XNAS:DRRX Durect Corp Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

For the quarterly period ended June 30, 2012

OR

 

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

For the transition period from            to            

Commission file number 000-31615

 

 

DURECT CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   94-3297098

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

10260 Bubb Road

Cupertino, California 95014

(Address of principal executive offices, including zip code)

(408) 777-1417

(Registrant’s telephone number, including area code)

 

 

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by a check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition 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   x      Smaller reporting company   ¨

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

As of July 31, 2012, there were 87,659,141 shares of the registrant’s Common Stock outstanding.

 

 

 


Table of Contents

INDEX

 

          Page  
PART I. FINANCIAL INFORMATION   

Item 1.

   Financial Statements      3   
   Condensed Balance Sheets as of June 30, 2012 and December 31, 2011      3   
   Condensed Statements of Comprehensive Income (Loss) for the three and six months ended June 30, 2012 and 2011      4   
   Condensed Statements of Cash Flows for the six months ended June 30, 2012 and 2011      5   
   Notes to Condensed Financial Statements      6   

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      16   

Item 3.

   Quantitative and Qualitative Disclosures about Market Risk      26   

Item 4.

   Controls and Procedures      26   
PART II. OTHER INFORMATION   

Item 1.

   Legal Proceedings      27   

Item 1A.

   Risk Factors      27   

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds      44   

Item 3.

   Defaults Upon Senior Securities      44   

Item 4.

   Mine Safety Disclosures      44   

Item 5.

   Other Information      44   

Item 6.

   Exhibits      44   
   (a) Exhibits   

Signatures

     45   

 

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Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

DURECT CORPORATION

CONDENSED BALANCE SHEETS

(in thousands)

 

     June 30,
2012
    December 31,
2011
 
     (unaudited)     (Note 1)  
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 4,156      $ 8,896   

Short-term investments

     14,878        19,535   

Short-term restricted investments

     0        367   

Accounts receivable (net of allowances of $144 at June 30, 2012 and $98 at December 31, 2011)

     2,598        3,448   

Inventories

     3,177        3,252   

Prepaid expenses and other current assets

     1,225        1,803   
  

 

 

   

 

 

 

Total current assets

     26,034        37,301   

Property and equipment (net of accumulated depreciation of $20,110 and $19,706 at June 30, 2012 and December 31, 2011, respectively)

     2,766        3,124   

Goodwill

     6,399        6,399   

Intangible assets, net

     44        53   

Long-term investments

     4,299        1,530   

Long-term restricted investments

     400        501   

Other long-term assets

     288        288   
  

 

 

   

 

 

 

Total assets

   $ 40,230      $ 49,196   
  

 

 

   

 

 

 
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Current liabilities:

    

Accounts payable

   $ 703      $ 1,274   

Accrued liabilities

     3,704        4,884   

Contract research liabilities

     429        1,361   

Deferred revenue, current portion

     312        7,372   
  

 

 

   

 

 

 

Total current liabilities

     5,148        14,891   

Deferred revenue, non-current portion

     1,636        30,090   

Other long-term liabilities

     689        738   

Commitments

    

Stockholders’ equity:

    

Common stock

     9        9   

Additional paid-in capital

     361,790        359,006   

Accumulated other comprehensive income

     (1     5   

Accumulated deficit

     (329,041     (355,543
  

 

 

   

 

 

 

Stockholders’ equity

     32,757        3,477   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 40,230      $ 49,196   
  

 

 

   

 

 

 

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

 

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Table of Contents

DURECT CORPORATION

CONDENSED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(in thousands, except per share amounts)

(unaudited)

 

                                                                               
     Three months ended
June 30,
    Six months ended
June 30,
 
     2012     2011     2012     2011  

Collaborative research and development and other revenue

   $ 2,227      $ 5,188      $ 40,555      $ 10,700   

Product revenue, net

     2,569        2,645        5,426        5,737   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     4,796        7,833        45,981        16,437   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses:

        

Cost of product revenues

     1,118        1,085        2,579        2,486   

Research and development

     4,982        8,708        10,616        18,588   

Selling, general and administrative

     3,049        3,327        6,329        7,043   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     9,149        13,120        19,524        28,117   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income (loss) from operations

     (4,353     (5,287     26,457        (11,680

Other income (expense):

        

Interest and other income

     27        43        49        83   

Interest and other expense

     (2     (1     (4     (5
  

 

 

   

 

 

   

 

 

   

 

 

 

Net other income

     25        42        45        78   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss)

   $ (4,328   $ (5,245   $ 26,502      $ (11,602
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income (loss) per share

        

Basic

   $ (0.05   $ (0.06   $ 0.30      $ (0.13
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

   $ (0.05   $ (0.06   $ 0.30      $ (0.13
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average shares used in computing net income (loss) per share

        

Basic

     87,602        87,404        87,575        87,338   
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

     87,602        87,404        87,593        87,338   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total comprehensive income (loss)

   $ (4,330   $ (5,242   $ 26,496      $ (11,585
  

 

 

   

 

 

   

 

 

   

 

 

 

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

 

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DURECT CORPORATION

CONDENSED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

                                 
     Six months ended
June 30,
 
     2012     2011  

Cash flows from operating activities

    

Net income (loss)

   $ 26,502      $ (11,602

Adjustments to reconcile net income (loss) to net cash used in operating activities:

    

Depreciation and amortization

     429        519   

Stock-based compensation

     2,246        3,517   

Changes in assets and liabilities:

    

Accounts receivable

     850        426   

Inventories

     66        (435

Prepaid expenses and other assets

     578        1,590   

Accounts payable

     (571     20   

Accrued liabilities

     (728     (2,182

Contract research liabilities

     (932     48   

Deferred revenue

     (35,514     (4,040
  

 

 

   

 

 

 

Total adjustments

     (33,576     (537
  

 

 

   

 

 

 

Net cash used in operating activities

     (7,074     (12,139
  

 

 

   

 

 

 

Cash flows from investing activities

    

Purchases of property and equipment

     (62     (907

Purchases of available-for-sale securities

     (14,204     (14,458

Proceeds from maturities of available-for-sale securities

     16,554        21,572   
  

 

 

   

 

 

 

Net cash provided by investing activities

     2,288        6,207   
  

 

 

   

 

 

 

Cash flows from financing activities

    

Payments on equipment financing obligations

     (3     (13

Net proceeds from issuances of common stock

     49        994   
  

 

 

   

 

 

 

Net cash provided by financing activities

     46        981   
  

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (4,740     (4,951

Cash and cash equivalents, beginning of the period

     8,896        10,437   
  

 

 

   

 

 

 

Cash and cash equivalents, end of the period

   $ 4,156      $ 5,486   
  

 

 

   

 

 

 

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

 

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Table of Contents

DURECT CORPORATION

NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

Note 1. Summary of Significant Accounting Policies

Nature of Operations

DURECT Corporation (the Company) was incorporated in the state of Delaware on February 6, 1998. The Company is a pharmaceutical company developing therapies based on its proprietary drug formulations and delivery platform technologies. The Company has several products under development by itself and with third party collaborators. The Company also manufactures and sells osmotic pumps used in laboratory research, and designs, develops and manufactures a wide range of standard and custom biodegradable polymers and excipients for pharmaceutical and medical device clients for use as raw materials in their products. In addition, the Company conducts research and development of pharmaceutical products in collaboration with third party pharmaceutical and biotechnology companies.

Basis of Presentation

The accompanying unaudited financial statements include the accounts of the Company. These financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission (SEC), and therefore, do not include all the information and footnotes necessary for a complete presentation of the Company’s results of operations, financial position and cash flows in conformity with U.S. generally accepted accounting principles (U.S. GAAP). The unaudited financial statements reflect all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation of the financial position at June 30, 2012, the operating results for the three and six months ended June 30, 2012 and 2011, and cash flows for the six months ended June 30, 2012 and 2011. The balance sheet as of December 31, 2011 has been derived from audited financial statements at that date but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements. These financial statements and notes should be read in conjunction with the Company’s audited financial statements and notes thereto, included in the Company’s annual report on Form 10-K for the year ended December 31, 2011 filed with the SEC.

The results of operations for the interim periods presented are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year.

Inventories

Inventories are stated at the lower of cost or market, with cost determined on a first-in, first-out basis. The Company’s inventories consisted of the following (in thousands):

 

         June 30,    
2012
     December 31,
2011
 
   (unaudited)         

Raw materials

   $ 1,099       $ 841   

Work in process

     1,000         1,172   

Finished goods

     1,078         1,239   
  

 

 

    

 

 

 

Total inventories

   $ 3,177       $ 3,252   
  

 

 

    

 

 

 

Revenue Recognition

Revenue from the sale of products is recognized when there is persuasive evidence that an arrangement exists, the product is shipped and title transfers to customers, provided no continuing obligation on the Company’s part exists, the price is fixed or determinable and the collectability of the amounts owed is reasonably assured. The Company enters into license and collaboration agreements under which it may receive upfront license fees, research funding and contingent milestone payments and royalties. The Company’s deliverables under these arrangements typically consist of granting licenses to intellectual property rights and providing research and development services. The accounting standards contain a presumption that separate contracts entered into at or near the same time with the same entity or related parties were negotiated as a package and should be evaluated as a single agreement.

In the first quarter of 2011, the Company adopted ASU No. 2009-13, Revenue Recognition—Multiple Deliverable Revenue Arrangements (ASU 2009-13) for multiple deliverable revenue arrangements, on a prospective basis, for applicable transactions originating or materially modified on or subsequent to January 1, 2011. ASU 2009-13 provides application guidance on whether multiple deliverables exist, how the deliverables should be separated and how the consideration should be allocated to one or more units of accounting. This update changes the requirements for establishing separate units of accounting in a multiple element arrangement and establishes a selling price hierarchy for determining the selling price of a deliverable. The selling price used for each deliverable is based on vendor-specific objective evidence, if available, third-party evidence if vendor-specific objective evidence is not available, or estimated selling price if neither vendor-specific nor third-party evidence is available.

 

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For multiple element arrangements entered into prior to January 1, 2011, the Company determined whether the elements had value on a stand-alone basis and whether there was objective and reliable evidence of fair value. When the delivered element did not have stand-alone value or there was insufficient evidence of fair value for the undelivered element(s), the Company recognized the consideration for the combined unit of accounting in the same manner as the revenue was recognized for the final deliverable, which was generally ratably over the longest period of involvement. For example, upfront payments received upon execution of collaborative agreements are recorded as deferred revenue and recognized as collaborative research and development revenue based on a straight-line basis over the period of the Company’s continuing involvement with the third-party collaborator pursuant to the applicable agreement. Such period generally represents the longer of the estimated research and development period or other continuing obligation period defined in the respective agreements between the Company and its third-party collaborators. Returns or credits related to the sale of products have not had a material impact on the Company’s revenues or net loss.

