10-K 1 insy-10k_20161231.htm 10-K insy-10k_20161231.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One) 

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

For the fiscal year ended December 31, 2016

OR

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

For the transition period from _______ to ________

Commission File Number: 001-35902

 

Insys Therapeutics, Inc. 

(Exact name of registrant as specified in its charter)

 

 

Delaware

 

51-0327886

(State or Other Jurisdiction of

 

(I.R.S. Employer

Incorporation)

 

Identification No.)

 

1333 S. Spectrum Blvd, Suite 100, Chandler, Arizona

 

85286

(Address of Principal Executive Offices)

 

(Zip Code) 

 

(480) 500-3127

(Registrant’s Telephone Number, Including Area Code)

Securities registered pursuant to Section 12(b) of the Act:

 

Title Of Each Class

 

Name Of Each Exchange On Which Registered

Common Stock, $0.01 Par Value Per Share

 

The NASDAQ Global Market LLC

 

Securities Registered Pursuant to Section 12(g) of the Act:

None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes    No  

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes      No  

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 Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes      No  

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K.    

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

 

Smaller reporting company

 

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was approximately $300 million as of June 30, 2016 based on the closing sales price of the common stock on the NASDAQ Global Market.

There were 71,957,343 shares of the registrant’s common stock issued and outstanding as of March 28, 2017.

Documents Incorporated by Reference

Portions of the registrant's Proxy Statement relating to its 2017 Annual Meeting of Stockholders, to be filed with the Securities and Exchange Commission (“SEC”) pursuant to Regulation 14A within 120 days after the registrant’s fiscal year ended December 31, 2016, are incorporated by reference in Part III of this Form 10-K.

 

 


TABLE OF CONTENTS

 

 

 

 

 

Page

Numbers

 

 

PART I

 

 

 

 

 

 

 

Item 1.

 

Business

 

1

Item 1A.

 

Risk Factors

 

24

Item 1B.

 

Unresolved Staff Comments

 

57

Item 2.

 

Properties

 

57

Item 3.

 

Legal Proceedings

 

57

Item 4.

 

Mine Safety Disclosures

 

57

 

 

 

 

 

 

 

PART II

 

 

 

 

 

 

 

Item 5.

 

Market for Registrant’s Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

 

58

Item 6.

 

Selected Financial Data

 

59

Item 7.

 

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

 

61

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

 

77

Item 8.

 

Financial Statements and Supplementary Data

 

78

Item 9.

 

Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

 

116

Item 9A.

 

Controls and Procedures

 

116

Item 9B.

 

Other Information

 

119

 

 

 

 

 

 

 

PART III

 

 

 

 

 

 

 

Item 10.

 

Directors, Executive Officers and Corporate Governance

 

120

Item 11.

 

Executive Compensation

 

120

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

 

120

Item 13.

 

Certain Relationships and Related Transactions, and Director Independence

 

120

Item 14.

 

Principal Accountant Fees and Services

 

120

 

 

 

 

 

 

 

PART IV

 

 

 

 

 

 

 

Item 15.

 

Exhibits, Financial Statement Schedules

 

121

Item 16.

 

Form 10-K Summary

 

124

SIGNATURES

 

125

 


2016 FORM 10-K ANNUAL REPORT

GLOSSARY OF TERMS

The following glossary provides definitions for certain acronyms and terms used in this Annual Report on Form 10-K. These acronyms and terms are specific to our company, commonly used in our industry, or are otherwise frequently used throughout our document.

 

Abbreviated Term

  

Defined Term

  

  

  

ANDA

 

Abbreviated New Drug Application

API

 

Active pharmaceutical ingredient

Aptar

 

AptarGroup, Inc.

ASC

 

Accounting Standards Codification

ASU

 

Accounting Standards Update

ATRA

 

American Taxpayer Relief Act of 2012

AUC

 

Area under the curve

AVC

 

Assurance of Voluntary Compliance

BTCP

 

Breakthrough cancer pain

Catalent

 

Catalent Pharma Solutions, LLC

CBD

 

Synthetic cannabidiol

cGMP

 

Current Good Manufacturing Practices

CID

 

Civil Investigative Demand

CINV

 

Chemotherapy-induced nausea and vomiting

CMS

 

Centers for Medicare & Medicaid Services

CRO

 

Contract Research Organization

CSA

 

Federal Controlled Substances Act of 1970

DEA

 

U.S. Drug Enforcement Administration

DPT

 

DPT Lakewood, LLC

ERP

 

Enterprise Resource Planning

ESI

 

Express Scripts, Inc.

FASB

 

Financial Accounting Standards Board

FDA

 

U.S. Food and Drug Administration

FDCA

 

Federal Food, Drug, and Cosmetic Act

FSS

 

Federal Supply Schedule

GAO

 

Government Accountability Office

GCP

 

Good Clinical Practices

GI

 

Gastrointestinal

GLP

 

Good Laboratory Practices

HHS

 

U.S. Department of Health and Human Services

HIPAA

 

Health Insurance Portability and Accountability Act of 1996

HITECH

 

Health Information Technology for Economic and Clinical Health Act of 2009

IMS

 

IMS Health

IND

 

Investigational New Drug Application

Insys Pharma

 

Insys Pharma, Inc.

Insys Therapeutics

 

Insys Therapeutics, Inc.

IPO

 

Initial public offering

IPR

 

Inter Partes Review

IRB

 

Institutional Review Board

MMA

 

Medicare Prescription Drug, Improvement, and Modernization Act of 2003

Mylan

 

Mylan Pharmaceuticals, Inc.

NDA

 

New Drug Application

NeoPharm

 

NeoPharm, Inc.

NOL

 

Net operating loss carryforward

NRV

 

Net Realizable Value

NSAID

 

Non-steroidal anti-inflammatory drug

Orange Book

 

FDA's Approved Drug Products with Therapeutic Equivalence Evaluations


ODOJ

 

Oregon Department of Justice

PBM

 

Pharmacy Benefit Managers

PDEs

 

Prescription Drug Events

PDMA

 

Prescription Drug Marketing Act

PDUFA

 

Prescription Drug User Fee Act

PK

 

Pharmacokinetics

PPACA

 

Patient Protection and Affordable Care Act of 2010, as amended by the Health Care and Education Reconciliation Act of 2010

QSR

 

FDA's Quality System Regulation

REMS

 

Risk Evaluation and Mitigation Strategy

RLD

 

Reference listed drug

SEC

 

U.S. Securities and Exchange Commission

THC

 

Delta-9-tetrahydrocannabinol

TIRF

 

Transmucosal immediate-release fentanyl

TIRF REMS

 

Transmucosal immediate release fentanyl risk evaluation and mitigation strategy

USAO

 

United States Attorney Office

U.S. GAAP

 

Accounting Principles Generally Accepted in the United States of America

USPTO

 

United States Patent and Trademark Office

VC

 

Vomiting center

 

 

 


PART I

ITEM 1.

BUSINESS

Overview

As used in this Form 10-K, “we,” “us,” and “our” refer to Insys Therapeutics, Inc. and our subsidiaries.

We are a commercial-stage specialty pharmaceutical company that develops and commercializes innovative supportive care products. We have one marketed product: SUBSYS®, a proprietary sublingual fentanyl spray for BTCP in opioid-tolerant adult patients.

Insys Therapeutics, Inc. was incorporated in Delaware in June 1990, and maintains headquarters in Chandler, Arizona.  

 For further detail concerning our company and communities, see the “Available Information” section included in this Item 1.

We are leveraging our capabilities in cannabinoid formulation and manufacturing, as well as our sublingual spray drug delivery technology, to develop a portfolio of differentiated, wholly-owned product candidates. Our lead product candidate is SYNDROS™, a proprietary, orally administered liquid formulation of dronabinol, which will be our second, branded supportive care product, if it successfully obtains all required regulatory approvals. We believe this product candidate may provide increased flexibility in dosing for doctors and an improved absorption profile for patients, which may contribute to increased patient compliance because of less dose-to-dose variability and allow us to further penetrate and potentially expand the market for the use of dronabinol. We received FDA approval for SYNDROS™ in July 2016. In March 2017, the DEA issued an interim final ruling that would result in SYNDROS™ being placed in Schedule II of the CSA. We are currently awaiting the finalization of labeling by the FDA as the final approval prior to commercial launch.

Our Products and Product Candidates 

SUBSYS® is a proprietary, single-use product that delivers fentanyl, an opioid analgesic, for transmucosal absorption underneath the tongue. We filed our NDA in March 2011 and received marketing approval for SUBSYS® ® from the FDA in January 2012 for the treatment of BTCP. BTCP is characterized by sudden, often unpredictable, episodes of pain that can peak in severity at less than one minute to 10 minutes despite background pain controlled by around-the-clock medication. We believe SUBSYS® is an important, differentiated treatment option for patients and physicians relative to other TIRF products due to its rapid onset of action, improved bioavailability, most complete range of dosage strengths and ease of administration. Our product label includes data from our pivotal clinical trial demonstrating that SUBSYS® may provide pain relief in as little as five minutes, which represents the most rapid onset of action in the TIRF class of products. Also, in a head-to-head study, SUBSYS® demonstrated 76% bioavailability versus 51% for Actiq. Further, SUBSYS® offers the most complete range of dosage strengths in the TIRF class of products, consisting of 100 to 1,600 microgram, or mcg, doses. Patients can administer SUBSYS® in less than one minute while Actiq and Fentora, the leading branded TIRF products, can require 14 to 30 minutes to administer. 

We launched SUBSYS® as a commercial product in March 2012. Upon launch, SUBSYS® was the fourth new branded product in the TIRF market over the prior five years. Within the first four weeks of product launch, SUBSYS® realized greater market share than the previous three branded products combined at their respective peak market penetration levels according to Source Healthcare Analytics. In December 2016, SUBSYS® was the most prescribed TIRF product, with 42% market share on a prescription basis according to IMS. According to Source Healthcare Analytics, in 2016, TIRF products generated $710 million in annual U.S. product sales. Traditionally, the physician prescriber base for TIRF products is concentrated, with approximately 1,600 physicians writing 90% of all TIRF product prescriptions in 2016, according to IMS. As a result, our commercial organization has been able to promote SUBSYS® using a highly targeted approach designed to maximize impact with physicians who are TIRF REMS enrolled. In addition, our commercial organization continues to specifically target oncology health care providers and practices.

1


SUBSYS® utilizes our proprietary sublingual spray technology consisting of a small, single-unit device that delivers our proprietary formulation of drug particles via a fine mist disbursed across a broad surface area of the highly permeable membrane underneath the tongue. This delivery platform is suitable for other molecules for which there may be a benefit to a greater rate and extent of absorption, which could lead to a more rapid onset of action and enhanced bioavailability versus other oral preparations and routes of administration. We are developing our proprietary sublingual spray technology in other product applications in order to expand our portfolio of product candidates.

Dronabinol, the active ingredient in Marinol, is a synthetic cannabinoid whose chemical name is THC, an approved second-line treatment for CINV and anorexia associated with weight loss in patients with AIDS. We believe that Marinol and its generic equivalents have limitations in their current formulations. Marinol is characterized by a highly variable bioavailability and an onset of action that ranges from 30 minutes to one hour.

Our lead product candidate is SYNDROS™, a proprietary, orally administered liquid formulation of dronabinol, which has yet to be approved for commercialization. SYNDROS™ has demonstrated more rapidly detectable blood levels and a more reliable absorption profile than Marinol in our clinical studies. In 2012, we completed a pre-NDA meeting with the FDA and a pivotal bioequivalence study. Our pivotal bioequivalence study measured the PK of SYNDROS™ versus Marinol. This PK study demonstrated that 100% of subjects receiving SYNDROS™ achieved detectable plasma levels at 15 minutes compared to less than 25% of subjects receiving Marinol. In this study, SYNDROS™ also demonstrated a 44% decrease in the patient coefficient of variation for area under the curve, or AUC, which is indicative of greater patient exposure to drug. We believe these product attributes could result in SYNDROS™ capturing a significant share of the existing U.S. market for dronabinol products and potentially expanding the usage of dronabinol-based products. We received FDA approval for SYNDROS™ in July 2016. In March 2017, the DEA issued an interim final ruling that would result in SYNDROS™ being placed in Schedule II of the CSA.  We are currently awaiting the finalization of labeling by the FDA as the final approval prior to commercial launch.

Our discontinued Dronabinol SG Capsule product was commercially launched in December 2011, and we sold Dronabinol SG Capsule exclusively to Mylan in the United States under a supply and distribution agreement. We do not have any current plans to manufacture or market this product in the future.

Strategy

Achieve finalization of labeling by the FDA for SYNDROS™ and advance our synthetic cannabinoid product pipeline.     We believe there is an unmet patient need for a more reliable synthetic THC for treating CINV and anorexia associated with weight loss in patients with AIDS. In a pivotal bioequivalence study, our SYNDROS™ product candidate has demonstrated rapid and less variable absorption, which we believe represents an attractive product profile relative to Marinol. We are also evaluating proprietary sublingual spray, inhaled and intravenous formulations of dronabinol in preclinical testing. We also have the capability to manufacture CBD and we are pursuing clinical studies that could result in future commercial products containing CBD. We received FDA approval for SYNDROS™ in July 2016. In March 2017, the DEA issued an interim final ruling that would result in SYNDROS™ being placed in Schedule II of the CSA.  We are currently awaiting the finalization of labeling by the FDA as the final approval prior to commercial launch.

SUBSYS® market share and revenues.     We launched SUBSYS® as a commercial product in March 2012. As of December 31, 2016, there were approximately 8,100 physicians enrolled in the TIRF REMS program. Enrollment in this class-wide REMS program is required by the FDA in order to prescribe TIRF products. Approximately 1,600 physicians comprise 90% of TIRF prescriptions dispensed in 2016, according to IMS. Our sales and marketing efforts have primarily targeted approximately 100% of these top 1,600 prescribing physicians with a focus on the highest prescribers.

Continue to leverage our commercial organization to market SUBSYS® and, if finalization of labeling by the FDA is obtained, SYNDROS™, and other complementary products. We commercialize SUBSYS® through our commercial sales organization. We intend to market SYNDROS™ when finalization of labeling by the FDA is obtained, and other proprietary supportive care products, if approved, using this same commercial sales

2


organization. We may also pursue opportunities to acquire commercial products or product candidates that could further leverage our supportive care commercial sales organization.

Research and develop additional sublingual spray product candidates.     We believe that the delivery of certain pharmaceutical products using our sublingual spray platform technology could have significant advantages over other methods of delivery. Our technology delivers drug product directly to the sublingual mucosa for rapid and efficient absorption into the bloodstream. This process is accomplished by delivering a ready-to-be absorbed formulation across the sublingual mucosa. The sublingual mucosa is an efficient medium for the delivery of certain drugs because this membrane is highly permeable with a high density of blood vessels, which allows for the portion of the drug absorbed to bypass first-pass metabolism in the liver. Certain drug products delivered utilizing our sublingual spray technology can be absorbed quickly and take effect more rapidly than many other forms of administration. We are developing several product candidates, including buprenorphine, buprenorphine with naloxone, naloxone, ondansetron, sildenafil, diclofenac, epinephrine and ketorolac, where we believe our proprietary sublingual spray technology has the potential to provide a clinically meaningful therapeutic advantage over existing delivery methods.

Use our core competencies and expertise to expand our dronabinol and cannabidiol manufacturing capabilities.     Because dronabinol is difficult to import, procure and produce, we have a U.S.-based, state-of-the-art dronabinol manufacturing facility, which we anticipate will be able to supply the API for initial launch quantities of SYNDROS™. In 2014, we completed construction of a second manufacturing facility that will enable us to supply sufficient commercial quantities of dronabinol API for the anticipated commercialization of our proprietary synthetic cannabinoid product candidates, once scheduled by the DEA, which is required prior to commercialization of this product.

Our Products and Product Candidates

The following table summarizes certain information regarding our marketed products and most advanced product candidates:

 

Product

Indication

Pathway

Status

SUBSYS® (fentanyl sublingual spray)

1.  Breakthrough Cancer Pain

505(b)(2)1

Marketed

SYNDROS™ (dronabinol oral solution)

 

1.  CINV

2.  Appetite Stimulation in AIDS Patients

505(b)(2)

NDA Filed;

Approved: April 1, 2016; Scheduled March 2017

Pending finalization of labeling by the FDA

Cannabidiol Oral Solution

1.Pediatric Epilepsy

2.Prader Willi

505(b)(1)2

  Pediatric study in refractory epilepsy ongoing

  Prader Willi Phase 2 planned for 2nd Half 2017

Buprenorphine Sublingual Spray

Acute Pain

505(b)(2)

Phase 3 completed;

NDA submission 2nd Half 2017

Buprenorphine/Naloxone Sublingual Spray

Opioid Dependence

505(b)(2)

Formulation under development

Naloxone Sublingual Spray

Opioid Antagonist

505(b)(2)

Formulation under development

Fentanyl/Naloxone

Abuse Deterrent for Intravenous

505(b)(2)

Formulation under development

 

1

Anticipated regulatory pathway. A 505(b)(2) NDA relies for its approval upon studies that were not conducted by or for the applicant, and for which the applicant has not obtained a right of reference. The applicant may rely on the FDA’s findings of safety and/or effectiveness for a previously approved drug (the “reference drug”). However, the applicant must still provide any additional preclinical or clinical data necessary to ensure that differences from the reference drug do not compromise safety and effectiveness. For Dronabinol Oral Solution and our Dronabinol Line Extensions, we expect to use Marinol as the reference drug.

2

Application is a complete NDA that contains all the studies conducted by the applicant necessary to demonstrate a drug’s safe and effective use.

3


Additionally, we intend to develop SUBSYS® for additional indications that may include management of pain for procedures conducted in a monitored setting such as bone marrow biopsy, burn dressing changes, radiation oncology, post-operative procedures. We anticipate initiating some of these studies to support a new indication in 2017 based on the guidance we anticipate receiving from the FDA.

Further in 2017, we intend to develop SYNDROS ™ for additional indications which may include the treatment of agitation in Alzheimer's Disease and the treatment of anorexia associated with weight loss in cancer patients.

We are also actively engaged in the development of other earlier stage product candidates. Specifically, we are currently completing preclinical work on six products that utilize our proprietary spray technology platform with the goal of expanding our supportive care franchise:

 

Epinephrine (Type I allergic reactions including anaphylaxis)

 

Ondansetron (nausea and vomiting in cancer chemotherapy)

 

Sildenafil (the active ingredient in Viagra)

 

Diclofenac (a NSAID taken or applied to reduce inflammation and as an analgesic reducing pain)

 

Ketorolac (for short-term management of moderate to moderately severe pain requiring analgesia at the opioid level)

 

Hydromorphone (opioid used to treat moderate to severe pain)

Further, we have the ability to manufacture pure, synthetic cannabidiol in our DEA-approved and FDA-inspected Round Rock, TX manufacturing facility and have received orphan drug designations from the FDA for the following:

 

Indication

Drug

Approval Date

Gastric Cancer

Liposomal Encapsulated Paclitaxel  

12/3/2014

Ovarian Cancer

Liposomal Encapsulated Paclitaxel  

1/21/2015

Malignant Glioma

IL-13

11/2/2001

Interstitial Pulmonary Fibrosis (IPF)

IL-13

4/30/2010

Lennox-Gastaut Syndrome                       (rare pediatric epilepsy)

Cannabidiol

6/23/2014

Dravet Syndrome

(rare pediatric epilepsy)

Cannabidiol

7/1/2014

West Syndrome

(Rare pediatric epilepsy)

Cannabidiol

7/23/2015

Glioblastoma multiforme

Cannabidiol

8/20/2014

Pontine glioma

Cannabidiol

9/24/2014

Pediatric Schizophrenia

Cannabidiol

11/17/2014

 

4


SUBSYS® -Sublingual Fentanyl Spray

SUBSYS® is a proprietary, single-use product developed to treat BTCP through the delivery of a liquid fentanyl formulation in 100, 200, 400, 600, 800, 1,200 and 1,600 mcg dosages. The 1,200 and 1,600 mcg doses of SUBSYS® are achieved by administering two 600 and 800 mcg doses, respectively. The mechanism by which the liquid is delivered is a highly consistent, one-step process in which a plume of fentanyl is generated by the actuation of the device. The plume disperses a small volume of liquid across the surface area of the sublingual mucosa and facilitates rapid absorption by the body. 

Cancer Pain Market Overview

Cancer pain can occur as a result of tumors pressing on nerves, damage caused by cancer cells in bone and treatments for cancer such as chemotherapy, radiation therapy or surgery. Many cancer patients experiencing pain suffer from two types of pain: (1) persistent or continuous pain, which is typically managed by long-acting or sustained-release drugs taken by patients on a regular schedule, and (2) breakthrough pain, which can be severe and sudden, and may require a stronger, fast-acting medication. Opioids are the most widely-prescribed treatment for cancer pain followed by medications commonly used to treat inflammatory pain, such as corticosteroids, anesthetics, NSAIDs, anticonvulsants and antidepressants. A report published by Worldwide Marketing Research estimated that the value of the U.S. cancer pain market was $3.1 billion in 2008 and will increase to $5.3 billion by 2018.

Following rapid onset that peaks at less than one minute to 10 minutes, BTCP episodes can last several minutes to an hour, and usually occur several times per day. Pain is a widely prevalent condition of cancer patients, approximately 60% of cancer patients with persistent pain may experience BTCP, which is particularly difficult to treat due to its severity, rapid onset and the often unpredictable nature of its occurrence. Physicians typically treat BTCP with a variety of short-acting opioid medications, including morphine, morphine and codeine derivatives and fentanyl.

Morphine and codeine derivatives have been available for decades in immediate-release forms of tablets, capsules or liquids that are ingested by the patient. More recently-approved short-acting opioid-based fentanyl formulations utilize transmucosal delivery in an attempt to improve upon existing fentanyl therapies. Teva Pharmaceutical Industries Ltd.’s Actiq®, approved by the FDA in 1998 and currently available in several generic options, is an oral transmucosal lozenge, and Fentora®, the second leading branded TIRF product, approved by the FDA in 2006, is a fentanyl buccal tablet. Three other companies have received approval for branded TIRF products since 2009 including BioDelivery Sciences International, Inc.’s Onsolis®, a soluble film placed on the buccal area after wetting the inside of the cheek with saliva or water, Sentynl Therapeutics’ Abstral®, an immediate-release transmucosal sublingual tablet, and Depomed’s Lazanda®, a nasal spray. According to Source Healthcare Analytics, TIRF products generated $821.6 million in 2015 U.S. sales. Although these existing therapies provide improvements over oral opioids, we believe that the market adoption of SUBSYS® to date demonstrates that the current treatment options have limitations and that there remains a significant unmet need for therapies that provide faster pain relief, more convenient dose administration and a better PK profile.

5


Limitations of Competing TIRF Therapies

We believe that the BTCP market is often underserved due to the limitations of other TIRF therapies, which include:

 

Time until significant pain relief:     Patients suffering from BTCP require rapid pain relief as peak intensity of episodic breakthrough pain can occur at less than one minute to 10 minutes from the onset of pain symptoms. The peak effect of Actiq and Fentora may be delayed as it may take up to 14 to 30 minutes for the lozenge or tablet to fully dissolve and be absorbed. In addition, oral immediate-release opioids are metabolized in the liver and consequently, may take up to 30 to 45 minutes to become effective.

 

Pharmacokinetic profile:     Actiq and its generic equivalents achieve bioavailability of approximately 51% and require 15 to 30 minutes for absorption. Up to half of the delivered dose of competing TIRF treatments is swallowed and is absorbed slowly through the GI tract which we believe may delay the onset of pain relief and contribute to side effects.

 

Inconvenient delivery:    We believe competing commercially available therapies do not adequately address patient ease of use and convenience needs. Competing TIRF therapies can require an administration period of several minutes, disrupt daily activities and cause patient discomfort. For example, Actiq requires patients to place a lozenge between their cheeks and lower gums and rub the lozenge from side to side over a 15-minute period. In addition, patients with dry mouth and oral mucositis may experience difficulty in using Actiq and other commercially available therapies.

Our Solution

We believe SUBSYS’® proprietary formulation and sublingual delivery mechanism offer several advantages over other FDA-approved TIRF products, and these advantages may lead to improved patient compliance and expanded medical use of fentanyl for BTCP. Such advantages include:

 

Pain relief in five minutes:    SUBSYS® is the only product to show pain relief when measuring the sum of pain intensity difference at five minutes in a Phase 3 BTCP clinical trial using fentanyl. We believe that SUBSYS® is able to achieve this rapid delivery of fentanyl through sublingual delivery because there is a high density of blood vessels beneath the tongue and the thin layer in the mucosa enables higher absorption. The product sprays in a manner that is designed to maximize the area covered by the product.

 

One-step administration:    SUBSYS® is administered in one step using a small handheld delivery system that sprays fentanyl beneath the patient’s tongue. This delivery mechanism allows for administration in less than one minute, rather than the 14 to 30 minutes required for Actiq and Fentora. Further, SUBSYS® can be administered without moistening the tongue or cheek, allowing for administration in cancer patients suffering from dry mouth and oral mucositis.

 

Pharmacokinetic profile.    As compared to Actiq’s PK profile, SUBSYS’® PK profile is characterized by higher peak blood concentrations, which are achieved at a more rapid rate. This profile is, in part, due to greater than 85% absorption occurring transmucosally, resulting in higher bioavailability. Because a small volume of liquid is sprayed on to the sublingual mucosa, we believe this method of administration reduces the amount of liquid swallowed and subsequently absorbed via the digestive system. As a result, we believe that less fentanyl is exposed to first-pass metabolism in the liver.

 

Broad spectrum of dosage strengths allows for proper titration and better pain relief.    SUBSYS® is available in the most complete range of dosage strengths in the TIRF market, at 100, 200, 400, 600, 800, 1,200 and 1,600 mcg. We believe it is important to offer a product in all dose ranges for the treatment of BTCP, as all branded products without generic equivalents, and, to our knowledge, all product candidates currently in development, are not, or will not be, available in the 1,200 and 1,600 mcg dosage strengths.

SUBSYS® Market Experience to Date

Prescription Trends:    Monthly prescription data through December 2016 shows that approximately 162,000 prescriptions of SUBSYS® have been dispensed since launch in March 2012. In December 2016, SUBSYS® was the most prescribed branded TIRF product with 42% market share according to IMS.

6


The continuing and heightened publicity surrounding the national opioid epidemic continues to result in sensitivity by some healthcare professionals to prescribe, and pharmacies to dispense, opioids. In part, this sensitivity by healthcare professionals and pharmacies is the result of third-party payers, such as insurance companies, and regulatory and government agencies increasingly scrutinizing the indications and uses for which healthcare professionals are prescribing, and pharmacies are dispensing, opioids. Moreover, ongoing state and federal investigations into our sales, marketing and other commercial practices and developments and media reports that may arise in connection with such investigations may negatively affect our relationships with healthcare professionals and pharmacies and their prescribing or dispensing habits.  Consequently, these current and potential future events have and will likely continue to affect the manner in which, and the situations when, SUBSYS® is being prescribed, dispensed and approved for coverage.

Physician Prescriber Base:    Approximately 1,600 physicians were responsible for 90% of all TIRF prescriptions dispensed in 2016, according to IMS. We have targeted our commercialization efforts towards approximately 100% of these top 1,600 prescribing physicians with a focus on the highest prescribers. As of December 2016, there were approximately 3,900 unique physician prescribers of SUBSYS®.

Patient Use:   Existing patient data generated by available databases demonstrates that the number of SUBSYS® -experienced patients has increased steadily since launch with over 22,100 unique patients as of December 2016. Importantly, the proportion of SUBSYS® prescriptions written for repeat SUBSYS® patients has continued to increase since July 2012 from 50% of prescriptions to over 92% of prescriptions as of December 2016. Generally, repeat SUBSYS® patients receive higher doses of SUBSYS® on average than first-time patients, as patients are titrated from a starter dose of SUBSYS® to their effective dose in accordance with the REMS protocol.

