Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended September 30, 2009

or

 

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

For the transition period from              to             

Commission File Number 000-51329

 

 

XenoPort, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   94-3330837

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

3410 Central Expressway,

Santa Clara, California

  95051
(Address of principal executive offices)   (Zip Code)

(408) 616-7200

(Registrant’s telephone number, including area code)

 

 

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    ¨  Yes    ¨  No

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

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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

Total number of shares of common stock outstanding as of October 15, 2009: 30,340,201.

 

 

 


Table of Contents

XENOPORT, INC.

TABLE OF CONTENTS

 

          Page
PART I. FINANCIAL INFORMATION    3

Item 1.

   Unaudited Financial Statements    3
   Balance Sheets as of September 30, 2009 and December 31, 2008    3
   Statements of Operations for the Three and Nine Months Ended September 30, 2009 and 2008    4
   Statements of Cash Flows for the Nine Months Ended September 30, 2009 and 2008    5
   Notes to Financial Statements    6

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    14

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk    21

Item 4.

   Controls and Procedures    22
PART II. OTHER INFORMATION    22

Item 1.

   Legal Proceedings    22

Item1A.

   Risk Factors    22

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds    40

Item 3.

   Defaults Upon Senior Securities    40

Item 4.

   Submission of Matters to a Vote of Security Holders    40

Item 5.

   Other Information    40

Item 6.

   Exhibits    41

Signatures

   42

XenoPort and Transported Prodrug are trademarks of XenoPort, Inc.

Requip XL is a trademark of GlaxoSmithKline.

 

2


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Unaudited Financial Statements

XENOPORT, INC.

BALANCE SHEETS

(Unaudited)

 

     September 30,
2009
    December 31,
2008
 
     (In thousands)  

Current assets:

    

Cash and cash equivalents

   $ 18,798      $ 66,050   

Short-term investments

     137,784        86,733   

Prepaids and other current assets

     4,073        2,920   
                

Total current assets

     160,655        155,703   

Property and equipment, net

     11,211        11,470   

Restricted investments and other assets

     2,028        1,924   
                

Total assets

   $ 173,894      $ 169,097   
                

Current liabilities:

    

Accounts payable

   $ 2,838      $ 2,261   

Accrued compensation

     5,183        4,832   

Accrued preclinical and clinical costs

     2,644        9,707   

Accrued unconsolidated joint operating activities

     937          

Other accrued liabilities

     742        2,001   

Deferred rent

     1,012        789   

Deferred revenue

     2,326        7,278   
                

Total current liabilities

     15,682        26,868   

Deferred revenue

     17,677        19,172   

Deferred rent

     209        1,083   

Commitments and contingencies

    

Stockholders’ equity:

    

Common stock, $0.001 par value; 60,000 shares authorized; 30,338 and 27,247 shares issued and outstanding at September 30, 2009 and December 31, 2008, respectively

     30        27   

Additional paid-in capital

     426,786        360,011   

Accumulated other comprehensive income

     99        539   

Accumulated deficit

     (286,589     (238,603
                

Total stockholders’ equity

     140,326        121,974   
                

Total liabilities and stockholders’ equity

   $ 173,894      $ 169,097   
                

The accompanying notes are an integral part of these interim financial statements.

 

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Table of Contents

XENOPORT, INC.

STATEMENTS OF OPERATIONS

(Unaudited)

 

     Three Months
Ended September 30,
    Nine Months
Ended September 30,
 
     2009     2008     2009     2008  
     (In thousands, except per share amounts)  

Revenues:

        

Collaboration revenue

   $ 379      $ 379      $ 4,137      $ 6,637   

Net revenue from unconsolidated joint operating activities

     24        4,484        24,374        24,744   
                                

Total revenues

     403        4,863        28,511        31,381   
                                

Operating expenses:

        

Research and development

     17,000        23,709        54,017        60,869   

Selling, general and administrative

     8,116        6,537        23,657        18,485   
                                

Total operating expenses

     25,116        30,246        77,674        79,354   
                                

Loss from operations

     (24,713     (25,383     (49,163     (47,973

Interest income

     226        909        1,080        3,934   

Interest and other expense

     (24     (29     (40     (165
                                

Loss before income taxes

     (24,511     (24,503     (48,123     (44,204

Income tax benefit

     (137     (390     (137     (390
                                

Net loss

   $ (24,374   $ (24,113   $ (47,986   $ (43,814
                                

Basic and diluted net loss per share

   $ (0.81   $ (0.96   $ (1.70   $ (1.74
                                

Shares used to compute basic and diluted net loss per share

     30,048        25,215        28,230        25,135   
                                

The accompanying notes are an integral part of these interim financial statements.

 

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Table of Contents

XENOPORT, INC.

STATEMENTS OF CASH FLOWS

(Unaudited)

 

     Nine Months Ended September 30,  
     2009     2008  
     (In thousands)  

Operating activities

    

Net loss

   $ (47,986   $ (43,814

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

    

Depreciation and amortization

     2,713        1,944   

Accretion of investment discounts and amortization of investment premiums, net

     705        (1,284

Stock-based compensation expense

     13,970        10,433   

Changes in assets and liabilities:

    

Accounts receivable

            (580

Prepaids and other current and noncurrent assets

     (1,153     (2,341

Accounts payable

     577        3,381   

Accrued compensation

     351        587   

Accrued preclinical and clinical costs

     (7,063     (2,481

Accrued unconsolidated joint operating activities

     937          

Other accrued liabilities

     (1,259     (1,157

Deferred revenue

     (6,447     2,620   

Deferred rent

     (651     60   
                

Net cash used in operating activities

     (45,306     (32,632
                

Investing activities

    

Purchases of investments

     (168,175     (165,485

Proceeds from sales of investments

            79,719   

Proceeds from maturities of investments

     115,979        125,446   

Change in restricted investments

     (104     (41

Purchases of property and equipment

     (2,454     (6,276
                

Net cash provided by (used in) investing activities

     (54,754     33,363   
                

Financing activities

    

Proceeds from issuance of common stock and exercise of stock options

     52,808        3,206   

Repurchases of common stock

            (6

Payments on equipment financing obligations

            (162
                

Net cash provided by financing activities

     52,808        3,038   
                

Net increase (decrease) in cash and cash equivalents

     (47,252     3,769   

Cash and cash equivalents at beginning of period

     66,050        17,961   
                

Cash and cash equivalents at end of period

   $ 18,798      $ 21,730   
                

The accompanying notes are an integral part of these interim financial statements.

 

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XENOPORT, INC.

NOTES TO FINANCIAL STATEMENTS

(Unaudited)

1. Organization and Summary of Significant Accounting Policies

Nature of Operations

XenoPort, Inc., or the Company, was incorporated in the state of Delaware on May 19, 1999. The Company is a biopharmaceutical company focused on developing a portfolio of internally discovered product candidates that utilize the body’s natural nutrient transport mechanisms to improve the therapeutic benefits of existing drugs. The Company’s development and commercialization efforts are currently focused on potential treatments of central nervous system disorders. Its facilities are located in Santa Clara, California.

In July 2009, the Company completed an underwritten public offering of 2,875,000 shares of its common stock at a price to the public of $19.00 per share, including 375,000 shares representing the exercise in full of the over-allotment option granted to the underwriters. Net cash proceeds from the public offering were $51,213,000, after deducting underwriting discounts, commissions and offering expenses.

Basis of Preparation

The accompanying financial statements as of September 30, 2009 and for the three and nine months ended September 30, 2009 and 2008 are unaudited. These unaudited financial statements have been prepared on the same basis as the annual financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary to present fairly the Company’s financial position as of September 30, 2009 and results of operations for the three and nine months ended September 30, 2009 and 2008 and cash flows for the nine months ended September 30, 2009 and 2008. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from these estimates. The results of operations for the three and nine months ended September 30, 2009 are not necessarily indicative of the results to be expected for the year ending December 31, 2009 or for any other interim period or any other future year. For more complete financial information, these financial statements, and the notes hereto, should be read in conjunction with the audited financial statements for the year ended December 31, 2008 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission, or SEC, on February 26, 2009.

In June 2009, the Financial Accounting Standards Board, or FASB, issued the FASB Accounting Standards Codification, or ASC. Effective this quarter, the ASC became the single source for all authoritative U.S. generally accepted accounting principles recognized by the FASB and is required to be applied to financial statements issued for interim and annual periods ending after September 15, 2009. The ASC does not change U.S. generally accepted accounting principles and did not impact the Company’s financial position or results of operations.

As a result of the Company’s election in April 2009 of the co-promotion option under its development and commercialization agreement with Glaxo Group Limited, or GSK, starting in the second quarter of 2009, this agreement falls within the scope of ASC 808-10, Collaborative Arrangements - Overall, or ASC 808-10. As such, the Company’s revenue from the GSK collaboration agreement has been reclassified within the statements of operations for all periods presented. The statements of operations include the line item “Net revenue from unconsolidated joint operating activities,” which includes all revenue resulting from the Company’s GSK collaboration agreement. Revenues that resulted from the Company’s collaboration agreements with Astellas Pharma Inc. and Xanodyne Pharmaceuticals, Inc. continue to be presented within the “Collaboration revenue” line item. This new presentation has no impact on net loss or net loss per share for any period presented.

 

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XENOPORT, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The following table illustrates the effect of the Company’s application of ASC 808-10 as a result of the Company’s election of the co-promotion option on the Company’s previously reported revenues section within the statements of operations for the three and nine months ended September 30, 2008:

 

     Three Months
Ended September 30,
   Nine Months
Ended September 30,
     2008    2008    2008    2008
     As Previously
Reported
   As
Revised
   As Previously
Reported
   As
Revised
     (In thousands)

Revenues:

           

Collaboration revenue

   $ 4,863    $ 379    $ 31,381    $ 6,637

Net revenue from unconsolidated joint operating activities

          4,484           24,744
                           

Total revenues

   $ 4,863    $ 4,863    $ 31,381    $ 31,381
                           

Revenue Recognition

Revenue arrangements are accounted for in accordance with the provisions of FASB ASC 605-25, Revenue Recognition-Multiple-Element Arrangements, or ASC 605-25, and ASC 808-10. A variety of factors are considered in determining the appropriate method of revenue recognition under these arrangements, such as whether the various elements can be considered separate units of accounting, whether there is objective and reliable evidence of fair value for these elements and whether there is a separate earnings process associated with a particular element of an agreement.

Where there are multiple deliverables combined as a single unit of accounting, revenues are deferred and recognized over the period during which the Company remains obligated to perform services or deliver product. The specific methodology for the recognition of the revenue (e.g., straight-line or according to specific performance criteria) is determined on a case-by-case basis according to the facts and circumstances applicable to a given contract. For contracts with specific performance criteria, the Company utilizes the performance-based expected revenue method of revenue recognition, which requires that the Company estimate the total amount of costs to be expended for a given unit of accounting and then recognize revenue equal to the portion of costs expended to date. The estimated total costs to be expended are subject to revision from time-to-time as the underlying facts and circumstances change.

Payments received in excess of revenues recognized are recorded as deferred revenue until such time as the revenue recognition criteria have been met.

The Company’s collaboration agreements also include potential payments for commercial product supply, product royalties and detail reimbursements. To date, the Company has not received any revenue from these activities.

Collaboration revenue includes revenues from the Company’s collaboration agreements with Astellas and Xanodyne. Net revenue from unconsolidated joint operating activities includes all revenue that results solely from the Company’s collaboration agreement with GSK. The Xanodyne collaboration agreement terminated in July 2009. The Company accounts for the revenue activities of these collaboration agreements as follows:

 

   

Up-front, licensing-type fees. Up-front, licensing-type payments are assessed to determine whether or not the licensee is able to obtain any stand-alone value from the license. Where this is not the case, the Company does not consider the license deliverable to be a separate unit of accounting, and the revenue is deferred with revenue recognition for the license fee being assessed in conjunction with the other deliverables that constitute the combined unit of accounting.

 

   

Milestones. Milestones are assessed on an individual basis, and revenue is recognized from these milestones when earned, as evidenced by acknowledgment from collaborators, provided that (i) the milestone event is substantive and its achievability was not reasonably assured at the inception of the agreement, (ii) the milestone represents the culmination, or progress towards the culmination, of an earnings process and (iii) the milestone payment is non-refundable. Where separate milestones do not meet these criteria, the Company typically uses a performance-based model, with revenue recognition following delivery of effort as compared to an estimate of total expected effort. Milestones that are received after all

 

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Table of Contents

XENOPORT, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

 

substantive deliverables have occurred are considered to be bonus payments and are recognized when earned, assuming all of the other revenue recognition criteria are met.

 

   

Cost-profit sharing. This represents the Company’s share of the profits and losses from the co-promotion of XP13512 with GSK. Amounts are recognized in the period in which the related activities occur, and their financial statement classification is based on the Company’s assessment that these activities constitute part of the Company’s ongoing central operations.

Clinical Trials

The Company accrues and expenses the costs for clinical trial activities performed by third parties based upon estimates of the percentage of work completed over the life of the individual study in accordance with agreements established with contract research organizations and clinical trial sites. The Company determines the estimates through discussions with internal clinical personnel and external service providers as to progress or stage of completion of trials or services and the agreed upon fee to be paid for such services. Costs of setting up clinical trial sites for participation in the trials are expensed immediately as research and development expenses. Clinical trial site costs related to patient enrollment are accrued as patients are entered into the trial and reduced by any initial payment made to the clinical trial site when the first patient is enrolled. Non-refundable advance payments for research and development goods or services are recognized as expense as the related goods are delivered or the related services are provided in accordance with the provisions of FASB ASC 730-20, Research and Development Arrangements, or ASC 730-20.

Fair Value Measurements

The fair value of certain assets and liabilities are accounted for in accordance with the provisions of FASB ASC 820-10, Fair Value Measurements and Disclosures—Overall, or ASC 820-10, which defines fair value and establishes a framework for measuring fair value. ASC 820-10 applies whenever other standards require or permit assets or liabilities to be measured at fair value but does not expand the use of fair value in any new circumstances. ASC 820-10 also requires expanded disclosure of the effect on earnings for items measured using unobservable data, establishes a fair value hierarchy that prioritizes the inputs used to measure fair value and requires separate disclosure by level within the fair value hierarchy.

As defined in ASC 820-10, fair value is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. The Company utilizes market data or assumptions that the Company believes market participants would use in pricing assets or liabilities, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated or generally unobservable. The Company applies the market approach valuation technique for fair value measurements on a recurring basis and maximizes the use of observable inputs and minimizes the use of unobservable inputs.

Subsequent Events

The Company’s policy is to evaluate its subsequent events through the date that the financial statements are issued, which is November 4, 2009 for the third quarter of 2009, in accordance with the provisions of the FASB ASC 855-10, Subsequent Events - Overall, or ASC 855-10. ASC 855-10 sets forth the period after the balance sheet date during which management of a reporting entity shall evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity shall recognize events or transactions occurring after the balance sheet date in its financial statements and the disclosures that an entity shall make about events or transactions that occurred after the balance sheet date.

Recent Accounting Pronouncement

In September 2009, the FASB Emerging Issues Task Force, or EITF, reached a consensus on ASC Update 2009-13 (Topic 605), Multiple-Deliverable Revenue Arrangements, or ASC Update 2009-13. ASC Update 2009-13 applies to multiple-deliverable revenue arrangements that are currently within the scope of ASC 605-25. ASC Update 2009-13 provides principles and application guidance on whether multiple deliverables exist and how the arrangement should be separated and the consideration allocated. ASC Update 2009-13 requires an entity to allocate revenue in an arrangement using estimated selling prices of deliverables, if a vendor does not have vendor-specific objective evidence or third-party evidence of selling price. The update eliminates the use of the residual method and requires an entity to allocate revenue using the relative selling price method and also significantly expands the disclosure requirements for multiple-deliverable revenue arrangements. ASC Update 2009-13 should be applied on a prospective basis for

 

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XENOPORT, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with earlier application permitted. As a result, ASC Update 2009-13 will be effective for the Company no later than the first quarter of fiscal 2011. The adoption of ASC Update 2009-13 may have a material impact on the Company’s financial position or results of operations for future collaborations arrangements.

2. Collaboration Agreements

Astellas Pharma Inc.

