Various statements throughout this report are forward-looking statements within the meaning of the Private Securities Litigation
Reform Act of 1995. Forward-looking statements may appear throughout this report. Words such as, but not limited to, believe, expect, anticipate, estimate, intend, plan,
project, target, goal, likely, will, would, and could, or the negative of these terms and similar expressions or words, identify forward-looking statements.
Forward-looking statements are based upon current expectations that involve risks, changes in circumstances, assumptions and uncertainties. Important factors that could cause actual results to differ materially from those reflected in our
forward-looking statements include, among others:
All written and verbal
forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. We caution investors not to rely too heavily on the
forward-looking statements we make or that are made on our behalf. We undertake no obligation, and specifically decline any obligation, to update or revise publicly any forward-looking statements, whether as a result of new information, future
events or otherwise.
ITEM 1. BUSINESS
Overview
Vanda Pharmaceuticals Inc. (we
or Vanda ) is a global biopharmaceutical company focused on the development and commercialization of innovative therapies to address high unmet medical needs and improve the lives of patients. Vanda commenced its operations in 2003 and our product
portfolio includes:
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HETLIOZ
®
(tasimelteon), a product for the treatment of Non-24-Hour Sleep-Wake Disorder (Non-24), was approved by the U.S. Food and Drug Administration (FDA)
in January 2014 and launched commercially in the U.S. in April 2014. In July 2015, the European Commission (EC) granted centralized marketing authorization with unified labeling for
HETLIOZ
®
for the treatment of Non-24 in totally blind adults. HETLIOZ
®
was commercially launched in Germany in August 2016.
HETLIOZ
®
has potential utility in a number of other circadian rhythm disorders and is presently in clinical development for the treatment of Pediatric Non-24, Jet Lag Disorder and
Smith-Magenis Syndrome (SMS).
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Fanapt
®
(iloperidone), a product for the treatment of schizophrenia, the oral formulation of which was approved by the FDA in May 2009 and launched
commercially in the U.S. by Novartis Pharma AG (Novartis) in January of 2010. Novartis transferred all the U.S. and Canadian commercial rights to the Fanapt
®
franchise to us on
December 31, 2014. Additionally, our distribution partners launched Fanapt
®
in Israel and Mexico in 2014. Fanapt
®
has
potential utility in a number of other disorders. An assessment of new Fanapt
®
clinical opportunities is ongoing.
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Tradipitant (VLY-686), a small molecule neurokinin-1 receptor (NK-1R) antagonist, which is presently in clinical development for the treatment of chronic pruritus in atopic dermatitis and gastroparesis.
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Trichostatin A, a small molecule histone deacetylase (HDAC) inhibitor which is in development for the treatment of hematologic malignancies.
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AQW051, a Phase II alpha-7 nicotinic acetylcholine receptor partial agonist.
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Since we began
operations in March 2003, we have devoted substantially all of our resources to the in-licensing, clinical development and commercialization of our products. Our ability to generate meaningful product sales and achieve profitability largely depends
on our ability to successfully commercialize HETLIOZ
®
and Fanapt
®
in the U.S. and Europe alone or with others, to complete
the development of our products, and to obtain the regulatory approvals for and to manufacture, market and sell our products. The results of our operations will vary significantly from year-to-year and quarter-to-quarter and depend on a number
of factors, including risks related to our business, risks related to our industry, and other risks which are detailed in Item 1A of Part I entitled
Risk Factors
and Item 7 of Part II entitled
Managements Discussion and
Analysis of Financial Condition and Results of Operations
of this annual report on Form 10-K.
Our activities will necessitate
significant uses of working capital in 2017 and beyond. We are currently concentrating our efforts on selling HETLIOZ
®
and Fanapt
®
in
the U.S. and our continued commercialization of HETLIOZ
®
in Europe. Additionally, we continue to pursue market approval of HETLIOZ
®
in
other regions and Fanapt
®
in Europe and other regions. We will continue to work with our distribution partners who launched Fanapt
®
in
Mexico and Israel. We see opportunities to grow our commercial products through life cycle management strategies that include the addition of new indications and formulations. We have built a research and development organization that includes
extensive expertise in the scientific disciplines of pharmacogenetics and pharmacogenomics. We operate cross-functionally and are led by an experienced research and development management team. Our pipeline includes novel programs that could address
largely unmet medical needs.
Our founder and Chief Executive Officer, Mihael H. Polymeropoulos, M.D., started Vandas operations in
early 2003 after establishing and leading the Pharmacogenetics Department at Novartis. In acquiring and developing our products, we have relied upon our deep expertise in the scientific disciplines of pharmacogenetics and pharmacogenomics. These
scientific disciplines examine both genetic variations among people that influence response to a particular drug, and the multiple pathways through which drugs affect people.
Our Strategy
Our goal is to create a
leading global biopharmaceutical company focused on developing and commercializing innovative therapies addressing high unmet medical needs through the application of our drug development expertise and our pharmacogenetics and pharmacogenomics
expertise. The key elements of our strategy to accomplish this goal are to:
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Maximize the commercial success of HETLIOZ
®
and Fanapt
®
;
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Enter into strategic partnerships to supplement our capabilities and to extend our commercial reach;
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Pursue the clinical development and regulatory approval of our products;
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Apply our pharmacogenetics and pharmacogenomics expertise to differentiate our products; and
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Expand our product portfolio through the identification and acquisition of additional products.
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2
Products
We have the following products on the market or under regulatory review:
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Product
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Indication
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Geography
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Select Historical Milestones
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HETLIOZ
®
(tasimelteon)
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Non-24
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United States
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FDA approval in January 2014;
Commercial launch in April 2014
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Europe
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EC approval in July 2015;
Commercial launch in Germany in August 2016
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Fanapt
®
(Oral)
(iloperidone)
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Schizophrenia
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United States
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FDA approval in May 2009;
Commercial launch in January 2010;
U.S. and
Canada rights sublicensed to Novartis in October 2009 and reacquired by Vanda in December 2014;
Long term maintenance sNDA approval in May
2016
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Fanaptum
®
(Oral)
(iloperidone)
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Europe
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EMA accepted for evaluation our MAA in December 2015
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Mexico
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Market approval in October 2013;
Commercial
launch in the fourth quarter of 2014 by our local distribution partner, Probiomed S.A. de C.V.
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Israel
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Market approval August 2012;
Commercial launch
in the fourth quarter of 2014 by our local distribution partner, Megapharm Ltd.
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We have the following products in clinical development:
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Product
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Target Indication
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Select Historical Milestones
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HETLIOZ
®
(tasimelteon)
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Pediatric Non-24
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Initiated a liquid formulation pharmacokinetic study in the fourth quarter of 2016
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SMS
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Initiated a placebo controlled study in the fourth quarter of 2016
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Jet Lag Disorder
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Initiated a placebo controlled study in the fourth quarter of 2016
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Fanapt
®
(Oral)
(iloperidone)
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Schizophrenia
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Long-acting injectable under evaluation;
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Other Disorders
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Potential indications are under evaluation including bipolar depression, major depressive disorder and post-traumatic stress disorder nightmares
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Tradipitant (VLY-686)
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Pruritus in patients with Atopic Dermatitis
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Initiated a placebo controlled pruritus clinical study in the second quarter of 2016
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Gastroparesis
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Initiated a placebo controlled study in fourth quarter of 2016
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Trichostatin A
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Oncology
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In development for hematologic malignancies
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AQW051
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CNS Disorders
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Potential indications are under strategic evaluation including cognitive impairment
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3
HETLIOZ
®
Commercial opportunity: Non-24
In January 2014, HETLIOZ
®
was approved in the U.S. for the treatment of Non-24. Non-24
is a serious, rare and chronic circadian rhythm disorder characterized by the inability to entrain (synchronize) the master body clock with the 24-hour day-night cycle. HETLIOZ
®
is the first
FDA approved treatment for Non-24. HETLIOZ
®
is a melatonin agonist of the human MT1 and MT2 receptors, with greater specificity for MT2. These receptors are thought to be involved in the
control of circadian rhythms. HETLIOZ
®
is believed to reset the master body clock in the suprachiasmatic nucleus (SCN), located in the hypothalamus, resulting in the entrainment and alignment
of the bodys melatonin and cortisol rhythms to the 24-hour day-night cycle. HETLIOZ
®
was launched commercially in the U.S. in April 2014. In addition, in July 2015, the EC granted
centralized marketing authorization with unified labeling for HETLIOZ
®
for the treatment of Non-24 in totally blind adults and included post-marketing commitments related to a pediatric
investigation plan. This authorization is valid in the 28 countries that are members of the European Union, as well as European Economic Area members Iceland, Liechtenstein and Norway.
HETLIOZ
®
was launched commercially in Germany in August 2016.
In January 2010,
the FDA granted orphan drug designation status for HETLIOZ
®
in Non-24 in blind individuals. The FDA grants orphan drug designation to drugs that may provide significant therapeutic advantage
over existing treatments and target conditions affecting 200,000 or fewer U.S. patients per year. Orphan drug designation provides potential financial and regulatory incentives, including study design assistance, tax credits, waiver of FDA user
fees, and up to seven years of market exclusivity upon marketing approval. In February 2011, the European Medicines Agency (EMA) designated HETLIOZ
®
as an orphan medicinal product for the same
indication.
Non-24 is a serious, rare and chronic circadian rhythm disorder characterized by the inability to synchronize the master body
clock with the 24-hour day-night cycle. Non-24 affects a majority of totally blind individuals, or approximately 80,000 people in the U.S. Non-24 occurs almost entirely in individuals who lack the light sensitivity necessary to synchronize the
master body clock in the brain with the 24-hour day-night cycle. Most people have a master body clock that naturally runs longer than 24-hours and light is the primary environmental cue that resets it to 24 hours each day. Individuals with Non-24
have a master body clock that is not reset, and continually delays, resulting in prolonged periods of misalignment between their circadian rhythms and the 24-hour day-night cycle, including the timing of melatonin and cortisol secretion. As a result
of this misalignment, Non-24 is associated with significant disruption of the sleep-wake cycle and impairments in social and occupational functioning, and marked subjective distress. Individuals with Non-24 cycle in-and out-of phase and suffer from
disrupted nighttime sleep patterns and/or excessive daytime sleepiness.
While there are no FDA or EC approved treatments for Non-24 other
than HETLIOZ
®
, there are a number of drugs approved and prescribed for patients with sleep disorders. The most commonly prescribed drugs are hypnotics. See
Competition
below for a
discussion of commonly prescribed drugs for patients with sleep disorders.
Therapeutic opportunity: Circadian Rhythm Sleep
Disorders
Sleep disorders are segmented into three major categories: primary insomnia, secondary insomnia and circadian rhythm
sleep disorders (CRSDs). Insomnia is a symptom complex that comprises difficulty falling asleep or staying asleep, or non-refreshing sleep, in combination with daytime dysfunction or distress. The symptom complex can be an independent disorder
(primary insomnia) or be a result of another condition such as depression or anxiety (secondary insomnia). CRSDs result from a misalignment of the sleep/wake cycle and an individuals daily activities or lifestyle. The circadian rhythm is the
rhythmic output of the human biological clock and is governed by the hormones melatonin and cortisol. Both the timing of behavioral events (activity, sleep, and social interactions) and the environmental light/dark cycle result in a sleep/wake cycle
that follows the circadian rhythm. Examples of CRSDs include transient disorders such as jet lag and chronic disorders such as delayed sleep phase disorder, shift work sleep disorder and Non-24. We are planning to develop HETLIOZ
®
for the treatment of pediatric Non-24. We initiated a pediatric liquid formulation pharmacokinetic study in the fourth quarter of 2016.
We initiated an open label interventional study in patients with SMS in the fourth quarter of 2015 and a SMS placebo controlled study in the
fourth quarter of 2016. Enrollment in these studies is ongoing. SMS is a rare genetic disorder caused by a deletion on chromosome 17. The U.S. National Institute of Health estimates that SMS affects approximately one in 20,000 births in the U.S.
We initiated an observational study in Jet Lag Disorder in the fourth quarter of 2015, which has been extended. We initiated a placebo
controlled study in the fourth quarter of 2016.
Fanapt
®
Commercial Opportunity: Schizophrenia
Fanapt
®
is a product for the treatment of schizophrenia. In May 2009, the FDA granted
U.S. marketing approval of Fanapt
®
for the acute treatment of schizophrenia in adults. In October 2009, we entered into an amended and restated sublicense agreement with Novartis. We had
originally entered into a sublicense agreement with Novartis in June 2004 pursuant to which we obtained certain worldwide exclusive licenses from Novartis relating to Fanapt
®
. Pursuant to the
amended and restated sublicense agreement, Novartis
4
had exclusive commercialization rights to all formulations of Fanapt
®
in the U.S. and Canada. In January 2010, Novartis launched Fanapt
®
in the U.S. On December 31, 2014, Novartis transferred all the U.S. and Canadian commercial rights to the Fanapt
®
franchise to Vanda
as part of the Settlement Agreement. See Note 3,
Settlement Agreement with Novartis
, to the consolidated financial statements included in Part II of this annual report on Form 10-K for additional information. In June 2015, we announced
positive results from REPRIEVE, a Phase III long-term maintenance study that was conducted by Novartis. In May 2016, the FDA approved a supplemental New Drug Application (sNDA) for Fanapt
®
for
the maintenance treatment of schizophrenia in adults.
We continue to explore the regulatory path and commercial opportunity for Fanapt
®
oral formulation outside of the U.S. In December 2012, the EMAs Committee for Medicinal Products for Human Use (CHMP) issued a negative opinion recommending against approval of Fanaptum
®
(oral iloperidone tablets) for the treatment of schizophrenia in adult patients in the European Union. The CHMP was of the opinion that the benefits of Fanaptum
®
did not outweigh its risks and recommended against marketing authorization. We initiated an appeal of this opinion and requested a re-examination of the decision by the CHMP, but withdrew our
Marketing Authorization Application (MAA) in the first quarter of 2013 because the additional clinical data requested by the CHMP would not have been available in the timeframe allowed by the EMAs Centralized Procedure. In December 2015, we
refiled a MAA with the EMA for Fanaptum
®
which included the results from the REPRIEVE study.
We have entered into agreements with the following partners for the commercialization of
Fanapt
®
in the countries set forth below:
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Country
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Partner
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Market Approval Date
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Mexico
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Probiomed S.A. de C.V.
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October 2013
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Israel
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Megapharm Ltd.
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August 2012
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Schizophrenia is a chronic, debilitating mental disorder characterized by hallucinations, delusions, racing
thoughts and other psychotic symptoms (collectively referred to as positive symptoms), as well as moodiness, anhedonia (inability to feel pleasure), loss of interest, eating disturbances and withdrawal (collectively referred to as
negative symptoms), and attention and memory deficits (collectively referred to as cognitive symptoms). Schizophrenia develops in late adolescence or early adulthood in approximately 1% of the worlds population. Most
schizophrenia patients today are treated with drugs known as atypical antipsychotics, which were first approved in the U.S. in the late 1980s. These antipsychotics have been named atypical for their ability to treat a broader
range of negative symptoms than the first-generation typical antipsychotics, which were introduced in the 1950s and are now generic. Atypical antipsychotics are generally regarded as having improved side effect profiles and efficacy
relative to typical antipsychotics. See
Competition
below for a discussion of commonly prescribed atypical antipsychotics in addition to Fanapt
®
.
Pursuant to the Settlement Agreement with Novartis, we reacquired the U.S. and Canadian rights to the long-acting injectable (depot)
formulation of Fanapt
®
. We are evaluating the commercial opportunity around the depot formulation.
Therapeutic opportunity: Other
We are currently in the process of evaluating potential indications, including bipolar depression, major depressive disorder and post-traumatic
stress disorder nightmares.
Tradipitant (VLY-686)
Tradipitant is a small molecule NK-1R antagonist that we licensed from Eli Lilly and Company (Lilly) in April 2012. NK-1R antagonists have been
evaluated in a number of indications including chemotherapy-induced nausea and vomiting (CINV), post-operative nausea and vomiting (PONV), gastroparesis, alcohol dependence, anxiety, depression and chronic pruritus associated with atopic dermatitis.
We commenced a Phase II clinical study of tradipitant in the treatment of chronic pruritus in patients with atopic dermatitis in 2014.
Results from this study, which were announced in March 2015, showed no significant difference from placebo on the pre-specified primary endpoint. Vanda believes this proof of concept study was informative, in that through subsequent analyses, it
revealed statistically significant and clinically meaningful responses across multiple outcomes evaluated in individuals with higher blood plasma levels of tradipitant at the time of their pruritus assessments. We initiated a placebo controlled
pruritus proof of concept study in the second quarter of 2016.
We initiated a placebo controlled Phase II clinical study of tradipitant
in the treatment of gastroparesis in the fourth quarter of 2016.
Trichostatin A
Trichostatin A is a small molecule HDAC inhibitor with potential use as a treatment for several oncology indications. We plan to file an IND
application in 2017.
5
AQW051
AQW051 is a Phase II alpha-7 nicotinic acetylcholine receptor partial agonist that we licensed from Novartis on December 31, 2014 pursuant
to the Settlement Agreement. We are evaluating potential indications, including cognitive impairment.
License Agreements
Our rights to develop and commercialize our products are subject to the terms and conditions of licenses granted to us by other pharmaceutical
companies.
HETLIOZ
®
In February 2004, we entered into a license agreement with Bristol-Myers Squibb Company (BMS) under which we received an exclusive worldwide
license under certain patents and patent applications, and other licenses to intellectual property, to develop and commercialize HETLIOZ
®
. In partial consideration for the license, we paid BMS
an initial license fee of $0.5 million. We made developmental milestone payments to BMS totaling $12.0 million under the license agreement, including an $8.0 million milestone payment in the first quarter of 2014 as a result of the FDAs
approval of our HETLIOZ
®
NDA. The $8.0 million milestone payment was capitalized as an intangible asset and is being amortized over the expected HETLIOZ
®
patent life in the U.S. We are obligated to make a future milestone payment to BMS of $25.0 million in the event that cumulative worldwide sales of HETLIOZ
®
reach $250.0 million, which we expect to reach by the end of 2018. Additionally, we are obligated to make royalty payments on
HETLIOZ
®
net sales to BMS in any territory where we commercialize HETLIOZ
®
for a period equal to the greater of 10 years post the first
commercial sale in the territory or the expiry of the new chemical entity patent in that territory. During the period prior to the expiry of the new chemical entity patent in a territory, we are obligated to pay a 10% royalty on net sales in
that territory. The royalty rate is decreased by half for countries in which no new chemical entity patent existed or for the remainder of the 10 years after the expiry of the new chemical entity patent. We are also obligated under the license
agreement to pay BMS a percentage of any sublicense fees, upfront payments and milestone and other payments (excluding royalties) that we receive from a third party in connection with any sublicensing arrangement, at a rate which is in the
mid-twenties. We have agreed with BMS in our license agreement for HETLIOZ
®
to use our commercially reasonable efforts to develop and commercialize HETLIOZ
®
.
