UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

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 FORM 10-Q

 

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

 

For the quarterly period ended June 30, 2015

 

or

 

☐	TRANSITION REPORTS PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

 

For the transition period from              to             

 

Commission File Number: 001-35068

 

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ACELRX PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

 

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Delaware	41-2193603
(State or other jurisdiction of incorporation or organization)	(IRS Employer Identification No.)

 

351 Galveston Drive

Redwood City, CA 94063

(650) 216-3500

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ☒    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 (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ☒    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. (Check one):

 

Large accelerated filer	☐	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 Exchange Act Rule 12b-2)    Yes  ☐    No  ☒

 

As of July 21, 2015, the number of outstanding shares of the registrant’s common stock was 44,374,509.

  

 

 

 

 

 

 

 

ACELRX PHARMACEUTICALS, INC.

 

QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2015

 

Table of Contents

 

			Page
Part I. Financial Information			3
	Item 1.	Financial Statements	3
		Condensed Balance Sheets as of June 30, 2015 and December 31, 2014	3
		Condensed Statements of Comprehensive Loss for the three and six months ended June 30, 2015 and 2014 (unaudited)	4
		Condensed Statements of Cash Flows for the six months ended June 30, 2015 and 2014 (unaudited)	5
		Notes to Condensed Financial Statements (unaudited)	6
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30
	Item 4.	Controls and Procedures	30
PART II. Other Information			31
	Item 1.	Legal Proceedings	31
	Item 1A.	Risk Factors	31
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	60
	Item 3.	Defaults Upon Senior Securities	60
	Item 4.	Mine Safety Disclosures	60
	Item 5.	Other Information	60
	Item 6.	Exhibits	60

 

Unless the context indicates otherwise, the terms “AcelRx,” “AcelRx Pharmaceuticals,” “we,” “us” and “our” refer to AcelRx Pharmaceuticals, Inc. “ACELRX” and “ACCELERATE, INNOVATE, ALLEVIATE” are U.S. registered trademarks owned by AcelRx Pharmaceuticals, Inc. This report also contains other trademarks and trade names that are the property of their respective owners. 

 

 

 

 

 

  

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

AcelRx Pharmaceuticals, Inc.

 

Condensed Balance Sheets

(In thousands, except share data)

 

		June 30, 2015 (Unaudited)				December 31, 2014(1)
Assets
Current Assets:
Cash and cash equivalents		$	35,842			$	60,038
Short-term investments			15,353				15,312
Prepaid expenses and other current assets			2,324				948
Total current assets			53,519				76,298
Property and equipment, net			9,715				9,818
Restricted cash			250				250
Other assets			76				81
Total Assets		$	63,560			$	86,447
Liabilities and Stockholders’ Equity
Current Liabilities:
Accounts payable		$	1,597			$	2,431
Accrued liabilities			2,048				3,654
Deferred revenue, current portion			152				787
Long-term debt, current portion			9,509				6,859
Total current liabilities			13,306				13,731
Deferred rent			479				529
Long-term debt, net of current portion			13,623				18,046
Deferred revenue, net of current portion			1,594				1,626
Contingent put option liability			251				282
Warrant liability			916				5,577
Total liabilities			30,169				39,791
Stockholders’ Equity:
Common stock, $0.001 par value—100,000,000 shares authorized as of June 30, 2015 and December 31, 2014; 44,374,509 and 43,712,363 shares issued and outstanding as of June 30, 2015 and December 31, 2014			44				43
Additional paid-in capital			231,074				225,423
Accumulated deficit			(197,728	)			(178,806	)
Accumulated other comprehensive income (loss)			1				(4	)
Total stockholders’ equity			33,391				46,656
Total Liabilities and Stockholders’ Equity		$	63,560			$	86,447

 

(1)	The condensed balance sheet as of December 31, 2014 has been derived from the audited financial statements as of that date included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014.

 

See notes to condensed financial statements.

  

  

AcelRx Pharmaceuticals, Inc.

 

Condensed Statements of Comprehensive Loss

(Unaudited)

(In thousands, except share and per share data)

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2015				2014				2015				2014
Revenue:
Contract		$	1,438			$	—			$	1,438			$	—
Collaboration agreement			486				71				667				166
Total revenue			1,924				71				2,105				166
Operating expenses:
Research and development			7,310				7,284				13,616				11,995
General and administrative			2,735				5,047				7,256				8,972
Restructuring costs			2				—				756				—
Total operating expenses			10,047				12,331				21,628				20,967
Loss from operations			(8,123	)			(12,260	)			(19,523	)			(20,801	)
Interest expense			(777	)			(530	)			(1,583	)			(1,002	)
Interest income and other income (expense), net			4				2,215				2,184				1,597
Net loss			(8,896	)			(10,575	)			(18,922	)			(20,206	)
Other comprehensive loss:
Unrealized gains (losses) on available-for-sale securities			1				(2	)			5				(2	)
Comprehensive loss		$	(8,895	)		$	(10,577	)		$	(18,917	)		$	(20,208	)
Net loss per share of common stock, basic		$	(0.20	)		$	(0.24	)		$	(0.43	)		$	(0.47	)
Net loss per share of common stock, diluted		$	(0.20	)		$	(0.30	)		$	(0.47	)		$	(0.50	)
Shares used in computing net loss per share of common stock, basic			44,343,270				43,333,210				44,109,488				43,262,204
Shares used in computing net loss per share of common stock, diluted – see Note 9			44,343,270				44,310,166				44,397,471				43,774,033

 

 

 

See notes to condensed financial statements.

  

  

AcelRx Pharmaceuticals, Inc.

 

Condensed Statements of Cash Flows

(Unaudited)

(In thousands)

 

		Six Months Ended June 30,
		2015				2014
Cash flows from operating activities:
Net loss		$	(18,922	)		$	(20,206	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization			997				318
Amortization of premium/discount on investments, net			47				140
Interest expense related to debt financing			472				279
Restructuring costs			(756	)			—
Stock-based compensation			2,649				1,869
Revaluation of put option and PIPE warrant liabilities			(2,148	)			(1,719	)
Changes in operating assets and liabilities:
Prepaid expenses and other assets			(1,376	)			(23	)
Accounts payable			(834	)			457
Accrued liabilities			(850	)			(871	)
Deferred revenue			(667	)			(167	)
Deferred rent			(50	)			(20	)
Net cash used in operating activities			(21,438	)			(19,943	)
Cash flows from investing activities:
Purchase of property and equipment			(894	)			(1,959	)
Purchase of investments			(5,543	)			(4,879	)
Proceeds from maturity of investments			5,460				5,379
Net cash used in investing activities			(977	)			(1,459	)
Cash flows from financing activities:
Proceeds from issuance of long-term debt			—				10,000
Payment of long-term debt			(2,240	)			—
Net proceeds from issuance of common stock through equity plans and exercise of warrants			459				729
Net cash (used in) provided by financing activities			(1,781	)			10,729
Net decrease in cash and cash equivalents			(24,196	)			(10,673	)
Cash and cash equivalents—Beginning of period			60,038				88,401
Cash and cash equivalents—End of period		$	35,842			$	77,728

 

 

 

See notes to condensed financial statements.

  

   

AcelRx Pharmaceuticals, Inc.

 

Notes to Condensed Financial Statements

(Unaudited)

 

1. Organization and Summary of Significant Accounting Policies

 

The Company

 

AcelRx Pharmaceuticals, Inc., or the Company or AcelRx, was incorporated in Delaware on July 13, 2005 as SuRx, Inc., and in January 2006, the Company changed its name to AcelRx Pharmaceuticals, Inc. The Company’s operations are based in Redwood City, California.

 

AcelRx is a specialty pharmaceutical company focused on the development and commercialization of innovative therapies for the treatment of acute pain. AcelRx intends to commercialize its product candidates in the United States and license the development and commercialization rights to its product candidates for sale outside of the United States through strategic partnerships and collaborations. AcelRx may also consider the option to enter into strategic partnerships for its product candidates in the United States. In March 2015, the Company began a pivotal Phase 3 study of ARX-04 (sufentanil sublingual tablet, 30 mcg), a proprietary, non-invasive, single-use tablet in a disposable, pre-filled, single-dose applicator, or SDA. This study, SAP301, is a multi-center, double-blind, placebo-controlled study that will evaluate the efficacy and safety of ARX-04 vs. placebo for the treatment of moderate-to-severe acute pain following ambulatory abdominal surgery. This study is fully enrolled and top-line data is expected early in the fourth quarter of 2015. The Company believes ARX-04 may be a candidate for use in a variety of medically supervised settings to manage moderate-to-severe acute pain, including in the emergency room, or for post-operative patients, following either short-stay or ambulatory surgery.

 

On July 25, 2014, the U.S. Food and Drug Administration, or FDA, issued a Complete Response Letter, or CRL, for the Company’s new drug application, or NDA, for Zalviso™ (sufentanil sublingual tablet system). In March 2015, the Company received correspondence from the FDA stating that in addition to the bench testing and two Human Factors studies the Company had performed in response to the issues identified in the CRL, a clinical trial is needed to assess the risk of inadvertent dispensing and overall risk of dispensing failures. The Company has been granted a General Advice meeting with the Division of Anesthesia, Analgesia, and Addiction Products in early September 2015 to discuss the FDA’s request for an additional clinical trial and the Company’s planned response to the CRL. Pending the outcome of that meeting, the Company intends to finalize its plans to refile the NDA for Zalviso. The proposed indication for Zalviso is for the management of moderate-to-severe acute pain in adult patients in the hospital setting. Zalviso consists of sufentanil sublingual tablets, 15 mcg, delivered by the Zalviso System, a needle-free, handheld, patient-administered, pain management system (together, “Zalviso”).

 

The Company has incurred recurring operating losses and negative cash flows from operating activities since inception and expects to continue to incur negative cash flows until its product candidates are approved for marketing in the United States and other countries, in which it has and intends to license its products, which may never occur.

 

The Company has one business activity, which is the development and commercialization of product candidates for the treatment of pain, and a single reporting and operating unit structure.

 

Basis of Presentation

 

The accompanying unaudited condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the rules and regulations of the U.S. Securities and Exchange Commission, or SEC. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.

 

Operating results for the three and six months ended June 30, 2015, are not necessarily indicative of the results that may be expected for the year ending December 31, 2015. The condensed balance sheet as of December 31, 2014, was derived from the Company’s audited financial statements as of December 31, 2014, included in the Company’s Annual Report on Form 10-K filed with the SEC. These financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, which includes a broader discussion of the Company’s business and the risks inherent therein.

  

 

Use of Estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the condensed financial statements and accompanying notes. Management evaluates its estimates on an ongoing basis including critical accounting policies. Estimates are based on historical experience and on various other market-specific and other relevant assumptions that the Company believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates.

 

Significant Accounting Policies 

 

The Company’s significant accounting policies are detailed in its Annual Report on Form 10-K for the year ended December 31, 2014. In addition, during the six months ended June 30, 2015, the Company has updated its revenue recognition policy to include Contract revenue, as discussed below. There are no other significant changes to the Company’s significant accounting policies from those previously disclosed in its Annual Report on Form 10-K.

 

Revenue Recognition - Contract Revenue

 

In May 2015, the Company entered into an award contract with the United States Army Medical Research and Materiel Command, or USAMRMC, to support the development of the Company’s product candidate, ARX-04. The contract provides for the reimbursement of qualified expenses for research and development activities as defined under the terms of the contract. Revenue under the contract is recognized when the related qualified research expenses are incurred.

 

Recently Issued Accounting Standards

 

In May 2014, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers, or ASU 2014-09, to provide guidance on revenue recognition. ASU 2014-09 requires a company to recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under today’s guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. In April 2015, the FASB proposed a one-year deferral of the effective date for ASU 2014-09. Under the proposal, ASU 2014-09 is effective for the Company in the first quarter of 2018. Early adoption up to the first quarter of 2017 is permitted. Upon adoption, ASU 2014-09 can be applied retrospectively to all periods presented or only to the most current period presented with the cumulative effect of changes reflected in the opening balance of retained earnings in the most current period presented. The Company is currently evaluating the method of adoption and the impact of adopting ASU 2014-09 on its results of operations, cash flows and financial position.

 

In April 2015, the FASB issued Accounting Standards Update No. 2015-03, Interest—Imputation of Interest, or ASU 2015-03. ASU 2015-03 will more closely align the presentation of debt issuance costs under U.S. GAAP with the presentation under comparable IFRS standards by requiring that debt issuance costs be presented on the balance sheet as a direct deduction from the carrying amount of the related debt liability, similar to the presentation of debt discounts or premiums. This accounting guidance is effective for us beginning in the first quarter of 2016. Early adoption is permitted. Upon adoption, ASU 2015-03 should be applied retrospectively to all periods presented. The Company does not expect this updated standard to have a material impact on its financial statements and related disclosures.

 

2. Investments and Fair Value Measurement

 

Investments

 

The Company classifies its marketable securities as available-for-sale and records its investments at fair value. Available-for-sale securities are carried at estimated fair value based on quoted market prices or observable market inputs of almost identical assets, with the unrealized holding gains and losses included in accumulated other comprehensive income. Marketable securities which have maturities beyond one year as of the end of the reporting period are classified as non-current.

 

 

The table below summarizes the Company’s cash, cash equivalents and investments (in thousands):

 

		As of June 30, 2015
		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
Cash and cash equivalents:
Cash		$	35,839			$	—			$	—			$	35,839
Money market funds			3				—				—				3
Total cash and cash equivalents			35,842				—				—				35,842
Marketable securities:
U.S. government agency securities			15,352				1				—			$	15,353
Total marketable securities			15,352				1				—			$	15,353
Total cash, cash equivalents and investments		$	51,194			$	1			$	—			$	51,195

 

		As of December 31, 2014
		Amortized Cost				Gross Unrealized Gains				Gross Unrealized Losses				Fair Value
Cash and cash equivalents:
Cash		$	60,005			$	—			$	—			$	60,005
Money market funds			33				—				—				33
Total cash and cash equivalents			60,038				—				—			$	60,038
Marketable securities:
U.S. government agency securities			15,316				—				(4	)			15,312
Total marketable securities			15,316				—				(4	)		$	15,312
Total cash, cash equivalents and investments		$	75,354			$	—			$	(4	)		$	73,350

 

As of June 30, 2015 and December 31, 2014, none of the available-for-sale securities held by the Company had material unrealized losses. There were no other-than-temporary impairments for these securities at June 30, 2015 or December 31, 2014. No gross realized gains or losses were recognized on the available-for-sale securities and, accordingly, there were no amounts reclassified out of accumulated other comprehensive income to earnings during the three and six months ended June 30, 2015 and 2014.

 

As of June 30, 2015 and December 31, 2014, the contractual maturity of all investments held was less than one year.

 

 

Fair Value Measurement

 

The Company’s financial instruments consist of Level I and Level II assets and Level III liabilities. Level I securities include highly liquid money market funds and are valued based on quoted market prices. For Level II instruments, the Company estimates fair value by utilizing third party pricing services in developing fair value measurements where fair value is based on valuation methodologies such as models using observable market inputs, including benchmark yields, reported trades, broker/dealer quotes, bids, offers and other reference data. Such Level II instruments typically include U.S. treasury and U.S. government agency obligations. As of June 30, 2015 and December 31, 2014, the Company held, in addition to Level I and Level II assets, a contingent put option liability associated with the Company’s Amended and Restated Loan and Security Agreement, or the Amended Loan Agreement, with Hercules Technology II, L.P. and Hercules Technology Growth Capital, Inc., collectively referred to as Hercules, which amends and restates the loan and security agreement with Hercules dated as of June 29, 2011, or the Original Loan Agreement, and which was classified as a Level III liability. See Note 5 “Long-Term Debt,” for further description. The Company’s estimate of fair value of the contingent put option liability was determined by using a risk-neutral valuation model, wherein the fair value of the underlying debt facility is estimated both with and without the presence of the default provisions, holding all other assumptions constant. The resulting difference between the two estimated fair values is the estimated fair value of the default provisions, or the contingent put option. Changes to the estimated fair value of these liabilities are recorded in interest income and other income (expense), net in the condensed statements of comprehensive loss. The fair value of the underlying debt facility is estimated by calculating the expected cash flows in consideration of an estimated probability of default and expected recovery rate in default, and discounting such cash flows back to the reporting date using a risk-free rate. As of June 30, 2015 and December 31, 2014, the Company also held a Level III liability associated with warrants, or PIPE warrants, issued in connection with the Company’s private placement equity offering, completed in June 2012. The PIPE warrants are considered a liability and are valued using the Black-Scholes option-pricing model, the inputs for which include exercise price of the PIPE warrants, market price of the underlying common shares, expected term, volatility based on a group of the Company’s peers and the risk-free rate corresponding to the expected term of the PIPE warrants. Changes to any of the inputs can have a significant impact to the estimated fair value of the PIPE warrants.

