Vanda Pharmaceuticals
Annual Report 2015

Plain-text annual report

Table of ContentsUNITED STATES SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549Form 10-K þANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934For the fiscal year ended December 31, 2015 ¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 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 þIndicate 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 þIndicate 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 þ 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 þ 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. þIndicate 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 þ 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 þAs of June 30, 2015, 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 $525.7 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 January 31, 2016 was 43,102,957.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 2016 Annual Meeting of Stockholders, which is to be filed pursuantto Regulation 14A within 120 days after the end of the registrant’s fiscal year ended December 31, 2015, are incorporated by reference into Part III of thisForm 10-K.Table of ContentsVanda Pharmaceuticals Inc.Form 10-KTable of Contents Page Part I Cautionary Note Regarding Forward-Looking Statements 1 Item 1 Business 3 Item 1A Risk Factors 20 Item 1B Unresolved Staff Comments 45 Item 2 Properties 45 Item 3 Legal Proceedings 45 Item 4 Mine Safety Disclosures 46 Part II Item 5 Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 47 Item 6 Selected Consolidated Financial Data 48 Item 7 Management’s Discussion and Analysis of Financial Condition and Results of Operations 50 Item 7A Qualitative and Quantitative Disclosures about Market Risk 64 Item 8 Financial Statements and Supplementary Data 64 Item 9 Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 64 Item 9A Controls and Procedures 64 Item 9B Other Information 65 Part III Item 10 Directors, Executive Officers and Corporate Governance 65 Item 11 Executive Compensation 65 Item 12 Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 65 Item 13 Certain Relationships and Related Transactions, and Director Independence 65 Item 14 Principal Accountant Fees and Services 65 Part IV Item 15 Exhibits and Financial Statement Schedules 66 Signatures 67 Exhibits 102 Table 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: • the ability of Vanda Pharmaceuticals Inc. (we, our or Vanda) to successfully commercialize HETLIOZ (tasimelteon) for the treatment of Non-24-Hour Sleep-Wake Disorder (Non-24) in the U.S. and Europe; • uncertainty as to the market awareness of Non-24 and the market acceptance of HETLIOZ; • our ability to generate U.S. sales of Fanapt (iloperidone) for the treatment of schizophrenia; • the timing and costs of continuing to build a sales and marketing, supply chain, distribution, pharmacovigilance, compliance and safetyinfrastructure to promote Fanapt in the U.S.; • our dependence on third-party manufacturers to manufacture HETLIOZ and Fanapt in sufficient quantities and quality; • our limited sales and marketing infrastructure; • the regulatory status of Fanapt in Europe; • our ability to successfully commercialize HETLIOZ and Fanapt outside of the U.S.; • our ability to prepare, file, prosecute, defend and enforce any patent claims and other intellectual property rights; • a loss of rights to develop and commercialize our products under our license agreements; • the ability to obtain and maintain regulatory approval of our products, and the labeling for any approved products; • the timing and success of preclinical studies and clinical trials conducted by us and our development partners; • a failure of our products to be demonstrably safe and effective; • the size and growth of the potential markets for our products and the ability to serve those markets; • our expectations regarding trends with respect to our revenues, costs, expenses and liabilities; • the scope, progress, expansion, and costs of developing and commercializing our products; • 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 litigation; • our ability to obtain the capital necessary to fund our research and development or commercial activities; • losses incurred from product liability claims made against us; and • use of our existing cash, cash equivalents and marketable securities. 1®®®®®®®®®Table of ContentsAll 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 thatare made on our behalf. We undertake no obligation, and specifically decline any obligation, to update or revise publicly any forward-looking statements,whether as 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 consolidatedfinancial statements 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 Risk Factors, which contains a more complete discussion of the risks and uncertainties associated with our business. In addition to the risks describedabove and in Item 1A of this report, other unknown or unpredictable factors also could affect our results. Therefore, the information in this report should beread together with other reports and documents that we file with the Securities and Exchange Commission from time to time, including on Form 10-Q andForm 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-lookingstatements in this report will prove to be accurate. Furthermore, if our forward-looking statements prove to be inaccurate, the inaccuracy may be material. Inlight of the significant uncertainties in these forward-looking statements, you should not regard these statements as a representation or warranty by us or anyother person that we will achieve our objectives and plans in any specified time frame, or at all. 2Table of ContentsITEM 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 and our product portfolio includes: • HETLIOZ (tasimelteon), a product for the treatment of Non-24-Hour Sleep-Wake Disorder (Non-24), was approved by the U.S. Food and DrugAdministration (FDA) in January 2014 and launched commercially in the U.S. in April 2014. In July 2015, the European Commission (EC) grantedcentralized marketing authorization with unified labeling for HETLIOZ for the treatment of Non-24 in totally blind adults. This authorization isvalid in the 28 countries that are members of the European Union, as well as European Economic Area members Iceland, Liechtenstein and Norway.HETLIOZ has potential utility in a number of other circadian rhythm disorders and is presently in clinical development for the treatment of Jet LagDisorder and Smith-Magenis Syndrome (SMS). • Fanapt (iloperidone), a product for the treatment of schizophrenia, the oral formulation of which was being marketed and sold in the U.S. byNovartis Pharma AG (Novartis) until December 31, 2014. On December 31, 2014, Novartis transferred all the U.S. and Canadian commercial rights tothe Fanapt franchise to us. See Note 3, Settlement Agreement with Novartis, to the consolidated financial statements included in Part II of thisannual report on Form 10-K for additional information. In September 2015, the FDA accepted for review a supplemental New Drug Application(sNDA) for Fanapt for the maintenance treatment of schizophrenia in adults. In December 2015, we refiled with the European Medicines Agency(EMA) a Marketing Authorization Application (MAA) for Fanaptum oral. Additionally, our distribution partners launched Fanapt in Israel andMexico in 2014. • Tradipitant (VLY-686), a small molecule neurokinin-1 receptor (NK-1R) antagonist, which is presently in clinical development for the treatment ofchronic pruritus in atopic dermatitis. • Trichostatin A, a small molecule histone deacetylase (HDAC) inhibitor. • AQW051, a Phase II alpha-7 nicotinic acetylcholine receptor partial agonist.Since we began operations in March 2003, we have devoted substantially all of our resources to the in-licensing, clinical development andcommercialization of our products. Our products target prescription markets with significant unmet medical needs. Our ability to generate revenue andachieve profitability largely depends on our ability, alone or with others, to complete the development of our products, and to obtain the regulatoryapprovals for and manufacture, market and sell our products, and our ability to successfully commercialize HETLIOZ for the treatment of Non-24 andFanapt for the treatment of schizophrenia. The results of our operations will vary significantly and depend on a number of factors, including risks related toour business, risks related to our industry, and other risks which are detailed in Item 1A of Part I entitled Risk Factors and Item 7 of Part II entitledManagement’s Discussion and Analysis of Financial Condition and Results of Operations of this annual report on Form 10-K.Our activities will necessitate significant uses of working capital throughout 2016 and beyond. We are currently concentrating our efforts on sellingHETLIOZ and Fanapt commercially in the U.S. and our upcoming commercial launch of HETLIOZ in Europe. Additionally, we continue to pursue marketapproval of HETLIOZ in other regions and Fanapt in Europe and other regions. We will continue to work with our distribution partners who launchedFanapt in Mexico and Israel during 2014. We see opportunities to grow our commercial products through life cycle management strategies that include theaddition of new indications and formulations. Our pipeline includes novel programs that could address largely unmet medical needs.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. 3®®®®®®®®®®®®®®®®Table of ContentsOur strategyOur goal is to create a leading biopharmaceutical company focused on developing and commercializing novel therapies addressing high unmetmedical needs through the application of our drug development expertise and our pharmacogenetics and pharmacogenomics expertise. The key elements ofour strategy to accomplish this goal are to: • Maximize the commercial success of HETLIOZ and Fanapt; • 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.ProductsWe have the following products on the market or under regulatory review: Product Indication Country Select MilestonesHETLIOZ(tasimelteon) Non-24 United States FDA approval in January 2014;Commercial launch in April 2014 Europe EC approval in July 2015;Expected commercial launch in Germany in 2016Fanapt (Oral)(iloperidone) Schizophrenia United States FDA approval in May 2009;Commercial launch in January 2010;U.S. and Canada rights sublicensed to Novartis inOctober 2009 and reacquired by Vanda in December2014;Long term maintenance sNDA accepted for review byFDA in September 2015 with a PDUFA date in May2016Fanaptum (Oral)(iloperidone) Europe EMA accepted for evaluation our MAA in December2015 Mexico Market approval in October 2013;Commercial launch in the fourth quarter of 2014 by ourlocal distribution partner, Probiomed S.A. de C.V. Israel Market approval August 2012;Commercial launch in the fourth quarter of 2014 by ourlocal distribution partner, Megapharm Ltd. 4®®®®®Table of ContentsWe have the following products in clinical development: Product Target Indication Select MilestonesHETLIOZ(tasimelteon) Pediatric Non-24 Plan to initiate a pharmacokinetic study in the second quarter2016;Plan to initiate a Phase III study in the second half of 2016 SMS Initiated open label interventional study in the fourth quarter2015;Plan to initiate placebo controlled Phase III study in the secondhalf of 2016 Jet Lag Disorder Completed observational study in the fourth quarter of 2015;Plan to initiate Phase III study in the second half of 2016Fanapt (Oral)(iloperidone) Schizophrenia Positive results from a Phase III long-term maintenance study inpatients with schizophrenia were announced in June 2015Tradipitant (VLY-686) Pruritus in patients with AtopicDermatitis Plan to initiate a pruritus proof of concept study during 2016Trichostatin A Oncology Plan to file an Investigational New Drug (IND) application in2016AQW051 CNS Disorders Potential indications are under strategic evaluation includingcognitive impairmentHETLIOZCommercial opportunity: Non-24In 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. HETLIOZ is a melatonin agonist of the human MT1 and MT2 receptors, with greater specificity for MT2. These receptors are thoughtto be involved in the control of circadian rhythms. HETLIOZ is believed to reset the master body clock in the suprachiasmatic nucleus (SCN), located in thehypothalamus, resulting in the entrainment and alignment of the body’s melatonin and cortisol rhythms to the 24-hour day-night cycle. HETLIOZ waslaunched commercially in the U.S. in April 2014. In addition, in July 2015, the EC granted centralized marketing authorization with unified labeling forHETLIOZ for the treatment of Non-24 in totally blind adults. This authorization is valid in the 28 countries that are members of the European Union, as wellas European Economic Area members Iceland, Liechtenstein and Norway.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.patients per year. Orphan drug designation provides potential financial and regulatory incentives, including study design assistance, tax credits, waiver ofFDA user fees, and up to seven years of market exclusivity upon marketing approval. In February 2011, the European Medicines Agency (EMA) designatedHETLIOZ as an orphan medicinal product for the same indication.Non-24 is a serious, rare and chronic circadian rhythm disorder characterized by the inability to synchronize the master body clock with the 24-hourday-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 almost entirely inindividuals who lack the light sensitivity necessary to synchronize the master body clock in the brain with the 24-hour day-night cycle. Most people have amaster body clock that naturally runs longer than 24-hours and light is the primary environmental 5®®®®®®®®®®®Table of Contentscue that resets it to 24 hours each day. Individuals with Non-24 have a master body clock that is not reset, and continually delays, resulting in prolongedperiods of misalignment between their circadian rhythms and the 24-hour day-night cycle, including the timing of melatonin and cortisol secretion. As aresult of this misalignment, Non-24 is associated with significant 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 excessivedaytime sleepiness.While there are no FDA or EC approved treatments for Non-24, other than HETLIOZ, there are a number of drugs approved and prescribed for patientswith sleep disorders. The most commonly prescribed drugs are hypnotics. See Competition below for a discussion of commonly prescribed drugs for patientswith sleep disorders.Therapeutic opportunity: Circadian Rhythm Sleep DisordersSleep 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 clock and is governed by the hormones melatonin and cortisol. Both the timing of behavioral events (activity,sleep, and social interactions) and the environmental light/dark cycle result in a sleep/wake cycle that follows the circadian rhythm. Examples of CRSDsinclude transient disorders such as jet lag and chronic disorders such as delayed sleep phase disorder, shift work sleep disorder and Non-24.Therapeutic opportunity: OtherWe are planning to develop HETLIOZ for the treatment of pediatric Non-24. We expect to initiate a pediatric pharmacokinetic study in the secondquarter of 2016 and a Phase III study in the second half of 2016.We initiated an open label interventional study in patients with SMS in the fourth quarter of 2015. We expect to initiate a placebo controlled Phase IIIstudy in the second half of 2016. SMS is a rare genetic disorder caused by a deletion on chromosome 17. The U.S. National Institute of Health estimates thatSMS affects approximately one in 20,000 births in the U.S.We initiated an observational study in Jet Lag Disorder in the fourth quarter of 2015. We expect to initiate a Phase III study in the second half of 2016.FanaptCommercial Opportunity: SchizophreniaFanapt 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 had exclusive commercialization rights to all formulations of Fanapt in the U.S. andCanada. In January 2010, Novartis launched Fanapt in the U.S. On December 31, 2014, Novartis transferred all the U.S. and Canadian commercial rights tothe Fanapt franchise to Vanda as part of the Settlement Agreement. See Note 3, Settlement Agreement with Novartis, to the consolidated financial statementsincluded in Part II of this annual report on Form 10-K for additional information. In June 2015, we announced positive results from REPRIEVE, a Phase IIIlong-term maintenance study that was conducted by Novartis. In September 2015, the FDA accepted for review a supplemental New Drug Application(sNDA) for Fanapt for the maintenance treatment of schizophrenia in adults. The FDA has set a May 2016 PDUFA date for the Fanapt sNDA. 6®®®®®®®®®®®Table of ContentsWe continue to explore the regulatory path and commercial opportunity for Fanapt oral formulation outside of the U.S. In December 2012, the EMA’sCommittee for Medicinal Products for Human Use (CHMP) issued a negative opinion recommending against approval of Fanaptum (oral iloperidonetablets) for the treatment of schizophrenia in adult patients in the European Union. The CHMP was of the opinion that the benefits of Fanaptum did notoutweigh its risks and recommended against marketing authorization. We initiated an appeal of this opinion and requested a re-examination of the decisionby the CHMP, but withdrew our Marketing Authorization Application (MAA) in the first quarter of 2013 because the additional clinical data requested bythe CHMP would not have been available in the timeframe allowed by the EMA’s Centralized Procedure. In December 2015, we refiled a MAA with the EMAfor Fanaptum which included the results from the REPRIEVE study.We have entered into agreements with the following partners for the commercialization of Fanapt in the countries set forth below: Country Partner Market Approval DateMexico Probiomed S.A. de C.V. October 2013Israel Megapharm Ltd. August 2012Schizophrenia 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” fortheir ability to treat a broader range of negative symptoms than the first-generation “typical” antipsychotics, which were introduced in the 1950s and are nowgeneric. Atypical antipsychotics are generally regarded as having improved side effect profiles and efficacy relative to typical antipsychotics and currentlycomprise approximately 90% of schizophrenia prescriptions. See Competition below for a discussion of commonly prescribed atypical antipsychotics inaddition to Fanapt.Pursuant to the Settlement Agreement with Novartis, we reacquired the U.S. and Canadian rights to the long-acting injectable (depot) formulation ofFanapt. We are evaluating the commercial opportunity around the depot formulation.Tradipitant (VLY-686)Tradipitant is a small molecule NK-1R antagonist that we licensed from Eli Lilly and Company (Lilly) in April 2012. NK-1R antagonists have beenevaluated in a number of indications including chemotherapy-induced nausea and vomiting (CINV), post-operative nausea and vomiting (PONV), alcoholdependence, anxiety, depression and pruritus. We commenced a Phase II clinical study of tradipitant in the treatment of chronic pruritus in patients withatopic dermatitis in 2014. Results from a Phase II study for the treatment of chronic pruritus in atopic dermatitis were announced in March 2015. This studyshowed no significant difference from placebo on the pre-specified primary endpoint. Vanda believes this proof of concept study was informative, in thatthrough subsequent analyses, it revealed significant and clinically meaningful responses across multiple outcomes evaluated in individuals with higherblood plasma levels of tradipitant at the time of their pruritus assessments. We plan to initiate a pruritus proof of concept study in 2016.Trichostatin ATrichostatin A is a small molecule HDAC inhibitor with potential use as a treatment for several oncology indications. We plan to file an INDapplication in the first half of 2016. 7®®®®®®®Table of ContentsAQW051AQW051 is a Phase II alpha-7 nicotinic acetylcholine receptor partial agonist that we licensed from Novartis on December 31, 2014 pursuant to theSettlement Agreement. We are currently in the process of transferring clinical data from Novartis and evaluating potential indications, including cognitiveimpairment.License agreementsOur rights to develop and commercialize our products are subject to the terms and conditions of licenses granted to us by other pharmaceuticalcompanies.HETLIOZIn February 2004, we entered into a license agreement with Bristol-Myers Squibb Company (BMS) under which we received an exclusive worldwidelicense under certain patents and patent applications, and other licenses to intellectual property, to develop and commercialize HETLIOZ. In partialconsideration for the license, we paid BMS an initial license fee of $0.5 million. We made developmental milestone payments to BMS totaling $12.0 millionunder the license agreement, including an $8.0 million milestone payment in the first quarter of 2014 as a result of the FDA’s approval of our HETLIOZNDA. The $8.0 million milestone payment was capitalized as an intangible asset and is being amortized over the expected HETLIOZ patent life in the U.S.We are obligated to make a future milestone payment to BMS of $25.0 million in the event that cumulative worldwide sales of HETLIOZ reach $250.0million. Additionally, we are obligated to make royalty payments on HETLIOZ net sales to BMS in any territory where we commercialize HETLIOZ for aperiod equal to the greater of 10 years post the first commercial sale in the territory or the expiry of the new chemical entity patent in that territory. During theperiod prior to the expiry of the new chemical entity patent in a territory, we are obligated to pay a 10% royalty on net sales in that territory. The royalty rateis decreased by half for countries in which no new chemical entity patent existed or for the remainder of the 10 years after the expiry of the new chemicalentity patent. We are also obligated under the license agreement to pay BMS a percentage of any sublicense fees, upfront payments and milestone and otherpayments (excluding royalties) that we receive from a third party in connection with any sublicensing arrangement, at a rate which is in the mid-twenties. Wehave agreed with BMS in our license agreement for HETLIOZ to use 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 willrevert or otherwise be licensed back to BMS on an exclusive basis.FanaptPursuant to the terms of the Settlement Agreement with Novartis, Novartis transferred all U.S. and Canadian rights in the Fanapt franchise to Vanda onDecember 31, 2014.A predecessor company of Sanofi, Hoechst Marion Roussel, Inc. (HMRI), discovered Fanapt and completed early clinical work on the compound. In1996, HMRI licensed its rights to the Fanapt patents and patent applications to Titan Pharmaceuticals, Inc. (Titan) on an exclusive basis. In 1997, soon afterit had acquired its rights, Titan sublicensed its rights to Fanapt on an exclusive basis to Novartis. In June 2004, we acquired exclusive worldwide rights tothese patents and patent applications as well as certain Novartis patents and patent applications to develop and commercialize Fanapt through a sublicenseagreement with Novartis. In partial consideration for this sublicense, we paid Novartis an initial license fee of $0.5 million and were obligated to make futuremilestone payments to Novartis of less than $100.0 million in the aggregate (the majority of which were tied to sales milestones), as well as royalty paymentsto Novartis at a rate which, as a percentage of net sales, was in the mid-twenties. As a result of the FDA’s approval of the NDA for Fanapt in May 2009, wemet a milestone under the sublicense agreement, which required us to make a payment of $12.0 million to Novartis. 8®®®®®®®®®®®®®®®®®Table of ContentsIn October 2009, we 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 had 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 was responsible for the further clinical developmentactivities in the U.S. and Canada. Pursuant to the amended and restated sublicense agreement, we received an upfront payment of $200.0 million and wereeligible for additional payments totaling up to $265.0 million upon Novartis’ achievement of certain commercial and development milestones for Fanapt inthe U.S. and Canada. We also received royalties, which, as a percentage of net sales, were in the low double-digits, on net sales of Fanapt in the U.S. andCanada. We retained exclusive rights to Fanapt outside the U.S. and Canada and are obligated to make royalty payments to Sanofi S.A. on Fanapt salesoutside the U.S. and Canada.Pursuant to the terms of the Settlement Agreement, Novartis transferred all U.S. and Canadian rights in the Fanapt franchise to the Company onDecember 31, 2014. We are obligated to make royalty payments to Sanofi, S.A. (Sanofi) and Titan, at a percentage rate equal to 23% on annual U.S. net salesof Fanapt up to $200.0 million, and at a percentage rate in the mid-twenties on sales over $200.0 million through November 2016. See Note 3, SettlementAgreement with Novartis, to the consolidated financial statements included in Part II of this annual report on Form 10-K for additional information. InFebruary 2016, we amended the agreement with Sanofi and Titan to remove Titan as the entity through which royalty payments from us are directed to Sanofifollowing the expiration of the new chemical entity (NCE) patent for Fanapt in the U.S. on November 15, 2016. Under the amended agreement, we will paydirectly to Sanofi a fixed royalty of 3% of net sales from November 16, 2016 through December 31, 2019 related to manufacturing know-how. We will makea $2.0 million payment applied to this 3% manufacturing know-how royalty and will make additional royalty payments only to the extent that ourcumulative royalty obligations during this period exceed the amount of the pre-payment. No further royalties on manufacturing know-how are payable by usafter December 31, 2019. This amended agreement does not alter Titan’s obligation under the License Agreement to make royalty payments to Sanofi prior toNovember 16, 2016 or our obligations under the Sublicense Agreement to pay Sanofi a fixed royalty on Fanapt net sales equal up to 6% on Sanofi know-hownot related to manufacturing under certain conditions for a period of up to 10 years in markets where the NCE patent has expired or was not issued.Tradipitant (VLY-686)In 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, tradipitant, 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 tradipitant. Lillyis also eligible to receive additional payments based upon achievement of specified development and commercialization milestones as well as tiered-royalties on net sales at percentage rates up to the low double digits. These milestones include $4.0 million for pre-NDA approval milestones and up to $95.0million for future regulatory approval and sales milestones. We have agreed to use commercially reasonable efforts to develop and commercialize tradipitant.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 royaltyon net sales of products that contain tradipitant.AQW051In December 2014, we entered into a license agreement with Novartis pursuant to which we acquired an exclusive worldwide license under certainpatents and patent applications, and other licenses to intellectual property, to develop and commercialize an alpha-7 nicotinic acetylcholine receptor partialagonist, AQW051, for all human indications. 9®®®®®®®®®Table of ContentsPursuant to the agreement, we will be responsible for all development costs for AQW051. Novartis is eligible to receive tiered royalties on net sales atpercentage rates up to the low double digits. We have agreed to use commercially reasonable efforts to develop and commercialize AQW051.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 Novartis terminates the agreement due to our breach or for certain other reasons set forth in the agreement, all rights licensedand developed by us under the agreement will revert or otherwise be licensed back to Novartis on an exclusive basis, subject to payment by Novartis to us ofa royalty on net sales of products that contain AQW051.Government regulationGovernment authorities in the U.S., at the federal, state and local level, as well as foreign countries and local foreign governments, regulate theresearch, development, testing, manufacture, labeling, promotion, advertising, distribution, sampling, marketing, import and export of our products. Otherthan HETLIOZ in the U.S. and the European Union and Fanapt in the U.S., Israel and Mexico, all of our products will require regulatory approval bygovernment agencies prior to commercialization. In particular, human pharmaceutical products are subject to rigorous pre-clinical and clinical trials andother approval procedures of the FDA and similar regulatory authorities in foreign countries. The process of obtaining these approvals and the subsequentcompliance with appropriate domestic 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 comply withthe 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 approvals, clinicalholds, warning letters, product recalls, product seizures, total or partial suspension of our operations, injunctions, fines, civil penalties or criminalprosecution. 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 10®®Table of Contentsproposed clinical trials outlined in the IND. In that case, the IND sponsor and the FDA must resolve any outstanding FDA concerns or questions beforeclinical 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 warrantsfurther clinical trials based on preliminary indications of efficacy. These pilot studies may be performed in the U.S. after an IND has become effective oroutside of the 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 patientsor healthy 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 to determine the common short-term side effects and risks associated with thedrug. These trials are typically well-controlled, closely monitored and conducted in a relatively small number of patients, usually involving nomore than several hundred subjects. • Phase III: refers to expanded controlled and uncontrolled clinical trials. These trials are performed after preliminary evidence suggestingeffectiveness of a drug has been obtained. Phase III trials are intended to gather additional information about the effectiveness and safety that isneeded to evaluate the overall benefit-risk relationship of the drug and to provide an adequate basis for physician labeling. Phase III trials usuallyinclude several hundred 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 ofthe disease, 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 protocolassessment, the FDA can also provide specific guidance on the acceptability of protocol design for clinical trials. The FDA, we or our partners may suspend orterminate clinical trials at any time for various reasons, including a finding that the subjects or patients are being exposed to an unacceptable health risk. TheFDA can also request additional clinical trials be conducted as a condition to drug approval. During all clinical trials, physicians monitor the patients todetermine effectiveness and to observe and report any reactions or other safety risks that may result from use of the drug. 11Table of ContentsAssuming successful completion of the required clinical trials, drug developers submit the results of pre-clinical studies and clinical trials, togetherwith other detailed information including information on the manufacture and composition of the drug, to the FDA, in the form of an NDA, requestingapproval to market 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 todetermine, 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,and complying with drug sampling and distribution requirements. We and our partners also are required to provide updated safety and efficacy informationand to comply with requirements concerning advertising and promotional labeling. Also, our quality control and manufacturing procedures must continue toconform to cGMP after approval. Drug manufacturers and their subcontractors are required to register their facilities and are subject to periodic unannouncedinspections by the FDA to assess compliance with cGMP which imposes certain procedural and documentation requirements relating to quality assurance andquality control. Accordingly, manufacturers must continue to expend time, money and effort in the area of production and quality control to maintaincompliance with cGMP and other aspects of regulatory compliance. The FDA may require post market testing and surveillance to monitor the drug’s safety orefficacy, 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, includingthe addition of new warnings and contraindications.In September 2007, the Food and Drug Administration Amendments Act (FDAAA), was enacted into law, amending the U.S. Federal Food, Drug, andCosmetic Act and the Public Health Service Act. The FDAAA made a number of substantive and incremental changes to the review and approval processes inways that could make it 12Table of Contentsmore 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, butwill expire 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 patents or that such patents are invalid is called a Paragraph IVcertification. If the applicant does not challenge the listed patents, the ANDA application will not be approved until all the listed patents claiming thereferenced 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 infringementlawsuit in response to the notice of the Paragraph IV certification. The filing of a patent infringement lawsuit within 45 days of the receipt of a Paragraph 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. The U.S. Drug Price Competition and Patent Term Restoration Act of 1984, more commonlyknown as the “Hatch-Waxman Act,” provides a period of five years following approval of a drug containing no previously approved active ingredients,during which ANDAs for generic versions of those drugs cannot be submitted unless the submission contains a Paragraph IV challenge to a listed patent, inwhich case the submission may be made four years following the original drug approval. Federal law provides for a period of three years of exclusivityfollowing approval of a listed drug that contains previously approved active ingredients but is approved in a new dosage form, route of administration orcombination, 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 FDAcannot grant effective approval of an ANDA based on that listed drug. 13Table of ContentsForeign 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 foreignequivalent of 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 isvalid for all European Union member states. This authorization is a marketing authorization approval. The decentralized procedure provides for mutualrecognition of national approval decisions. Under this procedure, the holder of a national marketing authorization may submit an application to theremaining member states. Within 90 days of receiving the applications and assessment report, each member state must decide whether to recognize approval.This procedure is referred 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, tradipitant and AQW051 are covered by new chemical entity and other patents and patent applications. The patents cover theactive pharmaceutical ingredient and provide patent protection for all formulations containing these active pharmaceutical ingredients. For more on theselicense and sublicense arrangements, see License agreements above. In addition, we have generated our own intellectual property, and filed patentapplications covering this intellectual property, for HETLIOZ and Fanapt.The table below is a summary of select patents for our commercial products. Number Type CountryHETLIOZ US 5,856,529US 8,785,492US 9,060,995US 7,754,902US 8,097,738US 8,558,017 NCEMethod of treatmentMethod of treatmentSynthesisSynthesisSynthesis Issued in 39 countries including US, EU and JapanUS issued, pending in 15 countries and EUUS issued, pending in 15 countries and EUUSUSUSFanapt RE 39198US 8,586,610US 9,138,432PCT/EP2002/012073PCT/EP2003/007619PCT/EP2002/013937 NCEMethod of treatmentMethod of treatmentIloperidone microparticle depot formulationIloperidone aq. crystal depot formulationMethod of treatment USUS & Japan, pending in Canada, EU, AustraliaUS, pending in Japan, Canada, EU, AustraliaUS, EU & Japan, issued in 29 countriesUS, EU & Japan, issued in 34 countriesUS, EU & Japan, issued in 30 countriesHETLIOZOur rights to the new chemical entity patent covering HETLIOZ and related intellectual property have been acquired through a license with BMS.HETLIOZ and its formulations, genetic markers and uses are covered by a total of 14 patent and patent application families worldwide. The primary newchemical entity patent covering HETLIOZ expires normally in 2017 in the U.S. and in most European markets. The “Hatch-Waxman Act” provides for anextension of new chemical entity patents for a period of up to five years following 14®®®®®®®®®Table of Contentsthe expiration of the patent covering that compound to compensate for time spent in development. We believe that HETLIOZ will meet the various criteriaof the Hatch-Waxman Act and will receive five additional years of patent protection in the U.S., which would extend its new chemical entity patentprotection in the U.S. until 2022. An application for the five year patent term extension has been filed and is being processed by the U.S. Patent andTrademark Office. In July 2014, a new method of use patent was issued to us by the U.S. Patent and Trademark Office for HETLIOZ in the treatment of Non-24. This method of use patent is expected to expire in 2033, potentially further extending the exclusivity protection of HETLIOZ. In June 2015, anadditional method of use patent was issued to us by the U.S. Patent and Trademark Office for HETLIOZ. This method of use patent is also expected to expirein 2033. Both the new chemical entity patent and the method of use patents are listed in the FDA’s Orange Book.In Europe, the law provides for ten years of data exclusivity (with the potential for an additional year if the drug is developed for a significant newindication). As such, in Europe, data exclusivity will protect HETLIOZ for at least ten years from approval. A completed Pediatric Investigation Plan couldfurther extend this exclusivity for two years in an orphan indication, for a total of 12 years of exclusivity. It is also possible that the term of the new chemicalentity patent in Europe could be extended by issuance of a supplementary protection certificate (SPC). The European Patent Office has granted theCompany’s patent application directed to the 20 mg/day dose. This patent will expire normally in 2027. Patent applications directed to the treatment of Non-24, if granted, would provide exclusivity in Europe for this indication until at least 2033.Outside the U.S. and Europe, data exclusivity will protect HETLIOZ from generic competition for varying numbers of years depending on the country.Additional patent applications directed to specific sleep disorders and to methods of treating patients with HETLIOZ, if issued, would provideexclusivity for such indications and methods of treatment, potentially extending the effective patent protection period in the U.S., Europe, and other majormarkets.FanaptThe new chemical entity patent for Fanapt is owned by Sanofi, and other patents and patent applications relating to Fanapt previously owned byNovartis are now owned by Vanda. We originally obtained exclusive worldwide rights to develop and commercialize the products covered by these patentsthrough license and sublicense arrangements. Then, pursuant to an amended sublicense agreement with Novartis, Novartis retained