Either party may terminate the
HETLIOZ
®
license agreement under certain circumstances, including a material breach of the agreement by the other. In the event we terminate our license, or if BMS terminates our license due
to our breach, all rights licensed and developed by us under this agreement will revert or otherwise be licensed back to BMS on an exclusive basis.
Fanapt
®
Pursuant to the terms of the Settlement Agreement with Novartis, Novartis transferred all U.S. and Canadian rights in the Fanapt
®
franchise to Vanda on December 31, 2014.
A predecessor company of Sanofi,
Hoechst Marion Roussel, Inc. (HMRI), discovered Fanapt
®
and completed early clinical work on the compound. In 1996, HMRI licensed its rights to the Fanapt
®
patents and patent applications to Titan Pharmaceuticals, Inc. (Titan) on an exclusive basis. In 1997, soon after it had acquired its rights, Titan sublicensed its rights to Fanapt
®
on an exclusive basis to Novartis. In June 2004, we acquired exclusive worldwide rights to these patents and patent applications as well as certain Novartis patents and patent applications to
develop and commercialize Fanapt
®
through a sublicense agreement with Novartis. In partial consideration for this sublicense, we paid Novartis an initial license fee of $0.5 million and were
obligated to make future milestone payments to Novartis of less than $100.0 million in the aggregate (the majority of which were tied to sales milestones), as well as royalty payments to Novartis at a rate which, as a percentage of net sales, was in
the mid-twenties. As a result of the FDAs approval of the NDA for Fanapt
®
in May 2009, we met a milestone under the sublicense agreement, which required us to make a payment of $12.0
million to Novartis.
In October 2009, we entered into an amended and restated sublicense agreement with Novartis, which amended and
restated the June 2004 sublicense agreement. Pursuant to the amended and restated sublicense agreement, Novartis had exclusive commercialization rights to all formulations of Fanapt
®
in the
U.S. and Canada. Novartis began selling Fanapt
®
in the U.S. during the first quarter of 2010. Novartis was responsible for the further clinical development activities in the U.S. and Canada.
Pursuant to the amended and restated sublicense agreement, we received an upfront payment of $200.0 million and were eligible for additional payments totaling up to $265.0 million upon Novartis achievement of certain commercial and development
milestones for Fanapt
®
in the U.S. and Canada. We also received royalties, which, as a percentage of net sales, were in the low double-digits, on net sales of Fanapt
®
in the U.S. and Canada. We retained exclusive rights to Fanapt
®
outside the U.S. and Canada and are obligated to make royalty payments to
Sanofi S.A. on Fanapt
®
sales outside the U.S. and Canada.
Pursuant to the terms
of the Settlement Agreement, Novartis transferred all U.S. and Canadian rights in the Fanapt
®
franchise to us on December 31, 2014. We are obligated to make royalty payments to Sanofi,
S.A. (Sanofi) and Titan, at a percentage rate equal to 23% on annual U.S. net sales of Fanapt
®
up to $200.0 million, and at a percentage rate in the mid-twenties on sales over
$200.0 million through November 2016. See Note 3,
Settlement Agreement with Novartis
, to the consolidated financial statements included in Part II of this annual report on Form 10-K for additional information. In February 2016, we
amended the agreement with Sanofi and Titan to remove Titan as the entity through which royalty payments from us are directed to Sanofi following the expiration of the new
6
chemical entity (NCE) patent for Fanapt
®
in the U.S. on November 15, 2016. Under the amended agreement, we will pay directly to
Sanofi a fixed royalty of 3% of net sales from November 16, 2016 through December 31, 2019 related to manufacturing know-how. We made a $2.0 million payment during the year ended December 31, 2016 that applied to this 3% manufacturing
know-how royalty and will make additional royalty payments only to the extent that our cumulative royalty obligations during this period exceed the amount of the pre-payment. No further royalties on manufacturing know-how are payable by us after
December 31, 2019. This amended agreement does not alter Titans obligation under the License Agreement to make royalty payments to Sanofi prior to November 16, 2016 or our obligations under the Sublicense Agreement to pay Sanofi a
fixed royalty on Fanapt net sales equal up to 6% on Sanofi know-how not related to manufacturing under certain conditions for a period of up to 10 years in markets where the NCE patent has expired or was not issued.
Tradipitant (VLY-686)
In April 2012, we entered into a license agreement with Lilly pursuant to which we acquired an exclusive worldwide license under certain
patents and patent applications, and other licenses to intellectual property, to develop and commercialize an NK-1R antagonist, tradipitant, for all human indications.
Pursuant to the agreement, we paid Lilly an initial license fee of $1.0 million and we will be responsible for all development costs for
tradipitant. Lilly is also eligible to receive additional payments based upon achievement of specified development and commercialization milestones as well as tiered-royalties on net sales at percentage rates up to the low double digits. These
milestones include $4.0 million for pre-NDA approval milestones and up to $95.0 million for future regulatory approval and sales milestones. We have agreed to use commercially reasonable efforts to develop and commercialize tradipitant.
Either party may terminate the agreement under certain circumstances, including a material breach of the agreement by the other. In the event
that we terminate the agreement, or if Lilly terminates the agreement due to our breach or for certain other reasons set forth in the agreement, all rights licensed and developed by us under the agreement will revert or otherwise be licensed back to
Lilly on an exclusive basis, subject to payment by Lilly to us of a royalty on net sales of products that contain tradipitant.
AQW051
In
December 2014, we entered into a license agreement with Novartis pursuant to which we acquired an exclusive worldwide license under certain patents and patent applications, and other licenses to intellectual property, to develop and commercialize an
alpha-7 nicotinic acetylcholine receptor partial agonist, AQW051, for all human indications.
Pursuant to the agreement, we will be
responsible for all development costs for AQW051. Novartis is eligible to receive tiered royalties on net sales at percentage rates up to the low double digits. We have agreed to use commercially reasonable efforts to develop and commercialize
AQW051.
Either party may terminate the agreement under certain circumstances, including a material breach of the agreement by the other.
In the event that we terminate the agreement, or if Novartis terminates the agreement due to our breach or for certain other reasons set forth in the agreement, all rights licensed and developed by us under the agreement will revert or otherwise be
licensed back to Novartis on an exclusive basis, subject to payment by Novartis to us of a royalty on net sales of products that contain AQW051.
Government Regulation
Government
authorities in the U.S., at the federal, state and local level, as well as foreign countries and local foreign governments, regulate the research, development, testing, manufacture, labeling, promotion, advertising, distribution, sampling,
marketing, import and export of our products. Other than HETLIOZ
®
in the U.S. and the European Union and Fanapt
®
in the U.S., Israel
and Mexico, all of our products will require regulatory approval by government agencies prior to commercialization. In particular, human pharmaceutical products are subject to rigorous pre-clinical and clinical trials and other approval procedures
of the FDA and similar regulatory authorities in foreign countries. The process of obtaining these approvals and the subsequent compliance with appropriate domestic and foreign laws, rules and regulations require the expenditure of significant time
and human and financial resources.
United States government regulation
FDA approval process
In
the U.S., the FDA regulates drugs under the Federal Food, Drug and Cosmetic Act, as amended, and implements regulations. If we fail to comply with the applicable requirements at any time during the product development process, approval process, or
after approval, we may become subject to administrative or judicial sanctions. These sanctions could include the FDAs refusal to approve pending applications, withdrawals of approvals, clinical holds, warning letters, product recalls, product
seizures, total or partial suspension of our operations, injunctions, fines, civil penalties or criminal prosecution. Any such sanction could have a material adverse effect on our business.
7
The steps required before a drug may be marketed in the U.S. include:
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pre-clinical laboratory tests, animal studies and formulation studies under Current Good Laboratory Practices (cGLP);
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submission to the FDA of an investigational new drug application (IND), which must become effective before human clinical trials may begin;
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execution of adequate and well-controlled clinical trials to establish the safety and efficacy of the drug for each indication for which approval is sought;
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submission to the FDA of an NDA;
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satisfactory completion of an FDA inspection of the manufacturing facility or facilities at which the drug is produced to assess compliance with Current Good Manufacturing Practices (cGMP); and
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FDA review and approval of the NDA.
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Pre-clinical studies generally are conducted in
laboratory animals to evaluate the potential safety and activity of a drug. Violation of the FDAs cGLP regulations can, in some cases, lead to invalidation of the studies, requiring these studies to be replicated. In the U.S., drug developers
submit the results of pre-clinical trials, together with manufacturing information and analytical and stability data, to the FDA as part of the IND, which must become effective before clinical trials can begin in the U.S. An IND becomes effective 30
days after receipt by the FDA unless before that time the FDA raises concerns or questions about issues such as the proposed clinical trials outlined in the IND. In that case, the IND sponsor and the FDA must resolve any outstanding FDA concerns or
questions before clinical trials can proceed. If these concerns or questions are unresolved, the FDA may not allow the clinical trials to commence.
Pilot studies generally are conducted in a limited patient population, approximately three to 25 subjects, to determine whether the drug
warrants further clinical trials based on preliminary indications of efficacy. These pilot studies may be performed in the U.S. after an IND has become effective or outside of the U.S. prior to the filing of an IND in the U.S. in accordance with
applicable government regulations and institutional procedures.
Clinical trials involve the administration of the investigational new
drug to human subjects under the supervision of qualified investigators. Clinical trials are conducted under protocols detailing, among other things, the objectives of the study, the parameters to be used in assessing the safety and the
effectiveness of the drug. Each protocol must be submitted to the FDA as part of the IND prior to beginning the trial.
Typically,
clinical evaluation involves a time-consuming and costly three-Phase sequential process, but the phases may overlap. Each trial must be reviewed, approved and conducted under the auspices of an independent Institutional Review Board, and each trial
must include the patients informed consent.
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Phase I: refers typically to closely-monitored clinical trials and includes the initial introduction of an investigational new drug into human patients or healthy volunteer subjects. Phase I trials are designed to
determine the safety, metabolism and pharmacologic actions of a drug in humans, the potential side effects associated with increasing drug doses and, if possible, to gain early evidence of the drugs effectiveness. Phase I trials also include
the study of structure-activity relationships and mechanism of action in humans, as well as studies in which investigational new drugs are used as research tools to explore biological phenomena or disease processes. During Phase I trials, sufficient
information about a drugs pharmacokinetics and pharmacological effects should be obtained to permit the design of well-controlled, scientifically valid Phase II studies. The total number of subjects and patients included in Phase I trials
varies, but is generally in the range of 20 to 80 people.
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Phase II: refers to controlled clinical trials conducted to evaluate appropriate dosage and the effectiveness of a drug for a particular indication or indications in patients with a disease or condition under study and
to determine the common short-term side effects and risks associated with the drug. These trials are typically well-controlled, closely monitored and conducted in a relatively small number of patients, usually involving no more than several hundred
subjects.
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Phase III: refers to expanded controlled and uncontrolled clinical trials. These trials are performed after preliminary evidence suggesting effectiveness of a drug has been obtained. Phase III trials are intended to
gather additional information about the effectiveness and safety that is needed to evaluate the overall benefit-risk relationship of the drug and to provide an adequate basis for physician labeling. Phase III trials usually include several hundred
to several thousand subjects.
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Phase I, II and III testing may not be completed successfully within any specified time
period, if at all. The FDA closely monitors the progress of each of the three phases of clinical trials that are conducted in the U.S. and may, at its discretion, reevaluate, alter, suspend or terminate the testing based upon the data accumulated to
that point and the FDAs assessment of the risk/benefit ratio to the patient. A clinical program is designed after assessing the causes of the disease, the mechanism of action of the active pharmaceutical ingredient of the drug and all clinical
and pre-clinical data of previous trials performed. Typically, the trial design protocols and efficacy endpoints are established in consultation with the FDA. Upon request through a special protocol assessment, the FDA can also provide specific
guidance on the acceptability of protocol design for clinical trials. The FDA, we or our partners may suspend or terminate clinical trials at any time for various reasons, including a finding that the subjects or patients are being exposed to an
unacceptable health risk. The FDA can also request additional clinical trials be conducted as a condition to drug approval. During all clinical trials, physicians monitor the patients to determine effectiveness and to observe and report any
reactions or other safety risks that may result from use of the drug.
8
Assuming successful completion of the required clinical trials, drug developers submit the
results of pre-clinical studies and clinical trials, together with other detailed information including information on the manufacture and composition of the drug, to the FDA, in the form of an NDA, requesting approval to market the drug for one or
more indications. In most cases, the NDA must be accompanied by a substantial user fee. The FDA reviews an NDA to determine, among other things, whether a drug is safe and effective for its intended use.
Before approving an NDA, the FDA will inspect the facility or facilities where the drug is manufactured. The FDA will not approve the
application unless cGMP compliance is satisfactory. The FDA will issue an approval letter if it determines that the application, manufacturing process and manufacturing facilities are acceptable. If the FDA determines that the NDA, manufacturing
process or manufacturing facilities are not acceptable, it will issue a complete response letter (CRL), in which it will outline the deficiencies in the submission and will often request additional testing or information. Notwithstanding the
submission of any requested additional information, the FDA may ultimately decide that the NDA does not satisfy the regulatory criteria for approval and refuse to approve the NDA.
The testing and approval process requires substantial time, effort and financial resources, and each may take several years to complete. The
FDA may not grant approval on a timely basis, or at all. We or our partners may encounter difficulties or unanticipated costs in our efforts to secure necessary governmental approvals, which could delay or preclude us or our partners from marketing
our products. Furthermore, the FDA may prevent a drug developer from marketing a drug under a label for its desired indications or place other conditions on distribution as a condition of any approvals, which may impair commercialization of the
drug. After approval, some types of changes to the approved drug, such as adding new indications, manufacturing changes and additional labeling claims, are subject to further FDA review and approval. Similar regulatory procedures must also be
complied within countries outside the U.S.
If the FDA approves the NDA, the drug becomes available for physicians to prescribe in the
U.S. After approval of our products, we have to comply with a number of post-approval requirements, including delivering periodic reports to the FDA, submitting descriptions of any adverse reactions reported, and complying with drug sampling and
distribution requirements. We and our partners also are required to provide updated safety and efficacy information and to comply with requirements concerning advertising and promotional labeling. Also, our quality control and manufacturing
procedures must continue to conform to cGMP after approval. Drug manufacturers and their subcontractors are required to register their facilities and are subject to periodic unannounced inspections by the FDA to assess compliance with cGMP which
imposes certain procedural and documentation requirements relating to quality assurance and quality control. Accordingly, manufacturers must continue to expend time, money and effort in the area of production and quality control to maintain
compliance with cGMP and other aspects of regulatory compliance. The FDA may require post market testing and surveillance to monitor the drugs safety or efficacy, including additional studies, known as Phase IV trials, to evaluate long-term
effects.
In addition to studies requested by the FDA after approval, we or our partners may have to conduct other trials and studies to
explore use of the approved product for treatment of new indications, which require FDA approval. The purpose of these trials and studies is to broaden the application and use of the product and its acceptance in the medical community.
We use, and will continue to use, third-party manufacturers to produce our products in clinical and commercial quantities. Future FDA
inspections may identify compliance issues at our facilities or at the facilities of our contract manufacturers that may disrupt production or distribution, or require substantial resources to correct. In addition, discovery of problems with a
product or the failure to comply with requirements may result in restrictions on a product, manufacturer or holder of an approved NDA, including withdrawal or recall of the product from the market or other voluntary or FDA-initiated action that
could delay further marketing. Newly discovered or developed safety or effectiveness data may require changes to a products approved labeling, including the addition of new warnings and contraindications.
In September 2007, the Food and Drug Administration Amendments Act (FDAAA), was enacted into law, amending the U.S. Federal Food, Drug, and
Cosmetic Act and the Public Health Service Act. The FDAAA made a number of substantive and incremental changes to the review and approval processes in ways that could make it more difficult or costly to obtain approval for new pharmaceutical
products, or to produce, market and distribute existing pharmaceutical products. Most significantly, the law changed the FDAs handling of postmarked drug product safety issues by giving the FDA authority to require post approval studies or
clinical trials, to request that safety information be provided in labeling, or to require an NDA applicant to submit and execute a Risk Evaluation and Mitigation Strategy (REMS).
The FDAAA made certain changes to the user fee provisions to permit the use of user fee revenue to fund the FDAs drug product safety
activities and the review of Direct-to-Consumer advertisements. The Food and Drug Administration Safety and Innovation Act of 2012, which became effective in October 2012, reauthorized the authority of the FDA to collect user fees to fund the
FDAs review activities.
In addition, new government requirements may be established that could delay or prevent regulatory approval
of our products under development.
9
The Hatch-Waxman Act
In seeking approval for a drug through an NDA, applicants are required to list with the FDA each patent with claims that cover the
applicants drug. Upon approval of a drug, each of the patents listed in the application for the drug is then published in the FDAs Approved Drug Products with Therapeutic Equivalence Evaluations, commonly known as the Orange Book. Drugs
listed in the Orange Book can, in turn be cited by potential competitors in support of approval of an abbreviated new drug application (ANDA). An ANDA provides for marketing of a drug that has the same active ingredients in the same strengths and
dosage form as the listed drug and has been shown through bioequivalence testing to be therapeutically equivalent to the listed drug. ANDA applicants are not required to conduct or submit results of pre-clinical or clinical tests to prove the safety
or effectiveness of their drug, other than the requirement for bioequivalence testing. Drugs approved in this way are commonly referred to as generic equivalents to the listed drug, and can often be substituted by pharmacists under
prescriptions written for the original listed drug.
The ANDA applicant is required to certify to the FDA concerning any patents listed
for the approved drug in the FDAs Orange Book. Specifically, the applicant must certify that: (i) the required patent information has not been filed; (ii) the listed patent has expired; (iii) the listed patent has not expired,
but will expire on a particular date and approval is sought after patent expiration; or (iv) the listed patent is invalid or will not be infringed by the new drug. A certification that the new drug will not infringe the already approved
drugs listed patents or that such patents are invalid is called a Paragraph IV certification. If the applicant does not challenge the listed patents, the ANDA application will not be approved until all the listed patents claiming the
referenced drug have expired.