Research and development revenue related to services performed under the collaborative arrangements with the Company’s third-party collaborators is recognized as the related research and development services are performed. These research payments received under each respective agreement are not refundable and are generally based on reimbursement of qualified expenses, as defined in the agreements. Research and development expenses under the collaborative research and development agreements generally approximate or exceed the revenue recognized under such agreements over the term of the respective agreements. Deferred revenue may result when the Company does not expend the required level of effort during a specific period in comparison to funds received under the respective agreement. For joint control and funding development activities, the Company recognizes revenue from the net reimbursement of the research and development expenses from our collaborators and records the net payment of research and development expenses to our collaborators as additional research and development expense.

Milestone payments under collaborative arrangements are triggered either by the results of the Company’s research and development efforts or by specified sales results by a third-party collaborator. Milestones related to the Company’s development-based activities may include initiation of various phases of clinical trials, successful completion of a phase of development or results from a clinical trial, acceptance of a New Drug Application by the FDA or an equivalent filing with an equivalent regulatory agency in another territory, or regulatory approval by the FDA or by an equivalent regulatory agency in another territory. Due to the uncertainty involved in meeting these development-based milestones, the development-based milestones are considered to be substantial (i.e. not just achieved through passage of time) at the inception of the collaboration agreement. In addition, the amounts of the payments assigned thereto are considered to be commensurate with the enhancement of the value of the delivered intellectual property as a result of the Company’s performance. The Company’s involvement is necessary to the achievement of development-based milestones. The Company would account for development-based milestones as revenue upon achievement of the substantive milestone events. Milestones related to sales-based activities may be triggered upon events such as the first commercial sale of a product or when sales first achieve a defined level. Under the Company’s collaborative agreements, the Company’s third-party collaborators will take the lead in commercialization activities and the Company is typically not involved in the achievement of sales-based milestones. These sales-based milestones would be achieved after the completion of the Company’s development activities. The Company would account for the sales-based milestones in the same manner as royalties, with revenue recognized upon achievement of the milestone. In addition, upon the achievement of either development-based or sales-based milestone events, the Company has no future performance obligations related to any milestone payments.

Revenue on cost-plus-fee contracts, such as under contracts to perform research and development for others, is recognized as the related services are rendered as determined by the extent of reimbursable costs incurred plus estimated fees thereon.

 

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Comprehensive Income (Loss)

Components of other comprehensive income (loss) are comprised entirely of unrealized gains and losses on the Company’s available-for-sale securities for all periods presented and are included in total comprehensive income (loss) as follows (in thousands).

 

     Three months ended
June 30,
    Six months ended
June 30,
 
     2012     2011     2012     2011  

Net loss

   $ (4,328   $ (5,245   $ 26,502      $ (11,602

Net change in unrealized gain on available-for-sale investments, net of tax

     (2     3        (6     17   
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income (loss)

   $ (4,330   $ (5,242   $ 26,496      $ (11,585
  

 

 

   

 

 

   

 

 

   

 

 

 

Accumulated other comprehensive income as of June 30, 2012 and December 31, 2011 is entirely comprised of net unrealized gains and losses on available-for-sale securities.

Net Income (Loss) Per Share

Basic net income (loss) per share is calculated by dividing the net income (loss) by the weighted-average number of common shares outstanding. Diluted net income (loss) per share is computed using the weighted-average number of common shares outstanding and common stock equivalents (i.e., options and warrants to purchase common stock) outstanding during the period, if dilutive, using the treasury stock method for options and warrants.

The numerators and denominators in the calculation of basic and diluted net income (loss) per share were as follows (in thousands except per share amounts):

 

     Three months ended
June 30,
    Six months ended
June 30,
 
     2012     2011     2012      2011  

Numerators:

         

Net income (loss)

   $ (4,328   $ (5,245   $ 26,502       $ (11,602

Denominators:

         

Outstanding dilutive securities not included in diluted net loss per share

         

Weighted average shares used to compute basic net income (loss) per share

     87,602        87,404        87,575         87,338   

Effect of dilutive securities:

         

Dilution from stock options

     0        0       18         0  
  

 

 

   

 

 

   

 

 

    

 

 

 

Dilutive common shares

     0        0        18         0  
  

 

 

   

 

 

   

 

 

    

 

 

 

Weighted average shares used to compute basic net income (loss) per share

     87,602        87,404        87,593         87,338   
  

 

 

   

 

 

   

 

 

    

 

 

 

Net income (loss) per share:

         

Basic

   $ (0.05   $ (0.06   $ 0.30       $ (0.13
  

 

 

   

 

 

   

 

 

    

 

 

 

Diluted

   $ (0.05   $ (0.06   $ 0.30       $ (0.13
  

 

 

   

 

 

   

 

 

    

 

 

 

Options to purchase approximately 21.1 million shares of common stock were excluded from the denominator in the calculation of diluted net income per share for the three and six months ended June 30, 2012, as the effect would be anti-dilutive.

 

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Note 2. Strategic Agreements

The collaborative research and development and other revenues associated with the Company’s major third-party collaborators are as follows (in thousands):

 

     Three months ended
June 30,
     Six months ended
June 30,
 
     2012      2011      2012      2011  

Collaborator

           

Hospira, Inc. (Hospira) (1)

   $ 952       $ 2,838       $ 23,726       $ 5,852   

Pfizer Inc. (Pfizer) (2)

     739         1,098         11,127         2,715   

Zogenix, Inc. (Zogenix) (3)

     352         693         1,636         1,243   

Pain Therapeutics, Inc. (Pain Therapeutics)

     1         21         2         43   

Nycomed Danmark, APS (Nycomed) (4)

     0         308         3,705         617   

Others

     183         230         359         230   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total collaborative research and development and other revenue

   $ 2,227       $ 5,188       $ 40,555       $ 10,700   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Amounts related to the recognition of upfront fees were zero and $21.8 million for the three and six months ended June 30, 2012, respectively, compared to $906,000 and $1.8 million for the corresponding periods in 2011. In March 2012, the Company was notified that Hospira was terminating the Development and License Agreement between Hospira and the Company dated June 1, 2010 relating to the development and commercialization of POSIDUR in the United States and Canada. As a result, the Company recognized as revenue all of the remaining upfront fees during the six months ended June 30, 2012 that had previously been deferred.
(2) Amounts related to the recognition of upfront fees were zero and $9.9 million for the three and six months ended June 30, 2012, respectively, compared to $804,000 and $1.6 million for the corresponding periods in 2011. In February 2011, Pfizer acquired King Pharmaceuticals (King) and thereby assumed the rights and obligations of King under the agreements we formerly had in place with King; accordingly amounts attributed to King are now shown as Pfizer figures. In February 2012, the Company was notified that Pfizer was terminating the worldwide Development and License Agreement between Alpharma (acquired by King which subsequently was acquired by Pfizer) and DURECT dated September 19, 2008 relating to the development and commercialization of ELADUR. As a result, the Company recognized as revenue all of the remaining upfront fees during the six months ended June 30, 2012 that had previously been deferred.
(3) Amounts related to the ratable recognition of upfront fees were $78,000 and $156,000 for the three and six months ended June 30, 2012, respectively, compared to zero for both of the corresponding periods in 2011. A development and license agreement with Zogenix was entered into on July 11, 2011; the Company and Zogenix had previously been working together under a feasibility agreement pursuant to which the Company’s research and development costs were reimbursed by Zogenix.
(4) Amounts related to the ratable recognition of upfront fees were zero and $3.7 million for the three months ended June 30, 2012, respectively, compared to $308,000 and $617,000 for the corresponding periods in 2011. In January 2012, the Company was notified that Nycomed was terminating the Development and License Agreement between Nycomed and the Company dated November 26, 2006, as amended, relating to the development and commercialization of POSIDUR (SABER-Bupivacaine) in Europe and their other licensed territories. As a result, the Company recognized as revenue all of the remaining upfront fees during the six months ended June 30, 2012 that had previously been deferred.

Agreement with Pain Therapeutics, Inc.

In December 2002, the Company entered into an exclusive agreement with Pain Therapeutics, Inc. (Pain Therapeutics) to develop and commercialize on a worldwide basis REMOXY and other oral sustained release, abuse deterrent opioid products incorporating four specified opioid drugs, using the ORADUR technology. Total collaborative research and development revenue recognized under the agreements with Pain Therapeutics was $730 and $1,500 for the three and six months ended June 30, 2012, respectively, compared with $21,000 and $43,000 for the corresponding periods in 2011. The cumulative aggregate payments received by the Company from Pain Therapeutics as of June 30, 2012 were $33.4 million under this agreement.

Under the terms of this agreement, Pain Therapeutics paid the Company an upfront license fee of $1.0 million, with the potential for an additional $9.3 million in performance milestone payments based on the successful development and approval of the four ORADUR-based opioids. Of these potential milestones, $9.3 million are development-based milestones (of which $1.7 million had been achieved as of June 30, 2012). There are no sales-based milestones under the agreement. In addition, if commercialized, the Company will receive royalties for Remoxy and other licensed products which do not contain an opioid antagonist of between 6.0% to 11.5% of net sales of the product depending on sales volume.

 

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In March 2009, King assumed the responsibility for further development of REMOXY from Pain Therapeutics. As a result of this change, the Company continues to perform REMOXY-related activities in accordance with the terms and conditions set forth in the license agreement between the Company and Pain Therapeutics. Accordingly, King was substituted in lieu of Pain Therapeutics with respect to interactions with the Company in its performance of those activities including the obligation to pay the Company with respect to all REMOXY-related costs incurred by the Company. In February 2011, Pfizer acquired King and thereby assumed the rights and obligations of King with respect to REMOXY; accordingly amounts attributed to King are now shown as Pfizer figures. Total collaborative research and development revenue recognized for Remoxy-related work performed by the Company for Pfizer was $678,000 and $1.1 million for the three and six months ended June 30, 2012, respectively, compared with $4,000 and $61,000 for the corresponding periods in 2011. Prior to March 2009, the Company recognized collaborative research and development revenue for Remoxy-related work under the agreements with Pain Therapeutics. The cumulative aggregate payments received by the Company from King (now Pfizer) as of June 30, 2012 were $7.4 million under this agreement.

Long Term Supply Agreement with King (now Pfizer)

In August 2009, the Company signed an exclusive long term excipient supply agreement with respect to REMOXY with King (now Pfizer). This agreement stipulates the terms and conditions under which the Company will supply to King, based on the Company’s manufacturing cost plus a specified percentage mark-up, two key excipients used in the manufacture of REMOXY. In February 2011, Pfizer acquired King and thereby assumed the rights and obligations of King under the agreements we formerly had in place with King; accordingly amounts attributed to King are now shown as Pfizer figures.

Total revenues recognized related to these excipients were zero and $51,000 in the three and six months ended June 30, 2012, compared to zero for the corresponding periods in 2011. The associated costs of goods sold were zero and $33,000 in the three and six months ended June 30, 2012, compared to zero for the corresponding periods in 2011.

Agreement with Zogenix, Inc.

On July 11, 2011, the Company and Zogenix, Inc., (Zogenix), entered into a Development and License Agreement (the License Agreement). The Company and Zogenix had previously been working together under a feasibility agreement pursuant to which the Company’s research and development costs were reimbursed by Zogenix. Under the License Agreement, Zogenix will be responsible for the clinical development and commercialization of a proprietary, long-acting injectable formulation of risperidone using the Company’s SABER controlled-release formulation technology in combination with Zogenix’s DosePro® needle-free, subcutaneous drug delivery system. DURECT will be responsible for non-clinical, formulation and CMC development activities. The Company will be reimbursed by Zogenix for its research and development efforts on the product.