 

The following table sets forth the fair value of the Company’s financial assets and liabilities by level within the fair value hierarchy (in thousands):

 

		As of June 30, 2015
		Fair Value				Level I				Level II				Level III
Assets
Money market funds		$	3			$	3			$	—			$	—
U.S. government agency obligations			15,353				—				15,353				—
Total assets measured at fair value		$	15,356			$	3			$	15,353			$	—
Liabilities
PIPE warrants		$	916				—				—			$	916
Contingent put option liability			251				—				—				251
Total liabilities measured at fair value		$	1,167			$	—			$	—			$	1,167

 

		As of December 31, 2014
		Fair Value				Level I				Level II				Level III
Assets
Money market funds		$	33			$	33			$	—			$	—
U.S. government agency obligations			15,312				—				15,312				—
Total assets measured at fair value		$	15,345			$	33			$	15,312			$	—
Liabilities
PIPE warrants		$	5,577				—				—			$	5,577
Contingent put option liability		$	282				—				—			$	282
Total liabilities measured at fair value		$	5,859			$	—			$	—			$	5,859

  

 

The following table sets forth the assumptions used in the Black-Scholes option-pricing model to estimate the fair value of the PIPE warrants as of June 30, 2015:

 

Market price		$	4.24
Exercise price		$	3.40
Risk-free interest rate			0.64	%
Expected volatility			57.0	%
Expected life (in years)			2.42
Expected dividend yield			0.0	%

 

The following table sets forth the assumptions used in the Black-Scholes option-pricing model to estimate the fair value of the PIPE warrants as of December 31, 2014:

 

Market price		$	6.73
Exercise price		$	3.40
Risk-free interest rate			1.10	%
Expected volatility			61.0	%
Expected life (in years)			2.92
Expected dividend yield			0.0	%

 

  

The following tables set forth a summary of the changes in the fair value of the Company’s Level III financial liabilities for the three and six months ended June 30, 2015 and June 30, 2014 (in thousands):

 

 

		Three Months Ended June 30, 2015				Six Months Ended June 30, 2015
Fair value—beginning of period		$	1,155			$	5,859
Change in fair value of PIPE warrants			68				(4,661	)
Change in fair value of contingent put option associated with Original Loan Agreement with Hercules			(56	)			(31	)
Fair value—end of period		$	1,167			$	1,167

 

		Three Months Ended June 30, 2014				Six Months Ended June 30, 2014
Fair value—beginning of period		$	14,091			$	13,445
Change in fair value of PIPE warrants			(2,507	)			(1,823	)
Change in fair value of contingent put option associated with Original Loan Agreement with Hercules			142				104
Fair value—end of period		$	11,726			$	11,726

  

 

3. U.S. Department of Defense Contract

 

On May 11, 2015, the Company entered into an award contract supported by the United States Army Medical Research and Materiel Command, or USAMRMC, within the U.S. Department of Defense, or the DoD, in which the DoD agreed to provide up to $17.0 million to the Company in order to support the development of the Company’s product candidate, ARX-04 (sufentanil sublingual tablet, 30 mcg), a proprietary, non-invasive, single-use tablet in a disposable, pre-filled SDA, for the treatment of moderate-to-severe acute pain. The DoD contract supports development of ARX-04 to perform Phase 3 clinical trials and manufacturing activities in order to submit an NDA to the FDA. Under the terms of the contract, the DoD will reimburse the Company for costs incurred for development, manufacturing and clinical costs outlined in the contract, including reimbursement for certain personnel and overhead expenses. The period of performance under the contract begins on May 11, 2015 and ends on November 10, 2016. The contract gives the DoD the option to extend the term of the contract and provide additional funding for the research. In addition, if ARX-04 is approved by the FDA, the DoD has the option to purchase a certain number of units of commercial product pursuant to the terms of the contract.

 

Revenue is recognized based on expenses incurred by the Company in conducting research and development activities set forth in the agreement. Revenue attributable to the research and development performed under the DoD contract, recorded as contract revenue in the condensed statements of comprehensive loss, was $1.4 million for the three and six months ended June 30, 2015. There was no such revenue recognized for the three and six months ended June 30, 2014.

 

4. Collaboration Agreement

 

On December 16, 2013, AcelRx and Grünenthal GmbH, or Grünenthal, entered into a Collaboration and License Agreement, or the License Agreement, and related Manufacture and Supply Agreement, or the MSA, and together with the License Agreement, the Agreements. The License Agreement grants Grünenthal rights to commercialize Zalviso, the Company’s novel sublingual patient-controlled analgesia, or PCA, system, or the Product, in the countries of the European Union, Switzerland, Liechtenstein, Iceland, Norway and Australia, or the Territory, for human use in pain treatment within or dispensed by hospitals, hospices, nursing homes and other medically-supervised settings, or the Field. The Company retains rights with respect to the Product in countries outside the Territory, including the United States, Asia and Latin America. Under the MSA, the Company will exclusively manufacture and supply the Product to Grünenthal for the Field in the Territory. The Agreements were amended on July 22, 2015, effective as of July 17, 2015. See Note 11 “Subsequent Events,” for further description.

 

License Agreement

 

Under the terms of the License Agreement, Grünenthal has the exclusive right to commercialize the Product in the Field in the Territory. The Company retains control of clinical development, while Grünenthal and the Company will be responsible for certain development activities pursuant to a development plan as agreed between the parties. The Company will not receive separate payment for such development activities. Grünenthal is exclusively responsible for marketing approval applications and other regulatory filings relating to the sufentanil sublingual tablet drug cartridge for the Product in the Field in the Territory, while the Company is responsible for the CE Mark and other regulatory filings relating to device portions of the Product. A CE Mark (#611742) for Zalviso was obtained in the fourth quarter 2014 which specifies AcelRx as the device design authority and manufacturer.

 

The Company received an upfront non-refundable cash payment of $30.0 million in December 2013, and a milestone payment of $5.0 million related to the MAA submission in the third quarter of 2014. The Company is eligible to receive an additional $15.0 million milestone payment upon the approval of the MAA. If the MAA is approved, the Company was initially eligible to receive approximately $200.0 million in additional milestone payments, based upon successful regulatory and product development efforts ($28.5 million) and net sales target achievements (initially $171.5 million). As mentioned above, the Agreements were amended on July 22, 2015, effective as of July 17, 2015. See Note 11 “Subsequent Events,” for further description. Grünenthal will also make tiered royalty and supply and trademark fee payments in the mid-teens up to the mid-twenties percent range on net sales of Zalviso.

 

Unless earlier terminated, the License Agreement continues in effect until the expiration of the obligation of Grünenthal to make royalty and supply and trademark fee payments, which supply and trademark fee continues for so long as the Company continues to supply the Product to Grünenthal. The License Agreement is subject to earlier termination in the event the parties mutually agree, by a party in the event of an uncured material breach by the other party, upon the bankruptcy or insolvency of either party, or by Grünenthal for convenience.

 

MSA

 

Under the terms of the MSA, the Company will manufacture and supply the Product for use in the Field for the Territory exclusively for Grünenthal. Grünenthal shall purchase from AcelRx, during the first five years after the effective date of the MSA, 100% and thereafter 80% of Grünenthal’s and its sublicensees’ and distributors’ requirements of Product for use in the Field for the Territory. The Product will be supplied at the Company’s fully burdened manufacturing cost, subject to certain caps (as defined in the MSA). The MSA requires the Company to use commercially reasonable efforts to enter stand-by contracts with third parties providing significant supply and manufacturing services and under certain specified conditions permits Grünenthal to use a third party back-up manufacturer to manufacture the Product for Grünenthal’s commercial sale in the Territory.

  

 

Unless earlier terminated, the MSA continues in effect until the later of the expiration of the obligation of Grünenthal to make royalty and supply and trademark fee payments or the end of any transition period for manufacturing obligations due to the expiration or termination of the License Agreement. The MSA is subject to earlier termination in connection with certain termination events in the License Agreement, in the event the parties mutually agree, by a party in the event of an uncured material breach by the other party or upon the bankruptcy or insolvency of either party.

 

The Company identified the following four significant non-contingent performance deliverables under the agreements: 1) intellectual property (license), 2) the obligation to provide research and development services, 3) the significant and incremental discount on the manufacturing of Zalviso for commercial purposes, and 4) the obligation to participate on the joint steering committee.

 

The Company considered the provisions of the multiple-element arrangement guidance in determining whether the deliverables outlined above have standalone value and thus should be treated as separate units of accounting. Company’s management determined that the license has standalone value and represents a separate unit of accounting because the rights conveyed permit Grünenthal to perform all efforts necessary to commercialize and begin selling the product upon regulatory approval. In addition, Grünenthal has the appropriate development, regulatory and commercial expertise with products similar to the product licensed under the agreement and has the ability to engage third parties to manufacture the product allowing Grünenthal to realize the value of the license without receiving any of the remaining deliverables. Grünenthal can also sublicense its license rights to third parties. Also, the Company’s management determined that the research services, committee participation and implied discount associated with the manufacturing services each represent individual units of accounting as Grünenthal could perform such services and/or could acquire these on a separate basis.

 

The Company developed best estimates of selling prices for each deliverable in order to allocate the noncontingent arrangement consideration to the four units of accounting.

 

The Company’s management determined the best estimate of selling price for the license based on Grünenthal’s estimated future cash flows arising from the arrangement. Embedded in the estimate were significant assumptions regarding regulatory expenses, revenue, including potential customer market for the product and product price, costs to manufacture the product and the discount rate. The Company’s management determined the best estimate of selling price of the research and development services and committee participation based on the nature and timing of the services to be performed and in consideration of personnel and other costs incurred in the delivery of the services. For the discount on manufacturing services, Company’s management estimated the selling price based on the market level of contract manufacturing margin it could have received if it were engaged to supply products to a customer in a separate transaction.

  

The Agreements entitle the Company to receive additional payments upon the achievement of certain development and sales milestones. Based on ASC Topic 605-28, Revenue Recognition — Milestone Method, the Company evaluates contingent milestones at inception of the agreement, and recognizes consideration that is contingent upon the achievement of a milestone in its entirety as revenue in the period in which the milestone is achieved only if the milestone is considered substantive in its entirety. Milestones are events which have the following characteristics: (i) they can be achieved based in whole or in part on either the Company’s performance or on the occurrence of a specific outcome resulting from the Company’s performance, (ii) there was substantive uncertainty at the date the agreement was entered into that the event would be achieved and, (iii) they would result in additional payments due to the Company. A milestone is considered substantive if the following criteria are met: (i) the consideration is commensurate with either (1) the entity’s performance to achieve the milestone, or (2) the enhancement of the value of the delivered item (s) as a result of a specific outcome resulting from the entity’s performance to achieve the milestone, (ii) the consideration relates solely to past performance and, (iii) the consideration is reasonable relative to all of the other deliverables and payment terms, including other potential milestone consideration, within the arrangement.

 

The substantive milestone payments will be recognized as revenue in their entirety upon the achievement of each substantive milestone. Based on the criteria noted above, the identified substantive milestones in the agreement pertain to post approval product enhancements, expanded market opportunities and manufacturing efficiencies for Zalviso. Each of these potential achievements is based primarily on the Company’s performance and involves substantive uncertainty as achievement of these milestones requires future research, development and regulatory activities, which are inherently uncertain in nature. The Company determined that the consideration for each milestone was commensurate with the Company’s performance to achieve the milestone, including future research, development, manufacturing and regulatory activities and that the consideration is reasonable relative to all of the other deliverables and payments within the arrangement. Aggregate potential payments for these milestones total $28.5 million.

  

 

In addition to substantive milestones, two milestones associated with the Agreements were deemed not to be substantive. These milestones pertain to regulatory developments for Zalviso in Europe, which Company’s management deemed to be not substantive due to the level of performance associated with future achievement of these milestones. Aggregate potential payments for these milestones total $20.0 million. In July 2014, Grünenthal submitted a Marketing Authorization Application, or MAA, to the European Medicines Agency, or EMA, for Zalviso for the management of acute moderate-to-severe post-operative pain in adult patients. Under the terms of the License Agreement with Grünenthal, the Company received a cash payment of $5.0 million for the MAA submission in the third quarter of 2014. The Company is eligible to receive an additional $15.0 million milestone payment upon the approval of the MAA. This $15.0 million non-substantive milestone payment will be allocated across the four significant non-contingent performance deliverables identified in the Agreements, based on the relative estimated selling price method, upon approval of the MAA, if approved.

 

The Agreements also include milestone payments related to specified net sales targets, initially totaling $171.5 million. As mentioned above, the Agreements were amended on July 22, 2015, effective as of July 17, 2015. See Note 11 “Subsequent Events,” for further description. The sales-based milestones do not meet the definition of a milestone under ASU 2010-17 because the achievement of these milestones is solely dependent on counter-party performance and not on any performance obligations of the Company.

 

The Company recognized $486,000 and $667,000 of previously deferred revenue related to research and development services under the collaboration agreement during the three and six months ended June 30, 2015, respectively, and $71,000 and $166,000, of previously deferred revenue related to research and development services under the collaboration agreement during the three and six months ended June 30, 2014, respectively. As of June 30, 2015, the Company had a deferred revenue balance of $1.7 million. There were no milestone payments received or recognized under these Agreements during the three and six months ended June 30, 2015.

 

5. Long-Term Debt 

 

Hercules Loan and Security Agreements

 

In June 2011, AcelRx entered into a loan and security agreement with Hercules, under which AcelRx borrowed $20.0 million in two tranches of $10.0 million each, represented by secured convertible term promissory notes. The Company’s obligations associated with the agreement are secured by a security interest in substantially all of its assets, other than its intellectual property.

 

The Company borrowed the first tranche of $10.0 million upon the closing of the transaction on June 29, 2011 and borrowed the second tranche of $10.0 million in December 2011. The Company used a portion of the proceeds from the first tranche to repay the remaining obligations under that certain loan and security agreement between the Company and Pinnacle Ventures, L.L.C., or Pinnacle Ventures, dated September 16, 2008. The agreement with Pinnacle Ventures is described further below. The interest rate for each tranche was 8.50%. In connection with the loan, the Company issued Hercules seven-year warrants to purchase an aggregate of 274,508 shares of common stock at a price of $3.06 per share. See Note 6 “Warrants,” for further description.

 

On December 16, 2013, AcelRx entered into an Amended and Restated Loan and Security Agreement, or the Loan Agreement with Hercules Technology II, L.P. and Hercules Technology Growth Capital, Inc., together, the Lenders, under which the Company may borrow up to $40.0 million in three tranches. The loans are represented by secured convertible term promissory notes, collectively, the Notes. The Loan Agreement amends and restates the Loan and Security Agreement between the Company and the Lenders dated as of June 29, 2011, or the Original Loan Agreement, as noted above. The Company borrowed the first tranche of $15.0 million upon closing of the transaction on December 16, 2013, and the second tranche of $10.0 million on June 16, 2014. The Company used approximately $8.6 million of the proceeds from the first tranche to repay its obligations under the Original Loan Agreement. The Company recorded the new debt at an estimated fair value of $24.9 million as of December 31, 2014.

 

On September 24, 2014, the Company entered into an amendment, or the Amendment, to the Loan Agreement with Hercules. The Amendment extends the time period under which the Company can draw down the third tranche, of up to $15.0 million, from March 15, 2015 to August 1, 2015, subject to the Company obtaining approval for Zalviso from the FDA. The Company did not receive FDA approval of Zalviso by August 1, 2015 and as such, did not have access to the third tranche under the Loan Agreement, as amended, or the Amended Loan Agreement.

  

 

The interest rate for each tranche will be calculated at a rate equal to the greater of either (i) 9.10% plus the prime rate as reported from time to time in The Wall Street Journal minus 5.25%, and (ii) 9.10%. Payments under the Amended Loan Agreement are interest only until April 1, 2015, followed by equal monthly payments of principal and interest through the scheduled maturity date on October 1, 2017, or the Loan Maturity Date. In addition, a final payment equal to $1.7 million will be due on the Loan Maturity Date, or such earlier date specified in the Amended Loan Agreement. The Company’s obligations under the Amended Loan Agreement are secured by a security interest in substantially all of its assets, other than its intellectual property.

 

If the Company prepays the Amended Loan Agreement prior to maturity, it will pay Hercules a prepayment charge, based on a percentage of the then outstanding principal balance, 2% if the prepayment occurs after December 16, 2014, but prior to December 16, 2015, or 1% if the prepayment occurs after December 16, 2015.

 

Subject to certain conditions and limitations set forth in the Amended Loan Agreement, the Company has the right to convert up to $5.0 million of scheduled principal installments under the Notes into freely tradeable shares of the Company’s common stock, or Common Stock. The number of shares of Common Stock that would be issued upon conversion of the Amended Notes would be equal to the number determined by dividing (x) the product of (A) the principal amount to be paid in shares of Common Stock and (B) 103%, by (y) $9.30 (subject to certain proportional adjustments as provided for in the Amended Loan Agreement).

 

The Amended Loan Agreement includes customary affirmative and restrictive covenants, but does not include any financial maintenance covenants, and also includes standard events of default, including payment defaults, breaches of covenants following any applicable cure period, a material impairment in the perfection or priority of Hercules’ security interest or in the value of the collateral, and events relating to bankruptcy or insolvency. Upon the occurrence of an event of default, a default interest rate of an additional 5% may be applied to the outstanding loan balances, and Hercules may declare all outstanding obligations immediately due and payable and take such other actions as set forth in the Amended Loan Agreement.