exclusivecommercialization rights to all formulations of Fanapt in the U.S. and Canada. However, as of December 2014, pursuant to an asset transfer agreement, weacquired all rights in Fanapt, including in the U.S. and Canada.Fanapt and its metabolites, formulations, genetic markers and uses are covered by a total of 17 patent and patent application families in the U.S.,Europe, and other markets. The primary new chemical entity patent covering Fanapt was set to expire normally in 2011 in the U.S. and expired in 2010 inmajor 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 newchemical entity patent in the U.S. has been extended until November 2016. In November 2013, a patent directed to a method of treating patients with Fanaptbased on genotype was issued to the Company by the U.S. Patent and Trademark Office. This patent, which was listed in the FDA’s Orange Book in January2015, is set to expire in 2027, potentially further extending the exclusivity protection of Fanapt. Additional method of treatment patents were issued andlisted in the Orange Book with the latest expected expiry in December 2031. We have asserted our patents against Roxane Laboratories and several otherparagraph IV filers. See Note 18, Legal Matters, to the consolidated financial statements included in Part II of this annual report on Form 10-K for additionalinformation.In Europe, the law provides 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 our rights to commercialize Fanapt will be exclusive for at least 10 years from approval in Europe. Outside the U.S. and Europe,data exclusivity will protect Fanapt from generic competition for varying numbers of years depending upon the country. Several other patent applicationscovering metabolites, uses, formulations and 15®®®®®®®®®®®®®®®®®®®®Table of Contentsgenetic markers relating to Fanapt extend beyond 2020. The patent family for the microsphere depot formulation of Fanapt expires in 2024 in the U.S. and2022 in most of the major markets in Europe. The patent family for the aqueous microcrystals depot formulation of Fanapt expires in 2023 in the U.S. and inmost of the major markets in Europe.TradipitantLilly owns a new chemical entity patent as well as patent applications directed to polymorphic forms of, and methods of making tradipitant. Thus,tradipitant is covered by a total of three patent and patent application families worldwide, which have been licensed to the Company. The new chemicalentity patent covering tradipitant expires in 2023, except in the U.S., where it expires normally in 2024 subject to any extension that may be received underHatch-Waxman. We have filed additional patent applications based on discoveries made during recent studies with tradipitant.AQW051Novartis owns a new chemical entity patent as well as patent applications directed to methods of using AQW051, AQW051 formulations, andcombinations of AQW051 with other active pharmaceutical ingredients. The new chemical entity patent expires normally in 2023 in the U.S., Europe, andother markets.Trichostatin ATrichostatin A is a small molecule HDAC inhibitor with potential use as a treatment for several oncology indications. We have pending patentapplications covering the use of Trichostatin A and plan on filing additional applications based on discoveries made throughout the development plan ofthis molecule.Other PatentsAside from the new chemical entity patents and other in-licensed patents relating to Fanapt, HETLIOZ, tradipitant, and AQW051, we have numerous patentand patent application families, most of which have been filed in key markets including the U.S., relating to our products and development compounds. Inaddition, we have several other patent application families relating to drugs not presently in clinical studies. The claims in these various patents and patentapplications are directed to compositions of matter, including claims covering other products, pharmaceutical compositions and methods of use.Proprietary Know-howFor 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.Where it is necessary to share our proprietary information or data with outside parties, our policy is to make available only that information and data requiredto accomplish 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, has changed and is expected to further significantly change the way healthcare is financed by both governmental and private insurers.The provisions of the ACA became effective over various periods from 2010 through 2014. We cannot predict the complete impact of the ACA onpharmaceutical companies because many of the ACA’s reforms require the promulgation of detailed regulations to implement the statutory provisions, whichhas not yet occurred. While we cannot predict the complete impact on federal reimbursement policies this law will have in general or specifically on anyproduct we commercialize, the ACA may result in downward pressure on pharmaceutical reimbursement, which could negatively affect market acceptance ofnew products. The rebates, discounts, taxes and other costs 16®®®®®Table of Contentsresulting from the ACA may have a significant effect on our profitability in the future. In addition, potential reductions of the per capita rate of growth inMedicare spending under the ACA, could potentially limit access to certain treatments or mandate price controls for our products. Moreover, although theUnited States Supreme Court has upheld the constitutionality of most of the ACA, some states have indicated that they intend not to implement certainsections of the ACA, and some members of the U.S. Congress are still working to repeal the ACA. We cannot predict whether these challenges will continueor other proposals will be made or adopted, or what impact these efforts may have on us 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 privatepayors. Our products may not be considered cost-effective, and coverage and reimbursement may not be available or sufficient to allow us or our partners tosell our compounds 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 amaterial adverse effect on our business, financial condition and profitability.Marketing and salesHETLIOZ was approved in the U.S. for the treatment of Non-24 in January 2014 and commercially launched in the U.S. in April 2014. Additionally,HETLIOZ was approved in the Europe Union for the treatment of Non-24 in July 2015 and we expect to commercially launch the product in Germany in2016.Given the range of potential indications for HETLIOZ, we may pursue one or more partnerships for the development and commercialization ofHETLIOZ worldwide.Fanapt was approved in the U.S. for the treatment of schizophrenia in May 2009 and commercially launched in the U.S. in January 2010. In October2009, we entered into an amended and restated sublicense agreement with Novartis pursuant to which 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. Pursuant to the terms of theSettlement Agreement with Novartis, Novartis transferred all U.S. and Canadian rights in the Fanapt franchise to Vanda on December 31, 2014.Fanapt was launched in Israel and Mexico by our distribution partners in 2014. We continue to explore the regulatory path and commercialopportunity for Fanapt oral formulation outside of the U.S. and Canada.ManufacturingWe 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, all of which could negatively impact our operationand our financial results. 17®®®®®®®®®®Table of ContentsIn January 2014, we entered into a manufacturing agreement with Patheon Pharmaceuticals Inc. (Patheon) for the manufacture of commercial suppliesof HETLIOZ 20 mg capsules at Patheon’s Cincinnati, Ohio manufacturing site. Under the HETLIOZ manufacturing agreement, we are responsible forsupplying the active pharmaceutical ingredient for HETLIOZ to Patheon and have agreed to certain minimum yearly order requirements. Patheon isresponsible for manufacturing the HETLIOZ 20 mg capsules, conducting quality control and stability testing, and packaging the HETLIOZ capsules. TheHETLIOZ manufacturing agreement has 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 its intention to terminate the agreement at least twelve months prior to the end of the then current term. Either party mayterminate the HETLIOZ manufacturing agreement under certain circumstances upon specified written notice to the other party.As part of the Settlement Agreement, we assumed Novartis’ manufacturing agreement with Patheon for the manufacture of commercial supplies ofFanapt. Under the Fanapt manufacturing agreement, we may procure bulk, partially packaged and finished supplies of various dosages of Fanapt for saleworldwide. We are responsible for sourcing the supply of the active pharmaceutical ingredient (iloperidone), and Patheon will manufacture 1, 2, 4, 6, 8, 10and 12 mg tablets pursuant to orders placed by us. The Fanapt manufacturing agreement contains specific forecasting, order lead time, minimum orderquantities, yield requirements, delivery terms and alternative manufacturing provisions. Generally, all product shipped to us must have a remaining shelf lifeof more than four-fifths of its total shelf life, but no less than one year of shelf life remaining for certain products. The Fanapt manufacturing agreementcontinues on a year-to-year basis, and can be terminated by either party on at least 12 months prior notice, or prior to the end of the then current term foruncured breach, insolvency/bankruptcy, or by us if a regulatory action prevents the supply of iloperidone to Patheon or otherwise the purchase or sale ofFanapt.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 weadvance our programs towards commercialization. We engage third parties to conduct portions of our preclinical research. In addition, we utilize multipleclinical sites to conduct our clinical trials; however, we are not substantially dependent upon any one of these sites for our clinical trials nor do any of themconduct a major portion of our clinical trials.We incurred $29.1 million, $19.2 million and $28.5 million in research and development expenses in the years ended December 31, 2015, 2014 and2013, respectively.CustomersOur revenue for the years ended December 31, 2015, 2014 and 2013 consisted of revenue from product sales, license revenue, and royalty revenue. Sixcustomers, each based in the U.S., accounted for 94% of our total revenue for the year ended December 31, 2015. No other customer accounted for more than10% of revenue in 2015. One company, headquartered in Switzerland with our revenue generated from sales in the U.S., accounted for 74% of our totalrevenue for the year ended December 31, 2014. No other customer accounted for more than 10% of revenue in 2014. One company, headquartered inSwitzerland with our revenue generated from sales in the U.S., accounted for 100% of our total revenue for the year ended December 31, 2013. No othercustomer accounted for more than 10% of revenue in 2013. Future revenue is uncertain and may fluctuate significantly from period to period. We have notexperienced any losses relating to receivables from customers.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 18®®®®®®®®®®®®®Table of Contentsmarket segment also includes several smaller emerging companies whose activities are directly focused on our target markets and areas of expertise. Ourproducts, once approved for commercial use, will compete with numerous therapeutic treatments offered by these competitors. While we believe that ourproducts will have certain favorable features, existing and new treatments may also possess advantages. Additionally, the development of other drugtechnologies and methods of disease prevention are occurring at a rapid pace. These developments may render our products or technologies obsolete ornoncompetitive.We believe the primary competitors for HETLIOZ and Fanapt are as follows: • For HETLIOZ in the treatment of Non-24, there are no FDA approved direct competitors. Sedative-Hypnotic treatments include, Ambien(zolpidem) by Sanofi (including Ambien CR), Lunesta (eszopiclone) by Sunovion Pharmaceuticals Inc., Sonata (zaleplon) by Pfizer Inc.,Rozerem (ramelteon) by Takeda Pharmaceuticals Company Limited, Silenor (doxepin) by Pernix Therapeutics, Belsomra (suvorexant) byMerck & Co., Inc., 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 Neurim Pharmaceuticals and the food supplement melatonin. Shift work and excessive sleepiness disordertreatments include Nuvigil (armodafinil) and Provigil (modafinil) both by Teva Pharmaceutical Industries Ltd. • For Fanapt in the treatment of schizophrenia, the atypical antipsychotics competitors are Risperdal (risperidone), including the depot formulationRisperdal Consta and Invega (paliperidone), including the depot formulation Invega Sustenna, each by Ortho-McNeil-JanssenPharmaceuticals, Inc., Zyprexa (olanzapine), including the depot formulation Zyprexa Relprevv™, each by Eli Lilly and Company, Seroquel(quetiapine) by AstraZeneca PLC, Abilify (aripiprazole) by BMS/Otsuka America Pharmaceutical Inc., Abilify Maintena (the depot formulationof Abilify) by Lundbeck/Otsuka America Pharmaceutical Inc., Geodon (ziprasidone) by Pfizer Inc., Saphris (asenapine) by Actavis plc, Latuda(lurasidone) by Sunovion Pharmaceuticals Inc., Rexulti (brexpiprazole) by Otsuka Pharmaceutical, Inc., Aristada™ (aripiprazole lauroxil)extended-release injectible suspension by Alkermes, 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.EmployeesWe had 118 full-time employees as of December 31, 2015, compared with 64 as of December 31, 2014. None of our employees are represented by alabor 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, WashingtonD.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 beaccessed through, 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 19®®®®®®®®®®®®®®®®®®®®®®®®®®®®®®®®®®®Table of Contentsmay read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. The public mayobtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains an internet website atwww.sec.gov that contains reports, proxy and information statements, and other information regarding issuers, including us, that file electronically with theSEC.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 Act assoon 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. ITEM 1A.RISK FACTORSOur business, financial condition and operating results can be affected by a number of factors, whether current known or unknown, including but notlimited to those described below, any one or more of which could, directly or indirectly, cause our actual operating results and financial condition to varymaterially from past, or anticipated future, operating results and financial condition. Any of these factors, in whole or in part, could materially andadversely affect our business, financial condition, operating results and the price of our common stock.The following discussion of risk factors contains forward-looking statements. These risk factors may be important to understanding any statement inthis annual report on Form 10-K or elsewhere. The following information should be read in conjunction with the consolidated financial statements andrelated notes in Part I, Item 1, Financial Statements and Part I, Item 2, Management’s, Discussion and Analysis of Financial Condition and Results ofOperations.Because of the following factors, as well as other factors affecting our financial condition and operating results, past financial performance shouldnot be considered to be a reliable indicator of future performance, and investors should not use historical trends to anticipate results or trends in futureperiods.Risks related to our business and industryWe are heavily dependent on the commercial success of HETLIOZ.Our future success is currently substantially dependent upon the commercial success of HETLIOZ for the treatment of Non-24-Hour Sleep-WakeDisorder (Non-24). In January 2014, the FDA approved our New Drug Application (NDA) for HETLIOZ for the treatment of Non-24 and in April 2014, wecommenced the U.S. commercial launch of HETLIOZ. In July 2015, the European Commission (EC) granted centralized marketing authorization withunified labeling for HETLIOZ for the treatment of Non-24 in blind adults. This authorization is valid in the 28 countries that are members of the EuropeanUnion, as well as European Economic Area members Iceland, Liechtenstein and Norway.Because we have limited information with regard to the market acceptance of HETLIOZ in the U.S. or elsewhere abroad, we may have to revise ourcommercial strategy for, or estimates regarding the market acceptance of, HETLIOZ or our strategy to commercialize the product.Market acceptance of and demand for HETLIOZ depends 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; 20®®®®®®®®®Table of Contents • 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.In addition, we expect to continue to incur significant expenses and to utilize a substantial portion of our cash resources as we continue thecommercialization of HETLIOZ and our Non-24 awareness campaign in the U.S., evaluate foreign market opportunities for HETLIOZ and continue to growour operational capabilities, both domestically and abroad. This represents a significant investment in the commercial success of HETLIOZ , which isuncertain.If we do not successfully commercialize HETLIOZ in the U.S., Europe or other jurisdictions in which HETLIOZ may be approved for sale, our abilityto generate increased product sales revenue may be jeopardized and, consequently, our business may be seriously harmed.We recently acquired further rights to Fanapt in the United States, and began selling, marketing and distributing Fanapt in the United States in thefirst quarter of 2015, and our ability to generate meaningful product sales from Fanapt will depend on the success of this product in the marketplace.Our ability to generate meaningful product sales from Fanapt will depend on many factors, including the following: • the unfavorable outcome or other negative effects of any pending litigation relating to Fanapt; • the effectiveness of our sales and marketing efforts in support 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 payors; • a satisfactory efficacy and safety profile as demonstrated in a broad patient population; • the size of the market for Fanapt; • the ability of our manufacturing partners to successfully expand and sustain 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; and • our or our partners’ ability to obtain regulatory approval for Fanapt in additional countries.For reasons outside of our control, including those mentioned above, sales of Fanapt may not meet our or financial or industry analysts’ expectations.Any significant negative developments relating to Fanapt, such as the loss of patent protection, safety or efficacy issues, the introduction or greateracceptance of competing products or adverse regulatory or legislative developments, will have an adverse effect on our financial condition and results ofoperations.As a company, we have minimal experience selling, marketing or distributing products, which may make commercializing our products difficult.At present, we as a company have minimal marketing experience. Therefore, in order for us to successfully commercialize HETLIOZ, Fanapt or ourother products, we must either acquire or continue to internally develop sales, marketing and distribution capabilities, or enter into collaborations withpartners to perform these services for us. We may, in some instances, rely significantly on sales, marketing and distribution arrangements with ourcollaborative partners and other third parties. 21®®®®®®®®®®®®®®®®®®®®®®Table of ContentsFor the commercialization of HETLIOZ, Fanapt or our other products, we may not be able to establish additional sales, marketing and distributioncapabilities or 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. Factors that may inhibit our efforts tocommercialize our products without partners or licensees 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 growing our own sales and marketing team or with entering into a partnering agreement with an independent salesand marketing organization.The cost of growing and maintaining a sales, marketing and distribution organization may exceed its cost effectiveness. If we fail to continue todevelop sales, marketing and distribution capabilities, if sales efforts are not effective or if costs of developing sales, marketing and distribution capabilitiesexceed their cost effectiveness, our business, results of operations and financial condition could be materially adversely affected.We may enter into third party collaborations from time to time in order to commercialize our products. If we are unable to identify or enter into anagreement with any material third-party collaborator, if our collaborations with any such third-party are not commercially successful or if ouragreement with any such third-party is terminated or allowed to expire, we could be adversely affected financially or our business reputation could beharmed.Our business strategy includes entering into collaborations with corporate collaborators for the commercialization of HETLIOZ, Fanapt and our otherproducts. Areas in which we may potentially enter into third-party collaboration arrangements include joint sales and marketing arrangements for sales andmarketing in certain European Union countries and elsewhere outside of the U.S., and future product development arrangements. If we are unable to identifyor enter into an agreement with any material third-party collaborator, this could result in an adverse effect on our business, results of operations or financialcondition. Any arrangements we do enter into may not be scientifically or commercially successful. The termination of any of these arrangements mightadversely affect our ability to develop, commercialize and market our products.The success of our collaboration arrangements will depend heavily on the efforts and activities of our collaborators. Our collaborators will havesignificant discretion in determining the efforts and resources that they will apply to these collaborations. We expect that the risks which we face inconnection with these future collaborations will include the following: • our collaboration agreements are expected to be for fixed terms and subject to termination under various circumstances, including, in many cases,on short notice without cause; • our collaborators may develop and commercialize, either alone or with others, products and services that are similar to or competitive with ourproducts which are the subject of their collaboration with us; and • our collaborators may change the focus of their commercialization efforts. In recent years there have been a significant number of mergers andconsolidations in the pharmaceutical and biotechnology industries, some of which have resulted in the participant companies reevaluating andshifting the focus of their business following the completion of these transactions. The ability of our products to reach their potential could belimited if any of our future collaborators decreases or fails to increase spending relating to such products.Collaborations with pharmaceutical companies and other third-parties often are terminated or allowed to expire by the other party. With respect to ourfuture collaborations, any such termination or expiration could adversely affect us financially as well as harm our business reputation. 22®®®®Table of ContentsEven after we or our partners obtain regulatory approvals of a product, acceptance of the product in the marketplace is uncertain and failure toachieve commercial acceptance will prevent or delay our ability to generate significant revenue from such product.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 therapeutic and cost-effective alternatives 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 our products,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’ marketingand distribution capabilities. If our approved products fail to gain market acceptance or do not become widely accepted by physicians, patients, third-partypayors and other members of the medical community, it is unlikely that we will ever become profitable on a sustained basis or achieve significant revenues.We rely and will continue to rely on outsourcing arrangements for many of our activities, including clinical development and supply of HETLIOZ,Fanapt and our other products.As of December 31, 2015, we had 118 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 distribution, clinical research and development, data collection and analysis and manufacturing, as well as forcertain functions as a public company. We may have limited control over these third parties and we cannot guarantee that they will perform their obligationsin an effective and timely manner.Disruptions to our HETLIOZ or Fanapt supply chains could materially affect our ability to successfully commercialize HETLIOZ or Fanapt,thereby reducing our future earnings and prospects.A loss or disruption with any one of our manufacturers or suppliers could disrupt the supply of HETLIOZ or Fanapt, possibly for a significant timeperiod, and we may not have sufficient inventories to maintain supply before the manufacturer or supplier could be replaced or the disruption is resolved. Inaddition, marketed drugs and their contract manufacturing organizations are subject to continual review, including review and approval of theirmanufacturing facilities and the manufacturing processes, which can result in delays in the regulatory approval process and/or commercialization.Introducing a replacement or backup manufacturer or supplier for HETLIOZ or Fanapt requires a lengthy regulatory and commercial process and there canbe no guarantee that we could obtain necessary regulatory approvals in a timely fashion or at all. In addition, it is difficult to identify and select qualifiedsuppliers and manufacturers with the necessary technical capabilities, and establishing new supply and manufacturing sources involves a lengthy andtechnical engineering process.We and our partners face heavy government regulation. We and our partners are also continually at risk of the FDA or applicable foreign agencyrequiring us or them to discontinue marketing any products that have obtained, or in the future may obtain, regulatory approval.Following marketing approval of a product, we and our partners will continue to face heavy governmental regulation. The marketing, distribution andmanufacture of approved products remain subject to extensive ongoing regulatory requirements. Failure to comply with applicable regulatory requirementscould result in, among other things: • warning letters; • fines; • civil penalties; • injunctions; • recall or seizure of products; 23®®®®®®®®®®Table of Contents • total or partial suspension of production; • refusal of the government to grant future approvals; • withdrawal of approvals; and • criminal prosecution.If we or our partners become subject to any of these foregoing items, our business, results of operations and financial condition could be materiallyadversely affected.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, suppliers or sponsors, including third-parties performing similar functions, of drugs and biologicals, by limiting thekinds of financial arrangements, including sales programs, with hospitals, physicians, and other potential purchasers of drugs and biologicals. Other federaland state laws generally prohibit individuals or entities from knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid,or other third party payors that are false or fraudulent, or are for items or services that were not provided as claimed. Anti-kickback and false claims lawsprescribe civil and criminal penalties for noncompliance that can be 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,including claims asserting antitrust violations, violations of the Federal False Claim Act, the Anti-Kickback Statute, the Prescription Drug Marketing Act andother violations in connection with off-label promotion of products and Medicare and/or Medicaid reimbursement or related to environmental matters andclaims under 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 areever evolving. 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,those actions 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.We intend to seek regulatory approvals for our products in additional foreign jurisdictions, but we may not obtain any such approvals.We intend to market our products, alone or with others, in foreign jurisdictions. In order to market our products in foreign jurisdictions, we or ourpartners may be required to obtain separate regulatory approvals and to comply with numerous and varying regulatory requirements. The approval procedurevaries among countries and jurisdictions and can involve additional trials, and the time required to obtain approval may differ from that required to obtainFDA approval. Additionally, the foreign regulatory approval process may include all of the risks associated with obtaining FDA approval. For all of thesereasons, we or our partners may not obtain foreign regulatory approvals on a timely basis, if at all. Approval by the FDA does not ensure approval byregulatory authorities in other countries or jurisdictions, and approval by one foreign regulatory authority does not ensure approval by regulatory authoritiesin other foreign countries or jurisdictions or by the FDA. We or our partners may not be able to file for regulatory approvals and may not receive necessaryapprovals to commercialize our products in any market. The failure to obtain these approvals could harm our business materially. 24Table of ContentsWe rely on a limited number of specialty pharmacies for distribution of HETLIOZ in the U.S., and the loss of one or more of these specialtypharmacies or their failure to distribute HETLIOZ effectively would materially harm our business.HETLIOZ is only available for distribution through a limited number of specialty pharmacies in the U.S. A specialty pharmacy is a pharmacy thatspecializes in the dispensing of medications for complex or chronic conditions, which often require a high level of patient education and ongoingmanagement. The use of specialty pharmacies involves certain risks, including, but not limited to, risks that these specialty pharmacies will: • not provide us accurate or timely information regarding their inventories, the number of patients who are using HETLIOZ or complaints aboutHETLIOZ; • reduce their efforts or discontinue to sell or support or otherwise not effectively sell or support HETLIOZ; • not devote the resources necessary to sell HETLIOZ in the volumes and within the time frames that we expect; • be unable to satisfy financial obligations to us or others; or • cease operations.In addition, if one or more of our specialty pharmacies do not fulfill their contractual obligations to us, or refuse or fail to adequately serve patients, ortheir agreements are terminated without adequate notice, shipments of HETLIOZ, and associated revenues, would be adversely affected. We expect that itwould take a significant amount of time if we were required to replace one or more of our specialty pharmacies.Our revenues from Fanapt are substantially dependent on sales through a limited number of wholesalers, and such revenues may fluctuate fromquarter to quarter.We sell Fanapt primarily through a limited number of pharmaceutical wholesalers in the U.S. The use of pharmaceutical wholesalers involves certainrisks, including, but not limited to, risks that these pharmaceutical wholesalers will: • not provide us accurate or timely information regarding their inventories, demand from wholesaler customers buying Fanapt or complaints aboutFanapt; • reduce their efforts or discontinue to sell or support or otherwise not effectively sell or support Fanapt; • not devote the resources necessary to sell Fanapt in the volumes and within the time frames that we expect; • be unable to satisfy financial obligations to us or others; or • cease operations.Additionally, our reliance on a small number of wholesalers could cause revenues to fluctuate from quarter to quarter based on the buying patterns ofthese wholesalers. In addition, if any of these wholesalers fails to pay on a timely basis or at all, our business, financial condition and results of operationscould be materially adversely affected.We 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 andour ability to identify and develop additional products. Large, fully integrated pharmaceutical companies, either alone or together with collaborativepartners, have substantially greater financial resources and have significantly greater experience than we do in: • developing products; • undertaking pre-clinical testing and clinical trials; 25®®®®®®®®®®®®®®Table of Contents • 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 othercompeting products before we do. Technological developments or the FDA or foreign regulatory approval of new therapeutic indications for existingproducts may make our products obsolete or may make them more difficult to market successfully, any of which could have a material adverse effect on ourbusiness, results of operations 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 FDA approved direct competitors. Sedative-Hypnotic treatments include, Ambien(zolpidem) by Sanofi (including Ambien CR), Lunesta (eszopiclone) by Sunovion Pharmaceuticals Inc., Sonata (zaleplon) by Pfizer Inc.,Rozerem (ramelteon) by Takeda Pharmaceuticals Company Limited, Silenor (doxepin) by Pernix Therapeutics, Belsomra (suvorexant) byMerck & Co., Inc., 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 Neurim Pharmaceuticals and the food supplement melatonin. Shift work and excessive sleepiness disordertreatments include Nuvigil (armodafinil) and Provigil (modafinil) both by Teva Pharmaceutical Industries Ltd. • For Fanapt in the treatment of schizophrenia, the atypical antipsychotics competitors are Risperdal (risperidone), including the depot formulationRisperdal Consta and Invega (paliperidone), including the depot formulation Invega Sustenna, each by Ortho-McNeil-JanssenPharmaceuticals, Inc., Zyprexa (olanzapine), including the depot formulation Zyprexa Relprevv™, each by Eli Lilly and Company, Seroquel(quetiapine) by AstraZeneca PLC, Abilify (aripiprazole) by BMS/Otsuka America Pharmaceutical Inc., Abilify Maintena (the depot formulationof Abilify) by Lundbeck/Otsuka America Pharmaceutical Inc., Geodon (ziprasidone) by Pfizer Inc., Saphris (asenapine) by Actavis plc, Latuda(lurasidone) by Sunovion Pharmaceuticals Inc., Rexulti (brexpiprazole) by Otsuka Pharmaceutical, Inc., Aristada™ (aripiprazole lauroxil)extended-release injectible suspension by Alkermes, 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 RestorationAct of 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 atchallenging an Abbreviated New Drug Application (ANDA), filed pursuant to the Hatch-Waxman Act, cheaper generic versions of our products, which maybe favored by insurers and third-party payors, may be launched commercially, which would significantly harm our business.In June 2014, we filed suit against Roxane Laboratories, Inc. (Roxane) in the U.S. District Court for the District of Delaware. The suit seeksadjudication that Roxane has infringed one or more claims of our U.S. Patent No. 8,586,610 (the ‘610 Patent) by submitting to the FDA an ANDA for genericversions of Fanapt oral tablets 26®®®®®®®®®®®®®®®®®®®®®®®®®®®®®®®®®®®®®®Table of Contentsin 1 mg, 2 mg, 4 mg, 6 mg, 8 mg, 10 mg and 12 mg strengths. The relief requested by us includes a request for a permanent injunction preventing Roxanefrom infringing the asserted claims of the ‘610 Patent by engaging in the manufacture, use, offer to sell, sale, importation or distribution of generic versions ofFanapt before the expiration of the ‘610 Patent in 2027.Pursuant to the Settlement Agreement, we assumed Novartis’ patent infringement action against Roxane in the U.S. District Court for the District ofDelaware. The suit alleges that Roxane’s filing of an ANDA for generic iloperidone with a paragraph IV certification infringes Sanofi’s new chemical entitypatent. Roxane is defending on the grounds that the patent claims are invalid or unenforceable or that certain patent claims are not infringed. Roxane alsofiled a motion to dismiss on the grounds that the court lacks jurisdiction.The two pending cases against Roxane were consolidated by agreement of the parties in April 2015 and are scheduled to be tried together in a four-daybench trial beginning on February 29, 2016.In May 2015, we filed a lawsuit against Inventia Healthcare Pvt. Ltd. (Inventia) in the U.S. District Court for the District of Delaware. The suit seeks anadjudication that Inventia has infringed one or more claims of the ‘610 Patent by submitting to the FDA an ANDA for a generic version of Fanapt. The reliefrequested by us includes a request for a permanent injunction preventing Inventia from infringing the asserted claims of the ‘610 Patent by engaging in themanufacture, use, offer to sell, sale, importation or distribution of generic versions of Fanapt before the expiration of the ‘610 Patent in 2027. This lawsuit isscheduled to be tried in a four-day bench trial beginning on January 17, 2017.In October 2015, we filed four separate patent infringement lawsuits in the United States District Court for the District of Delaware (the October 2015Lawsuits). Two of the October 2015 Lawsuits join the existing litigations against the previous Fanapt ANDA filers, Roxane and Inventia, described above.The other two October 2015 Lawsuits were filed against new ANDA filers, Taro Pharmaceuticals, U.S.A., Inc./Taro Pharmaceuticals Ltd. (Taro) and ApotexInc. (Apotex).The first of the October 2015 Lawsuits, which was filed against Roxane, seeks an adjudication that Roxane has infringed one or more claims of our U.S.Patent No. 9,138,432 (the ‘432 Patent) by submitting to the FDA its ANDA for a generic version of Fanapt prior to the expiration of the ‘432 Patent inSeptember 2025. The relief requested by us includes a request for a permanent injunction preventing Roxane from infringing the asserted claims of the ‘432Patent by engaging in the manufacture, use, offer to sell, sale, importation or distribution of generic versions of Fanapt before the expiration of the ‘432Patent in 2025.The second of the October 2015 Lawsuits, which was filed against Inventia, seeks an adjudication that Inventia has infringed one or more claims of the‘432 Patent by submitting to the FDA its ANDA for a generic version of Fanapt prior to the expiration of the ‘432 Patent in September 2025. The reliefrequested by us includes a request for a permanent injunction preventing Inventia from infringing the asserted claims of the ‘432 Patent by engaging in themanufacture, use, offer to sell, sale, importation or distribution of generic versions of Fanapt before the expiration of the ‘432 Patent in 2025.The third of the October 2015 Lawsuits, which was filed against Taro, seeks an adjudication that Taro has infringed one or more claims of the ‘432Patent and the ‘610 Patent by submitting to the FDA an ANDA for a generic version of Fanapt prior to the expiration of the ‘432 patent in September 2025and the ‘610 Patent in November 2027. The relief requested by us includes a request for a permanent injunction preventing Taro from infringing the assertedclaims of the ‘432 Patent and the ‘610 Patent by engaging in the manufacture, use, offer to sell, sale, importation or distribution of generic versions ofFanapt before the expiration of the ‘432 Patent in 2025 and the ‘610 Patent in 2027.The fourth of the October 2015 Lawsuits, which was filed against Apotex and Apotex Corp., seeks an adjudication that Apotex has infringed one ormore claims of the ‘432 Patent and the ‘610 Patent by submitting to the FDA an ANDA for a generic version of Fanapt prior to the expiration of the ‘432Patent in September 2025 and the ‘610 Patent in November 2027. The relief requested by us includes a request for a permanent injunction preventing Apotexfrom infringing the asserted claims of the ‘432 Patent and the ‘610 Patent by engaging in the manufacture, use, offer to sell, sale, importation or distributionof generic versions of Fanapt before the expiration of the ‘432 Patent in 2025 and the ‘610 Patent in 2027. 