If the ANDA applicant has provided a Paragraph IV certification to the FDA, the applicant must also send
notice of the Paragraph IV certification to the NDA and patent holders once the ANDA has been accepted for filing by the FDA. The NDA and patent holders may then initiate a patent infringement lawsuit in response to the notice of the Paragraph
IV certification. The filing of a patent infringement lawsuit within 45 days of the receipt of a Paragraph IV certification automatically prevents the FDA from approving the ANDA until the earlier of 30 months, expiration of the patent, settlement
of the lawsuit or a decision in the infringement case that is favorable to the ANDA applicant.
The ANDA application also will not be
approved until any non-patent exclusivity, such as exclusivity for obtaining approval of a new chemical entity, listed in the Orange Book for the referenced drug has expired. The U.S. Drug Price Competition and Patent Term Restoration Act of 1984,
more commonly known as the Hatch-Waxman Act, provides a period of five years following approval of a drug containing no previously approved active ingredients, during which ANDAs for generic versions of those drugs cannot be submitted
unless the submission contains a Paragraph IV challenge to a listed patent, in which case the submission may be made four years following the original drug approval. Federal law provides for a period of three years of exclusivity following approval
of a listed drug that contains previously approved active ingredients but is approved in a new dosage form, route of administration or combination, or for a new use, the approval of which was required to be supported by new clinical trials conducted
by or for the sponsor, during which FDA cannot grant effective approval of an ANDA based on that listed drug.
Foreign regulation
Whether or not we or our partners obtain FDA approval for a product, we must obtain approval by the comparable regulatory
authorities of foreign countries before we can commence clinical trials or marketing of the product in those countries. The approval process varies from country to country, and the time may be longer or shorter than that required for FDA approval.
The requirements governing the conduct of clinical trials, product licensing, pricing and reimbursement also vary greatly from country to country. Although governed by the applicable country, clinical trials conducted outside of the U.S. typically
are administered with the three-Phase sequential process that is discussed above under United States government regulation. However, the foreign equivalent of an IND is not a prerequisite to performing pilot studies or Phase I clinical
trials.
Under European Union regulatory systems, we may submit MAAs either under a centralized or decentralized procedure. The
centralized procedure, which is available for drugs produced by biotechnology or which are highly innovative, provides for the grant of a single marketing authorization that is valid for all European Union member states. This authorization is a
marketing authorization approval. The decentralized procedure provides for mutual recognition of national approval decisions. Under this procedure, the holder of a national marketing authorization may submit an application to the remaining member
states. Within 90 days of receiving the applications and assessment report, each member state must decide whether to recognize approval. This procedure is referred to as the mutual recognition procedure.
In addition, regulatory approval of prices is required in most countries other than the U.S. We face the risk that the resulting prices would
be insufficient to generate an acceptable return to us or our partners.
Patents and proprietary rights; Hatch-Waxman protection
We and our partners will be able to protect our products from unauthorized use by third parties only to the extent that our products are
covered by valid and enforceable patents, either licensed in from third parties or generated internally, that give us or our partners sufficient proprietary rights. Accordingly, patents and other proprietary rights are essential elements of our
business.
HETLIOZ
®
,
Fanapt
®
, tradipitant and AQW051 are covered by new chemical entity and other patents and patent applications. The patents cover the active pharmaceutical ingredient and provide patent
protection for all formulations containing these active
10
pharmaceutical ingredients. For more on these license and sublicense arrangements, see
License Agreements
above. In addition, we have generated our own intellectual property, and filed
patent applications covering this intellectual property, for HETLIOZ
®
and Fanapt.
The table below is a summary of FDAs Approved Drug Products with Therapeutic Equivalence Evaluations (Orange Book) listed patents for
our commercial products. Members of these patent families are also issued or pending in a number of major market territories, such as Europe and Japan.
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Number
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Type
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HETLIOZ
®
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US 5,856,529
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NCE
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US 8,785,492
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Method of treatment
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US 9,060,995
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Method of treatment
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US 9,539,234
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Method of treatment
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US 9,549,913
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Method of treatment
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Fanapt
®
|
|
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US 8,586,610
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Method of treatment
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US 8,652,776
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Method of treatment
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US 8,999,638
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Method of treatment
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US 9,072,742
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Method of treatment
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US 9,074,254
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Method of treatment
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US 9,074,255
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Method of treatment
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US 9,074,256
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Method of treatment
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US 9,138,432
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Method of treatment
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US 9,157,121
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Method of treatment
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HETLIOZ
®
Our rights to the new chemical entity patent covering HETLIOZ
®
and related
intellectual property have been acquired through a license with BMS. HETLIOZ
®
and its formulations, genetic markers and uses are covered by a total of 14 patent and patent application families
worldwide. The primary new chemical entity patent covering HETLIOZ
®
expires normally in 2017 in the U.S. and in most European markets. The Hatch-Waxman Act provides for an
extension of new chemical entity patents for a period of up to five years following the expiration of the patent covering that compound to compensate for time spent in development. We believe that
HETLIOZ
®
will meet the various criteria of the Hatch-Waxman Act and will receive five additional years of patent protection in the U.S., which would extend its new chemical entity patent
protection in the U.S. until 2022. An application for the five year patent term extension has been filed and is being processed by the U.S. Patent and Trademark Office. In July 2014, a new method of use patent was issued to us by the U.S. Patent and
Trademark Office for HETLIOZ
®
in the treatment of Non-24. This method of use patent is expected to expire in 2033, potentially further extending the exclusivity protection of HETLIOZ
®
. In June 2015, an additional method of use patent was issued to us by the U.S. Patent and Trademark Office for HETLIOZ
®
. This method of
use patent is also expected to expire in 2033. Both the new chemical entity patent and the method of use patents are listed in the FDAs Orange Book.
In Europe, the law provides for ten years of data exclusivity (with the potential for an additional year if the drug is developed for a
significant new indication). As such, in Europe, data exclusivity will protect HETLIOZ
®
for at least ten years from approval. A completed Pediatric Investigation Plan could further extend
this exclusivity for two years in an orphan indication, for a total of 12 years of exclusivity. It is also possible that the term of the new chemical entity patent in Europe could be extended by issuance of a supplementary protection
certificate (SPC). The European Patent Office has granted our patent application directed to the 20 mg/day dose. This patent will expire normally in 2027. Patent applications directed to the treatment of Non-24, if granted, would provide
exclusivity in Europe for this indication until at least 2033.
Outside the U.S. and Europe, data exclusivity will protect HETLIOZ
®
from generic competition for varying numbers of years depending on the country.
Additional patent applications directed to specific sleep disorders and to methods of treating patients with HETLIOZ
®
, if issued, would provide exclusivity for such indications and methods of treatment, potentially extending the effective patent protection period in the U.S., Europe, and other major markets.
Fanapt
®
The new chemical entity patent for Fanapt
®
, which expired in 2016, is owned by Sanofi,
and other patents and patent applications relating to Fanapt
®
previously owned by Novartis are now owned by Vanda. We originally obtained exclusive worldwide rights to develop and
commercialize the products covered by these patents through license and sublicense arrangements. Then, pursuant to an amended sublicense agreement with Novartis, Novartis retained exclusive commercialization rights to all formulations of Fanapt
®
in the U.S. and Canada. However, as of December 2014, pursuant to an asset transfer agreement, we acquired all rights in Fanapt
®
,
including in the U.S. and Canada.
Fanapt
®
and its metabolites, formulations,
genetic markers and uses are covered by a total of 17 patent and patent application families in the U.S., Europe, and other markets. The primary new chemical entity patent covering Fanapt
®
expired in November 2016
11
in the U.S. and expired in 2010 in major markets outside the U.S. In November 2013, a patent directed to a method of treating patients with
Fanapt
®
based on genotype was issued to us by the U.S. Patent and Trademark Office. This patent, which was listed in the FDAs Orange Book in January 2015, is set to expire in 2027,
potentially further extending the exclusivity protection of Fanapt
®
. Additional method of treatment patents were issued and listed in the Orange Book with the latest expected expiry in
December 2031. See Note 18,
Legal Matters
, to the consolidated financial statements included in Part II of this annual report on Form 10-K for additional information.
In Europe, the law provides for ten years of data exclusivity (with the potential for an additional year if the drug is developed for a
significant new indication). No generic versions of Fanapt
®
would be permitted to be marketed or sold during this 10-year (or
11-year)
period in most
European countries. Consequently, we expect our rights to commercialize Fanapt
®
will be exclusive for at least 10 years from approval in Europe. Outside the U.S. and Europe, data exclusivity
will protect Fanapt
®
from generic competition for varying numbers of years depending upon the country. Several other patent applications covering metabolites, uses, formulations and genetic
markers relating to Fanapt
®
extend beyond 2020. The patent family for the microsphere depot formulation of Fanapt
®
expires in 2024
in the U.S. and 2022 in most of the major markets in Europe. The patent family for the aqueous microcrystals depot formulation of Fanapt
®
expires in 2023 in the U.S. and in most of the
major markets in Europe.
Tradipitant
Lilly owns a new chemical entity patent as well as patent applications directed to polymorphic forms of, and methods of making tradipitant.
Thus, tradipitant is covered by a total of three patent and patent application families worldwide, which have been licensed to us. The new chemical entity patent covering tradipitant expires in 2023, except in the U.S., where it expires normally in
2024 subject to any extension that may be received under Hatch-Waxman. We have filed additional patent applications based on discoveries made during recent studies with tradipitant.
AQW051
Novartis owns a
new chemical entity patent as well as patent applications directed to methods of using AQW051, AQW051 formulations, and combinations of AQW051 with other active pharmaceutical ingredients. The new chemical entity patent expires normally in 2023 in
the U.S., Europe, and other markets.
Trichostatin A
Trichostatin A is a small molecule HDAC inhibitor with potential use as a treatment for several oncology indications. We have pending patent
applications covering the use of Trichostatin A and plan on filing additional applications based on discoveries made throughout the development plan of this molecule.
Other Patents
Aside from
the new chemical entity patents and other in-licensed patents relating to Fanapt
®
, HETLIOZ
®
, tradipitant, and AQW051, we have numerous
patent and patent application families, most of which have been filed in key markets including the U.S., relating to our products and development compounds. In addition, we have several other patent application families relating to drugs not
presently in clinical studies. The claims in these various patents and patent applications are directed to compositions of matter, including claims covering other products, pharmaceutical compositions and methods of use.
Proprietary Know-how
For
proprietary know-how that is not appropriate for patent protection, processes for which patents are difficult to enforce and any other elements of our discovery process that involve proprietary know-how and technology that are not covered by patent
applications, we generally rely on trade secret protection and confidentiality agreements to protect our interests. We require all of our employees, consultants and advisors to enter into confidentiality agreements. Where it is necessary to share
our proprietary information or data with outside parties, our policy is to make available only that information and data required to accomplish the desired purpose and only pursuant to a duty of confidentiality on the part of those parties.
Third-Party Reimbursement and Pricing Controls
The Patient Protection and Affordable Care Act, as amended by the Health Care and Education Affordability Reconciliation Act of 2010 (together,
PPACA), has changed and is expected to further significantly change the way healthcare is financed by both governmental and private insurers. The provisions of PPACA became effective over various periods from 2010 through 2014. We cannot
predict the complete impact of PPACA on pharmaceutical companies because many of PPACAs reforms require the promulgation of detailed regulations to implement the statutory provisions, which has not yet occurred. While we cannot predict the
complete impact on federal reimbursement policies this law will have in general or specifically on any product we commercialize, PPACA may result in downward pressure on pharmaceutical reimbursement, which could negatively affect market acceptance
of new products. The rebates, discounts, taxes and other costs resulting from PPACA may have a significant effect on our profitability in the future. In addition, potential reductions of the per capita rate of growth in Medicare spending under
PPACA, could potentially limit access to certain treatments or mandate price controls for our products. Moreover, although the United States Supreme Court has upheld the constitutionality of most of PPACA, some states have indicated that they intend
not to implement certain sections of PPACA, and some members of the U.S. Congress are still working to repeal PPACA. We cannot predict whether these challenges will continue or other proposals will be made or adopted, or what impact these efforts
may have on us or our partners.
12
In the U.S. and elsewhere, sales of pharmaceutical products depend in significant part on the
availability of reimbursement to the consumer from third-party payors, such as government and private insurance plans. Third-party payors are increasingly challenging the prices charged for medical products and services. It will be time consuming
and expensive for us or our partners to go through the process of seeking reimbursement from Medicare and private payors. Our products may not be considered cost-effective, and coverage and reimbursement may not be available or sufficient to allow
us or our partners to sell our compounds on a competitive and profitable basis. The passage of the Medicare Prescription Drug and Modernization Act of 2003 imposes additional requirements for the distribution and pricing of prescription drugs which
may affect the marketing of our products.
In many foreign markets, including the countries in the European Union and Japan, pricing of
pharmaceutical products is subject to governmental control. In the U.S., there have been, and we expect that there will continue to be, a number of federal and state proposals to implement similar governmental pricing control. While we cannot
predict whether such legislative or regulatory proposals will be adopted, the adoption of such proposals could have a material adverse effect on our business, financial condition and profitability.
Marketing and Sales
HETLIOZ
®
was approved in the U.S. for the treatment of Non-24 in January 2014 and commercially launched in the U.S. in April 2014. Additionally,
HETLIOZ
®
was approved in the Europe Union for the treatment of Non-24 in July 2015. We commercially launched HETLIOZ
®
in Germany in the
third quarter of 2016.
Given the range of potential indications for HETLIOZ
®
, we
may pursue one or more partnerships for the development and commercialization of HETLIOZ
®
worldwide.
Fanapt
®
was approved in the U.S. for the treatment of schizophrenia in May 2009 and
commercially launched in the U.S. in January 2010. In October 2009, we entered into an amended and restated sublicense agreement with Novartis pursuant to which Novartis has exclusive commercialization rights to all formulations of Fanapt
®
in the U.S. and Canada. Novartis began selling Fanapt
®
in the U.S. during the first quarter of 2010. Pursuant to the terms of the
Settlement Agreement with Novartis, Novartis transferred all U.S. and Canadian rights in the Fanapt
®
franchise to Vanda on December 31, 2014.
Fanapt
®
was launched in Israel and Mexico by our distribution partners in 2014. We
continue to explore the regulatory path and commercial opportunity for Fanapt
®
oral formulation in other regions.
Manufacturing
We currently utilize a
virtual supply manufacturing and distribution chain in which we do not have our own facilities to manufacture commercial or clinical trial supplies of drugs and we do not have our own distribution facilities. Additionally, we do not intend to
develop such facilities for any product in the near future. Instead, we contract with third parties for the manufacture, warehousing, order management, billing and collection and distribution of our products and product candidates.
We expect to continue to rely solely on third-party manufacturers to manufacture drug substance and final drug products for both clinical
development and commercial sale. However, there are numerous factors that could cause interruptions in the supply of our products, including regulatory reviews, changes in our sources for manufacturing, disputes with a manufacturer, or financial
instability of manufacturers, all of which could negatively impact our operation and our financial results.
In January 2014, we entered
into a manufacturing agreement with Patheon Pharmaceuticals Inc. (Patheon) for the manufacture of commercial supplies of HETLIOZ
®
20 mg capsules at Patheons Cincinnati, Ohio
manufacturing site. Under the HETLIOZ
®
manufacturing agreement, we are responsible for supplying the active pharmaceutical ingredient for
HETLIOZ
®
to Patheon and have agreed to certain minimum yearly order requirements. Patheon is responsible for manufacturing the HETLIOZ
®
20 mg capsules, conducting quality control and stability testing, and packaging the HETLIOZ
®
capsules. The HETLIOZ
®
manufacturing
agreement has an initial term of five years and will automatically renew after the initial term for successive terms of one year each, unless either party gives notice of its intention to terminate the agreement at least twelve months prior to the
end of the then current term. Either party may terminate the HETLIOZ
®
manufacturing agreement under certain circumstances upon specified written notice to the other party.
As part of the Settlement Agreement, we assumed Novartis manufacturing agreement with Patheon for the manufacture of commercial supplies
of Fanapt
®
In May 2016, we entered into a new manufacturing agreement with Patheon for the manufacture of commercial supplies of
Fanapt
®
1, 2, 4, 6, 8, 10 and 12 mg tablets at Patheons Mississauga, Ontario, Canada manufacturing site. Under the Fanapt
®
manufacturing agreement, we are responsible for sourcing the supply of the active pharmaceutical ingredient (iloperidone), and have agreed to order from Patheon at least 70% of the total yearly requirement of new units of Fanapt
®
tables for the U.S. and other specified countries each year for the term of the agreement. The Fanapt
®
manufacturing agreement has an
initial term of five years and will automatically renew after the initial term for successive terms of one year each, unless either party gives notice of its intention to terminate the agreement at least twelve months prior to the end of the then
current term. Either party may terminate the Fanapt
®
manufacturing agreement under certain circumstances upon specified written notice to the other party.
13
Research and Development
We have built a research and development organization that includes extensive expertise in the scientific disciplines of pharmacogenetics and
pharmacogenomics. We operate cross-functionally and are led by an experienced research and development management team. We use rigorous project management techniques to assist us in making disciplined strategic research and development program
decisions and to help limit the risk profile of our product pipeline. We also access relevant market information and key opinion leaders in creating target product profiles and, when appropriate, as we advance our programs towards commercialization.
We engage third parties to conduct portions of our preclinical research. In addition, we utilize multiple clinical sites to conduct our clinical trials; however, we are not substantially dependent upon any one of these sites for our clinical trials
nor do any of them conduct a major portion of our clinical trials.
Research and development expenses amounted to $29.2 million, $29.1
million and $19.2 million for the years ended December 31, 2016, 2015 and 2014, respectively.
Major Customers
Our revenues are generated from product sales and are concentrated with specialty pharmacies and wholesalers. There were five major customers
that each accounted for more than 10% of total revenues and, as a group, represented 86% of total revenues for the year ended December 31, 2016.
Competition
The pharmaceutical industry
and the central nervous system segment of that industry, in particular, is highly competitive and includes a number of established large and mid-sized companies with greater financial, technical and personnel resources than we have and significantly
greater commercial infrastructures than we have. Our market segment also includes several smaller emerging companies whose activities are directly focused on our target markets and areas of expertise. Our products, once approved for commercial use,
will compete with numerous therapeutic treatments offered by these competitors. While we believe that our products will have certain favorable features, existing and new treatments may also possess advantages. Additionally, the development of other
drug technologies and methods of disease prevention are occurring at a rapid pace. These developments may render our products or technologies obsolete or noncompetitive.
