it difficult to estimate the potential size of the obesity market. Obesity remains an epidemic and in the United States alone, the CDC estimates that over 108 million people are obese or overweight. Annual sales of approved drugs for diabetes worldwide were approximately $35 billion in 2010 and are expected to grow to approximately $50 billion by 2015. There are currently no approved pharmaceutical therapies for sleep apnea; however, the sales of devices and related consumables used to treat sleep apnea exceed $2 billion annually. Annual sales of approved drugs for erectile dysfunction currently exceed $4 billion.

 

Currently, our investigational drug candidate, QNEXA, is under review by regulators for approval as a treatment for obesity in the U.S. and the European Union. On October 28, 2010, we received a CRL regarding the New Drug Application, or NDA, for QNEXA® as a treatment for obesity. The CRL stated that in its current form, the NDA for QNEXA was not approvable. The CRL included the following areas: clinical, labeling, Risk Evaluation and Mitigation Strategy, or REMS, safety update, and drug scheduling. In the clinical section of the CRL, the Federal Drug Administration, or FDA, requested a comprehensive assessment of topiramate’s and QNEXA’s teratogenic potential including a detailed plan and strategy to evaluate and mitigate the potential teratogenic risks in women of childbearing potential taking the drug for the treatment of obesity. In addition, the FDA asked us to provide evidence that the elevation in heart rate (mean 1.6 beats per minute on the top dose) associated with QNEXA does not increase the risk for major adverse cardiovascular events. The FDA requested that we formally submit the results from the completed SEQUEL study (OB-305), a 52-week extension study for a subset of 675 patients who completed the previously reported 56-week CONQUER study. The FDA reserved the right to comment further on proposed labeling. On REMS, the FDA requested that a discussion of an already submitted REMS plan be continued after we have submitted the written response. The agency also requested a safety update of any new adverse events be submitted to the NDA. Finally, the FDA stated that if approved, QNEXA would be a Schedule IV drug due to the phentermine component. No new clinical studies were requested in the CRL. On January 19, 2011, we held an End-of-Review meeting with the FDA to discuss the items contained in the CRL and the information we plan to include in the resubmission of the NDA for QNEXA. In anticipation of the meeting, we provided a briefing document that included comprehensive assessment of the teratogenic potential of topiramate including analyses integrating existing non-clinical and clinical data. In addition,

 

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we provided several new analyses including cardiovascular data from our SEQUEL (OB-305) and Sleep Apnea (OB-204) studies to demonstrate that QNEXA does not increase the risk for major cardiovascular events and that the observed increases in heart rate, which occurred in some patients over the course of the clinical program, did not increase the risk of major cardiovascular events, as evidenced by adverse events reported in the trial. We also provided a synopsis of the final study report for the SEQUEL study. At the meeting, an overview was provided of the teratogenicity and cardiovascular risk material covered by the background package. The discussion also included elements of our proposed REMS program for QNEXA. The primary focus of the FDA at the meeting, however, concerned the teratogenic potential for topiramate, specifically the incidence of oral clefts observed in the North American AED Pregnancy Registry and in the UK Epilepsy and Pregnancy Registry. The FDA requested that we assess the feasibility of performing a retrospective observational study utilizing existing electronic medical claims healthcare databases to review fetal outcomes, including the incidence of congenital malformations and oral cleft, in the offspring of women who received prophylaxis treatment with 100 mg of topiramate for migraine during pregnancy, or the Feasibility Assessment. We held a follow up meeting with the FDA on April 14, 2011 to discuss the Feasibility Assessment. We have reached agreement, subject to the finalization of the written protocol and statistical analysis plan, with the FDA on the retrospective observational study objectives and design, primary endpoints, and eligibility criteria. During the April 2011 meeting, it was agreed the study would be expanded to include all doses of topiramate and all diagnoses. It was also agreed that the results would be stratified and that the diagnoses of those exposed to topiramate would be matched with control groups with similar diagnoses and patient profiles. The co-primary endpoints will be the relative risk of major congenital malformations and oral cleft in infants born to mothers exposed to topiramate during pregnancy as compared to a control group that was not exposed to topiramate. The retrospective observational study is called FORTRESS, for Fetal Outcome Retrospective TopiRamate ExpoSure Study. The FORTRESS study is underway and we expect the results in the fourth quarter of 2011. The final indication and timing of the resubmission will be dependent upon the results of the retrospective observational study. Our goal is to resubmit the QNEXA NDA in the fourth quarter of 2011. We have confirmed with the FDA that any resubmission will be considered a Class 2 resubmission with a 6-month review goal. The FDA has also indicated that a resubmission would likely be discussed at a second advisory committee meeting. Although no other requests for additional information or studies were made by the FDA at these meetings or in the CRL, there can be no assurance that the FDA will not request or require us to provide additional information or undertake additional prospective studies or retrospective observational studies in connection with the QNEXA NDA. In the QNEXA studies, which included 15 offspring from women exposed to QNEXA or topiramate, there were no reports of any congenital malformations.

 

In May 2011, we received a response to our MAA from the CHMP. The response was in the form of the “120-day questions.” We are currently reviewing the 120-day questions which cover a broad range of topics including, without limitation, issues relating to phentermine, which include historical concerns regarding its potential association with valvulopathy and pulmonary hypertension; heart rate and limited long-term safety data in high-risk patients; and known and suspected affects of topiramate which include CNS and teratogenic potential. The CHMP also had questions concerning our proposed risk management plan for QNEXA. The 120-day questions are consistent with the issues previously raised in the FDA review process. We are in the process of preparing our response.  We will meet with representatives from the CHMP to seek clarification on certain questions and we anticipate submitting a response in the fourth quarter of 2011. We expect the CHMP to issue the 180-day opinion in the first quarter of 2012. There can be no assurance that our response will be adequate or that our MAA will be approved by the EMA.

 

In May 2011, the Journal of the American Medical Association published the results of a study entitled, Newer-Generation Antiepileptic Drugs and the Risk of Major Birth Defects by Ditte Mølgaard-Nielsen, MSc, Anders Hviid, MSc, DrMedSci (JAMA. 2011;305(19):1996-2002) . The study was a population-based cohort study of 837,795 live-born infants in Denmark from January 1, 1996, through September 30, 2008. Individual-level information on dispensed antiepileptic drugs to mothers, birth defect diagnoses, and potential confounders were obtained from compulsory nationwide health registries. The main outcome measures were Prevalence Odds Ratios (PORs) of any major birth defect diagnosed within the first year of life by fetal exposure to antiepileptic drugs.

 

Of the 1,532 infants exposed to lamotrigine, oxcarbazepine, topiramate, gabapentin, or levetiracetam (newer-generation antiepileptic drugs) during the first trimester, 49 were diagnosed with a major birth defect compared with 19,911 of the 836,263 who were not exposed to an antiepileptic drug (3.2% vs. 2.4%, respectively; adjusted POR [APOR], 0.99; 95% confidence interval [CI], 0.72-1.36). For the topiramate subgroup, a major birth defect was diagnosed in five of 108 infants (4.6%) exposed to topiramate (APOR, 1.44; 95% CI, 0.58-3.58). The study concluded that among live-born infants in Denmark, first-trimester exposure to newer-generation antiepileptic drugs, including topiramate, compared with no exposure, was not associated with an increased risk of major birth defects.

 

In July 2011, abstracts for an international epilepsy conference became available. Included in these abstracts were the top-line results of an additional retrospective study of medical claims data on oral clefts, or OCs, and major congenital malformations, or MCMs, associated with in utero topiramate exposure. This study was conducted using medical claims and pharmacy prescription data from the Wolters Kluwer Pharma Solutions Source® Lx Patient Longitudinal Database. This study identified 778 mother-infant dyads exposed to topiramate within 10 months prior to giving birth. The study compared the incidence rate of OC and MCM in topiramate exposed dyads to two control groups, one comprised of 3,431 dyads exposed to other antiepileptic drugs, or AEDs, during pregnancy

 

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and a second of 2,307 dyads with a diagnosis of epilepsy (with or without treatment), but no exposure to topiramate during pregnancy. Dyads exposed to known teratogens were excluded from all cohorts. The results of the study found there were no statistically significant differences in OC or MCM frequency between the topiramate and control groups. The results of this retrospective study will be presented at the International Epilepsy Congress, or IEC, in Rome, Italy on August 31, 2011 by Dr. Alison Pack, Associate Professor of Clinical Neurology, Department of Neurology, Columbia University Medical Center.

 

The FDA has recently updated the label for topiramate to reflect a lower than previously reported relative risk of oral cleft.  In March 2011, based on data from the North American antiepileptic registry, the reported prevalence of oral cleft from topiramate exposure was 1.4% as compared to a historical control of 0.07%. In July 2011, the label was revised and now includes a prevalence rate for oral cleft of 1.2%. The historical control was corrected to 0.12%, which is more in line with the expected background rate in the general population. More importantly, the relative risk calculation dramatically improved from 21.3 to 9.6.

 

In addition to QNEXA, we have an investigational drug candidate, avanafil, to treat erectile dysfunction, or ED. We have completed the Phase 3 clinical studies for avanafil and we filed an NDA with the FDA in June 2011. In clinical studies, avanafil has demonstrated a fast onset of action, with full efficacy reported in some patients within 15 minutes after administration. The unique profile of avanafil suggests that the compound may be more selective than other oral phosphodiesterase type 5, or PDE5, inhibitors. Greater selectivity can potentially result in lower incidence of the side effects associated with activation of non-PDE5 isozymes.

 

Our Future

 

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

 

·                  seeking regulatory approval for QNEXA for the treatment of obesity in the U.S. and the European Union and other territories worldwide;

 

·                  seeking regulatory approval for avanafil for the treatment of ED in the U.S., the European Union and other territories worldwide;

 

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

 

·                  capitalizing on our clinical and regulatory expertise and experience to advance the development of investigational drug candidates in our pipeline.

 

It is our objective to become a leader in the development and commercialization of drugs for large underserved markets. We believe we have strong intellectual property supporting several opportunities in obesity and related disorders, such as sleep apnea and diabetes, and men’s sexual health. Our future growth depends on our ability to further develop and obtain regulatory approval of our investigational drug candidates for indications that we have studied, or plan to study, as well as in-licensing and product line extensions.

 

We have funded operations primarily through private and public offerings of our common stock, through the sale of the rights to Evamist and through sales of our former product, MUSE (alprostadil). 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 and for pre-commercialization activities. In connection with the sale of Evamist, to date we have received an aggregate of $150 million. On November 5, 2010, we sold MUSE to Meda A.B., for which we received an upfront payment of $22 million upon the closing and are eligible to receive an additional $1.5 million based on future sales of MUSE, provided that certain sales milestones are reached. As of June 30, 2011, we have incurred a cumulative deficit of $326.2 million and expect to incur operating losses in future years.

 

Our Investigational Drug Candidates

 

Our investigational drug pipeline includes two late-stage clinical investigational drug candidates. One of these investigational drug candidates, QNEXA, has completed Phase 3 clinical trials for obesity and Phase 2 clinical trials for diabetes and obstructive sleep apnea. We submitted an NDA to the FDA for QNEXA in December 2009. On October 28, 2010, we received a CRL from the FDA regarding the QNEXA NDA stating that the NDA could not be approved in its present form. In subsequent meetings with the FDA, we have come to an agreement, subject to finalization of the written protocol and statistical analysis plan, on a retrospective observational study of major congenital malformations and oral clefts, FORTRESS. The timing and final indication of the QNEXA NDA resubmission is dependent on the results of FORTRESS. In the EU, the MAA for QNEXA is currently under review through the centralized procedure. In May 2011, we received the 120-day questions from the CHMP. We are currently reviewing the 120-day questions and anticipate submitting our response in the fourth quarter of 2011. We expect the CHMP to issue the 180-day opinion in the first quarter of 2012. There can be no assurance that our response will be adequate or that our MAA will be approved by the EMA.

 

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We submitted an NDA for avanafil, our second late-stage investigational drug candidate, for the treatment of erectile dysfunction in June 2011 and expect to submit the MAA in the first half of 2012. Our investigational drug candidates are summarized as follows:

 

Drug

 

Indication

 

Status

 

Commercial rights

QNEXA (phentermine and topiramate CR)

 

Obesity

 

Phase 3 studies completed; NDA submitted; CRL received; MAA under review in EU; 120-day questions received

 

Worldwide

QNEXA (phentermine and topiramate CR)

 

Obstructive Sleep Apnea

 

Phase 2 study completed

 

Worldwide

QNEXA (phentermine and topiramate CR)

 

Diabetes

 

Phase 2 study completed

 

Worldwide

Avanafil (PDE5 inhibitor)

 

Erectile dysfunction

 

Phase 3 completed; NDA submitted; MAA preparation and submission in progress

 

Worldwide license from Mitsubishi Tanabe Pharma Corporation (excluding certain Asian markets)

 

QNEXA for Obesity

 

Obesity is a chronic disease condition that affects millions of people and often requires long-term or invasive treatment to promote and sustain weight loss. In the National Health and Nutrition Examination Survey, or NHANES, conducted for 2007-2008, 68% of adults in the U.S. (72.3% of men and 64.1% of women) were classified as overweight, defined as a body mass index, or BMI >25, and 33.8% were obese (BMI >30). The percentage of American men and women classified as overweight and obese has more than doubled since 1962. Researchers fear that the percentage of American adults that are obese could climb as high as 43% in the next 10 years. Obesity is the second leading cause of preventable death in the U.S. According to a study performed by the Centers for Disease Control and Prevention, or CDC, as reported in the Journal of the American Medical Association, an estimated 112,000 excess deaths a year in the U.S. are attributable to obesity. Additionally, Americans spend more than $30 billion annually on weight-loss products and services.

