TMCnet News

DEPOMED INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
[November 06, 2014]

DEPOMED INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


(Edgar Glimpses Via Acquire Media NewsEdge) FORWARD-LOOKING INFORMATION Statements made in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this Quarterly Report on Form 10-Q that are not statements of historical fact are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the Exchange Act). We have based these forward-looking statements on our current expectations and projections about future events. Our actual results could differ materially from those discussed in, or implied by, these forward-looking statements. Forward-looking statements are identified by words such as "believe," "anticipate," "expect," "intend," "plan," "will," "may" and other similar expressions. In addition, any statements that refer to expectations, projections or other characterizations of future events or circumstances are forward-looking statements. Forward-looking statements include, but are not necessarily limited to, those relating to: † the commercial success and market acceptance of Gralise® (gabapentin), our once-daily product for the management of postherpetic neuralgia, CAMBIA® (diclofenac potassium for oral solution), our non-steroidal anti-inflammatory drug for the acute treatment of migraine attacks, Zipsor® (diclofenac potassium) liquid filled capsules, our non-steroidal anti-inflammatory drug for the treatment of mild to moderate pain in adults, and Lazanda® (fentanyl) nasal spray, our product for the management of breakthrough cancer pain in adult, opioid-tolerant cancer patients; † the results of our ongoing litigation against filers of Abbreviated New Drug Applications (each, an ANDA) to market generic versions of our products in the United States; † the outcome of our ongoing patent infringement litigation against Purdue Pharma L.P. (Purdue) and Endo Pharmaceuticals Inc. (Endo); † any additional patent infringement or other litigation or proceeding that may be instituted related to Gralise, CAMBIA, Zipsor, Lazanda or any other of our products or product candidates; † our and our collaborative partners' compliance or non-compliance with legal and regulatory requirements related to the promotion of pharmaceutical products in the United States; † our plans to acquire, in-license or co-promote other products; † the results of our research and development efforts; † submission, acceptance and approval of regulatory filings; † our ability to raise additional capital; and † our collaborative partners' compliance or non-compliance with obligations under our collaboration agreements.



Factors that could cause actual results or conditions to differ from those anticipated by these and other forward-looking statements include those more fully described in the "RISK FACTORS" section and elsewhere in this Quarterly Report on Form 10-Q. Except as required by law, we assume no obligation to update any forward-looking statement publicly, or to revise any forward-looking statement to reflect events or developments occurring after the date of this Quarterly Report on Form 10-Q, even if new information becomes available in the future. Thus, you should not assume that our silence over time means that actual events are bearing out as expressed or implied in any such forward-looking statement.

ABOUT DEPOMED Depomed is a specialty pharmaceutical company focused on pain and other CNS conditions. The products that comprise our current specialty pharmaceutical business are Gralise® (gabapentin), a once-daily product for the management of postherpetic neuralgia (PHN) that we launched in October 2011, CAMBIA® (diclofenac potassium for oral solution), our non-steroidal anti-inflammatory drug for the acute treatment of migraine attacks that we acquired in December 2013, Zipsor® (diclofenac potassium) liquid filled capsules, our non-steroidal anti-inflammatory drug for the treatment of mild to moderate acute pain that we acquired in June 2012, and Lazanda® (fentanyl) nasal spray, our product for the management of breakthrough pain in cancer patients 18 years of age and older who are already receiving and who are tolerant to opioid therapy for their underlying persistent cancer pain, that we acquired in July 2013.We actively seek to expand our product portfolio through in-licensing, acquiring or obtaining co-promotion rights to commercially available products or late-stage product candidates that could be marketed and sold effectively with our existing products through our sales and marketing capability.


We also have a portfolio of royalty and milestone producing license agreements based on our proprietary Acuform® gastroretentive drug delivery technology with Mallinckrodt Inc. (Mallinckrodt), Ironwood Pharmaceuticals, Inc. (Ironwood) and Janssen Pharmaceuticals, Inc. (Janssen Pharma).

22 -------------------------------------------------------------------------------- Table of Contents In October 2013, we sold our interests in royalty and milestone payments under our license agreements in the Type 2 diabetes therapeutic area to PDL BioPharma, Inc. (PDL) for $240.5 million (PDL Transaction). The interests sold include royalty and milestone payments accruing from and after October 1, 2013 from: (a) Salix Pharmaceuticals, Inc. (Salix) with respect to sales of Glumetza® (metformin HCL extended-release tablets) in the United States; (b) Merck & Co. Inc. (Merck) with respect to sales of Janumet® XR (sitagliptin and metformin HCL extended-release); (c) Janssen Pharmaceutica N.V. and Janssen Pharma (collectively, Janssen) with respect to potential future development milestones and sales of Janssen's investigational fixed-dose combination of Invokana® (canagliflozin) and extended-release metformin; (d) Boehringer Ingelheim with respect to potential future development milestones and sales of the investigational fixed-dose combinations of drugs and extended-release metformin subject to our license agreement with Boehringer Ingelheim International GMBH (Boehringer Ingelheim); and (e) LG Life Sciences Ltd. (LG) and Valeant International Bermuda SRL (Valeant SRL) for sales of extended-release metformin in Korea and Canada, respectively.