We believe the primary competitors for HETLIOZ
®
and Fanapt
®
are as follows:
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For HETLIOZ
®
in the treatment of Non-24, there are no FDA approved direct competitors. Sedative-Hypnotic treatments for certain sleep related disorders include,
Ambien
®
(zolpidem) by Sanofi (including Ambien CR
®
), Lunesta
®
(eszopiclone) by
Sunovion Pharmaceuticals Inc., Sonata
®
(zaleplon) by Pfizer Inc., Rozerem
®
(ramelteon) by Takeda Pharmaceuticals Company Limited,
Silenor
®
(doxepin) by Pernix Therapeutics, Belsomra
®
(suvorexant) by Merck & Co., Inc., generic products such as zolpidem,
trazodone and doxepin, and over-the-counter remedies such as Benadryl
®
and Tylenol PM
®
. The class of melatonin agonists includes
Rozerem
®
(ramelteon) by Takeda Pharmaceuticals Company Limited, Valdoxan
®
(agemelatine) by Servier, Circadin
®
(long-acting melatonin) by Neurim Pharmaceuticals and the food supplement melatonin. Shift work and excessive sleepiness disorder treatments include Nuvigil
®
(armodafinil) and Provigil
®
(modafinil) both by Teva Pharmaceutical Industries Ltd.
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For Fanapt
®
in the treatment of schizophrenia, the atypical antipsychotics competitors are Risperdal
®
(risperidone), including the depot formulation Risperdal
®
Consta
®
and Invega
®
(paliperidone), including the depot formulation Invega
®
Sustenna
®
, each by Ortho-McNeil-Janssen Pharmaceuticals, Inc., Zyprexa
®
(olanzapine), including the depot formulation Zyprexa
®
Relprevv, each by Eli Lilly and Company, Seroquel
®
and Seroquel XR (quetiapine) by AstraZeneca PLC, Abilify
®
(aripiprazole) by BMS/Otsuka America Pharmaceutical Inc., Abilify
®
Maintena
®
(the depot formulation of Abilify
®
) by Lundbeck/Otsuka America
Pharmaceutical Inc., Geodon
®
(ziprasidone) by Pfizer Inc., Saphris
®
(asenapine) by Actavis plc, Latuda
®
(lurasidone) by Sunovion Pharmaceuticals Inc., Rexulti
®
(brexpiprazole) by Lundbeck/Otsuka America Pharmaceutical, Inc., Aristada
(aripiprazole lauroxil) extended-release injectible suspension by Alkermes, Inc., Vraylar (cariprazine) by Teva Pharmaceutical Industries Ltd., and generic clozapine, as well as the typical antipsychotics haloperidol, chlorpromazine,
thioridazine, and sulpiride (all of which are generic).
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Our ability to compete successfully will depend in part on our
ability to utilize our pharmacogenetics and pharmacogenomics and drug development expertise to identify, develop, secure rights to and obtain regulatory approvals for promising pharmaceutical products before others are able to develop competitive
products. Our ability to compete successfully will also depend on our ability to attract and retain skilled and experienced personnel. Additionally, our ability to compete may be affected because insurers and other third-party payors in some cases
seek to encourage the use of cheaper, generic products, which could make our products less attractive.
14
Employees
We had 142 full-time employees as of December 31, 2016, compared with 118 employees as of December 31, 2015. None of our employees
are represented by a labor union. We have not experienced any work stoppages and consider our employee relations to be good.
Corporate Information
We were incorporated in Delaware in 2002. Our principal executive offices are located at 2200 Pennsylvania Avenue NW, Suite 300E,
Washington D.C. 20037, and our telephone number is (202) 734-3400. Our website address is www.vandapharma.com and the information contained in, or that can be accessed through, our website is not part of this annual report and should not be
considered part of this annual report.
Available Information
We file annual, quarterly, and current reports, proxy statements, and other documents with the Securities and Exchange Commission (SEC) under
the Securities Exchange Act of 1934 (the Exchange Act). The public may read and copy any materials that we file with the SEC at the SECs Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. The public may obtain information on
the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains an internet website at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers, including
us, that file electronically with the SEC.
We also make available free of charge on our Internet website at www.vandapharma.com our
annual reports on
Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, and, if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the
Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
Our code of
ethics, other corporate policies and procedures, and the charters of our Audit Committee, Compensation Committee and Nominating/Corporate Governance Committee are available through our Internet website at www.vandapharma.com.
Our business, financial condition and operating results can be affected
by a number of factors, whether current known or unknown, including but not limited to those described below, any one or more of which could, directly or indirectly, cause our actual operating results and financial condition to vary materially from
past, or anticipated future, operating results and financial condition. Any of these factors, in whole or in part, could materially and adversely affect our business, financial condition, operating results and the price of our common stock.
The following discussion of risk factors contains forward-looking statements. These risk factors may be important to understanding any
statement in this annual report on Form 10-K or elsewhere. The following information should be read in conjunction with the consolidated financial statements and related notes in Part I, Item 1, Financial Statements and Part I, Item 2,
Managements, Discussion and Analysis of Financial Condition and Results of Operations.
Because of the following factors, as
well as other factors affecting our financial condition and operating results, past financial performance should not be considered to be a reliable indicator of future performance, and investors should not use historical trends to anticipate results
or trends in future periods.
Risks related to our business and industry
We are dependent on the commercial success of HETLIOZ
®
and Fanapt
®
.
Our future success is currently substantially dependent upon the commercial
success of HETLIOZ
®
for the treatment of
Non-24-Hour
Sleep-Wake Disorder (Non-24) and Fanapt
®
for the treatment of schizophrenia.
In January 2014, the FDA approved our New Drug
Application (NDA) for HETLIOZ
®
for the treatment of Non-24 and in April 2014, we commenced the U.S. commercial launch of HETLIOZ
®
. In
July 2015, the European Commission (EC) granted centralized marketing authorization with unified labeling for HETLIOZ
®
for the treatment of Non-24 in blind adults, and in August 2016 we
commenced the commercial launch of HETLIOZ
®
in Germany. This authorization is valid in the 28 countries that are members of the European Union, as well as European Economic Area members
Iceland, Liechtenstein and Norway.
In the first quarter of 2015, we acquired the U.S. commercial rights to Fanapt
®
, and began selling, marketing and distributing Fanapt
®
in the U.S.
Our ability to generate significant product revenue from sales of HETLIOZ
®
and Fanapt
®
, both in the U.S. and abroad, in the near term will depend on, among other things, our ability to:
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defend our patents and intellectual property from generic competition;
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maintain commercial manufacturing arrangements with third-party manufacturers;
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15
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produce, through a validated process, sufficiently large quantities of inventory of our products to meet demand;
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continue to maintain and grow a wide variety of internal sales, distribution and marketing capabilities sufficient to sustain growth in sales of our products;
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gain broad acceptance of our products from physicians, health care payors, patients, pharmacists and the medical community;
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properly price and obtain adequate coverage and reimbursement of these products by governmental authorities, private health insurers, managed care organizations and other third-party payors;
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maintain compliance with ongoing FDA labeling, packaging, storage, advertising, promotion, recordkeeping, safety and other post-market requirements;
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obtain approval from the FDA to expand the labeling of our approved products for additional indications;
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obtain regulatory approval for HETLIOZ
®
or Fanapt
®
in additional countries;
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adequately protect against and effectively respond to any claims by holders of patents and other intellectual property rights that our products infringe their rights; and
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adequately protect against and effectively respond to any unanticipated adverse effects or unfavorable publicity that develops in respect to our products, as well as the emergence of new or existing competitive
products, which may be proven to be more clinically effective and cost-effective.
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We expect to continue to incur
significant expenses and to utilize a substantial portion of our cash resources as we continue the commercialization of HETLIOZ
®
and
Fanapt
®
, evaluate foreign market opportunities for HETLIOZ
®
and Fanapt
®
and
continue to grow our operational capabilities, both domestically and abroad. This activity represents a significant investment in the commercial success of HETLIOZ
®
and Fanapt
®
, which is uncertain.
If our continued commercial efforts are not successful with
respect to HETLIOZ
®
and Fanapt
®
in the U.S., Europe or other jurisdictions in which these products may be approved for sale, our
ability to generate increased product sales revenue may be jeopardized and, consequently, our business may be seriously harmed.
The cost
of growing and maintaining a sales, marketing and distribution organization may exceed its cost effectiveness. If we fail to continue to develop sales, marketing and distribution capabilities, if sales efforts are not effective or if costs of
developing sales, marketing and distribution capabilities exceed their cost effectiveness, our business, results of operations and financial condition could be materially adversely affected.
Continued growth of HETLIOZ
®
and Fanapt
®
may be slow or limited for a variety of reasons including competing products or unanticipated safety issues. If either HETLIOZ
®
or Fanapt
®
is not successful in gaining broad commercial acceptance, our business would be harmed.
Any increase in sales of HETLIOZ
®
and Fanapt
®
will be dependent on several factors, including our ability to educate physicians and to increase physician awareness of the benefits and cost-effectiveness of our products relative to competing
products. The degree of further market acceptance of any of our products or market acceptance of approved product candidates among physicians, patients, health care payors and the medical community will depend on a number of factors, including:
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acceptable evidence of safety and efficacy;
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relative convenience and ease of administration;
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the prevalence and severity of any adverse side effects;
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availability of alternative treatments; and
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pricing and cost effectiveness.
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In addition, HETLIOZ
®
and Fanapt
®
are subject to continual review by the FDA, and we cannot assure that newly discovered or reported safety issues will not
arise. With the use of any newly marketed drug by a wider patient population, serious adverse events may occur from time to time that initially do not appear to relate to the drug itself. Any safety issues could cause us to suspend or cease
marketing of our approved products, cause us to modify how we market our approved products, subject us to substantial liabilities and adversely affect our revenues and financial condition. In the event of a withdrawal of either HETLIOZ
®
or Fanapt
®
from the market, our revenues would decline significantly and our business would be seriously harmed.
We may enter into third party collaborations from time to time in order to commercialize our products. If we are unable to identify or
enter into an agreement with any material third-party collaborator, if our collaborations with any such third-party are not commercially successful or if our agreement with any such third-party is terminated or allowed to expire, we could be
adversely affected financially or our business reputation could be harmed.
16
Our business strategy includes entering into collaborations with corporate collaborators for the
commercialization of HETLIOZ
®
, Fanapt
®
and our other products. Areas in which we may potentially enter into third-party collaboration
arrangements include joint sales and marketing arrangements for sales and marketing in certain European Union countries and elsewhere outside of the U.S., and future product development arrangements. If we are unable to identify or enter into an
agreement with any material third-party collaborator, this could result in an adverse effect on our business, results of operations or financial condition. Any arrangements we do enter into may not be scientifically or commercially successful. The
termination of any of these arrangements might adversely affect our ability to develop, commercialize and market our products.
The
success of our collaboration arrangements will depend heavily on the efforts and activities of our collaborators. Our collaborators will have significant discretion in determining the efforts and resources that they will apply to these
collaborations. We expect that the risks which we face in connection with these future collaborations will include the following:
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our collaboration agreements are expected to be for fixed terms and subject to termination under various circumstances, including, in many cases, on short notice without cause;
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our collaborators may develop and commercialize, either alone or with others, products and services that are similar to or competitive with our products which are the subject of their collaboration with us; and
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our collaborators may change the focus of their commercialization efforts.
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In recent years
there have been a significant number of mergers and consolidations in the pharmaceutical and biotechnology industries, some of which have resulted in the participant companies reevaluating and shifting the focus of their business following the
completion of these transactions. The ability of our products to reach their potential could be limited if any of our future collaborators decreases or fails to increase spending relating to such products.
Collaborations with pharmaceutical companies and other third-parties often are terminated or allowed to expire by the other party. With
respect to our future collaborations, any such termination or expiration could adversely affect us financially as well as harm our business reputation.
Even after we or our partners obtain regulatory approvals of a product, acceptance of the product in the marketplace is uncertain and
failure to achieve commercial acceptance will prevent or delay our ability to generate significant revenue from such product.
Even
after obtaining regulatory approvals for the sale of our products, the commercial success of these products will depend, among other things, on their acceptance by physicians, patients, third-party payors and other members of the medical community
as therapeutic and cost-effective alternatives to competing products and treatments. The degree of market acceptance of any product will depend on a number of factors, including the demonstration of its safety and efficacy, its cost-effectiveness,
its potential advantages over other therapies, the reimbursement policies of government and third-party payors with respect to such product, our ability to attract and maintain corporate partners, including pharmaceutical companies, to assist in
commercializing our products, receipt of regulatory clearance of marketing claims for the uses that we or our partners are developing and the effectiveness of our and our partners marketing and distribution capabilities. If our approved
products fail to gain market acceptance or do not become widely accepted by physicians, patients, third-party payors and other members of the medical community, it is unlikely that we will ever become profitable on a sustained basis or achieve
significant revenues.
We rely and will continue to rely on outsourcing arrangements for many of our activities, including clinical
development and supply of HETLIOZ
®
, Fanapt
®
and our other products.
As of December 31, 2016, we had 142 full-time employees. We rely on outsourcing arrangements for a significant portion of our activities,
including distribution, clinical research and development, data collection and analysis and manufacturing, as well as for certain functions as a public company. We may have limited control over these third parties and we cannot guarantee that they
will perform their obligations in an effective and timely manner.
Disruptions to our HETLIOZ
®
or Fanapt
®
supply chains could materially affect our ability to successfully commercialize HETLIOZ
®
or Fanapt
®
, thereby reducing our future earnings and prospects.
A loss or disruption with any one of our manufacturers or suppliers could disrupt the supply of HETLIOZ
®
or Fanapt
®
, possibly for a significant time period, and we may not have sufficient inventories to maintain supply before the manufacturer
or supplier could be replaced or the disruption is resolved. In addition, marketed drugs and their contract manufacturing organizations are subject to continual review, including review and approval of their manufacturing facilities and the
manufacturing processes, which can result in delays in the regulatory approval process and/or commercialization. Introducing a replacement or backup manufacturer or supplier for HETLIOZ
®
or
Fanapt
®
requires a lengthy regulatory and commercial process and there can be no guarantee that we could obtain necessary regulatory approvals in a timely fashion or at all. In addition, it is
difficult to identify and select qualified suppliers and manufacturers with the necessary technical capabilities, and establishing new supply and manufacturing sources involves a lengthy and technical engineering process.
Failure to comply with government regulations regarding the sale and marketing of our products could harm our business.
17
Our business is subject to extensive government regulation and oversight. As a result, we may
become subject to governmental actions which could materially and adversely affect our business, results of operations and financial condition, certain of which are described below.
Pharmaceutical Pricing and Reimbursement
In U.S. markets, our ability and that of our partners to commercialize our products successfully, and to attract commercialization partners for
our products, depends in significant part on the availability of adequate financial coverage and reimbursement from third-party payors, including, in the U.S., governmental payors such as the Medicare and Medicaid programs, managed care
organizations, and private health insurers.
We participate in the Medicaid Drug Rebate Program for both HETLIOZ
®
and Fanapt
®
. Under the Medicaid Drug Rebate Program, we are required to pay a rebate to each state Medicaid program for our covered
outpatient drugs that are dispensed to Medicaid beneficiaries and paid for by a state Medicaid program as a condition of having federal funds being made available to the states for our drugs under Medicaid and Medicare Part B. Those rebates are
based on pricing data that are reported by us on a monthly and quarterly basis to the Centers for Medicare & Medicaid Services (CMS). Federal law requires that any company that participates in the Medicaid Drug Rebate Program also
participate in the Public Health Services 340B drug pricing discount program (the 340B program), in order for federal funds to be available for the manufacturers drugs under Medicaid and Medicare Part B. The 340B program requires
participating manufacturers to agree to charge statutorily-defined covered entities no more than the 340B ceiling price for the manufacturers covered outpatient drugs. The ceiling price can represent a significant discount and is
based on the pricing data reporting to the Medicaid Drug Rebate Program.
PPACA expanded the 340B program to include additional entity
types: certain free-standing cancer hospitals, critical access hospitals, rural referral centers and sole community hospitals, each as defined by PPACA. PPACA exempts drugs designated under section 526 of the FDC Act as orphan drugs from
the ceiling price requirements for these newly-eligible entities.
PPACA also obligates HRSA to create regulations and processes to
improve the integrity of the 340B program and to update the agreement that manufacturers must sign to participate in the 340B program. HRSA issued a final regulation in January of 2017 regarding the calculation of the 340B ceiling price and the
imposition of civil monetary penalties on manufacturers that knowingly and intentionally overcharge covered entities. The final regulation regarding the 340B program include the requirement that a manufacturer calculate the 340B ceiling price on a
quarterly basis, the requirement that a manufacturer charge $0.01 per unit of measure if the 340B ceiling price calculation results in a ceiling price that equals zero (penny pricing), the methodology manufacturers must use when estimating the
ceiling price for a new covered outpatient drug, an explanation of how a civil monetary penalty (CMP) would be imposed on a manufacturer that knowingly and intentionally overcharges a covered entity; and an explanation of what would constitute an
instance of overcharging to trigger a CMP. This final regulation becomes effective March 6, 2017, but recognizing such date is in the middle of a quarter, HRSA plans to begin enforcing the requirements of this final rule at the start of the next
quarter, which begins April 1, 2017. HRSA recently issued a proposed regulation regarding an administrative dispute resolution process for the 340B program. Any final regulations and guidance could affect our obligations under the 340B program in
ways we cannot anticipate. In addition, legislation may be introduced that, if passed, would further expand the 340B program to additional covered entities or otherwise expand the 340B program.
Federal law also requires that for a drug manufacturers products to be eligible for payment with federal funds under the Medicaid and
Medicare Part B programs and to be purchased by certain federal agencies and grantees, the manufacturer must participate in the Department of Veterans Affairs Federal Supply Schedule (FSS), pricing program, established by Section 603 of the
Veterans Health Care Act of 1992. Manufacturers that participate in the FSS pricing program must list their covered (innovator) drugs on an FSS contract and charge no more than Federal Ceiling Price (FCP), to the Department of Veterans Affairs,
Department of Defense, Public Health Service, and Coast Guard when those agencies purchase from the FSS contract or a depot contract. FCP is calculated based on non-federal average manufacturer price data, which manufacturers must submit quarterly
and annually. In addition, because our products are available in the retail and specialty pharmacy setting, we are required to provide rebates to the Department of Defense for prescriptions dispensed to Tricare beneficiaries from Tricare retail
network pharmacies under the Tricare Retail Refund Program. These programs obligate the manufacturer to pay rebates and offer its drugs at certain prices to certain federal purchasers. To the extent we choose to participate in these government
healthcare programs for our current and future products, these and other requirements may affect our ability to profitably sell any product for which we obtain marketing approval.
Pricing and rebate calculations vary among products and programs. The calculations are complex and will often be subject to interpretation by
us, governmental or regulatory agencies and the courts. If we become aware that our reporting of pricing data for a prior quarter was incorrect, we will be obligated to resubmit the corrected data. For the Medicaid Drug Rebate Program, corrected
data must be submitted for a period not to exceed 12 quarters from the quarter in which the data originally were due. Such restatements and recalculations increase our costs for complying with the laws and regulations governing the Medicaid Drug
Rebate Program and other governmental pricing programs.