Patient Access:    SUBSYS® is a Tier 3 medication available under most major commercial health insurance plans. Some third-party payers require usage and failure on cheaper generic versions of Actiq prior to providing reimbursement for SUBSYS® and other branded TIRF products. We concentrate on assisting physicians and payers with developing greater familiarity with both the differentiated features of SUBSYS® and the process to achieve patient access to the product from continued and broader usage of SUBSYS® by their patients. We offer patients a free trial of SUBSYS® to allow for titration to their effective dose and bridge the prior authorization process. Once third-party payer reimbursement is in place, we may offer patients coupons to reduce out of pocket costs.

Cannabinoid Product Family

SYNDROS™ (dronabinol oral solution)

Our lead proprietary dronabinol product candidate is SYNDROS™.  The DEA has issued an interim final ruling that would result in SYNDROS™ being placed in Schedule II of the CSA and we now must interact with the FDA to finalize the labeling prior to commercial launch. In addition, we are evaluating proprietary sublingual spray, inhaled and intravenous formulations of dronabinol in preclinical studies. Dronabinol, the active ingredient in Marinol, is a synthetic form of THC. THC is an orally active cannabinoid which, like other cannabinoids, has complex effects on the central nervous system. Approved by the FDA in 1985, Marinol is indicated for the treatment of CINV in patients who have failed to respond adequately to conventional treatments, as well as for the treatment of anorexia associated with weight loss in patients with AIDS. Marinol is formulated in sesame oil and encapsulated in soft gelatin capsules and must be stored in cool storage conditions or in a refrigerator.

We believe a significant unmet medical need exists for formulations of dronabinol that act more rapidly and are subject to less variable patient absorption. We completed a pivotal bioequivalence study that was a 52-patient crossover bioavailability and PK clinical trial comparing SYNDROS™ with Marinol. In the study, 100% of subjects receiving SYNDROS™ achieved detectable plasma levels at 15 minutes compared to less than 25% of the subjects receiving Marinol. Additionally, SYNDROS™ demonstrated lower intra-subject variability relative to Marinol. We believe these attributes may be a consideration for the providers in selecting the appropriate formulation of dronabinol for patients, which we also believe will allow us to further penetrate and potentially expand the market for the medical use of dronabinol.  

7


Market Overview

CINV is a commonly known side effect of chemotherapy that can have a significant negative impact on quality of patient life. CINV is classified into five categories:

 

Acute: Occurs within 24 hours of chemotherapy administration.

 

Delayed: Occurs more than 24 hours after chemotherapy administration, with peak intensity two to three days post-administration and duration of up to one week.

 

Anticipatory: Occurs prior to treatment.

 

Breakthrough: Occurs after use of antiemetic agents.

 

Refractory: Occurs after failed use of breakthrough therapy.

The majority of chemotherapy patients experience at least one type of CINV. The National Comprehensive Cancer Network estimates that 70% to 80% of patients undergoing chemotherapy experience vomiting, with 10% to 44% experiencing anticipatory vomiting. Predictive factors for developing CINV can include: age of less than 50 years, female gender, vomiting during previous chemotherapy, pregnancy-induced nausea/vomiting, history of motion sickness and anxiety. In addition to generally affecting patient quality of life, CINV can result in weakness, weight loss, electrolyte imbalance, dehydration or anorexia. According to a study published by Ballatori, et al in 2007, 90% of patients who experienced CINV reported an impact on daily activities.

Although the pathophysiology of CINV is not clearly understood, it is thought that chemotherapeutic agents cause vomiting by activating neurotransmitter receptors located in the chemoreceptor trigger zone, GI tract, and VC. Activation of the VC directly or through the chemoreceptor trigger zone results in stimulation of the salivation and respiratory centers as well as control of the pharyngeal, GI and abdominal muscles. This stimulation can trigger the body to retch and vomit.

Treatment of CINV is highly patient-specific and is based on the emetogenic potential of the chemotherapy regimen. According to IMS Health, U.S. sales for drugs treating CINV were $1.3 billion in 2013, though published reports suggest that current therapies are not entirely effective. A 2004 report published in Cancer estimated that approximately 35% of patients treated with CINV therapies continue to experience acute nausea, with 13% of CINV patients experiencing acute vomiting after first-line treatment.

Limitations of Existing Therapies

We believe that the synthetic cannabinoid market is underserved due to the limitations of existing therapies, which include:

 

Delayed absorption:    Marinol is only available in a capsule formulation, which must be dissolved and digested before it is metabolized in the patient’s liver, where the drug is broken down by enzymes. We believe that this capsule formulation and digestion process delays onset of action and relief of nausea and vomiting. After oral administration, Marinol has an onset of action of approximately 30 minutes to one hour and peak effect at two to four hours.

 

Variable patient absorption:    The uptake of Marinol into systemic circulation varies widely from dose-to-dose and patient-to-patient. In general, this level of variability is atypical relative to approved pharmaceutical products. As such, physicians are unable to predict the level of efficacy or side effects that an individual patient might experience relative to other patients or even to a patient’s own last dose of dronabinol.

8


Our Solutions

We believe our SYNDROS™ product candidate has the potential to address many of the limitations that exist in synthetic cannabinoid products by providing a number of key advantages, including:

 

Faster absorption:    SYNDROS™ is a liquid solution and is absorbed faster than a capsule formulation which has to dissolve in the GI tract. We believe that quicker absorption may be an important consideration in the selection of a dronabinol product by physicians. Separately, we believe that our proprietary inhalation dronabinol formulation may further accelerate dronabinol’s onset of action due to their route of delivery bypassing first-pass metabolism in the liver.

 

Reduced dose-to-dose variability:    Based on our PK study, we believe SYNDROS™ has lower variability of absorption between patients.

Cannabidiol Oral Solution

Cannabidiol has been shown pre-clinically to protect from seizures in various rodent models of seizures, to alleviate neuropathic pain caused by chemotherapy-induced peripheral neuropathy mouse models treated with paclitaxel, and reduce tumor burden in xenograft mouse model of human glioblastoma tumors. We are developing a Cannabidiol Oral Solution, a synthetic cannabidiol, for childhood catastrophic epilepsy syndromes examples of which include infantile spasms, Dravet Syndrome and Lennox-Gastaut syndrome for which we have received Orphan Drug Designations for CBD.

In addition to the above epilepsy indications, we have also received Orphan Drug Designations for the treatment of CBD in glioblastoma multiforme, pontine glioma, and pediatric schizophrenia.

Early studies in animal models demonstrate that while CBD has anticonvulsant properties and the effectiveness of CBD-enriched cannabinoids in the treatment of epilepsy has been reported. A survey of children using a CBD-enriched plant product reported a reduction in their child’s seizures in 84% and 11% reported complete seizure freedom. In an open access program using a CBD-enriched plant deprived product, which included 214 patients who received drug, the median reduction in monthly motor seizures was 36.5% and the drug was generally well-tolerated. However, parental report can be subject to significant bias, especially where expectations are high.

Currently, we have one ongoing and one completed study in epilepsy. The first study, a Phase 1b pharmacokinetic study that is evaluating three different doses of CBD in pediatric patients with refractory epilepsy: 10mg/kg/day, 20mg/kg/day and 40mg/kg/day in pediatric patients with refractory seizures, is ongoing.

A second study, a Phase 2 study to assess the efficacy and safety of Cannabidiol Oral Solution for the treatment of refractory Infantile Spasms, studied the effect of Cannabidiol Oral Solution in patients who have failed all approved treatments. This study has been completed and we are evaluating the development in Infantile Spasms in a less refractory population. Should CBD demonstrate benefit in this population, it will provide a treatment option where currently only poorly tolerated options exist, fulfilling a large unmet need.

Further, we are exploring Cannabidiol Oral Solution for pediatric epilepsies and non-epilepsy indications. The initiation of these studies are planned for the second half of  2017.

Prader-Willi Syndrome, first described in 1956, is a multifaceted developmental disorder and the most common genetic syndrome associated with obesity. It is caused by the absent expression of paternally-inherited genes in the Prader-Willi Syndrome region on 15q11-q13. While it presents with generalized hypotonia and developmental delay in infancy, Prader-Willi Syndrome then manifests with uncontrollable appetite, hyperphagia, and excessive weight gain leading to severe obesity, and it is the appetite behavior classified as hyperphagia in Prader-Willi Syndrome that is the most life threatening. Until recently, no patient lived over the age of 50 due to morbid obesity and its related complications. The mortality rate in patients with Prader-Willi Syndrome is six times higher than patients with other intellectual disabilities.

Hyperphagic behaviors can also be dangerous in persons who are not obese, with increased risks of death due to choking while sneaking food, and gastric perforations after consuming more food than usual. Approximately 8%

9


of deaths in individuals with Prader-Willi Syndrome are reported due to the choking, especially on hot dogs. Prader-Willi Syndrome patients also are known to eat discarded (contaminated) food and items that are not for human consumption such as pet food, or even non-food items such as paint or paper.

Currently, there are no FDA-approved therapies for the treatment of hyperphagia or obesity in patients with Prader-Willi Syndrome. In addition, drugs that have demonstrated efficacy in the past have been withdrawn or have significant safety concerns (e.g., rimonabant, beloranib). Recent studies investigating modulation of the endocannabinoid system have shown promise.  

The endocannabinoid system appears to be critically involved in the regulation of appetite, body weight, metabolism, hypothalamic-pituitary-adrenal axis, and reward brain circuitry. In clinical studies, compounds with endocannabinoid effects (fenfluramine, rimonabant) have shown significant effects on weight and appetite suppression.  These effects on appetite also occurred in 19% of epilepsy patients treated with Epidiolex© (i.e., cannabidiol extracted from the cannabis plant) during an open-access program for patients with pediatric seizure disorder.

We also provide Cannabidiol Oral Solution and some financial support for Investigator Initiated Trials of Cannabidiol Oral Solution in various clinical settings such as cocaine dependence, analgesia, and early psychosis. These trials are currently ongoing.

Other Product Candidates

Our other product candidates include other dronabinol line extensions and sublingual spray product candidates.

Future Cannabinoid Line Extensions.    As described above, we plan to develop additional dronabinol delivery systems, including a proprietary inhalation dronabinol formulation. All of these product candidates are in preclinical development. We also have the capability to manufacture synthetic cannabidiol and intend to work with medical researchers to determine its viability.

Sublingual Spray Product Candidates.    As described above, we are conducting clinical and preclinical development for multiple well-known, approved molecules for delivery through our sublingual drug delivery technology. We intend to evaluate these and other products that we believe could have a differentiated efficacy and/or safety profile if formulated by us and delivered via a sublingual spray.

Sales and Marketing

We currently market SUBSYS® and intend to commercialize SYNDROS™, if finalization of labeling by the FDA is obtained, and future supportive care products, if approved, through our U.S.-based commercial sales organization focused on supportive care. Specifically, we currently market SUBSYS® in the United States through our commercial sales organization. Our product detailing efforts focus primarily on oncologists, pain specialists and centers that cater to supportive care.

We do not currently have sales and marketing capabilities outside of the United States. In international markets, we plan to enter into arrangements with third parties to pursue requisite regulatory approvals and market and sell our products.

We believe some of the key factors in generating continued growth in SUBSYS® usage include taking market share from other competing TIRF products and expanding the usage of SUBSYS® for BTCP by building awareness among oncologists of its rapid onset of action, improved bioavailability, most complete range of dosage strengths and ease of administration relative to other TIRF products. To successfully commercialize our family of proprietary dronabinol products, we intend to focus our commercial efforts on taking market share from Marinol and its generic alternatives.

As of December 31, 2016, there were approximately 8,100 physicians enrolled in the TIRF REMS program. Enrollment in this class-wide REMS program is required by the FDA as of March 2012 in order to prescribe TIRF

10


products. Approximately 1,600 physicians comprise 90% of TIRF prescriptions dispensed in 2016, according to IMS. Our sales and marketing efforts have primarily targeted approximately 100% of these top 1,600 prescribing physicians with a focus on the highest prescribers. We believe that key factors for driving future SUBSYS® growth include increasing the number of prescriptions written by those physicians who currently prescribe SUBSYS®, increasing the number of TIRF REMS enrolled physicians and oncologists who prescribe SUBSYS®, and allowing sufficient time for physicians and patients to identify their effective SUBSYS® dose among our broad spectrum of dosage strengths.

Manufacturing and Supply

We produce dronabinol, the API in our dronabinol product family, including our proprietary dronabinol product candidates, internally at our U.S.-based, state-of-the-art manufacturing facility. We believe that this facility has the capacity to supply sufficient commercial quantities of dronabinol API for the initial launch quantities of SYNDROS™, if finalization of labeling by the FDA is obtained, as well as to support the continued development of our other cannabinoid product candidates in the near-term. We believe this facility gives us a significant competitive advantage since dronabinol API is a Schedule I material and, consequently, is subject to annual production limits set by quota for each individual facility, cannot be readily procured, is difficult to import into the United States and has a limited number of suppliers domestically. For additional information, see “Risk Factors—Risks Related to Our Business and History—We produce our dronabinol API internally and may encounter manufacturing failures that could impede or delay commercial production of SYNDROS™, if finalization of labeling by the FDA is obtained, or our other dronabinol product candidates, if approved, or the preclinical and clinical development or regulatory approval of our dronabinol product candidates” in Part I, Item 1A of this report.

For our long-term needs, in 2014 we completed construction of a second domestic dronabinol manufacturing facility, which we believe will enable us to supply sufficient commercial quantities of dronabinol API for our continued commercialization of our proprietary dronabinol product candidates, if approved. For additional information, see “Risk Factors—Risks Related to Our Business and History—We have expanded our dronabinol API production capacity by constructing a second facility. We may encounter a number of challenges relating to the management and operation of such a facility, and we may never realize a return on our investment” in Part I, Item 1A of this report.

The chemical materials for dronabinol API are sourced from independent suppliers and are manufactured utilizing well-established chemical techniques. Our manufacturing facility utilizes these chemical materials to produce dronabinol through a series of synthetic reactions and purification cycles. We believe that our suppliers are equipped to meet our current and future chemical material needs for the commercialization of SYNDROS™, if finalization of labeling by the FDA is obtained, and the development and commercialization of our dronabinol-based product candidates. For additional information, see “Risk Factors—Risks Related to Our Business and History—We have no internal manufacturing capabilities other than for our dronabinol API, we are dependent on numerous third parties in our supply chain for the commercial supply of SUBSYS®, and if we fail to maintain our supply and manufacturing relationships with these third parties or develop new relationships with other third parties, we may be unable to continue to commercialize SUBSYS®  or to develop our product candidates.” in Part I, Item 1A of this report.

We purchase the fentanyl API utilized in connection with SUBSYS® from one vendor as our sole supplier of the API in this product. SUBSYS® is manufactured by contract manufacturers and sub-component fabricators. Aptar, a dispensing system company based in Illinois, developed the sublingual spray device we use for SUBSYS®. We entered into a supply agreement effective as of March 7, 2011, with Aptar pursuant to which Aptar supplies us with the delivery system to administer SUBSYS®. We are required to provide Aptar with rolling quarterly forecasts of our requirement for SUBSYS® drug delivery systems. Under certain circumstances, such forecasts are non-binding; however, some portions of such forecasts may constitute a firm commitment to purchase delivery systems. The agreement has a term of five years from the effective date, subject to early termination clauses. On October 30, 2015, we entered into an amended and restated supply, development & exclusive licensing agreement with Aptargroup, Inc. which, among other things, extended our exclusive supply rights to the current sublingual device, currently utilized by SUBSYS®, as well any new device(s) jointly developed by the two companies for a period of seven years. In addition to extending the term, this amendment added certain minimum purchase commitments and requires certain tiered royalties as a percentage of net revenue to be paid by us ranging from less than one percent to the low single digits, commencing in March 2016 through the term of the agreement, from our sales of SUBSYS® and future products that use the Aptar spray device technology. In January 2016, we assigned our rights, title, duties and

11


obligations of our manufacturing and supply agreement with DPT and our supply, development & exclusive licensing agreement with Aptar from our parent to our manufacturing subsidiary as part of a corporate restructuring.

We entered into a manufacturing agreement effective as of May 24, 2011 with DPT pursuant to which we engaged DPT on an exclusive basis to provide processing and packaging services with respect to SUBSYS®. The contract requires us to provide rolling quarterly forecasts, a portion of which constitute firm purchase commitments. In April 2015, we entered into an amendment to our manufacturing and supply agreement with DPT, which extends our existing manufacturing and supply agreement to produce SUBSYS® until the end of 2020. In addition to extending the term, this amendment added certain minimum purchase commitments. In July 2016, we, through our manufacturing subsidiary, entered into a further amendment to our DPT manufacturing and supply agreement dated May 24, 2011. This amendment effectively eliminates any prior minimum purchase (and batch) obligations that had been set forth in the amendment dated April 30, 2015 and replaces it with a new annual purchase commitment of $4 million per calendar year commencing January 1, 2017 through December 31, 2020. As a result, the cumulative effect related to this amendment reduces our aggregated minimum purchase commitments with DPT from $50 million to $16 million through December 31, 2020.

Aptar and DPT have been selected for their specific competencies in manufacturing, product design and materials. FDA regulations require that materials be produced under cGMPs or quality system regulations, as required for the respective unit operation within the manufacturing process. We believe both key suppliers have sufficient capacity to meet our projected product requirements.

Competition

Our industry is characterized by rapidly advancing technologies, intense competition and a strong emphasis on proprietary products. We face competition from many different sources, such as pharmaceutical companies, including generic drug companies, biotechnology companies, drug delivery companies and academic and research institutions. We believe the key competitive factors that will affect the commercial success of our products and the development of our product candidates include, but are not limited to, onset of action, bioavailability, efficacy, cost, convenience of dosing, safety, tolerability profile and intellectual property rights. Many of our potential competitors have substantially greater financial, scientific, technical, intellectual property, regulatory and human resources than we do, and greater experience than we do commercializing products and developing product candidates, including obtaining FDA and other regulatory approvals for product candidates. Consequently, our competitors may develop products for the treatment of BTCP, CINV and anorexia associated with weight loss in patients with AIDS, or other indications we pursue that are more effective, better tolerated, more widely-prescribed or accepted, more useful and less costly, and they may also be more successful in manufacturing and marketing their products. We also face competition from third parties in obtaining allotments of fentanyl and dronabinol under applicable DEA quotas, recruiting and retaining qualified personnel, establishing clinical trial sites and enrolling patients for clinical trials and in identifying and acquiring or in-licensing new products and product candidates.

SUBSYS®

SUBSYS® competes against numerous branded and generic products already being marketed and potentially those which are or will be in development. SUBSYS® is the fourth new product in the TIRF market over the last five years. In the BTCP market, physicians often treat patients with a variety of short-acting opioid medications, including morphine, morphine and codeine derivatives and fentanyl. Some currently marketed products against which we directly compete include Teva Pharmaceutical Industries Ltd.’s Fentora and Actiq, Galena Biopharma Inc.’s Abstral, Depomed Inc.’s Lazanda and BioDelivery Science International, Inc.’s Onsolis. Some generic fentanyl products against which SUBSYS® competes are marketed by Mallinckrodt, Inc., Par Pharmaceutical Companies and Actavis, Inc. In addition, we are aware of numerous companies developing other treatments and technologies for rapid delivery of opioids to treat BTCP, including transmucosal, transdermal, nasal spray, inhaled delivery systems and sublingual delivery systems, among others.

Cannabinoid Product Family

With respect to our dronabinol product candidates, the market in which we intend to compete is challenging in part because of the presence of generic products. We or our distributor may not be able to differentiate any products

12


that we may market from those of our competitors, successfully develop or introduce new products that are less costly or offer better performance than those of our competitors, or offer purchasers of our products payment and other commercial terms as favorable as those offered by our competitors. In addition, there are a number of established therapies and products already commercially available and under development by other companies that treat the indications which SYNDROS™ and our other dronabinol product candidates are intended to treat. Specifically, SYNDROS™, if finalization of labeling by the FDA is obtained, and our other dronabinol product candidates, will compete against therapies and products such as AbbVie, Inc.’s Marinol and Marinol generics. Par Pharmaceutical Companies markets an approved generic version of Marinol, and Actavis, Inc. markets an authorized generic version of Marinol. Moreover, our cannabinoid products may compete with non-synthetic cannabinoid drugs, including therapies such as GW Pharmaceuticals plc’s Sativex and Epidiolex, especially in many countries outside of the United States where non-synthetic cannabinoids are legal. In addition, literature has been published arguing the benefits of natural cannabis, or marijuana, over dronabinol, and there are a number of states that have already enacted laws legalizing medicinal and recreational marijuana. There is some support in the United States for further legalization of marijuana. We also cannot assess the extent to which patients utilize marijuana illegally to alleviate CINV, instead of using prescribed therapies such as approved dronabinol products. Furthermore, in the treatment of CINV, physicians typically offer conventional anti-nausea agents prior to initiating chemotherapy, such as Sanofi’s Anzemet, Eisai Inc./Helsinn Group’s Aloxi, Roche Holding AG’s Kytril, Par Pharmaceutical Companies’ Zuplenz and GlaxoSmithKline plc’s Zofran, as well as Neurokinin 1 receptor antagonists on the market including Kyowa Hakko Kirin Co., Ltd.’s Sancuso and Merck & Co., Inc.’s Emend. To the extent that SYNDROS™ and our other dronabinol product candidates, if approved, compete in a broader segment of the CINV market, we will also face competition from these products.

Additionally, we are aware of companies in late stage development for CINV product candidates, including A.P. Pharma, Inc.’s APF530 (Phase 3), Aphios Corp.’s Zindo (Phase 2/3), Tesaro, Inc.’s Rolapitant (Phase 3) and Roche Holding/Helsinn Group’s netupitant (Phase 3). If these products are successfully developed and approved over the next few years, they could represent significant competition for SYNDROS™.

Intellectual Property

The success of most of our product candidates will depend in large part on our ability to:

 

obtain and maintain patent and other legal protections for the proprietary technology, inventions and improvements we consider important to our business;

 

prosecute our patent applications and defend our issued patents;

 

preserve the confidentiality of our trade secrets; and

 

operate without infringing the patents and proprietary rights of third parties.

We intend to continue to seek appropriate patent protection for certain of our product candidates, drug delivery systems, molecular modifications, as well as other proprietary technologies and their uses by filing patent applications in the United States and selected other countries. We intend for these patent applications to cover, where possible, claims for medical uses, processes for preparation, processes for delivery and formulations.

As of February 13, 2017, we owned or licensed from third parties a total of twenty-nine worldwide patents and fifty-four patent applications including seventeen issued U.S. utility patents and twenty-eight pending U.S. utility patent applications. These U.S. patents and patent applications will expire between 2017 and 2036. Some of the issued patents and pending applications, if issued, may also be eligible for patent term adjustment and patent term restoration, thereby extending their patent terms.

SUBSYS®

Our SUBSYS® patent portfolio currently consists of five Orange Book listed (with the FDA) U.S. Patent Nos. 8,486,972, 8,486,973, 8,835,459, 8,835,460 and 9,241,935, one granted U.S. patent no. 9,289,387 and two pending U.S. patent applications. These patents are directed to SUBSYS® brand fentanyl and/or the use of the SUBSYS® sublingual fentanyl spray for the treatment of pain and will expire in 2027 and 2030. We also currently have eleven issued foreign patents and six pending foreign patent applications covering formulations and methods of use relating

13


to SUBSYS®. Any patents that issue from our pending foreign patents and applications are expected to expire no earlier than 2027.

Dronabinol

Our dronabinol patent portfolio currently consists of four issued U.S. patents and one pending U.S. patent application. Two of the U.S. patents are directed to formulations of dronabinol and methods of manufacturing and packaging dronabinol in capsules. Two of the U.S. patents and the pending applications are directed to SYNDROS™ brand oral solution formulations of dronabinol. Three of the issued dronabinol patents will expire in 2028, while the forth will expire in 2033. Any patents that issue from our pending patent application will likely expire in 2028.

Other

The rest of our patent portfolio relates to patents and applications owned or licensed by us and directed to other potential product candidates. 

Although we believe our rights under these patents and patent applications provide a competitive advantage, the patent positions of pharmaceutical and biotechnology companies are highly uncertain and involve complex legal and factual questions. In addition, we may not be able to obtain issued patents from pending applications. Even if patents are granted, the allowed claims may not be sufficient to adequately protect the technology owned by or licensed to us. Any patents or patent rights that we obtain carry some risk of being circumvented, challenged or invalidated by our competitors. For example, as described in Note 7 in the Notes to our Consolidated Financial Statements, a former officer of Insys Pharma sought unsuccessfully to rescind his assignment of his inventions concerning fentanyl and dronabinol patent applications described above. Ownership and inventorship disputes may arise for other patents and applications that we own or license.

We also rely on trade secrets, proprietary know-how and continuing innovation to develop and maintain our competitive position, especially when we do not believe that patent protection is appropriate or can be obtained. We require each of our employees, consultants and advisors to execute a proprietary information and inventions assignment agreement before they begin providing services to us. Among other things, this agreement obligates each employee, consultant or advisor to refrain from disclosing any of our confidential information received during the course of providing services and, with some exceptions, to assign to us any inventions conceived or developed during the course of these services. We also require confidentiality agreements from third parties that receive our confidential information.

The biotechnology and biopharmaceutical industries are characterized by the existence of a large number of patents and frequent litigation based on allegations of patent infringement. As our current and potential product candidates and others based upon our proprietary technologies progress toward commercialization, the possibility of an infringement claim against us increases. While we attempt to be certain that our products and proprietary technologies do not infringe other parties’ patents and other proprietary rights, competitors or other parties may assert that we infringe on their proprietary rights.

We have conducted certain clearance searches of issued U.S. patents for our fentanyl formulations but we have not conducted extensive clearance searches for our other product candidates, and cannot guarantee that the searches we have done were fully comprehensive and, therefore, whether SUBSYS®  or any of our product candidates, delivery devices, or methods of using, making or delivering our product candidates infringe the patents searched, or that other patents do not exist that cover SUBSYS®  or product candidates, delivery devices or these methods. Interpreting patent claims involves complex legal and scientific questions and it is difficult to assess whether or not our product candidates would infringe any patent. Likewise, it is difficult to predict whether or not third-party patent applications will issue and what claim scope they may obtain. If we conclude that any identified patents, or patent applications once issued as patents, cover SUBSYS® -or our product candidates, we cannot guarantee that we will be able to formulate around such patents at all or without material delay or whether we can obtain reasonable license terms from the patent owners, if at all. There may also be other pending patent applications that are unknown to us and, if granted, may prevent us from making, using or selling SUBSYS® or our product candidates. Other product candidates that we may develop, either internally or in collaboration with others, could be subject to similar uncertainties. If a product is

14


found to infringe a third-party patent, we could be prevented from developing and selling that product. Please see the section entitled “Risk Factors — Risks Relating to Intellectual Property.”

Environmental and Safety Matters

We use hazardous materials, including chemicals, biological agents and compounds that could be dangerous to human health and safety or the environment. Our operations also produce hazardous waste products. Federal, state and local laws and regulations govern, among other things, the use, generation, manufacture, storage, handling and disposal of these materials and wastes. Compliance with applicable environmental laws and regulations may be expensive, and current or future environmental laws and regulations may impair our product development efforts.

In addition, we cannot entirely eliminate the risk of accidental injury or contamination from these materials or wastes. If one of our employees was accidentally injured as a result of the use, storage, handling or disposal of these materials or wastes, the medical costs related to his or her treatment should be within the coverage terms of our workers’ compensation insurance policy. However, we do not carry specific biological or hazardous waste insurance coverage and our property and casualty and general liability insurance policies specifically exclude coverage for damages and fines arising from biological or hazardous waste exposure or contamination. Accordingly, in the event of contamination or injury, we could be held liable for damages or penalized with fines in an amount exceeding our resources, and our clinical trials or regulatory approvals could be suspended.