Commercialized Products and Product Candidate Development Pipeline The following table summarizes our and our partners' commercialized products and product candidate development pipeline: Depomed Commercialized Products Product Indication Status Gralise® Management of postherpetic Currently sold in the neuralgia United States.

Launched in October 2011 CAMBIA® Acute treatment of migraine Currently sold in the attacks in adults 18 years of United States age or older Acquired in December 2013 Zipsor® Mild to moderate acute pain Currently sold in the United States.

Acquired in June 2012 Lazanda® Breakthrough pain in cancer Currently sold in the patients 18 years of age and United States older who are already Acquired in July 2013 receiving and who are tolerant to continuous opioid therapy for their underlying persistent cancer pain Partner Commercialized Products and Product Candidates Product / Product Candidate Indication Partner Status XARTEMIS™ XR (oxycodone Management Mallinckrodt Approved by the FDA and hydrochloride and of acute launched in March 2014 acetaminophen) pain severe enough to require opioid treatment and in patients for whom alternative treatment options are ineffective, not tolerated or would otherwise be inadequate MNK-155 Pain Mallinckrodt New Drug Application (NDA) accepted for filing by the FDA in May 2014 Foreign regulatory filings in process NUCYNTA® ER Moderate to Janssen License covers sales of severe NUCYNTA® ER in the chronic United States, Canada pain; and Japan neuropathic pain associated with diabetic peripheral neuropathy (DPN) IW-3718 Refractory GERD Refractory Ironwood In clinical development program using Acuform® GERD 23 -------------------------------------------------------------------------------- Table of Contents Depomed Product Pipeline Product Indication Status DM-1992 Parkinson's disease Top-line results of Phase 2 study reported in November 2012 Commercialized Products Gralise® (Gabapentin) Tablets for the Management of Postherpetic Neuralgia (PHN) In October 2011, we launched and announced the commercial availability of Gralise. Gralise is prescribed for the treatment of postherpetic neuralgia.

Gralise product sales for the three and nine months ended September 30, 2014 were $16.3 million and $42.3 million, respectively. Gralise product sales for the three and nine months ended September 30, 2013 were $9.8 million and $24.5 million, respectively.

CAMBIA® (Diclofenac Potassium for Oral Solution) for the Acute Treatment of Migraine Attacks in Adults 18 Years of Age or Older CAMBIA is a non-steroidal anti-inflammatory drug (NSAID) indicated for the acute treatment of migraine attacks with or without aura in adults 18 years of age or older. We acquired CAMBIA and related product inventory on December 17, 2013 from Nautilus Neurosciences, Inc. (Nautilus), for $48.7 million and the assumption of certain product-related liabilities. We also assumed certain annual third party royalty obligations totaling not more than 11% of CAMBIA net sales.

We began selling CAMBIA in late December 2013 and began commercial promotion of CAMBIA in February 2014. Our CAMBIA product sales were $5.8 million and $15.4 million for the three and nine months ended September 30, 2014, respectively.

Zipsor® (Diclofenac Potassium) Liquid-Filled Capsules for Mild to Moderate Acute Pain Zipsor is a NSAID indicated for relief of mild to moderate acute pain in adults.

Zipsor uses proprietary ProSorb® delivery technology to deliver a finely dispersed, rapidly absorbed formulation of diclofenac. We acquired Zipsor in June 2012 from Xanodyne Pharmaceuticals, Inc. (Xanodyne) for $25.9 million in cash and the assumption of certain product-related liabilities.

We began selling Zipsor in late June 2012 and began commercial promotion of Zipsor in July 2012. We recognized $6.1 million and $18.3 million in Zipsor product sales for the three and nine months ended September 30, 2014, respectively. We recognized $6.0 million and $14.6 million in Zipsor product sales for the three and nine months ended September 30, 2013, respectively.

Lazanda® (Fentanyl) Nasal Spray for the Management of Breakthrough Pain in Cancer Patients, 18 Years of Age and Older, who are already receiving and who are tolerant to opioid therapy for their underlying persistent cancer pain Lazanda nasal spray is an intranasal fentanyl drug used to manage breakthrough pain in adults (18 years of age or older) who are already routinely taking other opioid pain medicines around-the-clock for cancer pain. We acquired Lazanda and certain related product inventory on July 29, 2013 from Archimedes Pharma US, Inc. and its affiliates for $4.0 million in cash and the assumption of certain product-related liabilities.