Zogenix paid a non-refundable upfront fee to the Company of $2.25 million in July 2011. The Company’s research and development services are considered integral to utilizing the licensed intellectual property and, accordingly, the deliverables are accounted for as a single unit of accounting. The $2.25 million upfront fee is being recognized as collaborative research and development revenue ratably over the term of the Company’s continuing research and development involvement with Zogenix with respect to this product candidate. Zogenix is obligated to pay the Company up to $103 million in total future milestone payments with respect to the product subject to and upon the achievement of various development, regulatory and sales milestones. Of these potential milestones, $28 million are development-based milestones (none of which had been achieved as of June 30, 2012), and $75 million are sales-based milestones (none of which had been achieved as of June 30, 2012). Zogenix is also required to pay a mid single-digit to low double-digit percentage patent royalty on annual net sales of the product determined on a jurisdiction-by-jurisdiction basis. The patent royalty term is equal to the later of the expiration of all DURECT technology patents or joint patent rights in a particular jurisdiction, the expiration of marketing exclusivity rights in such jurisdiction, or 15 years from first commercial sale in such jurisdiction. After the patent royalty term, Zogenix will continue to pay royalties on annual net sales of the product at a reduced rate for so long as Zogenix continues to sell the product in the jurisdiction. Zogenix is also required to pay to the Company a tiered percentage of fees received in connection with any sublicense of the licensed rights.

The Company granted to Zogenix an exclusive worldwide license, with sub-license rights, to the Company’s intellectual property rights related to the Company’s proprietary polymeric and non-polymeric controlled-release formulation technology to make and have made, use, offer for sale, sell and import risperidone products, where risperidone is the sole active agent, for administration by injection in the treatment of schizophrenia, bipolar disorder or other psychiatric related disorders in humans. The Company retains the right to supply Zogenix’s Phase 3 clinical trial and commercial product requirements on the terms set forth in the License Agreement.

 

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The Company retains the right to terminate the License Agreement with respect to specific countries if Zogenix fails to advance the development of the product in such country, either directly or through a sublicensee. In addition, either party may terminate the License Agreement upon insolvency or bankruptcy of the other party, upon written notice of a material uncured breach or if the other party takes any act impairing such other party’s relevant intellectual property rights. Zogenix may terminate the License Agreement upon written notice if during the development or commercialization of the product, the product becomes subject to one or more serious adverse drug experiences or if either party receives notice from a regulatory authority, independent review committee, data safety monitory board or other similar body alleging significant concern regarding a patient safety issue. Zogenix may also terminate the License Agreement with or without cause, at any time upon prior written notice.

The following table provides a summary of collaborative research and development revenue recognized under the agreements with Zogenix (in thousands). The cumulative aggregate payments received by the Company as of June 30, 2012 were $9.5 million under these agreements.

 

     Three months ended
June 30,
     Six months ended
June 30,
 
     2012      2011      2012      2011  

Ratable recognition of upfront payment

   $ 78       $ 0       $ 156       $ 0   

Research and development expenses reimbursable by Zogenix

     274         693         1,480         1,243   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total collaborative research and development revenue

   $ 352       $ 693       $ 1,636       $ 1,243   
  

 

 

    

 

 

    

 

 

    

 

 

 

Agreement with Hospira, Inc.

In June 2010, the Company and Hospira, Inc. (Hospira) entered into a license agreement to develop and market POSIDUR (SABER-bupivacaine) in the U.S. and Canada. POSIDUR is the Company’s investigational post-operative pain relief depot that recently completed a Phase III clinical study in the U.S. that utilizes the Company’s patented SABER technology to deliver bupivacaine to provide up to three days of pain relief after surgery.

Under the terms of the agreement, Hospira made an upfront payment of $27.5 million. In March 2012, the Company was notified that Hospira was terminating the agreement effective September 28, 2012, or, as permitted under the agreement, at an earlier date elected by the Company. Hospira’s termination returns to the Company the U.S. and Canadian rights to develop and commercialize POSIDUR and as such the Company now holds worldwide rights to POSIDUR. As a result of the termination of the Hospira agreement for POSIDUR, the Company recognized as revenue during the first quarter of 2012 the remaining $21.8 million of deferred revenue related to the upfront fee of the development and license agreement as the Company has no remaining performance obligations under the agreement; this recognition of revenue did not result in additional cash proceeds to the Company.

The following table provides a summary of collaborative research and development revenue recognized under the agreement with Hospira (in thousands). The cumulative aggregate payments received by the Company as of June 30, 2012 were $40.1 million under this agreement.

 

     Three months ended
June 30,
     Six months ended
June 30,
 
     2012      2011      2012      2011  

Ratable recognition of upfront payment (1)

   $ 0       $ 906       $ 21,758       $ 1,813   

Research and development expenses reimbursable by Hospira

     952         1,932         1,968         4,039   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total collaborative research and development revenue

   $ 952       $ 2,838       $ 23,726       $ 5,852   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) The Company’s estimate of the term of its continuing performance obligation was revised in the first quarter of 2012 as a result of the termination of the POSIDUR agreement by Hospira. As a result of the termination of the Hospira agreement for POSIDUR, the Company recorded as revenue during the first quarter of 2012 the remaining $21.8 million deferred revenue related to the upfront fee of the development and license agreement.

Agreement with Nycomed

In November 2006, the Company entered into a development and license agreement with Nycomed, which was amended in February 2010 and February 2011. Under the terms of the agreement, as amended, the Company licensed to Nycomed the exclusive commercialization rights to POSIDUR for the European Union (E.U.) and certain other countries.

Under the terms of the agreement as amended, Nycomed paid the Company an upfront license fee of $14 million and an $8 million development-based milestone payment. In October 2011, Takeda Pharmaceutical Company Limited (Takeda) acquired Nycomed and thereby assumed the rights and obligations of Nycomed under the agreements the Company formerly had in place with

 

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Nycomed. In January 2012, the Company was notified that Takeda (through Nycomed) was terminating the license agreement with us, and thereby returning their right to develop and commercialize POSIDUR (SABER®-Bupivacaine) in Europe and their other licensed territories to us. As a result of the termination of the Nycomed agreement for POSIDUR, the Company recognized revenue during the first quarter of 2012 for the remaining $3.7 million of deferred revenue related to the upfront fee of the development and license agreement as the Company had no remaining performance obligations under the agreement; this recognition of revenue did not result in additional cash proceeds to the Company.

The following table provides a summary of collaborative research and development revenue recognized under the agreement with Nycomed with regard to POSIDUR (in thousands). The cumulative aggregate payments received by the Company from Nycomed as of June 30, 2012 were $37.3 million under this agreement. In addition, the cumulative aggregate payments paid by the Company to Nycomed were $9.0 million as of June 30, 2012.

 

                                                       
     Three months ended
June 30,
     Six months ended
June 30,
 
     2012      2011      2012      2011  

Ratable recognition of upfront payment (1)

   $ 0       $ 308       $ 3,705       $ 617   

Research and development expenses reimbursable by Nycomed

     0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total collaborative research and development revenue

   $ 0       $ 308       $ 3,705       $ 617   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) The Company’s estimate of the term of its continuing performance obligation was revised in the first quarter of 2012 as a result of the termination of the agreement by Nycomed. As a result of the termination of the Nycomed agreement for POSIDUR, the Company recorded as revenue during the first quarter of 2012 the remaining $3.7 million deferred revenue related to the upfront fee of the development and license agreement.

Agreement with Alpharma Ireland Limited, an affiliate of Alpharma Inc. (Alpharma) (acquired by King which subsequently was acquired by Pfizer)

Effective October 2008, the Company and Alpharma, entered into a development and license agreement granting Alpharma the exclusive worldwide rights to develop and commercialize ELADUR, DURECT’s investigational transdermal bupivacaine patch. As a result of the acquisition of Alpharma by King in December 2008, King assumed the rights and obligations of Alpharma under the agreement. As a result of the acquisition of King by Pfizer in February 2011, Pfizer assumed the rights and obligations of King under the agreement; accordingly, amounts attributed to King are now shown as Pfizer figures.

Under the terms of the agreement, Alpharma paid the Company an upfront license fee of $20 million. The $20.0 million upfront fee had been recognized as collaborative research and development revenue ratably over the term of the Company’s continuing involvement with Pfizer with respect to ELADUR. The Company’s estimate of the remaining term of its continuing involvement was adjusted in the third quarter of 2011 as a result of an updated development plan for ELADUR.

In February 2012, the Company was notified that Pfizer was terminating the agreement, effective August 30, 2012, or, as permitted under the agreement, at an earlier date elected by the Company. Pfizer’s termination returns to the Company worldwide rights to develop and commercialize ELADUR. As a result of the termination of the agreement for ELADUR, the Company recognized revenue during the first quarter of 2012 for the remaining $9.9 million of deferred revenue related to the upfront fee of the development and license agreement as the Company has no remaining performance obligations under the agreement; this recognition of revenue did not result in additional cash proceeds to the Company.

The following table provides a summary of collaborative research and development revenue recognized under this agreement with regard to ELADUR (in thousands). The cumulative aggregate payments received by the Company as of June 30, 2012 were $29.2 million under this agreement.

 

                                                       
     Three months ended
June 30,
     Six months ended
June 30,
 
     2012      2011      2012      2011  

Ratable recognition of upfront payment (1)

   $ 0       $ 804       $ 9,895       $ 1,609   

Research and development expenses reimbursable by Pfizer

     61         290         83         1,045   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total collaborative research and development revenue

   $ 61       $ 1,094       $ 9,978       $ 2,654   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) The Company’s estimate of the term of our continuing performance obligation was revised in the first quarter of 2012 as a result of the termination of the agreement by Pfizer. As a result of the termination of this agreement for ELADUR, the Company recorded as revenue during the first quarter of 2012 the remaining $9.9 million deferred revenue related to the upfront fee of the development and license agreement.

 

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Note 3. Financial Instruments

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The Company’s valuation techniques used to measure fair value maximize the use of observable inputs and minimize the use of unobservable inputs. The Company follows a fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value. These levels of inputs are the following:

 

   

Level 1—Quoted prices in active markets for identical assets or liabilities.

 

   

Level 2—Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

 

   

Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The Company’s financial instruments are valued using quoted prices in active markets or based upon other observable inputs. Money market funds are classified as Level 1 financial assets. Certificates of deposit, commercial paper, corporate debt securities, and U.S. Government agency securities are classified as Level 2 financial assets. The fair value of the Level 2 assets is estimated using pricing models using current observable market information for similar securities. The Company’s Level 2 investments include U.S. government-backed securities and corporate securities that are valued based upon observable inputs that may include benchmark yields, reported trades, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers and reference data including market research publications. The fair value of the Company’s commercial paper is based upon the time to maturity and discounted using the three-month treasury bill rate. The average remaining maturity of the Company’s Level 2 investments as of June 30, 2012 is less than twelve months and these investments are rated by S&P and Moody’s at AAA or AA- for securities and A1 or P1 for commercial paper.