Government Regulation

FDA Approval Process

In the United States, pharmaceutical products are subject to extensive regulation by the FDA. The FDCA and other federal and state statutes and regulations, govern, among other things, the research, development, testing, manufacture, storage, recordkeeping, approval, labeling, promotion and marketing, distribution, post-approval monitoring and reporting, sampling, and import and export of pharmaceutical products. Failure to comply with applicable U.S. regulations may subject a company to a variety of administrative or judicial sanctions, such as FDA refusal to approve pending INDs, and NDAs or the issuance of warning letters, product recalls, product seizures, total or partial suspension of production or distribution, injunctions, fines, civil penalties and criminal prosecution.

FDA approval is required before any new unapproved drug or dosage form, including a new use of a previously approved drug, can be marketed in the United States. Pharmaceutical product development in the United States typically involves, among other things, preclinical laboratory and animal tests, the submission to the FDA of an IND, which must become effective before clinical testing may commence, and adequate and well-controlled clinical trials to establish the safety and effectiveness of the drug for each indication for which FDA approval is sought. Satisfaction of FDA pre-market approval requirements typically takes many years and the actual time required may vary substantially based upon the type, complexity and novelty of the product or disease indicated for treatment.

Preclinical tests include laboratory evaluation of product chemistry, stability, formulation and toxicity, as well as animal trials to assess the characteristics and potential safety and efficacy of the product. The conduct of the preclinical tests must comply with federal regulations and requirements including GLPs. The results of preclinical testing are submitted to the FDA as part of an IND along with other information including information about product chemistry, manufacturing and controls and a proposed clinical trial protocol. Certain nonclinical tests, such as animal tests of reproductive toxicity and carcinogenicity, may be conducted after the IND is submitted. A 30-day waiting period after the submission of each IND is required prior to the commencement of clinical testing in humans. If the FDA has not placed a clinical hold on the IND within this 30-day period, the proposed clinical trial may begin.

Clinical trials involve the administration of the investigational new drug to healthy volunteers or patients under the supervision of a qualified investigator. Clinical trials must be conducted in compliance with federal regulations, GCP, which include the requirement that all research subjects provide their informed consent in writing for their participation in any clinical trial, as well as under protocols detailing the objectives of the trial, the parameters to be used in monitoring safety and the effectiveness criteria to be evaluated. Each protocol involving testing in U.S. patients and subsequent protocol amendments must be submitted to the FDA as part of the IND. The FDA may order the temporary or permanent discontinuation of a clinical trial at any time or impose other sanctions if it believes that the

15


clinical trial is not being conducted in accordance with FDA requirements or presents an unacceptable risk to the clinical trial patients. The study protocol and informed consent information for patients in clinical trials must also be submitted to IRB for approval. An IRB may also require the clinical trial at the site to be halted, either temporarily or permanently, for failure to comply with the IRB’s requirements, or may impose other conditions.

Clinical trials to support NDAs for marketing approval are typically conducted in three sequential phases, but the phases may overlap. In Phase 1, the initial introduction of the drug into healthy human volunteers, the drug is tested to assess safety, metabolism, PK, pharmacological actions, side effects associated with increasing doses and, if possible, early evidence of effectiveness. Phase 2 usually involves trials in a limited patient population to evaluate the effectiveness of the drug for a particular indication or indications, dosage tolerance and optimum dosage, and identify possible adverse effects and safety risks. If a compound demonstrates evidence of effectiveness and an acceptable safety profile in Phase 2 evaluations, Phase 3 trials are undertaken to provide substantial evidence of clinical efficacy and safety in a larger number of patients, typically at geographically dispersed clinical trial sites, to establish the efficacy and safety of the drug and to provide adequate information for the labeling of the drug. In some cases, the FDA may condition approval on the sponsor’s agreement to conduct additional clinical trials to further assess the drug’s safety and effectiveness after approval. Such post-approval studies are typically referred to as Phase 4 studies.

The current FDA standards for approving new pharmaceutical products are more stringent than those that were applied in the past. These standards were not applied to many established products currently on the market, including certain opioid products. As a result, the FDA does not have as extensive safety databases on these products as on some products developed more recently. The FDA has recently expressed an intention to develop safety data for certain products, including many opioids. In particular, the FDA has expressed interest in specific impurities that may be present in a number of opioid narcotic APIs, such as oxycodone. Based on certain structural characteristics, these impurities may have the potential to cause mutagenic effects. If, after testing, such effects are ultimately demonstrated to exist, more stringent controls on the levels of these impurities may be required for FDA approval of products containing these impurities, such as oxymorphone. Any additional testing or remedial measures that may be necessary could result in increased costs for, or delays in, obtaining approval for certain of our products in development.

After completion of the required clinical testing, an NDA is prepared and submitted to the FDA. FDA approval of the NDA is required before marketing of the product may begin in the United States. The NDA must include the results of all preclinical, clinical and other testing and a compilation of data relating to the product’s pharmacology, chemistry, manufacture and controls, and proposed labeling, among other things. The cost of preparing and submitting an NDA is substantial. Under federal law, the submission of most NDAs is additionally subject to a substantial application user fee, and the manufacturer and/or sponsor under an approved NDA are also subject to annual product and establishment fees per product and per establishment. These fees are typically increased annually.

The FDA has 60 days from its receipt of an NDA to determine whether the application will be accepted for filing based on the agency’s threshold determination that it is sufficiently complete to permit substantive review. Once the submission is accepted for filing, the FDA begins an in-depth review. Under the PDUFA the FDA has agreed to certain performance goals in the review of NDAs. The FDA has a goal of reviewing applications for non-priority drug products within 12 months of NDA submission. The review process may be extended by the FDA for three additional months to consider certain information or clarification regarding information already provided in the submission. The FDA may also refer applications for novel drug products or drug products which present difficult questions of safety or efficacy to an advisory committee, typically comprised of a panel that includes clinicians and other experts, for review, evaluation and a recommendation as to whether the application should be approved. The FDA is not bound by the recommendations of an advisory committee, but it considers such recommendations carefully when making decisions. Additionally, the FDA will inspect the facility or the facilities at which the drug is manufactured. The FDA will not approve the product unless the facility demonstrates compliance with current cGMPs and the NDA contains data that provides substantial evidence that the drug is safe and effective for the indication sought in the proposed labeling. Additionally, the FDA will typically inspect one or more clinical trial sites to assure compliance with GCPs before approving an NDA.

After the FDA evaluates the data in the NDA and the manufacturing facilities, clinical sites, and the proposed product label, it may issue either an approval letter or a complete response letter. A complete response letter generally outlines the deficiencies in the submission and may require substantial additional testing or information in order for the FDA to reconsider the application. If and when those deficiencies have been addressed to the FDA’s satisfaction

16


in a resubmission of the NDA, the FDA will issue an approval letter. The FDA has committed to reviewing such resubmissions in two to six months depending on the type of information included.

An approval letter authorizes commercial marketing of the drug with specific prescribing information for specific indications. As a condition of NDA approval, the FDA may require substantial post-approval testing and surveillance to monitor the drug’s safety or efficacy and may impose other conditions, including labeling or distribution restrictions or other risk-management mechanisms that can materially affect the potential market and profitability of the drug. Further, if there are any modifications to the drug, including changes in indications, dosage, labeling, or manufacturing processes or facilities, a new or supplemental NDA may need to be submitted, which may require additional data or additional nonclinical studies and clinical trials. Once granted, product approvals may be withdrawn if compliance with regulatory standards is not maintained or problems are identified following initial marketing.

The FDA may require sponsors of investigational drugs to submit proposed REMS in order to ensure that the benefits of the drugs continue to outweigh the risks associated with its use. Sponsors of certain drug applications approved without a REMS program may also be required to submit a proposed REMS program if the FDA becomes aware of new safety information and makes a determination that a REMS program is necessary.

The Hatch-Waxman Act 

Abbreviated New Drug Applications

In seeking approval for a drug through an NDA, applicants are required to list with the FDA each patent with claims that cover the applicant’s product. Upon approval of a drug, each of the patents listed in the application for the drug is then published in the Orange Book. Drugs listed in the Orange Book can, in turn, be cited by potential competitors in support of approval of an ANDA. An ANDA provides for marketing of a drug product that has the same active ingredients in the same strengths and dosage form as the RLD and has been shown to be bioequivalent to the RLD. ANDA applicants are not required to conduct or submit results of preclinical or clinical tests to prove the safety or effectiveness of their drug product, but are required to conduct bioequivalence testing, which compares the bioavailability of their drug product to that of the RLD to confirm chemical and therapeutic equivalence. Drugs approved in this way are commonly referred to as generic versions of the listed drug, and can often be substituted by pharmacists under prescriptions written for the original listed drug.

The ANDA applicant is required to certify to the FDA that any patents listed for the approved product in the FDA’s Orange Book have expired or are not applicable. Specifically, the applicant must certify that: (1) the required patent information has not been filed; (2) the listed patent has expired; (3) the listed patent has not expired, but will expire on a particular date and approval is sought after patent expiration; or (4) the listed patent is invalid or will not be infringed by the new product. A certification that the new product will not infringe the already approved product’s listed patents or that such patents are invalid is called a Paragraph IV certification. If the applicant does not challenge the listed patents via a Paragraph IV certification, the FDA will not approve the ANDA application until all the listed patents claiming the referenced product have expired.

If the ANDA applicant has provided a Paragraph IV certification to the FDA, the applicant must also send notice of the Paragraph IV certification to the NDA and patent holders once the ANDA has been accepted for filing by the FDA. The NDA and patent holders may then initiate a patent infringement lawsuit in response to the notice of the Paragraph IV certification. The filing of a patent infringement lawsuit within 45 days of the receipt of a Paragraph IV certification prevents the FDA from approving the ANDA until the earlier of 30 months from the date of the lawsuit, expiration of the patent, settlement of the lawsuit or a decision in the infringement case that is favorable to the ANDA applicant. As an incentive for the rapid development of generic drug products, the first ANDA(s) filed that challenges a listed patent by filing a Paragraph IV certification may be granted a 180-day marketing exclusivity period during which the FDA may not approve another ANDA for the same product. There may be multiple such “first filers.” The 180-day marketing exclusivity period is triggered either by commercial launch of any first-filed ANDA approved product or from the date of a court decision finding the challenged patent to be invalid, unenforceable or not infringed, whichever is first. The 180-day exclusivity can be forfeited, among other reasons, if the first filed and approved ANDA is not marketed, does not obtain tentative approval or the challenged patent expires.

17


The ANDA application also will not be approved until any non-patent market exclusivity, such as exclusivity for obtaining approval of a new chemical entity, listed in the Orange Book for the referenced product has expired. Federal law provides an exclusive period of five years following approval of a drug containing no previously approved active ingredients, during which ANDAs for generic versions of those drugs cannot be submitted unless the submission contains a Paragraph IV challenge to a listed patent, in which case the submission may be made four years following the original product approval. Federal law additionally provides for a period of three years of exclusivity following approval of a drug that contains previously approved active ingredients but is approved in a new dosage form, route of administration or combination, or for a new use, the approval of which was required to be supported by new clinical trials conducted by or for the sponsor. The FDA cannot grant effective approval of an ANDA based on that listed drug during this three-year period.

Section 505(b)(2) Regulatory Pathway

Most drug products obtain FDA marketing approval pursuant to an NDA or an ANDA. A third alternative is a special type of NDA, commonly referred to as a Section 505(b)(2) NDA. Section 505(b)(2) of the FDCA enables the applicant to rely, in part, on the FDA’s findings of safety and efficacy for an existing product, or published literature, in support of its application.

505(b)(2) NDAs often provide an alternate regulatory pathway to FDA approval for new or improved formulations or new uses of previously approved products. Specifically, Section 505(b)(2) permits the filing of an NDA where at least some of the information required for approval comes from studies not conducted by or for the applicant and for which the applicant has not obtained a right of reference. The applicant may rely upon the FDA’s findings from preclinical or clinical studies conducted for an approved product. The FDA may also require 505(b)(2) applicants to perform additional studies or measurements to support the change from the approved product. The FDA may then approve the new product candidate for all or some of the label indications for which the referenced product has been approved, as well as for any new indication sought by the Section 505(b)(2) applicant. To the extent that the Section 505(b)(2) applicant is relying on findings of safety or efficacy for an already approved product, the applicant is subject to existing exclusivity for the reference product and is required to certify to the FDA concerning any patents listed for the approved product in the Orange Book to the same extent that an ANDA applicant would. Thus approval of a Section 505(b)(2) NDA can be stalled until all the listed patents claiming the referenced product have expired, until any non-patent exclusivity, such as exclusivity for obtaining approval of a new chemical entity, listed in the Orange Book for the referenced product has expired, and, in the case of a Paragraph IV certification and subsequent patent infringement suit, until the earlier of 30 months, settlement of the lawsuit or a decision in the infringement case that is favorable to the Section 505(b)(2) applicant.

Post-Approval FDA Requirements

Once an NDA is approved, a product is subject to extensive and ongoing post-approval requirements. For instance, the FDA closely regulates the post-approval marketing and promotion of drugs, including standards and regulations for direct-to-consumer advertising, off-label promotion, industry-sponsored scientific and educational activities and promotional activities involving the internet. FDA post-market regulations also include, among other things, requirements relating to drug listing, recordkeeping, periodic reporting, product sampling and distribution, manufacturing and reporting of adverse events arising from use of the product. Failure to comply with these regulatory requirements may result in restrictions on the marketing or manufacturing of the product, recall or market withdrawal, fines, warning letters, refusal to approve pending applications, suspension or revocation of approvals, product seizure or detention, injunctions and/or the imposition of civil or criminal penalties.

Drugs may be marketed only for the approved indications and in accordance with the provisions of the approved labeling. Changes to some of the conditions established in an approved application, including changes in indications, labeling, or manufacturing processes or facilities, require submission and FDA approval of a new NDA or NDA supplement before the change can be implemented. An NDA supplement for a new indication typically requires clinical data similar to that in the original application, and the FDA uses the same procedures and can take the same actions in reviewing NDA supplements as it does in reviewing original NDAs.

Adverse event reporting and submission of periodic reports is required following FDA approval of an NDA. The FDA also may require post-marketing testing, known as Phase 4 commitments or requirements, a REMS program

18


and surveillance to monitor the effects of an approved product or place conditions on an approval that could restrict the distribution or use of the product.

In addition, quality control as well as drug manufacture, packaging, and labeling procedures must continue to conform to cGMPs after approval. Drug manufacturers and certain of their subcontractors are required to register their establishments with FDA and certain state agencies, and are subject to periodic unannounced inspections by the FDA during which the agency inspects manufacturing facilities to assess compliance with cGMPs. Accordingly, manufacturers must continue to expend time, money and effort in the areas of production and quality control to maintain compliance with cGMPs. The FDA and comparable state regulatory authorities may withdraw product approvals or request product recalls if a company fails to comply with regulatory standards, if it encounters problems following initial marketing, or if previously unrecognized problems are subsequently discovered.

The distribution of prescription pharmaceutical products is also subject to the PDMA which governs the distribution of drugs and drug samples at the federal level, and sets minimum standards for the licensing and regulation of drug distributors by the states. Both the PDMA and state laws limit the distribution of prescription pharmaceutical product samples and impose requirements to ensure accountability in distribution.

Risk Evaluation and Mitigation Strategies

On December 29, 2011, the FDA approved a single shared REMS for TIRF products. TIRF products, which include the brand-name drugs Abstral, Actiq, Fentora, Lazanda, Onsolis and SUBSYS®, are narcotic pain medicines called opioids used to manage breakthrough pain in adults with cancer who routinely take other opioid pain medicines around-the-clock. The program officially began in March 2012.

The goals of the TIRF REMS Access Program are to ensure patient access to important medications and mitigate the risk of misuse, abuse, addiction, overdose and serious complications due to medication errors by:

 

prescribing and dispensing TIRF products only to appropriate patients, including use only in opioid-tolerant patients;

 

preventing inappropriate conversion between fentanyl products;

 

preventing accidental exposure to children and others for whom TIRF products were not prescribed; and

 

educating prescribers, pharmacists, and patients on the potential for misuse, abuse, addiction, and overdose.

Health care professionals who prescribe TIRF products that will only be used in an inpatient setting (hospitals, hospices, or long-term care facilities) are not be required to enroll in the TIRF REMS Access Program. Similarly, patients who receive TIRF products in an inpatient setting are not required to enroll in the program. Long term care and hospice patients who obtain their medications from outpatient pharmacies, however, must be enrolled.

Controlled Substances; Drug Enforcement Administration

We sell products that are “controlled substances” as defined in the CSA which establishes registration, security, recordkeeping, reporting, storage and other requirements administered by the DEA. States impose similar requirements. The DEA regulates entities that handle controlled substances and the equipment and raw materials used in their manufacture and packaging, in order to prevent loss and diversion into illicit channels of commerce.

The DEA regulates controlled substances as Schedule I, II, III, IV or V substances. Schedule I substances by definition have high potential for abuse, no currently accepted medical use in the United States and lack accepted safety for use under medical supervision, and may not be marketed or sold in the United States. Except for research and industrial purposes, a pharmaceutical product may be listed as Schedule II, III, IV or V, with Schedule II substances considered to present the highest risk of abuse and Schedule V substances the lowest relative risk of abuse among such substances. Fentanyl, the active ingredient in our SUBSYS® product, is listed by the DEA as a Schedule II substance under the CSA. Consequently, its manufacture, shipment, storage, sale and use are subject to a high degree of regulation. For example, manufacturing of fentanyl is subject to a DEA regulated quota system. In addition,

19


generally all Schedule II drug prescriptions must be signed by a physician and physically presented to a pharmacist before filling and may not be refilled without a new prescription.

DEA registration is required for any facility that manufactures, distributes, dispenses, imports or exports any controlled substance. The registration is specific to the particular location, activity and controlled substance schedule. For example, separate registrations are needed for import and manufacturing, and each registration will specify which schedules of controlled substances are authorized to be handled under that registration.

The DEA typically inspects certain facilities to review their security controls, recordkeeping and reporting prior to issuing a registration. Security requirements vary by controlled substance schedule, with the most stringent requirements applying to Schedule I and Schedule II substances. Security measures required by the DEA include background checks on employees and physical control of inventory through measures such as vaults, cages, surveillance cameras and inventory reconciliations. Records must be maintained for the handling of all controlled substances, and periodic reports made to the DEA, for example distribution reports for Schedule I and II controlled substances, Schedule III substances that are narcotics, and other designated substances. Reports must also be made for thefts or losses of any controlled substance, suspicious orders, and to obtain authorization to destroy any controlled substance. In addition, special authorization and notification requirements apply to imports and exports.

A DEA quota system controls and limits the availability and production of controlled substances in Schedule I or II. This includes manufacturing of the API and production of dosage forms. Distributions of any Schedule I or II controlled substance must also be accompanied by special order forms, with copies provided to the DEA. Absent the Marinol-like formulation and encapsulation exception, dronabinol is a Schedule I controlled substance and, therefore, subject to the DEA’s production and procurement quota scheme. The DEA establishes annually an aggregate quota for how much total dronabinol may be produced in the United States based on the DEA’s estimate of the quantity needed to meet legitimate scientific and medicinal needs. This limited aggregate amount of dronabinol that the DEA allows to be produced in the United States each year is allocated among individual companies, who must submit applications annually to the DEA for individual manufacturing and procurement quotas. We or our partners, including our contract manufacturers, must obtain an annual quota from the DEA in order to produce or procure any Schedule I or Schedule II substance, including dronabinol and fentanyl. The DEA may adjust aggregate production quotas and individual manufacturing quotas from time to time during the year, although the DEA has substantial discretion in whether or not to make such adjustments. Our, or our contract manufacturers’, quota of the active ingredient may not be sufficient to meet commercial demand or complete clinical trials. Any delay or refusal by the DEA in establishing our, or our contract manufacturers’, quota for controlled substances could delay or stop our clinical trials or product launches which could have a material adverse effect on our business, financial position and results of operations.

The DEA conducts periodic inspections of certain registered establishments that handle controlled substances. Failure to maintain compliance with applicable requirements, particularly as manifested in loss or diversion, can result in enforcement action that could have a material adverse effect on our business, results of operations and financial condition. The DEA may seek civil penalties, refuse to renew necessary registrations, or initiate proceedings to restrict, suspend or revoke those registrations. In certain circumstances, violations could result in criminal proceedings.

Individual states also regulate controlled substances, and we and our contract manufacturers will be subject to state regulation on distribution of these products, including licensing, recordkeeping and security.

Controlled substances are also regulated pursuant to several international drug control treaties. These treaties are enforced by the United National Commission on Narcotic Drugs. The United States is a signatory to these treaties and thus must conform its laws and regulations to the international requirements, which generally include licensing, recordkeeping and reporting requirements. Both fentanyl and dronabinol are currently classified under the international treaties and current U.S. controls adequately address international requirements. Any change in the international treaties regarding classification of these products could affect regulation of these substances in the United States and in other countries.

Anti-Kickback and False Claims Laws

In addition to FDA restrictions on marketing of pharmaceutical products, several other types of state and federal laws have been applied to restrict certain marketing practices in the pharmaceutical industry in recent years. These

20


laws include Anti-Kickback and False Claims statutes. The federal Anti-Kickback Statute prohibits, among other things, knowingly and willfully offering, paying, soliciting or receiving remuneration to induce or in return for purchasing, leasing, ordering or arranging for the purchase, lease or order of any healthcare item or service reimbursable under Medicare, Medicaid or other federally financed healthcare programs. The term “remuneration” has been broadly interpreted to include anything of value, including for example, gifts, discounts, the furnishing of supplies or equipment, credit arrangements, payments of cash, waivers of payment, ownership interests and providing anything at less than its fair market value. The Anti-Kickback Statute has been interpreted to apply to arrangements between pharmaceutical manufacturers on the one hand and prescribers, purchasers and formulary managers on the other. Although there are a number of statutory exemptions and regulatory safe harbors protecting certain common activities from prosecution, the exemptions and safe harbors are drawn narrowly, and our practices may not in all cases meet all of the criteria for statutory exemptions or safe harbor protection. Practices that involve remuneration that may be alleged to be intended to induce prescribing, purchases, or recommendations may be subject to scrutiny if they do not qualify for an exemption or safe harbor. Several courts have interpreted the statute’s intent requirement to mean that if any one purpose of an arrangement involving remuneration is to induce referrals of federal healthcare covered business, the statute has been violated. The reach of the Anti-Kickback Statute was also broadened by the PPACA which amends the intent requirement of the federal Anti-Kickback Statute such that a person or entity no longer needs to have actual knowledge of this statute or specific intent to violate it in order to have committed a violation. In addition, PPACA provides that the government may assert that a claim including items or services resulting from a violation of the federal Anti-Kickback Statute constitutes a false or fraudulent claim for purposes of the federal False Claims Act (discussed below) or the civil monetary penalties statute, which imposes penalties against any person who is determined to have presented or caused to be presented a claim to a federal health program that the person knows or should know is for an item or service that was not provided as claimed or is false or fraudulent.

The federal False Claims Act prohibits any person from knowingly presenting, or causing to be presented, a false claim for payment to the federal government, or knowingly making, using or causing to be made or used, a false record or statement material to a false or fraudulent claim to the federal government. As a result of a modification made by the Fraud Enforcement and Recovery Act of 2009, a claim includes “any request or demand” for money or property presented to the U.S. government. Recently, several pharmaceutical and other healthcare companies have been prosecuted under these laws for allegedly inflating drug prices they report to pricing services, which in turn were used by the government to set Medicare and Medicaid reimbursement rates, and for allegedly providing free product to customers with the expectation that the customers would bill federal healthcare programs for the product. In addition, certain marketing practices, including off-label promotion, may also lead to violations of the False Claims Act. Many states also have statutes or regulations similar to the federal Anti-Kickback Statute and False Claims Act, which state laws apply to items and services reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payer. Moreover, qui tam suits filed under the False Claims Act can be brought by any individual on behalf of the government and such individuals, commonly known as “relators” or “whistleblowers,” may share in any amounts paid by the entity to the government in fines or settlement. The frequency of filing qui tam actions has increased significantly in recent years, causing greater numbers of health care companies to have to defend such qui tam actions and pay substantial sums to settle such actions.

Also, the HIPAA created new federal criminal statutes that prohibit knowingly and willfully executing a scheme to defraud any healthcare benefit program, including private third-party payers and knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement in connection with the delivery of or payment for healthcare benefits, items or services.

To the extent that any of our product candidates are ultimately sold in a foreign country, we may be subject to similar foreign laws and regulations, which may include, for instance, applicable post-marketing requirements, including safety surveillance, anti-fraud and abuse laws, and implementation of corporate compliance programs and reporting of payments or transfers of value to healthcare professionals.  

Coverage and Reimbursement

The commercial success of our products and our ability to commercialize any approved product candidates successfully will depend in part on the extent to which governmental authorities, private health insurers and other third-party payers provide coverage for and establish adequate reimbursement levels for our products, product candidates, and related treatments.

21


Government health administration authorities, private health insurers and other organizations generally decide which drugs they will pay for and establish reimbursement levels for health care. In particular, in the U.S., private health insurers and other third-party payers often provide reimbursement for products and services based on the level at which the government (through the Medicare or Medicaid programs) provides reimbursement for such treatments. In the U.S., the European Union and other potentially significant markets for our product candidates, government authorities and third-party payers are increasingly attempting to limit or regulate the price of medical products and services, particularly for new and innovative products and therapies, which has resulted in lower average selling prices. Further, the increased emphasis on managed healthcare in the U.S. and on country and regional pricing and reimbursement controls in the European Union will put additional pressure on product pricing, reimbursement and usage, which may adversely affect our future product sales and results of operations. These pressures can arise from rules and practices of managed care groups, judicial decisions and governmental laws and regulations related to Medicare, Medicaid and healthcare reform, pharmaceutical reimbursement policies and pricing in general. The cost containment measures that healthcare payers and providers are instituting and the effect of any healthcare reform could significantly reduce our revenues from the sale of any products or approved product candidates. We cannot provide any assurances that we will be able to obtain and maintain third-party coverage or adequate reimbursement for our product candidates in whole or in part.

The MMA imposed new requirements for the distribution and pricing of prescription drugs for Medicare beneficiaries. Under Part D, Medicare beneficiaries may enroll in prescription drug plans offered by private entities which provide coverage of outpatient prescription drugs. Part D plans include both stand-alone prescription drug benefit plans and prescription drug coverage as a supplement to Medicare Advantage plans. Unlike Medicare Part A and B, Part D coverage is not standardized. Part D prescription drug plan sponsors are not required to pay for all covered Part D drugs, and each drug plan can develop its own drug formulary that identifies which drugs it will cover and at what tier or level. However, Part D prescription drug formularies must include drugs within each therapeutic category and class of covered Part D drugs, though not necessarily all the drugs in each category or class. Any formulary used by a Part D prescription drug plan must be developed and reviewed by a pharmacy and therapeutic committee. Government payment for some of the costs of prescription drugs may increase demand for our products for which we receive marketing approval. However, any negotiated prices for our future products covered by a Part D prescription drug plan will likely be lower than the prices we might otherwise obtain. Moreover, while the MMA applies only to drug benefits for Medicare beneficiaries, private payers often follow Medicare coverage policy and payment limitations in setting their own payment rates. Any reduction in payment that results from Medicare Part D may result in a similar reduction in payments from non-governmental payers.