We began selling Lazanda in August 2013 and began commercial promotion of Lazanda in October 2013. Lazanda product sales were $2.3 million and $4.3 million for the three and nine months ended September 30, 2014, respectively.

Lazanda product sales were $0.4 million for the three and nine months ended September 30, 2013, respectively.

24 -------------------------------------------------------------------------------- Table of Contents License and Development Arrangements Janssen Pharmaceuticals, Inc. -NUCYNTA® ER In August 2012, we entered into a license agreement with Janssen Pharma that grants Janssen Pharma a non-exclusive license to certain patents and other intellectual property rights to our Acuform drug delivery technology for the development and commercialization of tapentadol extended release products, including NUCYNTA ER (tapentadol extended-release tablets). We received a $10.0 million upfront license fee in August 2012 and receive low single digit royalties on net sales of NUCYNTA ER in the U.S., Canada and Japan from and after July 2, 2012 through December 31, 2021.

Mallinckrodt Inc. (formerly Covidien, Ltd.)-Acetaminophen/Opiate Combination Products In November 2008, we entered into a license agreement related to acetaminophen/opiate combination products with Mallinckrodt. The license agreement grants Mallinckrodt worldwide rights to utilize our Acuform technology for the exclusive development of up to four products containing acetaminophen in combination with opiates, two of which Mallinckrodt has elected to develop.

We have received $27.5 million in upfront fees and milestones under the agreement. The upfront fees included a $4.0 million upfront license fee and a $1.5 million advance payment for formulation work we performed under the agreement. The milestone payments include four $0.5 million clinical development milestones, a $5.0 million milestone following the FDA's July 2013 acceptance for filing of the NDA for XARTEMIS XR (oxycodone hydrochloride and acetaminophen) Extended-Release Tablets (CII), previously known as MNK-795, a $10.0 million milestone on FDA approval of XARTEMIS XR, and a $5.0 million milestone following the FDA's May 2014 acceptance for filing of the NDA for MNK-155.

In March 2014, the FDA approved XARTEMIS XR for the management of acute pain severe enough to require opioid treatment and in patients for whom alternative treatment options (e.g., non-opioid analgesics) are ineffective, not tolerated or would otherwise be inadequate. The approval of the NDA triggered a $10.0 million milestone payment to us, which we recognized in first quarter 2014 and received in April 2014. In May 2014, the FDA accepted for filing the NDA for MNK-155. The acceptance for filing of the NDA triggered a $5.0 million milestone payment to us which we recognized in the second quarter of 2014 and received in June 2014. We receive high single digit royalties on net sales of XARTEMIS XR, which was launched in March 2014, and we will receive the same high single digit royalty on net sales of MNK-155 if it is approved.

Ironwood Pharmaceuticals, Inc.-IW-3718 for Refractory GERD In July 2011, we entered into a collaboration and license agreement with Ironwood granting Ironwood a license for worldwide rights to certain patents and other intellectual property rights to our Acuform drug delivery technology for an IW-3718, an Ironwood product candidate under evaluation for refractory GERD.

We have received $3.4 million under the agreement, which includes an upfront payment, reimbursement of initial product formulation work, and three milestones payments. We recognized a milestone payment of $1.0 million in March 2014 as a result of the initiation of clinical trials relating to IW-3718 by Ironwood.

Licensing and Development Agreements Sold to PDL in October 2013 In October 2013, we sold to PDL our milestone and royalty interests in our license agreements in the type 2 diabetes therapeutic area (and any replacements for the agreements) for $240.5 million. The interests sold include royalty and milestone payments accruing from and after October 1, 2013 from: (a) Salix with respect to sales of Glumetza® (metformin HCL extended-release tablets) in the United States; (b) Merck with respect to sales of Janumet® XR (sitagliptin and metformin HCL extended-release); (c) Janssen with respect to potential future development milestones and sales of Janssen's investigational fixed-dose combination of Invokana® (canagliflozin) and extended-release metformin; (d) Boehringer Ingelheim with respect to potential future development milestones and sales of the investigational fixed-dose combinations of drugs and extended-release metformin subject to our license agreement with Boehringer Ingelheim; and (e) LG and Valeant SRL for sales of extended-release metformin in Korea and Canada, respectively. From and after October 1, 2013, PDL will receive all royalty and milestone payments due under the agreements until PDL has received payments equal to $481 million, after which we and PDL will share evenly all net payments received.

25 -------------------------------------------------------------------------------- Table of Contents Salix Pharmaceuticals, Inc. (formerly Santarus, Inc.)-Glumetza® In August 2011, we entered into a commercialization agreement with Salix granting Salix exclusive rights to manufacture and commercialize Glumetza in the United States. The commercialization agreement supersedes the previous promotion agreement between the parties originally entered into in July 2008. Under the commercialization agreement, we granted Salix exclusive rights to manufacture and commercialize Glumetza in the United States in return for a royalty on Glumetza net sales. We recognized $14.6 million and $42.1 million in royalty revenue for the three and nine months ended September 30, 2013, respectively.