 

In connection with the Amended Loan Agreement, the Company issued a warrant to each Lender which, collectively, are exercisable for an aggregate of 176,730 shares of common stock and each carry an exercise price of $6.79 per share. See Note 6 “Warrants,” for further description.

 

Upon an event of default, including a change of control, Hercules has the option to accelerate repayment of the Amended Loan Agreement, including payment of any applicable prepayment charges, which range from 1%-3% of the outstanding loan balance and accrued interest, as well as a final payment fee of $1.7 million. This option is considered a contingent put option liability, as the holder of the loan may exercise the option in the event of default, and is considered an embedded derivative, which must be valued and separately accounted for in the Company’s financial statements. As the amendment of the loan agreement was considered an extinguishment, the contingent put option liability associated with the Original Loan Agreement, which had an estimated fair value of $32,000 at the time of the amendment, was written off as a part of the loss on extinguishment, and a new contingent put option liability was established. As of June 30, 2015 and December 31, 2014, the estimated fair value of the contingent put option liability was $251,000 and $282,000, respectively, which was determined by using a risk-neutral valuation model, wherein the fair value of the underlying debt facility is estimated both with and without the presence of the default provisions, holding all other assumptions constant. The resulting difference between the two estimated fair values is the estimated fair value of the default provisions, or the contingent put option. The fair value of the underlying debt facility is estimated by calculating the expected cash flows in consideration of an estimated probability of default and expected recovery rate in default, and discounting such cash flows back to the reporting date using a risk-free rate. The contingent put option liability was recorded as a debt discount to the loan and consequently a reduction to the carrying value of the loan. The contingent put option liability is revalued at the end of each reporting period and any change in the fair value is recognized in interest income and other income (expense), net in the statements of comprehensive loss.

 

As of June 30, 2015, the Company had outstanding borrowings under the Amended Loan Agreement of $23.1 million. Interest expense related to the Amended Loan Agreement was $0.8 million and $1.6 million for the three and six months June 30, 2015, respectively.

 

 

6. Warrants

 

Series A Warrants

 

As of June 30, 2015, warrants to purchase 3,425 shares of common stock had not been exercised and were still outstanding. These warrants expire in March 2017.

 

Hercules Warrants 

 

In connection with the Amended Loan Agreement, executed in December 2013, the Company issued warrants to Hercules which are exercisable for an aggregate of 176,730 shares of common stock with an exercise price of $6.79 per share (the “Warrants”). Each Warrant may be exercised on a cashless basis. The Warrants are exercisable for a term beginning on the date of issuance and ending on the earlier to occur of five years from the date of issuance or the consummation of certain acquisitions of the Company as set forth in the Warrants. The number of shares for which the Warrants are exercisable and the associated exercise price are subject to certain proportional adjustments as set forth in the Warrants. The Company estimated the fair value of these warrants as of the issuance date to be $1.1 million, which was used in the estimating the fair value of the amended debt instrument and was recorded as equity. The fair value of the warrants was calculated using the Black-Scholes option-valuation model, and was based on the strike price of $6.79, the stock price at issuance of $9.67, the five-year contractual term of the warrants, a risk-free interest rate of 1.55%, expected volatility of 71% and 0% expected dividend yield.

  

As of June 30, 2015, warrants to purchase 176,730 shares of common stock issued to Hercules had not been exercised and were still outstanding. These warrants expire in December 2018.

 

In connection with the original loan and security agreement with Hercules, executed in June 2011, the Company issued to Hercules warrants to purchase an aggregate of 274,508 shares of common stock at a price of $3.06 per share, which were net exercised for 183,404 shares of common stock during the year ended December 31, 2013.

 

2012 Private Placement Warrants

 

In connection with the Private Placement, completed in June 2012, the Company issued PIPE warrants to purchase up to 2,630,103 shares of common stock. The per share exercise price of the PIPE warrants was $3.40 which equals the closing consolidated bid price of the Company’s common stock on May 29, 2012, the effective date of the Purchase Agreement. The PIPE warrants issued in the Private Placement became exercisable six months after the issuance date, and expire on the five year anniversary of the initial exercisability date. Under the terms of the PIPE warrants, upon certain transactions, including a merger, tender offer, sale of all or substantially all of the assets of the Company or if a person or group shall become the owner of 50% of the Company’s issued and outstanding common stock, which is outside of the Company’s control, each PIPE warrant holder may elect to receive a cash payment in exchange for the warrant, in an amount determined by application of the Black-Scholes option-pricing model. Accordingly, the PIPE warrants were recorded as a liability at fair value, as determined by the Black-Scholes option-pricing model, and then marked to fair value each reporting period, with changes in estimated fair value recorded through the Statements of Comprehensive Loss in interest income and other income (expense), net. The Black-Scholes assumptions used to value the PIPE warrants are disclosed in Note 2 “Investments and Fair Value Measurement.”

 

Upon execution of the Purchase Agreement, the fair value of the PIPE warrants was estimated to be $5.8 million, which was recorded as a liability. As of June 30, 2015, the fair value of the PIPE warrants was estimated to be $0.9 million. The change in fair value for the three months ended June 30, 2015 was $0.1 million, which was recorded as other expense, and the change in fair value for the six months ended June 30, 2015 was $2.1 million, which was recorded as other income.

 

In March 2015, PIPE warrants to purchase 847,058 shares were net exercised for 527,101 shares of common stock. As of June 30, 2015, PIPE warrants to purchase 512,456 shares of common stock issued in connection with the Private Placement had not been exercised and were outstanding. These warrants expire in November 2017.

  

 

7. Stock-Based Compensation

 

The Company recorded total stock-based compensation expense for stock options, stock awards and the 2011 Employee Stock Purchase Plan as follows (in thousands):

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2015				2014				2015				2014
Expenses:
Research and development		$	629			$	560			$	1,331			$	1,039
General and administrative			482				334				1,318				830
Total stock-based compensation expense		$	1,111			$	894			$	2,649			$	1,869

 

As of June 30, 2015 there were 2,377,921 shares available for grant, 5,766,994 options outstanding and no restricted stock units outstanding under the Company’s 2011 Equity Incentive Plan.

 

8. Restructuring Costs

 

On March 19, 2015, the Board of Directors of the Company, in connection with its efforts to reduce operating costs, conserve capital, focus the Company's financial and development resources on working with the FDA to seek marketing approval for Zalviso, and continuing development of ARX-04, implemented a cost reduction plan. The cost reduction plan reduced the Company’s workforce by 19 employees, approximately 36% of total headcount, in the first quarter of 2015. Employee termination benefits related to this restructuring, are charged to restructuring costs in the Statements of Comprehensive Loss.

 

Restructuring costs for the three and six months ended June 30, 2015 (in thousands):

 

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2015				2014				2015				2014
Employee termination benefits		$	2			$	—			$	756			$	—
Total restructuring costs		$	2			$	—			$	756			$	—

 

The following table presents activities related to a cost reduction plan during the three and six months ended June 30, 2015 (in thousands): 

 

		Employee severance and related costs
Balance of restructuring liability at December 31, 2014		$	—
Charges			754
Payments			—
Balance of restructuring liability at March 31, 2015			754
Charges			2
Payments			(753	)
Balance of restructuring liability at June 30, 2015		$	3

 

The Company anticipates the restructuring liability will be fully disbursed by December 31, 2015.

 

9. Net Loss per Share of Common Stock

 

The Company’s basic net loss per share of common stock is calculated by dividing the net loss by the weighted average number of shares of common stock outstanding for the period. The diluted net loss per share of common stock is computed by giving effect to all potential common stock equivalents outstanding for the period determined using the treasury stock method. For purposes of this calculation, options to purchase common stock and warrants to purchase common stock were considered to be common stock equivalents. In periods with a reported net loss, common stock equivalents are excluded from the calculation of diluted net loss per share of common stock if their effect is antidilutive.

 

During the six months ended June 30, 2015, the PIPE warrants had a dilutive impact to net loss per share due to a lower share price at June 30, 2015, compared to the closing share price on December 31, 2014. Similarly, during the three and six months ended June 30, 2014, the PIPE warrants had a dilutive impact to net loss per share due to a lower share price at June 30, 2014, compared to the closing share price on March 31, 2014 and December 31, 2013. The decrease in share price created a lower Black-Scholes value and lower liability for the PIPE warrants, which resulted in other income during the six months ended June 30, 2015 and the three and six months ended June 30, 2014. There was no such dilutive impact for the PIPE warrants during the three months ended June 30, 2015, as the share price increased as compared to the closing share price on March 31, 2015. The calculation of diluted net loss per share requires that, to the extent the average market price of the underlying shares for the reporting period exceeds the exercise price of the PIPE warrants and the presumed exercise of such securities are dilutive to loss per share for the period, adjustments to net loss used in the calculation are required to remove the change in fair value of the PIPE warrants for the period. Likewise, adjustments to the denominator are required to reflect the related dilutive shares.

 

  

The following table sets forth the computation of the Company’s basic and diluted net loss per share of common stock during the three and six months ended June 30, 2015 and 2014 (in thousands, except for share and per share amounts):

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2015				2014				2015				2014
		(in thousands, except share and per share amounts)
Numerator
Net loss used to compute net loss per share:
Basic		$	(8,896	)		$	(10,575	)		$	(18,922	)		$	(20,206	)
Adjustments for change in fair value of warrant liability			—				(2,507	)			(2,117	)			(1,823	)
Diluted		$	(8,896	)		$	(13,082	)		$	(21,039	)		$	(22,029	)
Denominator
Weighted average shares outstanding used to compute net loss per share:
Basic			44,343,270				43,333,210				44,109,488				43,262,204
Dilutive effect of warrants			—				976,956				287,983				511,829
Diluted			44,343,270				44,310,166				44,397,471				43,774,033
Net loss per share — basic		$	(0.20	)		$	(0.24	)		$	(0.43	)		$	(0.47	)
Net loss per share — diluted		$	(0.20	)		$	(0.30	)		$	(0.47	)		$	(0.50	)

 

 

The following outstanding shares of common stock equivalents were excluded from the computation of diluted net loss per share of common stock for the periods presented because including them would have been antidilutive:

 

		June 30,
		2015				2014
Stock options to purchase common stock			5,766,994				5,160,416
Restricted stock units			—				—
Common stock warrants			692,611				1,674,669

 

 

10. Manufacturing Agreements

 

Patheon

 

In January 2013, the Company and Patheon Pharmaceuticals Inc., or Patheon, entered into a Manufacturing Services Agreement, or the Services Agreement, and a related Amended and Restated Capital Expenditure and Equipment Agreement, or the Capital Agreement, relating to the manufacture of sufentanil tablets, or the Product, for use with the Company’s Zalviso drug product.

 

Under the terms of the Services Agreement, the Company has agreed to purchase, subject to Patheon’s continued material compliance with the terms of the Services Agreement, all of its Product requirements for the United States, Canada and Mexico from Patheon during the Initial Term of the Services Agreement (as defined below), and at least eighty percent (80%) of its Product requirements for such territories after the Initial Term.

 

The term of the Services Agreement extends until December 31, 2017, or the Initial Term, and will automatically renew thereafter for periods of two years, unless terminated by either party upon eighteen months’ prior written notice; provided, however, that the Services Agreement may not be terminated without cause prior to the end of the Initial Term.

  

 

The Company also entered into a Capital Expenditure and Equipment Agreement, or the Capital Agreement. Under the terms of the Capital Agreement, as amended in January 2014, or the Amended Capital Agreement, the Company has made and has the option to make certain future modifications to Patheon’s Cincinnati facility and which would be the responsibility of the Company. If additional equipment and facility modifications are required to meet the Company’s Product needs, the Company may be required to contribute to the cost of such additional equipment and facility modifications.

 

Expenditures associated with the aforementioned agreements are primarily driven by the potential commercial requirements and demand for the Company’s products, none of which have been approved for commercialization; accordingly, the amounts and timing of such future expenditures cannot be determined at this time.

 

Grünenthal

 

On December 16, 2013, the Company and Grünenthal entered into a License Agreement and MSA, or the Agreements. The License Agreement grants Grünenthal rights to commercialize Zalviso, the Company’s Product in the countries of the European Union, Switzerland, Liechtenstein, Iceland, Norway and Australia, or the Territory, for human use in pain treatment within or dispensed by hospitals, hospices, nursing homes and other medically-supervised settings, or the Field. The Agreements were amended on July 22, 2015, effective as of July 17, 2015. See Note 11 “Subsequent Events,” for further description.

 

Under the terms of the MSA, the Company will manufacture and supply the Product for use in the Field for the Territory exclusively for Grünenthal. Grünenthal shall purchase from AcelRx, during the first five years after the effective date of the MSA, 100% and thereafter 80% of Grünenthal’s and its sublicensees’ and distributors’ requirements of Product for use in the Field for the Territory. The Product will be supplied at the Company’s fully burdened manufacturing cost (as defined in the MSA). The MSA requires the Company to use commercially reasonable efforts to enter stand-by contracts with third parties providing significant supply and manufacturing services and under certain specified conditions permits Grünenthal to use a third party back-up manufacturer to manufacture the Product for Grünenthal’s commercial sale in the Territory.

 

Unless earlier terminated, the MSA continues in effect until the later of the expiration of the obligation of Grünenthal to make royalty and supply and trademark fee payments or the end of any transition period for manufacturing obligations due to the expiration or termination of the License Agreement. The MSA is subject to earlier termination in connection with certain termination events in the License Agreement, in the event the parties mutually agree, by a party in the event of an uncured material breach by the other party or upon the bankruptcy or insolvency of either party.

 

Under the MSA, the Company will exclusively manufacture and supply the Product to Grünenthal for the Field in the Territory.

 

Expenditures associated with the aforementioned agreements are primarily driven by the potential commercial requirements and demand for the Company’s products, none of which are currently approved for commercial use; accordingly, the amounts and timing of such future expenditures cannot be determined at this time.

 

11. Subsequent Events

 

On July 22, 2015, the Company entered into amendments to the License Agreement, or the License Amendment, and the MSA, or the MSA Amendment, between the Company and Grünenthal, each effective as of July 17, 2015, and together with the License Agreement and the MSA, the Amended Agreements.

  

In the MSA Amendment and the License Amendment, the parties amended the Product supply configurations and packaging of Product components and accessories, and associated pricing therefor, which the Company will manufacture and supply to Grünenthal for the Territory. As consideration for an increase in the pricing of the Product components and accessories as part of the agreed packaging configurations, the total milestone payments from Grünenthal contingent upon achieving specified net sales target milestones were reduced from a total of $171.5 million to $166.0 million. The parties also updated the development plan for the Product in the Territory, providing for additional near-term development costs to be paid by Grünenthal.

 

On July 23, 2015, the Committee for Medicinal Products for Human Use, or CHMP, of the European Medicines Agency, or EMA, adopted a positive opinion for Zalviso. The opinion, while not binding, recommends marketing authorization for Zalviso for the management of acute moderate-to-severe post-operative pain in adult patients in a hospital setting. A decision by the European Commission on the approval of Zalviso is anticipated in late September or early October.

  

 

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, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, 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 them. In some cases you can identify forward-looking statements by words such as “may,” “will,” “should,” “could,” “would,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “projects,” “predicts,” “potential” and similar expressions intended to identify forward-looking statements. Examples of these statements include, but are not limited to, statements regarding: the process and timing of anticipated future development of AcelRx's product candidates, including Zalviso (sufentanil sublingual tablet system) and ARX-04 (sufentanil sublingual tablet, 30 mcg), including the upcoming General Advice meeting with the U.S. Food and Drug Administration, or FDA, for Zalviso scheduled in early September 2015; AcelRx's plans to seek a pathway forward towards gaining approval of Zalviso in the U.S., including potential additional clinical studies, additional Human Factors studies, or through the dispute resolution process provided for by the FDA; our belief that an additional clinical study should not be required to demonstrate the safety and efficacy of Zalviso beyond what has already been established in the Phase 3 clinical studies, as well as the bench testing and Human Factors studies; our ability to finalize the pathway towards resubmission of the Zalviso New Drug Application, or NDA, to the FDA; our ability to obtain and maintain regulatory approval for our product candidates, including Zalviso and ARX-04, in the United States and Europe; the anticipated timing of the European Commission’s decision regarding Zalviso; potential milestones and royalty payments under the Grünenthal agreement and the timing of receipt of those payments; the timing of the receipt of top-line data from the SAP301 Phase 3 clinical study of ARX-04; the success, cost and timing of all product development activities and clinical trials, including the additional clinical trial requested by the FDA for Zalviso and the Phase 3 ARX-04 clinical development program; our ability to obtain sufficient financing to receive regulatory approval for and commercialize Zalviso, and complete clinical development of ARX-04, including potential filing of an NDA; our future losses; the sufficiency of our cash resources; the market potential for our product candidates, including Zalviso and ARX-04, in the United States and Europe; and our estimates regarding expenses, capital requirements and needs for financing. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us and described in Part II, Item 1A of this Quarterly Report on Form 10-Q and our other filings with the SEC. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report on Form 10-Q. 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 those we expect. Except as required by law, we assume no obligation to update these forward-looking statements, whether as a result of new information, future events or otherwise.