The American Recovery and Reinvestment Act of 2009 provides funding for the federal government to compare the effectiveness of different treatments for the same illness. A plan for the research will be developed by the Department of Health and Human Services, the Agency for Healthcare Research and Quality and the National Institutes for Health, and periodic reports on the status of the research and related expenditures will be made to Congress. Although the results of the comparative effectiveness studies are not intended to mandate coverage policies for public or private payers, it is not clear what effect, if any, the research will have on the sales of any product, if any such product or the condition that it is intended to treat is the subject of a study. It is also possible that comparative effectiveness research demonstrating benefits in a competitor’s product could adversely affect the sales of our products or product candidates. If third-party payers do not consider our products to be cost-effective compared to other available therapies, they may not cover our products as a benefit under their plans or, if they do, the level of payment may not be sufficient to allow us to sell our products on a profitable basis.

The U.S. and some foreign jurisdictions are considering enacting or have enacted a number of additional legislative and regulatory proposals to change the healthcare system in ways that could affect our ability to sell our products profitably. Among policy makers and payers in the U.S. and elsewhere, there is significant interest in promoting changes in healthcare systems with the stated goals of containing healthcare costs, improving quality and/or expanding access. In the U.S., the pharmaceutical industry has been a particular focus of these efforts and has been significantly affected by major legislative initiatives, including, most recently, the PPACA, which changes the way healthcare is financed by both governmental and private insurers.

22


Healthcare Privacy and Security Laws

We may be subject to various privacy and security regulations, including but not limited to HIPAA, as amended by HITECH, and their respective implementing regulations, including the related final published omnibus rule. HIPAA mandates, among other things, the adoption of uniform standards for the electronic exchange of information in common healthcare transactions, as well as standards relating to the privacy and security of individually identifiable health information, which require the adoption of administrative, physical and technical safeguards to protect such information. Among other things, HITECH makes HIPAA’s privacy and security standards directly applicable to “business associates” — independent contractors or agents of covered entities that receive or obtain protected health information in connection with providing a service on behalf of a covered entity. HITECH also increased the civil and criminal penalties that may be imposed against covered entities, business associates and possibly other persons, and gave state attorneys general new authority to file civil actions for damages or injunctions in federal courts to enforce the federal HIPAA laws and seek attorney’s fees and costs associated with pursuing federal civil actions. In addition, state laws govern the privacy and security of health information in certain circumstances, some of which are more stringent then HIPAA and many of which differ from each other in significant ways and may not have the same effect, thus complicating compliance efforts. Failure to comply with these laws, where applicable, can result in the imposition of significant civil and criminal penalties.

Approval Outside the United States

In order to market any product outside of the United States, we must comply with numerous and varying regulatory requirements of other countries regarding safety and efficacy and governing, among other things, clinical trials and commercial sales and distribution of our products. Approval procedures vary among countries and can involve additional product testing and additional administrative review periods, and may be otherwise complicated by our product candidates being controlled substances such as synthetic cannabinoids and fentanyl. The time required to obtain approval in other countries might differ from and be longer than that required to obtain FDA approval and DEA classification. Regulatory approval in one country does not ensure regulatory approval in another, but a failure or delay in obtaining regulatory approval in one country may negatively impact the regulatory process in others.

To date, we have not initiated any discussions with the European Medicines Agency or any other foreign regulatory authorities with respect to seeking regulatory approval for any indication in Europe or in any other country outside the United States. As in the United States, the regulatory approval process in Europe and in other countries is a lengthy, challenging and inherently uncertain process.

Research and Development   

Our operating results will also depend significantly on our research and development activities and related regulatory developments. Our research and development expenses were $73.9 million, $56.7 million and $33.1 for the years ended December 31, 2016, 2015 and 2014, respectively. As of December 31, 2016, we had 59 full-time research and development personnel. We expect research and development expenses to increase as we increase related headcount and continue our planned preclinical studies and clinical trials for our product candidates, particularly our proprietary cannabinoid product candidates, including SYNDROS™, and sublingual spray product candidates. We do not expect to realize net revenues from all of these research and development initiatives in the near term and may never realize net revenues from these investments. For additional information, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Factors Affecting Our Performance—Product Development and Related Regulatory Processes.

Employees

As of December 31, 2016, we employed 423 full-time employees, including 44 manufacturing employees, 274 sales and marketing employees, 59 employees in research and development, and 46 employees in administration. As of the same date, 30 of our employees had a Ph.D. or M.D. degree. None of our employees is subject to a collective bargaining agreement and we consider our relationship with our employees to be good.

23


Scientific Advisory Board 

We have established a scientific advisory board consisting of industry experts with knowledge of our target markets. Our scientific advisors generally meet twice a year as a group to assist us in formulating our research, development, clinical and sales and marketing strategies. Some individual scientific advisors consult with and meet informally with us on a more frequent basis. Our scientific advisors are not our employees and may have commitments to, or consulting or advisory contracts with, other entities that may limit their availability to us. In addition, our scientific advisors may have arrangements with other companies to assist those companies in developing products or technologies that may compete with ours.

Available Information

We make our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports available, free of charge, in the “Investors” section of our Internet website as soon as reasonably practicable after we electronically file these materials with, or furnish these materials to, the SEC. Our website is www.insysrx.com.

You may also read or copy any materials that we file with the SEC at its Public Reference Room at 100 F. Street, N.E., Washington, DC 20549. You may obtain additional information about the Public Reference Room by calling the SEC at 1-800-SEC-0330. Additionally, you will find these materials on the SEC Internet site at http://www.sec.gov that contains reports, proxy statements and other information regarding issuers that file electronically with the SEC.

ITEM 1A.

RISK FACTORS

Risks Related to Our Business and Industry

We are largely dependent on the commercial success of our product, SUBSYS®, and although we have generated revenue and profit from sales of SUBSYS®, we may not be able to continue to be profitable.

We anticipate that in the near term our ability to maintain profitability will depend upon the continued commercial success of our main approved product, SUBSYS®. In addition to the risks discussed elsewhere in this section, our ability to continue to generate revenues from this product will depend on a number of factors, including, but not limited to:

 

achievement of broad market acceptance and coverage by third-party payers for our products;

 

the effectiveness of our efforts in marketing and selling SUBSYS®;

 

our and our contract manufacturers’ ability to successfully manufacture commercial quantities of our products at acceptable cost levels and in compliance with regulatory requirements;

 

our ability to maintain a cost-efficient commercial organization and, to the extent we seek to do so, successfully partner with additional third parties;

 

our ability to successfully expand and maintain intellectual property protection for SUBSYS®;

 

our ability to effectively work with physicians to ensure that patients are titrated to an effective dose of SUBSYS®;

 

the efficacy and safety of our products; and

 

our ability to comply with regulatory requirements.

The continuing and heightened publicity surrounding the national opioid epidemic continues to result in sensitivity by some healthcare professionals to prescribe, and pharmacies to dispense, opioids. In part, this sensitivity by healthcare professionals and pharmacies is the result of third-party payers, such as insurance companies, and regulatory and government agencies increasingly scrutinizing the indications and uses for which healthcare professionals are prescribing, and pharmacies are dispensing, opioids. Moreover, ongoing state and federal investigations into our sales, marketing and other commercial practices and developments and media reports that may

24


arise in connection with such investigations may negatively affect our relationships with healthcare professionals and pharmacies and their prescribing or dispensing habits.  Consequently, these current and potential future events have and will likely continue to affect the manner in which, and the situations when, SUBSYS® is being prescribed, dispensed and approved for coverage.

If SUBSYS®, SYNDROS™, or any of our product candidates for which we receive regulatory approval, do not maintain broad market acceptance or coverage by third-party payers, the revenues that we generate from this product will be limited.

The commercial success of SUBSYS®, SYNDROS™ and any product candidates for which we obtain marketing approval from the FDA or other regulatory authorities, will depend upon the continued acceptance of these products by physicians, patients, healthcare payers and the medical community. Coverage and reimbursement of our approved products by third-party payers is also necessary for commercial success. The degree of market acceptance of SUBSYS®, SYNDROS™ and any other product candidates for which we may receive regulatory approval will depend on a number of factors, including:

 

patients’ ability to obtain sufficient third-party payer coverage and reimbursement;

 

our ability to provide acceptable evidence of safety and efficacy;

 

acceptance by physicians and patients of the product as a safe and effective treatment; 

 

the relative convenience and ease of administration;

 

the prevalence and severity of adverse side effects;

 

limitations or warnings contained in a product’s FDA-approved labeling;

 

the clinical indications for which the product is approved;

 

the DEA scheduling classification for controlled substances, such as our dronabinol-based and fentanyl-based products;

 

availability and perceived advantages of alternative treatments;

 

any negative publicity related to our or our competitors’ products;

 

the effectiveness of our or any current or future collaborators’ sales, marketing and distribution strategies;

 

pricing and cost effectiveness;

 

the willingness of patients to pay out of pocket in the absence of third-party payer coverage; and

 

our ability to maintain compliance with regulatory requirements.

For example, while we believe our sublingual spray delivery method for SUBSYS® appeals to patients, some patients may not view our sublingual spray device as easy to administer, safe and effective, and otherwise may not react favorably to sublingual delivery. In accordance with the REMS protocol for all TIRF products, physicians are advised to begin patients at the lowest dose available for the applicable TIRF product, which for SUBSYS® is 100 mcg. If patients do not experience pain relief at initial low-dose prescriptions of SUBSYS®, they or their physicians may conclude that SUBSYS® is ineffective in general and may discontinue use of SUBSYS® before titrating to an effective dose. In addition, many third-party payers require usage and failure on cheaper generic versions of Actiq prior to providing reimbursement for SUBSYS® and other branded TIRF products, which limits SUBSYS®’ use as a first-line treatment option.

In addition, products used to treat and manage pain, especially in the case of controlled substances, are from time to time subject to negative publicity, including illegal use, overdoses, abuse, diversion, serious injury and death. These events have led to heightened regulatory scrutiny. Controlled substances are classified by the DEA as Schedule I through V substances, with Schedule I substances being prohibited for sale in the United States, Schedule II substances considered to present the highest risk of abuse and Schedule V substances being considered to present the lowest relative risk of abuse. SUBSYS® contains fentanyl, an opioid, and is regulated as a Schedule II controlled

25


substance, and despite the strict regulations on the marketing, distributing, prescribing and dispensing of such substances, illicit use and abuse of controlled substances is well-documented. Thus, the marketing of SUBSYS® and, if approved, our product candidates that contain controlled substances, may generate public controversy that may adversely affect market acceptance of SUBSYS® and, if approved, such product candidates.

Our efforts to educate the medical community and third-party payers on the benefits of SUBSYS®, and any of our product candidates for which we obtain marketing approval from the FDA or other regulatory authorities, and gain broad market acceptance requires significant resources and may not continue to be successful. If our products do not continue to receive an adequate level of acceptance by physicians, third-party payers and patients, we may not generate sufficient revenue from these products to remain profitable.

In addition, fentanyl and dronabinol treatments can be costly to third-party payers and patients. Accordingly, hospitals and physicians may resist prescribing our products and third-party payers and patients may not purchase our products due to cost.

Furthermore, the potential market for dronabinol products may not expand as we anticipate or may even decline based on numerous factors, including the introduction of superior alternative products and regulatory action negatively impacting the dronabinol market. Moreover, even our dronabinol product candidates are approved and successfully commercialized, there is no guarantee that introduction of improved formulations of dronabinol will result in expansion of the dronabinol market or permit us to gain share in that market or maintain or increase any market share we may capture. New dronabinol products that we introduce could potentially replace our then currently marketed dronabinol products, thus not impacting the overall size of the market or increasing our overall share of that market. If we are unable to expand the market for the medical use of dronabinol or gain, maintain or increase market share in that market, this failure would have a material adverse effect on our ability to execute on our business plan and ability to generate revenue.

The unpredictability and regulation surrounding reimbursement on SUBSYS® and SYNDROS™ may affect our financial condition and results of operations.

Our sales of, and revenue from, SUBSYS® (and our anticipated future revenue from SYNDROS™) depend in significant part on the coverage and reimbursement policies of third-party payers, including government payers such as Medicare and Medicaid, and private health insurers. All third-party payers are sensitive to the cost of drugs and consistently implement efforts to control these costs, which efforts include, but are not limited to, establishing excluded or preferred drug lists. SUBSYS® has been, and will likely continue to be, subject to these restrictions and impediments from third-party payers, particularly PBMs and private health insurers. Our product, SUBSYS®, has been included on an exclusion list for at least one significant PBM and may in the future be included on other PBM exclusion lists. These PBMs, which administer prescription drug benefits for employers and health plans and runs large mail-order pharmacies, have significant influence in the insurance industry. While most PBMs have an exception process that physicians may pursue to have an off-formulary, medically necessary drug covered for patients, being placed on an exclusion list makes it difficult for many patients covered through a PBM administered plan to have SUBSYS® covered by insurance.  In the future, we may not be able to work with other PBMs to evaluate price increases and to communicate with managed care and health-system decision-makers to ensure a balanced approach which takes into account the clinical performance and efficacy of our products. Moreover, in the United States, there have been, and we expect there will continue to be, a number of state and federal proposals that limit the amount that third-party payers may pay to reimburse the cost of drugs, particularly for state and federal government programs such as Medicare and Medicaid, as well as managed care providers and private insurance plans. We believe the increasing emphasis on managed care in the United States has and will continue to put pressure on the price and usage of SUBSYS®. Our ability to generate revenue is affected by the availability of third-party reimbursement for SUBSYS® and our results of operations will be negatively affected if we fail to manage adequate reimbursement levels for SUBSYS® from such third-party payers.

In addition, our business operations include administrative reimbursement support assistance for patients, in large part through our patient services hub, to help patients work with their insurance companies. The patient support assistance provided by us, including our patient services hub, is subject to extensive and complex federal and state laws and varied third-party payers standards, procedures, processes and conditions.  Our compliance with applicable laws, regulations and standards is expensive and time consuming and substantial governmental resources exist to

26


enforce and prosecute these applicable laws, regulations and standards and companies that violate such laws, regulations and standards may face substantial penalties. The potential sanctions include significant civil, criminal and administrative penalties, damages and fines and exclusion from participation in federal health care programs. Because of the breadth of these laws and the lack of extensive legal guidance in the form of regulations or court decisions, it is possible that some of our business activities could be subject to challenge or penalty under one or more of these laws. Such a challenge, irrespective of the underlying merits of the challenge or the ultimate outcome of the matter, could have a material adverse effect on our business, financial condition, results of operations and growth prospects.

We or our collaborators may not be successful in executing sales and marketing strategies for SUBSYS®, SYNDROS™, or any additional product candidates for which we obtain regulatory approval. If such sales and marketing strategies are not successful, we may not be able to maintain or increase our revenues.

Prior to our launch of SUBSYS® in March 2012, we built a commercial organization including sales, marketing, managed markets, trade and distribution functions, which is now focused exclusively on marketing and selling SUBSYS®. We utilize in the United States, with respect to SUBSYS®, and plan to utilize in the United States, with respect to SYNDROS™ or any of our product candidates for which we obtain regulatory approval and maintain sales and marketing responsibility, our commercial organization. Our commercial organization may not perform over time as we currently anticipate. To the extent our commercial organization does not perform over time as we currently anticipate, we will need to consider alternatives, such as entering into arrangements with third parties to market and sell our products. Any arrangement would likely result in significantly greater sales and marketing expenses or lower revenues than our current estimates.

Our field sales force promotes SUBSYS® primarily to oncologists, pain management specialists and centers that cater to supportive care in the United States. We may either increase or decrease the size of our sales force in the future based upon market conditions and actual sales performance, as well as in the event that we obtain regulatory approval for any of our product candidates. In addition, we could lose sales personnel or the performance of our sales personnel as measured by actual sales may be disappointing. Many of our competitors have significantly larger sales and marketing organizations, and significantly greater experience than we do in selling, marketing and distributing pharmaceuticals, and we may not be able to compete successfully with them with our existing commercial organization.

We have recently grown our business and will need to further increase the size and complexity of our organization in the future, and we may experience difficulties in managing our growth and executing our growth strategy.

Our management and personnel, systems and facilities currently in place may not be adequate to support our business plan and future growth. With the commercialization of SUBSYS® in March 2012 and our anticipated launch of SYNDROS™ in 2017, we have increased our number of full-time employees from 32 on December 31, 2010 to 423 as of December 31, 2016, primarily because we established a commercial organization and our commercial infrastructure over that period, and the complexity of our business operations has substantially increased. We will need to further expand our scientific, sales and marketing, managerial, operational, financial and other resources to support our planned research, development and commercialization activities.

Our need to effectively manage our operations, growth and various projects requires that we:

 

continue to improve our operational, financial, management and regulatory compliance controls and reporting systems and procedures;

 

attract and retain sufficient numbers of talented employees;

 

manage our commercialization activities for SUBSYS® effectively and in a cost-effective manner;

 

manage our clinical trials effectively;

 

manage our internal dronabinol production operations effectively and in a cost effective manner;

27


 

manage our development efforts effectively while carrying out our contractual obligations to contractors and other third parties; and

 

continue to improve and expand our facilities.

In addition, historically, we have utilized and continue to utilize the services of part-time outside consultants to perform a number of tasks for us, including tasks related to compliance programs, clinical trial management, regulatory affairs, formulation development and other drug development functions. For example, in addition to seeking advice from our scientific advisory board, we utilize consultants for tasks such as state licensing procurement. Our growth strategy may also entail expanding our use of consultants to implement these and other tasks going forward. Because we rely on consultants for certain functions of our business, we will need to be able to effectively manage these consultants to ensure that they successfully carry out their contractual obligations and meet expected deadlines. There can be no assurance that we will be able to manage our existing consultants or find other competent outside consultants, as needed, on economically reasonable terms, or at all. If we are not able to effectively expand our organization by hiring new employees and expanding our use of consultants, we may be unable to successfully implement the tasks necessary to effectively execute on our planned research, development and commercialization activities and, accordingly, may not achieve our research, development and commercialization goals.

We may not be able to obtain all necessary approvals for SYNDROS™, which would limit our near-term future revenue growth prospects.

In addition to growing sales of our main approved product, SUBSYS®, the ability to improve our business, results of operations and financial condition in the near-term will depend heavily on our ability to obtain all necessary approvals for the commercial launch of SYNDROS™. We received FDA approval for SYNDROS™ in July 2016. In March 2017, the DEA issued an interim final ruling that would result in SYNDROS™ being placed in Schedule II of the CSA.  We are currently awaiting the finalization of labeling by the FDA as the final approval prior to commercial launch.

If we are unable to obtain all necessary approvals for the commercial launch of SYNDROS™, our ability to generate additional near-term revenues beyond those derived from the commercial sale of SUBSYS® will be significantly, if not completely, limited or materially delayed, which would have a material adverse impact on our business, results of operations and financial condition.

We produce our dronabinol API internally and may encounter manufacturing failures that could impede or delay commercial production of SYNDROS™, if all necessary approvals are obtained, or our other dronabinol product candidates, if approved, or the preclinical and clinical development or regulatory approval of our dronabinol product candidates.

Any failure in our internal dronabinol API manufacturing operations could cause us to be unable to meet demand for SYNDROS™, if all necessary approvals are obtained, or our other dronabinol product candidates, if approved, and lose potential revenue, delay the preclinical and clinical development or regulatory approval of our dronabinol product candidates, and harm our reputation. Our internal manufacturing operations may encounter difficulties involving, among other things, production yields, regulatory compliance, contamination, quality control and quality assurance, obtaining DEA quotas which allow us to produce dronabinol in the quantities needed to execute on our business plan, and shortages of qualified personnel. Our ability to support regulatory approval of our dronabinol product candidates, could be impeded, delayed, limited or denied if the FDA does not approve and maintain the approval of our manufacturing processes and facilities. In addition, we have limited experience producing dronabinol in commercial quantities and may encounter difficulties with continuing to manufacture commercial quantities of dronabinol or the quantities needed for our preclinical studies or clinical trials. Such difficulties could result in a delay in the commercial launch of SYNDROS™, if all necessary approvals are obtained, or our other dronabinol product candidates, if approved, delays in our preclinical studies, clinical trials and regulatory submissions.

We are aware of only two other manufacturers that are able to produce pharmaceutical grade dronabinol in the United States. We are aware of only five manufacturers that hold Drug Master Files for the production of dronabinol in the United States. Because dronabinol is a controlled substance, inability to manufacture dronabinol in the United States would have a material adverse effect on our business given the regulatory restrictions associated with obtaining

28


authorization to import and transport controlled substances into the United States. Moreover, we believe dronabinol is difficult to produce and if there was any problem in manufacturing it internally, we may not be able to identify a third-party to manufacture it for us in a cost-effective manner, if at all.   

We must comply with current cGMPs enforced by the FDA through its facilities inspection program and review of submitted technical information. In addition, we must obtain and maintain necessary DEA and state registrations, and must establish and maintain processes to assure compliance with DEA and state requirements governing, among other things, the storage, handling, security, recordkeeping and reporting for controlled substances. We must also apply for and receive a quota for dronabinol. Any failure to comply with these requirements may result in penalties, including fines and civil penalties, suspension of production, suspension or delay in product approvals, product seizure or recall, operating restrictions, criminal prosecutions or withdrawal of product approvals, any of which could significantly and adversely affect our business. If the safety of any product or product candidate or component is compromised due to a failure to adhere to applicable laws or for other reasons, we may not be able to successfully commercialize or obtain regulatory approval for the affected product or product candidate, and we may be held liable for any injuries sustained as a result. Any of these factors could cause a delay or termination of commercialization, preclinical studies and clinical trials, regulatory submissions or approvals of our products or product candidates, entail higher costs or result in our being unable to effectively commercialize our approved products. Certain changes in our dronabinol API manufacturing processes or procedures, including a change in the location where the material is manufactured, generally require prior FDA, or foreign regulatory authority, review and/or approval. We may need to conduct additional preclinical studies and clinical trials to support approval of such changes. This review and approval process may be costly and time-consuming, and could impede, delay, limit or prevent commercialization of a product.

We have expanded our dronabinol API production capacity by constructing a second facility. We may encounter a number of challenges relating to the management and operation of such a facility, and we may never realize a return on our investment.

We have expanded our dronabinol API production capacity by constructing a second facility designed to meet our expected future dronabinol API supply needs. The construction of the second facility has required significant capital expenditures and has resulted in significantly increased fixed costs. In addition, we will need to transfer our manufacturing processes, technology and know-how to the second facility. We cannot assure you that we will be able to successfully operate the second facility in a timely or profitable manner, or at all, or within the budget that we currently project. If we are unable to transition our dronabinol API manufacturing operations to the second facility in a cost-efficient and timely manner, then we may experience disruptions in our operations, which could negatively impact our business and financial results. Further, if we are unable to achieve certain minimum production efficiencies at the second facility, or if we fail to obtain regulatory approval for and successfully commercialize our dronabinol product candidates, including SYNDROS™, we may never realize a return on our investment. If the demand for our dronabinol products decreases or if we do not produce the output we plan or anticipate after our new facility is operational, we may not be able to spread a significant amount of our fixed costs over the production volume, thereby increasing our per unit fixed cost, which would have a negative impact on our financial condition and results of operations.

We will need to obtain and maintain a number of regulatory approvals in connection with the production of dronabinol API at our second manufacturing facility. Our ability to obtain and maintain these approvals may be subject to additional costs and possible delays beyond what we initially anticipate. In addition, any new dronabinol API manufacturing facility must comply on an ongoing basis with applicable regulatory requirements as discussed in the preceding risk factor. Failure to comply with any such regulatory requirements would harm our business and our results of operations.

Our ability to operate a new, larger facility successfully will greatly depend on our ability to hire, train and retain an adequate number of additional manufacturing employees, in particular employees with the appropriate level of knowledge, background and skills. Should we be unable to hire such employees, our business and financial results could be negatively impacted.

Disruptions or other adverse developments during the construction and planned operations of our planned second facility could materially adversely affect our business. If our dronabinol API production is disrupted for any reason, we may be forced to locate alternative dronabinol API production facilities, including facilities operated by

29


third parties. Locating alternative facilities would be time-consuming and would disrupt our production. Additionally, we cannot assure you that alternative manufacturing facilities would offer the same cost structure as the planned second facility.   

We have no internal manufacturing capabilities other than for our dronabinol API, we are dependent on numerous third parties in our supply chain for the commercial supply of SUBSYS®, and if we fail to maintain our supply and manufacturing relationships with these third parties or develop new relationships with other third parties, we may be unable to continue to commercialize SUBSYS® or to develop our product candidates.

We rely on a number of third parties for the commercial supply of SUBSYS® and the clinical supply of our product candidates. Our ability to commercially supply SUBSYS® and to develop our product candidates depends, in part, on our ability to successfully obtain the API for SUBSYS® and the starting materials for dronabinol API for our dronabinol product candidates and the API for any other product candidates, and outsource most if not all of the aspects of their manufacturing at competitive costs, in accordance with regulatory requirements and in sufficient quantities for commercialization and clinical testing. If we fail to develop and maintain supply relationships with these third parties, we may be unable to continue to commercialize SUBSYS® or develop our SYNDROS™ or any other product candidates.

We purchase the fentanyl API utilized in connection with SUBSYS® from one vendor as our sole supplier of the API in this product. We purchase the starting materials for our dronabinol API from several third parties. We do not have long-term agreements with any of these parties, but rather purchase material on a purchase order basis. Moreover, some of the starting material for our dronabinol API is difficult to procure and produce. Our ability to obtain fentanyl API and the starting materials for our dronabinol API in sufficient quantities and quality, and on a timely basis, is critical to our continued commercialization of SUBSYS® and to our successful completion of preclinical studies and clinical trials for our product candidates. There is no assurance that these suppliers will continue to produce the materials in the quantities and quality and at the times they are needed, if at all, especially in light of the fact that we intend to significantly increase our orders for these materials in the near future. Moreover, the replacement of any of these suppliers, particularly the supplier of the starting material for our dronabinol API that is difficult to produce, could lead to significant delays and increase in our costs.

We do not own or operate manufacturing facilities for SUBSYS® and currently lack the in-house capabilities to manufacture SUBSYS®. Our SUBSYS® sub-component manufacturing is performed by Aptar, with the final fill, assembly and packaging of SUBSYS® performed by DPT. If there are problems relating to the equipment utilized by Aptar to manufacture SUBSYS®, we will be responsible for fixing or replacing that equipment. Any requirement to do so could result in unexpected costs and expenses and delay the production of SUBSYS®, which could in turn negatively impact our business.

The manufacture of pharmaceutical products generally requires significant expertise and capital investment, often including the development of advanced manufacturing techniques and process controls. Manufacturers of pharmaceutical products often encounter difficulties in production, particularly in scaling up and validating initial production. These problems can include difficulties with production costs and yields, quality control, including stability of the product, quality assurance testing, shortages of qualified personnel, as well as compliance with strictly enforced federal, state and foreign regulations. Additionally, our manufacturers may experience difficulties due to resource constraints, labor disputes, unstable political environments or natural disasters. If our manufacturers were to encounter any of these difficulties, or otherwise fail to comply with their contractual obligations for any reason, our ability to commercially supply SUBSYS® or to provide dronabinol for any product candidates for preclinical studies or clinical trials could be jeopardized. Any delay or interruption in our ability to commercially supply SUBSYS® will result in the loss of potential revenues and could adversely affect the market’s acceptance of these products. We cannot guarantee that we will not encounter other manufacturing issues in the future. In addition, any delay or interruption in the supply of preclinical study or clinical trial supplies could delay the completion of those studies or trials, increase the costs associated with maintaining our programs and, depending upon the period of delay, require us to commence new studies or trials at additional expense or terminate studies or trials completely.