In December 2005, the Company entered into a license agreement with Astellas for exclusive rights in Japan, Korea, the Philippines, Indonesia, Thailand and Taiwan (collectively referred to as the Astellas territory) to develop and commercialize the Company’s most advanced product candidate, XP13512, also known as ASP8825 in the Astellas territory. The Company received an initial license payment of $25,000,000 in December 2005, which has been deferred and is being recognized on a straight-line basis over a period that approximates the expected patent life of XP13512. At September 30, 2009, the Company had received milestone payments of $18,000,000, of which $3,000,000 was received in April 2009, and is eligible to receive potential clinical and regulatory milestone payments totaling up to an additional $42,000,000. In addition, the Company is entitled to receive percentage-based royalties on any net sales of XP13512 in the Astellas territory. In each of the three months ended September 30, 2009 and 2008, the Company recognized revenue of $379,000, representing amortization of the up-front license payment under this agreement. In the nine months ended September 30, 2009 and 2008, the Company recognized revenue of $4,137,000 and $1,137,000, respectively, representing amortization of the up-front license payment under this agreement and, for the 2009 period, recognition of a milestone payment in connection with the U.S. Food and Drug Administration, or FDA’s, acceptance for review of the new drug application, or NDA, filed by GSK for XP13512 (also known as GSK1838262). As of September 30, 2009, the Company had recognized an aggregate of $23,808,000 of revenue pursuant to this agreement. At September 30, 2009, $19,192,000 of revenue was deferred under this agreement, of which $1,515,000 was classified within current liabilities and the remaining $17,677,000 was recorded as a noncurrent liability. In addition, the agreement also required Astellas to source all product from the Company under a specified supply agreement and Astellas may request that the Company conduct development activities. In June 2009, the Company amended the terms of the supply agreement, such that Astellas is no longer required to source all finished product from the Company and is only required to source both clinical and commercial supplies of the active pharmaceutical ingredient, or API, form of XP13512 from the Company. Under the supply arrangement and requested development activities, the Company recorded a net offset to research and development expenses of $23,200 and $369,000 in the three months ended September 30, 2009 and 2008, respectively, and $601,000 and $1,296,000, in the nine months ended September 30, 2009 and 2008, respectively.

Glaxo Group Limited

In February 2007, the Company entered into an exclusive collaboration with GSK to develop and commercialize XP13512 in all countries of the world excluding the Astellas territory (collectively referred to as the GSK territory). In March 2007, GSK made an up-front, non-refundable license payment of $75,000,000. In addition, GSK has agreed to make additional payments of: (i) up to $275,000,000 upon the achievement of additional clinical and regulatory milestones, of which $85,000,000 has been received to date, including a milestone payment of $20,000,000 received in March 2009; and (ii) up to $290,000,000 upon the achievement of specified XP13512 sales levels. Under the terms of the agreement, GSK is responsible for all future development costs and GSK is solely responsible for the manufacturing of XP13512 to support its development and commercialization within the GSK territory. The Company has concluded that the up-front license payment does not have value to GSK on a stand-alone basis without the benefit of the specified development activities that the Company will perform in connection with XP13512 and that $85,000,000 of milestones payable for development activities were either not sufficiently substantive or not sufficiently at risk to be accounted for using the “when-earned” model. Accordingly, these milestones and the up-front payment were combined into one unit of accounting that is being recognized over the best estimate of the development period to commercialization of the product during which time delivery of substantially all of the efforts required for the completion of the Company’s contractual responsibilities under the GSK agreement is expected to occur. As of September 30, 2009, the Company had recognized an aggregate of $159,189,000 of up-front license and milestone revenue pursuant to this agreement. At September 30, 2009, $811,000 of up-front license and milestone revenue was deferred under this agreement, all of which was classified within current liabilities.

In April 2009, the Company exercised the option contained in the agreement to co-promote and share profits and losses from the potential future sales of XP13512 in the United States. Assuming FDA approval of the XP13512 NDA for the treatment of moderate-to-severe primary restless legs syndrome, or RLS, the Company will field a U.S. sales force of between 50 and 100 representatives

 

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XENOPORT, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

to promote XP13512. Under the terms of the agreement, as amended in February 2009, the Company has the right to commence the detailing of Requip XL, GSK’s product for Parkinson’s disease, around the time of the XP13512 launch, and the Company would be entitled to continue these detailing activities until the earlier of the launch of a generic form of Requip XL or July 1, 2011. The Company would be compensated by GSK for each detail of Requip XL completed by the Company’s sales representatives through a fee that is separate from the XP13512 joint profit and loss, or P&L, statement. Coincident with the election of the co-promotion option, all allowable expenses under the agreement and any potential future sales of XP13512 are accounted for using a joint P&L statement, in which the Company and GSK share in the resulting operating pre-tax profits and losses. Prior to the launch of XP13512, cash payments to GSK representing the Company’s share of any loss are deferred and will be repayable without interest over a period of time following the launch. Assuming FDA approval of the XP13512 NDA for RLS, GSK would be responsible for: establishing pricing and reimbursement; managed care contracting; receiving, accepting and filling orders; distributing; controlling invoicing, order processing and collecting accounts receivable; and recording sales of XP13512 in the United States. Expenses that can be charged to the joint P&L statement are the cost of goods and certain costs directly related to XP13512 marketing and sales. Sales and marketing expenses of XP13512 that the Company incurs that are not charged to the joint P&L statement are classified as selling, general and administrative operating expenses within the Company’s statements of operations. The Company’s exercise of the co-promotion option and its participation in the profit share arrangement may be reversed at any time upon notice to GSK with no penalty to the Company, in which case the original royalty-based compensation structure under the agreement would apply for net sales of XP13512 in the United States. The Company has concluded that the potential details of XP13512 and Requip XL and the amount from the joint P&L statement together constitute one unit of accounting separate from the previously established milestone and up-front payment unit of accounting. The Company also has determined the commercialization of its portfolio of product candidates to be part of its core operations, and accordingly concluded that all revenue resulting from the Company’s GSK collaboration agreement is presented in the net revenue from unconsolidated joint operating activities line item in the revenues section of the statements of operations in the period the related activities occur. The Company began recording its share of pre-launch operating losses from the joint P&L statement of XP13512 in the second quarter of 2009. No detailing activities occurred and no detail reimbursements were recognized in the three or nine months ended September 30, 2009. The collaboration between GSK and the Company was created through a contractual arrangement, not through a joint venture or other legal entity.

The Company’s net revenue from unconsolidated joint operating activities from the collaboration agreement was calculated as follows:

 

     Three Months
Ended September 30,
   Nine Months
Ended September 30,
     2009     2008    2009     2008
     (In thousands)

Up-front license and development milestone revenue

   $ 635      $ 4,484    $ 25,311      $ 24,744

XenoPort’s share of pre-launch operating losses

     (611          (937    
                             

Net revenue from unconsolidated joint operating activities

   $ 24      $ 4,484    $ 24,374      $ 24,744
                             

Xanodyne Pharmaceuticals, Inc.

In October 2007, the Company licensed to Xanodyne exclusive rights to develop and commercialize XP21510 in the United States, including for the potential treatment of women diagnosed with menorrhagia, or heavy menstrual bleeding. In exchange for these rights, the Company received and recognized non-refundable cash payments totaling $13,000,000, of which $6,000,000 was paid to the Company upon execution of the agreement, $6,000,000 was paid in October 2008 and $1,000,000 was paid in April 2008 as a milestone payment. In July 2009, the collaboration agreement with Xanodyne terminated and all XP21510 product rights reverted to the Company. In the three and nine months ended September 30, 2009, no revenue was recognized under this agreement. In the three and nine months ended September 30, 2008, the Company recognized revenue of $0 and $5,500,000, respectively, representing the Company’s completion of the transfer of manufacturing and supply responsibilities to Xanodyne and recognition of the first milestone payment with respect to XP21510 under this agreement. As of September 30, 2009, the Company had recognized an aggregate of $13,000,000 of revenue pursuant to this agreement. At September 30, 2009, no revenue was deferred under this agreement.

 

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XENOPORT, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

3. Net Loss per Share

Basic net loss per share is calculated by dividing the net loss by the weighted-average number of common shares outstanding for the period, less the weighted-average number of unvested common shares subject to repurchase, without consideration for potential common shares. Diluted net loss per share is computed by dividing the net loss by the weighted-average number of common shares outstanding for the period, less the weighted-average number of unvested common shares subject to repurchase, plus any dilutive potential common shares for the period determined using the treasury-stock method. For purposes of this calculation, restricted stock units, options to purchase stock and warrants are considered to be potential common shares and are only included in the calculation of diluted net loss per share when their effect is dilutive.

 

     Three Months
Ended September 30,
    Nine Months
Ended September 30,
 
     2009     2008     2009     2008  
     (In thousands, except per share amounts)  

Numerator:

        

Net loss

   $ (24,374   $ (24,113   $ (47,986   $ (43,814
                                

Denominator:

        

Weighted-average common shares outstanding

     30,048        25,226        28,230        25,161   

Less: Weighted-average unvested common shares subject to repurchase

            (11            (26
                                

Denominator for basic and diluted net loss per share

     30,048        25,215        28,230        25,135   
                                

Basic and diluted net loss per share

   $ (0.81   $ (0.96   $ (1.70   $ (1.74
                                

Outstanding securities not included in the computation of diluted net loss per share as they had an antidilutive effect:

        

Restricted stock units and options to purchase common stock

     4,185        3,557        4,185        3, 557   

Warrants outstanding

     305        21        305        21   
                                
     4,490        3,578        4,490        3,578   
                                

4. Comprehensive Loss

The Company displays comprehensive loss and its components as part of the annual statement of stockholders’ equity. Comprehensive loss is comprised of net loss and unrealized gains (losses) on available-for-sale securities. Total comprehensive loss was as follows:

 

     Three Months
Ended September 30,
    Nine Months
Ended September 30,
 
     2009     2008     2009     2008  
     (In thousands)  

Net loss

   $ (24,374   $ (24,113   $ (47,986   $ (43,814

Change in unrealized gains (losses) on available-for-sale securities

     (72     49        (440     (425
                                
   $ (24,446   $ (24,064   $ (48,426   $ (44,239
                                

 

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XENOPORT, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

5. Cash and Cash Equivalents, Short-Term Investments and Restricted Investments

The following are summaries of cash and cash equivalents, short-term investments and restricted investments (in thousands):

 

     Cost    Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Estimated
Fair Value

As of September 30, 2009:

          

Cash

   $ 2,794    $    $      $ 2,794

Money market funds

     11,754                  11,754

U.S. government sponsored agencies

     127,844      100      (4     127,940

U.S. treasury securities

     14,091      3             14,094

Certificates of deposit

     1,928                  1,928
                            
   $ 158,411    $ 103    $ (4   $ 158,510
                            

Reported as:

          

Cash and cash equivalents

           $ 18,798

Short-term investments

             137,784

Restricted investments

             1,928
              
           $ 158,510
              
     Cost    Gross
Unrealized
Gains
   Gross
Unrealized
Losses
    Estimated
Fair Value

As of December 31, 2008:

          

Cash

   $ 45,265    $    $      $ 45,265

Money market funds

     20,785                  20,785

U.S. government sponsored agencies

     60,266      408             60,674

Corporate debt securities

     25,928      131             26,059

Certificates of deposit

     1,824                  1,824
                            
   $ 154,068    $ 539    $      $ 154,607
                            

Reported as:

          

Cash and cash equivalents

           $ 66,050

Short-term investments

             86,733

Restricted investments

             1,824
              
           $ 154,607
              

At September 30, 2009 and December 31, 2008, the contractual maturities of all investments held were less than one year.

No gross realized gains or losses were recognized in the three or nine months ended September 30, 2009. The Company recognized $0 and $445,000 in the three and nine months ended September 30, 2008, respectively, of gross realized gains on sales of short-term investments based on the specific identification method.

 

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XENOPORT, INC.

NOTES TO FINANCIAL STATEMENTS—(Continued)

(Unaudited)

 

The Company’s available-for-sale investments, which include cash equivalents and short-term investments, are measured at fair value using the following inputs (in thousands):

 

          Fair Value Measurements at Reporting Date Using

Description

   Total As of
September 30,
2009
   Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)

Money market funds

   $ 11,754    $ 11,754    $    $

U.S. treasury securities

     14,094           14,094     

U.S. government sponsored agencies

     127,940           127,940     
                           

Total

   $ 153,788    $ 11,754    $ 142,034    $
                           
          Fair Value Measurements at Reporting Date Using

Description

   Total As of
December 31,
2008
   Quoted Prices in
Active Markets
for Identical
Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)

Money market funds

   $ 20,785    $ 20,785    $    $

U.S. government sponsored agencies

     60,674           60,674     

Corporate debt securities

     26,059           26,059     
                           

Total

   $ 107,518    $ 20,785    $ 86,733    $
                           

6. Stock-Based Compensation

Details of the Company’s employee non-cash stock-based compensation are as follows:

 

     Three Months
Ended September 30,
   Nine Months
Ended September 30,
     2009    2008    2009    2008
     (In thousands)

Research and development

   $ 2,589    $ 2,116    $ 7,722    $ 5,669

Selling, general and administrative

     2,130      1,747      6,248      4,764
                           
   $ 4,719    $ 3,863    $ 13,970    $ 10,433
                           

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains 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, which are subject to the “safe harbor” created by those sections. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to our management. All statements other than statements of historical facts are “forward-looking statements” for purposes of these provisions, including any projections or earnings. In some cases, you can identify forward-looking statements by terms such as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “should,” “will,” “would” and similar expressions intended to identify forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance, time frames or achievements to be materially different from any future results, performance, time frames or achievements expressed or implied by the forward-looking statements. We discuss many of these risks, uncertainties and other factors in this Quarterly Report on Form 10-Q in greater detail under the heading “Risk Factors.” Given these risks, uncertainties and other factors, you should not place undue reliance on these forward-looking statements. Also, these forward-looking statements represent our estimates and assumptions only as of the date of this filing. You should read this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from what we expect. We hereby qualify our forward-looking statements by these cautionary statements. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future.

Overview

We are a biopharmaceutical company focused on developing a portfolio of internally discovered product candidates that utilize the body’s natural nutrient transport mechanisms to improve the therapeutic benefits of existing drugs. Our innovative product candidates, which we refer to as Transported Prodrugs, are created by modifying the chemical structure of currently marketed drugs, referred to as parent drugs, and are designed to correct deficiencies in the oral absorption, distribution and/or metabolism of the parent drug. We are currently focusing our development and commercialization efforts on potential treatments of central nervous system, or CNS, disorders.

Our most advanced product candidate, XP13512, also known in the United States as GSK1838262 (gabapentin enacarbil), is being developed for the treatment of a number of CNS disorders. The U.S. Food and Drug Administration, or FDA, has accepted for review a new drug application, or NDA, that was submitted by our partner, Glaxo Group Limited, or GSK, for approval to market XP13512 in the United States for the treatment of moderate-to-severe primary restless legs syndrome, or RLS. RLS is a neurologicial disorder characterized by a compelling urge to move the legs and by uncomfortable and unpleasant sensations in the legs. In September 2009, GSK completed a double-blind, placebo-controlled, cross-over Phase 3b polysomnography clinical trial of XP13512 to evaluate the potential sleep benefits of XP13512 in patients with RLS. XP13512 demonstrated statistically significant improvements compared to placebo on the primary endpoint of the trial, which was wake time during sleep. XP13512 was generally well tolerated, with dizziness and somnolence as the most frequently reported treatment-emergent adverse events. In addition, in August 2009, Astellas Pharma Inc., our partner in Japan and five other Asian countries, announced that it plans to file an NDA with the Pharmaceutical and Medical Devices Agency, or PMDA, in Japan for XP13512 as a potential treatment for moderate-to-severe primary RLS in the second half of its 2009 fiscal year, which ends on March 31, 2010.

GSK is also evaluating XP13512 for the potential treatment of post-herpetic neuralgia, or PHN, a chronic type of neuropathic pain that can follow the resolution of shingles, and as a potential prophylactic therapy for migraine headaches. In September 2009, GSK announced top-line results from a 14-week, double-blind, placebo-controlled Phase 2b clinical trial that enrolled 376 subjects with PHN who had been experiencing pain for at least three months following healing of the herpes zoster skin rash. Subjects were randomized to receive placebo, 1200, 2400 or 3600 mg/day of XP13512 dosed twice a day. All doses of XP13512 demonstrated statistically significant improvements over placebo on the primary endpoint, which was the change from baseline to the end of maintenance treatment in the 24-hour average pain intensity score. XP13512 was generally well tolerated at all doses in this study. The most common adverse events were dizziness and somnolence, and most of these adverse events were mild or moderate in intensity. There was one serious adverse event (gastritis) in the 3600 mg/day dose group that was judged by the investigator to be related to treatment.

In addition, in October 2009, GSK announced top-line results from a double-blind, two-period cross-over Phase 2 clinical trial that enrolled 138 subjects diagnosed with PHN who had been experiencing pain for at least three months following healing of the herpes zoster skin rash. Subjects with a history of inadequate response to gabapentin entered a baseline period during which they received a dose of 1800 mg/day of gabapentin for two weeks. Subjects (N=96) who had a 24-hour average pain score of at least four on the 11-point pain intensity rating scale were then randomized to receive either 1200 mg/day of XP13512 for the first 28-day treatment period followed by 3600 mg/day for the second 28-day treatment period, or 3600 mg/day followed by 1200 mg/day.

 

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Subjects received 2400 mg/day of XP13512 for four days in between the two treatment periods. The primary endpoint in this trial was the change from baseline to the end of the treatment period in the 24-hour average pain intensity score. A greater reduction in the 24-hour average pain score was observed for the 3600 mg/day dose than for the 1200 mg/day dose, which reduction was statistically significant. XP13512 was well tolerated at both doses in this study. The only treatment-emergent adverse event occurring in greater than or equal to 5% of subjects taking XP13512 was nasopharyngitis.

We are evaluating our second product candidate, XP19986, also known as arbaclofen placarbil, for the potential treatment of gastroesophageal reflux disease, or GERD, and spasticity in patients with spinal cord injury. In October 2009, we announced the initiation of a multi-center, double-blind, placebo-controlled Phase 2b clinical trial of XP19986 in patients with GERD who remain symptomatic despite treatment with proton pump inhibitors, or PPIs. The Phase 2b trial is designed to assess the efficacy and safety of XP19986 as adjunctive therapy to PPIs and is expected to enroll approximately 425 patients. Subjects with a history of incomplete response to a PPI will undergo a three-week run-in PPI therapy followed by a six-week treatment period on PPI therapy plus either 20 mg or 40 mg of XP19986 dosed once daily, 20 mg or 30 mg of XP19986 dosed twice daily or placebo. The primary endpoint of the trial will examine heartburn. Regurgitation will be assessed as a key secondary endpoint.

In September 2009, we announced top-line results from a randomized, double-blind, placebo-controlled Phase 2 clinical trial of XP19986 in patients with acute moderate to severe muscle spasms in the lumbar region. The primary objective of this trial was to evaluate the safety and tolerability of twice-a-day, or BID, doses of 20 mg, 30 mg and 40 mg of XP19986 administered without titration to patients with acute back spasms. XP19986 was safe and generally well tolerated at all dose levels; there were no drug-related serious adverse events. Six subjects in the various XP19986 dose groups withdrew from the study due to adverse events (one in each of the 20 mg and 30 mg BID groups and four in the 40 mg BID group). The most common adverse events (reported more frequently in any XP19986 group than in the placebo group) were somnolence, dizziness and nausea. All adverse events were rated as mild to moderate in intensity. Several secondary efficacy measures were assessed, including pain severity score. Efficacy measures in subjects in all treatment groups were highly variable, and no differences between XP19986 doses and placebo on these secondary efficacy measures were observed. Given the high variability in efficacy measures observed in this trial, we will not be pursuing further development of XP19986 for patients with acute back spasms.

We are evaluating our third product candidate, XP21279, for the potential treatment of Parkinson’s disease. We are currently conducting a repeat-dose pharmacokinetic study of a sustained-release formulation of XP21279 for patients with Parkinson’s disease.

In July 2009, our collaboration agreement with Xanodyne Pharmaceuticals, Inc. terminated and all product rights to our fourth product candidate, XP21510, reverted to us. We are evaluating XP21510 for the potential treatment of women diagnosed with menorrhagia, or heavy menstrual bleeding.

We were incorporated in May 1999 and commenced active operations in August 1999. To date, we have not generated any product revenues. Prior to the three months ended June 30, 2007, we had incurred net losses since our inception. However, due to the recognition of revenues from up-front and milestone payments from our collaborations with GSK, Astellas and Xanodyne, we were profitable in the three-month periods ended June 30, September 30 and December 31, 2007, and for the year ended December 31, 2007. However, while recognition of these revenues resulted in a profitable year for 2007, we incurred net losses in 2008, and we expect to incur net losses in 2009 as we continue our research and development activities and seek to advance our product candidates into later stages of development. As of September 30, 2009, we had an accumulated deficit of approximately $286.6 million.

In April 2009, we exercised the option contained in our development and commercialization agreement with GSK to co-promote and share profits and losses from the potential future sales of XP13512 in the United States. Assuming FDA approval of the XP13512 NDA for RLS, we will field a U.S. sales force of between 50 and 100 representatives to promote XP13512. This sales force will be geographically distributed across the United States and will call on physicians who treat neurological diseases. In connection with the exercise of this option, we amended the agreement in February 2009 with respect to our rights to detail certain GSK products. Previously, we were entitled to detail Requip XL, GSK’s product for Parkinson’s disease, commencing upon the exercise of our co-promotion option and ending upon the launch of XP13512. Under the revised terms, we have the right to commence the detailing of Requip XL around the time of the XP13512 launch. We would be entitled to continue these detailing activities until the earlier of the launch of a generic form of Requip XL or July 1, 2011. We would be compensated by GSK for each detail of Requip XL completed by our sales representatives through a fee that is separate from the XP13512 joint profit and loss, or P&L, statement. Coincident with the election of the co-promotion option, all allowable expenses under the agreement and any potential future sales of XP13512 are accounted for using a joint P&L statement, and we will share in the resulting operating profits and losses. Prior to the launch of XP13512, cash payments to GSK representing our share of any loss will be deferred and will be repayable without interest over a period of time following the launch. Assuming FDA approval of the XP13512 NDA for RLS, GSK would be responsible for recording the sales of XP13512 in the United States. Expenses that can be charged to the joint P&L statement are the cost of goods and certain costs directly related to XP13512 marketing and sales. All future expenses related to the development of potential indications for XP13512 in addition to RLS will not be included in the joint P&L statement and will be borne fully by GSK. Our

 

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exercise of the co-promotion option and our participation in the profit share arrangement may be reversed at any time upon notice to GSK with no penalty to us, in which case the original royalty-based compensation structure under the agreement would apply for net sales of XP13512 in the United States.

In July 2009, we completed an underwritten public offering of 2,875,000 shares of our common stock at a price to the public of $19.00 per share, including 375,000 shares representing the exercise in full of the over-allotment option granted to the underwriters. Net cash proceeds from the public offering were $51.2 million, after deducting underwriting discounts, commissions and offering expenses.

In October 2009, we amended and restated our license agreement with Astellas to reflect that Astellas is no longer required to source the active pharmaceutical ingredient, or API, form of XP13512 from us and we do not have any remaining manufacturing or supply obligations to Astellas for XP13512 API or finished drug product.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenues and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates and judgments related to revenue recognition, stock-based compensation, income taxes and clinical development costs. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting policies and significant judgments and estimates are detailed in our Annual Report on Form 10-K. The following revenue recognition policy has been updated to include the recognition of revenue from cost-profit sharing as a result of our election of the co-promotion option contained in our development and commercialization agreement with GSK.

Revenue Recognition

We have current collaboration agreements with Astellas and GSK, each of which contains multiple elements. We account for these agreements in accordance with the provisions of Financial Accounting Standards Board, or FASB, Accounting Standards Codification, or ASC, 605-25, Revenue Recognition - Multiple-Element Arrangements, or ASC 605-25, and FASB ASC 808-10, Collaborative Arrangements - Overall, or ASC 808-10. We considered a variety of factors in determining the appropriate method of revenue recognition under these arrangements, such as whether the various elements can be considered separate units of accounting, whether there is objective and reliable evidence of fair value for these elements and whether there is a separate earnings process associated with a particular element of an agreement.

Where there are multiple deliverables combined as a single unit of accounting, revenues are deferred and recognized over the period that we remain obligated to perform services or deliver product. The specific methodology for the recognition of the revenue (e.g., straight-line or according to specific performance criteria) is determined on a case-by-case basis according to the facts and circumstances applicable to a given contract.

Our collaboration agreements also include potential payments for product royalties and detail reimbursements. To date, we have not received revenues from these activities.

We account for our current revenue activities as follows:

Up-front, licensing-type fees. To date, these types of fees have been classified within the collaboration agreements as license fees, access fees, rights fees and initial licensing fees, and each of them was non-refundable and payable in connection with the execution of the contract. Up-front, licensing-type payments are assessed to determine whether or not the licensee is able to obtain any stand-alone value from the license. Where this is not the case, we do not consider the license deliverable to be a separate unit of accounting, and we defer the revenue with revenue recognition for the license fee being assessed in conjunction with the other deliverables that constitute the combined unit of accounting.

Milestones. We assess milestones on an individual basis and recognize revenue from these milestones when earned, as evidenced by acknowledgment from our collaborator, provided that (i) the milestone event is substantive and its achievability was not reasonably assured at the inception of the agreement, (ii) the milestone represents the culmination, or progress towards the culmination, of an earnings process and (iii) the milestone payment is non-refundable. Where separate milestones do not meet these

 

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criteria, we typically default to a performance-based model, with revenue recognition following delivery of effort as compared to an estimate of total expected effort. Milestones that are received after all substantive deliverables have occurred are considered to be bonus payments and are recognized when earned, assuming all of the other revenue recognition criteria are met.

Cost-profit sharing. This represents our share of the profits and losses from the co-promotion of XP13512 with GSK. Amounts are recognized in the period in which the related activities occur, and their financial statement classification is based on our assessment that these activities constitute part of our ongoing central operations.

Results of Operations

Three and Nine Months Ended September 30, 2009 and 2008

Revenues

Our collaboration revenue consisted of the recognition of revenues from up-front and milestone payments from our collaborations with Astellas and Xanodyne. Our net revenue from unconsolidated joint operating activities consisted of the recognition of revenue from up-front and milestone payments and the recognition of our share of profits and losses from
co-promotion of XP13512 with GSK.

As a result of our election in April 2009 of the co-promotion option under our development and commercialization agreement with GSK, starting in the second quarter of 2009, this agreement falls within the scope of ASC 808-10. As such, our revenue from the GSK collaboration agreement has been reclassified within the statements of operations for all periods presented. The statements of operations now include the line item “Net revenue from unconsolidated joint operating activities,” which includes all revenue resulting from our GSK collaboration agreement. Revenues that resulted from our collaboration agreements with Astellas and Xanodyne continue to be presented within the “Collaboration revenue” line item. This new presentation has no impact on net loss or net loss per share for any period presented. See Basis of Preparation in Note 1 of the Notes to Financial Statements for the table that illustrates the effect of our adoption of ASC 808-10 and our election of the co-promotion option on our previously reported revenues section within the statements of operations for the three and nine months ended September 30, 2008.

 

     Three Months
Ended September 30,
   Change     Nine Months
Ended September 30,
   Change  
     2009    2008    $     %     2009    2008    $     %  
     (In thousands, except percentages)  

Collaboration revenue

   $ 379    $ 379    $      0   $ 4,137    $ 6,637    $ (2,500   (38 )% 

Net revenue from unconsolidated joint operating activities

     24      4,484      (4,460   (99 )%      24,374      24,744      (370   (1 )% 
                                                

Total revenues

   $ 403    $ 4,863    $ (4,460   (92 )%    $ 28,511    $ 31,381    $ (2,870   (9 )% 
                                                

The decrease in collaboration revenue for the nine months ended September 30, 2009 compared to the same period in 2008 was the result of a $5.5 million decrease in revenue recognized from up-front license and milestone payments under our Xanodyne agreement, partially offset by a $3.0 million increase in revenue recognized from a milestone payment related to the FDA’s acceptance for review of the NDA for XP13512 under our Astellas agreement. The Xanodyne collaboration agreement terminated in July 2009.

The decrease in net revenue from unconsolidated joint operating activities for the three months ended September 30, 2009 compared to the same period in 2008 was the result of a $3.8 million decrease in revenue recognized from up-front license and milestone payments under our GSK agreement and the recognition of $0.6 million representing our share of pre-launch operating losses of XP13512 as a result of our election of the co-promotion option.

The decrease in net revenue from unconsolidated joint operating activities for the nine months ended September 30, 2009 compared to the same period in 2008 was the result of the recognition of $0.9 million representing our share of pre-launch operating losses of XP13512 as a result of our election of the co-promotion option, partially offset by a $0.6 million increase in revenue recognized from up-front license and milestone payments under our GSK agreement.

We expect revenues to fluctuate in the future primarily depending upon our progress against the deliverables specified in the terms of our collaboration with GSK, our share of the operating pre-tax profits and losses for XP13512 under the co-promotion with GSK, the timing of milestone-related activities under our Astellas and GSK collaborations and the extent to which we enter into new, or modify existing, collaborative agreements.

 

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Research and Development Expenses

Research and development expenses consisted of costs associated with our research activities and drug discovery efforts, as well as costs associated with conducting preclinical studies and clinical trials, manufacturing development efforts and activities related to regulatory filings. Of the total research and development expenses for the three and nine months ended September 30, 2009 and 2008, the allocation of costs associated with research and preclinical and clinical development activities approximated the following:

 

     Three Months
Ended September 30,
   Change     Nine Months
Ended September 30,
   Change  
     2009    2008    $     %     2009    2008    $     %  
     (In thousands, except percentages)  

Research

   $ 5,166    $ 5,904    $ (738   (13 )%    $ 15,599    $ 16,172    $ (573   (4 )% 

Preclinical and clinical development

     11,834      17,805      (5,971   (34 )%      38,418      44,697      (6,279   (14 )% 
                                                

Total research and development

   $ 17,000    $ 23,709    $ (6,709   (28 )%    $ 54,017    $ 60,869    $ (6,852   (11 )% 
                                                

The decrease in research and development expenses in the three months ended September 30, 2009 compared to the same period in 2008 was principally due to the following:

 

   

decreased net costs for XP13512 of $3.6 million primarily due to decreased clinical and manufacturing costs;

 

   

decreased net costs for XP19986 of $1.8 million primarily due to decreased clinical costs; and

 

   

decreased net costs for our other development programs of $2.2 million primarily due to decreased manufacturing and toxicology costs; partially offset by

 

   

increased net costs for XP21279 of $0.6 million due to increased clinical costs; and

 

   

increased personnel costs of $0.5 million resulting from increased non-cash stock-based compensation costs.

The decrease in research and development expenses in the nine months ended September 30, 2009 compared to the same period in 2008 was principally due to the following:

 

   

decreased net costs for XP13512 of $8.4 million primarily due to decreased clinical, manufacturing and consulting costs; and

 

   

decreased net costs for our other development programs of $4.2 million primarily due to decreased toxicology and manufacturing costs; partially offset by

 

   

increased net costs for XP21279 of $2.3 million primarily due to increased toxicology and clinical costs; and

 

   

increased personnel costs of $3.7 million resulting from increased headcount and increased non-cash stock-based compensation of $2.1 million.

We expect our research and development expenses to remain relatively constant with 2008 levels in 2009 and 2010. The timing and amount of expenses incurred will primarily depend upon the outcomes of current or future clinical trials for XP19986 and XP21279, as well as the related expansion of our research and development organization, regulatory requirements, advancement of our preclinical programs and product candidate manufacturing costs.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consisted principally of salaries and other related costs for personnel in executive, finance, accounting, business development, information technology, legal, sales, marketing and human resources functions. Other selling, general and administrative expenses included facility costs not otherwise included in research and development expenses, patent-related costs and professional fees for legal, consulting and accounting services.

 

     Three Months
Ended September 30,
   Change     Nine Months
Ended September 30,
   Change  
     2009    2008    $    %     2009    2008    $    %  
     (In thousands, except percentages)  

Selling, general and administrative

   $ 8,116    $ 6,537    $ 1,579    24   $ 23,657    $ 18,485    $ 5,172    28

The increase in selling, general and administrative expenses in the three months ended September 30, 2009 compared to the same period in 2008 was primarily due to increased personnel costs of $1.3 million resulting from increased headcount and increased non-cash stock-based compensation of $0.4 million.

 

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The increase in selling, general and administrative expenses in the nine months ended September 30, 2009 compared to the same period in 2008 was primarily due to increased personnel costs of $4.1 million resulting from increased headcount and increased non-cash stock-based compensation of $1.5 million.

We expect selling, general and administrative expenses to increase in the future due to increasing commercial activities in support of our election of the co-promotion option under our development and commercialization agreement with GSK.

Interest Income and Interest and Other Expense

Interest income consisted primarily of interest earned on our cash equivalents and short-term investments.

 

     Three Months
Ended September 30,
   Change     Nine Months
Ended September 30,
   Change  
     2009    2008    $     %     2009    2008    $     %  
     (In thousands, except percentages)  

Interest income

   $ 226    $ 909    $ (683   (75 )%    $ 1,080    $ 3,934    $ (2,854   (73 )% 

Interest and other expense

   $ 24    $ 29    $ (5   (17 )%    $ 40    $ 165    $ (125   (76 )% 

The decrease in interest income in the three and nine months ended September 30, 2009 compared to the same periods in 2008 was primarily due to lower interest rates.

Income Tax Benefits

In the three and nine months ended September 30, 2009, we recorded $0.1 million of current income tax benefit due to the adoption of a provision in the American Recovery and Reinvestment Tax Act of 2009 that allows corporations to convert carry-forward research and development and Alternative Minimum Tax, or AMT, credits into a separate credit amount, which we plan to claim as a refund for cash in 2010. In the three and nine months ended September 30, 2008, we recorded $0.4 million of current income tax benefit due to the adoption of a provision in the Housing and Economic Recovery Act of 2008 that allows corporations to convert carry-forward research and development and AMT credits into a separate credit amount, which we claimed as a refund for cash in 2009.

Liquidity and Capital Resources

 

     As of
September 30,
2009
   As of
December 31,
2008
     (In thousands)

Cash and cash equivalents and short-term investments

   $ 156,582    $ 152,783

Working capital

     144,973      128,835

Restricted investments

     1,928      1,824

 

     Nine Months Ended September 30,  
     2009     2008  
     (In thousands)  

Cash provided by (used in):

    

Operating activities

   $ (45,306   $ (32,632

Investing activities

     (54,754     33,363   

Financing activities

     52,808        3,038   

Capital expenditures (included in investing activities above)

     (2,454     (6,276

Due to our significant research and development expenditures and the lack of regulatory agency approvals to sell products, we have generated cumulative operating losses since we incorporated in 1999. As such, we have funded our research and development operations primarily through sales of our preferred stock, our initial and subsequent public offerings, our registered direct offering, non-equity payments from our collaborators and government grants. We have received additional funding from capital lease financings, the proceeds from issuance of equity under our various stock plans and interest earned on investments. At September 30, 2009, we had available cash and cash equivalents and short-term investments of $156.6 million. Our cash and investment balances are held in a variety of interest-bearing instruments, including U.S. government sponsored agencies, U.S. treasury securities and money market accounts. Cash in excess of immediate requirements is invested with regard to liquidity and capital preservation, and we seek to minimize the potential effects of concentration and degrees of risk.

 

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In July 2009, we completed an underwritten public offering of 2,875,000 shares of our common stock at a price to the public of $19.00 per share, including 375,000 shares representing the exercise in full of the over-allotment option granted to the underwriters. Net cash proceeds from the public offering were $51.2 million, after deducting underwriting discounts, commissions and offering expenses.

Net cash used in operating activities was $45.3 million and $32.6 million in the nine months ended September 30, 2009 and 2008, respectively. The net cash used in operating activities in the nine months ended September 30, 2009 primarily reflected our net loss and, to a lesser extent, the non-cash changes in operating assets and liabilities, partially offset by non-cash stock-based compensation and depreciation. The net cash used in operating activities in the nine months ended September 30, 2008 primarily reflected our net loss, partially offset by non-cash stock-based compensation.

Net cash provided by (used in) investing activities was $(54.8) million and $33.4 million in the nine months ended September 30, 2009 and 2008, respectively. The net cash used in investing activities for the nine months ended September 30, 2009 was primarily related to the purchases of investments and capital expenditures, partially offset by proceeds from maturities of investments. The net cash provided by investing activities for the nine months ended September 30, 2008 was primarily related to the proceeds from sales and maturities of investments, partially offset by purchases of investments and capital expenditures.

Net cash provided by financing activities was $52.8 million and $3.0 million in the nine months ended September 30, 2009 and 2008, respectively. The net cash provided by financing activities for the nine months ended September 30, 2009 primarily reflected proceeds from the issuance of common stock and the exercise of stock options. The net cash provided by financing activities for the nine months ended September 30, 2008 primarily reflected proceeds from issuance of common stock and exercise of stock options, partially offset by payments on equipment financing obligations and repurchases of common stock.

We believe that our existing capital resources and expected milestone payments, together with interest thereon, will be sufficient to meet our projected operating requirements into the third quarter of 2011. We have based this estimate on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect. Further, our operating plan may change, and we may need additional funds to meet operational needs and capital requirements for product development and commercialization sooner than planned. We currently have no credit facility or committed sources of capital other than potential milestones receivable under our collaborations. Our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement and involves risks and uncertainties, and actual results could vary as a result of a number of factors, including the factors discussed in “Risk Factors.” Because of the numerous risks and uncertainties associated with the development and commercialization of our product candidates, and the extent to which we enter into additional collaborations with third parties to participate in their development and commercialization, we are unable to estimate the amounts of increased capital outlays and operating expenditures associated with our current and anticipated clinical trials. Our future funding requirements will depend on many factors, including:

 

   

the scope, rate of progress, results and cost of our preclinical testing, clinical trials and other research and development activities;

 

   

the timing of potential receipt of FDA approval of XP13512 and its potential commercialization;

 

   

the cost of manufacturing clinical, and establishing commercial, supplies of our product candidates and any products that we may develop;

 

   

the timing of any milestone payments under our collaborative arrangements;

 

   

the number and characteristics of product candidates that we pursue;

 

   

the cost, timing and outcomes of regulatory approvals;

 

   

the cost and timing of establishing sales, marketing and distribution capabilities;

 

   

the terms and timing of any other collaborative, licensing and other arrangements that we may establish;

 

   

the timing and amount of our share of operating losses, if any, from our GSK collaboration;

 

   

the timing, receipt and amount of sales, profit sharing or royalties, if any, from our potential products;

 

   

the cost of preparing, filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; and

 

   

the extent to which we acquire or invest in businesses, products or technologies, although we currently have no commitments or agreements relating to any of these types of transactions.

 

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If we need to raise additional money to fund our operations, funding may not be available to us on acceptable terms, or at all. The credit markets and the financial services industry have recently been experiencing a period of unusual turmoil and upheaval characterized by the bankruptcy, failure, collapse or sale of various financial institutions and an unprecedented level of intervention from the U.S. federal government. These events have generally made equity and debt financing more difficult to obtain. If we are unable to raise additional funds when needed, we may terminate or delay clinical trials for one or more of our product candidates, we may delay our establishment of sales and marketing capabilities or other activities that may be necessary to commercialize our product candidates or we may curtail significant drug development programs that are designed to identify new product candidates. In addition, at any time upon advance notice to GSK, we may exercise the right to revert to a net sales royalty-based compensation structure and forego the right to co-promote XP13512 in the United States. We may seek to raise any necessary additional funds through equity or debt financings, collaborative arrangements with corporate partners or other sources. To the extent that we raise additional capital through licensing arrangements or arrangements with collaborative partners, we may be required to relinquish, on terms that are not favorable to us, rights to some of our technologies or product candidates that we would otherwise seek to develop or commercialize ourselves. To the extent that we raise additional capital through equity financings, dilution to our stockholders would result. Any debt financing or additional equity that we raise may contain terms that are not favorable to our stockholders or us.

Off-Balance Sheet Arrangements

We currently have no material off-balance sheet arrangements as defined in Regulation S-K Item 303(a)(4)(ii).

Contractual Obligations

Our future contractual obligations at September 30, 2009 were as follows (in thousands):

 

     Payments Due by Period

Contractual Obligations

   Total    Less Than
1 Year
   1-3
Years
   3-5
Years
   Greater
Than 5
Years

Operating lease obligations

   $ 18,751    $ 5,455    $ 9,715    $ 3,581    $
                                  

Total fixed contractual obligations

   $ 18,751    $ 5,455    $ 9,715    $ 3,581    $
                                  

Recent Accounting Pronouncement

In September 2009, the FASB Emerging Issues Task Force, or EITF, reached a consensus on ASC Update 2009-13 (Topic 605), Multiple-Deliverable Revenue Arrangements, or ASC Update 2009-13. ASC Update 2009-13 applies to multiple-deliverable revenue arrangements that are currently within the scope of ASC 605-25. ASC Update 2009-13 provides principles and application guidance on whether multiple deliverables exist, how the arrangement should be separated and the consideration allocated. ASC Update 2009-13 requires an entity to allocate revenue in an arrangement using estimated selling prices of deliverables if a vendor does not have vendor-specific objective evidence or third-party evidence of selling price. The update eliminates the use of the residual method and requires an entity to allocate revenue using the relative selling price method and also significantly expands the disclosure requirements for multiple-deliverable revenue arrangements. ASC Update 2009-13 should be applied on a prospective basis for revenue arrangements entered into or materially modified in fiscal years beginning on or after June 15, 2010, with earlier application permitted. As a result, ASC Update 2009-13 will be effective for us no later than the first quarter of fiscal 2011. The adoption of ASC Update 2009-13 may have a material impact on our financial position or results of operations for future collaborations arrangements.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The primary objective of our investment activities is to preserve our capital to fund operations. We also seek to maximize income from our investments without assuming significant risk. To achieve our objectives, we maintain a portfolio of cash equivalents and investments in a variety of securities of high credit quality. As of September 30, 2009, we had cash and cash equivalents and short-term investments of $156.6 million consisting of cash and highly liquid investments deposited in highly-rated financial institutions in the United States. A portion of our investments may be subject to interest rate risk and could fall in value if market interest rates increase. However, because our investments are short-term in duration, we believe that our exposure to interest rate risk is not significant and a 1% movement in market interest rates would not have a significant impact on the total value of our portfolio. We actively monitor changes in interest rates.

 

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We contract for the conduct of certain manufacturing activities with a contract manufacturer in Europe. We made payments in the aggregate of $3.4 million and $2.2 million during the nine months ended September 30, 2009 and 2008, respectively, to this European contract manufacturer. We are exposed to fluctuations in foreign exchange rates in connection with these agreements. To date, the effect of this exposure to these fluctuations in foreign exchange rates has not been material, and we do not expect it to be material in the foreseeable future. We do not hedge our foreign currency exposures. We have not used derivative financial instruments for speculation or trading purposes.

 

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures.

Based on their evaluation as required by paragraph (b) of Rules 13a-15 or 15d-15 under the Securities Exchange Act of 1934, as amended, as of September 30, 2009, our chief executive officer and chief financial officer have concluded that our disclosure controls and procedures (as defined in Securities Exchange Act Rules 13a-15(e) and 15d-15(e)) were effective.

Changes in Internal Control over Financial Reporting.

There were no significant changes in our internal controls over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

We are not a party to any material legal proceedings at this time. From time to time, we may be involved in litigation relating to claims arising out of our ordinary course of business.

 

Item 1A. Risk Factors.

The following risks and uncertainties may have a material adverse effect on our business, financial condition or results of operations. Investors should carefully consider the risks described below before making an investment decision. The risks described below are not the only ones we face. Additional risks not presently known to us or that we currently believe are immaterial may also significantly impair our business operations. Our business could be harmed by any of these risks. The trading price of our common stock could decline due to any of these risks, and investors may lose all or part of their investment.

We have marked with an asterisk (*) those risk factors below that reflect substantive changes from the risk factors included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 26, 2009.

Risks Related to Our Business and Industry

We have incurred cumulative operating losses since inception, we expect to continue to incur losses for the foreseeable future and we may never sustain profitability.*

We have a limited operating history and have incurred cumulative losses of $286.6 million since our inception in May 1999. In the three months ended September 30, 2009 and 2008, we incurred net losses of $24.4 million and $24.1 million, respectively. In the nine months ended September 30, 2009 and 2008, we incurred net losses of $48.0 million and $43.8 million, respectively. Due to the recognition of revenues from up-front and milestone payments from our collaborations with Glaxo Group Limited, or GSK, Astellas Pharma Inc. and Xanodyne Pharmaceuticals, Inc., we were profitable in the three-month periods ended June 30, September 30 and December 31, 2007, and for the year ended December 31, 2007. However, while recognition of these revenues resulted in a profitable year for 2007, we incurred net losses in 2008, and we expect to incur net losses in 2009. We expect our research and development expenses to remain relatively constant with 2008 levels for 2009 and 2010. Subject to regulatory approval of any of our product candidates, we expect to incur significant expenses associated with the establishment of a North American specialty sales force. Annual losses have had, and will continue to have, an adverse effect on our stockholders’ equity.

Because of the numerous risks and uncertainties associated with drug development, we are unable to predict the timing or amount of increased expenses or when, or if, we will be able to achieve or sustain profitability. Currently, we have no products approved for commercial sale and, to date, we have not generated any product revenues. We have financed our operations primarily through the sale of equity securities, non-equity payments from collaborative partners, capital lease and equipment financings and government grants. We have devoted substantially all of our efforts to research and development, including clinical trials. If we or our

 

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collaborative partners are unable to develop and commercialize any of our product candidates, if development is delayed or if sales revenue from any product candidate that receives marketing approval is insufficient, we may never become profitable. Even if we do become profitable, we may not be able to sustain or increase our profitability on a quarterly or annual basis.

Our success depends substantially on our most advanced product candidates, which are still under development. If we or our collaborative partners are unable to bring any or all of these product candidates to market, or experience significant delays in doing so, our ability to generate product revenue and our likelihood of success will be harmed.*

Our ability to generate product revenue in the future will depend heavily on the successful development and commercialization of our product candidates. In March 2009, the U.S. Food and Drug Administration, or FDA, accepted for review GSK’s new drug application, or NDA, requesting approval of XP13512 (gabapentin enacarbil) for the treatment of moderate-to-severe primary restless legs syndrome, or RLS. XP13512 has been evaluated in a Phase 3 clinical program for RLS in the United States and a Phase 2 clinical trial for RLS in Japan and is being evaluated in Phase 2 clinical trials for neuropathic pain and migraine prophylaxis in the United States. Our other product candidates are either in Phase 1 or Phase 2 clinical development or in various stages of preclinical development. Any of our product candidates could be unsuccessful if it:

 

   

does not demonstrate acceptable safety and efficacy in preclinical studies or clinical trials or otherwise does not meet applicable regulatory standards for approval;

 

   

does not offer therapeutic or other improvements over existing or future drugs used to treat the same conditions;

 

   

is not capable of being produced in commercial quantities at acceptable costs; or

 

   

is not accepted in the medical community and by third-party payors.

We do not expect any of our current product candidates to be commercially available before the end of 2009, if at all. If we or our collaborative partners are unable to make our product candidates commercially available, we will not generate substantial product revenues and we will not be successful. The results of our clinical trials to date do not provide assurance that acceptable efficacy or safety will be shown upon completion of future clinical trials.

If we or our partners are not able to obtain required regulatory approvals, we or our partners will not be able to commercialize our product candidates, our ability to generate revenue will be materially impaired and our business will not be successful.*

Our product candidates and the activities associated with their development and commercialization are subject to comprehensive regulation by the FDA and other agencies in the United States and by comparable authorities in other countries. In February 2007, we announced an exclusive collaboration with GSK to develop and commercialize XP13512, also known as ASP8825 in Japan, Korea, the Philippines, Indonesia, Thailand and Taiwan (collectively referred to as the Astellas territory) and by the designation GSK1838262 outside the Astellas territory, in all countries of the world other than the Astellas territory. Pursuant to the terms of our agreement, GSK submitted to the FDA an NDA requesting approval of XP13512 for the treatment of moderate-to-severe primary RLS and GSK will lead the development and registration of XP13512 for all indications in GSK’s licensed territory. The inability to obtain FDA approval or approval from comparable authorities in other countries would prevent us and our collaborative partners from commercializing our product candidates in the United States or other countries. We or our collaborative partners may never receive regulatory approval for the commercial sale of any of our product candidates. Moreover, if the FDA requires that any of our product candidates be scheduled by the U.S. Drug Enforcement Agency, or DEA, we or our collaborative partners will be unable to begin commercial sale of that product until the DEA completes scheduling proceedings. If any of our product candidates is classified as a controlled substance by the DEA, we or our collaborative partners would have to register annually with the DEA and those product candidates would be subject to additional regulation.

Neither we nor our collaborative partners have received regulatory approval to market any of our product candidates in any jurisdiction. We have only limited experience in preparing and filing the applications necessary to gain regulatory approvals. The process of applying for regulatory approval is expensive, often takes many years and can vary substantially based upon the type, complexity and novelty of the product candidates involved. The application process begins with the submission of an NDA that the FDA initially reviews and either accepts or rejects for filing. NDA submissions are complex electronic filings, which include vast compilations of data sets, integrated documents and data calculations. The FDA has substantial discretion in the submission process and may refuse to accept an NDA submission if there are errors or omissions relating to the electronic transmittal process, data entry, data compilation or formatting. For example, in November 2008, GSK withdrew a previously submitted NDA for XP13512 for the treatment of moderate-to-severe primary RLS in connection with the FDA’s request that the data from a single study be reformatted. The NDA for XP13512 was resubmitted in January 2009, and the FDA accepted the NDA for review in March 2009.

 

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Changes in the regulatory approval policy during the development period, changes in, or the enactment of additional, regulations or statutes or changes in regulatory review for each submitted product application may cause delays in the approval or rejection of an NDA. For example, in 2008, the FDA announced that, due to staffing and resource limitations, it has given its managers discretion to miss certain timing goals for completing reviews of NDAs set forth under the Prescription Drug User Fee Act, or PDUFA. If the FDA were to miss a PDUFA timing goal for one of our product candidates, the development and commercialization of the product candidate could be delayed or impaired. In addition, the Food and Drug Administration Amendments Act of 2007, or FDAAA, mandates FDA advisory committee reviews of all new molecular entities as part of the NDA approval process, although the FDA maintains discretion under FDAAA to approve NDAs for new molecular entities without advisory committee reviews in certain instances. XP13512 is classified as a new molecular entity. The advisory committee review process can be a lengthy and uncertain process that could delay the FDA’s NDA approval and delay or impair the development and commercialization of our product candidates.

The FDA has substantial discretion in the approval process and may refuse to approve any application or decide that our or our collaborative partners’ data is insufficient for approval and require additional preclinical, clinical or other studies. For example, varying interpretations of the data obtained from preclinical and clinical testing could delay, limit or prevent regulatory approval of any of our product candidates. Even if the FDA or other regulatory agency approves a product candidate, the approval may impose significant restrictions on the indicated uses, conditions for use, labeling, advertising, promotion, marketing and/or production of such product and may impose ongoing requirements for post-approval studies, including additional research and development and clinical trials. The FDA and other agencies also may impose various civil or criminal sanctions for failure to comply with regulatory requirements, including withdrawal of product approval.

We and our collaborative partners will need to obtain regulatory approval from authorities in foreign countries to market our product candidates in those countries. Approval by one regulatory authority does not ensure approval by regulatory authorities in other jurisdictions. If we or our collaborative partners fail to obtain approvals from foreign jurisdictions, the geographic market for our product candidates would be limited.

We depend on collaborations to complete the development and commercialization of some of our product candidates. These collaborations may place the development of our product candidates outside our control, may require us to relinquish important rights or may otherwise be on terms unfavorable to us.*

In December 2005, we entered into a collaboration with Astellas for the development and commercialization of XP13512 in the Astellas territory. In February 2007, we entered into an exclusive collaboration with GSK to develop and commercialize XP13512 worldwide, excluding the Astellas territory.

We may enter into additional collaborations with third parties to develop and commercialize some of our product candidates. Our dependence on Astellas and GSK for the development and commercialization of XP13512 subjects us to, and our dependence on future collaborators for development and commercialization of additional product candidates will subject us to, a number of risks, including:

 

   

we may not be able to control the amount and timing of resources that our collaborators may devote to the development or commercialization of product candidates or to their marketing and distribution;

 

   

collaborators may delay clinical trials, provide insufficient funding for a clinical trial program, stop a clinical trial or abandon a product candidate, repeat or conduct new clinical trials or require a new formulation of a product candidate for clinical testing;

 

   

disputes may arise between us and our collaborators that result in the delay or termination of the research, development or commercialization of our product candidates or that result in costly litigation or arbitration that diverts management’s attention and resources;

 

   

collaborators may experience financial difficulties;

 

   

collaborators may not be successful in their efforts to obtain regulatory approvals in a timely manner, or at all;

 

   

collaborators may not properly maintain or defend our intellectual property rights or may use our proprietary information in such a way as to invite litigation that could jeopardize or invalidate our proprietary information or expose us to potential litigation;

 

   

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

 

   

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

 

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where we co-promote a product with a collaborator, if we do not receive timely and accurate information from our collaborator regarding sales activities, expenses and resulting operating profits and losses, our estimates at a given point of time could be incorrect and we could be required to record adjustments in future periods or restate our financial results for prior periods; and

 

   

the collaborations may be terminated or allowed to expire, which would delay the development and may increase the cost of developing our product candidates.

For example, in October 2007, we entered into a collaboration with Xanodyne for the development and commercialization of XP21510 in the United States. Effective July 2009, Xanodyne terminated the collaboration agreement.

As a further example, we cannot control the process for securing FDA approval of XP13512 for moderate-to-severe primary RLS or other indications. We cannot control the amount and timing of resources that GSK or Astellas may devote to the development or commercialization of XP13512 or its marketing and distribution. In addition, GSK or Astellas could independently direct their respective development and marketing resources to the development or commercialization of competitive products, which could delay or impair the commercialization of XP13512 and harm our business.

If we do not establish collaborations for our product candidates other than XP13512, we will have to alter our development and commercialization plans.*

Our strategy includes selectively collaborating with leading pharmaceutical and biotechnology companies to assist us in furthering development and potential commercialization of some of our product candidates. We intend to do so especially for indications that involve a large, primary care market that must be served by large sales and marketing organizations. We face significant competition in seeking appropriate collaborators, and these collaborations are complex and time consuming to negotiate and document. We may not be able to negotiate additional collaborations on acceptable terms, or at all. We are unable to predict when, if ever, we will enter into any additional collaborations because of the numerous risks and uncertainties associated with establishing additional collaborations. If we are unable to negotiate additional collaborations, we may have to curtail the development of a particular product candidate, reduce or delay its development program or one or more of our other development programs, delay its potential commercialization or reduce the scope of our sales or marketing activities or increase our expenditures and undertake development or commercialization activities at our own expense. If we elect to increase our expenditures to fund development or commercialization activities on our own, we may need to obtain additional capital, which may not be available to us on acceptable terms, or at all. If we do not have sufficient funds, we will not be able to bring our product candidates to market and generate product revenues.

We will need additional funding and may be unable to raise capital when needed, which would force us to delay, reduce or eliminate our product development programs or commercialization efforts.*

We will need to raise additional capital to fund our operations and complete the development of our product candidates. If any product candidates receive regulatory approval for commercial sale, we may need to raise additional capital to fund our commercialization efforts. Our future funding requirements will depend on many factors, including:

 

   

the scope, rate of progress, results and cost of our preclinical testing, clinical trials and other research and development activities;

 

   

the timing of potential receipt of FDA approval of XP13512 and its potential commercialization;

 

   

the cost of manufacturing clinical, and establishing commercial, supplies of our product candidates and any products that we may develop;

 

   

the timing of any milestone payments under our collaborative arrangements;

 

   

the number and characteristics of product candidates that we pursue;

 

   

the cost, timing and outcomes of regulatory approvals;

 

   

the cost and timing of establishing sales, marketing and distribution capabilities;

 

   

the terms and timing of any collaborative, licensing and other arrangements that we may establish;

 

   

the timing and amount of our share of operating losses, if any, from our GSK collaboration;

 

   

the timing, receipt and amount of sales, profit sharing or royalties, if any, from our potential products;

 

   

the cost of preparing, filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; and

 

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the extent to which we acquire or invest in businesses, products or technologies, although we currently have no commitments or agreements relating to any of these types of transactions.

Until we can generate a sufficient amount of product revenues, if ever, we expect to finance future cash needs through public or private equity offerings, debt financings or corporate collaboration and licensing arrangements, as well as through interest income earned on cash balances. However, the credit markets and the financial services industry have recently been experiencing a period of unusual turmoil and upheaval characterized by the bankruptcy, failure, collapse or sale of various financial institutions and an unprecedented level of intervention from the U.S. federal government. These events have generally made equity and debt financing more difficult to obtain.

If we raise additional funds by issuing equity securities, our stockholders may experience dilution. Any debt financing or additional equity that we raise may contain terms that are not favorable to our stockholders or us. To the extent that we raise additional capital through licensing arrangements or arrangements with collaborative partners, we may be required to relinquish, on terms that are not favorable to us, rights to some of our technologies or product candidates that we would otherwise seek to develop or commercialize ourselves.

We believe that our existing capital resources, which include the net proceeds of our public offering completed in July 2009, and expected milestone payments, together with interest thereon, will be sufficient to meet our projected operating requirements into the third quarter of 2011. We have based this estimate on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect. Further, our operating plan may change, and we may need additional funds to meet operational needs and capital requirements for product development and commercialization sooner than planned. We currently have no credit facility or committed sources of capital other than potential milestones receivable under our current collaborations.

Additional funds may not be available when we need them on terms that are acceptable to us, or at all. If adequate funds are not available on a timely basis, we may:

 

   

terminate or delay clinical trials for one or more of our product candidates;

 

   

delay our establishment of sales and marketing capabilities or other activities that may be necessary to commercialize our product candidates;

 

   

curtail significant drug development programs that are designed to identify new product candidates; or

 

   

exercise the right to revert to a net sales royalty-based compensation structure and forego the right to co-promote XP13512 in the United States.

For example, in January 2009, we suspended preclinical development activities for XP20925, our Transported Prodrug of propofol, to focus our resources on development of later-stage product candidates.

If our preclinical studies do not produce successful results or our clinical trials do not demonstrate safety and efficacy in humans, we will not be able to commercialize our product candidates.*

To obtain the requisite regulatory approvals to market and sell any of our product candidates, we must demonstrate, through extensive preclinical studies and clinical trials, that the product candidate is safe and effective in humans. Preclinical and clinical testing is expensive, can take many years and has an uncertain outcome. A failure of one or more of our clinical trials could occur at any stage of testing. For example, in April 2009, GSK completed a 14-week, double-blind, placebo-controlled, Phase 2 clinical trial of XP13512 as a potential treatment for painful diabetic neuropathy, or PDN, in which neither XP13512 nor pregabalin, the active control, demonstrated a statistically significant improvement on the primary endpoint when compared to placebo. In addition, success in preclinical testing and early clinical trials does not ensure that later clinical trials will be successful, and interim results of a clinical trial do not necessarily predict final results. We may experience numerous unforeseen events during, or as a result of, preclinical testing and the clinical trial process, which could delay or prevent our or our collaborative partners’ ability to commercialize our product candidates, including:

 

   

regulators or institutional review boards may not authorize us to commence a clinical trial at a prospective trial site;

 

   

our preclinical testing or clinical trials may produce negative or inconclusive results, which may require us to conduct additional preclinical or clinical testing or to abandon projects that we expect to be promising;

 

   

we may suspend or terminate our clinical trials if the participating patients are being exposed to unacceptable health risks;

 

   

risks associated with clinical trial design may result in a failure of the clinical trial to show statistically significant results even if the product candidate is effective;

 

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regulators or institutional review boards may suspend or terminate clinical research for various reasons, including noncompliance with regulatory requirements; and

 

   

the effects of our product candidates may not be the desired effects or may include undesirable side effects.

As an example of an unforeseen event, after having been discharged from a Phase 1 clinical trial in which a single dose of XP13512 was administered almost two days earlier, a volunteer died of a self-inflicted gunshot wound following a domestic dispute. We do not believe that this incident was related to XP13512. However, any unforeseen event could cause us to experience significant delays in, or the termination of, clinical trials. Any such events would increase our costs and could delay or prevent our ability to commercialize our product candidates, which would adversely impact our financial results.

Any failure or delay in commencing or completing clinical trials for our product candidates could severely harm our business.*

The commencement and completion of clinical trials for our product candidates may be delayed or terminated as a result of many factors, including:

 

   

delays in patient enrollment, which we have experienced in the past, and variability in the number and types of patients available for clinical trials;

 

   

our inability or the inability of our collaborators or licensees to manufacture or obtain from third parties materials sufficient for use in preclinical studies and clinical trials;

 

   

difficulty in maintaining contact with patients after treatment, resulting in incomplete data;

 

   

poor effectiveness of product candidates during clinical trials;

 

   

unforeseen safety issues or side effects; and

 

   

governmental or regulatory delays and changes in regulatory requirements, policy and guidelines.

For example, based on the results of a planned interim analysis of the clinical data, although no safety concerns were noted, Astellas terminated its Phase 2 clinical trial of XP13512 as a potential treatment for PDN due to difficulty in demonstrating a statistically significant advantage of XP13512 over placebo under the current clinical trial design. As a result, Astellas does not intend to continue the development of XP13512 in Japan as a potential treatment for PDN at this time. Any delay in commencing or completing clinical trials for our product candidates would delay commercialization of our product candidates and severely harm our business and financial condition. In addition, unforeseen safety issues or side effects could result from our collaborators’ current or future clinical trials, which could delay or negatively impact commercialization of our product candidates. It is also possible that none of our product candidates will complete clinical trials in any of the markets in which we or our collaborators intend to sell those product candidates. Accordingly, we or our collaborators would not receive the regulatory approvals needed to market our product candidates, which would severely harm our business and financial condition.

We rely on third parties to conduct our clinical trials. If these third parties do not perform as contractually required or expected, we may not be able to obtain regulatory approval for, or commercialize, our product candidates.

We do not have the ability to independently conduct clinical trials for our product candidates, and we must rely on third parties, such as contract research organizations, medical institutions, clinical investigators, collaborative partners and contract laboratories, to conduct our clinical trials. We have, in the ordinary course of business, entered into agreements with these third parties. Nonetheless, with the exception of XP13512, we are responsible for confirming that each of our clinical trials is conducted in accordance with its general investigational plan and protocol. Moreover, the FDA requires us to comply with regulations and standards, commonly referred to as good clinical practices, for conducting and recording and reporting the results of clinical trials to assure that data and reported results are credible and accurate and that the trial participants are adequately protected. Our reliance on third parties that we do not control does not relieve us of these responsibilities and requirements. For example, we need to prepare, and ensure our compliance with, various procedures required under good clinical practices, even though third-party contract research organizations have prepared and are complying with their own, comparable procedures. If these third parties do not successfully carry out their contractual duties or regulatory obligations or meet expected deadlines, if the third parties need to be replaced or if the quality or accuracy of the data they obtain is compromised due to the failure to adhere to our clinical protocols or regulatory requirements or for other reasons, our preclinical development activities or clinical trials may be extended, delayed, suspended or terminated, and we may not be able to obtain regulatory approval for, or successfully commercialize, our product candidates.

 

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If some or all of our patents expire, are invalidated or are unenforceable, or if some or all of our patent applications do not yield issued patents or yield patents with narrow claims, competitors may develop competing products using our intellectual property and our business will suffer.*

Our success will depend in part on our ability to obtain and maintain patent and trade secret protection for our technologies and product candidates both in the United States and other countries. We have a number of U.S. and foreign patents, patent applications and rights to patents related to our compounds, product candidates and technology, but we cannot guarantee that issued patents will be enforceable or that pending or future patent applications will result in issued patents. Alternatively, a third party may successfully circumvent our patents. Our rights under any issued patents may not provide us with sufficient protection against competitive products or otherwise cover commercially valuable products or processes.

The degree of future protection for our proprietary technologies and product candidates is uncertain because legal means afford only limited protection and may not adequately protect our rights or permit us to gain or keep our competitive advantage. For example:

 

   

we might not have been the first to make the inventions covered by each of our pending patent applications and issued patents;

 

   

we might not have been the first to file patent applications for these inventions;

 

   

others may independently develop similar or alternative technologies or duplicate any of our technologies;

 

   

it is possible that none of our pending patent applications will result in issued patents;

 

   

any patents issued to us or our collaborators may not provide a basis for commercially viable products or may be challenged by third parties; or

 

   

the patents of others may have an adverse effect on our ability to do business.

Even if valid and enforceable patents cover our product candidates and technologies, the patents will provide protection only for a limited amount of time.

Our and our collaborators’ ability to obtain patents is highly uncertain because, to date, some legal principles remain unresolved, there has not been a consistent policy regarding the breadth or interpretation of claims allowed in patents in the United States and the specific content of patents and patent applications that are necessary to support and interpret patent claims is highly uncertain due to the complex nature of the relevant legal, scientific and factual issues. Furthermore, the policies governing biotechnology patents outside the United States are even more uncertain. Changes in either patent laws or interpretations of patent laws in the United States and other countries may diminish the value of our intellectual property or narrow the scope of our patent protection.

Even if patents are issued regarding our product candidates or methods of using them, those patents can be challenged by our competitors who can argue such patents are invalid and/or unenforceable. For example, in September 2008, a law firm on behalf of an undisclosed client filed an opposition against the patent grant of one of our European patent applications covering XP13512, and in April 2009, we filed a response to the opposition. The European opposition hearing has been scheduled for April 15, 2010. Unlike in the United States, where an issued patent is presumed valid, third parties in Europe have nine months following the grant of a patent in which to file an opposition during which there is no presumption of patent validity. Accordingly, the grant of the European patent will be subject to a full review. While we cannot predict the duration or result of this opposition proceeding, a corresponding U.S. patent was issued, and the most important of the prior art that was cited in the European opposition as a basis for challenging the issuance of the European patent covering XP13512 was cited to the European Patent Office during the prosecution of that European patent. The possible revocation of the European patent or amendment of its granted claims would not preclude us from developing and commercializing XP13512 in Europe, but could increase the risk of competition. Patents also may not protect our product candidates if competitors devise ways of making these or similar product candidates without legally infringing our patents. The Federal Food, Drug and Cosmetic Act and FDA regulations and policies provide incentives to manufacturers to challenge patent validity and these same types of incentives encourage manufacturers to submit NDAs that rely on literature and clinical data not prepared for or by the drug sponsor.

Subject to possible patent term extension, the entitlement for which and the term of which we cannot predict, patent protection in the United States covering XP13512, our product candidate that is a Transported Prodrug of gabapentin, will expire no earlier than 2022. We believe that in all countries in which we hold or have licensed rights to patents or patent applications related to XP13512, the composition-of-matter patents relating to gabapentin have expired. For XP19986, our product candidate that is a Transported Prodrug of R-baclofen, U.S. composition-of-matter patents have issued that will expire no earlier than 2025. For XP21279, our product candidate that is a Transported Prodrug of L-dopa, a U.S. composition-of-matter patent has issued that will expire no earlier than 2025. For XP21510, our product candidate that is a Transported Prodrug of tranexamic acid, a U.S. composition-of-matter patent

 

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has issued that will expire no earlier than 2026. Although third parties may challenge our rights to, or the scope or validity of, our patents, to date, other than the European opposition described above, we have not received any communications from third parties challenging our patents or patent applications covering our product candidates.

We may obtain patents for certain product candidates many years before marketing approval is obtained for those products. Because patents have a limited life, which may begin to run prior to the commercial sale of the related product, the commercial value of the patent may be limited. However, we may be able to apply for patent term extensions.

As part of the approval process of our product candidates in the United States, the FDA may determine that the product candidates be granted an exclusivity period during which other manufacturers’ applications for approval of generic versions of our products will not be granted. Generic manufacturers often wait to challenge the patents protecting products that have been granted exclusivity until one year prior to the end of the exclusivity period. While the FDA has historically granted a five-year new chemical entity exclusivity to prodrugs such as XP13512 and XP19986, a lawsuit was recently filed by a generic drug company against the FDA challenging the grant of the five-year exclusivity to another company’s prodrug. In October 2009, the FDA, following a review of applicable statutes and regulations and a period for public comment, reaffirmed its decision to grant the five-year exclusivity to the prodrug. However, the generic drug company’s law suit against the FDA is expected to proceed. If such a suit against the FDA is successful, it could mean that XP13512 and XP19986 receive shorter or no exclusivity periods. It is also possible that generic manufacturers are considering attempts to seek FDA approval for a similar or identical drug as our product candidate through an abbreviated NDA, which is the application form typically used by manufacturers seeking approval of a generic drug. If our patents are subject to challenges, we may need to spend significant resources to defend such challenges and we may not be able to defend our patents successfully.

We also rely on trade secrets to protect our technology, especially where we do not believe that patent protection is appropriate or obtainable. However, trade secrets are difficult to protect. Our employees, consultants, contractors, outside scientific collaborators and other advisors may unintentionally or willfully disclose our confidential information to competitors. Enforcing a claim that a third party illegally obtained and is using our trade secrets is expensive and time-consuming, and the outcome is unpredictable. Failure to obtain or maintain trade secret protection could adversely affect our competitive business position.

Our research and development collaborators may have rights to publish data and other information in which we have rights. In addition, we sometimes engage individuals or entities to conduct research that may be relevant to our business. The ability of these individuals or entities to publish or otherwise publicly disclose data and other information generated during the course of their research is subject to certain contractual limitations. In most cases, these individuals or entities are, at the least, precluded from publicly disclosing our confidential information and are only allowed to disclose other data or information generated during the course of the research after we have been afforded an opportunity to consider whether patent and/or other proprietary protection should be sought. If we do not apply for patent protection prior to such publication or if we cannot otherwise maintain the confidentiality of our technology and other confidential information, then our ability to receive patent protection or protect our proprietary information may be jeopardized.

Third-party claims of intellectual property infringement would require us to spend significant time and money and could prevent us from developing or commercializing our products.

Our commercial success depends in part on not infringing the patents and proprietary rights of other parties and not breaching any licenses that we have entered into with regard to our technologies and products. Because others may have filed, and in the future are likely to file, patent applications covering products or other technologies of interest to us that are similar or identical to ours, patent applications or issued patents of others may have priority over our patent applications or issued patents. For example, we are aware of a family of third-party patent applications relating to prodrugs of gabapentin. We believe the applications have been abandoned in the United States, the European Patent Office, Canada, Australia and the United Kingdom. Additionally, we are aware of third-party patents relating to the use of baclofen in the treatment of gastroesophageal reflux disease, or GERD. If the patents are determined to be valid and construed to cover XP19986, the development and commercialization of XP19986 could be affected. With respect to the claims contained in these patent applications and patents, we believe that our activities do not infringe the patents at issue and/or that the third-party patent or patent applications are invalid. However, it is possible that a judge or jury will disagree with our conclusions regarding non-infringement and/or invalidity, and we could incur substantial costs in litigation if we are required to defend against patent suits brought by third parties or if we initiate these suits. Any legal action against our collaborators or us claiming damages and seeking to enjoin commercial activities relating to the affected products and processes could, in addition to subjecting us to potential liability for damages, require our collaborators or us to obtain a license to continue to manufacture or market the affected products and processes. Licenses required under any of these patents may not be available on commercially acceptable terms, if at all. Failure to obtain such licenses could materially and adversely affect our ability to develop, commercialize and sell our product candidates. We believe that there may continue to be significant litigation in the biotechnology and pharmaceutical industry

 

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regarding patent and other intellectual property rights. If we become involved in litigation, it could consume a substantial portion of our management and financial resources and we may not prevail in any such litigation.

Furthermore, our commercial success will depend, in part, on our ability to continue to conduct research to identify additional product candidates in current indications of interest or opportunities in other indications. Some of these activities may involve the use of genes, gene products, screening technologies and other research tools that are covered by third-party patents. Court decisions have indicated that the exemption from patent infringement afforded by 35 U.S.C. § 271(e)(1) does not encompass all research and development activities associated with product development. In some instances, we may be required to obtain licenses to such third-party patents to conduct our research and development activities, including activities that may have already occurred. It is not known whether any license required under any of these patents would be made available on commercially acceptable terms, if at all. Failure to obtain such licenses could materially and adversely affect our ability to maintain a pipeline of potential product candidates and to bring new products to market. If we are required to defend against patent suits brought by third parties relating to third-party patents that may be relevant to our research activities, or if we initiate such suits, we could incur substantial costs in litigation. Moreover, an adverse result from any legal action in which we are involved could subject us to damages and/or prevent us from conducting some of our research and development activities.

If third parties do not manufacture our product candidates in sufficient quantities or at an acceptable cost, clinical development and commercialization of our product candidates would be delayed.*

We do not currently own or operate manufacturing facilities for the production of clinical or commercial quantities of any of our product candidates. To date, we have relied on, and we expect to continue to rely on, a limited number of third-party compound manufacturers and active pharmaceutical ingredient, or API, formulators for the production of preclinical, clinical and commercial quantities of our product candidates. We do not have commercial supply agreements with any of these third parties, and our agreements with these parties are generally terminable at will by either party at any time. If, for any reason, these third parties are unable or unwilling to perform under our agreements or enter into new agreements, we may not be able to locate alternative manufacturers or formulators or enter into favorable agreements with them. Any inability to acquire sufficient quantities of our product candidates in a timely manner from these third parties could delay clinical trials and prevent us or our partners from developing and commercializing our product candidates in a cost-effective manner or on a timely basis.

Under the terms of our collaborations with Astellas and GSK, Astellas and GSK are each solely responsible for the manufacture of XP13512 to support their development and commercialization within their respective licensed territories. As a result, if Astellas or GSK fails to manufacture or contract to manufacture sufficient quantities of XP13512, development and commercialization of this product candidate could be impaired or delayed in the applicable territory.

We currently rely on Excella GmbH and Sumitomo Seika Chemicals Company Ltd as our source suppliers of R-baclofen, the active agent used to make XP19986, under purchase orders issued from time to time. In the event that Excella or Sumitomo determines to not sell R-baclofen to us at a price that is commercially attractive, and if we were unable to qualify an alternative supplier of R-baclofen, this could delay the development of, and impair our ability to commercialize, this product candidate.

We currently rely on Lonza Ltd. as the single source supplier of our current worldwide requirements of XP19986 in API form under a manufacturing services and product supply agreement. Our current agreement with Lonza does not provide for the entire supply of the API necessary for our Phase 2 and Phase 3 clinical trials or for full-scale commercialization. In the event that the parties cannot agree to the terms and conditions for Lonza to provide some or all of our API clinical and commercial supply needs, we would not be able to manufacture API until a qualified alternative supplier is identified, which could also delay the development of, and impair our ability to commercialize, this product candidate.

We currently rely on DSM Pharmaceuticals, Inc. as our single source supplier for XP19986 formulated in sustained-release tablets for future clinical trials at specified transfer prices under quotations agreed upon by the parties as a part of a master services agreement. In the event that DSM terminates the agreement under specified circumstances, we would not be able to commercialize XP19986 sustained-release tablets until an alternative supplier is qualified. This could delay the development of, and impair our ability to commercialize, XP19986.

We currently rely on Ajinomoto Company as our single source supplier of L-Dopa, which is used to make XP21279, under purchase orders issued from time to time. We are aware of several alternative suppliers of L-Dopa, and we believe at least one alternative manufacturer could potentially supply L-Dopa, in the event that Ajinomoto determines to not sell L-Dopa to us at a price that is commercially attractive. If we were unable to qualify an alternative supplier of L-Dopa, this could delay the development of, and impair our ability to commercialize, XP21279.

 

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We have purchased from Raylo Chemicals, Inc., a subsidiary of Gilead Sciences, Inc., all of our current worldwide requirements of XP21279 in API form through our Phase 1 clinical trials under a manufacturing services and product supply agreement. We recently qualified Piramal Healthcare as an alternative supplier for manufacture of XP21279 in API form. In the event that the parties cannot agree to the terms and conditions for Piramal to provide some or all of our API clinical and commercial supply needs, we would not be able to manufacture API until a qualified alternative supplier is identified, which could also delay the development of, and impair our ability to commercialize, this product candidate.

We currently rely on Metrics, Inc. as our single source supplier for XP21279 formulated in sustained-release tablets at specified transfer prices under quotations agreed upon by the parties as a part of a master services agreement. We have recently qualified Patheon Inc. as an alternative supplier for the manufacture of XP21279 in sustained-release tablets. In the event that Metrics terminates the agreement under specified circumstances or we cannot agree with Patheon on the terms and conditions for manufacture of XP21279 sustained-release tablets, we would not be able to manufacture XP21279 until an alternative supplier is qualified. This could delay the development of, and impair our ability to commercialize, XP21279.

If we are required to obtain alternate third-party manufacturers, it could delay or prevent the clinical development and commercialization of our product candidates.*

We may not be able to maintain or renew our existing or any other third-party manufacturing arrangements on acceptable terms, if at all. If we are unable to continue relationships with Excella, Sumitomo, Lonza or DSM for XP19986 or Ajinomoto, Piramal, Metrics or Patheon for XP21279 or to continue relationships at an acceptable cost or if these suppliers fail to meet our requirements for these product candidates for any reason, we would be required to obtain alternative suppliers. Any inability to obtain qualified alternative suppliers, including an inability to obtain, or delay in obtaining, approval of an alternative supplier from the FDA, would delay or prevent the clinical development and commercialization of these product candidates, and could impact our ability to meet our supply obligations to Astellas.

Use of third-party manufacturers may increase the risk that we or our partners will not have adequate supplies of our product candidates.*

Our current reliance, and our and our partners’ anticipated future reliance, on third-party manufacturers will expose us and our partners to risks that could delay or prevent the initiation or completion of clinical trials by us or our partners, the submission of applications for regulatory approvals, the approval of our products by the FDA or foreign regulatory authorities or the commercialization of our products or could result in higher costs or lost product revenues. In particular, our contract manufacturers:

 

   

could encounter difficulties in achieving volume production, quality control and quality assurance or suffer shortages of qualified personnel, which could result in their inability to manufacture sufficient quantities of drugs to meet clinical schedules or to commercialize our product candidates;

 

   

could terminate or choose not to renew manufacturing agreements, based on their own business priorities, at a time that is costly or inconvenient for us;

 

   

could fail to establish and follow FDA-mandated current good manufacturing practices, or cGMPs, which are required for FDA approval of our product candidates, or fail to document their adherence to cGMPs, either of which could lead to significant delays in the availability of material for clinical study and delay or prevent marketing approval for our product candidates;

 

   

could encounter financial difficulties that would interfere with their obligations to supply our product candidates; and

 

   

could breach, or fail to perform as agreed under, manufacturing agreements.

If we are not able to obtain adequate supplies of our product candidates, it will be more difficult to develop our product candidates and compete effectively. Our product candidates and any products that we may develop may compete with other product candidates and products for access to manufacturing facilities.

In addition, the manufacturing facilities of Excella, Sumitomo, Lonza, Ajinomoto and Patheon are located outside of the United States. This may give rise to difficulties in importing our product candidates or their components into the United States or other countries as a result of, among other things, regulatory agency import inspections, incomplete or inaccurate import documentation or defective packaging.

 

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Safety issues with the parent drugs or other components of our product candidates, or with approved products of third parties that are similar to our product candidates, could give rise to delays in the regulatory approval process, restrictions on labeling or product withdrawal.*

Discovery of previously unknown problems with an approved product may result in restrictions on its permissible uses, including withdrawal of the medicine from the market. The FDA approved gabapentin, the parent drug for our XP13512 product candidate, in 1993, and, to date, it has been used in at least 12 million patients. Baclofen, the R-isomer of which is the parent drug for our XP19986 product candidate, has been used since 1977. The FDA has not approved the R-isomer of baclofen for use in humans. The FDA approved levadopa, or L-Dopa, the parent drug for our XP21279, in 1967. The FDA has not approved oral tranexamic acid, which is the parent drug for our XP21510 product candidate, although it has been used in European and other countries for many years and is approved in intravenous form in the United States for tooth extractions in hemophiliacs. Although gabapentin, baclofen, L-Dopa and tranexamic acid have been used successfully in patients for many years, newly observed toxicities, or worsening of known toxicities, in patients receiving gabapentin, baclofen, L-Dopa or tranexamic acid could result in increased regulatory scrutiny of XP13512, XP19986, XP21279 and XP21510, respectively.

Our product candidates are engineered to be broken down by the body’s natural metabolic processes and to release the parent drug and other substances. While these breakdown products are generally regarded as safe, it is possible that there could be unexpected toxicity associated with these breakdown products that will cause any or all of XP13512, XP19986, XP21279 and XP21510 to be poorly tolerated by, or toxic to, humans. Any unexpected toxicity of, or suboptimal tolerance to, our Transported Prodrugs would delay or prevent commercialization of these product candidates.

Additionally, problems with approved products marketed by third parties that utilize the same therapeutic target or belong to the same therapeutic class as the parent drug of our product candidates could adversely affect the development of our product candidates. For example, the product withdrawals of Vioxx from Merck & Co., Inc. and Bextra from Pfizer in 2005 due to safety issues have caused other drugs that have the same therapeutic target, such as Celebrex from Pfizer, to receive additional scrutiny from regulatory authorities. If either gabapentin or pregabalin, drugs from Pfizer that are marketed as Neurontin and Lyrica, respectively, encounters unexpected toxicity problems in humans, the FDA may delay or prevent the regulatory approval of XP13512 since it is believed to share the same therapeutic target as gabapentin and pregabalin. In 2005, the FDA requested that all makers of epilepsy drugs analyze their clinical trial data to determine whether these drugs increase the risk of suicide in patients. In December 2008, the FDA added warnings to 11 antiepileptic drugs, including gabapentin, regarding an increased risk of suicide or suicidal thoughts. In April 2009, the FDA approved safety label changes for all approved antiepileptic drugs, except those indicated only for short-term use, to include a warning about an increased risk of suicidal thoughts or actions. At this time, it is unclear if XP13512, as a compound that is believed to share the same therapeutic target as gabapentin and pregabalin, would, if approved by the FDA, require a similar warning in its label. Finally, if the FDA determines that a drug may present a risk of substance abuse, it can recommend to the DEA that the drug be scheduled under the Controlled Substances Act. While gabapentin is not a scheduled drug at the present time, pregabalin has been scheduled as a controlled substance. Since pregabalin is a scheduled drug, it is possible that the FDA may require additional testing of XP13512, the results of which could lead the FDA to conclude that XP13512 should be scheduled as well. Scheduled substances are subject to DEA regulations relating to manufacturing, storage, distribution and physician prescription procedures, and the DEA regulates the amount of a scheduled substance that is available for clinical trials and commercial distribution. Accordingly, any scheduling action that the FDA or DEA may take with respect to XP13512 may delay its clinical trial and approval process. Any failure or delay in commencing or completing clinical trials or obtaining regulatory approvals for our product candidates would delay commercialization of our product candidates and severely harm our business and financial condition.