 

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The following is a summary of available-for-sale securities as of June 30, 2012 and December 31, 2011 (in thousands):

 

                                                       
     June 30, 2012  
     Amortized
Cost
     Unrealized
Gain
     Unrealized
Loss
    Estimated
Fair
Value
 

Money market funds

   $ 708       $ —         $ —        $ 708   

Certificates of deposit

     902         —           —          902   

Commercial paper

     2,074         —           —          2,074   

Corporate debt

     1,056         —           —          1,056   

U.S. Government agencies

     15,835         2         (3     15,834   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 20,575       $ 2       $ (3   $ 20,574   
  

 

 

    

 

 

    

 

 

   

 

 

 

Reported as:

          

Cash and cash equivalents

   $ 997       $ —         $ —        $ 997   

Short-term investments

     14,877         2         (1     14,878   

Long-term investments

     4,301         —           (2     4,299   

Long-term restricted investments

     400         —           —          400   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 20,575       $ 2       $ (3   $ 20,574   
  

 

 

    

 

 

    

 

 

   

 

 

 
     December 31, 2011  
     Amortized
Cost
     Unrealized
Gain
     Unrealized
Loss
    Estimated
Fair
Value
 

Money market funds

   $ 3,635       $ 0      $ 0     $ 3,635   

Certificates of deposit

     1,720         1         (1     1,720   

Commercial paper

     6,986         1         0       6,987   

Corporate debt

     809         0        (1     808   

U.S. Government agencies

     14,763         6         (1     14,768   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 27,913       $ 8       $ (3   $ 27,918   
  

 

 

    

 

 

    

 

 

   

 

 

 

Reported as:

          

Cash and cash equivalents

   $ 5,985       $ 0      $ 0     $ 5,985   

Short-term investments

     19,530         7         (2     19,535   

Short-term restricted investments

     367         0        0        367   

Long-term investments

     1,530         1         (1     1,530   

Long-term restricted investments

     501         0         0        501   
  

 

 

    

 

 

    

 

 

   

 

 

 
   $ 27,913       $ 8       $ (3   $ 27,918   
  

 

 

    

 

 

    

 

 

   

 

 

 

The following is a summary of the cost and estimated fair value of available-for-sale securities at June 30, 2012, by contractual maturity (in thousands):

 

                           
     June 30, 2012  
   Amortized
Cost
     Estimated
Fair
Value
 

Mature in one year or less

   $ 15,566       $ 15,567   

Mature after one year through five years

     4,301         4,299   
  

 

 

    

 

 

 
   $ 19,867       $ 19,866   
  

 

 

    

 

 

 

There were no securities that have had an unrealized loss for more than 12 months as of June 30, 2012.

As of June 30, 2012, unrealized losses on available-for-sale investments are not attributed to credit risk and are considered to be temporary. The Company believes that it is more-likely-than-not that investments in an unrealized loss position will be held until maturity or the recovery of the cost basis of the investment. To date, the Company has not recorded any impairment charges on marketable securities related to other-than-temporary declines in market value.

 

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Note 4. Stock-Based Compensation

As of June 30, 2012, the Company has four stock-based employee compensation plans. The employee stock-based compensation cost that has been included in the statements of comprehensive income (loss) is shown as below (in thousands):

 

                                                       
     Three months ended
June  30,
     Six months ended
June  30,
 
     2012      2011      2012      2011  

Cost of product revenues

   $ 61       $ 82       $ 125       $ 167   

Research and development

     624         1,072         1,322         2,199   

Selling, general and administrative

     385         580         799         1,151   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total stock-based compensation

   $ 1,070       $ 1,734       $ 2,246       $ 3,517   
  

 

 

    

 

 

    

 

 

    

 

 

 

As of June 30, 2012 and December 31, 2011, $29,000 and $40,000, respectively, of stock-based compensation cost was capitalized in inventory on the Company’s balance sheets.

The Company uses the Black-Scholes option pricing model to value its stock options. The expected life computation is based on historical exercise patterns and post-vesting termination behavior. The Company considered its historical volatility in developing its estimate of expected volatility.

The Company used the following assumptions to estimate the fair value of options granted and shares purchased under its employee stock purchase plan for the three and six months ended June 30, 2012 and 2011:

 

     Three months ended
June  30,
    Six months ended
June 30,
 
     2012     2011     2012     2011  

Stock options

        

Risk-free rate

     0.8-1.2     2.1-2.4     0.8-1.5     2.1-2.7

Expected dividend yield

     —          —          —          —     

Expected life of option (in years)

     5.50-6.50        6.25        5.25-6.50        6.25   

Volatility

     78-81     73-75     78-82     73-75

Forfeiture rate

     7.7     6.1     7.7     6.1
     Three months ended
June  30,
    Six months ended
June  30,
 
     2012     2011     2012     2011  

Employee Stock Purchase Plan

        

Risk-free rate

     0.1-1.0     0.1-1.0     0.1-1.0     0.1-1.0

Expected dividend yield

     —          —          —          —     

Expected life of option (in years)

     1.25        1.25        1.25        1.25   

Volatility

     86-101     50-163     86-101     50-163

Note 5. Reduction in Force

In February 2012, the Company reduced the size of its workforce by 15 employees or approximately 12% of its headcount. The goal of this action was to better align the Company’s cost structure with anticipated revenues and operating expenses, while not compromising the Company’s key corporate objectives for that year. The Company completed this headcount reduction during the first quarter of 2012, and incurred approximately $336,000 in severance costs for the impacted employees, of which $195,000 was recorded in research and development expenses and $141,000 was recorded in selling, general and administrative expenses in the first quarter of 2012. All severance costs were paid during the first quarter of 2012.

 

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

This Management’s Discussion and Analysis of Financial Condition and Results of Operations for the three and six months ended June 30, 2012 and 2011 should be read in conjunction with our annual report on Form 10-K for the year ended December 31, 2011 filed with the Securities and Exchange Commission and “Risk Factors” section included elsewhere in this Form 10-Q. This Form 10-Q contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. When used in this report, the words “believe,” “anticipate,” “intend,” “plan,” “estimate,” “expect,” “may,” “will,” “could,” “potentially” and similar expressions are forward-looking statements. Such forward-looking statements are based on current expectations and beliefs. Any such forward-looking statements are not guarantees of future performance and involve risks and uncertainties. Actual events or results may differ materially from those discussed in the forward-looking statements as a result of various factors.

Forward-looking statements made in this report include, for example, statements about:

 

   

potential regulatory filings for or approval of REMOXY, POSIDUR or any of our other product candidates;

 

   

the progress of our third-party collaborations, including estimated milestones;

 

   

our intention to seek, and ability to enter into strategic alliances and collaborations;

 

   

the potential benefits and uses of our products;

 

   

responsibilities of our collaborators, including the responsibility to make cost reimbursement, milestone, royalty and other payments to us, and our expectations regarding our collaborators’ plans with respect to our products;

 

   

our responsibilities to our collaborators, including our responsibilities to conduct research and development, clinical trials and manufacture products;

 

   

our ability to protect intellectual property, including intellectual property licensed to our collaborators;

 

   

market opportunities for products in our product pipeline;

 

   

the number of patients enrolled and the timing of patient enrollment in clinical trials;

 

   

the progress and results of our research and development programs;

 

   

requirements for us to purchase supplies and raw materials from third parties, and the ability of third parties to provide us with required supplies and raw materials;

 

   

the results and timing of clinical trials and the commencement of future clinical trials;

 

   

conditions for obtaining regulatory approval of our product candidates;

 

   

submission and timing of applications for regulatory approval;

 

   

the impact of FDA, DEA, EMEA and other government regulation on our business;

 

   

the impact of potential Risk Evaluation and Mitigation Strategies (REMS) on our business;

 

   

uncertainties associated with obtaining and protecting patents and other intellectual property rights, as well as avoiding the intellectual property rights of others;

 

   

products and companies that will compete with the products we license to third-party collaborators;

 

   

the possibility we may commercialize our own products and build up our commercial, sales and marketing capabilities and other required infrastructure;

 

   

our intention to develop additional manufacturing capabilities;

 

   

our employees, including the number of employees and the continued services of key management, technical and scientific personnel;

 

   

our future performance, including our anticipation that we will not derive meaningful revenues from our pharmaceutical systems for at least twelve months and our expectations regarding our ability to achieve profitability;

 

   

sufficiency of our cash resources, anticipated capital requirements and capital expenditures and our need for additional financing;

 

   

our expectations regarding marketing expenses, research and development expenses, and selling, general and administrative expenses;

 

   

the composition of future revenues; and

 

   

accounting policies and estimates, including revenue recognition policies.

 

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Forward-looking statements are not guarantees of future performance and involve risks and uncertainties. Actual events or results may differ materially from those discussed in the forward-looking statements as a result of various factors. For a more detailed discussion of such forward looking statements and the potential risks and uncertainties that may impact upon their accuracy, see the “Risk Factors” section and “Overview” section of this Management’s Discussion and Analysis of Financial Condition and Results of Operations. These forward-looking statements reflect our view only as of the date of this report. We undertake no obligations to update any forward-looking statements. You should also carefully consider the factors set forth in other reports or documents that we file from time to time with the Securities and Exchange Commission.

Overview

We are a specialty pharmaceutical company focused on the development of pharmaceutical products based on our proprietary drug delivery technology platforms. Our product pipeline currently consists of seven investigational drug candidates in clinical development, including one New Drug Application (NDA) submitted to the U.S. Food and Drug Administration (FDA) that is the subject of a Complete Response Letter, one Phase III product candidate, two Phase II product candidates and three Phase I programs. The more advanced programs are in the field of pain management and we believe that each of these targets large market opportunities with product features that are differentiated from existing therapeutics. We have other research programs underway in fields outside of pain management, including various diseases and disorders of the central nervous system, cardiovascular disease and cancer.

A central aspect of our business strategy involves advancing multiple product candidates at one time, which is enabled by leveraging our resources with those of corporate collaborators. Thus, certain of our programs are currently licensed to corporate collaborators on terms which typically call for our collaborator to fund all or a substantial portion of future development costs and then pay us milestone payments based on specific development or commercial achievements plus a royalty on product sales. At the same time, we have retained the rights to other programs, which are the basis of future collaborations and which over time may provide a pathway for us to develop our own commercial, sales and marketing organization.

Additional details of these programs and related strategic agreements are contained in our annual report on Form 10-K for the year ended December 31, 2011 or in Note 2 above.

REMOXY ® and other ORADUR-based opioid products licensed to Pain Therapeutics

In December 2002, we entered into an agreement with Pain Therapeutics, amended in December 2005, under which we granted Pain Therapeutics the exclusive, worldwide right to develop and commercialize selected long-acting oral opioid products using our ORADUR technology incorporating four specified opioid drugs. The first product being developed under the collaboration is REMOXY, a novel long-acting oral formulation of the opioid oxycodone targeted to decrease the potential for oxycodone abuse. REMOXY is intended for patients with chronic pain. In November 2005, Pain Therapeutics and King entered into collaboration and license agreements for the development and commercialization of REMOXY by King. In February 2011, Pfizer acquired King and thereby assumed the rights and obligations of King with respect to REMOXY and to the other ORADUR-based opioids.