Salix pays royalties on Glumetza net product sales in the United States as follows: 26.5% in 2011; 29.5% in 2012; 32.0% in 2013 and 2014; and 34.5% in 2015 and beyond, prior to generic entry of a Glumetza product. In the event of generic entry of a Glumetza product in the United States, the parties will thereafter equally share Glumetza proceeds based on a gross margin split.

Janssen Pharmaceutica N.V.

We have received $10.0 million in upfront and milestone payments, and are eligible for additional milestone payments and royalties under an August 2010 non-exclusive license agreement between us and Janssen related to fixed dose combinations of extended release metformin and Janssen's type 2 diabetes product candidate canagliflozin.

Under the agreement, we granted Janssen a license to certain patents related to our Acuform drug delivery technology to be used in developing the combination products. We also granted Janssen a right to reference the Glumetza NDA in Janssen's regulatory filings covering the products.

In February 2013, we completed a project for Janssen related to this program and recognized $2.2 million in revenue during the first quarter of 2013.

Product Candidate DM-1992 for Parkinson's Disease In January 2012, we initiated a Phase 2 study to evaluate DM-1992 for the treatment of motor symptoms associated with Parkinson's disease. The trial was a randomized, active-controlled, open-label, crossover study testing DM-1992 dosed twice daily against a generic version of immediate-release carbidopa-levodopa dosed as needed. The trial enrolled 34 patients at eight U.S. centers. The study assessed efficacy, safety and pharmacokinetic variables. The primary endpoint for the study was change in off time as measured by patient self-assessment and clinician assessment.

Enrollment was completed in July 2012 and the study was completed in September 2012. In November 2012, we reported top-line results of the Phase 2 study. We continue to evaluate clinical and regulatory strategies and commercial prospects for DM-1992.

CRITICAL ACCOUNTING POLICIES Critical accounting policies are those that require significant judgment and/or estimates by management at the time that the financial statements are prepared such that materially different results might have been reported if other assumptions had been made. We consider certain accounting policies related to revenue recognition, accrued liabilities and stock-based compensation to be critical policies. There have been no changes to our critical accounting policies since we filed our 2013 Form 10-K with the SEC on March 17, 2014. For a description of our critical accounting policies, please refer to our 2013 Form 10-K.

On September 9, 2014, we issued and sold $345.0 million aggregate principal amount of convertible senior notes in a public offering. The convertible debt offering resulted in net proceeds of $334.2 million after deducting the underwriting discount and offering expenses of $10.4 million and $0.4 million, respectively. The 2021 Notes are accounted for in accordance with ASC Subtopic 470-20, Debt with Conversion and Other Options. Under ASC Subtopic 470-20, issuers of certain convertible debt instruments that have a net settlement feature and may be settled in cash upon conversion, including partial cash settlement, are required to separately account for the liability (debt) and equity (conversion option) components of the instrument. The carrying amount of the liability component of any outstanding debt instrument is computed by estimating the fair value of a similar liability without the conversion option.

The amount of the equity component is then calculated by deducting the fair value of the liability component from the principal amount of the convertible debt instrument. See "Note 9 - Debt" of the Note to Consolidated Financial Statements for further information regarding the 2021 Notes.

26 -------------------------------------------------------------------------------- Table of Contents RESULTS OF OPERATIONS Three and Nine Months Ended September 30, 2014 and 2013 Revenue Total revenues are summarized in the following table (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 2014 2013 Product sales: Gralise $ 16,331 $ 9,812 $ 42,301 $ 24,455 Zipsor 6,147 6,022 18,312 14,614 Cambia 5,833 - 15,415 - Lazanda 2,273 444 4,307 444 Total product sales 30,584 16,278 80,335 39,513 Royalties: Glumetza US - 14,578 - 42,060 Others 370 844 1,295 2,539 Total royalty revenue 370 15,422 1,295 44,599 Non-cash PDL royalty revenue $ 19,771 $ - $ 95,852 $ - License and Other revenue: Glumetza $ 760 $ 760 $ 2,280 $ 2,280 Mallinckrodt - 5,000 15,000 5,000 Janssen - - - 2,203 Other - - 1,000 1 Total license and other revenue: 760 5,760 18,280 9,484 Total revenues $ 51,485 $ 37,460 $ 195,762 $ 93,596 Product sales Gralise. We launched and began commercial promotion of Gralise in October 2011.

The increase in Gralise product sales in the first nine months of 2014 relative to the comparable period in 2013 is primarily the result of higher prescription demand and, to a lesser extent, price increases. We expect Gralise product sales and prescriptions to increase from current levels for the remainder of 2014.