 

The following discussion and analysis should be read in conjunction with the unaudited financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q and with the audited consolidated financial statements and related notes thereto included as part of our Annual Report on Form 10-K for the year ended December 31, 2014.

 

About AcelRx Pharmaceuticals

 

We are a specialty pharmaceutical company focused on the development and commercialization of innovative therapies for the treatment of acute pain. We intend to commercialize our product candidates in the United States and license the development and commercialization rights to our product candidates for sale outside of the United States through strategic partnerships and collaborations. We may also consider the option to enter into strategic partnerships for our product candidates in the United States. Our product candidate, Zalviso™, is intended for the management of moderate-to-severe acute pain in hospitalized adult patients. Zalviso consists of sufentanil sublingual tablets, 15 mcg, delivered by the Zalviso System, a needle-free, handheld, patient-administered, pain management system (together, “Zalviso”).

 

On July 25, 2014, the U.S. Food and Drug Administration, or FDA, issued a Complete Response Letter, or CRL, for our New Drug Application, or NDA, for Zalviso. The CRL contains requests for additional information on the Zalviso System to ensure proper use of the device. The requests include submission of data demonstrating a reduction in the incidence of optical system errors, changes to address inadvertent dosing, among other items, and submission of additional data to support the shelf life of the product. There were no requests for additional clinical studies in the CRL. In the third quarter of 2014, we held a Type A meeting with the FDA to discuss the Zalviso CRL received in July. During the meeting we discussed the resubmission of the Zalviso NDA and the steps necessary for the resubmission. In advance of resubmitting our Zalviso NDA, we agreed with the FDA to submit protocols for the bench testing and Human Factors, or HF, studies for their review and comment. In addition, the FDA requested in the minutes of the meeting that we provide a risk assessment that analyzes the risks associated with inadvertent dosing and the rationale that bench testing and HF studies are sufficient to address the specific items included in the CRL. We submitted the protocols and this rationale in the fourth quarter of 2014. In January 2015, we received feedback from the FDA on the protocol and the planned analysis of the results of the bench test. No modifications to the conduct of the bench test were necessary; however, in response to the FDA’s request, we refined the planned analysis of the bench test results. In February 2015, we received feedback from the FDA on the HF protocols. In this feedback, the FDA confirmed that the HF studies as proposed were acceptable to evaluate the design changes related to inadvertent dispensing of tablets. In March 2015, we received correspondence from the FDA stating that in addition to the bench testing and two HF studies we had performed in response to the issues identified in the CRL, a clinical trial is needed to assess the risk of inadvertent dispensing and overall risk of dispensing failures. On April 21, 2015, we submitted a request to the Division of Anesthesia, Analgesia, and Addiction Products, or the Division, of the FDA for a Type B meeting. On May 1, 2015, the Division notified us that the request for a meeting was denied and restated the Division’s view that a clinical study is required. Subsequently, we have been granted a General Advice meeting with the Division in early September 2015 to discuss the FDA’s request for an additional clinical trial and our planned response to the CRL. Pending the outcome of that meeting, we intend to determine what additional work, if any, is required and finalize our plans to refile the NDA for Zalviso. We will then evaluate next steps to seek a pathway forward towards gaining approval of Zalviso in the U.S. The FDA has precleared certain aspects of our proposed Risk Evaluation and Mitigation Strategy, or REMS, and indicated that they will continue discussion of our proposed REMS after the Zalviso NDA has been resubmitted.

  

  

In July 2014, Grünenthal GmbH, or Grünenthal, filed a Marketing Authorization Application, or MAA, with European Medicines Agency, or EMA, under the centralized procedure in the European Union, or EU, for Zalviso for the management of acute moderate-to-severe post-operative pain in adult patients. In July 2015, the Committee for Medicinal Products for Human Use, or CHMP, met to discuss the MAA for Zalviso. On July 23, 2015, the CHMP adopted a positive opinion for Zalviso for the management of acute moderate-to-severe post-operative pain in adult patients in a hospital setting. This opinion has been transmitted to the European Commission, or EC, which has the ultimate authority for granting marketing authorizations in the EU. A decision by the EC on the approval of Zalviso is anticipated in late September or early October. For additional information on the collaboration agreement with Grünenthal, see Note 4 “Collaboration Agreement” in the accompanying notes to condensed financial statements.

 

Zalviso

 

Zalviso is an investigational, pre-programmed, non-invasive, system to allow hospital patients with moderate-to-severe acute pain to self-dose with sufentanil sublingual tablets, 15 mcg, to manage their pain. Zalviso is designed to help address certain problems associated with post-operative intravenous patient-controlled analgesia, by offering:

 

•

A high therapeutic index opioid: Zalviso uses sufentanil, an opioid that has a high therapeutic index. The therapeutic index is the ratio of the effective dose versus the lethal dose. In animal studies, the therapeutic index for sufentanil was approximately 100 times larger than fentanyl and 300 times larger than morphine.

 

•

A non-invasive route of delivery: Zalviso utilizes a sufentanil tablet which allows for a sublingual (under the tongue) route of delivery. Sufentanil is highly lipophilic which provides for rapid absorption in the fatty cells (or mucosal tissue) found under the tongue, and for rapid transit across the blood-brain barrier to reach the mu-opioid receptors in the brain. The sublingual delivery used by Zalviso provides rapid onset of analgesia. The sublingual delivery system also eliminates the risk of IV-related analgesic gaps and IV complications, such as catheter-related infections. In addition, because patients do not require direct connection to an IV patient-controlled analgesia, or PCA, infusion pump through IV tubing, Zalviso allows for ease of patient mobility.

 

•

A simple, pre-programmed PCA solution: Zalviso allows patients to self-dose sufentanil sublingual tablets via a pre-programmed, secure system designed to eliminate the risk of programming errors.

 

We submitted an NDA for Zalviso in September 2013 and, in December 2013, we announced that the FDA accepted for filing the Zalviso NDA. As mentioned above, the FDA issued a CRL for Zalviso on July 25, 2014, and in March 2015, we received correspondence from the FDA stating that in addition to the bench testing and two HF studies we had performed in response to the issues identified in the CRL, a clinical trial is needed to assess the risk of inadvertent dispensing and overall risk of dispensing failures. We believe that an additional clinical study should not be required to demonstrate the safety and efficacy of the Zalviso System beyond what has already been established in the Phase 3 clinical studies, as well as the bench testing and Human Factors studies.

 

ARX-04

 

We are also developing ARX-04 (sufentanil sublingual tablet, 30 mcg), a proprietary, non-invasive, single-use tablet in a disposable, pre-filled, single-dose applicator, or SDA, for the treatment of moderate-to-severe acute pain to be administered by a healthcare professional to a patient in medically supervised settings of acute pain. If approved, potential examples include: emergency room patients; post-operative patients who are transitioning from the operating room to the recovery floor; patients who are recovering from either short-stay or ambulatory surgery and do not require more long-term patient-controlled analgesia; treatment of battlefield casualties; and patients being transported by paramedics. In December 2013, we completed an End-of-Phase 2 Meeting with the FDA to identify a Phase 3 program pathway forward for evaluation of ARX-04. We reported dosing of the first patient in SAP301, a pivotal Phase 3 study of ARX-04, in March 2015. This trial is fully enrolled and we anticipate top-line data from this study early in the fourth quarter of 2015.

 

On May 11, 2015, we entered into an award contract supported by the United States Army Medical Research and Materiel Command, or USAMRMC, within the U.S. Department of Defense, or the DoD, in which the DoD agreed to provide up to $17.0 million to support the development of ARX-04 to perform Phase 3 clinical trials and manufacturing activities in order to submit an NDA to the FDA. Under the terms of the contract, the DoD will reimburse us for costs incurred for development, manufacturing and clinical costs outlined in the contract, including reimbursement for certain personnel and overhead expenses. The period of performance under the contract begins on May 11, 2015 and ends on November 10, 2016. The contract gives the DoD the option to extend the term of the contract and provide additional funding for the research. In addition, if ARX-04 is approved by the FDA, the DoD has the option to purchase a certain number of units of commercial product pursuant to the terms of the contract.

  

In the third quarter of 2015, we plan to initiate an additional Phase 3 clinical trial, an open-label safety study of patients who present to the emergency room with moderate-to-severe acute pain due to trauma or injury.

 

 

Financial Overview

 

We have incurred net losses and generated negative cash flows from operations since inception and expect to incur losses in the future as we continue our research and development activities and pre-commercialization activities. As we pursue development of our product candidates, including regulatory review and potential commercial development, subject to FDA approval, of our product candidates, we expect the business aspects of our company to become more complex. In the future, we plan to add personnel and incur additional costs related to the maturation of our business and the potential commercialization of Zalviso. In addition, we believe that continued investment in research and development is critical to attaining our strategic objectives. In order to develop our product candidates as commercially viable therapeutics, we expect to expend significant resources for expertise in manufacturing, regulatory affairs, clinical research and other aspects of pharmaceutical development.

 

To date, we have funded our operations primarily through the issuance of equity securities, borrowings, payments from our corporate collaboration and our DoD contracts. 

 

Our revenues since inception have consisted primarily of revenues from our collaboration with Grünenthal and our research contracts with the USAMRMC within the DoD. As mentioned above, in May 2015, the DoD agreed to provide us up to $17.0 million to support the development of ARX-04. The DoD contract will support development of ARX-04 to perform Phase 3 clinical trials and manufacturing activities in order to submit an NDA to the FDA.

 

There can be no assurance that we will enter into other collaborative agreements or receive research-related contract awards in the future. We expect revenues to continue to fluctuate from period-to-period. There can be no assurance that our existing collaboration with Grünenthal will continue beyond the initial term, or that we will be able to meet the milestones specified in this agreement, or that the DoD contract will result in an NDA submission for ARX-04, or that we will obtain marketing approval for our product candidates and subsequently generate revenue from those product candidates in excess of our operating expenses.

 

Our net loss for the three months and six months ended June 30, 2015 was $8.9 million and $18.9 million, respectively. As of June 30, 2015, we had an accumulated deficit of $197.7 million. As of June 30, 2015, we had cash, cash equivalents and investments totaling $51.2 million compared to $75.4 million as of December 31, 2014.

 

In December 2013, we entered into an Amended and Restated Loan and Security Agreement, or the Amended Loan Agreement, with Hercules Technology II, L.P. and Hercules Technology Growth Capital, Inc., collectively referred to as Hercules, under which we may borrow up to $40.0 million in three tranches, represented by secured convertible promissory notes. The Loan Agreement amends and restates the loan and security agreement with Hercules dated as of June 29, 2011, or the Original Loan Agreement. We borrowed the first tranche of $15.0 million upon closing of the transaction on December 16, 2013 and used approximately $8.6 million of the proceeds from the first tranche to repay our obligations under the Original Loan Agreement with Hercules. On June 16, 2014, we borrowed the second tranche of $10.0 million. On September 24, 2014, we entered into an amendment, or the Amendment, to the Loan Agreement with Hercules. The Amendment extended the time period under which we can draw down the third tranche, of up to $15.0 million, from March 15, 2015 to August 1, 2015, subject to our obtaining approval for Zalviso from the FDA. We did not receive FDA approval of Zalviso by August 1, 2015 and as such, did not have access to the third tranche under the Loan Agreement, as amended, or the Amended Loan Agreement. The interest rate for each tranche will be calculated at a rate equal to the greater of either (i) 9.10% plus the prime rate as reported from time to time in The Wall Street Journal minus 5.25%, and (ii) 9.10%. Payments under the Amended Loan Agreement are interest only until April 1, 2015 followed by equal monthly payments of principal and interest through the scheduled maturity date on October 1, 2017, or the Loan Maturity Date. In addition, a final payment equal to $1.7 million will be due on the Loan Maturity Date, or such earlier date specified in the Amended Loan Agreement. Our obligations under the Amended Loan Agreement are secured by a security interest in substantially all of our assets, other than our intellectual property.

  

As of June 30, 2015, the outstanding principal owed to Hercules was $23.1 million.

  

 

On December 16, 2013, AcelRx and Grünenthal GmbH, or Grünenthal, entered into a Collaboration and License Agreement, or the License Agreement, and related Manufacture and Supply Agreement, or the MSA, and together with the License Agreement, the Agreements. The License Agreement grants Grünenthal rights to commercialize Zalviso, or the Product, in the countries of the European Union, Switzerland, Liechtenstein, Iceland, Norway and Australia, or the Territory, for human use in pain treatment within or dispensed by hospitals, hospices, nursing homes and other medically-supervised settings, or the Field. AcelRx retains rights with respect to the Product in countries outside the Territory, including the United States, Asia and Latin America. Under the MSA, AcelRx will exclusively manufacture and supply the Product to Grünenthal for the Field in the Territory.  

 

On July 22, 2015, we entered into amendments to the License Agreement, or the License Amendment, and the MSA, or the MSA Amendment, between AcelRx and Grünenthal, each effective as of July 17, 2015, and together with the License Agreement, and the MSA, the Amended Agreements.

 

In the MSA Amendment and the License Amendment, the parties amended the Product supply configurations and packaging of Product components and accessories, and associated pricing therefor, which AcelRx will manufacture and supply to Grünenthal for the Territory. As consideration for an increase in the pricing of the Product components and accessories as part of the agreed packaging configurations, the total milestone payments from Grünenthal contingent upon achieving specified net sales target milestones were reduced from a total of $171.5 million to $166.0 million. The parties also updated the development plan for the Product in the Territory, providing for additional near-term development costs to be paid by Grünenthal.

  

Under the terms of the Amended Agreements with Grünenthal, we received an upfront cash payment of $30.0 million in December 2013, and in the third quarter of 2014, we received a milestone payment of $5.0 million related to the MAA submission to EMA. We are eligible to receive an additional $15.0 million milestone payment upon the approval of the MAA. If approved, under the terms of the Amended Agreements, we are eligible to receive approximately $194.5 million in additional milestone payments, based upon successful regulatory and product development efforts ($28.5 million) and net sales target achievements ($166.0 million). Grünenthal will also make tiered royalty, supply and trademark fee payments in the mid-teens up to the mid-twenties percent range, on net sales of Zalviso in the Grünenthal territory.

 

Grünenthal will be responsible for all commercial activities for Zalviso, including obtaining and maintaining pharmaceutical product regulatory approval in the Grünenthal territory. We will be responsible for obtaining and maintaining device regulatory approval in the Grünenthal territory and manufacturing and supply of Zalviso to Grünenthal for commercial sales.

 

As mentioned above, in July 2014, Grünenthal filed an MAA with EMA under the centralized procedure in the EU for Zalviso for the management of acute moderate-to-severe post-operative pain in adult patients. On July 23, 2015, the CHMP adopted a positive opinion for Zalviso for the management of acute moderate-to-severe post-operative pain in adult patients in a hospital setting. A decision by the EC on the approval of Zalviso is anticipated in late September or early October.

 

In association with potential commercialization of Zalviso in the European Union, we underwent a Conformite Europeenne approval process for the Zalviso device, more commonly known as a CE Mark approval process. We received CE Mark approval in December 2014, which permits the commercial sale of the Zalviso device in the European Union. However, as a drug-device combination product, Zalviso will not be utilized commercially unless and until EMA approves the Zalviso MAA. In connection with the CE Mark approval, we were also granted International Standards Organization, or ISO, 13485:2003 certification of our quality management system in November 2014. This is an internationally recognized quality standard for medical devices. Certification of our quality management system was issued by the British Standards Institution, or BSI, a Notified Body.

 

ISO 13485:2003 certification recognizes that consistent quality policies and procedures are in place for the development, design and manufacturing of medical devices. The certification indicates that we have successfully implemented a quality system that conforms to ISO 13485 standards for medical devices. Certification to this standard is one of the key regulatory requirements for a CE Mark in the European Union as well as to meet equivalent requirements in other international markets. The certification applies to the Redwood City, California location which designs, manufactures and distributes finished medical devices, and includes critical suppliers.

  

 

Critical Accounting Estimates

 

The accompanying discussion and analysis of our financial condition and results of operations are based upon our financial statements and the related disclosures, 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, assumptions and judgments that affect the reported amounts in our financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected. Our critical accounting policies and estimates are detailed in our Annual Report on Form 10-K for the year ended December 31, 2014. In addition, during the six months ended June 30, 2015, we have updated our revenue recognition policy to include contract revenue, as discussed below. There are no other significant changes to our critical accounting policies and estimates from those previously disclosed in our Annual Report on Form 10-K.

 

Revenue Recognition - Contract Revenue

 

In May 2015, we entered into an award contract with the USAMRMC to support the development of our product candidate, ARX-04. The contract provides for the reimbursement of qualified expenses for research and development activities as defined under the terms of the contract. Revenue under the contract is recognized when the related qualified research expenses are incurred.