27®®®®®®®®®®®®Table of ContentsIn November 2015, we filed a patent infringement lawsuit in the United States District Court for the District of Delaware against Lupin Limited andLupin Pharmaceuticals, Inc. (collectively, Lupin). The suit seeks an adjudication that Lupin has infringed one or more claims of the ‘432 Patent and the ‘610Patent by submitting to the FDA its ANDA for a generic version of Fanapt prior to the expiration of the ‘432 Patent in September 2025 and the ‘610 Patentin November 2027. The relief requested by us in the lawsuit includes a request for a permanent injunction preventing Lupin from infringing the assertedclaims of the ‘432 Patent and the ‘610 Patent by engaging in the manufacture, use, offer to sell, sale, importation or distribution of generic versions ofFanapt before the expiration of the ‘432 Patent in 2025 and the ‘610 Patent in 2027.FDA and foreign regulatory approval of our products is uncertain.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, as well as foreign regulatory authorities in jurisdictionsin which we seek approval. To obtain regulatory approval of such products, we or our partners must demonstrate to the satisfaction of the applicableregulatory agency that, among other things, the product is safe and effective for its intended use. In addition, we or our partners must show that themanufacturing facilities used to produce such products are in compliance with current Good Manufacturing Practices regulations (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-clinical and clinical trials that will be required for FDA or foreign regulatory approval varies depending on the product, the disease or condition that theproduct is in development for, and the requirements applicable to that particular product. The FDA or applicable foreign regulatory agency can delay, limit ordeny approval of a product for many reasons, including that: • a product may not be shown to be safe or effective; • the FDA or foreign agency may interpret data from pre-clinical and clinical trials in different ways than we or our partners do; • the FDA or foreign agency 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 or foreign agency may change its approval policies or adopt new regulations; • the FDA or foreign agency may not meet, or may extend, the Prescription Drug User Fee Act (PDUFA-V) date or its foreign equivalent with respect toa particular NDA or foreign application; and • the FDA or foreign agency may not agree with our or our partners’ regulatory approval strategies or components of the regulatory filings, such asclinical trial designs.For example, if certain of our or our partners’ methods for analyzing trial data are not accepted by the FDA or the applicable foreign agency, we or ourpartners may fail to obtain regulatory approval for our products.Any 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 the 31 countries in Europe covered by therecent centralized marketing authorization by the EC, and Fanapt in the U.S., Mexico and Israel, we have not received regulatory approval to market any ofour products in any jurisdiction.Even following regulatory approval of our products, the FDA or the applicable foreign agency may impose limitations on the indicated uses for whichsuch products may be marketed, subsequently withdraw approval or take other actions against us, our partners or such products that are adverse to ourbusiness. The FDA and foreign agencies generally approve drugs for particular indications. An approval for a more limited indication reduces the size of thepotential market for the product. Product approvals, once granted, may be withdrawn or modified if problems occur after initial marketing. 28®®®®Table of ContentsWe and our partners also are subject to numerous federal, state, local and foreign laws, regulations and recommendations relating to safe workingconditions, laboratory and manufacturing practices, the environment and the use and disposal of hazardous substances used in connection with discovery,research and development 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 orregulations, and we may be adversely affected by the cost of such compliance or the inability to comply with such laws or regulations.If our products are determined to be unsafe or ineffective in humans, whether commercially or in clinical trials, our business will be materially harmed.Despite the FDA’s approval of the NDA for HETLIOZ in January 2014 and the NDA for Fanapt in May 2009, the EC’s grant of the centralizedmarketing authorization for HETLIOZ in July 2015, and the positive results of our completed trials for HETLIOZ and Fanapt, we are uncertain whethereither of these products will ultimately prove to be effective and safe in humans. Frequently, products that have shown promising results in clinical trialshave suffered significant setbacks in later clinical trials or even after they are approved for commercial sale. Future uses of our products, whether in clinicaltrials or commercially, may reveal that the product is ineffective, unacceptably toxic, has other undesirable side effects, is difficult to manufacture on a largescale, is uneconomical, infringes on proprietary rights of another party or is otherwise not fit for further use. If our products are determined to be unsafe orineffective 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 our products couldseverely 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 togethertake several years to complete. Before obtaining regulatory approvals for the commercial sale of any of our products, we or our partners must demonstratethrough preclinical testing and clinical trials that such product is safe and effective for use in humans. We have incurred, and we will continue to incur,substantial expense 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 and efficacyto obtain the requisite regulatory approvals for our products. Regulatory authorities may not permit us or our partners to undertake any additional clinicaltrials 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 new indications.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. 29®®®®®Table of ContentsIf we or our partners fail to complete successfully one or more clinical trials for our products, we or they may not receive the regulatory approvalsneeded to market that product. Therefore, any failure or delay in commencing or completing these clinical trials would harm our business materially.Our products may cause undesirable side effects or have other properties that could delay, prevent or result in the revocation of their regulatoryapproval 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 will continue to assess the side effect profile of our products in ongoingclinical development programs. However, we cannot predict whether the commercial use of our approved products (or our products in development, if andwhen they are approved for commercial use) will produce undesirable or unintended side effects that have not been evident in the use of, or in clinical trialsconducted for, such products to date. Additionally, incidents of product misuse may occur. These events, among others, could result in product recalls,product liability actions or withdrawals or additional regulatory controls, all of which could have a material adverse effect on our business, results ofoperations and financial condition.In addition, if after receiving marketing approval of a product, we, our partners or others identify undesirable side effects caused by such product, we orour 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 continued commercialization of HETLIOZ and Fanapt will require substantial additional expenditures.As of December 31, 2015, we had an accumulated deficit of $327.8 million and we cannot estimate with precision the extent of our future losses. InApril 2014, we commercially launched HETLIOZ in the U.S. for the treatment of Non-24. We are currently evaluating the commercial opportunity forHETLIOZ in Europe. In the fourth quarter of 2014, we acquired all further rights to Fanapt from Novartis. The continued commercialization of HETLIOZand Fanapt will require substantial additional expenditures. In addition, we may not succeed in commercializing HETLIOZ, Fanapt or any other products.Novartis launched Fanapt in the U.S. in the first quarter of 2010 and we began selling Fanapt on our own in the first quarter of 2015. We may not succeed ingaining additional market acceptance of Fanapt in the U.S. and we may not succeed in commercializing HETLIOZ or Fanapt outside of the U.S. We maynot be profitable even if our products are successfully commercialized. We may be unable to fully develop, obtain regulatory approval for, commercialize,manufacture, market, sell and derive revenue from our products in the timeframes we project, if at all, and our inability to do so would materially andadversely impact the market price of our common stock and our ability to raise capital and continue operations. 30®®®®®®®®®®®®®®Table of ContentsThere can be no assurance that we will achieve sustained profitability. Our ability to achieve sustained profitability in the future depends, in part,upon: • our ability to obtain and maintain regulatory approval for our products, particularly HETLIOZ for the treatment of Non-24, both in the U.S. and inforeign countries; • our ability to successfully commercialize HETLIOZ in the U.S., Europe and other jurisdictions in which HETLIOZ may receive regulatoryapproval, if any; • our ability to successfully raise awareness regarding Non-24 in the medical and patient communities; • our ability to successfully market and sell Fanapt in the U.S. and our or our partners’ ability to successfully market and sell Fanapt in Israel,Mexico and other jurisdictions in which we may receive regulatory approval, if any; • 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 andother third 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 (IRC), a corporation that undergoes an “ownership change” is subjectto limitations on its ability to utilize its pre-change net operating losses (NOLs) and certain other tax assets (tax attributes) to offset future taxable income. Ingeneral, an ownership change occurs if the aggregate stock ownership of certain stockholders increases by more than 31®®®®®Table of Contents50 percentage points over such stockholders’ lowest percentage ownership during the testing period (generally three years). Transactions involving ourcommon stock, even those outside our control, such as purchases or sales by investors, within the testing period could result in an ownership change. Alimitation on our ability to utilize some or all of our NOLs or credits could have a material adverse effect on our results of operations and cash flows.Ownership changes did occur as of December 31, 2008 and December 31, 2014. Our management determined that there was sufficient Built-In-Gain as ofDecember 31, 2008 to offset the IRC Section 382 limitation generated by the ownership change. Our management believes that there is sufficient Built-In-Gain as of December 31, 2014 to offset the IRC Section 382 limitation generated by the ownership change. Any future ownership changes may cause ourexisting tax attributes to have additional limitations.If we fail to obtain the capital necessary to fund our research and development activities and commercialization efforts, we may be unable to continueoperations or we may be forced to share our rights to commercialize our products with third parties on terms that may not be attractive to us.Our activities will necessitate significant uses of working capital throughout 2016 and beyond. It is uncertain whether our existing funds will besufficient to meet our operating needs. As of December 31, 2015, our total cash and cash equivalents and marketable securities were $143.2 million. Our longterm capital requirements are expected to depend on many factors, including, among others: • our ability to successfully commercialize HETLIOZ and Fanapt globally; • costs of developing and maintaining sales, marketing and distribution channels and our ability to sell our products; • market acceptance of our products; • costs involved in establishing manufacturing capabilities for commercial quantities of our products; • 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; • costs for recruiting and retaining employees and consultants; • costs for training physicians; and • legal, accounting, insurance and other professional and business related costs.As a result, we may need to raise additional capital to fund our anticipated operating expenses and execute on our business plans. In our capital-raisingefforts, we may seek to sell debt securities or additional equity securities, obtain a bank credit facility, or enter into partnerships or other collaborationagreements. The sale of additional equity or debt securities, if convertible, could result in dilution to our stockholders and may also result in a lower price forour common stock. The incurrence of indebtedness would result in increased fixed obligations and could also result in covenants that could restrict ouroperations. 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 fund ourplanned 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. 32®®Table of ContentsIf our contract research organizations do not successfully carry out their duties or if we lose our relationships with contract research organizations, ourdrug 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 trialsrelated to our drug discovery and development efforts and we will likely continue to depend on them to assist in our future discovery and developmentefforts. These parties are not our employees and we cannot control the amount or timing of resources that they devote to our programs. As such, they may notcomplete activities on schedule or may not conduct our clinical trials in accordance with regulatory requirements or our stated protocols. The parties withwhich we contract for execution of our clinical trials play a significant role in the conduct of the trials and the subsequent collection and analysis of data. Ifthey fail to devote sufficient time and resources to our drug development programs or if their performance is substandard, it will delay the development,approval and commercialization of our products. Moreover, these parties may also have relationships with other commercial entities, some of which maycompete with us. If they 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 comparableprovider and then contracting for its services. We may be unable to retain an alternative provider on reasonable terms, if at all. Even if we locate analternative 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 asthe original provider. In addition, any provider that we retain will be subject to current Good Laboratory Practices, and similar foreign standards and we donot have control over compliance with these regulations by these providers. Consequently, if these practices and standards are not adhered to by theseproviders, the development 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 seriously harmed if thesemanufacturers 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-house manufacturing capability and depend completely on a small number of third-party manufacturers and active pharmaceutical ingredient formulators forthe manufacture 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. In addition, we assumed Novartis’ agreement with Patheon for the manufacture of Fanapt in the fourth quarter of 2014. We donot have exclusive long-term agreements with any other third party manufacturers of our products. If Patheon, or any other third party manufacturer, is unableor unwilling to perform its obligations under our manufacturing agreements for any reason, we may not be able to locate alternative acceptable manufacturersor formulators 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, manufacturers of our products are subject to cGMP and similar foreign standards and we do not have control over compliance with 33®®Table of Contentsthese regulations by our manufacturers. If one of our contract manufacturers fails to maintain compliance, the production of our products could beinterrupted, resulting in delays and additional costs. In addition, if the facilities of such manufacturers do not pass a pre-approval or post-approval plantinspection, the FDA will not grant approval 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 the development,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 andour partners’ 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 toacquire rights to commercialize additional products, we may not be able to develop a diverse portfolio of products and our business may be harmed.Additionally, it may take substantial human and financial resources to secure commercial rights to promising products. Moreover, if other firms developpharmacogenetics and 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 thoseassociated with our programs with collaborative partners. 34Table 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 otherkey personnel, or the inability to attract and retain additional qualified personnel, could result in delays to development or approval, loss of sales anddiversion of management resources. In addition, we depend on our ability to attract and retain other highly skilled personnel, including research scientists.Competition for qualified personnel is intense, and the process of hiring and integrating such qualified personnel is often lengthy. We may be unable torecruit such personnel on 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 liable inany 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 more ofour products. Although we maintain product liability insurance, our aggregate coverage limit under this insurance is $25.0 million, and while we believe thisamount 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 futureclaim. This could prevent the commercialization or limit the commercial potential of our products. Even if we are able to maintain insurance that we believeis adequate, our results of operations and financial condition may be materially adversely affected by a product liability claim. Uncertainties resulting fromthe initiation and continuation of products liability litigation or other proceedings could have a material adverse effect on our ability to compete in themarketplace. Product liability litigation and other related proceedings may also require significant management time.European Union Member States tend to impose strict price controls, which may delay or prevent the commercial launch or impede the commercialsuccess of HETLIOZ in Europe and adversely affect our future results of operations.In the European Union, prescription drug pricing and reimbursement are subject to governmental control and reimbursement mechanisms used byprivate and public health insurers in the European Union vary by Member State. For the public systems, reimbursement is determined by guidelinesestablished by the legislature or responsible national authority. As elsewhere, inclusion in reimbursement catalogues focuses on the medical usefulness, need,quality and economic benefits to patients and the health care system. Acceptance for reimbursement comes with cost, use and often volume restrictions,which can vary by Member State. Although we have received marketing authorization for HETLIOZ from the EC, pricing negotiations with governmentalauthorities may take a considerable amount of time in those Member States that impose price controls. In 35®®Table of Contentsaddition, to obtain reimbursement or pricing approval for HETLIOZ in some Member States, we may be required to conduct a clinical trial that compares thecost-effectiveness of HETLIOZ, to other available therapies.Some Member States require approval of the sale price of a drug before it can be marketed. In many countries, the pricing review period begins aftermarketing or product licensing approval is granted. In some Member States, prescription pharmaceutical pricing remains subject to continuing governmentalcontrol even after initial approval is granted. As a result, we may be subject to lengthy price regulations that delay or prevent the commercial launch ofHETLIOZ in a particular Member State and negatively impact the revenues that are generated from the sale of HETLIOZ in that country. If reimbursementof HETLIOZ is unavailable or limited in scope or amount, or if pricing for HETLIOZ is set at unsatisfactory levels or takes too long to establish, or if thereis competition from lower priced cross-border sales, our results of operations will be negatively affected.Legislative or regulatory reform of the healthcare system in the U.S. and foreign jurisdictions may affect our ability to sell our products 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 third-party payors are increasingly challenging the prices charged for medicalproducts and services. It will be time-consuming and expensive for us or our partners to go through the process of seeking reimbursement from Medicare andprivate payors. Our products may not be considered cost effective, and coverage and reimbursement may not be available or sufficient to allow the sale ofsuch products on a competitive and profitable basis. Further federal and state proposals and healthcare reforms are likely which could limit the prices that canbe charged for the drugs we develop and may further limit our commercial opportunity. Our results of operations could be materially adversely affected bythe Medicare prescription drug coverage legislation, by the possible effect of this legislation on amounts that private insurers will pay and by otherhealthcare 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 (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 asof March 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 creationof new 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 theamount of Medicaid drug rebates to states. Substantial new provisions affecting compliance also have been added, which may require us to modify ourbusiness practices with health care practitioners.The reforms imposed by PPACA significantly impact the pharmaceutical industry; however, the full effects of the PPACA cannot be known until theseprovisions are implemented and the Centers for Medicare & Medicaid Services and other federal and state agencies issue applicable regulations or guidance.Moreover, in the coming years, additional changes could be made to governmental healthcare programs that could significantly 36®®®®®®Table of Contentsimpact the success of our products. We will continue to evaluate the PPACA, as amended, the implementation of regulations or guidance related to variousprovisions of the PPACA by federal agencies, as well as trends and changes that may be encouraged by the legislation and that may potentially impact on ourbusiness over time. The financial impact of the U.S. healthcare reform legislation over the next few years will depend on a number of factors including but notlimited to the policies reflected in implementing regulations and guidance and changes in sales volumes for products affected by the new system of rebates,discounts and fees. These developments could, however, have a material adverse effect on our business, financial condition and results of operations.Further, in September 2007, the Food and Drug Administration Amendments Act of 2007 was enacted giving the FDA enhanced post-marketingauthority including the authority to require post-marketing studies and clinical trials, labeling changes based on new safety information and compliance withREMS approved by the FDA. The FDA’s exercise of this authority could result in delays or increased costs during product development, clinical trials andregulatory review, increased costs to ensure compliance with post-approval regulatory requirements and potential restrictions on the sale and/or distributionof approved products.Moreover, we cannot predict what healthcare reform initiatives may be adopted in the future. Further federal and state legislative and regulatorydevelopments are likely, and we expect ongoing initiatives in the United States to increase pressure on drug pricing. Such reforms could have an adverseeffect on anticipated revenues from product candidates that we may successfully develop and for which we may obtain regulatory approval and may affectour overall financial condition and ability to develop product candidates.In addition, other legislative changes have been proposed and adopted in the United States since the PPACA was enacted. On August 2, 2011, theBudget Control Act of 2011 among other things, created measures for spending reductions by Congress. A Joint Select Committee on Deficit Reduction,tasked with recommending a targeted deficit reduction of at least $1.2 trillion for the years 2013 through 2021, was unable to reach required goals, therebytriggering the legislation’s automatic reduction to several government programs. This includes aggregate reductions to Medicare payments to providers of upto 2% per fiscal year, starting in 2013, which will remain in effect until 2024 unless additional congressional action is taken. On January 2, 2013, theAmerican Taxpayer Relief Act of 2012 was signed into law, which, among other things, increased the statute of limitations period for the government torecover overpayments to providers from three to five years. We expect that additional federal healthcare reform measures will be adopted in the future, any ofwhich could limit the amounts that federal and state governments will pay for healthcare products and services, and in turn could significantly reduce theprojected value of certain development projects and reduce our profitability.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.Additionally, drug prices are under significant scrutiny, and along with other health care costs, continue to be subject to intense political and societalpressures, which we anticipate will continue and escalate, including on a global basis. As a result, our business and reputation may be harmed, our stock pricemay be adversely impacted and experience periods of volatility, and our results of operations may be adversely impacted.Our business is subject to extensive governmental regulation and oversight and changes in laws could adversely affect our results of operations.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; 37Table 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.Future 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 or sustainprofitability.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 acquiredbusinesses or technologies could be expensive and time-consuming, resulting in the diversion of resources from our current business. We may not be able tointegrate any acquired business successfully. We cannot assure you that, following an acquisition, we will achieve revenues, specific net income or losslevels that justify the acquisition or that the acquisition will result in increased earnings, or reduced losses, for the combined company in any future period.Moreover, we may need to raise additional funds through public or private debt or equity financing to acquire any businesses, which would result in dilutionfor stockholders or the incurrence of indebtedness and may not be available on terms which would otherwise be acceptable to us. We may not be able tooperate acquired businesses profitably or otherwise implement our growth strategy successfully.Our operating results may fluctuate significantly due to a number of factors which make our future results difficult to predict and could cause ouroperating results to fall below expectations or our guidance.Our operating results will continue to be subject to fluctuations. The revenues we generate and our operating results will be affected by numerousfactors, including: • product sales; • cost of product sales; • marketing and other expenses; • manufacturing or supply issues; • the timing and amount of royalties or milestone payments; • our addition or termination of development programs; 38Table of Contents • variations in the level of expenses related to our products or future development programs; • regulatory developments affecting our products or those of our competitors; our execution of collaborative, licensing or other arrangements, and thetiming of payments we may make or receive under these arrangements; • any intellectual property infringement or other lawsuit in which we may become involved; and • the timing and recognition of stock-based compensation expense.If our operating results fall below the expectations of investors or securities analysts or below any guidance we may provide, the price of our commonstock 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 our financial results are not necessarily meaningful and should not be relied upon as an indication of our future performance.We are increasingly dependent on information technology systems, infrastructure and data.We are increasingly dependent upon information technology systems, infrastructure and data. Our computer systems may be vulnerable to serviceinterruption or destruction, malicious intrusion and random attack. Security breaches pose a risk that sensitive data, including intellectual property, tradesecrets or personal information may be exposed to unauthorized persons or to the public. Cyber-attacks are increasing in their frequency, sophistication andintensity, and have become increasingly difficult to detect. Cyber-attacks could include the deployment of harmful malware, denial-of service, socialengineering and other means to affect service reliability and threaten data confidentiality, integrity and availability. Our key business partners face similarrisks, and a security breach of their systems could adversely affect our security posture. While we continue to invest data protection and informationtechnology, there can be no assurance that our efforts will prevent service interruptions, or identify breaches in our systems, that could adversely affect ourbusiness and operations and/or result in the loss of critical or sensitive information, which could result in financial, legal, business or reputational harm.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 by otherpharmaceutical 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 dueto our breach, all rights to HETLIOZ (including any intellectual property we develop with respect to HETLIOZ) will revert or otherwise be licensed back toBMS on an exclusive basis. Any termination or reversion of our rights to develop or commercialize HETLIOZ, including any reacquisition by BMS of ourrights, would have a material adverse effect on our business.Fanapt is based in part on patents and other intellectual property owned by Sanofi. Titan Pharmaceuticals, Inc. (Titan) holds an exclusive license fromSanofi to the intellectual property owned by Sanofi, and Titan has sublicensed its rights under such license on an exclusive basis to Novartis. We acquiredexclusive rights to this and other intellectual property through a further sublicense from Novartis. The sublicense with Novartis was amended and restated inOctober of 2009 to provide Novartis with exclusive rights to commercialize Fanapt in the U.S. and Canada. We retained exclusive rights to Fanapt outsidethe U.S. and Canada. We acquired all of Novartis’ rights to Fanapt in the fourth quarter of 2014 pursuant to an asset transfer agreement and relatedagreements with Novartis. We may lose our rights to develop and commercialize Fanapt if we fail to comply with certain requirements in the Titan licenseagreement regarding our financial condition, or if we fail to comply with certain diligence obligations regarding our development or commercializationactivities. Our loss of rights in Fanapt would have a material adverse effect on our business, financial condition and results of operations. 39®®®®®®®®®®®Table of ContentsTradipitant is based in part on patents that we have licensed on an exclusive basis and other intellectual property licensed from Eli Lilly and Company(Lilly). Lilly may terminate our license if we fail to use our commercially reasonable efforts to develop and commercialize tradipitant or if we materiallybreach the agreement and fail to cure that breach. In the event that we terminate our license, or if Lilly terminates our license for the reasons stated above, allof our rights to tradipitant (including any intellectual property we develop with respect to tradipitant) will revert back to Lilly, subject to payment by Lilly tous of a royalty on net sales of products that contain tradipitant.AQW051, to which we acquired rights from Novartis in the fourth quarter of 2014, is based on patents and other intellectual property that we havelicensed on an exclusive basis from Novartis. Novartis may terminate our license if we materially breach the agreement, which includes an obligation to usecommercially reasonable efforts to develop and commercialize AQW051, and fail to cure that breach. In the event that Novartis terminates our license for thereasons stated above, all of our rights to AQW051 (including any intellectual property we develop with respect to AQW051) will revert back to Novartiswithout compensation.If our efforts to protect the proprietary nature of the intellectual property related to our products are not adequate, we may not be able to competeeffectively in our markets.Method of treatment patents protect the use of a product for the method specified in the patent claims. This type of patent does not prevent acompetitor from making and marketing a product that is identical to our product for a use that is outside the scope of the patented method. Moreover, even ifcompetitors do not actively promote their product for our patented methods, physicians may prescribe these products “off-label.” Although off-labelprescriptions may infringe or contribute to the infringement of method of treatment patents, such infringement may be difficult to prevent.Our patents and patent applications may be challenged or fail to result in issued patents and our existing or future patents may be too narrow to preventthird parties from developing or designing around these patents. In addition, we generally rely on trade secret protection and confidentiality agreements toprotect certain proprietary know-how that is not patentable, for processes for which patents are difficult to enforce and for any other elements of our drugdevelopment processes that involve proprietary know-how, information and technology that is not covered by patent applications. While we require all ofour employees, consultants, advisors and any third parties who have access to our proprietary know-how, information and technology to enter intoconfidentiality agreements, we cannot be certain that this know-how, information and technology will not be disclosed or that competitors will not otherwisegain access to our trade secrets or independently develop substantially equivalent information and techniques. Further, the laws of some foreign countries donot protect proprietary rights to the same extent as the laws of the U.S. As a result, we may encounter significant problems in protecting and defending ourintellectual property both in the U.S. and abroad. If we are unable to protect or defend the intellectual property related to our technologies, we will not beable 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 market exclusivity forour 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 extension for HETLIOZ, and that we continue to have rights under our license agreement with respect to thisproduct, we would have exclusive rights to the HETLIOZ U.S. “new chemical entity” patent (the primary patent covering the product as a new compositionof matter) until 2022. We also own two HETLIOZ U.S. method of treatment patents (directed to the approved method of treatment as described in theHETLIOZ label approved by the FDA). These patents expire normally in 2033. The Fanapt U.S. “new chemical entity” patent has received the full five-yearpatent term extension under the Hatch-Waxman Act and so the term of this patent in the U.S. has been extended until November 2016. In November 2013, apatent directed to a method of treating patients with Fanapt based on genotype was issued to us by the U.S. Patent and Trademark Office. This patent, whichwas listed in the FDA’s Orange Book in January 2015, is set to expire in 2027. Eight additional U.S. patents directed to methods of treating patients withFanapt, which are set to expire between 2025 and 2031, were issued to us in 2014 and 2015. 40®®®®®®®Table of ContentsA directive in the European Union provides that companies that receive regulatory approval for a new medicinal product will have a 10-year period ofmarket exclusivity for that product (with the possibility of a further one-year extension), beginning on the date of such European regulatory approval,regardless of when the European new chemical entity patent covering such product expires. A generic version of the approved drug may not be marketed orsold in Europe during such market exclusivity period. This directive is of material importance with respect to Fanapt, since the European new chemicalentity patent for Fanapt has expired.Assuming we gain a five-year patent term restoration for tradipitant, and that we continue to have rights under our license agreement with respect tothis product, we would have exclusive rights to tradipitant’ s U.S. new chemical entity patent until 2029. Assuming we gain a five-year patent termrestoration for AQW051, and that we continue to have rights under our license agreement with respect to this product, we would have exclusive rights toAQW051’s U.S. new chemical entity patent until 2028.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 drug discoveryand 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 ourtechnologies infringes 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. We may fail to obtain any of these licenses at a reasonable cost or on reasonable terms, if at all. In that event, wewould be unable to develop and commercialize further 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. Prosecutionof these 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.As described elsewhere in these risk factors and in Part I, Item 3, Legal Proceedings, of this annual report on Form 10-K, we have initiated lawsuits toenforce our patent rights against Roxane, Inventia, Taro, Apotex and Lupin.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, 2015 and December 31, 2015, the high and low sale prices of our common stock as reported on The NASDAQGlobal Market varied between $8.00 and $15.00. 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 fluctuations for reasonsthat were unrelated to the operating performance of any one company. 41®®Table of ContentsThe 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; • the outcome of pending litigation or the initiation of new litigation concerning us, our products or our intellectual property; • 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; • financial guidance or business updates we may provide; • announcements about our financial results that are not in line with analyst expectations or guidance we provide; • 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.We 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. 