Manufacturers and suppliers are subject to regulatory requirements including cGMPs, which cover, among other things, manufacturing, testing, quality control and recordkeeping relating to our products and product candidates, and are subject to ongoing inspections by FDA, DEA and other regulatory agencies. Moreover, if we seek regulatory

30


approval for any product candidate, the facilities to be used by us or our third-party manufacturers for the manufacture of the product candidate must be approved by the applicable regulatory authorities before the product candidate may be approved and marketed. We do not control the manufacturing processes of third-party manufacturers and except for dronabinol API, we are currently completely dependent on them. If any of our third-party manufacturers cannot successfully manufacture product that conforms to our specifications and the applicable regulatory authorities’ strict regulatory requirements, they will not be able to secure or maintain regulatory approval for the manufacturing facilities. In addition, we have no control over the ability of third-party manufacturers to maintain adequate quality control, quality assurance and qualified personnel. If the FDA or any other applicable regulatory authorities do not approve these facilities for the manufacture of our products or product candidates or if they withdraw any such approval in the future, we may need to find alternative manufacturing facilities, which would significantly impact our ability to commercially supply SUBSYS® or develop or obtain regulatory approval for our product candidates.  

If our third-party manufacturers or suppliers fail to deliver the required commercial quantities of SUBSYS®  and the respective sub-components and starting materials, on a timely basis and at commercially reasonable prices, and we are unable to find one or more replacement manufacturers or suppliers capable of production at a substantially equivalent cost in substantially equivalent volumes and quality, and on a timely basis, the continued commercialization of SUBSYS®  and the development of our product candidates would be impeded, delayed, limited or prevented, which could have a material adverse effect on our business, results of operations, financial condition and prospects.

We may encounter delays in the manufacturing of SUBSYS® or fail to generate revenue if our supply of the components of our sublingual spray delivery system is interrupted.

Our sublingual spray drug delivery system is sourced, manufactured and assembled by multiple third parties across different geographic locations in the United States and Europe. All contract manufacturers and component suppliers have been selected for their specific competencies in the manufacturing processes and materials that make up the sublingual spray system. The components of the spray system include the actuator subassembly, vial subassembly, and the setting mechanism. The actuator subassembly is comprised of nine individual components which are collectively supplied by six different third-party manufacturers. The vial subassembly that houses the sterile drug formulation fentanyl is comprised of five different components supplied by four third-party manufacturers. Each of these third-party manufacturers is currently the single source of their respective components. If any of these manufacturers is unable to supply its respective component for any reason, including due to violations of cGMPs for medical devices, known as QSR, our ability to both have the finished sublingual spray device manufactured and to commercially supply SUBSYS® will be adversely affected and we would lose potential revenue. Accordingly, a failure in any part of our supply chain may cause a material adverse effect on our ability to generate revenue from SUBSYS®, which in turn could have a material adverse effect on our business, results of operations, financial condition and prospects.

We face intense competition, including from generic products. If our competitors market or develop alternative treatments that are approved more quickly or marketed more effectively than our product candidates or are demonstrated to be safer or more effective than our products, our commercial opportunities will be reduced or eliminated.

The pharmaceutical industry is characterized by rapidly advancing technologies, intense competition and a strong emphasis on developing proprietary therapeutics. We face competition from a number of sources, some of which may target the same indications as our products or product candidates, such as pharmaceutical companies, including generic drug companies, biotechnology companies, drug delivery companies and academic and research institutions, many of which have greater financial resources, marketing capabilities, including well-established sales forces, manufacturing capabilities, research and development capabilities, experience in obtaining regulatory approvals for product candidates and other resources than us.

SUBSYS® competes against numerous branded and generic products already being marketed and potentially those which are or will be in development. Many of these competitive products are offered in the United States by large, well-capitalized companies. SUBSYS® is the fourth new branded TIRF product in the last six years. In the BTCP market, physicians often treat BTCP with a variety of short-acting opioid medications, including morphine, morphine and codeine derivatives and fentanyl. Some currently marketed products against which we directly compete include Teva Pharmaceutical Industries Ltd.’s Fentora and Actiq, Galena’s Abstral, Depomed’s Lazanda and

31


BioDelivery Sciences International, Inc.’s Onsolis. Some generic fentanyl products against which SUBSYS® competes are marketed by Mallinckrodt, Inc., Par Pharmaceutical Companies, Inc. and Actavis, Inc. In addition, we are aware of numerous companies developing other treatments and technologies for rapid delivery of opioids to treat BTCP, including transmucosal, transdermal, nasal spray, and inhaled sublingual delivery systems. If these treatments and technologies are successfully developed and approved, they could represent significant additional competition to SUBSYS®.  

With respect to our dronabinol product candidates, the market in which we intend to compete is challenging in part because generic products generally face greater price competition than branded products and the competition from generic products may have an effect on our product prices, market share, revenues and profitability. We may not be able to differentiate any products that we may market from those of our competitors, successfully develop or introduce new products that are less costly or offer better performance than those of our competitors, or offer purchasers of our products payment and other commercial terms as favorable as those offered by our competitors. In addition, there are a number of established therapies and products already commercially available and under development by other companies that treat the indications that our dronabinol product candidates are intended to treat. Specifically, if approved, our dronabinol product candidates will compete, against therapies and products such as Abbvie, Inc.’s Marinol and Marinol generics. Par Pharmaceutical Companies markets an approved generic version of Marinol and Actavis markets an authorized generic version of Marinol. We cannot give any assurance that other companies will not obtain regulatory approval or acceptable DEA classification for, or commercialize additional generic dronabinol products.

Moreover, our dronabinol products may compete with non-synthetic cannabinoid drugs, including therapies such as GW Pharmaceuticals plc’s Sativex, especially in many countries outside of the United States where non-synthetic cannabinoids are legal. In addition, literature has been published arguing the benefits of natural cannabis, or marijuana, over dronabinol, and there are a number of states that have already enacted laws legalizing medicinal and recreational marijuana. There is some support in the United States for further legalization of marijuana. We also cannot assess the extent to which patients utilize marijuana illegally to alleviate CINV, instead of using prescribed therapies such as approved dronabinol products. Furthermore, in the treatment of CINV, physicians typically offer conventional anti-nausea drugs prior to initiating chemotherapy, such as Sanofi’s Anzemet, Eisai Inc./Helsinn Group’s Aloxi, Roche Holding AG’s Kytril, Par Pharmaceutical Companies’ Zuplenz and GlaxoSmithKline plc’s Zofran, as well as Neurokinin 1 receptor antagonists on the market including Kyowa Hakko Kirin Co., Ltd.’s Sancuso and Merck & Co., Inc.’s Emend. To the extent that SYNDROS™ and our dronabinol product candidates compete in the broader CINV market, we will also face competition from these products and their generic equivalents, as applicable.

Additionally, we are aware of companies in late stage development for CINV product candidates, including A.P. Pharma, Inc.’s APF530 (Phase 3) Aphios Corp.’s Zindo (Phase 2/3), Tesaro, Inc.’s Rolapitant (Phase 3) and Roche Holding/Helsinn Group’s Netupitant (Phase 3). If these products are successfully developed and approved over the next few years, they could represent significant competition for our dronabinol product candidates.

We also face competition from third parties in obtaining allotments of fentanyl and dronabinol under applicable DEA annual quotas, recruiting and retaining qualified personnel, establishing clinical trial sites and enrolling patients in clinical trials, and in identifying and acquiring or in-licensing new products and product candidates.

Our competitors may also develop products that are more effective, better tolerated, subject to fewer or less severe side effects, more useful, more widely-prescribed or accepted, or less costly than ours. For each product we commercialize, sales and marketing efficiency are likely to be significant competitive factors. We have built a commercial organization to market SUBSYS®  in the United States without using third-party sales or marketing channels, and expect to expand and utilize this commercial organization in the United States for any additional proprietary product candidates that we develop, and there can be no assurance that we can maintain and augment these capabilities in a manner that will be cost efficient and competitive with the sales and marketing efforts of our competitors, especially since some or all of those competitors could expend greater economic resources than we do and/or employ third-party sales and marketing channels.

32


If we are unable to achieve and maintain adequate levels of coverage and reimbursement from third-party payers for SUBSYS®, or any future products we may seek to commercialize, on reasonable pricing terms, their commercial success may be severely hindered.

Successful sales of our products depend on the availability of adequate coverage and reimbursement from third-party payers. Patients who are prescribed medicine for the treatment of their conditions generally rely on third-party payers to reimburse all or part of the costs associated with their prescription drugs. Adequate coverage and reimbursement from governmental healthcare programs, such as Medicare and Medicaid, and commercial payers is critical to new product acceptance. Coverage decisions may depend upon clinical and economic standards that disfavor new drug products when more established or lower cost therapeutic alternatives are already available or subsequently become available. Assuming we obtain coverage for a given product, the resulting reimbursement payment rates might not be adequate or may require co-payments that patients find unacceptably high. Patients are unlikely to use our products unless coverage is provided and reimbursement is adequate to cover a significant portion of the cost of our products.

In addition, the market for our products will depend significantly on access to third-party payers’ drug formularies, or lists of medications for which third-party payers provide coverage and reimbursement. The competition to be included in such formularies often leads to downward pricing pressures on pharmaceutical companies. Also, third-party payers may refuse to include a particular branded drug in their formularies or otherwise restrict patient access to a branded drug when a less costly generic equivalent or other alternative is available. For example, many third-party payers require usage and failure on cheaper generic versions of Actiq prior to providing reimbursement for SUBSYS® and other branded TIRF products, which limits SUBSYS®’ use as a first-line treatment option.

Third-party payers, whether foreign or domestic, or governmental or commercial, are developing increasingly sophisticated methods of controlling healthcare costs. In addition, in the United States, no uniform policy of coverage and reimbursement for drug products exists among third-party payers. Therefore, coverage and reimbursement for drug products can differ significantly from payer to payer. As a result, the coverage determination process is often a time-consuming and costly process that will require us to provide scientific and clinical support for the use of our products to each payer separately, with no assurance that coverage and adequate reimbursement will be obtained.

Further, we believe that future coverage and reimbursement will likely be subject to increased restrictions both in the United States and in international markets. Third-party coverage and reimbursement for SUBSYS® or any of our product candidates for which we may receive regulatory approval may not be available or adequate in either the United States or international markets, which could have a material adverse effect on our business, results of operations, financial condition and prospects.

We depend on wholesale pharmaceutical distributors for retail distribution of SUBSYS®; if we lose any of our significant wholesale pharmaceutical distributors, our business could be harmed.

The majority of our sales of SUBSYS® are to wholesale pharmaceutical distributors who, in turn, sell the products to pharmacies, hospitals and other customers. For the year ended December 31, 2016, four wholesale pharmaceutical distributors, Rochester Drug Cooperative, Inc., AmerisourceBergen Corporation, McKesson Corporation, and Cardinal Health, Inc., individually comprised approximately 15%, 17%, 16% and 14%, respectively, of our total gross sales of SUBSYS®. The loss by us of any of these wholesale pharmaceutical distributors’ accounts or a material reduction in their purchases could have a material adverse effect on our business, results of operations, financial condition and prospects.

In addition, these wholesale customers comprise a significant part of the distribution network for pharmaceutical products in the United States. This distribution network has undergone, and may continue to undergo, significant consolidation marked by mergers and acquisitions. As a result, a small number of large wholesale distributors control a significant share of the market. Consolidation of drug wholesalers has increased, and may continue to increase, competitive and pricing pressures on pharmaceutical products. We cannot assure you that we can manage these pricing pressures or that wholesaler purchases will not fluctuate unexpectedly from period to period.

Our sales of SUBSYS® can be greatly affected by the inventory levels our respective wholesalers carry. We monitor wholesaler inventory of SUBSYS® using a combination of methods. Pursuant to distribution service

33


agreements with our three largest wholesale customers, we receive inventory level reports. For most other wholesalers where we do not receive inventory level reports, however, our estimates of wholesaler inventories may differ significantly from actual inventory levels. Significant differences between actual and estimated inventory levels may result in excessive production (requiring us to hold substantial quantities of unsold inventory), inadequate supplies of products in distribution channels, and insufficient product available at the retail level. These changes may cause our revenues to fluctuate significantly from quarter to quarter, and in some cases may cause our operating results for a particular quarter to be below our expectations or the expectations of securities analysts or investors. In addition, at times, wholesaler purchases may exceed customer demand, resulting in reduced wholesaler purchases in later quarters, which may result in substantial fluctuations in our results of operations from period to period. If our financial results are below expectations for a particular period, the market price of our common stock may drop significantly.

We rely on third parties to perform many necessary services for SUBSYS®, including services related to distribution, invoicing, storage and transportation, and expect to do so for any future branded proprietary products, if approved.

We have retained third-party service providers to perform a variety of functions related to the sale and distribution of SUBSYS®, key aspects of which are out of our direct control. For example, we rely on Cardinal Health 105, Inc. (a/k/a Specialty Pharmaceutical Services) to provide key services related to logistics, warehousing and inventory management, distribution, contract administration and chargeback processing, accounts receivable management and call center management, and, as a result, most of our SUBSYS® inventory is stored at a single warehouse maintained by the service provider. We must rely on this provider as well as other third-party providers that perform services for us, including entrusting our inventories of SUBSYS® to their care and handling. If these third-party service providers fail to comply with applicable laws and regulations, fail to meet expected deadlines, or otherwise do not carry out their contractual duties to us, or encounter physical damage or natural disaster at their facilities, our ability to deliver SUBSYS® to meet commercial demand would be significantly impaired. In addition, we utilize third parties to perform various other services for us relating to sample accountability and regulatory monitoring, including adverse event reporting, safety database management and other product maintenance services. If the quality or accuracy of the data maintained by these service providers is insufficient, our ability to continue to market SUBSYS® could be jeopardized or we could be subject to regulatory sanctions. We do not currently have the internal capacity to perform these important commercial functions, and we may not be able to maintain commercial arrangements for these services on reasonable terms.

In addition to the level of commercial success of our approved products, our future growth is also dependent on our ability to successfully develop a pipeline of product candidates, and we cannot give any assurance that any of our product candidates will receive regulatory approval or acceptable DEA classification, if applicable, or that any approved products will be successfully commercialized.

Our long-term growth will be limited unless we can successfully develop a pipeline of additional product candidates. We do not have internal new drug discovery capabilities, and our primary focus is on developing improved formulations and delivery methods for existing FDA-approved products.

The research, testing, manufacturing, labeling, approval, sale, marketing and distribution of drug products containing controlled substances, among other things, are subject to extensive regulation by the FDA, the DEA and other regulatory authorities in the United States. Obtaining approval of an NDA is a lengthy, expensive and uncertain process. The FDA also has substantial discretion in the drug approval process, including the ability to delay, limit or deny approval of a product candidate for many reasons. For example:

 

the FDA may not deem a product candidate safe and effective;

 

the FDA may not find the data from pre-clinical studies and clinical trials sufficient to support approval;

 

the FDA may require additional pre-clinical studies or clinical trials;

 

the FDA may not approve our third-party manufacturers’ processes and facilities; or

 

the FDA may change its approval policies or adopt new regulations.

34


Any of our product candidates may fail to achieve their specified endpoints in clinical trials. Furthermore, product candidates may not be approved even if they achieve their specified endpoints in clinical trials. The FDA may disagree with our trial design and our interpretation of data from clinical trials, or may change the requirements for approval even after it has reviewed and commented on the design for our clinical trials. The FDA may also approve a product candidate for fewer or more limited indications than we request, or may grant approval contingent on the performance of costly post-approval clinical trials (i.e., Phase IV trials). In addition, the FDA may not approve the labeling claims that we believe are necessary or desirable for the successful commercialization of our product candidates.

If we are unable to expand our pipeline and obtain regulatory approval for our product candidates on the timelines we anticipate, we will not be able to execute our business strategy effectively and our ability to substantially grow our revenues will be limited, which would have a material adverse impact on our long-term business, results of operations, financial condition and prospects.

Our clinical trials may fail to demonstrate acceptable levels of safety and efficacy of any of our product candidates, which could prevent or significantly delay their regulatory approval.

Our product candidates are prone to the risks of failure inherent in drug development. Before obtaining U.S. regulatory approval for the commercial sale of any product candidate, we must gather substantial evidence from well-controlled clinical trials that demonstrate to the satisfaction of the FDA that the product candidate is safe and effective for its proposed indication, and similar regulatory approvals would be necessary to commercialize the product candidate in other countries.

In light of widely publicized events concerning the safety risk of certain drug products, particularly drug products that contain controlled substances, regulatory authorities, members of Congress, the GAO, medical professionals and the general public have raised concerns about potential drug safety issues. These events have resulted in the withdrawal of drug products, revisions to drug labeling that further limit use of the drug products and establishment of risk management programs that may, for instance, restrict distribution of drug products after approval. In addition, the FDCA authorizes the FDA to, among other things, require post-approval studies and clinical trials, mandate changes to drug labeling to reflect new safety information and require a REMS for certain drugs, including certain currently approved drugs. Under the FDCA, companies that violate these and other provisions of the law are subject to substantial civil monetary penalties, among other regulatory, civil and criminal penalties.

The increased attention to drug safety issues may result in a more cautious approach by the FDA in its review of our clinical trials. Data from clinical trials may receive greater scrutiny with respect to safety, which may make the FDA or other regulatory authorities more likely to terminate clinical trials before completion, or require longer or additional clinical trials that may result in a delay or failure in obtaining approval or approval for a more limited indication than originally sought.

Clinical trials for our product candidates are expensive, time consuming, uncertain and susceptible to change, delay or termination.

Clinical trials are very expensive, time consuming and difficult to design and implement. Other than with respect to our lead product candidate, SYNDROS™, most of our other product candidates are in preclinical development. We estimate that clinical trials for these product candidates, if and when initiated, will continue for several years and may take significantly longer than expected to complete. In addition, we, the FDA, an IRB, or other regulatory authorities, including state and local, may suspend, delay or terminate our clinical trials at any time, or the DEA could suspend or terminate the registrations and quota allotments we require in order to procure and handle controlled substances, for various reasons, including:

 

lack of effectiveness of any product candidate during clinical trials;

 

discovery of serious or unexpected toxicities or side effects experienced by study participants or other safety issues;

 

slower than expected rates of subject recruitment and enrollment rates in clinical trials;

35


 

difficulty in retaining subjects who have initiated a clinical trial but may withdraw at any time due to adverse side effects from the therapy, insufficient efficacy, fatigue with the clinical trial process or for any other reason;

 

delays or inability in manufacturing or obtaining sufficient quantities of materials for use in clinical trials, in particular obtaining sufficient quantities of dronabinol due to regulatory and manufacturing constraints;

 

inadequacy of or changes in our manufacturing process or product formulation;

 

delays in obtaining regulatory authorization to commence a study, or “clinical holds” or delays requiring suspension or termination of a study by a regulatory agency, such as the FDA, before or after a study is commenced;

 

DEA-related recordkeeping, reporting, or security violations at a clinical site, leading the DEA or state authorities to suspend or revoke the site’s controlled substance license and causing a delay or termination of planned or ongoing studies;

 

changes in applicable regulatory policies and regulations;

 

delays or failure in reaching agreement on acceptable terms in clinical trial contracts or protocols with prospective clinical trial sites;

 

uncertainty regarding proper dosing;

 

unfavorable results from ongoing clinical trials and preclinical studies;

 

failure of our CROs or other third-party contractors to comply with all contractual and regulatory requirements or to perform their services in a timely or acceptable manner;

 

failure by us, our employees, our CROs or their employees to comply with all applicable FDA, DEA or other regulatory requirements relating to the conduct of clinical trials or the handling, storage, security and recordkeeping for controlled substances;

 

scheduling conflicts with participating clinicians and clinical institutions;

 

failure to design appropriate clinical trial protocols;

 

insufficient data to support regulatory approval;

 

inability or unwillingness of medical investigators to follow our clinical protocols;

 

difficulty in maintaining contact with subjects during or after treatment, which may result in incomplete data; or

 

regulatory concerns with cannabinoid or opioid products generally and the potential for abuse of the drugs.

Generally, there is a high rate of failure for drug candidates proceeding through clinical trials. We may suffer significant setbacks in our clinical trials similar to the experience of a number of other companies in the pharmaceutical and biotechnology industries, even after receiving promising results in earlier trials. Further, even if we view the results of a clinical trial to be positive, the FDA or other regulatory authorities may disagree with our interpretation of the data. In the event that we abandon or are delayed in our clinical development efforts related to our product candidates, we may not be able to execute on our business plan effectively, we may not be able to become profitable, our reputation in the industry and in the investment community would likely be significantly damaged and our stock price would likely decrease significantly.

We have in the past relied and expect to continue to rely on third parties to conduct and oversee our clinical trials. If these third parties do not meet our deadlines or otherwise conduct the trials as required, we may not be able to obtain regulatory approval for or commercialize our product candidates when expected or at all.

We have in the past relied and expect to continue to rely on third-party CROs to conduct and oversee our clinical trials. For example, we contracted with Worldwide Clinical Trials to conduct and oversee our pivotal bioequivalence study for SYNDROS™.

36


We also rely upon various medical institutions, clinical investigators and contract laboratories to conduct our trials in accordance with our clinical protocols and all applicable regulatory requirements, including the FDA’s good clinical practice regulations and DEA and state regulations governing the handling, storage, security and recordkeeping for controlled substances. These CROs and third parties play a significant role in the conduct of these trials and the subsequent collection and analysis of data from the clinical trials. We rely heavily on these parties for the execution of our clinical and preclinical studies, and control only certain aspects of their activities.

If any of our clinical trial sites terminate their involvement in one of our clinical trials for any reason, we may experience the loss of follow-up information on patients enrolled in our ongoing clinical trials unless we are able to transfer the care of those patients to another qualified clinical trial site. In addition, principal investigators for our clinical trials may serve as scientific advisors or consultants to us from time to time and receive cash or equity compensation in connection with such services. If these relationships and any related compensation result in perceived or actual conflicts of interest, the integrity of the data generated at the applicable clinical trial site may be questioned by the FDA.

We have conducted and may in the future conduct clinical trials for our products or product candidates outside the United States and the FDA may not accept data from such trials.

We have conducted and may in the future choose to conduct one or more of our clinical trials outside the United States. For example, our Phase 3 SUBSYS® safety trial was conducted at 46 sites in the United States and ten sites in India. Although the FDA may accept data from clinical trials conducted outside the United States, acceptance of such study data by the FDA is subject to certain conditions. For example, the study must be well designed and conducted and performed by qualified investigators in accordance with ethical principles. The study population must also adequately represent the U.S. population, and the data must be applicable to the U.S. population and U.S. medical practice in ways that the FDA deems clinically meaningful. Generally, the patient population for any clinical studies conducted outside of the United States must be representative of the population for whom we intend to label the product in the United States. In addition, such studies would be subject to the applicable local laws and FDA acceptance of the data would be dependent upon its determination that the studies also complied with all applicable U.S. laws and regulations. There can be no assurance the FDA will accept data from trials conducted outside of the United States. If the FDA does not accept any such data, it would likely result in the need for additional trials, which would be costly and time-consuming and delay aspects of our business plan.

Since the starting materials we utilize to manufacture dronabinol are sourced out of India, we are exposed to a number of risks and uncertainties associated with that geographic region.

The suppliers of the starting materials we utilize to manufacture dronabinol are located in India. This exposes us to a number of risks and uncertainties outside our control. India has suffered political instability in the past due to various factors. There have also been armed conflicts between India and neighboring Pakistan. Moreover, extremist groups within India and neighboring Pakistan have from time to time targeted Western interests. In addition, India is susceptible to natural disasters such as earthquakes and floods. Political instability, future hostilities with countries such as Pakistan, targeting of our interests by extremist attacks, and earthquakes or other natural disasters in India could harm our operations and impede our ability to produce dronabinol on our anticipated timeline, or at all.

If the FDA does not conclude that certain of our product candidates satisfy the requirements for the Section 505(b)(2) regulatory approval pathway, or if the requirements for such product candidates under Section 505(b)(2) are not as we expect, the approval pathway for those product candidates will likely take significantly longer, cost significantly more and entail significantly greater complications and risks than anticipated, and in either case may not be successful.

We are developing several proprietary dronabinol product candidates, including SYNDROS™ and Dronabinol Inhalation Device, for which we intend to seek FDA approval through the Section 505(b)(2) regulatory pathway. Section 505(b)(2), if applicable to us under the FDCA, would allow an NDA we submit to FDA to rely in part on data in the public domain or the FDA’s prior conclusions regarding the safety and effectiveness of approved compounds, which could expedite the development program for our product candidates by potentially decreasing the amount of clinical data that we would need to generate in order to garner FDA approval. If the FDA does not allow us to pursue the Section 505(b)(2) regulatory pathway as anticipated, we may need to conduct additional clinical trials, provide

37


additional data and information, and meet additional standards for regulatory approval. If this were to occur, the time and financial resources required to obtain FDA approval for these product candidates, and complications and risks associated with these product candidates, would likely substantially increase. We could need to obtain more additional funding, which could result in significant dilution to the ownership interests of our then existing stockholders to the extent we issue equity securities or convertible debt. We cannot assure you that we would be able to obtain such additional financing on terms acceptable to us, if at all. Moreover, inability to pursue the Section 505(b)(2) regulatory pathway would likely result in new competitive products reaching the market more quickly than our product candidates, which would likely materially adversely impact our competitive position and prospects. Even if we are allowed to pursue the Section 505(b)(2) regulatory pathway, we cannot assure you that our product candidates will receive the requisite approvals for commercialization.

In addition, notwithstanding the approval of a number of products by the FDA under Section 505(b)(2) over the last few years, certain brand-name pharmaceutical companies and others have objected to the FDA’s interpretation of Section 505(b)(2). If the FDA’s interpretation of Section 505(b)(2) is successfully challenged, the FDA may be required to change its 505(b)(2) policies and practices, which could delay or even prevent the FDA from approving any NDA that we submit under Section 505(b)(2). In addition, the pharmaceutical industry is highly competitive, and Section 505(b)(2) NDAs are subject to special requirements designed to protect the patent rights of sponsors of previously approved drugs that are referenced in a Section 505(b)(2) NDA. These requirements may give rise to patent litigation and mandatory delays in approval of our NDAs for up to 30 months or longer depending on the outcome of any litigation. It is not uncommon for a manufacturer of an approved product to file a citizen petition with the FDA seeking to delay approval of, or impose additional approval requirements for, pending competing products. If successful, such petitions can significantly delay, or even prevent, the approval of the new product. However, even if the FDA ultimately denies such a petition, the FDA may substantially delay approval while it considers and responds to the petition. In addition, even if we are able to utilize the Section 505(b)(2) regulatory pathway, there is no guarantee this would ultimately lead to accelerated product development or earlier approval.

Moreover, even if our product candidates are approved under Section 505(b)(2), the approval may be subject to limitations on the indicated uses for which the products may be marketed or to other conditions of approval, or may contain requirements for costly post-marketing testing and surveillance to monitor the safety or efficacy of the products.

Annual DEA quotas on the amount of dronabinol allowed to be produced in the United States and our specific allocation of dronabinol by the DEA could significantly limit the production or sale of any dronabinol product candidates for which we obtain regulatory approval as well as significantly delay the clinical development of our dronabinol product candidates.

Dronabinol, a Schedule I substance, is subject to the DEA’s production and procurement quota scheme. The DEA establishes annually an aggregate quota for the amount of dronabinol that may be produced in the United States based on the DEA’s estimate of the quantity needed to meet legitimate scientific and medicinal needs. This limited aggregate amount of dronabinol that the DEA allows to be produced in the United States each year is allocated among individual companies, who must submit applications annually to the DEA for individual production and procurement quotas. We are required to obtain an annual quota from the DEA in order to manufacture and produce dronabinol. The DEA may adjust aggregate production quotas and individual production and procurement quotas from time to time during the year and has substantial discretion in deciding whether or not to make such adjustments. For 2017, we were allocated what we believe is a sufficient quantity of dronabinol to meet our currently anticipated production and testing needs through 2017. However, we may need additional amounts of dronabinol in future years to implement our business plan.

