Vanda Pharmaceuticals Annual Report 2013

Plain-text annual report

Table of ContentsUNITED STATES SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549Form 10-K ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGEACT OF 1934For the fiscal year ended December 31, 2013 ¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIESEXCHANGE ACT OF 1934Commission File No. 001-34186VANDA PHARMACEUTICALS INC.(Exact name of registrant as specified in its charter) Delaware 03-0491827(State or other jurisdiction ofincorporation or organization) (I.R.S. EmployerIdentification No.)2200 Pennsylvania Avenue NW, Suite 300 EWashington D.C. 20037(202) 734-3400(Address and telephone number, including area code, of registrant’s principal executive offices)Securities registered pursuant to Section 12(b) of the Exchange Act: Title of Each Class Name of Each Exchange on Which RegisteredCommon Stock, par value $0.001 The Nasdaq Stock Market LLC (NASDAQ Global Market)Rights to Purchase Series A Junior Participating Preferred Stock The Nasdaq Stock Market LLC(NASDAQ Global Market)Securities registered pursuant to Section 12(g) of the Exchange Act: NoneIndicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934during 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 filingrequirements for the past 90 days. Yes  No ¨Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data Filerequired 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 shorterperiod that the registrant was required to submit and post such files). Yes  No ¨Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to thebest of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to thisForm 10-K. Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. Seethe definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer ¨ Accelerated filer  Non-accelerated filer ¨ Smaller reporting company ¨ (Do not check if a smaller reporting company) Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes ¨ No As of June 28, 2013, the last business day of the registrant’s last completed second quarter, the aggregate market value of the Common Stock held bynon-affiliates of the registrant was approximately $194.0 million based on the closing price of the registrant’s Common Stock, as reported by the NASDAQGlobal Market, on such date. Shares of Common Stock held by each executive officer and director and stockholders known by the registrant to own 10% ormore of the outstanding stock based on public filings and other information known to the registrant have been excluded since such persons may be deemedaffiliates. This determination of affiliate status is not necessarily a conclusive determination for other purposes.The number of shares of the registrant’s Common Stock, par value $0.001 per share, outstanding as of February 20, 2014 was 33,501,902.The exhibit index as required by Item 601(a) of Regulation S-K is included in Item 15 of Part IV of this report.DOCUMENTS INCORPORATED BY REFERENCESpecified portions of the registrant’s proxy statement with respect to the registrant’s 2014 Annual Meeting of Stockholders, which is to be filed pursuant toRegulation 14A within 120 days after the end of the registrant’s fiscal year ended December 31, 2013, are incorporated by reference into Part III of this Form10-K.Table of ContentsVanda Pharmaceuticals Inc.Form 10-KTable of Contents Page Part I Cautionary Note Regarding Forward-Looking Statements 2 Item 1 Business 3 Item 1A Risk Factors 18 Item 1B Unresolved Staff Comments 39 Item 2 Properties 39 Item 3 Legal Proceedings 39 Item 4 Mine Safety Disclosures 40 Part II Item 5 Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 40 Item 6 Selected Consolidated Financial Data 41 Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations 43 Item 7A Qualitative and Quantitative Disclosures about Market Risk 55 Item 8 Financial Statements and Supplementary Data 56 Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 56 Item 9A Controls and Procedures 56 Item 9B Other Information 56 Part III Item 10 Directors, Executive Officers and Corporate Governance 57 Item 11 Executive Compensation 57 Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 57 Item 13 Certain Relationships and Related Transactions, and Director Independence 58 Item 14 Principal Accountant Fees and Services 58 Part IV Item 15 Exhibits and Financial Statement Schedules 58 Signatures 59 Exhibits 87 1Table of ContentsPART ICAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTSVarious statements throughout this report are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.Forward-looking statements may appear throughout this report. Words such as, but not limited to, “believe,” “expect,” “anticipate,” “estimate,” “intend,”“plan,” “project,” “target,” “goal,” “likely,” “will,” “would,” and “could,” or the negative of these terms and similar expressions or words, identify forward-looking statements. Forward-looking statements are based upon current expectations that involve risks, changes in circumstances, assumptions anduncertainties. Important factors that could cause actual results to differ materially from those reflected in our forward-looking statements include, amongothers: • our ability to successfully commercialize (alone or with others) HETLIOZ™ (tasimelteon) for the treatment of Non-24-Hour Sleep-Wake Disorder(Non-24) in the U.S.; • uncertainty as to market awareness of Non-24 and the market acceptance of HETLIOZ™; • our dependence on third-party manufacturers to manufacture HETLIOZ™ in sufficient quantities and quality; • our failure to develop or obtain sales, marketing and distribution resources and expertise or to otherwise manage our growth; • our ability to obtain the capital necessary to fund our research and development or commercial activities; • a loss of rights to develop and commercialize our products under our license and sublicense agreements; • the failure to obtain, or any delay in obtaining, regulatory approval for our products, particularly HETLIOZ™ outside the U.S., or to comply withongoing regulatory requirements; • the extent and effectiveness of the development, sales and marketing and distribution support Fanapt receives; • our inability to successfully commercialize Fanapt outside of the U.S. and Canada; • delays in the completion of our or our partners’ clinical trials; • a failure of our products to be demonstrably safe and effective; • our expectations regarding trends with respect to our revenues, costs, expenses and liabilities; • our failure to identify or obtain rights to new products; • a loss of any of our key scientists or management personnel; • limitations on our ability to utilize some of all of our prior net operating losses and orphan drug and research and development credits; • the cost and effects of potential litigation; and • losses incurred from product liability claims made against us.All written and verbal forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by thecautionary statements contained or referred to in this section. We caution investors not to rely too heavily on the forward-looking statements we make or that aremade on our behalf. We undertake no obligation, and specifically decline any obligation, to update or revise publicly any forward-looking statements, whetheras a result of new information, future events or otherwise.We encourage you to read Management’s Discussion and Analysis of our Financial Condition and Results of Operations and our consolidated financialstatements contained in this annual report on Form 10-K. We also encourage you to read Item 1A of Part I of this annual report on Form 10-K, entitled “RiskFactors,” which contains a more complete discussion of the risks and uncertainties associated with our business. In addition to the risks described above andin Item 1A of this report, other unknown or unpredictable factors also could affect our results. Therefore, the information in this report should be read togetherwith other reports and documents that 2®®Table of Contentswe file with the Securities and Exchange Commission (SEC) from time to time, including on Form 10-Q and Form 8-K, which may supplement, modify,supersede or update those risk factors. As a result of these factors, we cannot assure you that the forward-looking statements in this report will prove to beaccurate. Furthermore, if our forward-looking statements prove to be inaccurate, the inaccuracy may be material. In light of the significant uncertainties inthese forward-looking statements, you should not regard these statements as a representation or warranty by us or any other person that we will achieve ourobjectives and plans in any specified time frame, or at all. ITEM 1.BUSINESSOverviewVanda Pharmaceuticals Inc. (we, Vanda or the Company) is a biopharmaceutical company focused on the development and commercialization ofproducts for the treatment of central nervous system disorders. Vanda commenced its operations in 2003. Vanda’s product portfolio includes: • HETLIOZ™ (tasimelteon), a product for the treatment of Non-24-Hour Sleep-Wake Disorder (Non-24), which was approved by the U.S. Food andDrug Administration (FDA) in January 2014; • Fanapt(iloperidone), a product for the treatment of schizophrenia, the oral formulation of which is currently being marketed and sold in the U.S. byNovartis Pharma AG (Novartis); and • VLY-686 (tradipitant), a small molecule neurokinin-1 receptor (NK-1R) antagonist.Since we began operations in March 2003, we have devoted substantially all of our resources to the in-licensing and clinical development of ourproducts. Our products target prescription markets with significant unmet medical needs. Our ability to generate revenue and achieve profitability largelydepends on our ability, alone or with others, to complete the development of our products, and to obtain the regulatory approvals for and manufacture, marketand sell our products, including HETLIOZ™ for the treatment of Non-24 and Novartis’ ability to successfully commercialize Fanapt in the U.S. The resultsof our operations will vary significantly and depend on a number of factors, including risks related to our business, risks related to our industry, and otherrisks which are detailed in Item 1A of Part I of this annual report on Form 10-K, entitled “Risk Factors.”Our activities will necessitate significant uses of working capital throughout 2014 and beyond. We are currently concentrating our efforts on the U.S.commercial launch of HETLIOZ™. Additionally, we and our partners continue to pursue market approval of Fanapt in a number of foreign jurisdictions,with Mexico, Israel and Argentina having already approved Fanapt for the treatment of schizophrenia.Our founder and Chief Executive Officer, Mihael H. Polymeropoulos, M.D., started Vanda’s operations early in 2003 after establishing and leading thePharmacogenetics Department at Novartis. In acquiring and developing our products, we have relied upon our deep expertise in the scientific disciplines ofpharmacogenetics and pharmacogenomics. These scientific disciplines examine both genetic variations among people that influence response to a particulardrug, and the multiple pathways through which drugs affect people.Our strategyOur goal is to create a leading biopharmaceutical company focused on developing and commercializing products that address critical unmet medicalneeds relating to central nervous system disorders through the application of our drug development expertise and our pharmacogenetics and pharmacogenomicsexpertise. The key elements of our strategy to accomplish this goal are to: • Maximize the commercial success of HETLIOZ™; • Enter into strategic partnerships to supplement our capabilities and to extend our commercial reach; • Pursue the clinical development and regulatory approval of our products; • Apply our pharmacogenetics and pharmacogenomics expertise to differentiate our products; and • Expand our product portfolio through the identification and acquisition of additional products. 3®®®®Table of ContentsProductsWe have the following products on the market or in clinical development: Product Target Indications Select MilestonesHETLIOZ™ (tasimelteon) Non-24 FDA approval in January 2014;Two ongoing open label safety studies;Expected U.S. commercial launch in second quarter of 2014 Major DepressiveDisorder (MDD) Phase IIb/III trial (MAGELLAN) completed in January 2013;All development activities have been discontinuedFanapt (Oral) (iloperidone) Schizophrenia FDA approval in May 2009;Commercial rights in the U.S. and Canada sublicensed to Novartis inOctober 2009;Launched in the U.S. by Novartis in January 2010VLY-686 (tradipitant) Pruritus in patients with AtopicDermatitis Proof of concept study initiated in second half of 2013;Phase II study expected to begin in 2014.HETLIOZ™In January 2014, HETLIOZ™ was approved in the U.S. for the treatment of Non- 24. Non-24 is a serious, rare, and chronic circadian rhythm disordercharacterized by the inability to entrain (synchronize) the master body clock with the 24-hour day-night cycle. HETLIOZ™ is the first FDA approvedtreatment for Non-24. The precise mechanism by which HETLIOZ™ exerts its therapeutic effect in patients with Non-24 is not known. HETLIOZ™ is amelatonin agonist of the human MT1 and MT2 receptors, with greater specificity for MT2. These receptors are thought to be involved in the control ofcircadian rhythms. HETLIOZ™ is believed to reset the master body clock in the suprachiasmatic nucleus (SCN), located in the hypothalamus, resulting inthe entrainment and alignment of the body’s melatonin and cortisol rhythms to the 24-hour day-night cycle. We expect the U.S. commercial launch ofHETLIOZ™ to occur in the second quarter of 2014. In addition, we are preparing to file a Marketing Authorization Application (MAA) for HETLIOZ forthe treatment of Non-24 with the European Medicines Agency (EMA) during 2014.In January 2010, the FDA granted orphan drug designation status for HETLIOZ™ in Non-24 in blind individuals. The FDA grants orphan drugdesignation to drugs that may provide significant therapeutic advantage over existing treatments and target conditions affecting 200,000 or fewer U.S. patientsper year. Orphan drug designation provides potential financial and regulatory incentives, including study design assistance, tax credits, waiver of FDA userfees, and up to seven years of market exclusivity upon marketing approval. In February 2011, the EMA designated HETLIOZ™ as an orphan medicinalproduct for the same indication.HETLIOZ™ has also been studied in Major Depressive Disorder (MDD) and insomnia.Therapeutic opportunitySleep disorders are segmented into three major categories: primary insomnia, secondary insomnia and circadian rhythm sleep disorders (CRSDs).Insomnia is a symptom complex that comprises difficulty falling asleep or staying asleep, or non-refreshing sleep, in combination with daytime dysfunctionor distress. The symptom complex can be an independent disorder (primary insomnia) or be a result of another condition such as depression or anxiety(secondary insomnia). CRSDs result from a misalignment of the sleep/wake cycle and an individual’s daily activities or lifestyle. The circadian rhythm is therhythmic output of the human biological 4®TMTable of Contentsclock and is governed by the hormones melatonin and cortisol. Both the timing of behavioral events (activity, sleep, and social interactions) and theenvironmental light/dark cycle result in a sleep/wake cycle that follows the circadian rhythm. Examples of CRSDs include transient disorders such as jet lagand chronic disorders such as shift work sleep disorder and Non-24.Non-24 is a serious, rare, and chronic circadian rhythm disorder characterized by the inability to entrain (synchronize) the master body clock with the24-hour day-night cycle. Non-24 affects a majority of totally blind individuals, or between 65,000 and 95,000 people in the U.S. Non-24 occurs almostentirely in individuals who lack the light sensitivity necessary to entrain the master body clock in the brain with the 24-hour day-night cycle. Most people havea master body clock that naturally runs longer than 24-hours and light is the primary environmental cue that resets it to 24 hours each day. Individuals withNon-24 have a master body clock that is not reset, and continually delays, resulting in prolonged periods of misalignment between their circadian rhythmsand the 24-hour day-night cycle, including the timing of melatonin and cortisol secretion. As a result of this misalignment, Non-24 is associated withsignificant disruption of the sleep-wake cycle and impairments in social and occupational functioning, and marked subjective distress. Individuals with Non-24 cycle in-and out-of phase and suffer from disrupted nighttime sleep patterns and/or excessive daytime sleepiness.While there are no FDA-approved treatments for CRSDs, other than HETLIOZ™ for the treatment of Non-24, there are a number of drugs approvedand prescribed for patients with sleep disorders. The most commonly prescribed drugs are hypnotics, such as generic zolpidem, Ambien (zolpidem) bySanofi (including Ambien CR), Lunesta (eszopiclone) by Sunovion Pharmaceuticals Inc., Sonata (zaleplon) by Pfizer Inc. and Silenor (doxepin) by PernixTherapeutics. Hypnotics work by acting upon a set of brain receptors known as GABA receptors, which are separate and distinct from the melatoninreceptors to which HETLIOZ™ binds. Several drugs in development also utilize a mechanism of action involving binding to GABA receptors. Members ofthe benzodiazepine class of sedatives are also approved for insomnia, but their usage has declined due to an inferior safety profile compared to hypnotics.Anecdotal evidence also suggests that sedative antidepressants, such as trazodone and doxepin, are prescribed off-label for insomnia. FDA approved drugs forthe treatment of insomnia also includes Rozerem (ramelteon) by Takeda Pharmaceuticals Company Limited, a compound with a mechanism of action similarto HETLIOZ™. The class of melatonin agonists includes Rozerem (ramelteon) by Takeda Pharmaceuticals Company Limited, Valdoxan (agemelatine) byServier, Circadin (long-acting melatonin) by Neurim Pharmaceuticals and the food supplement melatonin.Overview of HETLIOZ™ clinical developmentIn January 2014, HETLIOZ™ was approved in the U.S. for the treatment of Non- 24. The HETLIOZ New Drug Application (NDA) includedefficacy and safety data from the Non-24 development program as well as safety data from previously conducted clinical studies.Two open-label safety studies are ongoing for HETLIOZ™ in Non-24. The 3202 and 3204 clinical trials are open-label, multicenter, studies in totallyblind subjects with Non-24 to further assess the safety of HETLIOZ™.Vanda previously conducted double blind, placebo controlled studies of HETLIOZ in chronic primary insomnia and transient insomnia. Noadditional development is being conducted for these indications.In November 2006, we reported positive top-line results in a randomized, double-blind, multi-center, placebo-controlled Phase III trial that enrolled 412adults in a sleep laboratory setting using a phase-advance, first-night assessment model of induced transient insomnia. The trial examined HETLIOZ™ dosed30 minutes before bedtime at 20mg, 50mg and 100mg versus placebo.HETLIOZ™ achieved significant results in multiple endpoints, demonstrating a benefit in both sleep onset, or time to fall asleep, and sleepmaintenance, or ability to stay asleep. In June 2008, we reported positive top-line results in a randomized, double-blind, placebo-controlled Phase III trial inchronic primary insomnia that enrolled 324 patients. The trial examined HETLIOZ™ at 20mg and 50mg versus placebo over a period of 35 days. The trialmeasured time to fall asleep and sleep maintenance, as well as next-day performance.In January 2013, Vanda reported top-line results of the Phase IIb/III clinical study (MAGELLAN) in MDD, investigating the efficacy and safety ofHETLIOZ™ as a monotherapy in the treatment of patients with MDD. The clinical study did not meet the primary endpoint of change from baseline in theHamilton Depression Scale 5®®®®®®®®®™™Table of Contents(HAMD-17) after eight weeks of treatment as compared to placebo. HETLIOZ™ was shown to be safe and well-tolerated, consistent with observations in priorstudies. Based on the proof of concept clinical study results, we decided to discontinue all activities in this indication.Intellectual propertyHETLIOZ™ and its formulations, genetic markers and uses are covered by a total of 11 patent and patent application families worldwide. The primarynew chemical entity patent covering HETLIOZ™ expires normally in 2017 in the U.S. and in most European markets. In the U.S., the United States DrugPrice Competition and Patent Term Restoration Act of 1984, more commonly known as the “Hatch-Waxman Act” provides for an extension of new chemicalentity patents for a period of up to five years following the expiration of the patent covering that compound to compensate for time spent in development. Webelieve that HETLIOZ™ will meet the various criteria of the Hatch-Waxman Act and will receive five additional years of patent protection in the U.S., whichwould extend its new chemical entity patent protection in the U.S. until 2022. In Europe, statutes provide for ten years of data exclusivity (with the potential foran additional year if the drug is developed for a significant new indication). As such, in Europe, data exclusivity will protect HETLIOZ™ for at least tenyears from approval. Outside the U.S. and Europe, data exclusivity will protect HETLIOZ™ from generic competition for varying number of years dependingon the country. Additional patent applications directed to specific sleep disorders and to methods of administration, if issued, would provide exclusivity forsuch indications and methods of administration. Patent applications directed to the treatment of Non-24, if granted, would provide exclusivity for thisindication until at least 2033.Our rights to the new chemical entity patent covering HETLIOZ™ and related intellectual property have been acquired through a license with Bristol-Myers Squibb Company (BMS). Please see “License agreements” below for a discussion of this license.FanaptFanapt is a product for the treatment of schizophrenia. In May 2009, the FDA granted U.S. marketing approval of Fanapt for the acute treatment ofschizophrenia in adults. In October 2009, we entered into an amended and restated sublicense agreement with Novartis. We had originally entered into asublicense agreement with Novartis in June 2004 pursuant to which we obtained certain worldwide exclusive licenses from Novartis relating to Fanapt.Pursuant to the amended and restated sublicense agreement, Novartis has exclusive commercialization rights to all formulations of Fanapt in the U.S. andCanada. In January 2010, Novartis launched Fanapt in the U.S. We do not expect Novartis to commercialize Fanapt in Canada.We continue to explore the regulatory path and commercial opportunity for Fanapt oral formulation outside of the U.S. and Canada. In December 2012,the EMA’s CHMP issued a negative opinion recommending against approval of Fanaptum™ (oral iloperidone tablets) for the treatment of schizophrenia inadult patients in the European Union. The CHMP was of the opinion that the benefits of Fanaptum™ did not outweigh its risks and recommended againstmarketing authorization. We initiated an appeal of this opinion and requested a re-examination of the decision by the CHMP, but withdrew our MAA in thefirst quarter of 2013 because the additional clinical data requested by the CHMP would not have been available in the timeframe allowed by the EMA’sCentralized Procedure. We intend to reassess our European regulatory strategy for Fanaptum™ once the results from the REPRIEVE study being conducted byNovartis become available.We have entered into agreements with the following partners for the commercialization of Fanapt in the countries set forth below: Country PartnerMexico Probiomed S.A. de C.V.Israel Megapharm Ltd.In August 2012, the Israeli Ministry of Health granted market approval for Fanapt for the treatment of schizophrenia. In November 2012, we werenotified that Fanapt had been granted market approval in Argentina for the treatment of schizophrenia. In October 2013, the Mexican Federal Commission forProtection Against Sanitary Risks (COFEPRIS) granted market approval for Fanapt for the treatment of schizophrenia. 6®®®®®®®®®®®®Table of ContentsOur rights to the new chemical entity patent covering Fanapt and related intellectual property have been acquired through a sublicense with Novartis.Please see “License agreements” below for a discussion of this license.Therapeutic opportunitySchizophrenia is a chronic, debilitating mental disorder characterized by hallucinations, delusions, racing thoughts and other psychotic symptoms(collectively referred to as “positive symptoms”), as well as moodiness, anhedonia (inability to feel pleasure), loss of interest, eating disturbances andwithdrawal (collectively referred to as “negative symptoms”), and attention and memory deficits (collectively referred to as “cognitive symptoms”).Schizophrenia develops in late adolescence or early adulthood in approximately 1% of the world’s population. Most schizophrenia patients today are treatedwith drugs known as “atypical” antipsychotics, which were first approved in the U.S. in the late 1980s. These antipsychotics have been named “atypical”for their ability to treat a broader range of negative symptoms than the first-generation “typical” antipsychotics, which were introduced in the 1950s and arenow generic. Atypical antipsychotics are generally regarded as having improved side effect profiles and efficacy relative to typical antipsychotics and currentlycomprise approximately 90% of schizophrenia prescriptions. Currently approved atypical antipsychotics include, in addition to Fanapt, Risperdal(risperidone), including the depot formulation Risperdal Consta, and Invega (paliperidone), including the depot formulation Invega Sustenna™, each byOrtho-McNeil-Janssen Pharmaceuticals, Inc., Zyprexa (olanzapine), including the depot formulation Zyprexa Relprevv™, by Eli Lilly and Company,Seroquel (quetiapine) by AstraZeneca PLC, Abilify (aripiprazole) by BMS/Otsuka Pharmaceutical Co., Ltd., Geodon (ziprasidone) by Pfizer Inc.,Saphris (asenapine) by Merck & Co. Inc., Latuda (lurasidone) by Sunovion Pharmaceuticals Inc., and generic clozapine.Intellectual propertyFanapt and its metabolites, formulations, genetic markers and uses are covered by a total of 17 patent and patent application families worldwide. Theprimary new chemical entity patent covering Fanapt was set to expire normally in 2011 in the U.S. and expired in 2010 in major markets outside the U.S.Fanapt has qualified for the full five-year patent term extension under the Hatch-Waxman Act and so the term of the new chemical entity patent in the U.S.has been extended until November 2016. Previously we expected Fanapt to be eligible for six additional months of pediatric exclusivity; however, in 2014, webecame aware of events that led us to believe that Novartis would not complete the ongoing pediatric efficacy studies in a time that would enable it to receive theincremental six-month pediatric term extension. This will result in a six-month reduction to the estimated patent life of Fanapt from May 2017 to November2016. In Europe, statutes provide for ten years of data exclusivity (with the potential for an additional year if the drug is developed for a significant newindication). No generic versions of Fanapt would be permitted to be marketed or sold during this 10-year (or 11-year) period in most European countries.Consequently, we expect that Novartis’ rights to commercialize Fanapt will be exclusive until November 2016 in the U.S. and our rights to commercializeFanapt will be exclusive for at least 10 years from approval in Europe. Outside the U.S. and Europe, data exclusivity will protect Fanapt from genericcompetition for varying numbers of years depending upon the country. Several other patent applications covering metabolites, uses, formulations and geneticmarkers relating to Fanapt extend beyond 2020.We acquired worldwide, exclusive rights to the new chemical entity patent covering Fanapt and certain related intellectual property from Novartis undera sublicense agreement we entered into in 2004, which was amended and restated in 2009. Please see “License agreements” below for a more completedescription of the rights we acquired from and relinquished to Novartis with respect to Fanapt.VLY-686VLY-686 is an NK-1R antagonist that we licensed from Eli Lilly and Company (Lilly) in April 2012. NK-1R antagonists have been evaluated in anumber of indications including chemotherapy-induced nausea and vomiting (CINV), post-operative nausea and vomiting (PONV), alcohol dependence,anxiety, depression and pruritus. We initiated a proof of concept study in the second half of 2013 to evaluate VLY-686 in the treatment of pruritus in patientswith atopic dermatitis. We plan to commence a Phase II clinical study of VLY-686 in the treatment of pruritus in patients with atopic dermatitis in 2014. 7®®®®®®®®®®®®®®®®®®®®®®®®®®Table of ContentsIntellectual propertyVLY-686 is covered by a total of three patent and patent application families worldwide. The new chemical patent covering VLY-686 expires in April2023, except in the U.S., where it expires in June 2024 absent any applicable patent term adjustments.License agreementsOur rights to develop and commercialize our products are subject to the terms and conditions of licenses granted to us by other pharmaceuticalcompanies.HETLIOZ™In February 2004, we entered into a license agreement with Bristol-Myers Squibb (BMS) under which we received an exclusive worldwide license undercertain patents and patent applications, and other licenses to intellectual property, to develop and commercialize HETLIOZ™. In partial consideration for thelicense, we paid BMS an initial license fee of $0.5 million. Pursuant to the license agreement, we would be obligated to make future milestone payments toBMS of up to $37.0 million in the aggregate. We made a milestone payment to BMS of $1.0 million under the license agreement in 2006 relating to theinitiation of our first Phase III clinical trial for HETLIOZ™. As a result of the FDA acceptance of our NDA for HETLIOZ™ for the treatment of Non-24 inJuly 2013, we incurred a $3.0 million milestone obligation under our license agreement with BMS. As a result of the FDA’s approval of our HETLIOZ™NDA in January 2014, we incurred an $8.0 million milestone obligation in the first quarter of 2014 under the same license agreement that will be capitalized asan intangible asset and amortized over the expected HETLIOZ™ patent life in the U.S.. We will be obligated to make future milestone payments to BMS of upto $25.0 million in the event that sales of HETLIOZ™ reach a certain agreed upon sales threshold. Additionally, we will be obligated to make royaltypayments based on net sales of HETLIOZ™ which, as a percentage of net sales, are in the low teens. We are also obligated under the license agreement to payBMS a percentage of any sublicense fees, upfront payments and milestone and other payments (excluding royalties) that we receive from a third party inconnection with any sublicensing arrangement, at a rate which is in the mid-twenties. We have agreed with BMS in our license agreement for HETLIOZ™ touse our commercially reasonable efforts to develop and commercialize HETLIOZ™.Either party may terminate the HETLIOZ™ license agreement under certain circumstances, including a material breach of the agreement by the other. Inthe event we terminate our license, or if BMS terminates our license due to our breach, all rights licensed and developed by us under this agreement will revertor otherwise be licensed back to BMS on an exclusive basis.FanaptWe acquired exclusive worldwide rights to patents and patent applications for Fanapt through a sublicense agreement with Novartis. A predecessorcompany of Sanofi, Hoechst Marion Roussel, Inc. (HMRI), discovered Fanapt and completed early clinical work on the compound. In 1996, HMRI licensedits rights to the Fanapt patents and patent applications to Titan Pharmaceuticals, Inc. (Titan) on an exclusive basis. In 1997, soon after it had acquired itsrights, Titan sublicensed its rights to Fanapt on an exclusive basis to Novartis. In June 2004, we acquired exclusive worldwide rights to these patents andpatent applications as well as certain Novartis patents and patent applications to develop and commercialize Fanapt through a sublicense agreement withNovartis.In October 2009, we entered into an amended and restated sublicense agreement with Novartis which amended and restated our June 2004 sublicenseagreement with Novartis relating to Fanapt. Pursuant to the amended and restated sublicense agreement, Novartis has exclusive commercialization rights to allformulations of Fanapt in the U.S. and Canada. Novartis began selling Fanapt in the U.S. during the first quarter of 2010. Novartis is responsible for thefurther clinical development activities in the U.S. and Canada. We do not expect Novartis to commercialize Fanapt in Canada. Pursuant to the amended andrestated sublicense agreement, we received an upfront payment of $200.0 million and are eligible for additional payments totaling up to $265.0 million uponthe achievement of certain commercial and development milestones for Fanapt in the U.S. and Canada. Based on the current sales performance of Fanapt inthe U.S., we expect that some or all of these commercial and development milestones will not be achieved by Novartis. We also receive royalties, which, as a 8®®®®®®®®®®®®Table of Contentspercentage of net sales, are in the low double-digits, on net sales of Fanapt in the U.S. and Canada. We retain exclusive rights to Fanapt outside the U.S. andCanada and we have exclusive rights to use any of Novartis’ data for Fanapt for developing and commercializing Fanapt outside the U.S. and Canada. AtNovartis’ option, we will enter into good faith discussions with Novartis relating to the co-commercialization of Fanapt outside of the U.S. and Canada or,alternatively, Novartis will receive a royalty on net sales of Fanapt outside of the U.S. and Canada.We may lose our rights to develop and commercialize Fanapt outside the U.S. and Canada if we fail to comply with certain requirements in theamended and restated sublicense agreement regarding our financial condition, or if we fail to comply with certain diligence obligations regarding ourdevelopment or commercialization activities or if we otherwise breach the amended and restated sublicense agreement and fail to cure such breach. Our rights todevelop and commercialize Fanapt outside the U.S. and Canada may be impaired if we do not cure breaches by Novartis of similar obligations contained inits sublicense agreement with Titan for Fanapt. In addition, if Novartis breaches the amended and restated sublicense agreement with respect to itscommercialization activities in the U.S. or Canada, we may terminate Novartis’ commercialization rights in the applicable country and we would no longerreceive royalty payments from Novartis in connection with such country in the event of such termination.VLY-686In April 2012, we entered into a license agreement with Lilly pursuant to which we acquired an exclusive worldwide license under certain patents andpatent applications, and other licenses to intellectual property, to develop and commercialize an NK-1R antagonist, VLY-686, for all human indications.Pursuant to the agreement, we paid Lilly an initial license fee of $1.0 million and we will be responsible for all development costs for VLY-686. Lilly isalso eligible to receive additional payments based upon achievement of specified development and commercialization milestones as well as tiered-royalties onnet sales at percentage rates up to the low double digits. These milestones include $4.0 million for pre-NDA approval milestones and up to $95.0 million forfuture regulatory approval and sales milestones. We have agreed to use commercially reasonable efforts to develop and commercialize VLY-686.Either party may terminate the agreement under certain circumstances, including a material breach of the agreement by the other. In the event that weterminate the agreement, or if Lilly terminates the agreement due to our breach or for certain other reasons set forth in the agreement, all rights licensed anddeveloped by us under the agreement will revert or otherwise be licensed back to Lilly on an exclusive basis, subject to payment by Lilly to us of a royalty onnet sales of products that contain VLY-686.Government regulationGovernment authorities in the U.S., at the federal, state and local level, as well as foreign countries and local foreign governments, regulate the research,development, testing, manufacture, labeling, promotion, advertising, distribution, sampling, marketing, import and export of our products. Other thanHETLIOZ™ in the U.S. and Fanapt in the U.S., Israel, Mexico and Argentina, all of our products will require regulatory approval by government agenciesprior to commercialization. In particular, human pharmaceutical products are subject to rigorous pre-clinical and clinical trials and other approval proceduresof the FDA and similar regulatory authorities in foreign countries. The process of obtaining these approvals and the subsequent compliance with appropriatedomestic and foreign laws, rules and regulations require the expenditure of significant time and human and financial resources.United States government regulationFDA approval processIn the U.S., the FDA regulates drugs under the Federal Food, Drug and Cosmetic Act, as amended, and implements regulations. If we fail to complywith the applicable requirements at any time during the product development process, approval process, or after approval, we may become subject toadministrative or judicial sanctions. These sanctions could include the FDA’s refusal to approve pending applications, withdrawals of 9®®®®®®®®®®Table of Contentsapprovals, clinical holds, warning letters, product recalls, product seizures, total or partial suspension of our operations, injunctions, fines, civil penalties orcriminal prosecution. Any such sanction could have a material adverse effect on our business.The steps required before a drug may be marketed in the U.S. include: • pre-clinical laboratory tests, animal studies and formulation studies under Current Good Laboratory Practices (cGLP); • submission to the FDA of an investigational new drug application (IND), which must become effective before human clinical trials may begin; • execution of adequate and well-controlled clinical trials to establish the safety and efficacy of the drug for each indication for which approval issought; • submission to the FDA of an NDA; • satisfactory completion of an FDA inspection of the manufacturing facility or facilities at which the drug is produced to assess compliance withCurrent Good Manufacturing Practices (cGMP); and • FDA review and approval of the NDA.Pre-clinical studies generally are conducted in laboratory animals to evaluate the potential safety and activity of a drug. Violation of the FDA’s cGLPregulations can, in some cases, lead to invalidation of the studies, requiring these studies to be replicated. In the U.S., drug developers submit the results ofpre-clinical trials, together with manufacturing information and analytical and stability data, to the FDA as part of the IND, which must become effectivebefore clinical trials can begin in the U.S. An IND becomes effective 30 days after receipt by the FDA unless before that time the FDA raises concerns orquestions about issues such as the proposed clinical trials outlined in the IND. In that case, the IND sponsor and the FDA must resolve any outstanding FDAconcerns or questions before clinical trials can proceed. If these concerns or questions are unresolved, the FDA may not allow the clinical trials to commence.Pilot studies generally are conducted in a limited patient population, approximately three to 25 subjects, to determine whether the drug warrants furtherclinical trials based on preliminary indications of efficacy. These pilot studies may be performed in the U.S. after an IND has become effective or outside ofthe U.S. prior to the filing of an IND in the U.S. in accordance with applicable government regulations and institutional procedures.Clinical trials involve the administration of the investigational new drug to human subjects under the supervision of qualified investigators. Clinicaltrials are conducted under protocols detailing, among other things, the objectives of the study, the parameters to be used in assessing the safety and theeffectiveness of the drug. Each protocol must be submitted to the FDA as part of the IND prior to beginning the trial.Typically, clinical evaluation involves a time-consuming and costly three-Phase sequential process, but the phases may overlap. Each trial must bereviewed, approved and conducted under the auspices of an independent Institutional Review Board, and each trial must include the patient’s informedconsent. • Phase I: refers typically to closely-monitored clinical trials and includes the initial introduction of an investigational new drug into human patients orhealthy volunteer subjects. Phase I trials are designed to determine the safety, metabolism and pharmacologic actions of a drug in humans, thepotential side effects associated with increasing drug doses and, if possible, to gain early evidence of the drug’s effectiveness. Phase I trials alsoinclude the study of structure-activity relationships and mechanism of action in humans, as well as studies in which investigational new drugs areused as research tools to explore biological phenomena or disease processes. During Phase I trials, sufficient information about a drug’spharmacokinetics and pharmacological effects should be obtained to permit the design of well-controlled, scientifically valid Phase II studies. Thetotal number of subjects and patients included in Phase I trials varies, but is generally in the range of 20 to 80 people. • Phase II: refers to controlled clinical trials conducted to evaluate appropriate dosage and the effectiveness of a drug for a particular indication orindications in patients with a disease or condition under study and 10Table of Contents to determine the common short-term side effects and risks associated with the drug. These trials are typically well-controlled, closely monitored andconducted in a relatively small number of patients, usually involving no more than several hundred subjects. • Phase III: refers to expanded controlled and uncontrolled clinical trials. These trials are performed after preliminary evidence suggesting effectivenessof a drug has been obtained. Phase III trials are intended to gather additional information about the effectiveness and safety that is needed to evaluatethe overall benefit-risk relationship of the drug and to provide an adequate basis for physician labeling. Phase III trials usually include severalhundred to several thousand subjects.Phase I, II and III testing may not be completed successfully within any specified time period, if at all. The FDA closely monitors the progress of each ofthe three phases of clinical trials that are conducted in the U.S. and may, at its discretion, reevaluate, alter, suspend or terminate the testing based upon thedata accumulated to that point and the FDA’s assessment of the risk/benefit ratio to the patient. A clinical program is designed after assessing the causes of thedisease, the mechanism of action of the active pharmaceutical ingredient of the drug and all clinical and pre-clinical data of previous trials performed.Typically, the trial design protocols and efficacy endpoints are established in consultation with the FDA. Upon request through a special protocol assessment,the FDA can also provide specific guidance on the acceptability of protocol design for clinical trials. The FDA, we or our partners may suspend or terminateclinical trials at any time for various reasons, including a finding that the subjects or patients are being exposed to an unacceptable health risk. The FDA canalso request additional clinical trials be conducted as a condition to drug approval. During all clinical trials, physicians monitor the patients to determineeffectiveness and to observe and report any reactions or other safety risks that may result from use of the drug.Assuming successful completion of the required clinical trials, drug developers submit the results of pre-clinical studies and clinical trials, together withother detailed information including information on the manufacture and composition of the drug, to the FDA, in the form of an NDA, requesting approval tomarket the drug for one or more indications. In most cases, the NDA must be accompanied by a substantial user fee. The FDA reviews an NDA to determine,among other things, whether a drug is safe and effective for its intended use.Before approving an NDA, the FDA will inspect the facility or facilities where the drug is manufactured. The FDA will not approve the applicationunless cGMP compliance is satisfactory. The FDA will issue an approval letter if it determines that the application, manufacturing process and manufacturingfacilities are acceptable. If the FDA determines that the NDA, manufacturing process or manufacturing facilities are not acceptable, it will issue a completeresponse letter (CRL), in which it will outline the deficiencies in the submission and will often request additional testing or information. Notwithstanding thesubmission of any requested additional information, the FDA may ultimately decide that the NDA does not satisfy the regulatory criteria for approval andrefuse to approve the NDA.The testing and approval process requires substantial time, effort and financial resources, and each may take several years to complete. The FDA maynot grant approval on a timely basis, or at all. We or our partners may encounter difficulties or unanticipated costs in our efforts to secure necessarygovernmental approvals, which could delay or preclude us or our partners from marketing our products. Furthermore, the FDA may prevent a drug developerfrom marketing a drug under a label for its desired indications or place other conditions on distribution as a condition of any approvals, which may impaircommercialization of the drug. After approval, some types of changes to the approved drug, such as adding new indications, manufacturing changes andadditional labeling claims, are subject to further FDA review and approval. Similar regulatory procedures must also be complied within countries outside theU.S.If the FDA approves the NDA, the drug becomes available for physicians to prescribe in the U.S. After approval of our products, we have to complywith a number of post-approval requirements, including delivering periodic reports to the FDA, submitting descriptions of any adverse reactions reported, andcomplying with drug sampling and distribution requirements. We and our partners also are required to provide updated safety and efficacy information and tocomply with requirements concerning advertising and promotional labeling. Also, our quality control and manufacturing procedures must continue to conformto cGMP after approval. Drug manufacturers and their subcontractors are required to register their facilities and are subject to periodic 11Table of Contentsunannounced inspections by the FDA to assess compliance with cGMP which imposes certain procedural and documentation requirements relating to qualityassurance and quality control. Accordingly, manufacturers must continue to expend time, money and effort in the area of production and quality control tomaintain compliance with cGMP and other aspects of regulatory compliance. The FDA may require post market testing and surveillance to monitor the drug’ssafety or efficacy, including additional studies, known as Phase IV trials, to evaluate long-term effects.In addition to studies requested by the FDA after approval, we or our partners may have to conduct other trials and studies to explore use of theapproved product for treatment of new indications, which require FDA approval. The purpose of these trials and studies is to broaden the application and useof the product and its acceptance in the medical community.We use, and will continue to use, third-party manufacturers to produce our products in clinical and commercial quantities. Future FDA inspections mayidentify compliance issues at our facilities or at the facilities of our contract manufacturers that may disrupt production or distribution, or require substantialresources to correct. In addition, discovery of problems with a product or the failure to comply with requirements may result in restrictions on a product,manufacturer or holder of an approved NDA, including withdrawal or recall of the product from the market or other voluntary or FDA-initiated action thatcould delay further marketing. Newly discovered or developed safety or effectiveness data may require changes to a product’s approved labeling, including theaddition of new warnings and contraindications.In September 2007, the Food and Drug Administration Amendments Act (FDAAA), was enacted into law, amending both the FDC Act and the PublicHealth Service Act. The FDAAA made a number of substantive and incremental changes to the review and approval processes in ways that could make itmore difficult or costly to obtain approval for new pharmaceutical products, or to produce, market and distribute existing pharmaceutical products. Mostsignificantly, the law changed the FDA’s handling of postmarked drug product safety issues by giving the FDA authority to require post approval studies orclinical trials, to request that safety information be provided in labeling, or to require an NDA applicant to submit and execute a Risk Evaluation andMitigation Strategy (REMS).The FDAAA made certain changes to the user fee provisions to permit the use of user fee revenue to fund the FDA’s drug product safety activities andthe review of Direct-to-Consumer advertisements. The Food and Drug Administration Safety and Innovation Act of 2012, which became effective in October2012, reauthorized the authority of the FDA to collect user fees to fund the FDA’s review activities.In addition, new government requirements may be established that could delay or prevent regulatory approval of our products under development.The Hatch-Waxman ActIn seeking approval for a drug through an NDA, applicants are required to list with the FDA each patent with claims that cover the applicant’s drug.Upon approval of a drug, each of the patents listed in the application for the drug is then published in the FDA’s Approved Drug Products with TherapeuticEquivalence Evaluations, commonly known as the Orange Book. Drugs listed in the Orange Book can, in turn be cited by potential competitors in support ofapproval of an abbreviated new drug application (ANDA). An ANDA provides for marketing of a drug that has the same active ingredients in the samestrengths and dosage form as the listed drug and has been shown through bioequivalence testing to be therapeutically equivalent to the listed drug. ANDAapplicants are not required to conduct or submit results of pre-clinical or clinical tests to prove the safety or effectiveness of their drug, other than therequirement for bioequivalence testing. Drugs approved in this way are commonly referred to as “generic equivalents” to the listed drug, and can often besubstituted by pharmacists under prescriptions written for the original listed drug.The ANDA applicant is required to certify to the FDA concerning any patents listed for the approved drug in the FDA’s Orange Book. Specifically, theapplicant must certify that: (i) the required patent information has not been filed; (ii) the listed patent has expired; (iii) the listed patent has not expired, but willexpire on a particular date and approval is sought after patent expiration; or (iv) the listed patent is invalid or will not be infringed by the new drug. Acertification that the new drug will not infringe the already approved drug’s listed 12Table of Contentspatents or that such patents are invalid is called a Paragraph IV certification. If the applicant does not challenge the listed patents, the ANDA application willnot be approved until all the listed patents claiming the referenced drug have expired.If the ANDA applicant has provided a Paragraph IV certification to the FDA, the applicant must also send notice of the Paragraph IV certification to theNDA and patent holders once the ANDA has been accepted for filing by the FDA. The NDA and patent holders may then initiate a patent infringement lawsuitin response to the notice of the Paragraph IV certification. The filing of a patent infringement lawsuit within 45 days of the receipt of a Paragraph IVcertification automatically prevents the FDA from approving the ANDA until the earlier of 30 months, expiration of the patent, settlement of the lawsuit or adecision in the infringement case that is favorable to the ANDA applicant.The ANDA application also will not be approved until any non-patent exclusivity, such as exclusivity for obtaining approval of a new chemical entity,listed in the Orange Book for the referenced drug has expired. Federal law provides a period of five years following approval of a drug containing no previouslyapproved active ingredients, during which ANDAs for generic versions of those drugs cannot be submitted unless the submission contains a Paragraph IVchallenge to a listed patent, in which case the submission may be made four years following the original drug approval. Federal law provides for a period ofthree years of exclusivity following approval of a listed drug that contains previously approved active ingredients but is approved in a new dosage form, routeof administration or combination, or for a new use, the approval of which was required to be supported by new clinical trials conducted by or for the sponsor,during which FDA cannot grant effective approval of an ANDA based on that listed drug.Foreign regulationWhether or not we or our partners obtain FDA approval for a product, we must obtain approval by the comparable regulatory authorities of foreigncountries before we can commence clinical trials or marketing of the product in those countries. The approval process varies from country to country, and thetime may be longer or shorter than that required for FDA approval. The requirements governing the conduct of clinical trials, product licensing, pricing andreimbursement also vary greatly from country to country. Although governed by the applicable country, clinical trials conducted outside of the U.S. typicallyare administered with the three-Phase sequential process that is discussed above under “United States government regulation.” However, the foreign equivalentof an IND is not a prerequisite to performing pilot studies or Phase I clinical trials.Under European Union regulatory systems, we may submit MAAs either under a centralized or decentralized procedure. The centralized procedure,which is available for drugs produced by biotechnology or which are highly innovative, provides for the grant of a single marketing authorization that is validfor all European Union member states. This authorization is a marketing authorization approval. The decentralized procedure provides for mutual recognitionof national approval decisions. Under this procedure, the holder of a national marketing authorization may submit an application to the remaining memberstates. Within 90 days of receiving the applications and assessment report, each member state must decide whether to recognize approval. This procedure isreferred to as the mutual recognition procedure.In addition, regulatory approval of prices is required in most countries other than the U.S. We face the risk that the resulting prices would beinsufficient to generate an acceptable return to us or our partners.Patents and proprietary rights; Hatch-Waxman protectionWe and our partners will be able to protect our products from unauthorized use by third parties only to the extent that our products are covered by validand enforceable patents, either licensed in from third parties or generated internally, that give us or our partners sufficient proprietary rights. Accordingly,patents and other proprietary rights are essential elements of our business.HETLIOZ™, Fanapt and VLY-686 are covered by new chemical entity and other patents. These patents cover the active pharmaceutical ingredient andprovide patent protection for all formulations containing these active pharmaceutical ingredients. For more on these license and sublicense arrangements, pleasesee “License agreements” above. In addition, we have generated our own intellectual property, and filed patent applications covering this intellectual property,for HETLIOZ™ and Fanapt. 13®®Table of ContentsFanaptThe new chemical entity patent for Fanapt is owned by Sanofi, and other patents and patent applications relating to Fanapt are owned by Novartis.We originally obtained exclusive worldwide rights to develop and commercialize the products covered by these patents through license and sublicensearrangements. However, pursuant to the amended and restated sublicense agreement with Novartis, Novartis now retains exclusive commercialization rights toall formulations of Fanapt in the U.S. and Canada.The new chemical entity patent covering Fanapt was set to expire normally in 2011 in the U.S. and expired in 2010 in major markets outside of theU.S. However, in the U.S., Fanapt has qualified for a full five-year patent term extension and so the term of the new chemical entity patent in the U.S. hasbeen extended until November 2016 (see Subsequent Events footnote for further information). In Europe, statutes provide for ten years of data exclusivity,with the potential for an additional year if the company develops the drug for a significant new indication. No generic versions of Fanapt would be permittedto be marketed or sold during this 10-year (or 11-year) period in most European countries. Consequently, assuming we receive regulatory approval in Europe,we expect that Novartis’ rights to commercialize Fanapt will be exclusive until November 2016 in the U.S. and our rights in Europe would be exclusive for atleast 10 years from approval in Europe. Data exclusivity periods in other countries vary from country to country. Several other patent applications coveringmetabolites, uses, formulations and genetic markers relating to Fanapt extend beyond 2020.HETLIOZThe new chemical entity patent for HETLIOZ™, which is owned by BMS, expires in 2017 in the U.S. and most European markets. We expect thepatent to receive a five-year patent term extension under the Hatch-Waxman Act, which would extend new chemical entity patent protection for HETLIOZ to2022. In addition, we have applied for our own patents directed to methods of using HETLIOZ, which, if granted, could extend the period of effective patentprotection for the product in the U.S. and other major markets. It is also possible that the term of the new chemical entity patent could be extended in Europeand other major markets outside the U.S. We expect the product to be protected by data exclusivity outside the U.S., the terms of which vary by country.VLY-686The new chemical entity patent covering VLY-686, which is owned by Lilly, expires in April 2023, except in the U.S., where it expires in June 2024. Webelieve a five-year patent term extension may be available for VLY-686 in the U.S. and possibly elsewhere. Lilly owns additional patent applications, whichare licensed to us, directed to polymorphic forms of, and methods of making VLY-686.Aside from the new chemical entity patents and other in-licensed patents relating to Fanapt, HETLIOZ™ and VLY-686, as of December 31, 2013 wehad 27 patent and patent application families, most of which have been filed in key markets including the U.S., relating to HETLIOZ™ and Fanapt. Inaddition, we had five other patent applications relating to products not presently in clinical studies. The claims in these various patents and patent applicationsare directed to compositions of matter, including claims covering other products, pharmaceutical compositions and methods of use.For proprietary know-how that is not appropriate for patent protection, processes for which patents are difficult to enforce and any other elements of ourdiscovery process that involve proprietary know-how and technology that are not covered by patent applications, we generally rely on trade secret protectionand confidentiality agreements to protect our interests. We require all of our employees, consultants and advisors to enter into confidentiality agreements. Whereit is necessary to share our proprietary information or data with outside parties, our policy is to make available only that information and data required toaccomplish the desired purpose and only pursuant to a duty of confidentiality on the part of those parties.Third-party reimbursement and pricing controlsThe Patient Protection and Affordable Care Act, as amended by the Health Care and Education Affordability Reconciliation Act of 2010, collectivelyreferred to as the ACA, is expected to significantly change the way healthcare is financed by both governmental and private insurers. The provisions of theACA became 14®®®®®®®®®TMTMTM®®Table of Contentseffective over various periods from 2010 through 2014. While we cannot predict what impact on federal reimbursement policies this law will have in general orspecifically on any product we commercialize, the ACA may result in downward pressure on pharmaceutical reimbursement, which could negatively affectmarket acceptance of new products. The rebates, discounts, taxes and other costs resulting from the ACA may have a significant effect on our profitability inthe future. In addition, potential reductions of the per capita rate of growth in Medicare spending under the ACA, could potentially limit access to certaintreatments or mandate price controls for our products. Moreover, although the United States Supreme Court has upheld the constitutionality of most of theACA, some states have indicated that they intend not to implement certain sections of the ACA, and some members of the U.S. Congress are still working torepeal the ACA. We cannot predict whether these challenges will continue or other proposals will be made or adopted, or what impact these efforts may have onus or our partners.In the U.S. and elsewhere, sales of pharmaceutical products depend in significant part on the availability of reimbursement to the consumer from third-party payors, such as government and private insurance plans. Third-party payors are increasingly challenging the prices charged for medical products andservices. It will be time consuming and expensive for us or our partners to go through the process of seeking reimbursement from Medicare and private payors.Our products may not be considered cost-effective, and coverage and reimbursement may not be available or sufficient to allow us or our partners to sell ourcompounds on a competitive and profitable basis. The passage of the Medicare Prescription Drug and Modernization Act of 2003 imposes additionalrequirements for the distribution and pricing of prescription drugs which may affect the marketing of our products.In many foreign markets, including the countries in the European Union and Japan, pricing of pharmaceutical products is subject to governmentalcontrol. In the U.S., there have been, and we expect that there will continue to be, a number of federal and state proposals to implement similar governmentalpricing control. While we cannot predict whether such legislative or regulatory proposals will be adopted, the adoption of such proposals could have a materialadverse effect on our business, financial condition and profitability.Marketing and salesIn January 2014, HETLIOZ™ was approved in the U.S. for the treatment of Non- 24. We currently anticipate commercially launching HETLIOZ™ inthe U.S. in the second quarter of 2014.We are preparing to file a MAA for HETLIOZ for the treatment of Non-24 with the EMA during 2014. Given the range of potential indications forHETLIOZ™, we may pursue one or more partnerships for the development and commercialization of HETLIOZ™ worldwide.In October 2009, we entered into an amended and restated sublicense agreement with Novartis pursuant to which Novartis has exclusivecommercialization rights to all formulations of Fanapt in the U.S. and Canada. Novartis began selling Fanapt in the U.S. during the first quarter of 2010.We do not expect Novartis to commercialize Fanapt in Canada.We continue to explore the regulatory path and commercial opportunity for Fanapt oral formulation outside of the U.S. and Canada. We have enteredinto agreements with the following partners for the commercialization of Fanapt in the countries set forth below: Country PartnerMexico Probiomed S.A. de C.V.Israel Megapharm Ltd.In August 2012, the Israeli Ministry of Health granted market approval for Fanapt for the treatment of schizophrenia. In November 2012, we werenotified that Fanapt had been granted market approval in Argentina for the treatment of schizophrenia. In October 2013, the Mexican Federal Commission forProtection Against Sanitary Risks (COFEPRIS) granted market approval for Fanapt for the treatment of schizophrenia. 15TM®®®®®®®®Table of ContentsManufacturingWe currently utilize a virtual supply manufacturing and distribution chain in which we do not have our own facilities to manufacture commercial orclinical trial supplies of drugs and we do not have our own distribution facilities. Additionally, we do not intend to develop such facilities for any product inthe near future. Instead, we contract with third parties for the manufacture, warehousing, order management, billing and collection and distribution of ourproducts and product candidates.We expect to continue to rely solely on third-party manufacturers to manufacture drug substance and final drug products for both clinical developmentand commercial sale. However, there are numerous factors that could cause interruptions in the supply of our products, including regulatory reviews; changesin our sources for manufacturing; disputes with a manufacturer; or financial instability of manufacturers, which could negatively impact our operation.In January 2014, we entered into a manufacturing agreement with Patheon Pharmaceuticals Inc. for the manufacture of commercial supplies ofHETLIOZ™ 20 mg capsules at Patheon’s Cincinnati, Ohio manufacturing site. Under the agreement, we are responsible for supplying the activepharmaceutical ingredient for HETLIOZ™ to Patheon and have agreed to certain minimum yearly order requirements. Patheon is responsible formanufacturing the HETLIOZ™ 20 mg capsules, conducting quality control and stability testing, and packaging the HETLIOZ™ capsules. The agreementhas an initial term of five years and will automatically renew after the initial term for successive terms of one year each, unless either party gives notice of itsintention to terminate the agreement at least twelve months prior to the end of the then current term. Either party may terminate the agreement under certaincircumstances upon specified written notice to the other party.Research and DevelopmentWe have built a research and development organization that includes extensive expertise in the scientific disciplines of pharmacogenetics andpharmacogenomics. We operate cross-functionally and are led by an experienced research and development management team. We use rigorous projectmanagement techniques to assist us in making disciplined strategic research and development program decisions and to help limit the risk profile of ourproduct pipeline. We also access relevant market information and key opinion leaders in creating target product profiles and, when appropriate, as we advanceour programs towards commercialization. We engage third parties to conduct portions of our preclinical research. In addition, we utilize multiple clinical sitesto conduct our clinical trials; however we are not substantially dependent upon any one of these sites for our clinical trials nor do any of them conduct a majorportion of our clinical trials.We incurred $28.2 million, $45.4 million and $29.0 million in research and development expenses in the years ended December 31, 2013, 2012 and2011, respectively.CompetitionThe pharmaceutical industry and the central nervous system segment of that industry, in particular, is highly competitive and includes a number ofestablished large and mid-sized companies with greater financial, technical and personnel resources than we have and significantly greater commercialinfrastructures than we have. Our market segment also includes several smaller emerging companies whose activities are directly focused on our target marketsand areas of expertise. Our products, once approved for commercial use, will compete with numerous therapeutic treatments offered by these competitors.While we believe that our products will have certain favorable features, existing and new treatments may also possess advantages. Additionally, thedevelopment of other drug technologies and methods of disease prevention are occurring at a rapid pace. These developments may render our products ortechnologies obsolete or noncompetitive.We believe the primary competitors for HETLIOZ and Fanapt are as follows: • For HETLIOZ in the treatment of CRSDs, there are no approved direct competitors. Insomnia treatments include, Rozerem (ramelteon) by TakedaPharmaceuticals Company Limited, hypnotics such as Ambien (zolpidem) by Sanofi (including Ambien CR), Lunesta (eszopiclone) bySunovion Pharmaceuticals Inc., Sonata (zaleplon) by Pfizer Inc., Silenor (doxepin) by Pernix Therapeutics, 16TM®TM®®®®®®Table of Contents generic compounds such as zolpidem, trazodone and doxepin, and over-the-counter remedies such as Benadryl and Tylenol PM. The class ofmelatonin agonists includes Rozerem (ramelteon) by Takeda Pharmaceuticals Company Limited, Valdoxan (agemelatine) by Servier, Circadin(long-acting melatonin) by Neurim Pharmaceuticals and the food supplement melatonin. • For Fanapt in the treatment of schizophrenia, the atypical antipsychotics Risperdal (risperidone), including the depot formulation RisperdalConsta, and Invega (paliperidone), including the depot formulation Invega Sustenna™, each by Ortho-McNeil-Janssen Pharmaceuticals, Inc.,Zyprexa (olanzapine), including the depot formulation Zyprexa Relprevv™, by Eli Lilly and Company, Seroquel (quetiapine) by AstraZenecaPLC, Abilify (aripiprazole) by BMS/Otsuka Pharmaceutical Co., Ltd., Geodon (ziprasidone) by Pfizer Inc., Saphris (asenapine) by Merck &Co. Inc., Latuda (lurasidone) by Sunovion Pharmaceuticals Inc., and generic clozapine, as well as the typical antipsychotics haloperidol,chlorpromazine, thioridazine, and sulpiride (all of which are generic).Our ability to compete successfully will depend in part on our ability to utilize our pharmacogenetics and pharmacogenomics and drug developmentexpertise to identify, develop, secure rights to and obtain regulatory approvals for promising pharmaceutical products before others are able to developcompetitive products. Our ability to compete successfully will also depend on our ability to attract and retain skilled and experienced personnel. Additionally,our ability to compete may be affected because insurers and other third-party payors in some cases seek to encourage the use of cheaper, generic products,which could make our products less attractive.EmployeesAs of December 31, 2013, we had 53 full-time employees. Of these employees, 25 were primarily engaged in research and development activities. Noneof our employees are represented by a labor union. We have not experienced any work stoppages and consider our employee relations to be good.Corporate InformationWe were incorporated in Delaware in 2002. Our principal executive offices are located at 2200 Pennsylvania Avenue NW, Suite 300E, Washington D.C.20037, and our telephone number is (202) 734-3400. Our website address is www.vandapharma.com and the information contained in, or that can be accessedthrough, our website is not part of this annual report and should not be considered part of this annual report.Available InformationWe file annual, quarterly, and current reports, proxy statements, and other documents with the Securities and Exchange Commission (SEC) under theSecurities Exchange Act of 1934 (the Exchange Act). The public may read and copy any materials that we file with the SEC at the SEC’s Public ReferenceRoom at 100 F Street, NE, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at1-800-SEC-0330. Also, the SEC maintains an internet website at www.sec.gov that contains reports, proxy and information statements, and other informationregarding issuers, including us, that file electronically with the SEC.We also make available free of charge on our Internet website at www.vandapharma.com our annual reports on Form 10-K, quarterly reports on Form10-Q, current reports on Form 8-K, and, if applicable, amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Actas soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.Our code of ethics, other corporate policies and procedures, and the charters of our Audit Committee, Compensation Committee andNominating/Corporate Governance Committee are available through our Internet website at www.vandapharma.com. 17®®®®®®®®®®®®®®®®®®Table of ContentsITEM 1A.RISK FACTORSInvesting in our common stock involves a high degree of risk. You should consider carefully the risks and uncertainties described below, togetherwith all of the other information in this annual report on Form 10-K including the consolidated financial statements and the related notes appearingherein, with respect to any investment in shares of our common stock. If any of the following risks actually occurs, our business, financial condition,results of operations and future prospects could be materially and adversely affected. In that event, the market price of our common stock could declineand you could lose all or part of your investment. Additional risks and uncertainties not presently known to us or that we currently deem immaterialmay also impair our operations and results.Risks related to our business and industryHETLIOZ™ may not be commercially successful.Market acceptance of and demand for HETLIOZ™ will depend on many factors, including, but not limited to: • cost of treatment; • pricing and availability of alternative products; • the cost and success of our Non-24 awareness campaign; • our ability to obtain third-party coverage or reimbursement for HETLIOZ™; • perceived efficacy relative to other available therapies; • shifts in the medical community to new treatment paradigms or standards of care; • relative convenience and ease of administration; and • prevalence and severity of adverse side effects associated with treatment.Because we have not yet initiated the commercialization of HETLIOZ™, we have limited information with regard to the market acceptance ofHETLIOZ™ in the U.S. or elsewhere. As a result, we may have to revise our estimates regarding the acceptance of HETLIOZ™ under our anticipated pricingstructure and reevaluate and/or change the anticipated pricing for HETLIOZ™.In addition, we have incurred and expect to continue to incur significant expenses and to utilize a substantial portion of our cash resources as we preparefor the commercial launch of HETLIOZ™ in the U.S., continue our Non-24 awareness campaign and continue to grow our operational capabilities. Thisrepresents a significant investment in the commercial success of HETLIOZ™, which is uncertain.We are heavily dependent on the commercial success of HETLIOZ™, which only recently received marketing authorization in the U.S., and onthe regulatory approval of HETLIOZ™ for the treatment of Non-24 in other countries, which may never occur.Our future success is currently dependent upon the commercial success of HETLIOZ™ for the treatment of Non-24 in the U.S. In January 2014, theFDA approved our NDA for HETLIOZ™ for the treatment of Non-24. Our future success is dependent upon successfully obtaining regulatory approval fromforeign regulatory bodies to market HETLIOZ™ for the treatment of Non-24 in other jurisdictions, and if approved, successfully commercializingHETLIOZ™ in such jurisdictions. We are preparing to file a Marketing Authorization Application (MAA) for HETLIOZ for the treatment of Non-24 withthe European Medicines Agency (EMA) during 2014.If we do not successfully commercialize HETLIOZ™ in other countries in which HETLIOZ™ may be approved for sale, our ability to generate revenuemay be jeopardized and, consequently, our business may be seriously harmed. We may not receive regulatory approval in other jurisdictions forHETLIOZ™; and if we do receive regulatory approval in such other jurisdictions for HETLIOZ™, we may not be able to commercialize HETLIOZ™successfully, all of which would have a material adverse effect on our business and prospects. 18TMTable of ContentsIn addition, we have incurred and expect to continue to incur significant expenses and to utilize a substantial portion of our cash resources as we preparefor the approval of HETLIOZ™ in other jurisdictions. This represents a significant investment in the regulatory success of HETLIOZ™, which is uncertain.As a company, we have no experience selling, marketing or distributing products, other than providing assistance to Novartis relating to theU.S. commercialization of Fanapt, which may make commercializing our products difficult.At present, we as a company have no marketing experience, other than providing assistance to Novartis relating to the U.S. commercialization ofFanapt. Therefore, in order for us to commercialize HETLIOZ™, Fanapt (outside the U.S. and Canada) or our other products, we must either acquire orinternally develop sales, marketing and distribution capabilities, or enter into collaborations with partners to perform these services for us. We may, in someinstances, rely significantly on sales, marketing and distribution arrangements with our collaborative partners and other third parties. For example, we relycompletely on Novartis to market, sell and distribute Fanapt in the U.S. and Canada.For the commercialization of HETLIOZ™, Fanapt (outside the U.S. and Canada) or our other products, we may not be able to establish additionalsales and distribution partnerships on acceptable terms or at all. In regard to our current foreign partners and any additional distribution arrangements or otheragreements we may enter into, our success will be materially dependent upon the performance of our partners. In the event that we attempt to acquire or developour own in-house sales, marketing and distribution capabilities, factors that may inhibit our efforts to commercialize our products without partners orlicensees include: • our inability to recruit and retain adequate numbers of effective sales and marketing personnel; • the inability of sales personnel to obtain access to or persuade adequate numbers of physicians to prescribe our products; • the lack of complementary products to be offered by our sales personnel, which may put us at a competitive disadvantage with respect to companieswith broader product lines; and • unforeseen costs associated with creating our own sales and marketing team or with entering into a partnering agreement with an independent salesand marketing organization.The cost of establishing and maintaining a sales, marketing and distribution organization may exceed its cost effectiveness. If we fail to develop salesand marketing capabilities, if sales efforts are not effective or if costs of developing sales and marketing capabilities exceed their cost effectiveness, ourbusiness, results of operations and financial condition could be materially adversely affected.We rely and will continue to rely on outsourcing arrangements for many of our activities, including clinical development and supply ofHETLIOZ™ and our other products.As of December 31, 2013 we had 53 full-time employees and, as a result, we rely, and expect to continue to rely, on outsourcing arrangements for asignificant portion of our activities, including clinical research, data collection and analysis, manufacturing, financial reporting and accounting and humanresources, as well as for certain functions as a public company. We may have limited control over these third parties and we cannot guarantee that they willperform their obligations in an effective and timely manner.Disruptions to our HETLIOZ™ supply chain could materially reduce our future earnings and prospects.A loss or disruption with any one of our manufacturers or suppliers could disrupt supply of HETLIOZ™, possibly for a significant time period, andwe may not have sufficient inventories to maintain supply before the manufacturer or supplier could be replaced or the disruption is resolved. In addition,marketed drugs and their contract manufacturing organizations are subject to continual review, including review and approval of their manufacturing facilitiesand the manufacturing processes, which can result in delays in the regulatory approval process and/or commercialization. Introducing a replacement orbackup manufacturer or supplier for HETLIOZ™ requires a lengthy regulatory and commercial process and there can be no guarantee that we could 19®®®®®Table of Contentsobtain necessary regulatory approvals in a timely fashion or at all. In addition, it is difficult to identify and select qualified suppliers and manufacturers withthe necessary technical capabilities, and establishing new supply and manufacturing sources involves a lengthy and technical engineering process.We and our partners face heavy government regulation. FDA regulatory approval of our products is uncertain and we and our partners arealso continually at risk of the FDA requiring us or them to discontinue marketing any products that have obtained, or in the future mayobtain, regulatory approval.The research, testing, manufacturing and marketing of products such as those that we have developed or that we or our partners are developing aresubject to extensive regulation by federal, state and local government authorities, including the FDA. To obtain regulatory approval of such products, we or ourpartners must demonstrate to the satisfaction of the applicable regulatory agency that, among other things, the product is safe and effective for its intended use.In addition, we or our partners must show that the manufacturing facilities used to produce such products are in compliance with current GoodManufacturing Practices regulations or cGMP.The process of obtaining FDA and other required regulatory approvals and clearances can take many years and will require us and our partners, asapplicable, to expend substantial time and capital. Despite the time and expense expended, regulatory approval is never guaranteed. The number of pre-clinicaland clinical trials that will be required for FDA approval varies depending on the product, the disease or condition that the product is in development for, andthe requirements applicable to that particular product. The FDA can delay, limit or deny approval of a product for many reasons, including that: • a product may not be shown to be safe or effective; • the FDA may interpret data from pre-clinical and clinical trials in different ways than we or our partners do; • the FDA may not approve our or our partners’ manufacturing processes or facilities; • a product may not be approved for all the indications we or our partners request; • the FDA may change its approval policies or adopt new regulations; • the FDA may not meet, or may extend, the Prescription Drug User Fee Act (PDUFA-V) date with respect to a particular NDA; and • the FDA may not agree with our or our partners’ regulatory approval strategies or components of the regulatory filings, such as clinical trial designs.For example, if certain of our or our partners’ methods for analyzing trial data are not accepted by the FDA, we or our partners may fail to obtainregulatory approval for our products.Moreover, the marketing, distribution and manufacture of approved products remain subject to extensive ongoing regulatory requirements. Failure tocomply with applicable regulatory requirements could result in, among other things: • warning letters; • fines; • civil penalties; • injunctions; • recall or seizure of products; • total or partial suspension of production; • refusal of the government to grant future approvals; • withdrawal of approvals; and • criminal prosecution. 20Table of ContentsAny delay or failure to obtain regulatory approvals for our products will result in increased costs, could diminish competitive advantages that we mayattain and would adversely affect the marketing and sale of our products. Other than HETLIOZ™ in the U.S. and Fanapt in the U.S., Mexico, Israel andArgentina, we have not received regulatory approval to market any of our products in any jurisdiction.Even following regulatory approval of our products, the FDA may impose limitations on the indicated uses for which such products may be marketed,subsequently withdraw approval or take other actions against us, our partners or such products that are adverse to our business. The FDA generally approvesdrugs for particular indications. An approval for a more limited indication reduces the size of the potential market for the product. Product approvals, oncegranted, may be withdrawn or modified if problems occur after initial marketing.We and our partners also are subject to numerous federal, state and local laws, regulations and recommendations relating to safe working conditions,laboratory and manufacturing practices, the environment and the use and disposal of hazardous substances used in connection with discovery, research anddevelopment work. In addition, we cannot predict the extent to which new governmental regulations might significantly impede the discovery, development,production and marketing of our products. We or our partners may be required to incur significant costs to comply with current or future laws or regulations,and we may be adversely affected by the cost of such compliance or the inability to comply with such laws or regulations.We intend to seek regulatory approvals for our products in foreign jurisdictions, but we may not obtain any such approvals.We intend to market our products in foreign jurisdictions. In order to market our products in foreign jurisdictions, we or our partners may be required toobtain separate regulatory approvals and to comply with numerous and varying regulatory requirements. The approval procedure varies among countries andjurisdictions and can involve additional trials, and the time required to obtain approval may differ from that required to obtain FDA approval. Additionally,the foreign regulatory approval process may include all of the risks associated with obtaining FDA approval. For all of these reasons, we or our partners maynot obtain foreign regulatory approvals on a timely basis, if at all. Approval by the FDA does not ensure approval by regulatory authorities in other countriesor jurisdictions, and approval by one foreign regulatory authority does not ensure approval by regulatory authorities in other foreign countries or jurisdictionsor by the FDA. We or our partners may not be able to file for regulatory approvals and may not receive necessary approvals to commercialize our products inany market. The failure to obtain these approvals could harm our business materially.Even after we or our partners obtain regulatory approvals of a product, acceptance of such product in the marketplace is uncertain and failureto achieve commercial acceptance will prevent or delay our ability to generate product revenues.Even after obtaining regulatory approvals for the sale of our products, the commercial success of these products will depend, among other things, ontheir acceptance by physicians, patients, third-party payors and other members of the medical community as a therapeutic and cost-effective alternative tocompeting products and treatments. The degree of market acceptance of any product will depend on a number of factors, including the demonstration of itssafety and efficacy, its cost-effectiveness, its potential advantages over other therapies, the reimbursement policies of government and third-party payors withrespect to such product, our ability to attract and maintain corporate partners, including pharmaceutical companies, to assist in commercializing ourproducts, receipt of regulatory clearance of marketing claims for the uses that we or our partners are developing and the effectiveness of our and our partners’marketing and distribution capabilities. If our approved products fail to gain market acceptance, we may be unable to earn sufficient revenue to continue ourbusiness. If our approved products do not become widely accepted by physicians, patients, third-party payors and other members of the medical community,it is unlikely that we will ever become profitable on a sustained basis or achieve significant revenues. 21®Table of ContentsIf we fail to obtain the capital necessary to fund our research and development activities and commercialization efforts, we may be unable tocontinue operations or we may be forced to share our rights to commercialize our products with third parties on terms that may not beattractive to us.Our activities will necessitate significant uses of working capital throughout 2014 and beyond. It is uncertain whether our existing funds will besufficient to meet our operating needs. As of December 31, 2013, our total cash and cash equivalents and marketable securities were $130.4 million. In August2013, we completed a public offering of 4,680,000 shares of our common stock resulting in net proceeds to us of $48.5 million after deducting underwritingdiscounts and commissions and other estimated offering expenses. Our long term capital requirements are expected to depend on many factors, including,among others: • our ability to commercialize HETLIOZ globally; • costs of developing and maintaining sales, marketing and distribution channels and our ability to sell our products; • costs involved in establishing manufacturing capabilities for commercial quantities of our products; • the amount of royalty and milestone payments received from our commercial partners; • our ability to commercialize Fanapt outside the U.S. and Canada; • the number of potential formulations and products in development; • progress with pre-clinical studies and clinical trials; • time and costs involved in obtaining regulatory (including FDA) approval; • costs involved in preparing, filing, prosecuting, maintaining and enforcing patent, trademark and other intellectual property claims; • competing technological and market developments; • market acceptance of our products; • costs for recruiting and retaining employees and consultants; • costs for training physicians; and • legal, accounting, insurance and other professional and business related costs.We expect to continue to receive royalty payments in connection with our amended and restated sublicense agreement with Novartis. Based on the currentsales performance of Fanapt in the U.S., we expect that some or all of these commercial and development milestones will not be achieved by Novartis. Overtime, Novartis has reduced the size of the Fanapt sales organization and this could have a negative impact on the success of the product in the U.S.. We donot expect Novartis to commercialize Fanapt in Canada. We do not expect to receive revenue from HETLIOZ sales in the U.S. until the second quarter of2014, at the earliest. As a result, we may need to raise additional capital to fund our anticipated operating expenses and execute on our business plans. In ourcapital-raising efforts, we may seek to sell debt securities or additional equity securities or obtain a bank credit facility, or enter into partnerships or othercollaboration agreements. The sale of additional equity or debt securities, if convertible, could result in dilution to our stockholders and may also result in alower price for our common stock. The incurrence of indebtedness would result in increased fixed obligations and could also result in covenants that couldrestrict our operations. However, we may not be able to raise additional funds on acceptable terms, or at all. If we are unable to secure sufficient capital to fundour planned activities, we may not be able to continue operations, or we may have to enter into partnerships or other collaboration agreements that could requireus to share commercial rights to our products to a greater extent or at earlier stages in the drug development process than is currently intended. Thesepartnerships or collaborations, if consummated prior to proof-of-efficacy or safety of a given product, could impair our ability to realize value from thatproduct. If additional financing is not available when required or is not available on acceptable terms, we may be unable to fund our operations and plannedgrowth, develop or enhance our technologies or products, take advantage of business opportunities or respond to competitive market pressures, any of whichwould materially harm our business, financial condition and results of operations. 22TM®®®®TMTable of ContentsWe face substantial competition which may result in others developing or commercializing products before or more successfully than we do.Our future success will depend on our or our partners’ ability to demonstrate and maintain a competitive advantage with respect to our products and ourability to identify and develop additional products through the application of our pharmacogenetics and pharmacogenomics expertise. Large, fully integratedpharmaceutical companies, either alone or together with collaborative partners, have substantially greater financial resources and have significantly greaterexperience than we do in: • developing products; • undertaking pre-clinical testing and clinical trials; • obtaining FDA and other regulatory approvals of products; and • manufacturing, marketing and selling products.These companies may invest heavily and quickly to discover and develop novel products that could make our products obsolete. Accordingly, ourcompetitors may succeed in obtaining patent protection, receiving FDA or foreign regulatory approval or commercializing superior products or other competingproducts before we do. Technological developments or the FDA or foreign regulatory approval of new therapeutic indications for existing products may makeour products obsolete or may make them more difficult to market successfully, any of which could have a material adverse effect on our business, results ofoperations and financial condition.Our products, if successfully developed and approved for commercial sale, will compete with a number of drugs and therapies currently manufacturedand marketed by major pharmaceutical and other biotechnology companies. Our products may also compete with new products currently under developmentby others or with products which may cost less than our products. Physicians, patients, third party payors and the medical community may not accept orutilize any of our products that may be approved. If HETLIOZ™, Fanapt and our other products, if and when approved, do not achieve significant marketacceptance, our business, results of operations and financial condition would be materially adversely affected. We believe the primary competitors forHETLIOZ™ and Fanapt are as follows: • For HETLIOZ™ in the treatment of Non-24, there are no approved direct competitors. Insomnia treatments include, Rozerem (ramelteon) by TakedaPharmaceuticals Company Limited, hypnotics such as Ambien (zolpidem) by Sanofi (including Ambien CR), Lunesta (eszopiclone) bySunovion Pharmaceuticals Inc., Sonata (zaleplon) by Pfizer Inc., Silenor (doxepin) by Pernix Therapeutics, generic products such as zolpidem,trazodone and doxepin, and over-the-counter remedies such as Benadryl and Tylenol PM. The class of melatonin agonists includes Rozerem(ramelteon) by Takeda Pharmaceuticals Company Limited, Valdoxan (agemelatine) by Servier, Circadin (long-acting melatonin) by NeurimPharmaceuticals and the food supplement melatonin. • For Fanapt in the treatment of schizophrenia, the atypical antipsychotics Risperdal (risperidone), including the depot formulation RisperdalConsta, and Invega (paliperidone), including the depot formulation Invega Sustenna™, each by Ortho-McNeil-Janssen Pharmaceuticals, Inc.,Zyprexa (olanzapine), including the depot formulation Zyprexa Relprevv™, by Eli Lilly and Company, Seroquel (quetiapine) by AstraZenecaPLC, Abilify (aripiprazole) by BMS/Otsuka Pharmaceutical Co., Ltd., Geodon (ziprasidone) by Pfizer Inc., Saphris (asenapine) by Merck &Co. Inc., Latuda (lurasidone) by Sunovion Pharmaceuticals Inc., and generic clozapine, as well as the typical antipsychotics haloperidol,chlorpromazine, thioridazine, and sulpiride (all of which are generic).Additionally, we may face competition from newly developed generic products. Under the U.S. Drug Price Competition and Patent Term Restoration Actof 1984, more commonly known as the “Hatch-Waxman Act,” newly approved drugs and indications may benefit from a statutory period of non-patentmarketing exclusivity. The Hatch-Waxman Act seeks to stimulate competition by providing incentives to generic pharmaceutical manufacturers to introducenon-infringing forms of patented pharmaceutical products and to challenge patents on branded pharmaceutical products. If we are unsuccessful at challengingan Abbreviated New Drug Application (ANDA), filed pursuant to the Hatch-Waxman Act, cheaper generic versions of our products, which may be favored byinsurers and third-party payors, may be launched commercially, which would harm our business. 23®®®®®®®®®®®®®®®®®®®®®®®®®®Table of ContentsNovartis began selling, marketing and distributing our first approved product, Fanapt, in the U.S. in the first quarter of 2010 and our abilityto generate meaningful product revenue from Fanapt will depend on the success of this product in the marketplace.Our ability to generate product revenue from Fanapt will depend on the success of Fanapt and the sales of this product by Novartis in the U.S. Theability of Fanapt to generate meaningful product revenue will depend on many factors, including the following: • the extent and effectiveness of the development, sales and marketing and distribution support Fanapt receives; • the amount of resources and efforts utilized by Novartis in relation to the commercialization of Fanapt; • the ability of patients to be able to afford Fanapt or obtain health care coverage that covers Fanapt; • acceptance of, and ongoing satisfaction, with Fanapt by the medical community, patients receiving therapy and third party payers; • a satisfactory efficacy and safety profile as demonstrated in a broad patient population; • the size of the market for Fanapt; • successfully expanding and sustaining manufacturing capacity to meet demand; • cost and availability of raw materials; • safety concerns in the marketplace for schizophrenia therapies; • regulatory developments relating to the manufacture or continued use of Fanapt; • decisions as to the timing of product launches, pricing and discounts; • the competitive landscape for approved and developing therapies that will compete with Fanapt; • our or our partners’ ability to obtain regulatory approval for Fanapt in countries outside the U.S. and Canada; • our ability to successfully develop and commercialize Fanapt outside of the U.S. and Canada; and • the unfavorable outcome or other negative effects of any potential litigation relating to Fanapt.We entered into an amended and restated sublicense agreement with Novartis to commercialize Fanapt in the U.S. and Canada. As such, we are notdirectly involved in the marketing or sales efforts for Fanapt in the U.S. and Canada. Our ability to generate meaningful product revenue from Fanaptdepends on royalties and milestone payments we may receive from Novartis. Pursuant to the amended and restated sublicense agreement with Novartis, wereceived an upfront payment of $200.0 million and are eligible for additional payments totaling up to $265.0 million upon Novartis’ achievement of certaincommercial and development milestones for Fanapt in the U.S. and Canada. Based on the current sales performance of Fanapt in the U.S., we expect thatsome or all of these commercial and development milestones will not be achieved by Novartis.We also receive royalties, which, as a percentage of net sales, are in the low double-digits, on net sales of Fanapt in the U.S. and Canada. Suchroyalties may not be significant and will depend on numerous factors, many of which we cannot control. We cannot control the amount and timing ofresources that Novartis may devote to Fanapt. If Novartis fails to successfully commercialize Fanapt in the U.S, if Novartis’ efforts are not effective, or ifNovartis focuses its efforts on other schizophrenia therapies or schizophrenia drug candidates, our business will be negatively affected. If Novartis does notsuccessfully commercialize Fanapt in the U.S, we will receive limited revenues from them. Over time, Novartis has reduced the size of the Fanapt salesorganization and this could have a negative impact on the success of the product in the United States. For reasons outside of our control, including thosementioned above, sales of Fanapt may not meet our or financial or industry analysts’ expectations. Any significant negative developments relating to Fanapt,such as safety or efficacy issues, the introduction or greater acceptance of competing products or adverse regulatory or legislative developments, will have anadverse effect on our financial condition and results of operations. 24®®®®®®®®®®®®®®®®®®®®®®®®®®®®Table of ContentsIf our products are determined to be unsafe or ineffective in humans, whether commercially or in clinical trials, our business will be materiallyharmed.Despite the FDA’s approval of the NDA for HETLIOZ™ in January 2014 and the NDA for Fanapt in May 2009, and the positive results of ourcompleted trials for HETLIOZ™ and Fanapt, we are uncertain whether either of these products will ultimately prove to be effective and safe in humans.Frequently, products that have shown promising results in clinical trials have suffered significant setbacks in later clinical trials or even after they areapproved for commercial sale. Future uses of our products, whether in clinical trials or commercially, may reveal that the product is ineffective, unacceptablytoxic, has other undesirable side effects, is difficult to manufacture on a large scale, is uneconomical, infringes on proprietary rights of another party or isotherwise not fit for further use. If our products are determined to be unsafe or ineffective in humans, our business will be materially harmed.Clinical trials for our products are expensive and their outcomes are uncertain. Any failure or delay in completing clinical trials for ourproducts could severely harm our business.Pre-clinical studies and clinical trials required to demonstrate the safety and efficacy of our products are time-consuming and expensive and together takeseveral years to complete. Before obtaining regulatory approvals for the commercial sale of any of our products, we or our partners must demonstrate throughpreclinical testing and clinical trials that such product is safe and effective for use in humans. We have incurred, and we will continue to incur, substantialexpense for, and devote a significant amount of time to, preclinical testing and clinical trials.Historically, the results from preclinical testing and early clinical trials often have not predicted results of later clinical trials. A number of new drugshave shown promising results in clinical trials, but subsequently failed to establish sufficient safety and efficacy data to obtain necessary regulatoryapprovals. Clinical trials conducted by us, by our partners or by third parties on our or our partners’ behalf may not demonstrate sufficient safety andefficacy to obtain the requisite regulatory approvals for our products. Regulatory authorities may not permit us or our partners to undertake any additionalclinical trials for our products, may force us to stop any ongoing clinical trials and it may be difficult to design efficacy studies for our products in newindications.Clinical development efforts performed by us or our partners may not be successfully completed. Completion of clinical trials may take several years ormore. The length of time can vary substantially with the type, complexity, novelty and intended use of the products and the size of the prospective patientpopulation. The commencement and rate of completion of clinical trials for our products may be delayed by many factors, including: • the inability to manufacture or obtain from third parties materials sufficient for use in pre-clinical studies and clinical trials; • delays in beginning a clinical trial; • delays in patient enrollment and variability in the number and types of patients available for clinical trials; • difficulty in maintaining contact with patients after treatment, resulting in incomplete data; • poor effectiveness of our products during clinical trials; • unforeseen safety issues or side effects; and • governmental or regulatory delays and changes in regulatory requirements and guidelines.If we or our partners fail to complete successfully one or more clinical trials for our products, we or they may not receive the regulatory approvals neededto market that product. Therefore, any failure or delay in commencing or completing these clinical trials would harm our business materially. 25®®Table of ContentsOur products may cause undesirable side effects or have other properties that could delay, prevent or result in the revocation of theirregulatory approval or limit their marketability.Undesirable side effects caused by our products could interrupt, delay or halt clinical trials and could result in the denial of regulatory approval by theFDA or other regulatory authorities for any or all targeted indications, and in turn prevent us or our partners from commercializing or continuing thecommercialization of such products and generating revenues from their sale. We and our partners, as applicable, will continue to assess the side effect profileof our products in ongoing clinical development programs. However, we cannot predict whether the commercial use of our approved products (or our productsin development, if and when they are approved for commercial use) will produce undesirable or unintended side effects that have not been evident in the useof, or in clinical trials conducted for, such products to date. Additionally, incidents of product misuse may occur. These events, among others, could result inproduct recalls, product liability actions or withdrawals or additional regulatory controls, all of which could have a material adverse effect on our business,results of operations and financial condition.In addition, if after receiving marketing approval of a product, we, our partners or others later identify undesirable side effects caused by such product,we or our partners could face one or more of the following: • regulatory authorities may require the addition of labeling statements, such as a “black box” warning or a contraindication; • regulatory authorities may withdraw their approval of the product; • we or our partners may be required to change the way the product is administered, conduct additional clinical trials or change the labeling of theproduct; and • our, our partner’s or the product’s reputation may suffer.Any of these events could prevent us or our partners from achieving or maintaining market acceptance of the affected product or could substantiallyincrease the costs and expenses of commercializing the product, which in turn could delay or prevent us from generating significant revenues from its sale.We have a history of operating losses, anticipate future losses and may never become profitable on a sustained basis.We have been engaged in identifying and developing products since March 2003, which has required, and will continue to require, significant researchand development expenditures. The commercial launch for HETLIOZ™ will require substantial additional expenditures.As of December 31, 2013, we had an accumulated deficit of $311.4 million, and we cannot estimate with precision the extent of our future losses. Ourability to generate meaningful product revenue prior to the commercialization of HETLIOZ™ depends on Novartis’ and our ability to sell Fanapt. Novartislaunched Fanapt in the U.S. in the first quarter of 2010 and sales to date have not met our expectations. We do not expect Novartis to commercialize Fanaptin Canada. Fanapt may continue to not be as commercially successful as we expected, Novartis may not succeed in gaining additional market acceptance ofFanapt in the U.S. and we may not succeed in commercializing Fanapt outside of the U.S. and Canada. The commercial launch for HETLIOZ™ and ourcontinuing Non-24 awareness campaign will require substantial additional expenditures. In addition, we may not succeed in commercializing HETLIOZ™ orany other products. We may not be profitable even if our products are successfully commercialized. We may be unable to fully develop, obtain regulatoryapproval for, commercialize, manufacture, market, sell and derive revenue from our products in the timeframes we project, if at all, and our inability to do sowould materially and adversely impact the market price of our common stock and our ability to raise capital and continue operations.There can be no assurance that we will achieve sustained profitability. Our ability to achieve sustained profitability in the future depends, in part, upon: • our and our partners’ ability to obtain and maintain regulatory approval for our products, particularly HETLIOZ™ for the treatment of Non-24,both in the U.S. and in foreign countries; 26®®®®®®Table of Contents • our ability to successfully commercialize HETLIOZ™ in the U.S. and other jurisdictions in which HETLIOZ™ may receive regulatory approval, ifany; • our ability to successfully raise awareness regarding Non-24 in the medical and patient communities; • Novartis’ ability to successfully market and sell Fanapt in the U.S.; • our and our partners’ ability to successfully commercialize Fanapt outside the U.S. and Canada; • our ability to enter into and maintain agreements to develop and commercialize our products; • our and our partners’ ability to develop, have manufactured and market our products; • our and our partners’ ability to obtain adequate reimbursement coverage for our products from insurance companies, government programs and otherthird party payors; and • our ability to obtain additional research and development funding from collaborative partners or funding for our products.In addition, the amount we spend will impact our profitability. Our spending will depend, in part, upon: • the costs of our marketing or awareness campaigns; • the progress of our research and development programs for our products, including clinical trials; • the time and expense that will be required to pursue FDA and/or foreign regulatory approvals for our products and whether such approvals areobtained on a timely basis, if at all; • the time and expense required to prosecute, enforce and/or challenge patent and other intellectual property rights; • the cost of operating and maintaining development and research facilities; • the cost of third party manufacturers; • the number of additional products we pursue; • how competing technological and market developments affect our products; • the cost of possible acquisitions of technologies, products, product rights or companies; • the cost of obtaining licenses to use technology owned by others for proprietary products and otherwise; • the costs and effects of potential litigation; and • the costs associated with recruiting and compensating a highly skilled workforce in an environment where competition for such employees may beintense.We may not achieve all or any of these goals and, thus, we cannot provide assurances that we will ever be profitable on a sustained basis or achievesignificant revenues. Even if we do achieve some or all of these goals, we may not achieve significant or sustained commercial success.Our ability to use net operating loss carryforwards and tax credit carryforwards to offset future taxable income may be limited as a result oftransactions involving our common stock.In general, under Section 382 of the Internal Revenue Code of 1986, as amended (Code), a corporation that undergoes an “ownership change” is subjectto limitations on its ability to utilize its pre-change net operating losses, or NOLs, and certain other tax assets to offset future taxable income. In general, anownership change occurs if the aggregate stock ownership of certain stockholders increases by more than 50 percentage points over such stockholders’ lowestpercentage ownership during the testing period (generally three years). Transactions involving our common stock, even those outside our control, such aspurchases or sales by investors, within the testing period could result in an ownership change. A limitation on our ability to utilize some or all of our NOLs orcredits could have a material adverse effect on our results of operations and cash flows. 27®®Table of ContentsIf our contract research organizations do not successfully carry out their duties or if we lose our relationships with contract researchorganizations, our drug development efforts could be delayed.Our arrangements with contract research organizations are critical to our success in bringing our products to the market and promoting such marketedproducts profitably. We are dependent on contract research organizations, third-party vendors and investigators for pre-clinical testing and clinical trials relatedto our drug discovery and development efforts and we will likely continue to depend on them to assist in our future discovery and development efforts. Theseparties are not our employees and we cannot control the amount or timing of resources that they devote to our programs. As such, they may not completeactivities on schedule or may not conduct our clinical trials in accordance with regulatory requirements or our stated protocols. The parties with which wecontract for execution of our clinical trials play a significant role in the conduct of the trials and the subsequent collection and analysis of data. If they fail todevote sufficient time and resources to our drug development programs or if their performance is substandard, it will delay the development, approval andcommercialization of our products. Moreover, these parties may also have relationships with other commercial entities, some of which may compete with us. Ifthey assist our competitors, it could harm our competitive position.Our contract research organizations could merge with or be acquired by other companies or experience financial or other setbacks unrelated to ourcollaboration that could, nevertheless, materially adversely affect our business, results of operations and financial condition.If we lose our relationship with any one or more of these parties, we could experience a significant delay in both identifying another comparable providerand then contracting for its services. We may be unable to retain an alternative provider on reasonable terms, if at all. Even if we locate an alternative provider,it is likely that this provider may need additional time to respond to our needs and may not provide the same type or level of service as the original provider. Inaddition, any provider that we retain will be subject to current Good Laboratory Practices or cGLP, and similar foreign standards and we do not have controlover compliance with these regulations by these providers. Consequently, if these practices and standards are not adhered to by these providers, thedevelopment and commercialization of our products could be delayed.We rely on a limited number of third party manufacturers to formulate and manufacture our products and our business will be seriouslyharmed if these manufacturers are not able to satisfy our demand and alternative sources are not available.Our expertise is primarily in the research and development and pre-clinical and clinical trial phases of product development. We do not have an in-housemanufacturing capability and depend completely on a small number of third-party manufacturers and active pharmaceutical ingredient formulators for themanufacture of our products. Therefore, we are dependent on third parties for our formulation development and manufacturing of our products. This mayexpose us to the risk of not being able to directly oversee the production and quality of the manufacturing process and provide ample commercial supplies tosuccessfully launch and maintain the marketing of our products. Furthermore, these third party contractors, whether foreign or domestic, may experienceregulatory compliance difficulty, mechanical shut downs, employee strikes, or other unforeseeable events that may delay or limit production. Our inability toadequately establish, supervise and conduct (either ourselves or through third parties) all aspects of the formulation and manufacturing processes would havea material adverse effect on our ability to develop and commercialize our products.In January 2014, we entered into a manufacturing agreement with Patheon Pharmaceuticals Inc. (“Patheon”) for the manufacture of commercial suppliesof HETLIOZ™ 20 mg capsules. This agreement has an initial term of five years. If Patheon is unable to perform its duties under the manufacturingagreement, it could adversely affect sales of our HETLIOZ™ products, delay clinical trials and prevent us from developing our HETLIOZ™ products in acost-effective manner or on a timely basis. We do not have exclusive long-term agreements with any other third party manufacturers. If any of our third partymanufacturers, including Patheon, are unable or unwilling to perform for any reason, we may not be able to locate alternative acceptable manufacturers orformulators or enter into favorable agreements with them. Any inability to acquire sufficient quantities of our products in a timely manner from these thirdparties could adversely affect sales of our products, delay clinical trials and prevent us from developing our products in a cost-effective manner or on a timelybasis. In addition, 28Table of Contentsmanufacturers of our products are subject to cGMP and similar foreign standards and we do not have control over compliance with these regulations by ourmanufacturers. If one of our contract manufacturers fails to maintain compliance, the production of our products could be interrupted, resulting in delays andadditional costs. In addition, if the facilities of such manufacturers do not pass a pre-approval or post-approval plant inspection, the FDA will not grantapproval and may institute restrictions on the marketing or sale of our products.Our manufacturing strategy presents the following additional risks: • because most of our third-party manufacturers and formulators are located outside of the U.S., there may be difficulties in importing our products ortheir components into the U.S. as a result of, among other things, FDA import inspections, incomplete or inaccurate import documentation ordefective packaging; and • because of the complex nature of our products, our manufacturers may not be able to successfully manufacture our products in a cost-effectiveand/or timely manner.Materials necessary to manufacture our products may not be available on commercially reasonable terms, or at all, which may delay thedevelopment, regulatory approval and commercialization of our products.We and our partners rely on manufacturers to purchase from third-party suppliers the materials necessary to produce our products for clinical trials andcommercialization. Suppliers may not sell these materials to such manufacturers at the times we or our partners need them or on commercially reasonableterms. We do not have any control over the process or timing of the acquisition of these materials by these manufacturers. Moreover, we currently do not haveany agreements for the commercial production of these materials. If the manufacturers are unable to obtain these materials for our or our partners’ clinicaltrials, product testing, potential regulatory approval of our products and commercial scale manufacturing could be delayed, significantly affecting our and ourpartners’ ability to further develop and commercialize our products. If we, our manufacturers or our partners, as applicable, are unable to purchase thesematerials for our products, there would be a shortage in supply or the commercial launch of such products would be delayed, which would materially andadversely affect our or our partners’ ability to generate revenues from the sale of such products.If we cannot identify, or enter into licensing arrangements for, new products, our ability to develop a diverse product portfolio will be limited.A component of our business strategy is acquiring rights to develop and commercialize products discovered or developed by other pharmaceutical andbiotechnology companies for which we may find effective uses and markets through our unique pharmacogenetics and pharmacogenomics expertise for thetreatment of central nervous system disorders. Competition for the acquisition of these products is intense. If we are not able to identify opportunities to acquirerights to commercialize additional products, we may not be able to develop a diverse portfolio of products and our business may be harmed. Additionally, itmay take substantial human and financial resources to secure commercial rights to promising products. Moreover, if other firms develop pharmacogeneticsand pharmacogenomics capabilities, we may face increased competition in identifying and acquiring additional products.We may not be successful in the development of products for our own account.In addition to our business strategy of acquiring rights to develop and commercialize products, we may develop products for our own account byapplying our technologies to off-patent drugs as well as developing our own proprietary molecules. Because we will be funding the development of suchprograms, there is a risk that we may not be able to continue to fund all such programs to completion or to provide the support necessary to perform theclinical trials, obtain regulatory approvals or market any approved products. We expect the development of products for our own account to consumesubstantial resources. If we are able to develop commercial products on our own, the risks associated with these programs may be greater than those associatedwith our programs with collaborative partners. 29Table of ContentsIf we lose key scientists or management personnel, or if we fail to recruit additional highly skilled personnel, it will impair our ability to identify,develop and commercialize products.We are highly dependent on principal members of our management team and scientific staff, including our Chief Executive Officer, Mihael H.Polymeropoulos, M.D. These executives each have significant pharmaceutical industry experience. The loss of any such executives, includingDr. Polymeropoulos, or any other principal member of our management team or scientific staff, would impair our ability to identify, develop and market newproducts. Our management and other employees may voluntarily terminate their employment with us at any time. The loss of the services of these or other keypersonnel, or the inability to attract and retain additional qualified personnel, could result in delays to development or approval, loss of sales and diversion ofmanagement resources. In addition, we depend on our ability to attract and retain other highly skilled personnel, including research scientists. Competition forqualified personnel is intense, and the process of hiring and integrating such qualified personnel is often lengthy. We may be unable to recruit such personnelon a timely basis, if at all, which would negatively impact our development and commercialization programs.Additionally, we do not currently maintain “key person” life insurance on the lives of our executives or any of our employees. This lack of insurancemeans that we may not have adequate compensation for the loss of the services of these individuals.Product liability lawsuits could divert our resources, result in substantial liabilities and reduce the commercial potential of our products.The risk that we may be sued on product liability claims is inherent in the development and sale of pharmaceutical products. For example, we face arisk of product liability exposure related to the testing of our products in clinical trials and will face even greater risks upon commercialization by us or ourpartners of our products. We believe that we may be at a greater risk of product liability claims relative to other pharmaceutical companies because ourproducts are intended to treat central nervous system disorders, and it is possible that we may be held liable for the behavior and actions of patients who useour products. These lawsuits may divert our management from pursuing our business strategy and may be costly to defend. In addition, if we are held liablein any of these lawsuits, we may incur substantial liabilities and we or our partners may be forced to limit or forego further commercialization of one or moreof our products. Although we maintain product liability insurance, our aggregate coverage limit under this insurance is $10.0 million, and while we believethis amount of insurance is sufficient to cover our product liability exposure, these limits may not be high enough to fully cover potential liabilities. As ourdevelopment activities and commercialization efforts progress and we and our partners sell our products, this coverage may be inadequate, we may be unableto obtain adequate coverage at an acceptable cost or we may be unable to get adequate coverage at all or our insurer may disclaim coverage as to a future claim.This could prevent the commercialization or limit the commercial potential of our products. Even if we are able to maintain insurance that we believe isadequate, our results of operations and financial condition may be materially adversely affected by a product liability claim. Uncertainties resulting from theinitiation and continuation of products liability litigation or other proceedings could have a material adverse effect on our ability to compete in the marketplace.Product liability litigation and other related proceedings may also require significant management time.Legislative or regulatory reform of the healthcare system in the U.S. and foreign jurisdictions may affect our or our partners’ ability to sell ourproducts profitably.The continuing efforts of the U.S. and foreign governments, insurance companies, managed care organizations and other payors of health care servicesto contain or reduce health care costs may adversely affect our or our partners’ ability to set prices for our products which we or our partners believe are fair,and our ability to generate revenues and achieve and maintain profitability.Specifically, in both the U.S. and some foreign jurisdictions there have been a number of legislative and regulatory proposals to change the healthcaresystem in ways that could affect our or our partners’ ability to sell our products profitably. In the U.S., the Medicare Prescription Drug Improvement andModernization Act of 2003 reformed the way Medicare covered and provided reimbursement for pharmaceutical products. This legislation could decrease thecoverage and price that we or our partners may receive for our products. Other 30Table of Contentsthird-party payors are increasingly challenging the prices charged for medical products and services. It will be time-consuming and expensive for us or ourpartners to go through the process of seeking reimbursement from Medicare and private payors. Our products may not be considered cost effective, andcoverage and reimbursement may not be available or sufficient to allow the sale of such products on a competitive and profitable basis. Further federal andstate proposals and healthcare reforms are likely which could limit the prices that can be charged for the drugs we develop and may further limit ourcommercial opportunity. Our results of operations could be materially adversely affected by the Medicare prescription drug coverage legislation, by thepossible effect of this legislation on amounts that private insurers will pay and by other healthcare reforms that may be enacted or adopted in the future.The Patient Protection and Affordable Care Act of 2010, as amended by the Health Care and Education Reconciliation Act of 2010, or PPACA, is asweeping measure intended to expand healthcare coverage within the U.S., primarily through the imposition of health insurance mandates on employers andindividuals and expansion of the Medicaid program, and the establishment of health care exchanges. Several provisions of the new law, which have varyingeffective dates, may affect us, and will likely increase certain of our costs. For example, an increase in the Medicaid rebate rate from 15.1% to 23.1% waseffective as of January 1, 2010, and the volume of rebated drugs was expanded to include beneficiaries in Medicaid managed care organizations effective as ofMarch 23, 2010. The PPACA also imposes an annual fee on pharmaceutical manufacturers which began in 2011, based on the manufacturer’s sale ofbranded pharmaceuticals and biologics (excluding orphan drugs); expands the 340B drug discount program (excluding orphan drugs) including the creation ofnew penalties for non-compliance; and includes a 50% discount on brand name drugs for Medicare Part D participants in the coverage gap, or “doughnuthole”. The law also revised the definition of “average manufacturer price” for reporting purposes (effective October 1, 2010), which could increase the amountof Medicaid drug rebates to states. Substantial new provisions affecting compliance also have been added, which may require us to modify our businesspractices with health care practitioners.The reforms imposed by the new law will significantly impact the pharmaceutical industry; however, the full effects of the PPACA cannot be knownuntil these provisions are implemented and the Centers for Medicare & Medicaid Services and other federal and state agencies issue applicable regulations orguidance. Moreover, in the coming years, additional changes could be made to governmental healthcare programs that could significantly impact the successof our products. We will continue to evaluate the PPACA, as amended, the implementation of regulations or guidance related to various provisions of thePPACA by federal agencies, as well as trends and changes that may be encouraged by the legislation and that may potentially impact on our business overtime. These developments could, however, have a material adverse effect on our business, financial condition and results of operations.In some foreign countries, including major markets in the European Union and Japan, the pricing of prescription pharmaceuticals is subject togovernmental control. In these countries, pricing negotiations with governmental authorities can take nine to twelve months or longer after the receipt ofregulatory marketing approval for a product. To obtain reimbursement or pricing approval in some countries, we may be required to conduct a clinical trialthat compares the cost-effectiveness of our product to other available therapies. Our business could be materially harmed if reimbursement of our products isunavailable or limited in scope or amount or if pricing is set at unsatisfactory levels.Our business is subject to extensive governmental regulation and oversight and changes in laws could adversely affect our revenues andprofitability.Our business is subject to extensive government regulation and oversight. As a result, we may become subject to governmental actions which couldmaterially and adversely affect our business, results of operations and financial condition, including: • new laws, regulations or judicial decisions, or new interpretations of existing laws, regulations or decisions, related to patent protection andenforcement, health care availability, method of delivery and payment for health care products and services or our business operations generally; 31Table of Contents • changes in the FDA and foreign regulatory approval processes that may delay or prevent the approval of new products and result in lost marketopportunity; • new laws, regulations and judicial decisions affecting pricing or marketing; and • changes in the tax laws relating to our operations.In addition, the Food and Drug Administration Amendments Act of 2007 ( FDAAA) included new authorization for the FDA to require post-marketsafety monitoring, along with a clinical trials registry, and expanded authority for the FDA to impose civil monetary penalties on companies that fail to meetcertain commitments. The amendments, among other things, require some new drug applicants to submit risk evaluation and minimization strategies tomonitor and address potential safety issues for products upon approval, grant the FDA the authority to impose risk management measures for marketedproducts and to mandate labeling changes in certain circumstances, and establish new requirements for disclosing the results of clinical trials. Companies thatviolate the law are subject to substantial civil monetary penalties. Additional measures have also been enacted to address the perceived shortcomings in theFDA’s handling of drug safety issues, and to limit pharmaceutical company sales and promotional practices. While the FDAAA has had, and is expected tohave, a substantial effect on the pharmaceutical industry, the full extent of that effect is not yet known. As the FDA issues further regulations, guidance andinterpretations relating to this legislation, the impact on the industry as well as our business will become clearer. The requirements and other changes that theFDAAA imposes may make it more difficult, and likely more costly, to obtain approval of new pharmaceutical products and to produce, market anddistribute existing products. Our and our partners’ ability to commercialize approved products successfully may be hindered, and our business may beharmed as a result.Failure to comply with government regulations regarding the sale and marketing of our products could harm our business.Our and our partners’ activities, including the sale and marketing of our products, are subject to extensive government regulation and oversight,including regulation under the federal Food, Drug and Cosmetic Act and other federal and state statutes. We are also subject to the provisions of the FederalAnti-Kickback Statute and several similar state laws, which prohibit payments intended to induce physicians or others either to purchase or arrange for orrecommend the purchase of healthcare products or services. While the federal law applies only to products or services for which payment may be made by afederal healthcare program, state laws may apply regardless of whether federal funds may be involved. These laws constrain the sales, marketing and otherpromotional activities of manufacturers of drugs and biologicals, such as us, by limiting the kinds of financial arrangements, including sales programs, withhospitals, physicians, and other potential purchasers of drugs and biologicals. Other federal and state laws generally prohibit individuals or entities fromknowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid, or other third party payors that are false or fraudulent, or arefor items or services that were not provided as claimed. Anti-kickback and false claims laws prescribe civil and criminal penalties for noncompliance that canbe substantial, including the possibility of exclusion from federal healthcare programs (including Medicare and Medicaid).Pharmaceutical and biotechnology companies have been the target of lawsuits and investigations alleging violations of government regulation, includingclaims asserting antitrust violations, violations of the Federal False Claim Act, the Anti-Kickback Statute, the Prescription Drug Marketing Act and otherviolations in connection with off-label promotion of products and Medicare and/or Medicaid reimbursement or related to environmental matters and claimsunder state laws, including state anti-kickback and fraud laws.While we continually strive to comply with these complex requirements, interpretations of the applicability of these laws to marketing practices are everevolving. If any such actions are instituted against us or our partners and we or they are not successful in defending such actions or asserting our rights, thoseactions could have a significant and material adverse impact on our business, including the imposition of significant fines or other sanctions. Even anunsuccessful challenge could cause adverse publicity and be costly to respond to, and thus could have a material adverse effect on our business, results ofoperations and financial condition. 32Table of ContentsFuture transactions may harm our business or the market price of our stock.We regularly review potential transactions related to technologies, products or product rights and businesses complementary to our business. Thesetransactions could include: • mergers; • acquisitions; • strategic alliances; • licensing agreements; and • co-promotion and similar agreements.We may choose to enter into one or more of these transactions at any time, which may cause substantial fluctuations in the market price of our stock.Moreover, depending upon the nature of any transaction, we may experience a charge to earnings, which could also materially adversely affect our results ofoperations and could harm the market price of our stock.We may undertake strategic acquisitions in the future, and difficulties integrating such acquisitions could damage our ability to achieve orsustain profitability.Although we have no experience in acquiring businesses, we may acquire businesses or assets that complement or augment our existing business. If weacquire businesses with promising products or technologies, we may not be able to realize the benefit of acquiring such businesses if we are unable to moveone or more products through preclinical and/or clinical development to regulatory approval and commercialization. Integrating any newly acquired businessesor technologies could be expensive and time-consuming, resulting in the diversion of resources from our current business. We may not be able to integrate anyacquired business successfully. We cannot assure you that, following an acquisition, we will achieve revenues, specific net income or loss levels that justifythe acquisition or that the acquisition will result in increased earnings, or reduced losses, for the combined company in any future period. Moreover, we mayneed to raise additional funds through public or private debt or equity financing to acquire any businesses, which would result in dilution for stockholders orthe incurrence of indebtedness and may not be available on terms which would otherwise be acceptable to us. We may not be able to operate acquiredbusinesses profitably or otherwise implement our growth strategy successfully.Our operating results may fluctuate significantly.Our operating results will continue to be subject to fluctuations. The revenues we generate, if any, and our operating results will be affected by numerousfactors, including: • our addition or termination of development programs; • variations in the level of expenses related to our products or future development programs; • our execution of collaborative, licensing or other arrangements, and the timing of payments we may make or receive under these arrangements; • the timing and amount of royalties or milestone payments; • regulatory developments affecting our products or those of our competitors; • product sales; • cost of product sales; • marketing and other expenses; • manufacturing or supply issues; • any intellectual property infringement or other lawsuit in which we may become involved; and • the timing and recognition of stock-based compensation expense. 33Table of ContentsIf our operating results fall below the expectations of investors or securities analysts, the price of our common stock could decline substantially.Furthermore, any fluctuations in our operating results may, in turn, cause the price of our stock to fluctuate substantially. We believe that comparisons of ourfinancial results are not necessarily meaningful and should not be relied upon as an indication of our future performance.Risks related to intellectual property and other legal mattersOur rights to develop and commercialize our products are subject in part to the terms and conditions of licenses or sublicenses granted to us byother pharmaceutical companies.HETLIOZ™ is based in part on patents that we have licensed on an exclusive basis and other intellectual property licensed from Bristol-Myers SquibbCompany (BMS). BMS holds certain rights with respect to HETLIOZ™ in the license agreement. Either party may terminate the license agreement undercertain circumstances, including a material breach of the agreement by the other. In the event we terminate our license, or if BMS terminates our license due toour breach, all rights to HETLIOZ™ (including any intellectual property we develop with respect to HETLIOZ™) licensed and developed by us under thisagreement will revert or otherwise be licensed back to BMS on an exclusive basis. Any termination or reversion of our rights to develop or commercializeHETLIOZ™, including any reacquisition by BMS of our rights, may have a material adverse effect on our business.Fanapt (iloperidone) is based in part on patents and other intellectual property owned by Sanofi and Novartis. Titan Pharmaceuticals, Inc. (Titan)holds an exclusive license from Sanofi to the intellectual property owned by Sanofi, and Titan has sublicensed its rights under such license on an exclusivebasis to Novartis. We acquired exclusive rights to this and other intellectual property through a further sublicense from Novartis. The sublicense withNovartis was amended and restated in October of 2009 to provide Novartis with exclusive rights to commercialize Fanapt in the U.S. and Canada. Weretained exclusive rights to Fanapt outside the U.S. and Canada and we have exclusive rights to use any of Novartis’ data for Fanapt for developing andcommercializing Fanapt outside the U.S. and Canada. At Novartis’ option, we will enter into good faith discussions with Novartis relating to the co-commercialization of Fanapt outside of the U.S. and Canada or, alternatively, Novartis will receive a royalty on net sales of Fanapt outside of the U.S. andCanada. Novartis has chosen not to co-commercialize Fanapt in Europe and certain other countries and will instead receive a royalty on net sales in thosecountries. These include, but are not limited to, the countries in the European Union, as well as Switzerland, Norway, Liechtenstein and Iceland. We may loseour rights to develop and commercialize Fanapt outside the U.S. and Canada if we fail to comply with certain requirements in the amended and restatedsublicense agreement regarding our financial condition, or if we fail to comply with certain diligence obligations regarding our development orcommercialization activities or if we otherwise breach the amended and restated sublicense agreement and fail to cure such breach. Our rights to develop andcommercialize Fanapt outside the U.S. and Canada may be impaired if we do not cure breaches by Novartis of similar obligations contained in its sublicenseagreement with Titan. Our loss of rights in Fanapt to Novartis would have a material adverse effect on our business, financial condition and results ofoperations. In addition, if Novartis breaches the amended and restated sublicense agreement with respect to its commercialization activities in the U.S. orCanada, we may terminate Novartis’ commercialization rights in the applicable country. We would no longer receive royalty payments from Novartis inconnection with such country in the event of such termination.VLY-686 is based in part on patents that we have licensed on an exclusive basis and other intellectual property licensed from Lilly. Lilly may terminateour license if we fail to use our commercially reasonable efforts to develop and commercialize VLY-686 or if we materially breach the agreement and fail tocure that breach. In the event that we terminate our license, or if Lilly terminates our license for the reasons stated above, all of our rights to VLY-686(including any intellectual property we develop with respect to VLY-686) will revert back to Lilly, subject to payment by Lilly to us of a royalty on net sales ofproducts that contain VLY-686.If our efforts to protect the proprietary nature of the intellectual property related to our products are not adequate, we may not be able tocompete effectively in our markets.In addition to the rights we have licensed from BMS, Novartis and Lilly relating to our products, we rely upon intellectual property we own relating tothese products, including patents, patent applications and trade secrets. As of December 31, 2013, excluding in-licensed patents and patent applications, wehad 27 patent and 34®®®®®®®®®®®Table of Contentspatent application families, most of which have been filed in key markets including the U.S., relating to HETLIOZ™ and Fanapt. In addition, we had fiveother patent applications relating to products not presently in clinical studies. Our patent applications may be challenged or fail to result in issued patents andour existing or future patents may be too narrow to prevent third parties from developing or designing around these patents. In addition, we generally rely ontrade secret protection and confidentiality agreements to protect certain proprietary know-how that is not patentable, for processes for which patents aredifficult to enforce and for any other elements of our drug development processes that involve proprietary know-how, information and technology that is notcovered by patent applications. While we require all of our employees, consultants, advisors and any third parties who have access to our proprietary know-how, information and technology to enter into confidentiality agreements, we cannot be certain that this know-how, information and technology will not bedisclosed or that competitors will not otherwise gain access to our trade secrets or independently develop substantially equivalent information and techniques.Further, the laws of some foreign countries do not protect proprietary rights to the same extent as the laws of the U.S. As a result, we may encounter significantproblems in protecting and defending our intellectual property both in the U.S. and abroad. If we are unable to protect or defend the intellectual property relatedto our technologies, we will not be able to establish or maintain a competitive advantage in our market.If we do not obtain protection under the Hatch-Waxman Act and similar foreign legislation to extend our patents and to obtain marketexclusivity for our products, our business will be harmed.The Hatch-Waxman Act provides for an extension of patent term for drugs for a period of up to five years to compensate for time spent in development.Assuming we gain a five-year patent term restoration for HETLIOZ™, and that we continue to have rights under our license agreement with respect to thisproduct, we would have exclusive rights to HETLIOZ™’s U.S. “new chemical entity” patent (the primary patent covering the product as a new composition ofmatter) until 2022. In August 2011, the U.S. Patent and Trademark Office issued a certificate of extension under the Hatch-Waxman Act, extending by fiveyears the term of Sanofi’s new chemical entity patent relating to Fanapt to November 2016. A directive in the European Union provides that companies thatreceive regulatory approval for a new product will have a 10-year period of market exclusivity for that product (with the possibility of a further one-yearextension) in most countries in Europe, beginning on the date of such European regulatory approval, regardless of when the European new chemical entitypatent covering such product expires. A generic version of the approved drug may not be marketed or sold in Europe during such market exclusivity period.This directive is of material importance with respect to Fanapt, since the European new chemical entity patent for Fanapt has expired. Assuming we gain afive-year patent term restoration for VLY-686, and that we continue to have rights under our license agreement with respect to this product, we would haveexclusive rights to VLY-686’s U.S. new chemical entity patent until 2029.However, there is no assurance that we will receive the extensions of our patents or other exclusive rights available under the Hatch-Waxman Act orsimilar foreign legislation. If we fail to receive such extensions or exclusive rights, our or our partners’ ability to prevent competitors from manufacturing,marketing and selling generic versions of our products will be materially impaired.Litigation or third-party claims of intellectual property infringement could require us to divert resources and may prevent or delay our drugdiscovery and development efforts.Our commercial success depends in part on our not infringing the patents and proprietary rights of third parties. Third parties may assert that we areemploying their proprietary technology without authorization. In addition, third parties may obtain patents in the future and claim that use of our technologiesinfringes upon these patents.Furthermore, parties making claims against us may obtain injunctive or other equitable relief, which could effectively block our ability to develop andcommercialize one or more of our products. Defense of these claims, regardless of their merit, would divert substantial financial and employee resources fromour business. In the event of a successful claim of infringement against us, we may have to pay substantial damages, obtain one or more licenses from thirdparties or pay royalties. In addition, even in the absence of litigation, we may need to obtain additional licenses from third parties to advance our research orallow commercialization of our products. 35®®®®Table of ContentsWe may fail to obtain any of these licenses at a reasonable cost or on reasonable terms, if at all. In that event, we would be unable to develop and commercializefurther one or more of our products.In addition, in the future we could be required to initiate litigation to enforce our proprietary rights against infringement by third parties. Prosecution ofthese claims to enforce our rights against others could divert substantial financial and employee resources from our business. If we fail to enforce ourproprietary rights against others, our business will be harmed.Risks related to our common stockOur stock price has been highly volatile and may be volatile in the future, and purchasers of our common stock could incur substantial losses.The realization of any of the risks described in these risk factors or other unforeseen risks could have a dramatic and adverse effect on the market priceof our common stock. Between January 1, 2013 and December 31, 2013, the high and low sales prices of our common stock as reported on The NASDAQGlobal Market varied between $3.57 and $15.65 per share. Additionally, market prices for securities of biotechnology and pharmaceutical companies,including ours, have historically been very volatile. The market for these securities has from time to time experienced significant price and volume fluctuationsfor reasons that were unrelated to the operating performance of any one company.The following factors, in addition to the other risk factors described in this section, may also have a significant impact on the market price of ourcommon stock: • publicity regarding actual or potential testing or trial results relating to products under development by us or our competitors; • the outcome of regulatory review relating to products under development by us or our competitors; • regulatory developments in the U.S. and foreign countries; • developments concerning any collaboration or other strategic transaction we may undertake; • announcements of patent issuances or denials, technological innovations or new commercial products by us or our competitors; • termination or delay of development or commercialization program(s) by our partners; • safety issues with our products or those of our competitors; • our or our partners’ ability to successfully commercialize our products; • our ability to successfully execute our commercialization strategies; • announcements of technological innovations or new therapeutic products or methods by us or others; • actual or anticipated variations in our quarterly operating results; • changes in estimates of our financial results or recommendations by securities analysts or failure to meet such financial expectations; • changes in government regulations or policies; • changes in patent legislation or patent decisions or adverse changes to patent law; • additions or departures of key personnel or members of our board of directors; • the publication of negative research or articles about our company, our business or our products by industry analysts or others; • publicity regarding actual or potential transactions involving us; and • economic, political and other external factors beyond our control. 36Table of ContentsWe may be subject to litigation, which could harm our stock price, business, results of operations and financial condition.We have been the subject of litigation in the past and may be subject to litigation in the future. In the past, following periods of volatility in the marketprice of their stock, many companies, including us, have been the subjects of securities class action litigation. Any such litigation can result in substantialcosts and diversion of management’s attention and resources and could harm our stock price, business results of operations and financial condition. As aresult of these factors, holders of our common stock might be unable to sell their shares at or above the price they paid for such shares.If there are substantial sales of our common stock, our stock price could decline.A small number of institutional investors and private equity funds hold a significant number of shares of our common stock. Sales by thesestockholders of a substantial number of shares, or the expectation of such sales, could cause a significant reduction in the market price of our common stock.In addition to our outstanding common stock, as of December 31, 2013, there were a total of 6,417,308 shares of common stock that we have registeredand that we are obligated to issue upon the exercise of currently outstanding options and settlement of restricted stock unit awards granted under our SecondAmended and Restated Management Equity Plan and 2006 Equity Incentive Plan. Upon the exercise of these options or settlement of the shares underlyingthese restricted stock units, as the case may be, in accordance with their respective terms, these shares may be resold freely, subject to restrictions imposed onour affiliates under Rule 144. If significant sales of these shares occur in short periods of time, these sales could reduce the market price of our common stock.Any reduction in the trading price of our common stock could impede our ability to raise capital on attractive terms, if at all.If we fail to maintain the requirements for continued listing on The NASDAQ Global Market, our common stock could be delisted fromtrading, which would adversely affect the liquidity of our common stock and our ability to raise additional capital.Our common stock is currently listed for quotation on The NASDAQ Global Market. We are required to meet specified listing criteria in order tomaintain our listing on The NASDAQ Global Market. If we fail to satisfy The NASDAQ Global Market’s continued listing requirements, our common stockcould be delisted from The NASDAQ Global Market, in which case we may transfer to The NASDAQ Capital Market, which generally has lower financialrequirements for initial listing or, if we fail to meet its listing requirements, the over-the-counter bulletin board. Any potential delisting of our common stockfrom The NASDAQ Global Market would make it more difficult for our stockholders to sell our stock in the public market and would likely result indecreased liquidity and increased volatility for our common stock.If securities or industry analysts do not publish research or reports or publish unfavorable research about our business, our stock price andtrading volume could decline.The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or ourbusiness. We currently have research coverage by securities and industry analysts. If one or more of the analysts who covers us downgrades our stock, ourstock price would likely decline. If one or more of these analysts ceases coverage of our Company or fails to regularly publish reports on us, interest in thepurchase of our stock could decrease, which could cause our stock price or trading volume to decline.You may experience future dilution as a result of future equity offerings.In order to raise additional capital, we may in the future offer additional shares of our common stock or other securities convertible into or exchangeablefor our common stock at prices that may not be the same as the price per share in recent offerings. We may sell shares or other securities in any other offeringat a price per share that is less than the price per share paid by investors in recent offerings, and investors purchasing shares or other securities in the futurecould have rights superior to existing stockholders. The price per share at which we sell additional shares of our common stock, or securities convertible orexchangeable into common stock, in future transactions may be higher or lower than the price per share paid by investors in recent offerings. 37Table of ContentsOur management will have broad discretion over the use of the proceeds we receive in future equity offerings and might not apply the proceedsin ways that increase the value of your investment.Management will have broad discretion to use the net proceeds from equity offerings, and you will be relying on the judgment of our managementregarding the application of the net proceeds. They might not apply the net proceeds in ways that increase the value of your investment. Our management mightnot be able to yield a significant return, if any, on any investment of net proceeds. You will not have the opportunity to influence our decisions on how to usethe proceeds.Our business could be negatively affected as a result of the actions of activist stockholders.Proxy contests have been waged against many companies in the biopharmaceutical industry, including us, over the last few years. If faced with a proxycontest or other type of shareholder activism, we may not be able to respond successfully to the contest or dispute, which would be disruptive to our business.Even if we are successful, our business could be adversely affected by a proxy contest or shareholder dispute involving us or our partners because: • responding to proxy contests and other actions by activist stockholders can be costly and time-consuming, disrupting operations and diverting theattention of management and employees; • perceived uncertainties as to future direction may result in the loss of potential acquisitions, collaborations or in-licensing opportunities, and maymake it more difficult to attract and retain qualified personnel and business partners; and • if individuals are elected to a board of directors with a specific agenda, it may adversely affect our ability to effectively and timely implement ourstrategic plan and create additional value for our stockholders.These actions could cause our stock price to experience periods of volatility.Anti-takeover provisions in our charter and bylaws, and in Delaware law, and our rights plan could prevent or delay a change in control ofour company.We are a Delaware corporation and the anti-takeover provisions of Section 203 of the Delaware General Corporation Law may discourage, delay orprevent a change in control by prohibiting us from engaging in a business combination with an interested stockholder for a period of three years after theperson becomes an interested stockholder, even if a change of control would be beneficial to our existing stockholders. In addition, our amended and restatedcertificate of incorporation and bylaws may discourage, delay or prevent a change in our management or control over us that stockholders may considerfavorable. Our amended and restated certificate of incorporation and bylaws: • authorize the issuance of “blank check” preferred stock that could be issued by our board of directors to thwart a takeover attempt; • do not provide for cumulative voting in the election of directors, which would allow holders of less than a majority of the stock to elect somedirectors; • establish a classified board of directors, as a result of which the successors to the directors whose terms have expired will be elected to serve from thetime of election and qualification until the third annual meeting following their election; • require that directors only be removed from office for cause; • provide that vacancies on the board of directors, including newly-created directorships, may be filled only by a majority vote of directors then inoffice; • limit who may call special meetings of stockholders; • prohibit stockholder action by written consent, requiring all actions to be taken at a meeting of the stockholders; and • establish advance notice requirements for nominating candidates for election to the board of directors or for proposing matters that can be acted uponby stockholders at stockholder meetings. 38Table of ContentsMoreover, in September 2008, our board of directors adopted a rights agreement, the provisions of which could result in significant dilution of theproportionate ownership of a potential acquirer and, accordingly, could discourage, delay or prevent a change in our management or control over us.Prolonged economic uncertainties or downturns, as well as unstable market, credit and financial conditions, may exacerbate certain risksaffecting our business and have serious adverse consequences on our business.The global economic downturn and market instability has made the business climate more volatile and more costly. These economic conditions, anduncertainty as to the general direction of the macroeconomic environment, are beyond our control and may make any necessary debt or equity financing moredifficult, more costly, and more dilutive. While we believe we have adequate capital resources to meet current working capital and capital expenditurerequirements, a lingering economic downturn or significant increase in our expenses could require additional financing on less than attractive rates or on termsthat are excessively dilutive to existing stockholders. Failure to secure any necessary financing in a timely manner and on favorable terms could have amaterial adverse effect on our stock price and could require us to delay or abandon clinical development plans.Sales of our products will be dependent, in large part, on reimbursement from government health administration authorities, private health insurers,distribution partners and other organizations. As a result of negative trends in the general economy in the U.S. or other jurisdictions in which we may dobusiness, these organizations may be unable to satisfy their reimbursement obligations or may delay payment. In addition, federal and state health authoritiesmay reduce Medicare and Medicaid reimbursements, and private insurers may increase their scrutiny of claims. A reduction in the availability or extent ofreimbursement could negatively affect our or our partners’ product sales and revenue.In addition, we rely on third parties for several important aspects of our business. For example, we depend upon Novartis for Fanapt royalty revenue,we use third party contract research organizations for many of our clinical trials, and we rely upon several single source providers of raw materials andcontract manufacturers for the manufacture of our products. During challenging and uncertain economic times and in tight credit markets, there may be adisruption or delay in the performance of our third party contractors, suppliers or partners. If such third parties are unable to satisfy their commitments to us,our business and results of operations would be adversely affected. ITEM 1B.UNRESOLVED STAFF COMMENTSNot applicable. ITEM 2.PROPERTIESOur headquarters is located in Washington, D.C., consisting of approximately 21,400 square feet of office space. Our lease for this facility expires in2023, subject to a five year renewal option. Management believes that this facility is suitable and adequate to meet the company’s anticipated near-term needs.We anticipate that following the expiration of the lease, additional or alternative space will be available at commercially reasonable terms. ITEM 3.LEGAL PROCEEDINGSOn June 24, 2013, a securities class action complaint was filed in the United States District Court for the District of Columbia, naming the Companyand certain of its officers as defendants. The complaint, filed purportedly on behalf of a class of stockholders of the Company, sought to assert violations ofSection 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, in connection with allegedly false and misleadingstatements and alleged omissions regarding the Company’s Phase III trial results for HETLIOZ™ and other disclosures between December 18, 2012 andJune 18, 2013 (the “Class Period”). The plaintiff sought to represent a class comprised of purchasers of the Company’s common stock during the ClassPeriod and sought damages, costs and expenses, and such other relief as determined by the Court. A similar complaint was filed on July 8, 2013. OnDecember 4, 2013, the court consolidated the two pending actions and appointed lead plaintiff and lead counsel. On February 3, 2014, the complaint wasvoluntarily dismissed with prejudice by the lead plaintiff. 39®Table of ContentsITEM 4.MINE SAFETY DISCLOSURESNot applicable.PART II ITEM 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASESOF EQUITY SECURITIESOur common stock is quoted on The NASDAQ Global Market under the symbol “VNDA.” The following table sets forth, for the periods indicated,the range of high and low sale prices of our common stock as reported on The NASDAQ Global Market: Year Ended December 31, 2013 High Low First quarter $4.41 $3.57 Second quarter 13.30 3.87 Third quarter 13.47 7.99 Fourth quarter 15.65 5.70 Year Ended December 31, 2012 High Low First quarter $5.47 $4.40 Second quarter 4.82 3.93 Third quarter 4.64 3.90 Fourth quarter 4.42 2.92 As of February 14, 2014, there were 9 holders of record of our common stock.DividendsWe have not paid dividends to our stockholders (other than a dividend of preferred share purchase rights which was declared in September 2008) sinceour inception and do not plan to pay dividends in the foreseeable future. We currently intend to retain earnings, if any, to finance our growth. 40Table of ContentsMarket Price of and Dividends on the Registrant’s Common Equity and Related Stockholder MattersThe following graph shows the cumulative five-year total return on our common stock relative to the cumulative total returns of the NASDAQComposite Index and the NASDAQ Biotechnology Index. An investment of $100 (with reinvestment of dividends) is assumed to have been made in ourcommon stock and in each of the indexes on December 31, 2008 and its relative performance is tracked through December 31, 2013. The comparisons in thetable are required by the SEC and are not intended to forecast or be indicative of possible future performance of our common stock. We have not paiddividends to our stockholders since the inception (other than a dividend of preferred share purchase rights which was declared in September 2008) and do notplan to pay dividends in the foreseeable future. The following graph and related information is being furnished solely to accompany this annual report onForm 10-K pursuant to Item 201(e) of Regulation S-K and shall not be deemed “soliciting materials” or to be “filed” with the SEC (other than as provided inItem 201), nor shall such information be incorporated by reference into any of our filings under the Securities Act of 1933 or the Securities Exchange Act of1934, whether made before or after the date hereof, and irrespective of any general incorporation language in any such filing. ITEM 6.SELECTED CONSOLIDATED FINANCIAL DATAThe consolidated statements of operations data for the years ended December 31, 2013, 2012 and 2011 and the consolidated balance sheet data as ofDecember 31, 2013 and 2012 are each derived from our audited consolidated financial statements included in this annual report on Form 10-K. Theconsolidated statements of operations data for the years ended December 31, 2010 and 2009, and the consolidated balance sheet data as of December 31, 2011,2010 and 2009 are each derived from our audited consolidated financial statements not included herein. Our historical results for any prior period are notnecessarily indicative of results to be expected in any future period. 41Table of ContentsThe following data should be read together with our consolidated financial statements and accompanying notes and the section entitled “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” included in this annual report on Form 10-K. Year Ended December 31, (in thousands, except for share and per shareamounts) 2013 2012 2011 2010 2009 Statements of operations data Revenue $33,879 $32,727 $31,270 $35,709 $4,548 Operating expenses: Cost of sales — 129 — 2,891 1,915 Research and development 28,190 45,446 28,996 12,338 13,874 General and administrative 24,594 13,882 11,486 10,147 23,724 Intangible asset amortization 1,495 1,495 1,495 1,495 983 Total operating expenses 54,279 60,952 41,977 26,871 40,496 Income (loss) from operations (20,400) (28,225) (10,707) 8,838 (35,948) Other income 145 561 461 431 89 Income (loss) before tax provision (20,255) (27,664) (10,246) 9,269 (35,859) Tax provision (benefit) — — (444) 2,077 — Net income (loss) $(20,255) $(27,664) $(9,802) $7,192 $(35,859) Net income (loss) per share: Basic $(0.67) $(0.98) $(0.35) $0.26 $(1.33) Diluted $(0.67) $(0.98) $(0.35) $0.25 $(1.33) Shares used in calculations of net income (loss) pershare: Basic 30,351,353 28,228,409 28,106,831 27,916,388 27,015,271 Diluted 30,351,353 28,228,409 28,106,831 28,534,617 27,015,271 December 31, 2013 2012 2011 2010 2009 Balance sheet data Cash and cash equivalents $64,764 $88,772 $87,923 $42,559 $205,295 Marketable securities, current 65,586 31,631 60,961 155,478 — Marketable securities, non-current — — 19,012 — — Working capital 102,763 93,705 121,882 169,546 181,417 Total assets 143,349 135,448 182,618 213,101 225,714 Total liabilities 99,225 125,543 149,144 175,370 202,683 Accumulated deficit (311,362) (291,107) (263,443) (253,641) (260,833) Total stockholders’ equity 44,124 9,905 33,474 37,731 23,031 42Table of ContentsITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSYou should read the following discussion and analysis of our financial condition and results of operations together with “Selected ConsolidatedFinancial Data” and our consolidated financial statements and related notes appearing in this annual report on Form 10-K. Some of the informationcontained in this discussion and analysis or set forth elsewhere in this annual report on Form 10-K include historical information and otherinformation with respect to our plans and strategy for our business and contain forward-looking statements that involve risks, uncertainties andassumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors,including but not limited to those set forth under the “Risk Factors” section of this report and elsewhere in this annual report on Form 10-K.OverviewWe are a biopharmaceutical company focused on the development and commercialization of products for the treatment of central nervous systemdisorders. We believe that each of our products will address a large market with significant unmet medical needs. Our product portfolio includes HETLIOZ™(tasimelteon), a product for the treatment of Non-24-Hour Sleep-Wake Disorder (Non-24) and for which a New Drug Application (NDA) was approved by theU.S. Food and Drug Administration (FDA) in January 2014, Fanapt, a product for the treatment of schizophrenia, the oral formulation of which is currentlybeing marketed and sold in the U.S. by Novartis Pharma AG (Novartis), and VLY-686, a small molecule neurokinin-1 receptor (NK-1R) antagonist.In January 2014, the FDA approved the NDA for HETLIOZ™ for the treatment of Non-24. As a result of achieving this regulatory milestone, we willincur additional milestone obligations in the first quarter of 2014, including an $8.0 million cash milestone obligation under our license agreement with BMSthat will be capitalized as an intangible asset and amortized over the expected patent life of HETLIOZ™ in the U.S. and a $2.0 million milestone obligationunder a regulatory consulting agreement that will be charged to research and development expense. We expect the U.S. commercial launch of HETLIOZ™ tooccur in the second quarter of 2014.In January 2013, we reported top-line results of the Phase IIb/III clinical study (MAGELLAN) in Major Depressive Disorder (MDD), investigating theefficacy and safety of HETLIOZ™ as a monotherapy in the treatment of patients with MDD. The clinical study did not meet the primary endpoint of changefrom baseline in the Hamilton Depression Scale (HAMD-17) after eight weeks of treatment as compared to placebo. As a result, all activities have beendiscontinued related to the MDD indication for HETLIOZ™.We incurred $23.9 million in research and development costs for the year ended December 31, 2013 directly attributable to our development ofHETLIOZ™.We continue to explore the regulatory path and commercial opportunity for Fanapt oral formulation outside of the U.S. and Canada. We incurred $0.5million in research and development costs for the year ended December 31, 2013 directly attributable to our development of Fanapt.In the second half of 2013, we initiated a proof of concept study for VLY-686 in treatment resistant pruritus in atopic dermatitis. We incurred $2.6million in research and development costs for the year ended December 31, 2013 directly attributable to our development of VLY-686.Since we began operations in March 2003, we have devoted substantially all of our resources to the in-licensing and clinical development of ourproducts. Our ability to generate meaningful product revenue and achieve profitability largely depends on our ability to successfully commercializeHETLIOZ™ in the U.S., on our ability, alone or with others, to complete the development of our products, and to obtain the regulatory approvals for and tomanufacture, market and sell our products, and on Novartis’ ability to successfully commercialize Fanapt in the U.S. The results of our operations willvary significantly from year-to-year and quarter-to-quarter and depend on a number of factors, including risks related to our business, risks related to ourindustry, and other risks which are detailed in “Risk Factors” reported in Item 1A of Part I of this annual report on Form 10-K. 43®®®®Table of ContentsRevenuesOur revenues are derived primarily from our amended and restated sublicense agreement with Novartis and include an upfront payment, product salesand future milestone and royalty payments. Revenues are considered both realizable and earned when the following four conditions are met: (i) persuasiveevidence of an arrangement exists, (ii) the arrangement fee is fixed or determinable, (iii) delivery or performance has occurred, and (iv) collectability isreasonably assured. Revenue related to the $200.0 million upfront payment is being recognized ratably on a straight-line basis from the date the amended andrestated sublicense agreement became effective (November 2009) through the expected life of the U.S. patent for Fanapt which we expect to last untilNovember 2016 (see Subsequent Events footnote for further information). This includes the Hatch-Waxman extension that extends patent protection for drugcompounds for a period of five years to compensate for time spent in development, for which Fanapt has qualified. We recognize revenues from Fanaptroyalties and commercial and development milestones from Novartis when realizable.Research and development expensesResearch and development expenses consist primarily of fees for services provided by third parties in connection with the clinical trials, costs ofcontract manufacturing services, milestone payments made under licensing agreements prior to regulatory approval, costs of materials used in clinical trialsand research and development, costs for regulatory consultants and filings, depreciation of capital resources used to develop products, related facilities costs,and salaries, other employee-related costs and stock-based compensation for research and development personnel. We expense research and development costsas they are incurred for products in the development stage, including manufacturing costs and milestone payments made under license or sublicenseagreements prior to FDA approval. Upon and subsequent to FDA approval, manufacturing and milestone payments made under license agreements arecapitalized. Milestone payments are accrued when it is deemed probable that the milestone event will be achieved. Costs related to the acquisition of intellectualproperty are expensed as incurred if the underlying technology is developed in connection with our research and development efforts and has no alternativefuture use.We incurred research and development expenses in the aggregate of $28.2 million for the year ended December 31, 2013 including employee stock-basedcompensation expense of $1.7 million. Milestone payments relating to research and development activities are accrued when it is deemed probable that themilestone event will be achieved. As a result of the FDA acceptance of our NDA for HETLIOZ™ for the treatment of Non-24 in July 2013, we incurredmilestone obligations of $3.5 million for the year ended December 31, 2013 including a $3.0 million milestone obligation under our license agreement withBMS and a $0.5 million milestone obligation under a regulatory consulting agreement.We expect to incur significant research and development expenses as we continue to develop our products. We expect to incur licensing costs in the futurethat could be substantial, as we continue our efforts to develop our products. 44®®®Table of ContentsThe following table summarizes our product development initiatives for 2013, 2012 and 2011, respectively. Included in this table are the research anddevelopment expenses recognized in connection with the clinical development of HETLIOZ™, Fanapt and VLY-686. Year Ended December 31, (in thousands) 2013 2012 2011 Direct project costs (1) HETLIOZ™ $23,860 $40,939 $24,810 Fanapt 520 1,494 2,197 VLY-686 2,551 1,144 — Total direct product costs $26,931 $43,577 $27,007 Indirect project costs (1) Facility $645 $1,280 $1,507 Depreciation 217 354 259 Other indirect overhead costs 397 235 223 Total indirect expenses $1,259 $1,869 $1,989 Total research and development expenses $28,190 $45,446 $28,996 (1)Many of our research and development costs are not attributable to any individual project because we share resources across several developmentprojects. We record direct costs, including personnel costs and related benefits and stock-based compensation, on a project-by-project basis. We recordindirect costs that support a number of our research and development activities in the aggregate.General and administrative expenses.General and administrative expenses consist primarily of salaries, other related costs for personnel, including employee stock-based compensation,related to executive, finance, accounting, information technology, marketing, medical affairs and human resource functions. Other costs include facility costsnot otherwise included in research and development expenses and fees for marketing, medical affairs, legal, accounting and other professional services.General and administrative expenses also include third party expenses incurred to support business development, marketing and other business activities. Weincurred general and administrative expenses of $24.6 million for the year ended December 31, 2013, including employee stock-based compensation expenseof $2.8 million. General and administrative expenses are expected to increase in future periods as we prepare to commercially launch HETLIOZ™ in the U.S.in the second quarter of 2014.Other income. Other income consists of interest income earned on our cash and cash equivalents, marketable securities and restricted cash and non-recurring income (expense) transactions that are outside of our normal business operations.Critical Accounting PoliciesThe preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets andliabilities and the disclosure of contingent assets and liabilities at the date of our financial statements, as well as the reported revenues and expenses during thereported periods. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the resultsof which form the basis for making judgments about the carrying value of assets and liabilities that are not apparent from other sources. Actual results maydiffer from these estimates under different assumptions or conditions. 45®®Table of ContentsA summary of our significant accounting policies appears in the notes to our audited consolidated financial statements for the year ended December 31,2013 included in this annual report on Form 10-K. However, we believe that the following accounting policies are important to understanding and evaluatingour reported financial results, and we have accordingly included them in this discussion.Accrued liabilities. As part of the process of preparing financial statements we are required to estimate accrued liabilities. The estimation of accruedliabilities involves identifying services that have been performed on our behalf, and then estimating the level of service performed and the associated costincurred for such services as of each balance sheet date in the financial statements. Accrued liabilities include professional service fees, such as lawyers andaccountants, contract service fees, such as those under contracts with clinical monitors, data management organizations and investigators in conjunction withclinical trials, fees to contract manufacturers in conjunction with the production of clinical materials, and fees for marketing and other commercializationactivities. Pursuant to our assessment of the services that have been performed on clinical trials and other contracts, we recognize these expenses as the servicesare provided. Our assessments include, but are not limited to: (i) an evaluation by the project manager of the work that has been completed during the period,(ii) measurement of progress prepared internally and/or provided by the third-party service provider, (iii) analyses of data that justify the progress, and(iv) our judgment. In the event that we do not identify certain costs that have begun to be incurred or we under- or over-estimate the level of services performedor the costs of such services, our reported expenses for such period would be too low or too high.Revenue Recognition. Our revenues are derived primarily from our amended and restated sublicense agreement with Novartis and include an upfrontpayment, product revenue and future milestone and royalty revenues. Revenue related to the upfront payment is being recognized ratably from the date theamended and restated sublicense agreement became effective (November 2009) through the expected life of the U.S. patent for Fanapt, which we expect to lastuntil November 2016 (see Subsequent Events footnote for further information). This includes the Hatch-Waxman extension that extends patent protection fordrug compounds for a period of five years to compensate for time spent in development, for which Fanapt has qualified. We recognize revenue related toFanapt royalties and commercial and development milestones as they are realizable and earned, and product revenue upon delivery of our products toNovartis.Employee stock-based compensation. We use the Black-Scholes-Merton option pricing model to determine the fair value of stock options. Thedetermination of the fair value of stock options on the date of grant using an option pricing model is affected by our stock price as well as assumptionsregarding a number of complex and subjective variables. These variables include the expected stock price volatility over the expected term of the awards, actualand projected employee stock option exercise behaviors, risk-free interest rate and expected dividends. Expected volatility rates are based on the historicalvolatility of our publicly traded common stock and other factors. The weighted average expected term of stock options granted is based on the simplifiedmethod as the options meet the “plain vanilla” criteria required by authoritative guidance. Significant changes in the market price of the Company’s commonstock in recent years has made historical data less reliable for the purpose of estimating future vesting, exercise, and employment behavior. The simplifiedmethod provided a more reasonable approach for estimating the weighted average expected term for options that were granted in 2013.The risk-free interest rates are based on the U.S. Treasury yield for a period consistent with the expected term of the option in effect at the time of thegrant. We have not paid dividends to our stockholders since our inception (other than a dividend of preferred share purchase rights which was declared inSeptember 2008) and do not plan to pay dividends in the foreseeable future. Employee stock-based compensation expense for a period is also affected by theexpected forfeiture rate for the respective option grants. If our estimates of the fair value of these equity instruments or expected forfeitures are too high or toolow, it would have the effect of overstating or understating expenses. 46®®®Table of ContentsEmployee stock-based compensation expense related to stock-based awards for the years ended December 31, 2013, 2012 and 2011, was comprised ofthe following: Year Ended December 31, (in thousands) 2013 2012 2011 Research and development $1,727 $1,356 $2,450 General and administrative 2,750 2,718 3,036 Total employee stock-based compensation expense $4,477 $4,074 $5,486 Income taxes. On a periodic basis, we evaluate the realizability of our deferred tax assets and liabilities and will adjust such amounts in light ofchanging facts and circumstances, including but not limited to future projections of taxable income, the reversal of deferred tax liabilities, tax legislation,rulings by relevant tax authorities and tax planning strategies. Settlement of filing positions that may be challenged by tax authorities could impact our incometaxes in the year of resolution.In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets willnot be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the period in which thosetemporary differences becomes deductible or the net operating losses (NOLs) and credit carryforwards can be utilized. When considering the reversal of thevaluation allowance, we consider the level of past and future taxable income, the reversal of deferred tax liabilities, the utilization of the carryforwards andother factors. Revisions to the estimated net realizable value of the deferred tax asset could cause our provision for income taxes to vary significantly fromperiod to period.Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of thedeferred tax assets will not be realized. The fact that we have historically generated NOLs serves as strong evidence that it is more likely than not that deferredtax assets will not be realized in the future. Therefore, we have a full valuation allowance against all deferred tax assets as of December 31, 2013.Recent Accounting PronouncementsSee Note 2 to the consolidated financial statements included in Part II of this annual report on Form 10-K for information on recent accountingpronouncements.Results of OperationsWe anticipate that our results of operations will fluctuate for the foreseeable future due to several factors, including our and our partners’ ability tosuccessfully commercialize our products, any possible payments made or received pursuant to license or collaboration agreements, progress of our researchand development efforts, the timing and outcome of clinical trials and related possible regulatory approvals. Our limited operating history makes predictions offuture operations difficult or impossible. Since our inception, we have incurred significant losses resulting in an accumulated deficit of $311.4 million as ofDecember 31, 2013. Our total stockholders’ equity was $44.1 million as of December 31, 2013, and reflects net proceeds of $48.5 million from the publicoffering of common stock completed in August 2013.Year ended December 31, 2013 compared to year ended December 31, 2012Revenues. Total revenues increased by $1.2 million, or 3.5%, to $33.9 million for the year ended December 31, 2013 compared to $32.7 million forthe year ended December 31, 2012. Revenues for both annual periods include licensing revenue of $26.8 million representing amortization of deferred revenuefrom straight-line recognition of the up-front license fee of $200.0 million received from Novartis for Fanapt in 2009. Revenues for the year endedDecember 31, 2013 included royalty revenue of $7.1 million from Novartis based on quarterly sales of Fanapt by Novartis compared to $5.9 million for theyear ended December 31, 2012. 47®®Table of ContentsIntangible asset amortization. Intangible asset amortization was $1.5 million for both the year ended December 31, 2013 and the year endedDecember 31, 2012. Intangible amortization relates to the capitalized intangible asset of $12.0 million resulting from the Fanapt milestone payment toNovartis in 2009.Research and development expenses. Research and development expenses decreased by $17.2 million, or 38.0%, to $28.2 million for the year endedDecember 31, 2013 compared to $45.4 million for the year ended December 31, 2012. Expenses were lower for the year ended December 31, 2013 as a result ofcompletion of the HETLIOZ™ Non-24 and MDD efficacy studies, partially offset by milestone obligations of $3.5 million incurred for the year endedDecember 31, 2013 as a result of the FDA acceptance of our NDA for HETLIOZ™ for the treatment of Non-24.The following table discloses the components of research and development expenses reflecting all of our project expenses for the years endedDecember 31, 2013 and 2012: Year EndedDecember 31, (in thousands) 2013 2012 Direct project costs: Clinical trials $7,746 $28,296 Contract research and development manufacturing, consulting, materials and other direct costs 12,734 9,047 Salaries, benefits and related costs 4,724 4,878 Employee stock-based compensation expense 1,727 1,356 Total direct costs 26,931 43,577 Indirect project costs 1,259 1,869 Total $28,190 $45,446 Total direct costs decreased by $16.7 million, or 38.2%, to $26.9 million for the year ended December 31, 2013 compared to $43.6 million for the yearended December 31, 2012 primarily as a result of decreases in clinical trial costs partially offset by higher contract research and development manufacturing,consulting, materials and other direct costs.Clinical trials costs decreased by $20.6 million, or 72.6%, to $7.7 million for the year ended December 31, 2013 compared to $28.3 million for theyear ended December 31, 2012 as a result of completion of the HETLIOZ™ Non-24 and MDD efficacy studies.Contract research and development, consulting, materials and other direct costs increased by $3.7 million, or 40.8%, to $12.7 million for the year endedDecember 31, 2013 compared to $9.0 million for the year ended December 31, 2012 primarily as a result of milestone obligations of $3.5 million incurred as aresult of the FDA acceptance of our NDA for HETLIOZ™ for the treatment of Non-24.Salaries, benefits and related costs decreased by $0.2 million, or 3.2%, to $4.7 million for the year ended December 31, 2013 compared to $4.9 millionfor the year ended December 31, 2012 as costs for 2012 included severance costs associated with an employee termination.Employee stock-based compensation expense increased by $0.3 million, or 27.4%, to $1.7 million for the year ended December 31, 2013 compared to$1.4 million for the year ended December 31, 2012. Expense reflects the reversal of expense from the cancellation of equity awards due to employeeterminations.Indirect project costs decreased by $0.6 million, or 32.6%, to $1.3 million for the year ended December 31, 2013 compared to $1.9 million for the yearended December 31, 2012 primarily as a result of the lease exit liability and accelerated depreciation related to our former headquarters lease in Rockville,Maryland that was recognized in the first quarter of 2012. 48®Table of ContentsGeneral and administrative expenses. General and administrative expenses increased by $10.7 million, or 77.2%, to $24.6 million for the yearended December 31, 2013 compared to $13.9 million for the year ended December 31, 2012 primarily due to an increase in costs as we build our marketingand sales organization for the commercial launch of HETLIOZ™, for the treatment of Non-24.The following table discloses the components of our general and administrative expenses for the years ended December 31, 2013 and 2012: Year Ended December 31, (in thousands) 2013 2012 Salaries, benefits and related costs $5,252 $3,247 Employee stock-based compensation expense 2,750 2,718 Marketing, medical affairs, legal, accounting and other professional services 13,426 4,777 Other expenses 3,166 3,140 Total $24,594 $13,882 Salaries, benefits and related costs increased by $2.1 million, or 61.7%, to $5.3 million for the year ended December 31, 2013 compared to $3.2million for the year ended December 31, 2012 primarily due to an increase in our employee headcount as we build our marketing and sales organization.Marketing, medical affairs, legal, accounting and other professional expenses increased by $8.6 million, or 181.1%, to $13.4 million for the year endedDecember 31, 2013 compared to $4.8 million for the year ended December 31, 2012 primarily due to increased expenses associated with the commerciallaunch of HETLIOZ™, for the treatment of Non-24.Other income. Other income decreased $0.5 million, or 74.2%, to $0.1 million for the year ended December 31, 2013 compared to $0.6 million forthe year ended December 31, 2012 primarily as a result of a legal settlement related to a lawsuit filed against one of our stockholders partially offset by lowerinterest income. While we did not participate in the lawsuit proceedings, we received a portion of the settlement.Tax benefit. The tax benefit for the years ended December 31, 2013 and 2012 was fully offset by a tax valuation allowance resulting from ourassessment that it is more likely than not that our deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon thegeneration of future taxable income during the period in which NOLs and credit carryforwards can be utilized.Year ended December 31, 2012 compared to year ended December 31, 2011Revenues. Revenues were $32.7 million for the year ended December 31, 2012 compared to revenues of $31.3 million for the year ended December 31,2011. Revenues for the year ended December 31, 2012 included $26.8 million recognized from Novartis related to straight-line recognition of upfront licensefees and $5.9 million in royalty revenue based on 2012 net sales of Fanapt. Revenues for the year ended December 31, 2011 included $26.8 millionrecognized from Novartis related to straight-line recognition of upfront license fees and $4.5 million in royalty revenue based on 2011 net sales of Fanapt.Intangible asset amortization. Intangible asset amortization was $1.5 million for both the year ended December 31, 2012 and the year endedDecember 31, 2011. Intangible amortization relates to the capitalized intangible asset of $12.0 million resulting from the Fanapt milestone payment toNovartis in May 2009. 49®®®Table of ContentsResearch and development expenses. Research and development expenses increased by $16.4 million, or 56.7%, to $45.4 million for the year endedDecember 31, 2012 compared to $29.0 million for the year ended December 31, 2011.The following table discloses the components of research and development expenses reflecting all of our project expenses for the years endedDecember 31, 2012 and 2011: Year Ended December 31, (in thousands) 2012 2011 Direct project costs: Clinical trials $28,296 $14,440 Contract research and development manufacturing, consulting, materials and other direct costs 9,047 5,987 Salaries, benefits and related costs 4,878 4,130 Employee stock-based compensation expense 1,356 2,450 Total direct costs 43,577 27,007 Indirect project costs 1,869 1,989 Total $45,446 $28,996 Total direct costs increased by $16.6 million, or 61.4%, to $43.6 million for the year ended December 31, 2012 compared to $27.0 million for the yearended December 31, 2011 primarily as a result of increases in clinical trial costs, contract research and development, consulting, materials and other directcosts and salaries, benefits and related costs partially offset by lower stock-based compensation.Clinical trials costs increased by $13.9 million, or 96.0%, to $28.3 million for the year ended December 31, 2012 compared to $14.4 million for theyear ended December 31, 2011 primarily due to costs related to the HETLIOZ™ trials for the treatment of Non-24 and the HETLIOZ™ trial for the treatmentof MDD.Contract research and development, consulting, materials and other direct costs increased by $3.0 million, or 51.1%, to $9.0 million for the year endedDecember 31, 2012 compared to $6.0 million for the year ended December 31, 2011 primarily due to costs related to the HETLIOZ™ Non-24 and MDDtrials, costs related to the preparation for the HETLIOZ™ NDA filing with the FDA and the $1.0 million initial license fee associated with VLY-686.Salaries, benefits and related costs increased by $0.8 million, or 18.1%, to $4.9 million for the year ended December 31, 2012 compared to $4.1million for the year ended December 31, 2011 due to new employees hired in 2011 and 2012 and severance costs associated with an employee termination.Employee stock-based compensation expense decreased by $1.1 million, or 44.7%, to $1.4 million for the year ended December 31, 2012 compared to$2.5 million for the year ended December 31, 2011 due to the reversal of expense from the cancellation of equity awards due to employee terminations in 2012and a reduction in the amortization of employee stock-based compensation expense from the lower fair value of equity awards granted during 2011 and 2012compared to equity awards granted in prior periods.General and administrative expenses. General and administrative expenses increased by $2.4 million, or 20.9%, to $13.9 million for the year endedDecember 31, 2012 compared to $11.5 million for the year ended December 31, 2011. 50Table of ContentsThe following table discloses the components of our general and administrative expenses for the years ended December 31, 2012 and 2011: Year Ended December 31, (in thousands) 2012 2011 Salaries, benefits and related costs $3,247 $2,065 Employee stock-based compensation expense 2,718 3,036 Marketing, legal, accounting and other professional services 4,777 3,575 Other expenses 3,140 2,810 Total $13,882 $11,486 Salaries, benefits and related costs increased by $1.1 million, or 57.2%, to $3.2 million for the year ended December 31, 2012 compared to $2.1million for the year ended December 31, 2011 primarily due to the hiring of an executive in the fourth quarter of 2011 and other new hires in 2011 and 2012.Marketing, legal, accounting and other professional expenses increased by $1.2 million, or 33.6%, to $4.8 million for the year ended December 31,2012 compared to $3.6 million for the year ended December 31, 2011 primarily due to increased legal costs associated with developing Fanapt outside theU.S. and Canada and increased market development expenses associated with HETLIOZ™.Other expenses included lease exit costs and related accelerated depreciation in 2012 and a lease termination penalty in 2011 relating to our formerheadquarters lease in Rockville, Maryland.Other income. Other income increased $0.1 million, or 21.7%, to $0.6 million for the year ended December 31, 2012 compared to $0.5 million forthe year ended December 31, 2011 primarily due to income from a legal settlement related to a lawsuit filed against one of our stockholders partially offset bylower interest income. While we did not participate in the lawsuit proceedings, we received a portion of the settlement.Tax provision (benefit). The tax benefit for the years ended December 31, 2012 and 2011 were fully offset by a tax valuation allowance resulting fromour assessment that it is more likely than not that our deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent uponthe generation of future taxable income during the period in which NOLs and credit carryforwards can be utilized. The benefit for income taxes of $0.4 millionfor the year ended December 31, 2011 is the result of the approval for a change in accounting method from the Internal Revenue Service.Intangible AssetThe following is a summary of our intangible asset as of December 31, 2013: (in thousands) EstimatedUsefulLife(Years) December 31, 2013 GrossCarryingAmount AccumulatedAmortization NetCarryingAmount Fanapt 8 $12,000 $6,963 $5,037 In 2009, we announced that the FDA had approved the NDA for Fanapt. As a result of the FDA’s approval of the NDA, we met a milestone under ouroriginal sublicense agreement with Novartis which required us to make a payment of $12.0 million to Novartis. The $12.0 million was capitalized and isbeing amortized over the remaining life of the U.S. patent for Fanapt, which as of December 31, 2013 we expected to last until May 2017. This includes theHatch-Waxman extension that provides patent protection for drug compounds for a period of five years to compensate for time spent in development and a six-month pediatric term extension. Fanapt has qualified for the full five-year patent term Hatch-Waxman extension. However, in 2014, we became aware ofevents that led us to believe that Novartis would not complete the ongoing pediatric efficacy studies in a time that would enable it to receive the incremental six-month pediatric term extension. Therefore the estimated patent life was decreased in 2014 by six months to November 2016. This term is our best estimate ofthe life of 51®®®®®Table of Contentsthe patent. All tables in this section reflect the May 2017 patent life (see Subsequent Events in the Notes to the Consolidated Financial Statements for furtherinformation).We capitalized and began amortizing the asset immediately following the FDA approval of the NDA for Fanapt. The intangible asset is being amortizedover its estimated useful economic life using the straight-line method. Amortization expense was $1.5 million for the years ended December 31, 2013, 2012and 2011, respectively.The following table summarizes our future intangible asset amortization schedule as of December 31, 2013: (in thousands) Total 2014 2015 2016 2017 Intangible asset $5,037 $1,495 $1,495 $1,495 $552 Deferred RevenueThe following is a summary of changes in total deferred revenue for the years ended December 31, 2013, 2012 and 2011: (in thousands) Balance atBeginning ofYear ReductionsfromLicensingRevenueRecognized Balance atEnd ofYear Year ended: December 31, 2013 $117,064 $26,789 $90,275 December 31, 2012 143,853 26,789 117,064 December 31, 2011 170,642 26,789 143,853 We entered into an amended and restated sublicense agreement with Novartis in October 2009, pursuant to which Novartis has the right tocommercialize and develop Fanapt in the U.S. and Canada. Under the amended and restated sublicense agreement, we received an upfront payment of $200.0million in December 2009. We established a Joint Steering Committee (JSC) with Novartis following the effective date of the amended and restated sublicenseagreement. We concluded that the JSC constitutes a deliverable under the amended and restated sublicense agreement and that revenue related to the upfrontpayment will be recognized ratably over the term of the JSC; however, the delivery or performance has no term as the exact length of the JSC is undefined. As aresult, we deemed the performance period of the JSC to be the life of the U.S. patent for Fanapt, which as of December 31, 2013 we expected to last until May2017. This includes the Hatch-Waxman extension that provides patent protection for drug compounds for a period of five years to compensate for time spent indevelopment and a six-month pediatric term extension. Fanapt has qualified for the full five-year patent term Hatch-Waxman extension. However, in 2014, webecame aware of events that led us to believe that Novartis would not complete the ongoing pediatric efficacy studies in a time that would enable it to receive theincremental six-month pediatric term extension. Therefore the estimated patent life was decreased in 2014 by six months to November 2016. This term is ourbest estimate of the life of the patent. All tables in this section reflect the May 2017 patent life (see Subsequent Events footnote in the Notes to the ConsolidatedFinancial Statements for further information). Revenue related to the upfront payment will be recognized ratably from the date the amended and restatedsublicense agreement became effective (November 2009) through the expected life of the U.S. patent for Fanapt. For each of the years ended December 31,2013, 2012 and 2011, we recognized revenue of $26.8 million for the license agreement.Liquidity and Capital ResourcesIn August 2013, we completed a public offering of 4,680,000 shares of common stock at a price to the public of $11.14 per share. Net cash proceedsfrom the public offering were $48.5 million, after deducting the underwriting discounts and commissions and offering expenses.As of December 31, 2013, our total cash and cash equivalents and marketable securities were $130.4 million, including net proceeds from the publicoffering of common stock completed in August 2013, compared 52®®®®®Table of Contentsto $120.4 million at December 31, 2012. Our cash and cash equivalents are deposits in operating accounts and highly liquid investments with an originalmaturity of 90 days or less at date of purchase and consist of time deposits, investments in money market funds with commercial banks and financialinstitutions, and commercial paper of high-quality corporate issuers. Our marketable securities consist of investments in government sponsored enterprisesand commercial paper.As of December 31, 2013 and 2012, our liquidity resources are summarized as follows: As of December 31, (in thousands) 2013 2012 Cash and cash equivalents $64,764 $88,772 Marketable securities: U.S. Treasury and government agencies 31,566 14,442 Corporate debt 34,020 17,189 Total marketable securities 65,586 31,631 Total cash equivalents and marketable securities $130,350 $120,403 As of December 31, 2013, we maintained all of our cash and cash equivalents in two financial institutions. Deposits held with these institutions mayexceed the amount of insurance provided on such deposits, but we do not anticipate any losses with respect to such deposits.We expect to incur substantial costs and expenses as a result of the FDA approval of our NDA for HETLIOZ™ for the treatment of Non-24 in January2014. As a result of the FDA approval of the NDA for HETLIOZ™ in January 2014, we are obligated to make milestone payments of $8.0 million under thelicense agreement and $2.0 million under a regulatory consulting agreement in the first quarter of 2014. Additionally, we expect to incur substantial expenses inpreparation for the commercial launch of HETLIOZ™ for the treatment of Non-24.Because of the uncertainties discussed above, the costs to advance our research and development projects and the commercial launch of HETLIOZ™,are difficult to estimate and may vary significantly. It is uncertain whether our existing funds will be sufficient to meet our operating needs. Our future capitalrequirements and the adequacy of our available funds will depend on many factors, primarily including the scope and costs of our commercial,manufacturing and process development activities and the magnitude of our discovery, preclinical and clinical development programs.We may need or desire to obtain additional capital to finance our operations through debt, equity or alternative financing arrangements. We may alsoseek capital through collaborations or partnerships with other companies. The issuance of debt could require us to grant liens on certain of our assets that maylimit our flexibility. If we raise additional capital by issuing equity securities, the terms and prices for these financings may be much more favorable to the newinvestors than the terms obtained by our existing stockholders. These financings also may significantly dilute the ownership of our existing stockholders. Ifwe are unable to obtain additional financing, we may be required to reduce the scope of our future activities which could harm our business, financialcondition and operating results. There can be no assurance that any additional financing required in the future will be available on acceptable terms, if at all. 53Table of ContentsCash flowThe following table summarizes our cash flows for the years ended December 31, 2013, 2012 and 2011. Year Ended December 31, (in thousands) 2013 2012 2011 Net cash provided by (used in): Operating activities $(39,592) $(44,917) $(28,410) Investing activities (34,275) 45,754 73,749 Financing activities 49,859 12 25 Net increase (decrease) in cash and cash equivalents $(24,008) $849 $45,364 In assessing cash used in operating activities, we consider several principal factors: (i) net loss for the period; (ii) adjustments for non-cash chargesincluding stock-based compensation expense, amortization of intangible assets and depreciation and amortization of property and equipment; and (iii) theextent to which receivables, accounts payable and other liabilities, or other working capital components increase or decrease.Year ended December 31, 2013 compared to year ended December 31, 2012Net cash used in operating activities was $39.6 million for the year ended December 31, 2013, a reduction of $5.3 million from net cash used inoperating activities of $44.9 million for the year ended December 31, 2012. The decrease in net cash used for operating activities primarily resulted from areduction in the net loss of $7.4 million, which was partially offset by a cash contribution of $1.8 million for tenant improvements that was received from thelandlord for our Washington, D.C. headquarters for the year ended December 31, 2012.Net cash used in investing activities of $34.3 million for the year ended December 31, 2013 consisted of net purchases and maturities of marketablesecurities of $34.1 million. Net cash provided by investing activities of $45.8 million for the year ended December 31, 2012 consisted of net purchases, salesand maturities of marketable securities of $47.8 million reduced by purchases of property and equipment of $2.0 million.Net cash provided by financing activities of $49.9 million for the year ended December 31, 2013 reflects the net proceeds of $48.5 million receivedfrom the public offering of 4,680,000 shares of common stock completed in August 2013 and $1.6 million received from the exercise of employee stockoptions.Year ended December 31, 2012 compared to year ended December 31, 2011Net cash used in operations was $44.9 million for the year ended December 31, 2012 compared to $28.4 million for the year ended December 31, 2011.The increase in net cash used in operations for the year ended December 31, 2012 as compared to the year ended December 31, 2011 was primarily due to thecosts associated with four Phase III clinical trials for HETLIOZ™ in Non-24 in totally blind individuals, which were initiated in 2010 and 2011, and onePhase IIb/III clinical trial for HETLIOZ™ in MDD, which was initiated in the third quarter of 2011. Adjustments to reconcile net loss to net cash used inoperating activities for the year ended December 31, 2012 included non-cash charges for depreciation and amortization of $2.7 million, employee and non-employee stock-based compensation expense of $4.1 million, landlord contributions for tenant improvements of $1.8 million, a net increase of $0.9 million inprepaid expenses and other assets, accounts receivable, inventory, accounts payable, accrued liabilities and other liabilities and a decrease in deferred revenueof $26.8 million.Net cash provided by investing activities for the year ended December 31, 2012 was $45.8 million and consisted of net maturities, sales and purchasesof marketable securities of $47.8 million and purchases of property and equipment of $2.0 million.Off-balance sheet arrangementsWe have no off-balance sheet arrangements, as defined in Item 303(a)(4) of the Securities and Exchange Commission’s Regulation S-K. 54Table of ContentsContractual obligations and commitmentsThe following is a summary of our non-cancellable long-term contractual cash obligations as of December 31, 2013: Cash payments due by period (in thousands) (1)(2)(3) Total 2014 2015 2016 2017 2018 After 2018 Operating leases $10,750 $1,111 $1,079 $1,106 $1,133 $1,162 $5,159 (1)This table does not include various agreements that we have entered into for services with third party vendors, including agreements to conduct clinicaltrials, to manufacture products, and for consulting and other contracted services due to the cancelable nature of the services. We accrued the costs ofthese agreements based on estimates of work completed to date. (2)This table as of December 31, 2013 does not include a 2014 payment obligation of $2.0 million for a milestone payment due to a regulatory consultant ora 2014 payment obligation of $8.0 million for a milestone payment due to BMS. These payments became contractually due as a result of the FDAapproval of HETLIOZ™. Also, this table does not include potential future milestone obligations under our license agreement with BMS, where we couldbe obligated to make future milestone payments of up to $25.0 million in the event sales of HETLIOZ reach a certain agreed upon threshold. (3)This table does not include potential future milestone obligations under our license agreement with Eli Lilly and Company for the exclusive rights todevelop and commercialize VLY-686 where we could be obligated to make future milestone payments of up to $4.0 million for pre-NDA approvalmilestones and up to $95.0 million for future regulatory approval and sales milestones.Operating leasesOur commitments related to operating leases represent the minimum annual payments for the operating lease for our headquarters located in Washington,D.C., which expires in 2023.In 2011, we entered into an office lease with Square 54 Office Owner LLC (the Landlord) for our current headquarters, consisting of 21,400 square feetat 2200 Pennsylvania Avenue, N.W. in Washington, D.C. (Lease). Under the Lease, rent payments are abated for the first 12 months. The Landlord providedus with a cash contribution of $1.9 million for tenant improvements during the year ended December 31, 2012. Subject to the prior rights of other tenants inthe building, we have the right to renew the Lease for five years following the expiration of its original term. We also have the right to sublease or assign all or aportion of the premises, subject to standard conditions. The Lease may be terminated early by us or the Landlord upon certain conditions. ITEM 7A.QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISKInterest ratesOur exposure to market risk is currently confined to our cash and cash equivalents, marketable securities and restricted cash. We currently do not hedgeinterest rate exposure. We have not used derivative financial instruments for speculation or trading purposes. Because of the short-term maturities of our cashand cash equivalents and marketable securities, we do not believe that an increase in market rates would have any significant impact on the realized value ofour investments.Marketable securitiesWe deposit our cash with financial institutions that we consider to be of high credit quality and purchase marketable securities which are generallyinvestment grade, liquid, short-term fixed income securities and money-market instruments denominated in U.S. dollars. Our marketable securities consist ofcertificates of deposit, commercial paper, corporate notes and U.S. government agency notes. 55TMTable of ContentsEffects of inflationInflation has not had a material impact on our results of operations. ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATAThe consolidated financial statements and related financial statement schedules required to be filed are listed in the Index to Consolidated FinancialStatements and are incorporated herein. ITEM 9.CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURENone. ITEM 9A.CONTROLS AND PROCEDURESConclusion Regarding the Effectiveness of Disclosure Controls and ProceduresUnder the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we evaluatedthe effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities andExchange Act of 1934 (Exchange Act)) as of December 31, 2013. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures are effective as of December 31, 2013, the end of the period covered by this annual report, to ensure thatthe information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reportedwithin the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicatedto our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.Management’s Report on Internal Control over Financial ReportingOur management is responsible for establishing and maintaining an adequate system of internal control over financial reporting, as defined in theExchange Act Rule 13a-15(f). Management conducted an assessment of our internal control over financial reporting based on the original frameworkestablished in 1992 by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control — Integrated Framework. Based onthe assessment, management concluded that, as of December 31, 2013, our internal control over financial reporting was effective.The effectiveness of our internal control over financial reporting as of December 31, 2013 has been audited by PricewaterhouseCoopers LLP, anindependent registered public accounting firm, as stated in their report included in this annual report on Form 10-K.Changes in Internal Control over Financial ReportingThere has been no change in our internal controls over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during thefourth quarter of 2013 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. ITEM 9B.OTHER INFORMATIONNone. 56Table of ContentsPART III ITEM 10.DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCEInformation required under this item will be contained in our Proxy Statement for the Annual Meeting of Stockholders to be filed with the SEC within120 days after the end of the fiscal year ended December 31, 2013, under the captions “Election of Directors,” “Executive Officers,” “Corporate Governance”,and “Section 16(a) Beneficial Ownership Reporting Compliance” and is incorporated herein by reference pursuant to General Instruction G(3) to Form 10-K. ITEM 11.EXECUTIVE COMPENSATIONInformation required under this item will be contained in our Proxy Statement for the Annual Meeting of Stockholders to be filed with the SEC within120 days after the end of the fiscal year ended December 31, 2013, under the captions “Corporate Governance” and “Executive Compensation,” and isincorporated herein by reference pursuant to General Instruction G(3) to Form 10-K, except that information required by Item 407(e)(5) of Regulation S-K willbe deemed furnished in this Form 10-K and will not be deemed incorporated by reference into any filing under the Securities Act of 1933 or the SecuritiesExchange Act of 1934, except to the extent that we specifically incorporate it by reference into such filing. ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDERMATTERSIn addition to the information set forth under the caption “Securities Authorized for Issuance Under Equity Compensation Plans” below, the informationrequired under this item will be contained in our Proxy Statement for the Annual Meeting of Stockholders to be filed with the SEC within 120 days after theend of the fiscal year ended December 31, 2013, under the caption “Security Ownership by Certain Beneficial Owners and Management” and is incorporatedherein by reference pursuant to General Instruction G(3) to Form 10-K.Securities Authorized for Issuance Under Equity Compensation PlansThe following table provides certain information regarding our equity compensation plans in effect as of December 31, 2013:Equity Compensation Plan Information Plan Category Number of Securities to beIssued Upon Exercise ofOutstanding Options,Warrants and Rights Weighted-AverageExercise Price ofOutstandingOptions,Warrants andRights Number of SecuritiesRemaining Available forIssuance Under EquityCompensation Plans(Excluding SecuritiesReflected in Column (a)) (a) (b) (c) Equity compensation plans approved by security holders 7,088,052 $9.98 1,029,399 Equity compensation plans not approved by securityholders — — — Total 7,088,052 $9.98 1,029,399 (a)Includes 6,204,362 shares issuable upon exercise of outstanding options and 883,690 shares issuable upon settlement of RSUs under the 2006 EquityIncentive Plan and Second Amended and Restated Management Equity Plan.(b)Does not take into account RSUs which have no exercise price.(c)On January 1 of each year, the number of shares reserved under the 2006 Equity Incentive Plan is automatically increased by 4% of the total number ofshares of common stock that are outstanding at that time, or, if less, by 1,500,000 shares (or such lesser number as may be approved by theCompany’s Board of Directors). 57Table of ContentsITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCEInformation required under this item will be contained in our Proxy Statement for the Annual Meeting of Stockholders to be filed with the SEC within120 days after the end of the fiscal year ended December 31, 2013, under the caption “Corporate Governance” and is incorporated herein by reference pursuantto General Instruction G(3) to Form 10-K. ITEM 14.PRINCIPAL ACCOUNTANT FEES AND SERVICESInformation required under this item will be contained in our Proxy Statement for the Annual Meeting of Stockholders to be filed with the SEC within120 days after the end of the fiscal year ended December 31, 2013, under the caption “Ratification of Selection of Independent Registered Public AccountingFirm” and is incorporated herein by reference pursuant to General Instruction G(3) to Form 10-K.PART IV ITEM 15.EXHIBITS AND FINANCIAL STATEMENTS SCHEDULESThe consolidated financial statements filed as part of this annual report on Form 10-K are listed in the Index to Consolidated Financial Statements.Certain schedules are omitted because they are not applicable, or not required, or because the required information is included in the consolidated financialstatements or notes thereto. The Exhibits are listed in the Exhibit Index. 58Table of ContentsSignaturesPursuant to the requirements of Section 13 and 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this annual report on Form10-K to be signed on its behalf by the undersigned, thereunto duly authorized. Vanda Pharmaceuticals Inc.February 25, 2014 By: /s/ Mihael H. Polymeropoulos, M.D. Mihael H. Polymeropoulos, M.D. President and Chief Executive OfficerPursuant to the requirements of the Securities Act of 1934, this annual report on Form 10-K has been signed below by the following persons on behalf ofthe registrant and in the capacities and on the dates indicated. Name Title Date/s/ Mihael H. Polymeropoulos, M.D. Mihael H. Polymeropoulos, M.D. President and Chief Executive Officer and Director(principal executive officer) February 25, 2014/s/ James P. Kelly James P. Kelly Senior Vice President, Chief Financial Officer,Secretary and Treasurer (principal financial officerand principal accounting officer) February 25, 2014/s/ Howard Pien Howard Pien Chairman of the Board and Director February 25, 2014/s/ Michael Cola Michael Cola Director February 25, 2014/s/ Richard W. Dugan Richard W. Dugan Director February 25, 2014/s/ Steven K. Galson, M.D. Steven K. Galson, M.D. Director February 25, 2014/s/ Vincent J. Milano Vincent J. Milano Director February 25, 2014/s/ H. Thomas Watkins H. Thomas Watkins Director February 25, 2014 59Table of ContentsVanda Pharmaceuticals Inc.Index to Consolidated Financial Statements Page Report of Independent Registered Public Accounting Firm 61 Consolidated Balance Sheets at December 31, 2013 and 2012 62 Consolidated Statements of Operations for the years ended December 31, 2013, 2012 and 2011 63 Consolidated Statements of Comprehensive Loss for the years ended December 31, 2013, 2012 and 2011 64 Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2013, 2012 and 2011 65 Consolidated Statements of Cash Flows for the years ended December 31, 2013, 2012 and 2011 66 Notes to the Consolidated Financial Statements 67 60Table of ContentsReport of Independent Registered Public Accounting FirmTo the Board of Directors and Stockholders of Vanda Pharmaceuticals Inc.In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations, of comprehensive loss, of changesin stockholders’ equity, and of cash flows present fairly, in all material respects, the financial position of Vanda Pharmaceuticals, Inc. and Subsidiary(collectively, the Company) at December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the three years in the periodended December 31, 2013 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Companymaintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on criteria established in InternalControl—Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’smanagement is responsible for these financial statements, for maintaining effective internal control over financial reporting and for its assessment of theeffectiveness of internal control over financial reporting, included in Management’s Report on Internal Control over Financial Reporting appearing under item9A. Our responsibility is to express opinions on these financial statements and on the Company’s internal control over financial reporting based on ourintegrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Thosestandards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatementand whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements includedexamining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reportingincluded obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluatingthe design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as weconsidered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal controlover financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are beingmade only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluationof effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliancewith the policies or procedures may deteriorate./s/ PricewaterhouseCoopers LLPMcLean, VirginiaFebruary 25, 2014 61Table of ContentsVanda Pharmaceuticals Inc.Consolidated Balance Sheets December 31, (in thousands, except for share and per share amounts) 2013 2012 Assets Current assets Cash and cash equivalents $64,764 $88,772 Marketable securities, current 65,586 31,631 Accounts receivable 2,031 1,168 Prepaid expenses and other current assets 2,703 3,967 Restricted cash, current 530 430 Total current assets 135,614 125,968 Property and equipment, net 2,198 2,348 Intangible asset, net 5,037 6,532 Restricted cash, non-current 500 600 Total assets $143,349 $135,448 Liabilities and Stockholders’ Equity Current liabilities Accounts payable $661 $287 Accrued liabilities 5,180 5,187 Deferred rent, current 221 — Deferred revenues, current 26,789 26,789 Total current liabilities 32,851 32,263 Deferred rent, non-current 2,888 3,005 Deferred revenues, non-current 63,486 90,275 Total liabilities 99,225 125,543 Commitments and contingencies (Notes 10 and 17) Stockholders’ equity Preferred stock, $0.001 par value; 20,000,000 shares authorized, and no shares issued or outstanding — — Common stock, $0.001 par value; 150,000,000 shares authorized; 33,338,543 and 28,241,743 shares issued andoutstanding at December 31, 2013 and 2012, respectively 33 28 Additional paid-in capital 355,432 300,974 Accumulated other comprehensive income 21 10 Accumulated deficit (311,362) (291,107) Total stockholders’ equity 44,124 9,905 Total liabilities and stockholders’ equity $143,349 $135,448 The accompanying notes are an integral part of these consolidated financial statements. 62Table of ContentsVanda Pharmaceuticals Inc.Consolidated Statements of Operations Year Ended December 31, (in thousands, except for share and per share amounts) 2013 2012 2011 Revenue: Licensing agreement $26,789 $26,789 $26,789 Royalty revenue 7,090 5,938 4,481 Total revenue 33,879 32,727 31,270 Operating expenses: Cost of sales — 129 — Research and development 28,190 45,446 28,996 General and administrative 24,594 13,882 11,486 Intangible asset amortization 1,495 1,495 1,495 Total operating expenses 54,279 60,952 41,977 Loss from operations (20,400) (28,225) (10,707) Other income 145 561 461 Loss before tax benefit (20,255) (27,664) (10,246) Tax benefit — — (444) Net loss $(20,255) $(27,664) $(9,802) Net loss per share: Basic $(0.67) $(0.98) $(0.35) Diluted $(0.67) $(0.98) $(0.35) Weighted average shares used in calculations of net loss per share: Basic 30,351,353 28,228,409 28,106,831 Diluted 30,351,353 28,228,409 28,106,831 The accompanying notes are an integral part of these consolidated financial statements. 63Table of ContentsVanda Pharmaceuticals Inc.Consolidated Statements of Comprehensive Loss Year Ended December 31, (in thousands) 2013 2012 2011 Net loss $(20,255) $(27,664) $(9,802) Other comprehensive income (loss): Change in net unrealized gain (loss) on marketable securities 11 (11) 19 Tax provision on other comprehensive income (loss) — — — Other comprehensive income (loss), net of tax 11 (11) 19 Comprehensive loss $(20,244) $(27,675) $(9,783) The accompanying notes are an integral part of these consolidated financial statements. 64Table of ContentsVanda Pharmaceuticals Inc.Statements of Changes in Stockholders’ Equity (in thousands, except for share amounts) Common Stock AdditionalPaid-InCapital OtherComprehensiveIncome (Loss) AccumulatedDeficit Total Shares Par Value Balances at December 31, 2010 28,041,379 $28 $291,342 $2 $(253,641) $37,731 Issuance of common stock from the exercise of stockoptions and settlement of restricted stock units 75,647 — 25 — — 25 Employee and non-employee stock-based compensation — — 5,501 — — 5,501 Net loss — — — — (9,802) (9,802) Other comprehensive income, net of tax — — — 19 — 19 Balances at December 31, 2011 28,117,026 28 296,868 21 (263,443) 33,474 Issuance of common stock from the exercise of stockoptions and settlement of restricted stock units 124,717 — 12 — — 12 Employee and non-employee stock-based compensation — — 4,094 — — 4,094 Net loss — — — — (27,664) (27,664) Other comprehensive loss, net of tax — — — (11) — (11) Balances at December 31, 2012 28,241,743 28 300,974 10 (291,107) 9,905 Net proceeds from public offering of common stock 4,680,000 5 48,500 — — 48,505 Issuance of common stock from the exercise of stockoptions and settlement of restricted stock units 466,320 — 1,550 — — 1,550 Shares withheld upon settlement of restricted stockunits (49,520) — (196) — — (196) Employee and non-employee stock-based compensation — — 4,604 — — 4,604 Net loss — — — — (20,255) (20,255) Other comprehensive income, net of tax — — — 11 — 11 Balances at December 31, 2013 33,338,543 $33 $355,432 $21 $(311,362) $44,124 The accompanying notes are an integral part of these consolidated financial statements. 65Table of ContentsVanda Pharmaceuticals Inc.Consolidated Statements of Cash Flows Year Ended December 31, (in thousands) 2013 2012 2011 Cash flows from operating activities Net loss $(20,255) $(27,664) $(9,802) Adjustments to reconcile net loss to net cash used in operating activities Depreciation and amortization of property and equipment 432 633 469 Employee and non-employee stock-based compensation 4,604 4,094 5,501 Amortization of discounts and premiums on marketable securities 155 560 900 Intangible asset amortization 1,495 1,495 1,495 Deferred tax expense (benefit) — — 1,821 Landlord contributions for tenant improvements — 1,826 — Changes in assets and liabilities: Accounts receivable (863) 450 (1,107) Prepaid expenses and other current assets 1,264 (884) (1,240) Accounts payable 374 (709) 348 Accrued liabilities (113) 1,806 1,836 Other liabilities 104 265 424 Deferred revenue (26,789) (26,789) (26,789) Accrued income taxes — — (2,266) Net cash used in operating activities (39,592) (44,917) (28,410) Cash flows from investing activities Purchases of property and equipment (176) (2,017) (275) Purchases of marketable securities (65,598) (60,866) (160,213) Proceeds from sale of marketable securities — 2,497 8,667 Maturities of marketable securities 31,499 106,140 226,170 Changes in restricted cash — — (600) Net cash provided by (used in) investing activities (34,275) 45,754 73,749 Cash flows from financing activities Net proceeds from public offering of common stock 48,505 — — Tax obligations paid in connection with settlement of restricted stock units (196) — — Proceeds from exercise of stock options 1,550 12 25 Net cash provided by financing activities 49,859 12 25 Net increase (decrease) in cash and cash equivalents (24,008) 849 45,364 Cash and cash equivalents Beginning of period 88,772 87,923 42,559 End of period $64,764 $88,772 $87,923 Non-cash investing activities Purchases of property and equipment in accrued liabilities $106 $— $221 The accompanying notes are an integral part of these consolidated financial statements. 66Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements1. Business Organization and PresentationBusiness organizationVanda Pharmaceuticals Inc. (Vanda or the Company) is a biopharmaceutical company focused on the development and commercialization of productsfor the treatment of central nervous system disorders. Vanda commenced its operations in 2003. Vanda’s product portfolio includes HETLIOZ™ (tasimelteon),a product for the treatment of Non-24-Hour Sleep-Wake Disorder (Non-24) and for which a New Drug Application (NDA) was approved by the U.S. Foodand Drug Administration (FDA) in January 2014, Fanapt a product for the treatment of schizophrenia, the oral formulation of which is currently beingmarketed and sold in the U.S. by Novartis Pharma AG (Novartis), and VLY-686, a small molecule neurokinin-1 receptor (NK-1R) antagonist.Basis of presentationThe accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the UnitedStates of America. All intercompany accounts and transactions have been eliminated in consolidation.2. Summary of Significant Accounting PoliciesUse of estimatesThe preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requiresmanagement to make estimates that affect the reported amounts of assets and liabilities at the date of the financial statements, disclosure of contingent assetsand liabilities, and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.Cash and cash equivalentsFor purposes of the consolidated balance sheets and consolidated statements of cash flows, cash equivalents represent highly-liquid investments with amaturity date of three months or less at the date of purchase.Marketable securitiesThe Company classifies all of its marketable securities as available-for-sale securities. The Company’s investment policy requires the selection of high-quality issuers, with bond ratings of AAA to A1+/P1. Available-for-sale securities are carried at fair market value, with unrealized gains and losses reported asa component of stockholders’ equity in accumulated other comprehensive income/loss. Interest and dividend income is recorded when earned and included ininterest income. Premiums and discounts on marketable securities are amortized and accreted, respectively, to maturity and included in interest income. TheCompany uses the specific identification method in computing realized gains and losses on the sale of investments, which would be included in theconsolidated statements of operations when generated. Marketable securities with a maturity of more than one year as of the balance sheet date and which theCompany does not intend to sell within the next twelve months are classified as non-current. All other marketable securities are classified as current.InventoryThe Company values its inventory at acquisition cost following the first-in first-out method. The Company reviews its inventory levels quarterly andwrites down inventory that has become obsolete, has a cost basis in excess of its expected net realizable value or inventory quantities in excess of expectedrequirements. Expired inventory is disposed of and the related costs are written off to cost of sales. Prior to FDA approval, manufacturing-related costs areincluded in research and development expenses.Intangible assetCosts incurred for products not yet approved by the FDA and for which no alternative future use exists are recorded as expense. In the event a producthas been approved by the FDA or an alternative future use exists for 67®,Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) a product, patent and license costs are capitalized and amortized over the expected patent life of the related product. Milestone payments to the Company’spartners are recognized when it is deemed probable that the milestone event will occur.As a result of the FDA’s approval of the NDA for Fanapt in May 2009, the Company met a milestone under its original sublicense agreement withNovartis which required the Company to make a payment of $12.0 million to Novartis. The $12.0 million is being amortized on a straight line basis over theremaining life of the U.S. patent for Fanapt, which the Company expects to last until November 2016 (see Subsequent Events footnote for furtherinformation). This includes the Hatch-Waxman extension that extends patent protection for drug compounds for a period of five years to compensate for timespent in development. Fanapt has qualified for the full five-year patent term Hatch-Waxman extension. This term is the Company’s best estimate of the life ofthe patent. The carrying value of the intangible asset is periodically reviewed to determine if the facts and circumstances suggest that a potential impairmentmay have occurred. The Company has had no impairment of its intangible asset.Property and equipmentProperty and equipment are stated at cost less accumulated depreciation and amortization. The costs of leasehold improvements funded by orreimbursed by the lessor are capitalized and amortized as leasehold improvements along with a corresponding deferred rent liability. Depreciation of propertyand equipment is provided on a straight-line basis over the estimated useful lives of the assets. Amortization of leasehold improvements is provided on astraight-line basis over the shorter of their estimated useful life or the lease term. The costs of additions and improvements are capitalized, and repairs andmaintenance costs are charged to operations in the period incurred. Upon retirement or disposition of property and equipment, the cost and accumulateddepreciation and amortization are removed from the accounts and any resulting gain or loss is reflected in the statement of operations for that period.Revenue recognitionThe Company’s revenues are derived primarily from the amended and restated sublicense agreement with Novartis and include an upfront payment,product sales and future milestone and royalty payments. Revenue is considered both realizable and earned when the following four conditions are met:(i) persuasive evidence of an arrangement exists, (ii) the arrangement fee is fixed or determinable, (iii) delivery or performance has occurred, and(iv) collectability is reasonably assured. Pursuant to the amended and restated sublicense agreement, Novartis has the right to commercialize and developFanapt in the U.S. and Canada. Under the agreement, the Company received an upfront payment of $200.0 million in December of 2009. The Company andNovartis established a Joint Steering Committee (JSC) following the effective date of the amended and restated sublicense agreement. The Company concludedthat the JSC constitutes a deliverable under the amended and restated sublicense agreement and that revenue related to the upfront payment will be recognizedratably over the term of the JSC; however, the delivery or performance has no term as the exact length of the JSC is undefined. As a result, the Companydeems the performance period of the JSC to be the life of the U.S. patent of Fanapt, which the Company expects to last until November 2016 (see SubsequentEvents footnote for further information). This includes the Hatch-Waxman extension that provides patent protection for drug compounds for a period of fiveyears to compensate for time spent in development. Fanapt has qualified for the full five-year patent term Hatch-Waxman extension. This term is theCompany’s best estimate of the life of the patent. Revenue related to the upfront payment will be recognized ratably from the date the amended and restatedsublicense agreement became effective (November 2009) through the expected life of the U.S. patent for Fanapt. The Company recognizes revenue fromFanapt royalties and commercial and development milestones from Novartis when realizable and earned.Concentrations of credit riskFinancial instruments which potentially subject the Company to significant concentrations of credit risk consist primarily of cash, cash equivalentsand marketable securities. The Company places its cash, cash 68®®®®®®®®Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) equivalents and marketable securities with highly-rated financial institutions. At December 31, 2013, the Company maintained all of its cash, cashequivalents and marketable securities in two financial institutions. Deposits held with these institutions may exceed the amount of insurance provided on suchdeposits. Generally, these deposits may be redeemed upon demand, and the Company believes there is minimal risk of losses on such balances.Accrued liabilitiesThe Company’s management is required to estimate accrued liabilities as part of the process of preparing financial statements. The estimation of accruedliabilities involves identifying services that have been performed on the Company’s behalf, and then estimating the level of service performed and theassociated cost incurred for such services as of each balance sheet date in the financial statements. Accrued liabilities include professional service fees, such aslawyers and accountants, contract service fees, such as those under contracts with clinical monitors, data management organizations and investigators inconjunction with clinical trials, fees to contract manufacturers in conjunction with the production of clinical materials, and fees for marketing and othercommercialization activities. Pursuant to management’s assessment of the services that have been performed on clinical trials and other contracts, theCompany recognizes these expenses as the services are provided. Such management assessments include, but are not limited to: (i) an evaluation by the projectmanager of the work that has been completed during the period, (ii) measurement of progress prepared internally and/or provided by the third-party serviceprovider, (iii) analyses of data that justify the progress, and (iv) management’s judgment. In the event that the Company does not identify certain costs thathave begun to be incurred or the Company under- or over-estimates the level of services performed or the costs of such services, the Company’s reportedexpenses for such period would be too low or too high.Research and development expensesResearch and development expenses consist primarily of fees for services provided by third parties in connection with the clinical trials, costs ofcontract manufacturing services, milestone payments, costs of materials used in clinical trials and research and development, costs for regulatory consultantsand filings, depreciation of capital resources used to develop products, related facilities costs, and salaries, other employee-related costs and stock-basedcompensation for research and development personnel. The Company expenses research and development costs as they are incurred for products in thedevelopment stage, including manufacturing costs and milestone payments made under license agreements prior to FDA approval. Upon and subsequent toFDA approval, manufacturing and milestone payments related to license agreements are capitalized. Milestone payments are accrued when it is deemedprobable that the milestone event will be achieved. Costs related to the acquisition of intellectual property are expensed as incurred if the underlying technologyis developed in connection with the Company’s research and development efforts and has no alternative future use.General and administrative expensesGeneral and administrative expenses consist of salaries, including employee stock-based compensation, facilities and third party expenses. General andadministrative expenses are associated with the activities of the executive, finance, accounting, information technology, business development, marketing,legal, medical affairs and human resource functions.Employee stock-based compensationCompensation costs for all stock-based awards to employees and directors are measured based on the grant date fair value of those awards andrecognized over the period during which the employee or director is required to perform service in exchange for the award. The Company generally recognizesthe expense over the award’s vesting period. 69Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) The fair value of stock options granted is amortized using the accelerated attribution method. Under this method, also known as the graded-vestingmethod, compensation expense for stock options is amortized over the requisite service period for each separately vesting tranche as though the stock optionaward was in substance multiple awards, resulting in accelerated expense recognition over the vesting period. The fair value of restricted stock units (RSUs)awarded is amortized using the straight line method. As stock-based compensation expense recognized in the consolidated statements of operations is based onawards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are required to be estimated at the time of grant and revised, ifnecessary, in subsequent periods if actual forfeitures differ from those estimates.Total employee stock-based compensation expense recognized for the years ended December 31, 2013, 2012 and 2011, was comprised of the following: Year Ended December 31, (in thousands) 2013 2012 2011 Research and development $1,727 $1,356 $2,450 General and administrative 2,750 2,718 3,036 Total employee stock-based compensation expense $4,477 $4,074 $5,486 The fair value of each option award is estimated on the date of grant using the Black-Scholes-Merton option pricing model that uses the assumptionsnoted in the following table. Expected volatility rates are based on the historical volatility of the Company’s publicly traded common stock and other factors.The weighted average expected term of stock options granted is based on the simplified method as the options meet the “plain vanilla” criteria required byauthoritative guidance. Significant changes in the market price of the Company’s common stock in recent years have made historical data less reliable for thepurpose of estimating future vesting, exercise, and employment behavior. The simplified method provided a more reasonable approach for estimating theweighted average expected term for options granted in 2013. The risk-free interest rates are based on the U.S. Treasury yield for a period consistent with theexpected term of the option in effect at the time of the grant. The Company has not paid dividends to its stockholders since its inception (other than a dividendof preferred share purchase rights, which was declared in September 2008) and does not plan to pay dividends in the foreseeable future.Assumptions used in the Black-Scholes-Merton option pricing model for employee and director stock options granted during the years endedDecember 31, 2013, 2012 and 2011 were as follows: Year Ended December 31, 2013 2012 2011 Expected dividend yield —% —% —% Weighted average expected volatility 65% 68% 71% Weighted average expected term (years) 6.03 6.03 6.03 Weighted average risk-free rate 1.59% 0.94% 1.45% Weighted average fair value $6.10 $2.08 $3.50 Income taxesThe Company accounts for income taxes in accordance with the authoritative guidance on accounting for income taxes, which requires companies toaccount for deferred income taxes using the asset and liability method. Under the asset and liability method, current income tax expense or benefit is theamount of income taxes expected to be payable or refundable for the current year. A deferred income tax asset or liability is recognized for future taxconsequences attributable to differences between the financial statement carrying 70Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) amounts of existing assets and liabilities and their respective tax bases and tax credits and loss carryforwards. Deferred tax assets are reduced by a valuationallowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The fact that theCompany has historically generated net operating losses (NOLs) serves as strong evidence that it is more likely than not that deferred tax assets will not berealized in the future. Therefore, the Company has a full valuation allowance against all deferred tax assets as of December 31, 2013 and 2012, respectively.Tax rate changes are reflected in income during the period such changes are enacted. Changes in ownership may limit the amount of NOL carryforwards thatcan be utilized in the future to offset taxable income.Segment informationThe Company’s management has determined that the Company operates in one business segment which is the development and commercialization ofpharmaceutical products.Recent accounting pronouncementsOn January 1, 2013, the Company adopted changes issued by the Financial Accounting Standards Board (FASB) for the reporting of amountsreclassified out of accumulated other comprehensive income. The changes require an entity to report the effect of significant reclassifications out ofaccumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required to be reclassified in its entiretyto net income. For other amounts that are not required to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures that provide additional detail about those amounts. Adoption of these changes did not have a material impact on the Company’scondensed consolidated financial statements.In July 2013, the FASB issued Accounting Standard Update (ASU) 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized TaxBenefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. This new standard requires the netting ofunrecognized tax benefits against a deferred tax asset for a loss or other carryforward that would apply in settlement of the uncertain tax positions. Under thenew standard, unrecognized tax benefits will be netted against all available same-jurisdiction loss or other tax carryforwards that would be utilized, rather thanonly against carryforwards that are created by the unrecognized tax benefits. The new standard is effective for public companies for fiscal years, and interimperiods within those fiscal years, beginning after December 15, 2013. The Company does not expect that this new standard will have a material impact on theCompany’s condensed consolidated financial statements.Certain risks and uncertaintiesThe Company’s products under development require approval from the FDA or other international regulatory agencies prior to commercial sales. Therecan be no assurance the products will receive the necessary clearance. If the Company is denied clearance or clearance is delayed, it may have a materialadverse impact on the Company.The Company’s products are concentrated in rapidly-changing, highly-competitive markets, which are characterized by rapid technological advances,changes in customer requirements and evolving regulatory requirements and industry standards. Any failure by the Company to anticipate or to respondadequately to technological developments in its industry, changes in customer requirements or changes in regulatory requirements or industry standards or anysignificant delays in the development or introduction of products or services could have a material adverse effect on the Company’s business, operating resultsand future cash flows.The Company depends on single source suppliers for critical raw materials for manufacturing, as well as other components required for theadministration of its products. The loss of these suppliers could delay the clinical trials or prevent or delay commercialization of the products. 71Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) 3. Earnings per ShareBasic earnings per share (EPS) is calculated by dividing the net income (loss) by the weighted average number of shares of common stock outstanding.Diluted EPS is computed by dividing the net income (loss) by the weighted average number of shares of common stock outstanding, plus potentialoutstanding common stock for the period. Potential outstanding common stock includes stock options and shares underlying RSUs, but only to the extent thattheir inclusion is dilutive.The following table presents the calculation of basic and diluted net loss per share of common stock for the years ended December 31, 2013, 2012, and2011: Year Ended December 31, (in thousands, except for share and per share amounts) 2013 2012 2011 Numerator: Net loss $(20,255) $(27,664) $(9,802) Denominator: Weighted average shares of common stock outstanding, basic 30,351,353 28,228,409 28,106,831 Stock options and restricted stock units related to the issuance of common stock — — — Weighted average shares of common stock outstanding, diluted 30,351,353 28,228,409 28,106,831 Net income (loss) per share: Basic $(0.67) $(0.98) $(0.35) Diluted $(0.67) $(0.98) $(0.35) Anti-dilutive securities excluded from calculations of diluted net loss per share: Options to purchase common stock and restricted stock units 4,444,912 5,219,183 4,559,432 The Company incurred a net loss for each of the years ended December 31, 2013, 2012 and 2011 causing inclusion of any potentially dilutive securitiesto have an anti-dilutive effect, resulting in dilutive loss per share and basic loss per share attributable to common stockholders being equivalent.4. Marketable SecuritiesThe following is a summary of the Company’s available-for-sale marketable securities as of December 31, 2013: (in thousands) AmortizedCost GrossUnrealizedGains GrossUnrealizedLosses Fair MarketValue Current: U.S. Treasury and government agencies $31,557 $9 $— $31,566 Corporate debt 34,008 18 (6) 34,020 $65,565 $27 $(6) $65,586 72Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) The following is a summary of the Company’s available-for-sale marketable securities as of December 31, 2012: (in thousands) AmortizedCost GrossUnrealizedGains GrossUnrealizedLosses Fair MarketValue Current: U.S. Treasury and government agencies $14,439 $3 $— $14,442 Corporate debt 17,182 7 — 17,189 $31,621 $10 $— $31,631 5. Prepaid Expenses and Other Current AssetsThe following is a summary of the Company’s prepaid expenses and other current assets as of December 31, 2013 and 2012: December 31, (in thousands) 2013 2012 Prepaid insurance $167 $155 Other prepaid expenses and vendor advances 2,408 3,536 Accrued interest income 128 276 Total prepaid expenses and other current assets $2,703 $3,967 6. Property and EquipmentThe following is a summary of the Company’s property and equipment-at cost, as of December 31, 2013 and 2012: EstimatedUseful Life(Years) December 31, (in thousands) 2013 2012 Computer equipment 3 $983 $768 Furniture and fixtures 7 580 572 Leasehold improvements 11 1,884 1,826 3,447 3,166 Less—accumulated depreciation and amortization (1,249) (818) $2,198 $2,348 Depreciation and amortization expense for the years ended December 31, 2013, 2012 and 2011 was $0.4 million, $0.6 million and $0.5 million,respectively.7. Intangible AssetThe following is a summary of the Company’s intangible asset as of December 31, 2013: EstimatedUseful Life(Years) December 31, 2013 (in thousands) Gross CarryingAmount AccumulatedAmortization Net CarryingAmount Fanapt 8 $12,000 $6,963 $5,037 73®Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) The following is a summary of the Company’s intangible asset as of December 31, 2012: EstimatedUseful Life(Years) December 31, 2012 (in thousands) Gross CarryingAmount AccumulatedAmortization Net CarryingAmount Fanapt 8 $12,000 $5,468 $6,532 In May 2009, the Company announced that the FDA had approved the NDA for Fanapt. As a result of the FDA’s approval of the NDA for Fanapt,the Company met a milestone under its original sublicense agreement with Novartis which required the Company to make a license payment of $12.0 millionto Novartis. The $12.0 million is being amortized on a straight line basis over the remaining life of the U.S. patent for Fanapt, which as of December 31,2013, the Company expected to last until May 2017. This includes the Hatch-Waxman extension that provides patent protection for drug compounds for aperiod of five years to compensate for time spent in development and a six-month pediatric term extension. Fanapt has qualified for the full five-year patentterm Hatch-Waxman extension. However, in 2014, the Company became aware of events that led it to believe that Novartis would not complete the ongoingpediatric efficacy studies in a time that would enable it to receive the incremental six-month pediatric term extension. Therefore the estimated patent life wasdecreased in 2014 by six months to November 2016. This term is the Company’s best estimate of the life of the patent. All tables in this section reflect the May2017 patent life (see Subsequent Events footnote for further information).The intangible asset is being amortized over its estimated useful economic life using the straight line method. Amortization expense was $1.5 million foreach of the years ended December 31, 2013, 2012 and 2011. The Company capitalized and began amortizing the asset immediately following the FDAapproval of the NDA for Fanapt.The following is a summary of the future intangible asset amortization schedule as of December 31, 2013: (in thousands) Total 2014 2015 2016 2017 Intangible asset $5,037 $1,495 $1,495 $1,495 $552 8. Accrued LiabilitiesThe following is a summary of the Company’s accrued liabilities as of December 31, 2013 and 2012: December 31, (in thousands) 2013 2012 Accrued research and development expenses $2,324 $3,900 Accrued consulting and other professional fees 2,015 386 Employee benefits 176 127 Accrued lease exit liability (refer to footnote 10) 59 453 Other accrued liabilities 606 321 Total accrued liabilities $5,180 $5,187 74®®®®®®Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) 9. Deferred RevenueThe following is a summary of changes in total deferred revenue for the years ended December 31, 2013, 2012 and 2011: (in thousands) Balance atBeginning ofYear Reductionsfrom LicensingRevenueRecognized Balance at Endof Year Year ended: December 31, 2013 $117,064 $26,789 $90,275 December 31, 2012 143,853 26,789 117,064 December 31, 2011 170,642 26,789 143,853 The Company entered into an amended and restated sublicense agreement with Novartis in October 2009, pursuant to which Novartis has the right tocommercialize and develop Fanapt in the U.S. and Canada. Under the amended and restated sublicense agreement, the Company received an upfrontpayment of $200.0 million in December 2009. The Company and Novartis established a Joint Steering Committee (JSC) following the effective date of theamended and restated sublicense agreement. The Company concluded that the JSC constitutes a deliverable under the amended and restated sublicenseagreement and that revenue related to the upfront payment will be recognized ratably over the term of the JSC; however, the delivery or performance has noterm as the exact length of the JSC is undefined. As a result, the Company deems the performance period of the JSC to be the life of the U.S. patent of Fanapt,which as of December 31, 2013, the Company expected to last until May 2017. This includes the Hatch-Waxman extension that provides patent protection fordrug compounds for a period of five years to compensate for time spent in development and a six-month pediatric term extension. Fanapt has qualified for thefull five-year patent term Hatch-Waxman extension. However, in 2014, the Company became aware of events that led it to believe that Novartis would notcomplete the ongoing pediatric efficacy studies in a time that would enable it to receive the incremental six-month pediatric term extension. Therefore theestimated patent life was decreased in 2014 by six months to November 2016. This term is the Company’s best estimate of the life of the patent. All tables inthis section reflect the May 2017 patent life (see Subsequent Events footnote for further information). Revenue related to the upfront payment will be recognizedratably from the date the amended and restated sublicense agreement became effective (November 2009) through the expected life of the U.S. patent forFanapt. For each of the years ended December 31, 2013, 2012 and 2011, the Company recognized revenue of $26.8 million for the license agreement.10. Commitments and ContingenciesOperating leasesThe following is a summary of the minimum annual future payments under operating leases as of December 31, 2013: Cash payments due by period (in thousands) Total 2014 2015 2016 2017 2018 After 2018 Operating leases $10,750 $1,111 $1,079 $1,106 $1,133 $1,162 $5,159 The minimum annual future payments for operating leases consists of the lease for office space for the Company’s headquarters located in Washington,D.C., which expires in 2023 and the lease exit liability for the Company’s former headquarters located in Rockville, Maryland, up to the lease termination dateof June 30, 2013.In 2011, the Company entered into an office lease with Square 54 Office Owner LLC (the Landlord) for Vanda’s current headquarters, consisting of21,400 square feet at 2200 Pennsylvania Avenue, N.W. in 75®®®®Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) Washington, D.C. (the Lease). Under the Lease, rent payments were abated for the first 12 months. The Landlord provided the Company with a cashcontribution of $1.9 million for tenant improvements that was reflected in the consolidated financial statements as an increase to capitalized leaseholdimprovements and an increase to deferred rent for the year ended December 31, 2012. Subject to the prior rights of other tenants in the building, the Companyhas the right to renew the Lease for five years following the expiration of its original term. The Company has the right to sublease or assign all or a portion ofthe premises, subject to standard conditions. The Lease may be terminated early by the Company or the Landlord upon certain conditions.As a result of the Company’s relocation from its former headquarters office space in Rockville, Maryland, to Washington, D.C., the Companyprovided notice in the fourth quarter of 2011 to the landlord that it was terminating the Rockville lease effective June 30, 2013. As a result, the Companyrecognized an expense of $0.7 million in the year ended December 31, 2011 related to a lease termination penalty. Of this amount, $0.6 million was includedas research and development expense and $0.1 million was included as general and administrative expense in the consolidated statement of operations for theyear ended December 31, 2011. In the first quarter of 2012, the Company ceased using the Rockville, Maryland, location and, as a result, recognizedadditional rent expense of $0.8 million. This $0.8 million consisted of a lease exit liability of $1.3 million for the remaining lease payments, net of reversal ofthe deferred rent liability of $0.5 million related to the Rockville lease. Of the $0.8 million, $0.6 million is included as research and development expense and$0.2 million is included as general and administrative expense in the consolidated statement of operations for the year ended December 31, 2012.The following is a summary of the Company’s lease exit activity: (in thousands) Balance at Beginningof Period Costs Incurred andCharged to Expense Costs Paid orOtherwise Settled Balance at Endof Period Year ended December 31, 2013 $453 $(10) $384 $59 Year ended December 31, 2012 740 1,220 1,507 453 Year ended December 31, 2011 — 740 — 740 Rent expense under operating leases, including lease exit costs, was $1.1 million, $2.0 million and $2.1 million for the years ended December 31, 2013,2012 and 2011, respectively.Consulting feesThe Company has engaged a regulatory consultant to assist the Company’s efforts to prepare, file and obtain FDA approval of an NDA forHETLIOZ™. As a result of the FDA acceptance of the NDA filing for HETLIOZ™ for the treatment of Non-24, the Company made a milestone payment of$0.5 million to the regulatory consultant during the year ended December 31, 2013. The payment was included as research and development expense in theconsolidated statement of operations for the year ended December 31, 2013. As a result of the FDA approval of the NDA for HETLIOZ in January 2014, theCompany is obligated to make a milestone payment of $2.0 million in the first quarter of 2014. In addition to consulting fees and milestone payments, theCompany is obligated to reimburse the consultant for ordinary and necessary business expenses incurred in connection with the engagement. The Companymay terminate the engagement at any time upon prior notice; however, subject to certain conditions, the Company would remain obligated to make themilestone payment if the milestone is achieved following such termination.Guarantees and indemnificationsThe Company has entered into a number of standard intellectual property indemnification agreements in the ordinary course of its business. Pursuant tothese agreements, the Company indemnifies, holds harmless, and agrees to reimburse the indemnified party for losses suffered or incurred by the indemnifiedparty, generally the Company’s business partners or customers, in connection with any U.S. patent or any copyright or other intellectual propertyinfringement claim by any third party with respect to the Company’s products. The term of 76™Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) these indemnification agreements is generally perpetual from the date of execution of the agreement. The maximum potential amount of future payments theCompany could be required to make under these indemnification agreements is unlimited. Since inception, the Company has not incurred costs to defendlawsuits or settle claims related to these indemnification agreements. The Company also indemnifies its officers and directors for certain events or occurrences,subject to certain conditions.License agreementsThe Company’s rights to develop and commercialize its products are subject to the terms and conditions of licenses granted to the Company by otherpharmaceutical companies.HETLIOZ™. In February 2004, the Company entered into a license agreement with Bristol-Myers Squibb (BMS) under which the Company receivedan exclusive worldwide license under certain patents and patent applications, and other licenses to intellectual property, to develop and commercializeHETLIOZ™. In partial consideration for the license, the Company paid BMS an initial license fee of $0.5 million. Pursuant to the license agreement, theCompany would be obligated to make future milestone payments to BMS of up to $37.0 million in the aggregate. The Company made a milestone payment toBMS of $1.0 million under the license agreement in 2006 relating to the initiation of its first Phase III clinical trial for HETLIOZ™. As a result of the FDAacceptance of the Company’s NDA for HETLIOZ™ for the treatment of Non-24 in July 2013, the Company incurred a $3.0 million milestone obligationunder the license agreement with BMS, which is included in research and development expense in the consolidated statement of operations for the year ended2013. As a result of the FDA approval of the NDA for HETLIOZ in January 2014, the Company is obligated to make a milestone payment of $8.0 million inthe first quarter of 2014. The Company will be obligated to make future milestone payments to BMS of up to $25.0 million in the event that sales ofHETLIOZ™ reach a certain agreed upon sales threshold. Additionally, the Company would be obligated to make royalty payments based on net sales ofHETLIOZ™ which, as a percentage of net sales, are in the low teens. The Company is also obligated under the license agreement to pay BMS a percentage ofany sublicense fees, upfront payments and milestone and other payments (excluding royalties) that the Company receives from a third party in connectionwith any sublicensing arrangement, at a rate which is in the mid-twenties. The Company has agreed with BMS in the license agreement for HETLIOZ™ touse commercially reasonable efforts to develop and commercialize HETLIOZ™ and to meet certain milestones in initiating and completing certain clinicalwork.The license agreement was amended in April 2013 to add a process that would allow BMS to waive the right to develop and commercialize HETLIOZ™in those countries not covered by a development and commercialization agreement. Subsequent to the execution of the April 2013 amendment, BMS providedthe Company with formal written notice that it irrevocably waived the option to exercise the right to reacquire any or all rights to any product (as defined in thelicense agreement) containing HETLIOZ™, or to develop or commercialize any such product, in the countries not covered by a development andcommercialization agreement.Either party may terminate the HETLIOZ™ license agreement under certain circumstances, including a material breach of the agreement by the other. Inthe event the Company terminates the license, or if BMS terminates the license due to the Company’s breach, all rights licensed and developed by theCompany under the license agreement will revert or otherwise be licensed back to BMS on an exclusive basis.Fanapt. The Company acquired exclusive worldwide rights to patents and patent applications for Fanapt (iloperidone) in 2004 through a sublicenseagreement with Novartis. A predecessor company of Sanofi, Hoechst Marion Roussel, Inc. (HMRI), discovered Fanapt and completed early clinical work onthe product. In 1996, following a review of its product portfolio, HMRI licensed its rights to the Fanapt patents and patent applications to TitanPharmaceuticals, Inc. (Titan) on an exclusive basis. In 1997, soon after it had acquired its rights, Titan sublicensed its rights to Fanapt on an exclusivebasis to Novartis. In June 2004, the Company acquired exclusive worldwide rights to these patents and patent applications, as well as certain Novartis patents 77™®®®®®Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) and patent applications to develop and commercialize Fanapt, through a sublicense agreement with Novartis. In partial consideration for this sublicense, theCompany paid Novartis an initial license fee of $0.5 million and was obligated to make future milestone payments to Novartis of less than $100.0 million inthe aggregate (the majority of which were tied to sales milestones), as well as royalty payments to Novartis at a rate which, as a percentage of net sales, was inthe mid-twenties. As a result of the FDA’s approval of the NDA for Fanapt in May 2009, the Company met an additional milestone under the sublicenseagreement, which required the Company to make a payment of $12.0 million to Novartis.In October 2009, Vanda entered into an amended and restated sublicense agreement with Novartis, which amended and restated the June 2004 sublicenseagreement. Pursuant to the amended and restated sublicense agreement, Novartis has exclusive commercialization rights to all formulations of Fanapt in theU.S. and Canada. Novartis began selling Fanapt in the U.S. during the first quarter of 2010. Novartis is responsible for the further clinical developmentactivities in the U.S. and Canada. The Company does not expect Novartis to commercialize Fanapt in Canada. Pursuant to the amended and restatedsublicense agreement, Vanda received an upfront payment of $200.0 million and is eligible for additional payments totaling up to $265.0 million uponNovartis’ achievement of certain commercial and development milestones for Fanapt in the U.S. and Canada. Based on the current sales performance ofFanapt in the U.S., Vanda expects that some or all of these commercial and development milestones will not be achieved by Novartis. Vanda also receivesroyalties, which, as a percentage of net sales, are in the low double-digits, on net sales of Fanapt in the U.S. and Canada. Vanda retains exclusive rights toFanapt outside the U.S. and Canada and Vanda has exclusive rights to use any of Novartis’ data for Fanapt for developing and commercializing Fanaptoutside the U.S. and Canada. At Novartis’ option, Vanda will enter into good faith discussions with Novartis relating to the co-commercialization of Fanaptoutside of the U.S. and Canada or, alternatively, Novartis will receive a royalty on net sales of Fanapt outside of the U.S. and Canada. Novartis has chosennot to co-commercialize Fanapt with Vanda in Europe and certain other countries and will instead receive a royalty on net sales in those countries. Theseinclude, but are not limited to, the countries in the European Union as well as Switzerland, Norway, Liechtenstein and Iceland. Vanda has entered intoagreements with the following partners for the commercialization of Fanapt in the countries set forth below: Country PartnerMexico Probiomed S.A. de C.V.Israel Megapharm Ltd.In August 2012, the Israeli Ministry of Health granted market approval for Fanapt for the treatment of schizophrenia. In November 2012, Vanda wasnotified that Fanapt had been granted market approval in Argentina for the treatment of schizophrenia. In October 2013, the Mexican Federal Commission forProtection Against Sanitary Risks (COFEPRIS) granted market approval for Fanapt for the treatment of schizophrenia.VLY-686. In April 2012, the Company entered into a license agreement with Eli Lilly and Company (Lilly) pursuant to which the Company acquired anexclusive worldwide license under certain patents and patent applications, and other licenses to intellectual property, to develop and commercialize an NK-1Rantagonist, VLY-686, for all human indications. The patent describing VLY-686 as a new chemical entity expires in April 2023, except in the U.S., where itexpires in June 2024 absent any applicable patent term adjustments.Pursuant to the license agreement, the Company paid Lilly an initial license fee of $1.0 million and will be responsible for all development costs. Theinitial license fee was recognized as research and development expense in the consolidated statement of operations for the year ended December 31, 2012. Lillyis also eligible to receive additional payments based upon achievement of specified development and commercialization milestones as well as tiered-royalties onnet sales at percentage rates up to the low double digits. These milestones include $4.0 million for pre-NDA approval milestones and up to $95.0 million forfuture regulatory approval and sales milestones. Vanda is obligated to use its commercially reasonable efforts to develop and commercialize VLY-686. 78®®®®®®®®®®®®®®®®®®Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) Either party may terminate the license agreement under certain circumstances, including a material breach of the license agreement by the other. In theevent that Vanda terminates the license agreement, or if Lilly terminates due to Vanda’s breach or for certain other reasons set forth in the license agreement, allrights licensed and developed by Vanda under the license agreement will revert or otherwise be licensed back to Lilly on an exclusive basis, subject to paymentby Lilly to the Company of a royalty on net sales of products that contain VLY-686.Future milestone payments. No amounts were recorded as liabilities nor were any future contractual obligations relating to the license agreementsincluded in the consolidated financial statements as of December 31, 2013 because the criteria for recording the future milestone payments have not yet beenmet. These criteria include the successful outcome of future clinical trials, regulatory filings, favorable FDA regulatory approvals, growth in product sales andother factors.Research and development and marketing agreementsIn the course of its business, the Company regularly enters into agreements with clinical organizations to provide services relating to clinical developmentand clinical manufacturing activities under fee service arrangements. The Company’s current agreements for clinical services may be terminated on at most 60days’ notice without incurring additional charges, other than charges for work completed but not paid for through the effective date of termination and othercosts incurred by the Company’s contractors in closing out work in progress as of the effective date of termination.11. Income TaxesAs of December 31, 2013 and 2012, the Company has provided a valuation allowance for the full amount of its net deferred tax asset since realization ofany future benefit from deductible temporary differences and NOLs could not be sufficiently assured.The following is a summary of the Company’s current and deferred income tax provision (benefit) for years ended December 31, 2013, 2012 and 2011: Year Ended December 31, (in thousands) 2013 2012 2011 Current income tax expense (benefit): Federal $— $— $(1,114) State — — (1,151) Deferred income tax expense (benefit): Federal — — 1,821 State — — — Total income tax expense (benefit) $— $— $(444) 79Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) The following is a reconciliation between the Company’s statutory tax rate and effective tax rate for the years ended December 31, 2013, 2012 and 2011: Year Ended December 31, 2013 2012 2011 Federal tax at statutory rate (34.0)% (34.0)% (34.0)% State taxes (4.0)% (3.3)% (5.3)% Change in valuation allowance 43.9% 70.3% 101.1% Research and development credit (1.1)% 0.8% (4.6)% Orphan drug credit (22.7)% (30.3)% (60.4)% Stock options —% 1.4% (0.2)% Section 162(m) limitation 1.2% —% —% Tax rate change (0.3)% (7.0)% —% Change in Maryland NOL 18.5% —% —% Other non-deductible items (1.5)% 2.1% (0.9)% Effective tax rate —% —% (4.3)% During the year ended December 31, 2011, the Company received approval for a change in accounting method from the Internal Revenue Service (the“IRS”). The Company originally treated certain expenses as start-up expenditures under Section 195 of the Internal Revenue Code of 1986, as amended (the“IRC”) and requested a change in this accounting method to re-characterize the expenditures as trade or business expenses under IRC Section 162. As a resultthe Company was able to deduct $53.8 million, which resulted in the Company not needing to utilize NOL carryforwards and research and developmentcredits in the year ended December 31, 2010. In the year ended December 31, 2011, the Company reflected a benefit in the statement of operations in theamount of $0.4 million. The benefit recognized in the year ended December 31, 2011 was from the reduction in income tax expense for the year endedDecember 31, 2010, due to the change in accounting method. As a result the Company has reestablished NOL carryforwards and credits in its deferred taxassets that are fully offset by a tax valuation allowance.The following is a summary of the components of the Company’s deferred tax assets, net, and the related valuation allowance as of December 31, 2013and 2012: December 31, (in thousands) 2013 2012 Deferred tax assets: Net operating loss carryforwards $48,206 $38,840 Stock-based compensation 17,626 17,348 Deferred revenue 36,670 47,509 Accrued and deferred expenses 566 522 Research and development and orphan drug credit carryforwards 38,597 31,302 Depreciation and amortization, net 110 28 Total deferred tax assets 141,775 135,549 Deferred tax liabilities: Licensing agreements (616) (2,273) Unrealized gain on available for sale securities (9) (4) Total deferred tax liabilities (625) (2,277) Deferred tax assets 141,150 133,272 Valuation allowance (141,150) (133,272) Net deferred tax assets $— $— 80Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) The fact that the Company has historically generated NOLs serves as strong evidence that it is more likely than not that deferred tax assets will not berealized in the future. Therefore, the Company has a full valuation allowance against all deferred tax assets as of December 31, 2013 and 2012. The netincrease in the tax valuation allowance was $7.9 million, $19.4 million and $10.3 million for the years ended December 31, 2013, 2012 and 2011,respectively.As of December 31, 2013, the Company had federal NOL carryforwards of $130.6 million, state NOL carryforwards of $140.2 million, which include$1.3 million of excess windfall benefits generated from stock options. The Company also has research and development credits of $6.4 million and orphandrug carryforward credits of $32.2 million. These NOL carryforwards and credits will begin to expire in 2028 and 2024, respectively.Because the Company has generated NOLs from inception through December, 31, 2013, all income tax returns filed by the Company are open toexamination by tax jurisdictions. As of December 31, 2013, the Company’s income tax returns have not been under examination by any federal or state taxjurisdictions.The Company’s tax attributes, including NOLs and credits, are subject to any ownership changes as defined under IRC Section 382. A change inownership could affect the Company’s ability to use its NOLs and credit carryforwards. An ownership change did occur as of December 31, 2008. However,the Company had sufficient Built-In-Gain to offset the IRC Section 382 limitation as well as any remaining NOL carryforwards generated as of the ownershipchange. As of December 31, 2013, the Company does not believe that an additional ownership change has occurred. Any future ownership changes may causethe Company’s existing tax attributes to have additional limitations.As of December 31, 2013 and 2012, the Company had no uncertain tax positions.12. Fair Value MeasurementsAuthoritative guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: • Level 1 — defined as observable inputs such as quoted prices in active markets • Level 2 — defined as inputs other than quoted prices in active markets that are either directly or indirectly observable • Level 3 — defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptionsMarketable securities classified in Level 1 and Level 2 at December 31, 2013 and 2012 are available-for-sale marketable securities. The valuation ofLevel 1 instruments is determined using a market approach, and is based upon unadjusted quoted prices for identical assets in active markets. The valuationof investments classified in Level 2 also is determined using a market approach based upon quoted prices for similar assets in active markets, or other inputsthat are observable for substantially the full term of the financial instrument. Level 2 securities include certificates of deposit, commercial paper, corporatenotes and U.S. government agency notes that use as their basis readily observable market parameters.As of December 31, 2013, the Company held certain assets that are required to be measured at fair value on a recurring basis, as follows: Fair Value Measurements at Reporting Date Using (in thousands) December 31,2013 Quoted Prices inActive markets forIdentical Assets(Level 1) Significant OtherObservable Inputs(Level 2) SignificantUnobservableInputs(Level 3) Description: Available-for-sale securities $65,586 $31,566 $34,020 $— 81Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) As of December 31, 2012, the Company held certain assets that are required to be measured at fair value on a recurring basis, as follows: Fair Value Measurements at Reporting Date Using (in thousands) December 31,2012 Quoted Prices inActive marketsfor Identical Assets(Level 1) Significant OtherObservable Inputs(Level 2) SignificantUnobservableInputs (Level 3) Description: Available-for-sale securities $31,631 $14,442 $17,189 $— The Company also has financial assets and liabilities, not required to be measured at fair value on a recurring basis, which primarily consist of cashand cash equivalents, accounts receivable, restricted cash, accounts payable and accrued liabilities, the carrying value of which materially approximate theirfair values. During the years ended December 31, 2013 and 2012, there were no transfers between Level 1 and Level 2 of the fair value hierarchy.13. Restricted CashThe following is a summary of the Company’s restricted cash used to collateralize various letters of credit as of December 31, 2013 and 2012: December 31, (in thousands) 2013 2012 Current: Rockville, Maryland office lease $430 $430 Maryland Board of Pharmacy license 100 — Total current $530 $430 Non-current: Washington, D.C. office lease $500 $500 Maryland Board of Pharmacy license — 100 Total non-current $500 $600 14. Public Offering of Common StockIn August 2013, the Company completed a public offering of 4,680,000 shares of common stock at a price to the public of $11.14 per share. Net cashproceeds from the public offering were $48.5 million, after deducting the underwriting discounts and commissions and offering expenses.15. Equity Incentive PlansAs of December 31, 2013, the Company had two equity incentive plans, the Second Amended and Restated Management Equity Plan (the 2004 Plan)and the 2006 Equity Incentive Plan (the 2006 Plan) that were adopted in December 2004 and April 2006, respectively. An aggregate of 670,744 shares weresubject to outstanding options granted under the 2004 Plan as of December 31, 2013, and no additional options will be granted under this plan. As ofDecember 31, 2013, there were 8,995,930 shares of the Company’s common stock reserved for issuance under the 2006 Plan, of which 6,417,308 shareswere subject to outstanding options and RSUs granted to employees and non-employees and 1,029,399 shares remained available for future grant. OnJanuary 1 of each year, the number of shares reserved under the 2006 Plan is automatically increased by 4% of the total number of shares of common stockthat are outstanding at that time, or, if less, by 1,500,000 shares (or such lesser number 82Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) as may be approved by the Company’s board of directors). As of January 1, 2014, the number of shares of common stock that may be issued under the 2006Plan was automatically increased by 1,333,542 shares, representing 4% of the total number of shares of common stock outstanding on January 1, 2014,increasing the number of shares of common stock available for issuance under the Plan to 10,329,472 shares.The Company has granted option awards with service conditions (service option awards) that are subject to terms and conditions established by thecompensation committee of the board of directors. Service option awards have 10-year contractual terms and all service option awards granted prior toDecember 31, 2006, service option awards granted to new employees, and certain service option awards granted to existing employees vest and becomeexercisable on the first anniversary of the grant date with respect to the 25% of the shares subject to service option awards. The remaining 75% of the sharessubject to the service option awards vest and become exercisable monthly in equal installments thereafter over three years. Certain service option awardsgranted to existing employees after December 31, 2006 vest and become exercisable monthly in equal installments over four years. The initial service optionawards granted to directors upon their election vest and become exercisable in equal monthly installments over a period of four years, while the subsequentannual service option awards granted to directors vest and become exercisable in equal monthly installments over a period of one year. Certain service optionawards to executives and directors provide for accelerated vesting if there is a change in control of the Company. Certain service option awards to employeesand executives provide for accelerated vesting if the respective employee’s or executive’s service is terminated by the Company for any reason other than causeor permanent disability. As of December 31, 2013, $7.3 million of unrecognized compensation costs related to unvested service option awards are expected tobe recognized over a weighted average period of 2.0 years. No option awards are classified as a liability as of December 31, 2013.The following is a summary of option activity for the 2004 Plan for the years ended December 31, 2013, 2012, and 2011: (in thousands, except for share and per share amounts) Number ofShares Weighted AverageExercise Price atGrant Date Weighted AverageRemaining Term(Years) AggregateIntrinsic Value Outstanding at December 31, 2010 680,754 $1.77 4.77 $5,232 Exercised (3,609) 0.33 22 Outstanding at December 31, 2011 677,145 1.78 3.78 2,016 Exercised (5,000) 0.33 14 Outstanding at December 31, 2012 672,145 1.79 2.78 1,512 Expired (115) 4.73 Exercised (1,286) 3.67 Outstanding at December 31, 2013 670,744 1.79 1.78 7,124 Exercisable at December 31, 2013 670,744 1.79 1.78 7,124 There are no options expected to vest as of December 31, 2013 under the 2004 Plan, given that the Company stopped issuing options from this plan in2006. 83Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) The following is a summary of option activity for the 2006 Plan for the years ended December 31, 2013, 2012, and 2011: (in thousands, except for share and per share amounts) Number ofShares Weighted AverageExercise Price atGrant Date Weighted AverageRemaining Term(Years) AggregateIntrinsic Value Outstanding at December 31, 2010 3,324,790 $14.07 8.01 $3,426 Granted 982,000 5.55 Forfeited (26,764) 9.24 Expired (15,369) 13.51 Exercised (9,976) 2.38 37 Outstanding at December 31, 2011 4,254,681 12.16 7.65 396 Granted 846,000 3.42 Forfeited (149,091) 7.50 Expired (76,103) 10.68 Exercised (10,000) 1.02 22 Outstanding at December 31, 2012 4,865,487 10.83 7.15 634 Granted 1,245,500 10.18 Forfeited (54,226) 6.14 Expired (259,295) 10.65 Exercised (263,848) 5.86 1,545 Outstanding at December 31, 2013 5,533,618 10.98 6.93 21,264 Exercisable at December 31, 2013 3,411,214 12.90 5.58 11,673 Expected to vest at December 31, 2013 2,025,061 7.83 9.07 9,291 Proceeds from the exercise of stock options amounted to $1.6 million, $0.01 million and $0.03 million for the years ended December 31, 2013, 2012and 2011, respectively.An RSU is a stock award that entitles the holder to receive shares of the Company’s common stock as the award vests. The fair value of each RSU isbased on the closing price of the Company’s stock on the date of grant. The Company has granted RSUs with service conditions (service RSUs) that vest infour equal annual installments provided that the employee remains employed with the Company. As of December 31, 2013, $5.4 million of unrecognizedcompensation costs related to unvested service RSUs are expected to be recognized over a weighted average period of 2.2 years. No service RSUs are classifiedas a liability as of December 31, 2013. 84Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) The following is a summary of RSU activity for the 2006 Plan for the years ended December 31, 2013, 2012, and 2011: (in thousands, except for share and per share amounts) Number ofShares Weighted AverageGrant Date FairValue Unvested at December 31, 2010 359,563 $9.75 Granted 283,000 5.39 Vested (2,500) 0.80 Vested and unissued (109,717) 9.74 Forfeited (8,000) 9.57 Unvested at December 31, 2011 522,346 7.43 Granted 245,000 3.28 Forfeited (61,970) 7.64 Unvested at December 31, 2012 705,376 5.91 Granted 400,500 10.29 Forfeited (21,000) 6.41 Vested (201,186) 6.71 Unvested at December 31, 2013 883,690 7.70 The vesting date fair value for the 201,186 shares underlying RSUs that vested during the year ended December 31, 2013 was $1.3 million. In order forcertain employees to satisfy the minimum statutory employee tax withholding requirements related to the issuance of common stock underlying certain RSUsthat vested and settled during the year ended December 31, 2013, the Company withheld 49,520 shares of common stock and paid employee payrollwithholding taxes of $0.2 million relating to the vesting and settlement of the RSUs.16. Employee Benefit PlanThe Company has a defined contribution plan under the Internal Revenue Code Section 401(k). This plan covers substantially all employees who meetminimum age and service requirements and allows participants to defer a portion of their annual compensation on a pre-tax basis. Currently, the Companymatches 50 percent up to the first six percent of employee contributions. All matching contributions have been paid by the Company. The Company matchvests over a 4 year period. The total Company match was $0.2 million for the year ended December 31, 2013 and $0.1 million for each of the years endedDecember 31, 2012 and 2011.17. Legal MattersOn June 24, 2013, a securities class action complaint was filed in the United States District Court for the District of Columbia, naming the Companyand certain of its officers as defendants. The complaint, filed purportedly on behalf of a class of stockholders of the Company, sought to assert violations ofSection 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, in connection with allegedly false and misleadingstatements and alleged omissions regarding the Company’s Phase III trial results for HETLIOZ™ and other disclosures between December 18, 2012 andJune 18, 2013 (the “Class Period”). The plaintiff sought to represent a class comprised of purchasers of the Company’s common stock during the ClassPeriod and sought damages, costs and expenses, and such other relief as determined by the Court. A similar complaint was filed on July 8, 2013. OnDecember 4, 2013, the court consolidated the two pending actions and appointed lead plaintiff and lead counsel. On February 3, 2014, the complaint wasvoluntarily dismissed with prejudice by the lead plaintiff. 85Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) 18. Subsequent EventsOn January 31, 2014, the FDA approved Vanda’s NDA for HETLIOZ™ for the treatment of Non-24. As a result of achieving this regulatory milestone,the Company incurred additional milestone obligations, including an $8.0 million cash milestone obligation under its license agreement with BMS that will becapitalized and amortized as an intangible asset and a $2.0 million cash milestone obligation under a regulatory consulting agreement that will be charged toresearch and development expense. These amounts are not reflected in the balance sheet or statement of operations as of December 31, 2013.In 2014, the Company became aware of events that led it to believe that Novartis would not complete the ongoing pediatric efficacy studies in a time thatwould enable it to receive the incremental six-month pediatric term extension. This will result in a six-month reduction to the estimated patent life of Fanaptfrom May 2017 to November 2016. The Company previously expected to recognize amortization expenses of $1.5 million in each of the years from 2014 to2016 and $0.6 million in 2017. The Company now expects to recognize $1.7 million in each of 2014 and 2015 and $1.6 million in 2016. Additionally, theCompany previously expected to recognize deferred revenue of $26.8 million in each of the years from 2014 to 2016 and $9.9 million in 2017. The Companywill now recognize deferred revenue of $30.7 million, $31.1 million and $28.5 million in the years 2014, 2015, and 2016, respectively.19. Quarterly Financial Data (unaudited) (in thousands, except for per share amounts) FirstQuarter SecondQuarter ThirdQuarter FourthQuarter 2013 Revenue $8,068 $8,319 $8,709 $8,783 Loss from operations (4,219) (3,109) (5,405) (7,667) Net loss (4,173) (3,079) (5,380) (7,623) Net loss per share: Basic $(0.15) $(0.11) $(0.17) $(0.23) Diluted $(0.15) $(0.11) $(0.17) $(0.23) 2012 Revenue $8,141 $8,378 $8,288 $7,920 Loss from operations (8,317) (8,085) (5,395) (6,428) Net loss (7,962) (8,007) (5,326) (6,369) Net loss per share: Basic $(0.28) $(0.28) $(0.19) $(0.23) Diluted $(0.28) $(0.28) $(0.19) $(0.23) 86®Table of ContentsVANDA PHARMACEUTICALS INC.EXHIBITS ExhibitNumber Description 3.8 Form of Amended and Restated Certificate of Incorporation of the registrant (filed as Exhibit 3.8 to Amendment No. 2 to the registrant’sRegistration Statement on Form S-1 (File No. 333-130759), as filed on March 17, 2006, and incorporated herein by reference). 3.10 Form of Certificate of Designation of Series A Junior Participating Preferred Stock (filed as Exhibit 3.10 to the registrant’s current report onForm 8-K (File No. 001-34186) as filed on September 25, 2008 and incorporated herein by reference). 3.11 Second Amended and Restated Bylaws of the registrant, as amended and restated on December 16, 2008 (filed as Exhibit 3.11 to theregistrant’s current report on Form 8-K (File No. 001-34186) as filed on December 17, 2008 and incorporated herein by reference). 4.1 2004 Securityholder Agreement (as amended) (filed as Exhibit 4.1 to the registrant’s Registration Statement on Form S-1 (File No. 333-130759), as originally filed on December 29, 2005, and incorporated herein by reference). 4.4 Specimen certificate representing the common stock of the registrant (filed as Exhibit 4.4 to Amendment No. 2 to the registrant’s RegistrationStatement on Form S-1 (File No. 333-130759), as filed on March 17, 2006, and incorporated herein by reference). 4.5 Rights Agreement, dated as of September 25, 2008, between the registrant and American Stock Transfer & Trust Company, LLC, asRights Agent (filed as Exhibit 4.5 to the registrant’s current report on Form 8-K (File No. 001-34186) as filed on September 25, 2008 andincorporated herein by reference). 4.6 Amendment to Rights Agreement, dated as of December 22, 2009, between the registrant and American Stock Transfer & Trust Company,LLC, as Rights Agent (filed as Exhibit 4.6 to the registrant’s current report on Form 8-K (File No. 001-34186) as filed on December 22,2009 and incorporated herein by reference).10.1 Registrant’s Second Amended and Restated Management Equity Plan (filed as Exhibit 10.1 to the registrant’s Registration Statement onForm S-1 (File No. 333-130759), as originally filed on December 29, 2005, and incorporated herein by reference).10.2# Sublicense Agreement between the registrant and Novartis Pharma AG dated June 4, 2004 (as amended) (relating to Fanapt) (filed asExhibit 10.2 to Amendment No. 1 to the registrant’s Registration Statement on Form S-1 (File No. 333-130759), as filed on February 16,2006, and incorporated herein by reference).10.3# Amended and Restated License, Development and Commercialization Agreement by and between Bristol-Myers Squibb Company and theregistrant dated July 24, 2005 (relating to HETLIOZ™) (filed as Exhibit 10.3 to Amendment No. 1 to the registrant’s Registration Statementon Form S-1 (File No. 333-130759), as filed on February 16, 2006, and incorporated herein by reference).10.7 Lease Agreement between the registrant and Red Gate III LLC dated June 25, 2003 (lease of Rockville, MD office space) (filed as Exhibit10.7 to the registrant’s Registration Statement on Form S-1 (File No. 333-130759), as originally filed on December 29, 2005, andincorporated herein by reference).10.8 Amendment to Lease Agreement between the registrant and Red Gate III LLC dated September 27, 2003 (filed as Exhibit 10.8 to theregistrant’s Registration Statement on Form S-1 (File No. 333-130759), as originally filed on December 29, 2005, and incorporated hereinby reference). 87®Table of ContentsExhibitNumber Description10.9 Lease Agreement between the registrant and MCC3 LLC (by Spaulding and Slye LLC) dated August 4, 2005 (filed as Exhibit 10.9 to theregistrant’s Registration Statement on Form S-1 (File No. 333-130759), as originally filed on December 29, 2005, and incorporated hereinby reference).10.10 Summary Plan Description provided for the registrant’s 401(k) Profit Sharing Plan & Trust (filed as Exhibit 10.10 to the registrant’sRegistration Statement on Form S-1 (File No. 333-130759), as originally filed on December 29, 2005, and incorporated herein byreference).10.11 Form of Indemnification Agreement entered into by directors (filed as Exhibit 10.11 to the registrant’s Registration Statement on Form S-1(File No. 333-130759), as originally filed on December 29, 2005, and incorporated herein by reference).10.17 2006 Equity Incentive Plan (filed as Exhibit 10.17 to Amendment No. 2 to the registrant’s Registration Statement on Form S-1 (File No. 333-130759), as filed on March 17, 2006, and incorporated herein by reference).10.19 Amendment to Lease Agreement between the registrant and MCC3 LLC (by Spaulding and Slye LLC) dated November 15, 2006 (filed asExhibit 10.19 to the registrant’s annual report on Form 10-K (File No. 000-51863) for the year ending December 31, 2006 and incorporatedherein by reference).10.20 Form of Tax Indemnity Agreement (filed as Exhibit 10.20 to the registrant’s quarterly report on Form 10-Q (File No. 000-51863) for theperiod ending September 30, 2007 and incorporated herein by reference).10.22 Second Amendment to Lease Agreement between the registrant and MCC3 LLC (by Spaulding and Slye MCC3 LLC) dated September 14,2007 (filed as Exhibit 10.22 to the registrant’s annual report on Form 10-K (File No. 000-51863) for the year ending December 31, 2007and incorporated herein by reference).10.34 Amended and Restated Employment Agreement for Mihael H. Polymeropoulos dated December 16, 2008 (filed as Exhibit 10.34 to theregistrant’s quarterly report on Form 10-Q (File No. 001-34186) for the quarter ending June 30, 2009 and incorporated herein by reference).10.36 Employment Agreement for John Feeney dated May 22, 2009 (filed as Exhibit 10.36 to the registrant’s quarterly report on Form 10-Q (FileNo. 001-34186) for the quarter ending June 30, 2009 and incorporated herein by reference).10.37# Amended and Restated Sublicense Agreement between the registrant and Novartis Pharma AG dated October 12, 2009 (relating to Fanapt)(filed as Exhibit 10.37 to the registrant’s annual report on Form 10-K for the year ending December 31, 2009 and incorporated herein byreference).10.38 Employment Agreement for James Kelly dated December 13, 2010 (filed as Exhibit 10.38 to the registrant’s annual report on Form 10-K forthe year ending December 31, 2010 and incorporated herein by reference).10.39 Amendment dated December 16, 2010 to Amended and Restated Employment Agreement for Mihael H. Polymeropoulos dated December16, 2008 (filed as Exhibit 10.39 to the registrant’s annual report on Form 10-K for the year ending December 31, 2010 and incorporatedherein by reference).10.40 Amendment dated December 16, 2010 to Employment Agreement for John Feeney dated May 22, 2009 (filed as Exhibit 10.39 to theregistrant’s annual report on Form 10-K for the year ending December 31, 2010 and incorporated herein by reference). 88®Table of ContentsExhibitNumber Description10.41 Amended and Restated Tax Indemnity Agreement dated December 16, 2010 by and between the Registrant and Mihael H. Polymeropoulos(filed as Exhibit 10.41 to the registrant’s annual report on Form 10-K for the year ending December 31, 2010 and incorporated herein byreference).10.42 Lease effective as of July 25, 2011 by and between Registrant and Square 54 Office Owner LLC filed as Exhibit 10.42 to the registrant’squarterly report on Form 10-Q for the quarter ending September 31, 2011 and incorporated herein by reference).10.43 Employment Agreement for Robert Repella dated October 24, 2011 (filed as Exhibit 10.43 to the registrant’s annual report on Form 10-K forthe year ended December 31, 2011 and incorporated herein by reference).10.44 Form of Notice of Stock Option Grant and Stock Option Agreement under 2006 Equity Incentive Plan 2011 (filed as Exhibit 10.44 to theregistrant’s annual report on Form 10-K for the year ended December 31, 2011 and incorporated herein by reference).10.45 Form of Restricted Stock Unit Award Agreement under 2006 Equity Incentive Plan 2011 (filed as Exhibit 10.45 to the registrant’s annualreport on Form 10-K for the year ended December 31, 2011 and incorporated herein by reference).10.46 Amendment to Amended and Restated License, Development and Commercialization Agreement, dated as of April 15, 2010 (filed asExhibit 10.38 to the registrant’s current report on Form 8-K filed on April 19, 2010 and incorporated herein by reference).10.47 Amendment to Amended and Restated License, Development and Commercialization Agreement, dated as of May 24, 2012, by andbetween the Registrant and Bristol-Myers Squibb Company (filed as Exhibit 10.46 to the registrant’s current report on Form 8-K filed onMay 30, 2012 and incorporated herein by reference).10.48# License, Development and Commercialization Agreement, dated as of April 12, 2012, by and between Eli Lilly and Company and theRegistrant (filed as Exhibit 10.48 to the registrant’s quarterly report on Form 10-Q for the quarter ended June 30, 2012 and incorporatedherein by reference).10.49 Separation and Release Agreement for John Feeney, M.D., dated as of September 18, 2012 (filed as Exhibit 10.49 to the registrant’squarterly report on Form 10-Q for the quarter ended September 30, 2012 and incorporated herein by reference).10.50 Amendment to Amended and Restated License, Development and Commercialization Agreement, dated as of April 25, 2013, by andbetween the Registrant and Bristol-Myers Squibb Company (filed as Exhibit 10.50 to the registrant’s current report on Form 8-K filed onApril 29, 2013 and incorporated herein by reference).10.51 Employment Agreement, dated as of April 15, 2013, by and between the Registrant and Paolo Baroldi (filed as Exhibit 10.51 to theregistrant’s quarterly report on Form 10-Q for the quarter ended June 30, 2013 and incorporated herein by reference).10.52 Separation and Release Agreement for Robert Repella dated as of December 2, 2013.23.1 Consent of PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm.31.1 Certification of the Chief Executive Officer, as required by Section 302 of the Sarbanes-Oxley Act of 2002.31.2 Certification of the Chief Financial Officer as required by Section 302 of the Sarbanes-Oxley Act of 2002. 89Table of ContentsExhibitNumber Description32.1 Certification of the Chief Executive Officer and Chief Financial Officer as required by Section 906 of the Sarbanes-Oxley Act of 2002.101 The following financial information from this annual report on Form 10-K for the fiscal year ended December 31, 2013, formatted inXBRL (eXtensible Business Reporting Language) and furnished electronically herewith: (i) Consolidated Balance Sheets as of December31, 2013 and December 31, 2012; (ii) Consolidated Statements of Operations for the years ended December 31, 2013, 2012 and 2011;(iii) Consolidated Statements of Comprehensive Loss for the years ended December 31, 2013, 2012 and 2011; (iv) ConsolidatedStatements of Changes in Stockholders’ Equity for the years ended December 31, 2013, 2012 and 2011; (v) Consolidated Statements ofCash Flows for the years ended December 31, 2013, 2012 and 2011; and (vi) Notes to the Consolidated Financial Statements. #Confidential treatment has been granted with respect to certain provisions of this exhibit. 90Table of ContentsVANDA PHARMACEUTICALS INC.EXHIBIT INDEX ExhibitNumber Description10.52 Separation and Release Agreement for Robert Repella dated as of December 2, 2013. 23.1 Consent of PricewaterhouseCoopers LLP, Independent Registered Public Accounting Firm 31.1 Certification of the Chief Executive Officer, as required by Section 302 of the Sarbanes-Oxley Act of 2002 31.2 Certification of the Chief Financial Officer as required by Section 302 of the Sarbanes-Oxley Act of 2002 32.1 Certification of the Chief Executive Officer and Chief Financial Officer as required by Section 906 of the Sarbanes-Oxley Act of 2002101 The following financial information from this annual report on Form 10-K for the fiscal year ended December 31, 2013, formatted in XBRL(eXtensible Business Reporting Language) and furnished electronically herewith: (i) Consolidated Balance Sheets as of December 31, 2013and December 31, 2012; (ii) Consolidated Statements of Operations for the years ended December 31, 2013, 2012 and 2011; (iii)Consolidated Statements of Comprehensive Loss for the years ended December 31, 2013, 2012 and 2011; (iv) Consolidated Statements ofChanges in Stockholders’ Equity for the years ended December 31, 2013, 2012 and 2011; (v) Consolidated Statements of Cash Flows for theyears ended December 31, 2013, 2012 and 2011; and (vi) Notes to the Consolidated Financial Statements 91EXHIBIT 10.52VANDA PHARMACEUTICALS INC.December 2, 2013Dear Bob:This letter (the “Agreement”) confirms the agreement between you and Vanda Pharmaceuticals Inc. (the “Company”) regarding the termination ofyour employment with the Company.1. Termination Date. Your employment with the Company will continue until it terminates on January 1, 2014 (the “Termination Date”). Duringthe remainder of your employment with the Company, the Company will continue to pay you your current base salary and provide you all employee benefitsto which you are entitled. You agree that during the remainder of your employment with the Company: you will not enter the Company’s office unless you arerequested to do so by the Chief Executive Officer of the Company; you will not communicate in any manner with any director, officer or employee of theCompany unless you are requested to do so by the Chief Executive Officer of the Company; you will not engage in any conduct detrimental to the best interestsof the Company; and you will make yourself reasonably available to the Company to address Company-related matters.2. Effective Date and Revocation. You have up to 21 days after you receive this Agreement to review it (the “Release Deadline”). You are advisedto consult an attorney of your own choosing (at your own expense) before signing this Agreement. Furthermore, you have up to seven days after you sign thisAgreement to revoke it. If you wish to revoke this Agreement after signing it, you may do so by delivering a letter of revocation to me. If you do not revoke thisAgreement, the eighth day after the date you sign it will be the “Effective Date.” Because of the seven-day revocation period, no part of this Agreement willbecome effective or enforceable until the Effective Date.3. Salary and Vacation Pay. The Company will pay you all of your salary earned through the Termination Date and all of your accrued butunused vacation time (less all applicable withholding taxes and other deductions). You will receive this payment on the day following the TerminationDate. You acknowledge that the only payments and benefits that you are entitled to receive from the Company in the future are those specified in thisAgreement.4. Severance Pay. Pursuant to Section 6 of your Employment Agreement with the Company dated October 24, 2011 (the “EmploymentAgreement”), if you sign this Agreement by the Release Deadline, and do not revoke, this Agreement, the Company will: (a) pay you an amount equal to yourcurrent base monthly salary of $30,666.67 (less all applicable withholding taxes) for twelve (12) months following the Termination Date and such severancepay shall be paid to you in accordance with the Company’s standard payroll procedures, starting on the Company’s first payroll date that occurs on orfollowing the 61st day after the TerminationPage 2 Date (the aggregate amount of these severance payments is equal to $368,000 (less all applicable withholding taxes)) and once said payments commence, theyshall be retroactive to the Termination Date and; (b) pay you a lump sum payment of $147,200, less all applicable withholdings, which equals your currentAnnual Target Bonus (as defined in the Employment Agreement) and such amount shall be payable to you on the Company’s first payroll date that occurs onor following the 61st day after the Termination Date. If you breach any provision of this Agreement, you understand that no unpaid severance payments willbe made to you; however, in such event this Agreement shall remain in full force and effect.5. COBRA Premiums. You will receive information about your right to continue your group health insurance coverage under the ConsolidatedOmnibus Budget Reconciliation Act (“COBRA”) after the Termination Date. In order to continue your coverage, you must file the required election form.Pursuant to Section 6 of the Employment Agreement, if you sign, and do not revoke, this Agreement and elect to continue group health insurance coverage, theCompany will pay your monthly premium under COBRA for you and, if applicable, for your dependents until the earliest of (a) the end of the period oftwelve (12) months following the month in which the Termination Date occurs, (b) the expiration of your continuation coverage under COBRA or (c) the datewhen you are offered substantially equivalent health insurance in connection with new employment or self-employment. You acknowledge that the paymentsprovided for in this Section 5 may be considered taxable income to you.6. Additional Option Vesting and Extension of Exercise Period. The Company granted you one or more options to purchase shares of itsCommon Stock, as set forth in the report attached hereto as Exhibit A (the “Options”). As of the Termination Date, you would have been vested in the numberof shares set forth in Exhibit A. If you sign, and do not revoke, this Agreement, you will become vested in additional shares as set forth in Exhibit A, effectiveas of the date immediately prior to the Termination Date. By their original terms, the Options would have been exercisable with respect to the vested shares atany time until the date three months after the Termination Date. If you sign, and do not revoke, this Agreement, the Company will extend the post-terminationexercise period applicable to the original vested shares and the additional vested shares at any time that occurs (a) after the Effective Date and (b) not more thansix (6) months after the Termination Date. The Options will expire with respect to the remaining unvested shares on the Termination Date. You acknowledgethat, by the original terms of the Options, no additional shares would have vested. In all other respects, the Stock Option Agreements relating to the Optionswill remain in full force and effect, and you agree to remain bound by those Agreements. You acknowledge and agree that you have no stock rights in theCompany other than those enumerated in this paragraph.7. Rent and Parking Privileges. If you sign, and do not revoke, this Agreement, until the Rent Termination Date (as defined below), theCompany will (a) continue to pay the monthly rent for your apartment located in the District of Columbia (the “Apartment”) on the same terms, in the sameamount and in accordance with the same procedures employed by the Company prior to the Termination Date and (b) continue to provide you with access toone parking space in the garage located at the Company’s headquarters. The “Rent Termination Date” shall be the earlier to occur of (x) last day of the currentterm of the lease for the Apartment and (y) the date on which you move out of the Apartment. You acknowledge that the benefits provided to you in thisSection 7 may be considered taxable income to you. Page 3 8. Release of All Claims. In consideration for receiving the severance benefits described in Paragraphs 4, 5, 6 and 7 above, to the fullest extentpermitted by law, you waive, release and promise never to assert any claims or causes of action, whether or not now known, against the Company or itspredecessors, successors or past or present subsidiaries, stockholders, directors, officers, employees, consultants, attorneys, agents, assigns and employeebenefit plans with respect to any matter, including (without limitation) any matter related to your employment with the Company or the termination of thatemployment, including (without limitation) claims relating to taxes incurred due to the severance benefits, claims to attorneys’ fees or costs, claims ofwrongful discharge, constructive discharge, emotional distress, defamation, invasion of privacy, fraud, breach of contract or breach of the covenant of goodfaith and fair dealing and any claims of discrimination or harassment based on sex, age, race, national origin, disability or any other basis under Title VII ofthe Civil Rights Act of 1964 the District of Columbia Human Rights Act, Article 49B of the Maryland Code, the Age Discrimination in Employment Act of1967, the Americans with Disabilities Act and all other laws and regulations relating to employment. However, this release covers only those claims that aroseprior to the execution of this Agreement and only those claims that may be waived by applicable law. Execution of this Agreement does not bar any claim thatarises hereafter, including (without limitation) a claim for breach of this Agreement.9. No Admission. Nothing contained in this Agreement will constitute or be treated as an admission by you or the Company of liability, anywrongdoing or any violation of law.10. Other Agreements. At all times in the future, you will remain bound by your Confidential Information Agreement with the Company, whichyou signed on October 24, 2011, and a copy of which is attached as Exhibit B. Except as expressly provided in this Agreement and the IndemnificationAgreement between you and the Company dated as of October 24, 2011, this Agreement renders null and void all prior agreements between you and theCompany and constitutes the entire agreement between you and the Company regarding the subject matter of this Agreement. This Agreement may be modifiedonly in a written document signed by you and a duly authorized officer of the Company.11. Company Property. You represent that you have returned to the Company all property that belongs to the Company, including (withoutlimitation) copies of documents that belong to the Company and files stored on your computer(s) that contain information belonging to the Company.12. Confidentiality of Agreement. You agree that you will not disclose to others the existence or terms of this Agreement, except that you maydisclose such information to your spouse, attorney or tax adviser if such individuals agree that they will not disclose to others the existence or terms of thisAgreement. Page 4 13. No Disparagement. You agree that you will never make any negative or disparaging statements (orally or in writing) about the Company orits stockholders, directors, officers, employees, products, services or business practices, except as required by law.14. Severability. If any term of this Agreement is held to be invalid, void or unenforceable, the remainder of this Agreement will remain in fullforce and effect and will in no way be affected, and the parties will use their best efforts to find an alternate way to achieve the same result.15. Choice of Law. This Agreement will be construed and interpreted in accordance with the laws of the District of Columbia (other than theirchoice-of-law provisions).16. Execution. This Agreement may be executed in counterparts, each of which will be considered an original, but all of which together willconstitute one agreement. Execution of a facsimile copy will have the same force and effect as execution of an original, and a facsimile signature will be deemedan original and valid signature.Please indicate your agreement with the above terms by signing below. Very truly yours,VANDA PHARMACEUTICALS INC.By: /s/ Mihael H. Polymeropoulos, M.D. Mihael H. Polymeropoulos, M.D. Chief Executive OfficerI agree to the terms of this Agreement, and I am voluntarily signing this release of all claims. I acknowledge that I have read and understand this Agreement,and I understand that I cannot pursue any of the claims and rights that I have waived in this Agreement at any time in the future. /s/ Robert RepellaSignature of Robert RepellaDated: December 12, 2013 EXHIBIT AOPTIONS Grant Date Options vestedas ofTerminationDate Additional optionsvested under Section6(d) of EmploymentAgreement Total vested options(including additionaloptions under Section6(d)) 10/24/2011 61,027 14,375 75,402 12/07/2012 586 1,758 2,344 TOTAL 61,613 16,133 77,746 EXHIBIT BCONFIDENTIAL INFORMATION AGREEMENTExhibit 23.1CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMWe hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 333-133368, No. 333-138070, No. 333-141571, No. 333-148924, No. 333-156995, No. 333-164567, No. 333-171962, No. 333-179265, No. 333-186509 and No. 333-193614) and on Form S-3 (No. 333-171963, No. 333-190401 and No. 333-191434) of Vanda Pharmaceuticals Inc. of our report dated February 25, 2014 relating to the financial statements andthe effectiveness of internal control over financial reporting, which appears in this Form 10-K./s/ PricewaterhouseCoopers LLPMcLean, VirginiaFebruary 25, 2014EXHIBIT 31.1CERTIFICATION OF CHIEF EXECUTIVE OFFICERPURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002I, Mihael H. Polymeropoulos, certify that: 1.I have reviewed this annual report on Form 10-K of Vanda Pharmaceuticals Inc.; 2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4.The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))for the registrant and have: a.Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, toensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within thoseentities, particularly during the period in which this report is being prepared; b.Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles; c.Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d.Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recentfiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materiallyaffect, the registrant’s internal control over financial reporting; and 5.The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): a.All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonablylikely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b.Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controlover financial reporting. February 25, 2014 /s/ Mihael H. Polymeropoulos, M.D. Mihael H. Polymeropoulos, M.D. President and Chief Executive Officer (Principal Executive Officer)EXHIBIT 31.2CERTIFICATION OF CHIEF FINANCIAL OFFICERPURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002I, James P. Kelly, certify that: 1.I have reviewed this annual report on Form 10-K of Vanda Pharmaceuticals Inc.; 2.Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make thestatements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3.Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects thefinancial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4.The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined inExchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f))for the registrant and have: a.Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, toensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within thoseentities, particularly during the period in which this report is being prepared; b.Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under oursupervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for externalpurposes in accordance with generally accepted accounting principles; c.Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about theeffectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d.Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recentfiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materiallyaffect, the registrant’s internal control over financial reporting; and 5.The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to theregistrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): a.All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonablylikely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b.Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controlover financial reporting. February 25, 2014 /s/ James P. Kelly James P. KellySenior Vice President, Chief Financial Officer,Secretary and Treasurer(Principal Financial Officer and PrincipalAccounting Officer)EXHIBIT 32.1CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICERPursuant to Section 906 of the Sarbanes-Oxley Act of 2002(Subsections (a) and (b) of Section 1350, Chapter 63 of Title 18, United States Code)Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of title 18, United States Code), each of theundersigned officers of Vanda Pharmaceuticals Inc., (the “Company”), does hereby certify, to the best of such officer’s knowledge, that:The Annual Report on Form 10-K for the year ended December 31, 2013 (the Form 10-K) of the Company fully complies with the requirements ofSection 13(a) or 15(d) of the Securities Exchange Act of 1934, and the information contained in the Form 10-K fairly presents, in all material respects, theconsolidated financial condition and results of operations of the Company. February 25, 2014 /s/ Mihael H. Polymeropoulos, M.D. Mihael H. Polymeropoulos, M.D.President and Chief Executive Officer(Principal Executive Officer)February 25, 2014 /s/ James P. Kelly James P. KellySenior Vice President, Chief Financial Officer,Secretary and Treasurer(Principal Financial Officer and PrincipalAccounting Officer)A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company andfurnished to the Securities and Exchange Commission (SEC) or its staff upon request. This certification “accompanies” the Form 10-K to which itrelates, is not deemed filed with the SEC and is not to be incorporated by reference into any filing of the Company under the Securities Act of 1933, asamended, or the Securities Exchange Act of 1934, as amended (whether made before or after the date of the Form 10-K), irrespective of any generalincorporation language contained in such filing.

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