42Table of ContentsIn addition to our outstanding common stock, as of December 31, 2015 there were a total of 7,275,129 shares of our common stock that we haveregistered and that we are obligated to issue upon the exercise of currently outstanding options and settlement of restricted stock unit awards granted underour 2006 Equity Incentive Plan. Upon the exercise of these options or settlement of the shares underlying these restricted stock units, as the case may be, inaccordance with their respective terms, these shares may be resold freely, subject to restrictions imposed on our affiliates under Rule 144. If significant salesof 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 ourcommon 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 from trading, whichwould 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 and tradingvolume 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 orexchangeable for our common stock at prices that may not be the same as the price per share in previous offerings. We may sell shares or other securities inany other offering at a price per share that is less than the price per share paid by investors in previous offerings, and investors purchasing shares or othersecurities in the future could have rights superior to existing stockholders. The price per share at which we sell additional shares of our common stock, orsecurities convertible or exchangeable into common stock, in future transactions may be higher or lower than the price per share paid by investors.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 several years. If faced with aproxy contest or other type of shareholder activism, we may not be able to respond successfully to the contest or dispute, which would be disruptive to ourbusiness. 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 43Table of Contents • 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 under Delaware law, and our rights plan could prevent or delay a change in control of ourcompany.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 actedupon by stockholders at stockholder meetings.Moreover, in September 2008, our board of directors adopted a rights agreement that unless renewed expires in September 2018, the provisions ofwhich could result in significant dilution of the proportionate ownership of a potential acquirer and, accordingly, could discourage, delay or prevent achange in our management or control over us.Prolonged economic uncertainties or downturns, as well as unstable market, credit and financial conditions, may exacerbate certain risks affecting ourbusiness 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 financingmore difficult, 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 onterms that 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 44Table of Contentsorganizations may be unable to satisfy their reimbursement obligations or may delay payment. In addition, federal and state health authorities may reduceMedicare and Medicaid reimbursements, and private insurers may increase their scrutiny of claims. A reduction in the availability or extent of reimbursementcould 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 use third parties for sales, distribution, medical affairsand clinical research, and we rely upon several single source providers of raw materials and contract manufacturers for the manufacture of our products.During challenging and uncertain economic times and in tight credit markets, there may be a disruption or delay in the performance of our third partycontractors, suppliers or partners. If such third parties are unable to satisfy their commitments to us, our business and results of operations would be adverselyaffected. ITEM 1B.UNRESOLVED STAFF COMMENTSNot applicable. ITEM 2.PROPERTIESOur headquarters is located in Washington, D.C., consisting of approximately 30,260 square feet of office space. Our lease and a subsequentamendment for additional space for this facility expire in 2023 and 2027, respectively, each subject to five year renewal options. Management believes thatthis facility is suitable and adequate to meet our anticipated near-term needs. We anticipate that following the expiration of the lease, additional oralternative space will be available at commercially reasonable terms. ITEM 3.LEGAL PROCEEDINGSIn June 2014, we filed suit against Roxane Laboratories, Inc. (Roxane) in the U.S. District Court for the District of Delaware. The suit seeks anadjudication that Roxane has infringed one or more claims of our U.S. Patent No. 8,586,610 (the ‘610 Patent) by submitting to the FDA an Abbreviated NewDrug Application (ANDA) for generic versions of Fanapt oral tablets in 1 mg, 2 mg, 4 mg, 6 mg, 8 mg, 10 mg and 12 mg strengths. The relief requested by usincludes a request for a permanent injunction preventing Roxane from infringing the asserted claims of the ‘610 Patent by engaging in the manufacture, use,offer to sell, sale, importation or distribution of generic versions of Fanapt before the expiration of the ‘610 Patent in 2027.Pursuant to the Settlement Agreement, we assumed Novartis’ patent infringement action against Roxane in the U.S. District Court for the District ofDelaware. The suit alleges that Roxane’s filing of an ANDA for generic iloperidone with a paragraph IV certification infringes Sanofi’s new chemical entitypatent. Roxane is defending on the grounds that the patent claims are invalid or unenforceable or that certain patent claims are not infringed. Roxane alsofiled a motion to dismiss on the grounds that the court lacks jurisdiction.The two pending cases against Roxane were consolidated by agreement of the parties in April 2015 and are scheduled to be tried together in a four-daybench trial beginning on February 29, 2016.In May 2015, we filed a lawsuit against Inventia Healthcare Pvt. Ltd. (Inventia) in the U.S. District Court for the District of Delaware. The suit seeks anadjudication that Inventia has infringed on one or more claims of the ‘610 Patent by submitting to the FDA an ANDA for a generic version of Fanapt. Therelief requested by us includes a request for a permanent injunction preventing Inventia from infringing the asserted claims of the ‘610 Patent by engaging inthe manufacture, use, offer to sell, sale, importation or distribution of generic versions of Fanapt before the expiration of the ‘610 Patent in 2027. Thislawsuit is scheduled to be tried in a four-day bench trial beginning on January 17, 2017.In October 2015, we filed four separate patent infringement lawsuits in the United States District Court for the District of Delaware (the October 2015Lawsuits). Two of the October 2015 Lawsuits join the existing litigations against the previous Fanapt ANDA filers, Roxane and Inventia, described above.The other two October 2015 Lawsuits were filed against new ANDA filers, Taro Pharmaceuticals, U.S.A., Inc./Taro Pharmaceuticals Ltd. (Taro) and ApotexInc. (Apotex). 45®®®®®Table of ContentsThe first of the October 2015 Lawsuits, which was filed against Roxane, seeks an adjudication that Roxane has infringed one or more claims of our U.S.Patent No. 9,138,432 (the ‘432 Patent) by submitting to the FDA its ANDA for a generic version of Fanapt prior to the expiration of the ‘432 Patent inSeptember 2025. The relief requested by us includes a request for a permanent injunction preventing Roxane from infringing the asserted claims of the ‘432Patent by engaging in the manufacture, use, offer to sell, sale, importation or distribution of generic versions of Fanapt before the expiration of the ‘432Patent in 2025.The second of the October 2015 Lawsuits, which was filed against Inventia, seeks an adjudication that Inventia has infringed one or more claims of the‘432 Patent by submitting to the FDA its ANDA for a generic version of Fanapt prior to the expiration of the ‘432 Patent in September 2025. The reliefrequested by us includes a request for a permanent injunction preventing Inventia from infringing the asserted claims of the ‘432 Patent by engaging in themanufacture, use, offer to sell, sale, importation or distribution of generic versions of Fanapt before the expiration of the ‘432 Patent in 2025.The third of the October 2015 Lawsuits, which was filed against Taro, seeks an adjudication that Taro has infringed one or more claims of the ‘432Patent and the ‘610 Patent by submitting to the FDA an ANDA for a generic version of Fanapt prior to the expiration of the ‘432 patent in September 2025and the ‘610 Patent in November 2027. The relief requested by us includes a request for a permanent injunction preventing Taro from infringing the assertedclaims of the ‘432 Patent and the ‘610 Patent by engaging in the manufacture, use, offer to sell, sale, importation or distribution of generic versions ofFanapt before the expiration of the ‘432 Patent in 2025 and the ‘610 Patent in 2027.The fourth of the October 2015 Lawsuits, which was filed against Apotex and Apotex Corp., seeks an adjudication that Apotex has infringed one ormore claims of the ‘432 Patent and the ‘610 Patent by submitting to the FDA an ANDA for a generic version of Fanapt prior to the expiration of the ‘432Patent in September 2025 and the ‘610 Patent in November 2027. The relief requested by us includes a request for a permanent injunction preventing Apotexfrom infringing the asserted claims of the ‘432 Patent and the ‘610 Patent by engaging in the manufacture, use, offer to sell, sale, importation or distributionof generic versions of Fanapt before the expiration of the ‘432 Patent in 2025 and the ‘610 Patent in 2027.In November 2015, we filed a patent infringement lawsuit in the United States District Court for the District of Delaware against Lupin Limited andLupin Pharmaceuticals, Inc. (collectively, Lupin). The suit seeks an adjudication that Lupin has infringed one or more claims of the ‘432 Patent and the ‘610Patent by submitting to the FDA its ANDA for a generic version of Fanapt prior to the expiration of the ‘432 Patent in September 2025 and the ‘610 Patentin November 2027. The relief requested by us in the lawsuit includes a request for a permanent injunction preventing Lupin from infringing the assertedclaims of the ‘432 Patent and the ‘610 Patent by engaging in the manufacture, use, offer to sell, sale, importation or distribution of generic versions ofFanapt before the expiration of the ‘432 Patent in 2025 and the ‘610 Patent in 2027. ITEM 4.MINE SAFETY DISCLOSURESNot applicable. 46®®®®®®®®®®Table of ContentsPART II ITEM 5.MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OFEQUITY SECURITIESOur common stock is quoted on The NASDAQ Global Market under the symbol “VNDA.” The following table sets forth, for the periods indicated, therange of high and low sale prices of our common stock as reported on The NASDAQ Global Market: Year Ended December 31, 2015 High Low First quarter $15.00 $8.80 Second quarter 13.92 8.92 Third quarter 14.50 10.57 Fourth quarter 12.28 8.00 Year Ended December 31, 2014 High Low First quarter $19.25 $10.00 Second quarter 17.69 9.27 Third quarter 16.48 10.33 Fourth quarter 15.51 8.34 As of January 31, 2016, there were 11 holders of record of our common stock. The number of holders of record of our common stock does not reflect thenumber of beneficial holders whose shares are held by depositors, brokers or other nominees.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. 47Table 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, 2010 and its relative performance is tracked through December 31, 2015. 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, as amended, or the SecuritiesExchange Act of 1934, as amended, 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, 2015, 2014 and 2013 and the consolidated balance sheet data as ofDecember 31, 2015 and 2014 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, 2012 and 2011, and the consolidated balance sheet data as of December 31,2013, 2012 and 2011 are each derived from our audited consolidated financial statements not included herein. Our historical results for any prior period arenot necessarily indicative of results to be expected in any future period. 48Table 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) 2015 2014 (1) 2013 2012 2011 Statements of Operations Data Total revenues $109,925 $50,157 $33,879 $32,727 $31,270 Operating expenses: Cost of goods sold 23,462 1,583 — 129 — Research and development 29,145 19,230 28,502 45,764 28,857 Selling, general and administrative 84,531 84,644 25,082 14,517 11,294 Intangible asset amortization 12,972 2,254 1,495 1,495 1,495 Gain on arbitration settlement — (77,616) — — — Total operating expenses 150,110 30,095 55,079 61,905 41,646 Income (loss) from operations (40,185) 20,062 (21,200) (29,178) (10,376) Other income 320 124 145 561 461 Income (loss) before taxes (39,865) 20,186 (21,055) (28,617) (9,915) Tax provision (benefit) — — — — (444) Net income (loss) $(39,865) $20,186 $(21,055) $(28,617) $(9,471) Net income (loss) per share: Basic $(0.94) $0.58 $(0.69) $(1.01) $(0.34) Diluted $(0.94) $0.55 $(0.69) $(1.01) $(0.34) Weighted average shares outstanding: Basic 42,250,254 34,774,163 30,351,353 28,228,409 28,106,831 Diluted 42,250,254 36,686,723 30,351,353 28,228,409 28,106,831 Year Ended December 31, 2015 2014 2013 2012 2011 Balance Sheet Data Cash and cash equivalents $50,843 $60,901 $64,764 $88,772 $87,923 Marketable securities, current 92,337 68,921 65,586 31,631 60,961 Marketable securities, non-current — — — — 19,012 Working capital 115,230 133,944 102,763 93,705 121,882 Total assets 213,050 171,704 143,349 135,448 182,618 Total liabilities 80,023 10,887 99,225 125,543 149,144 Accumulated deficit (327,849) (287,984) (308,170) (287,115) (258,498) Total stockholders’ equity 133,027 160,817 44,124 9,905 33,474 (1)Net income for the year ended December 31, 2014 included a gain on arbitration settlement of $77.6 million, or $2.23 and $2.12 per basic and dilutedshare, respectively. 49Table 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 other informationwith respect to our plans and strategy for our business and contain forward-looking statements that involve risks, uncertainties and assumptions. Ouractual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including but not limited tothose set forth under the “Risk Factors” section of this report and elsewhere in this annual report on Form 10-K.OverviewVanda Pharmaceuticals Inc. (we, our or Vanda) is a biopharmaceutical company focused on the development and commercialization of novel therapiesaddressing high unmet medical needs. We commenced operations in 2003 and our product portfolio includes: • HETLIOZ (tasimelteon), a product for the treatment of Non-24-Hour Sleep-Wake Disorder (Non-24), was approved by the U.S. Food and DrugAdministration (FDA) in January 2014 and launched commercially in the U.S. in April 2014. In July 2015, the European Commission (EC) grantedcentralized marketing authorization with unified labeling for HETLIOZ for the treatment of Non-24 in totally blind adults. This authorization isvalid in the 28 countries that are members of the European Union, as well as European Economic Area members Iceland, Liechtenstein and Norway.We are preparing to launch HETLIOZ in Germany in 2016. HETLIOZ has potential utility in a number of other circadian rhythm disorders and ispresently in clinical development for the treatment of Jet Lag Disorder and Smith-Magenis Syndrome (SMS). • Fanapt (iloperidone), a product for the treatment of schizophrenia, the oral formulation of which was being marketed and sold in the U.S. byNovartis Pharma AG (Novartis) until December 31, 2014. On December 31, 2014, Novartis transferred all of the U.S. and Canadian commercial rightsto the Fanapt franchise to us. See Note 3, Settlement Agreement with Novartis, to the consolidated financial statements included in Part II of in thisannual report on Form 10-K for additional information. In September 2015, the FDA accepted for review a supplemental New Drug Application(sNDA) for Fanapt for the maintenance treatment of schizophrenia in adults. In December 2015, we refiled with the European Medicines Agency(EMA) a Marketing Authorization Application (MAA) for Fanaptum oral. Additionally, our distribution partners launched Fanapt in Israel andMexico in 2014. • Tradipitant (VLY-686), a small molecule neurokinin-1 receptor (NK-1R) antagonist, which is presently in clinical development for the treatment ofchronic pruritus in atopic dermatitis. • Trichostatin A, a small molecule histone deacetylase (HDAC) inhibitor. • AQW051, a Phase II alpha-7 nicotinic acetylcholine receptor partial agonist.Operational HighlightsHETLIOZ (tasimelteon) • HETLIOZ net product sales grew to $15.1 million in the fourth quarter of 2015, a 30% increase compared to $11.7 million in the third quarter of2015 and a 152% increase compared to $6.0 million reported in the fourth quarter of 2014. • HETLIOZ net product sales were $44.3 million for the full year 2015, a 246% increase compared to $12.8 million reported for the full year 2014. • During the fourth quarter of 2015, we initiated an open label interventional study of tasimelteon for the treatment of SMS. A placebo controlled,Phase III study is planned to begin in the second half of 2016. 50®®®®®®®®®®®®Table of Contents • During the fourth quarter of 2015, we completed an observational study of Jet Lag Disorder. A placebo controlled, Phase III study is planned tobegin in the second half of 2016.Fanapt (iloperidone) • Fanapt net product sales were $16.7 million for the fourth quarter of 2015, compared to $16.7 million in the third quarter of 2015. • Fanapt net product sales were $65.6 million for the full year 2015, compared to $65.0 million in 2014, as reported by Novartis. • In December 2015, the MAA for oral Fanaptum tablets was accepted for evaluation by the EMA for the treatment of schizophrenia in adults. • The FDA review of the sNDA for Fanapt for the maintenance treatment of schizophrenia in adults is ongoing. The FDA has set a PDUFA goal datein May 2016.Since we began operations in March 2003, we have devoted substantially all of our resources to the in-licensing, clinical development andcommercialization of our products. Our ability to generate meaningful product sales and achieve profitability largely depends on our ability to successfullycommercialize HETLIOZ and Fanapt in the U.S. and Europe, on our ability, alone or with others, to complete the development of our products, and toobtain the regulatory approvals for and to manufacture, market and sell our products. The results of our operations will vary significantly from year-to-yearand quarter-to-quarter and depend on a number of factors, including risks related to our business, risks related to our industry, and other risks which aredetailed in Risk Factors reported in Item 1A of Part I of this annual report on Form 10-K.As described in Part I, Item 3, Legal Proceedings, of this annual report on Form 10-K, we have initiated lawsuits to enforce our patent rights againstRoxane Laboratories, Inc., Inventia Healthcare Pvt. Ltd., Taro Pharmaceuticals, U.S.A., Inc./Taro Pharmaceuticals Ltd., Apotex Inc. and Lupin Limited andLupin Pharmaceuticals, Inc.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 duringthe reported periods. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, theresults of which form the basis for making judgments about the carrying value of assets and liabilities that are not apparent from other sources. Actual resultsmay differ from these estimates under different assumptions or conditions.A summary of our significant accounting policies appears in the notes to our audited consolidated financial statements for the year endedDecember 31, 2015 included in this annual report on Form 10-K. However, we believe that the following accounting policies are important to understandingand evaluating our reported financial results, and we have accordingly included them in this discussion.Inventory. Inventory, which is recorded at the lower of cost or market, includes the cost of third-party manufacturing and other direct and indirectcosts and is valued using the first-in, first-out method. We capitalize inventory costs associated with our products upon regulatory approval when, based onmanagement’s judgment, future commercialization is considered probable and the future economic benefit is expected to be realized; otherwise, such costsare expensed as research and development. Inventory is evaluated for impairment by consideration of factors such as lower of cost or market, net realizablevalue, obsolescence or expiry.Net Product Sales. Our net product sales consist of sales of HETLIOZ and sales of Fanapt. We apply the revenue recognition guidance inaccordance with Financial Accounting Standards Board Accounting Standards Codification (ASC) Subtopic 605-15, Revenue Recognition—Products. Werecognize revenue from product sales when there is persuasive evidence that an arrangement exists, title to product and associated risk of loss has passed tothe customer, the price is fixed or determinable, collectability is reasonably assured and we have no further performance obligations. 51®®®®®®®®®Table of ContentsHETLIOZ is only available in the U.S. for distribution through a limited number of specialty pharmacies, and is not available in retail pharmacies.Fanapt is available in the U.S. for distribution through a limited number of wholesalers and is available in retail pharmacies. We invoice and record revenuewhen our customers, specialty pharmacies and wholesalers, receive product from the third-party logistics warehouse. Revenues and accounts receivable areconcentrated with these customers.We have entered into distribution agreements with Probiomed S.A. de C.V. (Probiomed) for the commercialization of Fanapt in Mexico andMegapharm Ltd. for the commercialization of Fanapt in Israel.Product Sales Discounts and Allowances. Product sales are recorded net of applicable discounts, chargebacks, rebates, co-pay assistance, service feesand product returns that are applicable for various government and commercial payors. Reserves established for discounts and returns are classified asreductions of accounts receivable if the amount is payable to direct customers, with the exception of service fees. Service fees are classified as a liability.Reserves established for chargebacks, rebates or co-pay assistance are classified as a liability if the amount is payable to a party other than customers. Wecurrently record sales allowances for the following:Rebates: Allowances for rebates include mandated and supplemental discounts under the Medicaid Drug Rebate Program as well as contracted rebateprograms with other payors. Rebate amounts owed after the final dispensing of the product to a benefit plan participant are based upon contractualagreements or legal requirements with public sector benefit providers, such as Medicaid. The allowance for rebates is based on statutory or contracteddiscount rates and expected utilization. Estimates for the expected utilization of rebates are based on historical activity and, where available, actual andpending prescriptions for which we have validated the insurance benefits. Rebates are generally invoiced and paid in arrears, such that the accrual balanceconsists of an estimate of the amount expected to be incurred for the current quarter’s activity, plus an accrual balance for known prior quarter’s unpaidrebates. If actual future invoicing varies from estimates, we may need to adjust accruals, which would affect net revenue in the period of adjustment.Chargebacks: Chargebacks are discounts that occur when contracted customers purchase directly from specialty pharmacies and wholesalers.Contracted customers, which currently consist primarily of Public Health Service institutions, non-profit clinics, and Federal government entities purchasingvia the Federal Supply Schedule, generally purchase the product at a discounted price. The specialty pharmacy or wholesaler, in turn, charges back thedifference between the price initially paid by the specialty pharmacy or wholesaler and the discounted price paid to the specialty pharmacy or wholesaler bythe contracted customer. The allowance for chargebacks is based on historical activity and, where available, actual and pending prescriptions for which wehave validated the insurance benefits.Medicare Part D Coverage Gap: Medicare Part D prescription drug benefit mandates manufacturers to fund approximately 50% of the MedicarePart D insurance coverage gap for prescription drugs sold to eligible patients. Estimates for expected Medicare Part D coverage gap are based in part onhistorical activity and, where available, actual and pending prescriptions for which we have validated the insurance benefits. Funding of the coverage gap isgenerally invoiced and paid in arrears so that the accrual balance consists of an estimate of the amount expected to be incurred for the current quarter’sactivity, plus an accrual balance for known prior quarter activity. If actual future funding varies from estimates, we may need to adjust accruals, which wouldaffect net sales in the period of adjustment.Service Fees: We also incur specialty pharmacy fees and wholesaler for services and their data. These fees are based on contracted terms and areknown amounts. We accrue service fees at the time of revenue recognition, resulting in a reduction of product sales and the recognition of an accruedliability, unless it receives an identifiable and separate benefit for the consideration and it can reasonably estimate the fair value of the benefit received. Inwhich case, service fees are recorded as selling, general and administrative expense.Co-payment Assistance: Patients who have commercial insurance and meet certain eligibility requirements may receive co-payment assistance. Co-pay assistance utilization is based on information provided by our third-party administrator. The allowance for co-pay assistance is based on actual sales andan estimate for pending sales based on either historical activity or pending sales for which we have validated the insurance benefits. 52®®®®Table of ContentsPrompt-pay: Specialty pharmacies and wholesalers are offered discounts for prompt payment. We expect that the specialty pharmacies andwholesalers will earn prompt payment discounts and, therefore, deduct the full amount of these discounts from total product sales when revenues arerecognized.Product Returns: Consistent with industry practice, we generally offer direct customers a limited right to return as defined within our returns policy.We consider several factors in the estimation process, including historical return activity, expiration dates of product shipped to specialty pharmacies,inventory levels within the distribution channel, product shelf life, prescription trends and other relevant factors.The following table summarizes sales discounts and allowance activity as of and for the years ended December 31, 2015 and 2014. (in thousands) Rebates &Chargebacks Discounts,Returnsand Other Total Balance at December 31, 2013 $— $— $— Provision related to current period sales 419 720 1,139 Adjustments for prior period sales — — — Credits/payments made (51) (452) (503) Balance at December 31, 2014 368 268 636 Provision related to current period sales 57,424 17,940 75,364 Adjustments for prior period sales (114) (25) (139) Credits/payments made (24,255) (14,626) (38,881) Balance at December 31, 2015 $33,423 $3,557 $36,980 The provision of $57.4 million for rebates and chargebacks for the year ended December 31, 2015 primarily represents Medicaid rebates and contractedrebate programs applicable to sales of Fanapt. The provision of $17.9 million for discounts, returns and other for the year ended December 31, 2015primarily represents wholesaler distribution fees applicable to sales of Fanapt and co-pay assistance costs and prompt pay discounts applicable to the salesof both HETLIOZ and Fanapt.License revenue. Our license revenues in 2014 and prior years were derived from the amended and restated sublicense agreement with Novartis andinclude an upfront payment and future milestone and royalty payments. Pursuant to the amended and restated sublicense agreement, Novartis had 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$200.0 million. Revenue related to the upfront payment was recognized ratably from the date the amended and restated sublicense agreement becameeffective (November 2009) through the expected duration of the Novartis commercialization of Fanapt in the U.S. which was estimated to be through theexpiry of the Fanapt composition of patent, including a granted Hatch-Waxman extension (November 2016). In connection with the Settlement Agreement,we recognized the remaining deferred revenue as of December 31, 2014 as part of the gain on arbitration settlement. See Note 3, Settlement Agreement withNovartis, to the consolidated financial statements included in Part II of this annual report on Form 10-K for additional information.Stock-based compensation. We use the Black-Scholes-Merton option pricing model to determine the fair value of stock options. The determinationof 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 assumptions regarding a numberof complex and subjective variables. These variables include the expected stock price volatility over the expected term of the awards, actual and projectedemployee stock option exercise behaviors, risk-free interest rate and expected dividends. Expected volatility rates are based on the historical volatility of ourpublicly traded common stock and other factors. The risk-free interest rates are based on the U.S. Treasury yield for a period consistent with the expected termof the option in effect at the time of the grant. We have not paid dividends to our stockholders since our inception (other than a dividend of preferred sharepurchase rights which was declared in September 2008) and do not plan to pay dividends in the foreseeable future. Stock-based compensation expense is also 53®®®®®®®Table of Contentsaffected by the expected forfeiture rate for the respective option grants. If our estimates of the fair value of these equity instruments or expected forfeitures aretoo high or too low, it would have the effect of overstating or understating expenses.Stock-based compensation expense related to stock-based awards for the years ended December 31, 2015, 2014 and 2013, was included in thefollowing: Year Ended December 31, (in thousands) 2015 2014 2013 Research and development $2,269 $1,933 $2,166 Selling, general and administrative 5,692 3,945 3,238 $7,961 $5,878 $5,404 Stock-based compensation expense increased by $2.1 million, or 36%, for the year ended December 31, 2015 to $8.0 million compared to $5.9 millionfor the year ended December 31, 2014. The increase in expense was primarily the result of an increase in the number of employees during 2015 due to thehiring of new members of the executive management team, the field-based sales team and the medical affairs team.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 developmentcosts as they are incurred for products in the development stage, including manufacturing costs and milestone payments made under license agreements priorto FDA approval. Upon and subsequent to FDA approval, manufacturing and milestone payments made under license agreements are capitalized. Milestonepayments are accrued when it is deemed probable that the milestone event will be achieved. Costs related to the acquisition of intellectual property areexpensed as incurred if the underlying technology is developed in connection with our research and development efforts and has no alternative future use.Selling, general and administrative expensesSelling, general and administrative expenses consist primarily of salaries, other related costs for personnel, including 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.Selling, general and administrative expenses also include third party expenses incurred to support sales, business development, marketing and other businessactivities. Additionally, selling, general and administrative expenses included our estimate for the annual Patient Protection and Affordable Care fee.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 ourincome taxes 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 54Table of Contentsreversal of deferred tax liabilities, the utilization of the carryforwards and other factors. Revisions to the estimated net realizable value of the deferred taxasset could cause our provision for income taxes to vary significantly from period 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 thatdeferred tax assets will not be realized in the future. Therefore, we have a full valuation allowance against all deferred tax assets as of December 31, 2015.Intangible AssetsThe following is a summary of our intangible assets as of December 31, 2015: December 31, 2015 (in thousands) EstimatedUseful Life(Years) GrossCarryingAmount AccumulatedAmortization NetCarryingAmount HETLIOZ January 2033 $33,000 $3,460 $29,540 Fanapt November 2016 27,941 18,729 9,212 $60,941 $22,189 $38,752 In January 2014, we announced that the FDA had approved the NDA for HETLIOZ. As a result of this approval, we met a milestone under our licenseagreement with Bristol-Myers Squibb (BMS) that required us to make a license payment of $8.0 million to BMS. The $8.0 million is being amortized on astraight-line basis over the remaining life of the U.S. patent for HETLIOZ, which prior to June 2014, we expected to last until December 2022. In June 2014,we received a notice of allowance from the U.S. Patent and Trademark Office for a patent covering the method of use of HETLIOZ. The patent expires inJanuary 2033, thereby potentially extending the exclusivity protection in the U.S. beyond the composition of matter patent. As a result of the patentallowance, we extended the estimated useful life of the U.S. patent for HETLIOZ from December 2022 to January 2033.We are obligated to make a future milestone payment to BMS of $25.0 million in the event that cumulative worldwide sales of HETLIOZ reach$250.0 million. The likelihood of achieving the milestone and the related milestone obligation was determined to be probable during the year endedDecember 31, 2015. As a result, the future obligation of $25.0 million was recorded as a non-current liability as of December 31, 2015 along with an additionof $25.0 million to capitalized intangible assets relating to HETLIOZ. The $25.0 million was determined to be additional consideration for the acquisitionof the HETLIOZ intangible asset, which was created upon FDA approval on January 31, 2014. The actual payment of the $25.0 million will occur once the$250.0 million in cumulative worldwide sales of HETLIOZ is realized. The $25.0 million is being amortized on a straight-line basis over the remaining lifeof the U.S. patent for HETLIOZ, which is expected to be January 2033. Amortization of intangible assets relating to HETLIOZ amounted to $2.9 million forthe year ended December 31, 2015 and includes a catch-up adjustment of $1.2 million to retroactively record cumulative amortization from January 31, 2014to December 31, 2014 for the milestone obligation of $25.0 million. In future periods, we expect annual amortization of capitalized intangible asset costsrelating to HETLIOZ will amount to $1.7 million until the expiration of the patent in 2033.In 2009, we announced that the FDA had approved the NDA for Fanapt. As a result of this approval, we met a milestone under our original sublicenseagreement with Novartis that required us to make a license payment of $12.0 million to Novartis. The $12.0 million is being amortized on a straight-linebasis over the remaining life of the U.S. composition of matter patent for Fanapt to November 2016.Pursuant to the Settlement Agreement, Novartis transferred all U.S. and Canadian rights in the Fanapt franchise to us. As a result, we recognized anintangible asset of $15.9 million on December 31, 2014 related to the reacquired rights to Fanapt, which is being amortized on a straight-line basis throughNovember 2016. The useful life estimation for the Fanapt intangible asset is based on the market participant methodology prescribed 55®®®®®®®®®®®®®®®®®®Table of Contentsby ASC 805, and therefore does not reflect the impact of additional Fanapt patents solely owned by us with varying expiration dates, the latest of which isDecember 2031. Amortization of intangible assets relating to Fanapt amounted to $10.1 million for the year ended December 31, 2015. See Note 3,Settlement Agreement with Novartis, to the consolidated financial statements included in Part II of this annual report on Form 10-K for additionalinformation.The intangible assets are being amortized over their estimated useful economic life using the straight line method. Total amortization expense was$13.0 million, $2.3 million and $1.5 million for the years ended December 31, 2015, 2014 and 2013, respectively.The following is a summary of the future intangible asset amortization schedule as of December 31, 2015: (in thousands) Total 2016 2017 2018 2019 2020 Thereafter HETLIOZ $29,540 $1,721 $1,721 $1,721 $1,721 $1,721 $20,935 Fanapt 9,212 9,212 — — — — — $38,752 $10,933 $1,721 $1,721 $1,721 $1,721 $20,935 Recent Accounting PronouncementsSee Note 2, Summary of Significant Accounting Policies, to the consolidated financial statements included in Part II of this annual report on Form 10-Kfor information on recent accounting pronouncements.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 predictionsof future operations difficult. Since our inception, we have incurred significant losses resulting in an accumulated deficit of $327.8 million as ofDecember 31, 2015. Our total stockholders’ equity was $133.0 million as of December 31, 2015, and reflects net proceeds of $62.3 million from the publicoffering of common stock completed in October 2014 and $25.0 million from the issuance of common stock to Novartis in December 2014.Year ended December 31, 2015 compared to year ended December 31, 2014Revenues. Total revenues increased by $59.7 million, or 119%, to $109.9 million for the year ended December 31, 2015 compared to $50.2 millionfor the year ended December 31, 2014. During the years ended December 31, 2015 and 2014, revenues consisted of the following: Year Ended December 31, (in thousands) 2015 2014 Change HETLIOZ product sales, net $44,302 $12,802 $31,500 Fanapt product sales, net 65,623 107 65,516 Fanapt royalty revenue — 6,502 (6,502) Fanapt licensing agreement — 30,746 (30,746) $109,925 $50,157 $59,768 HETLIOZ was commercially launched in the U.S. in April 2014. Pursuant to the terms of the Settlement Agreement, Novartis transferred all U.S. andCanadian rights in the Fanapt franchise to us in December 2014. We began selling Fanapt commercially in the U.S. in January 2015. Fanapt royaltyrevenue for the year ended December 31, 2014 represented amounts due from Novartis based on quarterly U.S. sales of Fanapt by Novartis, and Fanaptlicense revenue for the year ended December 31, 2014 represented amortization of 56®®®®®®®®®®®®®®Table of Contentsdeferred revenue from the $200.0 million up-front license fee received from Novartis. Pursuant to the Settlement Agreement, royalties from Novartis ceased,and the remaining balance of the deferred revenue as of December 31, 2014 related to the up-front license fee was recognized as part of gain on arbitrationsettlement in the consolidated statement of operations for the year ended December 31, 2014. See Note 3, Settlement Agreement with Novartis, to theconsolidated financial statements included in Part II of this annual report on Form 10-K for additional information.Cost of goods sold. Cost of goods sold was $23.5 million for the year ended December 31, 2015, compared to $1.6 million for the year endedDecember 31, 2014. HETLIOZ was commercially launched in the U.S. in April 2014, and we began selling Fanapt commercially in the U.S. in January2015. Cost of goods sold includes third party manufacturing costs of product sold, third party royalty costs and distribution and other costs. Third partyroyalty costs are 10% of net U.S. sales of HETLIOZ and 23% of net U.S. sales of Fanapt.HETLIOZ cost of goods sold as a percentage of HETLIOZ revenue depends upon our cost to manufacture inventory at normalized production levelswith our third party manufacturers. We expect that, in the future, total HETLIOZ manufacturing costs included in cost of goods sold will be less than 2% ofour net HETLIOZ product sales.Fanapt work-in-process inventory and finished goods inventory acquired from Novartis as part of the acquisition of the Fanapt business wererecorded at fair value. The fair value of the inventory acquired from Novartis represents a higher cost than if new work-in-process inventory and finishedgoods inventory was manufactured at this time. We expect that, in the future, total U.S. Fanapt manufacturing costs included in cost of goods sold will beless than 4% of our net U.S. Fanapt product sales.Research and development expenses. Research and development expenses increased by $9.9 million, or 52%, to $29.1 million for year endedDecember 31, 2015 compared to $19.2 million for the year ended December 31, 2014. The increase is primarily the result of the close out of Fanapt clinicaltrial expenses transitioned to us as part of the Settlement Agreement and regulatory expenses related to our sNDA and EMA filings. The following tablesummarizes the costs of our product development initiatives for the years ended December 31, 2015 and 2014. Included in this table are the research anddevelopment expenses recognized in connection with the clinical development of HETLIOZ, Fanapt, tradipitant and Trichostatin A. Year Ended December 31, (in thousands) 2015 2014 Direct project costs (1) HETLIOZ $10,444 $12,478 Fanapt 8,501 160 Tradipitant 4,006 2,303 Trichostatin A 1,681 335 24,632 15,276 Indirect project costs (1) Stock-based compensation 2,269 1,933 Other indirect overhead 2,244 2,021 4,513 3,954 Total research & development expense $29,145 $19,230 (1)We record direct costs, including personnel costs and related benefits, on a project-by-project basis. Many of our research and development costs arenot attributable to any individual project because we share resources across several development projects. We record indirect costs that support anumber of our research and development activities in the aggregate, including stock-based compensation expense. 