We do not know what amounts of dronabinol other companies developing or marketing dronabinol product candidates may have requested for 2018 or will request in future years. The DEA, in assessing factors such as medical need, abuse potential and other policy considerations, may have chosen to set the aggregate dronabinol quota for 2017 lower than the total amount requested by the companies, and may do so in the future. Though companies are permitted to petition the DEA to increase the aggregate quota for dronabinol in a given year after it is initially established, there is no guarantee the DEA would act promptly or favorably upon such a petition. The success of our business plan will depend in part on our being able to expand the overall market for the medical use of dronabinol by introducing new dronabinol formulations, and to sell significant amounts of our approved dronabinol products. In order to do so, we

38


will need to receive from the DEA significantly increased allotments of dronabinol quotas over time and likely an increase in the aggregate annual quota. Any delay or refusal by the DEA in establishing quotas necessary for us to execute on our business plan could negatively impact our ability to sell SYNDROS™, if finalization of labeling by the FDA is obtained, and any other dronabinol product candidate for which we obtain regulatory approval, as well as our preclinical studies and clinical trials, which would in turn have a material adverse effect on our business, our ability to execute on our business plan, our financial position and results of operations, our prospects, and our ability to generate revenue to fund the development of our other product candidates.

Our failure to successfully develop, acquire and market additional product candidates or approved products would impair our ability to grow our business.

As part of our growth strategy we intend to seek to expand our product pipeline by developing or exploring acquisition or in-licensing opportunities of proven drugs that can be paired with our sublingual spray drug delivery system. Some of these drugs may require reformulation to accommodate the approved doses in smaller volumes that are compatible with our delivery system. Any reformulation may increase the risk of failure during development, extend the development timelines, increase development costs and add complexity to the regulatory approval process and in some cases reformulation may not be possible. If we are not able to identify additional drug compounds that can be delivered via the current version of our sublingual spray technology, or if we are unable to successfully develop higher dose versions of this technology, our ability to develop additional product candidates and grow our business would be adversely affected.

Furthermore, we intend to in-license, acquire, develop and/or market additional products and product candidates in the areas of supportive care. Because our internal research and development capabilities are limited, we may be dependent upon pharmaceutical and biotechnology companies, academic scientists and other researchers to license or sell products or technology to us. The success of this strategy depends partly upon our ability to identify and select promising pharmaceutical product candidates and products, negotiate licensing or acquisition agreements with their current owners and finance these arrangements.

The process of proposing, negotiating and implementing a license or acquisition of a product candidate or approved product is lengthy and complex. Other companies, including some with substantially greater financial, marketing, sales and other resources, may compete with us for the license or acquisition of product candidates and approved products. We have limited resources to identify and execute the acquisition or in-licensing of third-party products, businesses and technologies and integrate them into our current infrastructure. Moreover, we may devote resources to potential acquisitions or licensing opportunities that are never completed, or we may fail to realize the anticipated benefits of such efforts. We may not be able to acquire the rights to additional product candidates on terms that we find acceptable, or at all.

Further, any product candidate that we acquire may require additional development efforts prior to commercial sale, including pre-clinical or clinical testing and approval by the FDA and applicable foreign regulatory authorities. All product candidates are prone to risks of failure typical of pharmaceutical product development, including the possibility that a product candidate will not be shown to be sufficiently safe and effective for approval by regulatory authorities. In addition, we cannot provide assurance that any approved products that we acquire will be manufactured or sold profitably or achieve market acceptance.

If we fail to attract and keep management and other key personnel, as well as our board members, we may be unable to continue to successfully commercialize SUBSYS® or SYNDROS™, develop our product candidates or otherwise implement our business plan.

Our ability to compete in the highly competitive biotechnology and pharmaceuticals industries depends upon our ability to attract and retain highly qualified managerial, scientific, medical and other personnel. We are highly dependent on our management, scientific and medical personnel, as well as our board members. The loss of the services of any of these individuals could impede, delay or prevent the continuing commercialization of SUBSYS® or SYNDROS™ and the development of our product candidates and could negatively impact our ability to successfully implement our business plan. If we lose the services of any of these individuals, we may not be able to find suitable replacements on a timely basis or at all, and our business would likely be harmed as a result. We do not maintain “key man” insurance policies on the lives of these individuals or the lives of any of our other employees. We employ all of

39


our executive officers and key personnel on an at-will basis and their employment can be terminated by us or them at any time, for any reason and without notice; provided, however, that under certain circumstances we may owe them additional compensation in connection with such termination.

In order to retain valuable employees at our company, in addition to salary and cash incentives, we provide incentive stock options that vest over time as well as certain other market based benefits and compensation. The value to employees of stock options that vest over time will be significantly affected by movements in our stock price that are beyond our control, and may at any time be insufficient to counteract offers from other companies.

We may not be able to attract or retain qualified management and other key personnel in the future due to the intense competition for qualified personnel among biotechnology, pharmaceutical and other businesses, particularly in the Chandler, Arizona area where we are headquartered. Our industry has experienced a high rate of turnover of management personnel in recent years. As such, we could have difficulty attracting experienced personnel to our company and may be required to expend significant financial resources in our employee recruitment and retention efforts. Many of the other biotechnology and pharmaceutical companies with whom we compete for qualified personnel have greater financial and other resources, different risk profiles and longer histories in the industry than we do. They also may provide more diverse opportunities and better chances for career advancement. Some of these characteristics may be more appealing to high quality candidates than that which we have to offer. If we are not able to attract and retain the necessary personnel to accomplish our business objectives, we may experience constraints that will impede significantly our ability to implement our business strategy and achieve our business objectives.

In addition, we have scientific and clinical advisors who assist us in formulating our development and clinical strategies. These advisors are not our employees and may have commitments to, or consulting or advisory contracts with, other entities that may limit their availability or loyalty to us. In addition, our advisors may have arrangements with other companies to assist those companies in developing products or technologies that may compete with ours.

Our employees may engage in misconduct or other improper activities, including noncompliance with regulatory standards.

We are exposed to the risk of fraud or other misconduct of our employees, contractors or agents. Misconduct by employees, contractors or agents could include intentional failures to comply with FDA regulations, provide accurate information by our employees, contractors and agents to the FDA, comply with applicable manufacturing standards, comply with federal and state healthcare privacy, fraud and abuse laws and regulations, report financial information or data accurately or disclose unauthorized activities to us. In particular, sales, marketing and business arrangements in the healthcare industry are subject to extensive laws and regulations intended to prevent fraud, misconduct, kickbacks, self-dealing and other abusive practices. These laws and regulations may restrict or prohibit a wide range of pricing, false claims, discounting, marketing and promotion, sales commission, customer incentive programs and other business arrangements. These laws also dictate the proper use of patient information and data which is subject to privacy laws such as HIPAA. Misconduct could also involve the improper use of information obtained in the course of clinical trials, or illegal misappropriation of drug product, or illegal promotion of a drug product for off-label use, which could result in regulatory sanctions and serious harm to our reputation. We have adopted a Code of Business Conduct and Ethics, but it is not always possible to identify and deter employee misconduct, and the precautions we take to detect and prevent this activity may not be effective in controlling unknown or unmanaged risks or losses or in protecting us from governmental investigations or other actions or lawsuits stemming from a failure to be in compliance with such laws or regulations. If any such actions are instituted against us, and we are not successful in defending ourselves or asserting our rights, those actions could have a significant impact on our business, including the imposition of significant fines or other sanctions.

Our ability to utilize our net operating loss carryforwards, or NOLs, and research and development income tax credit carryforwards may be limited.

Under Section 382 of the Internal Revenue Code of 1986, as amended, or the Code, substantial changes in our ownership may limit the amount of NOLs and research and development income tax credit carryforwards that could be utilized annually in the future to offset taxable income, if any. Specifically, this limitation may arise in the event of a cumulative change in ownership of our company of more than 50% within a three-year period. Any such annual limitation, whether as the result of prior transactions, sales of common stock by our existing stockholders or additional

40


sales of common stock by us, may significantly reduce the utilization of the NOLs before they expire and could have an adverse effect on our future results of operations.

On November 8, 2010, we entered into the NeoPharm merger. The NeoPharm merger was accounted for as a reverse acquisition and resulted in a change of 50% or more of the ownership of NeoPharm. Based on the above, we have estimated the amount of pre-merger federal NOLs that are available to offset our post-merger income is limited to an aggregate of $1.1 million as of December 31, 2016. For state income tax purposes, we have $268.1 million of state NOLs, all of which relate to Illinois state NOLs, which are available to offset future Illinois taxable income. We have placed a valuation allowance on a significant portion of our Illinois state NOLs because it is not more likely than not that such amounts will be realized due to current levels of activity in Illinois.

We may engage in strategic transactions that could impact our liquidity, increase our expenses and present significant distractions to our management.

From time to time we may consider strategic transactions, such as acquisitions of companies, asset purchases and out-licensing or in-licensing of products, product candidates or technologies. Additional potential transactions that we may consider include a variety of different business arrangements, including spin-offs, strategic partnerships, joint ventures, restructurings, divestitures, business combinations and investments. Any such transaction may require us to incur non-recurring or other charges, may increase our near and long-term expenditures and may pose significant integration challenges or disrupt our management or business, which could adversely affect our operations and financial results. For example, these transactions may entail numerous operational and financial risks, including:

 

exposure to unknown or unanticipated liabilities;

 

disruption of our business and diversion of our management’s time and attention in order to develop acquired products, product candidates or technologies;

 

incurrence of substantial debt or dilutive issuances of equity securities to pay for acquisitions;

 

higher than expected acquisition and integration costs;

 

write-downs of assets or goodwill or impairment charges;

 

increased amortization expenses;

 

difficulty and cost in combining the operations and personnel of any acquired businesses with our operations and personnel;

 

impairment of relationships with key suppliers or customers of any acquired businesses due to changes in management and ownership; and

 

inability to retain key employees of any acquired businesses.

Accordingly, although there can be no assurance that we will undertake or successfully complete any transactions of the nature described above, any transactions that we do complete could have a material adverse effect on our business, results of operations, financial condition and prospects.

We face potential product liability exposure, and if successful claims are brought against us, we may incur substantial liability if our insurance coverage for those claims is inadequate.

The commercial use of our products and clinical use of our product candidates expose us to the risk of product liability claims. This risk exists even if a product is approved for commercial sale by the FDA and manufactured in facilities licensed and regulated by the FDA, such as the case with SUBSYS®, SYNDROS™ and our discontinued Dronabinol SG Capsule, or an applicable foreign regulatory authority. Our products and product candidates are designed to affect important bodily functions and processes. Any side effects, manufacturing defects, misuse or abuse associated with SUBSYS® SYNDROS™, or Dronabinol SG Capsule or our product candidates could result in injury to a patient or even death. For example, because our sublingual spray technology is designed to be self-administered by patients, it is possible that a patient could fail to follow instructions and as a result apply a dose in a manner that results in injury or death. In addition, SUBSYS® is an opioid pain reliever that contains fentanyl, and

41


SYNDROS™ and our discontinued Dronabinol SG Capsule are synthetic cannabinoids, which are regulated “controlled substances” under the CSA and could result in harm to patients relating to its potential for abuse. In addition, a liability claim may be brought against us even if our products or product candidates merely appear to have caused an injury. Product liability claims may be brought against us by consumers, health care providers, pharmaceutical companies or others selling or otherwise coming into contact with our products or product candidates, among others. If we cannot successfully defend ourselves against product liability claims, we will incur substantial liabilities. In addition, regardless of merit or eventual outcome, product liability claims may result in:

 

the inability to commercialize our products or, if approved, our product candidates;

 

decreased demand for our products or, if approved, product candidates;

 

impairment of our business reputation;

 

product recall or withdrawal from the market;

 

withdrawal of clinical trial participants;

 

costs of related litigation;

 

distraction of management’s attention from our primary business;

 

substantial monetary awards to patients or other claimants; or

 

loss of revenues.

We have obtained product liability insurance coverage for commercial product sales and clinical trials with a $10.0 million per occurrence and a $10.0 million annual aggregate coverage limit. We also carry excess product liability insurance coverage for commercial product sales and clinical trials with an additional $10.0 million per occurrence and an additional $10.0 million annual aggregate coverage limit. Our insurance coverage may not be sufficient to cover all of our product liability related expenses or losses and may not cover us for any expenses or losses we may suffer. Moreover, insurance coverage is becoming increasingly expensive, and, in the future, we may not be able to maintain insurance coverage at a reasonable cost, in sufficient amounts or upon adequate terms to protect us against losses due to product liability. If we determine that it is prudent to increase our product liability coverage based on sales of SUBSYS® and of other product candidates or otherwise, we may be unable to obtain this increased product liability insurance on commercially reasonable terms or at all. Large judgments have been awarded in class action or individual lawsuits based on drugs that had unanticipated side effects, including side effects that are less severe than those associated with SUBSYS®, our discontinued Dronabinol SG Capsule and our product candidates. A successful product liability claim or series of claims brought against us could cause our stock price to decline and, if judgments exceed our insurance coverage, could decrease our cash and have a material adverse effect our business, results of operations, financial condition and prospects.

Our business involves the use of hazardous materials and we and our third-party manufacturers and suppliers must comply with environmental laws and regulations, which can be expensive and restrict how we do business.

Our research and development activities and our third-party manufacturers’ and suppliers’ activities involve the controlled storage, use and disposal of hazardous materials owned by us, including the components of our products and product candidates and other hazardous compounds. We and our manufacturers and suppliers are subject to laws and regulations governing the use, manufacture, storage, handling and disposal of these hazardous materials. In some cases, these hazardous materials and various wastes resulting from their use are stored at our and our manufacturers’ facilities pending use and disposal. We cannot completely eliminate the risk of contamination, which could cause an interruption of our commercialization efforts, research and development efforts and business operations, injury to our employees and others, environmental damage resulting in costly clean-up and liabilities under applicable laws and regulations governing the use, storage, handling and disposal of these materials and specified waste products. Although we believe that the safety procedures utilized by our third-party manufacturers for handling and disposing of these materials generally comply with the standards prescribed by these laws and regulations, we cannot guarantee that this is the case or eliminate the risk of accidental contamination or injury from these materials. In such an event, we may be held liable for any resulting damages and such liability could exceed our resources. We do not currently

42


carry biological or hazardous waste insurance coverage and our property and casualty and general liability insurance policies specifically exclude coverage for damages and fines arising from biological or hazardous waste exposure or contamination.

Our business and operations would suffer in the event of system failures.

Despite the implementation of security measures, our internal computer systems and those of our current and any future partners, contractors and consultants are vulnerable to damage from computer viruses, unauthorized access, natural disasters, terrorism, war and telecommunication and electrical failures. While we have not experienced any such material system failure, accident or security breach to date, if such an event were to occur and cause interruptions in our operations, it could result in a material disruption of our commercialization activities, drug development programs and our business operations. For example, the loss of clinical trial data from completed or future clinical trials could result in delays in our regulatory approval efforts and significantly increase our costs to recover or reproduce the data. Likewise, we rely on a large number of third parties to supply components for and manufacture our products and product candidates, warehouse and distribute SUBSYS® and conduct clinical trials, and similar events relating to their computer systems could also have a material adverse effect on our business. To the extent that any disruption or security breach were to result in a loss of, or damage to, our data or applications, or inappropriate disclosure of confidential or proprietary information, we could incur liability and the further commercialization and development of our products and product candidates could be delayed.

We may be adversely affected by natural disasters or other events that disrupt our business operations and our business continuity and disaster recovery plans may not adequately protect us from a serious disaster.

Our corporate headquarters and other facilities are located in Chandler, Arizona and Round Rock, Texas, which are not areas that have experienced severe earthquakes. We do not carry earthquake insurance. However, other natural disasters or similar events, like fires or explosions or large-scale accidents or power outages, could severely disrupt our operations, and have a material adverse effect on our business, results of operations, financial condition and prospects.

Our enterprise financial systems are located in our Chandler, Arizona headquarters. Our dronabinol API manufacturing facilities are in Round Rock, Texas. If a disaster, power outage or other event occurred that prevented us from using all or a significant portion of our headquarters or our Round Rock facilities, that damaged critical infrastructure, such as enterprise financial systems or manufacturing resource planning and enterprise quality systems, or that otherwise disrupted operations at either location, it may be difficult or, in certain cases, impossible for us to continue our business for a substantial period of time. The disaster recovery and business continuity plans we have in place currently are limited and are unlikely to prove adequate in the event of a serious disaster or similar event. We may incur substantial expenses as a result of the limited nature of our disaster recovery and business continuity plans which, particularly when taken together with our lack of earthquake insurance, could have a material adverse effect on our business.

Risks Related to Our Financial Position and Capital Requirements

We have had significant and increasing operating expenses and may require additional funding.

Our operations have consumed substantial amounts of cash since inception. We expect our operating and general and administrative expenses to continue to be significant and increase substantially in connection with our planned research, development and commercialization activities. We believe that cash generated from operations and our existing cash and cash equivalents, together with interest thereon, will be sufficient to fund our operations through at least the next 12 months from the issuance of this Annual Report. We have based these estimates, however, on assumptions that may prove to be wrong, and we could spend our available financial resources much faster than we currently expect. Further, we may need to raise additional capital to fund our operations and continue to support our planned research and development and commercialization activities.

43


The amount and timing of our future funding requirements will depend on many factors, including, but not limited to:

 

the timing and amount of revenue from sales of our main approved product, SUBSYS®, and any subsequently approved product candidates that are commercialized;

 

the size and cost of our commercial infrastructure;

 

the timing of FDA approval and DEA classification of our product candidates, if at all;

 

the timing, rate of progress and cost of any future clinical trials and other product development activities for our dronabinol product candidates and any other product candidates that we may develop, in-license or acquire;

 

costs associated with marketing and distributing SUBSYS® and any subsequently approved product candidates;

 

costs and timing of completion of any additional outsourced commercial manufacturing supply arrangements that we may establish;

 

costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights associated with SUBSYS®   and our product candidates;

 

costs associated with prosecuting or defending any litigation that we are or may become involved in and any damages payable by us that result from such litigation;

 

costs of operating as a public company;

 

the effect of competing technological and market developments;

 

our ability to acquire or in-license products and product candidates, technologies or businesses;

 

personnel, facilities and equipment requirements; and

 

the terms and timing of any additional collaborative, licensing, co-promotion or other arrangements that we may establish.

We may also need to raise additional funds to finance future cash needs through public or private equity offerings, debt financings, receivables or royalty financings or corporate collaboration and licensing arrangements. We cannot be certain that additional funding will be available on acceptable terms, or at all. To the extent that we raise additional capital by issuing equity securities or convertible debt, your ownership will be diluted. Any future debt financing into which we enter may impose upon us covenants that restrict our operations, including limitations on our ability to incur liens or additional debt, pay dividends, redeem our stock, make certain investments and engage in certain merger, consolidation or asset sale transactions. In addition, if we raise additional funds through corporate collaboration and licensing arrangements, it may be necessary to relinquish potentially valuable rights to products or product candidates, or grant licenses on terms that are not favorable to us.

If we are unable to raise additional capital when required or on acceptable terms, we may be required to significantly delay, scale back or discontinue one or more of our product development programs or commercialization efforts, or other aspects of our business plan. We also may be required to relinquish, license or otherwise dispose of rights to products or product candidates that we would otherwise seek to commercialize or develop ourselves on terms that are less favorable than might otherwise be available. In addition, our ability to achieve profitability or to respond to competitive pressures would be significantly limited.

Risks Related to Regulation of our Products and Product Candidates

If we fail to comply with federal and state healthcare laws, including fraud and abuse and health information privacy and security laws, we could face substantial penalties and our business, results of operations, financial condition and prospects could be adversely affected.

As a pharmaceutical company, even though we do not and will not control referrals of healthcare services or bill directly to Medicare, Medicaid or other third-party payers, certain federal and state healthcare laws and regulations

44


pertaining to fraud and abuse and patients’ rights are and will be applicable to our business. We could be subject to healthcare fraud and abuse and patient privacy regulation by both the federal government and the states in which we conduct our business. The laws that may affect our ability to operate include:

 

the federal Anti-Kickback Statute, which constrains our marketing practices, educational programs, pricing policies, and relationships with healthcare providers or other entities, by prohibiting, among other things, soliciting, receiving, offering or paying remuneration, directly or indirectly, to induce, or in return for, either the referral of an individual or the purchase or recommendation of an item or service reimbursable under a federal healthcare program, such as the Medicare and Medicaid programs;

 

federal civil and criminal false claims laws and civil monetary penalty laws, which prohibit, among other things, individuals or entities from presenting, or causing to be presented, claims for payment from Medicare, Medicaid, or other third-party payers that are false or fraudulent;

 

HIPAA, which created new federal criminal statutes that prohibit executing a scheme to defraud any healthcare benefit program or making false statements relating to healthcare matters;

 

HIPAA, as amended by the HITECH, and its implementing regulations, which imposes certain requirements relating to the privacy, security and transmission of individually identifiable health information; and

 

state and foreign law equivalents of each of the above federal laws, such as the Anti-Kickback Statute and false claims laws which may apply to items or services reimbursed by any third-party payer, including commercial insurers, and state and foreign laws governing the privacy and security of health information in certain circumstances, many of which differ from each other in significant ways and often are not preempted by HIPAA, thus complicating compliance efforts.

Because of the breadth of these laws and the narrowness of the statutory exceptions and safe harbors available under the U.S. federal Anti-Kickback Statute, it is possible that some of our business activities could be subject to challenge under one or more of such laws. To the extent that any product we make is sold in a foreign country, we may be subject to similar foreign laws and regulations. If we or our operations are found to be in violation of any of the laws described above or any other governmental regulations that apply to us, we may be subject to penalties, including civil and criminal penalties, damages, fines, exclusion from participation in U.S. federal or state health care programs, and the curtailment or restructuring of our operations. Any penalties, damages, fines, curtailment or restructuring of our operations could materially adversely affect our ability to operate our business and our financial results.

The FDA provides guidelines with respect to appropriate drug and product promotion, product labeling, and continuing medical and health education activities. Although we endeavor to follow these guidelines, the FDA or the Office of the Inspector General: U.S. Department of Health and Human Services may disagree, and we may be subject to significant liability, including civil and administrative remedies as well as criminal sanctions. In addition, management’s attention could be diverted and our reputation could be damaged. See Note 7 under the heading “Legal Matters” in the Notes to our Consolidated Financial Statements for a discussion of ongoing investigations by HHS, Office of Inspector General, the U.S. District Attorney’s Office for the District of Massachusetts and other attorney generals from several states, of potential violations involving our SUBSYS® marketing activities.

Although compliance programs can mitigate the risk of investigation and prosecution for violations of these laws, the risks cannot be entirely eliminated. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business. Moreover, achieving and sustaining compliance with applicable federal and state privacy, security and fraud laws may prove costly.

Our currently marketed product, SUBSYS®, and any of our product candidates that receive regulatory approval, will be subject to ongoing and continued regulatory review, which may result in significant expense and limit our ability to commercialize such products.

Even after we achieve U.S. regulatory approval for a product, the FDA may still impose significant restrictions on the approved indicated uses for which the product may be marketed or on the conditions of approval. For example,

45


a product’s approval may contain requirements for potentially costly post-approval studies and surveillance, including Phase IV clinical trials, to monitor the safety and efficacy of the product. We are also subject to ongoing FDA obligations and continued regulatory review with respect to the manufacturing, processing, labeling, packaging, distribution, adverse event reporting, storage, advertising, promotion and recordkeeping for our product. These requirements include submissions of safety and other post-marketing information and reports, registration, as well as continued compliance with cGMPs and with GCPs and GLPs, which are regulations and guidelines enforced by the FDA for all of our products in clinical and pre-clinical development, and for any clinical trials that we conduct post-approval. To the extent that a product is approved for sale in other countries, we may be subject to similar restrictions and requirements imposed by laws and government regulators in those countries.

In the case of SUBSYS® and any of our product candidates containing controlled substances, we and our contract manufacturers will also be subject to ongoing DEA regulatory obligations, including, among other things, annual registration renewal, security, recordkeeping, theft and loss reporting, periodic inspection and annual quota allotments for the raw material for commercial production of our products. In addition, manufacturers of drug products and their facilities are subject to continual review and periodic inspections by the FDA and other regulatory authorities for compliance with cGMP regulations, QSR requirements for medical device components or similar requirements, if applicable. If we or a regulatory agency discovers previously unknown problems with a product, such as adverse events of unanticipated severity or frequency, or problems with the facility where, or processes by which, the product is manufactured, a regulatory agency may impose restrictions on that product, the manufacturer or us, including requiring product recall, notice to physicians, withdrawal of the product from the market or suspension of manufacturing. In that regard, because certain of our contract manufacturers for SUBSYS® are located outside the United States, they may be subject to foreign laws and regulations governing the manufacture of drugs and devices, and any failure by them to comply with those laws and regulations may delay or interrupt supplies of our products.

If we, our products or product candidates or the manufacturing facilities for our products or product candidates fail to comply with applicable regulatory requirements, a regulatory agency may:

 

impose restrictions on the marketing or manufacturing of the product, suspend or withdraw product approvals or revoke necessary licenses;

 

issue warning letters, show cause notices or untitled letters describing alleged violations, which may be publicly available;

 

commence criminal investigations and prosecutions;

 

impose injunctions, suspensions or revocations of necessary approvals or other licenses;

 

impose fines or other civil or criminal penalties;

 

suspend any ongoing clinical trials;

 

deny or reduce quota allotments for the raw material for commercial production of our controlled substance products;

 

delay or refuse to approve pending applications or supplements to approved applications filed by us;

 

refuse to permit drugs or precursor chemicals to be imported or exported to or from the United States;

 

suspend or impose restrictions on operations, including costly new manufacturing requirements; or

 

seize or detain products or require us to initiate a product recall.

In addition, our product labeling, advertising and promotion are subject to regulatory requirements and continuing regulatory review. The FDA strictly regulates the promotional claims that may be made about prescription drug products. In particular, a drug product may not be promoted for uses that are not approved by the FDA as reflected in the product’s approved labeling, although the FDA does not regulate the prescribing practices of physicians. The FDA and other agencies actively enforce the laws and regulations prohibiting the promotion of off-label uses, and a company that is found to have improperly promoted off-label uses may be subject to significant liability, including substantial monetary penalties and criminal prosecution. For example, we have received subpoenas from the HHS, Office of Inspector General, the U.S. District Attorney’s Office for the District of Massachusetts and other attorney

46


generals from several states. The subpoenas primarily request documents relating to the marketing of SUBSYS®. We are cooperating in responding to the subpoenas. See Note 7 under the heading “Legal Matters” in the Notes to our Consolidated Financial Statements for a discussion regarding these ongoing investigations.

The FDA’s regulations, policies or guidance may change and new or additional statutes or government regulations may be enacted that could prevent or delay regulatory approval of our product candidates or further restrict or regulate post-approval activities. We cannot predict the likelihood, nature or extent of adverse government regulation that may arise from future legislation or administrative action, either in the United States or abroad. If we are not able to achieve and maintain regulatory compliance, we may not be permitted to market our products, which would adversely affect our ability to generate revenue and achieve or maintain profitability.

Our products and our product candidates may cause undesirable side effects or have other unexpected properties that could result in post-approval regulatory action.

If we or others identify undesirable side effects, or other previously unknown problems, caused by our products, other products with the same or related active ingredients or our product candidates, after obtaining U.S. regulatory approval, a number of potentially significant negative consequences could result, including:

 

regulatory authorities may withdraw their approval of the product;

 

regulatory authorities may require us to recall product;

 

regulatory authorities may require the addition of warnings in the product label or narrowing of the indication in the product label;

 

we may be required to create a Medication Guide outlining the risks of such side effects for distribution to patients;

 

we may be required to change the way the product is administered or modify the product in some other way;

 

the FDA may require us to conduct additional clinical trials or costly post-marketing testing and surveillance to monitor the safety or efficacy of the product;

 

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

 

our reputation may suffer.

Any of the above events resulting from undesirable side effects or other previously unknown problems could prevent us from achieving or maintaining market acceptance of the affected product and could substantially increase the costs of commercializing our products.