 

QNEXA is our proprietary oral investigational drug candidate for the treatment of obesity, incorporating low doses of active ingredients from two previously approved drugs, phentermine and topiramate. We believe that by combining these compounds, QNEXA targets 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 phentermine and topiramate. Our first U.S. patent on QNEXA (U.S. 7,056,890 B2) and our EU patent on QNEXA (EU EP 1187603) both expire in 2020.

 

On January 19, 2011, we held an End-of-Review meeting with the FDA to discuss our planned response to the CRL received on October 28, 2010, regarding the New Drug Application, or NDA, for QNEXA as a treatment for obesity. The CRL stated that in its current form, the NDA for QNEXA was not approvable. The CRL included the following areas: clinical, labeling, REMS, safety update, and drug scheduling. In the clinical section of the CRL, the FDA requested a comprehensive assessment of topiramate’s and QNEXA’s teratogenic potential including a detailed plan and strategy to evaluate and mitigate the potential teratogenic risks in women of childbearing potential taking the drug for the treatment of obesity. In addition, the FDA asked us to provide evidence that the elevation in heart rate (mean 1.6 beats per minute on the top dose) associated with QNEXA does not increase the risk for major adverse cardiovascular events. The FDA requested that we formally submit the results from the completed SEQUEL study (OB-305), a 52-week extension study for a subset of 675 patients who completed the previously reported 56-week CONQUER study. The FDA reserved the right to comment further on proposed labeling. On REMS, the FDA requested that a discussion of an already-submitted REMS plan be continued after we have submitted the written response. The agency also requested a safety update of any new adverse events be submitted to the NDA. Finally, the FDA stated that if approved, QNEXA would be a Schedule IV drug due to the phentermine component. No new clinical studies were requested in the CRL. In anticipation of the meeting held with the FDA on January 19, 2011, we provided a briefing document that included comprehensive assessment of the teratogenic potential of topiramate including analyses integrating existing non-clinical and clinical data. In addition, we provided several new analyses including cardiovascular data from our SEQUEL (OB-305) and Sleep Apnea (OB-204) studies to demonstrate that QNEXA does not increase the risk for major cardiovascular events and that the observed increases in heart rate, which occurred in some patients over the course of the clinical program, did not increase the risk of major cardiovascular events, as evidenced by adverse events reported in the trial. We also provided a synopsis of the final study report for the SEQUEL study. At the meeting, an overview was provided of the teratogenicity and cardiovascular risk material covered in the background package. The discussion also included elements of our proposed REMS program for QNEXA. The primary focus of the FDA at the meeting, however, concerned the teratogenic potential for topiramate. The FDA requested that we complete the Feasibility Assessment. The Feasibility Assessment is complete and in April 2011 we again met with the FDA and agreed to conduct the retrospective observational study, FORTRESS, prior to the resubmission

 

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of the QNEXA NDA. Although no other requests for additional information or studies were made by the FDA at these meetings or in the CRL, there can be no assurance that the FDA will not request or require us to provide additional information or undertake additional studies in connection with the QNEXA NDA. In the QNEXA studies, which included 15 births from women exposed to QNEXA or topiramate, there were no reports of any congenital malformations or low birth weight.

 

On March 4, 2011, the FDA issued a drug safety communication informing the public of new data that show that there is an increased risk for the development of cleft lip and/or cleft palate (oral clefts) in infants born to women treated with topiramate (Topamax and generic products) during pregnancy. The communication stated that the benefits and the risks of topiramate should be carefully weighed when prescribing this drug to women of childbearing age, particularly for conditions not usually associated with permanent injury or death. The communication also indicated that alternative medications that have a lower risk of oral clefts and other adverse birth outcomes should be considered for these patients. If the decision is made to use topiramate in women of childbearing age, effective birth control should be used. Oral clefts occur in the first trimester of pregnancy before many women know they are pregnant.  Topiramate was previously classified as a Pregnancy Category C drug, which means that data from animal studies suggested potential fetal risks, but no adequate data from human clinical trials or studies were available at the time of approval. However, because of preliminary human data that show an increased risk for oral clefts, topiramate was placed in Pregnancy Category D. Pregnancy Category D means there is positive evidence of human fetal risk based on human data but the potential benefits from use of the drug in pregnant women may be acceptable in certain situations despite its risks.  The safety communication and changes in the Pregnancy Category were due in part to data from the North American Antiepileptic Drug, or NAAED, Pregnancy Registry which indicated an increased risk of oral clefts in infants born to mothers exposed to topiramate monotherapy during the first trimester of pregnancy. The prevalence of oral clefts was 1.4% (3/289) compared to a prevalence of 0.38% - 0.55% in infants born to mothers exposed to other antiepileptic drugs, or AEDs, and a purported prevalence of 0.07% in infants born to mothers without epilepsy or treatment with other AEDs. The relative risk of oral clefts in topiramate-exposed pregnancies in the NAAED Pregnancy Registry was 21.3 as compared to the risk in a background population of untreated women (95% Confidence Interval:7.9 — 57.1). The UK Epilepsy and Pregnancy Register reported a similarly increased prevalence of oral clefts (3.2%) among infants born to mothers exposed to topiramate monotherapy, a 16-fold increase in risk compared to the risk in their background population (0.2%).

 

The FDA has recently updated the label for topiramate to reflect a lower than previously reported relative risk of oral cleft.  In March 2011, based on data from the North American antiepileptic registry, the reported prevalence of oral cleft from topiramate exposure was 1.4% as compared to a historical control of 0.07%. In July 2011, the label was revised and now includes a prevalence rate for oral cleft of 1.2%. The historical control was corrected to 0.12%, which is more in line with the expected background rate in the general population. More importantly, the relative risk calculation dramatically improved from 21.3 to 9.6.

 

In May 2011, the Journal of the American Medical Association published the results of a study entitled, Newer-Generation Antiepileptic Drugs and the Risk of Major Birth Defects by Ditte Mølgaard-Nielsen, MSc, Anders Hviid, MSc, DrMedSci (JAMA. 2011;305(19):1996-2002) . The study was a population-based cohort study of 837,795 live-born infants in Denmark from January 1, 1996 through September 30, 2008. Individual-level information on dispensed antiepileptic drugs to mothers, birth defect diagnoses, and potential confounders were obtained from compulsory nationwide health registries. The main outcome measures were Prevalence Odds Ratios (PORs) of any major birth defect diagnosed within the first year of life by fetal exposure to antiepileptic drugs. Of the 1,532 infants exposed to lamotrigine, oxcarbazepine, topiramate, gabapentin, or levetiracetam (newer-generation antiepileptic drugs) during the first trimester, 49 were diagnosed with a major birth defect compared with 19,911 of the 836,263 who were not exposed to an antiepileptic drug (3.2% vs. 2.4%, respectively; adjusted POR [APOR], 0.99; 95% confidence interval [CI], 0.72-1.36). For the small topiramate subgroup, a major birth defect was diagnosed in five of 108 infants (4.6%) exposed to topiramate (APOR, 1.44; 95% CI, 0.58-3.58). The study concluded that among live-born infants in Denmark, first-trimester exposure to newer-generation antiepileptic drugs, including topiramate, compared with no exposure, was not associated with an increased risk of major birth defects.

 

In July 2011, abstracts for an international epilepsy conference became available. Included in these abstracts were the top-line results of an additional retrospective study of medical claims data on oral clefts, or OCs, and major congenital malformations, or MCMs, associated with in utero topiramate exposure. This study was conducted using medical claims and pharmacy prescription data from the Wolters Kluwer Pharma Solutions Source® Lx Patient Longitudinal Database. This study identified 778 mother-infant dyads exposed to topiramate within 10 months prior to giving birth. The study compared the incidence rate of OC and MCM in topiramate exposed dyads to two control groups, one comprised of 3,431 dyads exposed to other antiepileptic drugs, or AEDs, during pregnancy and a second of 2,307 dyads with a diagnosis of epilepsy (with or without treatment), but no exposure to topiramate during pregnancy. Dyads exposed to known teratogens were excluded from all cohorts. The results of the study found there were no statistically significant differences in OC or MCM frequency between the topiramate and control groups. The results of this retrospective study will be presented at the International Epilepsy Congress, or IEC, in Rome, Italy on August 31, 2011 by Dr. Alison Pack, Associate Professor of Clinical Neurology, Department of Neurology, Columbia University Medical Center.

 

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The risk of OC and MCM due to topiramate exposure was calculated in comparison to the other AED exposed and the non-topiramate exposed epilepsy groups.  The results are as follows:

 

Frequency of:

 

Topiramate Group

 

AED Group

 

Epilepsy Group

 

Oral Cleft

 

0.26

%

0.20

%

0.30

%

Major malformations

 

4.11

%

3.50

%

4.72

%

 

The relative risk (95% CI) for the topiramate group vs. other AEDs group for OCs was 1.26 (0.26-6.05) and the relative risk of MCMs was 1.18 (0.80-1.72). For the topiramate vs. the non-topiramate exposed epilepsy group, the relative risk was 0.85 (0.18-4.07) for OCs and the relative risk was 0.87 (0.59-1.28) for MCMs. There were no statistically significant differences in OC or MCM frequency between the topiramate and control groups.

 

On December 17, 2010, we filed an MAA with the EMA for QNEXA Controlled-Release Capsules in the European Union, or EU. The MAA was officially validated for the central procedure on January 19, 2011. The proposed indication in the EU is for the treatment of obesity, including weight loss and maintenance of weight loss, and should be used in conjunction with a mildly hypocaloric diet. If approved in the EU, QNEXA could be recommended for obese adult patients (BMI > 30 kg/m2), or overweight patients (BMI > 27 kg/m2) with weight-related co-morbidities such as hypertension, type 2 diabetes, dyslipidemia, or central adiposity (abdominal obesity). In Europe, approximately 150 million adults are considered overweight or obese, and the prevalence is rising. According to EMA guidelines for medicinal products used in weight control, a demonstration of weight loss of at least 10% of baseline weight, which is at least statistically greater than that associated with placebo, is considered to be a valid primary efficacy criterion. We believe QNEXA has met this efficacy criterion set by the EMA for obesity therapies. The mean weight loss for the mid and top dose of QNEXA at the end of two years was 10.4% and 11.4%, respectively, which we believe met the efficacy benchmark described by the EMA guidelines for obesity therapies. The MAA filing is comprised of data from over 4,500 overweight or obese patients with a broad range of weight-related co-morbidities. Two-year, double-blind data from SEQUEL (OB-305) were also included in the filing to demonstrate durability of treatment response and long-term safety. The EMA’s review of QNEXA will follow their centralized marketing authorization procedure. In May 2011, we received the 120-day questions from the CHMP. We are currently reviewing the 120-day questions which cover a broad range of topics including, without limitation, issues relating to phentermine, which include historical concerns regarding its potential association with valvulopathy and pulmonary hypertension; heart rate and limited long-term safety data in high-risk patients; and known and suspected affects of topiramate which include CNS and teratogenic potential. The CHMP also had questions concerning our proposed risk management plan for QNEXA. The 120-day questions are consistent with the issues previously raised in the FDA review process. We are in the process of preparing our response. We will meet with representatives from the CHMP to seek clarification on certain questions and anticipate submitting a response in the fourth quarter of 2011. We expect the CHMP to issue the 180-day opinion in the first quarter of 2012. There can be no assurance that our response will be adequate or that our MAA will be approved by the EMA. If approved, QNEXA could receive marketing authorization in all EU member countries.

 

EQUIP (OB-302) AND CONQUER (0B-303) One-Year Phase 3 Studies

 

The QNEXA development program included two large Phase 3 randomized, double-blind, placebo-controlled, 3-arm, prospective studies across 93 centers comparing QNEXA to placebo over a 56-week treatment period. All Phase 3 studies utilized our once-a-day formulation of QNEXA, which at top dose contains 15 mg phentermine and 92 mg of a proprietary controlled release formulation of topiramate. The Phase 3 studies were designed to prospectively demonstrate the safety and efficacy of QNEXA in obese and overweight patients with different baseline characteristics. The co-primary endpoints for these studies evaluated 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 patients achieving weight loss of 5% or more. Patients were asked to follow a hypocaloric diet representing a 500-calorie/day deficit and were advised to implement a simple lifestyle modification program.