We may not be successful in our efforts to identify or discover additional Transported Prodrug candidates.

An important element of our strategy is to identify, develop and commercialize Transported Prodrugs that improve upon the absorption, distribution and/or metabolism of drugs that have already received regulatory approval. Research programs to identify new product candidates require substantial technical, financial and human resources. These research programs may initially show promise in identifying potential product candidates, yet fail to yield product candidates for clinical development for a number of reasons, including:

 

   

the research methodology used may not be successful in identifying potential product candidates; or

 

   

potential product candidates may, on further study, be shown to have inadequate efficacy, harmful side effects, suboptimal pharmaceutical profile or other characteristics suggesting that they are unlikely to be effective products.

If we are unable to develop suitable product candidates through internal research programs or otherwise, we will not be able to increase our revenues in future periods, which could result in significant harm to our financial position and adversely impact our stock price.

 

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Our product candidates will remain subject to ongoing regulatory review, even if they receive marketing approval. If we or our collaborative partners fail to comply with continuing regulations, these approvals could be rescinded and the sale of our products could be suspended.

Even if we or our collaborative partners receive regulatory approval to market a particular product candidate, the approval could be conditioned on conducting additional, costly, post-approval studies, implementing a risk evaluation and mitigation strategy or could limit the indicated uses included in the labeling. Moreover, the product may later cause adverse effects that limit or prevent its widespread use, force us or our collaborative partners to withdraw it from the market or impede or delay our or our collaborative partners’ ability to obtain regulatory approvals in additional countries. In addition, the manufacturer of the product and its facilities will continue to be subject to FDA review and periodic inspections to ensure adherence to applicable regulations. After receiving marketing approval, the manufacturing, labeling, packaging, adverse event reporting, storage, advertising, promotion and record keeping related to the product will remain subject to extensive regulatory requirements.

If we or our collaborative partners fail to comply with the regulatory requirements of the FDA and other applicable U.S. and foreign regulatory authorities or previously unknown problems with our products, manufacturers or manufacturing processes are discovered, we and our partners could be subject to administrative or judicially imposed sanctions, including:

 

   

restrictions on the products, manufacturers or manufacturing processes;

 

   

warning letters;

 

   

civil or criminal penalties or fines;

 

   

injunctions;

 

   

product seizures, detentions or import bans;

 

   

voluntary or mandatory product recalls and publicity requirements;

 

   

suspension or withdrawal of regulatory approvals;

 

   

total or partial suspension of production; and

 

   

refusal to approve pending applications for marketing approval of new drugs or supplements to approved applications.

Because we have a number of product candidates and are considering a variety of target indications, we may expend our limited resources to pursue a particular candidate or indication and fail to capitalize on candidates or indications that may be more profitable or for which there is a greater likelihood of success.

Because we have limited financial and managerial resources, we must focus on research programs and product candidates for the specific indications that we believe are the most promising. As a result, we may forego or delay pursuit of opportunities with other product candidates or other indications that later prove to have greater commercial potential. Our resource allocation decisions may cause us to fail to capitalize on viable commercial products or profitable market opportunities. In addition, we may spend valuable time and managerial and financial resources on research programs and product candidates for specific indications that ultimately do not yield any commercially viable products. If we do not accurately evaluate the commercial potential or target market for a particular product candidate, we may relinquish valuable rights to that product candidate through collaboration, licensing or other royalty arrangements in situations where it would have been more advantageous for us to retain sole rights to development and commercialization.

The commercial success of any products that we or our partners may develop will depend upon the degree of market acceptance among physicians, patients, healthcare payors and the medical community.

Any products that result from our product candidates may not gain market acceptance among physicians, patients, healthcare payors and the medical community. If these products do not achieve an adequate level of acceptance, we may not generate material product revenues and we may not become profitable. The degree of market acceptance of any products resulting from our product candidates will depend on a number of factors, including:

 

   

demonstration of efficacy and safety in clinical trials;

 

   

the prevalence and severity of any side effects;

 

   

potential or perceived advantages over alternative treatments;

 

   

perceptions about the relationship or similarity between our product candidates and the parent drug upon which each Transported Prodrug candidate is based;

 

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the timing of market entry relative to competitive treatments;

 

   

the ability to offer product candidates for sale at competitive prices;

 

   

relative convenience and ease of administration;

 

   

the strength of marketing and distribution support;

 

   

sufficient third-party coverage or reimbursement; and

 

   

the product labeling or product insert required by the FDA or regulatory authorities in other countries.

If we are unable to establish sales and marketing capabilities or enter into additional agreements with third parties to market and sell our product candidates, we may be unable to generate product revenues.*

We have a limited sales and marketing organization and have limited experience in the sales, marketing and distribution of pharmaceutical products. There are risks involved with establishing our own sales and marketing capabilities, as well as entering into arrangements with third parties to perform these services. Developing an internal sales force is expensive and time-consuming. On the other hand, if we enter into arrangements with third parties to perform sales, marketing and distribution services, as we have for XP13512, our product revenues will be lower than if we market and sell any products that we develop ourselves.

Under the terms of our collaboration with GSK, we are entitled to a royalty based on a percentage of net sales of XP13512 outside of the United States. In the United States, subject to approval from the FDA of an NDA for XP13512, until such time, if any, as we exercise the right to revert to a net sales royalty, we will share marketing and commercialization costs and share operating profits from net sales of XP13512, if any. We intend to establish our own specialty sales force to sell and market our products. We are eligible to receive payments on details we perform on Requip XL, GSK’s product for Parkinson’s disease in the United States, as well as payments from details we perform on XP13512. We would co-promote XP13512 and co-detail RequipXL in the United States to the same prescribers.

Factors that may inhibit our efforts to commercialize our products include:

 

   

our inability to recruit and retain adequate numbers of effective sales and marketing personnel;

 

   

the inability of sales personnel to obtain access to adequate numbers of physicians to provide information on the advantages and risks of prescribing our products;

 

   

the lack of complementary products to be offered by sales personnel, which may put us at a competitive disadvantage compared to companies with more extensive product lines; and

 

   

unforeseen costs and expenses associated with creating an independent sales and marketing organization.

Because of the numerous risks and uncertainties involved with establishing our own sales and marketing capabilities, we are unable to predict when we will establish our own sales and marketing capabilities. If we are not successful in recruiting sales and marketing personnel or in building a sales and marketing infrastructure, we will have difficulty commercializing our product candidates, which would adversely affect our business and financial condition.

Our ability to generate revenue from any products that we may develop will depend on reimbursement and drug pricing policies and regulations.*

Many patients may be unable to pay for any products that we or our collaborative partners may develop. In the United States, many patients will rely on Medicare, Medicaid, private health insurers and other third-party payors to pay for their medical needs. Our and our partners’ ability to achieve acceptable levels of reimbursement for drug treatments by governmental authorities, private health insurers and other organizations will have an effect on our and our partners’ ability to successfully commercialize, and attract additional collaborators to invest in the development of, our product candidates. We cannot be sure that reimbursement in the United States, Europe or elsewhere will be available for any products that we or our partners may develop, and any reimbursement that may become available may be decreased or eliminated in the future. Third-party payors increasingly are challenging prices charged for medical products and services, and many third-party payors may refuse to provide reimbursement for particular drugs when an equivalent generic drug is available. Although we believe any products that may result from our product candidates will represent an improvement over the parent drugs upon which they are based and be considered unique and not subject to substitution by a generic parent drug, it is possible that a third-party payor may consider our product candidate and the generic parent drug as equivalents and only offer to reimburse patients for the generic drug. Even if we show improved efficacy or improved convenience of administration with our product candidate, pricing of the existing parent drug may limit the amount we will be able to charge for our product

 

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candidate. If reimbursement is not available or is available only at limited levels, we or our partners may not be able to successfully commercialize our product candidates, and may not be able to obtain a satisfactory financial return on such products.

The trend toward managed healthcare in the United States and the changes in health insurance programs, as well as legislative proposals to reform healthcare or reduce government insurance programs, may result in lower prices for pharmaceutical products, including any products that may result from our product candidates. In addition, any future regulatory changes regarding the healthcare industry or third-party coverage and reimbursement may affect demand for any products that we may develop and could harm our sales and profitability.

Pursuant to the Medicare Prescription Drug Improvement and Modernization Act of 2003, or the 2003 Medicare Modernization Act, Medicare beneficiaries are eligible to obtain subsidized prescription drug coverage from a choice of private sector plans. Approximately 90 percent of Medicare beneficiaries now have coverage for prescription medicines. It remains difficult to predict the long-term impact of the 2003 Medicare Modernization Act on pharmaceutical companies. The use of pharmaceuticals has increased slightly among some patients as the result of the expanded access to medicines afforded by coverage under Medicare. However, such expanded utilization has been largely offset by increased pricing pressure and competition due to the enhanced purchasing power of the private sector plans that negotiate on behalf of Medicare beneficiaries and by an increase in the use of generic medicines in this population. In addition, legislative changes have been proposed to mandate government rebates in Medicare and to allow the federal government to directly negotiate prices with pharmaceutical manufacturers. If legislation were enacted to mandate rebates or provide for direct government negotiation in Medicare prescription drug benefits, access and reimbursement for our product candidates upon commercialization could be restricted.

If our competitors are able to develop and market products that are more effective, safer or less costly than any products that we may develop, our commercial opportunity will be reduced or eliminated.*

We face competition from established pharmaceutical and biotechnology companies, as well as from academic institutions, government agencies and private and public research institutions. Our commercial opportunity will be reduced or eliminated if our competitors develop and commercialize products that are safer, more effective, have fewer side effects or are less expensive than any products that we may develop. In addition, significant delays in the development of our product candidates could allow our competitors to bring products to market before us and impair our ability to commercialize our product candidates.

Products that we believe could compete with XP13512 include the following drugs approved for the treatment of moderate-to-severe primary RLS: Mirapex (pramipexole) from Boehringer Ingelheim GmbH; Requip (ropinirole hydrochloride) from GSK; and generic ropinirole hydrochloride that is marketed by, among others, Roxane Laboratories, Inc., Mylan Pharmaceuticals Inc. and Teva Pharmaceuticals Industries, Ltd. In addition, we could experience competition from the Neupro (rotigotine transdermal system) patch from the UCB Group, which filed its NDA for the treatment of moderate-to-severe primary RLS with the FDA in 2007 and has received a complete response letter from the FDA. Products that we believe could compete with XP13512 for the treatment of neuropathic pain and migraine prophylaxis include drugs that act on the same target as XP13512, such as Lyrica (pregabalin) and Neurontin (gabapentin) from Pfizer, and generic gabapentin that is marketed by Alpharma Inc., IVAX Corp, Pfizer and Teva, among others. Competition for XP13512 could also include drugs such as Cymbalta (duloxatine) from Eli Lilly and Company, which is approved for the management of painful diabetic neuropathy, or Topamax (topiramate) from Johnson & Johnson, which is approved for the prevention of migraines. In addition, DM-1796 (gabapentin GR) from Depomed, Inc., an extended-release formulation of gabapentin, has recently reported positive results from a Phase 3 clinical trial for the treatment of post-herpetic neuralgia. We believe that XP19986 could experience competition from several generic drugs approved for the treatment of spasticity, including racemic baclofen, diazepam, dantrolene sodium and tizanidine. Therapies in development for the treatment of spasticity include Fampridine-SR (4-aminopyridine) from Acorda Therapeutics, Inc. and IPX056, an extended-release formulation of baclofen, from Impax Laboratories, Inc. Products that could compete with XP19986 in the GERD therapeutic area include: Protonix (pantoprazole sodium) from Pfizer; Prevacid (lansoprazole) from Takeda Pharmaceutical Company Limited; Nexium (esomeprazole) and Prilosec (omeprazole) from AstraZeneca Pharmaceuticals LP; Aciphex (rabeprazole) from Eisai/Johnson & Johnson; and generic H2 receptor antagonists such as cimetidine, ranitidine, famotidine and nizatidine. Product candidates in development for the treatment of GERD include: ADX10059 (mGluR5 NAM) from Addex Pharmaceuticals; and AZD3355, a GABA(B) receptor agonist, from AstraZeneca. Products that could compete with XP21279 include generic L-Dopa/carbidopa drugs and other drugs approved for the treatment of Parkinson’s disease, including Stalevo, a combination therapy of L-Dopa/carbidopa/entacapone that is marketed in the United States by Novartis, dopamine agonists such as Mirapex, Requip and Neupro, which are marketed by Boehringer-Ingelheim, GSK and UCB, respectively, as well as generic ropinirole hydrochloride that is marketed by, among others, Roxane, Teva and Mylan. In addition, IPX066 from Impax, an extended-release formulation of L-Dopa/carbidopa, is in Phase 3 clinical development. There may be other compounds of which we are not aware that are at an earlier stage of development and may compete with our product candidates. If any of those compounds are successfully developed and approved, they could compete directly with our product candidates.

 

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Many of our competitors have significantly greater financial resources and expertise in research and development, manufacturing, preclinical testing, conducting clinical trials, obtaining regulatory approvals and marketing approved products than we do. Established pharmaceutical companies may invest heavily to quickly discover and develop novel compounds that could make our product candidates obsolete. Smaller or early-stage companies may also prove to be significant competitors, particularly through collaborative arrangements with large and established companies. In addition, these third parties compete with us in recruiting and retaining qualified scientific and management personnel, establishing clinical trial sites and patient registration for clinical trials, as well as in acquiring technologies and technology licenses complementary to our programs or advantageous to our business. Accordingly, our competitors may succeed in obtaining patent protection, receiving FDA approval or discovering, developing and commercializing medicines before we do. We are also aware of other companies that may currently be engaged in the discovery of medicines that will compete with the product candidates that we are developing. In addition, in the markets that we are targeting, we expect to compete against current market-leading medicines. If we are not able to compete effectively against our current and future competitors, our business will not grow and our financial condition will suffer.

Off-label sale or use of generic gabapentin products could decrease sales of XP13512 and could lead to pricing pressure if such products become available at competitive prices and in dosages that are appropriate for the indications for which we or our collaborative partners are developing XP13512.

Physicians are permitted to prescribe legally available drugs for uses that are not described in the drug’s labeling and that differ from those uses tested and approved by the FDA. Such off-label uses are common across medical specialties. Various products are currently sold and used off-label for some of the diseases and conditions that we or our partners are targeting, and a number of companies are, or may be, developing new treatments that may be used off-label. The occurrence of such off-label uses could significantly reduce our or our partners’ ability to market and sell any products that we or our partners may develop.

We believe that in all countries in which we hold or have licensed rights to patents or patent applications related to XP13512, the composition-of-matter patents relating to gabapentin have expired. Off-label prescriptions written for gabapentin for indications for which we or our partners are marketing XP13512 could adversely affect our ability to generate revenue from the sale of XP13512, if approved for commercial sale. This could result in reduced sales and pricing pressure on XP13512, if approved, which in turn would reduce our ability to generate revenue and have a negative impact on our results of operations.

Our investment portfolio may become impaired by further deterioration of the capital markets.*

Our cash equivalent and short-term investment portfolio as of September 30, 2009 consisted of bonds of U.S. treasury securities, U.S. government sponsored agencies and money market mutual funds. We follow an established investment policy and set of guidelines to monitor, manage and limit our exposure to interest rate and credit risk. The policy sets forth credit quality standards and limits our exposure to any one issuer, as well as our maximum exposure to various asset classes.

As a result of recent adverse financial market conditions, investments in some financial instruments, such as structured investment vehicles, sub-prime mortgage-backed securities and collateralized debt obligations, may pose risks arising from liquidity and credit concerns. As of September 30, 2009, we had no direct holdings in these categories of investments and our indirect exposure to these financial instruments through our holdings in money market mutual funds was immaterial. As of September 30, 2009, we had no impairment charge associated with our short-term investment portfolio relating to such adverse financial market conditions. Although we believe our current investment portfolio has very little risk of impairment, we cannot predict future market conditions or market liquidity and can provide no assurance that our investment portfolio will remain unimpaired.

If we fail to attract and keep senior management and key scientific personnel, we may be unable to successfully develop or commercialize our product candidates.

Our success depends on our continued ability to attract, retain and motivate highly qualified management, clinical and scientific personnel and on our ability to develop and maintain important relationships with leading clinicians. If we are not able to retain Drs. Ronald Barrett, Kenneth Cundy, Mark Gallop, David Savello and David Stamler, we may not be able to successfully develop or commercialize our product candidates. Competition for experienced scientists and development staff may limit our ability to hire and retain highly qualified personnel on acceptable terms. In addition, none of our employees have employment commitments for any fixed period of time and could leave our employment at will. We do not carry “key person” insurance covering members of senior management or key scientific personnel. If we fail to identify, attract and retain qualified personnel, we may be unable to continue our development and commercialization activities.