57®®®®®®®®®®®®®®®®®Table of ContentsWe expect to incur significant research and development expenses as we continue to develop our products. In addition, we expect to incur licensingcosts in the future that could be substantial, as we continue our efforts to develop our products.Selling, general and administrative expenses. Selling, general and administrative expenses were $84.5 million for the year ended December 31, 2015,relatively unchanged from $84.6 million for the year ended December 31, 2014. We incurred costs associated with our Non-24 Disease Awareness campaignand HETLIOZ branded advertising campaign during the year ended December 31, 2014. During the year ended December 31, 2015, we continued to incurcosts associated with these campaigns but at reduced amounts when compared with the year ended December 31, 2014. The decrease associated with thesecampaigns was partially offset by marketing and sales efforts around both HETLIOZ and Fanapt in the U.S., an increase in the number of employees duringthe year ended December 31, 2015, as well as increased legal fees associated with ongoing patent litigation. Stock-based compensation expense associatedwith selling, general and administrative expense increased by $1.8 million, or 46%, to $5.7 million, for year ended December 31, 2015 compared to $3.9million for the year ended December 31, 2014. The increase in expense was primarily the result of an increase in the number of employees during 2015 due tothe hiring of new members of the executive management team, the field-based sales team and the medical affairs team.Intangible asset amortization. Intangible asset amortization increased by $10.7 million to $13.0 million for year ended December 31, 2015 comparedto $2.3 million for the year ended December 31, 2014. The increase reflects additional amortization of $8.3 million relating to Fanapt. Pursuant to the termsof the Settlement Agreement, Novartis transferred all U.S. and Canadian rights in the Fanapt franchise to us in December 2014 resulting in an increase incapitalized intangible assets of $15.9 million that is being amortized until November 2016. The increase also reflects additional amortization of $2.4 millionrelating to HETLIOZ. The likelihood of achieving a future milestone obligation that becomes payable to BMS when cumulative sales of HETLIOZ equal$250.0 million was determined to be probable in the first quarter of 2015 resulting in an increase in capitalized intangible assets of $25.0 million and acorresponding increase in accrued non-current liabilities. The additional amortization relating to HETLIOZ in 2015 includes a catch-up adjustment of $1.2million to retroactively record cumulative amortization from February 1, 2014 to December 31, 2014. We expect that annual amortization of capitalizedintangible asset costs relating to HETLIOZ will amount to $1.7 million in future years until the expiration of the patent in 2033.Gain on arbitration settlement. Pursuant to the Settlement Agreement with Novartis, we recorded a gain of $77.6 million for the year endedDecember 31, 2014. See Note 3, Settlement Agreement with Novartis, to the consolidated financial statements included in Part II of this annual report onForm 10-K for additional information.Tax provision (benefit). The tax provision (benefit) for the years ended December 31, 2015 and 2014 was fully offset by a tax valuation allowanceresulting from our assessment that it is more likely than not that our deferred tax assets will not be realized. The ultimate realization of deferred tax assets isdependent upon the generation of future taxable income during the period in which NOLs and credit carryforwards can be utilized.Year ended December 31, 2014 compared to year ended December 31, 2013Revenues. Total revenues increased by $16.3 million, or 48%, to $50.2 million for the year ended December 31, 2014 compared to $33.9 million forthe year ended December 31, 2013. During the years ended December 31, 2014 and 2013, revenues consisted of the following: Year Ended December 31, (in thousands) 2014 2013 Change HETLIOZ product sales, net $12,802 $— $12,802 Fanapt product sales, net 107 — 107 Fanapt royalty revenue 6,502 7,090 (588) Fanapt licensing agreement 30,746 26,789 3,957 $50,157 $33,879 $16,278 58®®®®®®®®®®®®®Table of ContentsHETLIOZ was commercially launched in the U.S. in April 2014. Fanapt royalty revenues for the years ended December 31, 2014 and 2013 representamounts due from Novartis based on U.S. sales of Fanapt by Novartis.Fanapt license revenues for the years ended December 31, 2014 and 2013 represent amortization of deferred revenue from the $200.0 million up-frontlicense fee received from Novartis. The following is a summary of changes in total deferred licensing revenue for the years ended December 31, 2014 and2013: Year Ended December 31, (in thousands) 2014 2013 Balance beginning of year $90,275 $117,064 Licensing revenue recognized (30,746) (26,789) Recognized as part of gain on arbitration settlement (59,529) — Balance end of year $— $90,275 We entered into an amended and restated sublicense agreement with Novartis in 2009, pursuant to which Novartis had the right to commercialize anddevelop Fanapt in the U.S. and Canada. Under the amended and restated sublicense agreement, we received an upfront payment of $200.0 million. Revenuerelated to the upfront payment was recognized ratably from the date the amended and restated sublicense agreement became effective (November 2009)through the expected life of the U.S. patent for Fanapt (November 2016). During the years ended December 31, 2014 and 2013, we recognized revenue of$30.7 million and $26.8 million, respectively, related to the license agreement.In connection with the Settlement Agreement with Novartis, we recognized the remaining deferred revenue balance of $59.5 million as part of the gainon arbitration settlement. See Note 3, Settlement Agreement with Novartis, to the consolidated financial statements included in Part II of this annual report onForm 10-K for additional informationCost of goods sold. Cost of goods sold for the year ended December 31, 2014 was $1.6 million compared to zero for the year ended December 31,2013. Cost of goods sold includes third party manufacturing costs of product sold, third party royalty costs and distribution and other costs. During the yearended December 31, 2014, we made royalty payments to BMS equal to 10% of net sales of HETLIOZ.Cost of goods sold as a percentage of revenue for the expected sales of inventory capitalized after FDA approval will depend upon our cost tomanufacture inventory at normalized production levels with our third party manufacturers. However, we expect that, in the future, total HETLIOZmanufacturing cost included in cost of goods sold will be less than 2% of our net HETLIOZ product sales. 59®®®®®®®®®Table of ContentsResearch and development expenses. Research and development expenses decreased by $9.3 million, or 33%, to $19.2 million for year endedDecember 31, 2014 compared to $28.5 million for the year ended December 31, 2013. Lower research and development expenses were primarily due to 2013costs incurred for the HETLIOZ NDA submission to the FDA and completion of Non-24 and Major Depressive Disorder efficacy studies in 2013. Thefollowing table summarizes the costs of our product development initiatives for the years ended December 31, 2014 and 2013. Included in this table are theresearch and development expenses recognized in connection with the clinical development of HETLIOZ, tradipitant, Trichostatin A and Fanapt. Year Ended December 31, (in thousands) 2014 2013 Direct project costs (1) HETLIOZ $12,478 $22,307 Fanapt 160 493 Tradipitant 2,303 2,343 Trichostatin A 335 — 15,276 25,143 Indirect project costs (1) Stock-based compensation 1,933 2,166 Other indirect overhead 2,021 1,193 3,954 3,359 Total research & development expense $19,230 $28,502 (1)We record direct costs, including personnel costs and related benefits, on a project-by-project basis. Many of our research and development costs arenot attributable to any individual project because we share resources across several development projects. We record indirect costs that support anumber of our research and development activities in the aggregate, including stock-based compensation expense.Selling, general and administrative expenses. Selling, general and administrative expenses increased by $59.5 million, or 237%, to $84.6 million forthe year ended December 31, 2014 compared to $25.1 million for the year ended December 31, 2013. The increase is primarily due to the commercial launchof HETLIOZ in the U.S. for the treatment of Non-24. Our sales and marketing effort included the addition of marketing programs, field-based sales andnational account teams. We incurred cost associated with a HETLIOZ branded advertising campaign and our Non-24 Disease Awareness campaign, whichincluded radio and television advertisements broadcast nationwide. In addition, we added a medical affairs team, which were deployed in 2014 to supportHETLIOZ and Non-24 medical education.Gain on arbitration settlement. Pursuant to the Settlement Agreement with Novartis, we recorded a gain of $77.6 million for the year endedDecember 31, 2014. See Note 3, Settlement Agreement with Novartis, to the consolidated financial statements included in Part II of this annual report onForm 10-K for additional information.Intangible asset amortization. Intangible asset amortization was $2.3 million for year ended December 31, 2014 compared to $1.5 million for theyear ended December 31, 2013. The increase is primarily due to amortization related to the $8.0 million milestone payment made to BMS as a result ofreceiving FDA approval for HETLIOZ that was capitalized in the first quarter of 2014.Tax provision (benefit). The tax provision (benefit) for the years ended December 31, 2014 and 2013 was fully offset by a tax valuation allowanceresulting from our assessment that it is more likely than not that our deferred tax assets will not be realized. The ultimate realization of deferred tax assets isdependent upon the generation of future taxable income during the period in which NOLs and credit carryforwards can be utilized. 60®®®®®®®®®Table of ContentsLiquidity and Capital ResourcesAs of December 31, 2015, our total cash and cash equivalents and marketable securities were $143.2 million compared to $129.8 million atDecember 31, 2014. Our cash and cash equivalents are deposits in operating accounts and highly liquid investments with an original maturity of 90 days orless at date of purchase and consist of time deposits, investments in money market funds with commercial banks and financial institutions, and commercialpaper of high-quality corporate issuers. Our marketable securities consist of investments in government sponsored enterprises and commercial paper.As of December 31, 2015 and 2014, our liquidity resources are summarized as follows: December 31, December 31, (in thousands) 2015 2014 Cash and cash equivalents $50,843 $60,901 Marketable securities: U.S. Treasury and government agencies 44,057 30,618 Corporate debt 48,280 38,303 Total marketable securities 92,337 68,921 Total cash and cash equivalents $143,180 $129,822 As of December 31, 2015, 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 throughout 2016 and beyond in connection with our U.S. commercial activities for HETLIOZ andFanapt, including Medicaid rebates, the European commercial launch activities for HETLIOZ and a probable future milestone payment of $25.0 million toBMS in the event cumulative worldwide sales of HETLIOZ reach $250.0 million. During this time, we will evaluate the commercial opportunity for Fanaptin Europe, assuming EMA approval. Additionally, we continue to pursue market approval of HETLIOZ and Fanapt in other regions. Because of theuncertainties discussed above, the costs to advance our research and development projects and the U.S. commercial activities for HETLIOZ and Fanapt, aredifficult to estimate and may vary significantly. Management believes that our existing funds will be sufficient to meet our operating plans for theforeseeable future. Our future capital requirements and the adequacy of our available funds will depend on many factors, primarily including our ability togenerate revenue, the scope and costs of our commercial, manufacturing and process development activities and the magnitude of our discovery, preclinicaland 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 and debt securities may be convertible into common stock. If we raise additional capital by issuing equity securities, the terms and pricesfor these financings may be much more favorable to the new investors than the terms obtained by our existing stockholders. These financings also maysignificantly dilute the ownership of our existing stockholders. If we are unable to obtain additional financing, we may be required to reduce the scope of ourfuture activities which could harm our business, financial condition and operating results. There can be no assurance that any additional financing requiredin the future will be available on acceptable terms, if at all. 61®®®®®®®®®Table of ContentsCash flowThe following table summarizes our cash flows from operating, investing and financing activities for the years ended December 31, 2015, 2014 and2013: Year Ended December 31, 2015 2014 2013 Net cash provided by (used in): Operating activities $12,449 $(81,554) $(39,592) Investing activities (26,598) (12,037) (34,275) Financing activities 4,091 89,728 49,859 Net decrease in cash and cash equivalents $(10,058) $(3,863) $(24,008) In assessing cash used in operating activities, we consider several principal factors: (i) net income (loss) for the period; (ii) adjustments for non-cashcharges and credits, including deferred revenue, stock-based compensation expense, amortization of intangible assets and depreciation of property andequipment; and (iii) the extent to which receivables, accounts payable and accrued liabilities, or other working capital components increase or decrease.Year ended December 31, 2015 compared to year ended December 31, 2014Net cash provided by operating activities was $12.4 million for the year ended December 31, 2015, an increase of $94.0 million from net cash used inoperating activities of $81.6 million for the year ended December 31, 2014. The increase resulted from a reduction in the net loss of $17.6 million, excludingthe non-cash gain of $77.6 million on arbitration settlement recognized in 2014, and an increase of $44.2 million in net non-cash charges and credits. Non-cash charges resulting from the amortization of intangible assets increased $10.7 million, of which $8.3 million was for Fanapt and $2.4 million was forHETLIOZ. Non-cash charges for stock-based compensation increased $2.1 million reflecting an increase in the number of employees during 2015. The yearended December 31, 2014 included a credit for non-cash licensing revenue of $30.6 million from the amortization of deferred licensing revenue relating toFanapt. In addition, the increase in net cash provided by operating activities reflects a net increase in accrued government and other rebates of $34.6 millionprimarily for sales allowances relating to initial sales of Fanapt in 2015 and an increase in accounts payable and accrued liabilities of $8.4 million. Theincrease in net cash provided by operating activities was partly offset by a net increase of $11.1 million in accounts receivable resulting from U.S. sales ofFanapt which we commenced in 2015.Net cash used in investing activities was $26.6 million for the year ended December 31, 2015, an increase of $14.6 million from net cash used ininvesting activities of $12.0 million for the year ended December 31, 2014. The increase resulted primarily from net purchases of marketable securities of$24.1 million in 2015 compared with net purchases of marketable securities of $3.5 million in 2014. Additionally, purchases of property, plant andequipment increased $1.8 million related to leasehold improvements, furniture and fixtures and computer equipment. Net cash used by investing activitiesfor the year ended December 31, 2014 included a milestone payment of $8.0 million to BMS as a result of the FDA approval of HETLIOZ in January 2014.Net cash provided by financing activities was $4.1 million for the year ended December 31, 2015, compared with $89.7 million for the year endedDecember 31, 2014 that had included cash proceeds of $62.3 million from a public offering of common stock and cash proceeds of $25.0 million related tothe issuance of common stock to Novartis. See Note 3, Settlement Agreement with Novartis, to the consolidated financial statements included in Part II of thisannual report on Form 10-K for additional information. Proceeds from the exercise of stock options increased by $1.5 million for 2015 compared with 2014.Year ended December 31, 2014 compared to year ended December 31, 2013Net cash used in operating activities was $81.6 million for the year ended December 31, 2014, an increase of $42.0 million from net cash used inoperating activities of $39.6 million for the year ended December 31, 2013. The increase in net cash used for operating activities resulted from an increase of$79.9 million in net non-cash credits, driven primarily by a $77.6 million gain on arbitration settlement recognized in 2014 and a $3.3 million net use ofworking capital. These increases were partially offset by a change in net income (loss) of $41.2 million. 62®®®®®®Table of ContentsNet cash used in investing activities of $12.0 million for the year ended December 31, 2014, a decrease of $22.3 million, from net cash used ininvesting activities of $34.3 million for the year ended December 31, 2013. The decrease primarily resulted from $30.6 million in higher net proceeds fromsales, maturities and purchases of marketable securities, which was partially offset by an $8.0 million milestone payment to BMS as a result of the FDAapproval of HETLIOZ in January 2014.Net cash provided by financing activities of $89.7 million for the year ended December 31, 2014, an increase of $39.8 million from net cash providedby financing activities of $49.9 million for the year ended December 31, 2013. The increase primarily reflects the proceeds related to the issuance of stock toNovartis of $25.0 million, $13.8 million in higher net proceeds received from the public offering of common stock in 2014 versus 2013 and $1.3 millionhigher proceeds received from the exercise of stock options.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.Contractual obligations and commitmentsThe following is a summary of our non-cancellable long-term contractual cash obligations as of December 31, 2015: Cash payments due by year (1) (2) (3) (in thousands) Total 2016 2017 2018 2019 2020 Thereafter Operating leases $13,315 $1,500 $1,538 $1,576 $1,616 $1,656 $5,429 (1)This table does not include various agreements that we have entered into for services with third party vendors, including agreements to conductclinical trials, to manufacture products, and for consulting and other contracted services due to the cancelable nature of the services. We accrued thecosts of these agreements based on estimates of work completed to date. Additionally, this table does not include rebates, chargebacks or discountsrecorded as liabilities at the time that product sales are recognized as revenue. (2)This table does not include a probable future milestone obligation under our license agreement with BMS, where we will be obligated to make a futuremilestone payment of $25.0 million in the event cumulative worldwide sales of HETLIOZ reach $250.0 million. This probable obligation has beenaccrued as a non-current liability in our consolidated balance sheet as of December 31, 2015. (3)This table does not include potential future milestone obligations under our license agreement with Eli Lilly for the exclusive rights to develop andcommercialize tradipitant where we could be obligated to make future milestone payments of up to $4.0 million for pre-NDA approval milestones andup 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 leases for our headquarters located inWashington, D.C., which expires in 2023. In 2011 we entered into an office lease, which was subsequently amended in 2014, with Square 54 Office OwnerLLC (Landlord) for our headquarters, consisting of a total of 30,260 square feet of office space at 2200 Pennsylvania Avenue, N.W. in Washington, D.C.(Lease). Subject to the prior rights of other tenants in the building, we have the right to renew the Lease for five years following its expiration. We also havethe right to sublease or assign all or a portion of the premises, subject to standard conditions. The Lease may be terminated early by us or the Landlord uponcertain conditions. 63®®Table of ContentsITEM 7A.QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISKInterest rate risksOur 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.Concentrations of credit riskWe 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.Revenues and accounts receivable are concentrated with specialty pharmacies and wholesalers. The top six customers represented 94% of totalrevenues for the year ended December 31, 2015, and the top five customers represented 87% of accounts receivable at December 31, 2015. We have notexperienced any losses relating to receivables from customers.Effects 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, 2015. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officerconcluded that our disclosure controls and procedures are effective as of December 31, 2015, the end of the period covered by this annual report on Form 10-K, to ensure that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to ourmanagement, 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 2013 by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control — Integrated Framework. Based 64Table of Contentson the assessment, management concluded that, as of December 31, 2015, our internal control over financial reporting was effective. The effectiveness of ourinternal control over financial reporting as of December 31, 2015 has been audited by PricewaterhouseCoopers LLP, an independent registered publicaccounting 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 control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) duringthe fourth quarter of 2015 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. ITEM 9B.OTHER INFORMATIONNone.PART III ITEM 10.DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCEInformation required under this item will be contained in our Proxy Statement for the 2016 Annual Meeting of Stockholders to be filed with the SECwithin 120 days after the end of the fiscal year ended December 31, 2015, under the captions “Election of Directors,” “Executive Officers,” “CorporateGovernance,” 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 2016 Annual Meeting of Stockholders to be filed with the SECwithin 120 days after the end of the fiscal year ended December 31, 2015, 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-Kwill be deemed furnished in this Form 10-K and will not be deemed incorporated by reference into any filing under the Securities Act of 1933, as amended, orthe Securities Exchange Act of 1934, as amended, 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 STOCKHOLDER MATTERSInformation required under this item will be contained in our Proxy Statement for the 2016 Annual Meeting of Stockholders to be filed with the SECwithin 120 days after the end of the fiscal year ended December 31, 2015, under the captions “Equity Compensation Plan Information” and “SecurityOwnership of Certain Beneficial Owners and Management” and is incorporated herein by reference pursuant to General Instruction G(3) to Form 10-K. ITEM 13.CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCEInformation required under this item will be contained in our Proxy Statement for the 2016 Annual Meeting of Stockholders to be filed with the SECwithin 120 days after the end of the fiscal year ended December 31, 2015, under the caption “Corporate Governance” and is incorporated herein by referencepursuant to 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 2016 Annual Meeting of Stockholders to be filed with the SECwithin 120 days after the end of the fiscal year ended December 31, 2015, under the caption “Ratification of Selection of Independent Registered PublicAccounting Firm” and is incorporated herein by reference pursuant to General Instruction G (3) to Form 10-K. 65Table of ContentsPART 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. 66Table of ContentsSignaturesPursuant to the requirements of Section 13 and 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this annualreport on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. Vanda Pharmaceuticals Inc.February 12, 2016 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 behalfof the 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 ExecutiveOfficer and Director (principalexecutive officer) February 12, 2016/s/ James P. Kelly James P. Kelly Senior Vice President, ChiefFinancial Officer and Treasurer(principal financial officer andprincipal accounting officer) February 12, 2016/s/ H. Thomas Watkins H. Thomas Watkins Chairman of the Board andDirector February 12, 2016/s/ Kenneth M. Bate Kenneth M. Bate Director February 12, 2016/s/ Michael Cola Michael Cola Director February 12, 2016/s/ Richard W. Dugan Richard W. Dugan Director February 12, 2016/s/ Vincent J. Milano Vincent J. Milano Director February 12, 2016/s/ Howard Pien Howard Pien Director February 12, 2016 67Table of ContentsVanda Pharmaceuticals Inc.Index to Consolidated Financial Statements Page Report of Independent Registered Public Accounting Firm 69 Consolidated Balance Sheets at December 31, 2015 and 2014 70 Consolidated Statements of Operations for the years ended December 31, 2015, 2014 and 2013 71 Consolidated Statements of Comprehensive Income (Loss) for the years ended December 31, 2015, 2014 and 2013 72 Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2015, 2014 and 2013 73 Consolidated Statements of Cash Flows for the years ended December 31, 2015, 2014 and 2013 74 Notes to the Consolidated Financial Statements 75 68Table 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 income (loss),of changes in stockholders’ equity, and of cash flows present fairly, in all material respects, the financial position of Vanda Pharmaceuticals Inc. andsubsidiaries at December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the three years in the period endedDecember 31, 2015 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, 2015, based on criteria established in InternalControl—Integrated Framework (2013) 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 underitem 9A. 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 financialreporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’sinternal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail,accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded asnecessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of thecompany are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assuranceregarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on thefinancial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of anyevaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degreeof compliance with the policies or procedures may deteriorate./s/ PricewaterhouseCoopers LLPBaltimore, MarylandFebruary 12, 2016 69Table of ContentsVANDA PHARMACEUTICALS INC.CONSOLIDATED BALANCE SHEETS December 31, December 31, (in thousands, except for share and per share amounts) 2015 2014 ASSETS Current assets: Cash and cash equivalents $50,843 $60,901 Marketable securities 92,337 68,921 Accounts receivable, net 16,331 3,654 Inventory 1,294 5,170 Prepaid expenses and other current assets 5,742 3,084 Total current assets 166,547 141,730 Property and equipment, net 4,570 2,437 Intangible assets, net 38,752 26,724 Non-current inventory and other 3,181 813 Total assets $213,050 $171,704 LIABILITIES AND STOCKHOLDERS’ EQUITY Current liabilities: Accounts payable and accrued liabilities $15,767 $7,291 Accrued government and other rebates 35,550 495 Total current liabilities 51,317 7,786 Milestone obligation under license agreement 25,000 — Other non-current liabilities 3,706 3,101 Total liabilities 80,023 10,887 Commitments and contingencies (Notes 13 and 18) 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; 42,815,291 and 41,486,361 shares issued andoutstanding at December 31, 2015 and December 31, 2014, respectively 43 41 Additional paid-in capital 460,794 448,744 Accumulated other comprehensive income 39 16 Accumulated deficit (327,849) (287,984) Total stockholders’ equity 133,027 160,817 Total liabilities and stockholders’ equity $213,050 $171,704 The accompanying notes are an integral part of these consolidated financial statements. 70Table of ContentsVANDA PHARMACEUTICALS INC.CONSOLIDATED STATEMENTS OF OPERATIONS Year Ended December 31, (in thousands, except for share and per share amounts) 2015 2014 2013 Revenues: Net product sales $109,925 $12,909 $— Royalty revenue — 6,502 7,090 Licensing agreement — 30,746 26,789 Total revenues 109,925 50,157 33,879 Operating expenses: Cost of goods sold 23,462 1,583 — Research and development 29,145 19,230 28,502 Selling, general and administrative 84,531 84,644 25,082 Intangible asset amortization 12,972 2,254 1,495 Gain on arbitration settlement — (77,616) — Total operating expenses 150,110 30,095 55,079 Income (loss) from operations (40,185) 20,062 (21,200) Other income 320 124 145 Net income (loss) $(39,865) $20,186 $(21,055) Net income (loss) per share: Basic $(0.94) $0.58 $(0.69) Diluted $(0.94) $0.55 $(0.69) Weighted average shares outstanding: Basic 42,250,254 34,774,163 30,351,353 Diluted 42,250,254 36,686,723 30,351,353 The accompanying notes are an integral part of these consolidated financial statements. 71Table of ContentsVANDA PHARMACEUTICALS INC.CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) Year Ended December 31, (in thousands) 2015 2014 2013 Net income (loss) $(39,865) $20,186 $(21,055) Other comprehensive income (loss): Change in net unrealized gain (loss) on marketable securities 23 (5) 11 Tax provision on other comprehensive income (loss) — — — Other comprehensive income (loss), net of tax 23 (5) 11 Comprehensive income (loss) $(39,842) $20,181 $(21,044) The accompanying notes are an integral part of these consolidated financial statements. 72Table of ContentsVANDA PHARMACEUTICALS INC.CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY Common Stock AdditionalPaid-in Capital OtherComprehensiveIncome (Loss) AccumulatedDeficit Total (in thousands, except for share amounts) Shares Par Value Balances at December 31, 2012 28,241,743 $28 $296,982 $10 $(287,115) $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 stock options andsettlement of restricted stock units 466,320 — 1,550 — — 1,550 Shares withheld upon settlement of restricted stock units (49,520) — (196) — — (196) Stock-based compensation expense — — 5,404 — — 5,404 Net loss — — — — (21,055) (21,055) Other comprehensive income, net of tax — — — 11 — 11 Balances at December 31, 2013 33,338,543 33 352,240 21 (308,170) 44,124 Net proceeds from public offering of common stock 5,750,000 5 62,308 — — 62,313 Issuance of common stock to Novartis Pharma AG 1,808,973 2 25,903 — — 25,905 Issuance of common stock from the exercise of stock options andsettlement of restricted stock units 621,231 1 2,851 — — 2,852 Shares withheld upon settlement of restricted stock units (32,386) — (436) — — (436) Stock-based compensation expense — — 5,878 — — 5,878 Net income — — — — 20,186 20,186 Other comprehensive loss, net of tax — — — (5) — (5) Balances at December 31, 2014 41,486,361 41 448,744 16 (287,984) 160,817 Issuance of common stock from the exercise of stock options andsettlement of restricted stock units 1,353,877 2 4,372 — — 4,374 Shares withheld upon settlement of equity awards (24,947) — (283) — — (283) Stock-based compensation expense — — 7,961 — — 7,961 Net loss — — — — (39,865) (39,865) Other comprehensive income, net of tax — — — 23 — 23 Balances at December 31, 2015 42,815,291 $43 $460,794 $39 $(327,849) $133,027 The accompanying notes are an integral part of these consolidated financial statements. 73Table of ContentsVANDA PHARMACEUTICALS INC.CONSOLIDATED STATEMENTS OF CASH FLOWS Year Ended December 31, (in thousands) 2015 2014 2013 Cash flows from operating activities Net income (loss) $(39,865) $20,186 $(21,055) Adjustments to reconcile net loss to net cash used in operating activities: Depreciation of property and equipment 582 530 432 Stock-based compensation 7,961 5,878 5,404 Amortization of discounts and premiums on marketable securities 677 174 155 Intangible asset amortization 12,972 2,254 1,495 Gain on arbitration settlement with Novartis Pharma AG — (77,616) — Deferred revenues (174) (30,572) (26,789) Other non-cash adjustments 657 239 104 Changes in assets and liabilities: Accounts receivable (12,677) (1,623) (863) Prepaid expenses and other current assets (2,558) (318) 1,264 Inventory 387 (2,210) — Accounts payable and accrued liabilities 9,432 1,029 261 Accrued government and other rebates 35,055 495 — Net cash provided by (used in) operating activities 12,449 (81,554) (39,592) Cash flows from investing activities Acquisition of intangible assets — (8,000) — Purchases of property and equipment (2,527) (769) (176) Purchases of marketable securities (193,111) (93,343) (65,598) Proceeds from sale of marketable securities 999 8,948 — Maturities of marketable securities 168,041 80,882 31,499 Change in restricted cash — 245 — Net cash used in investing activities (26,598) (12,037) (34,275) Cash flows from financing activities Net proceeds from public offering of common stock — 62,313 48,505 Net proceeds from offering common stock to Novartis Pharma AG — 25,000 — Tax obligations paid in connection with settlement of restricted stock units (283) (436) (196) Proceeds from exercise of employee stock options 4,374 2,851 1,550 Net cash provided by financing activities 4,091 89,728 49,859 Net decrease in cash and cash equivalents (10,058) (3,863) (24,008) Cash and cash equivalents Beginning of year 60,901 64,764 88,772 End of year $50,843 $60,901 $64,764 Non-cash investing and financing activities Acquisition of intangible asset accrued in non-current liabilities $25,000 $— $— Intangible asset related to re-acquired right to Fanapt — (15,940) — Inventories — 2,960 — Prepaid services — 91 — Purchases of property and equipment accrued in current liabilities 187 — 106 The accompanying notes are an integral part of these consolidated financial statements. 74®Table 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 noveltherapies addressing high unmet medical needs. Vanda commenced its operations in 2003 and the Company’s portfolio includes the following products: • HETLIOZ (tasimelteon), a product for the treatment of Non-24-Hour Sleep-Wake Disorder (Non-24), which was approved by the U.S.Food and Drug Administration (FDA) in January 2014 and launched commercially in the U.S. in April 2014. In July 2015, the EuropeanCommission (EC) granted centralized marketing authorization with unified labeling for HETLIOZ for the treatment of Non-24 in totallyblind adults. This authorization is valid in the 28 countries that are members of the European Union, as well as European Economic Areamembers Iceland, Liechtenstein and Norway. HETLIOZ has potential utility in a number of other circadian rhythm disorders and ispresently in clinical development for the treatment of Jet Lag Disorder and Smith-Magenis Syndrome (SMS). • Fanapt (iloperidone), a product for the treatment of schizophrenia, the oral formulation of which was being marketed and sold in theU.S. by Novartis Pharma AG (Novartis) until December 31, 2014. On December 31, 2014, Novartis transferred all the U.S. and Canadiancommercial rights to the Fanapt franchise to the Company. See Note 3, Settlement Agreement with Novartis, for additional information.Additionally, the Company’s distribution partners launched Fanapt in Israel and Mexico in 2014. • Tradipitant (VLY-686), a small molecule neurokinin-1 receptor (NK-1R) antagonist, which is presently in clinical development for thetreatment of chronic pruritus in atopic dermatitis. • Trichostatin A, a small molecule histone deacetylase (HDAC) inhibitor. • AQW051, a Phase II alpha-7 nicotinic acetylcholine receptor partial agonist.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.ReclassificationsCertain reclassifications have been made to prior year amounts to conform with current year classifications. 75®®®®®®Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) 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. Restricted cash of $0.8 million included in current and non-current assets at December 31, 2015and 2014, respectively, relates to the lease for office space for the Company’s headquarters located in Washington, D.C.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 includedin interest income. Premiums and discounts on marketable securities are amortized and accreted, respectively, to maturity and included in interest income.The Company 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.InventoryInventory, which is recorded at the lower of cost or market, includes the cost of third-party manufacturing and other direct and indirect costs and isvalued using the first-in, first-out method. The Company capitalizes inventory costs associated with its products upon regulatory approval when, based onmanagement’s judgment, future commercialization is considered probable and the future economic benefit is expected to be realized; otherwise, such costsare expensed as research and development. Inventory is evaluated for impairment by consideration of factors such as lower of cost or market, net realizablevalue, obsolescence or expiry. Inventory not expected to be consumed within 12 months following the balance sheet date are classified as non-current.Intangible AssetsCosts 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 a product, patent and license costs are capitalized and amortized over the expectedpatent life of the related product. Milestone payments to the Company’s partners are recognized when it is deemed probable that the milestone event willoccur.Property and EquipmentProperty and equipment are stated at cost less accumulated depreciation. The costs of leasehold improvements funded by or reimbursed by the lessorare capitalized and amortized as leasehold improvements along with a corresponding deferred rent liability. Depreciation of property and equipment isprovided on a straight-line basis over the estimated useful lives of the assets. Amortization of leasehold improvements is 76Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) provided on a straight-line basis over the shorter of their estimated useful life or the lease term. The costs of additions and improvements are capitalized, andrepairs and maintenance costs are charged to operations in the period incurred. Upon retirement or disposition of property and equipment, the cost andaccumulated depreciation are removed from the accounts and any resulting gain or loss is reflected in the statement of operations for that period.Accounts Payable and Accrued LiabilitiesThe Company’s management is required to estimate accrued liabilities as part of the process of preparing financial statements. The estimation ofaccrued liabilities involves identifying services that have been performed on the Company’s behalf, and then estimating the level of service performed andthe associated cost incurred for such services as of each balance sheet date in the financial statements. Accrued liabilities include professional service fees,such as lawyers and accountants, contract service fees, such as those under contracts with clinical monitors, data management organizations and investigatorsin conjunction 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 theproject manager of the work that has been completed during the period, (ii) measurement of progress prepared internally and/or provided by the third-partyservice provider, (iii) analyses of data that justify the progress, and (iv) management’s judgment. In the event that the Company does not identify certaincosts that have begun to be incurred or the Company under- or over-estimates the level of services performed or the costs of such services, the Company’sreported expenses for such period would be too low or too high.Net Product SalesThe Company’s net product sales consist of sales of HETLIOZ and, beginning in 2015, sales of Fanapt. Net sales by product for the years endedDecember 31, 2015, 2014 and 2014 were as follows: Year Ended December 31, (in thousands) 2015 2014 2013 HETLIOZ product sales, net $44,302 $12,802 $— Fanapt product sales, net 65,623 107 — $109,925 $12,909 $— The Company applies the revenue recognition guidance in accordance with Financial Accounting Standards Board (FASB) Accounting StandardsCodification (ASC) Subtopic 605-15, Revenue Recognition—Products. The Company recognizes revenue from product sales when there is persuasiveevidence that an arrangement exists, title to product and associated risk of loss has passed to the customer, the price is fixed or determinable, collectability isreasonably assured and the Company has no further performance obligations.Product Sales Discounts and AllowancesThe Company’s product sales are recorded net of applicable discounts, chargebacks, rebates, co-pay assistance, service fees and product returns that areapplicable for various government and commercial payors. Reserves established for discounts and returns are classified as reductions of accounts receivable ifthe amount is payable to direct customers, with the exception of service fees. Service fees are classified as a liability. Reserves established for chargebacks,rebates or co-pay assistance are classified as a liability if the amount is payable to a party other than customers. The Company currently records salesallowances for the following: 77®®®®Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) Rebates: Allowances for rebates include mandated and supplemental discounts under the Medicaid Drug Rebate Program as well as contracted rebateprograms with other payors. Rebate amounts owed after the final dispensing of the product to a benefit plan participant are based upon contractualagreements or legal requirements with public sector benefit providers, such as Medicaid. The allowance for rebates is based on statutory or contracteddiscount rates and expected utilization. Estimates for the expected utilization of rebates are based on historical activity and, where available, actual andpending prescriptions for which the Company has validated the insurance benefits. Rebates are generally invoiced and paid in arrears, such that the accrualbalance consists of an estimate of the amount expected to be incurred for the current quarter’s activity, plus an accrual balance for known prior quarter’sunpaid rebates. If actual future invoicing varies from estimates, the Company may need to adjust accruals, which would affect net revenue in the period ofadjustment.Chargebacks: Chargebacks are discounts that occur when contracted customers purchase directly from specialty pharmacies and wholesalers.Contracted customers, which currently consist primarily of Public Health Service institutions, non-profit clinics, and Federal government entities purchasingvia the Federal Supply Schedule, generally purchase the product at a discounted price. The specialty pharmacy or wholesaler, in turn, charges back thedifference between the price initially paid by the specialty pharmacy or wholesaler and the discounted price paid to the specialty pharmacy or wholesaler bythe contracted customer. The allowance for chargebacks is based on historical activity and, where available, actual and pending prescriptions for which theCompany has validated the insurance benefits.Medicare Part D Coverage Gap: Medicare Part D prescription drug benefit mandates manufacturers to fund approximately 50% of the MedicarePart D insurance coverage gap for prescription drugs sold to eligible patients. Estimates for expected Medicare Part D coverage gap are based in part onhistorical activity and, where available, actual and pending prescriptions for which the Company has validated the insurance benefits. Funding of thecoverage gap is generally invoiced and paid in arrears so that the accrual balance consists of an estimate of the amount expected to be incurred for the currentquarter’s activity, plus an accrual balance for known prior quarter activity. If actual future funding varies from estimates, the Company may need to adjustaccruals, which would affect net revenue in the period of adjustment.Service Fees: The Company also incurs specialty pharmacy and wholesaler fees for services and their data. These fees are based on contracted termsand are known amounts. The Company accrues service fees at the time of revenue recognition, resulting in a reduction of product sales and the recognition ofan accrued liability, unless it receives an identifiable and separate benefit for the consideration and it can reasonably estimate the fair value of the benefitreceived. In which case, service fees are recorded as selling, general and administrative expense.Co-payment Assistance: Patients who have commercial insurance and meet certain eligibility requirements may receive co-payment assistance. Co-pay assistance utilization is based on information provided by the Company’s third-party administrator. The allowance for co-pay assistance is based onactual sales and an estimate for pending sales based on either historical activity or pending sales for which the Company has validated the insurance benefits.Prompt-pay: Specialty pharmacies and wholesalers are offered discounts for prompt payment. The Company expects that the specialty pharmacies andwholesalers will earn prompt payment discounts and, therefore, deducts the full amount of these discounts from total product sales when revenues arerecognized.Product Returns: Consistent with industry practice, the Company generally offers direct customers a limited right to return as defined within theCompany’s returns policy. The Company considers several factors in the estimation process, including historical return activity, expiration dates of productshipped to specialty pharmacies, inventory levels within the distribution channel, product shelf life, prescription trends and other relevant factors 78Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) The following table summarizes accounts receivable allowance activity as of and for the years ended December 31, 2015, 2014 and 2013. (in thousands) AccountsReceivableAllowances Balance at December 31, 2012 $— Provision related to current period sales — Adjustments for prior period sales — Credits/payments made — Balance at December 31, 2013 $— Provision related to current period sales 85 Adjustments for prior period sales — Credits/payments made — Balance at December 31, 2014 $85 Provision related to current period sales 1,071 Adjustments for prior period sales (85) Credits/payments made (12) Balance at December 31, 2015 $1,059 License RevenueThe Company’s license revenues for the years ended December 31, 2014 and 2013 were derived from the amended and restated sublicense agreementwith Novartis and include an upfront payment and future milestone and royalty payments. Pursuant to the amended and restated sublicense agreement,Novartis had the right to commercialize and develop Fanapt in the U.S. and Canada. Under the amended and restated sublicense agreement, the Companyreceived an upfront payment of $200.0 million. Revenue related to the upfront payment was recognized ratably from the date the amended and restatedsublicense agreement became effective (November 2009) through the expected duration of the Novartis commercialization of Fanapt in the U.S. which wasestimated to be through the expiry of the Fanapt composition of patent, including a granted Hatch-Waxman extension (November 2016). In connection withthe Settlement Agreement with Novartis, the Company recognized the remaining deferred revenue as of December 31, 2014 as part of the gain on arbitrationsettlement. See Note 3, Settlement Agreement with Novartis, for additional information.Major CustomersHETLIOZ is only available in the U.S. for distribution through a limited number of specialty pharmacies, and is not available in retail pharmacies.Fanapt is available in the U.S. for distribution through a limited number of wholesalers and is available in retail pharmacies. The Company invoices andrecords revenue when its customers, specialty pharmacies and wholesalers, receive product from the third-party logistics warehouse. Revenues and accountsreceivable are concentrated with these customers. The Company has not experienced any losses relating to receivables from customers. 79®®®®®Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) The following table presents each major customer that represented more than 10% of total revenues for the years ended December 31, 2015, 2014 and2013: Year Ended December 31, Percent of Total Revenues 2015 2014 2013 Novartis -royalty revenue — 13% 21% Novartis -license agreement — 61% 79% Distributor A 17% — — Distributor B 18% — — Distributor C 19% — — Distributor D 14% — — Distributor E 14% — — Distributor F 12% — — The following table presents each major customer that represented more than 10% of accounts receivable, net, as of December 31, 2015 and 2014: December 31, Percent of Accounts Receivable, Net 2015 2014 Novartis -royalty — 42% Distributor A 22% — Distributor B 24% — Distributor C 17% — Distributor D 12% 21% Distributor E 12% 17% Distributor F — 20% Cost of Goods SoldCost of goods sold includes royalties payable, the cost of inventory sold, manufacturing and supply chain costs and product shipping and handlingcosts related to U.S. sales of HETLIOZ and sales of Fanapt to the Company’s distribution partners.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 underlyingtechnology is developed in connection with the Company’s research and development efforts and has no alternative future use. 80®®Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) Selling, General and Administrative ExpensesSelling, general and administrative expenses consist of salaries, stock-based compensation, facilities and third party expenses. Selling, general andadministrative expenses are associated with the activities of the executive, finance, accounting, information technology, business development, commercialsupport, trade and distribution, sales, marketing, legal, medical affairs and human resource functions. Additionally, selling, general and administrativeexpenses included an estimate for the annual Patient Protection and Affordable Care fee.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 recognizes theexpense over the award’s vesting period. The fair value of stock options granted and restricted stock units (RSUs) awarded are amortized using the straight-line method. As stock-based compensation expense recognized in the consolidated statements of operations is based on awards ultimately expected to vest, ithas been reduced for estimated forfeitures. Forfeitures are required to be estimated at the time of grant and revised, if necessary, in subsequent periods if actualforfeitures differ from those estimatesThe 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 otherfactors. 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. The Company has not paid dividends to its stockholders since its inception (other than a dividend of preferred share purchase rights, which wasdeclared 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, 2015, 2014 and 2013 were as follows: Year Ended December 31, 2015 2014 2013 Expected dividend yield 0% 0% 0% Weighted average expected volatility 60% 62% 65% Weighted average expected term (years) 6.00 5.90 6.03 Weighted average risk-free rate 1.67% 1.73% 1.59% Weighted average fair value per share $11.74 $6.99 $6.10 Stock-based compensation expense recognized for the years ended December 31, 2015, 2014 and 2013 was comprised of the following: Year Ended December 31, (in thousands) 2015 2014 2013 Research and development $2,269 $1,933 $2,166 Selling, general and administrative 5,692 3,945 3,238 $7,961 $5,878 $5,404 81Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) Advertising ExpenseThe Company expenses the costs of advertising, including branded promotional expenses, as incurred. Branded advertising expenses, recorded inselling, general and administrative expenses, were $3.4 million and $5.0 million for the years ended December 31, 2015 and 2014, respectively. TheCompany did not incur any advertising expense during the year ended December 31, 2013.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 amounts of existing assets and liabilities and their respective tax bases andtax credits and loss carryforwards. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than notthat some portion or all of the deferred tax assets will not be realized. The fact that the Company has historically generated net operating losses (NOLs) servesas strong evidence that it is more likely than not that deferred tax assets will not be realized in the future. Therefore, the Company has a full valuationallowance against all deferred tax assets as of December 31, 2015 and 2014. Tax rate changes are reflected in income during the period such changes areenacted. Changes in ownership may limit the amount of NOL carryforwards that can be utilized in the future to offset taxable income.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 orany significant delays in the development or introduction of products or services could have a material adverse effect on the Company’s business, operatingresults and 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.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 equivalents and marketable securities with highly-rated financial institutions. At December 31,2015, the Company maintained all of its cash, cash equivalents and marketable securities in two financial institutions. Deposits held with these institutionsmay exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand, and the Company believes there isminimal risk of losses on such balances. 82Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) Segment informationThe Company operates in one reporting segment and, accordingly, no segment disclosures are presented herein.Recent accounting pronouncementsIn November 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2015-17, Balance SheetClassification of Deferred Taxes. Currently deferred taxes for each tax jurisdiction are presented as a net current asset or liability and net noncurrent asset orliability on the balance sheet. To simplify the presentation, the new guidance requires that all deferred tax assets and liabilities for each jurisdiction, alongwith any related valuation allowance, be classified as noncurrent on the balance sheet. The new guidance becomes effective for public business entities infiscal years beginning after December 15, 2016. The Company adopted this new standard in the fourth quarter of 2015, and adoption did not have a materialimpact on the Company’s consolidated financial statements.In September 2015, the FASB issued ASU 2015-16, Simplifying the Accounting for Measurement –Period Adjustments. Changes to the accounting formeasurement-period adjustments relate to business combinations. Currently, an acquiring entity is required to retrospectively adjust the balance sheetamounts of the acquiree recognized at the acquisition date with a corresponding adjustment to goodwill as a result of changes made to the balance sheetamounts of the acquiree. The measurement period is the period after the acquisition date during which the acquirer may adjust the balance sheet amountsrecognized for a business combination (generally up to one year from the date of acquisition). The changes eliminate the requirement to make suchretrospective adjustments, and, instead require the acquiring entity to record these adjustments in the reporting period they are determined. The new standardis effective for both public and private companies for periods beginning after December 15, 2015. Adoption of this new standard is not expected to have amaterial impact on the Company’s consolidated financial statements.In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory, dealing with changes to the subsequent measurement ofinventory. Currently, an entity is required to measure its inventory at the lower of cost or market, whereby market can be replacement cost, net realizablevalue, or net realizable value less an approximately normal profit margin. The changes require that inventory be measured at the lower of cost and netrealizable value, thereby eliminating the use of the other two market methodologies. Net realizable value is defined as the estimated selling prices in theordinary course of business less reasonably predictable costs of completion, disposal, and transportation. The new standard is effective for both public andprivate companies for periods beginning after December 15, 2016. Adoption of this new standard is not expected to have a material impact on the Company’sconsolidated financial statements.In January 2015, the FASB issued ASU 2015-01, Income Statement-Extraordinary and Unusual Items, to simplify income statement classification byremoving the concept of extraordinary items from U.S. GAAP. As a result, items that are both unusual and infrequent will no longer be separately reported netof tax after continuing operations. The new standard is effective for both public and private companies for periods beginning after December 15, 2015.Adoption of this new standard is not expected to have a material impact on the Company’s consolidated financial statements.In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements – Going Concern. The new standard requires management ofpublic and private companies to evaluate whether there is substantial doubt about the entity’s ability to continue as a going concern and, if so, disclose thatfact. Management will also be required to evaluate and disclose whether its plans alleviate that doubt. The new standard is effective for annual periodsending after December 15, 2016, and interim periods within annual periods beginning after December 15, 2016. Adoption of this new standard is notexpected to have a material impact on the Company’s consolidated financial statements. 83Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). This new standards requires companies torecognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which a company expects to beentitled in exchange for those goods or services. Under the new standard, revenue is recognized when a customer obtains control of a good or service. Thestandard allows for two transition methods—entities can either apply the new standard (i) retrospectively to each prior reporting period presented, or(ii) retrospectively with the cumulative effect of initially applying the standard recognized at the date of initial adoption. At the time the new standard wasissued, it was set to be effective for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. InJuly 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606), which defers the effective date by one year to December 15,2017 for fiscal years, and interim periods within those fiscal years, beginning after that date. Early adoption of the standard is permitted, but not before theoriginal effective date of December 15, 2016. The Company is evaluating this standard to determine if adoption will have a material impact on theCompany’s consolidated financial statements.3. Settlement Agreement with NovartisIn May 2014, the Company commenced arbitration proceedings with Novartis relating to the license of Fanapt (the Fanapt Arbitration). In December2014, the Company entered into a settlement agreement with Novartis and certain of its affiliates (the Settlement Agreement). Pursuant to the terms of theSettlement Agreement, the Company and Novartis dismissed the Fanapt Arbitration and released each other from any related claims. In addition, inconnection with the Settlement Agreement, Novartis (i) transferred all U.S. and Canadian rights in the Fanapt franchise to the Company, (ii) purchased $25.0million of the Company’s common stock at a price per share equal to $13.82, and (iii) granted to the Company an exclusive worldwide license to AQW051, aPhase II alpha-7 nicotinic acetylcholine receptor partial agonist.Pursuant to the stock purchase agreement entered into as part of the Settlement Agreement, Novartis purchased $25.0 million of the Company’scommon stock. The Company issued to Novartis an aggregate of 1,808,973 shares at $13.82 per share, which per share represented a 10% premium to theaverage closing prices of the Company’s common stock for the ten trading days prior to December 22, 2014. The Company recorded a loss of $0.9 million aspart of gain on arbitration settlement in the consolidated statement of operations for the period ending December 31, 2014 related to the issuance of stock,which was valued using the Company’s closing stock price on December 31, 2014, the effective date of the transaction.In connection with the Settlement Agreement, the Company received an exclusive worldwide license under certain patents and patent applications,and other licenses to intellectual property, to develop and commercialize AQW051. Under the AQW051 license agreement, the Company is obligated to useits commercially reasonable efforts to develop and commercialize AQW051 and is responsible for all development costs under the AQW051 licenseagreement. Novartis is eligible to receive tiered-royalties on net sales at percentage rates up to the mid-teens. The Company evaluated AQW051 anddetermined that the asset is both incomplete and has substance. However, given the early stage of AQW051 and the future costs of development, notransaction value was allocated to this asset. 84®®®®Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) The Company accounted for the Settlement Agreement in accordance with the provisions of ASC Subtopic 805, Business Combinations (ASC 805).Under the provisions of ASC 805, the acquisition date for a business is the date on which the company obtains control of the acquiree. The Companyobtained control on December 31, 2014, the effective date of the Settlement Agreement. The following summarizes the fair value of consideration exchangedas part of the Settlement Agreement: (in thousands) Equity issued $25,904 Cash received (25,000) Settlement of pre-existing non-contractual relationship 18,087 $18,991 Assets acquired and recorded at fair value as of December 31, 2014 were as follows: (in thousands) Inventory $2,960 Intangible—Re-acquired right 15,940 Prepaid services 91 $18,991 The Company recorded the reacquired right as an intangible asset as of December 31, 2014. The Company is amortizing the reacquired right on astraight-line basis through November 2016.Due to the effective date of the Settlement Agreement being December 31, 2014, the Company did not recognize any revenue or operating expensesrelated to U.S. or Canadian commercial sales of Fanapt in the consolidated statement of operations for the year ended December 31, 2014.In connection with the Settlement Agreement, the Company and Novartis terminated the 2009 Amended Sublicense Agreement (the 2009 Agreement).Given the termination of this pre-existing contractual relationship and that there is no further obligation under the 2009 Agreement, the Company recognizeda gain of $59.5 million, representing the remaining deferred revenue related to the $200.0 million upfront payment received from Novartis under the 2009Agreement. This amount was included in gain on arbitration settlement in the consolidated statement of operations in the fourth quarter of 2014.The Settlement Agreement provided for a mutual release of claims and dismissed the Fanapt Arbitration, which effectively settled a pre-existing non-contractual relationship. As a result, the Company recorded an $18.1 million gain on the settlement of arbitration, which represented the value of a potentialfuture arbitration outcome. This amount was valued based on a probability weighted scenario analysis that took into consideration the probability of eachpotential future alternative outcomes of the arbitration between the parties. This amount is included in gain on arbitration settlement in the consolidatedstatement of operations in the fourth quarter of 2014.4. 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 extentthat their inclusion is dilutive. 85®®Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) The following table presents the calculation of basic and diluted net income (loss) per share of common stock for the years ended December 31, 2015,2014, and 2013: Year Ended December 31, (in thousands, except for share and per share amounts) 2015 2014 2013 Numerator: Net income (loss) $(39,865) $20,186 $(21,055) Denominator: Weighted average shares outstanding: Basic 42,250,254 34,774,163 30,351,353 Effect of dilutive securities — 1,912,560 — Weighted average shares outstanding: Diluted 42,250,254 36,686,723 30,351,353 Net income (loss) per share, basic and diluted: Basic $(0.94) $0.58 $(0.69) Diluted $(0.94) $0.55 $(0.69) Antidilutive securities excluded from calculations of diluted net income (loss) per share 5,660,199 3,524,656 4,409,811 The Company incurred a net loss for each of the years ended December 31, 2015 and 2013 causing inclusion of any potentially dilutive securities tohave an anti-dilutive effect, resulting in dilutive loss per share and basic loss per share attributable to common stockholders being equivalent.5. Marketable SecuritiesThe following is a summary of the Company’s available-for-sale marketable securities as of December 31, 2015, all of which have contract maturities ofless than one year: December 31, 2015(in thousands) AmortizedCost GrossUnrealizedGains GrossUnrealizedLosses FairMarketValue U.S. Treasury and government agencies $44,059 $6 $(8) $44,057 Corporate debt 48,239 46 (5) 48,280 $92,298 $52 $(13) $92,337 The following is a summary of the Company’s available-for-sale marketable securities as of December 31, 2014: December 31, 2014(in thousands) AmortizedCost GrossUnrealizedGains GrossUnrealizedLosses FairMarketValue U.S. Treasury and government agencies $30,618 $4 $(4) $30,618 Corporate debt 38,287 25 (9) 38,303 $68,905 $29 $(13) $68,921 86Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) 6. 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 as of December 31, 2015 and 2014 consist of available-for-sale marketable securities. Thevaluation of Level 1 instruments is determined using a market approach, and is based upon unadjusted quoted prices for identical assets in active markets.The valuation of investments classified in Level 2 also is determined using a market approach based upon quoted prices for similar assets in active markets,or other inputs that are observable for substantially the full term of the financial instrument. Level 2 securities include certificates of deposit, commercialpaper and corporate notes that use as their basis readily observable market parameters. The Company did not transfer any assets between Level 2 and Level 1during the years ended December 31, 2015 and 2014.As of December 31, 2015, the Company held certain assets that are required to be measured at fair value on a recurring basis, as follows: Fair Value Measurement as of December 31, 2015 Using (in thousands) December 31,2015 Quoted Prices inActive Markets forIdentical Assets(Level 1) Significant OtherObservable Inputs(Level 2) SignificantUnobservableInputs(Level 3) Available-for-sale securities: U.S. Treasury and government agencies $44,057 $44,057 $— $— Corporate debt 48,280 — 48,280 $92,337 $44,057 $48,280 $— As of December 31, 2014, the Company held certain assets that are required to be measured at fair value on a recurring basis, as follows: Fair Value Measurement as of December 31, 2014 Using (in thousands) December 31,2014 Quoted Prices inActive Markets forIdentical Assets(Level 1) Significant OtherObservable Inputs(Level 2) SignificantUnobservableInputs(Level 3) Available-for-sale securities: U.S. Treasury and government agencies $30,618 $30,618 $— $— Corporate debt 38,303 — 38,303 $68,921 $30,618 $38,303 $— The Company also has financial assets and liabilities, not required to be measured at fair value on a recurring basis, which primarily consist of cash andcash equivalents, accounts receivable, restricted cash, accounts payable and accrued liabilities, the carrying value of which materially approximate their fairvalues. 87Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) 7. InventoryThe Company evaluates expiry risk by evaluating current and future product demand relative to product shelf life. The Company builds demandforecasts by considering factors such as, but not limited to, overall market potential, market share, market acceptance and patient usage. Inventory levels areevaluated for the amount of inventory that would be sold within one year. At certain times, the level of inventory can exceed the forecasted level of cost ofgoods sold for the next twelve months. The Company classifies the estimate of such inventory as non-current. Inventory consisted of the following as ofDecember 31, 2015 and 2014: December 31, December 31, (in thousands) 2015 2014 Current assets Raw materials $— $198 Work-in-process — 1,326 Finished goods 1,294 3,394 Deferred cost of goods sold — 252 $1,294 $5,170 Non-Current assets Raw materials $127 $— Work-in-process 2,369 — $2,496 $— 8. Prepaid Expenses and Other Current AssetsThe following is a summary of the Company’s prepaid expenses and other current assets as of December 31, 2015 and 2014: December 31, December 31, (in thousands) 2015 2014 Prepaid insurance $423 $270 Prepaid manufacturing cost 346 358 Other prepaid expenses and vendor advances 4,763 2,302 Other current assets 210 154 $5,742 $3,084 88Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) 9. Property and EquipmentThe following is a summary of the Company’s property and equipment-at cost, as of December 31, 2015 and 2014: (in thousands) EstimatedUseful Life(Years) December 31, 2015 2014 Computer and other equipment 3 $2,046 $1,316 Furniture and fixtures 7 1,318 765 Leasehold improvements 11 3,519 2,089 6,883 4,170 Accumulated depreciation and amortization (2,313) (1,733) $4,570 $2,437 Depreciation expense for the years ended December 31, 2015, 2014 and 2013 was $0.6 million, $0.5 million and $0.4 million, respectively.10. Intangible AssetsThe following is a summary of the Company’s intangible assets as of December 31, 2015: December 31, 2015 (in thousands) Estimated UsefulLife (Years) Gross CarryingAmount AccumulatedAmortization Net CarryingAmount HETLIOZ January 2033 $33,000 $3,460 $29,540 Fanapt November 2016 27,941 18,729 9,212 $60,941 $22,189 $38,752 The following is a summary of the Company’s intangible assets as of December 31, 2014: December 31, 2014 (in thousands) EstimatedUseful life Gross CarryingAmount AccumulatedAmortization Net CarryingAmount HETLIOZ January 2033 $8,000 $539 $7,461 Fanapt November 2016 27,941 8,678 19,263 $35,941 $9,217 $26,724 In January 2014, the Company announced that the FDA had approved the NDA for HETLIOZ. As a result of this approval, the Company met amilestone under its license agreement with Bristol-Myers Squibb (BMS) that required the Company to make a license payment of $8.0 million to BMS. The$8.0 million is being amortized on a straight-line basis over the remaining life of the U.S. patent for HETLIOZ, which prior to June 2014, the Companyexpected to last until December 2022. In June 2014, the Company received a notice of allowance from the U.S. Patent and Trademark Office for a patentcovering the method of use of HETLIOZ. The patent expires in January 2033, thereby potentially extending the exclusivity protection in the U.S. beyondthe composition of matter patent. As a result of the patent allowance, the Company extended the estimated useful life of the U.S. patent for HETLIOZ fromDecember 2022 to January 2033. 89®®®®®®®®Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) The Company is obligated to make a future milestone payment to BMS of $25.0 million in the event that cumulative worldwide sales of HETLIOZreach $250.0 million. The likelihood of achieving the milestone and the related milestone obligation was determined to be probable during the year endedDecember 31, 2015. As a result, the future obligation of $25.0 million was recorded as a non-current liability as of December 31, 2015 along with an additionof $25.0 million to capitalized intangible assets relating to HETLIOZ. The $25.0 million was determined to be additional consideration for the acquisitionof the HETLIOZ intangible asset, which was created upon FDA approval on January 31, 2014. The actual payment of the $25.0 million will occur once the$250.0 million in cumulative worldwide sales of HETLIOZ is realized. The $25.0 million is being amortized on a straight-line basis over the remaining lifeof the U.S. patent for HETLIOZ, which is expected to be January 2033. Amortization of intangible assets relating to HETLIOZ amounted to $2.9 million forthe year ended December 31, 2015 and includes a catch-up adjustment of $1.2 million to retroactively record cumulative amortization from January 31, 2014to December 31, 2014 for the milestone obligation of $25.0 million. In future periods the Company expects annual amortization of capitalized intangibleasset costs relating to HETLIOZ will amount to $1.7 million until the expiration of the patent in 2033.In 2009, the Company announced that the FDA had approved the NDA for Fanapt. As a result of this approval, the Company met a milestone under itsoriginal sublicense agreement with Novartis that required the Company to make a license payment of $12.0 million to Novartis. The $12.0 million is beingamortized on a straight-line basis over the remaining life of the U.S. composition of matter patent for Fanapt to November 2016.Pursuant to the Settlement Agreement, Novartis transferred all U.S. and Canadian rights in the Fanapt franchise to the Company. As a result, theCompany recognized an intangible asset of $15.9 million on December 31, 2014 related to the reacquired rights to Fanapt, which is being amortized on astraight-line basis through November 2016. The useful life estimation for the Fanapt intangible asset is based on the market participant methodologyprescribed by ASC 805, and therefore does not reflect the impact of additional Fanapt patents solely owned by the Company with varying expiration dates,the latest of which is December 2031. Amortization of intangible assets relating to Fanapt amounted to $10.1 million for the year ended December 31, 2015.See Note 3, Settlement Agreement with Novartis, for additional information.The intangible assets are being amortized over their estimated useful economic life using the straight line method. Total amortization expense was$13.0 million, $2.3 million and $1.5 million for the years ended December 31, 2015, 2014 and 2013, respectively.The following is a summary of the future intangible asset amortization schedule as of December 31, 2015: (in thousands) Total 2016 2017 2018 2019 2020 Thereafter HETLIOZ $29,540 $1,721 $1,721 $1,721 $1,721 $1,721 $20,935 Fanapt 9,212 9,212 — — — — — $38,752 $10,933 $1,721 $1,721 $1,721 $1,721 $20,935 90®®®®®®®®®®®®®®®®Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) 11. Accounts Payable and Accrued LiabilitiesThe following is a summary of the Company’s accounts payable and accrued liabilities as of December 31, 2015 and 2014: (in thousands) December 31,2015 December 31,2014 Research and development expenses $3,199 $1,759 Consulting and other professional fees 5,088 2,522 Compensation and employee benefits 468 388 Royalties payable 5,328 602 Other 1,684 2,020 $15,767 $7,291 12. Deferred Licensing RevenueThe following is a summary of changes in deferred licensing revenue for the years ended December 31, 2014 and 2013: Year Ended December 31, (in thousands) 2015 2014 2013 Balance beginning of year $— $90,275 $117,064 Licensing revenue recognized — (30,746) (26,789) Recognized as part of gain on arbitration settlement — (59,529) — Balance end of year $ — $— $90,275 The Company entered into an amended and restated sublicense agreement with Novartis in 2009, pursuant to which Novartis had 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. Revenue related to the upfront payment was recognized ratably from the date the amended and restated sublicense agreementbecame effective (November 2009) through the expected duration of the Novartis commercialization of Fanapt in the U.S. which was estimated to bethrough the expiry of the Fanapt composition of patent, including a granted Hatch-Waxman extension (November 2016). During the year endedDecember 31, 2014, the Company recognized revenue of $30.7 million related to the license agreement. In connection with the Settlement Agreement, theCompany recognized the remaining deferred revenue balance of $59.5 million during the three months ended December 31, 2014, as part of the gain onarbitration settlement. See Note 3, Settlement Agreement with Novartis, for additional information.13. Commitments and ContingenciesOperating LeasesThe following is a summary of the minimum annual future payments under operating leases as of December 31, 2015: Cash payments due by year (1) (2) (3) (in thousands) Total 2016 2017 2018 2019 2020 Thereafter Operating leases $13,315 $1,500 $1,538 $1,576 $1,616 $1,656 $5,429 91®®®Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) 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. In 2011 the Company entered into an office lease, which was subsequently amended in 2014, with Square 54 Office Owner LLC(Landlord) for its headquarters, consisting of a total of 30,260 square feet of office space at 2200 Pennsylvania Avenue, N.W. in Washington, D.C. (Lease).Subject to the prior rights of other tenants in the building, the Company has the right to renew the Lease for five years following its expiration. The companyhas the right to sublease or assign all or a portion of the premises, subject to standard conditions. The Lease may be terminated early by the Company or theLandlord upon certain conditions. The Landlord provided the Company with a cash allowance of $0.8 million for tenant improvements. The allowance fortenant improvements is reflected in the consolidated financial statements as an increase to the deferred rent liability for the year ended December 31, 2015.Rent expense under operating leases, was $1.9 million, $1.7 million and $1.1 million for the years ended December 31, 2015, 2014 and 2013,respectively.Guarantees and IndemnificationsThe Company has entered into a number of standard intellectual property indemnification agreements in the ordinary course of its business. Pursuantto these agreements, the Company indemnifies, holds harmless, and agrees to reimburse the indemnified party for losses suffered or incurred by theindemnified party, 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 these indemnification agreements is generally perpetual from thedate of execution of the agreement. The maximum potential amount of future payments the Company could be required to make under these indemnificationagreements is unlimited. Since inception, the Company has not incurred costs to defend lawsuits 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 BMS under which it 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, the Company paid BMS an initial license fee of $0.5 million. The Company made a milestone payment to BMS of $1.0 million under the licenseagreement in 2006 relating to the initiation of its first Phase III clinical trial for HETLIOZ. As a result of the FDA acceptance of the Company’s NDA forHETLIOZ for the treatment of Non-24 in July 2013, the Company incurred a $3.0 million milestone obligation under the license agreement with BMS. As aresult of the FDA’s approval of the HETLIOZ NDA in January 2014, the Company incurred an $8.0 million milestone obligation in the first quarter of 2014under the same license agreement that was capitalized as an intangible asset and is being amortized over the expected HETLIOZ patent life in the U.S. TheCompany is obligated to make a future milestone payment to BMS of $25.0 million in the event that cumulative worldwide sales of HETLIOZ reach $250.0million. During the first quarter of 2015, the likelihood of achieving the milestone and the related milestone obligation was determined to be probable. Assuch, the $25.0 million milestone obligation was capitalized as an intangible asset and is being amortized over the expected HETLIOZ patent life in the U.S.The actual payment of the $25.0 million will occur once the $250.0 million in cumulative worldwide sales of HETLIOZ is realized. Additionally, theCompany is obligated to make royalty payments on HETLIOZ net sales to BMS in any territory where the Company commercializes HETLIOZ for a periodequal to the greater of 10 years following the first commercial sale in the territory or the expiry of the new chemical entity patent in that territory. During theperiod prior to the expiry of the new chemical entity patent in a territory, the Company is obligated to pay a 10% royalty on net sales in that territory. Theroyalty rate is decreased by half 92®®®®®®®®®®®Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) for countries in which no new chemical entity patent existed or for the remainder of the 10 years after the expiry of the new chemical entity patent. TheCompany is also obligated under the license agreement to pay BMS a percentage of any sublicense fees, upfront payments and milestone and other payments(excluding royalties) that it receives from a third party in connection with any sublicensing arrangement, at a rate which is in the mid-twenties. The Companyhas agreed with BMS in the license agreement for HETLIOZ to use its commercially reasonable efforts to develop and commercialize HETLIOZ.The license agreement was amended in April 2013 to add a process that would allow BMS to waive the right to develop and commercialize HETLIOZin those countries not covered by a development and commercialization agreement. Subsequent to the execution of the April 2013 amendment, BMSprovided the Company with formal written notice that it irrevocably waived the option to exercise the right to reacquire any or all rights to any product (asdefined in the license agreement) containing HETLIOZ, or to develop or commercialize any such product, in the countries not covered by a developmentand commercialization 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. Pursuant to the terms of the Settlement Agreement, Novartis transferred all U.S. and Canadian rights in the Fanapt franchise to the Companyon December 31, 2014.A predecessor company of Sanofi, Hoechst Marion Roussel, Inc. (HMRI) discovered Fanapt and completed early clinical work on the product. In1996, following a review of its product portfolio, HMRI licensed its rights to the Fanapt patents and patent applications to Titan Pharmaceuticals, Inc.(Titan) on an exclusive basis. In 1997, soon after it had acquired its rights, Titan sublicensed its rights to Fanapt on an exclusive basis to Novartis. In June2004, the Company acquired exclusive worldwide rights to these patents and patent applications, as well as certain Novartis patents and patent applicationsto develop and commercialize Fanapt, through a sublicense agreement with Novartis. In October 2009, subsequent to the FDA’s approval of the NDA forFanapt, the Company 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 had 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 was responsible for the further clinical developmentactivities in the U.S. and Canada. The Company also received royalties equal to 10% of net sales of Fanapt in the U.S. and Canada. The Company retainedexclusive rights to Fanapt outside the U.S. and Canada and was obligated to make royalty payments to Sanofi S.A. (Sanofi) on Fanapt sales outside the U.S.and Canada.Pursuant to the terms of the Settlement Agreement, Novartis transferred all U.S. and Canadian rights in the Fanapt franchise to the Company onDecember 31, 2014. The Company is obligated to make royalty payments to Sanofi and Titan, at a percentage rate equal to 23% on annual U.S. net sales ofFanapt up to $200.0 million, and at a percentage rate in the mid-twenties on sales over $200.0 million through November 2016. See Note 3, SettlementAgreement with Novartis, for additional information. In February 2016, the Company amended the agreement with Sanofi and Titan to remove Titan as theentity through which royalty payments from Vanda are directed to Sanofi following the expiration of the new chemical entity (NCE) patent for Fanapt in theU.S. on November 15, 2016. Under the amended agreement, the Company will pay directly to Sanofi a fixed royalty of 3% of net sales from November 16,2016 through December 31, 2019 related to manufacturing know-how. The Company will make a $2.0 million payment applied to this 3% manufacturingknow-how royalty and will make additional royalty payments only to the extent that Vanda’s cumulative royalty obligations during this period exceed theamount of the pre-payment. No further royalties on manufacturing know-how are payable by Vanda after December 31, 2019. This amended agreement doesnot alter Titan’s obligation under the License Agreement to make royalty payments to Sanofi prior to November 16, 2016 or Vanda’s obligations under the 93®®®®®®®®®®®®®®®®®®®®Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) Sublicense Agreement to pay Sanofi a fixed royalty on Fanapt net sales equal up to 6% on Sanofi know-how not related to manufacturing under certainconditions for a period of up to 10 years in markets where the NCE patent has expired or was not issued.The Company has entered into agreements with the following partners for the commercialization of Fanapt in the countries set forth below: Country Partner Market Approval DateMexico Probiomed S.A. de C.V. October 2013Israel Megapharm Ltd. August 2012Tradipitant. In April 2012, the Company entered into a license agreement with Eli Lilly and Company (Lilly) pursuant to which the Companyacquired an exclusive worldwide license under certain patents and patent applications, and other licenses to intellectual property, to develop andcommercialize an NK-1R antagonist, tradipitant, for all human indications. The patent describing tradipitant as a new chemical entity expires in April 2023,except in the U.S., where it expires 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.Lilly is also eligible to receive additional payments based upon achievement of specified development and commercialization milestones as well as tiered-royalties on net sales at percentage rates up to the low double digits. These milestones include $4.0 million for pre-NDA approval milestones and up to $95.0million for future regulatory approval and sales milestones. Vanda is obligated to use its commercially reasonable efforts to develop and commercializetradipitant.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,all rights licensed and developed by Vanda under the license agreement will revert or otherwise be licensed back to Lilly on an exclusive basis, subject topayment by Lilly to the Company of a royalty on net sales of products that contain tradipitant.AQW051. In connection with the Settlement Agreement, the Company received an exclusive worldwide license under certain patents and patentapplications, and other licenses to intellectual property, to develop and commercialize AQW051, a Phase II alpha-7 nicotinic acetylcholine receptor partialagonist.Pursuant to the license agreement, the Company is obligated to use its commercially reasonable efforts to develop and commercialize AQW051 and isresponsible for all development costs under the AQW051 license agreement. The Company has no milestone obligations; however, Novartis is eligible toreceive tiered-royalties on net sales at percentage rates up to the mid-teens.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 clinicaldevelopment and clinical manufacturing activities under fee service arrangements. The Company’s current agreements for clinical services may be terminatedon generally 60 days’ notice without incurring additional charges, other than charges for work completed but not paid for through the effective date oftermination and other costs incurred by the Company’s contractors in closing out work in progress as of the effective date of termination. 94®Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) 14. Income TaxesDeferred tax assets are reduced by a tax valuation allowance when, in the opinion of management, it is more likely than not that some portion or all ofthe deferred tax assets will not be realized. The fact that the Company has historically generated net operating losses (NOLs) serves as strong evidence that itis more likely than not that deferred tax assets will not be realized in the future. Therefore, the Company has a full tax valuation allowance against alldeferred tax assets as of and December 31, 2015 and 2014. As a result of the tax valuation allowance against deferred tax assets, there was no provision forincome taxes for the years ended December 31, 2015, 2014 and 2013.The following is reconciliation between the Company’s statutory tax rate and effective tax rate for the years ended December 31, 2015, 2014 and 2013: Year Ended December 31, 2015 2014 2013 Federal tax at statutory rate 35.0% 34.0% -34.0% State taxes -0.1% 7.2% -4.0% Change in valuation allowance -25.4% -59.7% 43.9% Research and development credit 1.5% 1.3% -1.1% Orphan drug credit 1.6% 8.5% -22.7% Section 162(m) limitation -5.7% 1.1% 1.2% Tax rate change -0.3% 4.8% -0.3% Change in State NOLs -1.4% 0.0% 18.5% Non-deductible stock-based compensation -5.1% 0.0% 0.0% Other non-deductible items -0.1% 2.8% -1.5% Effective tax rate 0.0% 0.0% 0.0% As of December 31, 2015, the Company has early adopted the balance sheet reclassification of all current deferred taxes to non-current deferred taxes.The Company has presented this information prospectively; therefore, prior periods were not retrospectively adjusted.The following is a summary of the components of the Company’s deferred tax assets, net, and the related tax valuation allowance as of December 31,2015 and 2014: December 31, (in thousands) 2015 2014 Deferred tax assets: Net operating loss carry forwards $86,640 $73,626 Stock-based compensation 12,919 17,160 Accrued and deferred expenses 1,443 532 Research and development and orphan drug credit carryforwards 38,333 36,772 Other 802 806 Total deferred tax assets 140,137 128,896 Deferred tax liabilities: Other (1,100) (6) Total deferred tax liabilities (1,100) (6) Deferred tax assets, net 139,037 128,890 Valuation allowance (139,037) (128,890) Net deferred tax assets $— $— 95Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) The following is a summary of changes in the Company’s tax valuation allowance for the years ended December 31, 2015, 2014 and 2013: (in thousands) Balance atBeginningof Year Additions Chargedto Tax Expense Reductions Creditedto Tax Expense Balance at Endof Year Year Ended: December 31, 2015 $128,890 $17,002 $(6,855) 139,037 December 31, 2014 141,150 27,893 (40,153) 128,890 December 31, 2013 133,271 22,998 (15,119) 141,150 As of December 31, 2015, the Company had federal and state NOL carryforwards of $232.6 million, including $6.5 million of gross excess windfallbenefits generated from stock-based compensation from which the tax benefit would be recorded to Additional Paid in Capital if realized. As of December 31,2015, the Company also had research and development credits of $6.8 million and orphan drug carryforward credits of $31.6 million. These NOLcarryforwards and credits will begin to expire in 2028 and 2024, respectively.Because the Company has generated NOLs from inception through December, 31, 2015, all income tax returns filed by the Company are open toexamination by tax jurisdictions. As of December 31, 2015, the Company’s income tax returns have not been under examination by any federal or state taxjurisdictions. As of December 31, 2015 and 2014, the Company had no uncertain tax positions.Certain tax attributes of the Company, including NOLs and credits, are subject to any ownership change as defined under IRC Section 382, A changein ownership could affect the Company’s ability to use NOLs and credit carryforward (tax attributes). Ownership changes did occur as of December 31, 2014and December 31, 2008. However, the Company believes that it had sufficient Built-In-Gain to offset the Internal Revenue Code of 1986, as amended (IRC),Section 382 limitation generated by the ownership changes. Any future ownership changes may cause the Company’s existing tax attributes to haveadditional limitations. Additionally, the Company maintains a valuation allowance on its tax attributes, therefore, any IRC Section 382 limitation would nothave a material impact on the Company’s provision for income taxes as of December 31, 2015.15. Public Offering of Common StockIn October 2014, the Company completed a public offering of 5,750,000 shares of common stock at a price to the public of $11.60 per share. Net cashproceeds from the public offering were $62.3 million, after deducting the underwriting discounts and commissions and offering expenses. In 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 cash proceeds from the 2013public offering were $48.5 million, after deducting the underwriting discounts and commissions and offering expenses.16. Equity Incentive PlansDuring the year ended December 31, 2015, 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. There were no sharessubject to outstanding options granted under the 2004 Plan as of December 31, 2015, and no additional options will be granted under the 2004 Plan. As ofDecember 31, 2015, there were 11,829,472 shares of the Company’s common stock reserved for issuance under the 2006 Plan, of which 7,275,129 shares weresubject to outstanding options and RSUs and 1,733,142 shares remained available for future grant. On January 1 of each year, the number of shares reservedunder the 2006 Plan is automatically increased by the lesser of 4% of the total number of shares of common stock that are outstanding at that time or1,500,000 shares (or such lesser number as may be approved 96Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) by the Company’s board of directors). As of January 1, 2016, the number of shares of common stock that may be issued under the 2006 Plan wasautomatically increased by 1,500,000 shares, increasing the number of shares of common stock available for issuance under the Plan to 13,329,472 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 thancause or permanent disability. As of December 31, 2015, $12.6 million of unrecognized compensation costs related to unvested service option awards areexpected to be recognized over a weighted average period of 1.4 years. No option awards are classified as a liability as of December 31, 2015.The following is a summary of option activity for the 2004 Plan for the years ended December 31, 2015, 2014, and 2013: 2004 Option Plan (in thousands, except for share and per share amounts) Number ofShares Weighted AverageExercise Price atGrant Date Weighted AverageRemaining Term(Years) AggregateIntrinsicValue Outstanding at December 31, 2012 672,145 $1.79 2.78 $1,512 Exercised (115) 4.73 Expired (1,286) 3.67 Outstanding at December 31, 2013 670,744 1.79 1.78 7,124 Exercised (17,934) 3.57 Outstanding at December 31, 2014 652,810 1.74 0.78 8,212 Exercised (652,810) 1.74 6,129 Outstanding at December 31, 2015 — 97Table 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, 2015, 2014, and 2013: 2006 Option Plan (in thousands, except for share and per share amounts) Number ofShares Weighted AverageExercise Price atGrant Date Weighted AverageRemaining Term(Years) AggregateIntrinsicValue 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 Granted 1,324,337 12.17 Forfeited (237,108) 8.35 Exercised (393,735) 7.08 2,923 Outstanding at December 31, 2014 6,227,112 11.58 6.71 28,523 Granted 1,056,500 11.74 Forfeited (496,854) 10.75 Expired (64,336) 25.69 Exercised (469,974) 7.02 2,594 Outstanding at December 31, 2015 6,252,448 11.87 6.16 7,498 Exercisable at December 31, 2015 4,163,690 12.11 4.86 6,616 Vested and expected to vest at December 31, 2015 6,120,365 11.87 6.10 7,491 Proceeds from the exercise of stock options amounted to $4.4 million, $2.9 million and $1.6 million for the years ended December 31, 2015, 2014 and2013, 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, 2015, $8.5 million of unrecognizedcompensation costs related to unvested service RSUs are expected to be recognized over a weighted average period of 2.0 years. No service RSUs areclassified as a liability as of December 31, 2015. 98Table 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, 2015, 2014, and 2013: RSUs Number ofSharesUnderlyingRSUs WeightedAverageGrant DateFair Value 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 Granted 436,115 12.28 Forfeited (84,282) 6.75 Vested (209,562) 6.67 Unvested at December 31, 2014 1,025,961 9.94 Granted 417,000 11.51 Forfeited (189,187) 10.60 Vested (231,093) 7.96 Unvested at December 31, 2015 1,022,681 10.90 The grant date fair value for the 231,093 shares underlying RSUs that vested during the year ended December 31, 2015 was $1.8 million.17. Employee Benefit PlanThe Company has a defined contribution plan under IRC Section 401(k). This plan covers substantially all employees who meet minimum age andservice requirements and allows participants to defer a portion of their annual compensation on a pre-tax basis. Currently, the Company matches 50 percentup to the first six percent of employee contributions. All matching contributions have been paid by the Company. The Company match vests over a four yearperiod. The total Company match was $0.3 million, $0.2 million and $0.2 million for the years ended December 31, 2015, 2014 and 2013, respectively.18. Legal MattersIn June 2014, the Company filed suit against Roxane Laboratories, Inc. (Roxane) in the U.S. District Court for the District of Delaware. The suit seeksan adjudication that Roxane has infringed one or more claims of the Company’s U.S. Patent No. 8,586,610 (the ‘610 Patent) by submitting to the FDA anAbbreviated New Drug Application (ANDA) for generic versions of Fanapt oral tablets in 1 mg, 2 mg, 4 mg, 6 mg, 8 mg, 10 mg, and 12 mg strengths. Therelief requested by the Company includes a request for a permanent injunction preventing Roxane from infringing the asserted claims of the ‘610 Patent byengaging in the manufacture, use, offer to sell, sale, importation or distribution of generic versions of Fanapt before the expiration of the ‘610 Patent in2027.Pursuant to the Settlement Agreement, the Company assumed Novartis’ patent infringement action against Roxane in the U.S. District Court for theDistrict of Delaware. The suit alleges that Roxane’s filing of an ANDA for generic iloperidone with a paragraph IV certification infringes Sanofi’s newchemical entity patent. Roxane is defending on the grounds that the patent claims are invalid or unenforceable or that certain patent claims are not infringed.Roxane also filed a motion to dismiss on the grounds that the court lacks jurisdiction. 99®®Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) The two pending cases against Roxane were consolidated by agreement of the parties in April 2015 and are scheduled to be tried together in a four-daybench trial beginning on February 29, 2016.In May 2015, the Company filed a lawsuit against Inventia Healthcare Pvt. Ltd. (Inventia) in the U.S. District Court for the District of Delaware. Thesuit seeks an adjudication that Inventia has infringed on one or more claims of the ‘610 Patent by submitting to the FDA an ANDA for a generic version ofFanapt. The relief requested by the Company includes a request for a permanent injunction preventing Inventia from infringing the asserted claims of the‘610 Patent by engaging in the manufacture, use, offer to sell, sale, importation or distribution of generic versions of Fanapt before the expiration of the ‘610Patent in 2027. This lawsuit is scheduled to be tried in a four-day bench trial beginning on January 17, 2017.In October 2015, the Company filed four separate patent infringement lawsuits in the United States District Court for the District of Delaware (theOctober 2015 Lawsuits). Two of the October 2015 Lawsuits join the existing litigations against the previous Fanapt ANDA filers, Roxane and Inventia,described above. The other two October 2015 Lawsuits were filed against new ANDA filers, Taro Pharmaceuticals, U.S.A., Inc. /Taro Pharmaceuticals Ltd.(Taro) and Apotex Inc. (Apotex).The first of the October 2015 Lawsuits, which was filed against Roxane, seeks an adjudication that Roxane has infringed one or more claims of theCompany’s U.S. Patent No. 9,138,432 (the ‘432 Patent) by submitting to the FDA its ANDA for a generic version of Fanapt prior to the expiration of the ‘432Patent in September 2025. The relief requested by the Company includes a request for a permanent injunction preventing Roxane from infringing theasserted claims of the ‘432 Patent by engaging in the manufacture, use, offer to sell, sale, importation or distribution of generic versions of Fanapt before theexpiration of the ‘432 Patent in 2025.The second of the October 2015 Lawsuits, which was filed against Inventia, seeks an adjudication that Inventia has infringed one or more claims of the‘432 Patent by submitting to the FDA its ANDA for a generic version of Fanapt prior to the expiration of the ‘432 Patent in September 2025. The reliefrequested by the Company includes a request for a permanent injunction preventing Inventia from infringing the asserted claims of the ‘432 Patent byengaging in the manufacture, use, offer to sell, sale, importation or distribution of generic versions of Fanapt before the expiration of the ‘432 Patent in2025.The third of the October 2015 Lawsuits, which was filed against Taro, seeks an adjudication that Taro has infringed one or more claims of the ‘432Patent and the ‘610 Patent by submitting to the FDA an ANDA for a generic version of Fanapt prior to the expiration of the ‘432 patent in September 2025and the ‘610 Patent in November 2027. The relief requested by the Company includes a request for a permanent injunction preventing Taro from infringingthe asserted claims of the ‘432 Patent and the ‘610 Patent by engaging in the manufacture, use, offer to sell, sale, importation or distribution of genericversions of Fanapt before the expiration of the ‘432 Patent in 2025 and the ‘610 Patent in 2027.The fourth of the October 2015 Lawsuits, which was filed against Apotex and Apotex Corp., seeks an adjudication that Apotex has infringed one ormore claims of the ‘432 Patent and the ‘610 Patent by submitting to the FDA an ANDA for a generic version of Fanapt prior to the expiration of the ‘432Patent in September 2025 and the ‘610 Patent in November 2027. The relief requested by the Company includes a request for a permanent injunctionpreventing Apotex from infringing the asserted claims of the ‘432 Patent and the ‘610 Patent by engaging in the manufacture, use, offer to sell, sale,importation or distribution of generic versions of Fanapt before the expiration of the ‘432 Patent in 2025 and the ‘610 Patent in 2027.In November 2015, the Company filed a patent infringement lawsuit in the United States District Court for the District of Delaware against LupinLimited and Lupin Pharmaceuticals, Inc. (collectively, Lupin). The suit seeks an adjudication that Lupin has infringed one or more claims of the ‘432 Patentand the ‘610 Patent by submitting to the FDA its ANDA for a generic version of Fanapt prior to the expiration of the ‘432 Patent in September 2025 and the‘610 Patent in November 2027. The relief requested by the Company in the lawsuit includes a request for a permanent injunction preventing Lupin frominfringing the asserted claims of the ‘432 Patent and the ‘610 Patent by engaging in the manufacture, use, offer to sell, sale, importation or distribution ofgeneric versions of Fanapt before the expiration of the ‘432 Patent in 2025 and the ‘610 Patent in 2027. 100®®®®®®®®®®®®®Table of ContentsVanda Pharmaceuticals Inc.Notes to the Consolidated Financial Statements — (Continued) 19. Quarterly Financial Data (unaudited) First Second Third Fourth (in thousands, except for per share amounts) Quarter Quarter Quarter Quarter 2015 Revenue $22,150 $27,582 $28,344 $31,849 Gross profit 17,135 21,816 21,834 25,678 Loss from operations (10,293) (5,458) (9,541) (14,893) Net loss (10,221) (5,386) (9,461) (14,798) Net loss per share, basic and diluted $(0.24) $(0.13) $(0.22) $(0.35) 2014 Revenue $9,143 $10,862 $14,782 $15,370 Gross profit 9,143 10,664 14,079 14,688 Income (loss) from operations (26,578) (21,606) (1,448) 69,693 Net income (loss) (26,533) (21,575) (1,426) 69,719 Net income (loss) per share: Basic $(0.79) $(0.64) $(0.04) $1.85 Diluted $(0.79) $(0.64) $(0.04) $1.77 The Company’s results for the fourth quarter of 2014 include a gain on arbitration settlement of $77.6 million, or $2.06 and $1.97 per basic and dilutedshare, respectively. See Note 3, Settlement Agreement with Novartis, for additional information. Gross profit has been calculated by subtracting Cost ofGoods Sold from Total Revenues in the period. 101Table of ContentsVANDA PHARMACEUTICALS INC.EXHIBIT INDEX ExhibitNumber Description 3.1 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) on March 17, 2006 and incorporated herein by reference). 3.2 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) on September 25, 2008 and incorporated herein by reference). 3.3 Fourth Amended and Restated Bylaws of the registrant, as amended and restated on December 17, 2015 (filed as Exhibit 3.1 to the registrant’scurrent report on Form 8-K (File No. 001-34186) on December 21, 2015 and incorporated herein by reference). 4.1 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) on March 17, 2006, and incorporated herein by reference). 4.2 Rights Agreement, dated as of September 25, 2008, by and 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) on September 25, 2008 andincorporated herein by reference). 4.3 Amendment to Rights Agreement, dated as of December 22, 2009, by and between the registrant and American Stock Transfer & TrustCompany, LLC, as Rights Agent (filed as Exhibit 4.6 to the registrant’s current report on Form 8-K (File No. 001-34186) 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 on FormS-1 (File No. 333-130759) on December 29, 2005 and incorporated herein by reference).10.2# Amended and Restated License, Development and Commercialization Agreement, dated July 24, 2005, by and between Bristol-Myers SquibbCompany and the registrant (relating to HETLIOZ) (filed as Exhibit 10.3 to Amendment No. 1 to the registrant’s registration Statement onForm S-1 (File No. 333-130759) on February 16, 2006 and incorporated herein by reference).10.3 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) on December 29, 2005 and incorporated herein by reference).10.4 Form of Indemnification Agreement entered into by directors and executive officers (filed as Exhibit 10.11 to the registrant’s registrationstatement on Form S-1 (File No. 333-130759) on December 29, 2005 and incorporated herein by reference).10.5† 2006 Equity Incentive Plan, as amended (filed as Exhibit 10.38 to the registrant’s current report on Form 8-K (File No. 001-34186) on March7, 2010 and incorporated herein by reference).10.6 Form of Tax Indemnity Agreement (filed as Exhibit 10.20 to the registrant’s quarterly report on Form 10-Q (File No. 000-51863) on August 8,2007 and incorporated herein by reference).10.7† Amended and Restated Employment Agreement, dated December 16, 2008, by and between Mihael H. Polymeropoulos and the registrant(filed as Exhibit 10.34 to the registrant’s quarterly report on Form 10-Q (File No. 001-34186) on August 10, 2009 and incorporated herein byreference). 102®Table of ContentsExhibitNumber Description10.8† Employment Agreement, dated December 13, 2010, by and between James Kelly and the registrant (filed as Exhibit 10.38 to the registrant’sannual report on Form 10-K (File No. 001-34186) on March 10, 2011 and incorporated herein by reference).10.9† Amendment to Amended and Restated Employment Agreement, dated December 16, 2010, by and between Mihael H. Polymeropoulos andthe registrant (filed as Exhibit 10.39 to the registrant’s annual report on Form 10-K (File No. 001-34186) on March 10, 2011 and incorporatedherein by reference).10.10 Amended and Restated Tax Indemnity Agreement, dated December 16, 2010, by and between Mihael H. Polymeropoulos and the registrant(filed as Exhibit 10.41 to the registrant’s annual report on Form 10-K (File No. 001-34186) on March 10, 2011 and incorporated herein byreference).10.11 Lease, effective as of July 25, 2011, by and between Square 54 Office Owner LLC and the registrant (filed as Exhibit 10.42 to the registrant’squarterly report on Form 10-Q (File No. 001-34186) on November 7, 2011 and incorporated herein by reference).10.12† 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 (File No. 001-34186) on March 9, 2012 and incorporated herein by reference).10.13† 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 (File No. 001-34186) on March 9, 2012 and incorporated herein by reference).10.14 Amendment to Amended and Restated License, Development and Commercialization Agreement, dated as of April 15, 2010, by and betweenBristol-Myers Squibb Company and the registrant (filed as Exhibit 10.38 to the registrant’s current report on Form 8-K (File No. 001-34186)on April 19, 2010 and incorporated herein by reference).10.15 Amendment to Amended and Restated License, Development and Commercialization Agreement, dated as of May 24, 2012, by and betweenBristol-Myers Squibb Company and the registrant (filed as Exhibit 10.46 to the registrant’s current report on Form 8-K (File No. 001-34186)on May 30, 2012 and incorporated herein by reference).10.16# 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 (File No. 001-34186) on August 3, 2012 and incorporatedherein by reference).10.17 Amendment to Amended and Restated License, Development and Commercialization Agreement, dated as of April 25, 2013, by and betweenBristol-Myers Squibb Company and the registrant (filed as Exhibit 10.50 to the registrant’s current report on Form 8-K (File No. 001-34186)on April 29, 2013 and incorporated herein by reference).10.18† Employment Agreement, dated as of April 15, 2013, by and between Paolo Baroldi and the registrant (filed as Exhibit 10.51 to the registrant’squarterly report on Form 10-Q (File No. 001-34186) on July 31, 2013 and incorporated herein by reference).10.19# Manufacturing Agreement, dated January 24, 2014, by and between Patheon Pharmaceuticals Inc. and the registrant (relating to HETLIOZ)(filed as Exhibit 10.53 to the registrant’s quarterly report on Form 10-Q (File No. 001-34186) on May 8, 2014 and incorporated herein byreference).10.20 Amendment to Lease Agreement, dated March 18, 2014, by and between Square 54 Office Owner LLC and the registrant (filed as Exhibit10.54 to the registrant’s quarterly report on Form 10-Q (File No. 001-34186) on May 8, 2014 and incorporated herein by reference). 103®Table of ContentsExhibitNumber Description10.21 Settlement Agreement and Mutual General Release, dated December 22, 2014, by and among Novartis Pharma AG and the registrant (filed asExhibit 10.55 to the registrant’s annual report on Form 10-K (File No. 001-34186) on March 13, 2015 and incorporated herein by reference).10.22# Asset Transfer Agreement, dated December 22, 2014, by and among Novartis Pharma AG, Novartis AG and the registrant (relating to Fanapt)(filed as Exhibit 10.56 to the registrant’s annual report on Form 10-K/A (File No. 001-34186) on June 10, 2015 and incorporated herein byreference).10.23# Sublicense Agreement, dated November 20, 1997, by and between Titan Pharmaceuticals, Inc. and Novartis Pharma AG (filed as Exhibit10.30 to Titan Pharmaceutical Inc.’s registration statement on Form S-3 (File No. 333-42367) on December 16, 1997 and incorporated hereinby reference).10.24# Amendment No. 1 to Sublicense Agreement by and between Titan Pharmaceuticals, Inc. and Novartis Pharma AG, dated November 30, 1998(filed as Exhibit 10.58 to the registrant’s annual report on Form 10-K for the year ended December 31, 2014 and incorporated herein byreference).10.25# Amendment No. 2 to Sublicense Agreement, dated April 10, 2001, by and between Titan Pharmaceuticals, Inc. and Novartis Pharma AG (filedas Exhibit 10.59 to the registrant’s annual report on Form 10-K/A (File No. 001-34186) on June 10, 2015 and incorporated herein byreference).10.26# Amendment No. 3 to Sublicense Agreement, dated June 4, 2004, by and between Titan Pharmaceuticals, Inc. and Novartis Pharma AG (filedas Exhibit 10.60 to the registrant’s annual report on Form 10-K (File No. 001-34186) on March 13, 2015 and incorporated herein byreference).10.27 Stock Purchase Agreement, dated December 22, 2014, by and between Novartis AG and the registrant (filed as Exhibit 10.61 to theregistrant’s annual report on Form 10-K (File No. 001-34186) on March 13, 2015 and incorporated herein by reference).10.28# License Agreement, dated December 22, 2014, by and between Novartis Pharma AG and the registrant (relating to AQW051) (filed as Exhibit10.62 to the registrant’s annual report on Form 10-K (File No. 001-34186) on March 13, 2015 and incorporated herein by reference).10.29† Employment Agreement, dated April 20, 2015, by and between Thomas E. Gibbs, Senior Vice President and Chief Commercial Officer, andthe registrant (filed as Exhibit 10.65 to the registrant’s quarterly report on Form 10-Q (File No. 001-34186) on July 31, 2015 and incorporatedherein by reference).10.30† Employment Agreement, dated September 3, 2015, by and between Gian Piero Reverberi, Senior Vice President and General Manager Europe,and the registrant (filed as Exhibit 10.64 to the registrant’s quarterly report on Form 10-Q (File No. 001-34186) on November 4, 2015 andincorporated herein by reference).10.31† Employment Agreement, dated September 14, 2015, by and between Richard L. Gulino, Senior Vice President, General Counsel andSecretary, and the registrant (filed as Exhibit 10.65 to the registrant’s quarterly report on Form 10-Q (File No. 001-34186) on November 4,2015 and incorporated herein by reference).10.32 Agreement, dated February 2, 2016, by and among Titan Pharmaceuticals, Inc., Aventisub LLC, the successor-in-interest to Aventisub II Inc.Sanofi-Aventis and the registrant (filed as Exhibit 10.1 to the registrant’s current report on Form 8-K (File No. 001-34186) on February 4,2016 and incorporated herein by reference).10.33†* UK Sub Plan under the 2006 Equity Incentive Plan.10.34†* Form of Stock Option Grant and Stock Option Agreement under the UK Sub Plan. 104®Table of ContentsExhibitNumber Description10.35†* Form of Restricted Stock Unit Award Agreement under the UK Sub Plan.18.1 Preferability Letter of Independent Public Accounting Firm, dated May 8, 2014 (filed as Exhibit 18.1 to the registrant’s quarterly report onForm 10-Q (File No. 001-34186) on May 8, 2014 and incorporated herein by reference).21.1* List of Subsidiaries.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 2002.101* The following financial information from this annual report on Form 10-K for the fiscal year ended December 31, 2015, formatted in XBRL(eXtensible Business Reporting Language) and furnished electronically herewith: (i) Consolidated Balance Sheets as of December 31, 2015and 2014; (ii) Consolidated Statements of Operations for the years ended December 31, 2015, 2014 and 2013; (iii) Consolidated Statementsof Comprehensive Income (Loss) for the years ended December 31, 2015, 2014 and 2013; (iv) Consolidated Statements of Changes inStockholders’ Equity for the years ended December 31, 2015, 2014 and 2013; (v) Consolidated Statements of Cash Flows for the years endedDecember 31, 2015, 2014 and 2013; and (vi) Notes to the Consolidated Financial Statements. †Indicates management contract or compensatory plan.#Confidential treatment has been granted with respect to certain provisions of this exhibit.*Filed herewith. 105Exhibit 10.33Neither this document, nor any stock option agreement connected with it, is an approved prospectus for the purposes of section 85(1) of the FinancialServices and Markets Act 2000 (“FSMA”) and no offer of transferable securities to the public (for the purposes of section 102B of FSMA) is being madein connection with the UK Sub-Plan to the Vanda Pharmaceuticals Inc. 2006 Equity Incentive Plan (the “Sub-Plan”). The Sub-Plan is exclusivelyavailable to bona fide employees and former employees of Vanda Pharmaceuticals Inc., Vanda Pharmaceuticals Limited and any other UK Subsidiary.UK SUB-PLAN TO THEVANDA PHARMACEUTICALS INC.2006 EQUITY INCENTIVE PLANAdditional Terms and Conditions for Options received by Optionees resident in the UK 1.The purpose of this Sub-Plan is to provide incentives for present and future UK tax resident employees of Vanda Pharmaceuticals Inc., VandaPharmaceuticals Limited and any other UK Subsidiary through the grant of options over shares of Common Stock of Vanda Pharmaceuticals Inc (the“Company”). 