 

The first year-long Phase 3 study, known as EQUIP, enrolled 1,267 morbidly obese patients (1,050 females and 217 males) with a BMI that equaled or exceeded 35 kg/m2 with or without controlled co-morbidities. The average baseline BMI of the study population was 42.1 kg/m2 and baseline weight was 256 pounds. Patients had a 4-week dose titration period followed by 52 weeks of treatment, with patients randomized to receive once-a-day treatment with low-dose QNEXA, full-dose QNEXA or placebo. Weight loss results from the study are summarized as follows:

 

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ITT-LOCF

 

Completers

 

EQUIP (OB-302) 56 weeks

 

Placebo
(n=498)

 

QNEXA
low-dose
(n=234)

 

QNEXA
top dose
(n=498)

 

Placebo
(n=241)

 

QNEXA
low-dose
(n=138)

 

QNEXA
top dose
(n=301)

 

Mean weight loss (%)

 

1.6

%

5.1

%*

11

%

2.5

%

7

%*

14.7

%*

Greater than or equal to 5% weight loss rate

 

17

%

45

%*

67

%*

26

%

59

%*

84

%*

 


ITT-LOCF: Intent-to-treat with last observation carried forward

 

*                                         p<0.0001 vs. placebo

 

The EQUIP study met the co-primary endpoints by demonstrating that patients treated with top dose and low-dose QNEXA had an average weight loss of 11% and 5.1%, respectively, as compared to weight loss of 1.6% in the placebo group (ITT-LOCF p<0.0001). Average weight loss was 37 pounds and 18 pounds with top dose QNEXA and low-dose QNEXA, respectively, as compared to six pounds in the placebo group. The proportion of patients losing 5% or more of their initial body weight was 67% for top dose, 45% for low-dose and 17% for placebo (ITT-LOCF p<0.0001).

 

The most common drug-related adverse events reported in the EQUIP study for the top dose, low-dose and placebo group were tingling of the extremities, dry mouth, altered taste, headache and constipation. A significantly greater proportion of patients completed the study on QNEXA as compared to placebo patients. Overall average completion rates were 59%, 57% and 47% for patients taking top dose QNEXA, low-dose QNEXA and placebo, respectively.

 

The second year-long Phase 3 trial, known as CONQUER, enrolled 2,487 overweight and obese adult patients (1,737 females and 750 males) with BMI’s from 27 kg/m2 to 45 kg/m2 and at least two co-morbid conditions, such as hypertension, dyslipidemia and type 2 diabetes. The average baseline BMI of the study population was 36.6 kg/m2 and baseline weight was 227 pounds. Patients had a 4-week dose titration period followed by 52 weeks of treatment, with patients randomized to receive once-a-day treatment with top dose QNEXA, mid dose QNEXA or placebo. In April 2011, the results of this study were published in Lancet. Weight loss results from the study are summarized as follows:

 

 

 

ITT-LOCF

 

Completers

 

CONQUER (OB 303) 56 weeks

 

Placebo
(n=979)

 

QNEXA
mid dose
(n=488)

 

QNEXA
top dose
(n=981)

 

Placebo
(n=564)

 

QNEXA
mid dose
(n=344)

 

QNEXA
top dose
(n=634)

 

Mean weight loss (%)

 

1.8

%

8.4

%*

10.4

%*

2.4

%*

10.5

%*

13.2

%*

Greater than or equal to 5% weight loss rate

 

21

%

62

%*

70

%*

26

%

75

%*

85

%*

 


*                                         p<0.0001 vs. placebo

 

The CONQUER study also met the co-primary endpoints by demonstrating that patients treated with top dose and mid dose QNEXA had an average weight loss of 10.4% and 8.4%, respectively, as compared to weight loss of 1.8% in the placebo group (ITT-LOCF p<0.0001). Average weight loss was 30 pounds and 24 pounds with top dose QNEXA and mid dose QNEXA, respectively, as compared to six pounds in the placebo group. The proportion of patients losing 5% or more of their initial body weight was 70% for top dose, 62% for mid dose and 21% for placebo (ITT-LOCF p<0.0001).

 

The most common drug-related adverse events reported in the CONQUER study for the top dose, mid dose, and placebo group were tingling of the extremities, dry mouth, altered taste, headache and constipation. A significantly greater proportion of patients completed the study on QNEXA as compared to placebo patients. Overall average completion rates were 64%, 69%, and 57% for patients taking top dose QNEXA, mid dose QNEXA and placebo, respectively.

 

In April 2011, we announced that detailed results from the 56-week CONQUER study were published in The Lancet evaluating the efficacy and safety of investigational drug QNEXA in 2,487 patients across 93 sites in the U.S. Data published in the peer-reviewed journal provided an in-depth examination of QNEXA’s effects on weight loss and improvements in various weight-related co-morbidities including cardiovascular, metabolic and inflammatory risk factors.

 

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SEQUEL (0B-305) one-year extension study

 

We also conducted a one-year extension study of a subset of patients who completed the 56-week CONQUER study. The purpose of this study was to provide long-term safety and efficacy data to support the MAA filing in Europe. The SEQUEL study was a double-blind, placebo-controlled, 3-arm, prospective study across 36 centers comparing QNEXA to placebo over an additional 52-week treatment period for a total treatment duration of 108 weeks, or two years. SEQUEL included 675 obese or overweight patients, all of whom had two or more weight related co-morbidities and an average baseline BMI of 36.1. Patients in SEQUEL continued in a blinded fashion to receive the same treatment they were receiving when they completed the CONQUER study. The co-primary endpoints for this study were the differences between treatments in mean weight loss and percent weight loss from start of the OB-303 study (baseline) to the end of the treatment period (two-years). Secondary endpoints include the differences between treatments in the percentage of patients achieving weight loss of 5% and 10% and the change in waist circumference. Patients were asked to continue a hypocaloric diet representing a 500-calorie/day deficit and were advised to implement a simple lifestyle modification program.

 

Patients in the study taking the top dose of QNEXA achieved and maintained average weight loss through two years of 26 pounds (ITT-LOCF). Consistent with the first-year experience, QNEXA therapy was well tolerated, with no new or unexpected adverse events. The most common drug-related side effects seen were constipation, tingling, dry mouth, altered taste and insomnia.

 

Weight loss with QNEXA in SEQUEL was associated with statistically significant improvements in weight-related co-morbidities such as hypertension, dyslipidemia and diabetes. Among patients without diabetes at baseline, the incidence of new onset of type 2 diabetes was reduced by 54% and 76% (mid and top dose, respectively) as compared to placebo.

 

Specific SEQUEL findings include the following primary endpoints: Patients taking top and mid dose QNEXA achieved and maintained weight loss over two years of 11.4% and 10.4% of their initial body weight, respectively, as compared to placebo-treated patients with 2.5% weight loss (ITT-LOCF, p<0.0001). A majority of all patients taking QNEXA exceeded 10% weight loss, the goal established by the National Institutes of Health, or NIH, to decrease the severity of obesity-associated risk factors. The percentage of patients achieving categorical weight loss of at least 5%, 10% and 15% on both QNEXA doses was statistically significant compared to placebo:

 

Categorical Weight Loss (ITT-LOCF)

 

5%

 

10%

 

15%

 

Top dose

 

79

%*

54

%*

32

%*

Mid dose

 

75

%*

50

%*

24

%*

Placebo

 

30

%

12

%

7

%

 


*                                         p<0.0001 vs placebo

 

Treatment-emergent serious adverse event rates in SEQUEL were low (top dose = 4.1%; mid dose = 2.6%) and similar to placebo (4%), with no drug-related serious adverse events reported.

 

The completion rate in SEQUEL was approximately 83% for both QNEXA doses and 86% for the placebo group. Discontinuations due to adverse events were 3.9% and 4.1% for the mid and top dose, respectively, and 2.6% for the placebo group; with no single adverse event leading to discontinuation in more than 1% of patients. Additionally, SEQUEL data confirms previous safety findings, with no reports of suicidal attempts or behavior. Depression assessments, as measured by the PHQ-9 clinical depression scale, improved from baseline for all treatment groups. The incidence of targeted medical events for sleep disorders, depression, anxiety, cardiac disorders and cognitive disorders in SEQUEL was lower than observed during the one-year CONQUER study but still higher than placebo. Similar to previously presented data, effects of QNEXA in SEQUEL on heart rate were small and seen in conjunction with improvements in blood pressure from baseline. There were no clinically relevant decreases of serum bicarbonate in QNEXA -treated patients compared to placebo in year two of SEQUEL.

 

Across the entire QNEXA development program (4,323 patients), including the two-year data in SEQUEL, serious cardiovascular and neurovascular adverse event rates in patients taking QNEXA were similar to placebo with a relative risk of 0.54 (95% CI: 0.29-0.98). No major congenital malformations or oral clefts were observed across the entire development program in patients taking QNEXA or placebo.

 

The primary efficacy endpoint for Phase 3 weight loss trials in the U.S., as recommended by the FDA, is at least a 5% mean reduction in baseline body weight compared to placebo or at least 35% of patients losing 5% or more of their baseline body weight. 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 pivotal obesity studies to be conducted for at least one year. Although the

 

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results of our pivotal Phase 3 obesity trials met these current guidelines for efficacy, there can be no assurance that these results will be acceptable to the FDA or the EMA.

 

We completed a “Thorough QT,” or TQT, prolongation study evaluating patients taking QNEXA. The QT interval represents the time for both ventricular depolarization and repolarization to occur in the heart, and therefore roughly estimates the duration of an average ventricular action potential. If abnormally prolonged or shortened, there is a risk of developing ventricular arrhythmias. The study was completed with no QNEXA-related signal for QT prolongation. We also conducted studies evaluating cognitive and psychomotor functions in patients taking QNEXA. Patients underwent complex and extensive cognitive and psychomotor testing using validated, FDA recognized testing methodologies. There was no clinically relevant change in overall cognitive function or effect on psychomotor skills seen in patients taking QNEXA.

 

We have entered into a Master Services Agreement and related Task Orders with Medpace, Inc., or Medpace, pursuant to which Medpace will perform certain clinical research services in connection with the clinical trials for QNEXA and work related to the preparation of the NDA for avanafil. Our aggregate payment obligations under the agreement for services entered into during 2007 through June 30, 2011, out of pocket expenses and pass through costs totaled approximately $77.4 million, all of which has been paid. We have agreed to defend and indemnify Medpace against third party claims arising from the services other than claims resulting from Medpace’s negligence, willful misconduct, violation of law or material breach of the Master Service Agreement or a Task Order. We can terminate the agreement at any time without cause. Medpace may terminate the agreement following our material breach of the agreement that remains uncured.

 

QNEXA for Obstructive Sleep Apnea

 

Obstructive sleep apnea, or OSA, is a condition in which patients momentarily pause or stop breathing altogether while sleeping. The pauses in breathing can occur frequently throughout the course of sleep. Sleep apnea is often undiagnosed and can lead to severe health problems and even death if left untreated. It is estimated that about 18 million people in the U.S. have obstructive sleep apnea. Currently, there are no approved pharmacologic treatments for OSA. Modafinil is approved for the treatment of residual daytime sleepiness associated with OSA, but does not specifically treat the sleep apnea condition.

 

In January 2010, we announced positive results from a Phase 2 study evaluating the safety and efficacy of QNEXA for the treatment of OSA. This Phase 2 study (OB-204) was a single-center, randomized, double-blind, placebo-controlled parallel group trial including 45 obese men and women (BMI 30 to 40 kg/m2 inclusive), 30 to 65 years of age with OSA (apnea-hypopnea index, or AHI, greater than or equal to 15 at baseline), who had not been treated with, or who were not compliant with continuous positive airway pressure, or CPAP, within three months of screening. Patients were randomized to placebo or top dose QNEXA. CPAP is the current standard of care treatment for the majority of patients with moderate or severe OSA, defined as an apnea-hypopnea index, or AHI, of 15 or more events per hour. Although CPAP is reported to be effective in treating OSA when properly and consistently used, compliance (as defined by use for at least 4 hours per night, on at least 70% of nights) may be as low as 50-60%.

 

In the OB-204 study, patients underwent a four-week dose titration followed by 24 weeks of additional treatment. All patients were also provided with a lifestyle modification program focusing on diet and exercise. Overnight polysomnography in a sleep laboratory was performed at baseline, Week 8 and Week 28. The primary endpoint was the change in AHI between baseline and Week 28; secondary endpoints included weight loss, improvement in overnight oxygen saturation and reduction in blood pressure.

 

The study demonstrated statistically significant improvement in AHI in patients with OSA treated with QNEXA for 28 weeks. QNEXA-treated patients also experienced significant weight loss, improvements in blood pressure, and overnight blood oxygen saturation.