CAMBIA. We acquired and began selling CAMBIA in December 2013. We began commercial promotion of CAMBIA in February 2014. We expect CAMBIA product sales and prescriptions to increase from current levels for the remainder of 2014.

Zipsor. We acquired and began selling Zipsor in late June 2012. We began commercial promotion of Zipsor in July 2012. The increase in Zipsor product sales in the first nine months of 2014 relative to the comparable period in 2013 is primarily the result of price increases.

Lazanda. We acquired Lazanda in July 2013 and began selling Lazanda in August 2013. We began commercial promotion of Lazanda in October 2013. We expect Lazanda product sales and prescriptions to increase from current levels for the remainder of 2014.

27 -------------------------------------------------------------------------------- Table of Contents Royalties Glumetza US . Until October 1, 2013, we received royalties from Salix based on net sales of Glumetza in the United States. Royalty revenue from Salix for the three and nine months ended September 30, 2013 was $14.6 million and $42.1 million, respectively, which represents a 32.0% royalty on Salix's net sales of Glumetza. In October 2013, we sold our interest in the Glumetza royalties to PDL, as discussed below.

Other Royalties. Other royalties for the three and nine months ended September 30, 2014 include royalties from Janssen Pharma on net sales of NUCYNTA ER and royalties from Mallinckrodt on net sales of XARTEMIS XR, which was launched in March 2014. Other royalties in the three and nine months ended September 30, 2013 include royalties from Janssen Pharma on net sales of NUCYNTA ER, royalties from Merck on net sales of Janumet® XR, and royalties from Valeant SRL on net sales Glumetza in Canada. In October 2013, we sold our interests in Janumet® XR and Glumetza Canadian royalties to PDL.

Non-Cash Royalty Revenue Related to the PDL Transaction. In October 2013, as noted above, we sold our interests in royalty and milestone payments under our license agreements in the Type 2 diabetes therapeutic area to PDL for $240.5 million. This transaction was accounted for as debt that will be amortized using the interest method over the life of the arrangement. As a result of the debt accounting, even though we did not retain the related royalties and milestones under the transaction (as the amounts are remitted to PDL), we will continue to record revenue related to these royalties and milestones until the amount of the associated debt and related interest is fully amortized. We recognized $19.8 million and $95.9 million of non-cash revenue associated with the PDL Transaction for the three and nine months ended September 30, 2014.

Effective October 1, 2014, Depomed, Valeant, Salix and PDL executed an amended agreement which eliminated any and all continuing obligations on the part of Depomed in the supply of Glumetza 1000mg tablets. We are evaluating the impact of this amendment on the accounting for the PDL transaction.

License and Other Revenue Glumetza. Glumetza license revenue consists of license revenue recognized from the $25.0 million upfront license fee received from Valeant in July 2005 and the $12.0 million upfront fee received from Salix in July 2008.

We are recognizing the $25.0 million upfront license fee payment from Valeant as revenue ratably until October 2021, which represents the estimated length of time our obligations exist under the arrangement related to royalties we are obligated to pay Valeant on net sales of Glumetza in the United States and for our obligation to use Valeant as our sole supplier of the 1000mg Glumetza.

We are recognizing the $12.0 million upfront license payment from Salix as revenue ratably until February 2016, which is the estimated date we expect our obligations will be completed under the commercialization agreement.

Effective October 1, 2014, we assigned all of our rights and obligations under the Glumetza supply agreement to Salix, eliminated any and all continuing obligations on the part of Depomed in the supply of Glumetza 1000mg tablets. We are evaluating the impact of this amendment on our accounting for the deferred license revenue related to upfront payment received from Valeant and Salix.

Mallinckrodt. In March 2014, the FDA approved Mallinckrodt's NDA for XARTEMIS XR. The approval of the NDA triggered a $10.0 million nonrefundable milestone payment to us under our license agreement with Mallinckrodt, which we received in April 2014. In May 2014, the FDA accepted for filing the NDA for MNK-155. The acceptance for filing triggered a $5.0 million nonrefundable milestone payment to us under our license agreement with Mallinckrodt, which we received in July 2014. As the nonrefundable milestones were both substantive in nature and related to past performance, achievement was not reasonably assured at the inception of the agreement and the collectability of the milestones was reasonably assured, we recognized the entire $10.0 million milestone payment related to XARTEMIS approval as revenue in the first quarter of 2014 and we recognized the entire $5.0 million milestone payment related to FDA acceptance for filing of the NDA for MNK-155 in the second quarter of 2014.

Janssen. In February 2013, we completed a project for Janssen related to Janssen's type 2 diabetes product candidate canagliflozin and recognized $2.2 million in revenue.

28 -------------------------------------------------------------------------------- Table of Contents Other. In March 2014, we recognized $1.0 million in revenue relating to a milestone earned under our license agreement with Ironwood related to Ironwood's IW-3718 product candidate for refractory GERD commencing clinical trials. As the nonrefundable milestone was both substantive in nature and related to past performance, achievement was not reasonably assured at the inception of the agreement and the collectability of the milestone was reasonably assured, we recognized the entire $1.0 million as revenue during the first quarter of 2013.