  

Results of Operations

 

Three and Six Months Ended June 30, 2015 and 2014

 

Revenue

 

To date, we have not generated any commercial product revenue. We do not expect to receive any commercial sales revenue from any product candidates that we develop until we, or our collaborators, obtain regulatory approval and commercialize our products.

 

Revenue for the three and six months ended June 30, 2015, was $1.9 million and $2.1 million, respectively, the majority of which was generated from our contract for ARX-04 with the DoD. In the three and six months ended June 30, 2015, $1.4 million in revenue was generated under our DoD contract, while $486,000 and $667,000, respectively, related to development work associated with our collaboration agreement with Grünenthal. Revenue for the three and six months ended June 30, 2014, was $71,000 and $166,000, respectively, all of which related to development work associated with our collaboration agreement with Grünenthal.

 

  

 

Contract Revenue 

 

On May 11, 2015, we entered into an award contract supported by the USAMRMC within the DoD, in which the DoD agreed to provide up to $17.0 million to support the development of our product candidate ARX-04, a proprietary, non-invasive, single-use tablet in a disposable, pre-filled, single-dose applicator for the treatment of moderate-to-severe acute pain. The DoD contract will support development of ARX-04 to perform Phase 3 clinical trials and manufacturing activities in order to submit an NDA to the FDA. Under the terms of the contract, the DoD will reimburse us for costs incurred for development, manufacturing and clinical costs outlined in the contract, including reimbursement for certain personnel and overhead expenses. The period of performance under the contract begins on May 11, 2015 and ends on November 10, 2016. The contract gives the DoD the option to extend the term of the contract and provide additional funding for the research. In addition, if ARX-04 is approved by the FDA, the DoD has the option to purchase a certain number of units of commercial product pursuant to the terms of the contract.

 

Collaboration Agreement Revenue

 

As mentioned above, under the terms of the Agreements with Grünenthal, we received an upfront cash payment of $30.0 million, and a milestone payment of $5.0 million related to the MAA submission, which occurred in July 2014. We are eligible to receive an additional $15.0 million milestone payment upon the approval of the MAA. This $15.0 million non-substantive milestone payment will be allocated across the four significant non-contingent performance deliverables identified in the Agreements, based on the relative estimated selling price method, upon approval of the MAA, if approved. In addition, if the MAA is approved, under the terms of the Amended Agreements, we are eligible to receive approximately $194.5 million in additional milestone payments, based upon successful regulatory and product development efforts and net sales target achievements. Grünenthal will also make tiered royalty, supply and trademark fee payments in the mid-teens up to the mid-twenties percent range, on net sales of Zalviso in the Grünenthal territory.

 

Research and Development Expenses

 

Conducting research and development is central to our business model. The majority of our operating expenses to date have been for research and development activities related to Zalviso. Research and development expenses included the following:

 

•

expenses incurred under agreements with contract research organizations and clinical trial sites;

 

•

employee-related expenses, which include salaries, benefits and stock-based compensation;

 

•

payments to third party pharmaceutical and engineering development contractors;

 

•

payments to third party manufacturers;

 

•

depreciation and other allocated expenses, which include direct and allocated expenses for rent and maintenance of facilities and equipment, and equipment and laboratory and other supply costs; and

 

•

costs for equipment and laboratory and other supplies.

  

Product candidates in late stages of clinical development generally have higher development costs than those in earlier stages of clinical development, primarily due to the increased size and duration of late stage clinical trials. We will incur substantial future expenditures as we seek to continue development of Zalviso, including activities to address issues raised by the FDA during their regulatory review process, as well as activities associated with potential preparation for commercialization of Zalviso, should we receive approval from the FDA. In addition, we plan to continue to incur significant research and development expenses, including the expenses associated with the continued development of ARX-04. We do not plan to continue development of ARX-02 and ARX-03, unless additional funding or corporate partnership resources are available to support these programs.

 

We track external development expenses on a program-by-program basis. Our development resources are shared among all of our programs. Compensation and benefits, facilities, depreciation, stock-based compensation, and development support services are not allocated specifically to projects and are considered research and development overhead. Below is a summary of our research and development expenses during the three and six months ended June 30, 2015 and 2014 (in thousands):

 

 

		Three Months Ended June 30,												Six Months Ended June 30,
Drug Indication/Description		2015				2014				2015 vs. 2014 Increase/ (Decrease)				2015				2014				2015 vs. 2014 Increase/ (Decrease)
		(In thousands, except percentages)
Zalviso		$	1,082			$	3,578				(70	)%		$	2,752			$	5,300				(48	)%
ARX-04			2,996				994				201	%			4,157				1,700				145	%
Overhead			3,232				2,712				19	%			6,707				4,995				34	%
Total research and development expenses		$	7,310			$	7,284				0	%		$	13,616			$	11,995				14	%

 

 

Due to the inherently unpredictable nature of product development, development timelines and the probability of success, development costs can differ materially from expectations. While we are currently focused on advancing Zalviso and the continued development of ARX-04, our future research and development expenses will depend on the clinical success of each product candidate as well as ongoing assessments of the commercial potential of our product candidates. In addition, we cannot predict which product candidates may be subject to future collaborations, when these arrangements will be secured, if at all, and to what degree these arrangements would affect our development plans and capital requirements.

 

 

Total research and development expenses for the three and six months ended June 30, 2015 and 2014 were as follows (in thousands, except percentages):

 

		Three Months Ended June 30,																Six Months Ended June 30,
		2015				2014				Change				%				2015				2014				Change				%
		(In thousands, except percentages)
Research and development expenses		$	7,310			$	7,284			$	26				0	%		$	13,616			$	11,995			$	1,621				14	%

 

Research and development expenses during the three months ended June 30, 2015, as compared to the three months ended June 30, 2014, included a decrease of $2.5 million related to our Zalviso development program, partially offset by a $2.0 million increase related to the initiation of our ARX-04 Phase 3 clinical trial, and a $0.5 million increase in research and development overhead expenses, including a $0.4 million increase in facilities expense, primarily related to the amortization of the tenant improvements at our contract manufacturer’s facility and depreciation of manufacturing equipment.

 

The $1.6 million increase in research and development expenses during the six months ended June 30, 2015, as compared to the six months ended June 30, 2014, was primarily attributable to an increase of $2.5 million related to our ARX-04 development program, an increase of $0.8 million in manufacturing facilities expense, and an increase of $0.9 million in personnel-related expenses, including stock-based compensation, partially offset by a $2.5 million decrease related to our Zalviso Phase 3 clinical program.

 

General and Administrative Expenses

 

General and administrative expenses consisted primarily of salaries, benefits and stock-based compensation for personnel in administration, finance, marketing and business development activities. Other significant expenses included legal expenses related to litigation and patent protection of our intellectual property, allocated facility costs and professional fees for general legal, audit and consulting services. We expect general and administrative expenses to continue to decrease in the next quarter as a result of the cost reduction plan and then remain flat as we focus our efforts on seeking marketing approval for Zalviso, and the continued development of ARX-04.

 

Total general and administrative expenses for the three and six months ended June 30, 2015 and 2014 were as follows (in thousands, except percentages):

 

		Three Months Ended June 30,																Six Months Ended June 30,
		2015				2014				Change				%				2015				2014				Change				%
		(In thousands, except percentages)
General and administrative expenses		$	2,735			$	5,047			$	(2,312	)			(46	)%		$	7,256			$	8,972			$	(1,716	)			(19	)%

 

General and administrative expenses decreased over both comparative periods primarily due to a cost reduction plan implemented by our Board of Directors on March 19, 2015. See “Restructuring Costs” below for additional information.

 

The $2.3 million decrease in general and administrative expenses during the three months ended June 30, 2015, as compared to the three months ended June 30, 2014, was primarily due to a $2.3 million decrease in market research expenses and a significant reduction in pre-commercialization activities related to Zalviso.

 

The $1.7 million decrease in general and administrative expenses during the six months ended June 30, 2015, as compared to the six months ended June 30, 2014, was primarily due to a decrease in market research and outside services of $3.0 million, primarily related to market research activities for Zalviso, partially offset by an increase of $1.3 million, primarily due to a $1.2 million increase in headcount-related expenses, including a $0.5 million increase in stock-based compensation, due to the timing of new hires added in mid-2014 who were unaffected by the March 2015 cost reduction plan.

  

 

Restructuring Costs

 

In March 2015, we received correspondence from the FDA stating that in addition to the bench testing and two Human Factors studies we had performed in response to the issues identified in the CRL, a clinical trial is needed to assess the risk of inadvertent dispensing and overall risk of dispensing failures. On March 19, 2015, our Board of Directors, in connection with our efforts to reduce operating costs, conserve capital, focus the Company's financial and development resources on working with the FDA to seek marketing approval for Zalviso, and continuing development of ARX-04, implemented a cost reduction plan. The cost reduction plan reduced our workforce by 19 employees, approximately 36% of total headcount, in the first quarter of 2015.

 

		Three Months Ended June 30,																Six Months Ended June 30,
		2015				2014				Change				%				2015				2014				Change				%
		(In thousands, except percentages)
Restructuring costs		$	2			$	—			$	2				—	%		$	756			$	—			$	756				—	%

 

Restructuring costs in the three and six months ended June 30, 2015 consist of employee termination benefit costs of $0 and $0.8 million, respectively. 

 

Interest Expense 

 

Interest expense consisted primarily of interest accrued or paid on our debt obligation agreements and amortization of debt discounts. Total interest expense for the three and six months ended June 30, 2015 and 2014, was as follows (in thousands, except percentages):

 

		Three Months Ended June 30,																Six Months Ended June 30,
		2015				2014				Change				%				2015				2014				Change				%
Interest expense		$	777			$	530			$	247				47	%		$	1,583			$	1,002			$	581				58	%

 

Interest expense for both periods pertains to interest on our loan and security agreement with Hercules. In December 2013, we entered into the Amended Loan Agreement with Hercules, which amends and restates the Original Loan Agreement. The overall debt facility was increased to $40.0 million, $23.1 million of which was outstanding as of June 30, 2015, and the maturity was extended to October 1, 2017. On June 16, 2014, we borrowed the second tranche of $10.0 million. As a result, the amount of interest expense incurred during the three and six months ended June 30, 2015, increased as compared to the three and six months ended June 30, 2014.

 

Interest Income and Other Income (Expense), net

 

Interest income and other income (expense), net, during the three and six months ended June 30, 2015 and 2014, consisted primarily of the change in the fair value of our warrants, or PIPE warrants, issued in connection with our private placement of our common stock, which was completed in June 2012.

 

Total interest income and other income (expense), net for the three and six months ended June 30, 2014 and 2014 was as follows (in thousands):

 

 

		Three Months Ended June 30,												Six Months Ended June 30,
		2015				2014				Change				2015				2014				Change
Interest income and other income (expense), net		$	4			$	2,215			$	(2,211	)		$	2,184			$	1,597			$	587

 

The decrease in interest income and other income (expense), net, during the three months ended June 30, 2015 as compared to the three months ended June 30, 2014, of $2.2 million was primarily attributable to fewer PIPE warrants outstanding at June 30, 2015, as compared to June 30, 2014, in addition to an increase in the liability, as the stock price increased in the quarter ended June 30, 2015, whereas the liability decreased in the quarter ended June 30, 2014 due to a decrease in the stock price in that period. The increase in interest income and other income (expense), net, during the six months ended June 30, 2015, as compared to the six months ended June 30, 2014, of $0.6 million was primarily attributable to fewer PIPE warrants outstanding at June 30, 2015, compared to June 30, 2014, and a larger decrease in our stock price during the first half of 2015 as compared to the first half of 2014, which is the primary driver in the Black-Scholes valuation model used to estimate the fair value of the PIPE warrants.

  

 

Liquidity and Capital Resources

 

Liquidity

 

We have incurred losses and generated negative cash flows from operations since inception. We expect to continue to incur significant losses and negative cash flows in 2015 and may incur significant losses and negative cash flows for the foreseeable future. We have funded our operations primarily through the issuance of equity securities and debt financings, and through our collaboration agreement with Grünenthal, which we entered into in December 2013.

 

As of June 30, 2015, we had cash, cash equivalents and investments totaling $51.2 million compared to $75.4 million as of December 31, 2014. The decrease was primarily attributable to cash required to fund our continuing operations, as we continue our research and development activities. We anticipate that our existing capital resources will permit us to meet our capital and operational requirements through at least the first half of 2016, excluding any potential proceeds from sales or milestones associated with our collaboration with Grünenthal, additional financings or other corporate partnerships. While we believe we have sufficient capital to meet our operational requirements through at least the first half of 2016, our expectations may change depending on a number of factors. For example, based on potential future discussion with the FDA regarding their request for a clinical trial for Zalviso, the FDA may indicate a scope or design of clinical trial that is beyond what our current and estimated future capital resources can support. If we were to decide to proceed with a large scale clinical trial, we would need to raise additional capital. We believe that together with the support from the DoD contract, we have sufficient resources to complete the Phase 3 development program for ARX-04 through submission of the NDA to the FDA. However, our existing capital resources will not be sufficient to fund our operations until such time as we may be able to generate sufficient revenues to sustain our operations.

 

 In December 2013, we announced a commercial collaboration with Grünenthal, covering the territory of the European Union, certain other European countries and Australia for Zalviso for potential use in pain treatment within or dispensed by a hospital, hospice, nursing home or other medically supervised setting. We retain all rights in remaining countries, including the United States, Asia and Latin America. Under the terms of the Amended Agreements, we received an upfront cash payment of $30.0 million, and a milestone payment of $5.0 million related to the MAA submission. We are eligible to receive an additional $15.0 million milestone payment upon the approval of the MAA. If approved, under the terms of the Amended Agreements, we are eligible to receive approximately $194.5 million in additional milestone payments, based upon successful regulatory and product development efforts and net sales target achievements. Grünenthal will also make tiered royalty, supply and trademark fee payments in the mid-teens up to the mid-twenties percent range, on net sales of Zalviso in the Grünenthal territory.

 

In December 2013, we entered into an amended loan and security agreement, or the Amended Loan Agreement, with Hercules Technology II, L.P. and Hercules Technology Growth Capital, Inc., collectively referred to as Hercules, under which we may borrow up to $40.0 million in three tranches, represented by secured convertible promissory notes. The agreement amends and restates the loan and security agreement with Hercules dated as of June 29, 2011, or the Original Loan Agreement. We borrowed the first tranche of $15.0 million upon closing of the transaction on December 16, 2013 and used approximately $8.6 million of the proceeds from the first tranche to repay our obligations under the Original Loan Agreement with Hercules. On June 16, 2014, we borrowed the second tranche of $10.0 million, which we plan to provide additional funding for the commercialization of Zalviso, as a potential source of funding for clinical trials for other development programs in our pipeline and for general corporate purposes. On September 24, 2014, we entered into an amendment, or the Amendment, to the Amended Loan Agreement with Hercules. The Amendment extended the time period under which we can draw down the third tranche, of up to $15.0 million, from March 15, 2015 to August 1, 2015, subject to obtaining approval for Zalviso from the FDA. We did not receive FDA approval of Zalviso by August 1, 2015 and as such, did not have access to the third tranche under the Amended Loan Agreement.

 

Our cash and investment balances are held in a variety of interest bearing instruments, including obligations of U.S. government agencies, money market funds and time deposits. Cash in excess of immediate requirements is invested with a view toward capital preservation and liquidity.

  

 

Cash Flows

 

The following is a summary of our cash flows for the periods indicated and has been derived from our condensed financial statements which are included elsewhere in this Form 10-Q (in thousands):

 

		Six Months Ended June 30,
		2015				2014
Net cash used in operating activities		$	(21,438	)		$	(19,943	)
Net cash used in investing activities			(977	)			(1,459	)
Net cash (used in) provided by financing activities			(1,781	)			10,729

 

 

 

Cash Flows from Operating Activities

 

The primary use of cash for our operating activities during these periods was to fund the development of our product candidates, including commercial readiness activities for our product candidate, Zalviso. Our cash used for operating activities also reflected changes in our working capital, net of adjustments for non-cash charges, such as depreciation and amortization of our fixed assets, stock-based compensation, interest expense related to our debt financings and the revaluation of our PIPE warrant liability and the contingent put option liability.

 

Cash used in operating activities of $21.4 million during the six months ended June 30, 2015, reflected a net loss of $18.9 million, partially offset by aggregate non-cash charges of $1.3 million, and a net change of $3.8 million in our net operating assets and liabilities. Non-cash charges included $2.6 million for stock-based compensation, and $1.0 million for depreciation and amortization of our fixed assets, partially offset by $2.1 million for the change in fair value of our PIPE warrant liability and contingent put liability. The net change in our operating assets and liabilities included a $1.4 million increase in prepaid expenses and other assets, primarily due to the timing of payments, and a decrease in accrued liabilities of $0.9 million, largely due to payment of compensation-related expenses.

 

Cash used in operating activities of $19.9 million during the six months ended June 30, 2014, reflected a net loss of $20.2 million, partially offset by aggregate non-cash charges of $887,000, and a net change of $623,000 in our net operating assets and liabilities. Non-cash charges included $1.9 million for stock-based compensation, partially offset by $1.7 million for the change in fair value of our PIPE warrant liability and contingent put liability.