 

Sleep apnea is one of the leading co-morbidities associated with obesity and research has shown that weight loss can improve OSA. QNEXA treatment was well-tolerated with no serious adverse events reported in the QNEXA arm; the most common side effects were dry mouth, altered taste and sinus infection.

 

QNEXA for Diabetes

 

Diabetes is a significant worldwide disease. Based on the fourth edition of the Diabetes Atlas published in 2009, the International Diabetes Federation estimated that in 2008 there were 285 million people with diabetes worldwide, with 27 million of those people living in the U.S. Diabetes, mostly type 2 diabetes, was projected to reach 6.6% of the world’s adult population in 2010, with almost 70% of the total in developing countries. Based on the National Diabetes Fact Sheet, 2011, the CDC estimates that nearly 26 million people in the U.S. have diabetes, mostly type 2 diabetes, and that 79 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. Currently approved therapies for type 2 diabetes are directed toward correcting the body’s

 

25



Table of Contents

 

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. Approved injectable medications for type 2 diabetes treatment include glucagon-like peptide-1, or GLP-1, analogs such as Liraglutide, marketed under the brand name Victoza, developed by Novo Nordisk and Exenatide, marketed under the brand name Byetta, developed by Amylin Pharmaceuticals and Eli Lilly and Company. Studies to date suggest GLP-1s improve control of blood glucose by increasing insulin secretion, delaying gastric emptying, and suppressing prandial glucagon secretion. Clinical studies have reported that patients treated with GLP-1s have reported weight loss of approximately six to eight pounds.

 

The worldwide 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 common drug-related side effects, including hypoglycemia, weight gain and edema. Numerous pharmaceutical and biotechnology companies are seeking to develop insulin sensitizers, novel insulin formulations and other therapeutics to improve the treatment of diabetes. Previous clinical studies of topiramate, a component of QNEXA, 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. The DM-230 Phase 2 study enrolled 130 patients, who had completed our Phase 2 study for the treatment of obesity, at 10 study sites in the U.S., 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. Patients 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-treated standard of care group (ITT LOCF p=0.0381) at 56 weeks. All patients in the study were actively managed according to American Diabetes Association, or ADA, standards of care with respect to diabetes medications and lifestyle modification. For patients treated with placebo, 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 reduced over the course of the trial in patients treated with QNEXA (p<0.05).

 

Over 56 weeks, patients 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). Sixty-five percent of the QNEXA patients lost at least 5% of their body weight, as compared to 24% in the placebo group (p<0.001), and 37% of the QNEXA patients lost at least 10% of their body weight, as compared to 9% of patients in the placebo group (p<0.001). Patients treated with QNEXA had reductions in blood pressure, triglycerides and waist circumference. Both treatment groups had a study completion rate of greater than 90%.

 

The most common drug-related side effects reported were tingling, constipation and nausea. Patients on antidepressants such as SSRI’s or SNRI’s were allowed to participate in the studies. Patients 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. Patients treated with QNEXA demonstrated greater improvements in PHQ-9 scores from baseline to the end of the study than patients in the placebo group.

 

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

 

We also studied the effect of QNEXA on well-controlled diabetics as part of OB-303. The results were consistent and supportive of the Phase 2 results.

 

QNEXA for Other Indications

 

We believe QNEXA may be helpful in treating other obesity-related diseases including nonalcoholic steatohepatitis, or NASH, or its precursor, nonalcoholic fatty liver disease, or NAFLD, also known as fatty liver disease. QNEXA may also be helpful in treating hyperlipidemia, or an elevation of lipids (fats) in the bloodstream. These lipids include cholesterol, cholesterol esters (compounds), phospholipids and triglycerides. In addition, QNEXA may be helpful in patients with hypertension that do not respond well to antihypertensive medication.

 

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Table of Contents

 

Avanafil for Erectile Dysfunction

 

Erectile dysfunction, or ED, is defined as the inability to attain or maintain an erection sufficient for intercourse. ED was reported by 52% of men between the ages of 40 to 70 in the Massachusetts Male Aging Study, with the incidence increasing with age. Erectile dysfunction, 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 (Viagra), vardenafil (Levitra) and tadalafil (Cialis), which inhibit the breakdown of cyclic guanosine monophosphate, have been shown to be effective oral treatments for ED.

 

The worldwide sales in 2010 of PDE5 inhibitor products for the treatment of ED were in excess of $4.1 billion, including approximately $1.9 billion in sales of Viagra, approximately $1.7 billion in sales of Cialis and over $500 million in estimated sales of Levitra. Based on increased use of PDE5i’s, as evidenced by increasing annual sales of PDE5 inhibitors, we believe the market for PDE5 inhibitors will continue to grow.

 

Avanafil is an oral PDE5 inhibitor investigational drug candidate that 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 MTPC. Our U.S. patent on avanafil (U.S. 6,656,935) expires in 2020.

 

We have exclusive worldwide development and commercialization rights for avanafil with the exception of China, South Korea, North Korea, Taiwan, Singapore, Indonesia, Malaysia, Thailand, Vietnam and the Philippines.

 

In June 2011, we submitted an NDA to the FDA seeking approval of avanafil for the treatment of ED. The NDA submission follows the successful completion of a Phase 3 program for avanafil, which included over 1,350 patients, where avanafil was shown to be well tolerated and effective in treating men with ED.

 

Pre-clinical and clinical data suggest that avanafil:

 

·                  is highly selective to PDE5, which may support a favorable side effect profile; and

 

·                  is fast-acting (as early as 15 minutes) based on a shorter Tmax, or time to maximum plasma concentration.

 

In November 2009, we announced results from the first of several pivotal Phase 3 studies of avanafil. The first study, REVIVE (TA-301), was a randomized, double-blind, placebo-controlled Phase 3 study of avanafil in 646 men.

 

Patients underwent a four-week, non-treatment run-in period followed by 12 weeks of treatment with one of three doses of avanafil: 50 mg, 100 mg and 200 mg or placebo. Patients were instructed to attempt sexual intercourse 30 minutes after taking avanafil, with no restrictions on food or alcohol consumption. The primary endpoints of the study were improvement in erectile function as measured by the Sexual Encounter Profile, or SEP, and improvement in the International Index of Erectile Function, or IIEF, score; secondary endpoints included patient satisfaction with erections and with sexual experience. This Phase 3 study was conducted under a Special Protocol Assessment, or SPA, with the FDA.

 

The REVIVE study met all primary endpoints across the three doses studied by demonstrating statistically significant improvement in erectile function as measured by the SEP and improvement in the IIEF score. Highlights of the study include:

 

·                  Nearly 80% of sexual attempts among patients on the 200 mg dose of avanafil had erections sufficient for intercourse (SEP2);

 

·                  Full efficacy, as measured by successful intercourse (SEP3), was reported by some avanafil patients on all three dose levels within 15 minutes;

 

·                  All FDA-approved primary endpoints were met across all three doses of avanafil; and

 

·                  There were no reported drug-related serious adverse events in the study.

 

Patients on all three dose levels achieved a dose-related overall improvement in erectile function, as measured by improvement in the IIEF. IIEF scores range from 0-30 and measure the severity of erectile dysfunction as follows: severe dysfunction is less than or equal to 10; moderate is 11-16; and mild/minimal is 17-25. IIEF results of the study were:

 

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Table of Contents

 

 

 

Baseline

 

End of Treatment

 

Placebo

 

12.4

 

15.3

 

Avanafil 50 mg

 

12.7

 

18.1

 

Avanafil 100 mg

 

12.6

 

20.9

 

Avanafil 200 mg

 

12.7

 

22.2

 

 


(p</=0.001 vs. placebo)

 

Patients on avanafil had erections sufficient for vaginal penetration as measured by the Sexual Encounter Profile question number 2 (SEP2):

 

 

 

Baseline

 

End of Treatment

 

Placebo

 

47

%

54

%

Avanafil 50 mg

 

45

%

64

%

Avanafil 100 mg

 

46

%

74

%

Avanafil 200 mg

 

48

%

77

%

 


(p<0.001 vs. placebo)

 

Patients taking avanafil experienced successful intercourse as measured by the Sexual Encounter Profile question 3 (SEP3):

 

 

 

Baseline

 

End of Treatment

 

Placebo

 

13

%

27

%

Avanafil 50 mg

 

13

%

41

%

Avanafil 100 mg

 

14

%

57

%

Avanafil 200 mg

 

12

%

57

%

 


(p<0.001 vs. placebo)

 

The most commonly reported side effects in patients taking avanafil (all doses combined) included headache (7% vs. 1.2% placebo), flushing (4.6% vs. 0% placebo) and nasal congestion (2.3% vs. 1.2%). There were no reports of visual disturbances such as “blue vision.”

 

In January 2010, we announced new data from an analysis of REVIVE TA-301. Patients who attempted intercourse within 15 minutes of dosing were successful 67%, 69% and 72% of the time on 50, 100 and 200 mg of avanafil, respectively, as compared to 29% of the patients on placebo (p<0.05).

 

We completed a Phase 1 “Thorough QT”, or TQT, study evaluating 100 mg and 800 mg of avanafil compared to placebo and a known positive control. The study was successfully completed with no concern associated with QT prolongation.

 

In June 2010, we announced results from the Phase 3 REVIVE-Diabetes (TA-302) study, which evaluated the safety and efficacy of avanafil for the treatment of erectile dysfunction, or ED, in men with type 1 and type 2 diabetes. The REVIVE-Diabetes study met all three primary endpoints across the two doses studied by demonstrating statistically significant improvement in erectile function as measured by the Sexual Encounter Profile, or SEP, and improvement in the International Index of Erectile Function, or IIEF score. The study also demonstrated a favorable side effect profile and successful intercourse (as measured by SEP 3) in as early as 15 minutes and beyond six hours after dosing, without any restrictions for food or alcohol intake.

 

Highlights of the TA-302 study include:

 

·                  Eighty percent (80%) of sexual attempts among patients on avanafil had erections sufficient for intercourse (SEP2);

 

·                  Sixty-seven percent (67%) of patients taking avanafil experienced successful intercourse (SEP3);

 

·                  Successful intercourse was achieved as early as 15 minutes after dosing in some patients;

 

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·                  Avanafil was well tolerated as evidenced by a low rate of discontinuations due to adverse events (2.8%);

 

·                  The most common side effects reported were headache (5.6%), flushing (3.5%), nasopharyngitis (3.4%) and nasal congestion (2.1%); and

 

·                  There were no drug-related serious adverse events reported in the study.

 

In December 2010, we announced the positive results of the long term safety study, TA-314. TA-314 was conducted over one year in approximately 675 patients across 40 U.S. centers. Patients completing either the 12-week REVIVE or REVIVE-Diabetes studies were eligible to participate in TA-314. The study met all primary endpoints by demonstrating improvement from baseline in erectile function as measured by the Sexual Encounter Profile (both SEP2 and SEP3) and improvement in the International Index of Erectile Function, or IIEF. In the study, patients treated with avanafil who attempted sexual intercourse (SEP3) within the first 15 minutes of dosing had success rates of 80%. TA-314 confirms the longer term safety and efficacy results observed in the previously reported placebo-controlled Phase 3 studies of avanafil in patients with ED.

 

In May 2011, we announced positive results from a Phase 3, placebo-controlled clinical trial of avanafil for the treatment of ED in patients following a radical prostatectomy. The study (REVIVE-RP, TA-303) met all primary endpoints by demonstrating improvement from baseline in erectile function as measured by the Sexual Encounter Profile (both SEP2 and SEP3) and improvements in the IIEF. Consistent with other avanafil clinical studies, successful intercourse as measured by SEP3 was observed as early as 15 minutes after the administration of avanafil. The most common side effects were headache, flushing and nasopharyngitis, and dropouts due to adverse events were low.  There were no serious adverse events reported in the study. The results of the TA-303 study were not required for the avanafil NDA, but the final study report will be submitted to the FDA upon completion. We have been informed by the FDA that the submission of the TA-303 study results subsequent to our NDA filing will not impact the timing of their decision concerning the approvability of avanafil for other populations.

 

Highlights of the TA-303 study include:

 

·                  Treatment with both doses of avanafil (100 mg and 200 mg) was associated with significant improvements in each of the co-primary endpoints, SEP2, SEP3 and IIEF-EF in comparison with placebo (p <0.001)

 

·                  Patients treated with 100 mg and 200 mg of avanafil improved their ability to have successful intercourse (SEP3) four- and five-fold, respectively, from the start of treatment

 

·                  Treatment with avanafil improved erectile function in a dose-dependent manner with significant increases in the IIEF scores from the beginning of treatment through the end of treatment.  Erectile function scores increased 38% and 55% for patients on the 100 mg and 200 mg doses, respectively, as compared to the placebo group with an increase of 1%

 

·                  The most commonly reported side effects in patients taking avanafil included headache, flushing, and nasopharyngitis; and

 

·                  There were no serious adverse events or deaths reported in the study

 

We have entered into a Master Services Agreement and related Task Orders with Quintiles, Inc., or Quintiles, pursuant to which Quintiles will perform certain clinical research services in connection with the clinical trials for avanafil. Our aggregate payment obligations entered into during 2008 through June 30, 2011under the agreement for services, out of pocket expenses and pass through costs total approximately $27.1 million, of which we have paid approximately $26.1 million through June 30, 2011. We have agreed to defend and indemnify Quintiles against third party claims arising from the services other than claims resulting from Quintiles’s negligence, willful misconduct, violation of law or material breach of the Master Service Agreement or a Task Order. We can terminate the agreement at any time without cause. Quintiles may terminate the agreement following our material breach of the agreement that remains uncured.