An NDA was submitted in June 2008 by Pain Therapeutics, in response to which the FDA provided a Complete Response Letter in December 2008. King took over the NDA from Pain Therapeutics and resubmitted the NDA in December of 2010. On June 23, 2011, a Complete Response Letter from the FDA was received by Pfizer on the resubmission to the NDA for REMOXY. The issues raised in the Complete Response Letter relate primarily to manufacturing. Pfizer has efforts underway to resolve these issues. Sufficient information does not yet exist to accurately assess the time required to resolve the concerns raised in the FDA’s Complete Response Letter. On July 31, 2012, Pfizer stated that they are analyzing preliminary results from two bioavailability studies and hoping to meet with the FDA in the fourth quarter of 2012.

Phase I clinical trials have been conducted for two of the other ORADUR-based products (hydrocodone and hydromorphone), and an Investigational New Drug (IND) application has been accepted by the FDA for the fourth ORADUR-based opioid (oxymorphone).

 

NOTE: POSIDUR™, SABER®, TRANSDUR®, ORADUR®, ELADUR®, DURIN®, CHRONOGESIC™, MICRODUR™, ALZET® and LACTEL® are trademarks of DURECT Corporation. Other trademarks referred to belong to their respective owners.

 

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POSIDUR™ (SABER®-Bupivacaine)

Our post-operative pain relief depot, POSIDUR, is a sustained release formulation using our SABER delivery system to deliver bupivacaine, an off-patent anesthetic agent. SABER is a patented controlled drug delivery technology that can be formulated for systemic or local administration of drugs via the parenteral (i.e., injectable) route. POSIDUR is designed to be administered to a surgical site at the time of surgery for post-operative pain relief and is intended to provide local analgesia for up to 3 days, which we believe coincides with the time period of the greatest need for post-surgical pain control in most patients.

In November 2006, we entered into a development and license agreement with Nycomed (amended in February 2010 and February 2011) under which we licensed to Nycomed the exclusive commercialization rights to POSIDUR for the European Union (E.U.) and certain other countries. In June 2010, we entered into a development and license agreement with Hospira to develop POSIDUR for the U.S. and Canada and under which we licensed to Hospira exclusive commercialization rights in the U.S. and Canada. In October 2011, Takeda Pharmaceutical Company Limited (Takeda) acquired Nycomed and thereby assumed the rights and obligations of Nycomed under the agreements the Company formerly had in place with Nycomed. In January 2012, Takeda (through Nycomed) notified us that it was terminating the license agreement with us, and thereby returning their right to develop and commercialize POSIDUR in Europe and their other licensed territories to us. In March 2012, Hospira notified us that it was terminating the license agreement with us, and thereby returning their right to develop and commercialize POSIDUR in the U.S. and Canada to us by September 28, 2012, or an earlier date at our election. We have initiated discussions with other potential partners regarding licensing development and commercialization rights to this program to which we hold worldwide rights.

Clinical Development Program

A total of 12 clinical trials in subjects undergoing various surgical procedures have been conducted with POSIDUR, including a 305-patient randomized double-blind Phase 3 trial involving three abdominal surgical models, results of which were disclosed on January 5, 2012, and a 107 patient randomized double blind Phase 2b trial in shoulder surgery, results of which were disclosed February 9, 2011. In addition, two Phase I studies have been conducted in healthy subjects. In all, 1,060 subjects have been studied in the POSIDUR Phase 2 and 3 clinical development program, of which 668 have been treated with POSIDUR, 268 with SABER-Placebo (SABER vehicle without drug), and 124 with bupivacaine HCI solution. The studies have been conducted in the United States, Australia, New Zealand and Europe with the purpose of establishing the overall safety of POSIDUR and efficacy in the treatment of post-surgical pain.

Next Steps

In July 2012, we completed pre-NDA communications with the FDA regarding POSIDUR. Through this process, we have received guidance and thoughtful comments from the FDA covering various chemistry, manufacturing, non-clinical, clinical pharmacology, clinical, statistical and product labeling topics based on our pre-NDA meeting questions. We have sent to the FDA meeting minutes and are awaiting their final concurrence on those minutes. With the input we have received from the FDA, we intend to prepare and submit a new drug application under 505(b)(2) with the FDA in late 2012 or early 2013.

ELADUR® (TRANSDUR™-Bupivacaine)

Our transdermal bupivacaine patch (ELADUR) uses our proprietary TRANSDUR transdermal technology and is intended to provide continuous delivery of bupivacaine for up to three days from a single application, as compared to a wearing time limited to 12 hours with currently available lidocaine patches. In December 2007, we announced positive results from a 60 patient Phase IIa study for post-herpetic neuralgia (PHN or post-shingles pain).

Effective in October 2008, we entered into a development and license agreement with Alpharma granting Alpharma the exclusive worldwide rights to develop and commercialize ELADUR. Alpharma paid us an upfront license fee of $20 million in October 2008. Alpharma was acquired by King in December 2008 and, as a result, the rights and obligations of the agreement were assumed by King. In February 2011, Pfizer acquired King and thereby assumed the rights and obligations of King with respect to ELADUR.

We reported top line data from a Phase II clinical trial conducted by King for ELADUR in April 2011. In this study of 263 patients suffering from chronic low back pain, the primary efficacy endpoint of demonstrating a positive treatment difference for the mean change in pain intensity scores from baseline to the mean of weeks 11 and 12 between ELADUR as compared to placebo was not met.

 

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In February 2012, Pfizer notified us that it was terminating the license agreement with us, and thereby returning their worldwide right to develop and commercialize ELADUR to us by August 30, 2012, or an earlier date at our election. We have initiated discussions with other potential partners regarding licensing development and commercialization rights to this program.

TRANSDUR™-Sufentanil

Our transdermal sufentanil patch (TRANSDUR-Sufentanil) uses our proprietary TRANSDUR delivery system to deliver sufentanil, an opioid medication. TRANSDUR-Sufentanil is designed to provide extended chronic pain relief for up to seven days, as compared to the two to three days of relief provided with currently available fentanyl patches. We anticipate that the small size of our sufentanil patch (potentially as small as 1/5th the size of currently marketed transdermal fentanyl patches for a therapeutically equivalent dose) may offer improved convenience and compliance for patients. An end-of-Phase II meeting was conducted with the FDA in February 2009 and we have subsequently had discussions with the FDA and regulatory agencies in several major European countries to better understand development requirements for U.S. and European approval. We continue to have discussions with potential partners regarding licensing development and commercialization rights to this program to which we hold worldwide rights.

ORADUR-ADHD Program

We are developing a drug candidate (ORADUR-ADHD) based on DURECT’s ORADUR Technology for the treatment of ADHD. This drug candidate is intended to provide once-a-day dosing with added tamper-resistant characteristics to address common methods of abuse and misuse of these types of drugs.

In August 2009, we entered into a development and license agreement with Orient Pharma Co., Ltd., a diversified multinational pharmaceutical, healthcare and consumer products company with headquarters in Taiwan, under which we granted to Orient Pharma development and commercialization rights in certain defined Asian and South Pacific countries to ORADUR-ADHD. DURECT retains rights to North America, Europe, Japan and all other countries not specifically licensed to Orient Pharma. In the second quarter of 2012, we and Orient Pharma continued our ORADUR-ADHD program through a Phase I study and Pharmacokinetic (PK) analysis with multiple formulations. We are continuing to optimize the formulation and are planning next steps in our ORADUR-ADHD program.

Relday™ (risperidone) Program

On July 11, 2011, we and Zogenix, Inc. (Zogenix) entered into a development and license agreement for the purpose of developing and commercializing Relday, a proprietary, long-acting injectable formulation of risperidone using our SABER-controlled release formulation technology in combination with Zogenix’s DosePro® needle-free, subcutaneous drug delivery system. Risperidone is one of the most widely prescribed medications used to treat the symptoms of schizophrenia and bipolar I disorder in adults and teenagers 13 years of age and older. Under the agreement, we granted Zogenix worldwide development and commercialization rights to Relday. On July 12, 2012, Zogenix announced that it has initiated its first Phase I clinical trial for Relday. The Phase I clinical trial for Relday is a single-center, open-label, safety and pharmacokinetic (PK) trial that will enroll 30 patients with chronic, stable schizophrenia or schizoaffective disorder. Zogenix expects that study results will be available by the end of 2012.

Other Programs

Depot Injectable Programs

The proteins and genes identified by the biotechnology industry are large, complex, intricate molecules, and many are unsuitable as drugs. If these molecules are given orally, they are often digested before they can have an effect; if given by injection, they often require impractical, inconvenient frequent injections that may result in unwanted side effects. As a result, the development of biotechnology molecules for the treatment of human diseases has been limited, and advanced depot injectable systems such as we possess are required to realize the full potential of many of these protein and peptide drugs. In addition to biologic drugs, many traditional small molecule drugs have to be given by frequent injections, which is costly, inconvenient and may result in either unwanted side effects or suboptimal efficacy. We have active programs underway to improve our depot injectable systems and to apply those systems to various drugs and drug candidates, and have entered into a number of feasibility studies with biotechnology and pharmaceutical companies to test their products in our systems.

 

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Research and Development Programs in Other Therapeutic Categories

We have underway a number of research programs covering diseases and medical conditions other than pain. Such programs include various diseases and disorders of the central nervous system, cardiovascular disease and cancer. In conducting our research programs and determining which particular efforts to prioritize for formal development, we employ a rigorous opportunity assessment process that takes into account the unmet medical need, commercial opportunity, technical feasibility, clinical viability, intellectual property considerations, and the development path including costs to achieve various critical milestones.

Product Revenues

We also currently generate product revenue from the sale of three product lines:

 

   

ALZET® osmotic pumps for animal research use;

 

   

LACTEL® biodegradable polymers which are used by our customers as raw materials in their pharmaceutical and medical products; and

 

   

certain key excipients that are included in Remoxy.

Because we consider our core business to be developing and commercializing pharmaceutical systems, we do not intend to significantly increase our investments in or efforts to sell or market any of our existing product lines. However, we expect that we will continue to make efforts to increase our revenue related to collaborative research and development by entering into additional research and development agreements with third-party collaborators to develop product candidates based on our drug delivery technologies.

Reduction In Force

Our total number of employees was 105 at June 30, 2012 as compared to 124 at December 31, 2011, which was a 15% reduction in headcount. This was largely a result of a reduction in force of 15 employees implemented in February 2012. We completed this headcount reduction during February 2012, and incurred approximately $0.3 million in severance costs for the impacted employees in the first quarter of 2012. The goal of this action was to better align our cost structure with anticipated revenues and operating expenses, while not compromising our key corporate objectives.

In addition to the reduction in headcount, other steps were taken in the first quarter of 2012 to reduce our compensation expense. No cash bonuses were paid in the first quarter of 2012 relative to fiscal year 2011 performance and there were generally no salary increases at the Company for those at the director level and above. Our Chairman and Chief Scientific Officer transitioned, effective February 1, 2012, to 75% of time and took a corresponding reduction in his notional salary. In addition, in order to preserve cash and to more closely align the interests of the Company’s employees with the interests of the Company’s shareholders, six vice presidents and above volunteered to receive a reduced portion of their salary (totaling approximately $250,000) in cash effective February 1, 2012, for which they were correspondingly granted 478,519 options that vest quarterly over one year following the date of grant, subject to continued service.