Health care reform measures and changes in policies, funding, staffing and leadership at the FDA and other agencies could hinder or prevent the commercial success of our products and any of our product candidates that may be approved by the FDA.

In the United States, there have been a number of legislative and regulatory changes to the healthcare system in ways that could affect our future results of operations and the future results of operations of our potential customers. For example, the MMA established a new Part D prescription drug benefit, which became effective January 1, 2006. Under the prescription drug benefit, Medicare beneficiaries can obtain prescription drug coverage from private sector plans that are permitted to limit the number of prescription drugs that are covered in each therapeutic category and class on their formularies. If SUBSYS® or any of our product candidates that are approved by the FDA are not widely included on the formularies of these plans, our ability to market our products to the Medicare population could suffer.

47


Furthermore, there have been and continue to be a number of initiatives at the federal and state levels that seek to reduce healthcare costs. For example, PPACA includes measures to significantly change the way health care is financed by both governmental and private insurers. Among the provisions of the PPACA of importance to the pharmaceutical industry are the following:

 

an annual, nondeductible fee on any entity that manufactures or imports certain branded prescription drugs and biologic agents, apportioned among these entities according to their market share in certain government healthcare programs, beginning in 2011;

 

an increase in the statutory minimum rebates a manufacturer must pay under the Medicaid Drug Rebate Program, retroactive to January 1, 2010, to 23% and 13% of the average manufacturer price for most branded and generic drugs, respectively;

 

a new Medicare Part D coverage gap discount program, in which manufacturers must agree to offer 50% point-of-sale discounts off negotiated prices of applicable brand drugs to eligible beneficiaries during their coverage gap period, as a condition for the manufacturer’s outpatient drugs to be covered under Medicare Part D;

 

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

 

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% of the Federal Poverty Level, thereby potentially increasing both the volume of sales and manufacturers’ Medicaid rebate liability;

 

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

 

new requirements to report certain financial arrangements with physicians and teaching hospitals, as defined in PPACA and its implementing regulations, including reporting any “transfer of value” made or distributed to teaching hospitals, prescribers, and other healthcare providers and reporting any ownership and investment interests held by physicians and their immediate family members and applicable group purchasing organizations during the preceding calendar year, with data collection to be required and reporting to the CMS by the 90th day of each subsequent calendar year;

 

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

 

expansion of health care fraud and abuse laws, including the False Claims Act and the Anti-Kickback Statute, new government investigative powers, and enhanced penalties for noncompliance;

 

a licensure framework for follow-on biologic products;

 

a new Patient-Centered Outcomes Research Institute to oversee, identify priorities in, and conduct comparative clinical effectiveness research, along with funding for such research;

 

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 and those recommendations could have the effect of law even if Congress does not act on the recommendations; and

 

establishment of a Center for Medicare Innovation at the CMS to test innovative payment and service delivery models to lower Medicare and Medicaid spending, potentially including prescription drug spending.

In addition, other legislative changes have been proposed and adopted since the PPACA was enacted. On August 2, 2011, the Budget Control Act of 2011, among other things, created measures for spending reductions by Congress. A Joint Select Committee on Deficit Reduction, tasked with recommending a targeted deficit reduction of at least $1.2 trillion for the years 2013 through 2021, was unable to reach required goals, thereby triggering the legislation’s automatic reduction to several government programs. This includes aggregate reductions to Medicare

48


payments to providers of up to 2% per fiscal year, starting in 2013. On January 2, 2013, President Obama signed into law the ATRA which reduced Medicare payments to several providers, including hospitals, imaging centers and cancer treatment centers, and increased the statute of limitations period for the government to recover overpayments to providers from three to five years. These new laws may result in additional reductions in Medicare and other health care funding, which could have a material adverse effect on our customers and accordingly, our financial operations.

Additionally, individual states have become increasingly aggressive in passing legislation and implementing regulations designed to control pharmaceutical product pricing, including price or patient reimbursement constraints, discounts, restrictions on certain product access, and marketing cost disclosure and transparency measures, and to encourage importation from other countries and bulk purchasing. Legally-mandated price controls on payment amounts by third-party payers or other restrictions could harm our business, results of operations, financial condition and prospects.

In addition, regional healthcare authorities and individual hospitals are increasingly using bidding procedures to determine what pharmaceutical products and which suppliers will be included in their prescription drug and other healthcare programs. This can reduce demand for our products or put pressure on our product pricing, which could negatively affect our business, results of operations, financial condition and prospects.

In certain foreign markets, the pricing of prescription drugs is subject to government control and reimbursement and may, in some cases, be unavailable. In some non-U.S. jurisdictions, the proposed pricing for a drug must be approved before it may be lawfully marketed. The requirements governing drug pricing vary widely from country to country. For example, the European Union provides options for its member states to restrict the range of medicinal products for which their national health insurance systems provide reimbursement and to control the prices of medicinal products for human use. A member state may approve a specific price for the medicinal product or it may instead adopt a system of direct or indirect controls on the profitability of the company placing the medicinal product on the market. There can be no assurance that any country that has price controls or reimbursement limitations for pharmaceutical products will allow favorable reimbursement and pricing arrangements for any of our products.

In the United States, the commercial success of SUBSYS® and our product candidates, if and when commercialized, will depend, in part, upon the availability of coverage and reimbursement from third-party payers at the federal, state and private levels. Third-party payers include governmental programs such as Medicare or Medicaid, private insurance plans and managed care plans. These third-party payers may deny coverage or reimbursement for a product or therapy in whole or in part if they determine that the product or therapy was not medically appropriate or necessary. Also, third-party payers have attempted to control costs by limiting coverage through the use of formularies and other cost-containment mechanisms and the amount of reimbursement for particular procedures or drug treatments.

Additionally, given recent federal and state government initiatives directed at lowering the total cost of healthcare, Congress and state legislatures will likely continue to focus on healthcare reform, the cost of prescription drugs and the reform of the Medicare and Medicaid programs. While we cannot predict the full outcome of any such legislation, it may result in decreased reimbursement for prescription drugs, which may further exacerbate industry-wide pressure to reduce prescription drug prices. This could harm our ability to market our products and generate revenues or could result in lower margins. In addition, legislation has been introduced in Congress that, if enacted, would permit more widespread importation or re-importation of pharmaceutical products from foreign countries into the United States, including from countries where the products are sold at lower prices than in the United States. Such legislation, or similar regulatory changes, could lead to a decision to decrease our prices to better compete, which, in turn, could adversely affect our business, results of operations, financial condition and prospects. Alternatively, in response to legislation such as this, we might elect not to seek approval for or market our products in foreign jurisdictions in order to minimize the risk of re-importation, which could also reduce the revenue we generate from our product sales. It is also possible that other legislative proposals having similar effects will be adopted.

Furthermore, regulatory authorities’ assessment of the data and results required to demonstrate safety and efficacy can change over time and can be affected by many factors, such as the emergence of new information, including on other products, changing policies and agency funding, staffing and leadership. We cannot be sure whether future changes to the regulatory environment will be favorable or unfavorable to our business prospects. For example, average review times at the FDA for marketing approval applications have fluctuated over the last ten years, and we

49


cannot predict the review time for any of our submissions with any regulatory authorities. In addition, review times can be affected by a variety of factors, including budget and funding levels and statutory, regulatory and policy changes.

Heightened attention on the use of opioids, including government litigation changes in policies, legislation and leadership at the federal and state level could hinder or prevent the commercial success of SUBSYS® and any potential future opioid product candidates.

Many federal and governmental agencies are focused on the abuse of opioids in the United States and agencies such as the HHS have expressed their belief that the United States is in the midst of a prescription opioid abuse epidemic. Common prescription drugs that contain opioids are drugs such as oxycodone, hydrocodone, and fentanyl. Our product, SUBSYS®, is fentanyl based product in the TIRF class. To the extent that the healthcare community, regulatory bodies and governmental agencies associate us with, or determine that we are a part of, this perceived opioid abuse epidemic then this may negatively affect our stock price and our business in various ways including from a marketing, sales and public relations standpoint and these perceptions may also negatively affect our ongoing governmental investigations.

Risks Related to Intellectual Property

We may not be able to obtain and enforce patent rights or other intellectual property rights that cover our products or product candidates, such as SUBSYS®, SYNDROS™ and Dronabinol Inhalation Device, and that are of sufficient breadth to prevent third parties from competing against us.

Our success with respect to our products and product candidates, such as SUBSYS®, SYNDROS™ and Dronabinol Inhalation Device will depend in part on our ability to obtain and maintain patent protection in both the United States and other countries, to preserve our trade secrets, and to prevent third parties from infringing upon our proprietary rights on our product candidates. Our ability to protect any of our approved drug products from unauthorized or infringing use by third parties depends in substantial part on our ability to obtain and maintain valid and enforceable patents. Fentanyl and dronabinol have been approved for many years and therefore our ability to obtain any patent protection is limited. Composition of matter patents on APIs are a particularly effective form of intellectual property protection for pharmaceutical products as they apply without regard to any method of use. However, we will not be able to obtain composition of matter patents or methods of use patents that cover the APIs in any of our products or product candidates. As a result, competitors who obtain the requisite regulatory approval can offer products with the same active ingredients as our products or product candidates so long as the competitors do not infringe any formulation patents that we may obtain or license, if any.

Our patent portfolio related to our sublingual spray technology that is used in SUBSYS® includes patents and patent applications in the United States, Australia, Brazil, Canada, China, Europe, India Japan, Mexico, New Zealand and Russia. The covered technology and the scope of coverage vary from country to country. For those countries where we do not have granted patents, we may not have any ability to prevent the unauthorized use of our sublingual spray technology.

In addition, the only patent protection that we can expect will otherwise cover SUBSYS® and dronabinol products and product candidates consists of patents relating to formulations, methods of treatment using certain formulations and methods of manufacturing and packaging. Formulation patents preclude competitors from using a similar formulation. Manufacturing or packaging patents preclude competitors from using the same manufacturing or packaging methods. However, these type of patents do not preclude a competitor from making and marketing the same composition of matter unless they use the same formulation or manufacturing or packaging methods. Any patents that we may obtain may be too narrow in scope and thus easily circumvented by competitors.

Further, in countries where we do not have granted patents directed to our formulations or manufacturing or packaging, third parties may be able to make, use, or sell products identical to, or substantially similar to, SUBSYS®, our dronabinol products or product candidates.

We have multiple pending patent applications in the United States and in some foreign jurisdictions directed to formulations for our fentanyl and dronabinol products and product candidates. We have a number of pending

50


applications and issued patents in the United States and in many foreign countries that pertain to either fentanyl or dronabinol formulations. We can give no assurances that any patents will issue, that if they do issue or have issued, they will provide sufficient protection against competitors, or that they would be valid and enforceable.

Due to legal standards relating to patentability, validity, enforceability and claim scope of patents covering pharmaceutical inventions, our ability to obtain, maintain and enforce patents is uncertain and involves complex legal and factual questions. Accordingly, rights under any patents we may obtain or license may not provide us with sufficient protection for our products and product candidates to afford a commercial advantage against competitive products or processes, including those from branded and generic pharmaceutical companies. In addition, we cannot guarantee that any patents will issue from any pending or future patent applications owned by or licensed to us. Even if patents have issued or will issue, we cannot guarantee that the claims of these patents are or will be held valid or enforceable by the courts or will provide us with any significant protection against competitive products or otherwise be commercially valuable to us.

Patent applications in the United States are generally maintained in confidence for up to 18 months after their filing. Similarly, publication of discoveries in scientific or patent literature often lag behind actual discoveries. Consequently, we cannot be certain that we or our licensors were the first to invent, or the first to file patent applications on our products or product candidates. In the event that a third-party has also filed an U.S. patent application relating to our drug product or a similar invention, we may have to participate in interference proceedings declared by the USPTO to determine priority of invention in the United States. The costs of these proceedings could be substantial and it is possible that our efforts would be unsuccessful, resulting in a loss of our U.S. patent position.

In addition, third parties may challenge our in-licensed patents and any of our own patents that we may obtain, which could result in the invalidation or unenforceability of some or all of the relevant patent claims. Litigation or other proceedings to enforce or defend intellectual property rights is very complex, expensive, and may divert our management’s attention from our core business and may result in unfavorable results that could adversely affect our ability to prevent third parties from competing with us.

The laws of some foreign jurisdictions do not provide intellectual property rights to the same extent as in the United States and many companies have encountered significant difficulties in protecting and defending such rights in foreign jurisdictions. If we encounter such difficulties in protecting or are otherwise precluded from effectively protecting our intellectual property in foreign jurisdictions, our business prospects could be substantially harmed. The patent positions of pharmaceutical and biotechnology companies can be highly uncertain and involve complex legal and factual questions for which important legal principles remain evolving or unresolved. Changes in either the patent laws or in the interpretations of patent laws in the United States and other countries may diminish the value of our intellectual property. Accordingly, we cannot predict the breadth of claims that may be allowed or enforced in our patents or in third-party patents.

The degree of future protection of our proprietary rights is uncertain. Patent protection may be unavailable or severely limited in some cases and may not adequately protect our rights or permit us to gain or keep our competitive advantage. For example:

 

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

 

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

 

the patents of others may have an adverse effect on our business;

 

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

 

any patents we obtain or our licensors’ issued patents may not encompass commercially viable products, may not provide us with any competitive advantages, or may be challenged by third parties;

 

any patents we obtain or our in-licensed issued patents may not be valid or enforceable; or

 

we may not develop additional proprietary technologies that are patentable.

51


If we or our licensors fail to prosecute, maintain and enforce patent protection for our products or product candidates, our ability to develop and commercialize our products or product candidates may be adversely affected and we may not be able to prevent competitors from making, using and selling competing products. This failure to properly protect the intellectual property rights relating to our products or product candidates could have a material adverse effect on our business, financial condition and results of operation. Moreover, our competitors may independently develop equivalent knowledge, methods and know-how.

Proprietary trade secrets and unpatented know-how are also very important to our business. Although we have taken steps to protect our trade secrets and unpatented know-how, by entering into confidentiality agreements with third parties, and proprietary information and invention agreements with certain employees, consultants and advisors, third parties may still obtain this information or we may be unable to protect our rights. We also have limited control over the protection of trade secrets used by our licensors, collaborators and suppliers. There can be no assurance that binding agreements will not be breached, that we would have adequate remedies for any breach, or that our trade secrets and unpatented know-how will not otherwise become known or be independently discovered by our competitors. If trade secrets are independently discovered, we would not be able to prevent their use. Enforcing a claim that a third-party illegally obtained and is using our trade secrets or unpatented know-how is expensive and time consuming, and the outcome is unpredictable. In addition, courts outside the United States may be less willing to protect trade secret information.

We may incur substantial costs as a result of litigation or other proceedings relating to patent and other intellectual property rights, and we may be unable to protect our rights to our products and technology.

If we or our collaborators or licensors choose to go to court to stop a third-party from using the inventions claimed in our own or in-licensed patents, that third-party may ask the court to rule that the patents are invalid and/or should not be enforced against that third-party. These lawsuits are expensive and would consume time and other resources even if we or they, as the case may be, were successful in stopping the infringement of these patents. In addition, there is a risk that the court will decide that these patents are not valid and that we or they, as the case may be, do not have the right to stop others from using the inventions.

There is also the risk that, even if the validity of these patents is upheld, the court will refuse to stop the third-party on the ground that such third-party’s activities do not infringe our owned or in-licensed patents. In addition, our own or in-licensed patents may be subject to challenge and subsequent invalidation or significant narrowing of claim scope in a reexamination or opposition proceeding before a governmental patent agency, or during litigation.

We may also not be able to detect infringement of our own or in-licensed patents, which may be especially difficult for methods of manufacturing or formulation products. While we intend to take actions reasonably necessary to enforce our patent rights, we depend, in part, on our licensors and collaborators to protect a substantial portion of our proprietary rights.

If we are sued for alleged infringement of intellectual property rights of third parties, it will be costly and time consuming, and an unfavorable outcome in that litigation would have a material adverse effect on our business.

Our commercial success depends upon our ability and the ability of our collaborators to develop, manufacture, market and sell our products and product candidates and use our proprietary technologies without infringing the proprietary rights of third parties. Numerous U.S. and foreign issued patents and pending patent applications, which are owned by third parties, exist in the fields relating to our products and product candidates. As the medical device, biotechnology and pharmaceutical industries expand and more patents are issued, the risk increases that others may assert our products or product candidates infringe the patent rights of others. Moreover, it is not always clear to industry participants, including us, which patents cover various types of medical devices, drugs, products or their methods of use. Thus, because of the large number of patents issued and patent applications filed in our fields, there may be a risk that third parties may allege they have patent rights encompassing our products, product candidates, technology or methods.

In addition, there may be issued patents of third parties of which we are currently unaware, that are infringed or are alleged to be infringed by our products, product candidates or proprietary technologies. Because some patent

52


applications in the United States may be maintained in secrecy until the patents are issued, because patent applications in the United States and many foreign jurisdictions are typically not published until 18 months after filing, and because publications in the scientific literature often lag behind actual discoveries, we cannot be certain that others have not filed patent applications for technology covered by our own and in-licensed issued patents or our pending applications. Our competitors may have filed, and may in the future file, patent applications covering our products, product candidates or technology similar to ours. Any such patent application may have priority over our own and in-licensed patent applications or patents, which could further require us to obtain rights to issued patents covering such technologies. If another party has filed an U.S. patent application on inventions similar to those owned or in-licensed to us, we or, in the case of in-licensed technology, the licensor may have to participate, in the United States, in an interference proceeding to determine priority of invention.

If another party has reason to assert a substantial new question of patentability against any of our claims in our own and in-licensed U.S. patents, the third-party can request that the patent claims be reexamined, which may result in a loss of scope of some claims or a loss of the entire patent. In addition to potential infringement suits and, interference and reexamination proceedings, we may become a party to patent opposition proceedings where either the patentability of the inventions subject of our patents are challenged, or we are challenging the patents of others. The costs of these proceedings could be substantial, and it is possible that such efforts would be unsuccessful.

We may be exposed to, or threatened with, future litigation by third parties having patent or other intellectual property rights alleging that our products and/or product candidates and/or proprietary technologies infringe their intellectual property rights. These lawsuits are costly and could adversely affect our results of operations and divert the attention of managerial and technical personnel. There is a risk that a court would decide that we or our commercialization partners are infringing the third-party’s patents and would order us or our partners to stop the activities covered by the patents. In addition, there is a risk that a court will order us or our collaborators to pay the other party damages for having violated the other party’s patents.

If a third-party’s patents was found to cover our products and/or product candidates, proprietary technologies or their uses, we or our collaborators could be enjoined by a court and required to pay damages and could be unable to continue to commercialize our products or our product candidates or use our proprietary technologies unless we or they obtained a license to the patent. A license may not be available to us or our collaborators on acceptable terms, if at all. In addition, during litigation, the patent holder could obtain a preliminary injunction or other equitable relief which could prohibit us from making, using or selling our products, technologies or methods pending a trial on the merits, which could be years away.

There is a substantial amount of litigation involving patent and other intellectual property rights in the device, biotechnology and pharmaceutical industries generally. If a third-party claims that we or our collaborators infringe its intellectual property rights, we may face a number of issues, including, but not limited to:

 

infringement and other intellectual property claims which, regardless of merit, may be expensive and time-consuming to litigate and may divert our management’s attention from our core business;

 

substantial damages for infringement, which we may have to pay if a court decides that the product at issue infringes or violates the third-party’s rights, and if the court finds that the infringement was willful, we could be ordered to pay treble damages and the patent owner’s attorneys’ fees;

 

a court prohibiting us from selling or licensing the product unless the third-party licenses its product rights to us, which it is not required to do;

 

if a license is available from a third-party, we may have to pay substantial royalties, upfront fees and/or grant cross-licenses to intellectual property rights for our products; and

 

redesigning our products or processes so they do not infringe, which may not be possible or may require substantial monetary expenditures and time.

Some of our competitors may be able to sustain the costs of complex patent litigation more effectively than we can because they have substantially greater resources. In addition, any uncertainties resulting from the initiation and continuation of any litigation could have a material adverse effect on our ability to raise additional funds or otherwise have a material adverse effect on our business, results of operations, financial condition and prospects.

53


We may be subject to claims that our employees, consultants or independent contractors have wrongfully used or disclosed to us alleged trade secrets of their other clients or former employers.

As is common in the biotechnology and pharmaceutical industry, certain of our employees were formerly employed by other biotechnology or pharmaceutical companies, including our competitors or potential competitors. Moreover, we engage the services of consultants to assist us in the development of our products and product candidates, many of whom were previously employed at or may have previously been or are currently providing consulting services to, other biotechnology or pharmaceutical companies, including our competitors or potential competitors. We may be subject to claims that these employees and consultants or we have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their former employers or their former or current customers. For example, we have in the past received letters from third parties asserting that one of our employees may have used proprietary information of his former employers in connection with our prior regulatory filings. Litigation may be necessary to defend against these types of claims. Even if we are successful in defending against any such claims, any such litigation would likely be protracted, expensive, a distraction to our management team, not viewed favorably by investors and other third parties, and may potentially result in an unfavorable outcome.

Obtaining and maintaining our patent protection depends on compliance with various procedural, document submission, fee payment and other requirements imposed by governmental patent agencies, and our patent protection could be reduced or eliminated for non-compliance with these requirements.

Periodic maintenance fees on our own and in-licensed patents are due to be paid to the governmental patent agencies over the lifetime of the patents. Future maintenance fees will also need to be paid on other patents which may be issued to us. We have systems in place to remind us to pay these fees, and we employ outside firms to remind us or our licensor to pay annuity fees due to patent agencies on our patents and pending patent applications. The various governmental patent agencies require compliance with a number of procedural, documentary, fee payment and other similar provisions during the patent application process. In many cases, an inadvertent lapse can be cured by payment of a late fee or by other means in accordance with the applicable rules. However, there are situations in which noncompliance can result in abandonment or lapse of the patent or patent application, resulting in partial or complete loss of patent rights in the relevant jurisdiction. In such an event, our competitors might be able to enter the market and this circumstance would have a material adverse effect on our business.

Risks Relating to an Investment in Our Stock

Our founder and principal stockholder can individually control our direction and policies, and his interests may be adverse to the interests of our stockholders.

As of December 31, 2016, our founder and principal stockholder, Dr. John N. Kapoor, beneficially owned approximately 67% of our outstanding, publicly-traded common stock. By virtue of his holdings, Dr. Kapoor can and will continue to be able to effectively control the election of the members of our Board of Directors, our management and our affairs and prevent corporate transactions such as mergers, consolidations or the sale of all or substantially all of our assets that may be favorable from our standpoint or that of our other stockholders or cause a transaction that we or our other stockholders may view as unfavorable. Accordingly, this concentration of ownership may harm the market price of our common stock by:

 

delaying, deferring or preventing a change in control;

 

impeding a merger, consolidation, takeover or other business combination involving us;

 

discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of us; or

 

otherwise effectively limiting the rights of other stockholders because Dr. Kapoor has the ability to approve matters submitted to stockholders, including the election of directors, approval of significant transactions and the amendment of our certificate of incorporation.

In addition, sales of shares of our common stock beneficially owned by Dr. Kapoor could be viewed negatively by third parties and have a negative impact on our stock price. Moreover, upon his passing, we cannot assure you as to how these shares will be distributed and subsequently voted.

54


Our common stock price has been volatile, which could result in substantial losses for stockholders.

Our common stock is currently traded on The NASDAQ Global Market. We have in the past experienced, and may in the future experience, limited daily trading volume. The trading price of our common stock has been and may continue to be volatile. The market for pharmaceutical companies, in particular, has at various times experienced extreme volatility that often has been unrelated to the operating performance of particular companies. These broad market and industry fluctuations may significantly affect the trading price of our common stock, regardless of our actual operating performance. The trading price of our common stock could be affected by a number of factors, including, but not limited to, changes in expectations of our future performance, changes in estimates by securities analysts (or failure to meet such estimates), quarterly fluctuations in our sales and financial results and a variety of risk factors, including the ones described elsewhere in this report. Periods of volatility in the market price of a company’s securities sometimes result in securities class action litigation, which regardless of the merit of the claims, can be time-consuming, costly and divert management’s attention. In addition, if we needed to raise equity funds under adverse conditions, it would be difficult to sell a significant amount of our stock without causing a significant decline in the trading price of our stock.

If we are unable to successfully remediate any material weakness in our internal control over financial reporting, or identify any additional material weaknesses, the accuracy and timing of our financial reporting may be adversely affected, we may be unable to maintain compliance with securities law requirements regarding timely filing of periodic reports in addition to applicable stock exchange listing requirements, and our stock price may decline materially as a result.

In connection with the audit of our consolidated financial statements for the year ended December 31, 2016, our management and independent registered public accounting firm concluded that there were material weaknesses in our internal control over financial reporting. A material weakness is a significant deficiency, or a combination of significant deficiencies, in internal control over financial reporting such that it is reasonably possible that a material misstatement of the annual or interim financial statements will not be prevented or detected on a timely basis. The material weaknesses we and our independent registered public accounting firm identified related specifically to the lack of effective policies and procedures, or timely and effective reviews by personnel at an appropriate level, for accounting for the rebate component of our product sales allowances and the allowance for excess and obsolete inventory in accordance with U. S. GAAP. We did not have controls designed to validate the completeness and accuracy of underlying data used in the determination of these significant estimates. Overall the management in the finance and accounting group did not display adequate tone at the top with respect to judgment and rigor required to resolve the accounting for the rebates component of our product sales allowances and the allowance for excess and obsolete inventory matters.

While we expect to take the measures necessary to address the underlying causes of these material weaknesses, we cannot at this time estimate how long it will take and our efforts may not prove to be successful in remediating these material weaknesses. While we have not incurred and do not expect to incur material expenses specifically related to the remediation of these material weaknesses, actual expenses may exceed our current estimates and overall costs of compiling the system and processing documentation necessary to assess the effectiveness of our internal control over financial reporting may be material.

We cannot assure you that we have identified all, or that we will not in the future have additional, material weaknesses. If we are unable to successfully remediate any material weakness in our internal control over financial reporting, or identify any additional material weaknesses that may exist, the accuracy and timing of our financial reporting may be adversely affected, we may be unable to maintain compliance with securities law requirements regarding timely filing of periodic reports in addition to applicable stock exchange listing requirements, and our stock price may decline materially as a result.

If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.

The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or our business. If one or more of the analysts who covers us downgrades our stock or publishes inaccurate or unfavorable research about our business, our stock price would likely decline. If one or

55


more of these analysts ceases coverage of us or fails to publish reports on us regularly, demand for our stock could decrease, which could cause our stock price and trading volume to decline.

Future sales of our common stock or securities convertible into our common stock may depress our stock price.

Sales of a substantial number of shares of our common stock or securities convertible into our common stock in the public market could occur at any time. These sales, or the perception in the market that the holders of a large number of shares intend to sell shares, could reduce the market price of our common stock. As of December 31, 2016, we had (i) 71,923,550 outstanding shares of common stock; (ii) 7,300,873 shares of common stock issuable upon the exercise of stock options under our 2013 Equity Incentive Plan and other existing stock option plans; and (iii) 4,259,755 shares were available for future issuance under our 2013 Equity Incentive Plan. The exercise of outstanding stock options could result in increased sales of our common stock in the market, which could exert significant downward pressure on our stock price. These sales also might make it more difficult for us to sell equity or equity-related securities in the future at a time and price we deem appropriate.

If a large number of shares of our common stock or securities convertible into our common stock are sold in the public market after they become eligible for sale, the sales could reduce the trading price of our common stock and impede our ability to raise future capital.

Anti-takeover provisions in our stockholder rights plan, charter documents and Delaware law might deter acquisition bids for us that you might consider favorable.