 

MUSE for Erectile Dysfunction

 

In 1997, we commercially launched MUSE in the U.S. MUSE was the first minimally invasive therapy for erectile dysfunction approved by the FDA. On October 1, 2010, we entered into a definitive Asset Purchase Agreement with Meda AB, or Meda, to sell certain rights and assets related to MUSE, transurethral alprostadil, for the treatment of erectile dysfunction, or the MUSE Transaction. Meda had been our European distributor of MUSE since 2002. The assets sold in the MUSE Transaction include the U.S. and foreign MUSE patents, existing inventory, and the manufacturing facility located in Lakewood, New Jersey. We retained all of the liabilities associated with the pre-closing operations and products of the MUSE business and the accounts receivables for

 

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pre-closing MUSE sales. The transaction closed on November 5, 2010. Prior to the closing of the MUSE Transaction, we regained all of the rights to MUSE and avanafil held by Deerfield Management Company, L.P., and affiliates, and Crown Bank, N.A., or Crown.

 

On October 15, 2010, in preparation for the closing of the MUSE Transaction and in accordance with the terms of the agreements with Crown, we paid $4.8 million to Crown in satisfaction of all obligations owed to them under these agreements. As a result, the security interests and Certificate of Deposit held by Crown were terminated in our favor. On October 21, 2010, we exercised the Option under the Option and Put Agreement with the Deerfield Affiliates and the Deerfield Sub, dated April 3, 2008, and an Amended and Restated Option and Put Agreement dated March 16, 2009, or the OPA, and we paid an aggregate amount totaling $27.1 million, which consisted of the Base Option Price of $25 million, less the Option Premium Adjustment of $2 million, plus the Cash Adjustment of $2.8 million and the Royalty Adjustment of $1.3 million. These payments satisfied all of the financial obligations under the Funding and Royalty Agreement, or FARA, and the OPA. As a result, all of the outstanding shares and the $2.8 million of cash of the Deerfield Sub are owned by us, all of the outstanding loans owed by the Deerfield Sub have been repaid and the security interests in the collateral related to MUSE and avanafil held by the Deerfield Sub and the Deerfield Affiliates as part of the FARA and OPA were terminated. In December 2010, the Deerfield Sub was dissolved.

 

Under the terms of the MUSE Transaction, we received an upfront payment of $22 million upon the closing, on November 5, 2010, and are eligible to receive an additional $1.5 million based on future sales of MUSE, provided that certain sales milestones are reached. Meda is now responsible for the manufacturing, selling and marketing of MUSE. Meda also assumed all post-closing expenses and liabilities associated with MUSE. We have agreed not to develop, manufacture or sell any transurethral erectile dysfunction drugs for a period of three years following the closing of the MUSE Transaction. The assets and liabilities and results of operations associated with MUSE have been reported as discontinued operations for all periods presented.

 

Other Programs

 

We have licensed and intend to continue to license from third parties the rights to other investigational drug candidates 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 investigational drug candidate development to commercialize pharmaceuticals for unmet medical needs or for disease states that are underserved by currently approved drugs. We intend to develop products with a proprietary position or that complement our other products currently under development.

 

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 U.S. 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, research and development expenses, 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:

 

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 that 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.

 

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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 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 June 30, 2011, it was considered more likely than not that the Company’s deferred tax assets would not be realized. 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 (first in, first out) 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, or if our investigational product candidates do not receive approval, inventory write-downs may be required.

 

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. At June 30, 2011, all cash equivalents are invested in money market funds and U.S. Treasury securities. These accounts are recorded at fair value.

 

Available-for-Sale Securities

 

We focus on liquidity and capital preservation in our investments in available-for-sale securities. Our investment policy, as approved by the Audit Committee of the Board of Directors, allows us to 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. We periodically evaluate our investments to determine if impairment charges are required.

 

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. 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 securities with maturities beyond 12 months are classified as current assets.

 

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 intend to sell such securities before recovering their costs, 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.

 

SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, FSP SFAS 115-2 and SFAS 124-4, Recognition and Presentation of Other-than-Temporary Impairments (“FSP 115-2/SFAS 124-2”) and SAB Topic 5M, Accounting for Non-current Marketable Equity Securities, as codified in FASB ASC topic 320, Investments—Debt and Equity Securities, or ASC

 

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320, provide guidance on determining when an investment is other-than-temporarily impaired. FSP 115-2/124-2 is effective for all periods ending after June 15, 2009 and provides additional guidance designed to create a greater clarity and consistency in accounting for and presenting impairment losses on securities. 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.

 

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, as codified in FASB ASC topic 718, Compensation—Stock Compensation, or ASC 718. 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 $2.0 million and $4.1 million of share-based compensation expense from continuing operations in the quarter and six months ended June 30, 2011, respectively, and $1.5 million and $3.2 million of share-based compensation expense from continuing operations in the quarter and six months ended June 30, 2010, respectively. Share-based compensation expense is allocated among research and development, general and administrative expenses and discontinued operations 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, as codified in FASB ASC 820, Fair Value Measurements and Disclosures, or ASC 820, 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. On January 1, 2009, we adopted SFAS No 157 with respect to non-financial assets and non-financial liabilities. On June 15, 2009 we adopted FSP 157-4, Determining Fair Value When the Volume and Level of Activity for the Assets or Liabilities Have Significantly Decreased and Identifying Transactions That Are Not Orderly. Adoption of the provisions of these standards 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

 

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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).

 

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 have included certain corporate bonds, mortgage-backed securities and asset-backed securities. We had no Level 3 securities as of June 30, 2011 or December 31, 2010. 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. 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 June 30, 2011, our cash and cash equivalents and available-for-sale securities measured at fair value on a recurring basis totaled $121.6 million.

 

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All of our cash and cash equivalents and available-for-sale securities are in cash, money market instruments and U.S. Treasury securities at June 30, 2011, 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.

 

Recent Accounting Pronouncements

 

In January 2010, the Financial Accounting and Standards Board, or FASB, issued Accounting Standards Update, or ASU, No. 2010-06, Fair Value Measurements Disclosures, which amends Subtopic 820-10 of the FASB Accounting Standards Codification to require new disclosures for fair value measurements and provides clarification for existing disclosures requirements. More specifically, this update requires (a) an entity to disclose separately the amounts of significant transfers in and out of Levels 1 and 2 fair value measurements and to describe the reasons for the transfers; and (b) information about purchases, sales, issuances and settlements to be presented separately (i.e. present the activity on a gross basis rather than net) in the reconciliation for fair value measurements using significant unobservable inputs (Level 3 inputs). This update clarifies existing disclosure requirements for the level of disaggregation used for classes of assets and liabilities measured at fair value and requires disclosures about the valuation techniques and inputs used to measure fair value for both recurring and nonrecurring fair value measurements using Level 2 and Level 3 inputs. The adoption of this standard effective January 1, 2010 did not materially expand our condensed consolidated financial statement footnote disclosures.

 

In May 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, which amends Topic 820, Fair Value Measurement. ASU No. 2011-04 issues additional guidance on fair value measurements that clarifies the application of existing guidance and disclosure requirements, changes certain fair value measurement principles and requires additional disclosures about fair value measurements. The updated guidance is effective on a prospective basis for financial statements issued for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. The adoption of this guidance will not have a material impact on our financial statements.

 

In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income, to increase the prominence of other comprehensive income in the financial statements. ASU No. 2011-05 gives businesses two options for presenting other comprehensive income (OCI), which until now has typically been placed near the statement of shareholder’s equity. An OCI statement can be included with the net income statement, and together the two will make a statement of total comprehensive income. Alternatively, businesses can have an OCI statement separate from a net income statement, but the two statements will have to appear consecutively within a financial report. This standard eliminates the current option to report other comprehensive income and its components in the statement of changes in equity. This standard is effective as of the beginning of a fiscal year that begins after December 15, 2011 and for interim and annual reporting periods thereafter, with early adoption permitted and full retrospective application required. The adoption of this standard effective June 30, 2011 did not have a material effect on the determination or reporting of our financial results.

 

RESULTS OF OPERATIONS

 

Executive Overview

 

For the quarter ended June 30, 2011, we reported a net loss of $16.2 million or $0.20 net loss per share, as compared to a net loss of $22.8 million, or $0.28 net loss per share during the same period in 2010. The decreased net loss in the quarter ended June 30, 2011, as compared to the quarter ended June 30, 2010, was primarily attributable to reduced research and development spending on QNEXA for obesity, decreased QNEXA pre-commercialization related general and administrative expenses, decreased interest expense due to the payoff of the Deerfield loan and net income as compared to a net loss from discontinued operations due to the sale of MUSE.

 

In June 2011, we submitted an NDA to the FDA seeking approval of avanafil for the treatment of ED. The NDA submission follows the successful completion of a Phase 3 program for avanafil, which included over 1,350 patients, where avanafil was shown to be well tolerated and effective in treating men with ED.

 

On October 28, 2010, we received a Complete Response Letter, or CRL, from the FDA regarding the QNEXA NDA. The FDA issued the CRL to communicate its decision that the NDA could not be approved in its present form. No new clinical studies were requested in the CRL. On January 19, 2011, we held an End-of-Review meeting with the FDA to discuss the items contained in the CRL and the information we plan to include in the resubmission. In anticipation of the meeting, we provided a briefing document that included comprehensive assessment of the teratogenic potential of topiramate including analyses integrating existing non-clinical and clinical data. In addition, we provided several new analyses including cardiovascular data from our SEQUEL (OB-305) and Sleep Apnea (OB-204) studies to demonstrate that QNEXA does not increase the risk for major cardiovascular events and that the observed

 

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increases in heart rate, which occurred in some patients over the course of the clinical program, did not increase the risk of major cardiovascular events, as evidenced by adverse events reported in the trial. We also provided a synopsis of the final study report for the SEQUEL study. At the meeting, an overview was provided of the teratogenicity and cardiovascular risk material covered in the background package. The discussion also included elements of our proposed REMS program for QNEXA. The primary focus of the FDA at the meeting, however, concerned the teratogenic potential for topiramate, specifically the incidence of oral clefts observed in the North American AED Pregnancy Registry and in the UK Epilepsy and Pregnancy Registry. The FDA requested that we assess the feasibility of performing a retrospective observational study utilizing existing electronic medical claims healthcare databases to review fetal outcomes, including the incidence of congenital malformations and oral cleft, in the offspring of women who received prophylaxis treatment with 100 mg of topiramate for migraine during pregnancy, or the Feasibility Assessment. In the QNEXA studies, which included 15 births from women exposed to QNEXA or topiramate, there were no reports of any congenital malformations or low birth weight. We met with the FDA in April 2011 to discuss the Feasibility Assessment. We have reached agreement, subject to the finalization of the written protocol and statistical analysis plan, with the FDA on the retrospective observational study objectives and design, primary endpoints, and eligibility criteria. During the April 2011 meeting, it was agreed the study would be expanded to include all doses of topiramate and all diagnoses. It was also agreed that the results would be stratified and that the diagnoses of those exposed to topiramate would be matched with control groups with similar diagnoses and patient profiles. The co-primary endpoints will be the relative risk of major congenital malformations and oral cleft in the offspring of women exposed to topiramate during pregnancy as compared to a control group that was not exposed to topiramate. The retrospective observational study is called FORTRESS, for Fetal Outcome Retrospective TopiRamate ExpoSure Study. The FORTRESS study is underway and we expect results in the fourth quarter of 2011. The final indication and timing of the resubmission will be dependent upon the results of FORTRESS. Our goal is to resubmit the QNEXA NDA in the fourth quarter of 2011. Although no other requests for additional information or studies were made by the FDA at these meetings or in the CRL, there can be no assurance that the FDA will not request or require us to provide additional information or undertake additional studies in connection with the QNEXA NDA.

 

In May 2011, we received a response to our MAA from the CHMP. The response was in the form of the “120-day questions.” We are currently reviewing the 120-day questions which cover a broad range of topics including, without limitation, issues relating to phentermine, which include historical concerns regarding its potential association with valvulopathy and pulmonary hypertension; heart rate and limited long-term safety data in high-risk patients; and known and suspected affects of topiramate which include CNS and teratogenic potential. The CHMP also had questions concerning our proposed risk management plan for QNEXA. The 120-day questions are consistent with the issues previously raised in the FDA review process. We are in the process of preparing our response. We will meet with representatives from the CHMP to seek clarification on certain questions and anticipate submitting a response in the fourth quarter of 2011. We expect the CHMP to issue the 180-day opinion in the first quarter of 2012. There can be no assurance that our response will be adequate or that our MAA will be approved by the EMA.