 

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We will need to hire additional employees in order to commercialize our product candidates. Any inability to manage future growth could harm our ability to commercialize our product candidates, increase our costs and adversely impact our ability to compete effectively.

In order to commercialize our product candidates, we will need to expand the number of our managerial, operational, financial and other employees. We currently anticipate that we will need at least 65 additional employees by the time that XP13512 or XP19986 is initially commercialized, including at least 50 sales representatives. Because the projected timeframe of hiring these additional employees depends on the development status of our product candidates and because of the numerous risks and uncertainties associated with drug development, we are unable to project when we will hire these additional employees. The competition for qualified personnel in the pharmaceutical and biotechnology field is intense, and we may experience difficulties in recruiting, hiring and retaining qualified individuals.

Future growth will impose significant added responsibilities on members of management, including the need to identify, recruit, maintain and integrate additional employees. Our future financial performance and our ability to commercialize our product candidates and compete effectively will depend, in part, on our ability to manage any future growth effectively.

If product liability lawsuits are brought against us, we will incur substantial liabilities and may be required to limit commercialization of any products that we may develop.

We face an inherent risk of product liability exposure related to the testing of our product candidates in human clinical trials and will face an even greater risk if we commercially sell any products that we may develop. If we cannot successfully defend ourselves against claims that our product candidates or products that we may develop caused injuries, we will incur substantial liabilities.

Regardless of merit or eventual outcome, liability claims may result in:

 

   

decreased demand for any product candidates or products that we may develop;

 

   

injury to our reputation;

 

   

withdrawal of clinical trial participants;

 

   

costs to defend the related litigation;

 

   

substantial monetary awards to clinical trial participants or patients;

 

   

loss of revenue; and

 

   

the inability to commercialize any products that we may develop.

We have product liability insurance that covers our clinical trials up to a $10.0 million annual aggregate limit. We intend to expand our insurance coverage to include the sale of commercial products if marketing approval is obtained for any products that we may develop. Insurance coverage is increasingly expensive, and we may not be able to maintain insurance coverage at a reasonable cost and we may not be able to obtain insurance coverage that will be adequate to satisfy any liability that may arise.

If we use biological and hazardous materials in a manner that causes contamination or injury or violates laws, we may be liable for damages.

Our research and development activities involve the use of potentially harmful biological materials as well as hazardous materials, chemicals and various radioactive compounds. We cannot completely eliminate the risk of accidental contamination or injury from the use, storage, handling or disposal of these materials. In the event of contamination or injury, we could be held liable for damages that result, and any liability could exceed our resources. We, the third parties that conduct clinical trials on our behalf and the third parties that manufacture our product candidates are subject to federal, state and local laws and regulations governing the use, storage, handling and disposal of these materials and waste products. The cost of compliance with these laws and regulations could be significant. The failure to comply with these laws and regulations could result in significant fines and work stoppages and may harm our business.

Our facility is located in California’s Silicon Valley, in an area with a long history of industrial activity and use of hazardous substances, including chlorinated solvents. Environmental studies conducted prior to our leasing of the site found levels of metals and volatile organic compounds in the soils and groundwater at our site. While these constituents of concern predated our occupancy, certain environmental laws, including the U.S. Comprehensive, Environmental Response, Compensation and Liability Act of 1980, impose strict, joint and several liability on current operators of real property for the cost of removal or remediation of hazardous substances. These laws often impose liability even if the owner or operator did not know of, or was not responsible for, the release of

 

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such hazardous substances. As a result, while we have not been, we cannot rule out the possibility that we could in the future be held liable for costs to address contamination at the property beneath our facility, which costs could be material.

Our facility is located near known earthquake fault zones, and the occurrence of an earthquake, extremist attack or other catastrophic disaster could cause damage to our facilities and equipment, which could require us to cease or curtail operations.

Our facility is located near known earthquake fault zones and, therefore, is vulnerable to damage from earthquakes. In October 1989, a major earthquake struck this area and caused significant property damage and a number of fatalities. We are also vulnerable to damage from other types of disasters, including power loss, attacks from extremist organizations, fire, floods and similar events. If any disaster were to occur, our ability to operate our business could be seriously impaired. In addition, the unique nature of our research activities and of much of our equipment could make it difficult for us to recover from this type of disaster. We currently may not have adequate insurance to cover our losses resulting from disasters or other similar significant business interruptions, and we do not plan to purchase additional insurance to cover such losses due to the cost of obtaining such coverage. Any significant losses that are not recoverable under our insurance policies could seriously impair our business and financial condition.

Risks Related to Ownership of our Common Stock

Our stock price is volatile, and purchasers of our common stock could incur substantial losses.

The market prices for securities of biopharmaceutical companies in general have been highly volatile. The market price of our common stock may be influenced by many factors, including:

 

   

adverse results or delays in our or our collaborative partners’ clinical trials;

 

   

the timing of achievement of our clinical, regulatory, partnering and other milestones, such as the commencement of clinical development, the completion of a clinical trial, the filing for regulatory approval or the establishment of commercial partnerships for one or more of our product candidates;

 

   

announcement of FDA approvability, approval or non-approval of our product candidates or delays in the FDA review process;

 

   

actions taken by regulatory agencies with respect to our product candidates, our clinical trials or our sales and marketing activities;

 

   

actions taken by regulatory agencies with respect to products or drug classes related to our product candidates;

 

   

the commercial success of any of our products approved by the FDA or its foreign counterparts;

 

   

changes in our collaborators’ business strategies;

 

   

regulatory developments in the United States and foreign countries;

 

   

changes in the structure of healthcare payment systems;

 

   

any intellectual property matter involving us, including infringement lawsuits;

 

   

actions taken by regulatory agencies with respect to our or our partners’ compliance with regulatory requirements;

 

   

announcements of technological innovations or new products by us or our competitors;

 

   

market conditions for equity investments in general, or the biotechnology or pharmaceutical industries in particular;

 

   

changes in financial estimates or recommendations by securities analysts;

 

   

sales of large blocks of our common stock;

 

   

sales of our common stock by our executive officers, directors and significant stockholders;

 

   

restatements of our financial results and/or material weaknesses in our internal controls; and

 

   

the loss of any of our key scientific or management personnel.

The stock markets in general and the markets for biotechnology stocks in particular, have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the trading price of our common stock. In the past, class action litigation has often been instituted against companies whose securities have experienced periods of volatility in market price. Any such litigation brought against us could result in substantial costs, which would hurt our financial condition and results of operations, divert management’s attention and resources and possibly delay our clinical trials or commercialization efforts.

 

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Failure to maintain effective internal controls in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 could have a material adverse effect on our stock price.

Section 404 of the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the SEC require annual management assessments of the effectiveness of our internal control over financial reporting and a report by our independent registered public accounting firm attesting to, and reporting on, the effectiveness of our internal control over financial reporting. If we fail to maintain the adequacy of our internal control over financial reporting, as such standards are modified, supplemented or amended from time to time, we may not be able to ensure that we can conclude on an ongoing basis that we have effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act of 2002 and the related rules and regulations of the SEC. If we cannot favorably assess, or our independent registered public accounting firm is unable to provide an unqualified attestation report on, the effectiveness of our internal control over financial reporting, investor confidence in the reliability of our financial reports may be adversely affected, which could have a material adverse effect on our stock price.

Fluctuations in our operating results could cause our stock price to decline.

The following factors are likely to result in fluctuations of our operating results from quarter to quarter and year to year:

 

   

adverse results or delays in our or our collaborative partners’ clinical trials;

 

   

the timing and achievement of our clinical, regulatory, partnering and other milestones, such as the commencement of clinical development, the completion of a clinical trial, the filing for regulatory approval or the establishment of a commercial partnership for one or more of our product candidates;

 

   

announcement of FDA approvability, approval or non-approval of our product candidates or delays in the FDA review process;

 

   

actions taken by regulatory agencies with respect to our product candidates, our clinical trials or our sales and marketing activities;

 

   

actions taken by regulatory agencies with respect to products or drug classes related to our product candidates;

 

   

the commercial success of any of our products approved by the FDA or its foreign counterparts;

 

   

changes in our collaborators’ business strategies;

 

   

actions taken by regulatory agencies with respect to our or our partners’ compliance with regulatory requirements;

 

   

regulatory developments in the United States and foreign countries;

 

   

changes in the structure of healthcare payment systems;

 

   

any intellectual property matter involving us, including infringement lawsuits; and

 

   

announcements of technological innovations or new products by us or our competitors.

Due to these fluctuations in our operating results, a period-to-period comparison of our results of operations may not be a good predictor of our future performance. For example, due to the recognition of revenues from up-front and milestone payments from our collaborations with Astellas, GSK and Xanodyne, we were profitable in the three-month periods ended June 30, September 30 and December 31, 2007, and for the year ended December 31, 2007. However, while recognition of these revenues resulted in a profitable year for 2007, we incurred net losses in 2008, and we expect to incur net losses in 2009. In any particular financial period, the actual or anticipated fluctuations could be below the expectations of securities analysts or investors and our stock price could decline.

Because a small number of existing stockholders own a large percentage of our voting stock, they may be able to exercise significant influence over our affairs, acting in their best interests and not necessarily those of other stockholders.*

As of October 15, 2009, our executive officers, directors and holders of 5% or more of our outstanding common stock beneficially owned approximately 48.4% of our common stock. The interests of this group of stockholders may not always coincide with our interests or the interests of other stockholders. This concentration of ownership could also have the effect of delaying or preventing a change in our control or otherwise discouraging a potential acquiror from attempting to obtain control of us, which in turn could reduce the price of our common stock.

 

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Our stockholder rights plan and anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of us, which may be beneficial to our stockholders, more difficult and may prevent attempts by our stockholders to replace or remove our current management.

Provisions in our amended and restated certificate of incorporation and bylaws may delay or prevent an acquisition of us, a change in our management or other changes that stockholders may consider favorable. These provisions include:

 

   

a classified board of directors;

 

   

a prohibition on actions by our stockholders by written consent;

 

   

the ability of our board of directors to issue preferred stock without stockholder approval, which could be used to make it difficult for a third party to acquire us;

 

   

notice requirements for nominations for election to the board of directors; and

 

   

limitations on the removal of directors.

Moreover, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which prohibits a person who owns in excess of 15% of our outstanding voting stock from merging or combining with us for a period of three years after the date of the transaction in which the person acquired in excess of 15% of our outstanding voting stock, unless the merger or combination is approved in a prescribed manner.

We have adopted a rights agreement under which certain stockholders have the right to purchase shares of a new series of preferred stock at an exercise price of $140.00 per one one-hundredth of a share, if a person acquires more than 15% of our common stock. The rights plan could make it more difficult for a person to acquire a majority of our outstanding voting stock. The rights plan could also reduce the price that investors might be willing to pay for shares of our common stock and result in the market price being lower than it would be without the rights plan. In addition, the existence of the rights plan itself may deter a potential acquiror from acquiring us. As a result, either by operation of the rights plan or by its potential deterrent effect, mergers and acquisitions of us that our stockholders may consider in their best interests may not occur.

If there are large sales of our common stock, the market price of our common stock could drop substantially.*

If our existing stockholders sell a large number of shares of our common stock or the public market perceives that existing stockholders might sell shares of our common stock, the market price of our common stock could decline significantly. As of October 15, 2009, we had 30,340,201 outstanding shares of common stock. Of these shares, up to 14,691,906 shares of common stock are tradable under Rule 144 under the Securities Act of 1933, as amended, or the Securities Act, subject to the volume limitations and manner of sale requirements under Rule 144, and the remainder of the shares outstanding as of October 15, 2009, have been registered under the Securities Act and are freely tradable.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

None.

 

Item 3. Defaults Upon Senior Securities

None.

 

Item 4. Submission of Matters to a Vote of Security Holders

None.

 

Item 5. Other Information

None.

 

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Item 6. Exhibits

 

Exhibit

Number

  

Description of Document

3.1    Amended and Restated Certificate of Incorporation(1)
3.2    Amended and Restated Bylaws(1)
3.3    Certificate of Designation of Series A Junior Participating Preferred Stock(2)
4.1    Specimen Common Stock Certificate(3)
4.2    Fifth Amended and Restated Investors Rights Agreement, dated December 16, 2004, by and among the Company and certain stockholders of the Company(4)
4.3    Form of Right Certificate(5)
4.4    Form of Registered Direct Common Warrant(6)
  10.35†    Amended and Restated Distribution and License Agreement, dated as of October 31, 2009, between the Company and Astellas Pharma Inc.
31.1      Certification of the Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2      Certification of the Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1      Certification required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. §1350)(7)

 

Confidential treatment has been requested for portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.
(1) Incorporated herein by reference to the same numbered exhibit of our quarterly report on Form 10-Q (File No. 000-51329) for the period ended June 30, 2005, as filed with the SEC on August 11, 2005.
(2) Incorporated herein by reference to Exhibit 3.1 of our current report on Form 8-K, filed with the SEC on December 16, 2005.
(3) Incorporated herein by reference to the same numbered exhibit of our registration statement on Form S-1, as amended (File No. 333-122156), as filed with the SEC on April 13, 2005.
(4) Incorporated herein by reference to the same numbered exhibit of our registration statement on Form S-1 (File No. 333-122156), as filed with the SEC on January 19, 2005.
(5) Incorporated herein by reference to Exhibit 4.1 of our current report on Form 8-K, filed with the SEC on December 16, 2005.
(6) Incorporated herein by reference to Exhibit 4.1 of our current report on Form 8-K, filed with the SEC on December 30, 2008.
(7) This certification accompanies the quarterly report on Form 10-Q to which it relates, is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of the Registrant under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended (whether made before or after the date of the Form 10-Q), irrespective of any general incorporation language contained in such filing.

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    XenoPort, Inc.
    (Registrant)
November 4, 2009    

/s/    RONALD W. BARRETT        

    Ronald W. Barrett
    Chief Executive Officer and Director
    (principal executive officer)
November 4, 2009    

/s/    WILLIAM G. HARRIS        

    William G. Harris
    Senior Vice President of Finance and Chief Financial Officer
    (principal financial and accounting officer)
November 4, 2009    

/s/    MARTYN J. WEBSTER        

    Martyn J. Webster
    Vice President of Finance

 

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EXHIBIT INDEX

 

Exhibit

Number

  

Description of Document

3.1    Amended and Restated Certificate of Incorporation(1)
3.2    Amended and Restated Bylaws(1)
3.3    Certificate of Designation of Series A Junior Participating Preferred Stock(2)
4.1    Specimen Common Stock Certificate(3)
4.2    Fifth Amended and Restated Investors Rights Agreement, dated December 16, 2004, by and among the Company and certain stockholders of the Company(4)
4.3    Form of Right Certificate(5)
4.4    Form of Registered Direct Common Warrant(6)
  10.35†    Amended and Restated Distribution and License Agreement, dated as of October 31, 2009, between the Company and Astellas Pharma Inc.
31.1      Certification of the Chief Executive Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2      Certification of the Chief Financial Officer pursuant to Securities Exchange Act Rules 13a-14(a) and 15d-14(a) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1      Certification required by Rule 13a-14(b) or Rule 15d-14(b) and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. §1350)(7)

 

Confidential treatment has been requested for portions of this exhibit. Omitted portions have been filed separately with the Securities and Exchange Commission pursuant to Rule 24b-2 of the Securities Exchange Act of 1934, as amended.
(1) Incorporated herein by reference to the same numbered exhibit of our quarterly report on Form 10-Q (File No. 000-51329) for the period ended June 30, 2005, as filed with the SEC on August 11, 2005.
(2) Incorporated herein by reference to Exhibit 3.1 of our current report on Form 8-K, filed with the SEC on December 16, 2005.
(3) Incorporated herein by reference to the same numbered exhibit of our registration statement on Form S-1, as amended (File No. 333-122156), as filed with the SEC on April 13, 2005.
(4) Incorporated herein by reference to the same numbered exhibit of our registration statement on Form S-1 (File No. 333-122156), as filed with the SEC on January 19, 2005.
(5) Incorporated herein by reference to Exhibit 4.1 of our current report on Form 8-K, filed with the SEC on December 16, 2005.
(6) Incorporated herein by reference to Exhibit 4.1 of our current report on Form 8-K, filed with the SEC on December 30, 2008.
(7) This certification accompanies the quarterly report on Form 10-Q to which it relates, is not deemed filed with the Securities and Exchange Commission and is not to be incorporated by reference into any filing of the Registrant under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended (whether made before or after the date of the Form 10-Q), irrespective of any general incorporation language contained in such filing.

 

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