On August 15, 2014, after approval by our stockholders, we entered into a rights agreement traditionally referred to as a poison pill. This rights agreement will have certain anti-takeover effects which will cause substantial dilution to a person or group that attempts to acquire the Company on terms not approved by our Board. In addition, our amended and restated certificate of incorporation and bylaws contain provisions that may make the acquisition of our company more difficult without the approval of our Board of Directors. These provisions:

 

establish a classified Board of Directors so that not all members of our board are elected at one time;

 

authorize the issuance of undesignated preferred stock, the terms of which may be established and shares of which may be issued without stockholder approval, and which may include rights superior to the rights of the holders of common stock;

 

prohibit stockholder action by written consent, which requires all stockholder actions to be taken at a meeting of our stockholders;

 

provide that the Board of Directors is expressly authorized to make, alter, or repeal our bylaws; and

 

establish advance notice requirements for nominations for elections to our board or for proposing matters that can be acted upon by stockholders at stockholder meetings.

In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law which, subject to certain exceptions, prohibits stockholders owning in excess of 15% of our outstanding voting stock from merging or combining with us. These anti-takeover provisions and other provisions under Delaware law could discourage, delay or prevent a transaction involving a change in control of our company, even if doing so would benefit our stockholders. These provisions could also discourage proxy contests and make it more difficult for you and other stockholders to elect directors of your choosing so as to cause us to take certain corporate actions you desire.

We qualify as a “controlled company” under Nasdaq’s rules and may avail ourselves of exemptions from certain Nasdaq independence rules, which could make our common stock less attractive to investors.

As a result of Dr. Kapoor’s stock ownership and related voting power, we are a “controlled company” as defined in the Nasdaq Listing Rules and, therefore we may avail ourselves of certain exemptions under applicable Nasdaq rules, including exemptions from the rules that require us to have (i) a majority of independent directors on the Board;

56


(ii) independent director oversight of executive officer compensation; and (iii) independent director oversight of director nominations.

We have never paid dividends on our capital stock, and we do not anticipate paying any cash dividends in the foreseeable future.

The continued operation and expansion of our business may require substantial funding. Accordingly, we do not anticipate that we will pay any cash dividends on shares of our common stock for the foreseeable future. Any determination to pay dividends in the future will be at the discretion of our Board of Directors and will depend upon results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law and other factors our Board of Directors deems relevant.

ITEM 1B.

UNRESOLVED STAFF COMMENTS

Not applicable.

ITEM 2.

PROPERTIES

We lease a total of approximately 100,000 square feet of office and lab space in Chandler, Arizona under lease agreements that expire between August 2020 and June 2021. We believe that the Chandler, Arizona facilities are adequate to meet our current needs, and that suitable additional or alternative space will be available for our foreseeable future needs. Additionally, we lease a total of approximately 90,000 square feet for our U.S.-based, state-of-the-art dronabinol manufacturing facilities, which are both located in Round Rock, Texas under lease agreements that expire between January 2018 and March 2024. We have the option to extend our primary manufacturing facility lease for two 5-year periods following March 2024. We believe that the Round Rock, Texas manufacturing facilities are adequate to meet our current needs and that suitable additional or alternative space will be available for our foreseeable future needs.

ITEM 3.

LEGAL PROCEEDINGS  

The information included in Note 7 under the heading “Legal Matters” in the Notes to our Consolidated Financial Statements in Part II, Item 8. Financial Statements and Supplementary Data is incorporated herein by reference.

ITEM 4.

MINE SAFETY DISCLOSURES

Not applicable.

57


PART II

ITEM 5.

MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES

Beginning with our initial public offering on May 7, 2013, our common stock is traded on the NASDAQ Global Market under the symbol INSY. The following table sets forth the high and low sales prices for our common stock for the fiscal periods indicated as reported by the NASDAQ Global Market.

Price Range of Common Stock

 

 

 

Fourth Quarter

 

 

Third Quarter

 

 

Second Quarter

 

 

 

First Quarter

 

 

2016 price range per share

 

$

15.06

 

 

$

8.70

 

 

$

19.96

 

 

$

11.55

 

 

$

18.65

 

 

 

$

11.45

 

 

 

 

28.91

 

 

 

 

14.18

 

 

 

 

 

Fourth Quarter

 

 

Third Quarter

 

 

Second Quarter

 

 

 

First Quarter

 

 

2015 price range per share

 

$

33.88

 

 

$

20.15

 

 

$

46.17

 

 

$

26.07

 

 

$

42.69

 

(1)

 

$

25.67

 

(1)

 

 

31.24

 

(1)

 

 

20.79

 

(1)

 

(1)

Share price adjusted to reflect a 2-for-1 stock split that occurred on June 8, 2015.

Holders

As of March 28, 2017, there were approximately 37 holders of record of our common stock and 71,957,343 shares of our common stock outstanding.

Dividends

Since our initial public offering, we have not declared nor paid dividends on our common stock and we do not expect to pay cash dividends on our common stock in the foreseeable future.

Issuer Purchases of Equity Securities

Share Repurchase Program

On November 5, 2015, we announced a stock repurchase program which authorizes up to $50 million in repurchases of common stock. As of December 31, 2016, we had $17.4 million remaining under this program. There were no repurchases of our common stock during the three months ended December 31, 2016. Also see Note 8 of the Notes to our Consolidated Financial Statements for additional information on this repurchase program.

58


 

Company Stock Performance

The following graph compares our total cumulative shareholder return as compared to the NASDAQ Composite Index and the NASDAQ Pharmaceutical Index for the period beginning on May 3, 2013 (our IPO date) and ending on December 31, 2016. Total shareholder return assumes $100.00 invested at the beginning of the period in our common stock, the stocks represented by the NASDAQ Composite Index and the NASDAQ Pharmaceutical Index, respectively. Total return assumes reinvestment of dividends.

This stock performance graph shall not be considered soliciting material and shall not be deemed “filed” for purposes of Section 18 of the Exchange Act, or otherwise subject to the liabilities of that section, nor shall it be deemed incorporated by reference in any filing under the Securities Act of 1933, as amended, whether made on, before or after the date of this filing and irrespective of any general incorporation language in such filing.

59


ITEM 6.

SELECTED FINANCIAL DATA

The following table sets forth certain financial data with respect to our business. The selected consolidated financial data should be read in conjunction with our Consolidated Financial Statements and related Notes and Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other information contained elsewhere in this Annual Report on Form 10-K. The selected financial data in the table below as of December 31, 2014, 2013 and 2012 and for the years ended December 31, 2013 and 2012, were derived from our audited consolidated financial statements not included in this Annual Report on Form 10-K.

 

 

 

Years Ended December 31,

 

 

 

2016

 

 

2015

 

 

2014

 

 

2013

 

 

2012

 

 

 

(In thousands, except share and per share data)

 

 

 

 

 

 

 

(As Revised)

 

 

(As Revised)

 

 

 

 

 

 

 

 

 

Consolidated Statement of Comprehensive Income Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net revenue

 

$

242,275

 

 

$

330,323

 

 

$

219,092

 

 

$

99,289

 

 

$

15,476

 

Gross profit

 

 

216,882

 

 

 

301,469

 

 

 

196,514

 

 

 

86,624

 

 

 

7,849

 

Operating income (loss)

 

 

7,326

 

 

 

90,456

 

 

 

60,990

 

 

 

32,559

 

 

 

(23,440

)

Income tax expense (benefit)

 

 

834

 

 

 

32,941

 

 

 

25,089

 

 

 

(8,800

)

 

 

 

Net income (loss)

 

 

7,590

 

 

 

58,053

 

 

 

36,054

 

 

 

40,377

 

 

 

(24,378

)

Net income (loss) per common share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.11

 

 

$

0.81

 

 

$

0.52

 

 

$

0.78

 

 

$

(0.87

)

Diluted

 

$

0.10

 

 

$

0.77

 

 

$

0.49

 

 

$

0.70

 

 

$

(0.87

)

Weighted average common shares outstanding

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

71,618,793

 

 

 

71,592,581

 

 

 

68,759,070

 

 

 

51,839,536

 

 

 

27,948,102

 

Diluted

 

 

74,145,918

 

 

 

75,707,651

 

 

 

73,335,132

 

 

 

57,469,234

 

 

 

27,948,102

 

Dividends declared per common share

 

$

 

 

$

 

 

$

 

 

$

 

 

$

 

 

 

 

December 31,

 

 

 

2016

 

 

2015

 

 

2014

 

 

2013

 

 

2012

 

 

 

(In thousands)

 

 

 

 

 

 

 

(As Revised)

 

 

(As Revised)

 

 

 

 

 

 

 

 

 

Consolidated Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash, cash equivalents and short-term investments

 

$

182,880

 

 

$

159,091

 

 

$

82,863

 

 

$

45,782

 

 

$

361

 

Total current assets

 

 

230,972

 

 

 

252,051

 

 

 

146,465

 

 

 

78,350

 

 

 

11,889

 

Total assets

 

 

356,136

 

 

 

351,285

 

 

 

215,635

 

 

 

100,558

 

 

 

18,741

 

Total current liabilities, including debt

 

 

78,614

 

 

 

90,436

 

 

 

48,709

 

 

 

21,081

 

 

 

83,419

 

Total liabilities

 

 

86,547

 

 

 

98,980

 

 

 

52,445

 

 

 

21,081

 

 

 

83,419

 

Total stockholders' equity (deficit)

 

 

269,589

 

 

 

252,305

 

 

 

163,190

 

 

 

79,477

 

 

 

(64,678

)

 

Refer to Note 2 of the Consolidated Financial Statement for a summary of the amounts and financial statement line items impacted by the revision of previously issued financial statements for the correction of immaterial errrors.

 

60


ITEM 7.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

The information in this Annual Report on Form 10-K, or this Form 10-K, including this discussion in Management’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, contains forward-looking statements and information within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, which are subject to the “safe harbor” created by those sections. All statements, other than statements of historical facts, included or incorporated in this Form 10-K could be deemed forward-looking statements, particularly statements about our plans, strategies and prospects under this MD&A heading and under the heading “Business.” In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continue,” “intend” or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these identifying words. All forward-looking statements in this Form 10-K are made based on our current expectations, forecasts, estimates and assumptions, and involve risks, uncertainties and other factors that could cause results or events to differ materially from those expressed in the forward-looking statements. In evaluating these statements, you should specifically consider various factors, uncertainties and risks that could affect our future results or operations as described from time to time in our SEC reports, including those risks outlined under the heading “Risk Factors” in Part I, Item 1A of this Form 10-K. These factors, uncertainties and risks may cause our actual results to differ materially from any forward-looking statement set forth in this Form 10-K. You should carefully consider the trends, risks and uncertainties described below and other information in this Form 10-K and subsequent reports filed with or furnished to the SEC before making any investment decision with respect to our securities. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this cautionary statement.

These forward-looking statements include, but are not limited to, statements concerning our strategy, future operations, future financial position, future revenues, projected costs, prospects and plans and objectives of management; PBM formulary changes relative to SUBSYS® or established for SYNDROS™ (once commercially launched, if at all) may have a material impact on future net revenue; our intent to file an IND application for the treatment of epilepsy with cannabidiol; the sufficiency of our manufacturing capacity; the beneficial attributes of our dronabinol product candidates and delivery mechanisms; that our suppliers are equipped to supply us with our current and future chemical needs; that pending dronabinol candidates will default to Schedule II classification; that changes in healthcare laws will result in reduced Medicaid and Medicare payments for prescription drugs; that sales and marketing and research and development costs will be our largest categories of expenses; that sales and marketing expenses will fluctuate based on changes in SUBSYS®  net revenue; our development of different dronabinol delivery systems; our anticipated timing of the commercial launch of SYNDROS™; our ability to obtain finalization of labeling by the FDA as the final approval prior to commercial launch of SYNDROS™; that we can maintain or even grow market share and net revenue for SUBSYS®  and our strategies relating thereto; that we may pursue strategies relating to synthetic cannabidiol; our sales and marketing strategy for future products and delivery systems; that we may pursue strategic transactions such acquisitions or other companies, asset purchase out- or in-licensing of products, strategic partnerships, joint ventures, divestitures, business combinations and investments; our ability to obtain foundation materials and manufacture dronabinol in light of government quotas; our strategy of using Marinol as a reference drug in future drug approval applications; the expected pathway of drug applications we expect to file in the future; that physicians and payers will continue to gain familiarity about and accept the features of SUBSYS®; our plans and strategies for obtaining future international approvals; our plans and strategies to protect our intellectual property; our intention of not paying dividends; possible capital raising transactions we may pursue; that we may avail ourselves of certain Nasdaq governance provisions because of our status as a controlled company; that research and development and operating costs will increase; that our investments in our sales and research and development infrastructure will result in increased sales; accounting estimates and the impact of new or recently issued accounting pronouncements; that cash flows from operations will increase and/or stabilize as a result of sales of SUBSYS®; the source and sufficiency of our liquidity and capital resources to fund our operations; trends in restrictions and impediments relating to reimbursement policies imposed by PBMs;  the impact of pending litigation and our strategy relating thereto; that we will not recognize revenue in the near term from current research and development initiatives; our exposure to interest rate changes and market risks related to our investment; and the potential impact of Section 382 limitations on our NOLs. The words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,” “would” and similar expressions are intended to identify

61


forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements that we make. The forward-looking statements are applicable only as of the date on which they are made, and we do not assume any obligation to update any forward-looking statements.   

The following discussion and analysis of the results of operations and financial condition of Insys Therapeutics, Inc. for the years ended December 31, 2016 and 2015 should be read in conjunction with the consolidated financial statements and the notes thereto, and other financial information contained elsewhere in this Form 10-K.

Overview

We are a commercial-stage specialty pharmaceutical company that develops and commercializes innovative supportive care products. We have one commercially marketed product and one product awaiting final labeling approval by the FDA, prior to commercial launch, after receiving FDA approval in July 2016 and DEA scheduling in March 2017:  

 

SUBSYS® — a proprietary, single-use product that delivers fentanyl, an opioid analgesic, for transmucosal absorption underneath the tongue, offered in 100, 200, 400, 600, 800, 1,200 and 1,600 mcg dosages. SUBSYS® is approved for the treatment of BTCP in opioid-tolerant patients. We received FDA approval for SUBSYS® in January 2012 and commercially launched SUBSYS® in March 2012.

 

SYNDROS™ — a dronabinol oral solution that is equivalent to Marinol, an approved second-line treatment for CINV and anorexia associated with weight loss in patients with AIDS. We received FDA approval for SYNDROS™ in July 2016. In March 2017, the DEA issued an interim final ruling that would result in SYNDROS™ being placed in Schedule II of the CSA.  We are currently awaiting the finalization of labeling by the FDA as the final approval prior to commercial launch.

We also have one discontinued product:

 

Dronabinol SG Capsule — a dronabinol soft gelatin capsule that is a generic equivalent to Marinol, an approved second-line treatment for CINV and anorexia associated with weight loss in patients with AIDS, offered in 2.5, 5.0 and 10.0 milligram dosages. We received FDA approval for Dronabinol SG Capsule in August 2011. We commercially launched Dronabinol SG Capsule through our former exclusive distribution partner, Mylan Pharmaceuticals, Inc., in December 2011. We do not have any current plans to manufacture or market this product in the future.

We market SUBSYS® through our U.S.-based field sales force focused on supportive care physicians. Consistent with most pharmaceutical manufacturing companies, we sell and distribute SUBSYS® primarily to pharmaceutical wholesalers and collect sales proceeds from those wholesalers. For the year ended December 31, 2016, sales to our four largest wholesale customers accounted for 67% of gross revenue. We also sell SUBSYS® directly to certain specialty pharmaceutical retailers who distribute our product. For the year ended December 31, 2016 direct sales to specialty pharmaceutical retailers accounted for 33% of gross revenue.  We do not own or have any ownership stake in any pharmaceutical wholesaler or specialty pharmacy, nor do we have an option to acquire any wholesaler or specialty pharmacy. All pharmacies that fulfill SUBSYS® prescriptions are fully independent. Our relationships with every pharmacy that fulfills SUBSYS® prescriptions are non-exclusive in that each of these pharmacies may also fulfill prescriptions for other pharmaceutical manufacturers, including our competitors. For the year ended December 31, 2016, over 920 independent pharmacies have fulfilled at least one SUBSYS® prescription.

Our sales of, and revenue from, SUBSYS® depend in significant part on the coverage and reimbursement policies of third-party payers, including government payers such as Medicare and Medicaid, and private health insurers. All third-party payers are sensitive to the cost of drugs and consistently implement efforts to control these costs, which efforts include, but are not limited to, establishing excluded or preferred drug lists. SUBSYS® has been, and will likely continue to be, subject to these restrictions and impediments from third-party payers, particularly PBMs and private health insurers. We provide administrative reimbursement support assistance, in large part through our

62


insurance reimbursement support hub, which provides administrative support assistance to help patients coordinate with their insurance companies.

We are also developing other product candidates, such as cannabinoid line extensions and sublingual spray product candidates.

We produce the API for SYNDROS™ at our U.S.-based, state-of-the-art dronabinol manufacturing facility. While we believe that this facility has the capacity to supply sufficient commercial quantities of dronabinol API for our initial launch quantities of SYNDROS™, if final approvals are obtained, and support the continued development of our other dronabinol product candidates in the near-term, we have opened and expanded a second dronabinol manufacturing facility, which we anticipate will enable us to supply sufficient commercial quantities of dronabinol API for the anticipated commercialization of our proprietary dronabinol product candidates, if approved.

We have the capability to manufacture pharmaceutical CBD, an over 99.5% pure form of cannabidiol, in our Round Rock, Texas manufacturing facility. On April 23, 2015, we announced that we had commenced dosing of epilepsy patients in a Phase I PK study in pediatric subjects. We intend to file an IND application with the FDA for the treatment of epilepsy.

Factors Affecting Our Performance

We believe that our performance and future success are dependent upon a number of factors, including our approved product sales, investments in our infrastructure and growth, and our ability to successfully develop product candidates and complete related regulatory processes. In addition, our ability to ensure that our products, policies and practices adhere to the extensive national, state and local regulations applicable to our industry is critical to our success, particularly as our operations and product opportunities continue to grow at a rapid pace. While each of these areas presents significant opportunities for us, they also pose significant risks and challenges that we must successfully address.  

Approved Product Sales.    Our operating results will depend significantly upon our, and any of our third-party distributors’, sales of approved products. During the year ended December 31, 2016, all of our net revenues were generated from the sale of our approved product, SUBSYS®. We will not generate any revenue from the sale of our discontinued Dronabinol SG Capsule in future periods. Our results will depend on prescription volume generally, which we believe will be driven primarily by achievement of broad market acceptance and coverage by third-party payers and effectiveness of the marketing and selling efforts with respect to SUBSYS®. Moreover, our gross margins improve on a unit-by-unit basis as we sell higher dosage strengths of our products. Importantly, the proportion of prescriptions written for repeat SUBSYS® patients has continued to increase since July 2012 from 50% of prescriptions to approximately 92% of prescriptions as of December 31, 2016. Generally, repeat SUBSYS® patients receive significantly higher doses of SUBSYS® on average than first-time patients as patients are titrated from a starter dose of SUBSYS® to their effective dose in accordance with the TIRF REMS protocol.

According to IMS, the total market for TIRF products for the year ended December 31, 2016 was approximately 72,000 prescriptions and we estimate SUBSYS® prescriptions were approximately 43% of the TIRF market, compared to a total market for TIRF products of approximately 94,000 prescriptions and approximately 46% SUBSYS® market share for the year ended December 31, 2015.

The continuing and heightened publicity surrounding the national opioid epidemic continues to result in sensitivity by some healthcare professionals to prescribe, and pharmacies to dispense, opioids. In part, this sensitivity by healthcare professionals and pharmacies is the result of third-party payers, such as insurance companies, and regulatory and government agencies increasingly scrutinizing the indications and uses for which healthcare professionals are prescribing, and pharmacies are dispensing, opioids. Moreover, ongoing state and federal investigations into our sales, marketing and other commercial practices and developments and media reports that may arise in connection with such investigations may negatively affect our relationships with healthcare professionals and pharmacies and their prescribing or dispensing habits.  Consequently, these current and potential future events have and will likely continue to affect the manner in which, and the situations when, SUBSYS® is being prescribed, dispensed and approved for coverage. While we continue to sell directly into wholesalers and retail pharmacies for

63


our revenue, the direct pressures discussed above related to the retail demand-side components of our business contributed to the decline in full-year 2016 SUBSYS® revenue when compared to 2015.

Third-Party Payer Interactions and Government Programs Associated with Reimbursement. Our interaction with third-party payers is critical to the success of our business and financial condition. Our relationships with these third-party payers evolves on a regular basis and is often difficult to predict. By way of example, from time to time, third-party payers modify which drugs they choose to reimburse. For instance, on or around August 1, 2014, ESI officially released its exclusion list of drugs, effective January 1, 2015, in connection with its national preferred formulary. Other PBMs may take similar actions and these actions may have a material impact on our net revenue in the future. As we have in the past, we will continue working with PBMs to evaluate price increases and to communicate with managed care and health-system decision-makers to ensure a balanced approach, which takes into account the clinical performance and efficacy of our products.

In addition, from time to time, our business may be affected by evolving or new governmental programs in the reimbursement landscape. For instance, CMS, which is part of the HHS, has instituted The Recovery Audit Program. The program’s mission is to identify and correct improper Medicare payments through the efficient detection and collection of overpayments made on claims of health care services provided to Medicare beneficiaries, and the identification of underpayments to providers so that CMS can implement actions that will prevent future improper payments in all 50 states. We are aware that in January 2016, certain specialty pharmacies received written correspondence from Humana indicating that as a result of a CMS audit, Humana was initiating a deletion of certain PDEs related to SUBSYS® which will result in a reversal and recovery of identified claims paid to certain pharmacies. This audit by CMS may have been part of The Recovery Audit Program or a similar initiative of CMS. Based upon information available to us, all of these claims involve Medicare Part D patients whose prescriptions were in connection with off-label indications and related to approximately $5.6 million in SUBSYS® claims in the aggregate. Upon our inquiry for more information about these matters, Humana notified us that these deletions of certain PDEs resulting from the CMS audit also involve TIRF medications other than SUBSYS® and Humana intends to resolve these matters with the pharmacies. We believe that some affected pharmacies may alter their processes and or protocols related to dispensing off label TIRF prescriptions to Medicare patients as a result of these and similar events. 

Investments in Our Infrastructure and Growth.    Our ability to increase our sales and to further penetrate our target market segments is dependent in part on our ability to invest in our infrastructure and in our sales and marketing efforts. In order to drive further growth, we may hire additional sales and marketing personnel and invest in marketing our products to our target physician prescriber base. For example, as of December 31, 2016, we had 274 full-time sales and marketing personnel. This will lead to corresponding increases in our operating expenses, although we anticipate that these investments will result in increased product sales and net revenue. In addition, we have constructed a second dronabinol manufacturing facility, which we anticipate will supply us with sufficient commercial quantities of dronabinol API for the commercialization of our proprietary dronabinol product candidates, if approved. This second facility will also increase our operating expenses.

Product Development and Related Regulatory Processes.    Our operating results will also depend significantly on our research and development activities and related regulatory developments. Our research and development expenses were $75.4 million and $55.3 million for the years ended December 31, 2016 and 2015, respectively. As of December 31, 2016, we had 59 full-time research and development personnel. We expect research and development expenses to increase as we continue our planned preclinical studies and clinical trials for our product candidates, particularly our proprietary cannabinoid product candidates, including SYNDROS™, and sublingual spray product candidates. We do not expect to realize net revenues from all of these research and development initiatives in the near term and may never realize net revenues from these investments. Due to the risks inherent in conducting preclinical studies and clinical trials, the regulatory approval process and the costs of preparing, filing and prosecuting patent applications, our development completion dates and costs will vary significantly for each product candidate and are very difficult to estimate. The lengthy process of seeking regulatory approvals and the subsequent compliance with applicable regulations require the expenditure of substantial additional resources. Any failure by us to obtain, or any delay in obtaining, regulatory approvals or acceptable DEA classifications for our product candidates, in particular those related to SYNDROS™, could cause our research and development expenditures to increase significantly and, in turn, have a material adverse effect on our results of operations.

64


Basis of Presentation 

Revision of Previously issued Financial Statements for Correction of Immaterial Errors

During September 2016, we identified an error related to the accounting for the rebates component of our product sales allowances since 2014. We determined that we had miscalculated our rebate obligations on government payer and managed care contracts. In addition, we recorded out-of-period adjustments that resulted in an increase in operating expenses of $1,500,000 related to stock option modifications during the three months ended March 31, 2016 and a decrease in income tax expense of $834,000 related to the deductible interest expense portion of accrued litigation award and settlements recorded during 2016. We concluded that the errors were not material to previously issued annual financial statements. However, to correctly present net revenue, operating expenses and income tax expense in the appropriate annual period, management has revised the 2015 and 2014 financial statements. Refer to Note 2 of the Consolidated Financial Statements for a summary of the amounts and financial statement line items impacted by the revision. All amounts set forth in the discussion and analysis of the results of operations and financial condition for the years ended December 31, 2015 and 2014 have been adjusted to reflect these revisions.

 

Net Revenue

We sell SUBSYS® in packages of various sized single-dose units in dosage strengths of 100, 200, 400, 600, 800, 1,200 and 1,600 mcg, to wholesale pharmaceutical distributors and specialty retail pharmacies, collectively, our customers, on a wholesale basis. Sales to our customers are subject to specified rights of return. We record revenue for SUBSYS® at the time the customer receives the shipment.

Cost of Revenue, Gross Profit and Gross Margin

Cost of revenue consists primarily of materials, third-party manufacturing costs, freight in, indirect personnel costs, and other overhead costs based on units dispensed through patient prescriptions. Also included in cost of revenue are charges for reserves for excess, dated or obsolete commercial inventories and production manufacturing variances. 

Gross profit is net revenue less cost of revenue. Gross margin is gross profit expressed as a percentage of net revenue.

Sales and Marketing Expenses

Our sales and marketing expenses consist primarily of salaries, commissions, benefits, consulting fees, costs of obtaining prescription and market data, and market research studies related to SUBSYS®. As of December 31, 2016, we had 274 full-time sales and marketing personnel. We expect our sales and marketing expenses, along with our research and development expenses, to be our largest categories of operating expenses for the foreseeable future. In addition, because we use an incentive-based compensation model for our sales professionals, we expect our sales and marketing expenses to fluctuate from period to period based on changes in SUBSYS® net revenue. We will also incur expenses directly related to the launch of SYNDROS™, if finalization of labeling by the FDA is obtained.

Research and Development Expenses

Research and development expenses consist of costs associated with our preclinical studies and clinical trials, and other expenses related to our drug development efforts. Our research and development expenses consist primarily of:

 

external research and development expenses incurred under agreements with third-party CROs and investigative sites, third-party manufacturers and consultants;

 

employee-related expenses, which include salaries, benefits and stock-based compensation for the personnel involved in our preclinical and clinical drug development activities; and

 

facilities, depreciation and other allocated expenses, equipment and laboratory supplies.

65


To date, our research and development efforts have been focused primarily on our fentanyl, dronabinol and cannabidiol programs. As of December 31, 2016, we had 59 full-time research and development personnel. We expect research and development expenses to increase as we continue our planned preclinical studies and clinical trials for our product candidates. We determine which research and development projects to pursue, as well as the level of funding available for each project, based on the scientific and preclinical and clinical results of each product candidate and related regulatory action.

The following table provides a breakdown of our research and development expenses (in millions):

 

 

 

Years Ended December 31,

 

 

 

2016

 

 

2015

 

 

2014

 

 

 

 

 

 

 

(As Revised)

 

 

 

 

 

Cannabidiol

 

$

15.3

 

 

$

16.3

 

 

$

5.8

 

Buprenorphine

 

 

9.4

 

 

 

3.4

 

 

 

3.4

 

Fentanyl

 

 

4.5