 

On October 1, 2010, we entered into a definitive Asset Purchase Agreement with Meda to sell certain rights and assets related to MUSE, transurethral alprostadil, for the treatment of erectile dysfunction, or the MUSE Transaction. Meda has been our European distributor of MUSE since 2002. The assets sold in the MUSE Transaction include the U.S. and foreign MUSE patents, existing inventory, and the manufacturing facility located in Lakewood, New Jersey. We retained all of the liabilities associated with the pre-closing operations and products of the MUSE business and the accounts receivables for pre-closing MUSE sales. The transaction closed on November 5, 2010. The sale of MUSE will allow us to focus on the approval and commercialization of QNEXA and the development of avanafil. Prior to the closing of the MUSE Transaction, we regained all of the rights to MUSE and avanafil held by Deerfield Management Company, L.P., and affiliates, and Crown Bank, N.A., or Crown. On October 15, 2010, in preparation for the closing of the MUSE Transaction and in accordance with the terms of the agreements with Crown, we paid $4.8 million to Crown in satisfaction of all obligations owed to them under these agreements. As a result, the security interests and Certificate of Deposit held by Crown were terminated in our favor. Under the terms of the MUSE Transaction, we received an upfront payment of $22 million upon the closing and are eligible to receive an additional $1.5 million based on future sales of MUSE, provided that certain sales milestones are reached. Upon the closing of the MUSE Transaction, Meda is now responsible for the manufacturing, selling and marketing of MUSE. Meda also assumed all post-closing expenses and liabilities associated with MUSE. We have agreed not to develop, manufacture or sell any transurethral erectile dysfunction drugs for a period of three years following the closing of the MUSE Transaction. The assets and liabilities and results of operations associated with MUSE have been reported as discontinued operations for all periods presented.

 

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, which included the addition of Deerfield PDI Financing L.P. as a Deerfield Affiliate. Under the agreements, Deerfield and its affiliates provided us with $30 million in funding, consisting 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. We received all of the required payments under the FARA, or the Funding Payments. Under the FARA, we paid royalties on the net sales of MUSE to the Deerfield Sub. The FARA had a term of 10 years.

 

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We entered into the Option and Put Agreement with the Deerfield Affiliates and the Deerfield Sub, 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 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. Our obligation to pay royalties terminated upon the exercise of the Option.

 

In preparation for the closing of the MUSE Transaction and in accordance with the terms of the OPA, we exercised the Option, and on October 21, 2010 we paid an aggregate amount totaling $27.1 million, which consisted of the Base Option Price of $25 million, less the Option Premium Adjustment of $2 million, plus the Cash Adjustment of $2.8 million and the Royalty Adjustment of $1.3 million. These payments satisfied all of the financial obligations under the FARA and OPA. As a result, all of the outstanding shares and the $2.8 million of cash of the Deerfield Sub are owned by us, all of the outstanding loans owed by the Deerfield Sub have been repaid and the security interests in the collateral related to MUSE and avanafil held by the Deerfield Sub and the Deerfield Affiliates as part of the FARA and OPA were terminated. The payoff of the Deerfield loan resulted in a loss on the early extinguishment of debt of $6 million which was recognized in the fourth quarter of 2010. In December 2010, the Deerfield Sub was dissolved.

 

We may have continued losses in future years, depending on the timing of our research and development expenditures, and we plan to continue to invest in clinical development of our current research and investigational drug candidates to bring those potential drugs to market.

 

Continuing operations

 

Research and development. (Unaudited)

 

 

 

Three Months Ended
June 30

 

Six Months Ended
June 30,

 

 

 

2011

 

2010

 

2011 vs.
2010
(Decrease)

 

2011

 

2010

 

2011 vs.
2010
(Decrease)

 

 

 

(In thousands, except percentages)

 

Research and development

 

$

11,035

 

$

13,576

 

(19

)%

$

15,515

 

$

23,787

 

(35

)%

 

Research and development expenses in the second quarter of 2011 decreased $2.5 million, or 19%, to $11.0 million, as compared to $13.6 million in the second quarter of 2010. In the second quarter of 2011, this decrease in spending was primarily due to lower spending for QNEXA for obesity of $4.5 million due to the completion of pivotal Phase 3 studies, partially offset by increased spending for avanafil of $1.3 million (which includes $1.5 million in NDA filing fees and the $4.0 million milestone due to MTPC partially offset by lower spending on avanafil studies), an increase in non-cash share-based compensation expense of $300,000 and other net research and development spending increases of $393,000, as compared to the second quarter of 2010.

 

In the six months ended June 30, 2011, research and development expenses decreased $8.3 million, or 35%, to $15.5 million, as compared to $23.8 million in the same period last year. This decrease was primarily due to decreases in obesity program spending of $7.8 million and avanafil spending of $1.2 million, partially offset by an increase in non-cash share-based compensation expense of $507,000 and other net increases in research and development related spending of $221,000, as compared to the six months ended June 30, 2010.

 

We anticipate that our research and development expenses in 2011 will be significantly lower than expenses incurred in 2010 due to the completion of the pivotal Phase 3 studies for QNEXA and avanafil. The current remaining contractual obligation for payments to our primary contract research organization, or CRO, for the Phase 3 avanafil trials totals $986,000, which includes amounts in accrued research and clinical expenses as of June 30, 2011. There are likely to be additional research and development expenses related to avanafil and QNEXA and our other investigational drug candidates 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 pre-clinical studies. Regardless, if we are successful in obtaining FDA regulatory approval for any new investigational drug candidates being developed through our research and development efforts, we do not expect to recognize revenue from sales of such new drugs, if any, for at least a year or more due to the length of time required to develop investigational drug candidates into commercially viable products.

 

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General and administrative. (Unaudited)

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2011

 

2010

 

2011 vs.
2010
(Decrease)

 

2011

 

2010

 

2011 vs.
2010
(Decrease)

 

 

 

(In thousands, except percentages)

 

General and administrative

 

$

5,303

 

$

6,750

 

(21

)%

$

10,731

 

$

11,914

 

(10

)%

 

General and administrative expenses in the three months ended June 30, 2011 of $5.3 million decreased $1.4 million, or 21% as compared to the three months ended June 30, 2010. In the quarter ended June 30, 2011, this decrease is primarily due to lower spending on QNEXA pre-commercialization of $1.6 million partially offset by other net increases in general and administrative expenses totaling $134,000, as compared to the quarter ended June 30, 2010.

 

In the six months ended June 30, 2011, general and administrative expenses decreased $1.2 million, or 10% to $10.7 million as compared to the same period in 2010. In the six months ended June 30, 2011, the decrease is primarily due to lower spending on QNEXA pre-commercialization related expenses of $1.8 million, partially offset by an incremental increase of $444,000 in non-cash share-based compensation and other net increases in general and administrative expenses of $125,000, as compared to the six months ended June 30, 2010.

 

On January 19, 2011, we held an End-of-Review meeting with the FDA to discuss its requests in the CRL for QNEXA and our planned resubmission of the NDA for QNEXA. In April 2011, we held a meeting with the FDA and agreed to conduct a retrospective observational study of fetal outcomes, FORTRESS, prior to the resubmission of the QNEXA NDA. The FORTRESS study is underway and we expect results in the fourth quarter of 2011. As a result, we may defer spending on the pre-commercial activities for QNEXA. Ultimately, our general and administrative expenses in 2011 will depend upon the timing and outcome of the FDA’s decision on QNEXA, although at this time we do not anticipate a significant increase in these expenses as compared to 2010.

 

Interest income and expense.

 

Interest and other income, net for the quarter and six months ended June 30, 2011 was $38,000 and $81,000, respectively, as compared to $52,000 and $114,000 for the quarter and six months ended June 30, 2010, respectively. The decrease in interest and other income in the quarter and six months ended June 30, 2011 as compared to the same periods last year was largely due to lower cash balances and lower interest rates, year-over-year, on our cash, cash equivalents and available-for-sale securities.

 

Interest expense for the quarter and six months ended June 30, 2011 was $2,000 and $3,000, respectively, as compared to $1.3 million and $2.6 million for the quarter and six months ended June 30, 2010, respectively. The outstanding balance on the Deerfield loan was paid off in the fourth quarter of 2010.

 

Provision for income taxes

 

We recorded a provision for income taxes for the quarter and six months ended June 30, 2011 of $2,000 and $3,000, respectively, as compared to $0 and $1,000 for the quarter and six months ended June 30, 2010, respectively. Our income tax return for the year ended December 31, 2007 is currently under examination by the California Franchise Tax Board. Based on the progress of the audit to date, we believe adjustments may be made in early years that will reduce tax attributes available to offset tax due in 2007. Therefore, we increased our unrecognized tax benefits to $7,000 for the year ended December 31, 2010. We recognize interest and penalties accrued on any unrecognized tax benefits as a component of our provision for income taxes.

 

Discontinued operations

 

Revenue-discontinued operations. (Unaudited)

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2011

 

2010

 

2011 vs.
2010
(Decrease)

 

2011

 

2010

 

2011 vs.
2010
(Decrease)

 

 

 

(In thousands, except percentages)

 

United States product, net

 

$

97

 

$

3,036

 

(97

)%

$

97

 

$

4,138

 

(98

)%

International product

 

 

749

 

(100

)%

 

1,263

 

(100

)%

License and other revenue

 

 

115

 

(100

)%

 

231

 

(100

)%

Total revenues

 

$

97

 

$

3,900

 

(98

)%

$

97

 

$

5,632

 

(98

)%

 

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In the quarter and six months ended June 30, 2011, we recorded adjustments to our sales reserves for accrued product returns in the amount of $97,000. Product revenues for the quarter and six months ended June 30, 2010 were $3.8 million and $5.4 million, respectively. On November 5, 2010, we completed the sale of the MUSE product to Meda AB.

 

Cost of goods sold and manufacturing-discontinued operations. (Unaudited)

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2011

 

2010

 

2011 vs.
2010
(Decrease)

 

2011

 

2010

 

2011 vs.
2010
(Decrease)

 

 

 

(In thousands, except percentages)

 

Cost of goods sold and manufacturing

 

$

(26

)

$

2,904

 

(101

)%

$

(26

)

$

5,315

 

(100

)%

 

In the quarter and six months ended June 30, 2011, we recorded an adjustment to a MUSE-related liability in the amount of $26,000. As a result, cost of goods sold and manufacturing was $(26,000), in both the quarter and six months ended June 30, 2011 as compared to $2.9 million and $5.3 million, in the quarter and six months ended June 30, 2010, respectively. The decrease is due to the sale of MUSE in the fourth quarter of 2010.

 

Research and development—discontinued operations. (Unaudited)

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2011

 

2010

 

2011 vs.
2010
(Decrease)

 

2011

 

2010

 

2011 vs.
2010
(Decrease)

 

 

 

(In thousands, except percentages)

 

Research and development

 

$

 

$

599

 

(100

)%

$

 

$

611

 

(100

)%

 

Research and development expenses were $0 in the three and six months ended June 30, 2011, respectively, as compared to $599,000 and $611,000, respectively, for the three and six months ended June 30, 2010.

 

Selling, general and administrative—discontinued operations. (Unaudited) 

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

2011

 

2010

 

2011 vs.
2010
(Decrease)

 

2011

 

2010

 

2011 vs.
2010
(Decrease)

 

 

 

(In thousands, except percentages)

 

Selling, general and administrative

 

$

16

 

$

1,484

 

(99

)%

$

2

 

$

2,905

 

(100

)%

 

Selling, general and administrative expenses were $16,000 and $2,000 in the three and six months ended June 30, 2011, respectively, as compared to $1.5 million and $2.9 million in the three and six months ended June 30, 2010. The decrease is due to the sale of MUSE to Meda on November 5, 2010.

 

Interest income and expense—discontinued operations.

 

Interest and other income, net for both the quarter and six months ended June 30, 2011 was $0, as compared to $3,000 and $6,000, in the quarter and six months ended June 30, 2010, respectively. The Crown Bank loan was paid in full and the restricted cash certificate of deposit was redeemed in connection with the sale of MUSE to Meda in the fourth quarter 2010.

 

Interest expense for both the quarter and six months ended June 30, 2011 was $0, as compared to $94,000 and $187,000, in the quarter and six months ended June 30, 2010, respectively. The Crown Bank loan was paid in full in connection with the sale of MUSE to Meda in the fourth quarter 2010.

 

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Provision for income taxes—discontinued operations.

 

Provision for income taxes for both the quarter and six months ended June 30, 2011 was $0, as compared to $8,000 and $15,000 in the quarter and six months ended June 30, 2010. The provision for income taxes in the quarter and six months ended June 30, 2010 related to state income taxes.