2.Capitalized terms are defined in the Company’s 2006 Equity Incentive Plan (the “US Plan”), subject to the provisions of this Sub-Plan. 3.References to Incentive Stock Options and Nonstatutory Stock Options shall not apply to Options granted under the Sub-Plan. 4.The Options granted under this Sub-Plan shall be designated as Unapproved Options. 5.This Sub-Plan is governed by the US Plan and all its provisions shall be identical to those of the US Plan SAVE THAT (i) “Sub-Plan” shall besubstituted for “Plan” where applicable and (ii) the following provisions shall be as stated in this Sub-Plan in order to accommodate the specificrequirements of the laws of England and Wales: 6.ARTICLE 1. Introduction.The words “Outside Directors and Consultants” shall be deleted wherever they appear.The words “Options (which may constitute ISOs or NSOs) or stock appreciation rights” shall be deleted and replaced with “or Options”.The words “the Section 431 Election and Joint Election shall be governed by the laws of England and Wales” shall be added to the end of the secondparagraph. 7.ARTICLE 2. Administration.Article 2.1(b) shall be deleted.In Article 2.2 the words “Outside Directors and Consultants” shall be deleted.In Article 2.3 the words “and Consultants who are not Outside Directors and” shall be replaced with the word “who”.In Article 2.3 the words “such Employees and Consultants” shall be amended to read “such Employees”8.ARTICLE 3. Shares available for grants.In Article 3 the words “under the Plan” shall be replaced with the words “under the US Plan (together with the Plan)” wherever they appear.In Article 3.1 the words “All Common Shares available under the Plan may be issued upon the exercise of ISOs” shall be deleted.In Article 3.2 the words “the remaining term of the Plan” shall read “the remaining term of the US Plan”.In Article 3.3, the word “SARs” and the words “settled in cash (in whole or in part)” shall be deleted wherever they appear. In Article 3.3, the twosentences beginning with “If SARs are exercised” and “If Common Shares are tendered” respectively shall also be deleted in their entirety. 9.ARTICLE 4. Eligibility.Article 4.1 shall be deleted in its entirety.In Article 4.2 the words “Outside Directors and Consultants” shall be deleted. The words “NSOs or SARs” shall be deleted and replaced with thewords “or Unapproved Options”. 10.ARTICLE 5. Options.In Article 5.1 the words “The Stock Option Agreement shall specify whether the Option is an ISO or an NSO” shall be deleted.In Article 5.3 the words “(whether or not the Option is an ISO)” shall be deleted.In Article 5.4 the words “provided that the term of an ISO shall in no event exceed 10 years from the date of grant” shall be deleted.In Article 5.4 the final sentence, from “Options may be awarded” to “SARs are forfeited” shall be deleted.In Article 5.5 the words “However, in the case of an ISO, the acceleration of exercisability shall not occur without the Optionee’s written consent”shall be deleted.Article 5.7 shall be deleted in its entirety. 11.ARTICLE 6. Payment For Option Shares.In Article 6.1 the words “(together with any Award Tax Liability and Secondary NIC Liability)” shall be inserted immediately after the words“exercise of Options”.In Article 6.1 the words “cash equivalents” shall be deleted and replaced with the word “cheque”.The final sentence of Article 6.1, from “However, if the Optionee” to “section 13(k) of the Exchange Act” shall be deleted.Articles 6.2 and 6.4 shall be deleted in their entirety. 12.ARTICLE 7. Automatic Option Grants to Outside Directors.Article 7 shall be deleted in its entirety.13.ARTICLE 8. Stock Appreciation Rights.Article 8 shall be deleted in its entirety. 14.ARTICLE 9. Restricted Shares.The words“Specific UK securities laws advice must be taken where Restricted Shares are acquired by Participants other than on exercise of anOption.”shall be inserted at the beginning of this Article.In Article 7.2 the words from “cash equivalents” to “grant of Restricted Shares” shall be deleted and replaced with the words “or cheque”. 15.ARTICLE 10. Stock Units.In Article 10.5, the words “(a) cash, (b) Common Shares or (c) any combination of both, as determined by the Committee” shall be deleted andreplaced with “Common Shares only”. The words beginning “Methods of converting Stock Units” to “or by dividend equivalents” shall also bedeleted.Article 10.6 shall be deleted in its entirety and replaced with “Any Stock Units Award that becomes payable after the recipient’s death shall bedistributed to the recipient’s Personal Representative only”. 16.ARTICLE 11. Protection Against Dilution.In Article 11.1 the words “and SAR” shall be deleted wherever they appear.In Article 11.2 the word “SARs” shall be deleted.In Article 11.3 the words “or SARs”; “(whether or not the Options are ISOs)”; and “and SARs” shall be deleted wherever they appear. 17.ARTICLE 13. Payment of Directors Fees in Other Securities.Article 13 shall be deleted in its entirety 18.ARTICLE 14. Limitation on Rights.In Article 14 the words “Outside Director or Consultant” shall be deleted wherever they appear.In Article 14.1 the words “with or without cause” shall be deleted. 19.ARTICLE 15. Taxes.Article 15 shall be deleted in its entirety and replaced with the following:“ In the event that the Company or any Subsidiary determines that it is required to account to HM Revenue & Customs for any AwardTax Liability or Secondary NIC Liability (under the Stock Option Agreement or Restricted Stock Unit Award Agreement) arising from the grant,exercise, assignment, release, cancellation or any other disposal of an Award or arising out of the acquisition, retention and disposal of the Sharesacquired pursuant to this Award, the Participant, as a condition to the issue of Shares in connection with the exercise of an Award, or on the grant,assignment, release or cancellation of an Award, shall make such arrangements satisfactory to the Company to enable it or any Subsidiary to satisfyany requirement to account for any Award Tax Liability (and, if applicable, any Secondary NIC Liability) that may arise in connection with theAward or the award of Shares pursuant to it including, but not limited to, arrangements satisfactory to the Company for withholding Shares that wouldotherwise be issued pursuant to the Stock Option Agreement or Restricted Stock Unit Award Agreement to the Participant.”20.ARTICLE 17. Future of the Plan.In Article 17.1 the words “earlier of (a) the date when the Plan is terminated under Section 17.2 or (b) the 10th anniversary of the date when the Boardadopted the Plan” shall be deleted and replaced with the words “date when the US Plan is terminated”. 21.ARTICLE 18. Definitions.The following definitions shall be amended to read as follows:In the definition of “Award” the words “ an SAR” shall be deleted.In the definition of “Exercise Price” the second sentence shall be deleted.In the definition of “Option” the words “ISO or NSO” shall be deleted and replaced with the word “option”.In the definition of “Service” the words “Outside Director or Consultant” shall be deleted.The following definitions shall be deleted:“Consultant”; “ISO”; “NSO”; “Outside Director”; “SAR”; and “SAR Agreement”.The following definitions shall be inserted and will read as follows:“Award Tax Liability” means any liability or obligation of the Company and/or any related company or Subsidiary to account for income tax (underPay As You Earn) or any other taxation provisions and primary class 1 National Insurance Contributions in the United Kingdom to the extent arisingfrom the grant, exercise, assignment, release, cancellation or any other disposal of an Award or arising out of the acquisition, retention and disposal ofthe Shares acquired under this Plan.“Data” means certain personal information about the Participant, including, but not limited to, name, home address and telephone number, date ofbirth, social insurance number, salary, nationality, job title, any stock, units or directorships held in the Company, details of all options or otherentitlement to shares awarded, cancelled, exercised, vested, unvested, or outstanding in the Participant’s favour.“Data Recipients” means third parties assisting the Company in the implementation, administration, and management of the Plan.“ITEPA” means the Income Tax (Earnings and Pensions) Act 2003.“Joint Election” means an election (in such terms and such form as provided in paragraphs 3A and 3B of Schedule 1 to the Social SecurityContributions and Benefits Act 1992), which has been approved by HM Revenue & Customs for the transfer of the whole or any liability of thesecondary contributor for any Secondary NIC Liability.“Personal Representative” means the personal representative(s) of an Participant (being either the executors of his will or if he dies intestate the dulyappointed administrator(s) of his estate) who have provided to the Board evidence of their appointment as such.“Secondary Contributor” means a person or company who has a liability to account (or pay) the Secondary NIC Liability to HM Revenue andCustoms.“Secondary NIC Liability” means any liability to employer’s Class 1 National Insurance Contributions to the extent arising from the grant, exercise,release or cancellation of an Award or arising out of the acquisition, retention and disposal of the Shares acquired pursuant to an Award.“Section 431 Election” means an election made under section 431 of the Income Tax (Earnings and Pensions) Act 2003.“UK Subsidiary” means a Subsidiary of the Company which is incorporated in the UK.“Unapproved Option” means an option over shares in the Company that is neither an HM Revenue & Customs company share option (underSchedule 4 ITEPA) nor an enterprise management incentive (EMI) option which meets the requirements of Schedule 5 ITEPA.“US Plan” means the Vanda Pharmaceuticals Inc. 2006 Equity Incentive Plan, as amended from time to time.Exhibit 10.34UK SUB-PLAN TO THEVANDA PHARMACEUTICALS INC.2006 EQUITY INCENTIVE PLANNOTICE OF STOCK OPTION GRANTYou have been granted the following option to purchase shares of the Common Stock of Vanda Pharmaceuticals Inc. (the “Company”): Name of Optionee: [Name]Total Number of Shares: [Number of Shares]Type of Option: Unapproved OptionExercise Price Per Share: $[Exercise Price]Date of Grant: [Date]Vesting Commencement Date: [Date]Vesting Schedule: This option may be exercised with respect to 25% of the Shares subject to this option when theOptionee completes one year of continuous Service after the Vesting Commencement Date andwith respect to 2.08334% of the Shares subject to this option when the Optionee completeseach month of continuous Service thereafter.Expiration Date: [Date]. This option expires earlier if your Service terminates earlier, as described in the StockOption Agreement.You and the Company agree that this option is granted under and governed by the terms and conditions of the UK Sub-Plan to the Vanda PharmaceuticalsInc. 2006 Equity Incentive Plan (the “Plan”) and of the Stock Option Agreement, which is attached to and made a part of this document.You further agree that the Company may deliver by email all documents relating to the Plan or this option (including, without limitation, prospectusesrequired by the Securities and Exchange Commission) and all other documents that the Company is required to deliver to its security holders (including,without limitation, annual reports and proxy statements). You also agree that the Company may deliver these documents by posting them on a web sitemaintained by the Company or by a third party under contract with the Company. If the Company posts these documents on a web site, it will notify you byemail. OPTIONEE: VANDA PHARMACEUTICALS INC. By: [Name] Title UK SUB-PLAN TO THEVANDA PHARMACEUTICALS INC.2006 EQUITY INCENTIVE PLANSTOCK OPTION AGREEMENT Tax Treatment This option is intended to be an Unapproved Option, as provided in the Notice of Stock Option Grant.Vesting This option becomes exercisable in installments, as shown in the Notice of Stock Option Grant.This option will in no event become exercisable for additional shares after your Service has terminated for any reason.Term This option expires in any event at the close of business at Company headquarters on the day before the 10thanniversary of the Date of Grant, as shown in the Notice of Stock Option Grant. (It will expire earlier if your Serviceterminates, as described below.)RegularTermination If your Service terminates for any reason except death or total and permanent disability, then this option will expire atthe close of business at Company headquarters on the date three months after your termination date. The Companydetermines when your Service terminates for this purpose.Death If you die before your Service terminates, then this option will expire at the close of business at Company headquarterson the date 12 months after the date of death.Disability If your Service terminates because of your total and permanent disability, then this option will expire at the close ofbusiness at Company headquarters on the date 12 months after your termination date. For all purposes under this Agreement, “total and permanent disability” means that you are unable to engage in anysubstantial gainful activity by reason of any medically determinable physical or mental impairment which can beexpected to result in death or which has lasted, or can be expected to last, for a continuous period of not less than oneyear. 2Leaves of Absenceand Part-TimeWork For purposes of this option, your Service does not terminate when you go on a military leave, a sick leave or anotherbona fide leave of absence, if the leave was approved by the Company in writing and if continued crediting of Serviceis required by the terms of the leave or by applicable law. But your Service terminates when the approved leave ends,unless you immediately return to active work. If you go on a leave of absence, then the vesting schedule specified in the Notice of Stock Option Grant may beadjusted in accordance with the Company’s leave of absence policy or the terms of your leave. If you commenceworking on a part-time basis, then the vesting schedule specified in the Notice of Stock Option Grant may be adjustedin accordance with the Company’s part-time work policy or the terms of an agreement between you and the Companypertaining to your part-time schedule.Restrictions onExercise The Company will not permit you to exercise this option if the issuance of shares at that time would violate any law orregulation.Notice of Exercise In the event of your death, this option may be exercised by your Personal Representative only. When you wish to exercise this option, you must notify the Company by filing the proper “Notice of Exercise” form atthe address given on the form. Your notice must specify how many shares you wish to purchase. Your notice must alsospecify how your shares should be registered. The notice will be effective when the Company receives it, together withthe signed Section 431 Election and the signed Joint Election.Form of Payment When you submit your notice of exercise, together with the signed Section 431 Election and the signed Joint Election,you must include payment of the option exercise price for the shares that you are purchasing (together with any AwardTax Liability and Secondary NIC Liability). To the extent permitted by applicable law, payment may be made in one(or a combination of two or more) of the following forms: • Your personal cheque, a cashier’s cheque or a money order. • Irrevocable directions to a securities broker approved by the Company to sell all or part of your option shares andto deliver to the Company from the sale proceeds an amount sufficient to pay the option exercise price and anyAward Tax Liability and Secondary NIC Liability. (The balance of the sale proceeds, if any, will be delivered toyou.) The directions must be given by signing a special “Notice of Exercise” form provided by the Company. 3WithholdingTaxes and StockWithholding In the event that the Company determines that it or any Subsidiary is required to account to HM Revenue & Customsfor the Award Tax Liability and any Secondary NIC Liability or to withhold any other tax as a result of the exercise ofthis option you, as a condition to the exercise of this option, shall make arrangements satisfactory to the Company toenable it or any Subsidiary to satisfy all withholding liabilities. You shall also make arrangements satisfactory to theCompany to enable it to satisfy any withholding requirements that may arise in connection with the vesting ordisposition of Shares purchased by exercising this option.Tax Consultation. You understand that you may suffer adverse tax consequences as a result of your purchase or disposition of the Shares.You represent that you will consult with any tax advisors you deem appropriate in connection with the purchase ordisposition of the Shares and that you are not relying on the Company or any Affiliate for any tax advice.Section 431Election As a further condition of the exercise of this option, you shall have signed a Section 431 Election in the form set out inAppendix A or in such other form as may be determined by HM Revenue & Customs from time to time.Employer’sNationalInsurance Charges As a further condition of the exercise of this option you shall join with the Company or any other company or personwho is or becomes a Secondary Contributor in making a Joint Election which has been approved by HM Revenue &Customs, for the transfer of the whole of any Secondary NIC Liability.Your Tax Indemnity. • To the extent permitted by law, you hereby agree to indemnify and keep indemnified the Company, and theCompany as trustee for and on behalf of any related corporation, for any Award Tax Liability and Secondary NICLiability. • The Company shall not be obliged to allot and issue any Shares or any interest in Shares pursuant to the exercise ofthis option unless and until you have paid to the Company such sum as is, in the opinion of the Company,sufficient to indemnify the Company in full against the Award Tax Liability and the Secondary NIC Liability, oryou have made such other arrangement as in the opinion of the Company will ensure that the full amount of anyAward Tax Liability and any Secondary NIC Liability will be recovered from you within such period as theCompany may then determine. • In the absence of any such other arrangement being made, the Company shall have the right to retain out of theaggregate number of shares to which you would have otherwise been entitled upon the exercise of this option,such number of Shares as, in the opinion of the Company, will enable the Company to sell as agent for you (at thebest price which can reasonably expect to be obtained at the time of the sale) and to pay over to the Companysufficient monies out of the net proceeds of sale, after deduction of all fees, commissions and expenses incurred inrelation to such sale, to satisfy your liability under such indemnity. 4Data Protection By entering into this Stock Option Agreement, and as a condition of the grant of this option, you consent to thecollection, use, and transfer of personal data as described in this paragraph to the full extent permitted by and in fullcompliance with applicable laws. You understand that the Company and its Subsidiaries hold Data about you for the purpose of managing andadministering the Plan. You further understand that the Company and/or its Subsidiaries will transfer Data among themselves as necessary forthe purposes of implementation, administration, and management of your participation in the Plan, and that theCompany and/or its Subsidiary may each further transfer Data to any Data Recipients. You understand that these Data Recipients may be located in your country of residence or elsewhere, such as the UnitedStates. You authorise the Data Recipients to receive, possess, use, retain, and transfer Data in electronic or other form,for the purposes of implementing, administering, and managing your participation in the Plan, including any transfer ofsuch Data, as may be required for the administration of the Plan and/or the subsequent holding of Shares on your behalf,to a broker or third party with whom the Shares acquired on exercise may be deposited. Where the transfer is to be to adestination outside the European Economic Area, the Company shall take reasonable steps to ensure that your personaldata continues to be adequately protected and securely held. You understand that you may, at any time, review the Data, request that any necessary amendments be made to it, orwithdraw your consent herein in writing by contacting the Company. You further understand that withdrawing consentmay affect your ability to participate in the Plan. Restrictions onResale You agree not to sell any option shares at a time when applicable laws, Company policies or an agreement between theCompany and its underwriters prohibit a sale. This restriction will apply as long as your Service continues and for suchperiod of time after the termination of your Service as the Company may specify.Transfer ofOption Prior to your death, only you may exercise this option. You cannot transfer or assign this option. For instance, you maynot sell this option or use it as security for a loan. If you attempt to do any of these things, this option will immediatelybecome invalid. 5Retention Rights Your option or this Agreement does not give you the right to be retained by the Company or a subsidiary of theCompany in any capacity. The Company and its subsidiaries reserve the right to terminate your Service at any time.StockholderRights You or your Personal Representative have no rights as a stockholder of the Company until you have exercised thisoption by giving the required notice to the Company and paying the exercise price. No adjustments are made fordividends or other rights if the applicable record date occurs before you exercise this option, except as described in thePlan.Adjustments In the event of a stock split, a stock dividend or a similar change in Company stock, the number of shares covered bythis option and the exercise price per share will be adjusted pursuant to the Plan.Additional Terms You have no right to compensation or damages for any loss in respect of this option where such loss arises (or isclaimed to arise), in whole or in part, from the termination of your employment; or notice to terminate employmentgiven by or to you. This exclusion of liability shall apply however termination of employment, or the giving of notice,is caused other than in a case where a competent tribunal or court, from which there can be no appeal (or which therelevant employing company has decided not to appeal), has found that the cessation of your employment amounted tounfair or constructive dismissal of you and however compensation or damages may be claimed. You have no right to compensation or damages for any loss in respect of this option where such loss arises (or isclaimed to arise), in whole or in part, from any company ceasing to be a Subsidiary of the Company; or the transfer ofany business from a Subsidiary of the Company to any person which is not a Subsidiary of the Company. Thisexclusion of liability shall apply however the change of status of the relevant company, or the transfer of the relevantbusiness, is caused, and however compensation or damages may be claimed.Applicable Law This Agreement will be interpreted and enforced under the laws of the State of Delaware (without regard to their choice-of-law provisions). The Section 431 Election and Joint Election shall be governed by the laws of England and Wales. 6The Plan andOther Agreements The text of the Plan, the Section 431 Election and Joint Election are incorporated in this Agreement by reference. This Agreement, the Section 431 Election, the Joint Election and the Plan constitute the entire understanding betweenyou and the Company regarding this option. Any prior agreements, commitments or negotiations concerning thisoption are superseded. This Agreement may be amended only by another written agreement between the parties.BY SIGNING THE COVER SHEET OF THIS AGREEMENT, YOU AGREETO ALL OF THE TERMS AND CONDITIONS DESCRIBED ABOVE AND IN THE PLAN. 7Appendix ASECTION 431 ELECTION 8Exhibit 10.35UK SUB-PLAN TO THEVANDA PHARMACEUTICALS INC.2006 EQUITY INCENTIVE PLAN:NOTICE OF RESTRICTED STOCK UNIT AWARDSpecific UK Securities laws advice must be taken where Restricted Stock is acquired by Participants otherwise than on exercise of an OptionYou have been granted units representing shares of Common Stock of Vanda Pharmaceuticals Inc. (the “Company”) on the following terms: Name of Recipient: [Name]Total Number of Units Granted: [Number of Shares]Date of Grant: [Date]Vesting Schedule: 25% of the units subject to this award will vest on eachof January 1, [Year 1], January 1, [Year 2], January 1,[Year 3] and January 1, [Year 4].You and the Company agree that these units are granted under and governed by the terms and conditions of the UK Sub-Plan to the Vanda PharmaceuticalsInc. 2006 Equity Incentive Plan (the “Plan”) and the Restricted Stock Unit Award Agreement, both of which are attached to and made a part of this document.You further agree that the Company may deliver by email all documents relating to the Plan or this award (including, without limitation, prospectusesrequired by the Securities and Exchange Commission) and all other documents that the Company is required to deliver to its security holders (including,without limitation, annual reports and proxy statements). You also agree that the Company may deliver these documents by posting them on a websitemaintained by the Company or by a third party under contract with the Company. If the Company posts these documents on a website, it will notify you byemail. RECIPIENT: VANDA PHARMACEUTICALS INC. By: Title UK SUB-PLAN TO THEVANDA PHARMACEUTICALS INC.2006 EQUITY INCENTIVE PLAN:RESTRICTED STOCK UNIT AWARD AGREEMENT Payment for Units No payment is required for the units that you are receiving.Vesting The units vest in installments, as shown in the Notice of Stock Unit Award. No additional units vest after your Servicehas terminated for any reason.Forfeiture If your Service terminates for any reason, then your units will be forfeited to the extent that they have not vestedbefore the termination date. This means that any units that have not vested under this Agreement will be cancelledimmediately. You receive no payment for units that are forfeited. The Company determines when your Service terminates for this purpose.Settlement of Units Each unit will be settled on the first Permissible Trading Day that occurs on or after the day when the unit vests.However, each unit must be settled not later than the March 15 of the calendar year after the calendar year in whichthe unit vests. At the time of settlement, you will receive one share of the Company’s Common Stock for each vested unit.“Permissible TradingDay” “Permissible Trading Day” means a day that satisfies each of the following requirements: • The Nasdaq Global Market is open for trading on that day, • You are permitted to sell shares of the Company’s Common Stock on that day without incurring liability underSection 16(b) of the Securities Exchange Act of 1934, as amended, • Either (a) you are not in possession of material non-public information that would make it illegal for you to sellshares of the Company’s Common Stock on that day under Rule 10b-5 of the Securities and ExchangeCommission or (b) Rule 10b5 1 of the Securities and Exchange Commission is applicable, • Under the Company’s Policy Memorandum Concerning Securities Trading, you are permitted to sell shares of theCompany’s Common Stock on that day, and • You are not prohibited from selling shares of the Company’s Common Stock on that day by a written agreementbetween you and the Company or a third party. 2Section 409A This paragraph applies only if the Company determines that you are a “specified employee,” as defined in theregulations under Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”), at the time of your“separation from service,” as defined in those regulations. If this paragraph applies, then any units that otherwisewould have been settled during the first six months following your separation from service will instead be settledduring the seventh month following your separation from service, unless the settlement of those units is exempt fromSection 409A of the Code.Nature of Units Your units are mere bookkeeping entries. They represent only the Company’s unfunded and unsecured promise toissue shares of Common Stock on a future date. As a holder of units, you have no rights other than the rights of ageneral creditor of the Company.No Voting Rights orDividends Your units carry neither voting rights nor rights to cash dividends. You have no rights as a stockholder of theCompany unless and until your units are settled by issuing shares of the Company’s Common Stock.Units Nontransferable You may not sell, transfer, assign, pledge or otherwise dispose of any units. For instance, you may not use your unitsas security for a loan.Withholding Taxes In the event that the Company determines that it or any Subsidiary is required to account to HM Revenue & Customsfor the Award Tax Liability and any Secondary NIC Liability or to withhold any other tax as a result of the settlementof this Award you, as a condition to the settlement of this Award, shall make arrangements satisfactory to theCompany to enable it or any Subsidiary to satisfy all withholding liabilities. You shall also make arrangementssatisfactory to the Company to enable it to satisfy any withholding requirements that may arise in connection with thevesting or disposition of Shares purchased by settling this Award.Tax Consultation You understand that you may suffer adverse tax consequences as a result of your purchase or disposition of the Shares.You represent that you will consult with any tax advisors you deem appropriate in connection with the purchase ordisposition of the Shares and that you are not relying on the Company or any Affiliate for any tax advice. 3Section 431 Election As a further condition of the settlement of this Award, you shall have signed a Section 431 Election in the form set outin Appendix A or in such other form as may be determined by HM Revenue & Customs from time to time.Employer’s National InsuranceCharges As a further condition of the settlement of this Award you shall join with the Company or any other company orperson who is or becomes a Secondary Contributor in making a Joint Election which has been approved by HMRevenue & Customs, for the transfer of the whole of any Secondary NIC Liability.Your Tax Indemnity • To the extent permitted by law, you hereby agree to indemnify and keep indemnified the Company, and theCompany as trustee for and on behalf of any related corporation, for any Award Tax Liability and Secondary NICLiability. • The Company shall not be obliged to allot and issue any Shares or any interest in Shares pursuant to thesettlement of this Award unless and until you have paid to the Company such sum as is, in the opinion of theCompany, sufficient to indemnify the Company in full against the Award Tax Liability and the Secondary NICLiability, or you have made such other arrangement as in the opinion of the Company will ensure that the fullamount of any Award Tax Liability and any Secondary NIC Liability will be recovered from you within suchperiod as the Company may then determine. • In the absence of any such other arrangement being made, the Company shall have the right to retain out of theaggregate number of shares to which you would have otherwise been entitled upon the settlement of this Award,such number of Shares as, in the opinion of the Company, will enable the Company to sell as agent for you (atthe best price which can reasonably expect to be obtained at the time of the sale) and to pay over to the Companysufficient monies out of the net proceeds of sale, after deduction of all fees, commissions and expenses incurredin relation to such sale, to satisfy your liability under such indemnity. 4Data Protection By entering into this Stock Option Agreement, and as a condition of the grant of this Award, you consent to thecollection, use, and transfer of personal data as described in this paragraph to the full extent permitted by and in fullcompliance with applicable laws. You understand that the Company and its Subsidiaries hold Data about you for the purpose of managing andadministering the Plan. You further understand that the Company and/or its Subsidiaries will transfer Data among themselves as necessary forthe purposes of implementation, administration, and management of your participation in the Plan, and that theCompany and/or its Subsidiary may each further transfer Data to any Data Recipients. You understand that these Data Recipients may be located in your country of residence or elsewhere, such as theUnited States. You authorise the Data Recipients to receive, possess, use, retain, and transfer Data in electronic orother form, for the purposes of implementing, administering, and managing your participation in the Plan, includingany transfer of such Data, as may be required for the administration of the Plan and/or the subsequent holding ofShares on your behalf, to a broker or third party with whom the Shares acquired on exercise may be deposited. Wherethe transfer is to be to a destination outside the European Economic Area, the Company shall take reasonable steps toensure that your personal data continues to be adequately protected and securely held. You understand that you may, at any time, review the Data, request that any necessary amendments be made to it, orwithdraw your consent herein in writing by contacting the Company. You further understand that withdrawingconsent may affect your ability to participate in the Plan.Restrictions on Resale You agree not to sell any shares at a time when applicable laws, Company policies or an agreement between theCompany and its underwriters prohibit a sale. This restriction will apply as long as your Service continues and forsuch period of time after the termination of your Service as the Company may specify.Employment Your award or this Agreement does not give you the right to be retained by the Company or a subsidiary of theCompany in any capacity. The Company and its subsidiaries reserve the right to terminate your Service at any time.Adjustments In the event of a stock split, a stock dividend or a similar change in Company stock, the number of your units will beadjusted accordingly, as the Company may determine pursuant to the Plan. 5Personal Representative Your Personal Representative will receive any vested units that you hold at the time of your death.Effect of Merger If the Company is a party to a merger, consolidation or reorganization, then your units will be subject to theapplicable provision of the Plan, provided that any action taken must either (a) preserve the exemption of your unitsfrom Section 409A of the Code or (b) comply with Section 409A of the Code.Additional Terms You have no right to compensation or damages for any loss in respect of this Award where such loss arises (or isclaimed to arise), in whole or in part, from the termination of your employment; or notice to terminate employmentgiven by or to you. This exclusion of liability shall apply however termination of employment, or the giving ofnotice, is caused other than in a case where a competent tribunal or court, from which there can be no appeal (or whichthe relevant employing company has decided not to appeal), has found that the cessation of your employmentamounted to unfair or constructive dismissal of you and however compensation or damages may be claimed. You have no right to compensation or damages for any loss in respect of this Award where such loss arises (or isclaimed to arise), in whole or in part, from any company ceasing to be a Subsidiary of the Company; or the transfer ofany business from a Subsidiary of the Company to any person which is not a Subsidiary of the Company. Thisexclusion of liability shall apply however the change of status of the relevant company, or the transfer of the relevantbusiness, is caused, and however compensation or damages may be claimed.Applicable Law This Agreement will be interpreted and enforced under the laws of the State of Delaware (without regard to theirchoice-of-law provisions). The Section 431 Election and the Joint Election shall be governed by the laws of Englandand Wales.The Plan and OtherAgreements The text of the Plan, the Section 431 Election and the Joint Election are incorporated in this Agreement by reference. The Plan, this Agreement, the Notice of Restricted Stock Unit Award, the Section 431 Election and the Joint Electionconstitute the entire understanding between you and the Company regarding this award. Any prior agreements,commitments or negotiations concerning this award are superseded. This Agreement may be amended only by anotherwritten agreement between the parties. 6BY SIGNING THE COVER SHEET OF THIS AGREEMENT, YOU AGREE TO ALL OF THETERMS AND CONDITIONS DESCRIBED ABOVE AND IN THE PLAN. 7APPENDIX ASECTION 431 ELECTION 8EXHIBIT 21.1Vanda Pharmaceuticals Inc.List of Subsidiaries Name of Wholly-Owned Subsidiary Jurisdiction of Organization Name underwhich the subsidiary conducts businessVanda Pharmaceuticals Limited United Kingdom Vanda Pharmaceuticals LimitedVanda Pharmaceuticals LLC Switzerland Vanda Pharmaceuticals GmbHExhibit 23.1CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRMWe hereby consent to the incorporation by reference in the Registration Statements on Forms 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, No. 333-193614, No. 333-201754, and No. 333-209144) and on Forms S-3 (No. 333-191434 and No. 333-205513) of Vanda Pharmaceuticals Inc. of our report dated February 12, 2016 relating to thefinancial statements and the effectiveness of internal control over financial reporting, which appears in this Form 10-K./s/ PricewaterhouseCoopers LLPBaltimore, MarylandFebruary 12, 2016EXHIBIT 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 thisreport; 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 forexternal purposes 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 12, 2016 /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 thisreport; 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 forexternal purposes 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 12, 2016 /s/ James P. Kelly James P. KellySenior Vice President, Chief Financial Officer and Treasurer(Principal Financial Officer and Principal Accounting 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, 2015 (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 12, 2016 /s/ Mihael H. Polymeropoulos, M.D. Mihael H. Polymeropoulos, M.D.President and Chief Executive Officer(Principal Executive Officer)February 12, 2016 /s/ James P. Kelly James P. KellySenior Vice President, Chief Financial Officer and Treasurer(Principal Financial Officer and Principal Accounting 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 and furnishedto the Securities and Exchange Commission (SEC) or its staff upon request. This certification “accompanies” the Form 10-K to which it relates, is notdeemed filed with the SEC and is not to be incorporated by reference into any filing of the Company under the Securities Act of 1933, as amended, or theSecurities Exchange Act of 1934, as amended (whether made before or after the date of the Form 10-K), irrespective of any general incorporation languagecontained in such filing.

Continue reading text version or see original annual report in PDF format above