Operating Results

Since our inception in 1998, we have generally had a history of operating losses. At June 30, 2012, we had an accumulated deficit of $329.0 million. Our net income was $26.5 million for the six months ended June 30, 2012, resulting from the recognition of previously received upfront payments of $35.4 million in connection with agreements terminated by Pfizer, Hospira and Nycomed. This recognition of deferred revenue did not result in additional cash proceeds to us. Our net losses were $18.8 million, $22.9 million and $30.3 million for the years ended December 31, 2011, 2010 and 2009, respectively. These losses have resulted primarily from costs incurred to research and develop our product candidates and to a lesser extent, from selling, general and administrative costs associated with our operations and product sales. We expect our research and development expenses to decrease in the near future compared to recent quarters. We expect selling, general and administrative expenses to decrease modestly in the near future. We do not anticipate meaningful revenues from our pharmaceutical systems, should they be approved, for at least the next twelve months. Therefore, we expect to incur continuing losses and negative cash flow from operations for the foreseeable future.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenues and expenses during the reporting periods. The most significant estimates and assumptions relate to revenue recognition, the recoverability of our long-lived assets, including goodwill and other intangible assets, accrued liabilities, contract research liabilities, inventories and stock-based compensation. Actual amounts could differ significantly from these estimates. There have been no material changes to our critical accounting policies and estimates as compared to the disclosures in our annual report on Form 10-K for the year ended December 31, 2011.

 

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Results of Operations

Three and six months ended June 30, 2012 and 2011

Collaborative research and development and other revenue

We recognize revenues from collaborative research and development activities and service contracts. Collaborative research and development revenue primarily represents net reimbursement of qualified expenses related to the collaborative agreements with various third parties to research, develop and commercialize potential products using our drug delivery technologies, revenue recognized from ratable recognition of upfront fees and milestone payments in connection with our collaborative agreements.

We expect our collaborative research and development revenue to decrease in the near future, largely as a result of lower net reimbursement of qualified expenses related to the collaborative agreements due to termination of the agreements with Hospira (with respect to POSIDUR), Pfizer (with respect to ELADUR) and Nycomed (with respect to POSIDUR). In general, we expect our collaborative research and development revenue to fluctuate in future periods pending our efforts to enter into potential new collaborations and our existing third party collaborators’ commitment to and progress in the research and development programs as well as our role in the workplans for those programs at any point in time. The collaborative research and development and other revenues associated with our major collaborators are as follows (in thousands):

 

     Three months ended
June 30,
     Six months ended
June 30,
 
     2012      2011      2012      2011  

Collaborator

           

Hospira, Inc. (Hospira) (1)

   $ 952       $ 2,838       $ 23,726       $ 5,852   

Pfizer Inc. (Pfizer) (2)

     739         1,098         11,127         2,715   

Zogenix, Inc. (Zogenix) (3)

     352         693         1,636         1,243   

Pain Therapeutics, Inc. (Pain Therapeutics)

     1         21         2         43   

Nycomed Danmark, APS (Nycomed) (4)

     0         308         3,705         617   

Others

     183         230         359         230   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total collaborative research and development and other revenue

   $ 2,227       $ 5,188       $ 40,555       $ 10,700   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Amounts related to the recognition of upfront fees were zero and $21.8 million for the three and six months ended June 30, 2012, respectively, compared to $906,000 and $1.8 million for the corresponding periods in 2011. In March 2012, we were notified that Hospira was terminating the Development and License Agreement between Hospira and us dated June 1, 2010 relating to the development and commercialization of POSIDUR in the United States and Canada. As a result, we recognized as revenue all of the remaining upfront fees during the six months ended June 30, 2012 that had previously been deferred.
(2) Amounts related to the recognition of upfront fees were zero and $9.9 million for the three and six months ended June 30, 2012, respectively, compared to $804,000 and $1.6 million for the corresponding periods in 2011. In February 2011, Pfizer acquired King Pharmaceuticals (King) and thereby assumed the rights and obligations of King under the agreements we formerly had in place with King; accordingly amounts attributed to King are now shown as Pfizer figures. In February 2012, we were notified that Pfizer was terminating the Development and License Agreement between Alpharma (acquired by King which subsequently was acquired by Pfizer) and DURECT dated September 19, 2008 relating to the development and commercialization of ELADUR in the worldwide. As a result, we recognized as revenue all of the remaining upfront fees during the six months ended June 30, 2012 that had previously been deferred.
(3) Amounts related to the ratable recognition of upfront fees were $78,000 and $156,000 for the three and six months ended June 30, 2012, respectively, compared to zero for both of the corresponding periods in 2011. A development and license agreement with Zogenix was entered into on July 11, 2011; the Company and Zogenix had previously been working together under a feasibility agreement pursuant to which the Company’s research and development costs were reimbursed by Zogenix.
(4) Amounts related to the ratable recognition of upfront fees were zero and $3.7 million for the three months ended June 30, 2012, respectively, compared to $308,000 and $617,000 for the corresponding periods in 2011. In January 2012, we were notified that Nycomed was terminating the Development and License Agreement between Nycomed and us dated November 26, 2006, as amended, relating to the development and commercialization of POSIDUR in Europe and their other licensed territories. As a result, we recognized as revenue all of the remaining upfront fees during the six months ended June 30, 2012 that had previously been deferred.

 

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We recorded $2.2 million and $40.6 million of collaborative research and development revenue for the three and six months ended June 30, 2012, respectively, compared to $5.2 million and $10.7 million for the corresponding periods in 2011, respectively. The decrease in collaborative research and development revenue in the three months ended June 30, 2012 was primarily attributable to lower revenue recognized in connection with our agreements with Hospira, Pfizer, Nycomed, Zogenix, Pain Therapeutics and feasibility partners. The increase in collaborative research and development revenue in the six months ended June 30, 2012 was primarily attributable to revenue of $35.4 million recognized as a result of the termination of our agreements with Nycomed (with respect to POSIDUR), Pfizer (with respect to ELADUR) and Hospira (with respect to POSIDUR) in the first quarter of 2012; the termination of the agreements and the related recognition of deferred revenue did not result in additional cash proceeds to us. Excluding the impact of recognition of the upfront fees from our agreements with collaborative partners in the six months ended June 30, 2012 and 2011, collaborative research and development revenue decreased in the six months ended June 30, 2012 due to lower revenue recognized from our agreements with Hospira and Pfizer as the development activities for POSIDUR and ELADUR decreased in the first six months of 2012 compared with the corresponding period in 2011, partially offset by higher collaborative research and development revenue recognized in connection with our agreements with Pfizer (with respect to Remoxy), Zogenix and other feasibility partners.

We received a $2.25 million upfront fee in connection with the development and license agreement signed with Zogenix in July 2011 relating to Relday. The $2.25 million upfront fee is recognized as collaborative research and development revenue ratably over the term of our continuing involvement with Zogenix with respect to Relday.

We also received a $27.5 million upfront fee in connection with the development and license agreement signed with Hospira in June 2010 relating to POSIDUR. The $27.5 million upfront fee had been recognized as collaborative research and development revenue ratably over the term of our continuing involvement with Hospira with respect to POSIDUR. Our estimate of the remaining term of our continuing involvement was revised in the first quarter of 2012 as a result of Hospira’s termination notice received by us in March 2012. At June 30, 2012, all of the $27.5 million upfront fee had been recognized as revenue.

We also received a $20.0 million upfront fee in connection with the development and license agreement signed with Alpharma (acquired by King which was subsequently acquired by Pfizer) in September 2008 relating to ELADUR. The $20.0 million upfront fee had been recognized as collaborative research and development revenue ratably over the term of our continuing involvement with Alpharma with respect to ELADUR. Our estimate of the remaining term of our continuing involvement was revised in the first quarter of 2012 as a result of Pfizer’s termination notice received by us in February 2012. At June 30, 2012, all of the $20.0 million upfront fee had been recognized as revenue.

We also received a $14.0 million upfront fee in connection with the development and license agreement signed with Nycomed in November 2006 relating to POSIDUR. The $14.0 million upfront fee had been recognized as collaborative research and development revenue ratably over the term of our continuing involvement with Nycomed with respect to POSIDUR. Our estimate of the remaining term of our continuing involvement was revised in the first quarter of 2012 as a result of Nycomed’s termination notice received by us in January 2012. At June 30, 2012, all of the $14.0 million upfront fee had been recognized as revenue.

Product revenue

A portion of our revenues is derived from our product sales, which include our ALZET mini pump product line, our LACTEL biodegradable polymer product line and certain excipients that are included in Remoxy. Net product revenues were $2.6 million and $5.4 million in the three and six months ended June 30, 2012, respectively, compared to $2.6 million and $5.7 million for the corresponding periods in 2011, respectively. The product revenues in the three months ended June 30, 2012 and 2011 were comparable. The decrease in the six months ended June 30, 2012 was primarily attributable to lower product revenue from our ALZET mini pump product line and from our LACTEL polymer product line as a result of fewer units sold, partially offset by higher product revenue from the sale of certain excipients included in Remoxy to Pfizer compared to the corresponding periods in 2011.

Cost of product revenues. Cost of product revenues were $1.1 million and $2.6 million for the three and six months ended June 30, 2012, respectively, compared to $1.1 million and $2.5 million for the corresponding periods in 2011, respectively. The cost of product revenue in the three months ended June 30, 2012 and 2011 were comparable. The slight increase in the cost of product revenue in the six months ended June 30, 2012 compared to the corresponding period in 2011 was primarily the result of higher manufacturing costs associated with our LACTEL product line and higher cost of goods sold related to the sale of certain excipients to Pfizer as we had no revenue from that source in the first six months of 2011, partially offset by lower cost of goods sold from our ALZET product line arising from lower units sold. Cost of product revenue and gross profit margin will fluctuate from period to period depending upon the product mix in a particular period and unit volumes sold. Stock-based compensation expense recognized related to cost of product revenues was $61,000 and $125,000 for the three and six months ended June 30, 2012, respectively, compared to $82,000 and $167,000 for the corresponding periods in 2011, respectively.

 

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As of June 30, 2012 and 2011, we had 23 and 24 manufacturing employees, respectively. We expect the number of employees involved in manufacturing will remain comparable in the near future.