 

Cash Flows from Investing Activities

 

Our investing activities have consisted primarily of our capital expenditures and purchases and sales and maturities of our available-for-sale investments.

 

During the six months ended June 30, 2015, cash used in investing activities of $1.0 million was primarily as a result of $5.5 million for purchases of investments and $0.9 million for purchases of property and equipment, partially offset by $5.4 million in proceeds from maturity of investments.

 

During the six months ended June 30, 2014, cash used in investing activities of $1.5 million was primarily as a result of $4.9 million for purchases of investments and $2.0 million for purchases of property and equipment, partially offset by $5.4 million in proceeds from maturity of investments.  

 

Cash Flows from Financing Activities

 

Cash flows from financing activities primarily reflect proceeds from the sale of our securities, proceeds from our debt financings and payments made on such debt financings. As of June 30, 2015, we had outstanding debt of $23.1 million.

 

During the six months ended June 30, 2015, cash used in financing activities of $1.8 million was primarily due to payments on our loan and security agreement with Hercules. 

 

During the six months ended June 30, 2014, cash provided by financing activities of $10.1 million was primarily due to the drawdown of the second tranche of the Hercules debt of $10.0 million. 

  

 

Operating Capital and Capital Expenditure Requirements

 

We expect our rate of cash usage to increase in the future, in particular to support our product development activities, including continued development of Zalviso, ARX-04 and the potential commercialization of our product candidates, if approved. Our future cash needs are highly dependent on the receipt of the $15.0 million milestone from Grünenthal for approval of the MAA and receipt of reimbursement of approximately $7.0 million in 2015 under the contract with the DoD. We anticipate that our existing capital resources will permit us to meet our capital and operational requirements through at least the first half of 2016. Our current operating plan includes the continued development of ARX-04, specifically the filing of the NDA in 2016. Our operating plan does not include any significant spending for continued development of Zalviso. These assumptions may change as a result of many factors. For example, the FDA has informed us that a clinical trial is needed to assess the risk of inadvertent dispensing and overall risk of dispensing failures. We have been granted a General Advice meeting with the Division in early September 2015 to discuss the FDA’s request for an additional clinical trial and our planned response to the CRL. Pending the outcome of that meeting, we intend to determine what additional work, if any, is required and finalize our plans to refile the NDA for Zalviso. We will then evaluate next steps to seek a pathway forward towards gaining approval of Zalviso in the U.S. The pathway forward for Zalviso could have a material impact to our operating spend. Our forecast of the period of time through which our financial resources will be adequate to support our operations is a forward-looking statement that involves risks and uncertainties, and actual results could vary materially. Additional capital may not be available on terms acceptable to us, or at all. If adequate funds are not available, or if the terms underlying potential funding sources are unfavorable, our business and our ability to develop our product candidates would be harmed.

 

Our future capital requirements may vary materially from our expectations based on numerous forward looking factors, including but not limited to the following: 

 

•

the outcome, timing and cost of regulatory approvals;

 

•

expenditures related to the activities required in support of our resubmission of the Zalviso NDA, including an additional clinical trial for Zalviso, as requested by the FDA;

 

•

expenditures related to our commercialization preparation of Zalviso;

 

•

future manufacturing, selling and marketing costs related to Zalviso, if the product candidate is approved for marketing, including our contractual obligations to Grünenthal;

 

•

the initiation, progress, timing and completion of clinical trials for our product candidates, including ARX-04;

 

•

changes in the focus and direction of our business strategy and/or research and development programs;

 

•

milestone and royalty revenue we receive under our collaborative development and commercialization arrangements;

 

•

delays that may be caused by changing regulatory requirements;

 

•

the number of product candidates that we pursue;

 

•

the initiation, progress, timing and completion of clinical trials for our product candidates and potential product candidates;

 

•

the costs involved in filing and prosecuting patent applications and enforcing and defending patent claims;

 

•

the timing and terms of future in-licensing and out-licensing transactions;

 

•

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

 

•

the cost of procuring clinical and commercial supplies of our product candidates;

 

•

the extent to which we acquire or invest in businesses, products or technologies; and

 

•

the expenses associated with the pending securities lawsuit, as well as any other litigation.

 

We will need substantial funds to:

 

•

commercialize any products we market, including Zalviso, if approved;

 

•

manufacture and market our product candidates;

 

•

conduct preclinical and clinical testing of our product candidates; and

 

•

conduct research and development programs.

 

Our existing capital resources may not be sufficient to fund our operations until such time as we may be able to generate sufficient revenues to sustain our operations. To the extent that our capital resources are insufficient to meet our future capital requirements, we will have to raise additional funds through the sale of our equity securities, monetization of current and future assets, issuance of debt or debt-like securities or from development and licensing arrangements to continue our development programs. We may be unable to raise such additional capital on favorable terms, or at all. If we raise additional capital by selling our equity or convertible debt securities, the issuance of such securities could result in dilution of our shareholders’ equity positions. If adequate funds are not available we may have to:

 

•

significantly curtail or put on hold commercialization or development efforts of our product candidates or other operations;

 

•

obtain funds through entering into collaboration agreements on unattractive terms; and/or

 

•

delay, postpone or terminate planned clinical trials.

  

 

Contractual Obligations

 

During the six months ended June 30, 2015, there were no material changes to our contractual obligations, other than the fulfillment of existing obligations in the ordinary course of business, described under Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in Part II, Item 7 of our Annual Report on Form 10-K for our fiscal year ended December 31, 2014.

 

Off-Balance Sheet Arrangements

 

Through June 30, 2015, we have not entered into any off-balance sheet arrangements and do not have any holdings in variable interest entities.

 

 Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

Our cash, cash equivalents and short-term investments as of June 30, 2015, consisted primarily of primarily of money market funds and U.S. government agency securities. We do not have any auction rate securities on our balance sheet, as they are not permitted by our investment policy. Our cash is invested in accordance with an investment policy approved by our board of directors which specifies the categories, allocations, and ratings of securities we may consider for investment. We do not believe our cash, cash equivalents and short-term investments have significant risk of default or illiquidity.

 

Our primary exposure to market risk is interest income sensitivity, which is affected by changes in the general level of U.S. interest rates, particularly because the majority of our investments are in short-term marketable debt securities. The primary objective of our investment activities is to preserve principal while at the same time maximizing the income we receive from our investments without significantly increasing risk. In an attempt to limit interest rate risk, we follow guidelines to limit the average and longest single maturity dates, place our investments with high quality issuers and follow internally developed guidelines to limit the amount of credit exposure to any one issuer. Some of the securities that we invest in may be subject to market risk. This means that a change in prevailing interest rates may cause the value of the investment to fluctuate. For example, if we purchase a security that was issued with a fixed interest rate and the prevailing interest rate later rises, the value of our investment may decline. If a 10 percent change in interest rates were to have occurred on June 30, 2015, this change would not have had a material effect on the fair value of our investment portfolio as of that date. In general, money market funds are not subject to market risk because the interest paid on such funds fluctuates with the prevailing interest rate.

 

In addition, domestic and international equity markets have experienced and may continue to experience heightened volatility and turmoil based on domestic and international economic conditions and concerns. In the event these economic conditions and concerns continue and the markets continue to remain volatile, our results of operations could be adversely affected by those factors in many ways, including making it more difficult for us to raise funds if necessary and our stock price may further decline. In addition, we maintain significant amounts of cash and cash equivalents that are not federally insured. If economic instability continues, we cannot provide assurance that we will not experience losses on these investments.

 

Item 4. Controls and Procedures

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended, or the Exchange Act, and the rules and regulations thereunder, is recorded, processed, summarized and reported within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

 

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

   

Changes in internal control over financial reporting. There have been no changes in our internal control over financial reporting during our most recent fiscal quarter 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

 

On October 1, 2014, a securities class action complaint was filed in the U.S. District Court for the Northern District of California against AcelRx and certain of our current and former officers. On April 17, 2015, lead plaintiff filed an amended complaint. The amended complaint alleges that between September 30, 2013 and July 25, 2014, AcelRx and certain of our current and former officers violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 in connection with statements related to our drug candidate, Zalviso. The amended complaint seeks unspecified damages, interest, attorneys’ fees, and other costs. In response, the Company filed a Motion to Dismiss on June 1, 2015. Plaintiffs’ opposition was filed July 30, 2015 and a hearing date on the Motion to Dismiss has been scheduled for October 22, 2015. We believe that we have meritorious defenses and intend to defend against this lawsuit vigorously.

 

This lawsuit and any future related lawsuits are subject to inherent uncertainties, and the actual defense and disposition costs will depend upon many unknown factors. The outcome of such lawsuits is necessarily uncertain. Securities-related class action litigation often is expensive and diverts management's attention and our financial resources, which could adversely affect our business. Further, any negative outcome from such lawsuit could result in payments of monetary damages, or adversely affect our products, and accordingly our business, financial condition, or results of operations could be materially and adversely affected.

 

There can be no assurance that a favorable final outcome will be obtained in this case or any subsequent related case.  Defending any lawsuit is costly and can impose a significant burden on management and employees. Any litigation to which we are a party may result in an onerous or unfavorable judgment that may not be reversed upon appeal or in payments of monetary damages not covered by insurance, or we may decide to settle lawsuits on unfavorable terms, which could adversely affect our business, financial conditions, or results of operations.

 

From time to time we may be involved in additional legal proceedings arising in the ordinary course of business.

 

Item 1A. Risk Factors

 

This Quarterly Report on Form 10-Q contains forward-looking information based on our current expectations. Because our actual results may differ materially from any forward-looking statements made by or on behalf of us, this section includes a discussion of important factors that could affect our actual future results, including, but not limited to, our revenues, expenses, net loss and loss per share. You should carefully consider these risk factors, together with all of the other information included in this Quarterly Report on Form 10-Q as well as our other publicly available filings with the U.S. Securities and Exchange Commission, or SEC.

 

We have marked with an asterisk (*) those risks described below that reflect substantive changes from, or additions to, the risks described in our Annual Report on Form 10-K for the year ended December 31, 2014.

 

Risks Related to Clinical Development and Regulatory Approval 

 

We depend substantially on the success of Zalviso, which may not receive regulatory approval or be successfully commercialized.*

 

Since our inception in 2005, we have focused primarily on development of our product candidate, Zalviso^TM. Zalviso consists of sufentanil sublingual tablets, 15 mcg, delivered by the Zalviso System, a needle-free, handheld, patient-administered, pain management system (together, “Zalviso”). The success of our business depends primarily upon our ability to develop, receive regulatory approval for and commercialize Zalviso for the management of moderate-to-severe acute pain in adult patients in the hospital setting. We have not marketed, distributed or sold any products to date.

  

 

Our Phase 3 program for Zalviso consisted of three Phase 3 clinical trials. We reported positive top-line data from each of these trials and submitted a New Drug Application, or NDA, for Zalviso to the U.S. Food and Drug Administration, or FDA, on September 27, 2013, which the FDA then accepted for filing in December 2013. On July 25, 2014, the FDA issued a Complete Response Letter, or CRL, for our NDA for Zalviso. The CRL contains requests for additional information on the Zalviso System to ensure proper use of the device. The requests include submission of data demonstrating a reduction in the incidence of optical system errors, changes to address inadvertent dosing, among other items, and submission of additional data to support the shelf life of the product. In September 2014, we held a Type A meeting via a teleconference with representatives from the FDA to review our proposed response to the Zalviso CRL. We submitted a Briefing Document to the FDA ahead of the teleconference and received preliminary comments from the FDA on the Briefing Document. During the meeting, we discussed the resubmission of the Zalviso NDA and the steps necessary for the resubmission, including submission of protocols for the bench testing and Human Factors, or HF, studies for their review and comment. In addition, the FDA requested in the minutes of the meeting, that we provide a risk assessment that analyzes the risks associated with inadvertent dosing and the rationale that bench testing and HF studies are sufficient to address the specific items included in the CRL. We submitted the protocols and this rationale in the fourth quarter of 2014. In January 2015, we received feedback from the FDA on the protocol and planned analysis of the results of the bench test. Based on the FDA feedback, no modifications to the conduct of the bench test were necessary; however, in response to the FDA’s request, we refined the planned analysis of the bench test results. In February 2015, we received feedback from the FDA on the HF protocols. In this feedback, the FDA confirmed that the HF studies as proposed were acceptable to evaluate the design changes related to inadvertent dispensing of tablets. In March 2015, we received additional correspondence from the FDA stating that in addition to the bench testing and two Human Factors studies we had performed in response to the issues identified in the CRL, a clinical trial is needed to assess the risk of inadvertent dispensing and overall risk of dispensing failures. On April 21, 2015, we submitted a request to the Division of Anesthesia, Analgesia, and Addiction Products, or the Division, of the FDA for a Type B meeting. On May 1, 2015, the Division notified us that the request for a meeting was denied and restated the Division’s view that a clinical study is required. Subsequently, we have been granted a General Advice meeting with the Division in early September 2015 to discuss their request for an additional clinical trial and our planned response to the CRL. Pending the outcome of that meeting, we intend to determine what additional work, if any, is required and finalize our plans to refile the NDA for Zalviso. We will then evaluate next steps to seek a pathway forward towards gaining approval of Zalviso in the U.S. Based on clinical studies to date, we believe that Zalviso has been shown to be safe and effective in the management of moderate-to-severe acute pain in the hospital setting and therefore additional human clinical trials should not be needed. However, we cannot predict what the FDA will ultimately conclude as a result of the General Advice meeting and their review of the briefing materials. We intend to continue to work with the FDA to determine a regulatory path forward to refile the NDA for Zalviso.

 

Our proposed trade name of Zalviso has been approved by the FDA, which must approve all drug trade names to avoid medication errors and misbranding. However, the FDA may withdraw this approval in which case any brand recognition or goodwill that we establish with the name Zalviso prior to commercialization may be worthless.

 

Any delay in approval by the FDA of the Zalviso NDA, if, and when, it is resubmitted, may negatively impact our stock price and harm our business operations. Any delay in obtaining, or inability to obtain, regulatory approval would prevent us from commercializing Zalviso in the United States, generating revenues and achieving profitability. If any of these events occur, we may be forced to delay or abandon our development efforts for Zalviso, which would have a material adverse effect on our business and could potentially cause us to cease operations.

 

On December 16, 2013, we entered into a Collaboration and License Agreement, or the License Agreement, and related Manufacture and Supply Agreement, or the MSA, and together with the License Agreement, the Agreements, with Grünenthal GmbH, or Grünenthal. On July 22, 2015, we entered into amendments to the License Agreement, or the License Amendment, and the MSA, or the MSA Amendment, with Grünenthal, each effective as of July 17, 2015, and together with the License Agreement, and the MSA, the Amended Agreements. The Amended Agreements with Grünenthal grants them rights to commercialize Zalviso, in the European Union, or EU, Switzerland, Liechtenstein, Iceland, Norway and Australia, or the Territory, for human use in pain treatment within or dispensed by hospitals, hospices, nursing homes and other medically-supervised settings. Although the Committee for Medicinal Products for Human Use, or CHMP, has adopted a positive opinion for Zalviso and we have received CE Mark approval permitting the commercial use of the Zalviso device in the EU, Grünenthal may never achieve regulatory approval for Zalviso in their licensed territories, in which case, we would not receive development or sales milestones, or product royalties, which could have a material adverse effect on our business.

 

We may decide to enter into the dispute resolution process through the FDA prescribed pathway.*

 

As noted above, on May 1, 2015, the Division notified us that the request for a meeting was denied and restated the Division’s view that a clinical study is required. Subsequently, we have been granted a General Advice meeting with the Division in early September 2015 to discuss the FDA’s request for an additional clinical trial and our planned response to the CRL. Pending the outcome of that meeting, we intend to determine what additional work, if any, is required and finalize our plans to refile the NDA for Zalviso. We will then evaluate next steps to seek a pathway forward towards gaining approval of Zalviso in the U.S. We will be considering all options to determine a pathway forward for Zalviso, including the possibility of dispute resolution through the FDA prescribed pathway, as well as conducting additional clinical and Human Factors studies. Even if we determine a pathway forward for Zalviso that includes additional clinical and Human Factors studies, there is no guarantee that we will be able to define the nature and scope of any additional clinical trials and Human Factor studies to meet their request. We may choose to enter into the formal dispute resolution process with the FDA. Under FDA guidance, the formal dispute resolution process is a request for review above the FDA division level. There is no guarantee that the dispute resolution process, nor any additional work we perform related to Zalviso, including an additional human clinical trial, would be supportive of, or guarantee, an NDA resubmission, or result in our successfully obtaining FDA approval of Zalviso in a timely fashion, if at all. At any future point in time, the FDA could require us to complete further clinical, Human Factors, pharmaceutical, reprocessing or other studies, which could delay or preclude any approval of the NDA and could require us to obtain significant additional funding. There is no guarantee such funding would be available to us on favorable terms, if at all.