Cost of Sales Cost of sales consists of costs of the active pharmaceutical ingredient, contract manufacturing and packaging costs, inventory write-downs, product quality testing, internal employee costs related to the manufacturing process, distribution costs and shipping costs related to our product sales. Total cost of sales for the three and nine months ended September 30, 2014, as compared to the prior year, was as follows (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 2014 2013 Cost of sales $ 3,523 $ 1,751 $ 11,900 $ 4,923 Dollar change from prior year 1,772 6,977 Percentage change from prior year 101.2 % 141.7 % Cost of sales for the three and nine months ended September 30, 2014 relates to Gralise, CAMBIA, Zipsor and Lazanda. Cost of sales for the three and nine months ended September 30, 2013 relates to Gralise, Zipsor and Lazanda. Cost of sales increased in 2014 as a result of increased unit sales of Gralise and the acquisition of CAMBIA and Lazanda products in 2013.

We began selling CAMBIA in December 2013 and began commercial promotion of CAMBIA in February 2014. The fair value of inventories acquired included a step-up in the value of CAMBIA inventories of $3.7 million which is being amortized to cost of sales as the acquired inventories are sold. The cost of sales related to the step-up value of CAMBIA was $0.5 million and $3.6 million for the three and nine months ended September 30, 2014, respectively. We began selling Lazanda in August 2013 and began commercial promotion of Lazanda in October 2013. The fair value of inventories acquired included a step-up in the value of Lazanda inventories of $0.6 million which is being amortized to cost of sales as the acquired inventories are sold. The cost of sales related to the step-up value of Lazanda was $0.1 million and $0.2 million for the three and nine months ended September 30, 2014, respectively. The cost of sales related to the step-up value of Lazanda for the three and nine months ended September 30, 2013 was insignificant. The fair value of inventories acquired included a step-up in the value of Zipsor inventories of $1.9 million, of which zero and $0.7 million was amortized to cost of sales for the three and nine months ended September 30, 2013, respectively.

Research and Development Expense Our research and development expenses currently include salaries, clinical trial costs, consultant fees, supplies, manufacturing costs for research and development programs and allocations of corporate costs. The scope and magnitude of future research and development expenses cannot be predicted at this time for our product candidates in development, as it is not possible to determine the nature, timing and extent of clinical trials and studies, the FDA's requirements for a particular drug and the requirements and level of participation, if any, by potential partners. As potential products proceed through the development process, each step is typically more extensive, and therefore more expensive, than the previous step. Success in development therefore, generally results in increasing expenditures until actual product approval. Total research and development expense for the three and nine months ended September 30, 2014, as compared to the prior year, was as follows (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 2014 2013 Research and development expense $ 1,644 $ 1,339 $ 5,083 $ 6,049 Dollar change from prior year 305 (966 ) Percentage change from prior year 22.8 % -16.0 % The decrease in research and development expense for the nine months ended September 30, 2014, as compared to the same period in 2013 was primarily due to reduced costs related to our Sefelsa program, which ceased in the first quarter of 2013. We expect research and development expense for the fourth quarter of 2014 to slightly increase from the third quarter of 2013.

29 -------------------------------------------------------------------------------- Table of Contents Selling, General and Administrative Expense Selling, general and administrative expenses primarily consist of personnel, contract personnel, marketing and promotion expenses associated with our commercial products, personnel expenses to support our administrative and operating activities, facility costs and professional expenses, such as legal fees and accounting fees. Total selling, general and administrative expense, as compared to the prior year, was as follows (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2014 2013 2014 2013 Selling, general and administrative expense $ 27,078 $ 26,374 $ 92,166 $ 77,705 Dollar change from prior year 704 14,461 Percentage change from prior year 2.7 % 18.6 % The increase in selling, general and administrative expense for the three and nine months ended September 30, 2014, as compared to the three and nine months ended September 30, 2013 was primarily due to sales and marketing expense related to Lazanda and CAMBIA which we acquired in July 2013 and December 2013, respectively, and higher legal expenses related to our ongoing patent litigation. We expect selling, general and administrative expense in the fourth quarter of 2014 to increase slightly from the third quarter of 2014.

Amortization of Intangible Assets Three Months Ended September 30, Nine Months Ended September 30, (In thousands) 2014 2013 2014 2013 Amortization of intangible assets- Zipsor $ 964 $ 964 $ 2,894 $ 2,888 Amortization of intangible assets- Lazanda 291 194 875 194 Amortization of intangible assets- CAMBIA 1,285 - 3,852 - $ 2,540 $ 1,158 $ 7,621 $ 3,082 The Zipsor product rights of $27.1 million have been recorded as intangible assets on the accompanying condensed consolidated balance sheet and are being amortized over the estimated useful life of the asset on a straight-line basis through July 2019. Total amortization expense for the three and nine months ended September 30, 2013 and September 30, 2014 was approximately $1.0 million and $2.9 million, respectively. The estimated amortization expense for each of the four succeeding fiscal years is expected to be $3.9 million and $2.1 million for 2019.