We may be liable for errors associated with our submission of pricing data. If we
are found to have knowingly submitted false pricing data to the Medicaid program or the FSS pricing program, we may be liable for civil monetary penalties in the amount of up to $100,000 per item of false information. Our failure to submit pricing
data to the Medicaid program or the FSS pricing program on a timely basis could result in a civil monetary penalty of $10,000 per day for each day the information is late. Such failure also could be grounds for CMS to terminate our Medicaid drug
rebate agreement, which is the agreement under which we would participate in the Medicaid Drug Rebate Program. In the event that CMS terminates our rebate agreement, federal payments may not be available under Medicaid or Medicare Part B for our
covered outpatient drugs. We cannot assure you that our submissions will not be found to be incomplete or incorrect.
18
Third-party payors decide which drugs they will pay for and establish reimbursement and co-pay
levels. Third-party payors are increasingly challenging the prices charged for medical products and services and examining their cost effectiveness, in addition to their safety and efficacy. We may need to conduct expensive pharmacoeconomic studies
in order to demonstrate the cost effectiveness of our products. Even with such studies, any of our products that are commercialized may be considered less safe, less effective or less cost-effective than other products, and third-party payors may
not provide coverage and reimbursement, in whole or in part, for our products.
Political, economic and regulatory influences are
subjecting the healthcare industry in the U.S. to fundamental changes. There have been, and we expect there will continue to be, legislative and regulatory proposals to change the healthcare system and reimbursement systems in ways that could impact
our ability and that of our partners to profitably sell commercialized products.
Payors also are increasingly considering new metrics as
the basis for reimbursement rates, such as average sales price, average manufacturer price and actual acquisition cost. It is difficult to project the impact of these evolving reimbursement mechanics on the willingness of payors to cover any of our
products that are commercialized.
In addition, we anticipate that a significant portion of our or our partners revenue from sales
of commercialized products will be obtained through government payors, including Medicaid, and any failure to qualify for reimbursement for products we are able to commercialize under those programs would have a material adverse effect on revenues
and royalties from sales of such products.
Interactions with Healthcare Providers
Healthcare providers, physicians and others often play a primary role in the recommendation and prescription of pharmaceutical products.
Manufacturers of branded prescription drugs are subject to broadly applicable fraud and abuse and other healthcare laws and regulations that may constrain the business or financial arrangements and relationships through which manufacturers market,
sell and distribute the products for which they obtain marketing approval. Some of the laws and regulations that may affect our ability to operate are described below.
Anti-Kickback Laws
The federal
Anti-Kickback Statute prohibits, among other things, persons from knowingly and willfully offering, paying, soliciting, or receiving remuneration, directly or indirectly, in cash or in kind, to induce or reward the purchasing, leasing, ordering or
arranging for the purchase, lease, or order of any health care item or service reimbursable under federal healthcare programs such as Medicare and Medicaid. The term remuneration has been broadly interpreted to include anything of value,
and the government can establish a violation of the Anti-Kickback Statute without proving that a person or entity had actual knowledge of the law or specific intent to violate it. This statute has been interpreted to apply to arrangements between
pharmaceutical manufacturers on the one hand and prescribers, purchasers and formulary managers on the other. There are a number of statutory exceptions and regulatory safe harbors protecting certain common activities from prosecution or other
regulatory sanctions, however, the exceptions and safe harbors are drawn narrowly. Failure to meet all of the requirements of a particular statutory exception or regulatory safe harbor does not make the conduct per se illegal under the Anti-Kickback
Statute, but the legality of the arrangement will be evaluated on a case-by-case basis based on the totality of the facts and circumstances. A number of states also have anti-kickback laws that establish similar prohibitions that may apply to items
or services reimbursed by government programs, as well as any third-party payors, including commercial payors.
False Claims Act
The federal civil False Claims Act prohibits, among other things, individuals or entities from knowingly presenting, or causing to be presented
false or fraudulent claims for payment of government funds and knowingly making, or causing to be made or used, a false record or statement to get a false claim paid. Certain marketing practices may implicate the federal civil False Claims Act,
including promotion of pharmaceutical products for unapproved uses, providing free product to customers with the expectation that the customer would bill federal programs for the product, or inflating prices report to private price publication
services used to set drug reimbursement rates under federal healthcare programs. In addition, PPACA amended the Social Security Act to provide that a claim including items or services resulting from a violation of the Anti-Kickback Statute
constitutes a false or fraudulent claim for purposes of the False Claims Act. Actions under the False Claims Act may be brought by the government or as a qui tam action by a private individual in the name of the government. False Claims Act
liability is potentially significant in the healthcare industry because the statute provides for treble damages and mandatory penalties of $5,500 to $11,000 per false claim or statement, which will increase to a range of $10,781 to $21,563 for
violations after November 2, 2015, and assessed after August 1, 2016. Because of the potential for large monetary exposure, healthcare companies often resolve allegations without admissions of liability for significant and sometimes
material amounts to avoid the uncertainty of treble damages and per claim penalties that may awarded in litigation proceedings. They may be required, however, to enter into corporate integrity agreements with the government, which may impose
substantial costs on companies to ensure compliance. Pharmaceutical companies also are subject to other federal false claim laws, including laws that impose criminal penalties, including imprisonment and criminal fines, for making or presenting a
false or fictitious or fraudulent claim to the federal government.
19
Health Insurance Portability and Accountability Act
The federal Health Insurance Portability and Accountability Act of 1996 (HIPAA), created federal criminal statutes that prohibit among other
actions, knowingly and willfully executing, or attempting to execute, a scheme to defraud any healthcare benefit program, including private third-party payors, knowingly and willfully embezzling or stealing from a healthcare benefit program,
willfully obstructing a criminal investigation of a healthcare offense, and knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement in connection with the
delivery of or payment for healthcare benefits, items or services.
Physician Payment Sunshine Act
The federal Physician Payment Sunshine Act requires manufacturers of drugs, devices, biologics and medical supplies for which payment is
available under Medicare, Medicaid or the Childrens Health Insurance Program to report annually (with certain exceptions) to CMS, information related to payments or other transfers of value made to physicians and teaching
hospitals, and requires applicable manufacturers and group purchasing organizations to report annually to CMS ownership and investment interests held by physicians and their immediate family members and payments or other transfers of
value to such physician owners.
Analogous State and Foreign Laws
The majority of states also have statutes or regulations similar to the federal laws described above, including state anti-kickback and false
claims laws. These state laws apply to items and services reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payor. In addition, a number of states require pharmaceutical companies to report expenses
relating to the marketing and promotion of pharmaceutical products and to report gifts and payments to individual physicians in the states. Other states restrict when pharmaceutical companies may provide meals to prescribers or engage in other
marketing related activities, or require pharmaceutical companies to implement compliance programs or marketing codes of conduct.
Outside
the U.S., we are subject to similar regulations in those countries where we market and sell products. In some foreign countries, including major markets in the European Union and Japan, the pricing of prescription pharmaceuticals is subject to
governmental control. In these countries, pricing negotiations with governmental authorities can take nine to twelve months or longer after the receipt of regulatory marketing approval for a product. To obtain reimbursement or pricing approval in
some countries, we may be required to conduct a clinical trial that compares the cost-effectiveness of our product to other available therapies. Our business could be materially harmed if reimbursement of our products is unavailable or limited in
scope or amount or if pricing is set at unsatisfactory levels.
Additionally, drug prices are under significant scrutiny, and along with
other health care costs, continue to be subject to intense political and societal pressures, which we anticipate will continue and escalate, including on a global basis. As a result, our business and reputation may be harmed, our stock price may be
adversely impacted and experience periods of volatility, and our results of operations may be adversely impacted.
Foreign Corrupt
Practices Act
The U.S. Foreign Corrupt Practices Act (FCPA), prohibits U.S. corporations and their representatives and intermediaries from
offering, promising, authorizing or making payments to any foreign government official, government staff member, political party or political candidate in an attempt to obtain or retain business abroad. The scope of the FCPA includes interactions
with certain healthcare professionals in many countries. Other countries have enacted similar anti-corruption laws and/or regulations.
Efforts to ensure that business activities and business arrangements comply with applicable healthcare laws and regulations can be costly for
manufacturers of branded prescription products. If a manufacturers operations, including activities conducted by its sales team, are found to be in violation of any of these laws or any other governmental regulations that apply to the company,
the company may be subject to significant civil, criminal and administrative sanctions, including imprisonment, monetary penalties, damages, fines, exclusion from participation in federal healthcare programs, such as Medicare and Medicaid, and the
curtailment or restructuring of operations.
We intend to seek regulatory approvals for our products in additional foreign
jurisdictions, but we may not obtain any such approvals.
We intend to market our products, alone or with others, in foreign
jurisdictions. In order to market our products in foreign jurisdictions, we or our partners may be required to obtain separate regulatory approvals and to comply with numerous and varying regulatory requirements. The approval procedure varies among
countries and jurisdictions and can involve additional trials, and the time required to obtain approval may differ from that required to obtain FDA approval. Additionally, the foreign regulatory approval process may include all of the risks
associated with obtaining FDA approval. For all of these reasons, we or our partners may not obtain foreign regulatory approvals on a timely basis, if at all. Approval by the FDA does not ensure approval by regulatory
20
authorities in other countries or jurisdictions, and approval by one foreign regulatory authority does not ensure approval by regulatory authorities in other foreign countries or jurisdictions or
by the FDA. We or our partners may not be able to file for regulatory approvals and may not receive necessary approvals to commercialize our products in any market. The failure to obtain these approvals could harm our business materially.
We rely on a limited number of specialty pharmacies for distribution of
HETLIOZ
®
in the U.S., and the loss of one or more of these specialty pharmacies or their failure to distribute HETLIOZ
®
effectively
would materially harm our business.
HETLIOZ
®
is only available for
distribution through a limited number of specialty pharmacies in the U.S. A specialty pharmacy is a pharmacy that specializes in the dispensing of medications for complex or chronic conditions, which often require a high level of patient education
and ongoing management. The use of specialty pharmacies involves certain risks, including, but not limited to, risks that these specialty pharmacies will:
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not provide us accurate or timely information regarding their inventories, the number of patients who are using HETLIOZ
®
or complaints about HETLIOZ
®
;
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reduce their efforts or discontinue to sell or support or otherwise not effectively sell or support HETLIOZ
®
;
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not devote the resources necessary to sell HETLIOZ
®
in the volumes and within the time frames that we expect;
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be unable to satisfy financial obligations to us or others; or
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In addition, if one or more of our specialty pharmacies do not fulfill
their contractual obligations to us, or refuse or fail to adequately serve patients, or their agreements are terminated without adequate notice, shipments of HETLIOZ
®
, and associated revenues,
would be adversely affected. We expect that it would take a significant amount of time if we were required to replace one or more of our specialty pharmacies.
Our revenues from Fanapt
®
are substantially dependent on sales through a
limited number of wholesalers, and such revenues may fluctuate from quarter to quarter.
We sell Fanapt
®
primarily through a limited number of pharmaceutical wholesalers in the U.S. The use of pharmaceutical wholesalers involves certain risks, including, but not limited to, risks that these
pharmaceutical wholesalers will:
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not provide us accurate or timely information regarding their inventories, demand from wholesaler customers buying Fanapt
®
or complaints about Fanapt
®
;
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reduce their efforts or discontinue to sell or support or otherwise not effectively sell or support Fanapt
®
;
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not devote the resources necessary to sell Fanapt
®
in the volumes and within the time frames that we expect;
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be unable to satisfy financial obligations to us or others; or
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Additionally, our reliance on a small number of wholesalers could cause
revenues to fluctuate from quarter to quarter based on the buying patterns of these wholesalers. In addition, if any of these wholesalers fails to pay on a timely basis or at all, our business, financial condition and results of operations could be
materially adversely affected.
We face substantial competition, which may result in others developing or commercializing products
before or more successfully than we do.
Our future success will depend on our or our partners ability to demonstrate and
maintain a competitive advantage with respect to our products and our ability to identify and develop additional products. Large, fully integrated pharmaceutical companies, either alone or together with collaborative partners, have substantially
greater financial resources and have significantly greater experience than we do in:
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undertaking pre-clinical testing and clinical trials;
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obtaining FDA and other regulatory approvals of products; and
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manufacturing, marketing and selling products.
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These companies may invest heavily and quickly
to discover and develop novel products that could make our products obsolete. Accordingly, our competitors may succeed in obtaining patent protection, receiving FDA or foreign regulatory approval or commercializing superior products or other
competing products before we do. Technological developments or the FDA or foreign regulatory approval of new therapeutic indications for existing products may make our products obsolete or may make them more difficult to market successfully, any of
which could have a material adverse effect on our business, results of operations and financial condition.
21
Our products, if successfully developed and approved for commercial sale, will compete with a
number of drugs and therapies currently manufactured and marketed by major pharmaceutical and other biotechnology companies. Our products may also compete with new products currently under development by others or with products which may cost less
than our products. Physicians, patients, third party payors and the medical community may not accept or utilize any of our products that may be approved. If HETLIOZ
®
, Fanapt
®
and our other products, if and when approved, do not achieve significant market acceptance, our business, results of operations and financial condition would be materially adversely affected. We
believe the primary competitors for HETLIOZ
®
and Fanapt
®
are as follows:
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For HETLIOZ
®
in the treatment of Non-24, there are no FDA approved direct competitors. Sedative-Hypnotic treatments for certain sleep related disorders include,
Ambien
®
(zolpidem) by Sanofi (including Ambien CR
®
), Lunesta
®
(eszopiclone) by
Sunovion Pharmaceuticals Inc., Sonata
®
(zaleplon) by Pfizer Inc., Rozerem
®
(ramelteon) by Takeda Pharmaceuticals Company Limited,
Silenor
®
(doxepin) by Pernix Therapeutics, Belsomra
®
(suvorexant) by Merck & Co., Inc., generic products such as zolpidem,
trazodone and doxepin, and over-the-counter remedies such as Benadryl
®
and Tylenol PM
®
. The class of melatonin agonists includes
Rozerem
®
(ramelteon) by Takeda Pharmaceuticals Company Limited, Valdoxan
®
(agemelatine) by Servier, Circadin
®
(long-acting melatonin) by Neurim Pharmaceuticals and the food supplement melatonin. Shift work and excessive sleepiness disorder treatments include Nuvigil
®
(armodafinil) and Provigil
®
(modafinil) both by Teva Pharmaceutical Industries Ltd.
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For Fanapt
®
in the treatment of schizophrenia, the atypical antipsychotics competitors are Risperdal
®
(risperidone), including the depot formulation Risperdal
®
Consta
®
and Invega
®
(paliperidone), including the depot formulation Invega
®
Sustenna
®
, each by Ortho-McNeil-Janssen Pharmaceuticals, Inc., Zyprexa
®
(olanzapine), including the depot formulation Zyprexa
®
Relprevv, each by Eli Lilly and Company, Seroquel
®
and Seroquel XR (quetiapine) by AstraZeneca PLC, Abilify
®
(aripiprazole) by BMS/Otsuka America Pharmaceutical Inc., Abilify
®
Maintena
®
(the depot formulation of Abilify
®
) by Lundbeck/Otsuka America
Pharmaceutical Inc., Geodon
®
(ziprasidone) by Pfizer Inc., Saphris
®
(asenapine) by Actavis plc, Latuda
®
(lurasidone) by Sunovion Pharmaceuticals Inc., Rexulti
®
(brexpiprazole) by Lundbeck/Otsuka America Pharmaceutical, Inc., Aristada
(aripiprazole lauroxil) extended-release injectible suspension by Alkermes, Inc., Vraylar (cariprazine) by Teva Pharmaceutical Industries Ltd., and generic clozapine, as well as the typical antipsychotics haloperidol, chlorpromazine,
thioridazine, and sulpiride (all of which are generic).
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Additionally, we may face competition from newly developed generic
products. Under the Hatch-Waxman Act newly approved drugs and indications may benefit from a statutory period of non-patent marketing exclusivity. The Hatch-Waxman Act seeks to stimulate competition by providing incentives to generic pharmaceutical
manufacturers to introduce non-infringing forms of patented pharmaceutical products and to challenge patents on branded pharmaceutical products. If we are unsuccessful at challenging an Abbreviated New Drug Application (ANDA), filed pursuant to the
Hatch-Waxman Act, cheaper generic versions of our products, which may be favored by insurers and third-party payors, may be launched commercially, which would significantly harm our business.
In June 2014, we filed suit against Roxane Laboratories, Inc. (Roxane) in the U.S. District Court for the District of Delaware (the Delaware
District Court). The suit seeks an adjudication that Roxane has infringed one or more claims of our U.S. Patent No. 8,586,610 (the 610 Patent) by submitting to the U.S. Food and Drug Administration (the FDA) an ANDA for a generic version
of Fanapt
®
prior to the expiration of the 610 Patent in November 2027. In addition, pursuant to the Settlement Agreement with Novartis, we assumed Novartis patent infringement
action against Roxane in the Delaware District Court. That suit alleges that Roxane has infringed one or more claims of U.S Patent RE39198 (the 198 Patent), which is licensed exclusively to us, by filing an ANDA for a generic version of Fanapt
®
prior to the expiration of the 198 Patent in November 2016. These two cases against Roxane were consolidated by agreement of the parties and were tried together in a five-day bench trial
that concluded on March 4, 2016. On August 25, 2016, the Delaware District Court ruled in our favor, finding that Roxanes ANDA product infringed the asserted claims of the 610 Patent and the 198 Patent. The Delaware
District Court ruled that we are entitled to a permanent injunction against Roxane enjoining Roxane from infringing the 610 Patent, including the manufacture, use, sale, offer to sell, sale, distribution or importation of any generic
iloperidone product described in the 610 Patent ANDA until the expiration of the 610 Patent in November 2027. If we obtain pediatric exclusivity, the injunction against Roxane would be extended until May 2028 under the Delaware District
Courts order. On September 23, 2016, Roxane filed a notice of appeal with the Federal Circuit Court of Appeals. Roxane filed its opening appellate brief on February 7, 2017.
In 2015, we filed six separate patent infringement lawsuits in the Delaware District Court against Roxane, Inventia Healthcare Pvt. Ltd.
