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XNPT > SEC Filings for XNPT > Form 10-K on 28-Feb-2014All Recent SEC Filings

Show all filings for XENOPORT INC

Form 10-K for XENOPORT INC


28-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Overview

XenoPort, Inc. is a biopharmaceutical company focused on developing and commercializing a portfolio of internally discovered product candidates for the potential treatment of neurological and other disorders. We are currently commercializing HORIZANT® (gabapentin enacarbil) Extended-Release Tablets in the United States and developing our novel fumaric acid ester product candidate, XP23829, as a potential treatment for psoriasis and/or relapsing forms of multiple sclerosis, or MS. REGNITE® (gabapentin enacarbil) Extended-Release Tablets is being marketed in Japan by Astellas Pharma Inc. Our pipeline of product candidates also includes potential treatments for patients with spasticity related to spinal cord injury and Parkinson's disease.

HORIZANT has been approved by the U.S. Food and Drug Administration, or FDA, for the treatment of moderate-to-severe primary restless legs syndrome, or RLS, in adults and for the management of postherpetic neuralgia, or PHN, in adults. RLS, also known as Willis-Ekbom Disease, is a neurological disorder characterized by an urge to move the legs, usually caused or accompanied by uncomfortable and unpleasant sensations in the legs. PHN is a neuropathic (nerve) pain syndrome that can follow the healing of an outbreak of herpes zoster, commonly known as shingles. REGNITE has been approved by the Japanese Ministry of Health, Labor and Welfare, or MHLW, as a treatment for patients with moderate-to-severe primary RLS.

XP23829 is a fumaric acid ester compound and a patented prodrug of monomethyl fumarate, or MMF. Fumaric acid ester compounds have shown immuno-modulatory and neuroprotective effects in cell-based systems and preclinical models of disease. A fumaric acid ester product is approved in Germany for the treatment of psoriasis, and in the United States, a fumaric acid ester compound, known as TECFIDERA (dimethyl fumarate), was approved by the FDA in March 2013 for the treatment of relapsing forms of MS. We have evaluated XP23829 in Phase 1 studies with healthy subjects to determine its safety and pharmacokinetic profile.

We also have two other product candidates that have completed Phase 2 development that we may develop further to the extent that our resources permit or we enter into collaborations with third parties for such development:
arbaclofen placarbil, or AP, a potential treatment for spasticity in patients with spinal cord injury; and XP21279, a potential treatment for patients with advanced idiopathic Parkinson's disease. With respect to AP, we have decided to terminate further investment in AP as a treatment for spasticity in patients with MS; however, given a previous, successful Phase 2 clinical trial of AP as a potential treatment for spasticity in spinal cord injury patients, as resources permit, we may pursue AP for this indication.

In addition to our collaboration agreement with Astellas for REGNITE, we plan to enter into other agreements with pharmaceutical companies for our product candidates: (1) when access to a primary care physician or expanded sales force is necessary to maximize the commercial potential of our product candidates in the United States; (2) for the development and commercialization of our product candidates outside the United States; or (3) to develop and commercialize product candidates that fall outside our core focus or our core development capabilities.

On November 8, 2012, we executed a termination and transition agreement with Glaxo Group Limited, or GSK, that terminated our development and commercialization agreement with respect to HORIZANT, and also provided for a mutual release of claims and resolved all ongoing litigation between the parties. Pursuant to the termination and transition agreement, during a transition period that ended on April 30, 2013, GSK continued to exclusively commercialize, promote, manufacture and distribute HORIZANT in the United States. We did not receive any revenue nor incur any losses from GSK's sales of HORIZANT during the transition period. On May 1, 2013, we assumed all responsibilities for further development, manufacturing and commercialization of HORIZANT in the United States. The results of operations of the acquired HORIZANT business, along with the fair values of the assets acquired in the transaction, have been included in our financial statements since May 1, 2013.

On September 25, 2013, we entered into a commercial supply agreement with Patheon Pharmaceuticals Inc., or Patheon, pursuant to which Patheon agreed to supply us with commercial supplies of HORIZANT. Under the supply agreement, we provide Patheon with non-binding rolling forecasts of our long-term requirements for HORIZANT, and from time-to-time deliver binding firm purchase orders for manufacturing and supply of HORIZANT. We are responsible for providing Patheon with the active pharmaceutical ingredient in


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HORIZANT. Our purchase price for the manufacture and supply of HORIZANT from Patheon is volume-based. We are not subject to any minimum purchase requirements under the supply agreement, and may purchase our requirements of HORIZANT from other qualified suppliers, if any. Prior to our entry into the supply agreement with Patheon, GSK supplied us with HORIZANT. Earlier in 2013, due to manufacturing delays, there was a stockout of HORIZANT, meaning that an insufficient amount of HORIZANT was in the supply chain to meet the demand of orders by pharmacies and wholesalers. As a result of the stockout, we delayed implementation of our full commercial promotion of HORIZANT by approximately one month. If we or Patheon experience further manufacturing delays or issues, the demand for, and product sales of, HORIZANT could be reduced and our ability to commercialize HORIZANT and our business could be harmed.

In addition to our ability to obtain adequate supplies of HORIZANT for commercial sale, our future product sales of HORIZANT will be dependent upon the success of our strategies for commercialization, promotion and distribution, as well as our ability to successfully execute on these activities and to comply with applicable laws, regulations and regulatory requirements. Specifically, we are focusing our promotional and sales efforts on specialty doctors in certain geographic territories and have deployed a dedicated sales team through a contract sales organization to promote HORIZANT in these territories. We believe these efforts, if successful, will provide a scalable template for potential future commercial expansion. However, our commercialization strategy for HORIZANT is unproven, and our commercialization efforts may not be successful. In this regard, we rely on third parties to perform a variety of functions related to the sale and distribution of HORIZANT, key aspects of which are out of our direct control. If these third-party service providers fail to comply with applicable laws and regulations, fail to meet expected deadlines or otherwise do not carry out their contractual duties to us, or if HORIZANT encounters physical or natural damage at their facilities, our ability to deliver HORIZANT to meet commercial demand would be significantly impaired.

Historically, revenues recognized through May 1, 2013 were primarily comprised of up-front, milestone and contingent event-based payments from our collaboration agreements. However, as a result of our termination and transition agreement with GSK and the return of the commercialization rights to HORIZANT to us, our revenues for the year ended December 31, 2013 consisted primarily of revenues from HORIZANT product sales. Likewise, we expect the future composition of our revenues to consist primarily of revenues from HORIZANT product sales. Although we have begun to recognize revenue from HORIZANT product sales in the United States, we are early in our product launch, and our lack of commercialization experience, as an organization and with respect to HORIZANT product sales, will make future operating results difficult to predict. In this regard, our product sales revenue may vary significantly from period to period as the launch progresses, and we may be unable to meaningfully increase HORIZANT product sales above the levels recorded by GSK or otherwise successfully commercialize HORIZANT in a timely manner or at all. We also expect that the expenses of maintaining sales and marketing capabilities and a distribution and supply chain infrastructure will continue to be substantial, and these costs may exceed the revenues that we are able to generate from HORIZANT product sales. We recorded $6.4 million in net sales from HORIZANT after the transition period ended on April 30, 2013 through December 31, 2013.

Gabapentin enacarbil is licensed to Astellas in Japan. We are entitled to receive percentage-based high-teen royalties on net sales of REGNITE in Japan, and the royalties will be recognized as revenue when royalty payments are received. For the year ended December 31, 2013, the royalty revenue from net sales of REGNITE in Japan was $0.4 million. We expect royalty revenues from our collaboration with Astellas to fluctuate based on the results of their commercialization, marketing and distribution efforts for REGNITE in Japan. Additionally, we expect revenues to fluctuate to the extent we enter into new collaborative agreements for our marketed product or any of our product candidates. Prior to May 2013, Astellas also held rights to gabapentin enacarbil in five other Asian countries, including Korea, the Philippines, Indonesia, Thailand and Taiwan. In May 2013, all rights to gabapentin enacarbil in these five countries reverted to us.

We expect our research and development expenses to decrease in 2014 primarily due to our decision to terminate further investment in AP as a potential treatment for spasticity in patients with MS as a result of the negative results obtained in the pivotal Phase 3 clinical trial, which will be partially offset by our further development of XP23829, including our planned Phase 2 clinical trial in patients with moderate-to-severe plaque psoriasis expected to be initiated by mid-2014. The timing and amount of research and development expenses


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incurred will primarily depend upon the extent of current or future clinical trials for XP23829 as well as the related expenses associated with our development organization, regulatory requirements for our product candidates, product candidate manufacturing costs and our ability to raise additional funds. Our future research and development expenses are subject to numerous assumptions that may prove to be wrong and also are subject to risks related to the difficulty and uncertainty of clinical success and regulatory approvals of our product candidates. While we expect that our research and development expenses will decrease in 2014, we expect our selling, general and administrative expenses to increase compared to 2013 levels primarily due to the full-year effect of expenses incurred in maintaining sales, marketing, distribution and other commercial capabilities for HORIZANT, largely through third-party service providers.

On January 29, 2014, we completed an underwritten public offering of 12,000,000 shares of our common stock at a price to the public of $6.00 per share. Net cash proceeds from the public offering were approximately $67.3 million, after deducting the underwriting discounts and commissions and offering expenses payable by us. On February 21, 2014, the underwriters exercised in full their over-allotment option of 1,800,000 shares resulting in cash proceeds of approximately $10.1 million, after deducting the underwriting discounts and commissions and offering expenses payable by us.

We believe that our existing capital resources, which include the net proceeds of our public offering completed in January 2014, together with interest thereon and anticipated product revenue, will be sufficient to meet our projected operating requirements through 2015. We have based our cash sufficiency estimate on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we expect. Further, our operating plan may change, and we may need additional funds to meet operational needs and capital requirements for product development and commercialization sooner than planned. We have no credit facility or committed sources of capital other than potential contingent event-based and royalty payments that we are eligible to receive under our collaboration agreement with Astellas. We are responsible for all HORIZANT commercialization and development activities, including all post-marketing requirements and commitments. Such costs could be greater than we anticipate, or sales of HORIZANT may be less than we anticipate, either or both of which could accelerate our need for additional capital. In addition, we do not believe that revenues generated from HORIZANT and REGNITE sales and other revenues generated from our collaboration with Astellas will be sufficient alone to sustain our operations, at least in the near term, and we therefore expect to continue to experience negative cash flows for the foreseeable future as we fund our operating losses and capital expenditures. Additional funds may not be available to us on terms that are acceptable to us, or at all. If adequate funds are not, or we anticipate that they may not be, available on a timely basis, we may be required to, among other things, reduce the amount of resources devoted to medical affairs, advertising, promotion or sales of HORIZANT, curtail or delay further XP23829 development or conduct additional workforce or other expense reductions, any of which could have a material adverse effect on our business and prospects.

Critical Accounting Policies and Significant Judgments and Estimates

Our management's discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenues and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates and judgments related to each of our critical accounting areas. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.


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Revenue Recognition

Product Sales

We began selling HORIZANT to wholesalers in May 2013 upon the return of its commercial rights from GSK. We recognize revenue from HORIZANT product sales when there is persuasive evidence that an arrangement exists, delivery to the customer has occurred, the price is fixed or determinable and collectability is reasonably assured. We record estimated reductions to revenues for customer incentives such as cash discounts for prompt payment, distributor fees, expected returns, government rebates such as Medicaid reimbursements and our patient assistance program. These estimates are deducted from gross product sales at the time such revenues are recognized. If future actual results vary from our estimates, we may need to adjust these estimates, which could have an effect on product sales and earnings in the period of adjustment.

Items Deducted from Gross Product Sales

Prompt Pay Discount

We offer cash discounts to our customers, generally 2% of the sales price, as an incentive for prompt payment. Based on GSK's commercialization experience, we expect our customers to continue to comply with the prompt payment terms to earn the cash discount, as we are selling HORIZANT to the same customers under similar prompt payment terms and conditions. We estimate cash discounts for prompt payment based on contractual terms, GSK's historical customer utilization rates and our customer utilization rates. We account for cash discounts by reducing accounts receivable by the full amount and recognizing the discount as a reduction of revenue in the same period the related revenue is recognized.

Distributor Fees

Under our inventory management agreements with our significant wholesalers, we pay the wholesalers a fee for distribution services as well as the maintenance of inventory levels. These distributor fees are based on a contractually determined fixed percentage of sales. We accrue the contractual amount and recognize the discount as a reduction of revenue in the same period the related revenue is recognized.

Product Returns

We do not provide our customers with a general right of product return, but permit returns if the product is damaged or defective when received by the customer, or if the product has or is nearly expired. HORIZANT tablets currently have a shelf-life of 36 months from date of manufacture. We will accept returns for products that will expire within six months or that have expired up to one year after their expiration dates. We obtained actual return history by type from GSK since GSK's product launch in 2011, which provides a basis to reasonably estimate our future product returns. The sales returns accrual is estimated principally based on taking into consideration our specific adjustments to GSK's returns history, the shelf life of product, shipment and prescription trends and estimated distribution channel inventory level. Such estimates require significant judgment by management.

Government Rebates and Chargebacks

We participate in a number of government rebate programs, such as the Medicaid Drug Rebate Program that provides assistance to eligible low-income patients based on each individual state's guidelines regarding eligibility and services; Public Health Services or 340b programs, and the Medicare Part D Coverage Gap Discount Program, which provides rebates on prescriptions that fall within the "donut hole" coverage gap; and the Department of Veterans Affairs that offers discounts to authorized users of HORIZANT. HORIZANT is also listed on the Federal Supply Schedule, or FSS, of the General Services Administration, which provides a discount to the Department of Defense, Department of Veterans Affairs and TriCare. We estimate reductions to our revenues for government rebate programs based on product pricing, current rebates, GSK's historical utilization rates, our utilization rates, new information regarding changes in these programs' regulations and guidelines that would impact the amount of


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the actual rebates, our expectations regarding future rebates for these programs and estimated levels of inventory in the distribution channel. Such estimates require significant judgment by management.

Patient Assistance

We offer a co-pay card program to assist commercially insured patients with the cost of their HORIZANT-related co-payments. Participating retail pharmacies get reimbursed by us for the amount of the co-pay assistance provided to eligible patients. We estimate and accrue the cost of our co-pay program based on historical redemption activity for this program. We reimburse the participating pharmacies approximately one month after the prescriptions subject to co-pay assistance are filled. These estimates require complex and significant judgment by management and could vary based on program acceptance.

A rollforward of our product sales allowances for the period from May 1, 2013, the date we assumed all responsibilities for further development, manufacturing and commercialization of HORIZANT in the United States, through December 31, 2013 is as follows (in thousands):

                                              Contract
                                               Sales              Product            Cash
                                            Discounts(1)          Returns          Discounts          Total
Balance at December 31, 2012               $            -        $       -        $         -        $     -
Revenue Allowances:
Provision related to current period
sales                                                 961               80                152          1,193
Payments and credits related to sales
made in current period                               (537 )             (3 )             (130 )         (670 )

Balance at December 31, 2013               $          424        $      77        $        22        $   523

(1) Includes wholesaler fees, government rebates and chargebacks and our patient assistance program.

Multiple-Element Arrangements

Revenue arrangements are accounted for in accordance with the provisions of the Revenue Recognition-Multiple-Element Arrangements topic of the Financial Accounting Standards Board Accounting Standards Codification, or the Codification.

In evaluating arrangements with multiple elements, we considered whether components of the arrangement represent separate units of accounting based upon whether certain criteria are met, including whether the delivered element has stand-alone value to the customer and whether there is objective and reliable evidence of the fair value of the undelivered items. This evaluation required subjective determinations and required management to make judgments about the fair value of individual elements and whether such elements are separable from other aspects of the contractual relationship. The consideration received in such arrangements is allocated among the separate units of accounting based on the relative selling price method under which the selling price for each deliverable is determined using vendor-specific objective evidence of selling price, if it exists; otherwise, third-party evidence of selling price. If vendor-specific objective evidence and third-party evidence of selling price are not available for a deliverable, we used our best estimate of the selling price for that deliverable when applying the relative selling price method. The applicable revenue recognition criteria are applied to each of the separate units.

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

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

Collaboration revenue includes revenue from our current collaboration agreement with Astellas. Net revenue from unconsolidated joint operating activities included all revenue that resulted solely from our


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terminated collaboration agreement with GSK. We account for the revenue-related activities of these collaboration agreements as follows:

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

• Milestones. Revenue recognition for milestone payments will occur only if the consideration earned from the achievement of a milestone meets all the criteria for the milestone to be considered substantive at the inception of the arrangement, such that it: (i) is commensurate with either our performance to achieve the milestone or the enhancement of the value of the item delivered as a result of a specific outcome resulting from our performance to achieve the milestone; (ii) relates solely to past performance; and (iii) is reasonable relative to all deliverables and payment terms in the arrangement.

We will assess the nature of, and appropriate accounting for, contingent payments, on a case-by-case basis in accordance with the provisions of the Revenue Recognition topic of the Codification.

• Profit and loss sharing. This represented our share of the profits and losses from the co-promotion of HORIZANT with GSK until the termination of our collaboration agreement. Amounts were recognized in the period in which the related activities occurred, and their financial statement classification was based on our assessment that these activities constituted part of our ongoing central operations.

• Product royalties. We are entitled to receive royalties on net sales of REGNITE in Japan. Astellas initiated sales of REGNITE in Japan in July 2012, and we recognize the associated product royalties when they can be reliably measured and collectability is reasonably assured (generally upon receipt of the royalty payment).

Inventories

Inventories are stated at the lower of cost or market. Cost is determined on a first-in, first-out, or FIFO, basis. Inventories that are not expected to be consumed within 12 months following the balance sheet date are classified as long-term inventories. We will regularly evaluate our inventories for excess quantities and obsolescence (expiration), taking into account such factors as historical and anticipated future sales compared to quantities on hand and the remaining shelf life of HORIZANT. We will evaluate our long-range demand for HORIZANT and expected consumption of the API based on projected sales of HORIZANT. If future demand for HORIZANT is less than projected sales, we could incur an inventory write-down, which would have an adverse effect on earnings in the period of the write-down.

Accrued Expenses

As part of the process of preparing financial statements, we are required to estimate accrued expenses. This process involves communicating with our applicable personnel to identify services that have been performed on our behalf and estimating the level of service performed and the associated cost incurred for the service when we have not yet been invoiced or otherwise notified of actual cost. The majority of our service providers invoice us monthly in arrears for services performed. We make estimates of our accrued expenses as of each balance sheet date in our financial statements based on facts and circumstances known to us. We periodically confirm the accuracy of our estimates with selected service providers and make adjustments, if necessary. To date, we have not adjusted our estimate at any particular balance sheet date by any material amount. Examples of estimated accrued expenses include:

• fees paid to contract research organizations in connection with preclinical and toxicology studies and clinical trials;

• fees paid to investigative sites in connection with clinical trials;

• fees paid to contract manufacturers in connection with the production of clinical trial materials; and

• professional service fees, such as marketing fees and sales operations fees.


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We base our expenses related to clinical trials on our estimates of the services . . .

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