The Lazanda product rights of $10.5 million have been recorded as intangible assets on the accompanying condensed consolidated balance sheet and are being amortized over the estimated useful life of the asset on a straight-line basis through August 2022. Amortization commenced on July 29, 2013, the date on which we acquired Lazanda. Total amortization expense for the three and nine months ended September 30, 2014 was approximately $0.3 million and $0.9 million, respectively. The estimated amortization expense for each of the five succeeding fiscal years is expected to be $1.2 million.

The CAMBIA product rights of $51.4 million have been recorded as intangible assets on the accompanying condensed consolidated balance sheet and are being amortized over the estimated useful life of the asset on a straight-line basis through December 2023. Amortization commenced on December 17, 2013, the date on which we acquired CAMBIA. Total amortization expense for the three and nine months ended September 30, 2014 was approximately $1.3 million and $3.9 million, respectively. The estimated amortization expense for each of the five succeeding fiscal years is expected to be $5.1 million.

Interest Income and Expense Three Months Ended September 30, Nine Months Ended September 30, (In thousands) 2014 2013 2014 2013 Interest and other income $ 23 $ 27 $ 70 $ 142 Change in fair value of contingent consideration and unfavorable contract (558 ) (285 ) (1,784 ) (440 ) Interest expense on convertible debt (1,352 ) - (1,352 ) - Non-cash interest expense on liability related to sale of future royalties (4,364 ) - (14,646 ) - Other - (17 ) Net interest income (expense) $ (6,251 ) $ (258 ) $ (17,729 ) $ (298 ) Interest and other income decreased during the three and nine months ended September 30, 2014, as compared to the corresponding period in 2013 as a result of lower interest rates on investment balances.

30 -------------------------------------------------------------------------------- Table of Contents The increase in non-cash interest expense on liability related to the PDL Transaction for the three and nine months ended September 30, 2014 compared to the same period 2013 is attributable to the royalty sale transaction that we completed in October 2013. As described above, this transaction has been recorded as debt under the applicable accounting guidance. We impute interest on the transaction and record interest expense based on the amount and timing of royalty and milestone payments expected to be received by PDL over the life of the arrangement. There are a number of factors that could materially affect the estimated interest rate and we will assess this estimate on a periodic basis. As a result, future interest rates could differ significantly and any such change in interest rate will be adjusted prospectively.

Interest expense relates to the $345.0 million aggregate principal amount of the 2021 Notes issued in September 2014. The offering resulted in net proceeds of $334.2 million after deducting the underwriting discount and offering expenses of $10.4 million and $0.4 million, respectively. The interest rate for the 2021 Notes is fixed at 2.50% per annum and is payable semi-annually in arrears on March 1 and September 1 of each year, commencing on March 1, 2015. During the three and nine months ended September 30, 2014, we recognized $0.5 million of accrued coupon interest expense related to the 2021 Notes.

In accordance with accounting guidance on embedded conversion features, we valued and bifurcated the conversion option associated with the 2021 Notes from the respective host debt instrument and initially recorded the conversion option of $115.3 million for the 2021 Notes in "Shareholders' equity" on our Condensed Consolidated Balance Sheets. The resulting debt discounts on the 2021 Notes are being amortized to interest expense at an effective interest rate of 9.34% over the contractual term of the notes. During the three and nine months ended September 30, 2014, we recognized $0.8 million of interest expense related to the amortization of these debt discounts. We expect interest expense to increase in future periods as the three months ended September 30, 2014 reflect accrued interest and amortization of the debt discount and debt issuance costs since September 9, 2014.

Income Tax Provision At the end of 2013, we released our valuation allowance that impacts the comparison of the provision for income taxes for the three and nine months ended September 30, 2014 when compared to the comparable periods for 2013. For the three and nine months ended September 30, 2014, we recorded a provision from income taxes of $4.0 million and $24.1 million, respectively, compared to a provision from income taxes of $0.1 million and $0.1 million for the same period in 2013. The increase in the provision from income taxes in the three and nine months ended September 30, 2014, compared to the same period in 2013, is primarily attributable to an increase in income earned for the nine months ended September 30, 2014 compared to the same period in the prior year. We paid approximately zero and $58.8 million in taxes for the three and nine month period ended September 30, 2014, respectively.