(Inventia), Lupin Ltd. and Lupin Pharmaceuticals, Inc. (Lupin), Taro Pharmaceuticals USA, Inc. and Taro Pharmaceutical Industries, Ltd. (Taro), and Apotex Inc. and Apotex Corp., (collectively, the Defendants). The lawsuits each seek an adjudication
that the respective Defendants infringed one or more claims of the 610 Patent and/or our U.S. Patent No. 9,138,432 (the 432 Patent) by submitting to the FDA an ANDA for a generic version of Fanapt
®
prior to the expiration of the 610 Patent in November 2027 or the 432 Patent in September 2025. The Defendants have denied infringement and counterclaimed for declaratory judgment of
invalidity
22
and noninfringement of the 610 Patent and the 432 Patent. A trial on these matters was scheduled to begin on May 15, 2017. On December 15, 2016, following a submission by
the parties that it may be appropriate to remove the May 15, 2017 trial from the Delaware District Courts calendar pending the Federal Circuits decision in Roxanes appeal of the Delaware District Courts August 25,
2016 ruling finding that Roxanes proposed products infringed the asserted claims of the 610 Patent, the Delaware District Court removed the May 15, 2017 trial from the calendar and adopted a new schedule for discovery. The parties
agreed that within 14 days after any decision on the merits in the Roxane appeal, the parties will submit to the Delaware District Court a status report and request a schedule for trial. We entered into a confidential stipulation with Inventia
regarding any potential launch of Inventias generic ANDA product. We also entered into a confidential stipulation with Lupin regarding any potential launch of Lupins generic ANDA product.
Lupin filed counter claims for declaratory judgment of invalidity and noninfringement of seven of our method of treatment patents that are
listed in the
Approved Drug Products with Therapeutic Equivalence Evaluations
(the Orange Book) related to Fanapt
®
(such seven patents, the Method of Treatment Patents). We have not
sued Lupin for infringing the Method of Treatment Patents. On October 13, 2016, we, along with Lupin, filed a Stipulation of Dismissal in the Delaware District Court pursuant to which Lupins counterclaims relating to the Method of
Treatment Patents were dismissed without prejudice in recognition of an agreement reached between Lupin and us by which we would not assert those patents against Lupin absent certain changes in Lupins proposed prescribing information for its
iloperidone tablets.
On October 24, 2016, we entered into a License Agreement with Taro to resolve our patent litigation against
Taro regarding Taros ANDA seeking approval of its generic version of Fanapt
®
(the Taro License Agreement). Under the Taro License Agreement, we granted Taro a non-exclusive license to
manufacture and commercialize Taros version of Fanapt
®
in the U.S. effective November 2, 2027, unless prior to that date we obtain pediatric exclusivity for Fanapt
®
, in which case, the license will be effective May 2, 2028. Taro may enter the market earlier under certain limited circumstances. The Taro License Agreement, which is subject to review by
the U.S. Federal Trade Commission (FTC) and the U.S. Department of Justice (DOJ), provides for a full settlement and release by us and Taro of all claims that are the subject of the litigation.
On December 7, 2016, we entered into a License Agreement with Apotex to resolve our patent litigation against Apotex regarding
Apotexs ANDA seeking approval of its generic version of Fanapt
®
(the Apotex License Agreement). Under the Apotex License Agreement, we granted Apotex a non-exclusive license to
manufacture and commercialize Apotexs version of Fanapt
®
in the U.S. effective November 2, 2027, unless prior to that date we obtain pediatric exclusivity for Fanapt
®
, in which case, the license will be effective May 2, 2028. Apotex may enter the market earlier under certain limited circumstances. The Apotex License Agreement, which is subject to review
by the FTC and the DOJ, provides for a full settlement and release by us and Apotex of all claims that are the subject of the litigation.
On February 26, 2016, Roxane filed suit against us in the U.S. District Court for the Southern District of Ohio (Ohio District Court).
The suit seeks a declaratory judgment of invalidity and noninfringement of the Method of Treatment Patents. We have not sued Roxane for infringing the Method of Treatment Patents. We filed a motion to dismiss this lawsuit for lack of personal
jurisdiction or to transfer the lawsuit to the Delaware District Court. On December 20, 2016, the Ohio District Court ruled in our favor, dismissing Roxanes suit without prejudice for lack of personal jurisdiction.
On February 26, 2016, Roxane filed a Petition for
Inter Partes
Review (IPR) of the 432 Patent with the Patent Trials and
Appeals Board (PTAB) of the U.S. Patent and Trademark Office. We filed a Preliminary Response on June 7, 2016, and on August 30, 2016, the PTAB denied the request by Roxane to institute an IPR of the 432 Patent. On September 29,
2016, Roxane filed a Petition for Rehearing with the PTAB, and on October 13, 2016, we filed a Response to Roxanes Petition. On November 4, 2016, the PTAB denied Roxanes Petition for Rehearing.
FDA and foreign regulatory approval of our products is uncertain.
The research, testing, manufacturing and marketing of products such as those that we have developed or that we or our partners are developing
are subject to extensive regulation by federal, state and local government authorities, including the FDA, as well as foreign regulatory authorities in jurisdictions in which we seek approval. To obtain regulatory approval of such products, we or
our partners must demonstrate to the satisfaction of the applicable regulatory agency that, among other things, the product is safe and effective for its intended use. In addition, we or our partners must show that the manufacturing facilities used
to produce such products are in compliance with current Good Manufacturing Practices regulations (cGMP).
The process of obtaining FDA and
other required regulatory approvals and clearances can take many years and will require us and our partners, as applicable, to expend substantial time and capital. Despite the time and expense expended, regulatory approval is never guaranteed. The
number of pre-clinical and clinical trials that will be required for FDA or foreign regulatory approval varies depending on the product, the disease or condition that the product is in development for, and the requirements applicable to that
particular product. The FDA or applicable foreign regulatory agency can delay, limit or deny approval of a product for many reasons, including that:
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a product may not be shown to be safe or effective;
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23
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the FDA or foreign agency may interpret data from pre-clinical and clinical trials in different ways than we or our partners do;
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the FDA or foreign agency may not approve our or our partners manufacturing processes or facilities;
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a product may not be approved for all the indications we or our partners request;
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the FDA or foreign agency may change its approval policies or adopt new regulations;
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the FDA or foreign agency may not meet, or may extend, the Prescription Drug User Fee Act (PDUFA-V) date or its foreign equivalent with respect to a particular NDA or foreign application; and
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the FDA or foreign agency may not agree with our or our partners regulatory approval strategies or components of the regulatory filings, such as clinical trial designs.
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For example, if certain of our or our partners methods for analyzing trial data are not accepted by the FDA or the applicable foreign
agency, we or our partners may fail to obtain regulatory approval for our products.
Any delay or failure to obtain regulatory approvals
for our products will result in increased costs, could diminish competitive advantages that we may attain and would adversely affect the marketing and sale of our products. Other than HETLIOZ
®
in the U.S. and the 31 countries in Europe covered by the centralized marketing authorization by the EC, and Fanapt
®
in the U.S., Mexico and Israel, we have not received regulatory approval to
market any of our products in any jurisdiction.
Even following regulatory approval of our products, the FDA or the applicable foreign
agency may impose limitations on the indicated uses for which such products may be marketed, subsequently withdraw approval or take other actions against us, our partners or such products that are adverse to our business. The FDA and foreign
agencies generally approve drugs for particular indications. An approval for a more limited indication reduces the size of the potential market for the product. Product approvals, once granted, may be withdrawn or modified if problems occur after
initial marketing.
We and our partners also are subject to numerous federal, state, local and foreign laws, regulations and
recommendations relating to safe working conditions, laboratory and manufacturing practices, the environment and the use and disposal of hazardous substances used in connection with discovery, research and development work. In addition, we cannot
predict the extent to which new governmental regulations might significantly impede the discovery, development, production and marketing of our products. We or our partners may be required to incur significant costs to comply with current or future
laws or regulations, and we may be adversely affected by the cost of such compliance or the inability to comply with such laws or regulations.
If our products are determined to be unsafe or ineffective in humans, whether commercially or in clinical trials, our business will be
materially harmed.
Despite the FDAs approval of the NDA for
HETLIOZ
®
in January 2014 and the NDA for Fanapt
®
in May 2009, the ECs grant of the centralized marketing authorization for
HETLIOZ
®
in July 2015, and the positive results of our completed trials for HETLIOZ
®
and Fanapt
®
, we are uncertain whether either of these products will ultimately prove to be effective and safe in humans long term and in all uses. Frequently, products that have shown promising results in
clinical trials have suffered significant setbacks in later clinical trials or even after they are approved for commercial sale. Future uses of our products, whether in clinical trials or commercially, may reveal that the product is ineffective,
unacceptably toxic, has other undesirable side effects, is difficult to manufacture on a large scale, is uneconomical, infringes on proprietary rights of another party or is otherwise not fit for further use. If our products are determined to be
unsafe or ineffective in humans, our business will be materially harmed.
Clinical trials for our products are expensive and their
outcomes are uncertain. Any failure or delay in completing clinical trials for our products could severely harm our business.
Pre-clinical studies and clinical trials required to demonstrate the safety and efficacy of our products are time-consuming and expensive and
together take several years to complete. Before obtaining regulatory approvals for the commercial sale of any of our products, we or our partners must demonstrate through preclinical testing and clinical trials that such product is safe and
effective for use in humans. We have incurred, and we will continue to incur, substantial expense for, and devote a significant amount of time to, preclinical testing and clinical trials.
Historically, the results from preclinical testing and early clinical trials often have not predicted results of later clinical trials. A
number of new drugs have shown promising results in clinical trials, but subsequently failed to establish sufficient safety and efficacy data to obtain necessary regulatory approvals. Clinical trials conducted by us, by our partners or by third
parties on our or our partners behalf may not demonstrate sufficient safety and efficacy to obtain the requisite regulatory approvals for our products. Regulatory authorities may not permit us or our partners to undertake any additional
clinical trials for our products, may force us to stop any ongoing clinical trials and it may be difficult to design efficacy studies for our products in new indications.
Clinical development efforts performed by us or our partners may not be successfully completed. Completion of clinical trials may take several
years or more. The length of time can vary substantially with the type, complexity, novelty and intended use of the products and the size of the prospective patient population. The commencement and rate of completion of clinical trials for our
products may be delayed by many factors, including:
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the inability to manufacture or obtain from third parties materials sufficient for use in pre-clinical studies and clinical trials;
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delays in beginning a clinical trial;
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24
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delays in patient enrollment and variability in the number and types of patients available for clinical trials;
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difficulty in maintaining contact with patients after treatment, resulting in incomplete data;
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poor effectiveness of our products during clinical trials;
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unforeseen safety issues or side effects; and
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governmental or regulatory delays and changes in regulatory requirements and guidelines.
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If
we or our partners fail to complete successfully one or more clinical trials for our products, we or they may not receive the regulatory approvals needed to market that product. Therefore, any failure or delay in commencing or completing these
clinical trials would harm our business materially.
Our products may cause undesirable side effects or have other properties that
could delay, prevent or result in the revocation of their regulatory approval or limit their marketability.
Undesirable side
effects caused by our products could interrupt, delay or halt clinical trials and could result in the denial of regulatory approval by the FDA or other regulatory authorities for any or all targeted indications, and in turn prevent us or our
partners from commercializing or continuing the commercialization of such products and generating revenues from their sale. We will continue to assess the side effect profile of our products in ongoing clinical development programs. However, we
cannot predict whether the commercial use of our approved products (or our products in development, if and when they are approved for commercial use) will produce undesirable or unintended side effects that have not been evident in the use of, or in
clinical trials conducted for, such products to date. Additionally, incidents of product misuse may occur. These events, among others, could result in product recalls, product liability actions or withdrawals or additional regulatory controls, all
of which could have a material adverse effect on our business, results of operations and financial condition.
In addition, if after
receiving marketing approval of a product, we, our partners or others identify undesirable side effects caused by such product, we or our partners could face one or more of the following:
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regulatory authorities may require the addition of labeling statements, such as a black box warning or a contraindication;
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regulatory authorities may withdraw their approval of the product;
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we or our partners may be required to change the way the product is administered, conduct additional clinical trials or change the labeling of the product; and
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our, our partners or the products reputation may suffer.
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Any of these events
could prevent us or our partners from achieving or maintaining market acceptance of the affected product or could substantially increase the costs and expenses of commercializing the product, which in turn could delay or prevent us from generating
significant revenues from its sale.
We have a history of operating losses, anticipate future losses and may never become profitable
on a sustained basis.
We have been engaged in identifying and developing products since March 2003, which has required, and will
continue to require, significant research and development expenditures. The continued commercialization of HETLIOZ
®
and Fanapt
®
will
require substantial additional expenditures.
As of December 31, 2016, we had an accumulated deficit of $345.9 million and we cannot
estimate with precision the extent of our future losses. In April 2014, we commercially launched HETLIOZ
®
in the U.S. for the treatment of Non-24 and in August 2016 we commercially launched
HETLIOZ
®
in Germany for the treatment of Non-24. We are currently evaluating the commercial opportunity for HETLIOZ
®
in the rest of
Europe. In the fourth quarter of 2014, we acquired all further rights to Fanapt
®
from Novartis. The continued commercialization of
HETLIOZ
®
and Fanapt
®
will require substantial additional expenditures. In addition, we may not succeed in commercializing HETLIOZ
®
, Fanapt
®
or any other products. Novartis launched Fanapt
®
in the U.S. in the
first quarter of 2010 and we began selling Fanapt
®
on our own in the first quarter of 2015. We may not succeed in gaining additional market acceptance of Fanapt
®
in the U.S. and we may not succeed in commercializing HETLIOZ
®
or Fanapt
®
outside
of the U.S. We may not be profitable even if our products are successfully commercialized. We may be unable to fully develop, obtain regulatory approval for, commercialize, manufacture, market, sell and derive revenue from our products in the
timeframes we project, if at all, and our inability to do so would materially and adversely impact the market price of our common stock and our ability to raise capital and continue operations.
25
There can be no assurance that we will achieve sustained profitability. Our ability to achieve
sustained profitability in the future depends, in part, upon:
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our ability to obtain and maintain regulatory approval for our products, particularly HETLIOZ
®
for the treatment of Non-24, both in the U.S. and in foreign
countries;
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our ability to successfully commercialize HETLIOZ
®
in the U.S., Europe and other jurisdictions in which
HETLIOZ
®
may receive regulatory approval, if any;
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our ability to successfully raise awareness regarding Non-24 in the medical and patient communities;
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our ability to successfully market and sell Fanapt
®
in the U.S. and our or our partners ability to successfully market and sell Fanapt
®
in Israel, Mexico and other jurisdictions in which we may receive regulatory approval, if any;
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our ability to enter into and maintain agreements to develop and commercialize our products;
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our and our partners ability to develop, have manufactured and market our products;
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our and our partners ability to obtain adequate reimbursement coverage for our products from insurance companies, government programs and other third party payors; and
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our ability to obtain additional research and development funding from collaborative partners or funding for our products.
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In addition, the amount we spend will impact our profitability. Our spending will depend, in part, upon:
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the costs of our marketing or awareness campaigns;
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the progress of our research and development programs for our products, including clinical trials;
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the time and expense that will be required to pursue FDA and/or foreign regulatory approvals for our products and whether such approvals are obtained on a timely basis, if at all;
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the time and expense required to prosecute, enforce and/or challenge patent and other intellectual property rights;
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the cost of operating and maintaining development and research facilities;
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the cost of third party manufacturers;
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the number of additional products we pursue;
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how competing technological and market developments affect our products;
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the cost of possible acquisitions of technologies, products, product rights or companies;
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the cost of obtaining licenses to use technology owned by others for proprietary products and otherwise;
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the costs and effects of potential litigation; and
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the costs associated with recruiting and compensating a highly skilled workforce in an environment where competition for such employees may be intense.
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We may not achieve all or any of these goals and, thus, we cannot provide assurances that we will ever be profitable on a sustained basis or
achieve significant revenues. Even if we do achieve some or all of these goals, we may not achieve significant or sustained commercial success.
Our ability to use net operating loss carryforwards and tax credit carryforwards to offset future taxable income may be limited as a
result of transactions involving our common stock.
In general, under Section 382 of the Internal Revenue Code of 1986, as
amended (IRC), a corporation that undergoes an ownership change is subject to limitations on its ability to utilize its pre-change net operating losses (NOLs) and certain other tax assets (tax attributes) to offset future taxable income.
In general, an ownership change occurs if the aggregate stock ownership of certain stockholders increases by more than 50 percentage points over such stockholders lowest percentage ownership during the testing period (generally
three years). Transactions involving our common stock, even those outside our control, such as purchases or sales by investors, within the testing period could result in an ownership change. A limitation on our ability to utilize some or all of
our NOLs or credits could have a material adverse effect on our results of operations and cash flows. Ownership changes did occur as of December 31, 2008 and December 31, 2014. Our management determined that there was sufficient
Built-In-Gain as of December 31, 2008 to offset the IRC Section 382 limitation generated by the ownership change. Our management believes that there was sufficient Built-In-Gain as of December 31, 2014 to offset the IRC
Section 382 limitation generated by the ownership change. Any future ownership changes may cause our existing tax attributes to have additional limitations.
26
If we fail to obtain the capital necessary to fund our research and development activities
and commercialization efforts, we may be unable to continue operations or we may be forced to share our rights to commercialize our products with third parties on terms that may not be attractive to us.
Our activities will necessitate significant uses of working capital throughout 2017 and beyond. It is uncertain whether our existing funds will
be sufficient to meet our operating needs. As of December 31, 2016, our total cash and cash equivalents and marketable securities were $141.3 million. Our long term capital requirements are expected to depend on many factors, including, among
others:
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our ability to successfully commercialize HETLIOZ
®
and Fanapt
®
globally;
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outcomes of ongoing and potential patent litigation;
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costs of developing and maintaining sales, marketing and distribution channels and our ability to sell our products;
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market acceptance of our products;
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costs involved in establishing manufacturing capabilities for commercial quantities of our products;
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the number of potential formulations and products in development;
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progress with pre-clinical studies and clinical trials;
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time and costs involved in obtaining regulatory (including FDA) approval;
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costs involved in preparing, filing, prosecuting, maintaining and enforcing patent, trademark and other intellectual property claims;
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competing technological and market developments;
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costs for recruiting and retaining employees and consultants;
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costs for training physicians; and
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legal, accounting, insurance and other professional and business related costs.
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As a result,
we may need to raise additional capital to fund our anticipated operating expenses and execute on our business plans. In our capital-raising efforts, we may seek to sell debt securities or additional equity securities, obtain a bank credit facility,
or enter into partnerships or other collaboration agreements. The sale of additional equity or debt securities, if convertible, could result in dilution to our stockholders and may also result in a lower price for our common stock. The incurrence of
indebtedness would result in increased fixed obligations and could also result in covenants that could restrict our operations. However, we may not be able to raise additional funds on acceptable terms, or at all. If we are unable to secure
sufficient capital to fund our planned activities, we may not be able to continue operations, or we may have to enter into partnerships or other collaboration agreements that could require us to share commercial rights to our products to a greater
extent or at earlier stages in the drug development process than is currently intended. These partnerships or collaborations, if consummated prior to proof-of-efficacy or safety of a given product, could impair our ability to realize value from that
product. If additional financing is not available when required or is not available on acceptable terms, we may be unable to fund our operations and planned growth, develop or enhance our technologies or products, take advantage of business
opportunities or respond to competitive market pressures, any of which would materially harm our business, financial condition and results of operations.
If our contract research organizations do not successfully carry out their duties or if we lose our relationships with contract research
organizations, our drug development efforts could be delayed.
Our arrangements with contract research organizations are critical
to our success in bringing our products to the market and promoting such marketed products profitably. We are dependent on contract research organizations, third-party vendors and investigators for pre-clinical testing and clinical trials related to
our drug discovery and development efforts and we will likely continue to depend on them to assist in our future discovery and development efforts. These parties are not our employees and we cannot control the amount or timing of resources that they
devote to our programs. As such, they may not complete activities on schedule or may not conduct our clinical trials in accordance with regulatory requirements or our stated protocols. The parties with which we contract for execution of our clinical
trials play a significant role in the conduct of the trials and the subsequent collection and analysis of data. If they fail to devote sufficient time and resources to our drug development programs or if their performance is substandard, it will
delay the development, approval and commercialization of our products. Moreover, these parties may also have relationships with other commercial entities, some of which may compete with us. If they assist our competitors, it could harm our
competitive position.
Our contract research organizations could
merge with or be acquired by other companies or experience financial or other setbacks unrelated to our collaboration that could, nevertheless, materially adversely affect our business, results of operations and financial condition.
If we lose our relationship with any one or more of these parties, we could experience a significant delay in both identifying another
comparable provider and then contracting for its services. We may be unable to retain an alternative provider on reasonable terms, if at all. Even if we locate an alternative provider, it is likely that this provider may need additional time to
respond to our needs and may not provide the same type or level of service as the original provider. In addition, any provider that we retain will be subject to current Good Laboratory Practices, and similar foreign standards and we do not have
control over compliance with these regulations by these providers. Consequently, if these practices and standards are not adhered to by these providers, the development and commercialization of our products could be delayed.
27
We rely on a limited number of third party manufacturers to formulate and manufacture our
products and our business will be seriously harmed if these manufacturers are not able to satisfy our demand and alternative sources are not available.
Our expertise is primarily in the research and development and pre-clinical and clinical trial phases of product development. We do not have an
in-house manufacturing capability and depend completely on a small number of third-party manufacturers and active pharmaceutical ingredient formulators for the manufacture of our products. Therefore, we are dependent on third parties for our
formulation development and manufacturing of our products. This may expose us to the risk of not being able to directly oversee the production and quality of the manufacturing process and provide ample commercial supplies to successfully launch and
maintain the marketing of our products. Furthermore, these third party contractors, whether foreign or domestic, may experience regulatory compliance difficulty, mechanical shut downs, employee strikes, or other unforeseeable events that may delay
or limit production. Our inability to adequately establish, supervise and conduct (either ourselves or through third parties) all aspects of the formulation and manufacturing processes would have a material adverse effect on our ability to develop
and commercialize our products.
In January 2014, we entered into a manufacturing agreement with Patheon Pharmaceuticals Inc. (Patheon)
for the manufacture of commercial supplies of HETLIOZ
®
20 mg capsules. In May 2016, we entered into a manufacturing agreement with Patheon for the manufacture of commercial supplies of Fanapt
®
capsules. We do not have exclusive long-term agreements with any other third party manufacturers of our products. If Patheon, or any other third party manufacturer, is unable or unwilling to
perform its obligations under our manufacturing agreements for any reason, we may not be able to locate alternative acceptable manufacturers or formulators or enter into favorable agreements with them. Any inability to acquire sufficient quantities
of our products in a timely manner from these third parties could adversely affect sales of our products, delay clinical trials and prevent us from developing our products in a cost-effective manner or on a timely basis. In addition, manufacturers
of our products are subject to cGMP and similar foreign standards and we do not have control over compliance with these regulations by our manufacturers. If one of our contract manufacturers fails to maintain compliance, the production of our
products could be interrupted, resulting in delays and additional costs. In addition, if the facilities of such manufacturers do not pass a pre-approval or post-approval plant inspection, the FDA will not grant approval and may institute
restrictions on the marketing or sale of our products.
Our manufacturing strategy presents the following additional risks:
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because most of our third-party manufacturers and formulators are located outside of the U.S., there may be difficulties in importing our products or their components into the U.S. as a result of, among other things,
FDA import inspections, incomplete or inaccurate import documentation or defective packaging; and
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because of the complex nature of our products, our manufacturers may not be able to successfully manufacture our products in a cost-effective and/or timely manner.
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Materials necessary to manufacture our products may not be available on commercially reasonable terms, or at all, which may delay the
development, regulatory approval and commercialization of our products.
We and our partners rely on manufacturers to purchase from
third-party suppliers the materials necessary to produce our products for clinical trials and commercialization. Suppliers may not sell these materials to such manufacturers at the times we or our partners need them or on commercially reasonable
terms. We do not have any control over the process or timing of the acquisition of these materials by these manufacturers. Moreover, we currently do not have any agreements for the commercial production of these materials. If the manufacturers are
unable to obtain these materials for our or our partners clinical trials, product testing, potential regulatory approval of our products and commercial scale manufacturing could be delayed, significantly affecting our and our partners
ability to further develop and commercialize our products. If we, our manufacturers or our partners, as applicable, are unable to purchase these materials for our products, there would be a shortage in supply or the commercial launch of such
products would be delayed, which would materially and adversely affect our or our partners ability to generate revenues from the sale of such products.
If we cannot identify, or enter into licensing arrangements for, new products, our ability to develop a diverse product portfolio will
be limited.
A component of our business strategy is acquiring rights to develop and commercialize products discovered or developed
by other pharmaceutical and biotechnology companies for which we may find effective uses and markets through our unique pharmacogenetics and pharmacogenomics expertise for the treatment of central nervous system disorders. Competition for the
acquisition of these products is intense. If we are not able to identify opportunities to acquire rights to commercialize additional products, we may not be able to develop a diverse portfolio of products and our business may be harmed.
Additionally, it may take substantial human and financial resources to secure commercial rights to promising products. Moreover, if other firms develop pharmacogenetics and pharmacogenomics capabilities, we may face increased competition in
identifying and acquiring additional products.
We may not be successful in the development of products for our own account.
In addition to our business strategy of acquiring rights to develop and commercialize products, we may develop products for our
own account by applying our technologies to off-patent drugs as well as developing our own proprietary molecules. Because we will be funding the development of such programs, there is a risk that we may not be able to continue to fund all such
programs to
28
completion or to provide the support necessary to perform the clinical trials, obtain regulatory approvals or market any approved products. We expect the development of products for our own
account to consume substantial resources. If we are able to develop commercial products on our own, the risks associated with these programs may be greater than those associated with our programs with collaborative partners.
If we lose key scientists or management personnel, or if we fail to recruit additional highly skilled personnel, it will impair our
ability to identify, develop and commercialize products.
We are highly dependent on principal members of our management team and
scientific staff, including our Chief Executive Officer, Mihael H. Polymeropoulos, M.D. These executives each have significant pharmaceutical industry experience. The loss of any such executives, including Dr. Polymeropoulos, or any other
principal member of our management team or scientific staff, would impair our ability to identify, develop and market new products. Our management and other employees may voluntarily terminate their employment with us at any time. The loss of the
services of these or other key personnel, or the inability to attract and retain additional qualified personnel, could result in delays to development or approval, loss of sales and diversion of management resources. In addition, we depend on our
ability to attract and retain other highly skilled personnel, including research scientists. Competition for qualified personnel is intense, and the process of hiring and integrating such qualified personnel is often lengthy. We may be unable to
recruit such personnel on a timely basis, if at all, which would negatively impact our development and commercialization programs.
Additionally, we do not currently maintain key person life insurance on the lives of our executives or any of our employees. This
lack of insurance means that we may not have adequate compensation for the loss of the services of these individuals.
Product
liability lawsuits could divert our resources, result in substantial liabilities and reduce the commercial potential of our products.
The risk that we may be sued on product liability claims is inherent in the development and sale of pharmaceutical products. For example, we
face a risk of product liability exposure related to the testing of our products in clinical trials and will face even greater risks upon commercialization by us or our partners of our products. We believe that we may be at a greater risk of product
liability claims relative to other pharmaceutical companies because our products are intended to treat central nervous system disorders, and it is possible that we may be held liable for the behavior and actions of patients who use our products.
These lawsuits may divert our management from pursuing our business strategy and may be costly to defend. In addition, if we are held liable in any of these lawsuits, we may incur substantial liabilities and we or our partners may be forced to limit
or forego further commercialization of one or more of our products. Although we maintain product liability insurance, our aggregate coverage limit under this insurance is $25.0 million, and while we believe this amount of insurance is sufficient to
cover our product liability exposure, these limits may not be high enough to fully cover potential liabilities. As our development activities and commercialization efforts progress and we and our partners sell our products, this coverage may be
inadequate, we may be unable to obtain adequate coverage at an acceptable cost or we may be unable to get adequate coverage at all or our insurer may disclaim coverage as to a future claim. This could prevent the commercialization or limit the
commercial potential of our products. Even if we are able to maintain insurance that we believe is adequate, our results of operations and financial condition may be materially adversely affected by a product liability claim. Uncertainties resulting
from the initiation and continuation of products liability litigation or other proceedings could have a material adverse effect on our ability to compete in the marketplace. Product liability litigation and other related proceedings may also require
significant management time.
European Union Member States tend to impose strict price controls, which may delay or prevent the
further commercial launch or impede the commercial success of HETLIOZ
®
in Europe and adversely affect our future results of operations.
In the European Union, prescription drug pricing and reimbursement are subject to governmental control and reimbursement mechanisms used by
private and public health insurers in the European Union vary by Member State. For the public systems, reimbursement is determined by guidelines established by the legislature or responsible national authority. As elsewhere, inclusion in
reimbursement catalogues focuses on the medical usefulness, need, quality and economic benefits to patients and the health care system. Acceptance for reimbursement comes with cost, use and often volume restrictions, which can vary by Member State.
Although we have received marketing authorization for HETLIOZ
®
from the EC, pricing negotiations with governmental authorities may take a considerable amount of time in those Member States
that impose price controls. For example, we launched HETLIOZ
®
commercially in Germany in August 2016, but we have not yet concluded our pricing negotiations with German authorities. In
addition, to obtain reimbursement or pricing approval for HETLIOZ
®
in some Member States, we may be required to conduct a clinical trial that compares the cost-effectiveness of HETLIOZ
®
, to other available therapies.
Some Member States require approval of the sale
price of a drug before it can be marketed. In many countries, the pricing review period begins after marketing or product licensing approval is granted. In some Member States, prescription pharmaceutical pricing remains subject to continuing
governmental control even after initial approval is granted. As a result, we may be subject to lengthy price regulations that delay or prevent the commercial launch of HETLIOZ
®
in a particular
Member State and negatively impact the revenues that are generated from the sale of HETLIOZ
®
in that country. If reimbursement of
HETLIOZ
®
is unavailable or limited in scope or amount, or if pricing for HETLIOZ
®
is set at unsatisfactory levels or takes too long to
establish, or if there is competition from lower priced cross-border sales, our results of operations will be negatively affected.
29
We may not be able to effectively market and sell our future products, if approved, in the
U.S.
We plan on building our sales and marketing capabilities in the U.S. to commercialize future products, if approved. We expect
to build such capabilities by investing significant amounts of financial and management resources. Furthermore, the cost of establishing and maintaining marketing and sales capabilities may not be justifiable in light of the revenues generated by
any future products.
If we are unable to establish and maintain adequate sales and marketing capabilities for future products or are
unable to do so in a timely manner, we may not be able to generate product revenues from these products which may prevent us from reaching or maintaining profitability.
Legislative or regulatory reform of the healthcare system in the U.S. may affect our ability to sell our products profitably.
PPACA substantially changes the way healthcare is financed by both governmental and private insurers, and significantly impacts
the pharmaceutical industry. PPACA contains a number of provisions that are expected to impact our business and operations, in some cases in ways we cannot currently predict. Changes that may affect our business if we or our partners commercialize
our products in the future include those governing enrollment in federal healthcare programs, reimbursement changes, rules regarding prescription drug benefits under the health insurance exchanges, and fraud and abuse and enforcement. In addition,
continued implementation of PPACA may result in the expansion of new programs such as Medicare payment for performance initiatives, and may impact existing government healthcare programs, such as by improving the physician quality reporting system
and feedback program.
Additional provisions of PPACA may negatively affect our revenues from products that we or our partners
commercialize in the future. For example, as part of PPACAs provisions closing a coverage gap that currently exists in the Medicare Part D prescription drug program, manufacturers of branded prescription drugs are required to provide a 50%
discount on branded prescription drugs dispensed to beneficiaries within this coverage gap. Medicare Part D is a prescription drug benefit available to all Medicare beneficiaries. It is a voluntary benefit that is implemented through private plans
under contractual arrangements with the federal government. Similar to pharmaceutical coverage through private health insurance, Part D plans negotiate discounts from drug manufacturers and pass on some of those savings to Medicare beneficiaries.
PPACA also makes changes to the Medicaid Drug Rebate Program, discussed in more detail below, including increasing the minimum rebate from 15.1% to 23.1% of the average manufacturer price for most innovator products. On February 1, 2016, CMS,
the federal agency that administers the Medicare and Medicaid programs, issued final regulations to implement the changes to the Medicaid Drug Rebate Program under PPACA. These regulations became effective on April 1, 2016.
Many of PPACAs most significant reforms did not take effect until 2014 or thereafter, and the resulting new programs and requirements
will continue to evolve in the next few years. Some states have chosen not to expand their Medicaid programs by raising the income limit to 133% of the federal poverty level. In part because not all states have expanded their Medicaid programs, it
is unclear whether there will be more uninsured patients than anticipated when Congress passed PPACA. For each state that has opted not to expand its Medicaid program, there will be fewer insured patients overall. An increase in the proportion of
uninsured patients who are prescribed products resulting from our proprietary or partnered programs could impact the future sales of any products that are commercialized in the future and our business and results of operations.
Further, in September 2007, the Food and Drug Administration Amendments Act of 2007 was enacted giving the FDA enhanced post-marketing
authority including the authority to require post-marketing studies and clinical trials, labeling changes based on new safety information and compliance with REMS approved by the FDA. The FDAs exercise of this authority could result in delays
or increased costs during product development, clinical trials and regulatory review, increased costs to ensure compliance with post-approval regulatory requirements and potential restrictions on the sale and/or distribution of approved products.
In addition, other legislative changes have been proposed and adopted in the U.S. since PPACA was enacted. On August 2, 2011, the
Budget Control Act of 2011 among other things, created measures for spending reductions by Congress. A Joint Select Committee on Deficit Reduction, tasked with recommending a targeted deficit reduction of at least $1.2 trillion for the years 2013
through 2021, was unable to reach required goals, thereby triggering the legislations automatic reduction to several government programs. This includes aggregate reductions to Medicare payments to providers of up to 2% per fiscal year,
starting in 2013, which will remain in effect until 2024 unless additional congressional action is taken. On January 2, 2013, the American Taxpayer Relief Act of 2012 was signed into law, which, among other things, increased the statute of
limitations period for the government to recover overpayments to providers from three to five years. We expect that additional federal healthcare reform measures will be adopted in the future, any of which could limit the amounts that federal and
state governments will pay for healthcare products and services, and in turn could significantly reduce the projected value of certain development projects and reduce our profitability.
More recently, the new presidential administration and the U.S. Congress have indicated that they may seek to replace PPACA and related
legislation with new healthcare legislation. There is uncertainty with respect to the impact these potential changes may have, if any, and any changes will likely take time to unfold, and could have an impact on coverage and reimbursement for
healthcare items and services covered by plans that were authorized by PPACA. However, we cannot predict the ultimate content, timing or effect of any healthcare reform legislation or the impact of potential legislation on us.
30
We expect that additional state and federal healthcare reform measures will be adopted in the
future, any of which could limit the amounts that federal and state governments will pay for healthcare products and services, which could result in reduced demand for our products once approved or additional pricing pressures, and may adversely
affect our operating results.
Future transactions may harm our business or the market price of our stock.
We regularly review potential transactions related to technologies, products or product rights and businesses complementary to our business.
These transactions could include:
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licensing agreements; and
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co-promotion and similar agreements.
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We may choose to enter into one or more of these
transactions at any time, which may cause substantial fluctuations in the market price of our stock. Moreover, depending upon the nature of any transaction, we may experience a charge to earnings, which could also materially adversely affect our
results of operations and could harm the market price of our stock.
We may undertake strategic acquisitions in the future, and
difficulties integrating such acquisitions could damage our ability to achieve or sustain profitability.
Although we have no
experience in acquiring businesses, we may acquire businesses or assets that complement or augment our existing business. If we acquire businesses with promising products or technologies, we may not be able to realize the benefit of acquiring such
businesses if we are unable to move one or more products through preclinical and/or clinical development to regulatory approval and commercialization. Integrating any newly acquired businesses or technologies could be expensive and time-consuming,
resulting in the diversion of resources from our current business. We may not be able to integrate any acquired business successfully. We cannot assure you that, following an acquisition, we will achieve revenues, specific net income or loss levels
that justify the acquisition or that the acquisition will result in increased earnings, or reduced losses, for the combined company in any future period. Moreover, we may need to raise additional funds through public or private debt or equity
financing to acquire any businesses, which would result in dilution for stockholders or the incurrence of indebtedness and may not be available on terms which would otherwise be acceptable to us. We may not be able to operate acquired businesses
profitably or otherwise implement our growth strategy successfully.
Our operating results may fluctuate significantly due to a
number of factors which make our future results difficult to predict and could cause our operating results to fall below expectations or our guidance.
Our operating results will continue to be subject to fluctuations. The revenues we generate and our operating results will be affected by
numerous factors, including:
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marketing and other expenses;
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manufacturing or supply issues;
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the timing and amount of royalties or milestone payments;
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our addition or termination of development programs;
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variations in the level of expenses related to our products or future development programs;
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regulatory developments affecting our products or those of our competitors; our execution of collaborative, licensing or other arrangements, and the timing of payments we may make or receive under these arrangements;
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any intellectual property infringement or other lawsuit in which we may become involved; and
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the timing and recognition of stock-based compensation expense.
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If our operating results fall
below the expectations of investors or securities analysts or below any guidance we may provide, the price of our common stock could decline substantially. Furthermore, any fluctuations in our operating results may, in turn, cause the price of our
stock to fluctuate substantially. We believe that comparisons of our financial results are not necessarily meaningful and should not be relied upon as an indication of our future performance.
31
We are increasingly dependent on information technology systems, infrastructure and data.
We are increasingly dependent upon information technology systems, infrastructure and data. Our computer systems may be vulnerable
to service interruption or destruction, malicious intrusion and random attack. Security breaches pose a risk that sensitive data, including intellectual property, trade secrets or personal information may be exposed to unauthorized persons or to the
public. Cyber-attacks are increasing in their frequency, sophistication and intensity, and have become increasingly difficult to detect. Cyber-attacks could include the deployment of harmful malware, denial-of service, social engineering and other
means to affect service reliability and threaten data confidentiality, integrity and availability. Our key business partners face similar risks, and a security breach of their systems could adversely affect our security posture. While we continue to
invest data protection and information technology, there can be no assurance that our efforts will prevent service interruptions, or identify breaches in our systems, that could adversely affect our business and operations and/or result in the loss
of critical or sensitive information, which could result in financial, legal, business or reputational harm.
Risks related to intellectual property
and other legal matters
Our rights to develop and commercialize our products are subject in part to the terms and conditions of
licenses or sublicenses granted to us by other pharmaceutical companies.
HETLIOZ
®
is based in part on patents that we have licensed on an exclusive basis and
other intellectual property licensed from Bristol-Myers Squibb Company (BMS). BMS holds certain rights with respect to HETLIOZ
®
in the license agreement. Either party may terminate the license
agreement under certain circumstances, including a material breach of the agreement by the other. In the event we terminate our license, or if BMS terminates our license due to our breach, all rights to HETLIOZ
®
(including any intellectual property we develop with respect to HETLIOZ
®
) will revert or otherwise be licensed back to BMS on an exclusive
basis. Any termination or reversion of our rights to develop or commercialize HETLIOZ
®
, including any reacquisition by BMS of our rights, would have a material adverse effect on our business.
Fanapt
®
is based in part on patents and other intellectual property owned by
Sanofi. Titan Pharmaceuticals, Inc. (Titan) holds an exclusive license from Sanofi to the intellectual property owned by Sanofi, and Titan has sublicensed its rights under such license on an exclusive basis to Novartis. We acquired exclusive rights
to this and other intellectual property through a further sublicense from Novartis. The sublicense with Novartis was amended and restated in October of 2009 to provide Novartis with exclusive rights to commercialize Fanapt
®
in the U.S. and Canada. We retained exclusive rights to Fanapt
®
outside the U.S. and Canada. We acquired all of Novartis rights to
Fanapt
®
in the fourth quarter of 2014 pursuant to an asset transfer agreement and related agreements with Novartis. We may lose our rights to develop and commercialize Fanapt
®
if we fail to comply with certain requirements in the Titan license agreement regarding our financial condition, or if we fail to comply with certain diligence obligations regarding our
development or commercialization activities. Our loss of rights in Fanapt
®
would have a material adverse effect on our business, financial condition and results of operations.
Tradipitant is based in part on patents that we have licensed on an exclusive basis and other intellectual property licensed from Eli Lilly
and Company (Lilly). Lilly may terminate our license if we fail to use our commercially reasonable efforts to develop and commercialize tradipitant or if we materially breach the agreement and fail to cure that breach. In the event that we terminate
our license, or if Lilly terminates our license for the reasons stated above, all of our rights to tradipitant (including any intellectual property we develop with respect to tradipitant) will revert back to Lilly, subject to payment by Lilly to us
of a royalty on net sales of products that contain tradipitant.
AQW051, to which we acquired rights from Novartis in the fourth quarter
of 2014, is based on patents and other intellectual property that we have licensed on an exclusive basis from Novartis. Novartis may terminate our license if we materially breach the agreement, which includes an obligation to use commercially
reasonable efforts to develop and commercialize AQW051, and fail to cure that breach. In the event that Novartis terminates our license for the reasons stated above, all of our rights to AQW051 (including any intellectual property we develop with
respect to AQW051) will revert back to Novartis without compensation.
If our efforts to protect the proprietary nature of the
intellectual property related to our products are not adequate, we may not be able to compete effectively in our markets.
Method
of treatment patents protect the use of a product for the method specified in the patent claims. This type of patent does not prevent a competitor from making and marketing a product that is identical to our product for a use that is outside the
scope of the patented method. Moreover, even if competitors do not actively promote their product for our patented methods, physicians may prescribe these products off-label. Although off-label prescriptions may infringe or contribute to
the infringement of method of treatment patents, such infringement may be difficult to prevent.
Our patents and patent applications may
be challenged or fail to result in issued patents and our existing or future patents may be too narrow to prevent third parties from developing or designing around these patents. In addition, we generally rely on trade secret protection and
confidentiality agreements to protect certain proprietary know-how that is not patentable, for processes for which patents are difficult to enforce and for any other elements of our drug development processes that involve proprietary know-how,
information and technology that is not covered by patent applications. While we require all of our employees, consultants, advisors and any third parties who have access to our proprietary know-how, information and technology to enter into
confidentiality
32
agreements, we cannot be certain that this know-how, information and technology will not be disclosed or that competitors will not otherwise gain access to our trade secrets or independently
develop substantially equivalent information and techniques. Further, the laws of some foreign countries do not protect proprietary rights to the same extent as the laws of the U.S. As a result, we may encounter significant problems in protecting
and defending our intellectual property both in the U.S. and abroad. If we are unable to protect or defend the intellectual property related to our technologies, we will not be able to establish or maintain a competitive advantage in our market.
If we do not obtain protection under the Hatch-Waxman Act and similar foreign legislation to extend our patents and to obtain
market exclusivity for our products, our business will be harmed.
The Hatch-Waxman Act provides for an extension of patent term
for drugs for a period of up to five years to compensate for time spent in development. Assuming we gain a five-year patent term extension for HETLIOZ
®
, and that we continue to have rights
under our license agreement with respect to this product, we would have exclusive rights to the HETLIOZ
®
U.S. new chemical entity patent (the primary patent covering the product as a new
composition of matter) until 2022. We also own HETLIOZ
®
U.S. method of treatment patents (directed to the approved method of treatment as described in the HETLIOZ
®
label approved by the FDA). These patents expire normally in 2033. The Fanapt
®
U.S. new chemical entity patent received the full five-year
patent term extension under the Hatch-Waxman Act and so this patent in the U.S. expired in November 2016. In November 2013, a patent directed to a method of treating patients with Fanapt
®
based on genotype was issued to us by the U.S. Patent and Trademark Office. This patent, which was listed in the FDAs Orange Book in January 2015, is set to expire in 2027. Please see the risk factor entitled We face substantial
competition, which may result in others developing or commercializing products before or more successfully than we do, and Part I, Item 3,
Legal Proceedings,
of this annual report on Form 10-K for additional information. See also
Note 18,
Legal Matters
, to the consolidated financial statements included in Part II of this annual report on Form 10-K for additional information. Eight additional U.S. patents directed to methods of treating patients with Fanapt
®
, which are set to expire between 2025 and 2031, were issued to us in 2014 and 2015.
A directive in the European Union provides that companies that receive regulatory approval for a new medicinal product will have a 10-year
period of market exclusivity for that product (with the possibility of a further one-year extension), beginning on the date of such European regulatory approval, regardless of when the European new chemical entity patent covering such product
expires. A generic version of the approved drug may not be marketed or sold in Europe during such market exclusivity period. This directive is of material importance with respect to Fanapt
®
,
since the European new chemical entity patent for Fanapt
®
has expired.
Assuming
we gain a five-year patent term restoration for tradipitant, and that we continue to have rights under our license agreement with respect to this product, we would have exclusive rights to tradipitant s U.S. new chemical entity patent until
2029. Assuming we gain a five-year patent term restoration for AQW051, and that we continue to have rights under our license agreement with respect to this product, we would have exclusive rights to AQW051s U.S. new chemical entity patent
until 2028.
However, there is no assurance that we will receive the extensions of our patents or other exclusive rights available under
the Hatch-Waxman Act or similar foreign legislation. If we fail to receive such extensions or exclusive rights, our or our partners ability to prevent competitors from manufacturing, marketing and selling generic versions of our products will
be materially impaired.
Litigation or third-party claims of intellectual property infringement could require us to divert resources
and may prevent or delay our drug discovery and development efforts.
Our commercial success depends in part on our not infringing
the patents and proprietary rights of third parties. Third parties may assert that we are employing their proprietary technology without authorization. In addition, third parties may obtain patents in the future and claim that use of our
technologies infringes upon these patents.
Furthermore, parties making claims against us may obtain injunctive or other equitable relief,
which could effectively block our ability to develop and commercialize one or more of our products. Defense of these claims, regardless of their merit, would divert substantial financial and employee resources from our business. In the event of a
successful claim of infringement against us, we may have to pay substantial damages, obtain one or more licenses from third parties or pay royalties. In addition, even in the absence of litigation, we may need to obtain additional licenses from
third parties to advance our research or allow commercialization of our products. We may fail to obtain any of these licenses at a reasonable cost or on reasonable terms, if at all. In that event, we would be unable to develop and commercialize
further one or more of our products.
In addition, in the future we could be required to initiate litigation to enforce our proprietary
rights against infringement by third parties. Prosecution of these claims to enforce our rights against others could divert substantial financial and employee resources from our business. If we fail to enforce our proprietary rights against others,
our business will be harmed.
As described elsewhere in these risk factors and in Part I, Item 3,
Legal Proceedings
, of this
annual report on Form 10-K, we have initiated lawsuits to enforce our patent rights against certain generic pharmaceutical companies.
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Risks related to our common stock
Our stock price has been highly volatile and may be volatile in the future, and purchasers of our common stock could incur substantial
losses.
The realization of any of the risks described in these risk factors or other unforeseen risks could have a dramatic and
adverse effect on the market price of our common stock. Between January 1, 2016 and December 31, 2016, the high and low sale prices of our common stock as reported on The NASDAQ Global Market varied between $6.91 and $18.00. Additionally,
market prices for securities of biotechnology and pharmaceutical companies, including ours, have historically been very volatile. The market for these securities has from time to time experienced significant price and volume fluctuations for reasons
that were unrelated to the operating performance of any one company.
The following factors, in addition to the other risk factors
described in this section, may also have a significant impact on the market price of our common stock:
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our or our partners ability to successfully commercialize our products;
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our ability to successfully execute our commercialization strategies;
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publicity regarding actual or potential testing or trial results relating to products under development by us or our competitors;
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the outcome of regulatory review relating to products under development by us or our competitors;
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regulatory developments in the U.S. and foreign countries;
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developments concerning any collaboration or other strategic transaction we may undertake;
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publicity regarding actual or potential litigation involving us;
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announcements of patent issuances or denials, technological innovations or new commercial products by us or our competitors;
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termination or delay of development or commercialization program(s) by our partners;
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safety issues with our products or those of our competitors;
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announcements of technological innovations or new therapeutic products or methods by us or others;
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actual or anticipated variations in our quarterly operating results;
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changes in estimates of our financial results or recommendations by securities analysts or failure to meet such financial expectations;
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changes in government regulations or policies;
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changes in patent legislation or patent decisions or adverse changes to patent law;
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additions or departures of key personnel or members of our board of directors;
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the publication of negative research or articles about our company, our business or our products by industry analysts or others;
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market rumors or press reports;
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publicity regarding actual or potential transactions involving us; and
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economic, political and other external factors beyond our control.
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We have been and may
in the future be subject to litigation, which could harm our stock price, business, results of operations and financial condition.
We have been the subject of litigation in the past and may be subject to litigation in the future. In the past, following periods of volatility
in the market price of their stock, many companies, including us, have been the subjects of securities class action litigation. Any such litigation can result in substantial costs and diversion of managements attention and resources and could
harm our stock price, business results of operations and financial condition. As a result of these factors, holders of our common stock might be unable to sell their shares at or above the price they paid for such shares.
If there are substantial sales of our common stock, our stock price could decline.
A small number of institutional investors and private equity funds hold a significant number of shares of our common stock. Sales by these
stockholders of a substantial number of shares, or the expectation of such sales, could cause a significant reduction in the market price of our common stock.
In addition to our outstanding common stock, as of December 31, 2016 there were a total of 6,686,764 shares of our common stock that we
have registered and that we are obligated to issue upon the exercise of currently outstanding options and settlement of
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restricted stock unit awards granted under our 2006 and 2016 Equity Incentive Plans. Upon the exercise of these options or settlement of the shares underlying these restricted stock units, as the
case may be, in accordance with their respective terms, these shares may be resold freely, subject to restrictions imposed on our affiliates under Rule 144. If significant sales of these shares occur in short periods of time, these sales could
reduce the market price of our common stock. Any reduction in the trading price of our common stock could impede our ability to raise capital on attractive terms, if at all.
If we fail to maintain the requirements for continued listing on The NASDAQ Global Market, our common stock could be delisted from
trading, which would adversely affect the liquidity of our common stock and our ability to raise additional capital.
Our common
stock is currently listed for quotation on The NASDAQ Global Market. We are required to meet specified listing criteria in order to maintain our listing on The NASDAQ Global Market. If we fail to satisfy The NASDAQ Global Markets continued
listing requirements, our common stock could be delisted from The NASDAQ Global Market, in which case we may transfer to The NASDAQ Capital Market, which generally has lower financial requirements for initial listing or, if we fail to meet its
listing requirements, the over-the-counter bulletin board. Any potential delisting of our common stock from The NASDAQ Global Market would make it more difficult for our stockholders to sell our stock in the public market and would likely result in
decreased liquidity and increased volatility for our common stock.
If securities or industry analysts do not publish research or
reports or publish unfavorable research about our business, our stock price and trading volume could decline.
The trading market
for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business. We currently have research coverage by securities and industry analysts. If one or more of the analysts who
covers us downgrades our stock, our stock price would likely decline. If one or more of these analysts ceases coverage of our Company or fails to regularly publish reports on us, interest in the purchase of our stock could decrease, which could
cause our stock price or trading volume to decline.
You may experience future dilution as a result of future equity offerings.
In order to raise additional capital, we may in the future offer additional shares of our common stock or other securities
convertible into or exchangeable for our common stock at prices that may not be the same as the price per share in previous offerings. We may sell shares or other securities in any other offering at a price per share that is less than the price per
share paid by investors in previous offerings, and investors purchasing shares or other securities in the future could have rights superior to existing stockholders. The price per share at which we sell additional shares of our common stock, or
securities convertible or exchangeable into common stock, in future transactions may be higher or lower than the price per share paid by investors.
Our business could be negatively affected as a result of the actions of activist stockholders.
Proxy contests have been waged against many companies in the biopharmaceutical industry, including us, over the last several years. If faced
with a proxy contest or other type of shareholder activism, we may not be able to respond successfully to the contest or dispute, which would be disruptive to our business. Even if we are successful, our business could be adversely affected by a
proxy contest or shareholder dispute involving us or our partners because:
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responding to proxy contests and other actions by activist stockholders can be costly and time-consuming, disrupting operations and diverting the attention of management and employees;
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perceived uncertainties as to future direction may result in the loss of potential acquisitions, collaborations or in-licensing opportunities, and may make it more difficult to attract and retain qualified personnel and
business partners; and
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if individuals are elected to a board of directors with a specific agenda, it may adversely affect our ability to effectively and timely implement our strategic plan and create additional value for our stockholders.
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These actions could cause our stock price to experience periods of volatility.
Anti-takeover provisions in our charter and bylaws and under Delaware law, and our rights plan could prevent or delay a change in
control of our company.
We are a Delaware corporation and the anti-takeover provisions of Section 203 of the Delaware General
Corporation Law may discourage, delay or prevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after the person becomes an interested stockholder, even if a
change of control would be beneficial to our existing stockholders. In addition, our amended and restated certificate of incorporation and bylaws may discourage, delay or prevent a change in our management or control over us that stockholders may
consider favorable. Our amended and restated certificate of incorporation and bylaws:
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authorize the issuance of blank check preferred stock that could be issued by our board of directors to thwart a takeover attempt;
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do not provide for cumulative voting in the election of directors, which would allow holders of less than a majority of the stock to elect some directors;
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establish a classified board of directors, as a result of which the successors to the directors whose terms have expired will be elected to serve from the time of election and qualification until the third annual
meeting following their election;
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require that directors only be removed from office for cause;
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provide that vacancies on the board of directors, including newly-created directorships, may be filled only by a majority vote of directors then in office;
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limit who may call special meetings of stockholders;
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prohibit stockholder action by written consent, requiring all actions to be taken at a meeting of the stockholders; and
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establish advance notice requirements for nominating candidates for election to the board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings.
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Moreover, in September 2008, our board of directors adopted a rights agreement that unless renewed expires in September 2018, the provisions
of which could result in significant dilution of the proportionate ownership of a potential acquirer and, accordingly, could discourage, delay or prevent a change in our management or control over us.
Prolonged economic uncertainties or downturns, as well as unstable market, credit and financial conditions, may exacerbate certain risks
affecting our business and have serious adverse consequences on our business.
The global economic downturn and market instability
has made the business climate more volatile and more costly. These economic conditions, and uncertainty as to the general direction of the macroeconomic environment, are beyond our control and may make any necessary debt or equity financing more
difficult, more costly, and more dilutive. While we believe we have adequate capital resources to meet current working capital and capital expenditure requirements, a lingering economic downturn or significant increase in our expenses could require
additional financing on less than attractive rates or on terms that are excessively dilutive to existing stockholders. Failure to secure any necessary financing in a timely manner and on favorable terms could have a material adverse effect on our
stock price and could require us to delay or abandon clinical development plans.
Sales of our products will be dependent, in large part,
on reimbursement from government health administration authorities, private health insurers, distribution partners and other organizations. As a result of negative trends in the general economy in the U.S. or other jurisdictions in which we may do
business, these organizations may be unable to satisfy their reimbursement obligations or may delay payment. In addition, federal and state health authorities may reduce Medicare and Medicaid reimbursements, and private insurers may increase their
scrutiny of claims. A reduction in the availability or extent of reimbursement could negatively affect our or our partners product sales and revenue.
In addition, we rely on third parties for several important aspects of our business. For example, we use third parties for sales,
distribution, medical affairs and clinical research, and we rely upon several single source providers of raw materials and contract manufacturers for the manufacture of our products. During challenging and uncertain economic times and in tight
credit markets, there may be a disruption or delay in the performance of our third party contractors, suppliers or partners. If such third parties are unable to satisfy their commitments to us, our business and results of operations would be
adversely affected.