 

LIQUIDITY AND CAPITAL RESOURCES

 

Continuing Operations

 

Cash. Cash, cash equivalents and available-for-sale securities totaled $121.6 million at June 30, 2011, as compared to $139.2 million at December 31, 2010. The decrease in cash, cash equivalents and available-for-sale securities of $17.6 million is primarily the net result of cash used for operating activities and provided by financing activities. Included in these amounts is $1.9 million in net proceeds from common stock option exercises and 1994 ESPP purchases during the six months ended June 30, 2011.

 

Since inception, we have financed operations primarily from the issuance of equity securities. Through June 30, 2011, we have raised $409.5 million from financing activities, received $150 million from the sale of Evamist and had an accumulated deficit of $326.2 million at June 30, 2011.

 

At June 30, 2011, we had $28.3 million in cash and cash equivalents and $93.3 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. At June 30, 2011, all of our cash equivalents and available-for-sale securities were invested in either U.S. government securities or money market funds that invest only in U.S. Treasury securities. The investment policy has the primary investment objectives of preservation of principal; 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.

 

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.

 

Liabilities.  Total liabilities were $14.2 million at June 30, 2011, which is $1.9 million higher than at December 31, 2010. The change in total liabilities includes a $3.8 million increase in accounts payable primarily due to the $4.0 million milestone due to MTPC related to the filing of the NDA for avanafil, partially offset by a $705,000 decrease in accrued research and development expenses due to reduced project spending, a $115,000 decrease in accrued employee compensation and benefits, a $275,000 decrease in accrued and other liabilities and an $850,000 decrease in current liabilities of discontinued operations.

 

Operating Activities.  Our operating activities used $18.7 million and $34.2 million in cash during the six months ended June 30, 2011 and 2010, respectively. During the six months ended June 30, 2011, our net operating loss of $26.2 million was offset by $4.1 million in non-cash share-based compensation expense and a $3.8 million increase to accounts payable, primarily due to the timing of the $4.0 million milestone to MTPC for avanafil. These positive cash flows to our net operating loss were in turn offset by a $705,000 decrease in accrued research and clinical expenses.

 

During the six months ended June 30, 2010, our net operating loss of $38.2 million was offset by $3.2 million in non-cash share-based compensation expense, a $2.6 million increase in accrued research and clinical expenses and a $1.2 million increase in accrued and other liabilities. These positive cash flows to our net operating loss were in turn offset by a $3.6 million decrease in accounts payable, primarily due to the timing of payments.

 

We anticipate cash used in operations in 2011 will be lower than cash used in operations in 2010, primarily due to the completion of the pivotal Phase 3 studies for QNEXA and avanafil; however, the amount of cash used in operations in 2011 will be dependent upon the timing and outcome of the FDA’s decision on QNEXA.

 

Investing Activities.  Our investing activities provided $8.6 million and $3.0 million in cash during the six months ended June 30, 2011 and 2010, respectively. The fluctuations from period to period are due primarily to the timing of purchases, sales and maturity of investment securities.

 

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Financing Activities.  Financing activities provided cash of $1.9 million and $1.3 million during the six months ended June 30, 2011 and 2010, respectively. In the first six months of 2011, cash provided by financing activities included $1.8 million in proceeds from the exercise of stock options and $132,000 in proceeds from the sale of common stock through our 1994 ESPP. In the first six months of 2010, cash provided by financing activities included $1.1 million in net proceeds from the exercise of stock options and $215,000 in proceeds from the sale of common stock through our 1994 ESPP.

 

Discontinued Operations

 

Cash used for operating activities in the six months ended June 30, 2011 was $722,000. In the six months ended June 30, 2011, the $121,000 net income was offset by decreases in liabilities: $203,000 in accounts payable, $218,000 in accrued product returns, $197,000 in accrued chargeback reserve, $184,000 in accrued and other liabilities and $47,000 in accrued employee compensation and benefits. The extinguishment of the largest liability of the discontinued operations, accrued product returns, will be settled in accordance with the returns policy by cash payments made to former customers for the return of expired MUSE product sold by VIVUS. The return window for expired MUSE product will end in 2013.

 

Cash provided by operating activities in the six months ended June 30, 2010 was $779,000. In the six months ended June 30, 2010, the $3.4 million net loss was offset by adjustments to the net loss of $546,000 in depreciation expense and $520,000 in non-cash share-based compensation expense and by a $5.2 million decrease in accounts receivable. These positive cash flows to our net operating loss were in turn offset by a $575,000 decrease in accrued and other liabilities, a $1.0 million decrease in the accrued chargeback reserve and a $497,000 increase in inventories.

 

Our investing activities used $0 and $33,000 in cash during the six months ended June 30, 2011 and 2010, respectively. In the six months ended June 30, 2010, cash used in investing activities included purchases of property and equipment. Financing activities used $0 and $78,000 during the six months ended June 30, 2011 and 2010, respectively. In the six months ended June 30, 2010, the amount represents principal payments made under our Crown Bank loan. In the fourth quarter of 2010, we paid off the loan to Crown Bank.

 

Financing Activities

 

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 served as collateral for the Crown loan. The loan was payable over a 10-year term. The interest rate was 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 were payable monthly based upon a 20-year amortization schedule and were adjusted annually at the time of the interest rate reset. All remaining principal was due on February 1, 2016. The interest rate was 7.5% for 2010. On October 15, 2010, in preparation for the closing of the MUSE Transaction and in accordance with the terms of the agreements with Crown, we paid $4.8 million to Crown in satisfaction of all obligations owed to them under these agreements. As a result, the security interests and Certificate of Deposit held by Crown were terminated in our favor.

 

On October 1, 2010, we entered into a definitive Asset Purchase Agreement with Meda, to sell certain rights and assets related to MUSE, transurethral alprostadil, for the treatment of erectile dysfunction, or the MUSE Transaction. Meda has been our European distributor of MUSE since 2002. The assets sold in the MUSE Transaction include the U.S. and foreign MUSE patents, existing inventory, and the manufacturing facility located in Lakewood, New Jersey. We retained all of the liabilities associated with the pre-closing operations and products of the MUSE business and the accounts receivables for pre-closing MUSE sales. The transaction closed on November 5, 2010. Prior to the closing of the MUSE Transaction we regained all of the rights to MUSE and avanafil held by Deerfield Management Company, L.P., and affiliates, and Crown Bank, N.A.

 

Under the terms of the MUSE Transaction, we received an upfront payment of $22 million upon the closing and are eligible to receive an additional $1.5 million based on future sales of MUSE, provided that certain sales milestones are reached. Meda is now responsible for the manufacturing, selling and marketing of MUSE. Meda also assumed all post-closing expenses and liabilities associated with MUSE. We have agreed not to develop, manufacture or sell any transurethral erectile dysfunction drugs for a period of three years following the closing of the MUSE Transaction. The assets and liabilities and results of operations associated with MUSE have been reported as discontinued operations for all periods presented.

 

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, which included the addition of

 

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Table of Contents

 

Deerfield PDI Financing L.P. as a Deerfield Affiliate. Under the agreements, Deerfield and its affiliates provided us with $30 million in funding, consisting 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. We received all of the required payments under the FARA, or the Funding Payments. Under the FARA, we paid royalties on the net sales of MUSE to the Deerfield Sub. The FARA had a term of 10 years.

 

We entered into the Option and Put Agreement with the Deerfield Affiliates and the Deerfield Sub, 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 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. Our obligation to pay royalties terminated upon the exercise of the Option. On October 21, 2010, in preparation for the closing of the MUSE Transaction, we exercised the Option under the Deerfield OPA, and we paid an aggregate amount totaling $27.1 million, which consisted of the Base Option Price of $25 million, less the Option Premium Adjustment of $2 million, plus the addition of the Cash Adjustment of $2.8 million and the Royalty Adjustment of $1.3 million. These payments satisfied all of the financial obligations under the FARA and OPA. As a result, all of the outstanding shares and the $2.8 million of cash of the Deerfield Sub are owned by us, all of the outstanding loans owed by the Deerfield Sub have been repaid and the security interests in the collateral related to MUSE and avanafil held by the Deerfield Sub and the Deerfield Affiliates as part of the FARA and OPA were terminated. In December 2010, the Deerfield Sub was dissolved.

 

On September 17, 2009, we entered into an underwriting agreement, or the Underwriting Agreement, with J.P. Morgan Securities Inc., as representative of the several underwriters named therein, or the Underwriters, relating to the public offering and sale of 9,000,000 shares of our common stock. Pursuant to the Underwriting Agreement, the Underwriters agreed to purchase, subject to customary closing conditions, 9,000,000 shares of our common stock. We also granted the Underwriters a 30-day option to purchase up to 1,350,000 additional shares of common stock on the same terms and conditions as set forth above to cover over-allotments, which the Underwriters exercised in full. The 10,350,000 shares were sold at a price to the public of $10.50 per share which resulted in approximately $108.7 million in gross proceeds before deducting underwriting discounts and commissions and other offering expenses. The transaction closed on September 23, 2009. The offering was made pursuant to the effective shelf registration statement on Form S-3 (Registration No. 333-161948), including the prospectus dated September 16, 2009 contained therein, as supplemented.

 

On February 16, 2010, we filed a Form S-8 (File Number 333-164921) 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 July 14, 2010, we filed a Form S-8 (File Number 333-168106) with the SEC registering 16,615,199 shares of common stock, par value $0.001 per share, to be issued pursuant to the 2010 Equity Incentive Plan, and registering 400,000 shares of common stock, par value $0.001 per share, to be issued pursuant to the Stand-Alone Stock Option Agreement with Michael P. Miller.

 

On August 1, 2011, the Company filed a Form S-8 with the SEC registering 600,000 shares of common stock, par value $0.001 per share, under the 1994 Employee Stock Purchase Plan, as amended.

 

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 drug candidate. It is also important to note that if an investigational drug 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 drug candidates into commercially viable drugs include research to identify a clinical candidate, pre-clinical 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 drug 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 drug candidate may cause harmful side effects or is not effective;

 

·                  patient recruitment may be slower than expected; and

 

·                  patients may drop out of the trials.

 

For each of our investigational drug candidate development 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 were

 

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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 drug cannot be accurately estimated.

 

Our investigational drug 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 and retrospective data establish substantial evidence of safety and efficacy. The results from pre-clinical 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 clinical trials, but subsequently fail to demonstrate 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 drug candidate development programs are difficult to estimate and are subject to considerable variation. Our inability to complete our research and investigational drug candidate development 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 or be impacted by numerous factors, including:

 

·                  the cost, timing and outcome of FORTRESS;

 

·                  the FDA’s interpretation of the data we submitted and may submit relating to teratogenicity and cardiovascular safety;

 

·                  the FDA’s interpretation of the data from our SEQUEL study (OB-305) and Sleep Apnea study (OB-204);

 

·                  whether or not the FDA or EMA requires us to perform additional studies for QNEXA;

 

·                  whether or not the FDA requires us to perform additional studies for avanafil;

 

·                  the outcome of an Advisory Committee meeting to review the resubmission of the QNEXA NDA;

 

·                  the cost and time required to set up a distribution system and REMS program for QNEXA that is suitable to address any FDA concerns;

 

·                  our response to the EMA’s requests for information included in the 120-day questions for QNEXA;

 

·                  whether or not the FDA approves the NDA for avanafil;

 

·                  our ability to effectively partner or monetize avanafil, if approved, in the U.S. and worldwide;

 

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

 

·                  the scope, timing and results of pre-clinical, clinical and retrospective observational studies and trials;

 

·                  the cost of access to electronic records and databases that allow for retrospective observational studies;

 

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

 

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

 

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

 

·                  the establishment of collaborations, sublicenses and strategic alliances and the related costs, including milestone payments;

 

·                  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;

 

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·                  the cost, timing and outcome of regulatory reviews;

 

·                  the rate of technological advances;

 

·                  ongoing determinations of the potential commercial success of our investigational drug candidates under development;

 

·                  the state of the economy and financing environment;

 

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

 

·                  the cost, timing and outcome of litigations;

 

·                  the healthcare 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;

 

·                  perceptions and interpretations of QNEXA or the data by outside analysts or others; 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 into 2012. However, we anticipate that we may require additional funding to continue our research and investigational drug candidate development programs, to conduct pre-clinical, clinical and retrospective studies and trials, to fund operating expenses, to pursue regulatory approvals for our investigational drug 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, to manufacture quantities of our investigational drug candidates for approval and commercialization, or to launch a product. In particular, we expect to make other substantial payments to the inventor of QNEXA pending approval by the FDA and to MTPC, in accordance with our agreements with MTPC in connection with the licensing of avanafil. 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 investigational drug candidates in development 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 drug candidate 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 drug candidates and to pay royalties on future product sales. 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 sell one or more of our investigational drug 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 June 30, 2011 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 June 30, 2011. These do not include milestones and assumes non-termination of agreements. These obligations, commitments and supporting arrangements represent payments based on current operating plans, which are subject to change:

 

 

 

Payments Due by Period

 

Contractual obligations

 

Total

 

2011

 

2012-2014

 

2015-2016

 

Thereafter

 

 

 

(in thousands)

 

Operating leases

 

$

752

 

$

346

 

$

406

 

$

 

$

 

Other agreements

 

14,134

 

6,075

 

8,059

 

 

 

Clinical trials

 

5,638

 

4,503

 

1,135

 

 

 

Total contractual obligations

 

$

20,524

 

$

10,924

 

$

9,600

 

$

 

$

 

 

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Operating Leases

 

In November 2006, we entered into a 30-month lease for our corporate headquarters located in Mountain View, California. The lease commenced on February 1, 2007. The base monthly rent was set at $1.85 per square foot, or $26,000 per month. The lease expired on July 31, 2009. On December 16, 2008, we entered into a first amendment to this lease. Under the terms of the amended lease, we 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 was set at $1.64 per square foot, or $23,000 per month. The amended lease allowed us one option to extend the term of the lease for one year from the expiration of the lease. On November 12, 2009, we entered into a second amendment to this lease. The second amendment commenced on January 1, 2010, expires on July 31, 2011 and expands the leased space. The base rent for the expansion space was set at $2.25 per square foot, or $8,500 per month. The option to extend the term of the amended lease for one year from the expiration of the lease applies to this expansion space as well. In December 2010, we entered into a third amendment to this lease. The third amendment extended the lease term for the original premises and the expansion space for a period of twelve months commencing August 1, 2011 and terminating July 31, 2012. Under the third amendment, the base rent for the original space will be set at $1.69 per square foot, or $24,000 per month and the base rent for the expansion space will be set at $2.31 per square foot, or $8,700 per month. The amended lease allows us one additional option to extend the term of the lease for one year from the expiration of the lease. The option to extend the term of the amended lease for one year from the expiration of the lease applies to the expansion space as well.

 

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 research and development, pre-commercial obligations, general and administrative services, and media/market research contracts, as well as obligations related to those contracts that we are likely to continue, regardless of the fact that they were cancelable as of June 30, 2011.

 

We have remaining commitments under various general and administrative services agreements totaling $3.8 million at June 30, 2011, including $1.5 million related to Leland F. Wilson’s Employment Agreement. 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 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 had an initial term of two years commencing on the effective date, June 1, 2007, or the Effective Date. 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. On January 21, 2011, the Compensation Committee approved the second amendment to Mr. Wilson’s Employment Agreement. Pursuant to the second amendment, the initial term of the Employment Agreement is increased to four years commencing on June 1, 2007. As neither party provided notice of termination, the Employment Agreement was automatically extended for an additional one-year term commencing on June 1, 2011.

 

We have also entered into various agreements with our research consultants and other contractors to perform regulatory services, drug research and testing and, at June 30, 2011, our remaining commitment under these agreements totaled $3.9 million. These amounts represent 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. We have placed orders with MTPC for avanafil finished goods and our remaining commitment under these purchase obligations at June 30, 2011 totaled $6.4 million.

 

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 June 30, 2011, our remaining commitment under these agreements totaled $5.6 million, which includes nearly all of the accrued research and clinical expenses of $1.9 million in the condensed consolidated balance sheet as of June 30, 2011. 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.

 

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Additional Payments

 

We have entered into development, license and supply agreements that 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 Pharma Corporation

 

In January 2001, we entered into an exclusive development, license and supply agreement with Tanabe Seiyaku Co., Ltd., or Tanabe, now Mitsubishi Tanabe Pharma Corporation, or MTPC, and hereinafter collectively referred to as MTPC, 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, MTPC 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 MTPC an exclusive, royalty-free license within those countries for oral products that we develop containing avanafil. In addition, we agreed to grant MTPC an exclusive option to obtain an exclusive, royalty-bearing license within those countries for non-oral products that we develop containing avanafil. MTPC 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 MTPC 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. In 2006, we paid MTPC $2 million in connection with this milestone. We have further agreed to pay royalties on net sales of products containing avanafil. No payments were made under this agreement with MTPC in the years ended December 31, 2007 and 2008; however, we paid MTPC $4 million in January 2009 following the enrollment in December 2008 of the first patient in the first Phase 3 clinical studies. In the second quarter of 2011, we submitted an NDA to the FDA for avanafil and accrued a $4 million milestone due to MTPC under this agreement. We expect to make other substantial payments to MTPC in accordance with its agreements with MTPC 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 $11 million in the aggregate and include payments upon: the obtainment of the first regulatory approval in the U.S. and any major European country; and achievement of $250 million or more in calendar year sales.

 

The term of the MTPC agreement is based on a country-by-country and on a product-by-product basis. The term shall continue until the later of (i) 10 years after the date of the first sale for a particular product, or (ii) the expiration of the last-to-expire patents within the MTPC 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 MTPC with respect to such product.

 

Other

 

On October 16, 2001, we entered into an assignment agreement, or the Assignment Agreement, with Thomas Najarian, M.D. for a combination of pharmaceutical agents for the treatment of obesity and other disorders, or the Combination Therapy, that has since been the focus of our investigational drug candidate development program for QNEXA for the treatment of obesity, obstructive sleep apnea and diabetes. The Combination Therapy and all related patent applications, or the Patents, were transferred to us with worldwide rights to develop and commercialize the Combination Therapy and exploit the Patents. Pursuant to the Assignment Agreement, we have paid a total of $220,000 to Dr. Najarian through June 30, 2011 and have issued him options to purchase 40,000 shares of our common stock. We are obligated under the terms of the Assignment Agreement to make a milestone payment of $1 million and issue an option to purchase 20,000 shares of our common stock to Dr. Najarian upon marketing approval by the FDA of a product for the treatment of obesity that is based upon the Combination Therapy and Patents. The Assignment Agreement will require us to pay royalties on worldwide net sales of a product for the treatment of obesity that is based upon the Combination Therapy and Patents until the last-to-expire of the assigned Patents. To the extent that we decide not to commercially exploit the Patents, the Assignment Agreement will terminate and the Combination Therapy and Patents will be assigned back to Dr. Najarian. In 2006, Dr. Najarian joined us as a part-time employee and currently serves as a Principal Scientist.

 

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.

 

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Indemnifications

 

In the normal course of business, the Company provides indemnifications of varying scope to customers, third party service providers and business partners 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, among others. 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 that survive the closing date of the transaction, including a covenant not to operate a business that competes, in the U.S., and its territories and protectorates, with the Evamist product.

 

Pursuant to the terms of the Asset Purchase Agreement the Company entered into with Meda AB, or Meda, to sell certain of the assets related to the MUSE business to Meda, or the MUSE Transaction, the Company agreed to indemnify Meda in connection with the representations and warranties that it made concerning its rights, liabilities and assets related to the MUSE business and its authority to enter into and consummate the MUSE Transaction. The Company also made certain covenants in the Asset Purchase Agreement which survive the closing of the MUSE Transaction, including a three year covenant not to develop, manufacture, promote or commercialize a trans-urethral erectile dysfunction drug.

 

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

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

The Securities and Exchange Commission’s rule related to market risk disclosure requires that we describe and quantify our potential losses from market risk sensitive instruments attributable to reasonably possible market changes. Market risk sensitive instruments include all financial or commodity instruments and other financial instruments that are sensitive to future changes in interest rates, currency exchange rates, commodity prices or other market factors. We are not exposed to market risks from changes in foreign currency exchange rates or commodity prices. We do not hold derivative financial instruments nor do we hold securities for trading or speculative purposes.

 

Our cash, cash equivalents and available-for-sale securities as of June 30, 2011 consisted primarily of money market funds and U.S. Treasury securities. Our cash is invested in accordance with an investment policy approved by our Board of Directors that specifies the categories (money market funds, U.S. Treasury securities and debt securities of U.S. government agencies, corporate bonds, asset-backed securities, and other securities), allocations, and ratings of securities we may consider for investment. Currently, we have focused on investing in U.S. Treasuries until market conditions improve.

 

Our primary exposure to market risk is interest income sensitivity, which is affected by changes in the general level of U.S. interest rates, particularly because the majority of our investments are in short-term marketable debt securities. The primary objective of our investment activities is to preserve principal. Some of the securities that we invest in may be subject to market risk. This means that a change in prevailing interest rates may cause the value of the investment to fluctuate. For example, if we purchase a security that was issued with a fixed interest rate and the prevailing interest rate later rises, the value of our investment may decline. A hypothetical 100 basis point increase in interest rates would reduce the fair value of our available-for-sale securities at June 30, 2011 by approximately $303,000. In general, money market funds are not subject to market risk because the interest paid on such funds fluctuates with the prevailing interest rate.

 

There is ongoing concern in the credit markets regarding the value of a variety of mortgage-backed, asset-backed and auction rate securities and the resultant effect on various securities markets. In addition, continuing concerns over inflation, energy costs, geopolitical issues, the availability and cost of credit, the U.S. mortgage market and a declining residential real estate market in the U.S. have contributed to increased volatility and diminished expectations for the economy and the markets going forward. These factors combined with volatile oil prices, declining business and consumer confidence and increased unemployment, have precipitated an economic recession and fears of a possible depression. Domestic and international equity markets continue to experience heightened volatility and turmoil. These events and the continuing market upheavals may have an adverse effect on us. In the event of a continuing market downturn, our results of operations could be adversely affected by those factors in many ways including making it

 

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more difficult for us to raise funds if necessary and may cause stock price volatility. Our investment policy, as approved by our Board of Directors, allows us to invest in cash, cash equivalents and available-for-sale securities that are not federally insured. Given the current economic instability, we cannot provide assurance that we will not experience losses on these investments.

 

ITEM 4. CONTROLS AND PROCEDURES

 

(a.) Evaluation of disclosure controls and procedures. We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the timelines specified in the rules and forms of the Securities and Exchange Commission, or SEC, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can only provide reasonable assurance of achieving the desired control objectives, and in reaching a reasonable level of assurance, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

As required by SEC Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of VIVUS’ disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

 

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

 

PART II: OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

Securities Related Class Action Lawsuits

 

The Company and two of its officers are defendants in a putative class action lawsuit captioned Kovtun v. Vivus, Inc., et al., Case No. CV10-4957 PJH, pending in the U.S. District Court, Northern District of California. The action, filed in November 2010, alleges violations of Section 10(b) and 20(a) of the federal Securities Exchange Act of 1934 based on allegedly false or misleading statements made by defendants in connection with the Company’s clinical trials and New Drug Application, or NDA, for QNEXA as a treatment for obesity. In his Amended Class Action Complaint filed April 4, 2011, plaintiff alleges generally that defendants misled investors regarding the prospects for QNEXA’s NDA approval, and the drug’s efficacy and safety. On June 3, 2011, defendants filed a motion to dismiss, which is currently scheduled for hearing on October 5, 2011. Discovery is stayed pending resolution of the motion.

 

Additionally, the Company’s directors are defendants in a shareholder derivative lawsuit captioned Turberg v. Logan, et al., Case No. CV 10-05271 PJH, also pending in the same federal court. In her Verified Amended Shareholder Derivative Complaint filed June 3, 2011, plaintiff largely restates the allegations of the Kovtun action and alleges that the directors breached fiduciary duties to the Company by purportedly permitting the Company to violate the federal securities laws as alleged in Kovtun. The matter is stayed pending resolution of defendants’ motion to dismiss in Kovtun. The Company’s directors are also named defendants in consolidated shareholder derivative suits pending in the California Superior Court, Santa Clara County under the caption In re VIVUS, Inc. Derivative Litigation, Master File No. 11 0 CV188439. The allegations in the state court derivative suits are substantially similar to the other lawsuits. As with the federal derivative litigation, these consolidated actions are stayed pending resolution of the motion to dismiss in Kovtun.

 

The Company and its directors believe that the various shareholder lawsuits are without merit, and they intend to vigorously defend the various actions.

 

Other Matters

 

In the normal course of business, the Company receives claims and makes inquiries regarding patent and trademark infringement and other related legal matters. The Company believes that it has meritorious claims and defenses and intends to pursue any such matters vigorously. Additionally, the Company in the normal course of business may become involved in lawsuits and subject to various claims from current and former employees including wrongful termination, sexual discrimination and employment matters. Due to the current economic downturn, employees may be more likely to file employment-related claims following

 

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termination of their employment. Employment-related claims also may be more likely following a poor performance review. Although there may be no merit to such claims or legal matters, the Company may be required to allocate additional monetary and personnel resources to defend against these type of allegations. The Company believes the disposition of the current lawsuit and claims is not likely to have a material effect on its financial condition or liquidity.

 

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

 

ITEM 1A. RISK FACTORS

 

Set forth below and elsewhere in this Form 10-Q and in other documents we file with the S