LIQUIDITY AND CAPITAL RESOURCES The following table displays a summary of our cash, cash equivalents and marketable securities as of September 30, 2014 and December 31, 2013: September 30, December 31, (In thousands) 2014 2013 Cash, cash equivalents and marketable securities $ 559,612 $ 276,017 Since inception through September 30, 2014, we have financed our product development efforts and operations primarily from private and public sales of equity securities, including convertible debt securities; the sale of rights to future royalties and milestones to PDL; upfront license, milestone and termination fees from collaborative and license partners; and product sales. In September 2014, we issued and sold $345.0 million of 2021 Notes.

Our cash needs may vary materially from our current expectations because of numerous factors, including: † acquisitions or licenses of complementary businesses, products, technologies or companies; † sales of our marketed products; † expenditures related to our commercialization of Gralise, CAMBIA, Zipsor and Lazanda; † milestone and royalty revenue we receive under our collaborative development and commercialization arrangements; † interest and principal payments on our 2021 Notes; † financial terms of definitive license agreements or other commercial agreements we may enter into; † results of research and development efforts; † changes in the focus and direction of our business strategy and/or research and development programs; and † results of clinical testing requirements of the FDA and comparable foreign regulatory agencies.

31 -------------------------------------------------------------------------------- Table of Contents We fund our operations primarily through revenues from product sales and do not have any committed sources of capital. To the extent that our existing capital resources and revenues from ongoing operations are insufficient to fund our future operations, or product acquisitions and strategic transactions which we may pursue, we will have to raise additional funds through the sale of our equity securities, through debt financing, or from development and licensing arrangements. We may be unable to raise such additional capital on favorable terms or at all. If we raise additional capital by selling our equity or convertible debt securities, the issuance of such securities could result in dilution of our shareholders' equity positions.

The inability to raise any additional capital that may be required to fund our future operations or product acquisitions and strategic transactions which we may pursue could have a material adverse effect on our company.

Cash Flows from Operating Activities Net cash used in operating activities during the nine months ended September 30, 2014 was $59.1 million. Net cash provided by operating activities during the nine months ended September 30, 2013 was approximately $10.4 million. Net cash used in the nine months ended September 30, 2014 was primarily related to income tax payments totaling approximately $58.8 million related to the year ended December 31, 2013.

Cash Flows from Investing Activities Net cash provided by investing activities during the nine months ended September 30, 2014 was approximately $17.3 million primarily due to higher maturities of marketable securities relative to purchases of marketable securities. Net cash provided by investing activities during the nine months ended September 30, 2013 was approximately $22.5 million primarily due to higher proceeds from maturities of marketable securities relative to purchases of marketable securities.

Cash Flows from Financing Activities Cash provided by financing activities during the nine months ended September 30, 2014 was $343.8 million, primarily due to $334.4 million of net proceeds received from the issuance of the 2021 Notes and $7.2 million of proceeds received from employee option exercises. Cash provided by financing activities during the nine months ended September 30, 2013 was $2.3 million and consisted of proceeds from employee option exercises.

Contractual Obligations As of September 30, 2014, our aggregate contractual obligations are as shown in the following table (in thousands): More than 1 Year 2-3 Years 4-5 Years 5 Years Total Term loan - principal $ - $ - $ - $ 345,000 $ 345,000 Term loan - interest 8,433 17,250 17,250 17,250 60,183 Operating leases(1) 3,073 5,554 3,083 5,263 16,973 Purchase commitments 5,775 - - - 5,775 $ 17,281 $ 22,804 $ 20,333 $ 367,513 $ 427,931 -------------------------------------------------------------------------------- (1) Amounts represent payments under a noncancelable office and laboratory lease and under an operating lease for vehicles used by our sales force.

At September 30, 2014, we had non-cancelable purchase orders and minimum purchase obligations of approximately $5.8 million under our manufacturing agreements related to Gralise, Zipsor, Lazanda and CAMBIA. The amounts disclosed only represent minimum purchase requirements.

32 -------------------------------------------------------------------------------- Table of Contents In April 2012, we entered into an office and laboratory lease agreement to lease approximately 52,500 rentable square feet in Newark, California commencing on December 1, 2012 and an additional 8,000 rentable square feet commencing no later than December 1, 2015. The Newark lease included free rent for the first five months of the lease. Lease payments began in May 2013. We have the one-time right to terminate the lease in its entirety effective as of November 30, 2017 by delivering written notice to the landlord on or before December 1, 2016. In the event of such termination, we will pay the landlord the unamortized portion of the tenant improvement allowance, specified additional allowances made by the landlord, waived base rent and leasing commissions, in each case amortized at 8% interest. Our previous lease in Menlo Park, California ended in January 2013.

The table above also excludes non-cancelable purchase orders and minimum purchase obligations of approximately $1.4 million under our supply agreement with Valeant for the supply of 1000mg Glumetza, as these obligations will be fully reimbursed by Santarus.

Off-Balance Sheet Arrangements None.

[ Back To TMCnet.com's Homepage ]