 

 

Positive clinical results obtained to date for our product candidates may be disputed in FDA review, do not guarantee regulatory approval and may not be obtained from future clinical trials.*

 

We have reported positive top-line data from each of our three Zalviso Phase 3 clinical trials, as well as our Phase 2 clinical trial, which will be considered a pivotal study, for ARX-04 (sufentanil sublingual tablet, 30 mcg). However, even if we believe that the data from clinical trials is positive, the FDA could analyze our data using alternative strategies and determine that the data from our trials was negative or inconclusive. Negative or inconclusive results of a clinical trial could cause the FDA to require us to repeat the trial or conduct additional clinical trials prior to obtaining approval for commercialization, and there is no guarantee that additional trials would achieve positive results. Any such determination by the FDA would delay the timing of our commercialization plan for Zalviso, or further development of our other product candidates, and adversely affect our business operations. For example, although we had achieved the primary endpoints in each of our three Phase 3 clinical trials for Zalviso, which were included in our NDA filed in 2013, in March 2015, we received correspondence from the FDA stating that in addition to the bench testing and two Human Factors studies we had performed in response to the issues identified in the CRL, a clinical trial is needed to assess the risk of inadvertent dispensing and overall risk of dispensing failures.

 

Delays in clinical trials are common and have many causes, and any delay could result in increased costs to us and jeopardize or delay our ability to obtain regulatory approval and commence product sales.*

 

We have experienced and may in the future experience delays in clinical trials of our product candidates. While we have completed pre-commercial trials for Zalviso, and the Phase 2 clinical trial for ARX-04, current and potential future clinical trials may not begin on time, have an effective design, enroll a sufficient number of patients or be completed on schedule, if at all. For example, in June 2014, we completed a pharmacokinetic study in support of the ARX-04 development program. In this study of healthy volunteers, it was shown that two sublingual administrations of a Zalviso sufentanil sublingual tablet, 15 mcg, dosed 20 minutes apart were equivalent to one sublingual administration of an ARX-04 sufentanil sublingual tablet, 30 mcg. Based on the results of this study, we have proposed the inclusion of approximately 300 patients from the Zalviso clinical program in the ARX-04 safety database to the FDA and we have designed the two Phase 3 ARX-04 trials accordingly. The ARX-04 safety database required by the FDA is 500 patients. We have confirmation from the FDA that some of the Zalviso patients can be included in the overall ARX-04 safety database; however, further discussion is ongoing to determine the exact number of such patients that can be used towards achieving the 500 patient minimum total safety exposure number required for ARX-04. Based on the outcome of these discussions, we may need to increase enrollment in our planned Phase 3 clinical program to meet the FDA’s requested exposure requirements to ARX-04, which could delay completion of the Phase 3 clinical program and increase our clinical trial expenses.

 

Our clinical trials for any of our product candidates could be delayed for a variety of reasons, including:

 

•

inability to raise funding necessary to initiate or continue a trial;

 

•

delays in obtaining regulatory approval to commence a trial;

 

•

delays in reaching agreement with the FDA on final trial design;

 

•

imposition of a clinical hold following an inspection of our clinical trial operations or trial sites by the FDA or other regulatory authorities;

 

•

delays in reaching agreement on acceptable terms with prospective contract research organizations, or CROs, and clinical trial sites;

 

•

delays in obtaining required institutional review board approval at each site;

 

•

delays in recruiting suitable patients to participate in a trial;

 

•

delays in the testing, validation, manufacturing and delivery of the device components of our product candidates;

  

•

delays in having patients complete participation in a trial or return for post-treatment follow-up;

 

•

clinical sites dropping out of a trial to the detriment of enrollment or being delayed in entering data to allow for clinical trial database closure;

 

•

time required to add new clinical sites; or

 

•

delays by our contract manufacturers to produce and deliver sufficient supply of clinical trial materials.

 

 

If any future clinical trials are delayed for any of the above reasons, our development costs may increase, our approval process could be delayed and our ability to commercialize and commence sales of our product candidates could be materially harmed, which could have a material adverse effect on our business.

 

We have not yet responded to the Zalviso Complete Response Letter nor resubmitted the Zalviso NDA. Activities that we undertake to address issues raised in the CRL may be deemed insufficient by the FDA.*

 

We completed bench testing and additional Human Factors studies that we believed addressed certain items contained in the CRL. However, before the results from these studies were submitted as a part of the proposed NDA resubmission, the FDA, in March 2015, notified us of the need for a clinical trial prior to the resubmission of the Zalviso NDA.

 

In March 2015, we received correspondence from the FDA stating that in addition to the bench testing and two Human Factors studies we had performed in response to the issues identified in the CRL, a clinical trial is needed to assess the risk of inadvertent dispensing and overall risk of dispensing failures. On April 21, 2015, we submitted a request to the Division of Anesthesia, Analgesia, and Addiction Products, or the Division, of the FDA for a Type B meeting. On May 1, 2015, the Division notified us that the request for a meeting was denied and restated the Division’s view that a clinical study is required. Subsequently, we have been granted a General Advice meeting with the Division in early September 2015 to discuss the FDA’s request for an additional clinical trial and our planned response to the CRL. Pending the outcome of that meeting, we intend to determine what additional work, if any, is required and finalize our plans to refile the NDA for Zalviso. We will then evaluate next steps to seek a pathway forward towards gaining approval of Zalviso in the U.S. We will be considering all options to determine a pathway forward for Zalviso, including the possibility of dispute resolution through the FDA prescribed pathway, as well as conducting additional clinical and Human Factors studies. As a result of this most recent correspondence, we may require additional funding. Even if we have appropriate resources to conduct an additional clinical trial, there is no guarantee that the trial results would address the issues raised by the FDA. We may be unable to obtain additional funding on favorable terms, if at all. Any delay in obtaining, or inability to obtain, regulatory approval would prevent us from commercializing Zalviso in the United States, generating revenues and achieving profitability. If any of these events occur, we may be forced to delay or abandon our development and commercialization efforts for Zalviso, which would have a material adverse effect on our business and could potentially cause us to cease operations.

 

If we are able to resubmit an NDA for Zalviso with new clinical data, there is no guarantee that such data will be deemed sufficient by the FDA. In addition, the FDA may evaluate the HF studies and bench testing we completed in support of our anticipated response to the CRL and may have concerns or issues with those protocols and/or their results. While we designed the protocols for bench testing and the Human Factors studies to address the issues raised in the CRL, there is no guarantee that the FDA will deem such protocols and results sufficient to address those issues when they are formally reviewed as a part of an NDA resubmission.

 

Lastly, even if we believe that the test results from our bench testing and Human Factors studies are positive, and we are able to conduct and achieve positive results from the additional clinical trial the FDA has requested, the FDA may hold a different opinion and deem the results insufficient. The FDA may provide review commentary at any time during the resubmission and review process which could adversely affect or even prevent the approval of Zalviso, which would adversely affect our business. We may not be able to identify appropriate remediations to issues that the FDA may raise, and we may not have sufficient time nor financial resources to conduct future activities to remediate raised issues.

 

Our product candidates may cause adverse effects or have other properties that could delay or prevent their regulatory approval or limit the scope of any approved label or market acceptance.

 

Adverse events, or AEs, caused by our product candidates could cause us, other reviewing entities, clinical trial sites or regulatory authorities to interrupt, delay or halt clinical trials and could result in the denial of regulatory approval. In our Phase 3 active comparator clinical trial (IAP309), 7.9% of Zalviso-treated patients dropped out of the trial prematurely due to an AE, and we observed one serious adverse event, or SAE, that was assessed as possibly or probably related to Zalviso. In our Phase 3, double-blind, placebo-controlled, abdominal surgery trial (IAP310), adverse events reported in the trial were generally mild or moderate in nature and similar in both placebo and treatment groups. In addition, one patient in the trial, who was in the sufentanil sublingual tablet group, experienced an SAE, which was determined to be unrelated to the trial drug. In our Phase 3, double-blind, placebo-controlled, orthopedic surgery trial (IAP311), treatment-emergent adverse events were generally mild-to-moderate in nature and similar for the majority of adverse events between sufentanil sublingual tablet- and placebo-treated patients. Two patients (one each in the sufentanil sublingual tablet group and placebo group) experienced a serious adverse event considered possibly or probably related to the trial drug by the investigator.

  

 

In our Phase 2 ARX-04 trial, two serious adverse events (SAEs), both in the 20 mcg-dose group, occurred one week after the study (surgical infections) and were deemed unrelated to study drug. All but two adverse events reported in the study were mild-to-moderate in nature with 58 patients (58%) reporting a total of 135 adverse events. The most frequently reported adverse events for all patients were nausea (30%), vomiting (17%), dizziness (14%) and somnolence (11%). Two patients discontinued treatment, one unrelated to study drug (anxiety/chest pain) and the other probably related to study drug (somnolence/respiratory depression); however, both patients recovered without medical intervention.

 

Phase 2 clinical trials conducted by us with our Zalviso, ARX-02 and ARX-03 product candidates have to date generated some AEs, but no SAEs, related to the trial drug.

 

Further, if any of our future products, including Zalviso, cause serious or unexpected side effects after receiving marketing approval, a number of potentially significant negative consequences could result, including:

 

•

regulatory authorities may withdraw their approval of the product or impose restrictions on its distribution in the form of a modified Risk Evaluation and Mitigation Strategy, or REMS;

 

•

regulatory authorities may require the addition of labeling statements, such as warnings or contraindications;

 

•

we may be required to change the way the product is administered or conduct additional clinical trials;

 

•

we could be sued and held liable for harm caused to patients; or

 

•

our reputation may suffer.

 

Any of these events could prevent us from achieving or maintaining market acceptance of the affected product candidate and could substantially increase the costs of commercializing our product candidates.

  

 

Additional time may be required to obtain regulatory approval for Zalviso because it is a drug/device combination.*

 

Zalviso is a combination product candidate with both drug and device components. Zalviso is viewed as a combination product by the FDA, and both drug and device components were required for review as part of our NDA submission. There are very few examples of the FDA approval process for drug/device combination products such as Zalviso. As a result, we have in the past, and may in the future, experience delays in the development and commercialization of Zalviso due to regulatory uncertainties in the product development and approval process, in particular as it relates to a drug/device combination product approval under an NDA. For example, the Zalviso CRL received from the FDA in July 2014 contains requests for additional information on the Zalviso System to ensure proper use of the device. The requests include submission of data demonstrating a reduction in the incidence of optical system errors, changes to address inadvertent dosing, among other items, and submission of additional data to support the shelf life of the product. Furthermore, in March 2015, we received correspondence from the FDA stating that in addition to the bench testing and two Human Factors studies we had performed in response to the issues identified in the CRL, a clinical trial is needed to assess the risk of inadvertent dispensing and overall risk of dispensing failures. On April 21, 2015, we submitted a request to the Division of Anesthesia, Analgesia, and Addiction Products, or the Division, of the FDA for a Type B meeting. On May 1, 2015, the Division notified us that the request for a meeting was denied and restated the Division’s view that a clinical study is required. Subsequently, we have been granted a General Advice meeting with the Division in early September 2015 to discuss the FDA’s request for an additional clinical trial and our planned response to the CRL. Pending the outcome of that meeting, we intend to determine what additional work, if any, is required and finalize our plans to refile the NDA for Zalviso. We will then evaluate next steps to seek a pathway forward towards gaining approval of Zalviso in the U.S. We will be considering all options to determine a pathway forward for Zalviso, including the possibility of dispute resolution through the FDA prescribed pathway, as well as conducting additional clinical and Human Factors studies. We may be unable to come to an agreement with the FDA on the need, design or objectives of the requested clinical trial. Even if we come to an agreement on the design and objectives of the clinical trial and are able to complete the clinical trial, the FDA may deem the results of the clinical trial, as well as bench testing and/or the Human Factors studies inadequate, which could delay or preclude any approval of Zalviso.

  

 

We cannot predict when we will obtain regulatory approval to commercialize any of our product candidates, if at all, and we cannot, therefore, predict the timing of any future revenue.*

 

We cannot commercialize any of our product candidates, including Zalviso, until the appropriate regulatory authorities, such as the FDA or the European Medicines Agency, or EMA, have reviewed and approved the product candidate. The regulatory agencies may not complete their review processes in a timely manner, or we may be unable to obtain regulatory approval for our product candidates. We received a CRL for Zalviso on July 25, 2014, which contains requests for additional information on the Zalviso System. In the CRL, the FDA acknowledged that it had not reviewed several of the amendments to the NDA we submitted to the FDA before the CRL was issued. In addition, in March 2015, we received correspondence from the FDA stating that in addition to the bench testing and two Human Factors studies we had performed in response to the issues identified in the CRL, a clinical trial is needed to assess the risk of inadvertent dispensing and overall risk of dispensing failures. On April 21, 2015, we submitted a request to the Division of Anesthesia, Analgesia, and Addiction Products, or the Division, of the FDA for a Type B meeting. On May 1, 2015, the Division notified us that the request for a meeting was denied and restated the Division’s view that a clinical study is required. Subsequently, we have been granted a General Advice meeting with the Division in early September 2015 to discuss the FDA’s request for an additional clinical trial and our planned response to the CRL. Pending the outcome of that meeting, we intend to determine what additional work, if any, is required and finalize our plans to refile the NDA for Zalviso. We will then evaluate next steps to seek a pathway forward towards gaining approval of Zalviso in the U.S. We will be considering all options to determine a pathway forward for Zalviso, including the possibility of dispute resolution through the FDA prescribed pathway, as well as conducting additional clinical and Human Factors studies. Additional delays may result if any of our product candidates is taken before an FDA Advisory Committee which may recommend restrictions on approval or recommend non-approval. In addition, we may experience delays or rejections based upon additional government regulation from future legislation or administrative action, or changes in regulatory agency policy during the period of product development, clinical trials and the review process.

 

The FDA and other foreign regulatory agencies, such as EMA, can delay, limit or deny marketing approval for many reasons, including:

 

•

a product candidate may not be considered safe or effective;

 

•

the manufacturing processes or facilities we have selected may not meet the applicable requirements; and

 

•

changes in their approval policies or adoption of new regulations may require additional work on our part.

 

 Part of the regulatory approval process includes compliance inspections of manufacturing facilities to ensure adherence to applicable regulations and guidelines. The regulatory agency may delay, limit or deny marketing approval of our product candidates as a result of such inspections. In June 2014, the FDA completed an inspection at our corporate offices. We received a single observation on a Form 483 as a result of the inspection. In addition, in January 2015, EMA conducted a pre-approval inspection of our Zalviso contract manufacturer’s manufacturing and packaging site, and provided its observations. Although we believe we have adequately addressed these observations in revised standard operating procedures, we, our contract manufacturers, and their vendors, are all subject to preapproval inspections at any time. The results of these inspections could impact our ability to obtain FDA or EMA approval for Zalviso, and, if approved, our ability to launch and successfully commercialize Zalviso.

 

Any delay in, or failure to receive or maintain, approval for any of our product candidates could prevent us from generating meaningful revenues or achieving profitability. Our product candidates may not be approved even if they achieve their endpoints in clinical trials. Regulatory agencies, including the FDA or EMA, or their advisors, may disagree with our trial design and our interpretations of data from preclinical studies and clinical trials. Regulatory agencies may change requirements for approval even after a clinical trial design has been approved. The FDA exercises significant discretion over the regulation of combination products, including the discretion to require separate marketing applications for the drug and device components in a combination product. To date, our product candidates are being regulated as drug products under the NDA process administered by the FDA. The FDA could in the future require additional regulation of our product candidates under the medical device provisions of the FDCA. Our systems are designed to comply with the Quality Systems Regulation, or QSR, which sets forth the FDA’s current good manufacturing practice, or cGMP, requirements for medical devices, and other applicable government regulations and corresponding foreign standards for drug cGMPs. If we fail to comply with these regulations, it could have a material adverse effect on our business and financial condition.

 

Regulatory agencies also may approve a product candidate for fewer or more limited indications than requested or may grant approval subject to the performance of post-marketing trials. In addition, regulatory agencies may not approve the labeling claims that are necessary or desirable for the successful commercialization of our product candidates. For example, we intend to resubmit our NDA seeking approval of Zalviso for the management of moderate-to-severe acute pain in adult patients in the hospital setting; however, our clinical trial data was generated exclusively from the post-operative segment of this population, and the FDA may restrict any approval to post-operative patients only, which would reduce our commercial opportunity.

  

 

The process for obtaining approval of an NDA is time consuming, subject to unanticipated delays and costs, and requires the commitment of substantial resources. 

 

If the FDA determines that any of the clinical work submitted, including the clinical trials, Human Factors studies and bench testing submitted for a product candidate in support of an NDA were not conducted in full compliance with the applicable protocols for these trials, studies and testing as well as with applicable regulations and standards, or if the FDA does not agree with our interpretation of the results of such trials, studies and testing, the FDA may reject the data and results. The FDA may audit some of our clinical trial sites to determine the integrity of our clinical data. The FDA may audit some of our Human Factors study sites to determine the integrity of our data and may audit the data and results of bench testing. Any rejection of any of our data would negatively impact our ability to obtain marketing authorization for a product candidate and would have a material adverse effect on our business and financial condition. In addition, an NDA may not be approved, or approval may be delayed, as a result of changes in FDA policies for drug approval during the review period. For example, although many products have been approved by the FDA in recent years under Section 505(b)(2) of the Federal Food, Drug and Cosmetic Act, or FDCA, objections have been raised to the FDA’s interpretation of Section 505(b)(2). If challenges to the FDA’s interpretation of Section 505(b)(2) are successful, the FDA may be required to change its interpretation, which could delay or prevent the approval of such an NDA. Any significant delay in the acceptance, review or approval of an NDA that we have submitted would have a material adverse effect on our business and financial condition and would require us to obtain significant additional funding.