Research and development. Research and development expenses are primarily comprised of salaries, benefits, stock-based compensation and other compensation cost associated with research and development personnel, overhead and facility costs, preclinical and non-clinical development costs, clinical trial and related clinical manufacturing costs, contract services, and other outside costs. Research and development expenses were $5.0 million and $10.6 million for the three and six months ended June 30, 2012, respectively, compared to $8.7 million and $18.6 million for the corresponding periods in 2011, respectively. The decrease in the three months ended June 30, 2012 was primarily attributable to lower development costs associated with POSIDUR, Relday, ORADUR-ADHD, TRANSDUR-Sufentanil, ELADUR, our biologics programs and other research programs, partially offset by higher development costs associated with Remoxy and other ORADUR-based opioid products licensed to Pain Therapeutics compared to the corresponding period in 2011 as more fully discussed below. The decrease in the six months ended June 30, 2012 was primarily attributable to lower development costs associated with POSIDUR, ORADUR-ADHD, TRANSDUR-Sufentanil, ELADUR, our biologics programs and other research programs, partially offset by higher development costs associated with Relday and Remoxy and other ORADUR-based opioid products licensed to Pain Therapeutics compared to the corresponding period in 2011 as more fully discussed below. Stock-based compensation expense recognized related to research and development personnel was $624,000 and $1.3 million for the three and six months ended June 30, 2012, respectively, compared to $1.1 million and $2.2 million for the corresponding periods in 2011, respectively.

Research and development expenses associated with our major development programs approximate the following (in thousands):

 

     Three months ended
June 30,
     Six months ended
June 30,
 
     2012      2011      2012      2011  

POSIDUR (1)

   $ 2,377       $ 4,500       $ 4,726       $ 9,811   

Remoxy and other ORADUR-based opioid products licensed to Pain Therapeutics (1)

     643         543         1,230         950   

Depot Injectable Programs

     606         1,354         1,319         2,824   
  

 

 

    

 

 

    

 

 

    

 

 

 

Relday (1)

     389         525         1,398         998   

ORADUR-ADHD

     147         195         358         629   

TRANSDUR-Sufentanil

     118         265         189         537   

ELADUR (1)

     65         387         97         1,289   

Others

     637         939         1,299         1,550   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total research and development expenses

   $ 4,982       $ 8,708       $ 10,616       $ 18,588   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) See Note 2 Strategic Agreements in the condensed financial statements for more details about our agreements with Hospira, Nycomed, Pfizer, Pain Therapeutics and Zogenix.

POSIDUR

Our research and development expenses for POSIDUR were $2.4 million and $4.7 million in the three and six months ended June 30, 2012, respectively, compared to $4.5 million and $9.8 million in the corresponding periods in 2011. The decreases in the three and six months ended June 30, 2012 were primarily due to lower clinical trial expenses related to POSIDUR in the three and six months ended June 30, 2012 as we largely completed the Phase III clinical study for POSIDUR in the fourth quarter of 2011.

Remoxy and other select ORADUR-based opioid products

Our research and development expenses for REMOXY and other opioid products were $643,000 and $1.2 million in the three and six months ended June 30, 2012, respectively, compared to $543,000 and $950,000 in the corresponding periods in 2011. The increases in the three and six months ended June 30, 2012 were primarily due to increased research and development activities subsequent to the receipt of the complete response letter related to the Remoxy NDA in June 2011.

 

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Depot Injectable programs

Our research and development expenses for depot injectable programs were $606,000 and $1.3 million in the three and six months ended June 30, 2012, respectively, compared to $1.4 million and $2.8 million in the corresponding periods in 2011. The decreases in the three and six months ended June 30, 2012 were primarily due to lower employee-related costs and lower external costs for these programs.

Relday

Our research and development expenses for Relday were $389,000 and $1.4 million in the three and six months ended June 30, 2012, respectively, compared to $525,000 and $998,000 in the corresponding periods in 2011. The decrease in the three months ended June 30, 2012 was primarily due to decreased formulation development activities and non-clinical studies associated with Relday as Zogenix filed an IND for Relay in the second quarter of 2012. The increase in the six months ended June 30, 2012 was primarily due to higher employee-related cost as well as higher costs related to formulation development and non-clinical studies associated with Relday as we continued to support Zogenix with the development and the IND submission of Relay in the first half of 2012.

ORADUR-ADHD

Our research and development expenses for ORADUR-ADHD were $147,000 and $358,000 in the three and six months ended June 30, 2012, respectively, compared to $195,000 and $629,000 in the corresponding periods in 2011. The decreases in the three and six months ended June 30, 2012 were primarily due to lower employee-related costs for this drug candidate.

TRANSDUR-Sufentanil

Our research and development expenses for TRANSDUR-Sufentanil were $118,000 and $189,000 in the three and six months ended June 30, 2012, respectively, compared to $265,000 and $537,000 in the corresponding periods in 2011. The decreases in the three and six months ended June 30, 2012 were primarily due to decreased external costs and employee-related costs for this drug candidate.

ELADUR

Our research and development expenses for ELADUR were $65,000 and $97,000 in the three and six months ended June 30, 2012, respectively, compared to $387,000 and $1.3 million in the corresponding periods in 2011. The decreases in the three and six months ended June 30, 2012 were primarily due to lower employee-related costs, non-clinical studies and contract manufacturing expenses related to this product candidate.

Other DURECT research programs

Our research and development expenses for all other programs were $637,000 and $1.3 million in the three and six months ended June 30, 2012, respectively, compared to $939,000 and $1.6 million in the corresponding period in 2011. The decreases in the three and six months ended June 30, 2012 were primarily due to lower employee-related costs and decreased research and development activities.

As of June 30, 2012, we had 56 research and development employees compared with 74 as of June 30, 2011. We expect research and development expenses to decrease in the near future.

We cannot reasonably estimate the timing and costs of our research and development programs due to the risks and uncertainties associated with developing pharmaceutical systems, as outlined in the “Risk Factors” section of this report. The duration of development of our research and development programs may span as many as ten years or more, and estimation of completion dates or costs to complete would be highly speculative and subjective due to the numerous risks and uncertainties associated with developing pharmaceutical products, including significant and changing government regulation, the uncertainties of future preclinical and clinical study results, the uncertainties with our collaborators’ commitment and progress to the programs and the uncertainties associated with process development and manufacturing as well as sales and marketing. In addition, with respect to our development programs subject to third-party collaborations, the timing and expenditures to complete the programs are subject to the control of our collaborators. Therefore, we cannot reasonably estimate the timing and estimated costs of the efforts necessary to complete the research and development programs. For additional information regarding these risks and uncertainties, see “Risk Factors” below.

 

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Selling, general and administrative. Selling, general and administrative expenses are primarily comprised of salaries, benefits, stock-based compensation and other compensation cost associated with finance, legal, business development, sales and marketing and other administrative personnel, overhead and facility costs, and other general and administrative costs. Selling, general and administrative expenses were $3.0 million and $6.3 million for the three and six months ended June 30, 2012, respectively, compared to $3.3 million and $7.0 million in the corresponding period in 2011. The decrease in selling, general and administrative expenses was primarily due to lower employee-related costs incurred in the three and six months ended June 30, 2012 compared with the corresponding periods in 2011. Stock-based compensation expense recognized related to selling, general and administrative personnel was $385,000 and $799,000 for the three and six months ended June 30, 2012, respectively, compared to $580,000 and $1.2 million in the corresponding period in 2011.

As of June 30, 2012, we had 26 selling, general and administrative personnel compared with 29 as of June 30, 2011. We expect selling, general and administrative expenses to decrease in the near future.

Other income (expense). Interest and other income was $27,000 and $49,000 for the three and six months ended June 30, 2012, respectively, compared to $43,000 and $83,000 in the corresponding period in 2011. The decreases in interest income were primarily the result of lower average cash and investment balances during the three and six months ended June 30, 2012 compared to the corresponding periods in 2011.

Interest and other expense was $2,000 and $4,000 for the three and six months ended June 30, 2012, respectively, compared to $1,000 and $5,000 in the corresponding periods in 2011.

Liquidity and Capital Resources

We had cash, cash equivalents and investments totaling $23.7 million at June 30, 2012 compared to $30.8 million at December 31, 2011. These balances include $400,000 and $868,000 of interest-bearing marketable securities classified as restricted investments on our balance sheets as of June 30, 2012 and December 31, 2011, respectively. The decrease in cash, cash equivalents and investments during the three months ended June 30, 2012 was primarily the result of ongoing operating expenses, partially offset by payments received from customers.

We used $7.1 million of cash in operating activities for the six months ended June 30, 2012 compared to $12.1 million for the corresponding period in 2011. The cash used for operations was primarily to fund operations as well as our working capital requirements. Our cash used in operating activities differs from our net income (loss) primarily due to the timing and recognition of up-front payments under collaborative agreements. Upfront payments received upon execution of collaborative agreements are recorded as deferred revenue and generally recognized on a straight-line basis over the period of our continuing involvement with the third-party collaborator pursuant to the applicable agreement. The net income of $26.5 million for the six months ended June 30, 2012 was largely a result of the accelerated recognition of $35.4 million in deferred revenue associated with upfront fees previously received from terminated collaboration agreements; such revenue is non-recurring and has no cash flow impact on the Company. The decrease in cash used for operations was also attributable to the increases in accounts receivable and prepaid expenses and other assets, partially offset by the decreases in accounts payable, accrued liabilities and deferred revenue for the six months ended June 30, 2012 compared to the corresponding period in 2011.

We received $2.3 million of cash from investing activities for the six months ended June 30, 2012 compared to $6.2 million of cash received for the corresponding period in 2011. The decrease in cash received from investing activities was primarily due to a decrease in net proceeds from maturities of available-for-sale securities for the six months ended June 30, 2012 compared to the corresponding period in 2011.

We received $46,000 of cash from financing activities for the six months ended June 30, 2012 compared to $1.0 million for the corresponding period in 2011. The decrease in cash provided by financing activities was primarily a result of lower proceeds received from exercises of stock options and the ESPP plan in the six months ended June 30, 2012 compared to the corresponding period in 2011.

We anticipate that cash used in operating activities will be comparable in the near future as we continue to research, develop and manufacture our products through internal efforts and partnering activities.

During the six months ended June 30, 2012, we believe there have been no significant changes in our future payments due under commercial commitments and contractual obligations as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011.

We anticipate incurring capital expenditures of approximately $150,000 over the next 12 months to purchase research and development and other capital equipment. The amount and timing of these capital expenditures will depend on, among other things, our collaborative research and development activities.

 

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We believe that our existing cash, cash equivalents and investments will be sufficient to fund our planned operations, existing debt and contractual commitments, and planned capital expenditures through at least the next 12 months. We may consume available resources more rapidly than currently anticipated, resulting in the need for additional funding. Additionally, we do not expect to generate meaningful revenues from our pharmaceutical systems currently under development for at least the next twelve months, if at all. Depending on whether we enter into additional collaborative agreements in the near term, we may be required to raise additional capital through a variety of sources, including:

 

   

the public equity markets;

 

   

private equity financings;

 

   

collaborative arrangements; and/or

 

   

public or private debt.

There can be no assurance that we will enter into additional collaborative agreements in the near term or additional capital will be available on favorable terms, if at all. If adequate funds are not available, we may be required to significantly reduce or refocus our operations or to obtain funds through arrangements that may require us to relinquish rights to certain of our products, technologies or potential markets, either of which could have a material adverse effect on our business, financial condition and results of operations. To the extent that additional capital is raised through the sale of equity or convertible debt securities, the issuance of such securities would result in ownership dilution to our existing stockholders.

Our cash and investments policy emphasizes liquidity and preservation of principal over other portfolio considerations. We select investments that maximize interest income to the extent possible given these two constraints. We satisfy liquidity requirements by investing excess cash in securities with different maturities to match projected cash needs and limit concentration of credit risk by diversifying our investments among a variety of high credit-quality issuers.

Off-Balance Sheet Arrangements

We have not utilized “off-balance sheet” arrangements to fund our operations or otherwise manage our financial position.

 

Item3. Quantitative and Qualitative Disclosures about Market Risk

During the six months ended June 30, 2012, we believe there have been no significant changes in market risks as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011.

 

Item4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures: The Company’s principal executive and financial officers reviewed and evaluated the Company’s disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the period covered by this Form 10-Q. Based on that evaluation, the Company’s principal executive and financial officers concluded that the Company’s disclosure controls and procedures are effective at ensuring that information required to be disclosed by the Company in reports that the Company files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC rules and forms, and is accumulated and communicated to management, including the Company’s principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting: There were no significant changes in the Company’s internal control over financial reporting (as defined in Exchange Act Rule 13a-15(f)) during the Company’s most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

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PART II—OTHER INFORMATION

 

Item1. Legal Proceedings

We are not a party to any material legal proceedings.

 

Item1A. Risk Factors

In addition to the other information in this Form 10-Q, a number of factors may affect our business and prospects. These factors include but are not limited to the following, which you should consider carefully in evaluating our business and prospects. Changes to our risk factors contained below relate primarily to updates in the development of our product candidates, financial condition and intellectual property position.

Risks Related To Our Business

Development of our pharmaceutical systems is not complete, and we cannot be certain that our pharmaceutical systems will be able to be commercialized

To be profitable, we or our third-party collaborators must successfully research, develop, obtain regulatory approval for, manufacture, introduce, market and distribute our pharmaceutical systems under development. For each pharmaceutical system that we or our third-party collaborators intend to commercialize, we must successfully meet a number of critical developmental milestones for each disease or medical condition targeted, including:

 

   

selecting and developing a drug delivery platform technology to deliver the proper dose of drug over the desired period of time;

 

   

determining the appropriate drug dosage for use in the pharmaceutical system;

 

   

developing drug compound formulations that will be tolerated, safe and effective and that will be compatible with the system;

 

   

demonstrating the drug formulation will be stable for commercially reasonable time periods;

 

   

demonstrating through clinical trials that the drug and system combination is safe and effective in patients for the intended indication; and

 

   

completing the manufacturing development and scale-up to permit manufacture of the pharmaceutical system in commercial quantities and at acceptable prices.

 

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The time frame necessary to achieve these developmental milestones for any individual product is long and uncertain, and we may not successfully complete these milestones for any of our products in development. We have not yet completed development of POSIDUR, TRANSDUR-Sufentanil, ELADUR, Relday, REMOXY and our other ORADUR-based drug candidates, and we have limited experience in developing such products. We may not be able to finalize the design or formulation of any of these pharmaceutical systems. In addition, we may select components, solvents, excipients or other ingredients to include in our pharmaceutical systems that have not been previously approved for use in pharmaceutical products, which may require us or our collaborators to perform additional studies and may delay clinical testing and regulatory approval of our pharmaceutical systems. Even after we complete the design of a pharmaceutical system, the pharmaceutical system must still complete required clinical trials and additional safety testing in animals before approval for commercialization. We are continuing testing and development of our pharmaceutical systems and may explore possible design or formulation changes to address issues of safety, manufacturing efficiency and performance. We or our collaborators may not be able to complete development of any pharmaceutical systems that will be safe and effective and that will have a commercially reasonable treatment and storage period. If we or our third-party collaborators are unable to complete development of POSIDUR, TRANSDUR-Sufentanil, ELADUR, Relday, REMOXY and our ORADUR-based drug candidates, or other pharmaceutical systems, we will not be able to earn revenue from them, which would materially harm our business.

We or our third-party collaborators must show the safety and efficacy of our drug candidates in animal studies and human clinical trials to the satisfaction of regulatory authorities before they can be sold, and the failure to do so according to plan would significantly harm our business, prospects and financial condition

Before we or our third-party collaborators can obtain government approval to sell any of our pharmaceutical systems, we or they, as applicable, must demonstrate through laboratory performance studies and safety testing, nonclinical (animal) studies and clinical (human) trials that each system is safe and effective for human use for each targeted indication. The clinical development status of our most advanced publicly announced development programs is as follows:

 

   

REMOXY—In December 2010, King resubmitted the NDA in response to a Complete Response Letter received in December 2008 by Pain Therapeutics. On June 23, 2011, a Complete Response Letter from the FDA was received by Pfizer on the resubmission to the NDA for REMOXY. The issues raised in the Complete Response Letter relate primarily to manufacturing. Pfizer has efforts underway to resolve these issues. Sufficient information does not yet exist to accurately assess the time required to resolve the concerns raised in the FDA’s Complete Response Letter and they may never be resolved. On July 31, 2012, Pfizer stated that they are analyzing preliminary results from two bioavailability studies and hoping to meet with the FDA in the fourth quarter of 2012. There can be no assurance that these bioavailability studies will achieve results that will support product approval or that any regulatory meetings or product approvals will occur.

 

   

POSIDUR—A total of 12 clinical trials in subjects undergoing various surgical procedures have been conducted with POSIDUR. In all, 1,060 subjects have been studied in the POSIDUR Phase 2 and 3 clinical development program, of which 668 have been treated with POSIDUR, 268 with SABER-Placebo (SABER vehicle without drug), and 124 with bupivacaine HCI solution. In July 2012, we completed pre-NDA communications with the FDA regarding POSIDUR. Through this process, we have received guidance and thoughtful comments from the FDA covering various chemistry, manufacturing, non-clinical, clinical pharmacology, clinical, statistical and product labeling topics based on our pre-NDA meeting questions. We have sent to the FDA meeting minutes and are awaiting their final concurrence on those minutes. With the input we have received from the FDA, we intend to prepare and submit a new drug application under 505(b)(2) with the FDA in late 2012 or early 2013. There can be no assurance that such an NDA submission will be accepted for review by the FDA or that marketing approval will occur by the FDA or other regulatory agencies.

 

   

TRANSDUR-Sufentanil Patch—In February 2009, an end-of-Phase II meeting with the FDA was conducted for this program outlining a potential regulatory pathway for the Phase III program and NDA submission. In 2011, we had discussions with the FDA and regulatory agencies in several major European countries to better understand development requirements for U.S. and European countries. We are in discussions with potential partners regarding licensing development and commercialization rights to this program to which we hold worldwide rights. There can be no assurance that our planned development program for TRANSDUR-Sufentanil will generate data and information that will be deemed sufficient for marketing approval by the FDA or other regulatory agencies or that we will be able to find a collaborator with respect to the development and commercialization of this drug candidate.

 

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ELADUR—A Phase IIa clinical trial in post-herpetic neuralgia (PHN or post-shingles pain) was completed and positive efficacy trends were reported in the fourth quarter of 2007. King, which assumed worldwide development and commercialization rights for ELADUR through its acquisition of Alpharma, conducted a Phase II clinical trial to evaluate ELADUR for the treatment of chronic low back pain and reported in April 2011 that the primary efficacy endpoint for the trial was not met. In February 2012, Pfizer notified us that they are returning their worldwide development and commercialization rights to ELADUR. There can be no assurance that our planned development program for ELADUR will generate data and information that will be deemed sufficient for marketing approval by the FDA or other regulatory agencies or that we will be able to find a collaborator with respect to the development and commercialization of this drug candidate.

 

   

ORADUR-based opioids—Phase I clinical trials have been conducted for two of these ORADUR-based products (hydrocodone and hydromorphone), and an IND has been accepted by the FDA for the third ORADUR-based opioid (oxymorphone). There can be no assurance that we or our collaborators will be able to successfully develop ORADUR-based formulations of hydrocodone, hydromorphone or oxymorphone to obtain marketing approval by the FDA or other regulatory agencies.

 

   

ORADUR-ADHD—In 2010, 2011 and 2012, we and Orient Pharma conducted several Phase I studies to evaluate multiple formulations of ORADUR-ADHD. Based on information from these trials, we are continuing to evaluate the lead formulations and are planning next steps in the ORADUR-ADHD program. There can be no assurance that we will be able to successfully develop ORADUR-ADHD to obtain marketing approval by the FDA or other regulatory agencies.

We are currently in the clinical, preclinical or research stages with respect to all our other pharmaceutical systems under development. We plan to continue extensive and costly tests, clinical trials and safety studies in animals to assess the safety and effectiveness of our pharmaceutical systems. These studies include laboratory performance studies and safety testing, clinical trials and animal toxicological studies necessary to support regulatory approval of development products in the United States and other countries of the world. These studies are costly, complex and last for long durations, and may not yield data supportive of the safety or efficacy of our drug candidates or required for regulatory approval.

Early clinical trial results may not predict the results of later trials or satisfy regulatory agencies

While some clinical trials of our product candidates have shown indications of safety and efficacy of our product candidates, there can be no assurance that these results will be confirmed in subsequent clinical trials or provide a sufficient basis for regulatory approval. In addition, side effects observed in clinical trials, or other side effects that appear in later clinical trials, may adversely affect our or our collaborators’ ability to obtain regulatory approval or market our product candidates. For example, in the Phase IIb hysterectomy trial and the BESST Phase III abdominal surgery trial of POSIDUR, transient local hematoma-like discolorations were observed near the surgical site. Side effects such as these, toxicity or other safety issues associated with the use of our drug candidates could require us to perform additional studies or halt development of our drug candidates. We or our collaborators may be required by regulatory agencies to conduct additional animal or human studies regarding the safety and efficacy of our pharmaceutical systems which we have not planned or anticipated. For example, the FDA’s Complete Response Letter raised concerns related to, among other matters, the Chemistry, Manufacturing, and Controls section of the NDA for REMOXY. There can be no assurance that Pfizer will resolve these issues to the satisfaction of the FDA in a timely manner or ever, which could harm our business, prospects and financial condition. We may also be required to conduct additional clinical trials of POSIDUR, which would be expensive and could delay product approval, harming our business, prospects and financial condition.

Clinical trials and regulatory approval of our product candidates is subject to delay, which could harm our business

The length of clinical trials will depend upon, among other factors, the rate of trial site and patient enrollment and the number of patients required to be enrolled in such studies. We or our third-party collaborators may fail to obtain adequate levels of patient enrollment in our clinical trials. Delays in planned patient enrollment may result in increased costs, delays or termination of clinical trials, which could have a material adverse effect on us. In addition, even if we or our third-party collaborators enroll the number of patients we expect in the time frame we expect, such clinical trials may not provide the data necessary to support regulatory approval for the pharmaceutical systems for which they were conducted. Additionally, we or our third-party collaborators may fail to effectively oversee and monitor these clinical trials, which would result in increased costs or delays of our clinical trials. Even if these clinical trials are completed, we or our third-party collaborators may fail to complete and submit a new drug application as scheduled.

The FDA may not clear any such application in a timely manner or may deny the application entirely. Data already obtained from preclinical studies and clinical trials of our pharmaceutical systems do not necessarily p

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