 

Even if we obtain regulatory approval for Zalviso and our other product candidates in the United States, we and our collaborators face extensive regulatory requirements and our products may face future development and regulatory difficulties.*

 

Even if we obtain regulatory approval in the United States, the FDA may impose significant restrictions on the indicated uses or marketing of our product candidates, or impose ongoing requirements for potentially costly post-approval trials or post-market surveillance. Additionally, the labeling ultimately approved for Zalviso and our other product candidates, if approved, will likely include restrictions on use due to the opioid nature of sufentanil.

 

Zalviso and our other product candidates, if approved in the future, will also be subject to ongoing FDA requirements governing the labeling, packaging, storage, distribution, safety surveillance, advertising, promotion, record-keeping and reporting of safety and other post-market information. The holder of an approved NDA is obligated to monitor and report AEs and any failure of a product to meet the specifications in the NDA. The holder of an approved NDA must also submit new or supplemental applications and obtain FDA approval for certain changes to the approved product, product labeling or manufacturing process. Advertising and promotional materials must comply with FDA rules and are subject to FDA review, in addition to other potentially applicable federal and state laws.

 

We must also register and obtain various state prescription drug distribution licenses and controlled substance permits, and any delay or failure to obtain or maintain these licenses or permits may limit our market and materially impact our business. In addition, manufacturers of drug products and their facilities are subject to payment of user fees and continual review and periodic inspections by the FDA and other regulatory authorities for compliance with cGMPs and adherence to commitments made in the NDA. If we, or a regulatory agency, discover previously unknown problems with a product, such as AEs of unanticipated severity or frequency, or problems with the facilities where the product is manufactured, a regulatory agency may impose restrictions relative to that product or the manufacturing facilities, including requiring recall or withdrawal of the product from the market or suspension of manufacturing.

 

If we fail to comply with applicable regulatory requirements following approval of our product candidates, a regulatory agency may:

 

•

issue a warning letter asserting that we are in violation of the law;

 

•

seek an injunction or impose civil or criminal penalties or monetary fines;

 

•

suspend or withdraw regulatory approval;

 

•

suspend any ongoing clinical trials;

 

•

refuse to approve a pending NDA or supplements to an NDA submitted by us;

 

•

seize product; or

 

•

refuse to allow us to enter into supply contracts, including government contracts.

 

Any government investigation of alleged violations of law could require us to expend significant time and resources in response and could generate negative publicity. The occurrence of any event or penalty described above may inhibit our ability to commercialize any future approved products and generate revenues.

  

 

Even if we obtain FDA approval for Zalviso or any of our product candidates in the United States, we may never obtain approval for or commercialize our products outside of the United States, which would limit our ability to realize their full market potential.*

 

In order to market any products outside of the United States, we or our collaborators, including Grünenthal in Europe, must establish and comply with numerous and varying regulatory requirements of other countries regarding safety and efficacy. For example, in October 2012, we received notice from EMA that Zalviso was eligible for centralized European review, and in July 2014, Grünenthal filed a Marketing Authorization Application, or MAA, for Zalviso under the centralized procedure in the EU. On July 23, 2015, the CHMP of EMA adopted a positive opinion for Zalviso for the management of acute moderate-to-severe post-operative pain in adult patients in a hospital setting. The opinion, while not binding, recommends marketing authorization for Zalviso for the management of acute moderate-to-severe post-operative pain in adult patients. This opinion has been transmitted to the European Commission, which has the ultimate authority for granting marketing authorizations in the EU.

 

As noted elsewhere, in March 2015, we received correspondence from the FDA stating that a clinical trial is needed for Zalviso in order to assess the risk of inadvertent dispensing and overall risk of dispensing failures. We do not know what impact, if any, this may have on EMA’s regulatory review process of the Zalviso MAA. EMA may at any time during its review process find issues with the MAA, and may require additional activities and data, including additional clinical trials, in order to support its review of the Zalviso MAA. Outside of Europe, clinical trials conducted in one country may not be accepted by regulatory authorities in other countries, and regulatory approval in one country does not mean that regulatory approval will be obtained in any other country. Approval processes vary among countries and can involve additional product testing and validation and additional administrative review periods. Seeking foreign regulatory approval could result in difficulties and costs for us and require additional non-clinical trials or clinical trials, which could be costly and time consuming. Regulatory requirements can vary widely from country-to-country and could delay or prevent the introduction of our products in those countries. Our current clinical trial data may not be sufficient to support marketing approval in all territories. In addition, we lack the personnel, expertise and capabilities to gain regulatory approval of our product candidates on a global basis without a collaboration partner. If Zalviso is approved for sale in Europe, we will rely on Grünenthal to commercialize it. While Grünenthal does have products approved in international markets, we do not have any product candidates approved for sales in any jurisdiction, including international markets, and we do not have experience in obtaining regulatory approval in international markets. Grünenthal’s experience in international markets does not guarantee regulatory approval or compliance with regulatory requirements in international markets. If we fail to comply with regulatory requirements in international markets or to obtain and maintain required approvals, or if regulatory approvals in international markets are delayed, our target market will be reduced and our ability to realize the full market potential of our products will be harmed.

 

Zalviso and our other product candidates will require Risk Evaluation and Mitigation Strategies.

 

The FDA Amendments Act of 2007 implemented safety-related changes to product labeling and requires the adoption of REMS. Our product candidates, if approved, will require REMS. The REMS may include requirements for special labeling or medication guides for patients, special communication plans to health care professionals and restrictions on distribution and use. While we have received pre-clearance from the FDA regarding certain aspects of the proposed required REMS for Zalviso, we cannot predict the final REMS to be required as part of any FDA approval of Zalviso. Depending on the extent of the REMS requirements, the launch may be delayed, the costs to commercialize Zalviso may increase substantially and the potential commercial market could be restricted. ARX-02, ARX-03 and ARX-04, if approved, will also require REMS programs that may significantly increase our costs to commercialize these product candidates. Furthermore, risks of sufentanil that are not adequately addressed through proposed REMS for our future product candidates, if approved, may also prevent or delay their approval for commercialization.  

 

Existing and future legislation may increase the difficulty and cost for us to commercialize Zalviso and any of our product candidates that may obtain commercial approval in the future, and affect the prices we may obtain.

 

In the United States and some foreign jurisdictions, the legislative landscape continues to evolve. There have been a number of legislative and regulatory changes and proposed changes regarding healthcare systems that could prevent or delay marketing approval of our product candidates, including Zalviso, restrict or regulate post-approval activities and affect our ability to profitably sell any products for which we obtain marketing approval.

 

 

In the United States, the Health Care Reform Law (as defined below) was enacted in an effort to, among other things, broaden access to health insurance, reduce or constrain the growth of healthcare spending, enhance remedies against fraud and abuse, impose new taxes and fees on the health industry and impose additional health policy reforms. Aspects of the Health Care Reform Law that may impact our business include:

 

•

extension of manufacturers’ Medicaid rebate liability to covered drugs dispensed to individuals who are enrolled in Medicaid managed care organizations;

 

•

a deductible 2.3% excise tax, with limited exceptions, on the sale of certain medical devices by the manufacturer of the device;

  

•

new methodologies by which rebates owed by manufacturers under the Medicaid Drug Rebate Program are calculated for drugs that are inhaled, infused, instilled, implanted or injected, and for drugs that are line extensions;

 

•

expansion of the entities eligible for discounts under the Public Health Service pharmaceutical pricing program;

 

•

expansion of eligibility criteria for Medicaid programs by, among other things, allowing states to offer Medicaid coverage to additional individuals and by adding new mandatory eligibility categories for certain individuals with income at or below 133.0% of the Federal Poverty Level beginning in 2014, thereby potentially increasing manufacturers’ Medicaid rebate liability;

 

•

expansion of healthcare fraud and abuse laws, including the federal False Claims Act and the federal Anti-Kickback Statute, new government investigative powers and enhanced penalties for non-compliance;

 

•

a new requirement to annually report drug samples that manufacturers and distributors provide to physicians;

 

	•	a new Patient-Centered Outcomes Research Institute to oversee, identify priorities in, and conduct comparative clinical effectiveness research, along with funding for such research; and
	•	creation of the Independent Payment Advisory Board which has authority to recommend certain changes to the Medicare program that could result in reduced payments for prescription drugs.

 

The Health Care Reform Law has the potential to substantially change health care financing and delivery by both governmental and private insurers, and may also increase our regulatory burdens and operating costs.

 

In addition, other legislative changes have been proposed and adopted in the United States since the Health Care Reform Law was enacted. On August 2, 2011, the Budget Control Act of 2011 created measures for spending reductions by Congress. A Joint Select Committee on Deficit Reduction, tasked with recommending a targeted deficit reduction of at least $1.2 trillion for the years 2013 through 2021, was unable to reach required goals, thereby triggering the legislation’s automatic reduction to several government programs. This included aggregate reductions of Medicare payments to providers of 2% per fiscal year, which went into effect on April 1, 2013 and will stay in effect through 2024 unless additional Congressional action is taken. On January 2, 2013, the American Tax Payer Relief Act was signed into law, which, among other things, further reduced Medicare payments to several providers, including hospitals.

 

Moreover, the Drug Supply Chain Security Act of 2013, imposes new obligations on manufacturers of pharmaceutical products, among others, related to product tracking and tracing. Among the requirements of this new legislation, manufacturers will be required to provide certain information regarding the drug product to individuals and entities to which product ownership is transferred, label drug product with a product identifier, and keep certain records regarding the drug product.

 

Legislative and regulatory proposals have been made to expand post-approval requirements and further restrict sales and promotional activities for pharmaceutical products. We are not sure whether additional legislative changes will be enacted, or whether the FDA regulations, guidance or interpretations will be changed, or what the impact of such changes on the marketing approvals of our product candidates, if any, may be.

 

We expect that additional healthcare reform measures will be adopted within and outside the United States in the future, any of which could negatively impact our business. The continuing efforts of the government, insurance companies, managed care organizations and other payors of healthcare services to contain or reduce costs of healthcare may adversely affect the demand for any drug products for which we may obtain regulatory approval, our ability to set a price that we believe is fair for our products, our ability to obtain coverage and reimbursement approval for a product, our ability to generate revenues and achieve or maintain profitability, and the level of taxes that we are required to pay.

 

Risks Related to Our Financial Condition and Need for Additional Capital 

 

We have incurred significant losses since our inception, anticipate that we will continue to incur significant losses in 2015 and may continue to incur losses for the foreseeable future.*

 

Since our inception in 2005, we have focused primarily on development of our product candidate, Zalviso. In March 2015, we began a pivotal Phase 3 study of ARX-04. We have two additional product candidates that have completed Phase 2 development: the sufentanil sublingual tablet BTP management system, or ARX-02, the sufentanil/triazolam sublingual tablet, or ARX-03, and We have incurred significant net losses in each year since our inception in July 2005, and as of June 30, 2015, we had an accumulated deficit of $197.7 million.

  

 

We have devoted most of our financial resources to research and development, including our non-clinical development activities and clinical trials. To date, we have financed our operations primarily through the sale of equity securities, debt, government contract funding and proceeds from our collaboration with Grünenthal. The size of our future net losses will depend, in part, on the rate of future expenditures and our ability to generate revenues. We expect to continue to incur substantial expenses as we continue our research and development activities for our product candidates, including addressing issues raised by the FDA related to regulatory review of Zalviso, as well as to support manufacturing and supply for potential approval of Zalviso in Europe, in connection with our collaboration with Grünenthal. To date, none of our product candidates have been commercialized, and if Zalviso or our other product candidates are not successfully developed or commercialized, or if revenues are insufficient following marketing approval, we will not achieve profitability and our business may fail. Our success is also dependent on obtaining regulatory approval to market our product candidates outside of the United States through current and future collaborations which may not materialize or prove to be successful.

 

We have never generated product revenue and may never be profitable.*

 

Our ability to generate revenue from commercial sales and achieve profitability depends on our ability, alone or with collaborators, to successfully complete the development of, obtain the necessary regulatory approvals for, and commercialize our product candidates. We may never generate revenues from sales of Zalviso or our other product candidates in the United States. While we have a collaboration with Grünenthal for potential commercialization of Zalviso in Europe and Australia, we may never achieve the development milestones associated with the collaboration, and Grünenthal may never achieve regulatory approval or recognize commercial sales of Zalviso, for which we would receive sales milestone payments and product royalties. In addition, we do not anticipate generating revenues from our other product candidates for the foreseeable future, if ever. Our ability to generate future revenues from product sales depends heavily on our success in:

 

•

obtaining and maintaining regulatory approval for Zalviso in the United States and/or in Europe;

 

•

launching and commercializing Zalviso, including building internally or through entering a collaboration, a hospital-directed sales force in the United States and with third parties internationally, including Grünenthal, which may require additional funding; and

 

•

completing the clinical development of, obtaining regulatory approval for, and launching and commercializing ARX-04, which may require additional funding or corporate partnership resources.

  

Because of the numerous risks and uncertainties associated with pharmaceutical product development and the regulatory environment, we are unable to predict the timing or amount of increased expenses, or when, or if, we will be able to achieve or maintain profitability. Our expenses could increase beyond expectations if we are delayed in receiving regulatory approval, or in launching Zalviso, or if we are required by the FDA to complete activities in addition to those we currently anticipate or have already completed.

 

Even if one or more of our product candidates is approved for commercial sale, we anticipate incurring significant costs associated with commercializing any approved product candidate. Even if we are able to generate revenues from the sale of any future approved products, we may not become profitable and may need to obtain additional funding to continue operations.

 

We have a limited operating history that may make it difficult to predict our future performance or evaluate our business and prospects.*

 

We were incorporated in 2005. Since inception, our operations have been primarily limited to organizing and staffing our company, developing our technology and undertaking pharmaceutical development and clinical trials for our product candidates, understanding the market potential for our product candidates and preparing for the potential commercialization of Zalviso. We have not yet obtained regulatory approval of any of our product candidates, including Zalviso. Consequently, any predictions that are made about our future success, or viability, or evaluation of our business and prospects, may not be accurate.

 

We will require additional capital and may be unable to raise capital, which would force us to delay, reduce or eliminate our product development programs and could cause us to cease operations.*

 

Developing pharmaceutical products, including conducting preclinical studies and clinical trials, is expensive. We expect to incur significant expenditures in connection with our ongoing activities, including conducting ARX-04 Phase 3 clinical trials, development activities associated with Zalviso to respond to issues raised by the FDA and other research and development activities to advance our product candidates. While we believe we have sufficient capital resources to continue planned operations through at least the first half of 2016, we may need additional capital to continue development and commercialization of Zalviso, ARX-04, and our other product candidates and will need additional capital to potentially pursue commercialization of any of our product candidates.

  

 

Future events and circumstances, including those beyond our control, may cause us to consume capital more rapidly than we currently anticipate. For example, in March 2015, we received correspondence from the FDA stating that we needed to complete a clinical trial. This request, and the time needed to meet with the FDA to better understand the request, and any further development activities can be time consuming and costly. Even if we have sufficient resources to complete an additional clinical trial for Zalviso, and we may not depending on the size, scope and potential outcome of the trial, regulatory review for Zalviso, and a potential launch of a commercial product is expensive. In addition, commercialization costs for Zalviso in the United States may be significantly higher than estimated. We may experience technical difficulties in our commercialization efforts or otherwise, which could substantially increase the costs of commercialization. Revenues may be lower than expected and accordingly costs to produce such revenues may exceed those revenues. We will need to seek additional capital to continue operations. Such capital demands could be substantial. To raise capital, we may seek to sell additional equity or debt securities, monetize certain assets including future royalty streams and milestones, obtain a credit facility, or enter into product development, license or distribution agreements with third parties, or divest one or more of our product candidates. Such arrangements may not be available on favorable terms, if at all. Furthermore, any product development, licensing, distribution or sale agreements that we enter into may require us to relinquish valuable rights. We may not be able to obtain sufficient additional funding or enter into a strategic transaction in a timely manner. If adequate funds are not available, we would be required to reduce our workforce, delay, reduce the scope of, or eliminate, one or more of our research and development programs in advance of the date on which we exhaust our cash resources to ensure that we have sufficient capital to meet our obligations and continue on a path designed to preserve stockholder value.

 

Securing additional financing may divert our management from our day-to-day activities, which may adversely affect our ability to develop and commercialize our product candidates. In addition, we cannot guarantee that future financing will be available in sufficient amounts or on terms acceptable to us, if at all. If we are unable to raise additional capital when required or on acceptable terms, we may be required to: