Zogenix
Annual Report 2012

Plain-text annual report

Table of Contents UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, DC 20549____________________________________ Form 10-K ____________________________________(Mark One)xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the fiscal year ended December 31, 2012or¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the transition period from to ____________________________________ Commission file number: 001-34962Zogenix, Inc.(Exact Name of Registrant as Specified in its Charter)Delaware 20-5300780(State or Other Jurisdiction ofIncorporation or Organization) (I.R.S. EmployerIdentification No.) 12400 High Bluff Drive, Suite 650San Diego, California 92130(Address of Principal Executive Offices) (Zip Code)858-259-1165(Registrant’s Telephone Number, Including Area Code)Securities registered pursuant to Section 12(b) of the Act:Title of Each Class Name of Each Exchange on Which RegisteredCommon Stock, par value $0.001 per share The NASDAQ Global MarketSecurities registered pursuant to Section 12(g) of the 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 xIndicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ¨ No xIndicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90days. Yes x No ¨Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submittedand posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required tosubmit and post such files). x Yes ¨ NoIndicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of theregistrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “largeaccelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):Large accelerated filer ¨ Accelerated filer x Non-accelerated filer o 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 xAs of June 30, 2012, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant was approximately $90,904,936, based on theclosing price of the registrant’s common stock on the Nasdaq Global Market of $2.48 per share.The number of outstanding shares of the registrant’s common stock, par value $0.001 per share, as of March 1, 2013 was 100,808,601.DOCUMENTS INCORPORATED BY REFERENCEPortions of the registrant’s definitive proxy statement to be filed with the Securities and Exchange Commission pursuant to Regulation 14A in connection with theregistrant’s 2013 Annual Meeting of Stockholders, which will be filed subsequent to the date hereof, are incorporated by reference into Part III of this Form 10-K. Such proxystatement will be filed with the Securities and Exchange Commission not later than 120 days following the end of the registrant’s fiscal year ended December 31, 2012. Table of ContentsZOGENIX, INC.FORM 10-K — ANNUAL REPORTFor the Fiscal Year Ended December 31, 2012Table of Contents PagePART I Item 1Business3Item 1ARisk Factors72Item 1BUnresolved Staff Comments77Item 2Properties77Item 3Legal Proceedings77Item 4Mine Safety Disclosures77 PART II Item 5Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities78Item 6Selected Financial Data80Item 7Management’s Discussion and Analysis of Financial Condition and Results of Operations81Item 7AQuantitative and Qualitative Disclosures About Market Risk96Item 8Financial Statements and Supplementary Data96Item 9Changes in and Disagreements With Accountants on Accounting and Financial Disclosure96Item 9AControls and Procedures96Item 9BOther Information98 PART III Item 10Directors, Executive Officers and Corporate Governance99Item 11Executive Compensation99Item 12Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters99Item 13Certain Relationships, Related Transactions and Director Independence99Item 14Principal Accounting Fees and Services99 PART IV Item 15Exhibits, Financial Statement Schedules100 Signatures iTable of ContentsPART IForward-Looking Statements and Market DataThis Annual Report on Form 10-K and the information incorporated herein by reference contain forward-looking statements that involve substantialrisks and uncertainties. These forward looking statements include, but are not limited to, statements about:•our ability to maintain and increase market demand for, and sales of, Sumavel DosePro;•our ability to successfully execute our sales and marketing strategy for the commercialization of Sumavel DosePro;•the progress and timing of clinical trials for our product candidates;•the potential for the FDA to approve the NDA for Zohydro ER despite the advisory committee's recommendation against approval;•the timing of submissions to, and decisions made by, the FDA and other regulatory agencies, including foreign regulatory agencies, and demonstrating thesafety and efficacy of Zohydro ER or any other product candidates to the satisfaction of the FDA and such other agencies;•adverse side effects or inadequate therapeutic efficacy of Sumavel DosePro that could result in product recalls, market withdrawals or product liabilityclaims;•the safety and efficacy of Zohydro ER and our other product candidate;•the market potential for migraine treatments, and our ability to compete within that market;•the goals of our development activities and estimates of the potential markets for our product candidates, and our ability to compete within those markets;•estimates of the capacity of manufacturing and other facilities to support our product and product candidates;•our ability to ensure adequate and continued supply of Sumavel DosePro to successfully meet anticipated market demand;•our and our licensors ability to obtain, maintain and successfully enforce adequate patent and other intellectual property protection of our products andproduct candidates and the ability to operate our business without infringing the intellectual property rights of others;•our ability to obtain and maintain adequate levels of coverage and reimbursement from third-party payors for Sumavel DosePro or any of our otherproduct candidates that may be approved for sale, the extent of such coverage and reimbursement and the willingness of third-party payors to pay for ourproducts versus less expensive therapies;•the impact of healthcare reform legislation; and•projected cash needs and our expected future revenues, operations and expenditures.The forward-looking statements are contained principally in the sections entitled “Risk Factors,” “Management’s Discussion and Analysis of FinancialCondition and Results of Operations” and “Business.” In some cases, you can identify forward-looking statements by the following words: “may,” “will,”“could,” “would,” “should,” “expect,” “intend,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “project,” “potential,” “continue,” “ongoing” or thenegative of these terms or other comparable terminology, although not all forward-looking statements contain these words. These statements relate to futureevents or our future financial performance or condition and involve known and unknown risks, uncertainties and other factors that could cause our actualresults, levels of activity, performance or achievement to differ materially from those expressed or implied by these forward-looking statements. We discussmany of these risks, uncertainties and other factors in this Annual Report on Form 10-K in greater detail under the heading “Item 1A — Risk Factors.”Given these risks, uncertainties and other factors, we urge you not to place undue reliance on these forward-looking statements, which speak only as ofthe date of this report. You should read this Annual Report on Form 10-K completely and with the understanding that our actual future results may bematerially different from what we expect. For all forward-looking statements, we claim the protection of the safe harbor for forward-looking statementscontained in the Private Securities Litigation Reform Act of 1995. We undertake no obligation to revise or update publicly any forward-looking statements,whether as a result of new information, future events or otherwise, unless required by law.This Annual Report on Form 10-K also contains estimates, projections and other information concerning our industry, our business, and the marketsfor Sumavel DosePro, Zohydro ER, Relday and other drugs, including data regarding the estimated size of those markets, their projected growth rates, theincidence of certain medical conditions, statements that certain drugs, classes of drugs or dosages are the most widely prescribed in the United States or othermarkets, the perceptions and preferences of patients and physicians regarding certain therapies and other prescription, prescriber and patient data, as well asdata regarding market research, estimates and forecasts prepared by our management. Information that is based on estimates, forecasts, projections, marketresearch or similar methodologies is inherently subject to uncertainties and actual events or circumstances may differ materially from events andcircumstances reflected in this information. Unless otherwise expressly1Table of Contentsstated, we obtained this industry, business, market and other data from reports, research surveys, studies and similar data prepared by market researchfirms and other third parties, industry, medical and general publications, government data and similar sources. In particular, unless otherwise specified, allprescription, prescriber and patient data in this Annual Report on Form 10-K is from Source Healthcare Analytics, Source® Pharmaceutical Audit Suite(PHAST) Institution/Prescription, Source® PHAST Prescription, Source® Prescriber or Source® Dynamic Claims. In some cases, we do not expressly refer tothe sources from which this data is derived. In that regard, when we refer to one or more sources of this type of data in any paragraph, you should assume thatother data of this type appearing in the same paragraph is derived from the same sources, unless otherwise expressly stated or the context otherwise requires.DosePro®, Intraject®, Relday™, Sumavel®, Zogenix™ and Zohydro ER™ are our trademarks All other trademarks, trade names and service marksappearing in this Annual Report on Form 10-K are the property of their respective owners. Use or display by us of other parties’ trademarks, trade dress orproducts is not intended to and does not imply a relationship with, or endorsements or sponsorship of, us by the trademark or trade dress owner.Unless the context requires otherwise, references in this Annual Report on Form 10-K to “Zogenix,” “we,” “us” and “our” refer to Zogenix, Inc.,including, as of June 7, 2010, its consolidated subsidiary.2Table of ContentsItem 1. BusinessOverviewWe are a pharmaceutical company commercializing and developing products for the treatment of central nervous system disorders and pain. Our firstcommercial product, Sumavel® DosePro® (sumatriptan injection) Needle-free Delivery System, was launched in January 2010. Sumavel DosePro offers fast-acting, easy-to-use, needle-free subcutaneous administration of sumatriptan for the acute treatment of migraine and cluster headache in a pre-filled, single-usedelivery system. Sumavel DosePro is the first drug product approved by the U.S. Food and Drug Administration, or FDA, that allows for the needle-free,subcutaneous delivery of medication. We commercialize Sumavel DosePro through our internal sales and marketing organization and in collaboration withMallinckrodt LLC, our co-promotion partner.Our lead product candidate, Zohydro™ ER (hydrocodone bitartrate, formerly ZX002) is a 12-hour extended-release formulation of hydrocodonewithout acetaminophen for the treatment of moderate to severe chronic pain requiring around-the-clock opioid therapy. We completed Phase 3 development ofZohydro ER in 2011, and we submitted the New Drug Application, or NDA, for Zohydro ER to the FDA in May 2012. In July 2012, the FDA accepted ourNDA as being sufficiently complete for a full review and assigned a Prescription Drug User Fee Act, or PDUFA, target action date of March 1, 2013. InDecember 2012, an advisory committee convened by the FDA voted 2-11 (with 1 abstention) against the approval of Zohydro ER. The advisory committeeprovides the FDA with independent expert advice and recommendations; however, the final decision regarding approval is made by the FDA. In February2013, the FDA informed us that we were unlikely to receive an action letter for our NDA for Zohydro ER by the PDUFA target action date of March 1, 2013.The FDA has not provided us with information as to the reason for the delay, but has indicated that the delay would likely be brief and may last only severalweeks. We have not been informed of any deficiencies in the NDA for Zohydro ER during the review process to date.Sumavel DosePro and Zohydro ER, if approved, each has the potential to address significant unmet medical needs and become important and widely-used additions to the treatment options available to patients and physicians in the United States’ multi-billion dollar migraine and chronic pain markets,respectively.Sumavel DosePro serves as a treatment alternative to oral and nasal triptans, and may offer simple, convenient administration when compared totraditional, needle-based sumatriptan injection. According to its Prescribing Information, Sumavel DosePro can provide onset of migraine pain relief in as littleas ten minutes for some patients. As a result, we believe that Sumavel DosePro has the potential to be prescribed by a broad physician audience, especially fordifficult to treat migraine episodes.Migraine is a syndrome that affects over 29.5 million people in the United States, according to the National Headache Foundation, or NHF, website.Triptans are the class of drugs most often prescribed for treating migraines. In the United States in the 12 months ended December 2012, triptans generatedsales of approximately $4.4 billion and sumatriptan, including branded and generic forms, represented the largest market share of the seven approvedtriptans, with sales of approximately $2.6 billion, according to Source Healthcare Analytics (Source® PHAST Institutional Prescription January 2012 -December 2012).We launched the commercial sale of Sumavel DosePro in the United States in January 2010 with our original co-promotion partner, Astellas PharmaUS, Inc., or Astellas. Our collaboration with Astellas terminated on March 31, 2012, at which time we assumed full responsibility for the commercializationof Sumavel DosePro. In August 2012, Mallinckrodt began promoting Sumavel DosePro to a mutually agreed prescriber audience in the United States underour co-promotion agreement, pursuant to which we granted to Mallinckrodt a co-exclusive right (with us) to promote Sumavel DosePro to a mutually agreedprescriber audience in the United States. Mallinckrodt has committed to a minimum number of sales representatives for the initial term of the co-promotionagreement.Sumavel DosePro has demonstrated quarterly growth in total prescriptions since its launch in January 2010. For the twelve months ended December 31,2012, we recognized $35.9 million in net product revenue from sales of Sumavel DosePro, represented by more than 83,000 aggregate dispensed prescriptions(Source® PHAST Prescription, January 2012 — December 2012). Sumavel DosePro continues to add new and repeat prescribers in both the neurology andprimary care settings. The product is also gaining use from a range of patient segments, including new triptan users, patients being converted to the productfrom other migraine drugs and patients who have been prescribed Sumavel DosePro and also have other triptan prescriptions. This experience is consistentwith our belief that many patients will selectively use Sumavel DosePro for their more challenging migraine episodes, while continuing to use oral triptans totreat their less severe migraine episodes. Through our ongoing efforts with the largest commercial health plans, Sumavel DosePro is achieving broad coveragein the United States, with a reimbursement claims approval rate of approximately 82% since launch (Source® Dynamic Claims January 2010 — December2012).3Table of ContentsWe believe our lead product candidate, Zohydro ER, has the potential to be an important therapeutic alternative to existing hydrocodone products,including the branded products Vicodin, Norco, Lorcet, Lortab and their generic equivalents, which contain the analgesic combination ingredientacetaminophen and, if taken in high quantities over time, can lead to serious side effects such as liver toxicity. Zohydro ER utilizes the SODAS® Technology,Alkermes’ proprietary multiparticulate drug delivery system that allows the development of customized extended-release profiles and serves to enhance therelease profile of hydrocodone in Zohydro ER. We believe these release properties have the potential to provide longer lasting and more consistent pain reliefwith fewer daily doses than the commercially available formulations of hydrocodone. As a result of its unique single-entity extended-release profile, we believeZohydro ER has the potential to generate sales from both patients who use immediate-release products on a chronic basis and patients already using extended-release products in the prescription opioid market. We in-licensed exclusive U.S. rights to Zohydro ER from Alkermes in 2007.The Institute of Medicine Report from the Committee on Advancing Pain Research, Care, and Education reported in 2011 that an estimated 116 millionpeople in the United States are burdened with chronic pain, at a national economic cost of $560 to $635 billion annually. Chronic pain can be treated withboth immediate-release and extended-release opioids. We define our target market for Zohydro ER as prescription, non-injectable codeine-based and extended-release morphine-based pain products. This market generated U.S. sales of approximately $14.0 billion for the year ended December 2012, based on averagewholesale price, on approximately 216 million prescriptions. During the same period, existing hydrocodone products, the most commonly prescribedpharmaceutical products in the United States, generated $3.5 billion in sales on approximately 131 million prescriptions. (Source® PHAST PrescriptionJanuary 2012 - December 2012).We are also developing Relday™, a proprietary, long-acting injectable formulation of risperidone using Durect's SABER™ controlled-releaseformulation technology through a development and license agreement with Durect Corporation. Risperidone is used to treat the symptoms of schizophreniaand bipolar disorder in adults and teenagers 13 years of age and older. If successfully developed and approved, we believe Relday may be the firstsubcutaneous antipsychotic product that allows for once-monthly dosing. The existing long-acting injectable risperidone product achieved global net sales of$1.43 billion in 2012 with 69% of net sales outside of the United States, according to industry reports, and requires twice-monthly, 2 mL intramuscularinjections with a 21 gauge or larger needle. We believe Durect's SABER controlled-release technology will allow Relday to be delivered subcutaneously on aonce-monthly basis with a simplified dosing regimen, improved pharmacokinetic profile and significant reduction in injection volume versus currentlymarketed long-acting injectable antipsychotics. Based upon these characteristics, Relday may provide an important alternative to currently marketed long-acting injectable antipsychotics as well as a new long-acting treatment option for patients that currently use daily oral antipsychotic products. In May 2012, wefiled an investigational new drug, or IND, application with the FDA. In July 2012, we initiated our first IND clinical trial for Relday. This Phase 1 clinicaltrial was a single-center, open-label, safety and pharmacokinetic trial of 30 patients with chronic, stable schizophrenia or schizoaffective disorder. Weannounced positive single-dose pharmacokinetic results from the Phase 1 clinical trial in January 2013. Adverse events in the Phase 1 trial in patientsdiagnosed with schizophrenia were generally mild to moderate and consistent with other risperidone products. Based on the favorable safety andpharmacokinetic profile demonstrated with the 25 mg and 50 mg once-monthly doses tested in the Phase 1 trial, we extended the study to include an additionalcohort of 10 patients at a 100 mg dose of the same formulation. The addition of this 100 mg dose to the study will enable evaluation of dose proportionalityacross the full dose range that would be anticipated to be used in clinical practice. Positive results from this study extension would better position us to begin amulti-dose clinical trial, which would provide the required steady-state pharmacokinetic and safety data prior to initiating Phase 3 development studies. Weexpect to complete the extension of the Phase 1 clinical trial during the second quarter of 2013. The development of Relday will first focus on its delivery byconventional needle and syringe in order to allow the administration of different volumes of the same formulation of Relday by a healthcare professional. Weanticipate that the introduction of our DosePro needle-free technology for administration of Relday can occur later in development or as part of life cyclemanagement after further work involving formulation development, technology enhancements and applicable regulatory approvals.Our DosePro technology is a novel, patent-protected, needle-free drug delivery system designed for self-administration of a pre-filled, single dose ofliquid drug. We believe the FDA’s approval of Sumavel DosePro represents an important validation of the technology. Results from our pre-clinical and clinicalstudies demonstrate that DosePro can be used successfully with small molecules and biological products, including protein therapeutics and monoclonalantibodies. We are building our internal product pipeline by investigating proven drugs that can be paired with DosePro to enhance their benefits andcommercial attractiveness. We are also evaluating the market potential, formulation requirements and clinical development pathway of an additional centralnervous system, or CNS, compound that could be paired with DosePro to enhance its commercial attractiveness. We are also seeking to capitalize on ourDosePro technology by out-licensing it to potential partners enabling them to enhance, differentiate or extend the life cycle of their proprietary injectableproducts. We acquired the DosePro technology and related intellectual property from Aradigm Corporation in August 2006.Our Strategy4Table of ContentsOur core strategy is to commercialize and develop differentiated CNS and pain therapeutics that can address significant unmet medical needs andovercome limitations of existing products. Key elements of our strategy include:•Increasing sales and continuing to drive patient and physician adoption of Sumavel DosePro in the United States. Total U.S. net product revenuefrom sales of Sumavel DosePro from launch through December 31, 2012 was $84.5 million. We continue to leverage our established commercialinfrastructure and our investment in sales and marketing programs to help increase awareness and adoption of, and access to, Sumavel DosePro withprescribers, patients, third-party payors, pharmacists and employers. Our co-promotion collaboration with Astellas terminated in March 2012, andbeginning in the second quarter of 2012, we assumed full responsibility for the continued commercialization of Sumavel DosePro, with a focus onheadache specialists, neurologists and primary care physicians in the United States. In June 2012, we entered into the co-promotion agreement withMallinckrodt to complement the efforts of our internal sales force, with Mallinckrodt beginning promotion efforts in August 2012.•Developing and commercializing Zohydro ER for the treatment of moderate to severe chronic pain. If approved, Zohydro ER could be the firsthydrocodone product to offer the benefit of less frequent dosing and the ability to treat chronic pain patients without the risk of liver injury associatedwith the use of acetaminophen in high dosages or over long periods of time. We completed our Phase 3 clinical program for Zohydro ER in 2011, whichwas focused on establishing safety and efficacy of extended-release single-entity hydrocodone to treat moderate to severe chronic pain in patients requiringaround-the-clock opioid therapy. We reported results from our pivotal Phase 3 efficacy trial in August 2011 and submitted the NDA for Zohydro ER to theFDA in May 2012. In July 2012, the FDA accepted our NDA as being sufficiently complete for a full review and assigned a PDUFA target action date ofMarch 1, 2013. While there is a delay in the FDA providing an action letter for our NDA, the FDA indicated that the delay would likely be brief and maylast only several weeks after the PDUFA target action date of March 1, 2013. If we receive FDA approval, we intend to explore commercial strategiesincluding co-promotion and other partnering opportunities for Zohydro ER, and a staged expansion of our sales force to support broader reach to painspecialists for both Zohydro ER and Sumavel DosePro, and neurologists for Sumavel DosePro.•Developing Relday for the treatment of schizophrenia and bipolar disorder in adults and teenagers 13 years of age and older. We filed an INDapplication for Relday with the FDA in May 2012. In January 2012, we announced positive single-dose pharmacokinetic results from a Phase 1 clinicaltrial. Based on the favorable safety and pharmacokinetic profile demonstrated with the 25 mg and 50 mg once-monthly doses tested in the Phase 1 trial,we extended the study to include an additional cohort of 10 patients at a 100 mg dose of the same formulation. The addition of this 100 mg dose to thestudy will enable evaluation of dose proportionality across the full dose range that would be anticipated to be used in clinical practice. We expect tocomplete the extension of the Phase 1 clinical trial during the second quarter of 2013. Our development of Relday will first focus on its delivery byconventional needle and syringe in order to allow the administration of different volumes of the same formulation of Relday by a healthcare professional.We anticipate that the introduction of our DosePro needle-free technology for administration of Relday can occur later in development or as part of life cyclemanagement after further work involving formulation development, technology enhancements, and applicable regulatory approvals.•Expanding our product pipeline in CNS disorders and/or pain. We are utilizing our proprietary DosePro technology to add to our internal productpipeline. We are evaluating the market potential, formulation requirements and clinical development pathway of an additional CNS compound that couldbe paired with DosePro to enhance its commercial attractiveness.•Out-licensing our proprietary DosePro technology. We are seeking and evaluating opportunities to capitalize on our DosePro needle-free drug deliverytechnology by out-licensing it to potential partners enabling them to enhance, differentiate or extend the life-cycle of their injectable products. In March2012, we entered into a co-marketing and option agreement with Battelle Memorial Institute, or Battelle, pursuant to which we granted to Battelle theexclusive right to co-market our DosePro drug delivery technology to a specified list of Battelle's pharmaceutical clients.•Securing rights to complementary products and product candidates that address CNS disorders and/or pain. To strategically leverage ourcommercial resources and generate additional revenue, we are seeking third-party co-promotion opportunities. In the future, we will also consider in-licensing or acquisition opportunities with a focus on product candidates that utilize novel technologies to improve the profile of existing compounds forCNS disorders and/or pain.Our Product and Product CandidatesSumavel DosePro for the Acute Treatment of Migraine and Cluster HeadacheWe launched the commercial sale of Sumavel DosePro in the United States in January 2010 with our original co-promotion partner, Astellas. OurSumavel DosePro (sumatriptan injection) Needle-free Delivery System offers fast-acting, easy-to-use subcutaneous administration of sumatriptan for theacute treatment of migraine and cluster headache. Sumavel DosePro utilizes our proprietary DosePro system which enables patients to self-administersubcutaneous sumatriptan in three easy steps. Sumavel DosePro may serve as a treatment alternative to oral and nasal triptans and may offer simple,convenient5Table of Contentsadministration when compared to traditional, needle-based sumatriptan injection. As a result, we believe that Sumavel DosePro has the potential to beprescribed by a broad physician audience, especially for difficult to treat migraine episodes.Migraine MarketMigraine is a chronic neurovascular disorder characterized by episodic attacks. According to the NHF website, more than 29.5 million people in theUnited States suffer from migraines, with women three times more likely to suffer migraines than men. Migraine attacks typically manifest themselves asmoderate to severe headache pain, with symptoms that often include nausea and/or vomiting and abnormal sensitivity to light and sound. Migraines canseverely limit the normal daily functioning of patients, who may seek dark, quiet surroundings until the episode has passed. According to the InternationalHeadache Society, the duration of untreated or unsuccessfully treated migraine episodes ranges from four to 72 hours. According to data published in theMarch 2002 issue of Neurology, 63% of patients suffer one or more attacks per month, 25% of patients have one or more attacks per week and the medianduration of an untreated migraine is approximately 24 hours. Overall, the cost burden of migraine in the United States was estimated by Thomson Medstat inJune 2006 to approach $25 billion annually, including $12.7 billion in direct medical costs and $12 billion in indirect costs related to employee absenteeism,short-term disability and workers’ compensation costs to employers.Cluster headaches are characterized by groups or clusters of debilitating headaches lasting weeks or months, then disappearing for months or years.This type of headache affects an estimated one million sufferers in the United States, and approximately 90% of these sufferers are male, according to theNHF website. Due to the severe nature of cluster headache, patients are commonly treated with prescription medication.Acute therapies dominate the prescription migraine and cluster headache market and are used during intermittent attacks. The goals of acute therapy areto stop the attack quickly and consistently, minimize the use of backup and rescue medications, enhance self-care and restore the patient’s ability to function,use the least amount of medication and limit adverse side effects.A major advancement in the acute treatment of migraine began in 1993 with the launch of the first triptan, sumatriptan injection (Imitrex), in the UnitedStates. All triptans are selective agonists for the 5-HT1B and 5-HT1D receptors. Triptans presumably exert their antimigrainous effect through binding tovascular 5-HT1 receptors, which have been shown to be present on both the human basilar artery, one of the major arteries that supplies blood to the brain,and the outermost membrane covering the brain. Triptans activate these receptors to cause vasoconstriction, an action in humans correlated with the relief ofmigraine and cluster headache. Sumatriptan was subsequently joined by other drugs in the triptan class. By the year 2003, there were seven approved triptansin the United States with a focus on oral delivery forms to offer convenience of dosing for migraine patients. Sumatriptan is the only triptan available in oral,nasal and subcutaneous forms, each of which has different pharmacokinetic properties.Triptans remain the drugs of choice and the most often prescribed therapy for the acute treatment of migraine and cluster headache. The following tableprovides a breakdown of the U.S. triptan market, including sales and doses prescribed for oral (tablets and melts), nasal and injectable forms of triptan forthe 12 months ended December 2012.U.S. Triptan Market(12 months ended December 2012) Triptan FormSales (millions) $ Share Doses (millions) Dose ShareOral Tablet$3,410 78.0% 126.6 85.9%Oral Melt473 10.8 13.7 9.3Nasal120 2.7 2.9 2.0Injectable371 8.5 4.1 2.8Total$4,374 100% 147.3 100% Source ® PHAST Institution/Prescription.As indicated in the prior table, the triptan market is dominated by oral dosage forms (tablets and melts), with approximately 95% of U.S. triptan dosestaken as oral formulations and the remaining 5% split between injectable and nasal formulations. Branded and generic sumatriptan, in all dosage forms,remains the most prescribed triptan molecule with sales of approximately $2.6 billion (59% dollar share of the triptan market). Of that amount, the injectableforms of sumatriptan accounted for $371 million. By comparison, ergotamine agents, another class of drugs used for the acute treatment of migraine,including injectable DHE and Migranal, accounted for $87 million in sales in the United States during the same 12-month6Table of Contentsperiod. (Source® PHAST Institution/Prescription January 2012 - December 2012). Sumatriptan is the only triptan available to patients in the injectable formand, with the exception of Sumavel DosePro, all other forms of injectable sumatriptan make use of needle-based injections for their administration.In five major European countries (France, Germany, Italy, Spain and the United Kingdom), triptans generated total sales of approximately $550 millionfor the 12 months ended June 2007, according to average wholesale price data published by IMS Health MIDAS. Of that $550 million, the Europeanequivalent of Imitrex, Imigran, represented sales of approximately $148 million, of which the injectable form accounted for approximately $35 million.Migraine Market DynamicsThe type of migraine treatment utilized by patients often depends on the frequency and severity of the headache, its speed of onset and previous responseto medication. In published studies, migraine sufferers most often cite faster onset of pain relief as a key therapeutic attribute they would like from theirmigraine medication.Patients with more frequent or severe migraines or those who do not respond to simple analgesics may seek medical attention with a primary carephysician initially and then with a headache clinic or neurology specialist if needed. Once a physician makes a diagnosis of migraine, oral triptans aregenerally prescribed as first-line therapy.If a patient does not respond to one triptan product, the physician may switch to another triptan or dosage form or add another triptan or dosage form toa patient’s treatment armamentarium. Market research conducted on our behalf by Boston Healthcare Associates, Inc. indicates that it is common for amigraine patient to be offered several different oral triptan options before being offered a nasal or injectable product. In addition, the same market researchindicates that approximately 25% of migraine patients had two or more active prescriptions for different brands and/or forms of triptan therapy. We believethese patients maintain multiple prescriptions because they have found that certain medications or dosage forms work better for certain types of migraines andchoose which medication to use based on the type of migraine episode they are experiencing.Clinical research has substantiated that the nature of migraine episodes varies widely. In some episodes, patients can sense a migraine coming and taketheir medication accordingly. In other episodes, patients may wake up with a migraine already in progress or the migraine may come on suddenly. Anestimated 48% of migraines occur between the hours of 4:00 a.m. and 9:00 a.m., according to an article published in the June 1998 issue of Headache.Migraines may also be associated with nausea and/or vomiting. Twenty-nine percent of patients reported vomiting as a symptom of migraine attacks,according to the American Migraine Study II, and epidemiological studies in migraine reveal that over 90% of patients have experienced nausea during amigraine attack and more than 50% have nausea with the majority of attacks, according to an article published in Drugs in 2003 (Volume 63, Issue 21).Depending on the type of migraine episode, a treatment may be more or less effective. For example, oral treatments may be of little value in a patient who isvomiting or who is experiencing migraine-associated gastric stasis. There is also clinical evidence that oral agents may be less effective when taken at a laterstage of a migraine attack, rather than at an earlier stage. Consequently, rapid onset migraine and waking with a migraine attack may reduce the benefits topatients of oral triptans, because both represent fully-developed attacks.The following table compares the time to maximum drug concentration in blood, or Tmax, and pain relief of oral forms, including melts and tablets, andnasal forms of marketed triptans to sumatriptan injection. The data are derived from Prescribing Information for the different formulations of these marketedtriptans and not for head-to-head direct comparison studies:Triptan Prescribing Information Data7Table of ContentsForm/Product (API)Tmax Relief at 1hour (1)(2) Relief at 2hours (2) Subcutaneous Sumavel DosePro (sumatriptan injection)12 minutes 70% 81-82% Nasal Imitrex (sumatriptan)Not provided 38-46% 43-64% Zomig (zolmitriptan)3.0 hrs 60% 69-70% Oral — Melt Zomig-ZMT (zolmitriptan)3.0 hrs 33-43% 63% Maxalt-MLT (rizatriptan)1.6-2.5 hrs 38-43% 59-74% Oral — Tablets Imitrex (sumatriptan)2.0-2.5 hrs 28-36% 50-62% Treximet (sumatriptan/naproxen sodium)1.0 hrs 28% 57-65% Zomig (zolmitriptan)1.5 hrs 35-45% 59-67% Maxalt (rizatriptan)1.0-1.5 hrs 38-43% 60-77% Amerge (naratriptan)2.0-3.0 hrs 19-21% 50-66%(3) Axert (almotriptan)1.0-3.0 hrs 32-36% 55-65% Frova (frovatriptan)2.0-4.0 hrs 12% 37-46% Relpax (eletriptan)1.5 hrs 20-30% 47-77% (1)Other than Sumavel DosePro (sumatriptan injection), we have estimated one-hour pain relief data for all forms/products based on Kaplan-Meier plotsincluded in each product’s Prescribing Information of the probability over time of obtaining headache response following treatment.(2)Range reflects headache relief data obtained in placebo controlled clinical studies, which include different doses of the same triptan.(3)Represents pain relief at four hours.Tmax closely correlates to speed of onset of pain relief, and has also been shown to be correlated with completeness of pain relief and pain freedom overtime. Relief at two hours is the standard endpoint used in migraine studies and represents the percentage of patients reporting a reduction of migrainesymptoms from a classification of severe or moderate to mild or none within two hours after taking the medication. As indicated in the prior table,sumatriptan injection has the earliest Tmax, reaching maximum blood concentration in 12 minutes, as compared with one or more hours for the othermarketed triptan products, and exhibits the highest percentage of patients reporting pain relief at two hours (81%-82%) as compared to all other marketed oraland nasal triptan products (37-77%). Sumatriptan injection is the only migraine product that explicitly reports pain relief at one hour in its PrescribingInformation. The efficacy profile of sumatriptan injection has been suggested to be related to its faster rate (not extent) of drug absorption compared to oral andnasal forms of triptans. Nasal forms, while claimed by some to be fast-acting, have drug absorption profiles similar to oral forms because a large portion ofthe administered dose is usually swallowed prior to absorption.Unmet Needs in Acute Migraine TherapyTriptans have been widely used in clinical practice for more than 15 years and are generally considered to be safe and effective for many patients duringtheir migraine episodes. However, more than half of all patients are unsatisfied with their current migraine therapy, as reported from a national survey of 500migraine sufferers published by the NHF in June 2010 and supported by a grant from us and Astellas. Specifically, the NHF survey results indicate that threein four migraine sufferers said that their current medication did not work fast enough to get them back to their life when a migraine strikes suddenly or uponwaking, and a majority of migraine sufferers said their prescription oral migraine medication was not useful for every migraine attack. Limitations of oral andnasal triptan formulations include:•Slower onset of pain relief. As shown in the prior table, compared to Sumavel DosePro, each oral and nasal triptan has a longer Tmax, which iscorrelated with a slower onset of pain relief.•Lower degree of pain relief. As shown in the prior table, oral and nasal triptans may have a lower percentage of patients reporting pain relief at one andtwo hours following treatment as compared to Sumavel DosePro.•Significant numbers of non-responders. According to our market research with physicians and patients, approximately 30% of migraine patients fail torespond to an oral or nasal triptan.•Nasal route unpleasant. The nasal route is an alternative to oral delivery; however, nasal spray can be unpleasant in taste.8Table of ContentsSome of these limitations are more pronounced depending on the type of migraine episode the patient is suffering. For example, when waking with amigraine already in progress, speed to onset of pain relief is important. In migraines with nausea and/or vomiting, a patient may not be able to ingest an oraltreatment.Despite its speed of onset and completeness of pain relief advantages over oral and nasal triptans, needle-based sumatriptan injection has been limited toless than 10% of the U.S. triptan market on a dollar basis and less than 5% on a total dose basis (Source® PHAST Institution/Prescription, January 2012 —December 2012). We believe this is largely due to limitations related to its delivery system which include:•Needle-based. Approximately 50% of patients refuse to use a needle-based injectable product for migraine because of needle anxiety or fear, or a lack ofconfidence in their ability to administer an injection correctly, according to physician market research conducted in 2006 by Palace HealthcareGroup, Inc. on our behalf.•Cumbersome to use. The Imitrex STATdose System, or Imitrex STATdose, GlaxoSmithKline's, or GSK's, autoinjector for delivering sumatriptan witha needle, and its generic equivalents require more than 15 steps per their published instructions to prepare, administer and reload for its next use. Thismulti-step process, which patients have to complete during a migraine episode, is prone to error. Further, market research conducted by Palace HealthcareGroup on our behalf finds that physicians report that the training required for Imitrex STATdose is a barrier to prescribing.•Needlestick risk. Needle-based systems may require special handling and needle disposal, or sharps, containers to avoid needlestick injuries.Due to these limitations, there has historically been a limited prescriber base for injectable delivery forms of sumatriptan. Of an aggregate of over370,000 prescribers of triptans in the United States, only an approximate 69,000 had written a prescription for sumatriptan injection (including SumavelDosePro) in the 12 months ended December 31, 2012 (Source Healthcare Analytics, Source® PHAST Prescription, January 2012 — December 2012). As aresult, a limited number of patients are offered injectable delivery forms. Only 54% of migraine patients had ever been offered sumatriptan injection accordingto patient market research conducted by Boston Healthcare Associates, Inc. in 2007 on our behalf.Our Solution: Sumavel DoseProSumavel DosePro is a pre-filled, single-use disposable, needle-free drug delivery system that subcutaneously delivers 6 mg of sumatriptan in 0.5 mL ofsterile liquid. Sumavel DosePro was designed to be portable, intuitive and easy-to-use. To use, the patient simply snaps off a plastic tip, flips back a lever andpresses the end of the delivery system to the skin of the abdomen or thigh. Under the force of a small amount of compressed nitrogen gas, the liquid form ofsumatriptan is expelled out of the device as a thin jet of medication, which pierces the skin and selectively deposits into the subcutaneous tissue. This processoccurs in less than 1/10th of a second.Due to its unique attributes, Sumavel DosePro has the potential to expand the dosage share for injectable sumatriptan beyond the traditional needle-basedforms because it reduces the barriers inherent in needle-based delivery systems to being prescribed by physicians and accepted by patients. Sumavel DosePromay provide patients with the following benefits when compared to alternative triptan formulations:•Rapid, more complete, migraine pain relief. Sumavel DosePro can provide onset of migraine pain relief in as little as ten minutes for some patients,according to its Prescribing Information. The Prescribing Information for the product indicates that an average of 81% (vs. an average of 34% for placebo)of patients show pain relief at two hours following administration of Sumavel DosePro, and that 49% of patients were pain free within 1 hour (vs. 9% forplacebo) and 64% were pain free within two hours (vs. 15% for placebo) following administration.•Help for sufferers of morning migraines, fast onset migraine and migraines with vomiting. According to two studies published in the October 2006issue of Clinical Therapeutics, 48% and 57% of patients with waking migraines were pain free at two hours (vs. 18% and 19% for placebo) followingadministration of sumatriptan injection. Subcutaneous sumatriptan is also as efficacious when administered early during a migraine attack as when theattack is full-blown. In addition, the pharmacokinetics of subcutaneously delivered sumatriptan is not affected by gastric stasis, nausea and/orvomiting.•Help for triptan tablet non-responders. Clinical research published in the January 2007 issue of Journal of Headache and Pain suggests injectablesumatriptan provides relief in up to 90% of migraine patients who have not responded to oral tablet triptans in at least two of their last three migraines. Inthis study, 43 patients who had failed to respond to oral triptans in at least two of their last three migraines were given sumatriptan injection for their nextmigraine. Of these patients, 91% reported pain relief at two hours, 56% reported being pain free at two hours and 32% reported sustained pain freedomthrough 24 hours following treatment of their first headache.•Simplicity, through a new, convenient and easy-to-use option. Sumavel DosePro is based on our unique delivery system which was designed to beportable, intuitive and easy-to-use, and can be disposed following use without the need of a9Table of Contentssharps container. We believe healthcare providers appreciate the simplicity of DosePro because it is easy to train patients to use properly. Our usabilitystudy of Sumavel DosePro showed 98% of patients were able to self-administer Sumavel DosePro in the home during an acute migraine attack, withoutclinical supervision and with minimal prior training.•Needle-free, eliminating needle-based issues. Because it is needle-free, we believe Sumavel DosePro may eliminate the basis for patient needle phobiaand fear. Additionally, it removes the risks of needlestick injury, the cost and inconvenience of needle disposal, issues resulting from poor injectiontechnique and costs associated with professionally administered needle-based injections. Studies show when a choice between needle-based and needle-freeinjection is available, the majority of patients prefer needle-free injection. More specifically, in a head-to-head study conducted by GSK of SumavelDosePro versus the European branded version of Imitrex STATdose, a needle-based delivery system, 61% of migraine patients preferred using SumavelDosePro while only 18% preferred using the European branded version of Imitrex STATdose, with the remaining patients expressing no preference.In addition, we believe that the unique attributes of Sumavel DosePro have the potential to reduce productivity loss in the workplace for patientssuffering from migraine. According to a study published in the May 1998 issue of Archives of Internal Medicine, results from a placebo-controlled clinicalstudy of 135 patients having migraine indicated that use of sumatriptan injection may reduce migraine-associated productivity loss. This decrease is afunction of both a reduction in time lost due to reduced effectiveness while working and a reduction in time lost due to missing work altogether. Moreover,52% of patients using sumatriptan injection (vs. 9% for placebo) returned to normal work performance within two hours after dosing.Sumavel DosePro Commercialization StrategyWe continue to develop and execute a sophisticated and comprehensive commercialization strategy for Sumavel DosePro supported by a range ofmarketing programs. The strategy and tactical plan was built taking into consideration the unmet needs in the migraine market in conjunction with the uniqueproduct attributes of Sumavel DosePro. Key objectives of our commercialization strategy are to:•validate the unmet needs of patients during challenging migraine episodes and position Sumavel DosePro as an effective treatment solution that should beadded to the patient's treatment toolbox;•enhance speed of physician adoption by focusing promotional efforts on prescribers of migraine medications across specialties;•ensure a positive first-dose experience for patients; and•achieve broad patient access to Sumavel DosePro by ensuring nationwide retail distribution and adequate third-party payor reimbursement status, as wellas providing a co-pay discount program to all qualifying patients.In support of these strategic objectives, we are executing a variety of marketing programs to educate customers, which include a premier patient toolboxfor new customers, direct-to-physician promotional materials, speaker programs, digital media, participation in selected medical conventions andreimbursement support programs. In addition, we provide product samples to physicians so that their patients may try Sumavel DosePro during an acutemigraine attack before filling their first prescription.Sumavel DosePro Regulatory ApprovalWe sought and received FDA marketing approval of Sumavel DosePro under Section 505(b)(2) of the Federal Food, Drug and Cosmetic Act, or theFFDCA, utilizing Imitrex sumatriptan injection as the reference listed product. Section 505(b)(2) of the FFDCA permits the filing of an NDA where at leastsome of the information required for approval comes from studies not conducted by or for the applicant and for which the applicant has not obtained a right ofreference. This expedited the development program for Sumavel DosePro by decreasing the overall scope of clinical and pre-clinical work required to becompleted by us.The clinical efficacy of subcutaneous injectable sumatriptan for migraine and cluster headache has been established by the reference listed product,Imitrex sumatriptan injection, which was approved in 1992. Based on our clinical bioequivalence studies, the FDA concluded that Sumavel DosePro isbioequivalent to injectable sumatriptan administered to the thigh or abdomen using Imitrex STATdose and is well tolerated when compared to this referencelisted product. Our Sumavel DosePro NDA was approved by the FDA on July 15, 2009, and the Sumavel DosePro Prescribing Information includes thehistorical efficacy data of sumatriptan injection.Sumavel DosePro Pivotal Clinical ProgramBased on discussions with the FDA, and due to the existing body of data on injectable sumatriptan, our pivotal clinical program evaluated SumavelDosePro in studies for pharmacokinetics, bioequivalence, safety, local injection site signs and10Table of Contentsreactions, and usability by patients with migraine. We conducted a single pivotal pharmacokinetics and bioequivalence clinical trial for the purpose ofproviding evidence of bioequivalence and safety of Sumavel DosePro as compared to Imitrex STATdose. This study, completed in April 2007, was arandomized, open-label, cross-over trial comparing safety, tolerability and pharmacokinetics in 54 subjects. The primary endpoint of bioequivalence wasdemonstrated in the commonly used abdomen and thigh injection sites. A separate 52-patient usability study was conducted in the second half of 2007 toevaluate the usability of Sumavel DosePro in patients during acute migraine attacks in an outpatient setting. In this study, 98% were able to use SumavelDosePro correctly during a migraine attack on their first attempt, thus confirming the product candidate’s ease of use. Further use of Sumavel DosePro by thesame patients in their treatment of subsequent migraine attacks provided consistent evidence of usability in the outpatient setting. In addition, we concluded asuccessful safety trial with Sumavel DosePro in December 2007 to study the effect of repeat dosing and multiple injections. Adverse events seen in our clinicalstudies were consistent with previously reported adverse events for sumatriptan injection. The most common treatment-emergent adverse reactions (reported byat least 5% of patients) for sumatriptan injection as described in the Sumavel DosePro Prescribing Information summarizing two large placebo-controlledclinical trials were injection site reaction (59%), atypical sensations (42%), dizziness (12%), flushing (7%), chest discomfort (5%), weakness (5%), andneck pain/stiffness (5%).Desitin Arzneimittel GmbH, or Desitin, a private German pharmaceutical company focused on the development, manufacturing and distribution ofproducts for the treatment of CNS disorders, submitted a Marketing Authorization Application for Sumavel DosePro to the Federal Institute for Drugs andMedical Devices (Bundesinstitut für Arzneimittel und Medizinprodukte (BfArM)) in Germany, the reference member state, through the DecentralizedProcedure in October 2009, following completion of a European pivotal bioequivalence trial comparing needle-free Sumavel DosePro to a traditional needle-based autoinjector, Imigran-Inject, the European brand of Imitrex STATdose. In November 2010, Denmark became the first member of the European Union toapprove marketing of Sumavel DosePro in that country. Subsequently, Sumavel DosePro has received marketing approval in Germany, Sweden, the UnitedKingdom, Norway and France.Sumavel DosePro Post-Approval Clinical ProgramIn addition to the clinical program completed in support of product approval, we have completed a Phase 4 open-label, multicenter study in the UnitedStates to evaluate treatment satisfaction, treatment confidence and subject preference for Sumavel DosePro in adult subjects diagnosed with migraine andcurrently treated with triptans. More than 200 subjects, who were predominantly taking oral triptan therapy, tried Sumavel DosePro to treat up to fourmigraines over a 60-day period. The study utilized the Patient Perception of Migraine Questionnaire-Revised, or PPMQ-R, to evaluate patient satisfaction withmigraine treatment through analysis of efficacy, functionality, ease of use and tolerability/side effects. The primary endpoint PPMQ-R Overall Satisfactionscore increased significantly from baseline to end of treatment (p=0.0007), an improvement that met the criterion for clinical significance. From baseline to theend of treatment, PPMQ-R scores also improved significantly for efficacy (p<0.0001), functionality (p<0.0001) and tolerability (p=0.02), but declined for easeof use (p<0.0001). In addition, the percentage of patients confident or very confident in treating repeated migraine attacks increased from 41.0% at baseline to64.6% at the end of treatment with Sumavel DosePro. The magnitude of improvement in treatment satisfaction from baseline to the end of the treatment periodwas even greater in a prospectively defined subset of 90 patients who were identified as requiring a change in therapy through use of the Migraine-ACT(Migraine — Assessment of Current Therapy) questionnaire. The four-item questionnaire is an assessment tool for use by primary care physicians to identifypatients who require a change in their current acute migraine treatment. Using Sumavel DosePro, 33% of the 669 treated migraine episodes in the study hadpain relieved in 15 minutes, with 70% achieving pain relief within 30 minutes. Pain freedom was achieved in 61% of the treated attacks within two hours.These incidences of pain relief and pain-free response for needle-free Sumavel DosePro are consistent with those demonstrated by previous double-blind,placebo-controlled clinical studies of injectable sumatriptan. Given that rapid pain reduction is the primary determinant of patient satisfaction with migraine,these results may explain the high rate of satisfaction with Sumavel DosePro reported by patients in the current study.Sumavel DosePro 4mg Line ExtensionBased upon physician feedback, we have initiated development of a 4 mg dosage strength of Sumavel DosePro. We have completed registration batchmanufacture, and submitted an NDA supplement to the FDA to demonstrate the manufacturability and stability of the new dosage strength in January2013. We anticipate commercializing the 4mg dosage strength in late 2013 to early 2014, if approved.DosePro and Sumavel DosePro Sound EnhancementIn order to further enhance the DosePro technology and Sumavel DosePro, we have completed additional engineering and design work aimed at softeningthe sound emitted by the DosePro device upon drug delivery. Rather than the current sound, which is similar to the opening of a can of soda, heard upondelivery with the current DosePro device, this enhanced version will sound like the click of a pen upon drug delivery. We submitted a Prior ApprovalSupplement to the FDA regarding11Table of Contentsthe implementation of this minor change, and in October 2012, the FDA issued a complete response letter, or CRL, requesting more information. We plan tomeet with the FDA to discuss the CRL and any additional steps required to implement this improvement. The CRL has no impact on the currently marketedSumavel DosePro product.DosePro and Sumavel DosePro Clinical ExperienceThe DosePro drug delivery system has been in development for more than fifteen years. During this time, more than 9,000 injections have beenadministered in multiple clinical studies to assure the proper functioning of the system and to establish the safety and tolerability of needle-free administrationby DosePro. While our experience indicates that some patients will experience pain upon injection with the DosePro technology, this pain sensation is consistentwith the pain sensation associated with injection with a fine gauge needle and can be generally characterized as transient mild discomfort.Zohydro ER for the Treatment of Moderate to Severe Chronic PainOur lead product candidate, Zohydro ER (hydrocodone bitartrate), is a 12-hour extended-release formulation of hydrocodone without acetominophenfor the treatment of moderate to severe chronic pain requiring around-the-clock opioid therapy. We completed Phase 3 development of Zohydro ER in 2011, andwe submitted an NDA for Zohydro ER to the FDA in May 2012. In July 2012, the FDA accepted our NDA as being sufficiently complete for a full reviewand assigned a PDUFA target action date of March 1, 2013. In December 2012, an advisory committee convened by the FDA voted 2-11 (with 1 abstention)against the approval of Zohydro ER. The advisory committee provides the FDA with independent expert advice and recommendations; however, the finaldecision regarding approval is made by the FDA. In February 2013, the FDA informed us of a delay in providing an action letter for our NDA for Zohydro ERand indicated that the delay would likely be brief and may last only several weeks after the PDUFA target action date of March 1, 2013. We believe ZohydroER has the potential to be an important therapeutic alternative to existing extended-release opioids as well as immediate release hydrocodone products,including the branded products Vicodin, Norco, Lorcet, Lortab and their generic equivalents, which contain the analgesic combination ingredientacetaminophen and, if taken in high quantities over time, may lead to serious side effects such as liver toxicity. Zohydro ER utilizes the SODAS Technology,Alkermes’ proprietary multiparticulate drug delivery system that allows the development of customized extended-release profiles and serves to enhance therelease profile of hydrocodone in Zohydro ER. We believe these release properties have the potential to provide longer lasting and more consistent pain reliefwith fewer daily doses than the commercially available formulations of hydrocodone. As a result of its unique single-entity extended-release profile, we believeZohydro ER, if approved, will generate sales from both patients who use immediate-release products on a chronic basis and patients already using extended-release products in the prescription opioid market.If Zohydro ER is approved by the FDA, it will be subject to a Risk Evaluation and Mitigation Strategy, or REMS, program, with the goal to reduceserious adverse outcomes resulting from inappropriate prescribing, misuse, and abuse of the drug while maintaining patient access to pain medication. TheREMS program is required to comply with FDA mandates and will be consistent with the REMS program for other extended release opioids. This programrecognizes the abuse potential of opioids and lays out specific prescriber education materials and requires a medication guide for patients to facilitateappropriate prescribing, dispensing and use of extended release opioids.Zohydro ER, if approved, also is expected be designated as a U.S. Drug Enforcement Agency, or DEA, Schedule II product, which will make it moretightly regulated than currently available hydrocodone products, all of which are currently designated as Schedule III products. This means that Zohydro ERwill not qualify for automatic refills. We believe these restrictions will help facilitate more responsible prescribing of Zohydro ER in terms of the dose andcapsule count should it receive FDA approval.The Chronic Pain MarketPain is a worldwide problem with serious health and economic consequences. Chronic pain may be defined as pain that lasts beyond the healing of aninjury or that persists beyond three months. Common types of chronic pain include lower back pain, arthritis, headache and face and jaw pain. While mildpain does not typically stop an individual from participating in his or her daily activities, moderate pain may prevent an individual from participating in hisor her daily activities and severe pain typically stops an individual from participating in his or her daily activities and induces a patient to exhibit painavoidance behaviors.Chronic pain treatment depends on the individual patients, their diagnosis and their pain severity. Chronic pain patients typically first attempt to self-medicate with over-the-counter drugs such as acetaminophen, aspirin or another non-steroidal anti-inflammatory drug, or NSAID. Patients with moreconstant and/or moderate to severe pain typically seek medical attention and prescription pain medication from a primary care physician and, if necessary, arereferred to a neurologist or a physical12Table of Contentsmedicine or pain specialist. Physicians generally assess the patient and, if appropriate, start treatment with a trial of opioid therapy to determine the optimalopioid regimen. At this point, physicians commonly prescribe opioids, including products from the codeine and morphine classes. The general objective ofthe physician is to safely achieve adequate control of pain.Physicians generally prefer to start patients on less potent opioids where possible. A trial of opioid therapy usually begins with short-acting doses takenon an as-needed basis. This allows the clinician and patient to assess the total opioid requirement. Patients taking substantial doses of short-acting opioidsmultiple times per day may find substitution of an extended-release agent, taken one to two times per day, extremely helpful to provide more constant painrelief. In theory, the more constant opioid blood levels of extended-release products may provide better pain relief and better sleep quality. Dosing intervalslonger than every four to six hours may also provide improved patient adherence to the prescribed regimen and improved patient convenience. Finally,individual patients may do poorly on one opioid, but better after switching to another. This practice is called opioid rotation and is regularly employed inchronic pain management. Opioids, while generally effective for pain treatment, are associated with numerous potential adverse effects, including opioidinduced bowel dysfunction, sedation, nausea, vomiting, decreased respiratory function, addiction and, in some instances, death.Hydrocodone is often used as a “starter” opioid to initiate opioid therapy because it is viewed by many physicians as a less potent opioid andpotentially more tolerable. Historically, hydrocodone preparations in the United States have been utilized primarily for treatment of acute pain followingsurgery or injury. For this purpose, they were combined with non-opioid analgesics, including acetaminophen or an NSAID, which treat the acuteinflammatory component of the pain. These non-opioid analgesics are generally safe when used at lower doses or for short periods of time. However, at higherdoses or over extended periods of time, they may significantly increase patient risk for gastrointestinal, liver and kidney damage.As the practice of pain management has broadened to include chronic therapy for moderate to severe pain, physicians continue to broadly usehydrocodone combinations. In the United States, market research conducted by bioStrategies Group in 2011 on our behalf indicates that nearly 30% of theprescriptions of immediate-release combination products that include hydrocodone are for the treatment of chronic pain and that approximately half of thoseprescriptions, or 14%, would be replaced with an extended-release hydrocodone product if it were available . However, the non-opioid analgesic component incombination hydrocodone products can create a ceiling effect when physicians wish to escalate doses. For example, the most commonly prescribed dose ofVicodin (5 mg hydrocodone/500 mg acetaminophen) given at a maximum dose of eight tablets per day delivers 4 g of acetaminophen, which approaches orexceeds recommended acetaminophen dosing, while only delivering 40 mg of hydrocodone, based on the Vicodin Prescribing Information. If a furtherincrease in opioid dose is warranted, a physician is compelled to transition to an opioid not in combination, such as oxycodone, or more potent opioids suchas fentanyl or oxymorphone.In the 12 months ended December 2012, our target market, which we define as prescription non-injectable codeine-based and extended-releasemorphine-based pain products, generated sales of approximately $14.0 billion in the United States on approximately 216 million prescriptions. Of the$14.0 billion, hydrocodone products, the most commonly prescribed opioid and the most commonly prescribed pharmaceutical products in the UnitedStates, generated $3.5 billion in sales on approximately 131 million prescriptions. (Source® PHAST Prescription January 2012 - December 2012).In June 2009, the FDA organized a joint meeting of the Drug Safety and Risk Management Advisory Committee, Nonprescription Drugs AdvisoryCommittee, and the Anesthetic and Life Support Advisory Committee to discuss how to address the public health problem of liver injury related to the use ofacetaminophen in both over-the-counter and prescription products. The expert panel specifically considered the elimination of combination prescriptionproducts containing acetaminophen (including Vicodin and its generics) from the U.S. market. Twenty of the 37 working group members (ten saying thiswas a high priority) voted in favor of removing such products from the market. The working group ultimately did not recommend withdrawal of theseproducts stating that the benefits of access to Schedule III acetaminophen/ hydrocodone combination products over Schedule II opioids outweighed the risk ofremoving the combinations from the market. The working group also noted that the logical choice to substitute for the combination products would be a single-entity formulation of hydrocodone. Subsequently, in January 2011, the FDA asked manufacturers of prescription combination products that containacetaminophen to limit the amount of acetaminophen to no more than 325 mg in each tablet or capsule and announced that it would require manufacturers toupdate labels of all prescription combination acetaminophen products to warn of the potential risk for severe liver injury. Along with this announcement, theFDA issued letters to sponsors of prescription acetaminophen drugs proposing various modifications to the drug labeling, including adding a boxed warningfor hepatoxicity. Within 30 days of the date of the letters, the holders of approved applications for prescription acetaminophen drugs were required to submit asupplemental NDA to the FDA proposing labeling changes that reflect the new safety information about acetaminophen and liver toxicity, or a statementdetailing the reasons why such change would not be warranted. There are currently no approved products formulated with hydrocodone alone, and we believeZohydro ER has the potential to fill this treatment gap.13Table of ContentsIn January 2013, the FDA organized a meeting of the Drug Safety and Risk Management Advisory Committee to discuss the public health benefits andrisks, including the potential for abuse of drugs containing hydrocodone either combined with other analgesics or as an antitussive, and the impact ofrescheduling these hydrocodone products from Schedule III to Schedule II. Nineteen of the 29 Advisory Committee members voted in favor of recommendingthat products containing hydrocodone be reclassified from a Schedule III to a Schedule II controlled substance. The Advisory Committee's recommendation isfor the FDA's consideration and is not binding on the FDA. Zohydro ER is currently designed as a Schedule II product.Limitations of Current Hydrocodone Pain TherapiesWhile hydrocodone in combination products remains the most commonly prescribed opioid, currently available hydrocodone formulations haveseveral major limitations, including:•Hydrocodone only available in short-acting/immediate-release form. There are currently no extended-release hydrocodone formulations on the market.•Adherence dependent. Because hydrocodone is available only in immediate-release formulations that are dosed every four to six hours, its around-the-clock efficacy is dependent on diligent adherence by the patient. Published studies across therapeutic categories, including the treatment of diabetes,hypertension and infectious disease, demonstrate that patient adherence to drug regimens declines as the number of daily drug doses increases.•Inconsistent pain relief. Because of the dosing issues noted above, many patients experience suboptimal pain relief due to variable opioid blood levels,particularly towards the end of dosing intervals.•Opioid dose is limited by combination analgesics. The overwhelming majority of currently approved hydrocodone products include acetaminophen intheir formulation. Because of the potential side effects of increasing acetaminophen doses, the acetaminophen component of these combination productscan become a dose limiting factor. When this occurs, patients must limit their total hydrocodone dose to avoid potential liver and other side effects ofacetaminophen and thus may receive a sub-optimal daily dose of hydrocodone, or they must switch to other single-entity opioids, such as oxycodone.Hydrocodone combinations with NSAIDs have similar dose limitations due to the gastrointestinal side effects associated with NSAIDs.•Widespread use of acetaminophen leading to increased toxicity risk. Even when combination products are carefully prescribed, patients are at risk ofacetaminophen toxicity due to the prevalence of APAP in many over the counter products and individuals’ lack of knowledge about the dangers and/orawareness of APAP in other products.While extended-release, single-entity opioids exist, published study reports indicate that patients are regularly taking more daily doses of extended-releaseopioids than the recommended labeled dose, suggesting that not all of them provide true 12- or 24-hour dosing. For example, results from a study of 437patients published in the May/June 2003 issue of the Journal of Managed Care Pharmacy indicated that despite the “every 12-hours” dosing regimenrecommended in its Prescribing Information, patients taking extended-release oxycodone on average took 4.6 tablets per day, at an average dosing interval ofonly 7.8 hours. In the same study, among extended-release oxycodone patients, only 1.9% reported the duration of pain relief as 12 or more hours. A separatestudy published in the September/October 2004 issue of The Clinical Journal of Pain indicated that the prescribed frequency of dosing extended-releaseoxycodone determined through clinical practice was twice daily for 33% of patients, with 67% of patients requiring greater than twice daily dosing.Our Solution: Zohydro ERWe believe that Zohydro ER, if approved, may provide patients and physicians with the following benefits when compared to existing opioid painmedications:•Single-entity hydrocodone. Zohydro ER, if approved by the FDA, is expected to be the first non-combination, extended-release hydrocodone product tobe commercialized in the United States, giving physicians and patients a hydrocodone option unencumbered with acetaminophen or NSAIDs and theirpotential adverse effects.•Twelve hour exposure provides true around-the-clock relief when administered twice daily. Zohydro ER, via its unique extended-release profile, isdesigned to provide consistent relief of moderate to severe chronic pain over a 12-hour period per dose. Clinical studies have shown a pharmacokineticprofile that supports the expected extended relief profile of Zohydro ER. In addition, there are five other marketed products using SODAS technology thatare dosed every 24 hours, which we believe helps validate the controlled release technology underlying the formulation of Zohydro ER.•Easier adherence/greater patient convenience. Because of its 12-hour dosing regimen, Zohydro ER requires fewer daily doses than currently availablehydrocodone formulations, thereby increasing the likelihood of patient adherence and convenience.•Another opioid option for chronic medication rotation. The unique profile of Zohydro ER provides another option for physicians investigating newalternatives to offer patients who require medication rotation due to tolerance, side effects or poor pain control.14Table of ContentsZohydro ER Phase 3 Clinical Development ProgramWe initiated a single pivotal Phase 3 efficacy trial (Study 801) in March 2010 and completed patient enrollment in February 2011. This trial was arandomized, 12-week, double-blind, placebo-controlled trial to evaluate the safety and efficacy of Zohydro ER for the treatment of moderate to severe chroniclower back pain in opioid-experienced adult subjects. Our trial utilized a protocol design that has been used successfully to demonstrate the efficacy of otherextended-release opioid therapies for chronic pain. Patients in this study were converted from their existing opioid treatment regimen to Zohydro ER and titratedto an effective dose of Zohydro ER during an initial up to 6-week open-label conversion and titration phase, and were then randomized to receive either placeboor active drug for a 12-week placebo-controlled treatment phase. During the entire study period, patients in both arms of the clinical trial had access to rescuemedication. The primary efficacy endpoint in this trial was the mean change in average daily pain intensity scores between Zohydro ER and placebo. Weconfirmed the FDA’s agreement on the trial design for Study 801 and the overall safety database requirements for an NDA submission at our End of Phase 2meeting with the FDA conducted in June 2008. We did not seek a Special Protocol Assessment, or SPA, from the FDA for Study 801.We reported positive results for our pivotal Phase 3 efficacy trial in August 2011. The trial successfully met the primary efficacy endpoint indemonstrating a significant difference (p=0.008) between the mean changes from Baseline to Week 12 or Final Visit in average daily pain intensity NumericRating Scale (NRS) scores obtained from patient diaries between Zohydro ER and placebo groups. The two key secondary endpoints were also met. Withrespect to the responder analysis secondary endpoint, the proportion of patients with at least 30% improvement in pain intensity from screening to end of studywas significantly higher for Zohydro ER compared to placebo (67.5% versus 31.1%; p<0.001). The proportion of patients with at least 50% improvement inpain intensity from screening to end of study was also significantly higher for Zohydro ER versus placebo (47.7% versus 23.3%; p<0.001). The other keysecondary endpoint, using the Subject Global Assessment of Medication questionnaire, showed that patients on Zohydro ER were significantly more satisfied(p<0.001) with their pain treatment at the end of the study compared to their pre-study medication. The study further demonstrated that Zohydro ER was safeand generally well tolerated. The incidence of adverse events was 33.7% and 28.8% in the open label titration and double blind treatment periods, respectively.Overall, the most commonly reported adverse events (≤2%) were constipation, nausea, somnolence, vomiting, diarrhea, insomnia, fatigue, headache,dizziness and dry mouth. These are typical adverse events associated with chronic opioid therapy.To further assess the safety and tolerability of Zohydro ER as a chronic pain therapy, we also conducted an open-label Phase 3 trial in opioid-experiencedadult subjects with any indication appropriate for continuous, around-the-clock opioid therapy for an extended period of time (Study 802). We completed thetrial in December 2011. The goal of this trial was to evaluate the safety and tolerability of Zohydro ER for up to 12 months of treatment. The study furtherdemonstrated that Zohydro ER was safe and generally well tolerated, and the incidence of adverse events was generally consistent with that seen in our pivotalPhase 3 efficacy trial. The safety and efficacy data from this trial was submitted as part of our NDA to the FDA in May 2012.We have also initiated 2-year carcinogenicity studies in two animal species. We obtained FDA agreement on the protocols for both studies and haveagreed with the FDA that these studies are an ongoing commitment and are not required for submission or approval of the NDA for Zohydro ER. In July 2012,the FDA accepted our NDA as being sufficiently complete for a full review and assigned a PDUFA target action date of March 1, 2013. In December 2012, anadvisory committee convened by the FDA voted 2-11 (with 1 abstention) against the approval of Zohydro ER. The advisory committee provides the FDA withindependent expert advice and recommendations; however, the FDA is not bound by the advisory committee's recommendations and the final decisionregarding approval is made by the FDA. In February 2013, the FDA informed us that we were unlikely to receive an action letter for our NDA for Zohydro ERby the PDUFA target action date of March 1, 2013. The FDA has not provided us with information as to the reason for the delay, but has indicated that thedelay would likely be brief and may last only several weeks. We have not been informed of any deficiencies in the NDA for Zohydro ER during the reviewprocess to date.Prior Clinical Development of Zohydro EROur licensor for Zohydro ER, Alkermes, conducted pre-clinical and clinical studies of Zohydro ER under an IND initiated in 2002.Phase 1 and Phase 2 Clinical Development. In single and multiple dose pharmacokinetic evaluations, Zohydro ER demonstrated detectable plasmaconcentrations of hydrocodone within 15 minutes of administration. Zohydro ER also demonstrated a sustained release effect significantly longer thancurrently available hydrocodone combination products such as Vicodin, as well as dose proportional pharmacokinetics. Consistent, steady-state plasmalevels, which are believed to be desirable for chronic pain patients who require around-the-clock opioid therapy, were achieved within one week of the initiationof dosing. In addition, Zohydro ER has been tested under both fed and fasted conditions and the amount of drug15Table of Contentsexposure was not affected by food, which we believe provides the basis for a flexible administration regimen for chronic pain. We believe that these priorpharmacokinetic studies demonstrate that Zohydro ER displays a consistent, extended-release profile, dose-proportional pharmacokinetics and an acceptablesafety profile.Zohydro ER has also been evaluated in two separate Phase 2 pain studies. The first study was a randomized, single-dose, parallel group, placebo-controlled, active-comparator study to evaluate the safety, efficacy and pharmacokinetics of increasing doses of Zohydro ER in opioid-naive adultsimmediately following bunion removal surgery. This study was designed to evaluate pain prevention rather than pain treatment. In this 241-patient study,patients were treated with either one of four doses of Zohydro ER (10, 20, 30 or 40 mg extended-release hydrocodone bitartrate), an active immediate-releasecomparator consisting of 10 mg hydrocodone bitartrate plus 325 mg acetaminophen, or placebo. The primary efficacy measurement was the visual analogscale of pain intensity from 0 to 12 hours after dosing. The 40 mg dose of Zohydro ER was significantly more effective (p<0.05) versus placebo in controllingpostoperative pain. In addition, efficacy of the 40 mg dose did not significantly differ from the hydrocodone bitartrate/acetaminophen active comparator inany of the efficacy outcome measures. None of the three lower doses of Zohydro ER were superior to placebo in the primary efficacy measurements. All fourdoses were found to be safe and well-tolerated. We believe this efficacy and safety information is useful in establishing proof-of-concept for Zohydro ER.The second Phase 2 study was a four week, multiple-dose, safety, tolerability and pharmacokinetic dose-escalation study of Zohydro ER in opioid-experienced adults with chronic, moderate to severe osteoarthritis pain. The primary objective was to assess the safety, tolerability and pharmacokinetics ofZohydro ER at steady state over a range of escalating daily doses. Thirty-seven patients in two dosing cohorts received escalating doses of Zohydro ER overthree weeks. This study demonstrated a clinically acceptable safety profile and a reduction in pain intensity for chronic moderate to severe osteoarthritis painpatients across multiple dosage strengths. We believe that the study also demonstrated a steady-state pharmacokinetic profile that is appropriate for themanagement of chronic pain. In both Phase 2 studies, patients experienced mild to moderate adverse events, such as nausea, vomiting, headache, dizziness,sweating, constipation and drowsiness, which are similar to the reported effects of opioids currently prescribed for chronic pain.The data from these Phase 1 and Phase 2 studies were submitted to the FDA under our IND and were summarized in our End of Phase 2 meetingbriefing package in support of progressing Zohydro ER into pivotal Phase 3 clinical studies.Relday for the Treatment of SchizophreniaRelday is a proprietary, long-acting injectable formulation of risperidone using Durect’s SABER™ controlled-release formulation technology. Ifsuccessfully developed and approved, we believe Relday may be the first subcutaneous antipsychotic product that allows for once-monthly dosing. We believeDurect’s SABER controlled-release technology will allow Relday to be delivered subcutaneously on a once-monthly basis with a simplified dosing regimen,improved pharmacokinetic profile and significant reduction in injection volume versus currently marketed long-acting injectable antipsychotics. Based uponthese characteristics, Relday may provide an important alternative to currently marketed long-acting injectable antipsychotics as well as a new long-actingtreatment option for patients that currently use daily oral antipsychotic products. In May 2012, we filed an IND application with the FDA. In July 2012, weinitiated our first IND clinical trial for Relday. This Phase 1 clinical trial was a single-center, open-label, safety and pharmacokinetic trial of 30 patients withchronic, stable schizophrenia or schizoaffective disorder. We announced positive single-dose pharmacokinetic results from the Phase 1 clinical trial on January3, 2013. Adverse events in the Phase 1 trial in patients diagnosed with schizophrenia were generally mild to moderate and consistent with other risperidoneproducts. Based on the favorable safety and pharmacokinetic profile demonstrated with the 25 mg and 50 mg once-monthly doses tested in the Phase 1 trial,we extended the study to include an additional cohort of 10 patients at a 100 mg dose of the same formulation. The addition of this 100 mg dose to the studywill enable evaluation of dose proportionality across the full dose range that would be anticipated to be used in clinical practice. Positive results from this studyextension would better position us to begin a multi-dose clinical trial, which would provide the required steady-state pharmacokinetic and safety data prior toinitiating Phase 3 development studies. We expect to complete the extension of the Phase 1 clinical trial during the second quarter of 2013.The Antipsychotic MarketSchizophrenia is a complex, chronic, severe and debilitating mental disorder that often develops between the ages of 16 and 30 years, and the NationalInstitute of Mental Health, or NIMH, estimated in 1993 that the 12-month prevalence of schizophrenia is 1.1% of the U.S. adult population. The symptomsof schizophrenia are often categorized as positive, negative or cognitive in nature. Positive symptoms include hallucinations, delusions, disorganized thinkingand movement disorders. Negative symptoms of schizophrenia can include flat affect, inability to feel pleasure and speaking little, and the cognitivesymptoms of schizophrenia can include poor executive function, problems with working memory and attention deficits. This combination of symptoms oftenmakes it challenging for many schizophrenic patients to care for themselves or hold jobs,16Table of Contentsresulting in significant societal costs. The direct and indirect costs of schizophrenia in the United States in 2002 were estimated at $62.7 billion, including$22.7 billion in direct medical costs for outpatient care, medications, inpatient care, and long-term care, according to an article published in 2005 in TheJournal of Clinical Psychiatry.Bipolar disorder, or manic depressive illness, is another chronic, recurring psychiatric illness that is characterized by extreme or unusual shifts inmood, energy and activity levels. In general, patients with bipolar disorder suffer over time from episodes of both mania and depression. The NIMH estimatedin 2005 that the average age of onset for bipolar disorder is 25 years, and the 12-month prevalence of bipolar disorder is 2.6% of the U.S. adult population. Inmany cases, the recurring episodes of mania and depression are so severe that the patient cannot maintain normal relationships or function normally at home,work or school, and suicide attempts occur in 25-50% of bipolar disorder patients.First line therapy for most schizophrenia patients today are drugs generally known as atypical or second generation antipsychotics. Theseantipsychotics have been named atypical for their ability to treat a broader range of negative symptoms with improved side effect profiles versus the first-generation or typical antipsychotics, which were mostly introduced in the 1950s with drugs such as chlorpromazine and haloperidol. The first atypicalantipsychotics to be approved by FDA in the United States were Clozaril (clozapine) in 1989, followed by Risperdal (risperidone) in 1993 and Zyprexa(olanzapine) in 1996. Similarly, over the last decade, atypical antipsychotics have become increasingly utilized in the treatment of bipolar disorder, either asmonotherapy or as part of a polytherapy regimen, most often being prescribed in conjunction with a mood stabilizer such as lithium or valproic acid, andsometimes in conjunction with both a mood stabilizer and additional medications.Patient compliance with medication has been a long-standing problem in the treatment of both schizophrenia and bipolar disorder. Results from theClinical Antipsychotic Trials in Intervention Effectiveness conducted between 2001 and 2004, and published in The New England Journal of Medicine in2005, indicated that over 70% of schizophrenia patients became non-compliant with their medication within 18 months of commencing therapy. Similarly a2004 study of the VA National Psychosis Registry published in the journal Bipolar Disorder in October 2006 found that, of the 45% of bipolar patients whowere being prescribed an antipsychotic, just over half of individuals appeared to be fully adherent with their antipsychotic medications, while the remainingindividuals were either partially adherent or non-adherent with their antipsychotic medications.In an attempt to improve patient compliance, physicians increasingly administer antipsychotic drugs through long-acting depot injections. Long-actingdepot injections release medication slowly over weeks rather than over hours or days for conventional injections or oral medications, thereby dramaticallyreducing the number of times a patient needs to take their medication. Currently available long-acting injectable products include Risperdal Consta and InvegaSustenna, both marketed by Johnson & Johnson, and Zyprexa Relprevv, marketed by Eli Lilly & Co. These drugs provide two to four weeks of therapy perdose.Overall, the global atypical antipsychotic market was estimated to be in excess of $17.1 billion in 2011, based upon published sales reports of certainpharmaceutical companies. In 2012, atypical antipsychotics comprised approximately 91% of all antipsychotic prescriptions in the United States, accordingto data from Source Healthcare Analytics (Source® PHAST Prescription, January 2012 — December 2012). The existing long-acting injectable risperidoneproduct, Risperdal Consta, achieved global net sales of $1.4 billion in 2012, according to industry reports, and has a wholesale acquisition cost ofapproximately $286 per bi-weekly dose, or more than $500 per month, for the 25 mg dosage strength (Source: Gold Standard). Finally, in the United States,prescribers of long-acting antipsychotics are highly concentrated with approximately 16,600 total prescribers of long-acting injectable products, includingapproximately 9,600 psychiatrists in 2012 (Source® PHAST Prescription, January 2012 — December 2012).The Relday OpportunityMarket research conducted on our behalf by bioStrategies Group in 2007 indicates that psychiatrists see significant potential advantages for Relday overthe currently marketed long-acting risperidone injectable, specifically identifying the subcutaneous and once-monthly features of Relday as importantdifferentiators versus the currently marketed long-acting antipsychotics. We believe on the basis of our pre-clinical development work and market researchthat, if successfully developed and approved, Relday could potentially provide a significant improvements over existing treatment options for patientssuffering from schizophrenia as a result of:•Subcutaneous delivery: All the currently available long-acting atypical antipsychotics are administered intramuscularly and, other than the lowest dosagestrength of Invega Sustenna, have injection volumes greater than Relday. Intramuscular injections have been associated with inadvertent vascularinjection, leading to rapid release of the drug and related adverse events, and in addition can also result in slow, painful and/or difficult injections.Utilizing the unique attributes of the17Table of ContentsDurect’s SABER technology, Relday has been designed to be administered subcutaneously with injection volumes of 0.5 mL to 1.0 mL.•No reconstitution: Relday is formulated as a pre-filled, single-dose product that does not require reconstitution, or the addition of a liquid dilutent, priorto administration. Risperdal Consta and Zyprexa Relprevv both require reconstitution prior to injection, which is generally considered an inconveniencefor busy healthcare practitioners.•Once a month dosing with no oral supplementation: Relday is formulated with a goal of providing a pharmacokinetic profile that will allow for once-monthly dosing without the need for supplementation with oral risperidone. Risperdal Consta provides therapy for only two weeks, resulting in morefrequent physician visits and requires supplementation with oral risperidone for the first three weeks following initiation of therapy or following a misseddose of the injectable due to its pharmacokinetic profile.•Preferred active ingredient: Our market research indicated that in nearly all cases, long-acting injectable antipsychotics are prescribed to patients whohave experience taking the same molecule orally and have demonstrated some level of acceptable efficacy and tolerability. Oral risperidone is now thesecond most commonly prescribed atypical antipsychotic compound in the United States, accounting for 24% of total prescriptions in the twelve monthsended December 2012 (Source® PHAST Prescription, January 2012 — December 2012).•Potential Needle-free delivery: The currently available long-acting atypical antipsychotic products are delivered using a 23 gauge or larger needle, withRisperdal Consta requiring use of a 21 gauge or larger needle. The development of Relday will first focus on its delivery by conventional needle andsyringe in order to allow the administration of different volumes of the same formulation of Relday by a healthcare professional. We anticipate that theintroduction of our DosePro needle-free technology for administration of Relday can occur later in development or as part of life cycle management afterfurther work involving formulation development, technology enhancements, and applicable regulatory approvals.We plan to seek a development and commercialization partner or partners for Relday in territories outside of the United States such as Europe and Japan.While our current development plans are focused on schizophrenia, in the future we may consider expanding the program to address additional indications,such as bi-polar disorder. If successfully developed and approved by the FDA, we plan to commercialize Relday in the United States further leveraging ourcommercial infrastructure and sales force.Our DosePro Technology and Pre-clinical PipelineOur proprietary DosePro technology is a first-in-class, easy-to-use drug delivery system designed for self-administration of a pre-filled, single dose ofliquid drug, subcutaneously, without a needle. The DosePro technology (formerly known as Intraject) has undergone more than ten years of design, processengineering, clinical evaluation and development work, including significant capital investment by the predecessor owners of the technology, Weston MedicalGroup, plc and Aradigm. We acquired the DosePro technology and related intellectual property from Aradigm in August 2006. We believe the approval andlaunch of Sumavel DosePro in the United Sates validates the technology’s commercial viability and readiness for other potential drug applications.We believe that DosePro offers several benefits to patients compared to other subcutaneous delivery methods, and that it has the potential to become apreferred delivery option for patients and physicians for many injected medicines beyond sumatriptan, particularly those that are self-administered. Thesebenefits include less anxiety or fear due to the lack of a needle, easier disposal without the need for a sharps container, no risk of needlestick injury orcontamination, an easy-to-use three step process, no need to fill or manipulate the device, reliable performance, discreet use and portability. In several clinicaltrials and market research studies, DosePro has been shown to be preferred by patients over conventional needle-based systems. For example, in a head-to-headstudy conducted by GSK of Sumavel DosePro versus the European branded version of Imitrex STATdose, a needle-based delivery system, 61% of migrainepatients preferred using Sumavel DosePro while only 18% preferred using the European branded version of Imitrex STATdose, with the remaining patientsexpressing no preference. In addition, in a market study conducted on our behalf by Boston Healthcare Associates, Inc. in 2007, 76% of patients indicatedthat they preferred the Sumavel DosePro delivery method over Imitrex STATdose. In addition, DosePro requires less time from physicians and other caregiversto train patients to use the device.Physician preference for DosePro as a needle-free alternative to conventional needle-based injections has also been demonstrated in market researchstudies. For example, in a study conducted by Palace Healthcare Group, Inc. in 2006 on our behalf, 94% of primary care physicians and 98% of neurologistsindicated they would be more willing to prescribe an injectable migraine product if it were needle-free.In order to further enhance the DosePro technology and Sumavel DosePro, we have completed additional engineering and design work aimed at softeningthe sound emitted by the DosePro device upon drug delivery. Rather than the current sound, which is similar to the opening of a can of soda, heard upondelivery with the current DosePro device, this enhanced18Table of Contentsversion will sound like the click of a pen upon drug delivery. We submitted a Prior Approval Supplement to the FDA regarding the implementation of thisminor change, and the FDA issued a CRL requesting more information. We plan to meet with the FDA to discuss the CRL and any additional steps required toimplement this improvement. The CRL has no impact on the currently marketed Sumavel DosePro product.Clinical studies suggest that DosePro will have significant versatility in its ability to deliver various types of therapeutic compounds, including bothsmall molecules and biologic products where the dose volume is 0.5 mL or less. In addition to positive results using DosePro in clinical studies performed withsaline and sumatriptan, there have been three positive single-dose human pilot studies conducted with a combination of a protein pharmaceutical and DosePro.These studies include pharmacokinetic bioequivalence studies comparing DosePro to a conventional needle injection for human growth hormone anderythropoietin and pharmacodynamic equivalence study using granulocyte colony-stimulating factor. Pre-clinical work with monoclonal antibodies evaluatingbioavailability, pharmacokinetics and a lack of immunogenicity has also been conducted. In vitro studies with DosePro technology have demonstrated thepotential to allow the subcutaneous delivery of highly viscous formulations, which can be a limiting factor for use of traditional needle-based delivery systems.As a result of the versatility of DosePro to deliver various types of drug products, this technology may have significant market potential across a broad rangeof therapeutic areas, including those typically treated with small volume injectable products, such as hepatitis, infertility, multiple sclerosis and rheumatoidarthritis.Since some drug formulations cannot be accommodated in a 0.5 mL dose volume, we have initiated early stage design and development of a largervolume, second generation version of our DosePro technology, which if successfully developed, would allow for a broader range of potential applications forour technology. However, the full development of such technology will require substantial investment and we may consider entering into a third-partycollaboration in order to fully-develop such technology. There is no guarantee that we or any potential future third-party collaborator will be able to successfullydevelop such a device technology, whether for financial or technical reasons or otherwise.We are building our internal product pipeline by investigating proven drugs that can be paired with DosePro to enhance their benefits and commercialattractiveness. We are also evaluating the market potential, formulation requirements and clinical development pathway of an additional CNS compound thatcould be paired with DosePro to enhance its commercial attractiveness. We are also seeking to capitalize on our DosePro technology by out-licensing it topotential partners enabling them to enhance, differentiate or extend the life cycle of their proprietary injectable products. In March 2012, we entered into a co-marketing and option agreement with Battelle Memorial Institute, or Battelle, pursuant to which we granted to Battelle the exclusive right to co-market ourDosePro drug delivery technology to a specified list of Battelle's pharmaceutical clients.Sales and MarketingWe have built a highly experienced sales and marketing organization in the United States focused on marketing and selling Sumavel DosePro tophysicians, nurses and other healthcare professionals. As of December 31, 2012, our sales and marketing organization is comprised of 103 professionals,which includes approximately 85 field sales personnel. Our field sales force has historically promoted Sumavel DosePro primarily to neurologists and otherprescribers of migraine medications, including headache clinics and headache specialists.We believe the key factors in the continued successful adoption of Sumavel DosePro will include expanding its use as an alternative to oral and nasaltriptan therapy, converting current sumatriptan injectable users to Sumavel DosePro and building patient awareness and trial. We are specifically positioningSumavel DosePro as a therapeutic alternative for oral triptan non-responders and dissatisfied patients, including those with morning migraines, fastprogressing migraines and migraines accompanied by nausea and/or vomiting.We believe our sales force is differentiated by its level of experience and background in the industry and accountability for sales results. Our field salespersonnel have an average of approximately 14 years of prior experience promoting pharmaceutical products and most have prior experience in the neurologyand/or migraine space. In addition, our sales management team has on average 20 years of pharmaceutical industry experience, including an average of 10years of sales management experience. Each of our sales representatives and regional business directors undergoes a formal training program focused ondisease background, our product, competitive products and territory management, as well as compliance with applicable laws. Our training program alsoincludes significant ongoing and field-based learning to provide a comprehensive understanding and perspective as to our markets and disease states and theneeds of both physicians and patients.In addition to our field sales team, we also have an experienced team of field-based managed markets and trade directors. This team works closely withour regional business directors to engage with third-party payors to ensure and expand reimbursement coverage and patient access for our product andimplement pharmacy based educational programs. To date, we have entered into a number of contracts with private health insurers, managed careorganizations, government entities and other third-party payors that provide coverage for our products.19Table of ContentsWe are supporting this field based organization with an internal team which includes product management, communications, commercial analytics andsales operations staff. This team is focused on the implementation of a variety of marketing programs to educate customers, which include direct-to-physicianpromotional materials, speaker programs, direct-to-patient programs, digital media, participation in selected medical conventions and reimbursement supportprograms.In addition, in July 2009, we entered into an exclusive co-promotion agreement with Astellas under which Sumavel DosePro was historically marketedby Astellas in the United States and promoted primarily to primary care physicians (including internal medicine, family practice and general practice),OB/GYNs, emergency medicine physicians and urologists, or collectively the Astellas Segment, by approximately 400 Astellas sales representatives. The targetaudience for our sales effort was primarily comprised historically of neurologists and other prescribers of migraine medicines who fall outside the AstellasSegment. In addition, our representatives historically had the right to call upon a specified number of key prescribers within the Astellas Segment and Astellas’representatives historically had the right to call upon a specified number of neurologists. This exclusive co-promotion agreement with Astellas terminated onMarch 31, 2012, at which time we assumed full responsibility for the commercialization of Sumavel DosePro. We have expanded the focus of our existingsales force to include targeting a portion of the high-prescribing primary care physicians that were previously part of the Astellas Segment. In June 2012, weentered into a co-promotion agreement with Mallinckrodt, pursuant to which we granted to Mallinckrodt a co-exclusive right (with us) to promote SumavelDosePro to a mutually agreed prescriber audience in the United States. Mallinckrodt began promoting Sumavel DosePro in August 2012 and has committed toa minimum number of sales representatives for the initial term of the co-promotion agreement.In March 2008, we entered into a licensing and distribution agreement with Desitin. Under the terms of the agreement, we licensed to Desitin theexclusive development and commercialization rights to Sumavel DosePro for the European Union, Norway, Switzerland and Turkey. Desitin will oversee, andbe responsible for the expenses related to, all clinical development, regulatory approval and commercialization efforts required to market Sumavel DosePro inthe territories in which Desitin elects to develop and market Sumavel DosePro. Desitin received approval to market Sumavel DosePro in Denmark inNovember 2010 followed by approval in the United Kingdom, Sweden and Germany in December 2010 and Norway and France in February 2011. We haveagreed to manufacture and supply the product to Desitin for commercial sale. Desitin has agreed to pay us a specified transfer price for commercial productand a low single-digit percentage royalty on net sales of the product. We retain full commercial rights to Sumavel DosePro in all other countries not licensedunder the Desitin agreement, including the United States, Canada and the countries in Asia.For the launch of Zohydro ER, if approved, we intend to consider co-promotion and other partnering opportunities, and an expansion of our sales andmarketing infrastructure, including expanding our field sales force to between 100 and 200 representatives, to support broader reach to pain specialists for bothZohydro ER and Sumavel DosePro, and neurologists for Sumavel DosePro. We expect our primary target audiences may expand to include anesthesiologists,pain specialists, physical medicine specialists and additional primary care physicians. In addition, we expect that we will also consider opportunities topartner Zohydro ER to reach a broader physician audience. We are seeking and evaluating third-party co-promotion opportunities that would allow us tostrategically leverage our commercial resources and generate additional revenue in the United States.CompetitionThe pharmaceutical industry is characterized by rapidly advancing technologies, intense competition and a strong emphasis on proprietary therapeutics.We face competition from a number of sources, some of which may target the same indications as our product or product candidates, including largepharmaceutical companies, smaller pharmaceutical companies, biotechnology companies, academic institutions, government agencies and private and publicresearch institutions, many of which have greater financial resources, sales and marketing capabilities, including larger, well established sales forces,manufacturing capabilities, experience in obtaining regulatory approvals for product candidates and other resources than us. We face competition not only inthe commercialization of Sumavel DosePro or any product candidates for which we obtain marketing approval from the FDA or other regulatory authorities,but also for the in-licensing or acquisition of additional product candidates, and the out-licensing of our DosePro drug delivery technology.Sumavel DoseProSumavel DosePro competes against other marketed migraine therapeutics. The largest class of marketed prescription products for treatment of migraineis the triptan class. The largest selling triptan is sumatriptan, with the branded products Imitrex and Treximet marketed by GSK and Sumavel DosePromarketed by us. There are six other branded triptan therapies being sold by pharmaceutical companies including AstraZeneca plc, Endo PharmaceuticalsHoldings Inc., Johnson & Johnson, Merck & Co., and Pfizer, Inc. in the United States.20Table of ContentsWe also face competition from generic sumatriptan injectable, now marketed in the United States as an authorized generic of Imitrex STATdose by ParPharmaceutical Companies and Sandoz Inc. (a Novartis AG company). In addition, we face competition from alternative autoinjector forms of sumatriptaninjection including sumatriptan injection, a needle-based autoinjector which was developed and is manufactured and marketed by Pfizer, and a needle-basedgeneric sumatriptan auto-injector from Sun Pharmaceutical Industries Limited. Finally, generic injectable sumatriptan in the form of vials and prefilledsyringes is available from a number of pharmaceutical companies. Although these products and alternative autoinjector forms of sumatriptan injection maynot be directly substituted for Sumavel DosePro, generic versions of injectable sumatriptan may reduce the future adoption of Sumavel DosePro by third-party payors and consumers, as financial pressure to use generic products may encourage the use of a generic product over Sumavel DosePro. SumavelDosePro is currently more expensive on a per dose basis than most of the competing branded and all of the generic triptan products for migraine, which mayalso limit the coverage and reimbursement by third-party payors, which could adversely affect adoption by physicians and patients. In addition to thesemigraine therapeutics, there are other marketed non-triptan migraine therapeutics, such as Cambia sold by Nautilus Neurosciences, Inc. and Migranal sold byValeant Pharmaceuticals International. Moreover, there are several product candidates under development that could potentially be used to treat migraines andcompete with Sumavel DosePro, including products under development by large pharmaceutical companies such as GSK, Merck and Allergan, Inc. andsmaller companies such as OptiNose AS, Inc. In addition, Allergan, is now marketing BOTOX botulinum toxin for the treatment of chronic migraine, andNupathe, Inc. received FDA approval for its migraine patch, Zecuity, in January 2013.Zohydro ERIf approved for the treatment of moderate to severe chronic pain, Zohydro ER will compete against other marketed branded and generic pain therapeuticsand may compete with additional product candidates currently under development or developed in the future. Current competitors in the opioid paintherapeutics space include, but are not limited to, Abbott Laboratories, Endo Pharmaceuticals Holdings Inc., Johnson & Johnson, Mallinckrodt Inc., Pfizer,Purdue Pharma L.P., Teva Pharmaceutical Industries Limited and Watson Pharmaceuticals, Inc. There are at least 15 opioid product candidates underdevelopment, including abuse and diversion resistant formulations of currently available opioids, novel opioids and alternative delivery forms of variousopioids under development at other pharmaceutical companies, including single-entity extended-release hydrocodone product candidates being developed byEgalet A/S, Pfizer, Purdue Pharma L.P. and Teva Pharmaceutical Industries Limited. Zohydro ER may also face competition from non-opioid products,including new chemical entities, as well as alternative delivery forms of NSAIDs. In addition to the previously named companies, a number of pharmaceuticalcompanies are developing new product candidates for pain including, but not limited to, Acura Pharmaceuticals, Inc., Altea Therapeutics Corporation,Collegium Pharmaceutical, Inc., Eli Lilly and Company, Elite Pharmaceuticals, Inc., Hospira, Inc., Inspirion Delivery Technologies, LLC,Intellipharmaceutics International Inc. and QRxPharma Ltd.ReldayIf approved for the treatment of schizophrenia, we anticipate that Relday will compete against other marketed, branded and generic, typical and atypicalantipsychotics, including both long-acting injectable and oral products. Currently marketed long-acting injectable atypical antipsychotic products includeRisperdal Consta and Invega Sustenna marketed by Johnson & Johnson and Zyprexa Relprevv marketed by Eli Lilly & Company. In March 2013, the FDAapproved Abilify Maintena, a once-monthly depot formulation of apripiprazole from Otsuka Pharmaceutical Co, Ltd. and H. Lundbeck A/S. Currentlyapproved and marketed oral atypical antipsychotics include Risperdal (risperidone) and Invega (paliperidone) marketed by Johnson & Johnson, genericrisperidone, Zyprexa (olanzapine) marketed by Eli Lilly and Company, Seroquel (quetiapine) marketed by AstraZeneca plc, Abilify (aripiprazole)marketed by BMS/Otsuka Pharmaceutical Co., Ltd., Geodon (ziprasidone) marketed by Pfizer, Fanapt (iloperidone) marketed by Novartis AG, Saphris(asenapine) marketed by Merck, Latuda (lurasidone) marketed by Dainippon Sumitomo Pharma and generic clozapine. Finally, in addition to thesecurrently marketed products, we may also face competition from additional long-acting injectable product candidates that could be developed by the largecompanies listed above, as well and by other pharmaceutical companies such as Alkermes, NuPathe and Novartis AG, each of which has announced they aredeveloping long-acting antipsychotic product candidates.DosePro TechnologyTraditional needle and syringe remain the primary method for administering intramuscular and subcutaneous injections. The injectable drug market isincreasingly adopting new injection systems including pre-filled syringes, pen injectors and autoinjector devices. The majority of these devices, however, stillemploy a needle. We will compete with companies operating in the needle-based drug delivery market. These companies include, but are not limited to, Becton,Dickinson and Company, Owen Mumford Ltd. and Ypsomed AG. Additional competition may come from companies focused on out-licensing needle-freetechnology including Antares Pharma Inc. and Bioject Inc., which have commercialized gas- or spring-driven, multiple-use, patient-filled, needle-free injectors,primarily for injecting human growth hormone or insulin for diabetes. Other companies may also be developing single-use, pre-filled, needle-free deliverysystems. We also may experience future21Table of Contentscompetition from alternative delivery systems which bypass the need for an injection, including inhaled, nasal, sublingual or transdermal technologies.DistributionWe primarily sell Sumavel DosePro to wholesale pharmaceutical distributors, who, in turn, sell the products to pharmacies, hospitals and othercustomers. Two wholesale pharmaceutical distributors, Cardinal Health, Inc. and McKesson Corporation, individually comprised 36.1% and 35.5%,respectively, of our total gross sales of Sumavel DosePro for the year ended December 31, 2012.We use a third-party logistics provider, Cardinal Health 105, Inc. (a/k/a Specialty Pharmaceutical Services), for key services related to logistics,warehousing and inventory management, distribution, contract administration and chargeback processing, accounts receivable management and call centermanagement. In addition, we utilize third parties to perform various other services for us relating to sample accountability and regulatory monitoring,including adverse event reporting, safety database management and other product maintenance services.ManufacturingSumavel DosePro and our DosePro technology are manufactured by contract manufacturers, component fabricators and secondary service providers.Suppliers of components, subassemblies and other materials are located in the United Kingdom, Germany, Ireland and the United States. All contractmanufacturers and component suppliers have been selected for their specific competencies in the manufacturing processes and materials that make up theDosePro system. FDA regulations require that materials be produced under current Good Manufacturing Practices, or cGMPs, or Quality System Regulations,or QSR, as required for the respective unit operation within the manufacturing process. Manufacturing equipment specific to the production of criticalDosePro components and assemblies was developed and purchased by us and the prior owners of the DosePro technology and is currently owned by us.We manage the supply chain for Sumavel DosePro, consisting of the DosePro system and the active pharmaceutical ingredient, or API, internally withexperienced operations professionals, including employees residing in the United Kingdom who oversee European contract manufacturing operations. We haveentered into supply agreements relating to Sumavel DosePro with our critical contract manufacturers, most component fabricators and secondary serviceproviders to secure commercial supply for Sumavel DosePro and expect manufacturing capacity to adequately support our projected Sumavel DoseProdemand through 2013. Each of these manufacturers and each other company that supplies, fabricates or manufactures any component used in our DoseProdevice is currently the sole qualified source of their respective components. If demand exceeds our expectation in 2014 and beyond, we may be required toexpand the capacity of some of our existing contract manufacturers and suppliers or qualify new manufacturers or suppliers.DosePro systems intended for clinical trials of DosePro-based products other than Sumavel DosePro are provided by using the existing manufacturinginfrastructure, supplemented with clinical scale aseptic fill/finish as appropriate for the stage and scale of the product under clinical development.Clinical materials for our Zohydro ER clinical program are manufactured by Alkermes (formerly Elan Drug Delivery, Inc.) under the terms of ourlicense agreement described under “Collaborations, Commercial and License Agreements” below. Further, an affiliate of Alkermes, Alkermes Pharma IrelandLimited, or APIL, will be the exclusive manufacturer and supplier (subject to certain exceptions) for Zohydro ER, if approved for commercialization, under theterms of our commercial manufacturing and supply agreement described below.The following are manufacturing and supply arrangements and agreements that we believe are material to the ongoing operation of our business.Patheon UK LimitedIn November 2008, we entered into a manufacturing services agreement with Patheon UK Limited, or Patheon, located in Swindon, United Kingdom, aspecialist in the aseptic fill/finish of injectables and other sterile pharmaceutical products. Under the terms of the agreement, Patheon serves as our exclusivemanufacturer for the aseptic capsule assembly, filling and inspection, final device assembly and packaging of Sumavel DosePro, as well as othermanufacturing and support services. Although we are not required to have any minimum quantity of Sumavel DosePro manufactured under the agreement, wehave agreed to provide Patheon with forecasts of the required volumes of Sumavel DosePro we need, and we are required to pay Patheon a monthlymanufacturing fee of £311,000, or approximately $502,000 (based on the exchange rate as of December 31, 2012), over the remaining term of the agreement,aggregating to £3,111,000, or approximately $5,025,000, over the remaining initial term of the agreement. Under the agreement, we are also required to paysupport and service fees, with the level of22Table of Contentsservice fees increasing if annual production exceeds a specified volume. The agreement has an initial five-year term, which expires October 31, 2013.In February 2013, we entered into an additional manufacturing services agreement, or the amended services agreement, with Patheon which will replacethe Company's original manufacturing services agreement upon its expiration on October 31, 2013. The amended services agreement has similar terms to theoriginal agreement and will expire on April 30, 2015. The parties may mutually agree in writing to renew the term for additional terms prior to the expiration ofthe then-current term.Under both the original manufacturing services agreement and the amended services agreement, either party may terminate the agreement (1) uponspecified written notice to the other party, (2) upon written notice if the other party has failed to remedy a material breach of any of its representations,warranties or other obligations under the agreement within a specified period following receipt of written notice of such breach, and (3) immediately uponwritten notice to the other party in the event that the other party is declared insolvent or bankrupt by a court of competent jurisdiction, a voluntary petition ofbankruptcy is filed in any court of competent jurisdiction by such other party or the agreement is assigned by such other party for the benefit of creditors.Patheon may also terminate the agreement upon specified written notice if we assign the agreement to certain specified parties.Nypro LimitedNypro Limited, located in Bray, Ireland, manufactures the actuator assemblies and injection molded components for our DosePro device pursuant topurchase orders. We do not currently have a long-term commercial supply agreement with Nypro.Nipro Glass, Germany AG (formerly MGlas AG)In May 2009, we entered into a commercial manufacturing and supply agreement with Nipro Glass, Germany AG, or Nipro Glass, located inMunnerstadt, Germany. Under the terms of the agreement, Nipro Glass is our exclusive supplier of the glass capsule that houses the sumatriptan API inSumavel DosePro (and will be the exclusive supplier of glass capsules for any future 0.5 mL DosePro product candidates or products). The agreement had aninitial three-year term, which expired in May 2012. Although the commercial manufacturing and supply agreement with Nipro Glass expired in May 2012, wehave continued to exclusively purchase glass capsule from Nipro Glass under the expired agreement terms. We are currently negotiating an extension of thecommercial manufacturing and supply agreement with Nipro Glass to continue the exclusive supply of the glass capsule.Dr. Reddy’s Laboratories, Inc.We are party to a supply agreement with Dr. Reddy’s Laboratories, Inc., or Dr. Reddy’s, which was originally entered into between Aradigm andDr. Reddy’s in September 2004. Under the terms of the agreement, Dr. Reddy’s, a global pharmaceutical company and supplier of bulk API located in India,agreed to supply us with the sumatriptan API for Sumavel DosePro at a specified price. Dr. Reddy’s has agreed to sell to us, and we agreed to purchase on anon-exclusive basis from Dr. Reddy’s, not less than 50% of our quarterly requirements for sumatriptan in the United States, Canada and the EuropeanUnion. The initial term of the agreement expires in 2020. The term of the agreement may be extended by us for successive one-year periods by written notice toDr. Reddy’s, unless Dr. Reddy’s gives written notice to us that it does not wish to extend the term. We may terminate the agreement upon written notice ifDr. Reddy’s is unable to deliver sufficient amounts of sumatriptan over a specified period of time. We may also terminate the agreement if we are negotiatingan agreement with a third party to commercialize such third party’s formulation of sumatriptan and such agreement would preclude us from sourcingsumatriptan from any party other than such third party. Either party may terminate the agreement upon written notice if the other party commits a materialbreach of its obligations and fails to remedy the breach within a specified time period, if the other party becomes insolvent or subject to bankruptcyproceedings, or where a force majeure event continues for a specified period of time.Alkermes Pharma Ireland LimitedIn November 2012, we entered into a commercial manufacturing and supply agreement for Zohydro ER finished commercial product with APIL. Underthe agreement, APIL will be the exclusive manufacturer and supplier to us (subject to certain exceptions) of Zohydro ER. We must purchase all of ourrequirements of Zohydro ER, subject to certain exceptions, from APIL.Under the agreement, we will provide APIL with an 18 month forecast on a monthly basis and with a three-year forecast on an annual basis forcommercial supply requirements of Zohydro ER. In each of the four months following the submission of the 18-month forecast, we are obligated to order thequantity of Zohydro ER specified in the forecast. APIL will use commercially reasonable efforts to supply the orders of Zohydro ER subject to the availabilityof the DEA quota for hydrocodone. APIL is not obligated to supply us with quantities of Zohydro ER in excess of forecasted amounts, but has agreed23Table of Contentsto use commercially reasonable efforts to do so. Further, we are obligated to purchase at least 75% of forecasted quarterly quantities of Zohydro ER fromAPIL, and are required to make compensatory payments if we do not purchase 100% of our requirements from APIL, subject to certain exceptions.If a failure to supply occurs under the agreement, other than a force majeure event, APIL must use commercially reasonable efforts to assist us intransferring production of Zohydro ER to either us or a third-party manufacturer, provided that such third party is not a technological competitor of APIL. In afailure to supply circumstance, we would be able to utilize (or sublicense to a third party who is not a technological competitor of APIL) the manufacturinglicense rights granted to us in the license agreement with Alkermes, until such time as APIL can resume supply of Zohydro ER.Either party may terminate the agreement by written notice if the other party commits a material breach of its obligations which is either incapable ofremedy or is not remedied within a specified period following receipt of written notice of such breach. Unless otherwise terminated due to a material breach, theagreement will continue until the expiry or termination of the license agreement with Alkermes described below.Collaborations, Commercial and License AgreementsMallinckrodt LLC Co-Promotion AgreementIn June 2012, we entered into a co-promotion agreement with Mallinckrodt. Under the terms of the agreement, Mallinckrodt was granted a co-exclusiveright (with us) to promote Sumavel DosePro to a mutually agreed prescriber audience in the United States. Mallinckrodt’s sales team began selling SumavelDosePro to its customer base of prescribers in August 2012. Mallinckrodt has committed to a minimum number of sales representatives for the initial term ofthe agreement, which runs through June 30, 2014, and can be extended by mutual agreement of the parties in additional six month increments. We remainresponsible for the manufacture, supply and distribution of commercial product for sale in the United States. In addition, we will supply product samples toMallinckrodt at an agreed upon transfer price and Mallinckrodt will reimburse us for all other promotional materials used.In partial consideration of Mallinckrodt’s sales efforts, we will pay Mallinckrodt a service fee on a quarterly basis that represents a specified fixedpercentage of net sales of prescriptions generated from Mallinckrodt’s prescriber audience over a baseline amount of net sales to the same prescriber audience(the Baseline Net Sales). In addition, upon completion of the co-promotion term on June 30, 2014 (unless otherwise extended), and only if the agreement is notterminated as a result of certain circumstances, we will be required to pay Mallinckrodt an additional tail payment calculated as a fixed percentage of theMallinckrodt net sales over the Baseline Net Sales during the first full 12 months following the last day of the term.Mallinckrodt may terminate the agreement with 60 days’ written notice in the event a material change is made to the net sales price of Sumavel DoseProthat would result in a material adverse effect to Mallinckrodt’s financial return (as defined in the agreement). Mallinckrodt may also terminate the agreement ifits request for the inclusion on its call list of a certain number of additional prescribers is not mutually agreed upon. Lastly, Mallinckrodt may terminate theagreement if a governmental authority takes action or raises an objection that prevents or would reasonably be expected to make it unlawful for Mallinckrodt toperform, or subjects Mallinckrodt to any penalty or claim, investigation or similar action related to, its obligations under the agreement, in the event of ourinability to meet trade demand for commercial product or where a third party files an action alleging that the making or selling of Sumavel DosePro infringesthe intellectual property rights of such third party.We may terminate the agreement with 60 days’ written notice if Mallinckrodt does not achieve an agreed-upon minimum sales effort.Either party may terminate the agreement if certain minimum net sales thresholds are not met for any quarter ending after December 31, 2012 or certainlevels of prescriptions are not met in a specified period. In addition, either party may terminate the agreement related to safety concerns, in the event of a changeof control of itself or the other party (excluding with respect to Mallinckrodt, any public spin-off of Mallinckrodt from its corporate parent Covidien), uponthe introduction of a generic product, in connection with the material breach of the other party’s obligations or if a bankruptcy event occurs under certaincircumstances.Astellas Co-Promotion AgreementIn July 2009, we entered into a co-promotion agreement with Astellas. Under the terms of the agreement, we granted Astellas the co-exclusive right (withus) to market and sell Sumavel DosePro in the United States (excluding Puerto Rico and the other territories and possessions of the United States). Under theagreement, both Astellas and we were obligated to collaborate and fund the marketing of Sumavel DosePro and to provide annual minimum levels of saleseffort directed at Sumavel DosePro. In December 2011, we entered into an amendment to the agreement, whereby the agreement terminated on March 31, 2012.Under the terms of the agreement, we were responsible for the manufacture, supply and distribution of24Table of Contentscommercial product for sale in the United States. In addition, we supplied product samples to Astellas, at an agreed upon transfer price.The target audience for Astellas’ sales efforts was primarily comprised historically of prescribers classified as primary care physicians (includinginternal medicine, family practice and general practice), OB/GYNs, emergency medicine physicians and urologists, or collectively the Astellas Segment. Thetarget audience for our sales effort was primarily comprised historically of neurologists and other prescribers of migraine medicines who fell outside theAstellas Segment. In addition, our representatives historically had the right to call upon a specified number of key prescribers within the Astellas Segment;conversely Astellas’ representatives historically had the right to call upon a specified number of neurologists. Under the amended agreement, beginning in thefirst quarter of 2012, we began to assume responsibility from Astellas for marketing Sumavel DosePro to selected high prescribing primary care physiciansand other Astellas-targeted physicians and professionals within the Astellas Segment pursuant to a promotion transition plan. We then assumed fullresponsibility for the commercialization of Sumavel DosePro following termination of the agreement in March 2012.Under the agreement, Astellas paid us upfront and milestone payments in an aggregate amount of $20.0 million. Astellas is not obligated to pay us anyadditional milestone payments. In consideration for Astellas’ performance of its commercial efforts, we were required to pay Astellas a service fee on aquarterly basis that represents a fixed percentage of between 45% and 55% of Sumavel DosePro net sales to the Astellas Segment. Astellas was notcompensated for Sumavel DosePro sales to neurologists, any other prescribers not included in the Astellas Segment or for non-retail sales. In addition,following completion of the co-promotion term in March 2012, we are required to pay Astellas two additional annual tail payments in July 2013 and July 2014calculated as decreasing fixed percentages (ranging from a mid-twenties down to a mid-teen percentage) of net sales in the Astellas Segment during the 12months ending March 31, 2012.Durect Corporation Development and License AgreementIn July 2011, we entered into a development and license agreement with Durect. Under the terms of the agreement, we are responsible for the clinicaldevelopment and commercialization of Relday. Durect is responsible for non-clinical, formulation and chemistry, manufacturing and controls, or CMC,development responsibilities. Durect will be reimbursed by us for its research and development efforts on the product.We paid a non-refundable upfront fee to Durect of $2.25 million in July 2011. We are obligated to pay Durect up to $103.0 million in total futuremilestone payments with respect to the product subject to and upon the achievement of various development, regulatory and sales milestones. We are alsorequired to pay a mid single-digit to low double-digit percentage patent royalty on annual net sales of the product determined on a jurisdiction-by-jurisdictionbasis. Further, until an NDA for Relday has been filed in the United States, we are obligated to spend no less than $1.0 million in external expenses on thedevelopment of Relday in any trailing twelve-month period beginning in July 2012. The patent royalty term is equal to the later of the expiration of all Durecttechnology patents or joint patent rights in a particular jurisdiction, the expiration of marketing exclusivity rights in such jurisdiction, or 15 years from firstcommercial sale in such jurisdiction. After the patent royalty term, we will continue to pay royalties on annual net sales of the product at a reduced rate for solong as we continue to sell the product in the jurisdiction. We are also required to pay to Durect a tiered percentage of fees received in connection with anysublicense of the licensed rights.Durect granted to us an exclusive worldwide license, with sub-license rights, to Durect intellectual property rights related to Durect’s proprietarypolymeric and non-polymeric controlled-release formulation technology to make and have made, use, offer for sale, sell and import risperidone products,where risperidone is the sole active agent, for administration by injection in the treatment of schizophrenia, bipolar disorder or other psychiatric relateddisorders in humans. Durect retains the right to supply our Phase 3 clinical trial and commercial product requirements on the terms set forth in the agreement.Durect may terminate the agreement with respect to specific countries if we fail to advance the development of the product in such country within aspecified time period, either directly or through a sublicensee. In addition, either party may terminate the agreement upon insolvency or bankruptcy of the otherparty, upon written notice of a material uncured breach or if the other party takes any act that attempts to impair such other party’s relevant intellectualproperty rights. We may terminate the agreement upon written notice if during the development or commercialization of the product, the product becomessubject to one or more serious adverse drug experiences or if either party receives notice from a regulatory authority, independent review committee, data safetymonitory board or other similar body alleging significant concern regarding a patient safety issue and, as a result, we believe the long-term viability of theproduct would be seriously impacted. We may also terminate the agreement with or without cause, at any time upon prior written notice.Desitin License and Distribution AgreementIn March 2008, we entered into a licensing and distribution agreement with Desitin. Under the terms of the agreement, we granted Desitin the exclusiveright under our intellectual property rights related to Sumavel DosePro to develop, use,25Table of Contentsdistribute, sell, offer for sale, and import Sumavel DosePro and any potential modified versions of Sumavel DosePro in the European Union, Norway,Switzerland and Turkey. Under the agreement, Desitin has the right, but with the exception of Germany not the obligation, at its own expense, to develop,obtain marketing approval and commercialize Sumavel DosePro in these territories. In addition, Desitin has a right of first refusal on the commercialization ofany potential line extensions of Sumavel DosePro. We will manufacture and supply the product to Desitin for commercial sale in the licensed territories. Desitinwill pay us a specified transfer price for commercial product and a low single-digit percentage royalty on net sales of the product for an initial term, on acountry to country basis until the greater of ten years after the first commercial sale in that country or the expiration, in such country, of the last patent right toexpire under the licensed technology. After the initial term, in countries where the product has had commercial sales, the agreement will be automaticallyrenewed on a country-by-country basis by additional successive specified periods unless it is terminated by either party giving a specified prior written notice.Either party may terminate the agreement upon a material uncured breach, insolvency or bankruptcy, adverse event which affects the other party’sability to perform its obligations under the agreement or upon the enactment of any law, decree or regulation which would impair or restrict either our right, titleor interest in the intellectual property, or Desitin’s right to market or distribute the product in accordance with the agreement, either party’s right to terminate orelect not to renew the agreement as provided therein, or our right to collect the purchase price or royalties under the agreement. Either party may also terminatethe agreement by giving 90 days prior written notice if continued marketing in the relevant territories is no longer possible due to advice from a relevantregulatory authority or clinical review board in such countries or due to serious adverse events caused by Sumavel DosePro anywhere in the world. Desitinmay terminate the agreement upon a competent regulatory authority in the territories either imposing therapeutic indications not acceptable to Desitin orrequiring the product to be marketed as a generic drug. Desitin also may terminate the agreement if more than one study regarding bioequivalence is required toobtain marketing authorization. We may terminate the agreement upon a specified prior written notice if in each of a specified number of consecutive calendaryears Desitin fails to meet a specified percentage of sales forecasts to be mutually agreed upon under the agreement, if Desitin takes any act impairing ourintellectual property rights or if Desitin ceases to carry on business in the marketing of pharmaceutical products in the territories. Desitin may also terminatethe agreement, upon written notice, if the price at which we supply our product to Desitin exceeds a specified threshold.Alkermes License Agreement (formerly Elan Pharma International Limited)In November 2007, we entered into a license agreement with Alkermes, which was amended in September 2009. Under the terms of this licenseagreement, Alkermes granted to us an exclusive license in the United States and its possessions and territories, with defined sub-license rights to third partiesother than certain technological competitors of Alkermes, to certain Alkermes intellectual property rights related to our Zohydro ER product candidate. Theagreement grants us the exclusive right under certain Alkermes patents and patent applications to import, use, offer for sale and sell oral controlled-releasecapsule or tablet formulations of hydrocodone, where hydrocodone is the sole active ingredient, for oral prescriptions in the treatment or relief of pain, painsyndromes or pain associated with medical conditions or procedures in the United States. This right enables us to exclusively develop and sell Zohydro ER inthe United States. Alkermes has retained the exclusive right to take action in the event of infringement or threatened infringement by a third party of Alkermes’intellectual property rights under the agreement. We have the right to pursue an infringement claim against the alleged infringer should Alkermes decline to takeor continue an action.Under the terms of the agreement, the parties agreed that, subject to the negotiation of a supply agreement with Alkermes, or an affiliate of Alkermes,would have the sole and exclusive right to manufacture and supply finished commercial product of Zohydro ER to us under agreed upon financial terms. Asdiscussed above, we entered into a commercial manufacturing and supply agreement with an affiliate of Alkermes in November 2012.Alkermes also granted to us, in the event that Alkermes is unwilling or unable to manufacture or supply commercial product to us, a non-exclusivelicense to make product under Alkermes’ intellectual property rights. This non-exclusive license also includes the right to sublicense product manufacturing toa third party, other than certain technological competitors of Alkermes.Under the license agreement, we paid an upfront fee to Alkermes of $0.5 million. We paid additional milestone payments to Alkermes in the amount of$0.8 million in August 2011 in connection with the completion of the treatment phase of our pivotal efficacy Phase 3 clinical trial, Study 801, and $1.0million upon submission of the first NDA to the FDA in May 2012. We may be obligated to pay Alkermes up to $2.8 million in total future milestonepayments with respect to Zohydro ER depending upon the achievement of various development and regulatory events. These future milestone paymentsinclude a payment of $0.8 million upon successful completion of an FDA pre-approval inspection of the manufacturing facility and a payment of $2.0 millionupon the first NDA approval of Zohydro ER. We are also required to pay a mid single-digit percentage royalty on net sales of the product for an initial royaltyterm equal to the longer of the expiration of Alkermes’ patents covering the product in the United States, or 15 years after commercial launch, if Alkermes doesnot have patents covering the product in the United States. After the initial royalty term, the license agreement will continue automatically for three-year rollingperiods26Table of Contentsduring which we will continue to pay royalties on net sales of the product at a reduced low single-digit percentage rate in accordance with the terms of thelicense agreement.Either party may terminate the agreement upon a material, uncured default or certain insolvency events of the other party or upon 12 months’ writtennotice prior to the end of the initial royalty term or any additional three-year rolling period. Alkermes may terminate the agreement in the event that we fail tomeet specified development and commercialization milestones within specified time periods. We may terminate this agreement if the sale of Zohydro ER isprohibited by regulatory authorities, or if, despite commercially reasonable efforts, we are unable to obtain regulatory approval for Zohydro ER. We may alsoterminate the agreement, with or without cause, at any time upon six months’ written notice prior to NDA approval for Zohydro ER and at any time upon12 months’ prior written notice after NDA approval for Zohydro ER.Aradigm Corporation Asset Purchase AgreementIn August 2006, we entered into an asset purchase agreement with Aradigm. Under the terms of the agreement, Aradigm assigned and transferred to usall of its right, title and interest to tangible assets and intellectual property related to the DosePro (formerly known as Intraject) needle-free drug delivery system.Aradigm also granted to us a non-exclusive, fully paid, worldwide, perpetual, irrevocable, transferable, sublicensable license under all other intellectualproperty of Aradigm that was owned, controlled or employed by Aradigm prior to the closing of the asset purchase and that is necessary or useful to thedevelopment, manufacture or commercialization of the DosePro delivery system. Aradigm also retained a worldwide, royalty-free, non-exclusive license, with aright to sublicense, under all transferred intellectual property rights solely for purposes of the pulmonary field, and we granted Aradigm a license under otherintellectual property rights solely for use in the pulmonary field.At the time of the closing of the asset purchase, we paid to Aradigm a sum of $4.0 million as consideration. Under the agreement, we also paid asubsequent milestone payment to Aradigm of $4.0 million upon the U.S. commercialization of Sumavel DosePro in February 2010. We are also required to paya 3% royalty on global net sales of Sumavel DosePro, by us or one of our licensees, if any, until the expiration of the last valid claim of the transferred patentscovering the manufacture, use, or sale of the product.In addition, in the event we or one of our future licensees, if any, commercializes a non-sumatriptan product in the DosePro delivery system, we will berequired to pay Aradigm, at our election, either a 3% royalty on net sales of each non-sumatriptan product commercialized, or a fixed low-twenties percentageof the royalty revenues received by us from the licensee, if any, until the later of the ten year anniversary of the first commercial sale of the product in theUnited States or the expiration of the last valid claim of the transferred patents covering the manufacture, use or sale of the product. Royalty revenues underthis agreement include, if applicable, running royalties on the net sales of non-sumatriptan products, license or milestone fees not allocable to development orother related costs incurred by us, payments in consideration of goods or products in excess of their cost, or payments in consideration for equity in excess ofthe then fair market value of the equity.Intellectual PropertyOur success will depend to a significant extent on our ability to obtain, expand and protect our intellectual property estate, enforce patents, maintaintrade secret and trademark protection and operate without infringing the proprietary rights of other parties.Needle-free Drug Delivery TechnologiesSumavel DosePro is a drug-device combination that subcutaneously delivers sumatriptan utilizing our proprietary needle-free drug delivery system totreat migraine and cluster headache. Our patent portfolio is directed to various types and components of needle-free and other drug delivery systems. As ofFebruary 1, 2013, we have 20 issued U.S. patents, 12 pending U.S. patent applications, 49 issued foreign patents and 22 pending foreign patentapplications. Of the above, we have 12 issued U.S. patents, 4 pending U.S. patent applications, 40 issued foreign patents and 4 pending foreign patentapplications relating to various aspects of Sumavel DosePro and our DosePro technology.Our issued U.S. Patent No. 5,891,086 covers a particular actuator mechanism forming a part of the needleless injector device, and is expected to expirein 2014. We have a corresponding patent in Canada, and two each in Germany, Spain, France, United Kingdom, Italy and Japan, which are all expected toexpire in 2013. Our issued U.S. Patent No. 5,957,886 claims a needleless injector system using a viscous damping medium, and is expected to expire in2016. We have corresponding patents (one each in Canada, Germany, France, United Kingdom and Japan), which are all expected to expire in 2015. Ourissued U.S. Patent No. 6,135,979 covers a needleless injector with particular safety mechanisms, and is expected to expire in 2017. We have correspondingpatents in Germany, France, United Kingdom and Japan, which are all expected to expire in 2016. Our issued U.S. Patents Nos. 7,776,007 and 8,287,489each cover devices with a cap and latch mechanism, and are expected to expire in 2026 and 2024, respectively. We have a corresponding patent in Japan. Ourissued U.S. Patent Nos. 7,901,385 and27Table of Contents8,267,903 encompass various embodiments of the casing for enclosing the injection devices, and are expected to expire in 2026 and 2023. We havecorresponding patents in Australia, Canada, Germany, Spain, France, United Kingdom, Italy, and Japan. Our issued U.S. Patent Nos. 8,118,771,8,241,243 and 8,241,244 correspond to methods of reducing breakage of glass capsules used in the device, and are expected to expire in 2023, 2025 and2022, respectively. We have corresponding patents in Canada, Germany, France, United Kingdom and Japan. We have two U.S. Patents, Nos. 7,231,945and 7,320,346, related to methods of proof testing glass drug containers, such as those used in the manufacture of Sumavel DosePro, which both expire in2023. U.S. Patents 5,891,086; 5,957,886; 6,135,979; 7,776.007; 7,901,385; 8,267,903; 8,118,771; 8,241,243; 8,241,244; and 8,287,489 are listedin the FDA Orange Book for Sumavel DosePro.We also have three U.S. Patents Nos., 7,150,297, 6,554,818 and 6,280,410, and one each in Canada and Japan, and two each in Germany, Franceand the United Kingdom corresponding to methods of filling needle-free injector capsules and the filled capsules, such as those used in the manufacture ofSumavel DosePro. These patents, and applications if they issue, are expected to expire in 2022, 2017 and 2017, respectively.We also have three U.S. Patents Nos. 6,174,304, 6,681,810 and 6,251,091, and one in Japan corresponding to needle-free injector drug capsules aswell as methods and adaptors for filling capsules with liquid drug, such as those used in the manufacture of Sumavel DosePro. These patents are expected toexpire in 2022, 2025 and 2016, respectively.Our remaining issued patents, pending U.S. patent applications and pending foreign patent applications are not currently used in Sumavel DosePro, butmay be used with alternate versions of, or future product candidates utilizing, our DosePro technology.We do not have patent protection for Sumavel DosePro in a significant number of countries, including large territories such as India, Russia and China,and accordingly we are not able to use the patent system to provide for market exclusivity in those countries. Additionally, the ten U.S. patents listed in theFDA Orange Book for Sumavel DosePro expire on various dates between 2014 and 2026. Upon expiration, we will lose certain advantages that come withOrange Book listing of patents and will no longer be able to prevent others in the U.S. from practicing the inventions claimed by the nine patents.Zohydro ERZohydro ER is an oral version of an opioid pain reliever, which is designed to offer an extended-release profile that utilizes Alkermes’ proprietarySODAS delivery system. Our in-licensed patents from Alkermes relating to Zohydro ER include one issued U.S. Patent No. 6,902,742 and a pending U.S.Patent Application No. 11,372,857. The license agreement is described above in further detail. The issued patent is expected to expire in November 2019.Absent any award of patent term adjustments or extensions, the patent application, if it issues, is not expected to expire later than this date.ReldayWith respect to Relday, Zogenix has licensed a number of United States and foreign patent applications from Durect that are intended to cover theformulation of Relday and its delivery. However, as the formulation and delivery of Relday are the subject of on-going research it remains uncertain if theDurect patents or applications, should they issue as patents, will cover the final formulation or delivery of Relday.Government RegulationFDA Approval ProcessIn the United States, pharmaceutical products are subject to extensive regulation by the FDA. The FFDCA and other federal and state statutes andregulations, govern, among other things, the research, development, testing, manufacture, storage, recordkeeping, approval, labeling, promotion andmarketing, distribution, post-approval monitoring and reporting, sampling, and import and export of pharmaceutical products. Failure to comply withapplicable FDA or other requirements may subject a company to a variety of administrative or judicial sanctions, such as the FDA’s refusal to approvepending applications, a clinical hold, warning letters, recall or seizure of products, partial or total suspension of production, withdrawal of the product fromthe market, injunctions, fines, civil penalties or criminal prosecution.FDA approval is required before any new unapproved drug or dosage form, including a new use of a previously approved drug, can be marketed in theUnited States. The process required by the FDA before a drug may be marketed in the United States generally involves:•completion of pre-clinical laboratory and animal testing and formulation studies in compliance with the FDA’s current good laboratory practice, or CGLP,regulations;28Table of Contents•submission to the FDA of an IND for human clinical testing which must become effective before human clinical trials may begin in the United States;•approval by an independent institutional review board, or IRB, at each clinical trial site before each trial may be initiated;•performance of adequate and well-controlled human clinical trials in accordance with current good clinical practices, or CGCP, to establish the safety andefficacy of the proposed drug product for each intended use;•satisfactory completion of an FDA pre-approval inspection of the facility or facilities at which the product is manufactured to assess compliance with theFDA’s cGMP regulations, and for devices and device components, the QSR, and to assure that the facilities, methods and controls are adequate topreserve the drug’s identity, strength, quality and purity;•submission to the FDA of an NDA;•satisfactory completion of a potential review by an FDA advisory committee, if applicable; and•FDA review and approval of the NDA.The pre-clinical and clinical testing and approval process requires substantial time, effort and financial resources, and we cannot be certain that anyapprovals for our product candidates will be granted on a timely basis, if at all. Pre-clinical tests include laboratory evaluation of product chemistry,formulation, stability and toxicity, as well as animal studies to assess the characteristics and potential safety and efficacy of the product. The results of pre-clinical tests, together with manufacturing information, analytical data and a proposed clinical trial protocol and other information, are submitted as part of anIND to the FDA. Some pre-clinical testing may continue even after the IND is submitted. The IND automatically becomes effective 30 days after receipt by theFDA, unless the FDA, within the 30-day time period, raises concerns or questions relating to one or more proposed clinical trials and places the clinical trial ona clinical hold, including concerns that human research subjects will be exposed to unreasonable health risks. In such a case, the IND sponsor and the FDAmust resolve any outstanding concerns before the clinical trial can begin. As a result, our submission of an IND may not result in FDA authorization tocommence a clinical trial. A separate submission to an existing IND must also be made for each successive clinical trial conducted during productdevelopment.Further, an independent IRB, covering each site proposing to conduct the clinical trial must review and approve the plan for any clinical trial andinformed consent information for subjects before the trial commences at that site and it must monitor the study until completed. The FDA, the IRB, or thesponsor may suspend a clinical trial at any time on various grounds, including a finding that the subjects or patients are being exposed to an unacceptablehealth risk or for failure to comply with the IRB’s requirements, or may impose other conditions.As a separate amendment to an IND, a sponsor may submit a request for an SPA from the FDA. Under the SPA procedure, a sponsor may seek theFDA’s agreement on the proposed design and size of a clinical trial intended to form the primary basis for determining a product’s efficacy. Upon specificrequest by a sponsor, the FDA will evaluate the protocol and respond to a sponsor’s questions regarding, among other things, primary efficacy endpoints, trialconduct and data analysis within 45 days of receipt of the request with the goal of reaching an agreement that the Phase III trial protocol design, clinicalendpoints, and statistical analyses are acceptable to support regulatory approval of the drug product candidate with respect to effectiveness for the indicationstudied. Under an SPA, the FDA agrees to not later alter its position with respect to adequacy of the design, execution, or analyses of the clinical trial intendedto form the primary basis of an effectiveness claim in an NDA, without the sponsor’s agreement, unless the FDA identifies a substantial scientific issueessential to determining the safety or efficacy of the drug after testing begins. Moreover, any change to a study protocol after agreement with the FDA is reachedcan invalidate an SPA. Agreements and disagreements between the FDA and the sponsor regarding an SPA are documented by the FDA in an SPA letter to thesponsor or in the minutes of a meeting between the sponsor and the FDA.Clinical trials involve the administration of the investigational new drug to human subjects under the supervision of qualified investigators inaccordance with GCP requirements, which include the requirement that all research subjects provide their informed consent in writing for their participation inany clinical trial. Sponsors of clinical trials generally must register and report, at the NIH-maintained website ClinicalTrials.gov, key parameters of certainclinical trials. For purposes of an NDA submission and approval, human clinical trials are typically conducted in the following sequential phases, whichmay overlap or be combined:•Phase 1: The drug is initially introduced into healthy human subjects or patients and tested for safety, dose tolerance, absorption, metabolism,distribution and excretion and, if possible, to gain an early indication of its effectiveness.•Phase 2: The drug is administered to a limited patient population to identify possible adverse effects and safety risks, to preliminarily evaluate theefficacy of the product for specific targeted indications and to determine dose tolerance and optimal dosage. Multiple Phase 2 clinical trials may beconducted by the sponsor to obtain information prior to beginning larger and more extensive Phase 3 clinical trials.29Table of Contents•Phase 3: These are commonly referred to as pivotal studies. When Phase 2 evaluations demonstrate that a dose range of the product appears to beeffective and has an acceptable safety profile, Phase 3 trials are undertaken in large patient populations to further evaluate dosage, to obtain additionalevidence of clinical efficacy and safety in an expanded patient population at multiple, geographically-dispersed clinical trial sites, to establish the overallrisk-benefit relationship of the drug and to provide adequate information for the labeling of the drug.•Phase 4: In some cases, the FDA may condition approval of an NDA for a product candidate on the sponsor’s agreement to conduct additional clinicaltrials to further assess the drug’s safety and effectiveness after NDA approval. Such post-approval trials are typically referred to as Phase 4 studies.The results of product development, pre-clinical studies and clinical trials are submitted to the FDA as part of an NDA. NDAs must also containextensive information relating to the product’s pharmacology, CMC and proposed labeling, among other things.For some drugs, especially controlled substances, the FDA may require a REMS which could include measures imposed by the FDA such asprescribing restrictions, requirements for post-marketing studies or certain restrictions on distribution and use. Under federal law, the submission of mostNDAs is additionally subject to a substantial application user fee, and the manufacturer and/or sponsor under an approved NDA are also subject to annualproduct and establishment user fees. The FDA has 60 days from its receipt of an NDA to determine whether the application will be accepted for filing basedon the agency’s threshold determination that it is sufficiently complete to permit substantive review. The FDA may request additional information rather thanaccept an NDA for filing. In this event, the NDA must be resubmitted with the additional information and is subject to payment of additional user fees. Theresubmitted application is also subject to review before the FDA accepts it for filing.Once the submission has been accepted for filing, the FDA begins an in-depth substantive review. Under the PDUFA, the FDA agrees to specificperformance goals for NDA review time through a two-tiered classification system, Standard Review and Priority Review. Standard Review NDAs have a goalof being completed within a ten-month timeframe. A Priority Review designation is given to drugs that offer major advances in treatment, or provide a treatmentwhere no adequate therapy exists. The goal for completing a Priority Review is six months. It is likely that our product candidates will be granted a StandardReview. The review process may be extended by the FDA for three additional months to consider certain information or obtain clarification regardinginformation already provided in the submission, or for other reasons. In February 2013, the FDA informed us that we were unlikely to receive an action letterfor our NDA for Zohydro ER by the PDUFA target action date of March 1, 2013. The FDA has not provided us with information as to the reason for thedelay, but has indicated that the delay would likely be brief and may last only several weeks. We have not been informed of any deficiencies in the NDA forZohydro ER during the review process to date.The FDA may refer applications for novel drug products or drug products which present difficult questions of safety or efficacy to an advisorycommittee for review, evaluation and recommendation as to whether the application should be approved and under what conditions. In December 2012, theFDA convened an advisory committee that voted 2-11 (with 1 abstention) against the approval of Zohydro ER. The FDA is not bound by the recommendationof an advisory committee, but it considers such recommendations carefully when making decisions. The final decision regarding NDA approval is made bythe FDA. In addition, for combination products like Sumavel DosePro or future product candidates utilizing the DosePro technology, the FDA’s review mayinclude the participation of both the FDA’s Center for Drug Evaluation and Research and the FDA’s Center for Devices and Radiological Health, which maycomplicate or prolong the review.Before approving an NDA, the FDA may inspect the facility or facilities where the product is manufactured. The FDA will not approve an applicationunless it determines that the manufacturing processes and facilities are in compliance with cGMP, and if applicable, QSR, requirements and are adequate toassure consistent production of the product within required specifications. Additionally, the FDA will typically inspect one or more clinical sites to assurecompliance with GCP before approving an NDA. During 2012, the FDA inspected two clinical sites where Zohydro ER studies were conducted and did notissue any inspection observations.After the FDA evaluates the NDA and, in some cases, the related manufacturing facilities, it may issue an approval letter or a CRL to indicate that thereview cycle for an application is complete and that the application is not ready for approval. CRLs generally outline the deficiencies in the submission andmay require substantial additional testing or information in order for the FDA to reconsider the application. Even with submission of this additionalinformation, the FDA ultimately may decide that the application does not satisfy the regulatory criteria for approval. If and when the deficiencies have beenaddressed to the FDA’s satisfaction, the FDA will typically issue an approval letter. An approval letter authorizes commercial marketing of the drug withspecific prescribing information for specific indications.30Table of ContentsOnce issued, the FDA may withdraw product approval if ongoing regulatory requirements are not met or if safety problems are identified after theproduct reaches the market. In addition, the FDA may require post-approval testing, including Phase 4 studies, and surveillance programs to monitor the effectof approved products which have been commercialized, and the FDA has the authority to prevent or limit further marketing of a product based on the resultsof these post-marketing programs. Drugs may be marketed only for the approved indications and in accordance with the provisions of the approved label,and, even if the FDA approves a product, it may limit the approved indications for use for the product or impose other conditions, including labeling ordistribution restrictions or other risk-management mechanisms. Further, if there are any modifications to the drug, including changes in indications, labeling,or manufacturing processes or facilities, we may be required to submit and obtain FDA approval of a new or supplemental NDA, which may require us todevelop additional data or conduct additional pre-clinical studies and clinical trials.Post-Approval RequirementsOnce an NDA is approved, a product will be subject to pervasive and continuing regulation by the FDA, including, among other things, requirementsrelating to drug/device listing, recordkeeping, periodic reporting, product sampling and distribution, advertising and promotion and reporting of adverseexperiences with the product. There also are extensive U.S. Drug Enforcement Agency, or DEA, regulations applicable to marketed controlled substances.In addition, drug manufacturers and other entities involved in the manufacture and distribution of approved drugs are required to register theirestablishments with the FDA and state agencies, and are subject to periodic unannounced inspections by the FDA and these state agencies for compliance withcGMP requirements. Changes to the manufacturing process are strictly regulated and generally require prior FDA approval before being implemented. FDAregulations also require investigation and correction of any deviations from cGMP and impose reporting and documentation requirements upon us and anythird-party manufacturers that we may decide to use. Accordingly, manufacturers must continue to expend time, money, and effort in the area of productionand quality control to maintain cGMP compliance.Once an approval is granted, the FDA may withdraw the approval if compliance with regulatory requirements and standards is not maintained or ifproblems occur after the product reaches the market. Later discovery of previously unknown problems with a product, including adverse events ofunanticipated severity or frequency, or with manufacturing processes, or failure to comply with regulatory requirements, may result in, among other things:•restrictions on the marketing or manufacturing of the product, complete withdrawal of the product from the market or product recalls;•fines, warning letters or holds on post-approval clinical trials;•refusal of the FDA to approve pending applications or supplements to approved applications, or suspension or revocation of product license approvals;•product seizure or detention, or refusal to permit the import or export of products; or•injunctions or the imposition of civil or criminal penalties.The FDA strictly regulates marketing, labeling, advertising and promotion of products that are placed on the market. While physicians may prescribefor off label uses, manufacturers may only promote for the approved indications and in accordance with the provisions of the approved label. The FDA andother agencies actively enforce the laws and regulations prohibiting the promotion of off label uses, and a company that is found to have improperly promotedoff label uses may be subject to significant liability.In addition, the distribution of prescription pharmaceutical products is subject to the Prescription Drug Marketing Act, or PDMA, which regulates thedistribution of drugs and drug samples at the federal level, and sets minimum standards for the registration and regulation of drug distributors by the states.Both the PDMA and state laws limit the distribution of prescription pharmaceutical product samples and impose requirements to ensure accountability indistribution, including a drug pedigree which tracks the distribution of prescription drugs.The FDA may require post-approval studies and clinical trials if the FDA finds that scientific data, including information regarding related drugs, deemit appropriate. The purpose of such studies would be to assess a known serious risk or signals of serious risk related to the drug or to identify an unexpectedserious risk when available data indicate the potential for a serious risk. The FDA may also require a labeling change if it becomes aware of new safetyinformation that it believes should be included in the labeling of a drug.The FDA also has the authority to require a REMS to ensure the safe use of the drug. In determining whether a REMS is necessary, FDA must considerthe size of the population likely to use the drug, the seriousness of the disease or condition to be treated, the expected benefit of the drug, the duration oftreatment, the seriousness of known or potential adverse events, and31Table of Contentswhether the drug is a new molecular entity. If the FDA determines a REMS is necessary, the drug sponsor must agree to the REMS plan at the time ofapproval. A REMS may be required to include various elements, such as a medication guide or patient package insert, a communication plan to educate healthcare providers of the drug’s risks, limitations on who may prescribe or dispense the drug, or other measures that the FDA deems necessary to assure the safeuse of the drug. In addition, the REMS must include a timetable to assess the strategy at 18 months, three years, and seven years after the strategy’s approval.The FDA may also impose a REMS requirement on a drug already on the market if the FDA determines, based on new safety information, that a REMS isnecessary to ensure that the drug’s benefits outweigh its risks.In February 2009, the FDA informed drug manufacturers that it will require a REMS for sustained release opioid drug products. Subsequently, theFDA initiated efforts to develop a new standardized REMS for these opioid medications to ensure their safe use. An extended-release formulation ofhydrocodone would also be required to have a REMS. The FDA’s authority to take this action is based on risk management and post market safetyprovisions within the Food and Drug Administration Amendments Act, or FDAAA. In April 2011, after several public meetings, the FDA released the finalREMS for extended-release opioids. The REMS consists of a Medication Guide, elements to assure safe use (including an education program for prescribersand materials for prescribers to educate patients), and a timetable for submission of assessments of at least six months, 12 months, and annually after theREMS is approved. The FDA recommends that sponsors of extended-release opioids cooperate to establish a single monitoring system for these assessments.We submitted a REMS at the time of the NDA submission for Zohydro ER, which is consistent with current FDA and industry-wide guidelines for extended-release opioid products, and have also provided the FDA-approved opioid analgesic REMS as a supplement to our NDA submission in response to the FDA'srequest.With respect to post-market product advertising and promotion, the FDA imposes a number of complex regulations on entities that advertise andpromote pharmaceuticals, which include, among others, standards for direct-to-consumer advertising, off-label promotion, industry-sponsored scientific andeducational activities, and promotional activities involving the internet. The FDA has very broad enforcement authority under the FFDCA, and failure to abideby these regulations can result in penalties, including the issuance of a warning letter directing entities to correct deviations from FDA standards, a requirementthat future advertising and promotional materials be pre-cleared by the FDA, and state and federal civil and criminal investigations and prosecutions.Section 505(b)(2) New Drug ApplicationsAs an alternate path to FDA approval for modifications to formulations or uses of products previously approved by the FDA, an applicant may submitan NDA under Section 505(b)(2) of the FFDCA. Section 505(b)(2) was enacted as part of the Drug Price Competition and Patent Term Restoration Act of1984, also known as the Hatch-Waxman Amendments, and permits the filing of an NDA where at least some of the information required for approval comesfrom studies not conducted by or for the applicant and for which the applicant has not obtained a right of reference. The applicant may rely upon publishedliterature and the FDA’s findings of safety and effectiveness based on certain pre-clinical or clinical studies conducted for an approved product. The FDA mayalso require companies to perform additional studies or measurements to support the change from the approved product. The FDA may then approve the newproduct candidate for all or some of the label indications for which the referenced product has been approved, as well as for any new indication sought by theSection 505(b)(2) applicant.To the extent that a Section 505(b)(2) NDA relies on studies conducted for a previously approved drug product, the applicant is required to certify to theFDA concerning any patents listed for the approved product in the Orange Book. Specifically, the applicant must certify for each listed patent that (1) therequired patent information has not been filed; (2) the listed patent has expired; (3) the listed patent has not expired, but will expire on a particular date andapproval is sought after patent expiration; or (4) the listed patent is invalid, unenforceable or will not be infringed by the new product. A certification that thenew product will not infringe the already approved product’s listed patent or that such patent is invalid is known as a Paragraph IV certification. If theapplicant does not challenge the listed patents through a Paragraph IV certification, the Section 505(b)(2) NDA application will not be approved until all thelisted patents claiming the referenced product have expired. The Section 505(b)(2) NDA application also will not be accepted or approved until any non-patentexclusivity, such as exclusivity for obtaining approval of a New Chemical Entity, listed in the Orange Book for the referenced product, has expired.If the 505(b)(2) NDA applicant has provided a Paragraph IV certification to the FDA, the applicant must also send notice of the Paragraph IVcertification to the referenced NDA and patent holders once the 505(b)(2) NDA has been accepted for filing by the FDA. The NDA and patent holders maythen initiate a legal challenge to the Paragraph IV certification. Under the FFDCA, the filing of a patent infringement lawsuit within 45 days of their receipt of aParagraph IV certification in most cases automatically prevents the FDA from approving the Section 505(b)(2) NDA for 30 months, or until a court decisionor settlement finding that the patent is invalid, unenforceable or not infringed, whichever is earlier. The court also has the ability to shorten or lengthen the30 month stay if either party is found not to be reasonably cooperating in expediting the litigation.32Table of ContentsThus, the Section 505(b)(2) applicant may invest a significant amount of time and expense in the development of its product only to be subject to significantdelay and patent litigation before its product may be commercialized.The 505(b)(2) NDA applicant also may be eligible for its own regulatory exclusivity period, such as three-year exclusivity. The first approved505(b)(2) applicant for a particular condition of approval, or change to a marketed product, such as a new extended release formulation for a previouslyapproved product, may be granted three-year Hatch-Waxman exclusivity if one or more clinical studies, other than bioavailability or bioequivalence studies,was essential to the approval of the application and was conducted/sponsored by the applicant. Should this occur, the FDA would be precluded from makingeffective any other application for the same condition of use or for a change to the drug product that was granted exclusivity until after that three-yearexclusivity period has run. Additional exclusivities may also apply.Additionally, the 505(b)(2) NDA applicant may have relevant patents in the Orange Book, and if it does can initiate patent infringement litigationagainst those applicants that challenge such patents, which could result in a thirty-month stay delaying those applicants.DEA RegulationOne of our product candidates, Zohydro ER, will be regulated as a “controlled substance” as defined in the Controlled Substances Act of 1970, orCSA, which establishes registration, security, recordkeeping, reporting, storage, distribution and other requirements administered by the DEA. The DEA isconcerned with the control of handlers of controlled substances, and with the equipment and raw materials used in their manufacture and packaging, in orderto prevent loss and diversion into illicit channels of commerce.The DEA regulates controlled substances as Schedule I, II, III, IV or V substances. Schedule I substances by definition have no established medicinaluse, and may not be marketed or sold in the United States. A pharmaceutical product may be listed as Schedule II, III, IV or V, with Schedule II substancesconsidered to present the highest risk of abuse and Schedule V substances the lowest relative risk of abuse among such substances. Zohydro ER, ourproprietary oral, extended-release version of hydrocodone, if approved, is expected to be listed by the DEA as a Schedule II controlled substance under theCSA. Consequently, its manufacture, shipment, storage, sale and use will be subject to a high degree of regulation. For example, all Schedule II drugprescriptions must be signed by a physician, physically presented to a pharmacist and may not be refilled without a new prescription.Annual registration is required for any facility that manufactures, distributes, dispenses, imports or exports any controlled substance. The registrationis specific to the particular location, activity and controlled substance schedule. For example, separate registrations are needed for import and manufacturing,and each registration will specify which schedules of controlled substances are authorized.The DEA typically inspects a facility to review its security measures prior to issuing a registration. Security requirements vary by controlled substanceschedule, with the most stringent requirements applying to Schedule I and Schedule II substances. Required security measures include background checks onemployees and physical control of inventory through measures such as cages, surveillance cameras and inventory reconciliations. Records must be maintainedfor the handling of all controlled substances, and periodic reports made to the DEA, for example distribution reports for Schedule I and II controlledsubstances, Schedule III substances that are narcotics, and other designated substances. Reports must also be made for thefts or losses of any controlledsubstance, and to obtain authorization to destroy any controlled substance. In addition, special authorization and notification requirements apply to importsand exports.In addition, a DEA quota system controls and limits the availability and production of controlled substances in Schedule I or II. Distributions of anySchedule I or II controlled substance must also be accompanied by special order forms, with copies provided to the DEA. Because Zohydro ER, an oral,extended-release version of hydrocodone, is expected to be regulated as a Schedule II controlled substance, it will be subject to the DEA’s production andprocurement quota scheme. The DEA establishes annually an aggregate quota for how much hydrocodone may be produced in total in the United Statesbased on the DEA’s estimate of the quantity needed to meet legitimate scientific and medicinal needs. This limited aggregate amount of hydrocodone that theDEA allows to be produced in the United States each year is allocated among individual companies, who must submit applications annually to the DEA forindividual production and procurement quotas. We and our contract manufacturers must receive an annual quota from the DEA in order to produce or procureany Schedule I or Schedule II substance, including hydrocodone for use in manufacturing Zohydro ER. The DEA may adjust aggregate production quotasand individual production and procurement quotas from time to time during the year, although the DEA has substantial discretion in whether or not to makesuch adjustments. Our, or our contract manufacturers’, quota of an active ingredient may not be sufficient to meet commercial demand or complete clinicaltrials. Any delay or refusal by the DEA in establishing our, or our33Table of Contentscontract manufacturers’, quota for controlled substances could delay or stop our clinical trials or product launches, which could have a material adverse effecton our business, financial position and results of operations.To meet its responsibilities, the DEA conducts periodic inspections of registered establishments that handle controlled substances. Failure to maintaincompliance with applicable requirements, particularly as manifested in loss or diversion, can result in enforcement action that could have a material adverseeffect on our business, results of operations and financial condition. The DEA may seek civil penalties, refuse to renew necessary registrations, or initiateproceedings to revoke those registrations. In certain circumstances, violations could eventuate in criminal proceedings.Individual states also regulate controlled substances, and we and our contract manufacturers will be subject to state regulation on distribution of theseproducts.International RegulationIn addition to regulations in the United States, we are subject to a variety of foreign regulations regarding safety and efficacy and governing, among otherthings, clinical trials and commercial sales and distribution of our products. Whether or not we obtain FDA approval for a product, we must obtain thenecessary approvals by the comparable regulatory authorities of foreign countries before we can commence clinical trials or marketing of the product in thosecountries. The approval process varies from country to country and can involve additional product testing and additional review periods, and the time may belonger or shorter than that required to obtain FDA approval and, if applicable, DEA classification. The requirements governing, among other things, theconduct of clinical trials, product licensing, pricing and reimbursement vary greatly from country to country. Regulatory approval in one country does notensure regulatory approval in another, but a failure or delay in obtaining regulatory approval in one country may negatively impact the regulatory process inothers.Under European Union regulatory systems, marketing authorizations may be submitted either under a centralized or decentralized procedure. Thecentralized procedure provides for the grant of a single marketing authorization that is valid for all European Union member states. The decentralizedprocedure provides for mutual recognition of national approval decisions. Under this procedure, the holder of a national marketing authorization may submitan application to the remaining member states. Within 90 days of receiving the applications and assessment report, each member state must decide whether torecognize approval.In addition to regulations in Europe and the United States, we are subject to a variety of other foreign regulations governing, among other things, theconduct of clinical trials, pricing and reimbursement and commercial distribution of our products. If we fail to comply with applicable foreign regulatoryrequirements, we may be subject to fines, suspension or withdrawal of regulatory approvals, product recalls, seizure of products, operating restrictions andcriminal prosecution.Desitin submitted a Marketing Authorization Application for Sumavel DosePro to the Federal Institute for Drugs and Medical Devices (Bundesinstitutfür Arzneimittel und Medizinprodukte (BfArM)) in Germany, the reference member state, through the Decentralized Procedure in October 2009. In November2010, Desitin received marketing approved in Denmark and has received subsequent approvals in Germany, Sweden, the United Kingdom, Norway andFrance.Healthcare Fraud and Abuse LawsWe are subject to various federal, state and local laws targeting fraud and abuse in the healthcare industry. For example, in the United States, there arefederal and state anti-kickback laws that prohibit the payment or receipt of kickbacks, bribes or other remuneration intended to induce the purchase orrecommendation of healthcare products and services or reward past purchases or recommendations. Violations of these laws can lead to civil and criminalpenalties, including fines, imprisonment and exclusion from participation in federal healthcare programs. These laws are potentially applicable tomanufacturers of products regulated by the FDA, such as us, and hospitals, physicians and other potential purchasers of such products.In particular, the federal Anti-Kickback Statute prohibits persons from knowingly and willfully soliciting, receiving, offering or providingremuneration, directly or indirectly, to induce either the referral of an individual, or the furnishing, recommending, or arranging for a good or service, forwhich payment may be made under a federal healthcare program such as the TRICARE, Medicare and Medicaid programs. The term “remuneration” is notdefined in the federal Anti-Kickback Statute and has been broadly interpreted to include anything of value, including for example, gifts, discounts, thefurnishing of supplies or equipment, credit arrangements, payments of cash, waivers of payments, ownership interests and providing anything at less thanits fair market value. In addition, the recently enacted Patient Protection and Affordable Care Act, as amended by the Health Care and Education AffordabilityReconciliation Act, or collectively, the PPACA, among other things, amends the intent requirement of the federal Anti-Kickback Statute and the applicablecriminal healthcare fraud statutes contained within 42 U.S.C. § 1320a-7b effective March 23, 2010. Pursuant to the statutory amendment, a person or entityno longer needs to have actual knowledge of this statute or specific intent to violate it in order to have committed a violation. In addition, the PPACA34Table of Contentsprovides that the government may assert that a claim including items or services resulting from a violation of 42 U.S.C. § 1320a-7b constitutes a false orfraudulent claim for purposes of the civil False Claims Act (discussed below) or the civil monetary penalties statute, which imposes fines against any personwho is determined to have presented or caused to be presented claims to a federal health care program that the person knows or should know is for an item orservice that was not provided as claimed or is false or fraudulent. Moreover, the lack of uniform court interpretation of the Anti-Kickback Statute makescompliance with the law difficult.Recognizing that the Anti-Kickback Statute is broad and may technically prohibit many innocuous or beneficial arrangements within the healthcareindustry, the U.S. Department of Health and Human Services’ Office of Inspector General, or OIG, issued regulations in July of 1991, and periodically sincethat time, which the OIG refers to as “safe harbors.” These safe harbor regulations set forth certain provisions which, if met in form and substance, willassure pharmaceutical companies, healthcare providers and other parties that they will not be prosecuted under the federal Anti-Kickback Statute. Additionalsafe harbor provisions providing similar protections have been published intermittently since 1991. Although full compliance with these provisions ensuresagainst prosecution under the federal Anti-Kickback Statute, the failure of a transaction or arrangement to fit within a specific safe harbor does not necessarilymean that the transaction or arrangement is illegal or that prosecution under the federal Anti-Kickback Statute will be pursued. However, conduct andbusiness arrangements that do not fully satisfy each applicable safe harbor may result in increased scrutiny by government enforcement authorities, such asthe OIG or federal prosecutors. Additionally, there are certain statutory exceptions to the federal Anti-Kickback Statute, one or more of which could be used toprotect a business arrangement, although we understand that OIG is of the view that an arrangement that does not meet the requirements of a safe harborcannot satisfy the corresponding statutory exception, if any, under the federal Anti-Kickback Statute.Additionally, many states have adopted laws similar to the federal Anti-Kickback Statute. Some of these state prohibitions apply to referral of patientsfor healthcare items or services reimbursed by any third-party payor, not only the Medicare and Medicaid programs in at least some cases, and do not containsafe harbors or statutory exceptions. Government officials have focused their enforcement efforts on marketing of healthcare services and products, amongother activities, and have brought cases against numerous pharmaceutical and medical device companies, and certain sales and marketing personnel forallegedly offering unlawful inducements to potential or existing customers in an attempt to procure their business or reward past purchases orrecommendations.Another development affecting the healthcare industry is the increased use of the federal civil False Claims Act and, in particular, actions broughtpursuant to the False Claims Act’s “whistleblower” or “qui tam” provisions. The civil False Claims Act imposes liability on any person or entity who, amongother things, knowingly presents, or causes to be presented, a false or fraudulent claim for payment by a federal healthcare program. The qui tam provisionsof the False Claims Act allow a private individual to bring civil actions on behalf of the federal government alleging that the defendant has submitted a falseclaim to the federal government, and to share in any monetary recovery. In recent years, the number of suits brought by private individuals has increaseddramatically. In addition, various states have enacted false claim laws analogous to the False Claims Act. Many of these state laws apply where a claim issubmitted to any third-party payor and not merely a federal healthcare program. When an entity is determined to have violated the False Claims Act, it may berequired to pay up to three times the actual damages sustained by the government, plus civil penalties of $5,500 to $11,000 for each separate false claim.There are many potential bases for liability under the False Claims Act. Liability arises, primarily, when an entity knowingly submits, or causes another tosubmit, a false claim for reimbursement to the federal government. The False Claims Act has been used to assert liability on the basis of inadequate care,kickbacks and other improper referrals, improperly reported government pricing metrics such as Best Price or Average Manufacturer Price, improper use ofMedicare numbers when detailing the provider of services, improper promotion of off-label uses (i.e., uses not expressly approved by FDA in a drug’s label),and allegations as to misrepresentations with respect to the services rendered. Our activities relating to the reporting of discount and rebate information andother information affecting federal, state and third party reimbursement of our products, and the sale and marketing of our products and our servicearrangements or data purchases, among other activities, may be subject to scrutiny under these laws. We are unable to predict whether we would be subject toactions under the False Claims Act or a similar state law, or the impact of such actions. However, the cost of defending such claims, as well as any sanctionsimposed, could adversely affect our financial performance.Also, the Health Insurance Portability and Accountability Act of 1996, or HIPAA, created several new federal crimes, including health care fraud, andfalse statements relating to health care matters. The health care fraud statute prohibits knowingly and willfully executing a scheme to defraud any health carebenefit program, including private third-party payors. The false statements statute prohibits knowingly and willfully falsifying, concealing or covering up amaterial fact or making any materially false, fictitious or fraudulent statement in connection with the delivery of or payment for health care benefits, items orservices.35Table of ContentsThe PPACA also imposes new reporting and disclosure requirements on drug manufacturers for any “transfer of value” made or distributed toprescribers and other healthcare providers, effective March 30, 2013. Such information will be made publicly available in a searchable format beginningSeptember 30, 2013. In addition, drug manufacturers will also be required to report and disclose any investment interests held by physicians and theirimmediate family members during the preceding calendar year. Failure to submit required information may result in civil monetary penalties of up to anaggregate of $150,000 per year (and up to an aggregate of $1 million per year for “knowing failures”), for all payments, transfers of value or ownership orinvestment interests not reported in an annual submission.In addition, under California law, pharmaceutical companies must adopt a comprehensive compliance program that is in accordance with both the April2003 Office of Inspector General Compliance Program Guidance for Pharmaceutical Manufacturers, or OIG Guidance, and the Pharmaceutical Research andManufacturers of America Code on Interactions with Healthcare Professionals, or the PhRMA Code. The PhRMA Code seeks to promote transparency inrelationships between health care professionals and the pharmaceutical industry and to ensure that pharmaceutical marketing activities comport with thehighest ethical standards. The PhRMA Code contains strict limitations on certain interactions between health care professionals and the pharmaceuticalindustry relating to gifts, meals, entertainment and speaker programs, among others. Also, certain states, such as Massachusetts, Vermont and Minnesota,have imposed restrictions on the types of interactions that pharmaceutical and medical device companies or their agents (e.g., sales representatives) may havewith health care professionals, including bans or strict limitations on the provision of meals, entertainment, hospitality, travel and lodging expenses, and otherfinancial support, including funding for continuing medical education activities.Healthcare Privacy and Security LawsWe may be subject to, or our marketing activities may be limited by, HIPAA, and its implementing regulations, which established uniform standardsfor certain “covered entities” (healthcare providers, health plans and healthcare clearinghouses) governing the conduct of certain electronic healthcaretransactions and protecting the security and privacy of protected health information. The American Recovery and Reinvestment Act of 2009, commonlyreferred to as the economic stimulus package, included sweeping expansion of HIPAA’s privacy and security standards called the Health InformationTechnology for Economic and Clinical Health Act, or HITECH, which became effective on February 17, 2010. Among other things, the new law makesHIPAA’s privacy and security standards directly applicable to “business associates” — independent contractors or agents of covered entities that receive orobtain protected health information in connection with providing a service on behalf of a covered entity. HITECH also increased the civil and criminal penaltiesthat may be imposed against covered entities, business associates and possibly other persons, and gave state attorneys general new authority to file civilactions for damages or injunctions in federal courts to enforce the federal HIPAA laws and seek attorney’s fees and costs associated with pursuing federal civilactions.Third-Party Payor Coverage and ReimbursementThe commercial success of Sumavel DosePro and our product candidates, if and when commercialized, will depend, in part, upon the availability ofcoverage and reimbursement from third-party payors at the federal, state and private levels. Third-party payors include governmental programs such asMedicare or Medicaid, private insurance plans and managed care plans. These third-party payors may deny coverage or reimbursement for a product ortherapy in whole or in part if they determine that the product or therapy was not medically appropriate or necessary. Also, third-party payors have attempted tocontrol costs by limiting coverage through the use of formularies and other cost-containment mechanisms and the amount of reimbursement for particularprocedures or drug treatments.Changes in third-party payor coverage and reimbursement rules can impact our business. For example, the PPACA changes include increased rebates amanufacturer must pay to the Medicaid program and established a new Medicare Part D coverage gap discount program, in which manufacturers mustprovide 50% point-of-sale discounts on products covered under Part D. Further, the law imposes a significant annual, nondeductible fee on companies thatmanufacture or import branded prescription drug products. Substantial new provisions affecting compliance have also been enacted, which may require us tomodify our business practices with health care practitioners. A number of states have challenged the constitutionality of certain provisions of the PPACA, andmany of these challenges are still pending final adjudication in several jurisdictions. Congress has also proposed a number of legislative initiatives, includingpossible repeal of the PPACA. At this time, it remains unclear whether there will be any changes made to the PPACA, whether to certain provisions or itsentirety. We will not know the full effects of PPACA until applicable federal and state agencies issue regulations or guidance under the new law and theseprovisions are implemented. Although it is too early to determine the full effect of PPACA, the new law appears likely to continue the pressure onpharmaceutical pricing, and may also increase our regulatory burdens and operating costs.Moreover, other legislative changes have been proposed and adopted since the PPACA was enacted. In August 2011, the President signed into law theBudget Control Act of 2011, which, among other things, creates the Joint Select Committee on36Table of ContentsDeficit Reduction to recommend proposals in spending reductions to Congress. In the event that the Joint Select Committee is unable to achieve a targeted deficitreduction of at least $1.2 trillion for the years 2013 through 2021, or Congress does not act on the committee’s recommendation, without amendment, byDecember 23, 2011, an automatic reduction is triggered. These automatic cuts would be made to several government programs and, with respect to Medicare,would include aggregate reductions to Medicare payments to providers of up to 2% per fiscal year, starting in 2013. In the coming years, additional changescould be made to governmental healthcare programs that could significantly impact the success of our products.In addition, the cost of pharmaceuticals and devices continues to generate substantial governmental and third party payor interest. We expect that thepharmaceutical industry will experience pricing pressures due to the trend toward managed health care, the increasing influence of managed care organizationsand additional legislative proposals. Our results of operations and business could be adversely affected by current and future third-party payor policies as wellas health care legislative reforms.Some third-party payors also require pre-approval of coverage for new or innovative devices or drug therapies before they will reimburse health careproviders who use such therapies. While we cannot predict whether any proposed cost-containment measures will be adopted or otherwise implemented in thefuture, these requirements or any announcement or adoption of such proposals could have a material adverse effect on our ability to obtain adequate prices forSumavel DosePro and our product candidates and to operate profitably.In international markets, reimbursement and healthcare payment systems vary significantly by country, and many countries have instituted priceceilings on specific products and therapies. There can be no assurance that our products will be considered medically reasonable and necessary for a specificindication, that our products will be considered cost-effective by third-party payors, that an adequate level of reimbursement will be available or that the third-party payors’ reimbursement policies will not adversely affect our ability to sell our products profitably.Manufacturing RequirementsWe and our third-party manufacturers must comply with applicable FDA regulations relating to FDA’s cGMP regulations and, if applicable, QSRrequirements. The cGMP regulations include requirements relating to, among other things, organization of personnel, buildings and facilities, equipment,control of components and drug product containers and closures, production and process controls, packaging and labeling controls, holding and distribution,laboratory controls, records and reports, and returned or salvaged products. The manufacturing facilities for our products must meet cGMP requirements tothe satisfaction of the FDA pursuant to a pre-approval inspection before we can use them to manufacture our products. We and our third-party manufacturersare also subject to periodic unannounced inspections of facilities by the FDA and other authorities, including procedures and operations used in the testing andmanufacture of our products to assess our compliance with applicable regulations. Failure to comply with statutory and regulatory requirements subjects amanufacturer to possible legal or regulatory action, including, among other things, warning letters, the seizure or recall of products, injunctions, consentdecrees placing significant restrictions on or suspending manufacturing operations and civil and criminal penalties.Other Regulatory RequirementsWe are also subject to various laws and regulations regarding laboratory practices, the experimental use of animals, and the use and disposal ofhazardous or potentially hazardous substances in connection with our research. In each of these areas, as above, the FDA has broad regulatory andenforcement powers, including, among other things, the ability to levy fines and civil penalties, suspend or delay issuance of approvals, seize or recallproducts, and withdraw approvals, any one or more of which could have a material adverse effect on us.EmployeesAs of December 31, 2012, we employed 149 full-time employees. Of the full-time employees, 103 were engaged in sales and marketing, 8 were engagedin manufacturing operations, 19 were engaged in product development, quality assurance and clinical and regulatory activities and 19 were engaged in generaland administrative activities (including business and corporate development). We may expand our sales force in the future through direct hiring or throughpotential co-promotion partners to support continued sales and marketing of Sumavel DosePro and, if approved, to launch Zohydro ER. None of ouremployees are represented by a labor union, and we consider our employee relations to be good. We currently utilize TriNet Employer Group, Inc., an employerservices company, to provide human resource services. TriNet Employer Group is the employer of record for payroll, benefits, employee relations and otheremployment-related administration.Research and DevelopmentThe Company invested $21.4 million, $33.0 million and $28.6 million in research and development in the years 2012, 2011 and 2010, respectively.About Zogenix37Table of ContentsWe were formed as a Delaware corporation on May 11, 2006 as SJ2 Therapeutics, Inc. We commenced our operations on August 25, 2006 and changedour name to Zogenix, Inc. on August 28, 2006. Our principal executive offices are located at 12400 High Bluff Drive, Suite 650, San Diego, CA 92130, andour telephone number is 1-866-ZOGENIX (1-866-964-3649). We formed a wholly-owned subsidiary, Zogenix Europe Limited, in June 2010, a companyorganized under the laws of England and Wales and which is located in the United Kingdom, and whose principal operations are to support the manufactureof the DosePro technology.Financial Information about SegmentsWe operate only in one business segment, which is the commercialization and development of pharmaceutical products. See note 2 to our consolidatedfinancial statements included in this Annual Report on Form 10-K. For financial information regarding our business, see “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” and those financial statements and related notes.Available InformationWe file electronically with the Securities and Exchange Commission, or SEC, our annual reports on Form 10-K, quarterly reports on Form 10-Q andcurrent reports on Form 8-K pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. We make available on our website atwww.zogenix.com, free of charge, copies of these reports, as soon as reasonably practicable after we electronically file such material with, or furnish it to, theSEC. The public may read or copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street NE, Washington, D.C. 20549.The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet sitethat contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that siteis http://www.sec.gov. The information in or accessible through the SEC and our website are not incorporated into, and are not considered part of, this filing.Further, our references to the URLs for these websites are intended to be inactive textual references only.Item 1A. Risk FactorsWe operate in a dynamic and rapidly changing environment that involves numerous risks and uncertainties. Certain factors may have a materialadverse effect on our business prospects, financial condition and results of operations, and you should carefully consider them. Accordingly, inevaluating our business, we encourage you to consider the following discussion of risk factors, in its entirety, in addition to other informationcontained in this Annual Report on Form 10-K and our other public filings with the Securities and Exchange Commission, or SEC. Other events thatwe do not currently anticipate or that we currently deem immaterial may also affect our business, prospects, financial condition and results ofoperations.Risks Related to Our Business and IndustryWe are at an early stage of commercialization and have a history of significant net losses and negative cash flow from operations. We cannotpredict if or when we will become profitable and anticipate that our net losses and negative cash flow from operations will continue for at least thenext several years.We were organized in 2006 and are at an early stage of commercialization. Our business and prospects must be considered in light of the risks anduncertainties frequently encountered by pharmaceutical companies in the early stages of commercialization.We have generated substantial net losses and negative cash flow from operations since our inception in 2006. For example, for the years ended 2012,2011 and 2010, we incurred net losses of $47.4 million, $83.9 million and $73.6 million, respectively, our net cash used in operating activities was $52.2million, $80.5 million and $72.0 million, respectively, and, at December 31, 2012, our accumulated deficit was $329.4 million. We expect to continue toincur net losses and negative cash flow from operating activities for at least the next several years primarily as a result of the expenses incurred in connectionwith our efforts in seeking marketing approval for Zohydro ER, the clinical development for Relday, any additional required testing for Zohydro ER, and thecost of the sales and marketing expense associated with Sumavel DosePro, and, if approved, Zohydro ER. Our ability to generate revenues from SumavelDosePro or any of our product candidates will depend on a number of factors, including, in the case of Sumavel DosePro, the factors described in risk factorsbelow and, in the case of our product candidates, our ability to successfully complete clinical trials, obtain necessary regulatory approvals and negotiatearrangements with third parties to help finance the development of, and market and distribute, any product candidates that receive regulatory approval. Inaddition, we will be subject to the risk that the marketplace will not accept our products.38Table of ContentsBecause of the numerous risks and uncertainties associated with our product development and commercialization efforts, we are unable to predict theextent of our future losses or when or if we will become profitable and it is possible we will never become profitable. Our failure to increase sales of SumavelDosePro or to successfully commercialize any of our product candidates that may receive regulatory approval would likely have a material adverse effect onour business, results of operations, financial condition and prospects and could result in our inability to continue operations.We will require additional funding and may be unable to raise capital when needed, which would force us to delay, reduce or eliminate ourproduct development programs or commercialization efforts.Our operations have consumed substantial amounts of cash since inception. To date, our operations have been primarily financed through the proceedsfrom the issuance of our common and preferred stock, including the proceeds from our initial public offering completed in November 2010, our follow-onpublic offerings completed in September 2011 and July 2012, and borrowings under our loan and financing agreements with Healthcare Royalty Partners, orHealthcare Royalty, Oxford Finance LLC, as successor in interest to Oxford Finance Corporation, or Oxford, and Silicon Valley Bank, or SVB. Although it isdifficult to predict future liquidity requirements, we believe that our cash and cash equivalents as of December 31, 2012, and our projected product revenuesfrom Sumavel DosePro, will be sufficient to fund our operations into the fourth quarter of 2013. We will need to obtain additional funds to finance ouroperations beyond that point, or possibly earlier, in order to:• maintain our sales and marketing activities for Sumavel DosePro;•qualify secondary sources for the manufacturing of Sumavel DosePro;•fund our operations, fund further development of Zohydro ER, if required, Relday and any other product candidate to support potential regulatoryapproval of marketing applications; and•commercialize Zohydro ER or any of our product candidates or any products or product candidates that we may develop, in-license or otherwise acquire,if any of these product candidates receive regulatory approval.Further, if we receive FDA approval of Zohydro ER, we may need to obtain additional capital to finance the commercial launch of Zohydro ER,possibly prior to the fourth quarter of 2013.In addition, our estimates of the amount of cash necessary to fund our business and development and commercialization activities may prove to bewrong, and we could spend our available financial resources much faster than we currently expect. Our future funding requirements will depend on manyfactors, including, but not limited to:•the commercial success of Sumavel DosePro;•the timing of regulatory approval, if granted, of Zohydro ER or any other product candidates and the commercial success of any approved products;•the rate of progress and cost of our clinical trials and other product development programs for Relday and our other product candidates and any otherproduct candidates that we may develop, in-license or acquire;•the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights associated with Sumavel DosePro,Zohydro ER, Relday and any of our other product candidates;•the costs and timing of completion of outsourced commercial manufacturing supply arrangements for any product candidate;•the costs of maintaining and expanding our sales and marketing infrastructure or establishing distribution capabilities;•the effect of competing technological and market developments; and•the terms and timing of any additional collaborative, licensing, co-promotion or other arrangements that we may establish.In its report on our consolidated financial statements for the year ended December 31, 2012, our independent registered public accounting firm includedan explanatory paragraph expressing substantial doubt regarding our ability to continue as a going concern. A “going concern” opinion means, in general, thatour independent registered public accounting firm has substantial doubt about our ability to continue our operations without continuing infusions of capitalfrom external sources and this opinion could impair our ability to finance our operations through the sale of debt or equity securities or commercial bankloans.Until we can generate a sufficient amount of product revenue and cash flow from operations and achieve profitability, we expect to finance future cashneeds through public or private equity offerings, debt financings, receivables financings or corporate collaboration and licensing arrangements. We cannot becertain that additional funding will be available on acceptable terms, or at all. If we are unsuccessful in raising additional required funds, we may be requiredto significantly delay, reduce the scope of or eliminate one or more of our development programs or our commercialization efforts, or cease operating as a goingconcern. We also may be required to relinquish, license or otherwise dispose of rights to product candidates or products that we would otherwise seek todevelop or commercialize ourselves on terms that are less favorable than might otherwise be available. If we raise additional funds by issuing equity securities,substantial dilution to existing39Table of Contentsstockholders would result. If we raise additional funds by incurring debt financing, the terms of the debt may involve significant cash payment obligations aswell as covenants and specific financial ratios that may restrict our ability to operate our business. If we are unable to maintain sufficient financial resources,including by raising additional funds when needed, our business, financial condition and results of operations will be materially and adversely affected andwe may be unable to continue as a going concern.Our independent registered public accounting firm has expressed substantial doubt as to our ability to continue as a going concern.In its report accompanying our audited consolidated financial statements for the year ended December 31, 2012, our independent registered publicaccounting firm included an explanatory paragraph stating that our recurring losses from operations and lack of sufficient working capital raise substantialdoubt as to our ability to continue as a going concern. A “going concern” opinion could impair our ability to finance our operations through the sale of debt orequity securities or commercial bank loans. Our ability to continue as a going concern will depend, in large part, on our ability to generate positive cash flowfrom operations and obtain additional financing, neither of which is certain. If we are unable to achieve these goals, our business would be jeopardized and wemay not be able to continue operations and may have to liquidate our assets and may receive less than the value at which those assets are carried on ourconsolidated financial statements, and it is likely that investors will lose all or a part of their investment.We are largely dependent on the commercial success of Sumavel DosePro and although we have generated revenue from sales of SumavelDosePro, we may never significantly increase these sales or become profitable.We anticipate that, for at least the next several years, or until we receive regulatory approval for Zohydro ER, if at all, our ability to generate revenuesand become profitable will depend in large part on the commercial success of our only marketed product, Sumavel DosePro, which in turn, will depend onseveral factors, including our ability to:•successfully maintain and increase market demand for, and sales of, Sumavel DosePro through our sales and marketing efforts and those ofMallinckrodt LLC, our collaboration partner;•obtain greater acceptance of Sumavel DosePro by physicians and patients;•maintain adequate levels of coverage and reimbursement for Sumavel DosePro from commercial health plans and government health programs,which we refer to collectively as third-party payors, particularly in light of the availability of other branded and generic competitive products;•maintain compliance with regulatory requirements;•establish and maintain agreements with wholesalers and distributors on commercially reasonable terms;•maintain commercial manufacturing arrangements with third-party manufacturers as necessary to meet commercial demand for Sumavel DoseProand continue to manufacture commercial quantities at acceptable cost levels; and•successfully maintain intellectual property protection for Sumavel DosePro.We cannot be certain that our continued marketing of Sumavel DosePro will result in increased demand for, and sales of, the product. For example,while we have generally experienced annual growth in total prescriptions from the launch of Sumavel DosePro in January 2010 through December 31, 2012,we have at certain times experienced a reduction in total and new prescriptions month over month. If we and Mallinckrodt fail to successfully maintain andincrease sales of Sumavel DosePro, we may be unable to generate sufficient revenues to grow or sustain our business and we may never become profitable, andour business, financial condition and results of operations will be materially adversely affected.We may not be successful in executing our sales and marketing strategy for the commercialization of Sumavel DosePro, including as a result ofthe termination of our collaboration with Astellas in March 2012. As part of this strategy, we will be dependent on our collaboration withMallinckrodt to promote Sumavel DosePro primarily to primary care physicians and physicians specializing in internal medicine. If we are unableto successfully execute such strategy, we may not be able to generate significant revenue.Prior to the launch of Sumavel DosePro in January 2010, we built a commercial sales and marketing organization including sales, marketing,communications, managed markets, trade and distribution functions, which is now focused exclusively on marketing and selling Sumavel DosePro primarilyto physicians, nurses and other healthcare professionals in the United States. Our field sales force was comprised of approximately 85 field sales personnel asof December 31, 2012, and has historically promoted Sumavel DosePro primarily to neurologists and other prescribers of migraine medications, includingheadache clinics and headache specialists in the United States.To complement our sales force, we entered into an exclusive co-promotion agreement with Astellas in July 2009 under which Sumavel DosePro waspromoted primarily to primary care physicians, OB/GYNs, emergency medicine physicians and40Table of Contentsurologists, or collectively the Astellas Segment, in the United States by approximately 400 Astellas sales representatives. This agreement terminated onMarch 31, 2012, and beginning in the second quarter of 2012 our sales force assumed full responsibility for the continued promotion of Sumavel DosePro.We have expanded the focus of our existing sales force to include targeting a portion of the high-prescribing primary care physicians that were previously partof the Astellas Segment. We also entered into a new co-exclusive (with us) co-promotion agreement with Mallinckrodt in June 2012, or the Mallinckrodt co-promotion agreement, under which in August 2012 Mallinckrodt began promoting Sumavel DosePro to a mutually agreed prescriber audience in the UnitedStates. Mallinckrodt has committed to a minimum number of sales representatives for the initial term of the co-promotion agreement. Although we believe wehave adequately sized our sales force in order to reach our historically targeted audience, our existing sales force, along with the collaboration of Mallinckrodt'ssales force, may be unable to effectively target these additional primary care physicians.Although the Mallinckrodt co-promotion agreement stipulates minimum levels of sales effort, we have limited control over the amount and timing ofresources that Mallinckrodt dedicates to the promotion of Sumavel DosePro, and we do not hire or manage such resources. The ability to generate revenue fromour arrangement with Mallinckrodt depends on Mallinckrodt's efforts in promoting Sumavel DosePro and its ability to achieve broad market acceptance andprescribing of Sumavel DosePro in its targeted physician segment.We are subject to a number of additional risks associated with our dependence on our co-promotion arrangement with Mallinckrodt, including:•Mallinckrodt could fail to devote sufficient resources to the promotion of Sumavel DosePro, including by failing to develop, deploy or expand itssales force as necessary;•Mallinckrodt could fail to comply with applicable regulatory guidelines with respect to the promotion of Sumavel DosePro, which could result inadministrative or judicially imposed sanctions, including warning letters, civil and criminal penalties, and injunctions; and•disputes regarding the co-promotion agreement that negatively impact or terminate the commercialization efforts of Mallinckrodt may negativelyimpact or prevent the generation of sufficient revenue or result in significant litigation or arbitration.Under the terms of the Mallinckrodt co-promotion agreement, Mallinckrodt may terminate the agreement with 60 days' written notice in the event amaterial change is made to the net sales price of Sumavel DosePro that would result in a material adverse effect to Mallinckrodt's financial return, as defined inthe co-promotion agreement. Mallinckrodt may also terminate the co-promotion agreement if its request for the inclusion on its call list of a certain number ofadditional prescribers is not mutually agreed upon. Lastly, Mallinckrodt may terminate the co-promotion agreement if a governmental authority takes action orraises an objection that prevents or would reasonably be expected to make it unlawful for Mallinckrodt to perform, or subject Mallinckrodt to any penalty orclaim, investigation or similar action related to, its obligations under the co-promotion agreement, in the event of our inability to meet trade demand forcommercial product or where a third party files an action alleging that the making or selling of Sumavel DosePro infringes the intellectual property rights ofsuch third party.In addition, the initial term of our co-promotion agreement with Mallinckrodt expires on June 30, 2014, subject to extension of additional six monthincrements by mutual agreement of both parties. We cannot assure you that Mallinckrodt will enter into any extension of the co-promotion agreement or, if itdoes so, that it will not condition any such extension upon changes in the co-promotion agreement that could have a material adverse effect on us. IfMallinckrodt were to terminate the co-promotion agreement or elect not to extend the agreement upon its expiration, we would lose the efforts of their sales force,and we may be required to make arrangements with another third party to replace Mallinckrodt's sales force, or expand our sales and marketing organization.We may not be able to enter into such arrangements with third parties in a timely manner, on acceptable terms or at all. To the extent that we enter into anotherco-promotion or other licensing arrangement, our portion of retained product revenues is likely to be lower than if we directly marketed and sold SumavelDosePro solely on our own, and a portion of those revenues generated will depend upon the efforts of such third parties similar to our dependence onMallinckrodt, and these efforts may not be successful. If our co-promotion agreement with Mallinckrodt is terminated and we are unable to find anotherpartner for the promotion of Sumavel DosePro in the primary care segment in the United States, we may not be able to expand our own sales and marketingcapabilities or utilize our existing sales force effectively to cover this segment and any such expansion could, in any event, substantially increase our expensesand capital requirements that we might not be able to fund.If we are unable to successfully implement our commercialization plans and drive adoption by patients and physicians of Sumavel DosePro through oursales, marketing and commercialization efforts and the efforts of Mallinckrodt, then we will not be able to generate significant revenue which will have amaterial adverse effect on our business, results of operations, financial condition and prospects.41Table of ContentsIf Sumavel DosePro, and, if approved, Zohydro ER and Relday, or any other product candidate for which we receive regulatory approval does notachieve broad market acceptance or coverage by third-party payors, the revenues that we generate will be limited.The commercial success of Sumavel DosePro, and, if approved, Zohydro ER and Relday, or any other product candidates for which we obtainmarketing approval from the FDA or other regulatory authorities will depend upon the acceptance of these products by physicians, patients, healthcare payorsand the medical community. Coverage and reimbursement of our approved product by third-party payors is also necessary for commercial success. Thedegree of market acceptance of Sumavel DosePro and any other product candidates for which we may receive regulatory approval will depend on a number offactors, including:•our ability to provide acceptable evidence of safety and efficacy;•acceptance by physicians and patients of the product as a safe and effective treatment;•the relative convenience and ease of administration;•the prevalence and severity of adverse side effects;•limitations or warnings contained in a product’s FDA-approved labeling;•the clinical indications for which the product is approved;•in the case of product candidates that are controlled substances, the U.S. Drug Enforcement Agency, or DEA, scheduling classification;•availability and perceived advantages of alternative treatments;•any negative publicity related to our or our competitors’ products;•the effectiveness of our or any current or future collaborators’ sales, marketing and distribution strategies;•pricing and cost effectiveness;•our ability to obtain sufficient third-party payor coverage or reimbursement; and•the willingness of patients to pay out of pocket in the absence of third-party payor coverage.For example, while we believe the needle-free nature of our DosePro technology will appeal to patients, some patients may not react favorably to thesubcutaneous delivery of drug products by DosePro. Our experience indicates that some patients will experience pain upon injection with the DoseProtechnology and/or reactions at the site of injection. Any undesirable side effects have the potential to limit market acceptance of our product candidates.In addition, products used to treat and manage pain, especially in the case of opioids, are from time to time subject to negative publicity, includingpolitical influences, illegal use, overdoses, abuse, diversion, serious injury and death. These events have led to heightened regulatory scrutiny. Controlledsubstances are classified by the DEA as Schedule I through V substances, with Schedule I substances being prohibited for sale in the United States, ScheduleII substances considered to present the highest risk of abuse and Schedule V substances being considered to present the lowest relative risk of abuse. ZohydroER contains hydrocodone, and we anticipate it will be regulated as a Schedule II controlled substance, and despite the strict regulations on the marketing,prescribing and dispensing of such substances, illicit use and abuse of hydrocodone is well-documented. Thus, the regulatory approval process and themarketing of Zohydro ER may generate public controversy that may adversely affect regulatory approval and market acceptance of Zohydro ER.Our efforts to educate the medical community and third-party payors on the benefits of Sumavel DosePro, and, if approved, Zohydro ER and Relday orany of our other product candidates for which we obtain marketing approval from the FDA or other regulatory authorities and gain broad market acceptancemay require significant resources and may never be successful. If our products do not achieve an adequate level of acceptance by physicians, third-partypayors and patients, we may not generate sufficient revenue from these products to become or remain profitable.Our business and operations would suffer in the event of system failures.Despite the implementation of security measures, our internal computer systems and those of our current and any future partners, contractors andconsultants are vulnerable to damage from cyber-attacks, computer viruses, unauthorized access, natural disasters, terrorism, war and telecommunicationand electrical failures. For example, we have in the past experienced failures in our information systems and computer servers, which may have been the resultof a cyber-attack. These failures resulted in an interruption of our normal business operations and required substantial expenditure of financial andadministrative resources to remedy. We cannot be sure that similar failures will not occur in the future. System failures, accidents or security breaches cancause interruptions in our operations, and can result in a material disruption of our commercialization activities, drug development programs and our businessoperations. The loss of clinical trial data from completed or future clinical trials could result in delays in our regulatory approval efforts and significantlyincrease our costs to recover or reproduce the data. Similarly, we rely on a large number of third parties to supply components for and manufacture ourproduct and product candidates, warehouse and distribute Sumavel DosePro and conduct clinical trials, and similar events relating to their computer systemscould also have a material adverse effect on our business. To the extent that any disruption or42Table of Contentssecurity breach were to result in a loss of, or damage to, our data or applications, or inappropriate disclosure of confidential or proprietary information, wecould incur liability and the commercialization of Sumavel DosePro and development of Zohydro ER, Relday or any of our other product candidates could bedelayed.Our short operating history makes it difficult to evaluate our business and prospects.We commenced our operations on August 25, 2006. Our operations to date have been limited to organizing and staffing our company, scaling upmanufacturing operations with our third-party contract manufacturers, building a sales and marketing organization, conducting product developmentactivities for our product and product candidates, in-licensing rights to Zohydro ER and Relday, and commercializing Sumavel DosePro. Moreover, SumavelDosePro is our only product that is approved for sale. Consequently, any predictions about our future performance may not be as accurate as they could be ifwe had a history of successfully developing and commercializing pharmaceutical products.We depend on wholesale pharmaceutical distributors for retail distribution of Sumavel DosePro, and if we lose any of our significant wholesalepharmaceutical distributors, our business could be harmed.The majority of our sales of Sumavel DosePro are to wholesale pharmaceutical distributors who, in turn, sell the products to pharmacies, hospitals andother customers. Two wholesale pharmaceutical distributors, Cardinal Health, Inc. and McKesson Corporation, individually comprised 36.1% and 35.5%,respectively, of our total gross sales of Sumavel DosePro for the year ended December 31, 2012, which may result in substantial fluctuations in our results ofoperations from period to period. The loss of any of these wholesale pharmaceutical distributors’ accounts or a material reduction in their purchases couldhave a material adverse effect on our business, results of operations, financial condition and prospects.In addition, these wholesale customers comprise a significant part of the distribution network for pharmaceutical products in the United States. Thisdistribution network has undergone, and may continue to undergo, significant consolidation marked by mergers and acquisitions. As a result, a smallnumber of large wholesale distributors control a significant share of the market. Consolidation of drug wholesalers has increased, and may continue toincrease, competitive and pricing pressures on pharmaceutical products. In addition, at times, wholesaler purchases may exceed customer demand, resultingin reduced wholesaler purchases in later quarters, which may result in substantial fluctuations in our results of operations from period to period. We cannotassure you that we can manage these pricing pressures or that wholesaler purchases will not decrease as a result of this potential excess buying.Our sales can be greatly affected by the inventory levels our wholesalers carry. We monitor wholesaler inventory of Sumavel DosePro using acombination of methods. Pursuant to distribution service agreements with our three largest wholesale customers, we receive inventory level reports. For mostother wholesalers where we do not receive inventory level reports, however, our estimates of wholesaler inventories may differ significantly from actualinventory levels. Significant differences between actual and estimated inventory levels may result in excessive production (requiring us to hold substantialquantities of unsold inventory), inadequate supplies of products in distribution channels, insufficient product available at the retail level, and unexpectedincreases or decreases in orders from our wholesalers. These changes may cause our revenues to fluctuate significantly from quarter to quarter, and in somecases may cause our operating results for a particular quarter to be below our expectations or the expectations of securities analysts or investors. If our financialresults are below expectations for a particular period, the market price of our common stock may drop significantly.We face intense competition, including from generic products, and if our competitors market and/or develop treatments for migraine, pain orpsychotic disorders that are marketed more effectively, approved more quickly than our product candidates or demonstrated to be safer or moreeffective than our products, our commercial opportunities will be reduced or eliminated.The pharmaceutical industry is characterized by rapidly advancing technologies, intense competition and a strong emphasis on proprietary therapeutics.We face competition from a number of sources, some of which may target the same indications as our product or product candidates, including largepharmaceutical companies, smaller pharmaceutical companies, biotechnology companies, academic institutions, government agencies and private and publicresearch institutions, many of which have greater financial resources, sales and marketing capabilities, including larger, well-established sales forces,manufacturing capabilities, experience in obtaining regulatory approvals for product candidates and other resources than us. Many large, well-capitalizedcompanies offer products in the United States that compete with Sumavel DosePro. Sumavel DosePro currently competes with branded products in the triptanclass such as Imitrex and Treximet marketed by GlaxoSmithKline, or GSK, as well as six other branded triptan therapies being sold by AstraZeneca plc,Endo Pharmaceuticals Holdings Inc., Johnson & Johnson, Merck & Co., Inc., and Pfizer Inc. In addition to those migraine therapeutics, there are othermarketed non-triptan migraine therapeutics such as Cambia sold by Nautilus Neurosciences, Inc. and Migranal sold by Valeant43Table of ContentsPharmaceutical International. In addition, Allergan, Inc., is now marketing BOTOX botulinum toxin for the treatment of chronic migraine. We also facecompetition from generic sumatriptan oral tablets and sumatriptan injection, now marketed in the United States as an authorized generic of the ImitrexSTATdose System, or Imitrex STATdose, by Par Pharmaceutical Companies, Inc. and Sandoz Inc. (a Novartis AG company). In addition, in June 2010, theFDA approved Alsuma (sumatriptan injection), a needle-based autoinjector which was developed and is manufactured and marketed by Pfizer and itssubsidiary, Meridian Medical Technologies. Finally, generic injectable sumatriptan in the form of vials and prefilled syringes is available from a number ofpharmaceutical companies, and most recently, the FDA granted approval for a needle-based generic sumatriptan auto-injector from Sun PharmaceuticalIndustries Limited in June 2011. Although these products may not be directly substituted for Sumavel DosePro, generic versions of sumatriptan injection andalternative autoinjector forms of sumatriptan injection may reduce the future adoption of Sumavel DosePro by third-party payors and consumers, as financialpressure to use generic products may encourage the use of a generic product over Sumavel DosePro. Sumavel DosePro is currently more expensive on a perdose basis than most of the competing branded and all of the generic triptan products for migraine, which may also limit the coverage and reimbursement bythird-party payors, which could adversely affect adoption by physicians and patients.If approved for the treatment of moderate to severe chronic pain, we anticipate that Zohydro ER would compete against other marketed branded andgeneric pain therapeutics. Opioid therapeutics generally fall into two classes: codeines, which include oxycodones and hydrocodones, and morphines.Zohydro ER is a hydrocodone, the most commonly prescribed opioid in the United States, and we expect Zohydro ER will compete with therapeutics withinboth the codeine and morphine classes. These therapeutics include both Schedule II and Schedule III products (meaning that they are considered controlledsubstances by the DEA) being marketed by companies such as Endo Pharmaceuticals Holdings Inc., Johnson & Johnson, Mallinckrodt Inc., Pfizer, PurduePharma L.P., Teva Pharmaceutical Industries Limited and Watson Pharmaceuticals, Inc.In addition to already marketed therapeutics, we also face competition from product candidates that are or could be under development by many of theabove-mentioned entities and others. For example, there are several products for the treatment of migraine under development by large pharmaceuticalcompanies such as GSK, Merck & Co., and Allergan, Inc. and smaller companies such as OptiNose AS, Inc. In addition, Nupathe, Inc. received FDAapproval for its migraine patch, Zecuity, in January 2013. If approved, Zohydro ER may also compete with a significant number of opioid product candidatesunder development, including abuse and tamper resistant formulations of currently available opioids, novel opioids and alternative delivery forms of variousopioids under development at other pharmaceutical companies, including single-entity extended-release hydrocodone product candidates being developed byEgalet A/S, Pfizer, Purdue Pharma L.P. and Teva Pharmaceutical Industries Limited. Zohydro ER may also face competition from non-opioid productcandidates including new chemical entities, as well as alternative delivery forms of non-steroidal anti-inflammatory drugs. These new opioid and non-opioidproduct candidates are being developed by companies such as Acura Pharmaceuticals, Inc., Altea Therapeutics Corporation, Collegium Pharmaceutical, Inc.,Eli Lilly and Company, Elite Pharmaceuticals, Inc., Hospira Inc., Inspirion Delivery Technologies, LLC, Intellipharmaceuticals International, Inc., NektarTherapeutics, Pfizer and QRxPharma Ltd.If approved for the treatment of schizophrenia, we anticipate that Relday will compete against other marketed, branded and generic, typical and atypicalantipsychotics, including both long-acting injectable and oral products. Currently marketed long-acting injectable atypical antipsychotic products includeRisperdal Consta, and Invega Sustenna marketed by Johnson & Johnson, Zyprexa Relprevv marketed by Eli Lilly & Company, Abilify Maintena(apripiprazole) marketed by Otsuka Pharmaceutical Co., Ltd. and H. Lundbeck A/S. Currently approved and marketed oral atypical antipsychotics includeRisperdal (risperidone) and Invega (paliperidone) marketed by Johnson & Johnson, generic risperidone, Zyprexa (olanzapine) marketed by Eli Lilly andCompany, Seroquel (quetiapine) marketed by AstraZeneca plc, Abilify (aripiprazole) marketed by BMS/Otsuka Pharmaceutical Co., Ltd., Geodon(ziprasidone) marketed by Pfizer, Fanapt (iloperidone) marketed by Novartis AG, Saphris (asenapine) marketed by Merck & Co., Latuda (lurasidone)marketed by Dainippon Sumitomo Pharma, and generic clozapine. Finally, in addition to these currently marketed products, we may also face competitionfrom additional long-acting injectable product candidates that could be developed by the large companies listed above, as well and by other pharmaceuticalcompanies such as Alkermes and Novartis AG, each of which has announced they are developing long-acting antipsychotic product candidates.We expect Sumavel DosePro and, if approved, Zohydro ER, Relday and any of our other product candidates to compete on the basis of, among otherthings, product efficacy and safety, time to market, price, patient reimbursement by third-party payors, extent of adverse side effects and convenience oftreatment procedures. One or more of our competitors may develop needle-free injectable products, products to address chronic pain or other products thatcompete with ours, obtain necessary approvals for such products from the FDA, or other agencies, if required, more rapidly than us or develop alternativeproducts or therapies that are safer, more effective and/or more cost effective than any products developed by us. If any of our product candidates receive therequisite regulatory approval and classification and are marketed, the competition which we will encounter will have, and the competition we are currentlyencountering with our Sumavel DosePro product has had and will continue to have, an effect on our product prices, market share and results of operations.We may not be able to differentiate44Table of Contentsany products that we are able to market from those of our competitors, successfully develop or introduce new products that are less costly or offer betterresults than those of our competitors, or offer purchasers of our products payment and other commercial terms as favorable as those offered by ourcompetitors.In addition, competitors may seek to develop alternative formulations of our product candidates and/or alternative drug delivery technologies thataddress our targeted indications. The commercial opportunity for Sumavel DosePro and our product candidates could be significantly harmed if competitorsare able to develop alternative formulations and/or drug delivery technologies outside the scope of our products. Compared to us, many of our potentialcompetitors have substantially greater:•capital resources;•research and development resources and experience, including personnel and technology;•drug development, clinical trial and regulatory resources and experience;•sales and marketing resources and experience;•manufacturing and distribution resources and experience;•name recognition; and•resources, experience and expertise in prosecution and enforcement of intellectual property rights.As a result of these factors, our competitors may obtain regulatory approval of their products more rapidly than we are able to or may obtain patentprotection or other intellectual property rights that limit or block us from developing or commercializing our product candidates. Our competitors may alsodevelop drugs that are more effective, more useful, better tolerated, subject to fewer or less severe side effects, more widely prescribed or accepted or less costlythan ours and may also be more successful than us in manufacturing and marketing their products. If we are unable to compete effectively with the marketedtherapeutics of our competitors or if such competitors are successful in developing products that compete with Sumavel DosePro or any of our productcandidates that are approved, our business, results of operations, financial condition and prospects may be materially adversely affected.We are dependent on numerous third parties in our supply chain, all of which are currently single source suppliers, for the commercial supply ofSumavel DosePro and for the clinical supply of Zohydro ER and Relday, and if we experience problems with any of these suppliers, themanufacturing of Sumavel DosePro, Zohydro ER and Relday could be delayed.While we own most of the specialized equipment used to manufacture critical components of Sumavel DosePro, we do not own or operate manufacturingfacilities and currently lack the in-house capability to manufacture Sumavel DosePro, Zohydro ER, Relday or any other product candidates. Our DoseProdevice and Sumavel DosePro are manufactured by contract manufacturers, component fabricators and secondary service providers. Aseptic fill, finish,assembly and packaging of Sumavel DosePro are performed at Patheon UK Limited, Swindon, United Kingdom, or Patheon, a specialist in the asepticfill/finish of injectables and other sterile pharmaceutical products. In May 2012, Patheon announced plans to wind down or transfer its commercial productioncapacity for a number of products at this facility over a period of 24 to 36 months.We are presently identifying alternative suppliers for these services andexpect to identify an alternative supplier in sufficient time so that we can transfer the manufacturing processes that are presently handled by Patheon to a newsupplier in advance of the expected closure date of the Swindon, United Kingdom facility. In addition, Nypro Limited, located in Bray, Ireland, manufacturesthe actuator assemblies and injection molded components for our DosePro device and Nipro Glass, Germany AG (formerly MGlas AG), located inMünnerstadt, Germany, manufactures the specialized glass capsule (cartridge) that houses the sumatriptan active pharmaceutical ingredient, or API, in ourDosePro device. Each of these manufacturers and each other company that supplies, fabricates or manufactures any component used in our DosePro device iscurrently the only qualified source of their respective components. We currently rely on Dr. Reddy's Laboratories as the only supplier of sumatriptan API foruse in Sumavel DosePro. We also outsource all manufacturing and packaging of the clinical trial materials for Zohydro ER and Relday to third parties.Although we plan to qualify additional manufacturers and suppliers of some of the components used in Sumavel DosePro, there can be no assurance that wewill be able to do so and the current manufacturers and suppliers of these components will likely be single source suppliers to us for a significant period oftime. Similarly, an affiliate of Alkermes is the exclusive manufacturer of Zohydro ER and Durect is the exclusive manufacturer of the risperidone formulationusing Durect's SABER™ controlled-release technology for all Relday clinical trials through Phase 2 and has the option to supply the same formulation forPhase 3 clinical trials and, if approved, commercial production. We have restrictions on establishing a second source of supply under our agreement with anaffiliate of Alkermes, and we may never be able to establish additional sources of supply for Zohydro ER or Relday's risperidone formulation.Manufacturers and suppliers are subject to regulatory requirements covering, among other things, manufacturing, testing, quality control and recordkeeping relating to our product and product candidates, and are subject to ongoing inspections by regulatory agencies. Failure by any of our manufacturers orsuppliers to comply with applicable regulations may result in long delays and interruptions to our manufacturing supply, and increase our costs, while weseek to secure another supplier who45Table of Contentsmeets all regulatory requirements. Accordingly, the loss of any of our current third-party manufacturers or suppliers could have a material adverse effect onour business, results of operations, financial condition and prospects.Reliance on third-party manufacturers and suppliers entails risks to which we would not be subject if we manufactured Sumavel DosePro or ourproduct candidates ourselves, including:•reliance on the third parties for regulatory compliance and quality assurance;•the possible breach of the manufacturing agreements by the third parties because of factors beyond our control or the insolvency of any of these thirdparties or other financial difficulties, labor unrest, natural disasters or other factors adversely affecting their ability to conduct their business; and•the possibility of termination or non-renewal of the agreements by the third parties, at a time that is costly or inconvenient for us, because of ourbreach of the manufacturing agreement or based on their own business priorities.If our contract manufacturers or suppliers fail to deliver the required commercial quantities of Sumavel DosePro and its various components, thequantities of Zohydro ER, Relday or any of our other product candidates required for our clinical trials and, if approved, for commercial sale, on a timelybasis and at commercially reasonable prices, and we are unable to find one or more replacement manufacturers or suppliers capable of production at asubstantially equivalent cost, in substantially equivalent volumes and quality, and on a timely basis, we would likely be unable to meet demand for ourproducts and would have to delay or terminate our pre-clinical or clinical trials, and we would lose potential revenue. It may also take a significant period oftime to establish an alternative source of supply for our product, product candidates and components and to have any such new source approved by the FDAor any applicable foreign regulatory authorities. Furthermore, any of the above factors could cause the delay or suspension of initiation or completion ofclinical trials, regulatory submissions or required approvals of our product candidates, cause us to incur higher costs and could prevent us fromcommercializing our product candidates successfully.We may encounter delays in the manufacturing of Sumavel DosePro or fail to generate revenue if our supply of the components of our DoseProdrug delivery system is interrupted.Our DosePro drug delivery system is sourced, manufactured and assembled by multiple third parties across different geographic locations in Europe,including the United Kingdom, Germany and Ireland. All contract manufacturers and component suppliers have been selected for their specific competenciesin the manufacturing processes and materials that make up the DosePro system. The components of DosePro include the actuator subassembly, capsulesubassembly, and the setting mechanism. The actuator subassembly is comprised of nine individual components which are collectively supplied by sixdifferent third-party manufacturers. The capsule subassembly that houses the sterile drug formulation sumatriptan is comprised of five different componentsalso supplied by four third-party manufacturers. Each of these third-party manufacturers is currently the single source of their respective components. If anyof these manufacturers is unable to supply its respective component for any reason, including due to violations of the FDA’s Quality System Regulation, orQSR, requirements, our ability to manufacture the finished DosePro device will be adversely affected and our ability to meet the distribution requirements forany product sales of Sumavel DosePro and the resulting revenue therefrom will be negatively affected. Accordingly, there can be no assurance that any failurein any part of our supply chain will not have a material adverse effect on our ability to generate revenue from Sumavel DosePro, which in turn could have amaterial adverse effect on our business, results of operations, financial condition and prospects.We rely on third parties to perform many necessary services for our commercial products, including services related to the distribution, invoicing,storage and transportation of our products.We have retained third-party service providers to perform a variety of functions related to the sale and distribution of our products, key aspects of whichare out of our direct control. For example, we rely on Cardinal Health 105, Inc. (a/k/a Specialty Pharmaceutical Services) to provide key services related tologistics, warehousing and inventory management, distribution, contract administration and chargeback processing, accounts receivable management and callcenter management, and, as a result, most of our inventory is stored at a single warehouse maintained by the service provider. We place substantial reliance onthis provider as well as other third-party providers that perform services for us, including entrusting our inventories of products to their care and handling. Ifthese third-party service providers fail to comply with applicable laws and regulations, fail to meet expected deadlines, or otherwise do not carry out theircontractual duties to us, or encounter physical damage or natural disaster at their facilities, our ability to deliver product to meet commercial demand would besignificantly impaired. In addition, we utilize third parties to perform various other services for us relating to sample accountability and regulatory monitoring,including adverse event reporting, safety database management and other product maintenance services. If the quality or accuracy of the data maintained bythese service providers is insufficient, our ability to continue to market our products could be jeopardized or we could be subject to regulatory sanctions. Wedo not currently have the internal capacity to46Table of Contentsperform these important commercial functions, and we may not be able to maintain commercial arrangements for these services on reasonable terms.The perception that our DosePro needle-free drug delivery system should be pain free may limit patient adoption.We believe that there is a perception among some patients, physicians and other customers that a needle-free delivery system should be pain free. Whileour experience indicates that some patients will experience pain upon injection with the DosePro technology, this pain sensation is consistent with the painsensation associated with injection with a fine gauge needle and can be generally characterized as transient mild discomfort. In addition, some patients willexperience local injection site signs and reactions following injection with DosePro. The fact that the use of our DosePro system may be accompanied by acertain amount of pain upon injection and local injection site signs and reactions may limit its adoption by patients, physicians and other customers.Zohydro ER and Relday are subject to extensive regulation, and we cannot give any assurance that they or any of our other product candidateswill receive regulatory approval or be successfully commercialized.We currently are developing Zohydro ER for the treatment of moderate to severe chronic pain and Relday for the treatment of the symptoms ofschizophrenia. The research, testing, manufacturing, labeling, approval, sale, marketing and distribution of drug products, among other things, are subject toextensive regulation by the FDA, the DEA (in the case of Zohydro ER) and other regulatory authorities in the United States. We are not permitted to marketZohydro ER, Relday or any of our other product candidates in the United States unless and until we receive regulatory approval from the FDA. We cannotprovide any assurance that we will obtain regulatory approval for Zohydro ER, Relday or any of our other product candidates, or that any such productcandidates will be successfully commercialized.Under the policies agreed to by the FDA under The Prescription Drug User Fee Act, or PDUFA, as renewed by the Food and Drug Administration Safetyand Innovation Act, or FDASIA, the FDA is subject to a two-tiered system of review times for new drugs - Standard Review and Priority Review. For certaindrugs subject to standard review, such as Zohydro ER, the FDA has a goal to complete its review of the NDA and respond to the applicant within ten monthsfrom the date of receipt of an NDA. The FDA assigned a target action date of March 1, 2013 for the Zohydro ER NDA. The review process and the PDUFAtarget action date may be extended by three months if the FDA requests or the NDA sponsor otherwise provides additional information or clarificationregarding information already provided in the submission within the three months prior to the PDUFA target action date. The FDA's review goals are subject tochange, and the duration of the FDA's review may depend on the number and type of other NDAs that are submitted with the FDA around the same timeperiod. In February 2013, the FDA informed us that we were unlikely to receive an action letter for our NDA for Zohydro ER by the PDUFA target action dateof March 1, 2013. The FDA has not provided us with information as to the reason for the delay, but has indicated that the delay would likely be brief andmay last only several weeks past the PDUFA target action date. We have not been informed of any deficiencies in the NDA for Zohydro ER during the reviewprocess to date.The FDA may also refer applications for novel products or products which present difficult questions of safety or efficacy to an advisory committee,typically a panel that includes clinicians and other experts, for review, evaluation and a recommendation as to whether the application should be approved. Inconnection with the acceptance of our NDA for Zohydro ER, the FDA convened an advisory committee on December 7, 2012, which voted 2-11 (with 1abstention) against the approval of Zohydro ER. The FDA is not bound by the recommendation of the advisory committee and the final decision regardingapproval is made by the FDA. However, due to the advisory committee's recommendation against the approval of our NDA, we may not be able to succeed insecuring approval for Zohydro ER. Even if we obtain regulatory approval for Zohydro ER, the matters discussed at the advisory committee meetings, and inparticular any concerns regarding safety and abuse potential, could limit our ability to successfully commercialize the product candidate.As part of its review of the NDA, the FDA may inspect the facility or the facilities where the drug is manufactured. If the FDA's evaluations of the NDAand the clinical and manufacturing procedures and facilities are favorable, the FDA will issue an action letter, which will be either an approval letter,authorizing commercial marketing of the drug for a specified indication, or a “Complete Response Letter, or CRL” containing the conditions that must be metin order to secure approval of the NDA. These conditions may include deficiencies identified in connection with the FDA's evaluation of the NDA submissionor theclinical and manufacturing procedures and facilities. Until any such conditions or deficiencies have been resolved, the FDA may refuse to approve the NDA.If and when those conditions have been met to the FDA's satisfaction, the FDA will issue an approval letter. The FDA has substantial discretion in the drugapproval process, including the ability to delay, limit or deny approval of a product candidate for many reasons. For example:•the FDA may not deem a product candidate safe and effective;•the FDA may not find the data from pre-clinical studies and clinical trials sufficient to support approval;47Table of Contents•the FDA may require additional pre-clinical studies or clinical trials;•the FDA may not approve of our third-party manufacturers’ processes and facilities; or•the FDA may change its approval policies or adopt new regulations.Zohydro ER has undergone Phase 1 pharmacokinetics studies, Phase 2 clinical trials, and a Phase 3 clinical development program. However, some ofthese studies and trials were conducted by a third party and, accordingly, we did not directly participate in their design or execution. We initiated the Phase 3clinical development program for Zohydro ER in March 2010 and reported positive results from our pivotal Phase 3 efficacy trial, Study 801, in August 2011and completed our Phase 3 safety trial, Study 802, in December 2011, which showed Zohydro ER to be safe and generally well tolerated. However, productcandidates such as Zohydro ER may not be approved even if they achieve their specified endpoints in clinical trials. The FDA may disagree with our trialdesign and our interpretation of data from clinical trials, or may change the requirements for approval even after it has reviewed and commented on the designfor our clinical trials. The FDA may also approve a product candidate for fewer or more limited indications than we request, or may grant approval contingenton the performance of costly post-approval clinical trials. In addition, the FDA may not approve the labeling claims that we believe are necessary or desirablefor the successful commercialization of our product candidates. Approval may be contingent on a Risk Evaluation and Mitigation Strategy, or REMS, whichlimits the labeling, distribution or promotion of a drug product.Relday and any of our other product candidates may fail to achieve their specified endpoints in clinical trials. We initiated a Phase 1 safety andpharmacokinetic clinical trial for Relday in July 2012 and announced positive single-dose pharmacokinetic results from this trial in January 2013. Based onthe favorable safety and pharmacokinetic profile demonstrated with the 25 mg and 50 mg once-monthly doses tested in the Phase 1 trial, we extended thestudy to include an additional cohort of 10 patients at a 100 mg dose of the same formulation. We expect to complete the extension of the Phase 1 clinical trialduring the second quarter of 2013. The timing and outcome of this study and the subsequent development of Relday will be subject to most of the risksdescribed above.We believe that we have planned, designed and completed an adequate Phase 3 clinical trial program for Zohydro ER, and we presented the trial designfor our Phase 3 trials to the FDA at our End of Phase 2 meeting in June 2008. Although we believe the FDA has generally agreed with the design of our Phase 3clinical trial program, the FDA could still determine that it is not satisfied with our plan, the details of our pivotal clinical trial protocols and designs or theresults of our studies. In addition, we concluded our pre-NDA meetings with the FDA in December 2011 during which we discussed the non-clinical, clinicaland chemistry, manufacturing and controls, or CMC, development of Zohydro ER, and agreed on the submission requirements for the NDA under 505(b)(2)of the Federal Food, Drug, and Cosmetic Act, or FFDCA. While the FDA has provided us with a written record of our discussions and responses to ourquestions at our End of Phase 2 meeting and our pre-NDA meetings, such records and responses do not guarantee that the FDA will deem our trial design to besufficient for the purpose of obtaining marketing approval for Zohydro ER. We did not seek a Special Protocol Assessment from the FDA for our pivotalPhase 3 efficacy study for Zohydro ER (Study 801).If we are unable to obtain regulatory approval for Zohydro ER, Relday or any other product candidates on the timeline we anticipate, we will not be ableto execute our business strategy effectively and our ability to generate additional revenues beyond Sumavel DosePro will be limited, which would have amaterial adverse impact on our business, results of operations, financial condition and prospects.Our clinical trials may fail to demonstrate acceptable levels of safety and efficacy for Zohydro ER, Relday or any of our other product candidates,which could prevent or significantly delay their regulatory approval.Our Zohydro ER, Relday and any other product candidates are prone to the risks of failure inherent in drug development. Before obtaining U.S.regulatory approval for the commercial sale of Zohydro ER, Relday or any other product candidate, we must gather substantial evidence from well-controlledclinical trials that demonstrate to the satisfaction of the FDA that the product candidate is safe and effective, and similar regulatory approvals would benecessary to commercialize the product candidate in other countries.In light of widely publicized events concerning the safety risk of certain drug products, particularly opioid drug products, regulatory authorities,members of Congress, the Government Accountability Office, medical professionals and the general public have raised concerns about potential drug safetyissues. These events have resulted in the withdrawal of drug products, revisions to drug labeling that further limit use of the drug products and establishmentof risk management programs that may, for instance, restrict distribution of drug products after approval. In addition, the FFDCA, as amended by the Foodand Drug Administration Amendments Act of 2007, grants significant expanded authority to the FDA, much of which is aimed at improving the safety ofdrug products before and after approval. In particular, the FFDCA authorizes the FDA to, among other things, require post-approval studies and clinicaltrials, mandate changes to drug labeling to reflect new safety information and require a REMS for certain drugs, including certain currently approved drugs. Italso significantly expands the federal48Table of Contentsgovernment's clinical trial registry and results databank, which we expect will result in significantly increased government oversight of clinical trials. Underthe FFDCA, companies that violate these and other provisions of the law are subject to substantial civil monetary penalties, among other regulatory, civil andcriminal penalties.The increased attention to drug safety issues may result in a more cautious approach by the FDA in its review of our clinical trials. Data from clinicaltrials may receive greater scrutiny with respect to safety, which may make the FDA or other regulatory authorities more likely to terminate clinical trials beforecompletion, or require longer or additional clinical trials that may result in a delay or failure in obtaining approval or approval for a more limited indicationthan originally sought.With regard to Zohydro ER, results from our pivotal Phase 3 efficacy clinical trial in patients with chronic lower back pain has shown what we believeis a clinically acceptable efficacy and safety profile which supported submission of an NDA for the treatment of moderate to severe pain in patients requiringaround-the-clock opioid therapy. The trial successfully met the primary efficacy endpoint of the study in demonstrating a significant difference (p=0.008)between the mean changes in daily pain intensity Numeric Rating Scale (NRS) scores between Zohydro ER and placebo groups. The two key secondaryendpoints were also met, specifically, the proportion of patients with at least 30% improvement in pain intensity and the improvement of overall satisfaction ofmedication. In the pivotal Phase 3 efficacy trial, the observed adverse events were similar to the side effects we observed in prior Phase 2 trials of Zohydro ERand consistent with the reported side effects of opioids currently prescribed for chronic pain. The incidence of adverse events was 33.7% and 28.8% in theopen-label titration and double blind treatment periods, respectively. Overall, the most commonly reported adverse events (2%) were constipation, nausea,somnolence, vomiting, diarrhea, insomnia, fatigue, headache, dizziness and dry mouth. We also completed a 48-week open-label safety study to support thesafety profile of Zohydro ER and have reported results. While the overall incidence of adverse events in this study was higher than in the controlled efficacystudy, which we believe reflects the longer duration of the study, the results were consistent with results from similar studies with other extended-release andlong-acting opioid products and we believe support an overall conclusion that Zohydro ER is safe and generally well tolerated. In addition, the data we havereported and may continue to report from our Zohydro ER clinical trials may change in connection with the FDA's review of our NDA. A number ofcompanies in the biotechnology and pharmaceutical industries have suffered significant setbacks in advanced clinical trials, even after promising results inearlier trials. If Zohydro ER, Relday, or any of our other product candidates are not shown to be safe and effective in clinical trials, the program could bedelayed or terminated, which could have a material adverse effect on our business, results of operations, financial condition and prospects.Delays in the commencement or completion of any additional testing for Zohydro ER, if required, or clinical testing for Relday, or pre-clinical orclinical testing for any of our other product candidates could result in increased costs to us and delay or limit our ability to pursue regulatoryapproval for, or generate revenues from, such product candidates.Clinical trials are very expensive, time consuming and difficult to design and implement. Delays in the commencement or completion of any additionaltesting for Zohydro ER, if required, or clinical testing for Relday, or pre-clinical or clinical testing for any of our other product candidates could significantlyaffect our product development costs and business plan. We initiated clinical testing for Relday in patients with schizophrenia in July 2012 and announcedpositive single-dose pharmacokinetic results from the Phase 1 clinical trial in January 2013. Based on the favorable safety and pharmacokinetic profiledemonstrated in the Phase 1 trial, we extended the study to include an additional dose of the same formulation and expect to complete the extension during thesecond quarter of 2013. We do not know whether the extension of this trial will be completed on schedule, or whether any of our other pre-clinical or clinicaltrials will begin on time or be completed on schedule, if at all. The commencement and completion of clinical trials can be delayed for a number of reasons,including delays related to:•obtaining regulatory authorization to commence a clinical trial;•reaching agreement on acceptable terms with prospective clinical research organizations, or CROs, clinical investigators and trial sites, the terms ofwhich can be subject to extensive negotiation and may vary significantly among different CROs, clinical investigators and trial sites;•manufacturing or obtaining sufficient quantities of a product candidate for use in clinical trials;•obtaining institutional review board, or IRB, approval to initiate and conduct a clinical trial at a prospective site;•identifying, recruiting and training suitable clinical investigators;•identifying, recruiting and enrolling subjects to participate in clinical trials for a variety of reasons, including competition from other clinical trialprograms for the treatment of pain, migraine or similar indications;•retaining patients who have initiated a clinical trial but may be prone to withdraw due to side effects from the therapy, lack of efficacy, personalissues, or for any other reason they choose, or who are lost to further follow-up;•uncertainty regarding proper dosing; and•scheduling conflicts with participating clinicians and clinical institutions.In addition, if a significant number of patients fail to stay enrolled in any of our current or future clinical trials of Relday or any of our other productcandidates and such failure is not adequately accounted for in our trial design and enrollment49Table of Contentsassumptions, our clinical development program could be delayed. Clinical trials may also be delayed or repeated as a result of ambiguous or negative interimresults or unforeseen complications in testing. In addition, a clinical trial may be suspended or terminated by us, the FDA, the IRB overseeing the clinical trialat issue, any of our clinical trial sites with respect to that site, or other regulatory authorities due to a number of factors, including:•failure to design appropriate clinical trial protocols;•failure by us, our employees, our CROs or their employees to conduct the clinical trial in accordance with all applicable FDA, DEA or otherregulatory requirements or our clinical protocols;•inspection of the clinical trial operations or trial sites by the FDA or other regulatory authorities resulting in the imposition of a clinical hold;•discovery of serious or unexpected toxicities or side effects experienced by study participants or other unforeseen safety issues;•lack of adequate funding to continue the clinical trial, including the incurrence of unforeseen costs due to enrollment delays, requirements to conductadditional trials and studies and increased expenses associated with the services of our CROs and other third parties;•lack of effectiveness of any product candidate during clinical trials;•slower than expected rates of subject recruitment and enrollment rates in clinical trials;•failure of our CROs or other third-party contractors to comply with all contractual requirements or to perform their services in a timely or acceptablemanner;•inability or unwillingness of medical investigators to follow our clinical protocols; and•unfavorable results from on-going clinical trials and pre-clinical studies.Additionally, changes in applicable regulatory requirements and guidance may occur and we may need to amend clinical trial protocols to reflect thesechanges. Amendments may require us to resubmit our clinical trial protocols to IRBs for reexamination, which may impact the costs, timing or successfulcompletion of a clinical trial. All of the above risks will be applicable to Zohydro ER to the extent we are required by the FDA to conduct any additional clinicaltrials. If we experience delays in completion of, or if we terminate, any of our clinical trials, the commercial prospects for Zohydro ER, Relday and our otherproduct candidates may be harmed, which may have a material adverse effect on our business, results of operations, financial condition and prospects.Our competitors could receive FDA approval for an extended-release hydrocodone product before we receive FDA approval for Zohydro ER, andthus could be granted regulatory exclusivity that could significantly delay our ability to receive approval for and commercialize Zohydro ER andtherefore dramatically reduce its market potential. Our competitors could also pursue regulatory and other strategies to combat competition from505(b)(2) products, which also may negatively affect the approval and commercialization of Zohydro ER and any of our other product candidates.The Drug Price Competition and Patent Term Restoration Act of 1984, also known as the Hatch-Waxman Amendments, added Section 505(b)(2) to theFFDCA, or Section 505(b)(2). Section 505(b)(2) permits the filing of an NDA where at least some of the information required for approval comes fromstudies not conducted by or for the applicant and for which the applicant has not obtained a right of reference. For example, we obtained FDA marketingapproval of Sumavel DosePro under Section 505(b)(2), and we submitted the NDA for Zohydro ER under Section 505(b)(2), and as such the NDA will rely,in part, on the FDA's previous findings of safety and effectiveness for hydrocodone.Certain of our competitors may file a 505(b)(2) application for extended-release hydrocodone prior to the approval of our own NDA for Zohydro ER.The first approved 505(b)(2) applicant for a particular condition of use, or change to a marketed product, such as a new extended-release formulation for apreviously approved product, may be granted three-year Hatch-Waxman exclusivity if one or more clinical studies, other than bioavailability or bioequivalencestudies, was essential to the approval of the application and was conducted/sponsored by the applicant. Three-year Hatch-Waxman exclusivity delays theFDA's approval of other 505(b)(2) applicants for the same condition of use or change to the drug product that was granted exclusivity, regardless of the date ofsubmission of each NDA. We believe that several competitors are developing extended-release hydrocodone products, and if the FDA approves a competitor's505(b)(2) application for its extended-release hydrocodone product before our application, and granted the competitor three-year exclusivity, the FDA would beprecluded from making effective our NDA for Zohydro ER until after that three-year exclusivity period has expired, and such delay would dramatically reduceour expected market potential for Zohydro ER. Additionally, even if our 505(b)(2) application for extended-release hydrocodone is approved first, we may stillbe subject to competition by other hydrocodone products, including approved products or other 505(b)(2) applications for different conditions of use thatwould not be restricted by the three-year exclusivity.50Table of ContentsIn addition, approval under Section 505(b)(2) generally requires the absence of any other patents covering the product candidate in question andcompetitors and others have the ability to take numerous steps to block or delay approval of product candidates under Section 505(b)(2), including:•extending patent protection for existing products that would block Section 505(b)(2) approval of the product candidate by pursuing new patents forexisting products that may be granted just before the expiration of one patent, which could extend patent protection for a number of years or otherwisedelay the launch of generic, 505(b)(2) or other competing products;•submitting Citizen Petitions to request the FDA to take adverse administrative action with respect to approval of a generic, 505(b)(2) or othercompeting product;•filing patent infringement lawsuits, whether or not meritorious, to trigger up to a 30-month stay in the approval of a generic, 505(b)(2) or othercompeting product; and•engaging in state-by-state initiatives to enact legislation or regulatory policies that restrict the substitution of some generic, 505(b)(2) or othercompeting drugs for brand-name drugs.If any of these strategies are successful, our ability to obtain approval of and commercialize Zohydro ER and any of our other product candidates forwhich we rely on Section 505(b)(2) will be adversely affected.We rely on third parties to conduct our pre-clinical and clinical trials. If these third parties do not successfully carry out their contractual duties ormeet expected deadlines, we may not be able to obtain regulatory approval for or commercialize our product candidates and our business could besubstantially harmed.We conducted our Phase 3 trials for Zohydro ER under agreements with third-party CROs. We are also conducting our Phase 1 clinical trial for Reldayunder an agreement with a third-party CRO, and we anticipate that we may enter into agreements with third-party CROs in the future regarding Zohydro ER, iffurther clinical trials are required, Relday or any of our other product candidates. We rely heavily on these parties for the execution of our clinical and pre-clinical studies, and control only certain aspects of their activities. Nevertheless, we are responsible for ensuring that each of our studies is conducted inaccordance with the applicable protocol. We and our CROs are required to comply with current good clinical practices, or GCPs. The FDA enforces these GCPregulations through periodic inspections of trial sponsors, principal investigators and trial sites. If we or our CROs fail to comply with applicable GCPregulations, the data generated in our clinical trials may be deemed unreliable and the FDA may require us to perform additional clinical trials before approvingour marketing applications. We cannot assure you that, upon inspection, the FDA and similar foreign regulators will determine that any of our clinical trialscomply or complied with GCP regulations. In addition, our clinical trials must be conducted with product produced under current good manufacturingpractices, or cGMPs, regulations, and require a large number of test subjects. Our failure to comply with these regulations may require us to repeat clinicaltrials, which would delay the regulatory approval process.If any of our relationships with these third-party CROs terminate, we may not be able to enter into arrangements with alternative CROs on commerciallyreasonable terms, or at all. If CROs do not successfully carry out their contractual duties or obligations or meet expected deadlines, if they need to be replacedor if the quality or accuracy of the clinical data they obtain is compromised due to the failure to adhere to our clinical protocols or regulatory requirements orfor other reasons, our clinical trials may be extended, delayed or terminated and we may not be able to obtain regulatory approval for or successfullycommercialize our product candidates. As a result, our results of operations and the commercial prospects for our product candidates would be harmed, ourcosts could increase and our ability to generate additional revenues could be delayed.Switching or adding additional CROs can involve substantial cost and require extensive management time and focus. In addition, there is a naturaltransition period when a new CRO commences work. As a result, delays may occur, which can materially impact our ability to meet our desired clinicaldevelopment timelines. Though we carefully manage our relationships with our CROs, there can be no assurance that we will not encounter similar challengesor delays in the future or that these delays or challenges will not have a material adverse impact on our business, results of operations, financial condition andprospects.The development and implementation of a REMS for Zohydro ER could cause significant delays in the approval process for Zohydro ER and willadd additional layers of regulatory requirements, including the requirement for a Medication Guide and educational requirements for prescribersand patients, which could significantly impact our ability to commercialize Zohydro ER and dramatically reduce its market potential.The Food and Drug Administration Amendments Act, or FDAAA, added Section 505-1 to the FFDCA. Section 505-1 permits FDA to require a REMSfor a drug product to ensure the safe use of the drug. A REMS is a strategic safety program that the FDA requires to ensure that the benefits of a drug outweighits risks. In determining whether a REMS is necessary, the51Table of ContentsFDA will consider the size of the population likely to use the drug, the seriousness of the disease or condition to be treated, the expected benefit of the drug, theduration of treatment and the seriousness of known or potential adverse events. If the FDA determines a REMS is necessary, the drug sponsor must agree tothe REMS plan at the time of approval. A REMS may be required to include various elements, such as a medication guide or patient package insert, acommunication plan to educate health care providers of the drug's risks, limitations on who may prescribe or dispense the drug, requirements that patientsenroll in a registry or undergo certain health evaluations or other measures that the FDA deems necessary to assure the safe use of the drug. In addition, theREMS must include a timetable to assess the strategy minimally at 18 months, three years and seven years after the strategy's approval.In February 2009, the FDA informed opioid analgesic drug manufacturers that it will require a class-wide REMS for all long-acting and sustained-release opioid drug products. The FDA has since initiated efforts to develop a new standardized REMS for these opioid medications to ensure their safe use. InApril 2011, the FDA announced that it had finalized the elements of a class-wide REMS for these products. The central component of the opioid REMSprogram is an education program for prescribers and patients. Specifically, the REMS for these products must include a Medication Guide available fordistribution to patients who are dispensed the drug, as well as a number of elements to assure safe use. These elements include training for prescribers whoprescribe the drug; information provided to prescribers that prescribers can use to educate patients in the safe use, storage, and disposal of opioids; andinformation provided to prescribers of the existence of the REMS and the need to successfully complete the necessary training. The FDA expects that theprescriber training required as part of the REMS is to be conducted by accredited, independent continuing education providers, without cost to the healthcareprofessionals, under unrestricted grants to accredited continuing education providers funded by the opioid analgesic sponsor. In November 2011, the FDAissued a draft blueprint for this prescriber education that outlines the core messages that the FDA believes should be conveyed to prescribers in a basic two tothree hour educational module. This finalized and approved blueprint will be available for use by continuing education providers in developing continuingeducation courses. Moreover, the extended-release/long-acting opioid analgesic REMS must include a timetable for submission of assessments that shall be noless frequent than 6 months, 12 months, and annually after the REMS is approved to assess the extent to which the elements to assure safe use are meeting thegoals of the REMS and whether the goals or elements should be modified. The FDA expects that manufacturers of long-acting and extended-release opioidswork together to provide educational materials as part of a class-wide single shared system to reduce the burden of the REMS on the healthcare system.An extended-release formulation of hydrocodone, such as Zohydro ER, will be required to have a REMS that contains the elements of the recently-issued class-wide REMS for long-acting and sustained-release opioids. We submitted a REMS at the time of the NDA submission for Zohydro ER. TheREMS submission could cause significant delays in the approval process for the Zohydro ER NDA, and the educational requirements and requirements for aMedication Guide for patients could significantly impact our ability to commercialize Zohydro ER and dramatically reduce its market potential.Our commercialization partner for Sumavel DosePro in the European Union and three other countries, Desitin Arzneimittel GmbH, or Desitin,may not successfully develop, obtain approval for or commercialize Sumavel DosePro in those territories, which may adversely affect our ability tocommercialize Sumavel DosePro both inside and outside the United States.In March 2008, we entered into a licensing and distribution agreement with Desitin pursuant to which we granted Desitin the exclusive right under ourintellectual property rights related to Sumavel DosePro to develop, use, distribute, sell, offer for sale, and import Sumavel DosePro and any potential modifiedversions of Sumavel DosePro in the European Union, Norway, Switzerland and Turkey. In that regard, Desitin is not obligated under the agreement to pursueregulatory approval or commercialization of Sumavel DosePro in any of these countries except for Germany. Since we will depend on Desitin to develop, obtainregulatory approval for and, if regulatory approval is granted, commercialize Sumavel DosePro in these countries, we will have limited control over thesuccess of Desitin's development, regulatory approval and commercialization efforts. Desitin submitted a Marketing Authorization Application for SumavelDosePro to the Federal Institute for Drugs and Medical Devices (Bundesinstitut für Arzneimittel und Medizinprodukte (BfArM)) in Germany, the referencemember state, through the Decentralized Procedure in October 2009, following completion of a European pivotal bioequivalence trial comparing needle-freeSumavel DosePro to a traditional needle-based autoinjector, Imigran-Inject, the European brand of Imitrex STATdose. In November 2010, Denmark became thefirst member of the European Union to approve marketing of Sumavel DosePro in that country. Subsequently, Sumavel DosePro has received marketingapproval in Germany, Sweden, the United Kingdom, Norway and France.Any additional clinical studies Desitin may be required to conduct as part of the regulatory approval process may not corroborate the results of theclinical studies we have conducted or may have adverse results or effects on our ability to maintain regulatory approvals in the United States or obtain them inother countries. In addition, although we believe that the U.S. market represents the largest commercial opportunity for Sumavel DosePro, Desitin may notdevelop Sumavel DosePro as fast or generate as large of a market as we would like or as the market may expect and Desitin may not seek to develop, obtain52Table of Contentsapproval for or commercialize Sumavel DosePro in countries for which it has exclusive rights, other than in Germany, where Desitin is required to develop,seek approval for and commercialize Sumavel DosePro. Any failure by Desitin to successfully commercialize Sumavel DosePro or to successfully obtainapplicable foreign regulatory approval for Sumavel DosePro would limit our opportunity to receive revenue from the territories licensed to Desitin. Furthermore,negative developments occurring in those territories controlled by Desitin could have a negative impact on physician and patient impressions of our product inthe United States and elsewhere.Our failure to successfully establish new partnerships with pharmaceutical companies or contract sales organizations to co-promote SumavelDosePro and any additional product candidates that may receive regulatory approval may impair our ability to effectively market and sell suchproduct candidates.Major pharmaceutical companies usually employ groups of sales representatives numbering in the thousands to call on the large number of primary carephysicians. In connection with the launch of Sumavel DosePro in January 2010 we built a sales and marketing organization to promote Sumavel DosePro inthe United States, including a focused sales force, which as of December 31, 2012 was comprised of approximately 85 field sales personnel, primarilytargeting neurologists and other prescribers of migraine medications, including headache clinics and headache specialists. In July 2009, we entered into anexclusive agreement with Astellas under which Sumavel DosePro was also being marketed by Astellas in the United States and promoted primarily to primarycare physicians, OB/GYNs, emergency medicine physicians and urologists by approximately 400 Astellas sales representatives. Our Astellas agreementterminated on March 31, 2012. In June 2012, in order to maintain and expand the market opportunity for Sumavel DosePro into the broader primary carephysician audiences, we entered into a new co-exclusive (with us) co-promotion agreement with Mallinckrodt under which in August 2012 Mallinckrodt beganpromoting Sumavel DosePro to its customer base of prescribers.In addition, in order to promote any additional product candidates that receive regulatory approval to these broader primary care physician audiences,we will need to expand our sales and marketing personnel and commercial infrastructure and/or establish partnerships with pharmaceutical companies orcontract sales organizations to co-promote such additional products. We currently, and on an ongoing basis will have to, compete with other pharmaceuticaland biotechnology companies to recruit, hire, train and retain sales and marketing personnel. We also face competition in our search for collaborators andpotential co-promoters. To the extent we rely on additional third parties to co-promote or otherwise commercialize any product and/or product candidates thatmay receive regulatory approval, we are likely to receive less revenue than if we commercialized these products ourselves. Further, by entering into strategicpartnerships or similar arrangements, we may rely in part on such third parties for financial and commercialization resources. Even if we are able to identifysuitable partners to assist in the commercialization of our product and/or product candidates, they may fail to devote the resources necessary to realize the fullcommercial potential of our products. In addition, we may lack the financial and managerial resources to increase the size of our sales and marketingorganization to adequately promote and commercialize Sumavel DosePro and any product candidates that may be approved, and any increase in our salesforce would result in an increase in our expenses, which could be significant before we generate revenues from any newly approved product candidate. If weare unable to expand our sales and marketing infrastructure or enter into a third-party arrangement, we would not be able to successfully commercialize anyapproved products. Even if we are able to expand our sales and marketing personnel or successfully establish partnership arrangements, such sales force andmarketing teams may not be successful in commercializing our products, which would adversely affect our ability to generate revenue for such products,which will have a material adverse effect on our business, results of operations, financial condition and prospects.Our failure to successfully acquire, develop and market additional product candidates or approved products would impair our ability to grow ourbusiness. In that regard, our DosePro delivery system in its present form cannot be used with drug formulation volumes greater than 0.5 mL,which will likely limit its use with drugs requiring larger formulation volumes.As part of our growth strategy we intend to seek to expand our product pipeline by exploring acquisition or in-licensing opportunities of proven drugsthat can be paired with our DosePro needle-free drug delivery system. However, the current version of our DosePro drug delivery system cannot be used withdrug formulation volumes greater than 0.5 mL. Many marketed and development-stage injectable products, including most biologics, have formulationvolumes greater than 0.5 mL and would require reformulation, if possible, to accommodate the approved doses in smaller volumes that are compatible withDosePro. Any reformulation may increase the risk of failure during development, extend the development timelines, increase development costs and addcomplexity to the regulatory approval process and in some cases reformulation may not be possible. If we are not able to identify additional drug compoundsthat can be delivered via the current version of our DosePro technology, or if we are unable to successfully develop higher dose versions of this technology, ourability to develop additional product candidates and grow our business would be adversely affected. We and Battelle Memorial Institute, or Battelle, ourtechnology co-marketing partner, are also seeking opportunities to out-license the DosePro technology to partners seeking to enhance, differentiate, or extend thelife-cycle of their injectable products. However, there can be no assurance that our or53Table of ContentsBattelle's efforts to secure such a partnership will be successful. If we are unable to secure partnerships with companies that have compounds that can bedelivered via the current version of our DosePro technology, or if we are unable to successfully develop higher dose versions of this technology, we will not beable to generate revenues from out-licensing our DosePro technology.We have initiated early stage design and development of a larger volume, second generation version of our DosePro technology to accommodate drugformulation volumes greater than 0.5 mL, which if successfully developed, would allow for a broader range of potential applications for our technology.However, the full development of such technology will require substantial investment and we may enter into a third-party collaboration in order to obtainadditional financing to help fully develop such technology. For example, under our co-marketing and option agreement with Battelle, we granted Battelle anoption to enter into an exclusive co-development and commercialization arrangement with us related to a 1.2 mL DosePro drug delivery technology. There is noguarantee that we or any potential future third-party collaborator, including Battelle should it exercise its option, will be able to successfully develop such adevice technology, whether for financial or technical reasons or otherwise.In addition, we continue to examine potential improvements to the DosePro needle-free delivery system but cannot be certain that any improvements willobtain the necessary regulatory approvals or actually increase product sales. For example, we submitted a Prior Approval Supplement to the FDA regarding theimplementation of a minor change designed to soften the sound upon administration of Sumavel DosePro. The FDA issued a complete response letterrequesting more information. We plan to meet with the FDA to discuss the complete response letter and any additional steps required to implement thisimprovement. The complete response letter has no impact on the current Sumavel DosePro product.Furthermore, we intend to in-license, acquire, develop and/or market additional products and product candidates in the areas of pain and centralnervous system, or CNS, disorders. Because our internal research and development capabilities are limited, we may be dependent upon other pharmaceuticaland biotechnology companies, academic scientists and other researchers to sell or license products or technology to us. The success of this strategy dependspartly upon our ability to identify and select promising pharmaceutical product candidates and products, negotiate licensing or acquisition agreements withtheir current owners and finance these arrangements.The process of proposing, negotiating and implementing a license or acquisition of a product candidate or approved product is lengthy and complex.Other companies, including some with substantially greater financial, marketing, sales and other resources, may compete with us for the license or acquisitionof product candidates and approved products. We have limited resources to identify and execute the acquisition or in-licensing of third-party products,businesses and technologies and integrate them into our current infrastructure. Moreover, we may devote resources to potential acquisitions or licensingopportunities that are never completed, or we may fail to realize the anticipated benefits of such efforts. We may not be able to acquire the rights to additionalproduct candidates, or license the rights to our DosePro technology, on terms that we find acceptable, or at all.Further, any product candidate that we acquire may require additional development efforts prior to commercial sale, including pre-clinical or clinicaltesting and approval by the FDA and applicable foreign regulatory authorities. All product candidates are prone to risks of failure typical of pharmaceuticalproduct development, including the possibility that a product candidate will not be shown to be sufficiently safe and effective for approval by regulatoryauthorities. In addition, we cannot provide assurance that any products that we develop or approved products that we acquire will be manufactured or soldprofitably or achieve market acceptance.If we are unable to license or acquire additional product candidates or approved products and successfully develop and commercialize them, or if we areotherwise unable to pair our DosePro delivery system with other drugs or out-license the DosePro technology to others, it would likely have a material adverseeffect on our business, results of operations, financial condition and prospects.We may need to continue to increase the size of our organization, and we may experience difficulties in managing and financing growth.We increased our full-time employees from 48 as of October 31, 2009 to 149 as of December 31, 2012. In addition, we have expanded our sales force inthe United States from approximately 80 field sales personnel to approximately 85 field sales personnel as of December 31, 2012, and we intend to increaseour sales force if Zohydro ER is approved by the FDA. Any such increases in our sales force could substantially increase our expenses. We may need tocontinue to expand our managerial, operational and other resources in order to grow, manage and fund our existing business. Our management and personnel,systems and facilities currently in place may not be adequate to support this recent and any future growth, and we may be54Table of Contentsunable to fund the costs and expenses required to increase our necessary headcount and infrastructure. Our need to effectively manage our operations, anyfuture growth and various projects requires that we:•manage our internal and external commercialization efforts for Sumavel DosePro effectively while carrying out our contractual obligations to thirdparties and complying with all applicable laws, rules and regulations;•manage our internal development efforts for Zohydro ER, Relday and our other product candidates effectively while carrying out our contractualobligations to licensors, collaborators and other third parties and complying with all applicable laws, rules and regulations;•continue to improve our operational, financial and management controls, reporting systems and procedures; and•attract and retain sufficient numbers of talented employees.We may be unable to successfully implement or fund these tasks on a larger scale and, accordingly, may not achieve our commercialization anddevelopment goals. In addition, our management may have to divert a disproportionate amount of its attention away from day-to-day activities and towardsmanaging these growth-related activities. Likewise, any increase in our sales force would increase our expenses, perhaps substantially. Our future financialperformance and our ability to execute on our business plan will depend, in part, on our ability to effectively manage any future growth and our failure toeffectively manage any growth could have a material adverse effect on our business, results of operations, financial condition and prospects.If we are unable to attract and retain key personnel, we may not be able to manage our business effectively or develop our product candidates orcommercialize our product.Our success depends on our continued ability to attract, retain and motivate highly qualified management and key clinical development, regulatory,sales and marketing and other personnel. We are highly dependent on the development, regulatory, commercial and financial expertise of our seniormanagement team. We may not be able to attract or retain qualified management and scientific and clinical personnel in the future due to the intense competitionfor qualified personnel among biotechnology, pharmaceutical and other businesses, particularly in the areas in Southern and Northern California, where wecurrently operate. Our industry has experienced a high rate of turnover of management personnel in recent years. If we are not able to attract, retain andmotivate necessary personnel to accomplish our business objectives, we may experience constraints that will significantly impede the achievement of ourdevelopment and commercialization objectives, our ability to raise additional capital and our ability to implement our business strategy. The loss of theservices of any members of our senior management team, especially our Chief Executive Officer, Roger L. Hawley, and President and Chief Operating Officer,Stephen J. Farr, Ph.D., could negatively impact the commercialization of Sumavel DosePro and could delay or prevent the development and commercializationof any other product candidates, including Zohydro ER or Relday. Further, if we lose any members of our senior management team, we may not be able tofind suitable replacements, and our business may be harmed as a result. In addition to the competition for personnel, our locations in California in particularare characterized by a high cost of living. As such, we could have difficulty attracting experienced personnel to our company and may be required to expendsignificant financial resources in our employee recruitment and retention efforts.Although we have employment agreements with each of our executive officers, these agreements are terminable by them at will at any time with orwithout notice and, therefore, do not provide any assurance that we will be able to retain their services. We do not maintain “key man” insurance policies onthe lives of our senior management team or the lives of any of our other employees. In addition, we have clinical advisors who assist us in formulating ourclinical strategies. These advisors are not our employees and may have commitments to, or consulting or advisory contracts with, other entities that may limittheir availability to us, or may have arrangements with other companies to assist in the development of products that may compete with ours. If we are unableto attract and retain key personnel, our business, results of operations, financial condition and prospects will be adversely affected.We may engage in strategic transactions that could impact our liquidity, increase our expenses and present significant distractions to ourmanagement.From time to time we may consider strategic transactions, such as acquisitions of companies, asset purchases and out-licensing or in-licensing ofproducts, product candidates or technologies. Additional potential transactions that we may consider include a variety of different business arrangements,including spin-offs, strategic partnerships, joint ventures, restructurings, divestitures, business combinations and investments. Any such transaction mayrequire us to incur non-recurring or other charges, may increase our near and long-term expenditures and may pose significant integration challenges or disruptour management or business, which could adversely affect our operations and financial results. For example, these transactions may entail numerousoperational and financial risks, including:•exposure to unknown liabilities;55Table of Contents•disruption of our business and diversion of our management’s time and attention in order to develop acquired products, product candidates ortechnologies;•incurrence of substantial debt or dilutive issuances of equity securities to pay for acquisitions;•higher than expected acquisition and integration costs;•write-downs of assets or goodwill or impairment charges;•increased amortization expenses;•difficulty and cost in combining the operations and personnel of any acquired businesses with our operations and personnel;•impairment of relationships with key suppliers or customers of any acquired businesses due to changes in management and ownership; and•inability to retain key employees of any acquired businesses.Accordingly, although there can be no assurance that we will undertake or successfully complete any transactions of the nature described above, anytransactions that we do complete could have a material adverse effect on our business, results of operations, financial condition and prospects.If we are unable to achieve and maintain adequate levels of coverage and reimbursement for Sumavel DosePro, Zohydro ER, if approved, or anyof our other product candidates for which we may receive regulatory approval on reasonable pricing terms, their commercial success may beseverely hindered.Successful sales of our products depend on the availability of adequate coverage and reimbursement from third-party payors. Patients who areprescribed medicine for the treatment of their conditions generally rely on third-party payors to reimburse all or part of the costs associated with theirprescription drugs. Adequate coverage and reimbursement from governmental healthcare programs, such as Medicare and Medicaid, and commercial payorsis critical to new product acceptance. Coverage decisions may depend upon clinical and economic standards that disfavor new drug products when moreestablished or lower cost therapeutic alternatives are already available or subsequently become available. Assuming coverage is approved, the resultingreimbursement payment rates might not be adequate or may require co-payments that patients find unacceptably high. Patients are unlikely to use our productsunless coverage is provided and reimbursement is adequate to cover a significant portion of the cost of our products.In addition, the market for our products will depend significantly on access to third-party payors' drug formularies, or lists of medications for whichthird-party payors provide coverage and reimbursement. The industry competition to be included in such formularies often leads to downward pricingpressures on pharmaceutical companies. Also, third-party payors may refuse to include a particular branded drug in their formularies or otherwise restrictpatient access to a branded drug when a less costly generic equivalent or other alternative is available.Third-party payors, whether foreign or domestic, or governmental or commercial, are developing increasingly sophisticated methods of controllinghealthcare costs. In addition, in the United States, no uniform policy of coverage and reimbursement for drug products exists among third-party payors.Therefore, coverage and reimbursement for drug products can differ significantly from payor to payor.Further, we believe that future coverage and reimbursement will likely be subject to increased restrictions both in the United States and in internationalmarkets. Third-party coverage and reimbursement for Sumavel DosePro or any of our other product candidates for which we may receive regulatory approvalmay not be available or adequate in either the United States or international markets, which could have a material adverse effect on our business, results ofoperations, financial condition and prospects.We face potential product liability exposure, and if successful claims are brought against us, we may incur substantial liability if our insurancecoverage for those claims is inadequate.The commercial use of our product and clinical use of our product and product candidates expose us to the risk of product liability claims. This riskexists even if a product is approved for commercial sale by the FDA and manufactured in facilities licensed and regulated by the FDA, such as the case withSumavel DosePro, or an applicable foreign regulatory authority. Our product and product candidates are designed to affect important bodily functions andprocesses. Any side effects, manufacturing defects, misuse or abuse associated with Sumavel DosePro or our product candidates could result in injury to apatient or even death. For example, because our DosePro technology is designed to be self-administered by patients, it is possible that a patient could fail tofollow instructions and as a result apply a dose in a manner that results in injury. In addition, Zohydro ER is an opioid pain reliever that containshydrocodone, which is a regulated “controlled substance” under the Controlled Substances Act of 1970, or CSA, and could result in harm to patients relatingto its potential for abuse. In addition, a liability claim may be brought against us even if our product or product candidates merely appear to have caused aninjury.56Table of ContentsProduct liability claims may be brought against us by consumers, health care providers, pharmaceutical companies or others selling or otherwise coming intocontact with our product or product candidates, among others. If we cannot successfully defend ourselves against product liability claims we will incursubstantial liabilities. In addition, regardless of merit or eventual outcome, product liability claims may result in:•the inability to commercialize our product or product candidates;•decreased demand for our product or, if approved, product candidates;•impairment of our business reputation;•product recall or withdrawal from the market;•withdrawal of clinical trial participants;•costs of related litigation;•distraction of management’s attention from our primary business;•substantial monetary awards to patients or other claimants; or•loss of revenues.We have obtained product liability insurance coverage for commercial product sales and clinical trials with a $10 million per occurrence and a $10million annual aggregate coverage limit. Our insurance coverage may not be sufficient to cover all of our product liability related expenses or losses and maynot cover us for any expenses or losses we may suffer. Moreover, insurance coverage is becoming increasingly expensive, and, in the future, we may not beable to maintain insurance coverage at a reasonable cost, in sufficient amounts or upon adequate terms to protect us against losses due to product liability. Ifwe determine that it is prudent to increase our product liability coverage based on sales of Sumavel DosePro, approval of Zohydro ER or otherwise, we may beunable to obtain this increased product liability insurance on commercially reasonable terms or at all. Large judgments have been awarded in class action orindividual lawsuits based on drugs that had unanticipated side effects, including side effects that are less severe than those of Sumavel DosePro and ourproduct candidates. A successful product liability claim or series of claims brought against us could cause our stock price to decline and, if judgments exceedour insurance coverage, could decrease our cash and have a material adverse effect on our business, results of operations, financial condition and prospects.We may be adversely affected by earthquakes or other natural disasters and our business continuity and disaster recovery plans may notadequately protect us from a serious disaster.Our corporate headquarters and other facilities are located in San Diego and the San Francisco Bay Area, which in the past have both experienced severeearthquakes. We do not carry earthquake insurance. As a result, earthquakes or other natural disasters could severely disrupt our operations, and have amaterial adverse effect on our business, results of operations, financial condition and prospects.Our enterprise financial systems are located in our San Diego, California headquarters. Our manufacturing resource planning and enterprise qualitysystems are located in our Emeryville, California facility. If a disaster, power outage or other event occurred that prevented us from using all or a significantportion of our headquarters or our Emeryville facility, that damaged critical infrastructure, such as enterprise financial systems or manufacturing resourceplanning and enterprise quality systems, or that otherwise disrupted operations at either location, it may be difficult or, in certain cases, impossible for us tocontinue our business for a substantial period of time. The disaster recovery and business continuity plans we have in place currently are limited and areunlikely to prove adequate in the event of a serious disaster or similar event. We may incur substantial expenses as a result of the limited nature of our disasterrecovery and business continuity plans which, particularly when taken together with our lack of earthquake insurance, could have a material adverse effecton our business.Our business involves the use of hazardous materials and we and our third-party manufacturers and suppliers must comply with environmentallaws and regulations, which can be expensive and restrict how we do business.Our research and development activities and our third-party manufacturers' and suppliers' activities involve the controlled storage, use and disposal ofhazardous materials owned by us, including the components of our product and product candidates and other hazardous compounds. We and ourmanufacturers and suppliers are subject to laws and regulations governing the use, manufacture, storage, handling and disposal of these hazardous materials.In some cases, these hazardous materials and various wastes resulting from their use are stored at our and our manufacturers' facilities pending use anddisposal. We cannot completely eliminate the risk of contamination, which could cause an interruption of our commercialization efforts, research anddevelopment efforts and business operations, injury to our employees and others, environmental damage resulting in costly clean-up and liabilities underapplicable laws and regulations governing the use, storage, handling and disposal of these materials and specified waste products. Although we believe that thesafety procedures utilized by our third-party manufacturers for handling and disposing of these materials generally comply with the standards prescribed bythese laws and regulations, we cannot guarantee that this is the case or eliminate the risk of accidental contamination or injury from these57Table of Contentsmaterials. In such an event, we may be held liable for any resulting damages and such liability could exceed our resources. We do not currently carrybiological or hazardous waste insurance coverage.In connection with the reporting of our financial condition and results of operations, we are required to make estimates and judgments whichinvolve uncertainties, and any significant differences between our estimates and actual results could have an adverse impact on our financialposition, results of operations and cash flows.Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have beenprepared in accordance with generally accepted accounting principles in the United States, or GAAP. The preparation of these consolidated financialstatements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure ofcontingent assets and liabilities. In particular, as part of our revenue recognition policy, our estimates of product returns, rebates and chargebacks require ourmost subjective and complex judgment due to the need to make estimates about matters that are inherently uncertain. Any significant differences between ouractual results and our estimates and assumptions could negatively impact our financial position, results of operations and cash flows.Changes in accounting standards and their interpretations could adversely affect our operating results.GAAP are subject to interpretation by the Financial Accounting Standards Board, the American Institute of Certified Public Accountants, the SEC, andvarious other bodies that promulgate and interpret appropriate accounting principles. These principles and related implementation guidelines andinterpretations can be highly complex and involve subjective judgments. A change in these principles or interpretations could have a significant effect on ourreported financial results, and could affect the reporting of transactions completed before the announcement of a change.Fluctuations in the value of the Euro or U.K. pound sterling could negatively impact our results of operations and increase our costs.Payments to our material suppliers and contract manufacturers are denominated in the Euro and U.K. pound sterling. Our reporting currency is theU.S. dollar and to date all of the revenues generated by sales of Sumavel DosePro have been in U.S. dollars. For the year ended December 31, 2012, $17.1million (based on exchange rates as of December 31, 2012) of our materials, contract manufacturing costs and other manufacturing-related costs weredenominated in foreign currencies. As a result, we are exposed to foreign exchange risk, and our results of operations may be negatively impacted byfluctuations in the exchange rate between the U.S. dollar and the Euro or U.K. pound sterling. A significant appreciation in the Euro or U.K. pound sterlingrelative to the U.S. dollar will result in higher expenses and cause increases in our net losses. Likewise, to the extent that we generate any revenues denominatedin foreign currencies, or become required to make payments in other foreign currencies, fluctuations in the exchange rate between the U.S. dollar and thoseforeign currencies could also negatively impact our results of operations. We currently have not entered into any foreign currency hedging contracts to reducethe effect of changes in foreign currency exchange rates, and foreign currency hedging is inherently risky and may result in unanticipated losses.Our operating results are partially dependent on freight costs and our costs may increase significantly if we are unable to ship and transportfinished products efficiently and economically across long distances and international borders.Our Sumavel DosePro product is manufactured in Europe and we transport significant volumes of that product across long distances and internationalborders. As a result, our operating results can be affected by changes in transportation costs. We generally ship our product by air freight, and freight ratescan vary significantly due to a large number of factors beyond our control, including changes in fuel prices or general economic conditions. If demand for airfreight should increase substantially, it could make it difficult for us to procure transportation space at prices we consider acceptable.Because our products must cross international borders, we are subject to risk of delay due to customs inspection, if our documentation does not complywith customs rules and regulations or for similar reasons. In addition, any increases in customs duties or tariffs, as a result of changes to existing tradeagreements between countries or otherwise, could increase our costs or the final cost of our products to our customers or increase our expenses. The lawsgoverning customs and tariffs in many countries are complex, subject to many interpretations and often includes substantial penalties for noncompliance.Risks Related to Our Financial Position and Capital RequirementsWe have never generated net income or positive cash flow from operations and are dependent upon external sources of financing to fund ourbusiness and development.58Table of ContentsWe launched our only approved product, Sumavel DosePro, in January 2010. Without a long history of sales, we may not accurately predict futuresales, and we may never be able to significantly increase these sales, especially in light of the termination of our partnership with Astellas in March 2012 to co-promote Sumavel DosePro and our reliance on our new co-promotion partner, Mallinckrodt. We have financed our operations almost exclusively through theproceeds from the issuance of our common and preferred stock, including the proceeds from our initial public offering completed in November 2010, ourfollow-on public offerings completed in September 2011 and July 2012, and debt, and have incurred losses and negative cash flow from operations in eachyear since our inception. Our net loss was $47.4 million in 2012, $83.9 million in 2011 and $73.6 million in 2010, and our cash used in operating activitieswas $52.2 million in 2012, $80.5 million in 2011 and $72.0 million in 2010. As of December 31, 2012, we had an accumulated deficit of $329.4 million.These losses and negative cash flow from operations have had a material adverse effect on our stockholders' equity and working capital. Further, despite therevenues from Sumavel DosePro, we expect our losses to continue for at least the next several years primarily as a result of the expenses incurred in connectionwith our efforts in seeking marketing approval for Zohydro ER, the potential additional clinical development of Relday, any additional required testing forZohydro ER, and the cost of the sales and marketing expense associated with Sumavel DosePro, and, if approved, Zohydro ER. As a result, we may remaindependent upon external sources of financing to finance our business and the development and commercialization of our approved product and productcandidates. To the extent we need to raise additional capital in the future, we cannot ensure that debt or equity financing will be available to us in amounts, attimes or on terms that will be acceptable to us, or at all. Any shortfall in our cash resources could require that we delay or abandon certain development andcommercialization activities and could otherwise have a material adverse effect on our business, results of operations, financial condition and prospects.Our level of indebtedness could adversely affect our ability to raise additional capital to fund our operations, limit our ability to react to changes inthe economy or our industry and prevent us from meeting our obligations.As of December 31, 2012, we had $30.0 million of outstanding indebtedness under a financing agreement with Healthcare Royalty Partners, or theHealthcare Royalty financing agreement. Our outstanding debt and related debt service obligations could have important adverse consequences to us,including:•heightening our vulnerability to downturns in our business or our industry or the general economy and restricting us from making improvements oracquisitions, or exploring business opportunities;•requiring a significant amount of interest payments and fixed payments on our indebtedness, therefore reducing our ability to use our available cashto fund our operations, capital expenditures and future business opportunities;•limiting our ability to obtain additional financing for working capital, capital expenditures, debt service requirements, acquisitions and generalcorporate or other purposes;•limiting our ability to adjust to changing market conditions and placing us at a competitive disadvantage compared to our competitors who havegreater capital resources; and•subjecting us to financial and other restrictive covenants in our debt instruments, the failure with which to comply could result in an event of defaultunder the applicable debt instrument that allows the lender to demand immediate repayment of the related debt.If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay product development,sales and marketing, capital and other expenditures, sell assets, seek additional capital or restructure or refinance our indebtedness. These alternative measuresmay not be successful and may not permit us to meet our scheduled debt service obligations.Our debt instrument with Healthcare Royalty contains a number of provisions, including a requirement that we attain specified future levels ofrevenues, which, if violated, could result in the immediate acceleration of our outstanding indebtedness.Pursuant to the terms of our $30.0 million Healthcare Royalty financing agreement, we are required to make payments to Healthcare Royalty of $10.0million on each of January 31, 2015, 2016 and 2017, as well as fixed percentages of amounts received (in the case of co-promotion revenues and license fees)or recorded (in the case of net products sales).Our obligations under the Healthcare Royalty financing agreement are secured by a security interest in substantially all of our personal property(including, among other things, accounts receivable, equipment, inventory, contract rights or rights to payment of money, license agreements, generalintangibles, including all intellectual property, and cash), to the extent necessary or used to commercialize our products. The security interest will beextinguished once the aggregate payments made by us to Healthcare Royalty equals $75.0 million. If we are unable to repay the indebtedness or other amountswhen due, whether at maturity, upon termination or if declared due and payable by the lender following a default, Healthcare Royalty generally has the right toseize and sell the collateral securing the indebtedness, and other amounts owing to it thereunder.59Table of ContentsWe have the option to terminate the Healthcare Royalty financing agreement at our election prior to the termination date in connection with a change ofcontrol of our company, as defined in the Healthcare Royalty financing agreement, upon the payment of a base amount of $52.5 million, or, if higher, anamount that generates a 19% internal rate of return on the borrowed amount as of the date of prepayment, in each case reduced by the interest and fixedpayments received by Healthcare Royalty up to the date of such prepayment. In addition, Healthcare Royalty has the option to terminate the Healthcare Royaltyfinancing agreement at its election in connection with a change of control of our company, as defined in the Healthcare Royalty financing agreement, the sale ofall or substantially all of our assets (which includes the sale, transfer, assignment or licensing of our rights in the United States to either Sumavel DosePro orZohydro ER), or an event of default (which includes the occurrence of a bankruptcy event or other material adverse change in our business), as defined in theHealthcare Royalty financing agreement, occurring thereunder. Upon such a termination by Healthcare Royalty prior to the maturity date specified in theHealthcare Royalty financing agreement, we are obligated to make a payment of a base amount of $45.0 million, or, if higher, an amount that generates a 17%internal rate of return on the borrowed amount as of the date of prepayment, in each case reduced by the interests and fixed payments received by HealthcareRoyalty up to the date of prepayment. If we were required to accelerate the payment of these amounts upon a default, we would be required to find an alternatesource of capital from which to draw funds and there can be no assurances that we would be able to do so on terms acceptable to us, or at all.There can be no assurance that we will not breach the terms of, or that an event of default or termination event will not occur under, our HealthcareRoyalty financing agreement and, if a breach or event of default or termination event occurs, there can be no assurance that we will be able to obtain necessarywaivers or amendments from Healthcare Royalty or refinance the related indebtedness or other amounts due and payable on terms we find acceptable, or at all.As a result, any failure to pay our debt service obligations when due, any breach or default of our obligations under our Healthcare Royalty financingagreement, or any other event that allows Healthcare Royalty to demand immediate repayment of borrowings or termination payments, could have a materialadverse effect on our business, results of operations, financial condition and prospects. Furthermore, the arrangement under the Healthcare Royalty financingagreement may make us significantly less attractive to potential acquirers, and in the event that we exercised our change of control pay-off option in order tocarry out a change of control, the payment of such funds out of our available cash or acquisition proceeds would reduce acquisition proceeds for ourstockholders.Our results of operations and liquidity needs could be materially negatively affected by market fluctuations and economic downturn.Our results of operations and liquidity could be materially negatively affected by economic conditions generally, both in the United States and elsewherearound the world. Domestic and international equity and debt markets have experienced and may continue to experience heightened volatility and turmoil basedon domestic and international economic conditions and concerns. In the event these economic conditions and concerns continue or worsen and the marketscontinue to remain volatile, our results of operations and liquidity could be adversely affected by those factors in many ways, including making it moredifficult for us to raise funds if necessary, and our stock price may decline. In addition, we maintain significant amounts of cash and cash equivalents at oneor more financial institutions that are not federally insured. If economic instability continues, we cannot provide assurance that we will not experience losses onthese investments.Raising additional funds by issuing securities may cause dilution to existing stockholders and raising funds through lending and licensingarrangements may restrict our operations or require us to relinquish proprietary rights.We may need to raise additional funds through public or private equity offerings, debt financings, receivables or royalty financings or corporatecollaboration and licensing arrangements. To the extent that we raise additional capital by issuing equity securities or convertible debt, your ownership interestin us will be diluted. Debt financing typically contains covenants that restrict operating activities. Our obligations under the Healthcare Royalty financingagreement are secured by a security interest in substantially all of our personal property (including, among other things, accounts receivable, equipment,inventory, contract rights or rights to payment of money, license agreements, general intangibles, including all intellectual property, and cash). The securityinterest will be extinguished once the aggregate payments made by us to Healthcare Royalty equals $75.0 million.The Healthcare Royalty financing agreement contains provisions which allows Healthcare Royalty to accelerate the debt and seize and sell the collateralif, among other things, we fail to pay interest payments and fixed payments when due or breach our obligations under the agreement or if a material adversechange in our business or any other event of default occurs. Any future debt financing we enter into may involve more onerous covenants that restrict ouroperations, may be secured by some or all of our assets, and will likely allow the lenders to accelerate the debt and seize and sell any collateral following adefault. Our obligations under our outstanding Healthcare Royalty financing agreement or any future debt financing will need to be60Table of Contentsrepaid, which creates additional financial risk for our company, particularly if our business or prevailing financial market conditions are not conducive topaying-off or refinancing our outstanding debt obligations.If we raise additional funds through collaboration, licensing or other similar arrangements, it may be necessary to relinquish potentially valuable rightsto our current product or product candidates or proprietary technologies, or grant licenses on terms that are not favorable to us. If adequate funds are notavailable, our ability to achieve profitability or to respond to competitive pressures would be significantly limited and we may be required to delay,significantly curtail or eliminate the commercialization and development of our product or product candidates.Our ability to utilize our net operating loss and research and development income tax credit carryforwards may be limited.Under Section 382 of the Internal Revenue Code of 1986, as amended, or the IRC, substantial changes in our ownership may limit the amount of netoperating loss and research and development income tax credit carryforwards (collectively, tax attributes) that could be utilized annually in the future to offsettaxable income, if any. Specifically, this limitation may arise in the event of a cumulative change in ownership of our company of more than 50% within athree-year period as determined under the IRC, which we refer to as an ownership change. Any such annual limitation may significantly reduce the utilizationof these tax attributes before they expire. Prior to our initial public offering in November 2010, we performed an IRC Section 382 and 383 analysis anddetermined that we had one ownership change, which occurred in August 2006 upon the issuance of convertible preferred stock. We performed an additionalIRC Section 382 and 383 analysis upon the issuance of common stock in our follow-on public offering in September 2011, and together with the issuance ofcommon stock in our initial public offering and certain other transactions involving our common stock, resulted in an additional ownership change. As aresult of these ownership changes, our ability to use our then existing tax attributes to offset future taxable income, if any, was limited. We are currently in theprocess of completing a Section 382 and 383 study to determine the impact that ownership changes during the year ended December 31, 2012 have had on ourcarryforwards and expect to complete the analysis within the next three months. As a result of this analysis, we may have an adjustment in the net operatinglosses that are recorded at December 31, 2012. In addition, any future equity financing transactions, private placements and other transactions that occurwithin the specified three-year period may trigger additional ownership changes, which could further limit our use of such tax attributes. Any such limitations,whether as the result of prior or future offerings of our common stock or sales of common stock by our existing stockholders, could have an adverse effect onour consolidated results of operations in future years.Risks Related to Regulation of our Product and Product CandidatesOur currently marketed product, Sumavel DosePro, is and any of our other product candidates that receive regulatory approval will be, subject toongoing and continued regulatory review, which may result in significant expense and limit our ability to commercialize such products.Even after we achieve U.S. regulatory approval for a product, the FDA may still impose significant restrictions on the approved indicated uses forwhich the product may be marketed or on the conditions of approval. For example, a product's approval may contain requirements for potentially costly post-approval studies and surveillance, including Phase 4 clinical trials, to monitor the safety and efficacy of the product, or the restriction in a REMS program.We will also be subject to ongoing FDA obligations and continued regulatory review with respect to the manufacturing, processing, labeling, packaging,distribution, adverse event reporting, storage, advertising, promotion and recordkeeping for the product. These requirements include submissions of safetyand other post-marketing information and reports, registration, as well as continued compliance with cGMPs and with GCPs and good laboratory practices,which are regulations and guidelines enforced by the FDA for all of our products in clinical and pre-clinical development, and for any clinical trials that weconduct post-approval. To the extent that a product is approved for sale in other countries, we may be subject to similar restrictions and requirements imposedby laws and government regulators in those countries.In the case of Zohydro ER and any other product candidates or products containing controlled substances, we and our contract manufacturers will alsobe subject to ongoing DEA regulatory obligations, including, among other things, annual registration renewal, security, recordkeeping, theft and lossreporting, periodic inspection and annual quota allotments for the raw material for commercial production of our products. In addition, manufacturers of drugproducts and their facilities are subject to continual review and periodic inspections by the FDA and other regulatory authorities for compliance with cGMPregulations, QSR requirements for medical device components or similar requirements, if applicable. If we or a regulatory agency discovers previouslyunknown problems with a product, such as adverse events of unanticipated severity or frequency, or problems with the facility where, or processes by which,the product is manufactured, a regulatory agency may impose restrictions on that product, the manufacturer or us, including requiring product recall, noticeto physicians, withdrawal of the product from the market or suspension of manufacturing. In that regard, because all of our contract manufacturers forSumavel DosePro are located outside the United States, they may be subject to foreign laws and regulations governing the manufacture of drugs and devices,and any failure by them to comply with those laws and regulations may delay or interrupt supplies of our product.61Table of ContentsIf we, our product or product candidates or the manufacturing facilities for our product or product candidates fail to comply with applicable regulatoryrequirements, a regulatory agency may:•impose restrictions on the marketing or manufacturing of the product, suspend or withdraw product approvals or revoke necessary licenses;•issue warning letters, show cause notices or untitled letters describing alleged violations, which may be publicly available;•commence criminal investigations and prosecutions;•impose injunctions, suspensions or revocations of necessary approvals or other licenses;•impose fines or other civil or criminal penalties;•suspend any ongoing clinical trials;•deny or reduce quota allotments for the raw material for commercial production of our controlled substance products;•delay or refuse to approve pending applications or supplements to approved applications filed by us;•refuse to permit drugs or precursor chemicals to be imported or exported to or from the United States;•suspend or impose restrictions on operations, including costly new manufacturing requirements; or•seize or detain products or require us to initiate a product recall.In addition, our product labeling, advertising and promotion are subject to regulatory requirements and continuing regulatory review. The FDA strictlyregulates the promotional claims that may be made about prescription drug products. In particular, a drug may not be promoted for uses that are not approvedby the FDA as reflected in the product's approved labeling, although the FDA does not regulate the prescribing practices of physicians. The FDA and otheragencies actively enforce the laws and regulations prohibiting the promotion of off-label uses, and a company that is found to have improperly promoted off-label uses may be subject to significant liability, including substantial monetary penalties and criminal prosecution.The FDA's regulations, policies or guidance may change and new or additional statutes or government regulations may be enacted that could prevent ordelay regulatory approval of our product candidates or further restrict or regulate post-approval activities. For example, the FDASIA requires the FDA to issuenew guidance on permissible forms of internet and social media promotion of regulated medical products, and the FDA may soon specify new restrictions onthis type of promotion. We cannot predict the likelihood, nature or extent of adverse government regulation that may arise from pending or future legislation oradministrative action, either in the United States or abroad. If we are not able to achieve and maintain regulatory compliance, we may not be permitted tomarket our drugs, which would adversely affect our ability to generate revenue and achieve or maintain profitability.Sumavel DosePro, Zohydro ER, Relday and our other product candidates may cause undesirable side effects or have other unexpected propertiesthat could result in post-approval regulatory action.If we or others identify undesirable side effects, or other previously unknown problems, caused by our products, other products or our productcandidates with the same or related active ingredients, after obtaining U.S. regulatory approval, a number of potentially significant negative consequencescould result, including:•regulatory authorities may withdraw their approval of the product;•regulatory authorities may require us to recall product;•regulatory authorities may require the addition of warnings in the product label or narrowing of the indication in the product label;•we may be required to create a Medication Guide outlining the risks of such side effects for distribution to patients;•we may be required to change the way the product is administered or modify the product in some other way;•the FDA may require us to conduct additional clinical trials or costly post-marketing testing and surveillance to monitor the safety or efficacy of theproduct;•we could be sued and held liable for harm caused to patients; and•our reputation may suffer.The most common treatment-emergent adverse reactions (reported by at least 5% of patients) for sumatriptan injection as described in the SumavelDosePro Prescribing Information summarizing two large placebo-controlled clinical trials were injection site reaction (59%), atypical sensations (42%),dizziness (12%), flushing (7%), chest discomfort (5%), weakness (5%), and neck pain/stiffness (5%).The incidence of adverse events was 33.7% and 28.8% in the open label titration and double blind treatment periods of our Phase 3 efficacy trial forZohydro ER, respectively. Overall, the most commonly reported adverse events (>2%) in this trial62Table of Contentswere constipation, nausea, somnolence, vomiting, diarrhea, insomnia, fatigue, headache, dizziness and dry mouth. These are typical adverse eventsassociated with chronic opioid therapy.Any of the above events resulting from undesirable side effects or other previously unknown problems could prevent us from achieving or maintainingmarket acceptance of the affected product and could substantially increase the costs of commercializing our product candidates.Our development and commercialization strategy for Zohydro ER depends upon the FDA’s prior findings of safety and effectiveness of ZohydroER based on data not developed by us, but which the FDA may rely upon in reviewing our NDA.The Hatch-Waxman Amendments, added Section 505(b)(2) to the FFDCA. Section 505(b)(2) permits the filing of an NDA where at least some of theinformation required for approval comes from studies not conducted by or for the applicant and for which the applicant has not obtained a right of reference.Under this statutory provision, the FDA may rely, for purposes of approving an NDA, on findings of safety and effectiveness based on data not developed bythe filer of the NDA. Similar to Sumavel DosePro, we submitted the NDA for Zohydro ER under Section 505(b)(2), and as such the NDA will rely, in part,on the FDA's previous findings of safety and effectiveness for hydrocodone. Even though we may be able to take advantage of Section 505(b)(2) to supportpotential U.S. approval for Zohydro ER, the FDA may require us, and did require us with respect to Sumavel DosePro, to perform additional studies ormeasurements to support approval. In addition, the FDA's interpretation and use of Section 505(b)(2) has been controversial and has previously beenchallenged in court, but without a definitive ruling on the propriety of the FDA's approach. Future challenges, including a direct challenge to the approval ofour products, may be possible and, if successful, could limit or eliminate our ability to rely on the Section 505(b)(2) pathway for the approval of ourproducts. Such a result could require us to conduct additional testing and costly clinical trials, which could substantially delay or prevent the approval andlaunch of our products.Zohydro ER will be subject to DEA regulations and, failure to comply with these regulations, or the cost of compliance with these regulations, mayadversely affect our business.Zohydro ER contains hydrocodone, a regulated “controlled substance” under the CSA, which establishes, among other things, certain registration,production quotas, security, recordkeeping, reporting, import, export and other requirements administered by the DEA. The DEA regulates controlledsubstances as Schedule I, II, III, IV or V substances. Schedule I substances by definition have no established medicinal use and may not be marketed or soldin the United States. A pharmaceutical product may be listed as Schedule II, III, IV or V, with Schedule II substances considered to present the highest risk ofabuse and Schedule V substances the lowest relative risk of abuse among such substances. Zohydro ER, because it is a single-entity hydrocodone product, isexpected to be regulated by the DEA as a Schedule II controlled substance under the CSA. All Schedule II substance prescriptions, such as prescriptions forZohydro ER, must be in writing and signed by a physician, physically presented to a pharmacist and may not be refilled without a new prescription.The manufacture, shipment, storage, sale and use, among other things, of controlled substances that are pharmaceutical products are subject to a highdegree of regulation, including security, record-keeping and reporting obligations enforced by the DEA. Our failure to comply with these requirements couldresult in the loss of our DEA registration, significant restrictions on Zohydro ER, civil penalties or criminal prosecution.The DEA, and some states, also conduct periodic inspections of registered establishments that handle controlled substances. Facilities that conductresearch, manufacture, store, distribute, import or export controlled substances must be registered to perform these activities and have the security, control andinventory mechanisms required by the DEA to prevent drug loss and diversion. Failure to maintain compliance, particularly non-compliance resulting in lossor diversion, can result in regulatory action that could have a material adverse effect on our business, results of operations, financial condition and prospects.The DEA may seek civil penalties, refuse to renew necessary registrations, or initiate proceedings to revoke those registrations. In certain circumstances,violations could lead to criminal proceedings.Individual states also have controlled substances laws. Though state controlled substances laws often mirror federal law, because the states are separatejurisdictions, they may separately schedule drugs, as well. While some states automatically schedule a drug when the DEA does so, in other states there has tobe rulemaking or a legislative action. State scheduling may delay commercial sale of any controlled substance drug product for which we obtain federalregulatory approval and adverse scheduling could have a material adverse effect on the commercial attractiveness of such product. We or our partners mustalso obtain separate state registrations in order to be able to obtain, handle, and distribute controlled substances for clinical trials or commercial sale, andfailure to meet applicable regulatory requirements could lead to enforcement and sanctions from the states in addition to those from the DEA or otherwisearising under federal law.63Table of ContentsThe FDA, in consultation with the DEA, will require us to develop a comprehensive risk management program to reduce the inappropriate use of ourproduct candidate, including restrictions on the manner in which it is marketed and sold, so as to reduce the risk of improper patient selection and diversionor abuse of the product. We submitted a REMS at the time of the NDA submission for Zohydro ER and developing such a program in consultation with theFDA may be a time-consuming process and could delay approval of our product candidate. Such a program or delays of any approval from the FDA couldlimit market acceptance of the product.Pursuant to the terms of our license agreement with Alkermes, we entered into a commercial manufacturing and supply agreement for Zohydro ER withan affiliate of Alkermes, Alkermes Pharma Ireland Limited, or APIL. APIL has the exclusive right to manufacture and supply both clinical and commercialsupplies of Zohydro ER (subject to certain exceptions). While APIL is required to comply with applicable laws and regulations regarding controlledsubstances, we do not have any direct control over APIL's compliance in these regards, and any failure by APIL to comply with those laws and regulationscould result in a reduction or cessation of production of Zohydro ER.Annual DEA quotas on the amount of hydrocodone allowed to be produced in the United States and our specific allocation of hydrocodone by theDEA could significantly limit any additional clinical development of Zohydro ER, if required, as well as the production or sale of Zohydro ER evenif we obtain FDA approval.The DEA limits the availability and production of all Schedule II substances through a quota system which includes a national aggregate quota andindividual quotas. Because hydrocodone is subject to the DEA's production and procurement quota scheme, the DEA establishes annually an aggregate quotafor how much hydrocodone may be produced in total in the United States based on the DEA's estimate of the quantity needed to meet legitimate scientific andmedicinal needs. This limited aggregate amount of hydrocodone that the DEA allows to be produced in the United States each year is allocated amongindividual companies, who must submit applications annually to the DEA for individual production and procurement quotas. The DEA requires substantialevidence and documentation of expected legitimate medical and scientific needs before assigning quotas to manufacturers. The DEA may adjust aggregateproduction quotas and individual production and procurement quotas from time to time during the year, although the DEA has substantial discretion inwhether or not to make such adjustments. Alkermes, which has licensed us the right to sell Zohydro ER in the United States, if approved, was allocated asufficient quantity of hydrocodone to meet our planned clinical and pre-clinical needs during 2012. However, in future years, we will need significantlygreater amounts of hydrocodone to implement our commercialization plans if the FDA approves Zohydro ER.Moreover, we do not know what amounts of hydrocodone other companies developing product candidates containing hydrocodone may request forfuture years. The DEA, in assessing factors such as medical need, abuse and diversion potential and other policy considerations, may choose to set theaggregate hydrocodone quota lower than the total amount requested by the companies. Alkermes is permitted to petition the DEA to increase the annualaggregate quota after it is initially established, but there is no guarantee that the DEA would act favorably upon such a petition. Our procurement quota ofhydrocodone may not be sufficient to meet any future clinical development needs or commercial demand if we receive regulatory approval for Zohydro ER.Any delay or refusal by the DEA in establishing the procurement quota or a reduction in our quota for hydrocodone or a failure to increase it over time as weanticipate could delay or stop any additional clinical development of Zohydro ER, if required, or, if approved, the product launch or commercial sale ofZohydro ER or cause us to fail to achieve our expected operating results, which could have a material adverse effect on our business, results of operations,financial condition and prospects.We may need to obtain FDA approval of our proposed product trade names and any failure or delay associated with such approval may adverselyimpact our business.Any trade name we intend to use for our products will require approval from the FDA regardless of whether we have secured a formal trademarkregistration from the U.S. Patent and Trademark Office, or PTO. The FDA typically conducts a rigorous review of proposed trade names, including anevaluation of potential for confusion with other trade names. The FDA may also object to a trade name if it believes the name inappropriately implies medicalclaims. If the FDA objects to our proposed trade names, we may be required to adopt an alternative name for our product candidate. If we adopt an alternativename, we would lose the benefit of our existing trademark applications and may be required to expend significant additional resources in an effort to identify asuitable trade name that would qualify under applicable trademark laws, and not infringe the existing rights of third parties and be acceptable to the FDA. Wemay be unable to build a successful brand identity for a new trademark in a timely manner or at all, which would limit our ability to generate revenues fromour products.64Table of ContentsEven though Sumavel DosePro has received regulatory approval in the United States and a limited number of foreign countries, we, Desitin, orany other potential partners may never receive approval in other countries or commercialize our products anywhere outside of the United States.We have established an exclusive commercial partnership for Sumavel DosePro with Desitin in the European Union, Norway, Switzerland and Turkey,in order to seek to accelerate the development and regulatory approvals in those territories. We may also seek to establish commercial partnerships for SumavelDosePro in other foreign countries. In order to market Sumavel DosePro or any other products outside of the United States, we, Desitin, or any potentialpartner must obtain separate regulatory approvals and comply with numerous and varying regulatory requirements of other countries regarding safety andefficacy and governing, among other things, clinical trials and commercial sales, pricing and distribution of our products. The time required to obtainapproval in other countries might differ from and be longer than that required to obtain FDA approval. The regulatory approval process in other countries mayinclude all of the risks detailed in these “Risk Factors” and elsewhere in this Annual Report on Form 10-K regarding FDA approval in the United States, aswell as other risks. For example, legislation analogous to Section 505(b)(2) of the FFDCA in the United States does not exist in other countries. In territorieswhere data is not freely available, we or our partners may not have the ability to commercialize our products without negotiating rights from third parties torefer to their clinical data in our regulatory applications, which could require the expenditure of significant additional funds. We, Desitin, or any potentialpartner may be unable to obtain rights to the necessary clinical data and may be required to develop our own proprietary safety effectiveness dossiers. Desitinsubmitted a Marketing Authorization Application for Sumavel DosePro to the Federal Institute for Drugs and Medical Devices (Bundesinstitut für Arzneimittelund Medizinprodukte (BfArM)) in Germany, the reference member state, through the Decentralized Procedure in October 2009, following completion of aEuropean pivotal bioequivalence trial comparing needle-free Sumavel DosePro to a traditional needle-based autoinjector, Imigran-Inject, the European brand ofImitrex STATdose. However, regulatory approval in one country does not ensure regulatory approval in another, but a failure or delay in obtaining regulatoryapproval in one country may have a negative effect on the regulatory process in others.Failure to obtain regulatory approval in other countries or any delay or setback in obtaining such approval could have the same adverse effects detailedin these “Risk Factors” and elsewhere in this Annual Report on Form 10-K regarding FDA approval in the United States. As described above, such effectsinclude the risks that our product and product candidates may not be approved at all or for all requested indications, which could limit the uses of ourproduct and product candidates and have an adverse effect on their commercial potential or require costly, post-marketing studies. In addition, we, Desitin, orany potential partner may be subject to fines, suspension or withdrawal of regulatory approvals, product recalls, seizure of products, operating restrictionsand criminal prosecution if we fail to comply with applicable foreign regulatory requirements.Health care reform measures and changes in policies, funding, staffing and leadership at the FDA and other agencies could hinder or preventthe commercial success of Sumavel DosePro and any of our product candidates that may be approved by the FDA.In the United States, there have been a number of legislative and regulatory changes to the healthcare system in ways that could affect our future resultsof operations and the future results of operations of our potential customers. For example, the Medicare Prescription Drug, Improvement, and ModernizationAct of 2003 established a new Part D prescription drug benefit, which became effective January 1, 2006. Under the prescription drug benefit, Medicarebeneficiaries can obtain prescription drug coverage from private sector plans that are permitted to limit the number of prescription drugs that are covered ineach therapeutic category and class on their formularies. If Sumavel DosePro or any of our product candidates that are approved by the FDA are not widelyincluded on the formularies of these plans, our ability to market our products to the Medicare population could suffer.Furthermore, there have been and continue to be a number of initiatives at the federal and state levels that seek to reduce healthcare costs. In March 2010,President Obama signed into law the Patient Protection and Affordable Health Care Act, as amended by the Health Care and Education AffordabilityReconciliation Act, or collectively the PPACA, which includes measures to significantly change the way health care is financed by both governmental andprivate insurers. Among the provisions of the PPACA of greatest importance to the pharmaceutical industry are the following:•an annual, nondeductible fee on any entity that manufactures or imports certain branded prescription drugs and biologic agents, apportioned amongthese entities according to their market share in certain government healthcare programs;•an increase in the statutory minimum rebates a manufacturer must pay under the Medicaid Drug Rebate Program to 23% and 13% of the averagemanufacturer price for most branded and generic drugs, respectively;•a new Medicare Part D coverage gap discount program, in which manufacturers must agree to offer 50% point-of-sale discounts off negotiated pricesof applicable brand drugs to eligible beneficiaries during their coverage gap period, as a condition for the manufacturer’s outpatient drugs to becovered under Medicare Part D;65Table of Contents•extension of manufacturers’ Medicaid rebate liability to covered drugs dispensed to individuals who are enrolled in Medicaid managed careorganizations;•expansion of eligibility criteria for Medicaid programs by, among other things, allowing states to offer Medicaid coverage to additional individualsbeginning in April 2010 and by adding new mandatory eligibility categories for certain individuals with income at or below 133% of the FederalPoverty Level beginning in 2014, thereby potentially increasing both the volume of sales and manufacturers’ Medicaid rebate liability;•expansion of the entities eligible for discounts under the Public Health Service pharmaceutical pricing program;•new requirements to report certain financial arrangements with physicians and others, including reporting any “transfer of value” made or distributedto prescribers and other healthcare providers and reporting any investment interests held by physicians and their immediate family members duringeach calendar year beginning in 2012, and manufacturers will be required to begin data collection on August 1, 2013 and report such data to theCenters for Medicare & Medicaid Services by March 31, 2014;•a new requirement to annually report drug samples that manufacturers and distributors provide to physicians, effective April 1, 2012;•a licensure framework for follow-on biologic products;•a new Patient-Centered Outcomes Research Institute to oversee, identify priorities in, and conduct comparative clinical effectiveness research, alongwith funding for such research;•creation of the Independent Payment Advisory Board which, beginning in 2014, will have authority to recommend certain changes to the Medicareprogram that could result in reduced payments for prescription drugs and those recommendations could have the effect of law even if Congress doesnot act on the recommendations; and•establishment of a Center for Medicare Innovation at the Centers for Medicare & Medicaid Services to test innovative payment and service deliverymodels to lower Medicare and Medicaid spending.Other legislative changes have also been proposed and adopted in the United States since the PPACA was enacted. On August 2, 2011, the BudgetControl Act of 2011, among other things, created measures for spending reductions by Congress. A Joint Select Committee on Deficit Reduction, tasked withrecommending a targeted deficit reduction of at least $1.2 trillion for the years 2013 through 2021, was unable to reach required goals, thereby triggering thelegislation's automatic reduction to several government programs. This includes aggregate reductions to Medicare payments to providers of up to 2% per fiscalyear, starting in 2013. On January 2, 2013, President Obama signed into law the American Taxpayer Relief Act of 2012, or the ATRA, which, among otherthings, delayed for another two months the budget cuts mandated by these sequestration provisions of the Budget Control Act of 2011. The ATRA alsoreduced Medicare payments to several providers, including hospitals, imaging centers and cancer treatment centers, and increased the statute of limitationsperiod for the government to recover overpayments to providers from three to five years. These new laws may result in additional reductions in Medicare andother health care funding, which could have a material adverse effect on our customers and accordingly, our financial operations.Additionally, individual states have become increasingly aggressive in passing legislation and implementing regulations designed to controlpharmaceutical product pricing, including price or patient reimbursement constraints, discounts, restrictions on certain product access, and marketing costdisclosure and transparency measures, and designed to encourage importation from other countries and bulk purchasing. Legally-mandated price controls onpayment amounts by third-party payors or other restrictions could harm our business, results of operations, financial condition and prospects.In addition, regional healthcare authorities and individual hospitals are increasingly using bidding procedures to determine what pharmaceuticalproducts and which suppliers will be included in their prescription drug and other healthcare programs. This can reduce demand for our products or putpressure on our product pricing, which could negatively affect our business, results of operations, financial condition and prospects.In certain foreign markets, the pricing of prescription drugs is subject to government control and reimbursement and may, in some cases, beunavailable. In the United States, the commercial success of Sumavel DosePro and our product candidates, if and when commercialized, will depend, in part,upon the availability of coverage and reimbursement from third-party payors at the federal, state and private levels. Third-party payors include governmentalprograms such as Medicare or Medicaid, private insurance plans and managed care plans. These third-party payors may deny coverage or reimbursement fora product or therapy in whole or in part if they determine that the product or therapy was not medically appropriate or necessary. Also, third-party payors haveattempted to control costs by limiting coverage through the use of formularies and other cost-containment mechanisms and the amount of reimbursement forparticular procedures or drug treatments.Additionally, given recent federal and state government initiatives directed at lowering the total cost of healthcare, Congress and state legislatures willlikely continue to focus on healthcare reform, the cost of prescription drugs and the reform of the Medicare and Medicaid programs. While we cannot predictthe full outcome of any such legislation, it may result in decreased reimbursement for prescription drugs, which may further exacerbate industry-widepressure to reduce prescription drug prices. This could harm our ability to market our products and generate revenues. In addition, legislation has been66Table of Contentsintroduced in Congress that, if enacted, would permit more widespread importation or re-importation of pharmaceutical products from foreign countries intothe United States, including from countries where the products are sold at lower prices than in the United States. Such legislation, or similar regulatorychanges, could lead to a decision to decrease our prices to better compete, which, in turn, could adversely affect our business, results of operations, financialcondition and prospects. Alternatively, in response to legislation such as this, we might elect not to seek approval for or market our products in foreignjurisdictions in order to minimize the risk of re-importation, which could also reduce the revenue we generate from our product sales. It is also possible thatother legislative proposals having similar effects will be adopted.Furthermore, regulatory authorities' assessment of the data and results required to demonstrate safety and efficacy can change over time and can beaffected by many factors, such as the emergence of new information, including on other products, changing policies and agency funding, staffing andleadership. We cannot be sure whether future changes to the regulatory environment will be favorable or unfavorable to our business prospects. For example,average review times at the FDA for marketing approval applications have fluctuated over the last ten years, and we cannot predict the review time for any ofour submissions with any regulatory authorities. In addition, review times can be affected by a variety of factors, including budget and funding levels andstatutory, regulatory and policy changes.We may incur liability if our continuing medical or health education programs and/or product promotions are determined, or are perceived, to beinconsistent with regulatory guidelines.The FDA provides guidelines with respect to appropriate promotion and continuing medical and health education activities. Although we endeavor tofollow these guidelines, the FDA or the Office of the Inspector General: U.S. Department of Health and Human Services may disagree, and we may be subjectto significant liability, including civil and administrative remedies as well as criminal sanctions. In addition, management’s attention could be diverted andour reputation could be damaged.If we fail to comply with federal and state healthcare laws, including fraud and abuse and health information privacy and security laws, we couldface substantial penalties and our business, results of operations, financial condition and prospects could be adversely affected.As a pharmaceutical company, even though we do not and will not control referrals of healthcare services or bill directly to Medicare, Medicaid or otherthird-party payors, certain federal and state healthcare laws and regulations pertaining to fraud and abuse and patients’ rights are and will be applicable to ourbusiness. We could be subject to healthcare fraud and abuse and patient privacy regulation by both the federal government and the states in which we conductour business. The laws that may affect our ability to operate include:•the federal Anti-Kickback Statute, which constrains our marketing practices, educational programs, pricing policies, and relationships withhealthcare providers or other entities, by prohibiting, among other things, soliciting, receiving, offering or paying remuneration, directly or indirectly,to induce, or in return for, the purchase or recommendation of an item or service reimbursable under a federal healthcare program, such as theMedicare and Medicaid programs;•federal civil and criminal false claims laws and civil monetary penalty laws, which prohibit, among other things, individuals or entities fromknowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid, or other third-party payors that are false orfraudulent, and which may apply to entities like us which provide coding and billing advice to customers;•the federal Health Insurance Portability and Accountability Act of 1996, or HIPAA, and its implementing regulations, and the Health InformationTechnology for Economic and Clinical Health Act, and its implementing regulations, which prohibit executing a scheme to defraud any healthcarebenefit program or making false statements relating to healthcare matters and which also impose certain requirements relating to the privacy, securityand transmission of individually identifiable health information; and•state law equivalents of each of the above federal laws, such as anti-kickback and false claims laws which may apply to items or servicesreimbursed by any third-party payor, including commercial insurers, and state laws governing the privacy and security of health information incertain circumstances, many of which differ from each other in significant ways and often are not preempted by HIPAA, thus complicatingcompliance efforts.Because of the breadth of these laws and the narrowness of the statutory exceptions and safe harbors available under the U.S. federal Anti-KickbackStatute, it is possible that some of our business activities could be subject to challenge under one or more of such laws. To the extent that any product we makeis sold in a foreign country, we may be subject to similar foreign laws and regulations. If we or our operations are found to be in violation of any of the lawsdescribed above or any other governmental regulations that apply to us, we may be subject to penalties, including civil and criminal penalties, damages, fines,exclusion from participation in U.S. federal or state health care programs, and the curtailment or restructuring of our67Table of Contentsoperations. Any penalties, damages, fines, curtailment or restructuring of our operations could materially adversely affect our ability to operate our businessand our financial results. Although compliance programs can mitigate the risk of investigation and prosecution for violations of these laws, the risks cannot beentirely eliminated. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legalexpenses and divert our management's attention from the operation of our business. Moreover, achieving and sustaining compliance with applicable federaland state privacy, security and fraud laws may prove costly.Import/export regulations and tariffs may change and increase our costs.We are subject to risks associated with the regulations relating to the import and export of products and materials. We cannot predict whether the importand/or export of our products will be adversely affected by changes in, or enactment of, new quotas, duties, taxes or other charges or restrictions imposed byIndia (where our supplier of the sumatriptan used in Sumavel DosePro is located), the United Kingdom (where the assembly of Sumavel DosePro takes place)or any other country in the future. Any of these factors could adversely affect our business, results of operations, financial condition and prospects.Risks Related to Intellectual PropertyOur success depends in part on our ability to protect our intellectual property. It is difficult and costly to protect our proprietary rights andtechnology, and we may not be able to ensure their protection.Our commercial success will depend in large part on obtaining and maintaining patent, trademark and trade secret protection of our product, SumavelDosePro, and our product candidates, Zohydro ER and Relday, their respective components, formulations, methods used to manufacture them and methodsof treatment, as well as successfully defending these patents against third-party challenges. Our ability to stop unauthorized third parties from making, using,selling, offering to sell or importing Sumavel DosePro or our product candidates is dependent upon the extent to which we have rights under valid andenforceable patents or trade secrets that cover these activities.We in-license certain intellectual property for Zohydro ER from Alkermes, and certain intellectual property for Relday from Durect. We rely on theselicensors to file and prosecute patent applications and maintain patents and otherwise protect certain of the intellectual property we license from them. We havenot had and do not have primary control over these activities or any other intellectual property that may be related to our in-licensed intellectual property. Forexample, with respect to our license agreements with Alkermes and Durect, we cannot be certain that such activities by Alkermes and Durect have been or willbe conducted in compliance with applicable laws and regulations or will result in valid and enforceable patents and other intellectual property rights. Alkermeshas retained the first right, but not the obligation, to initiate an infringement proceeding against a third-party infringer of the intellectual property rights thatAlkermes has licensed to us, and enforcement of our licensed patents or defense of any claims asserting the invalidity or unenforceability of these patentswould also be subject to the control or cooperation of Alkermes. Similarly, Durect has retained the first right, but not the obligation, to initiate an infringementproceeding against a third-party infringer of certain of the intellectual property rights that Durect has licensed to us, and enforcement of certain of our licensedpatents or defense of any claims asserting the invalidity or unenforceability of these patents would also be subject to the control or cooperation of Durect. Weare not entitled to control the manner in which Alkermes or Durect may defend certain of the intellectual property that is licensed to us and it is possible thattheir defense activities may be less vigorous than had we conducted the defense ourselves.Most of our patents related to DosePro were acquired from Aradigm, who acquired those patents from a predecessor owner. Our patents related toZohydro ER are licensed from Alkermes. Thus, most of our patents, as well as many of our pending patent applications, were not written by us or ourattorneys, and we did not have control over the drafting and prosecution of these patents. Further, the former patent owners and our licensors might not havegiven the same attention to the drafting and prosecution of these patents and applications as we would have if we had been the owners of the patents andapplications and had control over the drafting and prosecution. In addition, the former patent owners and Alkermes may not have been completely familiarwith U.S. patent law, possibly resulting in inadequate disclosure and/or claims. This could possibly result in findings of invalidity or unenforceability of thepatents we own and in-license, patents issuing with reduced claim scope, or in pending applications not issuing as patents.In addition, as part of the agreement where we acquired patents related to DosePro from Aradigm, Aradigm retained, and we granted to Aradigm, a non-exclusive, worldwide, royalty free license to the acquired patents solely for purposes of the delivery of one or more aerosolized APIs directly into the bronchia orlungs. The agreement with Aradigm also includes a covenant not to compete with us regarding technologies or products for the delivery of one or more APIs vianeedle free injection. That covenant expired on August 26, 2010, giving Aradigm or its licensees the right to develop and sell other needle-free injectiontechnologies and products.The patent positions of pharmaceutical, biopharmaceutical and medical device companies can be highly uncertain and involve complex legal and factualquestions for which important legal principles remain unresolved. No consistent policy regarding the breadth of claims allowed in patents in these fields hasemerged to date in the United States. There have been recent changes regarding how patent laws are interpreted, and both the PTO and Congress have recentlyproposed radical changes to the patent system. We cannot accurately predict future changes in the interpretation of patent laws or changes to patent laws whichmight be enacted into law. Those changes may materially affect our patents, our ability to obtain patents and/or the patents and applications of ourcollaborators and licensors. The patent situation in these fields outside the United States is even more uncertain. Changes in either the patent laws or ininterpretations of patent laws in the United States and other countries may diminish the value of our intellectual property or narrow the scope of our patentprotection. Accordingly, we cannot predict the breadth of claims that may be allowed or enforced in the patents we own or to which we have a license or third-party patents.The degree of future protection for our proprietary rights is uncertain because legal means afford only limited protection and may not adequately protectour rights or permit us to gain or keep our competitive advantage. For example:•others may be able to make or use compounds that are similar to the pharmaceutical compounds used in Sumavel DosePro and our productcandidates but that are not covered by the claims of our patents;68Table of Contents•the APIs in Sumavel DosePro and our current product candidates are, or will soon become, commercially available in generic drug products, and nopatent protection will be available without regard to formulation or method of use;•we or our licensors, as the case may be, may not be able to detect infringement against our in-licensed patents, which may be especially difficult formanufacturing processes or formulation patents;•we or our licensors, as the case may be, might not have been the first to make the inventions covered by our owned or in-licensed issued patents orpending patent applications;•we or our licensors, as the case may be, might not have been the first to file patent applications for these inventions;•others may independently develop similar or alternative technologies or duplicate any of our technologies;•it is possible that our pending patent applications will not result in issued patents;•it is possible that there are dominating patents to Sumavel DosePro or our product candidates of which we are not aware;•it is possible that there are prior public disclosures that could invalidate our or our licensors’ inventions, as the case may be, or parts of our or theirinventions of which we or they are not aware;•it is possible that others may circumvent our owned or in-licensed patents;•it is possible that there are unpublished applications or patent applications maintained in secrecy that may later issue with claims covering ourproducts or technology similar to ours;•the laws of foreign countries may not protect our or our licensors’, as the case may be, proprietary rights to the same extent as the laws of the UnitedStates;•the claims of our owned or in-licensed issued patents or patent applications, if and when issued, may not cover our device or product candidates;•our owned or in-licensed issued patents may not provide us with any competitive advantages, or may be narrowed in scope, be held invalid orunenforceable as a result of legal challenges by third parties;•we may not develop additional proprietary technologies for which we can obtain patent protection; or•the patents of others may have an adverse effect on our business.We also may rely on trade secrets to protect our technology, especially where we do not believe patent protection is appropriate or obtainable. However,trade secrets are difficult to protect, and we have limited control over the protection of trade secrets used by our licensors, collaborators and suppliers.Although we use reasonable efforts to protect our trade secrets, our employees, consultants, contractors, outside scientific collaborators and other advisorsmay unintentionally or willfully disclose our information to competitors. Enforcing a claim that a third party illegally obtained and is using any of our tradesecrets is expensive and time consuming, and the outcome is unpredictable. In addition, courts outside the United States are sometimes less willing to protecttrade secrets. Moreover, our competitors may independently develop equivalent knowledge, methods and know-how. If our confidential or proprietaryinformation is divulged to or acquired by third parties, including our competitors, our competitive position in the marketplace will be harmed and our abilityto successfully penetrate our target markets could be severely compromised.If any of our owned or in-licensed patents are found to be invalid or unenforceable, or if we are otherwise unable to adequately protect our rights, it couldhave a material adverse impact on our business and our ability to commercialize or license our technology and products. Likewise, our patents covering certaintechnology used in our DosePro device are expected to expire on various dates from 2014 through 2026 and the patents licensed to us by Alkermes are expectedto expire in 2019. As of December 31, 2012, our patent portfolio included twelve issued U.S. patents, four pending U.S. patent applications, 40 issued foreignpatents and four pending foreign patent applications relating to various aspects of Sumavel DosePro and our DosePro technology. Ten of our U.S. patentsrelating to our DosePro technology, U.S. Patent Nos. 5,891,086, 5,957,886, 6,135,979, 7,776,007, 7,901,385, 8,267,903, 8,118,771, 8,241,243,8,241,244 and 8,287,489 are expected to expire in 2014, 2016, 2017, 2026, 2026, 2023, 2023, 2025, 2022 and 2024, respectively. U.S. PatentNo. 5,891,086 covers a particular actuator mechanism forming a part of the needleless injector device; U.S. Patent No. 5,957,886 claims a needlelessinjector system using a viscous damping medium; U.S. Patent No. 6,135,979 covers the needleless injector with particular safety mechanisms; U.S. PatentNos. 7,776,007 and 8,287,489 cover devices with a cap and latch mechanism; U.S. Patent Nos. 7,901,385 and 8,267,903 encompass variousembodiments of the casing for enclosing the injection devices; and U.S. Patent Nos. 8,118,771, 8,241,243 and 8,241,244 cover a method of reducingbreakage of glass capsules used in the Sumavel DosePro device. Upon the expiration of these patents, we will lose the right to exclude others from practicingthese inventions. Additionally, since these ten patents are the only patents currently listed in the FDA Orange Book for Sumavel DosePro, their expiration willmean that we lose certain advantages that come with Orange Book listing of patents. The expiration of these patents could also have a similar material adverseeffect on our business, results of operations, financial condition and prospects. Moreover, if Alkermes or Durect decides not to commence or continue anyaction relating to the defense of the patents they have licensed to us, they are required to notify us and we have the right to initiate proceedings after receivingtheir notice. Such proceedings will require the assistance of Alkermes or Durect, as applicable, and we have limited control over the amount or timing ofresources Alkermes or Durect devotes on our behalf or the priority they place on enforcing these patent rights.69Table of ContentsIf we fail to comply with our obligations in our intellectual property licenses with third parties, we could lose license rights that are important toour business.We are a party to a license agreement with Alkermes, pursuant to which we license key intellectual property for Zohydro ER. We also recently enteredinto a license agreement with Durect, pursuant to which we license key intellectual property for Relday. These existing licenses imposes various diligence,milestone payment, royalty, insurance and other obligations on us. If we fail to comply with these obligations, our licensors may have the right to terminate thelicense, in which event we would not be able to develop or market the affected products. If we lose such license rights, our business, results of operations,financial condition and prospects may be materially adversely affected. We may enter into additional licenses in the future and if we fail to comply withobligations under those agreements, we could suffer similar consequences.We may incur substantial costs as a result of litigation or other proceedings relating to patent and other intellectual property rights, and we may beunable to protect our rights to our products and technology.If we or our collaborators or licensors choose to go to court to stop a third party from using the inventions claimed in our owned or in-licensed patents,that third party may ask the court to rule that the patents are invalid and/or should not be enforced against that third party. These lawsuits are expensive andwould consume time and other resources even if we or they, as the case may be, were successful in stopping the infringement of these patents. In addition,there is a risk that the court will decide that these patents are not valid and that we or they, as the case may be, do not have the right to stop others from usingthe inventions.There is also the risk that, even if the validity of these patents is upheld, the court will refuse to stop the third party on the ground that such third-party's activities do not infringe our owned or in-licensed patents. In addition, the U.S. Supreme Court has recently changed some tests regarding grantingpatents and assessing the validity of patents. As a consequence, issued patents may be found to contain invalid claims according to the newly revisedstandards. Some of our own or in-licensed patents may be subject to challenge and subsequent invalidation or significant narrowing of claim scope in areexamination proceeding before the PTO, or during litigation, under the revised criteria which make it more difficult to obtain patents.We may also not be able to detect infringement of our own or in-licensed patents, which may be especially difficult for methods of manufacturing orformulation products. While we intend to take actions reasonably necessary to enforce our patent rights, we depend, in part, on our licensors and collaboratorsto protect a substantial portion of our proprietary rights. For example, Alkermes, our licensor, is primarily responsible for the enforcement of the intellectualproperty rights related to Zohydro ER. Under the agreement, Alkermes has the first right, but not the obligation, to initiate an infringement proceeding against athird-party infringer. If Alkermes decides not to commence or continue any action, they are required to notify us and grant us step in rights to enforce the in-licensed intellectual property. Such enforcement will require the cooperation of Alkermes, and we will be responsible for Alkermes' reasonable expenses andattorney's fees incurred as a result of that cooperation. We have limited control over the amount or timing of resources Alkermes devotes on our behalf or thepriority they place on enforcing these patent rights to our advantage. Similarly, Durect, our licensor, is primarily responsible for the enforcement of certain ofthe intellectual property rights it licenses to us related to Relday. Under the agreement, Durect has the first right, but not the obligation, to initiate aninfringement proceeding against a third-party infringer of those intellectual property rights through the use, marketing, sale or import of a product that iscompetitive to Relday. If Durect decides not to commence or continue any such action, we have the right, but not the duty, to do so and such enforcement willrequire the cooperation of Durect. We have limited control over the amount or timing of resources Durect devotes on our behalf or the priority it places onenforcing these patent rights to our advantage.If we are sued for infringing intellectual property rights of third parties, it will be costly and time consuming, and an unfavorable outcome in thatlitigation would have a material adverse effect on our business.Our commercial success depends upon our ability and the ability of our collaborators to develop, manufacture, market and sell our device and productcandidates and use our proprietary technologies without infringing the proprietary rights of third parties. Numerous U.S. and foreign issued patents andpending patent applications, which are owned by third parties, exist in the fields relating to Sumavel DosePro and our product candidates. As the medicaldevice, biotechnology and pharmaceutical industries expand and more patents are issued, the risk increases that others may assert our product or productcandidates infringe the patent rights of others. Moreover, it is not always clear to industry participants, including us, which patents cover various types ofmedical devices, drugs, products or their methods of use. Thus, because of the large number of patents issued and patent applications filed in our fields, theremay be a risk that third parties may allege they have patent rights encompassing our product, product candidates, technology or methods.In addition, there may be issued patents of third parties of which we are currently unaware, that are infringed or are alleged to be infringed by ourproduct, product candidates or proprietary technologies. Because some patent applications in the70Table of ContentsUnited States may be maintained in secrecy until the patents are issued, because patent applications in the United States and many foreign jurisdictions aretypically not published until eighteen months after filing, and because publications in the scientific literature often lag behind actual discoveries, we cannot becertain that others have not filed patent applications for technology covered by our owned and in-licensed issued patents or our pending applications, or that weor, if applicable, a licensor were the first to invent the technology. Our competitors may have filed, and may in the future file, patent applications covering ourproducts or technology similar to ours. Any such patent application may have priority over our owned and in-licensed patent applications or patents, whichcould further require us to obtain rights to issued patents covering such technologies. If another party has filed a U.S. patent application on inventions similarto those owned or in-licensed to us, we or, in the case of in-licensed technology, the licensor may have to participate in an interference proceeding declared bythe PTO to determine priority of invention in the United States. If another party has reason to assert a substantial new question of patentability against any ofour claims in our owned and in-licensed U.S. patents, the third party can request that the PTO reexamine the patent claims, which may result in a loss ofscope of some claims or a loss of the entire patent. In addition to potential infringement claims, interference and reexamination proceedings, we may become aparty to patent opposition proceedings in the European Patent Office where either our patents are challenged, or we are challenging the patents of others. Thecosts of these proceedings could be substantial, and it is possible that such efforts would be unsuccessful if the other party had independently arrived at thesame or similar invention prior to our own or, if applicable, our licensor's invention, resulting in a loss of our U.S. patent position with respect to suchinventions. We may be exposed to, or threatened with, future litigation by third parties having patent or other intellectual property rights alleging that our deviceand/or product candidates and/or proprietary technologies infringe their intellectual property rights. These lawsuits are costly and could adversely affect ourresults of operations and divert the attention of managerial and technical personnel. There is a risk that a court would decide that we or our commercializationpartners are infringing the third party's patents and would order us or our partners to stop the activities covered by the patents. In addition, there is a risk thata court will order us or our partners to pay the other party damages for having violated the other party's patents.If a third-party's patents was found to cover our device and/or product candidates, proprietary technologies or their uses, we or our collaborators couldbe enjoined by a court and required to pay damages and could be unable to commercialize Sumavel DosePro or our product candidates or use our proprietarytechnologies unless we or they obtained a license to the patent. A license may not be available to us or our collaborators on acceptable terms, if at all. Inaddition, during litigation, the patent holder could obtain a preliminary injunction or other equitable relief which could prohibit us from making, using orselling our products, technologies or methods pending a trial on the merits, which could be years away.There is a substantial amount of litigation involving patent and other intellectual property rights in the device, biotechnology and pharmaceuticalindustries generally. If a third party claims that we or our collaborators infringe its intellectual property rights, we may face a number of issues, including, butnot limited to:•infringement and other intellectual property claims which, regardless of merit, may be expensive and time-consuming to litigate and may divert ourmanagement’s attention from our core business;•substantial damages for infringement, which we may have to pay if a court decides that the product at issue infringes on or violates the third party’srights, and if the court finds that the infringement was willful, we could be ordered to pay treble damages and the patent owner’s attorneys’ fees;•a court prohibiting us from selling or licensing the product unless the third party licenses its product rights to us, which it is not required to do;•if a license is available from a third party, we may have to pay substantial royalties, upfront fees and/or grant cross-licenses to intellectual propertyrights for our products; and•redesigning our products or processes so they do not infringe, which may not be possible or may require substantial monetary expenditures and time.Some of our competitors may be able to sustain the costs of complex patent litigation more effectively than we can because they have substantially greaterresources. In addition, any uncertainties resulting from the initiation and continuation of any litigation could have a material adverse effect on our ability toraise the funds necessary to continue our operations or otherwise have a material adverse effect on our business, results of operations, financial condition andprospects.Although we own worldwide rights to Sumavel DosePro, we do not have patent protection for the product in a significant number of countries,and we will be unable to prevent infringement in those countries.Our patent portfolio related to DosePro includes patents in the United States, Canada, Germany, Spain, France, the United Kingdom, Italy, and Japan.The covered technology and the scope of coverage varies from country to country. For those countries where we do not have granted patents, we have no abilityto prevent the unauthorized use of our intellectual property, and third parties in those countries may be able to make, use, or sell products identical to, orsubstantially similar to DosePro.71Table of ContentsObtaining and maintaining our patent protection depends on compliance with various procedural, document submission, fee payment and otherrequirements imposed by governmental patent agencies, and our patent protection could be reduced or eliminated for non-compliance with theserequirements.Periodic maintenance fees on our owned and in-licensed patents are due to be paid to the PTO in several stages over the lifetime of the patents. Futuremaintenance fees will also need to be paid on other patents which may be issued to us. We have systems in place to remind us to pay these fees, and weemploy outside firms to remind us or our in-licensor to pay annuity fees due to foreign patent agencies on our pending foreign patent applications. The PTOand various foreign governmental patent agencies require compliance with a number of procedural, documentary, fee payment and other similar provisionsduring the patent application process. In many cases, an inadvertent lapse can be cured by payment of a late fee or by other means in accordance with theapplicable rules. However, there are situations in which noncompliance can result in abandonment or lapse of the patent or patent application, resulting inpartial or complete loss of patent rights in the relevant jurisdiction. In such an event, our competitors might be able to enter the market and this circumstancewould have a material adverse effect on our business. For the patents and patent applications related to Zohydro ER, Alkermes is obligated to maintain our in-licensed patents in the United States under our license agreement. Should Alkermes fail to pursue maintenance of our licensed patents and patent applications,Alkermes is obligated to notify us and, at that time, we will be granted an opportunity to maintain the prosecution and avoid withdrawal, cancellation,expiration or abandonment of the licensed U.S. patents and applications. For the patents and patent applications related to Relday, Durect is obligated tomaintain certain of our in-licensed patents on a worldwide basis, using commercially reasonable efforts, under our license agreement. Should Durect fail topursue maintenance of certain of those licensed patents and patent applications, Durect is obligated to notify us and, at that time, we will be granted anopportunity to maintain the prosecution and avoid withdrawal, cancellation, expiration or abandonment of those licensed patents and applications.We also may rely on trade secrets and confidentiality agreements to protect our technology and know-how, especially where we do not believe patentprotection is appropriate or obtainable. However, trade secrets are difficult to protect, and we have limited control over the protection of trade secrets used byour licensors, collaborators and suppliers. Although we use reasonable efforts to protect our trade secrets, our employees, consultants, contractors, outsidescientific collaborators and other advisors may unintentionally or willfully disclose our information to competitors. Enforcing a claim that a third partyillegally obtained and is using any of our trade secrets is expensive and time consuming, and the outcome is unpredictable. In addition, courts outside theUnited States are sometimes less willing to protect trade secrets. Moreover, our competitors may independently develop equivalent knowledge, methods andknow-how. If our confidential or proprietary information is divulged to or acquired by third parties, including our competitors, our competitive position in themarketplace will be harmed and our ability to successfully generate revenues from Sumavel DosePro and, if approved by the FDA or other regulatoryauthorities, our product candidates could be adversely affected.We may be subject to claims that our employees have wrongfully used or disclosed alleged trade secrets of their former employers.As is common in the device, biotechnology and pharmaceutical industries, we employ individuals who were previously employed at other device,biotechnology or pharmaceutical companies, including our competitors or potential competitors. Although no claims against us are currently pending, we maybe subject to claims that these employees or we have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of their formeremployers. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result insubstantial costs and be a distraction to management, which would adversely affect our financial condition.Risks Relating to the Securities Markets and an Investment in Our StockThe market price of our common stock has fluctuated and is likely to continue to fluctuate substantially.The market prices for securities of biotechnology and pharmaceutical companies have historically been highly volatile, and the market has recentlyexperienced significant price and volume fluctuations that are unrelated to the operating performance of particular companies. Since the commencement oftrading in connection with our initial public offering in November 2010, the publicly traded shares of our common stock have themselves experiencedsignificant price and volume fluctuations. During the year ended December 31, 2012, the price per share for our common stock on the Nasdaq Global Markethas ranged from a low sale price of $1.11 to a high sale price of $3.16. This market volatility is likely to continue. These and other factors could reduce themarket price of our common stock, regardless of our operating performance. In addition, the trading price of our common stock could change significantly,both over short periods of time and the longer term, due to many factors, including those described elsewhere in this “Risk Factors” section and the following:72Table of Contents•announcements concerning our and Mallinckrodt's commercial progress in promoting and selling Sumavel DosePro, including sales and revenuetrends;•announcements concerning our NDA for Zohydro ER;•FDA or international regulatory actions, including results and announcements from FDA advisory committee meetings convened with respect tohydrocodone and whether and when we receive regulatory approval for Zohydro ER or any of our other product candidates;•the development status of Relday or any of our other product candidates, including the results from our clinical trials;•other regulatory developments, including the FDA's potential grant of regulatory exclusivity to a competitor who receives FDA approval before us foran extended-release hydrocodone product, which could significantly delay our ability to receive approval for Zohydro ER;•announcements of the introduction of new products by us or our competitors;•announcements concerning product development results or intellectual property rights of others;•announcements relating to litigation, intellectual property or our business, and the public's response to press releases or other public announcementsby us or third parties;•variations in the level of expenses related to Zohydro ER, Relday or any of our other product candidates or clinical development programs, includingrelating to the timing of invoices from, and other billing practices of, our CROs and clinical trial sites;•market conditions or trends in the pharmaceutical sector or the economy as a whole;•changes in operating performance and stock market valuations of other pharmaceutical companies and price and volume fluctuations in the overallstock market;•litigation or public concern about the safety of Sumavel DosePro or our product candidates;•actual and anticipated fluctuations in our quarterly operating results;•the financial projections we may provide to the public, any changes in these projections or our failure to meet these projections;•deviations from securities analysts' estimates or the impact of other analyst comments;•ratings downgrades by any securities analysts who follow our common stock;•additions or departures of key personnel;•third-party payor coverage and reimbursement policies;•developments concerning current or future strategic collaborations, and the timing of payments we may make or receive under these arrangements;•developments affecting our contract manufacturers, component fabricators and service providers;•the development and sustainability of an active trading market for our common stock;•future sales of our common stock by our officers, directors and significant stockholders;•other events or factors, including those resulting from war, incidents of terrorism, natural disasters, security breaches, system failures or responsesto these events;•changes in accounting principles; and•discussion of us or our stock price by the financial and scientific press and in online investor communities.In addition, the stock markets, and in particular the Nasdaq Global Market, have experienced extreme price and volume fluctuations that have affectedand continue to affect the market prices of equity securities of many pharmaceutical companies. Stock prices of many pharmaceutical companies havefluctuated in a manner unrelated or disproportionate to the operating performance of those companies. The realization of any of the above risks or any of abroad range of other risks, including those described in these “Risk Factors” could have a dramatic and material adverse impact on the market price of ourcommon stock.There may not be a viable public market for our common stock.Our common stock had not been publicly traded prior to our initial public offering in November 2010, the trading volume of our common stock on theNasdaq Global Market has been limited and an active trading market may not be developed or sustained. We cannot predict the extent to which investorinterest in our company will lead to the development of an active trading market on the Nasdaq Global Market or otherwise or how liquid that market mightbecome. If an active public market does not develop or is not sustained, it may be difficult for you to sell your shares of common stock at a price that isattractive to you, or at all. Further, an inactive market may also impair our ability to raise capital by selling shares of our common stock and may impair ourability to enter into strategic partnerships or acquire companies or products, product candidates or technologies by using our shares of common stock asconsideration.We may invest or spend our cash in ways with which you may not agree or in ways which may not yield a significant return.73Table of ContentsOur management has considerable discretion in the use of our cash. Our cash may be used for purposes that do not increase our operating results ormarket value. Until the cash is used, it may be placed in investments that do not produce significant income or that may lose value. The failure of ourmanagement to invest or spend our cash effectively could result in unfavorable returns and uncertainty about our prospects, each of which could cause theprice of our common stock to decline.Our quarterly operating results may fluctuate significantly.Our quarterly operating results are difficult to predict and may fluctuate significantly from period to period, particularly because the commercialsuccess of, and demand for, Sumavel DosePro, as well as the success and costs of our Zohydro ER, Relday and other product candidate developmentprograms are uncertain and therefore our future prospects are uncertain. Our net loss and other operating results will be affected by numerous factors,including:•fluctuations in the quarterly revenues of Sumavel DosePro, including fluctuations resulting from the performance of Mallinckrodt under our new co-promotion agreement, and from our distributors' inventory management practices and buying patterns;•the level of underlying demand for Sumavel DosePro or any of our other product candidates that may receive regulatory approval;•our ability to control production spending and underutilization of production capacity;•variations in the level of development and/or regulatory expenses related to Zohydro ER, Relday or other development programs;•results of clinical trials for Zohydro ER, Relday or any other of our product candidates;•any intellectual property infringement lawsuit in which we may become involved;•regulatory developments and legislative changes, including healthcare reform, affecting our product and product candidates or those of ourcompetitors; and•our execution of any collaborative, licensing or similar arrangements, and the timing of payments we may make or receive under these arrangements.If our quarterly operating results fall below the expectations of investors or securities analysts, the price of our common stock could declinesubstantially. Furthermore, any quarterly fluctuations in our operating results may, in turn, cause the price of our stock to fluctuate substantially.We may become involved in securities class action litigation that could divert management’s attention and adversely affect our business and couldsubject us to significant liabilities.The stock markets have recently experienced significant price and volume fluctuations that have affected the market prices for the common stock ofpharmaceutical companies. These broad market fluctuations as well a broad range of other factors, including the realization of any of the risks described inthese “Risk Factors,” may cause the market price of our common stock to decline. In the past, securities class action litigation has often been brought against acompany following a decline in the market price of its securities. This risk is especially relevant for us because biotechnology and pharmaceutical companiesgenerally experience significant stock price volatility. We may become involved in this type of litigation in the future. Litigation often is expensive and divertsmanagement's attention and resources, which could adversely affect our business. Any adverse determination in any such litigation or any amounts paid tosettle any such actual or threatened litigation could require that we make significant payments.If securities or industry analysts do not publish research or publish inaccurate or unfavorable research about our business, our stock price andtrading volume could decline.The trading market for our common stock will depend in part on the research and reports that securities or industry analysts publish about us or ourbusiness. As of December 31, 2012, we had research coverage by only five securities analysts. If these securities analysts cease coverage of our company, thetrading price for our stock would be negatively impacted. If one or more of the analysts who covers us downgrades our stock or publishes inaccurate orunfavorable research about our business, our stock price would likely decline. If one or more of these analysts ceases coverage of us or fails to publish reportson us regularly, demand for our stock could decrease, which could cause our stock price and trading volume to decline.Our executive officers and directors and their affiliates will exercise significant control over stockholder voting matters in a manner that may notbe in the best interests of all of our stockholders.Our executive officers and directors and their affiliates together control, as of March 1, 2013, approximately 29% of our outstanding common stock,assuming no exercise of outstanding options or warrants. Four of our non-employee directors are, or are representatives designated by, significant stockholdersand two of our directors are executive officers. As a result, these74Table of Contentsstockholders will collectively be able to significantly influence and may be able to control all matters requiring approval of our stockholders, including theelection of directors and approval of significant corporate transactions such as mergers, consolidations or the sale of all or substantially all of our assets. Theconcentration of ownership may delay, prevent or deter a change in control of our company even when such a change may be in the best interests of somestockholders, impede a merger, consolidation, takeover or other business combination involving us, or could deprive our stockholders of an opportunity toreceive a premium for their common stock as part of a sale of our company or our assets and might adversely affect the prevailing market price of ourcommon stock.In addition, sales of shares beneficially owned by executive officers and directors and their affiliates could be viewed negatively by third parties andhave a negative impact on our stock price. Moreover, we cannot assure you as to how these shares will may be distributed and subsequently voted.Future sales of our common stock or securities convertible or exchangeable for our common stock may depress our stock price.Persons who were our stockholders prior to the sale of shares in our initial public offering in November 2010 continue to hold a substantial number ofshares of our common stock that they are able to sell in the public market, subject in some cases to certain legal restrictions. Significant portions of theseshares are held by a small number of stockholders. If these stockholders sell, or indicate an intention to sell, substantial amounts of our common stock in thepublic market, the trading price of our common stock could decline. The perception in the market that these sales may occur could also cause the trading priceof our common stock to decline. As of December 31, 2012, we had 100,808,601 shares of common stock outstanding. Of these shares, approximately71,702,414 are freely tradeable, without restriction, in the public market.In addition, shares of common stock that are either subject to outstanding options or reserved for future issuance under our employee benefit plans areeligible for sale in the public market to the extent permitted by the provisions of various vesting schedules and Rule 144 and Rule 701 under the Securities Actof 1933, as amended, or the Securities Act, and, in any event, we have filed a registration statement permitting shares of common stock issued on exercise ofoptions to be freely sold in the public market. If these additional shares of common stock are sold, or if it is perceived that they will be sold, in the publicmarket, the trading price of our common stock could decline.We have registered under the Securities Act 15,784,200 shares of our common stock issuable upon the exercise of the warrants we issued in July 2012,which warrants will be exercisable beginning on July 27, 2013 at an exercise price of $2.50 per share (subject to restrictions on exercise set forth in suchwarrants), which means that upon exercise of warrants, such shares will be freely tradeable without restriction under the Securities Act, except for shares heldby our affiliates. Further, certain holders of shares of our common stock are entitled to rights with respect to the registration of their shares under the SecuritiesAct, which, if registered, would also become freely tradeable without restriction under the Securities Act, except for shares held by our affiliates. In addition,our directors and executive officers may establish programmed selling plans under Rule 10b5-1 of the Securities Exchange Act of 1934, as amended, or theExchange Act, for the purpose of effecting sales of our common stock. Any sales of securities by these stockholders, warrantholders or executive officers anddirectors, or the perception that those sales may occur, could have a material adverse effect on the trading price of our common stock.Anti-takeover provisions under our charter documents and Delaware law could delay or prevent a change of control which could limit the marketprice of our common stock and may prevent or frustrate attempts by our stockholders to replace or remove our current management.Our amended and restated certificate of incorporation and amended and restated bylaws contain provisions that could delay or prevent a change ofcontrol of our company or changes in our board of directors that our stockholders might consider favorable. Some of these provisions include:•a board of directors divided into three classes serving staggered three-year terms, such that not all members of the board will be elected at one time;•a prohibition on stockholder action through written consent, which requires that all stockholder actions be taken at a meeting of our stockholders;•a requirement that special meetings of stockholders be called only by the chairman of the board of directors, the chief executive officer, the presidentor by a majority of the total number of authorized directors;•advance notice requirements for stockholder proposals and nominations for election to our board of directors;•a requirement that no member of our board of directors may be removed from office by our stockholders except for cause and, in addition to anyother vote required by law, upon the approval of not less than 66 2/3% of all outstanding shares of our voting stock then entitled to vote in the electionof directors;75Table of Contents•a requirement of approval of not less than 66 2/3% of all outstanding shares of our voting stock to amend any bylaws by stockholder action or toamend specific provisions of our certificate of incorporation; and•the authority of the board of directors to issue preferred stock on terms determined by the board of directors without stockholder approval and whichpreferred stock may include rights superior to the rights of the holders of common stock.In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporate Law, whichmay prohibit certain business combinations with stockholders owning 15% or more of our outstanding voting stock. These anti-takeover provisions andother provisions in our amended and restated certificate of incorporation and amended and restated bylaws could make it more difficult for stockholders orpotential acquirers to obtain control of our board of directors or initiate actions that are opposed by the then-current board of directors and could also delay orimpede a merger, tender offer or proxy contest involving our company. These provisions could also discourage proxy contests and make it more difficult foryou and other stockholders to elect directors of your choosing or cause us to take other corporate actions you desire. Any delay or prevention of a change ofcontrol transaction or changes in our board of directors could cause the market price of our common stock to decline.We have never paid dividends on our capital stock, and we do not anticipate paying any cash dividends in the foreseeable future.The continued operation and expansion of our business will require substantial funding. Investors seeking cash dividends in the foreseeable futureshould not purchase our common stock. We have paid no cash dividends on any of our classes of capital stock to date and we currently intend to retain ouravailable cash to fund the development and growth of our business. Any determination to pay dividends in the future will be at the discretion of our board ofdirectors and will depend upon results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law and other factors ourboard of directors deems relevant. In addition, our ability to pay cash dividends is currently prohibited by the terms of our loan and security agreements. Wedo not anticipate paying any cash dividends on our common stock in the foreseeable future. Any return to stockholders will therefore be limited to theappreciation in the market price of their stock, which may never occur.We have incurred and will continue to incur significant increased costs as a result of operating as a public company, and our management isrequired to devote substantial time to meet compliance obligations.As a public company, we have incurred and will continue to incur significant legal, accounting and other expenses that we did not incur as a privatecompany. We are subject to the reporting requirements of the Exchange Act, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, as well as rulessubsequently implemented by the SEC and the Nasdaq Stock Market, or Nasdaq, that impose significant requirements on public companies, includingrequiring establishment and maintenance of effective disclosure and financial controls and changes in corporate governance practices. The Exchange Actrequires, among other things, that we file annual, quarterly and current reports with respect to our business and financial condition. In addition, on July 21,2010, the Dodd-Frank Wall Street Reform and Protection Act, or the Dodd-Frank Act, was enacted. There are significant corporate governance and executivecompensation-related provisions in the Dodd-Frank Act that require the SEC to adopt additional rules and regulations in these areas. The requirements of theserules and regulations have increased and will continue to increase our legal and financial compliance costs, make some activities more difficult, time-consuming or costly and may also place considerable strain on our personnel, systems and resources. Our management and other personnel have devoted andwill continue to devote a substantial amount of time to these new compliance initiatives. In addition, we expect these rules and regulations to make it moredifficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage orincur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified people to serveon our board of directors, our board committees or as executive officers.The Sarbanes-Oxley Act requires, among other things, that we maintain effective internal controls for financial reporting and disclosure controls andprocedures. Ensuring that we have adequate internal financial and accounting controls and procedures in place is a costly and time-consuming effort thatneeds to be re-evaluated frequently. In particular, commencing in fiscal 2011, we performed system and process evaluation and testing of our internal controlsover financial reporting which allowed management to report on the effectiveness of our internal controls over financial reporting, as required by Section 404 ofthe Sarbanes-Oxley Act, or Section 404. Our future testing may reveal deficiencies in our internal controls over financial reporting that are deemed to be materialweaknesses or that may require prospective or retroactive changes to our consolidated financial statements or identify other areas for further attention orimprovement. We expect to incur significant expense and devote substantial management effort toward ensuring compliance with Section 404. Pursuant toSection 404(c) of the Sarbanes-Oxley Act, our independent registered public accounting firm is required to deliver an attestation report on the effectiveness ofour internal control over financial reporting commencing with the year ended December 31, 2012. We76Table of Contentscurrently do not have an internal audit function, and we may need to hire additional accounting and financial staff with appropriate public companyexperience and technical accounting knowledge. Implementing any appropriate changes to our internal controls may require specific compliance training for ourdirectors, officers and employees, entail substantial costs to modify our existing accounting systems, and take a significant period of time to complete. Suchchanges may not, however, be effective in maintaining the adequacy of our internal controls, and any failure to maintain that adequacy, or consequentinability to produce accurate consolidated financial statements or other reports on a timely basis, could increase our operating costs and could materiallyimpair our ability to operate our business. Moreover, effective internal controls are necessary for us to produce reliable financial reports and are important tohelp prevent fraud. If we are not able to comply with the requirements of Section 404 in a timely manner, or if we or our independent registered publicaccounting firm identifies deficiencies in our internal controls that are deemed to be material weaknesses, the market price of our stock could decline and wecould be subject to sanctions or investigations by Nasdaq, the SEC or other regulatory authorities, which would entail expenditure of additional financial andmanagement resources.Item 1B. Unresolved Staff CommentsNot applicable.Item 2. PropertiesOur facilities are located in San Diego and Emeryville, California. Our general and administrative and sales and marketing personnel are located at ourSan Diego facility. Our manufacturing operations, product development, quality assurance and clinical and regulatory personnel are located in our Emeryvillefacility.We occupy 13,124 square feet of office space in San Diego under a lease that we entered in April 2012 which expires in November 2014. Prior to April2012, we occupied 12,929 square feet of office space in San Diego under a lease that expired in April 2012.We occupy 12,128 square feet of office and laboratory space in Emeryville under a lease which expires in 2015.We believe that the space in San Diego and Emeryville is adequate to meet our needs in those locations, and that, if necessary, additional space can beleased to accommodate any future growth.The manufacturing equipment used to produce our DosePro technology is currently located at our contract manufacturers’ and component suppliers’facilities in Europe where we occupy an aggregate of more than 20,000 square feet of space that is used to manufacture Sumavel DosePro.Item 3. Legal ProceedingsWe are not currently a party to any legal proceedings.Item 4. Mine Safety DisclosuresNot Applicable.77Table of ContentsPART IIItem 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity SecuritiesMarket InformationOur common stock has been traded on the Nasdaq Global Market since November 23, 2010 under the symbol “ZGNX.” Prior to such time, there wasno public market for our common stock. The following table sets forth the high and low sales price of our common stock, as reported by the Nasdaq GlobalMarket for the period indicated: High LowYear Ended December 31, 2012 Fourth Quarter3.16 1.11Third Quarter2.86 1.99Second Quarter2.58 1.55First Quarter2.94 1.76Year Ended December 31, 2011 Fourth Quarter2.43 1.31Third Quarter5.11 1.83Second Quarter5.14 3.54First Quarter6.90 3.50Holders of Common StockAs of March 1, 2013, there were approximately 42 holders of record of our common stock.Performance GraphThe following stock performance graph illustrates a comparison of the total cumulative stockholder return on our common stock since November 23,2010, which is the date our common stock first began trading on the NASDAQ Global Market, to two indices: the NASDAQ Composite Index and theNASDAQ Biotechnology Index. The graph assumes an initial investment of $100 on November 23, 2010, and that all dividends were reinvested. Thecomparisons in the graph are required by the Securities and Exchange Commission and are not intended to forecast or be indicative of possible futureperformance of our common stock.78Table of ContentsDividend PolicyWe have never declared or paid any cash dividends on our capital stock and do not anticipate paying any cash dividends in the foreseeable future. Weexpect to retain available cash to finance ongoing operations and the potential growth of our business. Any future determination to pay dividends on ourcommon stock will be at the discretion of our board of directors and will depend upon, among other factors, our results of operations, financial condition,capital requirements, contractual restrictions, business prospects and other factors our board of directors may deem relevant.Equity Compensation Plan InformationThe following table summarizes securities available under our equity compensation plans as of December 31, 2012 (in thousands, except per sharedata). Weightedaverage pershareexercise priceof stockoptions Sharesissuable uponexercise ofoutstandingstock options Sharesissuable uponvesting ofoutstandingrestrictedstock units Total sharesissuableundercurrentoutstandingawards Number ofsecuritiesavailable forfutureissuanceEquity compensation plans approved by securityholders: 2006 Equity Incentive Plan$3.45 1,292 0 1,292 02010 Equity Incentive Plan$2.52 8,609 0 8,609 702Total Equity Incentive Plans 9,901 0 9,901 7022010 Employee Stock Purchase Plan 0 0 0 464Total Equity compensation plans approved bysecurity holders 9,901 0 9,901 1,166Equity compensation plans not approved bysecurity holders: None. Recent Sales of Unregistered SecuritiesNone.Issuer Repurchases of Equity SecuritiesNone.79Table of ContentsItem 6. Selected Financial Data.The following table summarizes certain of our selected financial data. The selected financial data for the years ended December 31, 2012, 2011, 2010,2009 and 2008 have been derived from our audited financial statements, of which the consolidated statement of operations and comprehensive loss data for thethree fiscal years ending December 31, 2012, 2011 and 2010 and consolidated balance sheet data as of December 31, 2012 and 2011 are included elsewhere inthis Annual Report on Form 10-K. Our historical results and financial condition are not necessarily indicative of the results or financial condition that may beexpected in the future. The selected financial data set forth below should be read together with our financial statements and related notes thereto and Item 7,“Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this Annual Report on Form 10-K. Year Ended December 31, 2012 2011 2010 2009 2008 (In Thousands, Except Per Share Amounts)Statement of Operations and Comprehensive Loss Data Revenue: Net product revenue$35,864 $30,411 $19,069 $— $—Contract revenue8,462 7,165 4,373 — —Total revenue44,326 37,576 23,442 — —Operating expenses: Cost of sales19,496 19,293 12,846 — —Royalty expense1,353 1,205 843 — —Research and development21,414 33,043 28,643 21,438 33,910Selling, general and administrative49,494 60,459 51,270 14,102 11,820Total operating expenses91,757 114,000 93,602 35,540 45,730Loss from operations(47,431) (76,424) (70,160) (35,540) (45,730)Other income (expense): Interest income53 37 5 10 696Interest expense(10,313) (7,644) (10,013) (9,188) (1,718)Change in fair value of warrant liability11,811 445 6,725 (755) 1,119Change in fair value of embedded derivatives(147) (240) — — —Other income (expense)(1,354) (86) (111) (416) 63Total other income (expense)50 (7,488) (3,394) (10,349) 160Loss before income taxes(47,381) (83,912) (73,554) (45,889) (45,570)Provision for income taxes(5) 9 (10) — —Net loss$(47,386) $(83,903) $(73,564) $(45,889) $(45,570)Net loss per share, basic and diluted (1)$(0.59) $(1.96) $(17.63) $(40.97) $(52.68)Weighted-average shares outstanding, basic and diluted (1)80,558 42,712 4,173 1,120 865Comprehensive loss(47,386) (83,903) (73,564) (45,889) (45,570) (1)See Note 2 of Notes to Consolidated Financial Statements for an explanation of the method used to calculate net loss per share and the number of sharesused in the computation of the net per share amounts.80Table of Contents As of December 31, 2012 2011 2010 2009 2008 (In Thousands)Balance Sheet Data: Cash and cash equivalents and investment securities, available for sale$41,228 $56,525 $49,172 $44,911 $14,255Working capital29,071 37,057 38,626 42,102 3,032Total assets80,686 100,640 94,268 74,568 27,625Long-term debt, less current portion28,481 42,070 19,934 8,778 15,336Convertible preferred stock warrant liability— — — 5,041 467Convertible preferred stock— — — 149,312 76,955Accumulated deficit(329,391) (282,005) (198,102) (124,538) (78,649)Total stockholders’ equity (deficit)14,473 9,312 28,734 (122,300) (77,534)Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONAND RESULTS OF OPERATIONSThe following discussion and analysis of our financial condition and results of operations should be read in conjunction with “Selected FinancialData” and our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. In addition to historicalinformation, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual resultsmay differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited, to those setforth under “Item 1A — Risk Factors” and elsewhere in this Annual Report on Form 10-K.OverviewBackgroundWe are a pharmaceutical company commercializing and developing products for the treatment of central nervous system disorders and pain. Our firstcommercial product, Sumavel® DosePro® (sumatriptan injection) Needle-free Delivery System, was launched in January 2010. Sumavel DosePro offers fast-acting, easy-to-use, needle-free subcutaneous administration of sumatriptan for the acute treatment of migraine and cluster headache in a pre-filled, single-usedelivery system. Sumavel DosePro is the first drug product approved by the U.S. Food and Drug Administration, or FDA, that allows for the needle-free,subcutaneous delivery of medication. We commercialize Sumavel DosePro through our internal sales and marketing organization and in collaboration withMallinckrodt LLC, our co-promotion partner.Our lead product candidate, Zohydro ER (hydrocodone bitartrate, formerly ZX002) is a 12-hour extended-release formulation of hydrocodone withoutacetaminophen for the treatment of moderate to severe chronic pain requiring around-the-clock opioid therapy. We completed Phase 3 development of ZohydroER in 2011, and we submitted the New Drug Application, or NDA, for Zohydro ER to the FDA in May 2012. In July 2012, the FDA accepted our NDA asbeing sufficiently complete for a full review and assigned a Prescription Drug User Fee Act (PDUFA) target date of March 1, 2013. In December 2012, anadvisory committee convened by the FDA voted 2-11 (with 1 abstention) against the approval of Zohydro ER. The advisory committee provides the FDA withindependent expert advice and recommendations; however, the final decision regarding approval is made by the FDA. In February 2013, the FDA informed usthat we were unlikely to receive an action letter for our NDA for Zohydro ER by the PDUFA target action date of March 1, 2013. The FDA has not providedus with information as to the reason for the delay, but has indicated that the delay would likely be brief and may last only several weeks. We have not beeninformed of any deficiencies in the NDA for Zohydro ER during the review process to date.Sumavel DosePro and Zohydro ER, if approved, each have the potential to address significant unmet medical needs and become important and widely-used additions to the treatment options available to patients and physicians in the United States’ multi-billion dollar migraine and chronic pain markets,respectively.We are also developing Relday™, a proprietary, long-acting injectable formulation of risperidone using Durect Corporation's SABER™ controlled-release formulation technology through a development and license agreement with Durect, or the Durect License Agreement. Risperidone is used to treat thesymptoms of schizophrenia and bipolar disorder in adults and teenagers 13 years of age and older. If successfully developed and approved, we believe Reldaymay be the first once-monthly, subcutaneous antipsychotic product. In May 2012 we filed an investigational new drug, or IND, application with the FDA. In81Table of ContentsJuly 2012, we initiated our first IND clinical trial for Relday. This Phase 1 clinical trial was a single-center, open-label, safety and pharmacokinetic trial of 30patients with chronic, stable schizophrenia or schizoaffective disorder. We announced positive single-dose pharmacokinetic results from the Phase 1 clinicaltrial on January 3, 2013. Based on the favorable safety and pharmacokinetic profile demonstrated with the 25 mg and 50 mg once-monthly doses tested in thePhase 1 trial, we extended the study to include an additional cohort of 10 patients at a 100 mg dose of the same formulation. The addition of this 100 mg doseto the study will enable evaluation of dose proportionality across the full dose range that would be anticipated to be used in clinical practice. We expect tocomplete the extension of the Phase 1 clinical trial during the second quarter of 2013. The development of Relday will first focus on its delivery byconventional needle and syringe in order to allow the administration of different volumes of the same formulation of Relday by a healthcare professional. Weanticipate that the introduction of our DosePro needle-free technology for administration of Relday can occur later in development or as part of life cyclemanagement after further work involving formulation development, technology enhancements, and applicable regulatory approvals.We have experienced net losses and negative cash flow from operating activities since inception, and as of December 31, 2012, had an accumulateddeficit of $329.4 million. We expect to continue to incur net losses and negative cash flow from operating activities for at least the next several years primarilyas a result of the expenses incurred in connection with our efforts in seeking marketing approval for Zohydro ER, any additional required clinical testing forZohydro ER, the clinical development for Relday and the cost of the sales and marketing expense associated with Sumavel DosePro, and, if approved,Zohydro ER. As of December 31, 2012, we had cash and cash equivalents of $41.2 million.On July 27, 2012, we completed a public offering of common stock and warrants for net proceeds of approximately $65.4 million (including over-allotment purchase), after deducting underwriting discounts and commissions of $4.2 million and offering expenses of $0.5 million. We sold a total of32,500,000 shares of our common stock and warrants to purchase 14,625,000 shares of common stock (excluding over-allotment purchase) in the offering, ata purchase price to the public of $1.99 per share of common stock and $0.01 per share underlying each warrant. The underwriters were granted a 30-dayoption to cover over-allotments, to purchase up to an additional 4,875,000 shares of common stock and warrants to purchase 2,193,750 shares of commonstock, of which the underwriters exercised their option with respect to 2,558,300 shares of common stock and warrants for 1,159,200 shares of commonstock. The warrants will be exercisable beginning on July 27, 2013 at an exercise price of $2.50 per share and will expire on July 27, 2017, which is fiveyears from the date of issuance.Although it is difficult to predict future liquidity requirements, we believe that our cash and cash equivalents as of December 31, 2012, and ourprojected product revenues from Sumavel DosePro, will be sufficient to fund our operations into the fourth quarter of 2013. We will need to obtain additionalcapital to finance our operations beyond that point, or possibly earlier. Further, if we receive FDA approval of Zohydro ER, we may need to obtain additionalcapital to finance the commercial launch of Zohydro ER, possibly prior to the fourth quarter of 2013. We intend to raise additional capital, if necessary,through public or private equity offerings, debt financings, receivables financings or through collaborations or partnerships with other companies. If we areunsuccessful in raising additional required funds, we may be required to significantly delay, reduce the scope of or eliminate one or more of our developmentprograms or our commercialization efforts, or cease operating as a going concern. We also may be required to relinquish, license or otherwise dispose of rightsto product candidates or products that we would otherwise seek to develop or commercialize ourselves on terms that are less favorable than might otherwise beavailable. In its report on our consolidated financial statements for the year ended December 31, 2012, our independent registered public accounting firmincluded an explanatory paragraph expressing substantial doubt regarding our ability to continue as a going concern.Mallinckrodt Co-Promotion AgreementIn June 2012, we entered into a co-promotion agreement with Mallinckrodt. Under the terms of the co-promotion agreement Mallinckrodt has committedto a minimum number of sales representatives for the initial term of the agreement, which runs through June 30, 2014, and can be extended by mutualagreement of the parties in additional six month increments. We remain responsible for the manufacture, supply and distribution of commercial product forsale in the United States. In addition, we will supply product samples to Mallinckrodt at an agreed upon transfer price and Mallinckrodt will reimburse us forall other promotional materials used.In partial consideration of Mallinckrodt's sales efforts, we will pay Mallinckrodt a service fee on a quarterly basis that represents a specified fixedpercentage of net sales of prescriptions generated from Mallinckrodt's prescriber audience over a baseline amount of net sales to the same prescriber audience,or baseline net sales. In addition, upon completion of the co-promotion term in June 30, 2014 (unless otherwise extended), and only if the co-promotionagreement is not terminated as a result of certain circumstances, we will be required to pay Mallinckrodt an additional tail payment calculated as a fixedpercentage of the Mallinckrodt net sales over the baseline net sales during the first full twelve months following the last day of the term.82Table of ContentsFor the year ended December 31, 2012, we incurred service fee expenses of $0.2 million under the co-promotion agreement.Astellas Co-Promotion AgreementWe launched the commercial sale of Sumavel DosePro in the United States in January 2010 with our co-promotion partner, Astellas Pharma US, Inc., orAstellas. Under our co-promotion agreement with Astellas that we entered into in July 2009, or the Astellas co-promotion agreement, Astellas primarilypromoted Sumavel DosePro to primary care physicians (including internal medicine, family practice and general practice), OB/GYNs, emergency medicinephysicians and urologists, or collectively, the Astellas Segment, in the United States. Our sales force historically promoted Sumavel DosePro primarily toneurologists and other key prescribers of migraine medications, including headache clinics and headache specialists in the United States. We jointly shared inthe cost of advertising, marketing and other promotional activities related to the Sumavel DosePro brand and were required to provide minimum levels of saleseffort to promote Sumavel DosePro.In December 2011, we entered into an amendment to the Astellas co-promotion agreement, whereby the agreement terminated on March 31, 2012. As aresult of the agreement termination, and pursuant to a promotion transition plan, beginning in the second quarter of 2012, our field sales force then consistingof approximately 95 representatives assumed full responsibility from approximately 400 Astellas sales representatives for the continued marketing of SumavelDosePro. This promotion transition expanded our focus to include a portion of the high-prescribing primary care physicians previously covered by Astellasunder the Astellas co-promotion agreement.At the inception of the Astellas co-promotion agreement and in exchange for the right to promote Sumavel DosePro, Astellas made a non-refundable up-front payment of $2.0 million to us and made aggregate additional payments of $18.0 million to us upon the achievement of a series of milestones. Theseproceeds are reflected as $8.5 million of deferred revenues on our consolidated balance sheet at December 31, 2011. Beginning with the launch of SumavelDosePro in January 2010, we began recognizing these proceeds as contract revenues on a ratable basis over 42 months (the original term of the agreement).Upon amendment of the Astellas co-promotion agreement on December 20, 2011, the remaining deferred proceeds were recognized as contract revenues on aratable basis over 3.4 months (the remaining term of the amended agreement). This acceleration in the recognition of the contract proceeds resulted in therecognition of $8.5 million of contract revenue during the three months ended March 31, 2012.Under the terms of the amended Astellas co-promotion agreement, we are required to make two annual tail payments to Astellas, estimated as a total of$5.3 million, calculated as decreasing fixed percentages (ranging from a mid-twenties down to a mid-teen percentage) of net sales in the Astellas Segment in thelast 12 months of its active promotion. The present value of such tail payments was recorded as a long-term liability on the amendment date and is payable inJuly 2013 and July 2014. The fair value of the tail payments will be accreted through interest expense on a monthly basis through the date of payment. As ofDecember 31, 2012, the short-term and long-term tail payment liability was $1.8 million and $1.0 million, respectively (including the service fee reductiondiscussed below), and there was $0.6 million of related interest expense recognized during the year ended December 31, 2012.In consideration for Astellas' performance of its commercial efforts, we were required to pay Astellas a service fee on a quarterly basis that represents afixed percentage of between 45% and 55% of Sumavel DosePro net sales to the Astellas Segment through the date of termination. Astellas paid us a fixed fee forall sample units they ordered for distribution to their sales force. Amounts received from Astellas for shared marketing costs and sample product are reflectedas a reduction of selling, general and administrative expenses, and amounts payable to Astellas for shared marketing expenses and service fees are reflected asselling, general and administrative expenses.In August 2012, we and Astellas completed a final reconciliation under the terms of the co-promotion agreement and agreed to adjust the service fees paidto Astellas over the term of the co-promotion agreement, resulting in a service fee receivable of $1.5 million, which will offset the two annual tail payments,and a reduction to the annual tail payment liability of $0.7 million. The present value of the service fee receivable and tail payment reduction of $1.9 millionwas recorded as a reduction in selling, general and administrative expenses during the twelve months ended December 31, 2012, and an offset to the tailpayment liability. The fair value of the service fee receivable and tail payment reduction will be accreted through interest income through the dates of the twotail payments in July 2013 and July 2014.For the years ended December 31, 2012, 2011 and 2010, we recognized shared marketing expense of $0.3 million, $1.7 million and $3.9 million,respectively. For the years ended December 31, 2012, 2011 and 2010, excluding tail payments recorded as service fee expenses, we recorded $1.8 million,$6.7 million and $3.7 million in service fee expenses, respectively.Durect License Agreement83Table of ContentsIn July 2011, we paid a non-refundable upfront fee to Durect of $2.25 million under the development and license agreement with Durect, or the Reldaylicense agreement. We are obligated to pay Durect up to $103.0 million in total future milestone payments with respect to Relday, subject to, and upon theachievement of various development, regulatory and sales milestones. We are also required to pay a mid single-digit to low double-digit percentage patentroyalty on annual net sales of the product determined on a jurisdiction-by-jurisdiction basis. Further, until an NDA for Relday has been filed in the UnitedStates, we are obligated to spend no less than $1.0 million in external expenses on the development of Relday in any trailing twelve month period beginning inJuly 2012. The patent royalty term in any jurisdiction is equal to the later of the expiration of all Durect technology patents or joint patent rights in a particularjurisdiction, the expiration of marketing exclusivity rights in such jurisdiction, or 15 years from first commercial sale in such jurisdiction. After the patentroyalty term, we will continue to pay royalties on annual net sales of the product at a reduced rate for so long as we continue to sell the product in thejurisdiction. We are also required to pay to Durect a tiered percentage of fees received in connection with any sublicense of the licensed rights. In connectionwith the license agreement, we incurred $2.1 million and $2.7 million (excluding the upfront fee of $2.25 million paid in July 2011) of research anddevelopment expenses for the years ended December 31, 2012 and 2011, respectively.Critical Accounting Policies and EstimatesOur management’s discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, whichhave been prepared in conformity with generally accepted accounting principles in the United States, or GAAP. The preparation of these consolidated financialstatements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, expenses and related disclosures. Actualresults could differ from those estimates.While our significant accounting policies are more fully described in Note 2 to our consolidated financial statements appearing elsewhere in this AnnualReport on Form 10-K, we believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our consolidatedfinancial statements.Revenue RecognitionWe recognize revenue from the sale of Sumavel DosePro and from license fees and milestones earned on collaborative arrangements. Revenue isrecognized when: (i) persuasive evidence that an arrangement exists, (ii) delivery has occurred and title has passed, (iii) the price is fixed or determinable and(iv) collectability is reasonably assured. Revenue from sales transactions where the buyer has the right to return the product is recognized at the time of saleonly if (i) our price to the buyer is substantially fixed or determinable at the date of sale, (ii) the buyer has paid us, or the buyer is obligated to pay us and theobligation is not contingent on resale of the product, (iii) the buyer’s obligation to us would not be changed in the event of theft or physical destruction ordamage of the product, (iv) the buyer acquiring the product for resale has economic substance apart from that provided by us, (v) we do not have significantobligations for future performance to directly bring about resale of the product by the buyer, and (vi) the amount of future returns can be reasonably estimated.Product Revenue, NetWe sell Sumavel DosePro product in the United States to wholesale pharmaceutical distributors and retail pharmacies, or collectively our customers,subject to rights of return. We recognize product sales at the time title transfers to our customer, and we reduce product sales for estimated future productreturns and sales allowances in the same period the related revenue is recognized. Product sales allowances include wholesaler and retail pharmacy distributionfees, prompt pay discounts, chargebacks, rebates and patient discount programs, and are based on amounts owed or to be claimed on the related sales. Theseestimates take into consideration the terms of our agreements with customers and third-party payors and the levels of inventory within the distribution andretail channels that may result in future rebates or discounts taken. In certain cases, such as patient support programs, we recognize the cost of patientdiscounts as a reduction of revenue based on estimated utilization. If actual future results vary, we may need to adjust these estimates, which could have aneffect on product revenue in the period of adjustment.Prior to the third quarter of 2011, Sumavel DosePro had a limited sales history, and we could not reliably estimate expected returns of the product at thetime of shipment. Accordingly, we deferred recognition of revenue on product shipments of Sumavel DosePro until the right of return no longer existed, whichoccurred at the earlier of the time Sumavel DosePro units were dispensed through patient prescriptions or expiration of the right of return. Units dispensed aregenerally not subject to return, except in the rare cases where the product malfunctions or the product is damaged in transit. We estimate patient prescriptionsdispensed using an analysis of third-party information, including third-party market research data.Product Returns. Our estimated product return allowances for Sumavel DosePro require a high degree of judgment and are subject to change based onour experience and certain quantitative and qualitative factors. Sumavel DosePro's shelf life is84Table of Contentsdetermined by the shorter expiry date of its two subassemblies, which is currently approximately 30 months from the date of manufacture. Our return policyallows for the customer to return unused product six months before and up to one year after its expiration date for a credit at the then-current wholesaleracquisition cost, or WAC, reduced by a nominal fee for processing the return.We have monitored actual return history on an individual product lot basis since product launch. Actual product return experience in 2012 and 2011included a disproportionately high amount of returns from a single retail chain. In addition, we have also experienced a high level of returned product from ourinitial launch stocking initiatives. We considered these factors as well as the dating of our product at the time of shipment into the distribution channel,prescription trends and changes in the estimated levels of inventory within the distribution channel to estimate our exposure for returned product. Because ofthe shelf life of Sumavel DosePro and the duration of time under which our customers may return product to us through our return policy, there may be asignificant period of time between when the product is shipped and when we issue credits on returned product. Accordingly, we may have to adjust theseestimates, which could have an effect on product sales and earnings in the period of adjustments. A 1% increase or decrease in our returns reserve as apercentage of product shipped in the years ended December 31, 2012 and 2011 would have a financial statement impact of approximately $0.5 million and$0.6 million for the years ended December 31, 2012 and 2011, respectively.We permit certain wholesale pharmaceutical distributors to purchase limited quantities of product after the announcement of an increase to the WAC ofour product and prior to the effectiveness of the increase. In turn, WAC price increases can result in accelerated purchases by wholesalers relative toanticipated retail and prescription demand. The timing of purchases made by wholesale distributors and retail pharmacies are subject to fluctuations for thesereasons among others. Absent accelerated purchasing by wholesalers or other periodic changes in buying patterns, the wholesale channel has historicallycontained approximately three to four weeks of product on hand. As of December 31, 2012, wholesale distributors reported approximately four weeks of ourproduct on hand.Wholesaler and Retail Pharmacy Distribution Fees. We offer distribution fees to certain wholesale distributors and retail pharmacies based oncontractually determined rates. We accrue the distribution fees on shipment to the respective wholesale distributors and retail pharmacies and recognize thedistribution fees as a reduction of revenue in the same period the related revenue is recognized.Prompt Pay Discounts. We offer cash discounts to our customers, generally 2% of the sales price, as an incentive for prompt payment. We account forcash discounts by reducing accounts receivable by the full amount and recognizing the discount as a reduction of revenue in the same period the relatedrevenue is recognized.Chargebacks. We provide discounts primarily to authorized users of the Federal Supply Schedule, or FSS, of the General Services Administrationunder an FSS contract negotiated by the Department of Veterans Affairs and various organizations under Medicaid contracts and regulations. These entitiespurchase products from the wholesale distributors at a discounted price, and the wholesale distributors then charge back to us the difference between thecurrent retail price and the price the federal entity paid for the product. We estimate and accrue chargebacks based on estimated wholesaler inventory levels,current contract prices and historical chargeback activity. Chargebacks are recognized as a reduction of revenue in the period the related revenue is recognized.Rebates. We participate in certain rebate programs, which provide discounted prescriptions to qualified insured patients. Under these rebate programs,we pay a rebate to the third-party administrator of the program, generally two to three months after the quarter in which prescriptions subject to the rebate arefilled. We estimate and accrue these rebates based on current contract prices, historical and estimated future percentages of product sold to qualified patientsand estimated levels of inventory in the distribution channel. Rebates are recognized as a reduction of revenue in the period the related revenue is recognized.Patient Discount Programs. We offer discount card programs to patients for Sumavel DosePro in which patients receive discounts on theirprescriptions that are reimbursed by us. We estimate the total amount that will be redeemed based on levels of inventory in the distribution and retail channelsand recognize the discount as a reduction of revenue in the same period the related revenue is recognized.Our procedures for estimating amounts accrued for rebates, chargebacks and other incentive programs at the end of any period are based on availablequantitative data and are supplemented by management's judgment with respect to many factors, including but not limited to, current market dynamics,changes in contract terms, impact of new contractual arrangements and changes in sales trends. Quantitatively, we use historical sales, inventory movementthrough commercial channels, product utilization and rebate data and apply forecasting techniques in order to estimate our liability amounts. Qualitatively,management's judgment is applied to these items to modify, if appropriate, the estimated liability amounts. There are inherent risks in this process. Forexample, patients may not achieve assumed utilization levels; third parties may misreport their85Table of Contentsutilization to us; and discounts determined under federal guidelines, which affect our rebate programs with U.S. federal government agencies, may differ fromthose estimated. On a quarterly basis, we analyze our estimates against actual rebate, chargeback and incentive program activity and adjust our estimates asnecessary. Given our limited history with the commercialization of Sumavel DosePro, we may experience variability in our provisions for these salesallowances as we continue to initiate new sales initiatives and/or managed care programs in connection with the commercialization of our product. Anadjustment to our estimated liabilities for rebates, chargebacks and other incentive programs of 1% of product sales, based on operating results for the yearended December 31, 2012, would have resulted in an increase or decrease to net product sales for that period of approximately $0.5 million. The sensitivity ofour estimates can vary by program and type of customer. Additionally, there is a time lag between the date we determine the estimated liability and when weactually pay the liability. Due to this time lag, we may record adjustments to our estimated liabilities over several reporting periods, which can result in a netincrease to net revenues or a net decrease to net revenues in those periods. Material differences may result in the amount of revenue we recognize from productsales if the actual amount of rebates, chargebacks and incentives differ materially from the amounts estimated by management. To date, there have been nomaterial differences between the amount recorded in a period and actual charges incurred.Contract RevenueContract revenue consists of the amortization of license fees and milestone payments received under our co-promotion agreements, which have multipledeliverables. Revenue arrangements with multiple deliverables are divided into separate units of accounting if criteria are met, including whether the deliverablehas stand-alone value to the customer and the customer has a general right of return relative to the delivered item and delivery or performance of the undelivereditem is probable and substantially within the vendor's control. Arrangement consideration is allocated at the inception of the arrangement to all deliverables onthe basis of their relative selling price. The selling price for each deliverable is determined using: (i) vendor-specific objective evidence of selling price, orVSOE, if it exists, (ii) third-party evidence of selling price, or TPE, if VSOE does not exist, and (iii) our best estimate of the selling price if neither VSOE norTPE exists. For transactions entered into prior to January 1, 2011, revenue is recognized for each deliverable based upon the applicable revenue recognitioncriteria discussed above and upon acceptance of goods or performance of service. Effective January 1, 2011, for new or significantly modified transactions,we allocate revenue consideration, excluding contingent consideration, based on the relative selling prices of the separate units of accounting contained withinan arrangement containing multiple deliverables.Inventories and Related ReservesInventories are stated at the lower of cost (FIFO) or market and consist of finished goods, work in progress and raw materials used in the manufacture ofSumavel DosePro. We have significant lead times for the procurement and manufacture of our finished goods and we therefore order goods from our suppliersand manufacturers based on our forecasts of future demand. To the extent we procure component materials or produce finished goods in excess of actual futuredemand, we may be required to provide reserves for potentially excess or dated inventories. We provide such reserves based on an analysis of inventory onhand and on firm purchase commitments compared to forecasts of future sales.Warrants for Common StockWe classify common stock warrants that contain covenants where compliance with such covenants may be outside of our control as short-termliabilities on the consolidated balance sheet. We record the warrant liability at fair value and adjust the carrying value of these common stock warrants to theirestimated fair value at each reporting date with the increases or decreases in the fair value of such warrants recorded as change in fair value of warrant liabilityin the consolidated statement of operations and comprehensive loss.Embedded DerivativesEmbedded derivatives are recorded in the consolidated balance sheet at fair value. We adjust the carrying value of the embedded derivatives to theirestimated fair value at each reporting date with the increases or decreases in the fair value of such embedded derivatives recorded as change in fair value ofembedded derivatives in the consolidated statement of operations and comprehensive loss. We measure the fair value of the embedded derivatives using variousdiscounted cash flow valuation models.Fair Value MeasurementsGAAP requires us to estimate the fair value of certain assets and liabilities as of the date of their acquisition or incurrence, on an ongoing basis, or both.Determining the fair value of an asset or liability requires the use of accounting estimates and assumptions which are judgmental in nature and could have asignificant impact on the determination of the amount of the fair value ascribed to the asset or liability.86Table of ContentsClinical Trial ExpensesOur expense accruals for clinical trials are based on estimates of the services received from clinical trial investigational sites and contract researchorganizations, or CROs. Payments under some of the contracts we have with such parties depend on factors such as the milestones accomplished, successfulenrollment of certain numbers of patients, site initiation and the completion of clinical trial milestones. In accruing service fees, we estimate the time period overwhich services will be performed and the level of effort to be expended in each period. If possible, we obtain information regarding unbilled services directlyfrom these service providers. However, we may be required to estimate these services based on information available to our product development oradministrative staff. If we underestimate or overestimate the activity associated with a study or service at a given point in time, adjustments to research anddevelopment expenses may be necessary in future periods. Historically, our estimated accrued liabilities have approximated actual expense incurred.Subsequent changes in estimates may result in a material change in our accruals.Stock-Based CompensationStock-based compensation expense is measured at the grant date, based on the estimated fair value of the award, and is recognized as expense over theemployee’s requisite service period, or vesting period, on a straight-line basis. Equity awards issued to non-employees are recorded at their fair value on thegrant date and are periodically re-measured as the underlying awards vest unless the instruments are fully vested, immediately exercisable and nonforfeitableon the date of grant.Results of OperationsComparison of Years Ended December 31, 2012, 2011 and 2010Revenue. We recognize net product sales upon the shipment of product to wholesale pharmaceutical distributors and retail pharmacies. Prior to the thirdquarter of 2011, we recognized product revenue based on product dispensed to patients as estimated by independent third party data providers, whichamounts were recorded net of estimated wholesaler and retail pharmacy distribution fees, stocking allowances, prompt pay discounts, chargebacks, rebatesand patient discount programs, as applicable. As a result, product revenue for the first six months of 2011 represents product revenue based on productdispensed to patients net of product-related discounts and allowances, as applicable, with the six months ended December 31, 2011 and year ended December31, 2012 consisting of Sumavel DosePro shipped to wholesale distributors and retail pharmacies, net of product-related discounts, allowances and productreturns, as applicable.Revenue for the years ended December 31, 2012, 2011 and 2010 was $44.3 million, $37.6 million and $23.4 million, respectively. Net product revenuefor the years ended December 31, 2012, 2011 and 2010 was $35.9 million, $30.4 million and $19.1 million, respectively.The aggregate $5.5 million, or 18%, increase in net product revenue during 2012 compared to 2011 was primarily due to an increase in unit volume of16%, offset by a decrease in our average selling price of approximately 1%. This decrease in our average selling price per unit was driven by charges related toestimated product returns and a 13% increase in sales allowances as a percentage of gross U.S. product revenue through increased third-party payorcontracting/rebates and patient incentives.The aggregate $11.3 million, or 59%, increase in net product revenue during 2011 compared to 2010 was primarily due to an increase in prescriptiondemand from the initial launch of Sumavel DosePro in late January 2010, offset by the establishment of a product returns reserve. While prescription volumeincreased in 2011 over 2010, the increase was offset by a decrease in our average selling price of Sumavel DosePro of 3%. This decrease in our average sellingprice in 2011 over 2010 was driven by an increase of $5.5 million in product sales allowances through increased third-party payor contracting/rebates andpatient incentives. In addition, net product revenues were negatively impacted by $4.4 million in charges related to actual and estimated returned product.Further, previously reported deferred product revenues of $0.7 million were recognized within net product sales in 2011.Contract revenue for the years ended December 31, 2012, 2011 and 2010 was $8.5 million, $7.2 million and $4.4 million, respectively. Contractrevenue represents amortization of license fee payments and milestone payments we received in connection with the Astellas co-promotion agreement we enteredinto in July 2009 and which we began recognizing upon the commencement of sales of Sumavel DosePro in January 2010. The contract revenue in 2010reflects a pro-rata amount of amortization of license fees and milestones as compared to the contract revenues in 2011, which reflects the full amortization of alllicense fees and milestone payments. On December 20, 2011, we amended the Astellas co-promotion agreement whereby the agreement terminated on March 31,2012, rather than the initial termination date of June 30, 2013. Based upon this revised termination date, all deferred contract revenue was recognized on anaccelerated basis during the year ended December 31, 2012. This acceleration resulted in the recognition of an additional $0.9 million of contract revenueduring the year ended December 31, 2011.87Table of ContentsCost of Sales. Cost of sales consists primarily of materials, third-party manufacturing costs, freight and indirect personnel and other overhead costsassociated with sales of Sumavel DosePro based on units sold to wholesale pharmaceutical distributors and retail pharmacies, as well as reserves for excess,dated or obsolete commercial inventories and production manufacturing variances. It represents the cost of Sumavel DosePro units recognized as net productrevenues in the period and the impact of underutilized production capacity and other manufacturing variances.Cost of sales for the years ended December 31, 2012, 2011 and 2010 was $19.5 million, $19.3 million and $12.8 million, respectively. Product grossmargin for the year ended December 31, 2012 was 45.6% compared to 36.6% for the year ended December 31, 2011 and 32.6% for the year ended December31, 2010. The improvement in product gross margin of 9.1% in 2012 compared to 2011 was primarily a result of a decrease in excess capacity charges of ourcontract manufacturing organizations. The improvement in product gross margin of 4.0% in 2011 compared to 2010 was primarily a result of increasedproduct sales, offset by an increase in excess capacity charges. In 2010, we produced product to meet estimated demand requirements, sample initiatives andfor the establishment of certain safety stock levels of Sumavel DosePro on hand, which resulted in higher utilization of our contract manufacturing facilities in2010 compared to 2011. We maintain certain lead times ranging from six to nine months for our production activities and therefore we may not be able to makesignificant near-term adjustments to production levels in response to changes in product demand.Royalty Expense. Royalty expense consists of royalties payable to Aradigm based on net sales of Sumavel DosePro by us or one of our licensees and theamortization of the $4.0 million milestone payment paid by us to Aradigm upon the first commercial sale of Sumavel DosePro in the United States (whichoccurred in January 2010). We are not required to make any further milestone payments to Aradigm. We are required to pay to Aradigm a 3% royalty on globalnet sales of Sumavel DosePro, by us or one of our licensees, if any, until the expiration of the last valid claim of the transferred patents covering themanufacture, use, or sale of the product. During the years ended December 31, 2012, 2011 and 2010, we recorded $1.4 million, $1.2 million and $0.8million, respectively, in royalty expense. The increases in royalty expense are primarily due to the increases in sales.Research and Development Expenses. Research and development expenses consist of expenses incurred in developing, testing and seeking marketingapproval of our product candidates, including: license and milestone payments; payments made to third-party CROs and investigational sites, which conductour trials on our behalf, and consultants; expenses associated with regulatory submissions, pre-clinical development and clinical trials; payments to third-party manufacturers, which produce our active pharmaceutical ingredient and finished product; personnel related expenses, such as salaries, benefits, traveland other related expenses, including stock-based compensation; and facility, maintenance, depreciation and other related expenses. We expense all researchand development costs as incurred.We utilize CROs, contract laboratories and independent contractors for the conduct of pre-clinical studies and clinical trials. We track third-party costsby type of study being conducted. We recognize the expenses associated with the services provided by CROs based on the percentage of each study completedat the end of each reporting period. We coordinate clinical trials through a number of contracted investigational sites and recognize the associated expense basedon a number of factors, including actual and estimated subject enrollment and visits, direct pass-through costs and other clinical site fees.The table below sets forth information regarding our research and development costs for our major development programs. The period over periodvariances for our major development programs are explained in the narrative beneath the table. Year Ended December 31, 2012 2011 2010 (In Thousands)Research and development expenses: Zohydro ER$11,544 $20,461 $20,174Relday3,358 5,066 761Sumavel DosePro757 1,129 1,672Other (1)5,755 6,387 6,036Total$21,414 $33,043 $28,643(1) Other research and development expenses include development costs incurred for the DosePro technology sound enhancement and other productcandidate development, as well as employee and infrastructure resources that are not tracked on a program-by-program basis.88Table of ContentsResearch and development costs decreased by $11.6 million for the year ended December 31, 2012 compared to the year ended December 31, 2011primarily due to a decrease in development expenses for Zohydro ER and Relday. The decrease in Zohydro ER development expenses is the result of Phase 3clinical trials that were initiated in March 2010 and were completed in December 2011 and a milestone payment made to Alkermes in 2011 upon completion ofthe Phase 3 clinical trials for Zohydro ER. These cost decreases were partially offset by increased expenses related to fees paid in connection with our ZohydroER NDA submission to the FDA in May 2012 and costs related to preparation for and participation in the December 2012 FDA advisory committee meetingfor Zohydro ER. The decrease in Relday development expenses was primarily due to an upfront fee paid to Durect in July 2011 upon execution of the Reldaylicense agreement.Research and development costs increased by $4.4 million for the year ended December 31, 2011 compared to the year ended December 31, 2010primarily due to an increase in development expenses for Relday, which was primarily related to an upfront fee paid Durect in July 2011 upon execution of theRelday license agreement and an increase in costs for pre-clinical studies and formulation and stability testing for Relday in 2011.We use our employee and infrastructure resources across our product and product candidate development programs. Therefore, we have not trackedsalaries, other personnel related expenses, facilities or other related costs to our product development activities on a program-by-program basis.We expect our research and development costs for 2013 to decrease over amounts incurred in 2012 as we incurred costs in 2012 related to our ZohydroER NDA submission and costs related to preparation for and participation in the December 2012 FDA advisory committee meeting for Zohydro ER, which wedo not expect to recur in 2013.Selling, General and Administrative Expenses. Selling expenses, which include sales and marketing costs, consists primarily of salaries andbenefits of sales and marketing management and sales representatives, shared marketing and advertising costs and service fees under our Astellas co-promotion agreement prior to its termination in March 2012, service fees under our Mallinckrodt co-promotion agreement, sample product costs, andconsulting fees. General and administrative expenses consist primarily of salaries and related costs for personnel in executive, finance, accounting, businessdevelopment and internal support functions. In addition, general and administrative expenses include facility costs and professional fees for legal, consultingand accounting services.Selling, general and administrative expenses decreased to $49.5 million for the year ended December 31, 2012 compared to $60.5 million for the yearended December 31, 2011. Selling expenses were $35.9 million for the year ended December 31, 2012 compared to $47.7 million for the year endedDecember 31, 2011. General and administrative expenses were $13.6 million for the year ended December 31, 2012 compared to $12.8 million for the yearended December 31, 2011. The decrease of $11.0 million in selling, general and administrative expenses was due to a decrease of $11.8 million of sales andmarketing expenses, offset by an increase of $0.8 million of general and administrative expenses.•The decrease in sales and marketing expenses is primarily the result of a $10.8 million decrease in service fees to Astellas due to the termination ofthe co-promotion agreement on March 31, 2012 and resulting reduction of service fees paid over the life of the agreement, and a decrease in otheradvertising and promotional activities. These selling and marketing expense decreases are partially offset by an increase in sales and marketingpersonnel costs primarily due to an increase in non-cash stock compensation expense and sales incentive compensation.•The increase in general and administrative expenses is primarily a result of an increase in non-cash stock-based compensation charges, salaryexpense and recruiting expenses, partially offset by a decrease in professional service related costs, such as legal and accounting and advisoryservices.Selling, general and administrative expenses increased to $60.5 million for the year ended December 31, 2011 compared to $51.3 million for the yearended December 31, 2010. Selling expenses were $47.7 million for the year ended December 31, 2011 compared to $42.3 million for the year endedDecember 31, 2010. General and administrative expenses were $12.8 million for the year ended December 31, 2011 compared to $9.0 million for the yearended December 31, 2010. The increase of $9.2 million in selling, general and administrative expenses was due to an increase of $5.4 million of sales andmarketing expenses and an increase of $3.8 million of general and administrative expenses.•The increase in sales and marketing expenses is primarily a result of increased service fees to Astellas resulting from higher product revenues andaccrued tail payments recorded in connection with the termination of the Astellas co-promotion agreement in December 2011. Sales and marketingexpenses also increased due to an increase in sales force costs resulting from an increase in the average number of sales representatives, as well as anincrease in advertising and promotional efforts. These selling and marketing expense increases are partially offset by a decrease in sampling efforts.89Table of Contents•The increase in general and administrative expenses is primarily a result of an increase in professional service related costs, such as legal, accountingand advisory services, insurance premiums, investor relations services and directors fees that we incur for operating as a public company, as well asan increase in non-cash stock-based compensation charges.We do not expect a significant change in general and administrative expense in 2013 as compared to 2012 levels; however, our selling expenses mayincrease significantly in 2013 if Zohydro ER is approved.Interest Income. During the years ended December 31, 2012, 2011 and 2010, interest income was $53,000, 37,000 and $5,000, respectively. Theincrease in interest in 2012 compared to 2011 and in 2011 compared to 2010, was primarily due to the increase in average cash and cash equivalent balancesduring the respective periods.Interest Expense. Interest expense consists of interest expense incurred in connection with our financing agreements and certain other arrangements,including the following:•our $30.0 million financing agreement, or the Healthcare Royalty financing agreement, with Healthcare Royalty Partners (formerly Cowen HealthcareRoyalty Partners II, LP), or Healthcare Royalty;•our $10.0 million revolving credit facility with Oxford Finance Corporation, or Oxford, and Silicon Valley Bank, or SVB;•our $25.0 million loan and security agreement with Oxford and SVB, or the amended Oxford/SVB loan agreement;•$4.5 million borrowed under our loan and security agreement with General Electric Capital Corporation, or GE Capital; and•imputed interest from the two annual tail payments to Astellas.Interest expense increased to $10.3 million for the year ended December 31, 2012 compared to $7.6 million for the year ended December 31, 2011. Theincrease of $2.7 million was primarily due to:•an increase in interest payments related to the $30.0 million borrowed from Healthcare Royalty and an increase in accrued non-cash interest expensebased on our estimate of future interest payments on this facility;•an increase in the amortization of debt discount and acquisition fees related to the amended Oxford/SVB loan agreement and an increase in finalpayment and prepayment fees due to the termination of our amended Oxford/SVB loan agreement in July 2012; and•an increase in non-cash interest expense related to imputed interest from the two annual tail payments payable to Astellas; offset by•a decrease in interest expense due to the termination of our amended Oxford/SVB loan agreement in July 2012.Interest expense decreased to $7.6 million for the year ended December 31, 2011 compared to $10.0 million for the year ended December 31, 2010. Thedecrease of $2.4 million was primarily was due to:•a decrease in interest expense related to a non-cash gain from conditional Series B warrants that expired unexercised upon the completion of our initialpublic offering in November 2010;•a decrease in the non-cash amortization of debt issuance and debt discount costs in connection with the $25.0 million amended Oxford/SVB loanagreement; and•a decrease in interest expense related to the early settlement of our outstanding principal balance on our $18.0 million amended loan and securityagreement with Oxford and CIT; offset by•an increase in interest payments related to the $30.0 million borrowed from Healthcare Royalty and an an increase in accrued non-cash interestexpense based on our estimate of future interest payments on this facility; and•an increase in interest expense due to higher debt balances associated with the amended Oxford/SVB loan agreement.We expect that 2013 interest expense will decrease over 2012 levels due to the repayment in full and termination of the revolving credit facility andamended Oxford/SVB loan agreement in July 2012.Change in Fair Value of Warrant Liabilities. The change in fair value of warrant liabilities relates to a fair value adjustment recorded on the warrantsto purchase common stock issued in connection with our July 2012 public offering and issued in connection with our Healthcare Royalty financing agreement.See Note 7 to the Consolidated Financial Statements.Change in Fair Value of Embedded Derivatives. The change in fair value of embedded derivatives relates to a fair value adjustment recorded on theembedded derivatives associated with the Healthcare Royalty financing agreement. See Note 3 to the Consolidated Financial Statements.90Table of ContentsOther Expense. Other expense for the year ended December 31, 2012 consists of expense incurred in July 2012 from the issuance of warrants in ourpublic offering, slightly offset by foreign currency transaction gains. Other expense for the year ended December 31, 2011 and 2010 consists primarily offoreign currency transaction gains and losses.Provision for Income Tax (Expense) Benefits. Provision for income tax (expense) benefit is primarily related to the taxable income generated by ourwholly-owned subsidiary, Zogenix Europe Limited.Net Operating Loss and Tax Credit Carryforwards. As of December 31, 2012, we had available federal and state net operating loss carryforwards ofapproximately $158.3 million and $164.1 million, respectively. If not utilized, the net operating loss carryforwards will begin expiring in 2026 for federal taxpurposes and 2015 for state tax purposes. As of December 31, 2012, we had federal and state research and development tax credit carryforwards ofapproximately $0.3 million and $2.0 million, respectively. The federal research and development income tax credit carryforwards will begin to expire in 2026unless previously utilized. The California research and development income tax credit carryforwards will carry forward indefinitely until utilized.Under Section 382 of the Internal Revenue Code of 1986, as amended, or the IRC, substantial changes in our ownership may limit the amount of netoperating loss and research and development income tax credit carryforwards that could be utilized annually in the future to offset taxable income. Specifically,this limitation may arise in the event of a cumulative change in ownership of our company of more than 50% within a three-year period. Any such annuallimitation may significantly reduce the utilization of the net operating loss carryforwards before they expire.We completed an analysis under IRC Sections 382 and 383 to determine if our net operating loss carryforwards and research and development creditsare limited due to a change in ownership. We determined that as of December 31, 2011 we had two ownership changes. The first ownership change occurred inAugust 2006 upon the issuance of our Series A-1 convertible preferred stock. As a result of this ownership change, we reduced our net operating losscarryforwards by $1.9 million and research and development income tax credits by $8,000. We determined that, as of December 31, 2011, we had a secondownership change, as defined by IRC Section 382 and 383, which occurred in September 2011 upon the issuance of stock in our follow-on offering. As aresult of this second ownership change, we reduced our federal and state net operating loss carryforwards as of December 31, 2010 by $83.5 million and$46.2 million, respectively, and research and development income tax credits as of December 31, 2010 by $2.2 million. We are currently in the process ofcompleting a Section 382 and 383 study to determine the impact that ownership changes during the year ended December 31, 2012 have had on ourcarryforwards and expect to complete the analysis within the next three months. As a result of this analysis, we may have an adjustment in the net operatinglosses that are recorded at December 31, 2012.Pursuant to IRC Section 382 and 383, the use of our net operating loss and research and development income tax credit carryforwards may be limited inthe event of a future cumulative change in ownership of more than 50% within a three-year period. Any such limitations, whether as the result of prior orfuture offerings of our common stock or sales of common stock by our existing stockholders, could have an adverse effect on our consolidated results ofoperations in future years. In each period since our inception, we have recorded a valuation allowance for the full amount of our deferred tax asset, as therealization of the deferred tax asset is uncertain. As a result, we have not recorded any federal or state income tax benefit in our consolidated statement ofoperations and comprehensive loss.Liquidity and Capital ResourcesWe have experienced net losses and negative cash flow from operations since inception, and as of December 31, 2012, had an accumulated deficit of$329.4 million. We expect to continue to incur net losses and negative cash flow from operating activities for at least the next several years primarily as a resultof the expenses incurred in connection with efforts in seeking marketing approval for Zohydro ER, the clinical development for Relday, any additionalrequired testing for Zohydro ER, and the cost of the sales and marketing expense associated with Sumavel DosePro, and, if approved, Zohydro ER. As ofDecember 31, 2012, we had cash and cash equivalents of $41.2 million.On July 27, 2012, we completed a public offering of common stock and warrants for net proceeds of approximately $65.4 million (including over-allotment purchase), after deducting underwriter discounts and commissions of $4.2 million and offering costs of $0.5 million.Although it is difficult to predict future liquidity requirements, we believe that our cash and cash equivalents as of December 31, 2012, and ourprojected product revenues from Sumavel DosePro, will be sufficient to fund our operations into the fourth quarter of 2013. We will need to obtain additionalcapital to finance our operations beyond that point, or possibly earlier. Further, if we receive FDA approval of Zohydro ER, we may need to obtain additionalcapital to finance the commercial launch of Zohydro ER, possibly prior to the fourth quarter of 2013. We intend to raise additional capital, if necessary,through public or private equity offerings, debt financings, receivables financings or through collaborations or partnerships with other91Table of Contentscompanies. If we are unsuccessful in raising additional required funds, we may be required to significantly delay, reduce the scope of or eliminate one or moreof our development programs or our commercialization efforts, or cease operating as a going concern. We also may be required to relinquish, license orotherwise dispose of rights to product candidates or products that we would otherwise seek to develop or commercialize ourselves on terms that are lessfavorable than might otherwise be available.In its report on our consolidated financial statements for the year ended December 31, 2012, our independent registered public accounting firm includedan explanatory paragraph expressing substantial doubt regarding our ability to continue as a going concern. A “going concern” opinion means, in general, thatour independent registered public accounting firm has substantial doubt about our ability to continue our operations without continuing infusions of capitalfrom external sources and this opinion could impair our ability to finance our operations through the sale of debt or equity securities or commercial bankloans. Our ability to continue as a going concern depends, in large part, on our ability to generate positive cash flow from operations and obtain additionalfinancing, neither of which is certain. If we are unable to achieve these goals, our business would be jeopardized and we may not be able to continue operationsand have to liquidate our assets and may receive less than the value at which those assets were carried on our financial statements, and it is likely thatinvestors will lose all or part of their investment.Since inception, our operations have been financed primarily through equity and debt financings, the issuance of convertible notes and paymentsreceived from Astellas under our Astellas co-promotion agreement. Through December 31, 2012, we received aggregate net cash proceeds of approximately$341.2 million from the sale of shares of our preferred and common stock, including the following recent financing transactions:•in July 2010, we issued unsecured convertible promissory notes in an aggregate amount of $15.0 million under which all the outstanding principal andinterest automatically converted to 3,873,756 shares of common stock upon the completion of our initial public offering;•in November 2010 and December 2010, we issued and sold a total of 14,436,493 shares of common stock in our initial public offering, including sharesissued upon the exercise of the underwriters’ overallotment option, for aggregate net proceeds of $51.7 million;•in July 2011, we entered into the Healthcare Royalty financing agreement pursuant to which we sold 388,601 shares of our common stock, resulting in$1.4 million of net proceeds;•in September 2011 and October 2011, we issued and sold a total of 30,711,566 shares of common stock in a follow-on public offering, including sharesissued upon the exercise of the underwriters’ option to purchase shares, for aggregate net proceeds of $57.9 million; and•in July 2012, we issued and sold a total of 35,058,300 shares of common stock and warrants to purchase 15,784,200 shares of common stock in apublic offering, including the underwriters' over-allotment purchase, for aggregate net proceeds of $65.4 million.On July 30, 2012, we terminated our amended Oxford/SVB loan agreement. The amended Oxford/SVB Agreement consisted of a $25.0 million termloan and a $10.0 million revolving credit facility. The obligations under the amended Oxford/SVB loan agreement were collateralized by our intellectualproperty (including among other things, copyrights, patents, patent applications, trademarks, service marks and trade secret rights) and personal property(including, among other things, accounts receivable, equipment, inventory, contract rights, rights to payment of money, license agreements, general intangiblesand cash). The $25.0 million term loan bore an interest rate of 12.06% per annum. Under the terms of the revolving credit facility, $10.0 million wasavailable to be borrowed within a specified percentage of our eligible accounts receivable and inventory balances (as defined in the agreement). Amountsoutstanding under the revolving credit facility accrued interest payable monthly at a floating rate per annum equal to the greater of 3.29% above SVB's primerate or 7.29%. In addition, we paid a monthly fee equal to 0.5% per annum of the average unused portion of the revolving credit facility.In connection with the repayment and termination of the amended Oxford/SVB loan agreement, we repaid $19.5 million of outstanding principal andinterest under the agreement. In addition to the repayment of all principal and interest outstanding, we were also required to make a final payment of $1.2million and a prepayment premium of $0.4 million, or 2% of the then outstanding principal. We also paid a $0.1 million prepayment premium to terminate therevolving credit facility. As a result of the termination of the amended Oxford/SVB loan agreement, the lenders no longer have a security interest in ourintellectual property and personal property (including, among other things, accounts receivable, equipment, inventory, contract rights, rights to payment ofmoney, license agreements, general intangibles and cash).On July 18, 2011, we closed the Healthcare Royalty financing agreement. Under the terms of the Healthcare Royalty Financing agreement, we borrowed$30.0 million and we are obligated to repay such borrowed amount together with a specified return to Healthcare Royalty, through the payment of tieredroyalties ranging from .5% to 5% of our direct product sales, co-promotion revenues and out-license revenues, or collectively, Revenue Interest, that we mayrecord or receive as a result of worldwide commercialization of our products including Sumavel DosePro, Zohydro ER, if approved, and other future92Table of Contentsproducts. Pursuant to the terms of the Healthcare Royalty financing agreement, our royalty rate increased to 5.75% in April 2012 in connection with the earlytermination of the Astellas co-promotion agreement.We are also obligated to make three fixed payments of $10.0 million on (or before at our option) each of January 31, 2015, January 31, 2016 andJanuary 31, 2017.We have the option to terminate the Healthcare Royalty financing agreement at our election in connection with a change of control of our company, uponthe payment of a base amount of $52.5 million, or, if higher, an amount that generates a 19% internal rate of return on the borrowed amount as of the date ofprepayment, in each case reduced by the Revenue Interest and principal payments received by Healthcare Royalty up to the date of prepayment.Healthcare Royalty has the option to terminate the Healthcare Royalty financing agreement at its election in connection with a change of control of ourcompany (which includes the sale, transfer, assignment or licensing of our rights in the United States to either Sumavel DosePro or Zohydro ER), or an eventof default (which includes the occurrence of a bankruptcy event or other material adverse change in our business), as defined in the Healthcare Royaltyfinancing agreement. Upon such a termination by Healthcare Royalty, we are obligated to make a payment of a base amount of $45.0 million, or, if higher, anamount that generates a 17% internal rate of return on the borrowed amount as of the date of prepayment, in each case reduced by the Revenue Interest andprincipal payments received by Healthcare Royalty up to the date of prepayment. Unless terminated earlier as discussed above, the Healthcare Royaltyfinancing agreement terminates on March 31, 2018.Any requirement that we repay the borrowed amount under the Healthcare Royalty financing agreement, whether as the result of our default under theapplicable agreement or otherwise, could have a material adverse effect on our business, results of operations and financial condition.Cash and Cash Equivalents. Cash and cash equivalents totaled $41.2 million and $56.5 million at December 31, 2012 and December 31, 2011,respectively.The following table summarizes our cash flows from (used in) operating, investing and financing activities for the years ended December 31, 2012,2011 and 2010: Year Ended December 31, 2012 2011 2010 (In Thousands)Statement of Cash Flows Data: Total cash provided by (used in): Operating activities$(52,202) $(80,471) $(71,952)Investing activities(293) (617) (3,442)Financing activities37,198 88,441 79,655Net (decrease) increase in cash and cash equivalents$(15,297) $7,353 $4,261Operating Activities. Net cash used in operating activities was $52.2 million, $80.5 million and $72.0 million for the years ended December 31, 2012,2011 and 2010, respectively. Net cash used for the year ended December 31, 2012 and 2011 primarily reflects the use of $49.3 million and $75.9 million,respectively, for operations (excluding non-cash items), which includes personnel-related costs, research and development costs (primarily for Zohydro ERand Relday), sales and marketing expenses for Sumavel DosePro, and other professional services. Net cash used for the year ended December 31, 2012 and2011 also includes $6.8 million and $6.1 million, respectively, used for other working capital purposes, offset by $3.9 million and $1.5 million,respectively, in the reduction of commercial inventory of Sumavel DosePro. Net cash used for the year ended December 31, 2010 primarily reflectsexpenditures relating to the commercial sale of Sumavel DosePro, personnel-related costs, third-party supplier expenses and professional fees.Investing Activities. Net cash used in investing activities was $0.3 million, $0.6 million, and $3.4 million for the years ended December 31, 2012,2011 and 2010, respectively. These amounts are the result of the purchase of property and equipment primarily for use in manufacturing Sumavel DosePro.We expect to incur capital expenditures of approximately $4.0 million to $5.0 million in 2013. These planned capital expenditures primarily relate tofurther investments in our manufacturing operations for Sumavel DosePro and toward enhancing our existing manufacturing technology and equipment.Financing Activities. Net cash provided by financing activities was $37.2 million, $88.4 million and $79.7 million for the years ended December 31,2012, 2011 and 2010, respectively. Net cash provided by financing activities for the year ended93Table of ContentsDecember 31, 2012 includes net proceeds from the issuance of common stock and warrants to purchase common stock during our July 2012 public offering,and net proceeds provided by our revolving credit facility with Oxford/SVB, offset by payments on our borrowed debt. Net cash provided by financingactivities for the year ended December 31, 2011 includes net proceeds received from the issuance of common stock in our follow-on public offering, netproceeds received in connection with our Healthcare Royalty financing agreement, net proceeds received from our $10.0 million revolving credit facility andproceeds from the issuance of common stock purchased through our Employee Stock Purchase Plan, offset by payments on borrowings of debt. Net cashprovided by financing activities for the year ended December 31, 2010 includes net proceeds received in connection with our initial public offering, netproceeds received in connection with the amended Oxford loan agreement and proceeds received in connection with our issuance of convertible promissorynotes in 2010, offset by principal repayments made on our outstanding debt facilities.Our sources of liquidity include our cash balances and cash receipts from the sale of Sumavel DosePro. Through December 31, 2012, we receivedaggregate net cash proceeds of approximately $341.2 million from the sale of shares of our preferred and common stock. As of December 31, 2012, we had$41.2 million in cash and cash equivalents. Other potential sources of near-term liquidity include (i) entering into a commercialization agreement for ZohydroER, if approved, or a licensing arrangement for Relday, (ii) equity, debt or other financing or (iii) leveraging our sales force capacity to promote a new product.Successful transition to profitability is dependent upon achieving a level of product revenues adequate to support our cost structure. We will continue tomonitor and evaluate our sales progress, the level of our research, development, manufacturing, sales and marketing and general and administrativeexpenditures and may adjust such expenditures based upon a variety of factors, such as our available cash, our ability to obtain additional cash, the resultsand progress of our Sumavel DosePro commercialization efforts, results and progress in our clinical program, the time and costs related to clinical trials andregulatory decisions, as well as the U.S. economic environment.As described above, we have agreed to specified positive and negative covenants under the Healthcare Royalty financing agreement and upon atermination by Healthcare Royalty, we are obligated to make a payment of a base amount of $45.0 million, or, if higher, an amount that generates a 17%internal rate of return on the borrowed amount as of the date of prepayment, in each case reduced by the payments received by Healthcare Royalty up to thedate of prepayment. If we were required to accelerate the payment of these amounts upon a default, we would be required to find an alternate source of capitalfrom which to draw funds and there can be no assurances that we would be able to do so on terms acceptable to us, or at all.If we fail to pay amounts owing under the Healthcare Royalty financing agreement when due, if we breach our other covenants or obligations under theagreement, or if other events of default under the agreement occur, Healthcare Royalty would be entitled to demand immediate repayment of all borrowings andother obligations thereunder and to seize and sell the collateral pledged as security under the agreements to satisfy those obligations. If we were to breach ourcovenants and obligations and we were unable to obtain a waiver or amendment from the lender, we would be required to seek additional equity or debtfinancing to refinance our obligations under the agreement. Additional debt or equity financing may not be available to us in amounts or on terms we consideracceptable, or at all. In that regard, we have from time to time been required to obtain waivers and amendments under our debt instruments in order to avoidbreaches or other defaults. For example, in each of 2012, 2011 and 2010 we were required to obtain amendments or waivers under our credit facilities.We cannot be certain if, when and to what extent we will generate positive cash flow from operations from the commercialization of our product and, ifapproved, product candidates. We expect our expenses to be substantial and to increase over the next few years as we continue to grow the Sumavel DoseProbrand and continue to advance our Zohydro ER product potentially through commercialization, and as we potentially advance Relday through clinicaldevelopment.Contractual Obligations and CommitmentsThe following table describes our long-term contractual obligations and commitments as of December 31, 2012:94Table of Contents Payments Due by Period Total Less than1 Year 1-3 Years 4-5 Years Morethan5 Years (In Thousands)Debt obligations (1)$30,000 $— $10,000 $20,000 $—Debt interest (2)24,930 2,526 9,748 10,325 2,331Operating lease obligations (3)3,688 1,572 2,116 — —Co-Promotion tail payments (4)3,250 2,032 1,218 — —Purchase obligations (5)9,225 8,899 326 — —Total$71,093 $15,029 $23,408 $30,325 $2,331 (1)Represents annual payments under the Healthcare Royalty financing agreement, which occur on January 1 of 2015, 2016 and 2017.(2)Includes the interest on scheduled debt payments under the Healthcare Royalty financing agreement, estimated using the effective interest method andrevenue projections.(3)Includes the minimum rental payments for our San Diego, California office pursuant to a lease entered into in April 2012, which expires in November2014. Also includes the minimum rental payments for our Emeryville, California office pursuant to a lease entered into in July 2007, which expires, asextended, in September 2015. Also includes the rental payments for a fleet of up to 95 vehicles pursuant to a lease entered into in August 2009. Eachvehicle has a lease term of 36 months.(4)Represents the two annual tail payments due to Astellas for the termination of our Astellas co-promotion agreement in March 2012, which are to be paid inJuly 2013 and July 2014.(5)Primarily represents non-cancellable purchase orders for the production of key components of Sumavel DosePro, a minimum manufacturing fee payableto Patheon UK Limited through the remaining term of our manufacturing services agreement, and a minimum annual spend in external expenses for thedevelopment of Relday. These purchase obligations are based on the exchange rate at December 31, 2012.Under our asset purchase agreement with Aradigm, we are required to pay a 3% royalty on global net sales of Sumavel DosePro by us or one of ourlicensees and, in the event that we or one of our future licensees, if any, commercializes a non-sumatriptan product in the DosePro delivery system, we arerequired to pay Aradigm, at our election, either a 3% royalty on net sales of each non-sumatriptan product commercialized or a fixed low-twenties percentage ofroyalty revenue received by us from the licensee.Under our development and license agreement with Alkermes we may be required to pay up to $2.8 million in total future milestone payments withrespect to Zohydro ER, depending upon the achievement of various development and regulatory events. These future milestone payments include a payment of$0.8 million upon successful completion of FDA pre-approval inspection of the manufacturing facility and a payment of $2.0 million upon the first NDAapproval of Zohydro ER. In addition, if Zohydro ER is approved, we will be required to pay a mid single-digit percentage royalty on its net sales for aspecified period of time and continue to pay royalties on net sales of the product thereafter at a reduced low single-digit percentage rate in accordance with theterms of the license agreement.Under our Relday license agreement with Durect we are obligated to pay Durect up to $103.0 million in total future milestone payments with respect tothe product subject to and upon the achievement of various development, regulatory and sales milestones. In addition, we are required to pay Durect a midsingle-digit to low double-digit percentage patent royalty on annual net sales of the product determined on a jurisdiction-by-jurisdiction basis, and we are alsorequired to pay to Durect a tiered percentage of fees received in connection with any sublicense of the licensed rights. Further, until an NDA for Relday hasbeen filed in the United States, we are obligated to spend no less than $1.0 million in external expenses on the development of Relday in any trailing twelvemonth period beginning in July 2012.Under our Healthcare Royalty financing agreement we are obligated to pay to Healthcare Royalty Revenue Interest on product sales between 5.0% and0.5%, depending upon the level of product sales made. Upon termination of our Astellas co-promotion agreement on March 31, 2012, the Revenue Interest rateincreased to 5.75%.We also maintain agreements with third parties to manufacture our product, conduct our clinical trials, and perform data collection and analysis. Ourpayment obligations under these agreements will likely depend upon the progress of our development programs, sales of our product and commercializationefforts. Therefore, we are unable at this time to estimate with certainty the future costs we will incur under these agreements.Recent Accounting Pronouncements95Table of ContentsIn May 2011, the FASB issued accounting guidance related to fair value measurements and disclosures to achieve common fair value measurements anddisclosures between GAAP and International Financial Reporting Standards. This guidance clarifies the application of certain existing fair value measurementguidance and expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. This guidance iseffective on a prospective basis for annual and interim reporting periods beginning on or after December 15, 2011. The adoption of this updated standard didnot have a material effect on our results of operations.In June 2011, the FASB issued an Accounting Standards Update which requires entities to present reclassification adjustments included in othercomprehensive income on the face of the financial statements and allows entities to present the total of comprehensive income, the components of net incomeand the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate consecutive statements.It also eliminates the option for entities to present components of other comprehensive income as part of the statement of changes to stockholders equity. Theupdated guidance is effective for fiscal and interim periods beginning after December 15, 2011, with early adoption permitted. The adoption of this updatedstandard did not have a material effect on our results of operations.Off-Balance Sheet ArrangementsWe have not engaged in any off-balance sheet activities.Item 7A. Quantitative and Qualitative Disclosures About Market RiskInterest Rate RiskOur cash and cash equivalents as of December 31, 2012 consisted of cash and money market funds. Our primary exposure to market risk is interestincome sensitivity, which is affected by changes in the general level of U.S. interest rates. The primary objective of our investment activities is to preserveprincipal. Instruments that meet this objective include commercial paper, money market funds and government and non-government debt securities. Some ofthe investment securities available-for-sale that we invest in may be subject to market risk. This means that a change in prevailing interest rates may cause thevalue of the investment securities available-for-sale to fluctuate. To minimize this risk, we intend to continue to maintain our portfolio of cash and moneymarket funds. Due to the short-term nature of our investments and our ability to hold them to maturity, we believe that there is no material exposure to interestrate risk.Foreign Exchange RiskAll of the revenues we have generated to date have been paid in U.S. dollars and we expect that our revenues will continue to be generated primarily inU.S. dollars for at least the next several years. Payments to our material suppliers and contract manufactures are denominated in the Euro and U.K. poundssterling, thereby increasing our exposure to exchange rate gains and losses on non-U.S. currency transactions. Foreign currency gains and losses associatedwith these expenditures have not been significant to date. However, fluctuations in the rate of exchange between the U.S. dollar and these or other foreigncurrencies could adversely affect our financial results in the future, particularly to the extent we increase production to support Sumavel DosePro salesdemands. For the twelve months ended December 31, 2012, approximately $17.1 million (based on exchange rates as of December 31, 2012) of our materialsand contract manufacturing costs were denominated in foreign currencies. We do not currently hedge our foreign currency exchange rate risk. As a result, weare exposed to gains and/or losses as the exchange rate of certain foreign currencies fluctuates. A 10% increase or decrease in the average rate of the Euro or theU.K. pound sterling during the twelve months ended December 31, 2012 would have resulted in approximately $0.7 million or $1.0 million in gains or losses,respectively. We intend to evaluate various options to mitigate the risk of financial exposure from transacting in foreign currencies in the future.Item 8. Financial Statements and Supplementary DataOur consolidated financial statements and the reports of our independent registered public accounting firm are included in this report on pages F-1through F-31.Item 9. Changes in and Disagreements with Accountants on Accounting and Financial DisclosureNone.Item 9A. Controls and ProceduresConclusions Regarding the Effectiveness of Disclosure Controls and Procedures96Table of ContentsWe maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports isrecorded, processed, summarized and reported within the timelines specified in the Securities and Exchange Commission’s rules and forms, and that suchinformation is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, toallow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that anycontrols and procedures, no matter how well designed and operated, can only provide reasonable assurance of achieving the desired control objectives, and inreaching a reasonable level of assurance, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possiblecontrols and procedures.As required by Securities and Exchange Commission Rule 13a-15(b), we carried out an evaluation, under the supervision and with the participation ofour management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controlsand procedures, as of the end of the period covered by this report. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concludedthat our disclosure controls and procedures were effective as of December 31, 2012 at the reasonable assurance level.Management’s Annual Report on Internal Control Over Financial ReportingInternal control over financial reporting refers to the process designed by, or under the supervision of, our Chief Executive Officer and Chief FinancialOfficer, and effected by our board of directors, management and other personnel, 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, and includes thosepolicies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions ofour assets; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance withgenerally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management anddirectors; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’sassets that could have a material effect on the financial statements.Internal control over financial reporting cannot provide absolute assurance of achieving financial reporting objectives because of its inherent limitations.Internal control over financial reporting is a process that involves human diligence and compliance and is subject to lapses in judgment and breakdownsresulting from human failures. Internal control over financial reporting also can be circumvented by collusion or improper management override. Because ofsuch limitations, there is a risk that material misstatements may not be prevented or detected on a timely basis by internal control over financial reporting.However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards toreduce, though not eliminate, this risk.Management is responsible for establishing and maintaining adequate internal control over our financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act. Under the supervision and with the participation of our management, including our Chief Executive Officer and ChiefFinancial Officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting. Management has used the framework setforth in the report entitled “Internal Control — Integrated Framework” published by the Committee of Sponsoring Organizations of the TreadwayCommission to evaluate the effectiveness of our internal control over financial reporting. Based on its evaluation, management has concluded that our internalcontrol over financial reporting was effective as of December 31, 2012, the end of our most recent fiscal year. Pursuant to Section 404(c) of the Sarbanes-OxleyAct, our independent registered public accounting firm has issued an attestation report on the effectiveness of our internal control over financial reporting forthe year ended December 31, 2012, which is included below.Report of Independent Registered Public Accounting FirmThe Board of Directors and Stockholders of Zogenix, Inc.We have audited Zogenix, Inc.'s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Zogenix, Inc.'s management isresponsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financialreporting included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on thecompany's internal control over financial reporting based on our audit.We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards requirethat we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in allmaterial respects. Our audit included obtaining an understanding97Table of Contentsof internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness ofinternal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our auditprovides a reasonable basis for our opinion.A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal controlover financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are beingmade only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention ortimely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluationof effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliancewith the policies or procedures may deteriorate.In our opinion, Zogenix, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based onthe COSO criteria.We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balancesheets of Zogenix, Inc. as of December 31, 2012 and 2011, and the related consolidated statements of operations and comprehensive loss, stockholders' equity(deficit), and cash flows for each of the three years in the period ended December 31, 2012 of Zogenix, Inc. and our report dated March 15, 2013 expressed anunqualified opinion thereon that included an explanatory paragraph regarding Zogenix, Inc.'s ability to continue as a going concern./s/ ERNST & YOUNG LLPSan Diego, CaliforniaMarch 15, 2013Changes in Internal Control Over Financial ReportingThere have been no changes in our internal control over financial reporting during our most recent fiscal quarter that have materially affected, or arereasonably likely to materially affect, our internal control over financial reporting.Item 9B. Other InformationNone.98Table of ContentsPART IIIItem 10. Directors, Executive Officers and Corporate GovernanceInformation required by this item will be contained in our Definitive Proxy Statement, or the Definitive Proxy Statement, to be filed with the Securitiesand Exchange Commission in connection with our 2013 Annual Meeting of Stockholders, which is expected to be filed not later than 120 days after the end ofour fiscal year ended December 31, 2012, under the headings “Election of Directors,” “Corporate Governance and Other Matters ,” “Executive Officers,” and“Section 16(a) Beneficial Ownership Reporting Compliance,” and is incorporated herein by reference .We have adopted a Code of Business Conduct and Ethics that applies to our officers, directors and employees which is available on our internet websiteat www.zogenix.com. The Code of Business Conduct and Ethics contains general guidelines for conducting the business of our company consistent with thehighest standards of business ethics, and is intended to qualify as a “code of ethics” within the meaning of Section 406 of the Sarbanes-Oxley Act of 2002 andItem 406 of Regulation S-K. In addition, we intend to promptly disclose (1) the nature of any amendment to our Code of Business Conduct and Ethics thatapplies to our principal executive officer, principal financial officer, principal accounting officer or controller or persons performing similar functions and(2) the nature of any waiver, including an implicit waiver, from a provision of our code of ethics that is granted to one of these specified officers, the name ofsuch person who is granted the waiver and the date of the waiver on our website in the future.Item 11. Executive CompensationInformation required by this item will be contained in our Definitive Proxy Statement under the heading “Executive Compensation and OtherInformation” and is incorporated herein by reference.Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder MattersInformation required by this item will be contained in our Definitive Proxy Statement under the headings “Security Ownership of Certain BeneficialOwners and Management” and is incorporated herein by reference.Item 13. Certain Relationships, Related Transactions and Director IndependenceInformation required by this item will be contained in our Definitive Proxy Statement under the headings “Certain Relationships and Related PartyTransactions” and “Independence of the Board of Directors” and is incorporated herein by reference.Item 14. Principal Accounting Fees and ServicesInformation required by this item will be contained in our Definitive Proxy Statement under the heading “Independent Registered Public AccountingFirm’s Fees” and is incorporated herein by reference.99Table of ContentsPART IVItem 15. Exhibits, Financial Statement Schedules(a) Documents filed as part of this report.1. Financial Statements. The following consolidated financial statements of Zogenix, Inc., together with the report thereon of Ernst & Young LLP, anindependent registered public accounting firm, are included in this Annual Report on Form 10-K: PageReport of Independent Registered Public Accounting FirmF-2Consolidated Balance SheetsF-3Consolidated Statements of Operations and Comprehensive LossF-4Consolidated Statements of Stockholders’ Equity (Deficit)F-5Consolidated Statements of Cash FlowsF-5Notes to Consolidated Financial StatementsF-62. Financial Statement Schedules.Schedule II. Valuation and Qualifying Accounts — Years ended December 31, 2012, 2011 and 2010. All other schedules are omitted as the requiredinformation is inapplicable, or the information is presented in the consolidated financial statements or related notes.3. Exhibits.A list of exhibits to this Annual Report on Form 10-K is set forth on the Exhibit Index immediately preceding such exhibits and is incorporated herein byreference.(b) See Exhibit Index.(b) See Item 15(a)(2) above.100Table of ContentsZogenix, Inc.Index to Consolidated Financial Statements Report of Independent Registered Public Accounting FirmF-2Consolidated Balance SheetsF-3Consolidated Statements of Operations and Comprehensive LossF-4Consolidated Statements of Stockholders’ Equity (Deficit)F-5Consolidated Statements of Cash FlowsF-5Notes to Consolidated Financial StatementsF-6F-1Table of ContentsReport of Independent Registered Public Accounting FirmThe Board of Directors and Stockholders of Zogenix, Inc.We have audited the accompanying consolidated balance sheets of Zogenix, Inc. as of December 31, 2012 and 2011, and the related consolidatedstatements of operations and comprehensive loss, stockholders' equity (deficit), and cash flows for each of the three years in the period ended December 31,2012. Our audits also included the financial statement schedule listed in the Index at Item 15(a)(2). These consolidated financial statements and schedule arethe responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An auditincludes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing theaccounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe thatour audits provide a reasonable basis for our opinion.In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Zogenix, Inc. atDecember 31, 2012 and 2011, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31,2012, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered inrelation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to thefinancial statements, the Company's recurring losses from operations and lack of sufficient working capital raise substantial doubt about its ability tocontinue as a going concern. Management's plans as to these matters also are described in Note 1. The December 31, 2012 financial statements do not includeany adjustments that might result from the outcome of this uncertainty.We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Zogenix, Inc.'s internalcontrol over financial reporting as of December 31, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee ofSponsoring Organizations of the Treadway Commission and our report dated March 15, 2013 expressed an unqualified opinion thereon./s/ ERNST & YOUNG LLPSan Diego, CaliforniaMarch 15, 2013F-2Table of ContentsZogenix, Inc.Consolidated Balance Sheets(In Thousands, except Par Value) December 31, 2012 2011Assets Current assets: Cash and cash equivalents$41,228 $56,525Trade accounts receivable, net5,643 4,913Inventory, net12,886 16,776Prepaid expenses and other current assets1,968 2,210Total current assets61,725 80,424Property and equipment, net13,561 14,590Other assets5,400 5,626Total assets$80,686 $100,640Liabilities and stockholders’ equity Current liabilities: Accounts payable$4,592 $5,168Accrued expenses14,343 10,748Common stock warrant liabilities9,493 345Accrued compensation4,226 3,805Revolving credit facility— 5,081Long-term debt, current portion— 9,758Deferred revenue, current portion— 8,462Total current liabilities32,654 43,367Long-term debt, less current portion28,481 42,070Other long-term liabilities5,078 5,891Commitments and contingencies Stockholders’ equity: Common stock, $0.001 par value; 200,000 shares authorized at December 31, 2012 and 100,000 shares authorized atDecember 31, 2011; 100,809 and 65,369 shares issued and outstanding at December 31, 2012 and 2011,respectively.101 65Additional paid-in capital343,763 291,252Accumulated deficit(329,391) (282,005)Total stockholders’ equity14,473 9,312Total liabilities and stockholders’ equity$80,686 $100,640See accompanying notes.F-3Table of ContentsZogenix, Inc.Consolidated Statements of Operations and Comprehensive Loss(In Thousands, except Per Share Amounts) Year Ended December 31, 2012 2011 2010Revenue: Net product revenue$35,864 $30,411 $19,069Contract revenue8,462 7,165 4,373Total revenue44,326 37,576 23,442Operating expenses: Cost of sales19,496 19,293 12,846Royalty expense1,353 1,205 843Research and development21,414 33,043 28,643Selling, general and administrative49,494 60,459 51,270Total operating expenses91,757 114,000 93,602Loss from operations(47,431) (76,424) (70,160)Other income (expense): Interest income53 37 5Interest expense(10,313) (7,644) (10,013)Change in fair value of warrant liabilities11,811 445 6,725Change in fair value of embedded derivatives(147) (240) —Other expense(1,354) (86) (111)Total other income (expense)50 (7,488) (3,394)Loss before income taxes(47,381) (83,912) (73,554)Provision for income tax benefit (expense)(5) 9 (10)Net loss$(47,386) $(83,903) $(73,564)Net loss per share, basic and diluted$(0.59) $(1.96) $(17.63)Weighted average shares outstanding, basic and diluted80,558 42,712 4,173Comprehensive loss(47,386) (83,903) (73,564)See accompanying notes.F-4Table of ContentsZogenix, Inc.Consolidated Statements of Stockholders’ Equity (Deficit)(In Thousands, except Per Share Amounts) Common Stock AdditionalPaid-inCapital AccumulatedDeficit TotalStockholders’Equity (Deficit) Shares Amount Balance at December 31, 20091,444 $1 $2,237 $(124,538) $(122,300)Net loss— — — (73,564) (73,564)Issuance of common stock from initial public offering, net ofissuance costs of $6,01314,436 14 51,719 — 51,733Conversion of convertible preferred stock to common stock at initialpublic offering14,240 14 149,298 — 149,312Issuance of common stock from conversion of convertible notes, netof issuance costs of $183,874 5 15,472 — 15,477Beneficial conversion feature from issuance of convertible notes— — 4,696 — 4,696Conversion of warrants from warrants for preferred stock towarrants for common stock— — 743 — 743Issuance of common stock in conjunction with exercise of stockoptions— — 71 — 71Vesting of early exercised stock options23 — 59 — 59Stock-based compensation— — 2,507 — 2,507Balance at December 31, 201034,017 34 226,802 (198,102) 28,734Net loss— — — (83,903) (83,903)Issuance of common stock from secondary offering, net of issuancecosts of $3,56430,712 31 57,828 — 57,859Issuance of common stock from financing agreement at $3.86 pershare, net of issuance costs of $96389 — 1,404 — 1,404Issuance of common stock in conjunction with exercise of stockoptions67 — 92 — 92Issuance of common stock from ESPP purchase172 — 263 — 263Issuance of common stock warrants— — 39 — 39Release of restricted stock units12 — — — —Vesting of early exercised stock options— — 15 — 15Stock-based compensation— — 4,809 — 4,809Balance at December 31, 201165,369 65 291,252 (282,005) 9,312Net loss— — — (47,386) (47,386)Issuance of common stock from July 2012 offering, net of issuancecosts of $3,32835,058 35 45,774 — 45,809Issuance of common stock in conjunction with exercise of stockoptions18 — 33 — 33Issuance of common stock from ESPP purchase364 1 547 — 548Stock-based compensation— — 6,157 — 6,157Balance at December 31, 2012100,809 $101 $343,763 $(329,391) $14,473See accompanying notes.Zogenix, Inc.Consolidated Statements of Cash Flows(In Thousands) Year Ended December 31, 2012 2011 2010Operating activities: Net loss$(47,386) $(83,903) $(73,564)Adjustments to reconcile net loss to net cash used in operating activities: Stock-based compensation6,157 4,809 2,507Depreciation and amortization1,599 1,584 1,428Amortization of debt issuance costs and non-cash interest2,017 1,793 1,582Change in fair value of warrant liabilities(11,811) (445) (6,725)Change in fair value of embedded derivatives147 240 —Beneficial conversion feature from issuance of convertible notes— — 4,696Loss on disposal and impairment of property and equipment Loss on disposal and impairment of property and equipment9 — 2Changes in operating assets and liabilities: Trade accounts receivable(730) (439) (4,474)Inventory3,890 1,517 (5,133)Prepaid expenses and other current assets163 24 537Other assets11 338 (3,976)Accounts payable and accrued expenses2,283 4,955 10,866Deferred rent(89) (57) (48)Deferred revenue(8,462) (10,887) 350Net cash used in operating activities(52,202) (80,471) (71,952)Investing activities: Purchases of property and equipment(293) (617) (3,442)Net cash used in investing activities(293) (617) (3,442)Financing activities: Proceeds from convertible notes, net of issuance costs— — 14,957Proceeds from borrowings of debt and revolving credit facility, net of issuance costs9,900 39,124 31,072Payments on borrowings of debt(25,000) (825) (18,178)Payments on revolving credit facility(15,051) (9,477) —Proceeds from exercise of common stock options33 92 71Proceeds from issuance of common stock and common stock warrants, net of issuance costs67,316 59,527 51,733Net cash provided by financing activities37,198 88,441 79,655Net (decrease) increase in cash and cash equivalents(15,297) 7,353 4,261Cash and cash equivalents at beginning of period56,525 49,172 44,911Cash and cash equivalents at end of period$41,228 $56,525 $49,172Supplemental disclosure of cash flow information: Cash paid for interest$5,284 $4,186 $2,403Noncash investing and financing activities: Warrants issued in connection with public offering$20,959 $— $—Asset retirement obligation$286 $— $—Warrants issued in connection with debt$— $866 $—Embedded derivatives related to debt$— $605 $—Purchase of property and equipment in accounts payable$— $123 $126Vesting of early exercised stock options$— $15 $59Conversion of convertible preferred stock to common stock at initial public offering$— $— $149,312Conversion of convertible notes and related interest to common stock, net of issuance costs$— $— $15,477Reclassification of convertible preferred stock warrants to common stock warrants$— $— $743Acquisition of leasehold paid by landlord$— $— $305See accompanying notes.F-5Table of ContentsZogenix, Inc.Notes to Consolidated Financial Statements 1.Organization and Basis of PresentationZogenix, Inc. (the Company) is a pharmaceutical company commercializing and developing products for the treatment of central nervous systemdisorders and pain. The Company’s first commercial product, Sumavel™ DosePro™ (sumatriptan injection) Needle-free Delivery System, offers fast-acting,easy-to-use, needle-free subcutaneous delivery of sumatriptan for the acute treatment of migraine and cluster headache in a pre-filled, single-use deliverysystem. Sumavel DosePro was approved by the U.S. Food and Drug Administration (FDA) on July 15, 2009 and was launched in the United States inJanuary 2010.The Company was incorporated in the state of Delaware on May 11, 2006 as SJ2 Therapeutics, Inc. and commenced operations on August 25, 2006.On August 28, 2006, the Company changed its name to Zogenix, Inc.The Company has incurred significant net losses since inception and has relied on its ability to fund its operations through equity financings, debtfinancings, revenues from the sale of its product Sumavel DosePro and proceeds from business collaborations. As the Company continues to incur losses,successful transition to profitability is dependent upon achieving a level of revenues adequate to support the Company’s cost structure. This may not occurand, unless and until it does, the Company will continue to need to raise additional cash. These conditions raise substantial doubt about the Company’sability to continue as a going concern. The accompanying financial statements have been prepared assuming that the Company will continue as a goingconcern and do not include any adjustments that might result from the outcome of this uncertainty. This basis of accounting contemplates the recovery of theCompany’s assets and the satisfaction of liabilities in the normal course of business.On July 27, 2012, the Company completed a public offering (the July 2012 Offering) of common stock and warrants for net proceeds of $65,352,000(including over-allotment purchase), after deducting underwriting discounts and commissions of $4,205,000 and offering expenses of $545,000. TheCompany sold a total of 32,500,000 shares of its common stock and warrants to purchase 14,625,000 shares of common stock (excluding over-allotmentpurchase) in the July 2012 Offering, at a purchase price of $1.99 per share of common stock and $0.01 per share underlying each warrant. The underwriterswere granted a 30-day option to cover over-allotments, if any, to purchase up to an additional 4,875,000 shares of common stock and warrants to purchase2,193,750 shares of common stock. The underwriters exercised their option to purchase over-allotment warrants for 1,159,200 shares of common stockconcurrent with the July 2012 Offering at a purchase price of $0.01 per warrant and then exercised their option with respect to 2,558,300 shares of commonstock at a purchase price of $1.99 per share on a subsequent date. The warrants will be exercisable beginning on July 27, 2013 at an exercise price of $2.50per share and will expire on July 27, 2017, which is five years from the date of issuance.Management expects operating losses and negative cash flows to continue for at least the next several years as the Company continues to incur costsrelated to the continued development of its product candidates and commercialization of its approved product. Management may pursue additionalopportunities to raise additional capital through public or private equity offerings, debt financings, receivables financings or through collaborations orpartnerships with other companies if required to further support its planned operations. There can be no assurance that the Company will be able to obtain anysource of financing on acceptable terms, or at all. If the Company is unsuccessful in raising additional required funds, it may be required to significantlydelay, reduce the scope of or eliminate one or more of its development programs or its commercialization efforts, or cease operating as a going concern. TheCompany also may be required to relinquish, license or otherwise dispose of rights to product candidates or products that it would otherwise seek to develop orcommercialize itself on terms that are less favorable than might otherwise be available.Initial Public OfferingOn November 29, 2010, the Company completed its Initial Public Offering (IPO) of common stock pursuant to a Registration Statement that wasdeclared effective on November 22, 2010. In the IPO, the Company sold 14,000,000 shares of its common stock, at a price of $4.00 per share. Theunderwriters had an option to sell up to an additional 2,100,000 shares at $4.00 per share pursuant to an over-allotment option granted. A total of 436,493shares were sold pursuant to the overallotment option on December 27, 2010. As a result of the IPO, the Company raised a total of $51,733,000 in netproceeds after deducting underwriting discounts and commissions of $2,743,000 and offering expenses of $3,270,000. These costs have been recorded as areduction of the proceeds received in arriving at the amount recorded in additional paid-in capital.Upon the closing of the IPO, all outstanding convertible preferred stock converted into 14,239,797 shares of common stock. Also upon the closing ofthe IPO, $15,495,000 of unsecured convertible notes (including accrued interest thereon)F-6Table of Contentsconverted into 3,873,756 shares of the Company’s common stock. Certain warrants to purchase convertible preferred stock were terminated unexercised at thecompletion of the offering and the remaining warrants to purchase convertible preferred stock converted into warrants to purchase common stock. Thepreferred stock warrant liability was reclassified to additional paid-in capital upon the conversion of warrants to purchase preferred stock into warrants topurchase common stock.2.Summary of Significant Accounting PoliciesUse of EstimatesThe preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States (GAAP) requiresmanagement to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actualresults may differ from those estimates.Principles of ConsolidationThe consolidated financial statements include the accounts of Zogenix, Inc. and its wholly owned subsidiary Zogenix Europe Limited, which wasincorporated under the laws of England and Wales in June 2010. All intercompany transactions and investments have been eliminated in consolidation.Zogenix Europe Limited’s functional currency is the U.S. dollar, the reporting currency of its parent.Cash and Cash EquivalentsThe Company considers cash equivalents to be only those investments which are highly liquid, readily convertible to cash and have an originalmaturity of three months or less when purchased.Restricted CashIn December 2009, the Company issued a letter of credit for $200,000 in connection with another operating lease. The letter of credit is collateralized by acertificate of deposit in the same amount. Restricted cash of $200,000 at December 31, 2012 and 2011 is included in other assets on the consolidated balancesheet.Accounts ReceivableTrade accounts receivable are recorded at the invoice amount net of allowances for cash discounts for prompt payment. The Company evaluates thecollectability of its accounts receivable based on a variety of factors including the length of time the receivables are past due, the financial health of thecustomer and historical experience. Based upon the review of these factors, the Company recorded an allowance of $2,000 and $127,000 at December 31,2012 and 2011, respectively. The need for bad debt allowance is evaluated each reporting period.Fair Value MeasurementsThe carrying amount of financial instruments consisting of cash, trade accounts receivable, prepaid expenses and other current assets, accountspayable, accrued expenses (excluding the long-term portion of the tail payments due to Astellas Pharmaceutical US, Inc. (Astellas)), accrued compensation,borrowings under the revolving credit facility, and current portion of long-term debt included in the Company’s consolidated financial statements arereasonable estimates of fair value due to their short maturities. Based on the borrowing rates currently available to the Company for loans with similar terms,management believes the fair value of long-term debt approximates its carrying value. The long-term liability for the annual tail payments due to Astellas (seeNote 3) for the termination of the Company’s co-promotion agreement were measured at fair value using a present value technique, which incorporated theCompany’s own credit risk as measured by the most recent round of debt financing with Healthcare Royalty Partners (Healthcare Royalty) (formerly CowenHealthcare Royalty Partners II, L.P.).Authoritative guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:Level 1:Observable inputs such as quoted prices in active markets;Level 2:Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; andF-7Table of ContentsZogenix, Inc.Notes to Consolidated Financial Statements (continued)Level 3:Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.We classify our cash equivalents within Level 1 of the fair value hierarchy because we value our cash equivalents using quoted market prices. Weclassify our common stock warrant liabilities and embedded derivative liabilities within Level 3 of the fair value hierarchy because they are valued usingvaluation models with significant unobservable inputs. Assets and liabilities measured at fair value on a recurring basis at December 31, 2012 andDecember 31, 2011 are as follows (in thousands): Fair Value Measurements at Reporting Date UsingQuoted Pricesin ActiveMarkets forIdentical Assets(Level 1) SignificantOtherObservableInputs(Level 2) SignificantUnobservableInputs(Level 3) TotalAt December 31, 2012 Assets Cash equivalents (1)$37,605 — — $37,605Liabilities Common stock warrant liabilities (2)$— — 9,493 $9,493Embedded derivative liabilities (3)$— — 992 $992 At December 31, 2011 Assets Cash equivalents (1)$49,752 — — $49,752Liabilities Common stock warrant liability (4)$— — 345 $345Embedded derivative liabilities (3)$— — 845 $845 (1)Cash equivalents are comprised of money market fund shares and are included as a component of cash and cash equivalents on the consolidated balancesheet.(2)Common stock warrants are measured at fair value using the Black-Scholes option pricing valuation model and the assumptions identified in (4) below.The following additional assumptions were used in the Black-Scholes option pricing valuation model to measure the fair value of the warrants sold in theJuly 2012 Offering: (a) management's projections regarding the probability of the occurrence of an extraordinary event that would require cash settlementof the warrants; and for the valuation scenario in which an extraordinary event occurs, (b) an expected volatility rate equal to the lesser of 40% and the180-day volatility rate obtained from the HVT function on Bloomberg as of the trading day immediately following the public announcement of anextraordinary transaction. Significant increases in the probability of an extraordinary event occurring would result in a significantly lower fair valuemeasurement.(3)Embedded derivative liabilities measured at fair value using various discounted cash flow valuation models are included as a component of other long-term liabilities on the consolidated balance sheets. The assumptions used in the discounted cash flow valuation models include: (a) management's revenueprojections and a revenue sensitivity analysis based on possible future outcomes; (b) probability weighted net cash flows based on the likelihood ofHealthcare Royalty receiving interest payments over the term of the financing agreement; (c) probability of bankruptcy; (d) weighted average cost ofcapital that included the addition of a company specific risk premium to account for uncertainty associated with the Company achieving future cashflows; (e) the probability of a change in control occurring during the term of the Healthcare Royalty financing agreement; and (f) the probability of anexercise of the embedded derivative instruments. The significant unobservable inputs used in measuring the fair value of the embedded derivatives aremanagement's revenue projections. Significant decreases in these significant inputs would result in a higher fair value measurement.(4)Common stock warrants are measured at fair value using the Black-Scholes option pricing valuation model. The assumptions used in the Black-Scholesoption pricing valuation model were: (a) a risk-free interest rate based on the rates for U.S. Treasury zero-coupon bonds with maturities similar to those ofthe remaining contractual term of the warrants; (b) an assumed dividend yield of zero based on the Company's expectation that it will not pay dividendsin the foreseeable future; (c) an expected term based on the remaining contractual term of the warrants; and (d) given the Company's lack of relevanthistorical data due to the Company's limited historical experience, an expected volatility based upon theF-8Table of ContentsZogenix, Inc.Notes to Consolidated Financial Statements (continued)Company's historical volatility, supplemented with historical volatility of comparable companies whose share prices have been publicly available for asufficient period of time. The significant unobservable input used in measuring the fair value of the warrant liabilities is the expected volatility. Significantincreases in the volatility would result in a higher fair value measurement.The following table provides a reconciliation of liabilities measured at fair value using significant unobservable inputs (Level 3) for the years endedDecember 31, 2012 and 2011 (in thousands): Common StockWarrant Liabilities EmbeddedDerivativeLiabilitiesBalance at December 31, 2010 $— $—Issuance 790 605Changes in fair value (445) 240Balance at December 31, 2011 345 845Issuance 20,959 —Changes in fair value (11,811) 147Balance at December 31, 2012 $9,493 $992Changes in fair value of the liabilities shown in the table above are recorded through a change in fair value of warrant liabilities and change in fair valueof embedded derivatives in other income (expense) in the consolidated statements of operations and comprehensive loss.Concentration of Credit Risk, Sources of Supply and Significant CustomersFinancial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash and cash equivalents and tradeaccounts receivable. The Company maintains accounts in federally insured financial institutions in excess of federally insured limits. The Company alsomaintains investments in money market funds and that are not federally insured. However, management believes the Company is not exposed to significantcredit risk due to the financial position of the depository institutions in which these deposits are held and of the money market funds and other entities inwhich these investments are made. Additionally, the Company has established guidelines regarding the diversification of its investments and their maturities,which are designed to maintain safety and liquidity.The Company sells its products primarily to established wholesale distributors and retailers in the pharmaceutical industry. Two wholesalepharmaceutical distributors individually comprised 36.1% and 35.5% of the Company’s total gross sales of Sumavel DosePro for the year endedDecember 31, 2012. Approximately 71.8% of the trade accounts receivable balance as of December 31, 2012 represents amounts due from these two wholesaledistributors. Credit is extended based on an evaluation of the customer’s financial condition, and collateral is not required. The Company evaluates thecollectability of its accounts receivable based on a variety of factors including the length of time the receivables are past due, the financial health of thecustomer and historical experience. Based upon the review of these factors, the Company recorded an allowance of doubtful accounts of $2,000 and $127,000at December 31, 2012 and December 31, 2011, respectively.The Company relies on third-party manufacturers for the production of Sumavel DosePro and single source third-party suppliers to manufacture severalkey components of Sumavel DosePro. If the Company’s third-party manufacturers are unable to continue manufacturing Sumavel DosePro, or if theCompany lost one or more of its single source suppliers used in the manufacturing process, the Company may not be able to meet market demand for itsproduct.InventoryInventory is stated at the lower of cost or market. Cost includes amounts related to materials, labor and overhead, and is determined in a manner whichapproximates the first-in, first-out (FIFO) method. The Company provides reserves for potentially excess, dated or obsolete inventories based on an analysis ofinventory on hand and on firm purchase commitments compared to forecasts of future sales.Property and Equipment, NetProperty and equipment is recorded at cost, net of accumulated depreciation and amortization. Depreciation is calculated on a straight-line basis over theestimated useful lives of the respective assets, as follows:F-9Table of ContentsZogenix, Inc.Notes to Consolidated Financial Statements (continued)Computer equipment and software 3 yearsFurniture and fixtures 3-7 yearsManufacturing equipment and tooling 3-15 yearsLeasehold improvements Shorter of estimated useful life or lease termImpairment of Long-Lived AssetsThe Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying value of an asset maynot be recoverable. There were immaterial charges as a result of impairment losses through December 31, 2012.Warrants for Common StockIn accordance with accounting guidance for warrants for shares in redeemable securities or warrants that could be settled for cash, the Companyclassifies warrants for common stock as current liabilities on the consolidated balance sheet. The Company adjusts the carrying value of these warrants forcommon stock that can be settled in cash to their estimated fair value at each reporting date with the increases or decreases in the fair value of such warrantsrecorded as change in fair value of warrant liabilities in the consolidated statement of operations and comprehensive loss.Embedded DerivativesThe Company records embedded derivatives in the consolidated balance sheet at fair value. The carrying value of the embedded derivatives are adjustedto their estimated fair value at each reporting date with the increases or decreases in the fair value of such embedded derivatives recorded as change in fair valueof embedded derivatives in the consolidated statement of operations and comprehensive loss.Revenue RecognitionThe Company recognizes revenue from the sale of Sumavel DosePro and from license fees and milestones earned on collaborative arrangements. Revenueis recognized when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred and title has passed, (iii) the price is fixed or determinable and(iv) collectability is reasonably assured. Revenue from sales transactions where the buyer has the right to return the product is recognized at the time of saleonly if (i) the Company’s price to the buyer is substantially fixed or determinable at the date of sale, (ii) the buyer has paid the Company, or the buyer isobligated to pay the Company and the obligation is not contingent on resale of the product, (iii) the buyer’s obligation to the Company would not be changed inthe event of theft or physical destruction or damage of the product, (iv) the buyer acquiring the product for resale has economic substance apart from thatprovided by the Company, (v) the Company does not have significant obligations for future performance to directly bring about resale of the product by thebuyer, and (vi) the amount of future returns can be reasonably estimated.Product Revenue, NetThe Company sells Sumavel DosePro product in the United States to wholesale pharmaceutical distributors and retail pharmacies, or collectively theCompany's customers, subject to rights of return. The Company recognizes product sales at the time title transfers to its customer, and reduces product salesfor estimated future product returns and sales allowances in the same period the related revenue is recognized. Product sales allowances include wholesaler andretail pharmacy distribution fees, prompt pay discounts, chargebacks, rebates and patient discount programs, and are based on amounts owed or to beclaimed on the related sales. These estimates take into consideration the terms of the Company's agreements with its customers and third-party payors and thelevels of inventory within the distribution and retail channels that may result in future rebates or discounts taken. In certain cases, such as patient supportprograms, the Company recognizes the cost of patient discounts as a reduction of revenue based on estimated utilization. If actual future results vary, theCompany may need to adjust these estimates, which could have an effect on product revenue in the period of adjustment.Prior to the third quarter of 2011, Sumavel DosePro had a limited sales history, and the Company could not reliably estimate expected returns of theproduct at the time of shipment. Accordingly, the Company deferred recognition of revenue on product shipments of Sumavel DosePro until the right of returnno longer existed, which occurred at the earlier of the time Sumavel DosePro units were dispensed through patient prescriptions or expiration of the right ofreturn. Units dispensed are generally not subject to return, except in the rare cases where the product malfunctions or the product is damaged in transit. TheF-10Table of ContentsZogenix, Inc.Notes to Consolidated Financial Statements (continued)Company estimates patient prescriptions dispensed using an analysis of third-party information, including third-party market research data.Product Returns. The Company's estimated product return allowances for Sumavel DosePro require a high degree of judgment and are subject to changebased on the Company's experience and certain quantitative and qualitative factors. Sumavel DosePro's shelf life is determined by the shorter expiry date of itstwo subassemblies, which is currently approximately 30 months from the date of manufacture. The Company's return policy allows for customers to returnunused product that is within six months before and up to one year after its expiration date for a credit at the then-current wholesaler acquisition cost, or WAC,reduced by a nominal fee for processing the return.The Company has monitored actual return history on an individual product lot basis since product launch. Actual product return experience in 2012and 2011 included a disproportionately high amount of returns from a single retail chain. In addition, the Company has also experienced a high level ofreturned product from its initial launch stocking initiatives. The Company considered these factors as well as the dating of its product at the time of shipmentinto the distribution channel, prescription trends and changes in the estimated levels of inventory within the distribution channel to estimate its exposure forreturned product. Because of the shelf life of Sumavel DosePro and the duration of time under which the Company's customers may return product throughthe Company's return policy, there may be a significant period of time between when the product is shipped and when the Company issues credits on returnedproduct. Accordingly, the Company may have to adjust these estimates, which could have an effect on product sales and earnings in the period ofadjustments.The Company permits certain wholesale pharmaceutical distributors to purchase limited quantities of product after the announcement of an increase tothe WAC of the Company’s product and prior to the effectiveness of the increase. In turn, WAC price increases can result in accelerated purchases bywholesalers relative to anticipated retail and prescription demand. The timing of purchases made by wholesale distributors and retail pharmacies are subject tofluctuations for these reasons among others.Wholesaler and Retail Pharmacy Distribution Fees. The Company offers distribution fees to certain wholesale distributors and retail pharmaciesbased on contractually determined rates. The Company accrues the distribution fees on shipment to the respective wholesale distributors and retail pharmaciesand recognizes the distribution fees as a reduction of revenue in the same period the related revenue is recognized.Prompt Pay Discounts. The Company offers cash discounts to its customers, generally 2% of the sales price, as an incentive for prompt payment. TheCompany accounts for cash discounts by reducing accounts receivable by the prompt pay discount amount and recognizes the discount as a reduction ofrevenue in the same period the related revenue is recognized.Chargebacks. The Company provides discounts primarily to authorized users of the Federal Supply Schedule (FSS) of the General ServicesAdministration under an FSS contract negotiated by the Department of Veterans Affairs and various organizations under Medicaid contracts and regulations.These entities purchase products from the wholesale distributors at a discounted price, and the wholesale distributors then charge back to the Company thedifference between the current retail price and the price the federal entity paid for the product. The Company estimates and accrues chargebacks based onestimated wholesaler inventory levels, current contract prices and historical chargeback activity. Chargebacks are recognized as a reduction of revenue in theperiod the related revenue is recognized.Rebates. The Company participates in certain rebate programs, which provide discounted prescriptions to qualified insured patients. Under these rebateprograms, the Company pays a rebate to the third-party administrator of the program, generally two to three months after the quarter in which prescriptionssubject to the rebate are filled. The Company estimates and accrues these rebates based on current contract prices, historical and estimated future percentagesof product sold to qualified patients and estimated levels of inventory in the distribution channel. Rebates are recognized as a reduction of revenue in the periodthe related revenue is recognized.Patient Discount Programs. The Company offers discount card programs to patients for Sumavel DosePro in which patients receive discounts on theirprescriptions that are reimbursed by the Company. The Company estimates the total amount that will be redeemed based on levels of inventory in thedistribution and retail channels and recognizes the discount as a reduction of revenue in the same period the related revenue is recognized.Contract RevenueContract revenue consists of the amortization of license fees and milestone payments received under co-promotion agreements, which have multipledeliverables. Revenue arrangements with multiple deliverables are divided into separate units of accounting if criteria are met, including whether the deliverablehas stand-alone value to the customer and the customer has aF-11Table of ContentsZogenix, Inc.Notes to Consolidated Financial Statements (continued)general right of return relative to the delivered item and delivery or performance of the undelivered item is probable and substantially within the vendor'scontrol. Arrangement consideration is allocated at the inception of the arrangement to all deliverables on the basis of their relative selling price. The selling pricefor each deliverable is determined using: (i) vendor-specific objective evidence of selling price (VSOE), if it exists, (ii) third-party evidence of selling price(TPE) if VSOE does not exist, and (iii) the Company's best estimate of the selling price if neither VSOE nor TPE exists. For transactions entered into prior toJanuary 1, 2011, revenue was recognized for each deliverable based upon the applicable revenue recognition criteria discussed above and upon acceptance ofgoods or performance of service. Effective January 1, 2011, for new or significantly modified transactions, the Company allocates revenue consideration,excluding contingent consideration, based on the relative selling prices of the separate units of accounting contained within an arrangement containing multipledeliverables.Collaborative ArrangementsThe Company records certain transactions between collaborators in the consolidated statement of operations and comprehensive loss on either a gross ornet basis within revenues or operating expenses, depending on the characteristics of the collaboration relationship, and provides for enhanced disclosure ofcollaborative relationships. The Company evaluates its collaborative agreements for proper classification of shared expenses, license fees, milestone paymentsand any reimbursed costs within the consolidated statement of operations and comprehensive loss based on the nature of the underlying activity. If paymentsto and from collaborative partners are not within the scope of other authoritative accounting literature, the statement of operations and comprehensive lossclassification for the payments is based on a reasonable, rational analogy to authoritative accounting literature that is applied in a consistent manner. Forcollaborations relating to commercialized products, if the Company acts as the principal in the sale of goods or services, the Company records revenue and thecorresponding operating costs in its respective line items within the consolidated statement of operations and comprehensive loss based on the nature of theshared expenses. Per authoritative accounting guidance, the principal is the party who is responsible for delivering the product to the customer, has latitudewith establishing price and has the risks and rewards of providing product to the customer, including inventory and credit risk.Research and Development ExpensesAll costs of research and development are expensed in the period incurred. Research and development costs primarily consist of salaries and relatedexpenses for personnel, stock-based compensation expense, outside service providers, facilities costs, fees paid to consultants, milestone payments, licensefees, professional services, travel costs, dues and subscriptions, depreciation and materials used in clinical trials and research and development. TheCompany expenses costs relating to the purchase and production of pre-approval inventories as research and development expense in the period incurred untilFDA approval is received.The Company reviews and accrues expenses related to clinical trials based on work performed, which relies on estimates of total costs incurred based oncompletion of patient studies and other events. The Company follows this method since reasonably dependable estimates of the costs applicable to variousstages of a research agreement or clinical trial can be made. Accrued clinical development costs are subject to revisions as trials progress to completion.Revisions are charged to expense in the period in which the facts that give rise to the revision become known.Advertising ExpenseThe Company records the cost of its advertising efforts when services are performed or goods are delivered. The Company incurred approximately$522,000, $1,180,000 and $1,123,000 in advertising costs for the years ended December 31, 2012, 2011 and 2010, respectively. At December 31, 2012 and2011, the Company capitalized advertising costs of $159,000 and $26,000 in prepaid expenses and other current assets, respectively.Income TaxesDeferred tax assets and liabilities are determined based on the differences between the financial reporting and tax basis of assets and liabilities usingenacted tax rates which will be in effect when the differences reverse. The Company provides a valuation allowance against net deferred tax assets unless,based upon the available evidence, it is more likely than not that the deferred tax asset will be realized. The Company recognizes the tax benefit from anuncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technicalmerits of the position.Foreign Currency TransactionsF-12Table of ContentsZogenix, Inc.Notes to Consolidated Financial Statements (continued)Gains or losses resulting from transactions denominated in foreign currencies are included in other expense in the consolidated statements of operations andcomprehensive loss. The Company recorded losses from foreign currency transactions in other income (expense) of $68,000, $86,000 and $111,000 for theyears ended December 31, 2012, 2011 and 2010, respectively.Stock-Based CompensationStock-based compensation cost is measured at the grant date, based on the estimated fair value of the award, and is recognized as expense over theemployee’s requisite service period on a straight-line basis. As of December 31, 2012, there were no outstanding equity awards with market or performanceconditions. Equity awards issued to non-employees are recorded at their fair value on the measurement date and are re-measured at each reporting date as theunderlying awards vest unless the instruments are fully vested, immediately exercisable and nonforfeitable on the date of grant.Net Loss per ShareBasic net loss per share is calculated by dividing the net loss by the weighted average number of common shares outstanding for the period reduced byweighted average shares subject to repurchase, without consideration for common stock equivalents. Diluted net loss per share is computed by dividing the netloss by the weighted average number of common share equivalents outstanding for the period determined using the treasury-stock method and as-if convertedmethod, as applicable. For purposes of this calculation, stock options, restricted stock units, warrants and common stock subject to repurchase areconsidered to be common stock equivalents and are only included in the calculation of diluted net loss per share when their effect is dilutive.The following table presents the computation of basic and diluted net loss per share (in thousands, except per share amounts): Year Ended December 31, 2012 2011 2010Numerator Net loss$(47,386) $(83,903) $(73,564)Denominator Weighted average common shares outstanding80,558 42,715 4,267Weighted average shares subject to repurchase— (3) (94)Weighted average shares outstanding, basic and diluted80,558 42,712 4,173Basic and diluted net loss per share$(0.59) $(1.96) $(17.63)Potentially dilutive securities not included in the calculation of diluted net loss per share because to do so would be anti-dilutive are as follows (inthousands, of common equivalent shares): Year Ended December 31, 2012 2011 2010Common stock subject to repurchase— — 15Common stock options and restricted stock units47 184 1,416 47 184 1,431Segment ReportingManagement has determined that the Company operates in one business segment, which is the commercialization and development of pharmaceuticalproducts.Recent Accounting PronouncementsIn May 2011, the Financial Accounting Standards Board (FASB) issued accounting guidance related to fair value measurements and disclosures toachieve common fair value measurements and disclosures between GAAP and International Financial Reporting Standards. This guidance clarifies theapplication of certain existing fair value measurement guidance and expands the disclosures for fair value measurements that are estimated using significantunobservable (Level 3) inputs. This guidance became effective on a prospective basis for annual and interim reporting periods beginning on or afterDecember 15, 2011. The Company adopted this guidance on January 1, 2012 and it did not have a material impact on the Company's results of operations.F-13Table of ContentsZogenix, Inc.Notes to Consolidated Financial Statements (continued)In June 2011, the FASB issued an Accounting Standards Update which requires entities to present reclassification adjustments included in othercomprehensive income on the face of the financial statements and allows entities to present the total of comprehensive income, the components of net incomeand the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate consecutive statements.It also eliminates the option for entities to present components of other comprehensive income as part of the statement of changes to stockholders equity. Theupdated guidance became effective for fiscal and interim periods beginning after December 15, 2011, with early adoption permitted. The Company adoptedthis guidance on January 1, 2012 and it did not have a material impact on the Company's results of operations.3.Collaboration, License and Purchase AgreementsAlkermes Commercial Manufacturing and Supply AgreementOn November 2, 2012, the Company entered into a commercial manufacturing and supply agreement for Zohydro ER finished commercial product (theSupply Agreement) with Alkermes Pharma Ireland Limited (APIL). Under the Supply Agreement, APIL is the exclusive manufacturer and supplier to theCompany (subject to certain exceptions) of Zohydro ER. The Company must purchase all of its requirements of Zohydro ER, subject to certain exceptions,from APIL.Under the Supply Agreement, the Company will provide APIL with an eighteen-month forecast on a monthly basis and with a three-year forecast on anannual basis for commercial supply requirements of Zohydro ER. In each of the four months following the submission of the eighteen-month forecast, theCompany is obligated to order the quantity of Zohydro ER specified in the forecast. APIL will use commercially reasonable efforts to supply the orders ofZohydro ER subject to the availability of the United States Drug Enforcement Administration quota for hydrocodone. APIL is not obligated to supply theCompany with quantities of Zohydro ER in excess of forecasted amounts, but has agreed to use commercially reasonable efforts to do so. Further, theCompany is obligated to purchase at least 75% of forecasted quarterly quantities of Zohydro ER from APIL, and is required to make compensatory paymentsif it does not purchase 100% of its requirements from APIL, subject to certain exceptions.If a failure to supply occurs under the Supply Agreement, other than a force majeure event, APIL must use commercially reasonable efforts to assist theCompany in transferring production of Zohydro ER to either the Company or a third-party manufacturer, provided that such third party is not a technologicalcompetitor of APIL. In a failure to supply circumstance, the Company would be able to utilize (or sublicense to a third party who is not a technologicalcompetitor of APIL) the manufacturing license rights granted to it under the license agreement with Alkermes, an affiliate of APIL, until such time as APIL canresume supply of Zohydro ER.Either party may terminate the Supply Agreement by written notice if the other party commits a material breach of its obligations which is eitherincapable of remedy or is not remedied within a specified period following receipt of written notice of such breach. Unless otherwise terminated due to amaterial breach, the Supply Agreement will continue until the expiry or termination of the license agreement with Alkermes.Mallinckrodt LLC Co-Promotion AgreementOn June 6, 2012, the Company and Mallinckrodt LLC (Mallinckrodt) entered into a co-promotion agreement (the Co-Promotion Agreement). Under theterms of the Co-Promotion Agreement, Mallinckrodt was granted a co-exclusive right (with the Company) to promote Sumavel DosePro to a mutually agreedprescriber audience in the United States. Mallinckrodt's sales team began selling Sumavel DosePro to its customer base of prescribers in August 2012.Mallinckrodt has committed to a minimum number of sales representatives for the initial term of the Co-Promotion Agreement, which runs through June 30,2014, and can be extended by mutual agreement of the parties in additional six month increments. The Company remains responsible for the manufacture,supply and distribution of commercial product for sale in the United States. In addition, the Company will supply product samples to Mallinckrodt at anagreed upon transfer price and Mallinckrodt will reimburse the Company for all other promotional materials used.In partial consideration of Mallinckrodt's sales efforts, the Company will pay Mallinckrodt a service fee on a quarterly basis that represents a specifiedfixed percentage of net sales of prescriptions generated from Mallinckrodt's prescriber audience over a baseline amount of net sales to the same prescriberaudience (the Baseline Net Sales). In addition, upon completion of the co-promotion term in June 30, 2014 (unless otherwise extended), and only if the Co-Promotion Agreement is not terminated as a result of certain circumstances, the Company will be required to pay Mallinckrodt an additional tail paymentcalculated as a fixed percentage of the Mallinckrodt net sales over the Baseline Net Sales during the first full 12 months following the last day of the term.F-14Table of ContentsZogenix, Inc.Notes to Consolidated Financial Statements (continued)Mallinckrodt may terminate the Agreement with sixty days' written notice in the event a material change is made to the net sales price of SumavelDosePro that would result in a material adverse effect to Mallinckrodt's financial return (as defined in the Co-Promotion Agreement). Mallinckrodt may alsoterminate the Co-Promotion Agreement if its request for the inclusion on its call list of a certain number of additional prescribers is not mutually agreed upon.Lastly, Mallinckrodt may terminate the Co-Promotion Agreement if a governmental authority takes action or raises an objection that prevents or wouldreasonably be expected to make it unlawful for Mallinckrodt to perform, or subject Mallinckrodt to any penalty or claim, investigation or similar action relatedto, its obligations under the Co-Promotion Agreement, in the event of Company's inability to meet trade demand for commercial product or where a third partyfiles an action alleging that the making or selling of Sumavel DosePro infringes the intellectual property rights of such third party.The Company may terminate the Co-Promotion Agreement with sixty days' written notice if Mallinckrodt does not achieve an agreed-upon minimumsales effort. Either party may terminate the agreement if certain minimum net sales thresholds are not met for any quarter ending after December 31, 2012 orcertain levels of prescriptions are not met in a specified period. In addition, either party may terminate the Co-Promotion Agreement related to safety concerns,in the event of a change of control of itself or the other party (excluding with respect to Mallinckrodt, any public spin-off of Mallinckrodt from its corporateparent Covidien), upon the introduction of a generic product, in connection with the material breach of the other party's obligations or if a bankruptcy eventoccurs under certain circumstances.For the year ended December 31, 2012, the Company incurred $161,000 in service fee expenses under the Co-Promotion Agreement.Astellas Pharma US, Inc. Co-Promotion AgreementIn July 2009, the Company entered into the Co-Promotion Agreement with Astellas (the Astellas Co-Promotion Agreement). Under the terms of theagreement, the Company granted Astellas the co-exclusive right (with the Company) to market and sell Sumavel DosePro in the United States until June 30,2013. Under the Astellas Co-Promotion Agreement, both Astellas and the Company were obligated to collaborate and fund the marketing of Sumavel DoseProand to provide annual minimum levels of sales effort directed at Sumavel DosePro during the term. In December 2011, the Company entered into anamendment to the Astellas Co-Promotion Agreement, or the amended Astellas Co-Promotion Agreement, whereby the agreement terminated on March 31, 2012.In connection with the execution of the Astellas Co-Promotion Agreement, Astellas made a non-refundable up-front payment of $2,000,000 and made anadditional $18,000,000 of payments to the Company upon the achievement of a series of milestones. In consideration for Astellas’ performance of itscommercial efforts, the Company paid Astellas a service fee on a quarterly basis that represented a fixed percentage of between 45% and 55% of SumavelDosePro net sales to primary care physicians, OB/GYNs, emergency medicine physicians, and urologists in the United States (the Astellas Segment).In accordance with accounting guidance for revenue arrangements with multiple deliverables, the Company initially recorded the $20,000,000 in upfrontand milestone payments received from Astellas as deferred revenue. Beginning with the launch of Sumavel DosePro in January 2010, the Company beganamortizing the upfront and milestone payments as contract revenue in the consolidated statement of operations and comprehensive loss over the term of theAstellas Co-Promotion Agreement. Upon termination of the Astellas Co-Promotion Agreement, the Company concluded that the remaining deferred revenuebalance should be recognized ratably through the amended term of the agreement, and consequently, the remaining $8,462,000 of these deferred contractrevenues as of December 31, 2011 was recognized during the three months ended March 31, 2012. For the years ended December 31, 2012, 2011 and 2010 theCompany recognized $8,462,000, $7,165,000 and $4,373,000, respectively, of contract revenue.The Company is required to make two annual tail payments to Astellas, calculated as decreasing fixed percentages (ranging from mid-twenties down to amid-teen percentage) of net sales in the Astellas Segment in the last 12 months of its active promotion. The value of such tail payments was estimated at a totalof $5,291,000 based upon the agreement termination date of March 31, 2012, and recorded as a long-term liability on the amendment date of December 20,2011. The fair value of the tail payments will be accreted through interest expense through the dates of payment in July 2013 and July 2014. As ofDecember 31, 2012 and 2011, the tail payment liability, after considering the August 2012 service fee reduction discussed below, was $2,795,000 and$4,016,000, respectively. The Company recognized $550,000 of related interest expense during the year ended December 31, 2012 and did not recognize anyrelated interest expense during the years ended December 31, 2011 and 2010.Further, under the terms of the amended Astellas Co-Promotion Agreement, Astellas contributed its agreed upon portion of marketing expenses throughMarch 31, 2012, and continued to earn a service fee based on product sales to the Astellas Segment during that period. As of April 1, 2012, the Company wasno longer required to pay service fees to Astellas for salesF-15Table of ContentsZogenix, Inc.Notes to Consolidated Financial Statements (continued)of Sumavel DosePro. Additionally, beginning in the second quarter of 2012, the Company's sales force assumed full responsibility for the commercializationand the continued marketing of Sumavel DosePro, expanding their focus to include headache specialists, neurologists and primary care physicians in theUnited States. Amounts received from Astellas for shared marketing costs and sample product are reflected as a reduction of selling, general andadministrative expenses, and amounts payable to Astellas for shared marketing expenses and service fees are reflected as selling, general and administrativeexpenses, inclusive of the estimated cost of the tail payments owed upon the termination of the agreement.In August 2012, the Company and Astellas completed a final reconciliation under the terms of the Astellas Co-Promotion Agreement and agreed to adjustthe service fees paid to Astellas over the term of the Astellas Co-Promotion Agreement, resulting in a service fee reduction of $1,500,000, which offsets the twoannual tail payments, and a reduction to the annual tail payment liability of $742,000. The present value of the service fee receivable and tail paymentreduction of $1,924,000 was recorded as a reduction in selling, general and administrative expenses during the year ended December 31, 2012, and an offsetto the tail payment liability. The fair value of the service fee receivable and tail payment reduction will be accreted through interest income through the dates ofthe two tail payments in July 2013 and July 2014.For the years ended December 31, 2012, 2011 and 2010, the Company recognized shared marketing expense of $253,000, $1,663,000 and$3,853,000, respectively, under the Astellas Co-Promotion Agreement. For the years ended December 31, 2012, 2011 and 2010, the Company incurred$1,756,000 (excluding the $1,924,000 service fee adjustment discussed above), $6,657,000 (excluding the $4,016,000 expense recognized when the tailpayments were initially recorded) and $3,660,000 in service fee expenses, respectively.Durect Development and License AgreementOn July 11, 2011, the Company entered into a development and license agreement with Durect Corporation (the License Agreement). Under the LicenseAgreement, the Company is responsible for the clinical development and commercialization of Relday, a proprietary, long-acting injectable formulation ofrisperidone using Durect’s SABER™ controlled-release formulation technology in combination with the Company’s DosePro® needle-free, subcutaneous drugdelivery system. Durect is responsible for non-clinical, formulation and chemistry, manufacturing and controls development. Durect will be reimbursed by theCompany for its research and development efforts on the product.The Company paid a non-refundable upfront fee to Durect of $2,250,000, which was recorded as research and development expenses in theconsolidated statement of operations and comprehensive loss during the year ended December 31, 2011. The Company is obligated to pay Durect up to$103,000,000 in total future milestone payments with respect to the product subject to and upon the achievement of various development, regulatory and salesmilestones. The Company is also required to pay a mid single-digit to low double-digit percentage patent royalty on annual net sales of the product determinedon a jurisdiction-by-jurisdiction basis. Further, until a New Drug Application (NDA) for Relday has been filed in the United States, the Company is obligatedto spend no less than $1,000,000 in external expenses on the development of Relday in any trailing twelve months period beginning in July 2012. The patentroyalty term is equal to the later of the expiration of all Durect technology patents or joint patent rights in a particular jurisdiction, the expiration of marketingexclusivity rights in such jurisdiction, or 15 years from first commercial sale in such jurisdiction. After the patent royalty term, the Company will continue topay royalties on annual net sales of the product at a reduced rate for so long as the Company continues to sell the product in the jurisdiction. The Company isalso required to pay to Durect a tiered percentage of fees received in connection with any sublicense of the licensed rights.Durect granted to the Company an exclusive worldwide license, with sub-license rights, to Durect intellectual property rights related to Durect’sproprietary polymeric and non-polymeric controlled-release formulation technology to make and have made, use, offer for sale, sell and import risperidoneproducts, where risperidone is the sole active agent, for administration by injection in the treatment of schizophrenia, bipolar disorder or other psychiatricrelated disorders in humans. Durect retains the right to supply the Company’s Phase 3 clinical trial and commercial product requirements on the terms setforth in the License Agreement.Durect retains the right to terminate the License Agreement with respect to specific countries if the Company fails to advance the development of theproduct in such country within a specified period, either directly or through a sublicensee. In addition, either party may terminate the License Agreement uponinsolvency or bankruptcy of the other party, upon written notice of a material uncured breach or if the other party takes any act impairing such other party’srelevant intellectual property rights. The Company may terminate the License Agreement upon written notice if during the development or commercialization ofthe product, the product becomes subject to one or more serious adverse drug experiences or if either party receives notice from a regulatory authority,independent review committee, data safety monitoring board or other similar body alleging significant concern regarding a patient safety issue and, as a result,the Company believes the long-term viabilityF-16Table of ContentsZogenix, Inc.Notes to Consolidated Financial Statements (continued)of the product would be seriously impacted. The Company may also terminate the License Agreement with or without cause, at any time upon prior writtennotice.Desitin Arzneimittel GmbH Licensing and Distribution AgreementIn 2008, the Company entered into a licensing and distribution agreement with Desitin Arzneimittel GmbH (Desitin), a private German pharmaceuticalcompany focused on the development, manufacturing and distribution of products for the treatment of central nervous system disorders. Under the terms ofthe agreement, the Company licensed to Desitin the exclusive development and commercialization rights to Sumavel DosePro for the European Union, Norway,Switzerland and Turkey. Desitin will oversee, and be responsible for the expenses related to, all clinical development, regulatory approval andcommercialization efforts required to market Sumavel DosePro in the territories in which Desitin elects to develop and market Sumavel DosePro. TheCompany has agreed to manufacture and supply the product to Desitin for commercial sale. Desitin has agreed to pay the Company a specified transfer pricefor commercial product and a low single-digit percentage royalty on net sales of the product. In November 2010, Desitin received regulatory approval for thecommercialization of Sumavel DosePro in Denmark. It received subsequent approvals in Germany, Sweden, the United Kingdom, Norway and France. TheCompany recognized $397,000, $0 and $422,000 in revenue for sales to Desitin for the years ended December 31, 2012, 2011 and 2010, respectively. Underthe terms of the agreement, Desitin does not have the right to return product that it has purchased.Alkermes License Agreement (formerly Elan Pharma International Limited)In 2007, the Company entered into a License Agreement with Alkermes, which was amended in 2009. Under the terms of this License Agreement,Alkermes granted the Company an exclusive license in the United States and its possessions and territories, with defined sub-license rights to third partiesother than certain technological competitors of Alkermes, to certain Alkermes intellectual property rights related to the Company’s Zohydro ER productcandidate. The License Agreement grants the Company the exclusive right under certain Alkermes patents and patent applications to import, use, offer for saleand sell oral controlled-release capsule or tablet formulations of hydrocodone, where hydrocodone is the sole active ingredient, for oral prescriptions in thetreatment or relief of pain, pain syndromes or pain associated with medical conditions or procedures in the United States. This right enables the Company toexclusively develop and sell Zohydro ER in the United States. Alkermes has retained the exclusive right to take action in the event of infringement or threatenedinfringement by a third party of Alkermes’ intellectual property rights under the License Agreement. The Company has the right to pursue an infringementclaim against the alleged infringer should Alkermes decline to take or continue an action.Under the terms of the License Agreement, the Company and Alkermes agreed that, subject to the negotiation of the Supply Agreement, Alkermes, or anaffiliate of Alkermes, would have the sole and exclusive right to manufacture and supply finished commercial product of Zohydro ER to the Company underagreed upon financial terms.Alkermes also granted to the Company, in the event that Alkermes is unwilling or unable to manufacture or supply commercial product to theCompany, a non-exclusive license to make product under Alkermes’ intellectual property rights. This non-exclusive license also includes the right tosublicense product manufacturing to a third party, other than certain technological competitors of Alkermes.Under the License Agreement, the Company paid an upfront fee of $500,000 to Alkermes, which was recorded as research and development expense.The Company paid additional milestone payments in the amount of $750,000 to Alkermes in August 2011 in connection with the completion of the treatmentphase of the Company’s pivotal efficacy Phase 3 clinical trial, Study 801, and $1,000,000 upon submission of the first Zohydro ER NDA to the FDA in May2012, which were recorded as research and development expense. The Company may be obligated to pay Alkermes up to $2,750,000 in total future milestonepayments with respect to Zohydro ER depending upon the achievement of various development and regulatory events. These future milestone paymentsinclude a payment of $750,000 upon successful completion of an FDA pre-approval inspection of the Company’s manufacturing facility and a payment of$2,000,000 upon the first NDA approval of Zohydro ER. In addition, if Zohydro ER is approved, the Company will be required to pay a mid single-digitpercentage royalty on its net sales for a specified period of time and continue to pay royalties on net sales of the product thereafter at a reduced low single-digitpercentage rate in accordance with the terms of the License Agreement.The Company is also required to pay a mid single-digit percentage royalty on net sales of the product for an initial royalty term equal to the longer of theexpiration of Alkermes’ patents covering the product in the United States, or 15 years after commercial launch, if Alkermes does not have patents covering theproduct in the United States. After the initial royalty term, the License Agreement will continue automatically for three-year rolling periods during which theCompany will continue to pay royalties to Alkermes on net sales of the product at a reduced low single-digit percentage rate in accordance with the terms of theLicense Agreement.F-17Table of ContentsZogenix, Inc.Notes to Consolidated Financial Statements (continued)Either party may terminate the License Agreement upon a material, uncured default or certain insolvency events of the other party or upon 12 monthswritten notice prior to the end of the initial royalty term or any additional three-year rolling period. Alkermes may terminate the License Agreement in the eventthat the Company fails to meet specified development and commercialization milestones within specified time periods. The Company may terminate theLicense Agreement if the sale of Zohydro ER is prohibited by regulatory authorities, or if, despite commercially reasonable efforts, the Company is unable toobtain regulatory approval for Zohydro ER. The Company may also terminate the License Agreement, with or without cause, at any time upon six months’written notice prior to NDA approval for Zohydro ER and at any time upon 12 months’ prior written notice after NDA approval for Zohydro ER.Aradigm Corporation Asset Purchase AgreementIn 2006, the Company entered into an asset purchase agreement with Aradigm Corporation (Aradigm). Under the terms of the agreement, Aradigmassigned and transferred to the Company all of its right, title and interest to tangible assets and intellectual property related to the DosePro (formerly known asIntraject) needle-free drug delivery system. Aradigm also granted to the Company a non-exclusive, fully paid, worldwide, perpetual, irrevocable, transferable,sublicensable license under all other intellectual property of Aradigm that was owned, controlled or employed by Aradigm prior to the closing of the assetpurchase and that is necessary or useful to the development, manufacture or commercialization of the DosePro delivery system. Aradigm also retained aworldwide, royalty-free, non-exclusive license, with a right to sublicense, under all transferred intellectual property rights solely for purposes of the pulmonaryfield, and the Company granted Aradigm a license under other intellectual property rights solely for use in the pulmonary field.The Company paid Aradigm $4,000,000 at the closing of the asset purchase and was required to make an additional $4,000,000 milestone payment toAradigm upon the U.S. commercialization of Sumavel DosePro (which payment was made in 2010). The Company is also required to pay a 3% royalty onglobal net sales of Sumavel DosePro, by the Company or one of the Company’s future licensees, if any, until the later of January 2020 or the expiration of thelast valid claim of the transferred patents covering the manufacture, use, or sale of the product. The Company recorded the second milestone payment as otherassets in the consolidated balance sheet and is amortizing the milestone over the estimated life of the technology. For the years ended December 31, 2012, 2011and 2010, the Company recorded $1,353,000, $1,205,000 and $843,000, respectively, of expense related to the amortization of the milestone and royaltiesfrom net sales of Sumavel DosePro. The Company expects to record annual amortization expense of approximately $286,000 during the years ended December2013 through 2017, and $1,714,000 in amortization expense thereafter related to the amortization of the milestone.In addition, in the event the Company or one of its future licensees, if any, commercializes a non-sumatriptan product in the DosePro delivery system,the Company will be required to pay Aradigm, at the Company’s election, either a 3% royalty on net sales of each non-sumatriptan product commercialized,or a fixed low-twenties percentage of the royalty revenues received by the Company from the licensee, if any, until the later of the ten year anniversary of thefirst commercial sale of the product in the United States or the expiration of the last valid claim of the transferred patents covering the manufacture, use or saleof the product. Royalty revenues under this agreement include, if applicable, running royalties on the net sales of non-sumatriptan products, license ormilestone fees not allocable to development or other related costs incurred by the Company, payments in consideration of goods or products in excess of theircost, or payments in consideration for equity in excess of the then fair market value of the equity.4.Consolidated Balance Sheet DetailsInventory, Net (in thousands) December 31, 2012 2011Raw materials$4,867 $5,785Work in process6,134 7,338Finished goods1,885 3,653 $12,886 $16,776Property and Equipment, Net (in thousands)F-18Table of ContentsZogenix, Inc.Notes to Consolidated Financial Statements (continued) December 31, 2012 2011Machinery, equipment and tooling$12,325 $11,902Construction in progress5,068 5,416Computer equipment and software961 1,122Leasehold improvements783 780Furniture and fixtures685 562Property and equipment, at cost19,822 19,782Less accumulated depreciation(6,261) (5,192) $13,561 $14,590Depreciation expense for the years ended December 31, 2012, 2011 and 2010 was $1,599,000, $1,584,000 and $1,428,000, respectively.Other Assets (in thousands) December 31, 2012 2011Prepaid Aradigm royalty expense$3,143 $3,429Deposits840 565Debt acquisition costs1,217 1,432Restricted cash200 200 $5,400 $5,626Accrued Expenses (in thousands) December 31, 2012 2011Accrued discounts and allowances$4,088 $2,153Accrued product returns3,034 2,446Accrued interest expense, current portion2,526 1,924Astellas tail payment, current portion1,820 —Other accrued expenses2,875 4,225 $14,343 $10,748Other Long-Term Liabilities (in thousands) December 31, 2012 2011Interest expense payable, less current portion$2,607 $—Astellas tail payment, less current portion975 4,016Embedded derivatives992 845Deferred Rent214 303Term loan final payment— 642Other long-term liabilities290 85 $5,078 $5,891 5.CommitmentsOperating LeasesThe Company had an operating lease for office facilities in San Diego, California, which commenced in September 2008 and expired in April 2012. InApril 2012, prior to the expiration of this lease, the Company entered into a new operating leaseF-19Table of Contentsfor office facilities located in San Diego, California, which commenced on April 23, 2012 and will expire on November 27, 2014. The Company received freerent for the second, third and fourth months of the lease term. The base rent will increase approximately 3% on an annual basis throughout the term. The leasealso requires the Company to pay, following the first 12 lease months, additional rent consisting of a portion of common area and pass-through expenses inexcess of base year amounts. This space is used for general and administrative and sales and marketing operations and personnel.The Company also leases office space for its supply chain and inventory management and research and product development operations in Emeryville,California under a non-cancelable operating lease that expires, as extended, in September 2015. The base rent is subject to a 3.0% increase each year for theduration of the lease. Under the terms of the lease, as amended, the Company received an option to expand into additional space. The Company also receivedfree rent for two months and a tenant improvement allowance of $305,000.In August 2009, the Company entered an operating lease agreement to lease up to 95 vehicles. Each vehicle has a lease term of 36 months with a fixedmonthly rental payment. As security for the vehicle leases, the lessor required a letter of credit for $200,000, which is collateralized by a certificate of deposit inthe same amount.The Company recognizes rent expense on a straight-line basis over the non-cancelable term of its operating leases. Rent expense for the years endedDecember 31, 2012, 2011 and 2010 was $828,000, $826,000 and $839,000, respectively.Future minimum lease payments as of December 31, 2012 are as follows (in thousands):2013$1,57220141,47320156432016 and thereafter—Total$3,688Manufacturing and Supply AgreementsThe Company has a manufacturing services agreement with Patheon UK Limited (Patheon) for the aseptic capsule assembly, filling and inspection,final device assembly and purchasing of Sumavel DosePro, as well as other manufacturing and support services, which agreement expires on October 31,2013. In February 2013, the Company entered into an additional manufacturing services agreement (the Amended Services Agreement), with Patheon whichwill replace the Company's original manufacturing services agreement upon its expiration on October 31, 2013. The Amended Services Agreement has similarterms to the original agreement and will expire on April 30, 2015. The parties may mutually agree in writing to renew the term for additional terms prior to theexpiration of the then-current term.The Company has manufacturing and supply agreements with several third-party suppliers for the production of key components of Sumavel DosePro,which expire on various dates between 2012 and 2020. As of December 31, 2012, the Company has non-cancellable purchase orders for 2013 totalingapproximately $3,327,000 under these arrangements. In addition, the Company is required to pay Patheon a monthly manufacturing fee of £311,000 orapproximately $502,000 (based on the exchange rate as of December 31, 2012). As of December 31, 2012, the Company was committed to pay Patheon a totalmanufacturing fee of £3,111,000, or approximately $5,025,000 (based on the exchange rate as of December 31, 2012), which is payable monthly over theremaining 10 months of the original Patheon manufacturing services agreement.6.DebtMaturities of long-term debt as of December 31, 2012, are as follows (in thousands):F-20Table of ContentsZogenix, Inc.Notes to Consolidated Financial Statements (continued)2013$2,52620144,226201515,521201615,104201715,22120182,332Total minimum payments54,930Less amount representing interest(24,930)Total long-term debt30,000Less current portion—Long-term portion$30,000Interest expense related to long-term debt for the years ended December 31, 2012, 2011 and 2010 was $6,708,000, $5,562,000 and $4,727,000,respectively.Healthcare Royalty Financing AgreementOn July 18, 2011, the Company closed the royalty financing agreement (the Financing Agreement) with Healthcare Royalty. Under the terms of theFinancing Agreement, the Company borrowed $30,000,000 from Healthcare Royalty (the Borrowed Amount) and the Company agreed to repay such BorrowedAmount together with a return to Healthcare Royalty, as described below, out of the Company’s direct product sales, co-promotion revenues and out-licenserevenues (collectively, Revenue Interest) that the Company may record or receive as a result of worldwide commercialization of the Company’s productsincluding Sumavel DosePro, Zohydro ER and other future products.In addition, upon the closing of and in connection with the Financing Agreement, the Company issued and sold to Healthcare Royalty $1,500,000 of theCompany’s common stock, or 388,601 shares, at a price of $3.86 per share. The Company also issued to Healthcare Royalty a warrant exercisable for up to225,000 shares of the Company’s common stock. The warrant is exercisable at $9.00 per share and has a term of 10 years. As the warrant contains covenantswhere compliance with such covenants may be outside the control of the Company, the warrant was recorded as a current liability and marked to market ateach reporting date using the Black-Scholes option pricing valuation model (see Note 2).Under the Financing Agreement, the Company is obligated to pay to Healthcare Royalty:•5% to 5.75% of the first $75,000,000 of Revenue Interest recorded (in the case of net product sales) or received (in the case of co-promotionrevenues and license fees) by the Company in a calendar year (initially 5% and then 5.75% after the Astellas Co-Promotion Agreement terminatedon March 31, 2012, with a reversion back to 5% if certain net sales of Sumavel DosePro are achieved or if Zohydro ER is commercialized in thefour calendar quarters immediately following the effective date of termination);•2.5% of the next $75,000,000 of Revenue Interest recorded (in the case of net product sales) or received (in the case of co-promotion revenues andlicense fees) by the Company in a calendar year; and•0.5% of Revenue Interest over and above $150,000,000 recorded (in the case of net product sales) or received (in the case of co-promotion revenuesand license fees) by the Company in a calendar year.Net sales of Sumavel DosePro outside the United States are only included in the Revenue Interest if such net sales exceed $10,000,000. Once the aggregatepayments, including the fixed payments described below, made by the Company to Healthcare Royalty equal $75,000,000, the percentage of Revenue Interestowed to Healthcare Royalty is reduced to 0.5% for the remainder of the term of the Financing Agreement, with only Sumavel DosePro and Zohydro ER subjectto the Revenue Interest payments thereafter. The Company is also obligated to make three fixed payments of $10,000,000 on (or before at the option of theCompany) each of January 31, 2015, January 31, 2016 and January 31, 2017. Unless terminated as discussed below, the Financing Agreement terminates onMarch 31, 2018.As security for the payment of the Company's obligations under the Financing Agreement, the Company also entered into a security agreement wherebythe Company granted to Healthcare Royalty a security interest in all assets of the Company, including intellectual property and other rights of the Company tothe extent necessary or used to commercialize the Company products. Healthcare Royalty entered into an intercreditor agreement under which its securityinterest was junior to the security interest of the lenders under the Company's $25.0 million loan and security agreement with Oxford Finance LLC (Oxford)and Silicon Valley Bank (SVB). The intercreditor agreement terminated on July 30, 2012 when the Company terminated its $25.0F-21Table of ContentsZogenix, Inc.Notes to Consolidated Financial Statements (continued)million loan and security agreement. Healthcare Royalty's security interest will be extinguished at the end of the term or once the aggregate payments made bythe Company to Healthcare Royalty equal $75,000,000, whichever is sooner. The Company has agreed to specified positive and negative covenants inconnection with the Financing Agreement.The Company has the option to terminate the Financing Agreement at the Company's election in connection with a change of control of the Company,upon the payment of a base amount of $52,500,000, or, if higher, an amount that generates a 19% internal rate of return on the Borrowed Amount as of thedate of prepayment, in each case reduced by the Revenue Interest and principal payments received by Healthcare Royalty up to the date of prepayment.Healthcare Royalty has the option to terminate the Financing Agreement at its election in connection with a change of control of the Company (whichincludes the sale, transfer, assignment or licensing of the Company's rights in the United States to either Sumavel DosePro or Zohydro ER), or an event ofdefault (which includes the occurrence of a bankruptcy event or other material adverse change in the Company's business), as defined in the FinancingAgreement. Upon such a termination by Healthcare Royalty, the Company is obligated to make a payment of a base amount of $45,000,000, or, if higher, anamount that generates a 17% internal rate of return on the Borrowed Amount as of the date of prepayment, in each case reduced by the Revenue Interest andprincipal payments received by Healthcare Royalty up to the date of prepayment.The rights of the Company and Healthcare Royalty to terminate the Financing Agreement early, as well the potential change in the Revenue Interest ratefrom 5% to 5.75% in connection with the early termination of the Astellas co-promotion agreement, meet the definition of an embedded derivative. As a result,the Company carved out these embedded derivatives from the Financing Agreement and determined the fair value of each derivative using various discountedcash flow valuation models taking into account the probability of these events occurring and various scenarios surrounding the potential Revenue Interestpayments that would be made if these events occurred (see Note 2). The aggregate fair value of the embedded derivatives as of December 31, 2012 and 2011was $992,000 and $845,000, respectively, and is included in other long-term liabilities. As the Company agreed to early terminate the Astellas Co-PromotionAgreement in December 2011, the related embedded derivative was derecognized, resulting in a $417,000 adjustment to the fair value of embedded derivativesfor the year ended December 31, 2011.The Company received aggregate net proceeds of $29,485,000 from the Financing Agreement (including the purchase of common stock). Thediscounts, which are being amortized using the effective interest method over the term of the arrangement within interest expense, include the fair value of thecommon stock warrants issued to Healthcare Royalty of $790,000 upon the closing of the Financing Agreement, fees payable to Healthcare Royalty inconnection with the execution of the arrangement of $476,000 and the fair value of embedded derivatives of $605,000 upon the closing of the FinancingAgreement. The Company has recognized other income in relation to the change in the fair value of the Healthcare Royalty common stock warrant of $160,000and $445,000 for the years ended December 31, 2012 and 2011, respectively, in the statement of operations and comprehensive loss. The Company hasrecognized other expense in relation to the change in the fair value of the embedded derivatives of $147,000 and $240,000 for the years ended December 31,2012 and 2011, respectively, in the statements of operations and comprehensive loss.Term DebtIn June 2008, the Company entered into a Loan and Security Agreement with Oxford and CIT Healthcare LLC (the Oxford Agreement) under which itborrowed $18,000,000. The obligations under the Oxford Agreement were collateralized by personal property excluding certain intellectual property and allequipment pledged to secure the equipment financing described below. In July and October 2010, the Company amended and restated the Oxford Agreement,and Oxford and SVB became party to the amended agreement. In June 2011, the Company entered into an amendment to the second amended and restatedOxford Agreement (the Amended Oxford/SVB Agreement), which provided among other things, the addition of intellectual property to the collateral securing theOxford/SVB loan and the deferral of principal repayment to commence on February 1, 2012. In connection with entering into the Amended Oxford/SVBAgreement, the Company issued to Oxford and SVB warrants exercisable into an aggregate of 26,455 shares of the Company’s common stock. The warrantsare exercisable at $3.78 per share of common stock and have a term of 7 years. The value of the warrants of approximately $76,000 was recorded as debtdiscount and additional paid in capital in the consolidated balance sheet as of December 31, 2011.The Amended Oxford/SVB Agreement consisted of a $25,000,000 term loan and a $10,000,000 revolving credit facility. The obligations under theAmended Oxford/SVB Agreement were collateralized by the Company's intellectual property (including among other things, copyrights, patents, patentapplications, trademarks, service marks and trade secret rights) and personal property (including, among other things, accounts receivable, equipment,inventory, contract rights, rights to payment of money, license agreements, general intangibles and cash). The $25,000,000 term loan bore an interest rate of12.06% per annum. Under the terms of the revolving credit facility, $10,000,000 was available to be borrowed within a specifiedF-22Table of ContentsZogenix, Inc.Notes to Consolidated Financial Statements (continued)percentage of the Company's eligible accounts receivable and inventory balances (as defined in the Amended Oxford/SVB Agreement). Amounts outstandingunder the revolving credit facility accrued interest payable monthly at a floating rate per annum equal to the greater of 3.29% above SVB's prime rate or7.29%. In addition, the Company paid a monthly fee equal to 0.5% per annum of the average unused portion of the revolving credit facility. The outstandingprincipal balance of the term loan and the revolving credit facility as of December 31, 2011 was $25,000,000 and $5,151,000, respectively.On July 30, 2012, the Company exercised its right to terminate the Amended Oxford/SVB Agreement prior to the loan maturity date of January 2, 2014and repaid $19,492,000 of outstanding principal and interest under the agreement. In addition to the repayment of all principal and interest outstanding, theCompany was also required to make a final payment of $1,200,000 and a prepayment premium of $400,000, or 2% of the then outstanding principal. TheCompany also paid a $100,000 prepayment premium to terminate the revolving credit facility. As a result of the termination of the Amended Oxford/SVBAgreement, the lenders no longer have a security interest in the Company's intellectual property and personal property.Bridge LoansIn July 2010, the Company entered into a Note Purchase Agreement, pursuant to which the Company borrowed an aggregate of $15,000,000 fromcertain existing investors (the 2010 Notes). Outstanding balances under the 2010 Notes accrued interest at a rate of 8% per annum. The principal amount of the2010 Notes and accrued interest thereon automatically converted into 3,873,756 shares of the Company’s common stock upon completion of the Company’sIPO at a conversion price equal to the Company’s IPO price of $4.00 per share.The holders of the 2010 Notes received the benefit of a deemed conversion price of the 2010 Notes that was below the estimated fair value of the Series Bconvertible preferred stock at the time of their issuance. The fair value of this beneficial conversion feature was estimated to be $8,182,000 and was recordedto debt discount and amortized to interest expense using the effective interest method over the term of the 2010 Notes. The Company recorded $4,696,000 ofinterest expense related to the beneficial conversion feature during the year ended December 31, 2010.Equipment FinancingIn March 2007, the Company entered into a $10,000,000 master loan and security agreement (GE Agreement) with GE Capital Corporation (GE Capital)for the purpose of financing capital equipment purchases. Each borrowing was under a promissory note repayable in 48 monthly installments based upon amonthly repayment schedule bearing interest at an annual rate determined on the date of borrowing. The first promissory note was executed in March 2007 for$3,500,000 with an interest rate of 10.08%. A second promissory note was executed in December 2007 for $1,000,000 with an interest rate of 9.91%. TheCompany’s ability to make further borrowing under the GE Agreement expired on December 21, 2007.The Company had the option to prepay the outstanding balance of the promissory notes in full, subject to a prepayment fee as defined in the GEAgreement. The outstanding principal balance of the GE Agreement was repaid in full on June 30, 2011.7.Preferred Stock and Stockholders’ EquityPreferred StockUnder the Company’s amended and restated certificate of incorporation, as of December 31, 2012 and 2011, the Company is authorized to issue10,000,000 shares of preferred stock with a $0.001 par value. As of December 31, 2012 and 2011, there were no shares of preferred stock issued oroutstanding.As of December 1, 2010, there were 77,891,000 shares of Series A convertible preferred stock for $76,955,000 and 64,507,000 shares of Series Bconvertible preferred stock for $72,357,000 outstanding. All of these 142,398,000 shares of preferred stock were converted to 14,240,000 shares of commonstock on a 10 for 1 basis upon completion of the Company's IPO in 2010.Common StockUnder the Company’s amended and restated certificate of incorporation, as of December 31, 2012 and 2011, the Company was authorized to issue200,000,000 and 100,000,000 shares of common stock, respectively, with a $0.001 par value. Each share of common stock is entitled to one vote. The holdersof common stock are also entitled to receive dividendsF-23Table of Contentswhenever funds are legally available, when declared by the board of directors, subject to the prior rights of holders of convertible preferred stock.Common stock reserved for future issuance is as follows (in thousands): December 31, 2012 2011Stock options9,901 3,517Warrants to purchase common stock16,292 508Shares authorized for future issuance under equity and purchase plans1,166 1,681 27,359 5,706Common Stock WarrantsIn connection with the July 2012 Offering (see Note 1), the Company sold warrants to purchase 15,784,200 shares of common stock (including over-allotment purchase). The warrants will be exercisable beginning on July 27, 2013 at an exercise price of $2.50 per share and will expire on July 27, 2017,which is five years from the date of issuance. As the warrants contain a cash settlement feature upon the occurrence of certain events that may be outside of theCompany's control, the warrants are recorded as a current liability and are marked to market at each reporting date (see Note 2). The fair value of the warrantswas approximately $9,308,000 as of December 31, 2012.In July 2011, upon the closing of and in connection with the Financing Agreement (see Note 6), the Company issued to Healthcare Royalty a warrantexercisable into 225,000 shares of common stock. The warrant is exercisable at $9.00 per share of common stock and has a term of 10 years. As the warrantcontains covenants where compliance with such covenants may be outside of the Company’s control, the warrant was recorded as a current liability and ismarked to market at each reporting date (see Note 2). The fair value of the warrant was approximately $185,000 and $345,000 as of December 31, 2012 and2011, respectively.In June 2011, and in connection with entering into the Amended Oxford/SVB Agreement (see Note 6), the Company issued to Oxford and SVB warrantsexercisable into an aggregate of 26,455 shares of common stock. The warrants are exercisable at $3.78 per share of common stock and have a term of 7 years.The value of the warrants of approximately $76,000 was recorded as debt discount and additional paid in capital in the consolidated balance sheet as ofDecember 31, 2011.Convertible Preferred Stock WarrantsIn connection with the execution of the amended Oxford Agreement in July 2010, the Company issued warrants to Oxford and SVB to purchase1,145,455 and 445,455 shares, respectively, of Series B convertible preferred stock at an exercise price of $1.10 per share. The warrants expire in November2015. In connection with the Company’s initial public offering in November 2010, these warrants were converted to 159,090 warrants for common stock atan exercise price of $11.00 per share.In accordance with accounting guidance for warrants for shares in redeemable securities, the Company classified warrants for convertible preferredstock as liabilities on the consolidated balance sheet based on fair value and increases or decreases in the fair value of such warrants were recorded as otherincome (expense) in the consolidated statement of operations and comprehensive loss. Upon the closing of the IPO on November 29, 2010, all preferred stockconverted into common stock. The warrants were converted into warrants to purchase common stock and reclassed from a liability to equity. 8.Stock-Based CompensationStock Option PlansDuring 2006, the Company adopted the 2006 Equity Incentive Award Plan (as amended, the 2006 Plan) under which 1,134,000 shares of commonstock were reserved for issuance to employees, directors and consultants of the Company at December 31, 2011 and 2010. The 2006 Plan provides for thegrant of incentive stock options, non-qualified stock options and rights to purchase restricted stock to eligible recipients. Recipients of stock options areeligible to purchase shares of the Company’s common stock at an exercise price equal to no less than the estimated fair market value of such stock on the dateof grant. The maximum term of options granted under the 2006 Plan is ten years.F-24Table of ContentsZogenix, Inc.Notes to Consolidated Financial Statements (continued)Options granted pursuant to the 2006 Plan generally vest over four years at a rate of 25% upon the first anniversary of the vesting commencement dateand 1/48th per month thereafter. The 2006 Plan allows the option holders to exercise their options early and acquire option shares, which are then subject torepurchase by the Company at the original exercise price of such options. At December 31, 2012 and 2011 there were zero unvested shares of common stockissued to employees of the Company in connection with the early exercise of stock option grants.During 2010, the Company adopted the 2010 Equity Incentive Award Plan (the 2010 Plan), which became effective immediately prior to the completionof the IPO. An initial 2,243,668 shares were reserved for issuance to employees, directors and consultants of the Company under the 2010 plan. The numberof shares initially reserved were subsequently increased by the number of shares of common stock related to awards granted under the 2006 Plan that arerepurchased, forfeited, expired or are cancelled on or after the effective date of the 2010 Plan, as well as an annual increase pursuant to an evergreen provision.The 2010 Plan provides for the grant of incentive stock options, non-qualified stock options, stock appreciation rights, restricted stock units and rights topurchase restricted stock to eligible recipients. Recipients of stock options are eligible to purchase shares of the Company’s common stock at an exercise priceequal to no less than the estimated fair market value of such stock on the date of grant. The maximum term of options granted under the 2010 Plan is tenyears.Options granted pursuant to the 2010 Plan generally vest over four years and vest at a rate of 25% upon the first anniversary of the vestingcommencement date and 1/48th per month thereafter. Restricted stock units granted pursuant to the 2010 Plan vest on the first anniversary of the vestingcommencement date.In June 2012, the Company amended and restated the 2010 Plan (the Restated 2010 Plan). Pursuant to the Restated 2010 Plan, the number of shares thatare reserved for issuance under the 2010 Plan was increased to 9,300,000, plus any shares related to outstanding options granted under the 2006 Plan that arerepurchased, forfeited, expire or are canceled on or after the effective date of the Restated 2010 Plan. Further, the 2010 Plan's evergreen provision was amendedsuch that, commencing on January 1, 2013, and on each January 1 thereafter during the term of the Restated 2010 Plan, the aggregate number of sharesavailable for issuance under the Restated 2010 Plan shall be increased by that number of shares of the Company's common stock equal to the lower of:•4% of the Company’s outstanding common stock on the applicable January 1; or•an amount determined by the board of directors.At December 31, 2012 and 2011, 701,976 and 1,103,579 shares of common stock were available for future issuance under the Restated 2010 Plan,respectively.The 2006 Plan and Restated 2010 Plan are intended to encourage ownership of stock by employees, consultants and non-employee directors of theCompany and to provide additional incentives for them to promote the success of the Company’s business. The board of directors is responsible fordetermining the individuals to receive equity grants, the number of shares subject to each grant, the exercise price per share and the exercise period of eachoption. The Company satisfies option exercises through issuance of new shares.During 2010, the Company adopted the 2010 Employee Stock Purchase Plan (the Purchase Plan), which allows employees to purchase shares of theCompany’s common stock during a specified offering period. The purchase price is 85% of the lower of the closing price of the stock on the first day of theoffering period or the closing price of the stock on the date of purchase. Eligible employees may elect to withhold up to 20% of their compensation during anyoffering period for the purchase of stock up to a maximum of 20,000 shares per purchase period. At December 31, 2012 and 2011, a total of 463,973 and577,852 shares of common stock are reserved for issuance under the Purchase Plan, respectively. The length of the offering period is determined by thecompensation committee and may be up to 27 months long. The first offering period under the Purchase Plan was from June 1, 2011 through May 31, 2012with two purchase periods of six months each. A total of 138,826, 225,053 and 172,148 shares were purchased under the Purchase Plan in November 2012,May 2012 and November 2011, respectively.Information with respect to the number and weighted average exercise price of stock options under the 2006 Plan and 2010 Plan is summarized asfollows (number of shares in thousands):F-25Table of ContentsZogenix, Inc.Notes to Consolidated Financial Statements (continued) Shares WeightedAverageExercisePrice WeightedAverageRemainingContractualTerm (years) AggregateIntrinsicValue(in thousands)Outstanding at December 31, 20113,517 $4.01 Granted6,698 $1.94 Exercised(18) $1.86 Canceled/Forfeited(296) $3.24 Outstanding at December 31, 20129,901 $2.64 8.8 $39Exercisable at December 31, 2012 (1)3,081 $3.13 8 $39Vested at December 31, 20129,423 $2.66 8.75 $39 (1)Includes awards with early exercise provisions that permit optionee to exercise unvested options.The intrinsic values above represent the aggregate value of the total pre-tax intrinsic value based upon a common stock price of $1.33 at December 31,2012, and the contractual exercise prices. Years Ended December 31, 2012 2011 2010Stock Options and Restricted Stock Units Weighted-average grant date fair value$1.35 $2.88 $11.52Aggregate intrinsic value of options exercised$9,000 $226,000 $61,000Total fair value of shares vested$3,564,000 $2,340,000 $660,000Stock-Based CompensationThe Company uses the Black-Scholes option-pricing model for determining the estimated fair value and stock-based compensation for stock-basedawards to employees and the board of directors. The assumptions used in the Black-Scholes option-pricing model are as follows: Year Ended December 31, 2012 2011 2010Stock Options and Restricted Stock Units Risk free interest rate0.2% to 1.2% 1.2% to 2.6% 1.7% to 2.3%Expected term5.0 to 6.1 years 5.1 to 6.1 years 5.0 to 6.1 yearsExpected volatility80.1% to 86.8% 72.3% to 89.7% 90.8% to 96.0%Expected dividend yield—% —% —%Employee Stock Purchase Plan Risk free interest rate0.1% 0.1% N/AExpected term0.5 to 1.0 years 0.5 to 1.0 years N/AExpected volatility81.5% to 85.7% 75.2% to 77.1% N/AExpected dividend yield—% —% N/AThe risk-free interest rate assumption was based on the rates for U.S. Treasury zero-coupon bonds with maturities similar to those of the expected termof the award being valued. The assumed dividend yield was based on the Company’s expectation of not paying dividends in the foreseeable future. Theweighted average expected term of options was calculated using the simplified method as prescribed by accounting guidance for stock-based compensation.This decision was based on the lack of relevant historical data due to the Company’s limited historical experience. In addition, due to the Company’s limitedhistorical data, the estimated volatility was calculated based upon the Company's historical volatility, supplemented with historical volatility of comparablecompanies whose share prices are publicly available for a sufficient period of time.The Company recognized stock-based compensation expense as follows (in thousands):F-26Table of ContentsZogenix, Inc.Notes to Consolidated Financial Statements (continued) Year Ended December 31, 2012 2011 2010Cost of sales$181 $137 $105Research and development921 768 393Selling, general and administrative5,055 3,904 2,009Total$6,157 $4,809 $2,507As of December 31, 2012, there was approximately $12,047,000 of total unrecognized compensation costs related to outstanding employee and board ofdirector options, which is expected to be recognized over a weighted average period of 2.9 years.At December 31, 2012, there were 157,000 unvested stock options outstanding to consultants, with approximately $138,000 of related unrecognizedcompensation expense based on a December 31, 2012 measurement date. These stock options outstanding to consultants are expected to vest overapproximately 3.3 years. In accordance with accounting guidance for stock-based compensation, the Company re-measures the fair value of stock optiongrants to non-employees at each reporting date and recognizes the related income or expense during their vesting period. Expense recognized for stock options toconsultants was immaterial for the years ended December 31, 2012, 2011 and 2010, respectively. Stock option expense for awards issued to consultants isincluded in the consolidated statement of operations and comprehensive loss within selling, general and administrative expense in the year ended December 31,2012 and within research and development expense in the years ended December 31, 2011 and 2010. 9.Employee Benefit PlanEffective February 1, 2007, the Company has established a defined contribution 401(k) plan (the Plan) for all employees who are at least 21 years ofage. Employees are eligible to participate in the Plan beginning on the first day of the month following one month of employment. Under the terms of the Plan,employees may make voluntary contributions as a percentage of compensation. The Company’s contributions to the Plan are discretionary, and nocontributions have been made by the Company to date.10.Income TaxesThe Company only recognizes tax benefits if it is more-likely-than-not to be sustained upon audit by the relevant taxing authority based upon itstechnical merits. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained.The following table summarizes the activity related to the Company’s unrecognized tax benefits (in thousands): December 31, 2012 2011Beginning balance of unrecognized tax benefits$678 $562Gross increases based on tax positions related to current year36 116Gross increases based on tax positions related to prior year— —Settlements with taxing authorities— —Expiration of statute of limitations— —Ending balance of unrecognized tax benefits$714 $678The Company’s policy is to recognize interest and/or penalties related to income tax matters in income tax expense. The Company had no accrued interestor penalties on the consolidated balance sheets at December 31, 2012 and 2011 and has recognized no interest and/or penalties in the consolidated statements ofoperations and comprehensive loss through the year ended December 31, 2012.The Company is subject to taxation in the U.S. and state jurisdictions. The Company’s tax years for 2006 and forward can be subject to examinationby the United States and state tax authorities due to the carry forward of net operating losses.At December 31, 2012, the Company had available federal and state income tax net operating loss carryforwards of approximately $158,282,000 and$164,122,000, respectively. The federal tax loss carryforwards will begin expiring in 2026unless previously utilized, and the state tax loss carryforwards will begin expiring in 2015 unless previously utilized. In addition, the Company has federaland California research and development income tax credit carryforwards of $311,000 and $1,970,000, respectively. The federal research and developmentincome tax credit carryforwards will begin to expire in 2026 unless previously utilized. The California research and development income tax creditcarryforwards will carry forward indefinitely until utilized.In January 2013, the American Taxpayer Relief Act of 2012 (the “Act”) was signed into law. The Act retroactively restored several expired business taxprovisions, including the research and experimentation credit. The impact to the Company of the reinstated credits was not recognized in 2012 as a change intax law is accounted for in the period of enactment. The additional credits that will be reported within the 2013 consolidated financial statements will have noimpact on operations due to the existence of a full valuation allowance on all deferred tax assets.The Company has completed an analysis under Internal Revenue Service Code (IRC) Sections 382 and 383 to determine if the Company’s net operatingloss carryforwards and research and development credits are limited due to a change in ownership. The Company has determined that as of December 31,2011 the Company had two ownership changes. The first ownership change occurred in August 2006 upon the issuance of the Series A-1 convertiblepreferred. As a result of this ownership change, the Company has reduced its net operating loss carryforwards by $1,900,000 and research and developmentincome tax credits by $8,000. The Company had a second ownership change as defined by IRC Sections 382 and 383, which occurred in September 2011upon the issuance of common stock in its follow-on offering. As a result of the second ownership change, the Company has reduced its federal net operatingloss carryforwards as of December 31, 2010 by $83,503,000 and research and development income tax credits as of December 31, 2010 by $2,203,000. TheCompany also reduced its California net operating loss carryforwards as of December 31, 2010 by $46,243,000 as a result of the second ownership change.Pursuant to IRC Section 382 and 383, use of the Company’s net operating loss and research and development income tax credit carryforwards may be limitedin the event of a future cumulative change in ownership of more than 50% within a three-year period. The Company is currently in the process of completing aSection 382 and 383 study to determine the impact that ownership changes during the year ended December 31, 2012 have had on its carryforwards andexpects to complete the analysis within the next three months. As a result of this analysis, the Company may have an adjustment in the net operating lossesthat are recorded at December 31, 2012.The reconciliation of income tax computed at the Federal statutory tax rate to the expense (benefit) for income taxes is as follows (in thousands): December 31, 2012 2011 2010Tax at statutory rate$(16,109) $(28,530) $(25,008)State taxes, net of federal benefit(1,580) (2,780) (2,953)Change in valuation allowance21,990 (16,807) 27,968Section 382 limitation— 45,728 —Permanent Interest Disallowed(4,466) (70) 526Credits and other170 2,450 (523) $5 $(9) $10Significant components of the Company’s deferred tax assets as of December 31, 2012 and 2011 are listed below. A valuation allowance of $80,347,000and $58,359,000 for the years ended December 31, 2012 and 2011, respectively, has been established to offset the deferred tax assets as realization of suchassets is uncertain. The components of the deferred tax assets are as follows (in thousands):F-27Table of ContentsZogenix, Inc.Notes to Consolidated Financial Statements (continued) December 31, 2012 2011Deferred tax assets: Net operating losses$61,739 $38,357Capitalized research and development8,903 7,901Accrued expenses3,707 3,728Research and development credits1,237 1,078Accrued product returns1,087 916Inventory reserve and UNICAP688 983Depreciation and amortization645 824Deferred revenue— 3,169Other, net2,341 1,403Total deferred tax assets80,347 58,359Less valuation allowance(80,347) (58,359)Net deferred tax assets$— $—The Company incurred $5,000 in income tax expense for the year ended December 31, 2012 and received a benefit of $9,000 in income tax expense forthe year ended December 31, 2011 related to taxable income generated by its wholly-owned subsidiary Zogenix Europe Limited. 11.Summarized Quarterly Data (Unaudited)The following financial information reflects all adjustments, which include only normal recurring adjustments, which are, in the opinion ofmanagement, necessary for a fair statement of the consolidated financial results of the interim periods. Summarized quarterly data for the years endedDecember 31, 2012 and 2011 are as follows: Fiscal 2012 Quarter Ended March 31, June 30, September 30, December 31, (in thousands, except per share amounts)Revenue$18,347 $8,030 $8,453 $9,496Cost of Sales$5,062 $4,167 $4,249 $6,018Gross Profit$13,285 $3,863 $4,204 $3,478Net loss$(10,292) $(17,169) $(19,282) $(643)Net loss per share, basic and diluted$(0.16) $(0.26) $(0.21) $(0.01)Weighted-average shares outstanding, basic and diluted65,369 65,449 90,370 100,714 Fiscal 2011 Quarter Ended March 31, June 30, September 30, December 31, (in thousands, except per share amounts)Revenue$9,040 $10,237 $10,398 $7,901Cost of Sales$4,875 $3,975 $5,482 $4,961Gross Profit$4,165 $6,262 $4,916 $2,940Net loss$(18,983) $(19,177) $(22,038) $(23,705)Net loss per share, basic and diluted$(0.56) $(0.56) $(0.59) $(0.36)Weighted-average shares outstanding, basic and diluted33,973 34,018 37,320 65,215F-28Table of ContentsSCHEDULE II – VALUATION AND QUALIFYING ACCOUNTS (in thousands): Balance atBeginning of Year AdditionsChargedtoExpense (Deductions) Balanceat Endof YearInventory reserves: 2012$1,659 $607 $(1,069) $1,1972011$1,681 $1,887 $(1,909) $1,659Table of ContentsSIGNATURESPursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to besigned on its behalf by the undersigned, thereunto duly authorized. ZOGENIX, INC. Date: March 15, 2013 By:/s/ Roger L. Hawley Chief Executive Officer Date: March 15, 2013 By:/s/ Ann D. Rhoads Executive Vice President, Chief FinancialOfficer, Treasurer and SecretaryPursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalfof the Registrant and in the capacities and on the dates indicated. Signature Title Date/S/ ROGER L. HAWLEY Chief Executive Officer and Director (Principal Executive Officer) March 15, 2013Roger L. Hawley /S/ ANN D. RHOADS Executive Vice President, Chief Financial Officer, Treasurer andSecretary (Principal Financial and Accounting Officer) March 15, 2013Ann D. Rhoads /S/ CAM L. GARNER Chairman of the Board March 15, 2013Cam L. Garner /S/ JAMES C. BLAIR, PH.D. Director March 15, 2013James C. Blair, Ph.D. /S/ LOUIS C. BOCK Director March 15, 2013Louis C. Bock /S/ STEPHEN J. FARR, PH.D. President, Chief Operating Officer and Director March 15, 2013Stephen J. Farr, Ph.D. /S/ MARK WIGGINS Director March 15, 2013Mark Wiggins /S/ ERLE T. MAST Director March 15, 2013Erle T. Mast /S/ KURT C. WHEELER Director March 15, 2013Kurt C. Wheeler Table of ContentsEXHIBIT INDEX ExhibitNumber Description3.1(3) Fifth Amended and Restated Certificate of Incorporation of the Registrant 3.2(7) Certificate of Amendment of Fifth Amended and Restated Certificate of Incorporation of the Registrant 3.3(3) Amended and Restated Bylaws of the Registrant 4.1(4) Form of the Registrant’s Common Stock Certificate 4.2(1) Third Amended and Restated Investors’ Rights Agreement dated December 2, 2009 4.3(1) Amendment to Third Amended and Restated Investors’ Rights Agreement dated July 1, 2010 4.4(5) Second Amendment to Third Amended and Restated Investors’ Rights Agreement dated June 30, 2011 4.5(1) Warrant dated March 5, 2007 issued by the Registrant to General Electric Capital Corporation 4.6(1) Warrant dated June 30, 2008 issued by the Registrant to Oxford Finance Corporation 4.7(1) Warrant dated June 30, 2008 issued by the Registrant to CIT Healthcare LLC (subsequently transferred to The CIT Group/EquityInvestments, Inc.) 4.8(1) Transfer of Warrant dated March 24, 2009 from CIT Healthcare LLC to The CIT Group/Equity Investments, Inc. 4.9(1) Warrant dated July 1, 2010 issued by the Registrant to Oxford Finance Corporation 4.10(1) Warrant dated July 1, 2010 issued by the Registrant to Silicon Valley Bank 4.11(5) Warrant dated June 30, 2011 issued by the Registrant to Oxford Finance LLC 4.12(5) Warrant dated June 30, 2011 issued by the Registrant to Silicon Valley Bank 4.13(5) Warrant dated July 18, 2011 issued by the Registrant to Cowen Healthcare Royalty Partners II, L.P. 10.1(3) Form of Director and Executive Officer Indemnification Agreement 10.2#(1) Form of Executive Officer Employment Agreement 10.3#(1) 2006 Equity Incentive Plan, as amended, and forms of option agreements thereunder 10.4#(3) Independent Director Compensation Policy 10.5#(3) 2010 Equity Incentive Award Plan and forms of option and restricted stock agreements thereunder 10.6#(3) 2010 Employee Stock Purchase Plan and form of Offering document thereunder 10.7#(1) Executive Officer Employment Agreement dated March 1, 2010 by and between the Registrant and Ann D. Rhoads 10.8†(1) Supply Agreement dated September 29, 2004 by and between the Registrant and Dr. Reddy’s Laboratories, Inc. 10.9†(1) Asset Purchase Agreement dated August 25, 2006 by and between the Registrant and Aradigm Corporation 10.10(1) Lease dated October 31, 2006 by and between the Registrant and Emery Station Joint Venture, LLC 10.11(1) First Amendment to Lease dated July 10, 2007 by and between the Registrant and Emery Station Joint Venture, LLC 10.12(1) Second Amendment to Lease dated October 20, 2009 by and between the Registrant and Emery Station Joint Venture, LLC 10.13(1) Consent to Assignment Agreement dated August 29, 2008 by and among the Registrant, R.B. Income Properties and VerusPharmaceuticals, Inc. and related Lease dated February 2, 2005 by and between R.B. Income Properties and Verus Pharmaceuticals, Inc. Table of Contents10.14†(1) License Agreement dated November 27, 2007 by and between the Registrant and Elan Pharma International Limited 10.15†(1) First Amendment to License Agreement dated September 28, 2009 by and between the Registrant and Elan Pharma International Limited 10.16†(3) Licensing and Distribution Agreement dated March 14, 2008 by and between the Registrant and Desitin Arzneimittel GmbH 10.17†(3) Manufacturing Services Agreement dated November 1, 2008 by and between the Registrant and Patheon U.K. Ltd. 10.18†(1) Commercial Manufacturing and Supply Agreement dated April 1, 2009 by and between the Registrant and MGlas AG 10.19†(3) Co-Promotion Agreement dated July 31, 2009 by and between the Registrant and Astellas Pharma US, Inc. 10.20#(1) General Release of Claims dated August 13, 2010 by and between the Registrant and Jennifer D. Haldeman 10.21†(2) Second Amended and Restated Loan and Security Agreement dated October 8, 2010 by and among the Registrant, Oxford FinanceCorporation and Silicon Valley Bank 10.22†(5) First Amendment to Second Amended and Restated Loan and Security Agreement dated June 30, 2011 by and among the Registrant,Oxford Finance LLC and Silicon Valley Bank 10.23†(5) Financing Agreement dated June 30, 2011 by and between the Registrant and Cowen Royalty Healthcare Partners II, L.P. 10.24(5) Stock and Warrant Purchase Agreement dated June 30, 2011 by and between the Registrant and Cowen Royalty Healthcare Partners II,L.P. 10.25†(5) Development and License Agreement dated July 11, 2011 by and between the Registrant and Durect Corporation 10.26#(5) 2011 Annual Incentive Plan 10.27(8)†† Amendment to Co-Promotion Agreement dated December 20, 2011 by and between the Registrant and Astellas Pharma US, Inc. 10.28(9)† Co-Marketing and Option Agreement dated March 29, 2012 by and between the Registrant and Battelle Memorial Institute 10.29(9)† Sublease dated April 12, 2012 by and between the Registrant and Relational Investors, LLC 10.30(9) Independent Director Compensation Policy as amended and restated effective April 16, 2012 10.31(10)† Co-Promotion Agreement dated June 6, 2012 by and between the Registrant and Mallinckrodt, LLC 10.32 Commercial Manufacturing and Supply Agreement dated November 2, 2012 by and between the Registrant and Alkermes PharmaIreland Ltd. 10.33 Employment Agreement dated November 26, 2012 by and between the Registrant and Richard Scott Shively 21.1(6) Subsidiaries of the Registrant. 23.1 Consent of Ernst & Young LLP, independent registered public accounting firm 24.1 Power of Attorney (reference is made to the signature page of this report) 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Public Company Accounting Reform and Investor Protection Act of2002 (18 U.S.C. §1350, as adopted) 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Public Company Accounting Reform and Investor Protection Act of2002 (18 U.S.C. §1350, as adopted) 32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Public Company Accounting Reform and Investor Protection Actof 2002 (18 U.S.C. §1350, as adopted) 32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Public Company Accounting Reform and Investor Protection Actof 2002 (18 U.S.C. §1350, as adopted) Table of Contents101 The following financial statements from Zogenix, Inc.’s Annual Report on Form 10-K for the year ended December 31, 2012, filed onMarch 15, 2013, formatted in XBRL: (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Operations and ComprehensiveLoss, (iii) Consolidated Statements of Cash Flows, and (iv) the Notes to Consolidated Financial Statements, tagged as blocks of text.(1)Filed with the Registrant’s Registration Statement on Form S-1 on September 3, 2010 (Registration No. 333-169210).(2)Filed with Amendment No. 1 to Registrant’s Registration Statement on Form S-1 on October 12, 2010 (Registration No. 333-169210).(3)Filed with Amendment No. 2 to Registrant’s Registration Statement on Form S-1 on October 27, 2010 (Registration No. 333-169210).(4)Filed with Amendment No. 3 to the Registrant’s Registration Statement on Form S-1 on November 4, 2010 (Registration No. 333-169210).(5)Filed with the Registrant’s Quarterly Report on Form 10-Q on August 11, 2011.(6)Filed with the Registrant’s Annual Report on Form 10-K on March 4, 2011.(7)Filed with the Registrant's Quarterly Report on Form 10-Q on November 8, 2012.(8)Filed with the Registrant's Quarterly Report on Form 10-K on March 12, 2012.(9)Filed with the Registrant's Quarterly Report on Form 10-Q on May 15, 2012.(10)Filed with the Registrant's Quarterly Report on Form 10-Q on August 9, 2012.† Confidential treatment has been granted for portions of this exhibit. These portions have been omitted from the Registration Statement and filed separatelywith the Securities and Exchange Commission# Indicates management contract or compensatory plan.ConfidentialExecution VersionCERTAIN MATERIAL (INDICATED BY AN ASTERISK) HAS BEEN OMITTED FROM THIS DOCUMENT PURSUANT TO A REQUEST FORCONFIDENTIAL TREATMENT. THE OMITTED MATERIAL HAS BEEN FILED SEPARATELY WITH THE SECURITIES AND EXCHANGECOMMISSION.Exhibit 10.32ALKERMES PHARMA IRELAND LIMITEDANDZOGENIX, INC. COMMERCIAL MANUFACTURING AND SUPPLYAGREEMENTTHIS AGREEMENT is dated November 2, 2012 (the "Effective Date")PARTIES:(1)ALKERMES PHARMA IRELAND LIMITED, an Irish company having an address at Monksland, Co Westmeath,Ireland("Alkermes") and(2)ZOGENIX, INC., a Delaware corporation having its principal place of business at 12400 High Bluff Drive, Suite 650, San Diego,California, USA 92130 ("Zogenix")BACKGROUND:(A)Elan Pharma International Limited (“EPIL”) and Zogenix entered into a License Agreement dated November 27, 2007, which was amendedpursuant to a First Amendment to License Agreement dated as of September 28, 2009 (such agreement, as amended through the date hereofand thereafter from time to time, the "License Agreement"). On August 2, 2011, EPIL assigned all of its rights and obligations in theLicense Agreement to EDT Pharma Holdings Limited, which has subsequently changed its name to Alkermes Pharma Ireland Limited.(B)The License Agreement provides, inter alia, for the Parties (or their party Affiliates) to negotiate in good faith and execute a CommercialManufacturing and Supply Agreement, whereby Alkermes or an Alkermes Affiliate will supply to Zogenix commercial quantities of theCommercial Product (as defined below) licensed under the License Agreement.(C)Accordingly, Alkermes has agreed to supply the Commercial Product to Zogenix through itself or an Affiliate upon the terms and conditionsset forth in this Agreement, and this Agreement is intended by the Parties to be the Commercial Manufacturing and Supply Agreement referredto in the License Agreement.TERMS:The Parties agree as follows:1. DEFINITIONS AND INTERPRETATION1.1Definitions:In this Agreement, the following expressions shall have the following meanings:"Affiliate"means any corporation or entity controlling, controlled or under common control withAlkermes, Zogenix or the entity referred to, as the case may be. For the purposes of thisAgreement, "control" means the direct or indirect ownership of more than 50% of theissued voting shares or other voting rights of the subject entity to elect directors, or if notmeeting the preceding criteria, any entity owned or controlled by or owning or controllingat the maximum control or ownership right permitted in the country where such entityexists."Agreement"means this agreement, including its recitals, with the attached Schedules."Alkermes Facility"means Alkermes's Affiliate's manufacturing facility at Gainesville, Georgia, or such otherfacility as Alkermes may nominate from time to time under this Agreement."Available Quota"means that part of the Procurement Quota which is at the applicable time unfilled (such thatAlkermes or Alkermes’s Affiliate would be permitted to supply the Commercial Product inquestion in the time requested)."Batch"means a single Manufacturing batch of a single dosage strength of the CommercialProduct, whose approximate sizes are set out in Schedule 1, as the same may be amendedfrom time to time by the mutual written agreement of the Parties through an amendment toSchedule 1.“Bead Blend Intermediate”means the Product intermediate created during Manufacture which contains the relevantblend of immediate release and sustained release components in a unified blend immediatelyprior to encapsulation.“Bead Blend Intermediate Batch”means the minimum quantity of Bead Blend Intermediate that must be created duringManufacture to supply Commercial Product to Zogenix."Business Day"means a day other than a Saturday, Sunday or any days on which the clearing banks aregenerally closed in Dublin Ireland and/or New York, New York.“Certificate of Analysis”means test results against the criteria specified in the Specifications and including testmethods, specification parameters and the pass/fail criteria and results used to show that aparticular Batch meets Product Specifications."cGMP"means the then-current Good Manufacturing Practices, as defined in the US Federal Food,Drug and Cosmetic Act, and the regulations promulgated thereunder, as may be amendedfrom time to time."Claims"means any and all claims (whether successful or otherwise), loss, liability, damages andexpenses, including reasonable attorneys' fees and expenses and legal costs.“Commercial Product”means the Product developed and licensed by Alkermes to Zogenix under the LicenseAgreement and for which Zogenix filed a Regulatory Application on May 1, 2012 in thedosage strengths specified in Schedule 1 (including such additional dosage strengths oradditional packaging configurations that may be subsequently added by mutual agreementthrough a written amendment to Schedule 1) that is packaged and labelled for commercialsale in the Territory or that is provided, if expressly agreed by the Parties, in bulkpackaging for onward packaging and commercial sale in the Territory. For clarity, unlessexpressly agreed and amended by the Parties in writing pursuant to Clause 23.10, thisAgreement shall not govern the commercial supply of any second or subsequentformulations of Product developed by Alkermes and Zogenix under the License Agreementor any Product manufactured for sale or use outside the Territory."Commercially Reasonable Efforts"means those efforts of a Party which are consistent with those utilised by such Party for itsown internally developed or in-licensed pharmaceutical products, taking into account allfactors that impact the manufacturing, development, regulatory approval, marketing, andsales of such products, as applicable."Compound"means the active drug substance hydrocodone bitartrate.“Confirmed Order”has the meaning set out in Clause 5.4.1.2"ControlledSubstance"has the same meaning as in the Controlled Substances Act 21 U.S.C. 801-904, as may beamended from time to time."DEA"means the United States Drug Enforcement Administration or any successor agency.“Developmentand ClinicalSupplyAgreement”means the development and clinical supply agreement relating to the Product that was entered intobetween Zogenix and Elan Drug Delivery, Inc. on December 20, 2007, as may be amended fromtime to time, and that has been subsequently assigned to Alkermes’s affiliate, AlkermesGainesville LLC.“[***] Forecasts”means those forecast quantities relating to [***]."EXW"has the meaning of that expression (ex works) set out in Incoterms 2010."Failure toSupply"has the same meaning as set out in Clause 1.1 of the License Agreement. For clarity, whereZogenix can meet its properly forecasted and ordered requirements of Commercial Product fromthe Second Facility in accordance with the terms of this Agreement, any inability of AlkermesFacility to provide such requirements shall not constitute a Failure to Supply.“First Approval”means receipt of the first Regulatory Approval for the Commercial Product in the Territory.“Forecast”has the meaning set out in Clause 5.1.3."Force MajeureEvent"has the meaning set out in Clause 22.1."GovernmentalAuthority"means all governmental and regulatory bodies, agencies, departments or entities, whether or notlocated in the country of manufacture or sale, which regulate, direct or control commercial andother related activities in or with the country of manufacture or sale.“Initial BatchSize”means the number of Product capsules constituting a single Batch in a single dosage strength ofCommercial Product at the initial commercial scale for Commercial Product Manufactured at theAlkermes Facility set out in Schedule 1 under the column “Initial Batch Size.”“Launch Stock”means any Commercial Product that is intended for commercial sale which is manufactured byor on behalf of Alkermes prior to First Approval. For clarity, Zogenix may designate validationbatches of Product as Launch Stock prior to First Approval.“LicenseAgreement”has the meaning set out in Section (A) of the Background Section above."Manufacture" or"Manufacturing"means all operations in the manufacturing, production, finishing, packaging, labelling,warehousing, quality control testing (including in-process release and stability testing, whenapplicable) and release for shipping of Commercial Product.“ManufacturingCost”has the same meaning as set out in the License Agreement but with [***].“ManufacturingLicense”has the same meaning as set out in Clause 9.1 of the License Agreement."Materials"means the Compound and all excipients and other materials necessary to Manufacture theCommercial Product.*** Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to theomitted portions.3"Minor Changes"means changes which affect only the manner and/or order in which activitiesunder the Process Transfer Plan are to be performed, and do not affect the scopeof those activities.“Net Sales”has the same meaning as set out in the License Agreement.“Notional NSP”has the same meaning as set out in the License Agreement.“NSP” or “Net Selling Price”has the same meaning as set out in the License Agreement.“Optimized Batch Size”means the number of Product capsules constituting a single Batch in a singledosage strength of Commercial Product following Batch size optimization forCommercial Product Manufacture at the Alkermes Facility set out in Schedule 1under the column “Optimized Batch Size.”“Party” or “Parties”has the same meaning as set out in the License Agreement.“Process Transfer Plan”has the meaning set out in Clause 3.1."Procurement Quota"means the quota for the Commercial Product or the Compound, as referenced inthe US CFR 1303.12, from time to time.“Product”has the meaning as set out in the License Agreement when used as a stand aloneterm in this Agreement but for clarity and as also set out in Section 1.3.4, unlessexpressly provided otherwise any reference in the definitions incorporated hereinfrom the License Agreement to the term “Product” shall for the purposes of thisAgreement mean “Commercial Product”."Product Specifications"means the specifications for the final manufactured dosage form(s) of theCommercial Product as set out in the Regulatory Approval in the Territory, or asmay be agreed between the Parties in writing in the Technical Agreement from timeto time, together with applicable cGMP.“Project Manager”has -the meaning set out in Clause 4.1.“Purchase Order”has the meaning set out in Clause 5.4.1.“Quota Forecast”has the meaning set out in Clause 5.2.“Recall”has the meaning set out in Clause 13.2.“Recall Costs”has the same meaning as set out in Clause 19.6.1"Regulatory Application"has the same meaning as set out in the License Agreement."Regulatory Approval"means the final approval to market the Commercial Product in the Territory,including any approval which is required to launch the Commercial Product inthe normal course of business."Safety Stocks"has the meaning set out in Clause 5.5.“Second Facility”has the meaning set out in Clause 9.1."Substantial Changes"means changes which affect the scope of the activities under the Process TransferPlan.“Supply Committee”has the meaning set out in Clause 4.34“Technical Agreement”has the meaning set out in Clause 2.3“Territory”means the United States of America and its possessions and territories, includingPuerto Rico.“Third Party”means any individual or entity which is neither a Party or an Affiliate of a Party.“Trade Demand”means [***].1.2Other Defined Terms: Other capitalised expressions not specifically defined in this Agreement shall have the same meaning as in theLicense Agreement.1.3Interpretation: In this Agreement:1.3.1the singular includes the plural and vice versa, and unless the context or subject otherwise requires, references to words in one gender includereferences to the other genders;1.3.2unless the context otherwise requires, reference to a recital, article, paragraph, provision, clause or schedule is to a recital, article, paragraph,provision, clause or schedule of or to this Agreement;1.3.3the headings in this Agreement are inserted for convenience only and do not affect its construction;1.3.4unless expressly provided otherwise, any references in the definitions incorporated herein from the License Agreement to “Product” or “BottledProduct” shall mean “Commercial Product”; and1.3.5the expressions "include", "includes", "including", "in particular" and similar expressions shall be construed without limitation.2.EXCLUSIVE SUPPLY2.1Appointment. Zogenix hereby appoints Alkermes as its exclusive manufacturer of the Commercial Product for the Territory, uponthe terms and conditions set out in this Agreement. Except as expressly provided in Clauses 9 and 10, during the Term Zogenixshall purchase its entire requirement of Commercial Product from Alkermes.2.2Technical Agreement. Prior to any supply of Commercial Product under this Agreement, the Parties shall enter into technicalagreement(s) in relation to Commercial Product supplied in Manufacturing (each, as applicable, the "Technical Agreement"),which shall specify:2.2.6which Party (or Third Party, if applicable) is responsible for handling which tasks associated with the cGMP aspects of Manufacturing the CommercialProduct;2.2.7the procedures pursuant to which Commercial Product will be released and delivered to Zogenix;2.2.8the inspection and testing for compliance of Compound to be conducted by Alkermes prior to incorporation into Commercial Product;*** Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to theomitted portions.52.2.9the testing and quality analysis of Commercial Product to be conducted by Alkermes prior to delivery of Commercial Product to Zogenix;2.2.10the format of the Certificate of Analysis and certificate of release to be furnished by Alkermes to Zogenix upon release of theCommercial Product to Zogenix;2.2.11any quality analysis or other activities to be conducted by Zogenix;2.2.12the manner in which changes to the Product Specifications and/or the process of Manufacturing may be made;2.2.13audit/inspection rights of manufacturing facilities that manufacture Compound and raw material suppliers;2.2.14the responsibilities of the Parties with respect to pharmacovigilance and Commercial Product Recall, including how the parties should share andexchange information with respect to adverse event data collection and reporting; and2.2.15such other matters relating to Manufacturing as the Parties may mutually agree should be addressed in the Technical AgreementIn the event there is a conflict in terms between this Agreement and the Technical Agreement(s), the terms and conditions of thisAgreement shall prevail.3.PROCESS TRANSFER3.1Transfer Plans. Alkermes shall create as needed process transfer plans ("Process Transfer Plan(s)") and work plans under theDevelopment and Clinical Supply Agreement, which shall include activities necessary for the transfer, validation and commercialscale-up of the Commercial Product’s manufacturing processes within the Alkermes Facility.3.2Conduct. The Parties shall use Commercially Reasonable Efforts to conduct their activities under such Process Transfer Plan(s)and work plans. In performing their activities, the Parties shall act collaboratively, reasonably and in good faith with a view to timelyachieving the aims of the Process Transfer Plan.3.3Inherent Uncertainties. The Parties acknowledge that there are inherent uncertainties involved in the scale up, transfer andmanufacture of pharmaceutical products and that such uncertainties form part of the business risk involved in undertaking the formof commercial collaboration set out in this Agreement.4.OVERSIGHT4.1Project Managers. Each Party shall designate a "Project Manager" who shall be the principal point of contact between the Partiesfor all matters relating to process transfer, scale up and validation. A Party may designate a new Project Manager by written notice tothe other Party.4.2Communications. The Project Managers shall communicate on a regular basis and make themselves reasonably available to eachother for this purpose.4.3Supply Committee. After the Effective Date, the Parties shall establish a supply committee (the "Supply Committee"). TheSupply Committee shall be comprised of a minimum of two (2) Alkermes employees and two (2) Zogenix employees havingappropriate technical credentials, knowledge and experience, or such other number as the Parties may agree. Additional invitees mayattend Supply Committee meetings upon the approval of both Alkermes and Zogenix.64.4General Remit. The Supply Committee shall serve as the coordinating body for the Manufacture and supply of Commercial Productunder this Agreement. The Supply Committee shall also work to resolve any matter which arises between the Parties relating to theManufacture and supply of Commercial Product under this Agreement. If the Parties are unable to resolve the matter through theSupply Committee, the Parties shall refer the matter to the committee organized and operating pursuant to Section 7.7.2 of theLicense Agreement, which is responsible for the overall development, regulatory and commercialization activities of CommercialProduct under all of the Product agreements. If the License Agreement committee set out in such Section 7.7.2 is also unable toresolve the issue, then the dispute resolution mechanism set out in Section 12.6 of the License Agreement shall be applied to theissue as if such mechanism was fully set forth herein.4.5Meetings. The Supply Committee shall meet monthly by telephone or in person. Meeting agendas shall include as appropriateinformation on (a) anticipated market demand and inventory positions (including Compound inventory) and any material changes inmarket demand or inventory positions (including Compound inventory), (b) supply capability, (c) any capacity problems, unusualproduction situations, or prioritization issues, including pursuant to Clause 10.1, (d) any changes in Compound or CommercialProduct delivery or sourcing, (e) any quality related issues, (f) any proposed amendments to Batch sizes based upon forecasteddemand or changes in Product Specifications, (g) any forecast trends or proposed amendments to forecasts, and (h) any othermatters which may impact or influence the Commercial Product supply chain.4.6Costs. Each Party shall be responsible for its own costs in respect of travel and accommodation expenses in attending suchmeetings.5.FORECASTING, ORDERING AND CAPACITY5.1Forecasts. Zogenix shall provide Alkermes with good faith, written, non-binding (subject to Clause 5.4.2 and 5.4.3) forecasts ofits expected commercial requirements of the Commercial Product to be delivered as follows:5.1.1within [***] of the Effective Date, an [***] forecast, broken down on [***] basis, for the period beginning [***];5.1.2thereafter every [***] until [***], an updated forecast prepared on the same basis;5.1.3within [***], and thereafter every calendar month not later than the [***], a rolling eighteen (18) month forecast, brokendown on [***] basis for the first [***] and [***] basis for the remaining [***], for the period commencingat the beginning of the following [***] in a form substantially similar to that which is mutually agreed by theParties ("Forecast"); and5.1.4not later than [***], a [***] forecast, broken down on a [***] basis.Each Forecast made by Zogenix shall supersede any previous Forecast. Forecast quantities for any [***] shall not be less thanseventy-five percent (75%) nor more than [***] of the aggregate forecast quantity for the previous [***], without the prior writtenagreement of Alkermes. For any [***] Forecasts that exceed these limitations, Alkermes will work in good faith with Zogenixthrough the Supply Committee to fulfil, delay or cancel outstanding Purchase Orders or minimize costs, taking into considerationAlkermes’s supply chain commitments in reference to Commercial Product, other manufacturing commitments and other capacityconstraints.5.2Additional Forecast for Procurement Quota. As a consequence of the restrictions currently imposed upon the importation, use anddistribution of the Compound in and into the Territory, the Parties acknowledge the requirement to order the appropriate quantity ofCompound in sufficient time to enable the supplier of the Compound to obtain the appropriate aggregate Procurement Quota forManufacture.*** Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to theomitted portions.7In this regard, the Parties shall negotiate and mutually agree not later than [***] a forecast for the supply of Compound for the[***], broken down on [***] ("Quota Forecast"). The Quota Forecast shall be in addition to and not in substitution for theForecasts. Alkermes shall use Commercially Reasonable Efforts to procure Compound in accordance with the Quota Forecast.Zogenix shall use Commercially Reasonable Efforts to obtain sufficient quantities of Zogenix Commercial Product ProcurementQuota, if required, to accept Commercial Product manufactured by Alkermes in compliance with the then-applicable Forecast andQuota Forecast.5.3Increased Capacity. If at any time after Commercial Product launch the Forecasts exceed Alkermes' then-current Manufacturingcapacity, Alkermes and Zogenix shall meet and discuss in good faith ways in which additional Alkermes capacity may be secured tomeet the Forecasts. If the additional capacity requires Alkermes capital expenditure, then the Parties shall negotiate (a) [***] whichshall ensure the Commercially Reasonable utilisation of such capital equipment or (b) the [***], in each case, taking into accountother products which could be manufactured on such equipment. For clarity, the maintenance of then-current Manufacturingcapacity, even if the purchase of replacement capital equipment is required, shall be at Alkermes’ sole cost and expense.5.4Purchase Orders.5.4.1A "Purchase Order" is a binding order for such quantities of Commercial Product as is set out in the order. The PurchaseOrder shall include: (i) the quantity of Commercial Product to be delivered and (ii) the date on which theCommercial Product should be delivered and (iii) any other information reasonably requested by Alkermes.For clarity, once a Purchase Order has been accepted (a “Confirmed Order”), Zogenix shall be required tocompensate Alkermes pursuant to the terms of this Agreement for any Commercial Product manufacturedunder such Confirmed Order, even if Zogenix or a Zogenix third party designee is unable to accept deliveryof such Commercial Product because of insufficient Commercial Product Procurement Quota or lack of avalid DEA registration by Zogenix or Zogenix’s third party designee to receive such Commercial Product.5.4.2Validation batches that are manufactured for potential use as Commercial Product/Launch Stock shall be forecasted, ordered, delivered and paidpursuant to the terms of this Agreement. In conjunction with execution of this Agreement, Zogenix has submitted and Alkermeshas accepted and confirmed a binding Purchase Order for validation batches that may be used as Commercial Product/LaunchStock which contains a delivery date that has been mutually agreed by the Parties. For other Launch Stock (if any), Zogenix shallsubmit a binding Purchase Order in which the date for delivery of the Commercial Product specified by Zogenix shall be not lessthan [***] following acceptance of such Purchase Order by Alkermes, taking into account Available Quota.On the first business day of each [***] after First Approval, Zogenix shall submit to Alkermes a PurchaseOrder for the quantity of Commercial Product specified in the first four (4) months of the last Forecast, lessany Confirmed Orders or Launch Stock for delivery in that period. Unless otherwise agreed by Alkermes, thedate for delivery of the Commercial Product specified by Zogenix shall be not less than four (4) monthsfollowing acceptance of each Purchase Order by Alkermes.5.4.3Upon receipt of a Purchase Order Alkermes shall either accept or reject (to the extent entitled) the Purchase Order by written notification to Zogenixwithin [***] after receipt of the applicable Purchase Order. An accepted Purchase Order shall be a"Confirmed Order," subject to Alkermes’ ability to obtain sufficient Procurement Quota for Compound toManufacture such Commercial Product.5.4.4Alkermes shall be entitled to reject any Purchase Order that does not conform to Clause 5.4.1 or that part of a Purchase Order that:*** Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to theomitted portions.8(a)Exceeds in the aggregate (together with other Purchases Orders previously submitted) one hundred percent (100%) of the [***] requirementthat was forecast by Zogenix for the [***] of delivery in the Forecast submitted [***];(b)exceeds the Available Quota;(c)exceeds (or in conjunction with Confirmed Orders in the relevant period exceeds) Alkermes's then-current maximum manufacturing capacity, whichAlkermes shall have previously shared with Zogenix in a timely manner through the Supply Committee; or(d)requests partial Batches or less than a single Batch or where the total aggregate amount of Commercial Product ordered in a Purchase Order, whentaken as a whole, does not [***].If Alkermes in its absolute discretion chooses to accept a Purchase Order that Alkermes is not required to accept pursuantto this Clause 5.4.4 or that may otherwise be rejected by Alkermes in accordance with this Agreement, that fulfilment shallnot affect Alkermes's right to reject any subsequent Purchase Order that it may not be required to accept pursuant to Clause5.4.4 or that may otherwise be rejected by Alkermes in accordance with this Agreement.5.4.5The terms of this Agreement are hereby incorporated by reference into each Purchase Order submitted by Zogenix. No other terms or conditions,including any contained in a Purchase Order, shall apply to the sale and purchase of Commercial Product as between the Partiesexcept pursuant to a modification duly executed as provided in this Agreement.5.5Safety Stocks. Zogenix shall use Commercially Reasonable Efforts to build during the first [***] and thereafter to maintain aninventory of Commercial Product [***] which is not less than the equivalent of the [***] ("Safety Stocks"), subject to AvailableQuota for the Commercial Product. Zogenix shall make Forecasts consistent with this requirement and will make good faithestimates of [***]. If requested by Zogenix, Alkermes and Zogenix shall discuss in good faith the ability of Alkermes or itsAffiliates to hold Safety Stocks, the storage of such Safety Stocks being at [***].6.MINIMUM ORDER QUANTITIES6.1Minima. Manufacture of validation batches and other Launch Stock shall be in Batch sizes of not less than the minimum quantitiesset out in Schedule 3 of this Agreement or in multiples thereof and the total aggregate amount of validation batches or other LaunchStock in a single Confirmed Order, when taken as a whole, must utilize [***]. Manufacture of Commercial Product shall be inBatch sizes of not less than the minimum quantities set out in Schedule 1 of this Agreement or in multiples thereof and the totalaggregate amount of Commercial Product in a single Confirmed Order, when taken as a whole, must utilize [***]. The Parties shalldiscuss and agree other minimum Batch quantities as necessary through the Supply Committee.7.SUPPLY OF COMMERCIAL PRODUCT7.1Supply. Alkermes shall use Commercially Reasonable Efforts to supply the quantities of Commercial Product requested in eachConfirmed Order.7.2Materials. Alkermes shall be responsible for procuring all Materials at its own cost; provided that:7.2.6in the event of (i) a change in the specifications for any Materials, or (ii) expiration or termination of this Agreement, Zogenix shall bear [***] lastForecast. Alkermes shall use Commercially Reasonable Efforts to mitigate such costs;7.2.7in the event that Compound that has been ordered and paid for, or must be paid for, by Alkermes pursuant to the Quota Forecast becomes obsoletefor any reason (other than failure to meet*** Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to theomitted portions.9Product Specifications or due to Alkermes’ negligence or misconduct) prior to use, Zogenix shall [***]. Alkermes shalluse Commercially Reasonable Efforts to obtain a Procurement Quota for the Compound consistent with the then applicableQuota Forecast.7.3Packaging Materials. Zogenix shall be responsible for and shall supply Alkermes with all packaging artwork and inserts required forthe Commercial Product. Except in reference to Alkermes trademarks reviewed and approved prior to their application, Zogenixshall indemnify Alkermes for any trademark, copyright or other content claims that may be made against Alkermes arising fromsuch materials.Zogenix shall bear the cost of changing and repackaging Commercial Product to meet regulatory requirements. Zogenix may also, atits sole cost, change such artwork from time to time by reasonable notice to Alkermes and subject to having obtained all requisiteapprovals from Governmental Authorities. If Alkermes requests a change to packaging artwork and inserts to accommodate anAlkermes business need and Zogenix accepts such proposed changes, then Alkermes shall bear the cost of any such artwork andinsert changes.7.4Supply Terms. Commercial Product supplied by Alkermes to Zogenix shall:7.4.1be delivered EXW the Alkermes Facility, except with respect to validation batches and Launch Stock which shall be delivered in accordance withSection 16.2;7.4.2be free from any liens, security interests or other encumbrances on title;7.4.3conform to Product Specifications and be manufactured in accordance with applicable cGMP and other applicable law;7.4.4have consumed no more than [***] with respect to Commercial Product that has [***] or, with respect to Commercial Productthat has [***], have consumed no more than [***] provided however that (i) Zogenix may, at its option,accept Commercial Product with [***] and (ii) in circumstances where Zogenix decides to reject CommercialProduct for not meeting [***] requirements, Zogenix will discuss its reasons in good faith with Alkermesthrough the Supply Committee. This provision shall not apply to validation batches/Launch Stock as providedin Section 16.2 of this Agreement or Commercial Product that is not released by Zogenix within theturnaround time that shall be agreed and defined in the Technical Agreement;7.4.5be packed in bottles in a packaging configuration provided by Zogenix and approved (or expected to be approved) by the FDA for CommercialProduct that is ready for distribution in the Field in the Territory, or if agreed by Alkermes and Zogenix in writing, bulk packagedin a suitable manner for shipment;7.4.6be accompanied by a Certificate of Analysis for such Batch of Commercial Product; and7.4.7conform in all material respects with applicable provisions of the Technical Agreement with respect to Commercial Product.7.5Obsolete Commercial Product. In the event that Zogenix does not obtain sufficient Zogenix Commercial Product ProcurementQuota or is otherwise unable to accept delivery of Commercial Product for which there is a Confirmed Order, then Alkermes shallbe entitled to invoice and seek payment for such Commercial Product, including in-process Commercial Product, from Zogenix inaccordance with Section 16 below.7.6Responsibility After Delivery. Title shall pass on delivery of Commercial Product to Zogenix. Zogenix shall be solely responsiblefor the storage, maintenance and transportation of Commercial Product from*** Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to theomitted portions.10the time of delivery to Zogenix, and, except as set forth in Clauses 12.7 and 13.3, all risks of loss shall pass upon delivery,whether or not such delivery is accepted.7.7Notification of Loss. Zogenix shall immediately notify Alkermes of the loss or damage of any Commercial Product in transit and/orshortfall in receipt before or after transit, and fully co-operate with Alkermes with respect to providing information to the DEA tosupport a notice of loss or theft and otherwise so as to enable Alkermes to comply with its obligations with regard to ControlledSubstances. For clarity, this shall not affect the passage of risk of loss upon EXW delivery.8.CHANGE CONTROL8.1Modification of Product Specifications. Neither Party shall implement modifications to the Product Specifications without theother’s prior written request and approval. The Technical Agreement will contain processes for requesting and implementingchanges to the Product Specifications.8.2Modification of Commercial Product Process. Zogenix shall have the right to review any proposed changes specific to CommercialProduct manufacturing, testing or controls documentation in advance of their implementation, and shall have the right to approveany proposed changes which reasonably require either prior approval by any Governmental Authority or notice to any GovernmentalAuthority. Any other changes that the Parties may agree require prior Zogenix approval and the review and approval process for anychanges which require prior approval shall be set out in the Technical Agreement.8.3Change of Manufacturing Facility. Alkermes shall not change the Alkermes Facility from Gainesville (or other subsequent location)without Zogenix’s prior written consent, not to be unreasonably withheld or delayed. If Alkermes has requested a change ofAlkermes Facility, Alkermes shall bear all costs and expenses associated with such change of Alkermes Facility, including costsassociated with notice to and any approvals required from a Governmental Authority. This provision related to cost shall not applywhere Zogenix has requested a change of Alkermes Facility, in which case it shall be at Zogenix’s cost, or the Parties otherwisemutually agree to change the Alkermes Facility, in which case the Parties shall allocate costs as mutually agreed.9.VOLUNTARY SECOND SOURCE9.1Voluntary Second Source Option. If after receipt of the First Approval and if so requested in writing by Zogenix, Alkermes shalluse Commercially Reasonable Efforts to enter into the relevant contracts and to validate a second manufacturing facility, whichshall at Alkermes's option be another facility operated by Alkermes or its Affiliates, or a facility operated by a Third Party identifiedby Zogenix and agreed to by Alkermes (each, a "Second Facility"). Under no circumstances shall the owner of any such SecondFacility be a Technological Competitor or be an Affiliate of a Technological Competitor without the prior written consent ofAlkermes and provided further that Zogenix must take steps in all instances related to any Second Facility operated by a Third Partyidentified and/or used by Zogenix to ensure that Technological Competitors do not gain access, directly or indirectly, to AlkermesConfidential Information. Additionally, in the event that the Second Facility operated by a Third Party becomes a TechnologicalCompetitor, or an Affiliate of a Technological Competitor, the Second Facility must ensure that Alkermes Confidential Informationand the manufacture of Commercial Product is “Contained Within a Ring Fence” as such phrase is defined in Section 16.3.2.1 ofthe License Agreement.9.2Voluntary Second Source Technology Transfer Plan. For this purpose and provided that Zogenix has exercised its right to validate asecond manufacturing facility, Alkermes shall develop a plan of activities to enable the Second Facility to Manufacture and supplycommercial quantities of Commercial Product to Zogenix in compliance with Product Specifications. Zogenix shall be responsiblefor the reasonable costs of all such activities, including all operator charges, Third Party expenses and the costs associated11with employing Alkermes personnel to facilitate the technology transfer, which shall be invoiced to Zogenix at Alkermes's then-current FTE (full time equivalent) rate.9.3Costs of Second Facility.9.3.1Zogenix shall be responsible for any costs associated with the scale up, validation and maintenance of any Second Facility and any equipmentpurchased by Second Facility to support and facilitate the Manufacture and supply of Commercial Product from the SecondFacility; provided, however, Zogenix shall not be responsible for maintenance costs associated with unused capacity of anyAlkermes-operated Second Facility in excess of amounts forecasted in the then-applicable Forecasts.9.3.2If Commercial Product is supplied from a Second Facility operated by a Third Party, Zogenix shall make compensating payments to Alkermespursuant to Clause 16.5.9.3.3Where the Second Facility is operated by a Third Party:(a)in no event shall any supply by the Second Facility exceed (i) [***] of Zogenix’s total aggregate requirements ofCommercial Product for any [***] and, only if and when applicable, (ii) additional amounts ofCommercial Product that Zogenix is entitled to obtain from a Third Party manufacturer inaccordance with Clause 10 of this Agreement;(b)any Third Party operator of the Second Facility (“Third Party Second Facility Operator”) shall directly invoiceZogenix for any Commercial Product Manufactured by the Third Party Second Facility Operatorand Zogenix shall pay the Third Party Second Facility Operator for any such Commercial Product;and(c)Zogenix shall be solely responsible for organizing and fully reimbursing the Third Party Second Facility Operator for all Materials, equipment, licenses,and process and equipment validations required by applicable law or regulations for the Second Facility operated by aThird Party and for ensuring such Second Facility passes all inspections required to Manufacture and supply CommercialProduct through the Second Facility.9.3.4Where the Second Facility is operated by Alkermes or an Alkermes Affiliate, Zogenix shall compensate Alkermes (or its Affiliate, as directed byAlkermes) for Commercial Product supplied at [***] and any other costs incurred by Alkermes or its Affiliate inaccordance with the terms of this Agreement.10.FAILURE TO SUPPLY10.1Notification of Failure to Supply. Subject to Zogenix keeping Alkermes informed as to their inventory position, if at any timeduring the Term, Alkermes anticipates that there will be a Failure to Supply, then Alkermes shall (a) give Zogenix prompt noticethereof and (b) use Commercially Reasonable Efforts to fulfil Purchase Orders with such quantities of Commercial Product as areavailable through itself on a timely basis.10.2Failure to Supply. In the event of a Failure to Supply and subject to the terms of this Clause 10, for so long as there is a Failure toSupply, Zogenix shall be entitled to obtain its requirements of Commercial Product from the Designated Manufacturer, as defined inClause 9.1 of the License Agreement and pursuant to the provisions of the Manufacturing License granted to Zogenix in Clause 9of the License Agreement. For clarity, the Third Party Second Facility Operator may be the Designated Manufacturer.10.3Supply Resumption. When Alkermes remedies the cause of the Failure to Supply and is once again able to fulfil Zogenix'sConfirmed Orders, Alkermes shall so notify Zogenix (the "Resumption Notice") and Zogenix shall cease, or procure that theDesignated Manufacturer ceases, Manufacturing the*** Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to theomitted portions.12Commercial Product and shall resume purchasing the Commercial Product exclusively from Alkermes pursuant to the terms of thisAgreement; provided that Zogenix shall be entitled to continue to obtain Commercial Product from the Designated Manufacturerpursuant to the Manufacturing License to the extent that [***].10.4Responsibility. In manufacturing the Commercial Product pursuant to the Manufacturing License, as between Alkermes andZogenix, Zogenix shall be solely responsible for all costs, Procurement Quotas for Compound and Commercial Product, licenses,process and equipment validation required by applicable law or regulations for a Designated Manufacturer which is a Third Partyand shall, subject to Alkermes obligations set forth in Clause 10.5, take all steps reasonably necessary to enable a DesignatedManufacturer which is a Third Party to Manufacture Commercial Product.10.5Technology Transfer. In the event of (a) a Failure to Supply or (b) where the circumstances set forth in Clause 12.3.2, 12.3.3 or12.3.4 of the License Agreement apply to Alkermes but Zogenix does not terminate this Agreement, Zogenix may notify Alkermesthat it wishes to effect a technology transfer. Upon receipt of such notice (and as previously set out in the License Agreement inClause 9.4), Alkermes shall:10.5.1provide Zogenix with any technical data incorporated in the Elan Know-How, including access to the CMC Section to give effect tothe provisions of Clause 9.1 of the License Agreement and Alkermes shall promptly provide to Zogenix the documentationconstituting the required material support, more particularly practical performance and advice, shop practice, specificationsas to materials to be used and control methods; and10.5.2assist Zogenix for a period of [***] with the working up and use of the technology and with the training of Zogenixpersonnel which may be reasonably necessary in relation to the exercise of the Manufacturing License, includingreceiving Zogenix representatives in its or its Affiliates’ premises for limited periods as may be agreed upon by theParties.Zogenix shall reimburse Alkermes for any actual and reasonable costs incurred in connection with any transfer of technologypursuant to this Clause 10 within [***]. For clarity, such a transfer of technology is solely for the purposes of the ManufacturingLicense and shall not be deemed to permit Zogenix to Manufacture or obtain supplies of Commercial Product from a Third Partyother than as expressly set out in this Clause 10. By way of example, although this technology transfer permits Zogenix to effect atechnology transfer where Alkermes goes into liquidation or receivership and Zogenix decides not to terminate this Agreement, itdoes not entitle Zogenix to utilize such technology transfer or the Manufacturing License granted under the License Agreementexcept where there has been a Failure to Supply and Alkermes shall be entitled to resume supplying the Commercial Product in suchcircumstances in accordance with this Clause 10.10.6Sole Remedy For Failure to Supply. This Clause 10 and also Clauses 12.3.1 and 13.2.5 of the License Agreement solely to theextent that Alkermes is found to have materially breached Section 9.4 of the License Agreement set out Zogenix's sole andexclusive remedies in respect of Failure to Supply Commercial Product.11.STABILITY TESTING11.1Alkermes shall conduct stability testing of Commercial Product as may be required by the Regulatory Approval on the CommercialProduct or cGMP, at Alkermes’ sole cost and expense. Zogenix shall reimburse Alkermes for any additional stability testingrequested by Zogenix at Alkermes’ then-current standard pull rates, currently [***]. For clarity, expenses related to stability testingof process validation lots will be governed by the Process Transfer Plan, as set forth in Clause 16.1.12.ACCEPTANCE AND REJECTION*** Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to theomitted portions.1312.1Acceptance Procedures. Zogenix shall determine suitability for acceptance and release of Commercial Product for commercialdistribution. If the Parties agree to additional acceptance procedures in the Technical Agreement, Alkermes shall use reasonableefforts to support transfer of any or all commercial methods to a third party laboratory and to provide test samples of any lot ofCommercial Product when requested in order to establish acceptance testing ability.12.2Deficiency Notice. If Zogenix determines that the Commercial Product deviates from the Product Specifications or there are othermaterial defects in Manufacturing that make such Commercial Product unsalable (a "Deviation"), Zogenix shall give Alkermeswritten notice (a "Deficiency Notice") outlining the Deviation, including such other information reasonably necessary to identify theDeviation, within [***]. Should Zogenix fail to provide Alkermes with a Deficiency Notice within the relevant and applicable timeperiods set out earlier in this paragraph, then delivery will be deemed to have been accepted by Zogenix, and Alkermes will have noliability for any Deviations for which it has not received notice within the applicable period.12.3Counter Notice. Within [***], Alkermes may provide written notice to Zogenix (a "Deficiency Counter Notice") that it contests theexistence of a Deviation.Where Alkermes is unable to make such a determination within that period, Alkermes may within that period request such access tothe Commercial Product delivered and/or testing data and/or any other information that Zogenix may have concerning the Deviation.Zogenix shall provide such access, data and/or information, and Alkermes may serve its Deficiency Counter Notice at any time[***].Should Alkermes fail to provide Zogenix with a Deficiency Counter Notice within the relevant and applicable time periods set outearlier in this Section, then Alkermes will be deemed to have accepted the Deviation specified in the Deficiency Notice.12.4Dispute Resolution. In the event of an unresolved dispute as to the conformity of Commercial Product with Product Specifications,the Parties shall appoint an independent testing laboratory, acceptable to both Parties and subject to the confidentiality agreementsherein, to undertake the relevant analysis, which analysis shall be performed in compliance with the applicable laws of the relevantregulatory Governmental Authority, to determine whether the Commercial Product conformed or did not conform to the ProductSpecifications. The test results obtained from such laboratory shall be conclusive and binding upon the Parties except in the case offraud or manifest error. The fees and expenses of such testing shall be borne by Alkermes if it is ultimately determined that theCommercial Product failed to meet Product Specifications, or Zogenix in other cases.12.5Right to Reject. Where Alkermes does not provide a Deficiency Counter Notice in response to a Deficiency Notice alleging aDeviation, or where a dispute is resolved in Zogenix's favour pursuant to Clause 12.4 or by written agreement of the Parties, theCommercial Product in question shall be deemed rejected.12.6No Effect on Remainder of Delivery. No Deviation shall affect the delivery of any conforming part of the delivery.12.7Remedy. In respect of Commercial Product properly rejected and agreed, Alkermes shall Manufacture and deliver replacementCommercial Product as soon as practicable, but in any event within [***], subject to the availability of Materials, availableManufacturing capacity and Available Quota. Alkermes shall be responsible for its own costs of doing so, including the cost of theMaterials and costs associated with the Manufacture and supply of replacement of such Commercial Product to Zogenix (includingreasonable Third Party costs incurred by Zogenix in connection with Zogenix receiving such replacement Commercial Product)and, for clarity, Zogenix shall not pay an Initial Fee or Final Fee with respect to any properly rejected Commercial Product untilsuch time as Zogenix accepts the*** Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to theomitted portions.14replacement Commercial Product. In the event that Alkermes is unable to deliver replacement Commercial Product within such[***], Alkermes shall [***].In the absence of fraud or willful misconduct by Alkermes, this Clause 12 sets out Zogenix’s sole remedies in respect of CommercialProduct delivered by Alkermes but not yet sold by Zogenix to a Third Party which Commercial Product does not conform to ProductSpecifications. Remedies and liabilities for Commercial Product sold by Zogenix to a Third Party shall be governed exclusively by the termsof Clause 13 below.13.ADVERSE EVENTS AND PRODUCT RECALL13.1Adverse Events and Safety Reporting. Each Party shall, in accordance with the timing and procedures set forth in the TechnicalAgreement, give the other Party written notice of:13.1.1any matter arising out of this Agreement that must be reported by such other Party to a regulatory Governmental Authority;13.1.2any complaint about the quality or safety of Commercial Product supplied by Alkermes or which may reasonably affect the other Party's activitiesunder this Agreement;The Technical Agreement shall set out the detailed procedures regarding the format, timing, responsibilities and content of noticesunder this Clause 13.1.13.2Zogenix's Discretion to Recall. If either Party is notified by a Governmental Authority that a recall, market withdrawal, stockrecovery or other corrective action related to Commercial Product in the Territory (collectively a “Recall”) is required, requested orotherwise advisable, it shall promptly notify the other Party in writing of such notification. In circumstance where such anotification has been made or, alternatively if Zogenix establishes a need to conduct a Recall, Zogenix shall have sole discretion(except where required to take an action by Governmental Authorities) over whether and under what circumstances to require aRecall. Zogenix shall be responsible for coordinating Recalls and for ensuring that such activities are conducted in a commerciallyreasonable manner and Alkermes shall afford Zogenix reasonable assistance in conducting any such activities.13.3Recall Costs.13.3.1Except as provided in Section 13.3.2, Zogenix shall bear all costs of any Recall. Alkermes shall not invoice Zogenix for the cost of any internalAlkermes activities associated with such Recall but shall be entitled to invoice Zogenix for all other reasonable costs.13.3.2In circumstances where:(a)Commercial Product Recall arises from (a) Alkermes failure (or its Affiliate’s failure) to supply Commercial Product in accordance with ProductSpecifications and cGMP, (b) the negligent acts or omissions of Alkermes (or its Affiliate) in Manufacturing theCommercial Product or (c) from Alkermes breach of this Agreement, including without limitation Clause 7.4 with respectto such Commercial Product; and also that(b)Zogenix could not have discovered such failure or acts or omissions prior to the sale of such Commercial Product by exercising reasonable diligence;Zogenix shall consult with Alkermes prior to implementing any Recall plan and Alkermes shall [***]. Zogenix costs shallnot include costs of any internal Zogenix activities associated with such Recall for which Zogenix shall not seekreimbursement. If Alkermes does not [***], Alkermes shall, at Zogenix’s option, [***]. Where the Recall is a multipleBatch Recall, the Parties shall discuss and agree on the specific Batches to be recalled. For*** Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to theomitted portions.15clarity, Zogenix may deliver more than one notification to Alkermes pursuant to this Clause 13.3.2 with respect to a singleRecall.14.REGULATORY MATTERS14.1Alkermes. As provided in Clause 6.1 of the License Agreement, Alkermes shall own, and shall be responsible at its own expense,for filing for and maintaining all necessary approvals to operate the Alkermes Facility as a cGMP manufacturing site.14.2DMF. In accordance with Clauses 6.1 and 6.6 of the License Agreement, Alkermes owns and shall be responsible, at its ownexpense, for filing and for maintaining the DMF. Pursuant to Clause 6.5 of the License Agreement, Alkermes has granted toZogenix reference rights under such DMF in respect of Regulatory Applications in the Territory.14.3Zogenix. Except as provided in Clauses 14.1 and 14.2 of this Agreement and as provided in Clause 6.2 of the License Agreement,Zogenix shall own and shall be responsible for filing for and maintaining all necessary Regulatory Approvals in the Territory inrespect of the Commercial Product and Zogenix shall provide Alkermes access to and use of such materials in accordance withClause 6.6 of the License Agreement.14.4Cooperation. Clause 6.3 of the License Agreement is hereby incorporated in its entirety by this reference.14.5Governmental Inspection. Each Party shall notify the other Party as soon as practicable of any notification received from the FDAin connection with conduct of a cGMP inspection of facilities in relation to the Commercial Product. Each Party shall promptlyprovide to the other Party copies of all correspondence with the FDA related to the Manufacture or supply of Commercial Productin the Territory.14.6Right to Inspect. Alkermes shall procure that such portion of the facility where the Commercial Product is manufactured, tested orstored by or on behalf of Alkermes, including all record and reference samples, are made available for inspection:14.6.1by Zogenix's duly qualified employees upon reasonable notice or, alternatively, by an agent or consultant (who has been retained by Zogenix toconduct such activity) upon reasonable notice, provided however that any such agent or consultant is bound by writtenconfidentiality provisions no less strict that those set out herein. Zogenix may exercise its rights under this Clause 14.6.1 toinspect the Alkermes Facility once in any calendar year utilising no more than two (2) inspectors during a single visit or on a “forcause” basis to investigate or resolve specific issues relating to the Manufacture of the Commercial Product at the AlkermesFacility; or14.6.2by the relevant Governmental Authority.14.7Cure of Deficiencies. Each Party shall be responsible for correcting any deficiencies associated with the activities for which it isresponsible under this Agreement or the License Agreement and identified by the FDA in the course of any inspection or audit.15.INTELLECTUAL PROPERTYThe terms of the License Agreement apply in respect of the ownership, prosecution, enforcement, defence and use of intellectual propertyrights under this Agreement.16.FINANCIAL PROVISIONS16.1Process Transfer Plan Activities. Zogenix shall compensate Alkermes for the costs of the activities specified in the ProcessTransfer Plan and all other activities directed to scale-up, optimisation, and*** Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to theomitted portions.16validation which may be invoiced and paid in accordance with fixed fees, timing and milestones agreed by the Parties in the ProcessTransfer Plan, workplans and the Development and Services Agreement.16.2Manufacturing – Validation Batches and Launch Stocks. Alkermes shall be entitled to partially invoice Zogenix for any validationbatches or other Launch Stock ordered by Zogenix pursuant to a Confirmed Order that is manufactured and held in bulk capsuleform by Alkermes prior to First Approval. Partial payments shall be invoiced at the time Alkermes delivers to Zogenix an appropriateCertificate of Analysis for such validation batch/other Launch Stock (which establishes that the validation batch/other LaunchStock have been manufactured and are being held by Alkermes in bulk form). These partial payment fees shall be invoiced per itemof validation batch/other Launch Stock as set out in Schedule 3. Partial payments made on validation batches/other Launch Stockinvoices shall be [***] irrespective of whether or when such the validation batch/other Launch Stock is delivered to Zogenix. TheParties shall also conduct a True-Up on all validation batches/other Launch Stock delivered before or at the time of launch to [***]as set forth in Clause 16.4 below (which, for clarity, shall be equivalent to [***] with the initial fee referred to in that section beingequal to the partial payment set forth above in this paragraph. In circumstances where Commercial Product is not delivered or thevalidation batches/other Launch Stock becomes obsolete prior to the time that any Regulatory Approval is obtained in the Territoryto facilitate delivery, the partial payment set out above in this paragraph shall be deemed the price of such validation batch/otherLaunch Stock, and no further payment shall be due. For clarity, validation batches/other Launch Stock with [***] at the time ofFirst Approval may be deemed obsolete by Zogenix.16.3Manufacturing – Initial Fee for Commercial Product other than Validation Batches and Launch Stock. [***] after the delivery ofCommercial Product (other than validation batches/other Launch Stock) which meets the requirements of Clause 7.4 or whichZogenix nonetheless accepts for delivery, Zogenix shall pay Alkermes the initial fee for such delivery, being [***] in effect duringthe [***] of scheduled delivery multiplied [***] (the "Initial Fee").16.4Final Fee True-Up. Upon provision of the Statement referred to in Clause 11.1 of the License Agreement, Zogenix shalladditionally deliver to Alkermes a statement setting out (i) [***] ("Final Fee"), and:16.4.3if the Final Fee exceeds the Initial Fee applicable to the Commercial Product delivered, Zogenix shall within [***] pay to Alkermesthe difference;16.4.4if the Initial Fee applicable to the Commercial Product delivered exceeds the Final Fee, Alkermes shall within [***] issue to Zogenix[***].16.4.5Except as provided in Clause 16.2 with respect to validation batches and Launch Stock, if for whatever reason the Commercial Product supplied byAlkermes to Zogenix which meets the requirements of Clause 7.4 when delivered to Zogenix is not sold by Zogenix, payment toAlkermes shall none-the-less be effected and the price for such Commercial Product shall be determined by reference to the[***] calculated pursuant to the provisions of this Clause.16.4.6An example of supply price calculations is set out in Schedule 2.16.5Compensating Payment for Third Party Second Source Supply.16.5.1In respect of all Commercial Product purchased from a Third Party Second Facility Operator pursuant to Clause 9, Zogenix shall make acompensating payment to Alkermes calculated [***].16.5.2Such compensating payment shall be made in respect of a particular [***] at the time of provision of the Statement, based on[***]. The Parties shall adjust their account as of the end of each [***] by Zogenix paying Alkermes, or byAlkermes crediting Zogenix (as the case may be),*** Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to theomitted portions.17the difference between the sum paid pursuant to Clause 16.5.1 and the actual payment calculated on the basis of [***]calculated at the end of the [***], or such other period as may be agreed by the Parties in writing.16.5.3For clarity, such compensating payment shall not be made with respect to Commercial Product purchased from the Designated Manufacturer duringa Failure to Supply pursuant to Clause 10 (Failure to Supply) or if the Second Facility is an Affiliate Voluntary Second SourceFacility.16.6Floor Price. Notwithstanding any other provisions set out in this Clause 16, under no circumstances shall Alkermes be obliged tosupply the Commercial Product for [***]. Accordingly the Initial Fee shall be not [***], no adjustment under Clause 16.4 shallreduce the supply price below [***].16.7VAT. All fees are exclusive of VAT, for which Zogenix will be additionally liable, if payable.16.8Sales and use tax. Prior to the supply of Commercial Product by Alkermes to Zogenix, Zogenix shall supply a sales and use taxexemption certificate to Alkermes. In the absence of such a certificate, sales and use tax may be charged by Alkermes to Zogenixon supplies of Commercial Product to Zogenix.16.9Manner of Payment, Interest and Correction of Discrepancies. The provisions of Clauses 11.6, 11.7 and 11.9 of the LicenseAgreement shall apply mutatis mutandis.16.10Audit. Each Party shall keep full, true and accurate books of account containing all particulars that may be necessary for thepurpose of showing the amounts payable hereunder. Such books of account and supporting data shall be kept at each Party’sprincipal place of business and shall be open, at all reasonable times and upon reasonable notice and subject to the confidentialityprovisions as contained in this Agreement during the Term [***], to the inspection of the other Party or the other Party’s independentcertified accountants (reasonably acceptable to the audited Party), for the sole purpose of verifying the accuracy and reasonablecomposition of the calculations under this Agreement, provided however that such examination shall not take place more often than[***] and shall not cover more than the preceding [***], with no right to audit any period previously audited.16.11Net Sale Deductions. Zogenix shall use good faith efforts to estimate and/or calculate Net Sales deductions when calculatingpayments due under this Agreement and the License Agreement. Estimates and actual deductions shall be shared [***] withAlkermes and reviewed [***]. If requested by Alkermes, the Parties shall (no more than once per year) meet in person to discusssuch estimates and actual deductions at Zogenix offices.17.DURATION AND TERMINATION17.1Term. This Agreement shall be deemed to have come into force on the Effective Date and shall continue in force until the expiry ortermination of the License Agreement (the "Term").17.2Termination for Breach. Either Party will be entitled forthwith to terminate this Agreement by written notice to the other Party if thatother Party commits a material breach of any of the provisions of this Agreement, and fails to cure the same within sixty (60) daysafter receipt of a written notice from the other Party giving full particulars of the breach and requiring it to be remedied; provided,that if the breaching Party has proposed a course of action to cure the breach and is acting in good faith to cure same but has notcured the breach by the sixtieth (60th) day, such period shall be extended by such period as is reasonably necessary to permit thebreach to be cured, provided that such period shall not be extended by more than ninety (90) days, unless otherwise agreed inwriting by the Parties. Notwithstanding the foregoing, if the alleged breaching Party disputes by written notice to the non-breachingParty such material breach in good faith within sixty (60) days of receipt of the notice described above, the non-breaching Partyshall not have the right to terminate unless it has been determined through the application of the dispute resolution mechanisms setout in Clause 12.6 of the License*** Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to theomitted portions.18Agreement that this Agreement was materially breached and the breaching Party fails to thereafter to cure such material breach withinsixty (60) days of the decision of the arbitrators. The right to terminate shall be in addition to and not in substitution for any otheravailable remedy at law or equity.1918.CONSEQUENCES OF TERMINATION/EXPIRY18.1General Consequence. Upon expiry or the exercise of those rights of termination specified in Clause 17, this Agreement shall,subject to Clause 18.2 automatically terminate forthwith and be of no further legal force or effect.18.2Specific Consequences. Upon expiry or termination of this Agreement by either Party, the following shall be the consequences:18.2.7any payments outstanding to Alkermes shall be made within [***];18.2.8in respect of any unbilled activities under any Process Transfer Plan, Alkermes shall be entitled to raise an invoice forthwith and Zogenixshall pay such invoice within [***] with any supporting documentation;18.2.9Subject to Section 13.2.4.6 of the License Agreement, Alkermes shall be entitled, but not obliged, to complete any Confirmed Orders then-outstanding and to receive payment for them accordingly;18.2.10the rights of inspection and audit shall continue in force for the period referred to in the relevant provisions of this Agreement; and18.2.11the following provisions shall additionally survive expiry or termination, namely:(a)Clause 1 (definitions and interpretation);(b)Clause 3.3 (inherent uncertainties);(c)Clause 4.6 (costs);(d)Clause 7.2 (Materials) as stated therein;(e)Clauses 10.6 with respect to remedies for Failure to Supply;(f)Clause 12 (acceptance and rejection) insofar as it applies to Commercial Product delivered prior to expiry or termination or pursuant to Clause18.2.3, provided that Alkermes shall not under any circumstances have the obligation to Manufacture any replacement CommercialProduct, and in respect of Commercial Product properly rejected and agreed, Zogenix's remedy shall be that its payment obligation inrespect of such delivery shall be reduced correspondingly;(g)Clause 13 (adverse events and product recall);(h)Clause 15 (intellectual property) insofar as that provision survives the expiration or termination of the License Agreement;(i)Clause 16 (financial provisions) insofar as it applies to Commercial Product delivered prior to expiry or termination or pursuant to Clause 18.2.3;(j)Clause 18 (consequences of termination);(k)Clause 19 (representations, warranties, indemnification and liability);(l)Clause 20 (confidentiality)(m)Clause 22 (force majeure); and*** Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to theomitted portions.20(n)Clause 23 (general)(o)together with any other provision of this Agreement which, by its nature, is intended to continue after expiry or termination.19.REPRESENTATIONS, WARRANTIES, INDEMNIFICATION AND LIABILITY19.1Mutual Warranties. Alkermes and Zogenix represent and warrant to each other as of the Effective Date, as follows:19.1.12It has the right to enter into this Agreement.19.1.13There are no agreements between it and any Third Party that conflict with this Agreement.19.1.14No consent, approval, authorization or order of any court or governmental agency or body or Third Party is required for the execution anddelivery of this Agreement.19.1.15It is not debarred and will not knowingly use in any capacity under this Agreement any person debarred under Section 306(a) or (b) of theU.S. Generic Drug Enforcement Act of 1992, as amended, or any comparable law of the EU or an ICH confirming country.19.1.16EXCEPT AS EXPRESSLY SET FORTH IN THIS AGREEMENT, NEITHER PARTY MAKES ANY REPRESENTATIONS OREXTENDS ANY WARRANTIES OF ANY KIND, EITHER EXPRESS OR IMPLIED, INCLUDING BUT NOT LIMITEDTO WARRANTIES OF MERCHANTABILITY, FITNESS FOR A PARTICULAR PURPOSE OR NON-INFRINGEMENTWHETHER ARISING UNDER STATUTE OR OTHERWISE, AND ALL SUCH REPRESENTATIONS ANDWARRANTIES ARE HEREBY DISCLAIMED.19.2Mutual Indemnification. Except as otherwise provided in this Clause 19, each of the Parties shall indemnify and hold harmlessthe other Party and its Affiliates and each of their officers, directors, employees, agents and consultants from and against any andall Claims by a Third Party insofar as they arise out of any material breach by the first Party of its warranties under this Agreementor from fraud or wilful misconduct under this Agreement that is conducted by or on behalf of the first Party, except in each caseto the extent due to the fraud or wilful misconduct of the other Party seeking the indemnification or such other Party’s Affiliates,officers, directors, employees, agents or consultants.19.3Zogenix Indemnity. Zogenix shall indemnify and hold harmless Alkermes and its Affiliates and each of their officers, directors,employees, agents and consultants (“Alkermes Indemnitees”) from and against any and all Claims (i) arising from themanufacture, storage, use or diversion of the Commercial Product, marketing, sale, use or promotion of the Commercial Product,in each case in the Territory, (ii) by Third Parties for personal injury (including death) and/or for costs of medical treatmentcaused by or attributed to the use of the Commercial Product supplied to Zogenix under this Agreement, and/or (iii) otherwisearising out of this Agreement and not otherwise provided for in this Clause 19. Notwithstanding the foregoing, Zogenix shall notbe required to indemnify and hold harmless Alkermes Indemnitees with respect to any Claim to the extent that the same is coveredby Alkermes’s indemnification obligations in Clause 19.2 and/or Clause 19.4.19.4Alkermes Indemnity. Alkermes shall indemnify and hold harmless Zogenix and its Affiliates and each of their officers, directors,employees, agents and consultants (“Zogenix Indemnitees”) from and against any and all Claims by Third Parties for personalinjury (including death) and/or for costs of medical treatment solely to the extent caused by the failure of any CommercialProduct supplied by Alkermes to conform to Sections 7.4.3 and 7.4.5 which Zogenix could not have discovered by exercisingreasonable diligence. Notwithstanding the foregoing, Alkermes shall not be required toindemnify and hold harmless Zogenix Indemnitees with respect to any Claim to the extent that the same is covered by Zogenix’sindemnification obligations in Clause 19.2 and/or Clause 19.3.19.5Conduct of Claims. The Party seeking an indemnity shall:19.5.1fully and promptly notify the other Party of any claim or proceedings, or threatened claim or proceedings;19.5.2permit the indemnifying Party to take full control of such claim or proceedings, with counsel of the indemnifying Party's choice, providedthat the indemnifying Party shall reasonably and regularly consult with the indemnified Party in relation to the progress andstatus of such claim or proceedings;19.5.3fully co-operate in the investigation and defense of such claim or proceedings at the indemnifying Party’s expense; and19.5.4take all reasonable steps to mitigate any loss or liability in respect of any such claim or proceedings.The indemnifying Party may settle a Claim on terms which provide only for monetary relief and do not include any admission of liability.Save as aforesaid, neither the indemnifying Party nor the Party to be indemnified shall acknowledge the validity of, compromise or otherwisesettle any Claim without the prior written consent of the other, which shall not be unreasonably withheld, conditioned or delayed.19.6Limitations of Liability.19.6.1Alkermes’s total aggregate liability in respect of any Recall costs arising out of Clause 13.3.2 shall not under any circumstances exceed[***], which for clarity [***] (“Recall Costs”).19.6.2Except with respect to Alkermes liability arising from Alkermes’s fraud or wilful misconduct, Alkermes's total aggregate liability arising outof this Agreement shall be as follows:(a)for all claims filed during the Term of this Agreement during [***], Alkermes total annual aggregate liability shall not exceed [***];provided that this limitation shall not apply so as to limit Recall Costs that may be recovered by Zogenix under Clause19.6.1; provided further that such Recall Costs shall count for purposes of computing the cap under this Clause 19.6.2(By way of illustration, if Recall Costs are [***]; and(b)Alkermes shall have no liability for any claims filed following the termination or expiration of this Agreement except with respect to Third Partypersonal injury claims filed within [***] of the expiration or termination of this Agreement. With respect to Third Party personalinjury claims filed within this [***], Alkermes’s total aggregate liability shall be calculated and capped on a [***], with each[***] ending respectively on the [***] of the expiration or termination of the Agreement. For each of these [***], Alkermestotal aggregate liability for any Third Party personal injury claims filed during that [***] shall not exceed [***] of the [***]during the [***] immediately preceding the expiration or termination of this Agreement.19.7Exclusion of Consequential and Other Losses. Without prejudice to the obligation of either Party to indemnify the other in respectof claims by Third Parties, notwithstanding anything to the contrary in this Agreement, Alkermes and Zogenix shall not be liableto the other by reason of any representation or warranty, condition or other term of any duty of common law or under the expressterms of this Agreement, for any indirect, consequential, special, incidental or punitive loss or damage (whether by way ofexample for loss of current profits, loss of enterprise value, loss of anticipated savings, loss of business opportunity, loss ofgoodwill or otherwise) and whether occasioned by the negligence of the respective Parties, their employees or agents or otherwise.*** Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to theomitted portions.2219.8Extension of Indemnification. Where this Agreement provides for the indemnification of a Party to this Agreement or for theexclusion or limitation of a Party's liability, such indemnification and/or exclusion and/or limitation (as the case may be) shall alsoapply for the benefit of such Party's Affiliates and the employees, officers, directors and agents of any of them, acting in suchcapacity.19.9Construction. For clarity, the provisions of Clauses 19.6 (limitation of liability), 19.7 (exclusion of consequential and other losses)and 19.8 (extension of indemnification) shall apply notwithstanding any contrary provision of this Agreement and shall becumulative.19.10Insurance. Zogenix shall maintain insurance consistent with the requirements set forth in Clause 14.13 of the License Agreement.Alkermes shall maintain comprehensive general liability insurance which is consistent with industry standards and which includesproduct liability insurance on the Commercial Product for the duration of this Agreement and for such period thereafter asnecessary to cover the insured risks.20.CONFIDENTIALITY20.1The provisions of Clause 15 of the License Agreement shall apply mutatis mutandis.21.ASSIGNMENT, SUBCONTRACTING21.1Agreement” in such provisions shall apply herein to this Agreement.22.FORCE MAJEURE22.1No Party hereto shall be liable to the other Party for any losses or damages attributable to a default in or breach of this Agreementwhich is the result of any cause beyond the reasonable control of such Party, including but not limited to war (whether declared orundeclared), acts of God, revolution, terrorism, civil commotion, strike or labor disruption, fire, earthquake, flood, pestilence,explosion, riot, enactment or change of laws and regulations, accident(s), or labor trouble (each, a “Force Majeure Event”). If aForce Majeure Event prevents or delays performance by a Party of any obligations under this Agreement, then the Party claiming theForce Majeure Event shall promptly notify the other Party in writing. The Parties shall thereafter, as soon as practicable, discusshow best to continue their operations in accordance with this Agreement and shall thereafter continue such discussions on a regularbasis while the Force Majeure Event continues. The performance of obligations hereunder shall be suspended during, but no longerthan, the existence of such Force Majeure Event and only if reasonably required by the Force Majeure Event. The Party affected bythe Force Majeure Event shall use all reasonable efforts to avoid, minimize or remove the cause of such delay or non-performanceand to mitigate its effects and shall continue performance with due dispatch whenever such causes are removed. In the event that aForce Majeure Event prevents performance of this Agreement by a Party for [***], the Party which is not experiencing the ForceMajeure Event shall be entitled to terminate this Agreement by written notice to the other provided it has complied with its obligationsunder this Clause 22.23.GENERAL23.1No Third Party Beneficiaries. Each of the Parties enters into this Agreement on its own behalf and not on behalf of any otherperson or entity.23.2Parties Bound. This Agreement shall be binding upon and run for the benefit of the Parties, their successors and permitted assigns.23.3Relationship of the Parties. In this Agreement, nothing shall be deemed to constitute a partnership between the Parties or makeeither Party an agent for the other, for any purpose whatsoever.*** Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to theomitted portions.2323.4Entire Agreement. This Agreement and the License Agreement constitutes the entire agreement and understanding between theParties with respect to their subject matter. In the event of a conflict between the License Agreement and this Agreement, theLicense Agreement shall prevail. Except with respect to the License Agreement, this Agreement supersedes all priorrepresentations, writings, negotiations and understandings with respect to the supply and manufacture of Commercial Product.The Parties acknowledge that, in entering into this Agreement, they have not relied on, and shall have no right or remedy in respectof, any statement, representation, assurance or warranty (whether made negligently or innocently) other than as expressly setforth in this Agreement. Nothing in this clause shall limit or exclude any liability for fraud.23.5Severability. If any provision in this Agreement is deemed to be, or becomes invalid, illegal, void or unenforceable underapplicable laws, such provision will be deemed amended to conform to applicable laws so as to be valid and enforceable, or if itcannot be so amended without materially altering the intention of the Parties, it will be deleted, but the validity, legality andenforceability of the remaining provisions of this Agreement shall not be impaired or affected in any way.23.6thing reasonably within its power to implement this Agreement.23.7Due Execution. This Agreement shall not become effective until each Party has executed a counterpart and exchanged it with theother Party. Exchange by fax or by e-mail attaching an executed copy of this Agreement in Adobe Portable Document Format(PDF) will be considered valid.23.8Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be considered an original andwhich together shall constitute this Agreement.23.9Waivers. A failure to exercise or delay in exercising a right or remedy provided by this Agreement or by law does not constitute awaiver of the right or remedy or a waiver of other rights or remedies. No single or partial exercise of a right or remedy providedby this Agreement or by law prevents further exercise of the right or remedy or the exercise of another right or remedy. No waiverof any right under this Agreement shall be deemed effective unless contained in a written document signed by the Party chargedwith such waiver.23.10Variations. No modification, amendment, or waiver of any provision of this Agreement shall be valid unless in writing and signedby a duly authorised officer or representative of each of the Parties hereto.23.11Notices.23.11.1A notice under or in connection with this Agreement (a "Notice"):(a)shall be in writing; and(b)may be delivered personally or sent by internationally recognized overnight courier or by fax to the Party due to receive the Notice at its address setout below:23.11.2The address referred to in Clause 23.11.1 is:(a)in the case of Alkermes:Address: Alkermes Pharma Ireland LimitedConnaught House1 Burlington RoadDublin 4Ireland24Tel: +353 1 772 8000Fax: +353 1 772 8001Marked for the attention of: Company Secretarywith a copy (receipt of which shall not constitute notice) to:VP, Alliance ManagementSame contact details as above(b)in the case of Zogenix:Address: 12400 High Bluff Drive, Ste 650San Diego, California, 92130United States of AmericaFax: +1 (858) 259-1166Marked for the attention of: Chief Financial Officerwith a copy (receipt of which shall not constitute notice) to:Address: Latham & Watkins LLP12636 High Bluff Drive, Suite 400San Diego, California 92130USAFax: +1 (858) 523-5450Marked for the attention of: Faye H. Russell, Esq.23.11.3Notice is deemed given:23.11.4if delivered personally, when the person delivering the notice obtains the signature of a person at the address referred to in Clause 23.11.223.11.5if sent by overnight courier, two (2) business days after posting it;23.11.6if sent by fax, when confirmation of its transmission has been recorded by the sender's fax machine.23.12Governing Law and Jurisdiction. This Agreement shall be governed by and construed in accordance with the laws of the State ofNew York, without regard to its conflict of laws principles, and shall be subject to the exclusive jurisdiction of the State andFederal Courts located in New York, New York.***25Schedule 1 COMMERCIAL PRODUCT COVERED BY THIS AGREEMENTDosage Strengths and Batch Sizes*Dosage StrengthInitial Batch Size (capsules)Optimized Batch Size(capsules)[***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***]*Initial Batch Sizes shall apply to all Purchase Orders for Commercial Product under this Agreement from the Effective Date of this Agreement untilZogenix’s [***] is projected to exceed on [***] per [***] for the forecast period [***] in the future or the Parties otherwise agree to move toOptimized Batch Sizes. Thereafter, Optimized Batch Sizes shall apply to all Purchase Orders unless otherwise agreed by the Parties in circumstancesrelating to any [***] following [***] in which [***].**Depending upon the sales forecast for the [***], the Optimized Batch Sizes for [***] will be mutually established as the [***]. For further clarity,Optimized Batch Size may be established as the following approximate capsule quantities for the [***].*** Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to theomitted portions.26Schedule 2 PRICE CALCULATION; TRUE-UP[***].*** Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to theomitted portions.27Schedule 3 Validation batches and other Launch StockDosage Strengths, Batch Sizes and Initial Fee Payments[***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***][***]Note: The total fee for validation batches and other Launch Stock deemed commercially saleable is [***]. The partial fees set out above will be trued-up for such Batches to [***] in accordance with Section 16 of this Agreement. Note also that the “Total cost” in the Validation Batch Fee table abovedoes not include amounts due under the Development and Clinical Supply Agreement.*See Clause 6.1 for limitations on Confirmed Order and Purchase Order Batch sizes.*** Certain information on this page has been omitted and filed separately with the Commission. Confidential treatment has been requested with respect to theomitted portions.28EXECUTED by the Parties on the date appearing at the top of page 1.SIGNED_/s/ Shane Cooke___________________Duly authorized for and on behalf ofALKERMES PHARMA IRELAND LIMITEDSIGNED_/s/ Roger L. Hawley________________Duly authorized for and on behalf ofZOGENIX, INC.Exhibit 10.33EMPLOYMENT AGREEMENTTHIS EMPLOYMENT AGREEMENT (this “Agreement”) is entered into by and between Zogenix, Inc., a Delawarecorporation (the “Company”), and Richard Scott Shively (“Executive”), and shall be effective as of the date on which Executivecommences employment with the Company, which date shall be no later than November 26, 2012 (the “Effective Date”).WHEREAS, the Company desires to continue to employ Executive, and Executive desires to commence employment withthe Company, on the terms and conditions set forth in this Agreement.NOW, THEREFORE, in consideration of the mutual promises herein contained, the parties agree as follows:1.Definitions. As used in this Agreement, the following terms shall have the following meanings:(a)Board. “Board” means the Board of Directors of the Company.(b)Bonus. “Bonus” means an amount equal to the average of the bonuses awarded to Executive for each of thethree (3) fiscal years prior to the date of Executive’s termination of employment, or such lesser number of years as may be applicable ifExecutive has not been employed for three (3) full years on the date of Executive’s termination of employment. For purposes ofdetermining Executive’s “Bonus,” to the extent Executive received no bonus in a year due to a failure to meet the applicableperformance objectives, such year will still be taken into account (using zero (0) as the applicable bonus) in determining Executive’s“Bonus” for purposes of Section 4. Further, for any year in which the Executive received less than the Executive’s maximum potentialbonus because the Executive’s employment with the Company began after January 1 of that year, the bonus for that year shall beannualized as part of the Bonus calculation hereunder. If any portion of the bonuses awarded to Executive consisted of securities or otherproperty, the fair market value thereof shall be determined in good faith by the Board. In no event will Executive’s signing bonuspursuant to Section 3(c) below constitute a “Bonus” for purposes of this definition.(c)California WARN Act. “California WARN Act” means California Labor Code Sections 1400 et seq.(d)Cause. “Cause” means any of the following:(i)the commission of an act of fraud, embezzlement or dishonesty by Executive, or the commission ofsome other illegal act by Executive (other than traffic violations or other offenses or violations outside of the course of Executive’semployment), that has a demonstrable material adverse impact on the Company or any successor or affiliate thereof;(ii)a conviction of, or plea of “guilty” or “no contest” to, a felony by Executive;SD\1213749.2(iii)any unauthorized use or disclosure by Executive of confidential information or trade secrets of theCompany or any successor or affiliate thereof that has, or may reasonably be expected to have, a material adverse impact on any suchentity;(iv)Executive’s gross negligence, insubordination or material violation of any duty of loyalty to theCompany or any successor or affiliate thereof, or any other demonstrable material misconduct on the part of Executive;(v)Executive’s ongoing and repeated failure or refusal to perform or neglect of Executive’s duties asrequired by this Agreement, which failure, refusal or neglect continues for thirty (30) days following Executive’s receipt of writtennotice from the Board or the Company’s Chief Executive Officer (the “CEO”) stating with specificity the nature of such failure,refusal or neglect; or(vi)Executive’s breach of any Company policy or any material provision of this Agreement;provided, however, that prior to the determination that “Cause” under this Section 1(d) has occurred, the Company shall (A) provide toExecutive in writing, in reasonable detail, the reasons for the determination that such “Cause” exists, (B) other than with respect toclause (v) above which specifies the applicable period of time for Executive to remedy his or her breach, afford Executive a reasonableopportunity to remedy any such breach, (C) provide the Executive an opportunity to be heard prior to the final decision to terminate theExecutive’s employment hereunder for such “Cause” and (D) make any decision that such “Cause” exists in good faith.The foregoing definition shall not in any way preclude or restrict the right of the Company or any successor or affiliatethereof to discharge or dismiss Executive for any other acts or omissions, but such other acts or omissions shall not be deemed, forpurposes of this Agreement, to constitute grounds for termination for Cause.(e)Change in Control. “Change in Control” means and includes each of the following:(i)a transaction or series of transactions (other than an offering of the Company’s common stock to thegeneral public through a registration statement filed with the Securities and Exchange Commission) whereby any “person” or related“group” of “persons” (as such terms are used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended (the“Exchange Act”)) (other than the Company, any of its subsidiaries, an employee benefit plan maintained by the Company or any of itssubsidiaries or a “person” that, prior to such transaction, directly or indirectly controls, is controlled by, or is under common controlwith, the Company) directly or indirectly acquires beneficial ownership (within the meaning of Rule 13d-3 under the Exchange Act),of securities of the Company possessing more than fifty percent (50%) of the total combined voting power of the Company’s securitiesoutstanding immediately after such acquisition; or(ii)the consummation by the Company (whether directly involving the Company or indirectlyinvolving the Company through one or more intermediaries) of (A) a merger, consolidation, reorganization, or business combination or(B) a sale or other disposition 2SD\1213749.2of all or substantially all of the Company’s assets in any single transaction or series of related transactions or (C) the acquisition of assetsor stock of another entity, in each case other than a transaction:(1)which results in the Company’s voting securities outstanding immediately before thetransaction continuing to represent (either by remaining outstanding or by being converted into voting securities of the Companyor the person that, as a result of the transaction, controls, directly or indirectly, the Company or owns, directly or indirectly, allor substantially all of the Company’s assets or otherwise succeeds to the business of the Company (the Company or suchperson, the “Successor Entity”) directly or indirectly, at least a majority of the combined voting power of the SuccessorEntity’s outstanding voting securities immediately after the transaction, and(2)after which no person or group beneficially owns voting securities representing fifty percent(50%) or more of the combined voting power of the Successor Entity; provided, however, that no person or group shall betreated for purposes of this clause (2) as beneficially owning fifty percent (50%) or more of combined voting power of theSuccessor Entity solely as a result of the voting power held in the Company prior to the consummation of the transaction. Notwithstanding the foregoing, a transaction shall not constitute a “Change in Control” if: (i) its sole purpose is to change thestate of the Company’s incorporation; (ii) its sole purpose is to create a holding company that will be owned in substantially the sameproportions by the persons who held the Company’s securities immediately before such transaction; (iii) it constitutes the Company’sinitial public offering of its securities; or (iv) it is a transaction effected primarily for the purpose of financing the Company with cash (asdetermined by the Board in its discretion and without regard to whether such transaction is effectuated by a merger, equity financing orotherwise). The Board shall have full and final authority, which shall be exercised in its discretion, to determine conclusively whether aChange in Control of the Company has occurred pursuant to the above definition, and the date of the occurrence of such Change inControl and any incidental matters thereto.(f)Code. “Code” means the Internal Revenue Code of 1986, as amended from time to time, and the TreasuryRegulations and other interpretive guidance issued thereunder.(g)Good Reason. “Good Reason” means the occurrence of any of the following events or conditions withoutExecutive’s written consent:(i)a material diminution in Executive’s authority, duties or responsibilities;(ii)a material diminution in Executive’s base compensation, unless such a reduction is imposed across-the-board to seniormanagement of the Company;(iii)a material change in the geographic location at which Executive must perform his or her duties (and the parties acknowledgethat a relocation of the Company’s principal executive offices to a location more than fifty (50) miles from the Company’s then-currentoffices (excepting reasonable travel on the Company’s business) shall constitute a material change for purposes of this clause (iii)); or 3SD\1213749.2(iv)any other action or inaction that constitutes a material breach by the Company or any successor or affiliate of its obligations toExecutive under this Agreement.Executive must provide written notice to the Company of the occurrence of any of the foregoing events or conditions withoutExecutive’s written consent within ninety (90) days of the occurrence of such event. The Company or any successor or affiliate shallhave a period of thirty (30) days to cure such event or condition after receipt of written notice of such event from Executive.(h)Involuntary Termination. “Involuntary Termination” means (i) the Executive’s Separation from Service byreason of Executive’s discharge by the Company other than for Cause, or (ii) the Executive’s Separation from Service by reason ofExecutive’s resignation of employment with the Company for Good Reason. Executive’s Separation from Service by reason ofExecutive’s death or discharge by the Company following Executive’s Permanent Disability shall not constitute an InvoluntaryTermination. The Executive’s Separation from Service by reason of resignation from employment with the Company for Good Reasonshall be an “Involuntary Termination” only if such Separation from Service occurs within two (2) years following the initial existenceof the act or failure to act constituting Good Reason. The Executive’s Separation from Service by reason of resignation fromemployment with the Company for Good Reason shall be treated as involuntary.(i)Permanent Disability. Executive’s “Permanent Disability” shall be deemed to have occurred if Executiveshall become physically or mentally incapacitated or disabled or otherwise unable fully to discharge his or her duties hereunder for aperiod of ninety (90) consecutive calendar days or for one hundred twenty (120) calendar days in any one hundred eighty (180)calendar-day period. The existence of Executive’s Permanent Disability shall be determined by the Company on the advice of aphysician chosen by the Company and the Company reserves the right to have the Executive examined by a physician chosen by theCompany at the Company’s expense.(j)Separation from Service. “Separation from Service,” with respect to the Executive, means the Executive’s“separation from service,” as defined in Treasury Regulation Section 1.409A-1(h). (k)Stock Awards. “Stock Awards” means all stock options, restricted stock and such other awards grantedpursuant to the Company’s stock option and equity incentive award plans or agreements and any shares of stock issued upon exercisethereof.(l)WARN Act. “WARN Act” shall mean the Worker Adjustment and Retraining Notification Act, 29 U.S.C.Sections 2101 et seq., and the Department of Labor regulations thereunder.2.Services to Be Rendered.(a)Duties and Responsibilities. Executive shall serve as Executive Vice President and Chief CommercialOfficer of the Company. In the performance of such duties, Executive shall report directly to the CEO and shall be subject to thedirection of the CEO and to such limits upon Executive’s authority as the CEO may from time to time impose. In the event 4SD\1213749.2of the CEO’s incapacity or unavailability, Executive shall be subject to the direction of the Board. Executive hereby consents to serve asan officer and/or director of the Company or any subsidiary or affiliate thereof without any additional salary or compensation, if sorequested by the CEO. Executive shall be employed by the Company on a full time basis. Executive’s primary place of work shall bethe Company’s facility in San Diego, California, or such other location within San Diego County as may be designated by the CEO fromtime to time. Executive shall also render services at such other places within or outside the United States as the CEO may direct fromtime to time. Executive shall be subject to and comply with the policies and procedures generally applicable to senior executives of theCompany to the extent the same are not inconsistent with any term of this Agreement.(b)Exclusive Services. Executive shall at all times faithfully, industriously and to the best of his or her ability,experience and talent perform to the satisfaction of the Board and the CEO all of the duties that may be assigned to Executive hereunderand shall devote substantially all of his or her productive time and efforts to the performance of such duties. Subject to the terms of theProprietary Information and Inventions Agreement referred to in Section 5(b), this shall not preclude Executive from devoting time topersonal and family investments or serving on community and civic boards, or participating in industry associations, provided suchactivities do not interfere with his or her duties to the Company, as determined in good faith by the CEO. Executive agrees that he or shewill not join any boards, other than community and civic boards (which do not interfere with his or her duties to the Company), withoutthe prior approval of the CEO.3.Compensation and Benefits. The Company shall pay or provide, as the case may be, to Executive the compensationand other benefits and rights set forth in this Section 3.(a)Base Salary. The Company shall pay to Executive a base salary of $335,000 per year, payable in accordancewith the Company’s usual pay practices (and in any event no less frequently than monthly). Executive’s base salary shall be subject toreview annually by and at the sole discretion of the Compensation Committee of the Board or its designee.(b)Annual Bonus. Executive shall participate in any bonus plan that the Board or its designee may approve forthe senior executives of the Company. For 2012 and 2013, Executive’s target bonus under the Company’s annual bonus plan shall beforty-five percent (45%) of Executive’s base salary; provided, however, that Executive’s annual bonus for 2012 shall be pro-rated basedon the number of days elapsed during 2012 following the Effective Date.(c)Signing Bonus. Executive shall be entitled to a one-time cash signing bonus in the amount of $130,000,payable on the first regularly scheduled payroll date of the Company that is at least ten (10) days following the Effective Date. IfExecutive voluntarily terminates his employment without Good Reason prior to August 31, 2013, Executive shall repay to theCompany a pro rata portion of the foregoing signing bonus based on the number of days elapsed during the period commencing on theEffective Date and ending on August 31, 2013. The Company will have the right to offset such amounts against any compensationotherwise payable to Executive on the date of Executive’s termination of employment.(d)Relocation. 5SD\1213749.2(i)The Company expects Executive to relocate his principal place of residence from New Jersey to theSan Diego, California metropolitan area on or before August 31, 2013. In furtherance of Executive’s relocation, the Company shall payfor or reimburse Executive in accordance with the Company’s written expense reimbursement policies and procedures for (i) themovement of Executive’s reasonable household goods, which includes two automobiles (excluding extraordinary or unusual movingcosts such as boat, recreational vehicle, playground equipment), (ii) reimbursement for up to two (2) house hunting trips to San Diegofor Executive, his spouse and his dependent children, (iii) reimbursement for transportation for Executive, his spouse and his dependentchildren from New Jersey to San Diego, California, and (iv) reasonable and customary realtor costs incurred by Executive in connectionwith the purchase of Executive’s residence in San Diego California and the sale of Executive’s residence in New Jersey (collectively,the “Relocation Reimbursement”).(ii)In addition, the Company shall pay to Executive a tax gross-up (the “Tax Gross-Up”) for any federaland state income and employment taxes Executive is required to pay resulting from the Relocation Reimbursement and from the TaxGross-Up, which Tax Gross-Up shall be paid in accordance with Treasury Regulation Section 1.409A-3(i)(1)(v). The RelocationReimbursement and any Tax Gross-Up shall be subject to an aggregate cap of $100,000. All amounts eligible for the RelocationReimbursement must be incurred by and paid to Executive during the term of his employment with the Company. The RelocationReimbursement and the Tax Gross-Up shall be paid to Executive within thirty (30) days following the Company’s receipt of a writtenrequest for such reimbursement, but subject to receipt by the Company of supporting receipts and/or documentation and/or receipts inform and substance reasonably acceptable to the Company. If Executive voluntarily terminates his employment without Good Reasonprior to the first anniversary of the Effective Date, Executive shall repay to the Company a pro rata portion of the RelocationReimbursement and any Tax Gross-Up based on the number of days elapsed in the one-year period ending on the first anniversary of theEffective Date. The Company will have the right to offset such amounts against any compensation otherwise payable to Executive onthe date of Executive’s termination of employment.(iii)In addition to the foregoing, during the period commencing on the Effective Date and ending on theearlier of (A) the date Executive relocates his primary residence to the San Diego, California area or (B) August 31, 2013, the Companywill pay for or reimburse Executive for temporary housing in the San Diego, California area, subject to the Company’s prior approval ofExecutive’s temporary housing arrangements.(e)Benefits. Executive shall be entitled to participate in benefits under the Company’s benefit plans andarrangements, including, without limitation, any employee benefit plan or arrangement made available in the future by the Company toits senior executives, subject to and on a basis consistent with the terms, conditions and overall administration of such plans andarrangements. The Company shall have the right to amend or delete any such benefit plan or arrangement made available by theCompany to its senior executives and not otherwise specifically provided for herein; provided, that any reduction of Executive’s benefitssuch that Executive’s benefits are, in the aggregate, materially less favorable to Executive than those benefits offered to Executive as ofthe Effective Date shall be considered a material breach of this Agreement by the Company. 6SD\1213749.2(f)Expenses. The Company shall reimburse Executive for reasonable out-of-pocket business expensesincurred in connection with the performance of his or her duties hereunder, subject to (i) such policies as the Company may from timeto time establish, (ii) Executive furnishing the Company with evidence in the form of receipts satisfactory to the Companysubstantiating the claimed expenditures, (iii) Executive receiving advance approval from the CEO in the case of expenses for traveloutside of North America, and (iv) Executive receiving advance approval from the CEO in the case of expenses (or a series of relatedexpenses) in excess of $5,000.(g)Paid Time Off. Executive shall be entitled to such periods of paid time off (“PTO”) each year as providedfrom time to time under the Company’s PTO policy and as otherwise provided for senior executive officers.(h)Equity Awards.(i)As soon as practicable following the Effective Date, and subject to the approval of the CompensationCommittee of the Board, Executive shall receive stock options to purchase 400,000 shares of the Company’s common stock pursuant tothe Company’s 2010 Equity Incentive Award Plan (the “2010 Plan”). Such stock options shall have an exercise price equal to the thencurrent fair market value per share of the Company’s common stock (as determined pursuant to the 2010 Plan) on the date of grant.Such stock options shall be incentive stock options to the extent permitted under Section 422 of the Code. The shares subject to suchstock options shall vest as follows: one-fourth (1/4th) of the shares subject to the option shall vest on the first anniversary of theEffective Date, and the remaining shares subject to the option shall vest in thirty-six (36) equal monthly installment over the three-year period thereafter, subject to Executive’s continued employment or service with the Company on each such date. Such stockoptions shall have a ten (10) year term and shall be subject to the terms and conditions of the 2010 Plan and the stock option agreementpursuant to which such stock options are granted.(ii)Executive shall be entitled to participate in any equity or other employee benefit plan that is generallyavailable to senior executive officers, as distinguished from general management, of the Company. Except as otherwise provided in thisAgreement, Executive’s participation in and benefits under any such plan shall be on the terms and subject to the conditions specified inthe governing document of the particular plan.(i)Stock Award Acceleration.(i)In the event of a Change in Control, the vesting and exercisability of fifty percent (50%) ofExecutive’s outstanding unvested Stock Awards shall be automatically accelerated effective immediately prior to the consummation ofsuch Change in Control.(ii)In the event of Executive’s Involuntary Termination or Executive’s Separation from Service byreason of Executive’s death or discharge by the Company following Executive’s Permanent Disability, the vesting and/or exercisabilityof each of Executive’s outstanding unvested Stock Awards shall be automatically accelerated on the date of Executive’s Separation fromService as to the number of Stock Awards that would vest over the twelve (12) month period following the date of Executive’sSeparation from Service had Executive remained 7SD\1213749.2continuously employed by the Company during such period.(iii)In the event of Executive’s Involuntary Termination within three (3) months prior to or twelve(12) months following a Change in Control, the vesting and/or exercisability of any outstanding unvested portions of such Stock Awardsshall be automatically accelerated on the later of (A) the date of Executive’s Separation from Service and (B) the date of the Change inControl. In addition, with respect to Stock Awards granted to Executive on or after the Effective Date, such Stock Awards may beexercised by Executive (or Executive’s legal guardian or legal representative) until the latest of (A) three (3) months after the date ofExecutive’s Separation from Service, (B) with respect to any portion of the Stock Awards that become exercisable on the date of aChange in Control pursuant to this Section 3(g)(iii), three (3) months after the date of the Change in Control, or (C) such longer periodas may be specified in the applicable Stock Award agreement; provided, however, that in no event shall any Stock Award remainexercisable beyond the original outside expiration date of such Stock Award.(iv)The vesting pursuant to clauses (i), (ii) and (iii) of this Section 3(g) shall be cumulative. Theforegoing provisions are hereby deemed to be a part of each Stock Award and to supersede any less favorable provision in any agreementor plan regarding such Stock Award.4.Severance. Executive shall be entitled to receive benefits upon a Separation from Service only as set forth in thisSection 4:(a)At-Will Employment; Termination. The Company and Executive acknowledge that Executive’semployment is and shall continue to be at-will, as defined under applicable law, and that Executive’s employment with the Companymay be terminated by either party at any time for any or no reason, with or without notice. If Executive’s employment terminates forany reason, Executive shall not be entitled to any payments, benefits, damages, awards or compensation other than as provided in thisAgreement. Executive’s employment under this Agreement shall be terminated immediately on the death of Executive.(b)Separation from Service by Death or Following Permanent Disability. Subject to Sections 4(e) and 9(o) andExecutive’s continued compliance with Section 5, in the event of Executive’s Separation from Service as a result of Executive’s deathor discharge by the Company following Executive’s Permanent Disability, Executive or Executive’s estate, as applicable, shall beentitled to receive, in lieu of any severance benefits to which Executive or Executive’s estate may otherwise be entitled under anyseverance plan or program of the Company, the benefits provided below, which, with respect to clause (ii) and the last sentence ofclause (iii) below, will be payable in a lump sum within ten (10) days following the effective date of Executive’s Release (or, in theevent of Executive’s incapacity as a result of his Permanent Disability, the Release executed by Executive’s legal representative) (or, inthe event of Executive’s death, within ten (10) days following the date of Executive’s death):(i)the Company shall pay to Executive or Executive’s estate, as applicable, Executive’s fully earnedbut unpaid base salary, when due, through the date of Executive’s Separation from Service at the rate then in effect, plus all otherbenefits, if any, under any Company group retirement plan, nonqualified deferred compensation plan, equity award plan 8SD\1213749.2or agreement (other than any such plan or agreement pertaining to Stock Awards whose treatment is prescribed by Section 3(g) above),health benefits plan or other Company group benefit plan to which Executive or Executive’s estate may be entitled pursuant to theterms of such plans or agreements at the time of Executive’s Separation from Service;(ii)Executive or Executive’s estate, as applicable, shall be entitled to receive severance pay in anamount equal to twelve (12) multiplied by Executive’s monthly base salary as in effect immediately prior to the date of Executive’sSeparation from Service; and(iii)for the period beginning on the date of Executive’s Separation from Service and ending on the datewhich is twelve (12) full months following the date of Executive’s Separation from Service (or, if earlier, the date on which theapplicable continuation period under the Consolidated Omnibus Budget Reconciliation Act of 1985, as amended (“COBRA”) expires),the Company shall arrange to provide Executive (in the case of Executive’s Separation of Service as a result of discharge by theCompany following Executive’s Permanent Disability) and/or his or her eligible dependents who were covered under the Company’shealth insurance plans as of the date of Executive’s Separation from Service with health (including medical and dental) insurancebenefits substantially similar to those provided to Executive and his or her dependents immediately prior to the date of such Separationfrom Service. If any of the Company’s health benefits are self-funded as of the date of Executive’s Separation from Service, or if theCompany cannot provide the foregoing benefits in a manner that is exempt from Section 409A (as defined below) or that is otherwisecompliant with applicable law (including, without limitation, Section 2716 of the Public Health Service Act), instead of providingcontinued health insurance benefits as set forth above, the Company shall instead pay to Executive or Executive’s estate, as applicable,an amount equal to twelve (12) multiplied by the monthly premium Executive or his or her dependents would be required to pay forcontinuation coverage pursuant to COBRA for Executive (if applicable) and his or her eligible dependents who were covered under theCompany’s health plans as of the date of Executive’s Separation from Service (calculated by reference to the premium as of the date ofExecutive’s Separation from Service), which amount shall be payable in a lump sum within ten (10) days following the effective date ofExecutive’s Release.(c)Severance Upon Involuntary Termination. Subject to Sections 4(e) and 9(o) and Executive’s continuedcompliance with Section 5, if Executive’s employment is Involuntarily Terminated, Executive shall be entitled to receive, in lieu ofany severance benefits to which Executive may otherwise be entitled under any severance plan or program of the Company, thebenefits provided below, which, with respect to clause (ii) and the last sentence of clause (iii) (if applicable) will be payable in a lumpsum within ten (10) days following the effective date of Executive’s Release:(i)the Company shall pay to Executive his or her fully earned but unpaid base salary, when due,through the date of Executive’s Involuntary Termination at the rate then in effect, plus all other benefits, if any, under any Companygroup retirement plan, nonqualified deferred compensation plan, equity award plan or agreement (other than any such plan or agreementpertaining to Stock Awards whose treatment is prescribed by Section 3(g) above), health benefits plan or other Company group benefitplan to which Executive may be entitled pursuant to the terms of such plans or agreements at the time of Executive’s InvoluntaryTermination; 9SD\1213749.2(ii)Executive shall be entitled to receive severance pay in an amount equal to twelve (12) multiplied byExecutive’s monthly base salary as in effect immediately prior to the date of Executive’s Involuntary Termination; and(iii)for the period beginning on the date of Executive’s Involuntary Termination and ending on the datewhich is twelve (12) full months following the date of Executive’s Involuntary Termination (or, if earlier, the date on which theapplicable continuation period under COBRA expires), the Company shall arrange to provide Executive and his or her eligibledependents who were covered under the Company’s health insurance plans as of the date of Executive’s Involuntary Termination withhealth (including medical and dental) insurance benefits substantially similar to those provided to Executive and his or her dependentsimmediately prior to the date of such Involuntary Termination. If any of the Company’s health benefits are self-funded as of the date ofExecutive’s Involuntary Termination, or if the Company cannot provide the foregoing benefits in a manner that is exempt from Section409A (as defined below) or that is otherwise compliant with applicable law (including, without limitation, Section 2716 of the PublicHealth Service Act), instead of providing continued health insurance benefits as set forth above, the Company shall instead pay toExecutive an amount equal to twelve (12) multiplied by the monthly premium Executive would be required to pay for continuationcoverage pursuant to COBRA for Executive and his or her eligible dependents who were covered under the Company’s health plans asof the date of Executive’s Involuntary Termination (calculated by reference to the premium as of the date of Involuntary Termination),which amount shall be payable in a lump sum within ten (10) days following the effective date of Executive’s Release.(iv)Notwithstanding anything to the contrary in this Section 4(c), and subject to Sections 4(e) and 9(o)and Executive's continued compliance with Section 5, in the event of Executive's Involuntary Termination during the periodcommencing sixty (60) days prior to a Change in Control or twelve (12) months following a Change in Control, Executive shall beentitled to receive, in addition to the severance benefits described in clauses (i), (ii) and (iii) above, an amount equal to Executive’s Bonusfor the year in which Executive’s Involuntary Termination occurs, which amount shall be payable in a lump sum within ten (10) daysfollowing the later of (A) the effective date of Executive’s Release and (B) the date of the Change in Control.(d)Termination for Cause or Voluntary Resignation Without Good Reason. In the event of Executive’stermination of employment as a result of Executive’s discharge by the Company for Cause or Executive’s resignation without GoodReason (other than as a result of Executive’s death or Separation of Service by reason of discharge by the Company followingExecutive’s Permanent Disability), the Company shall not have any other or further obligations to Executive under this Agreement(including any financial obligations) except that Executive shall be entitled to receive (i) Executive’s fully earned but unpaid base salary,through the date of termination at the rate then in effect, and (ii) all other amounts or benefits to which Executive is entitled under anycompensation, retirement or benefit plan or practice of the Company at the time of termination in accordance with the terms of suchplans or practices, including, without limitation, any continuation of benefits required by COBRA or applicable law. In addition, in theevent of Executive’s Separation from Service as a result of Executive’s discharge by the Company for Cause or Executive’s resignationwithout Good Reason (other than as a result of Executive’s death or Separation of Service by reason of discharge by the Companyfollowing Executive’s Permanent 10SD\1213749.2Disability), all vesting of Executive’s unvested Stock Awards previously granted to him or her by the Company shall cease and none ofsuch unvested Stock Awards shall be exercisable following the date of such termination. The foregoing shall be in addition to, and not inlieu of, any and all other rights and remedies which may be available to the Company under the circumstances, whether at law or inequity.(e)Release. As a condition to Executive’s receipt of any post-termination benefits pursuant to Sections 4(b) and(c) above, Executive (or, in the event of Executive’s incapacity as a result of his Permanent Disability, the Executive’s legalrepresentative) shall execute and not revoke a general release of all claims in favor of the Company (the “Release”) in the form attachedhereto as Exhibit A. In the event the Release does not become effective within the fifty-five (55) day period following the date ofExecutive’s Separation from Service, Executive shall not be entitled to the aforesaid payments and benefits.(f)Exclusive Remedy. Except as otherwise expressly required by law (e.g., COBRA) or as specificallyprovided herein, all of Executive’s rights to salary, severance, benefits, bonuses and other amounts hereunder (if any) accruing after thetermination of Executive’s employment shall cease upon such termination. In the event of Executive’s termination of employmentwith the Company, Executive’s sole remedy shall be to receive the payments and benefits described in this Section 4. In addition,Executive acknowledges and agrees that he or she is not entitled to any reimbursement by the Company for any taxes payable byExecutive as a result of the payments and benefits received by Executive pursuant to this Section 4, including, without limitation, anyexcise tax imposed by Section 4999 of the Code. Any payments made to Executive under this Section 4 shall be inclusive of anyamounts or benefits to which Executive may be entitled pursuant to the WARN Act or the California WARN Act.(g)No Mitigation. Except as otherwise provided in Section 4(b)(iii) or 4(c)(iii) above, Executive shall not berequired to mitigate the amount of any payment provided for in this Section 4 by seeking other employment or otherwise, nor shall theamount of any payment or benefit provided for in this Section 4 be reduced by any compensation earned by Executive as the result ofemployment by another employer or self-employment or by retirement benefits; provided, however, that loans, advances or otheramounts owed by Executive to the Company may be offset by the Company against amounts payable to Executive under this Section 4.(h)Return of the Company’s Property. In the event of Executive’s termination of employment for any reason,the Company shall have the right, at its option, to require Executive to vacate his or her offices prior to or on the effective date ofseparation and to cease all activities on the Company’s behalf. Upon Executive’s termination of employment in any manner, as acondition to the Executive’s receipt of any severance benefits described in this Agreement, Executive shall immediately surrender tothe Company all lists, books and records of, or in connection with, the Company’s business, and all other property belonging to theCompany, it being distinctly understood that all such lists, books and records, and other documents, are the property of the Company.Executive shall deliver to the Company a signed statement certifying compliance with this Section 4(h) prior to the receipt of anyseverance benefits described in this Agreement.(i)Waiver of the Company’s Liability. Executive recognizes that his or her 11SD\1213749.2employment is subject to termination with or without Cause for any reason and therefore Executive agrees that Executive shall hold theCompany harmless from and against any and all liabilities, losses, damages, costs and expenses, including but not limited to, court costsand reasonable attorneys’ fees, which Executive may incur as a result of Executive’s termination of employment. Executive furtheragrees that Executive shall bring no claim or cause of action against the Company for damages or injunctive relief based on a wrongfultermination of employment. Executive agrees that the sole liability of the Company to Executive upon termination of this Agreementshall be that determined by this Section 4. In the event this covenant is more restrictive than permitted by laws of the jurisdiction inwhich the Company seeks enforcement thereof, this covenant shall be limited to the extent permitted by law.5.Certain Covenants.(a)Noncompetition. Except as may otherwise be approved by the Board, during the term of Executive’semployment, Executive shall not have any ownership interest (of record or beneficial) in, or have any interest as an employee,salesman, consultant, officer or director in, or otherwise aid or assist in any manner, any firm, corporation, partnership, proprietorship orother business that engages in any county, city or part thereof in the United States and/or any foreign country in a business whichcompetes directly or indirectly (as determined by the Board) with the Company’s business in such county, city or part thereof, so long asthe Company, or any successor in interest of the Company to the business and goodwill of the Company, remains engaged in suchbusiness in such county, city or part thereof or continues to solicit customers or potential customers therein; provided, however, thatExecutive may own, directly or indirectly, solely as an investment, securities of any entity which are traded on any national securitiesexchange if Executive (i) is not a controlling person of, or a member of a group which controls, such entity; or (ii) does not, directly orindirectly, own one percent (1%) or more of any class of securities of any such entity.(b)Confidential Information. Executive and the Company have entered into the Company’s standard employeeproprietary information and inventions agreement (the “Employee Proprietary Information and Inventions Agreement”). Executiveagrees to perform each and every obligation of Executive therein contained.(c)Solicitation of Employees. Executive shall not during the term of Executive’s employment and for theapplicable severance period for which Executive receives severance benefits following any termination hereof pursuant to Section 4(b)or (c) above (regardless of whether Executive receives payment of severance amounts payable thereunder in a lump sum) (the“Restricted Period”), directly or indirectly, solicit or encourage to leave the employment of the Company or any of its affiliates, anyemployee of the Company or any of its affiliates.(d)Solicitation of Consultants. Executive shall not during the term of Executive’s employment and for theRestricted Period, directly or indirectly, hire, solicit or encourage to cease work with the Company or any of its affiliates any consultantthen under contract with the Company or any of its affiliates within one year of the termination of such consultant’s engagement by theCompany or any of its affiliates. 12SD\1213749.2(e)Rights and Remedies Upon Breach. If Executive breaches or threatens to commit a breach of any of theprovisions of this Section 5 (the “Restrictive Covenants”), the Company shall have the following rights and remedies, each of whichrights and remedies shall be independent of the other and severally enforceable, and all of which rights and remedies shall be in additionto, and not in lieu of, any other rights and remedies available to the Company under law or in equity:(i)Specific Performance. The right and remedy to have the Restrictive Covenants specifically enforcedby any court having equity jurisdiction, all without the need to post a bond or any other security or to prove any amount of actual damageor that money damages would not provide an adequate remedy, it being acknowledged and agreed that any such breach or threatenedbreach will cause irreparable injury to the Company and that money damages will not provide adequate remedy to the Company; and(ii)Accounting and Indemnification. The right and remedy to require Executive (A) to account for andpay over to the Company all compensation, profits, monies, accruals, increments or other benefits derived or received by Executive orany associated party deriving such benefits as a result of any such breach of the Restrictive Covenants; and (B) to indemnify theCompany against any other losses, damages (including special and consequential damages), costs and expenses, including actualattorneys’ fees and court costs, which may be incurred by them and which result from or arise out of any such breach or threatenedbreach of the Restrictive Covenants.(f)Severability of Covenants/Blue Pencilling. If any court determines that any of the Restrictive Covenants, orany part thereof, is invalid or unenforceable, the remainder of the Restrictive Covenants shall not thereby be affected and shall be givenfull effect, without regard to the invalid portions. If any court determines that any of the Restrictive Covenants, or any part thereof, areunenforceable because of the duration of such provision or the area covered thereby, such court shall have the power to reduce theduration or area of such provision and, in its reduced form, such provision shall then be enforceable and shall be enforced. Executivehereby waives any and all right to attack the validity of the Restrictive Covenants on the grounds of the breadth of their geographic scopeor the length of their term.(g)Enforceability in Jurisdictions. The Company and Executive intend to and do hereby confer jurisdiction toenforce the Restrictive Covenants upon the courts of any jurisdiction within the geographical scope of such covenants. If the courts ofany one or more of such jurisdictions hold the Restrictive Covenants wholly unenforceable by reason of the breadth of such scope orotherwise, it is the intention of the Company and Executive that such determination not bar or in any way affect the right of theCompany to the relief provided above in the courts of any other jurisdiction within the geographical scope of such covenants, as tobreaches of such covenants in such other respective jurisdictions, such covenants as they relate to each jurisdiction being, for thispurpose, severable into diverse and independent covenants.(h)Definitions. For purposes of this Section 5, the term “Company” means not only Zogenix, Inc., but also anycompany, partnership or entity which, directly or indirectly, controls, is controlled by or is under common control with Zogenix, Inc. 13SD\1213749.26.Insurance; Indemnification.(a)Insurance. The Company shall have the right to take out life, health, accident, “key-man” or other insurancecovering Executive, in the name of the Company and at the Company’s expense in any amount deemed appropriate by the Company.Executive shall assist the Company in obtaining such insurance, including, without limitation, submitting to any required examinationsand providing information and data required by insurance companies.(b)Indemnification. Executive will be provided with indemnification against third party claims related to his orher work for the Company as required by Delaware law. The Company shall provide Executive with directors and officers liabilityinsurance coverage at least as favorable as that which the Company may maintain from time to time for members of the Board and otherexecutive officers.7.Arbitration. Any dispute, claim or controversy based on, arising out of or relating to Executive’s employment or thisAgreement shall be settled by final and binding arbitration in San Diego, California, before a single neutral arbitrator in accordance withthe National Rules for the Resolution of Employment Disputes (the “Rules”) of the American Arbitration Association, and judgment onthe award rendered by the arbitrator may be entered in any court having jurisdiction. Arbitration may be compelled pursuant to theCalifornia Arbitration Act (Code of Civil Procedure §§ 1280 et seq.). If the parties are unable to agree upon an arbitrator, one shall beappointed by the AAA in accordance with its Rules. Each party shall pay the fees of its own attorneys, the expenses of its witnesses andall other expenses connected with presenting its case; however, Executive and the Company agree that, to the extent permitted by law,the arbitrator may, in his or her discretion, award reasonable attorneys’ fees to the prevailing party; provided, further, that the prevailingparty shall be reimbursed for such fees, costs and expenses within forty-five (45) days following any such award, but in no event laterthan the last day of the Executive’s taxable year following the taxable year in which the fees, costs and expenses were incurred;provided, further, that the parties’ obligations pursuant to this sentence shall terminate on the tenth (10th) anniversary of the date ofExecutive’s termination of employment. Other costs of the arbitration, including the cost of any record or transcripts of the arbitration,AAA’s administrative fees, the fee of the arbitrator, and all other fees and costs, shall be borne by the Company. This Section 7 isintended to be the exclusive method for resolving any and all claims by the parties against each other for payment of damages under thisAgreement or relating to Executive’s employment; provided, however, that neither this Agreement nor the submission to arbitrationshall limit the parties’ right to seek provisional relief, including without limitation injunctive relief, in any court of competentjurisdiction pursuant to California Code of Civil Procedure § 1281.8 or any similar statute of an applicable jurisdiction. Seeking any suchrelief shall not be deemed to be a waiver of such party’s right to compel arbitration. Both Executive and the Company expressly waivetheir right to a jury trial.8.General Relationship. Executive shall be considered an employee of the Company within the meaning of all federal,state and local laws and regulations including, but not limited to, laws and regulations governing unemployment insurance, workers’compensation, industrial accident, labor and taxes.9.Miscellaneous. 14SD\1213749.2(a)Modification; Prior Claims. This Agreement and the Employee Proprietary Information and InventionsAgreement set forth the entire understanding of the parties with respect to the subject matter hereof, supersedes all existing agreementsbetween them concerning such subject matter, including, without limitation, the offer letter between Executive and the Company datedNovember 5, 2012. This Agreement may be amended or modified only with the written consent of Executive and an authorizedrepresentative of the Company. No oral waiver, amendment or modification will be effective under any circumstances whatsoever.(b)Assignment; Assumption by Successor. The rights of the Company under this Agreement may, without theconsent of Executive, be assigned by the Company, in its sole and unfettered discretion, to any person, firm, corporation or otherbusiness entity which at any time, whether by purchase, merger or otherwise, directly or indirectly, acquires all or substantially all ofthe assets or business of the Company. The Company will require any successor (whether direct or indirect, by purchase, merger orotherwise) to all or substantially all of the business or assets of the Company expressly to assume and to agree to perform thisAgreement in the same manner and to the same extent that the Company would be required to perform it if no such succession hadtaken place; provided, however, that no such assumption shall relieve the Company of its obligations hereunder. As used in thisAgreement, the “Company” shall mean the Company as hereinbefore defined and any successor to its business and/or assets as aforesaidwhich assumes and agrees to perform this Agreement by operation of law or otherwise.(c)Survival. The covenants, agreements, representations and warranties contained in or made in Sections 3(g),4, 5, 6, 7 and 9 of this Agreement shall survive any Executive’s termination of employment.(d)Third‑Party Beneficiaries. This Agreement does not create, and shall not be construed as creating, any rightsenforceable by any person not a party to this Agreement.(e)Waiver. The failure of either party hereto at any time to enforce performance by the other party of anyprovision of this Agreement shall in no way affect such party’s rights thereafter to enforce the same, nor shall the waiver by eitherparty of any breach of any provision hereof be deemed to be a waiver by such party of any other breach of the same or any otherprovision hereof.(f)Section Headings. The headings of the several sections in this Agreement are inserted solely for theconvenience of the parties and are not a part of and are not intended to govern, limit or aid in the construction of any term or provisionhereof.(g)Notices. Any notice required or permitted by this Agreement shall be in writing and shall be delivered asfollows with notice deemed given as indicated: (i) by personal delivery when delivered personally; (ii) by overnight courier upon writtenverification of receipt; (iii) by email, telecopy or facsimile transmission upon acknowledgment of receipt of electronic transmission; or(iv) by certified or registered mail, return receipt requested, upon verification of receipt. Notice shall be sent to Executive at the addresslisted on the Company’s personnel records and to the Company at its principal place of business, or such other address as either partymay specify in writing. 15SD\1213749.2(h)Severability. All Sections, clauses and covenants contained in this Agreement are severable, and in the eventany of them shall be held to be invalid by any court, this Agreement shall be interpreted as if such invalid Sections, clauses or covenantswere not contained herein.(i)Governing Law and Venue. This Agreement is to be governed by and construed in accordance with the lawsof the State of California applicable to contracts made and to be performed wholly within such State, and without regard to the conflictsof laws principles thereof. Except as provided in Sections 5 and 7, any suit brought hereon shall be brought in the state or federal courtssitting in San Diego, California, the parties hereto hereby waiving any claim or defense that such forum is not convenient or proper.Each party hereby agrees that any such court shall have in personam jurisdiction over it and consents to service of process in any mannerauthorized by California law.(j)Non-transferability of Interest. None of the rights of Executive to receive any form of compensation payablepursuant to this Agreement shall be assignable or transferable except through a testamentary disposition or by the laws of descent anddistribution upon the death of Executive. Any attempted assignment, transfer, conveyance, or other disposition (other than as aforesaid)of any interest in the rights of Executive to receive any form of compensation to be made by the Company pursuant to this Agreementshall be void.(k)Gender. Where the context so requires, the use of the masculine gender shall include the feminine and/orneuter genders and the singular shall include the plural, and vice versa, and the word “person” shall include any corporation, firm,partnership or other form of association.(l)Counterparts. This Agreement may be executed in one or more counterparts, each of which shall be deemedan original, but all of which together shall constitute one and the same Agreement.(m)Construction. The language in all parts of this Agreement shall in all cases be construed simply, according toits fair meaning, and not strictly for or against any of the parties hereto. Without limitation, there shall be no presumption against anyparty on the ground that such party was responsible for drafting this Agreement or any part thereof.(n)Withholding and other Deductions. All compensation payable to Executive hereunder shall be subject tosuch deductions as the Company is from time to time required to make pursuant to law, governmental regulation or order.(o)Code Section 409A.(i)This Agreement is not intended to provide for any deferral of compensation subject to Section 409Aof the Code, and, accordingly, the severance payments payable under Sections 4(b)(ii) and (iii) and 4(c)(ii), (iii) and (iv) shall be paid nolater than the later of: (A) the fifteenth (15th) day of the third month following Executive’s first taxable year in which such severancebenefit is no longer subject to a substantial risk of forfeiture, and (B) the fifteenth (15th) day of the third month following first taxableyear of the Company in which such severance benefit is no longer subject to substantial risk of forfeiture, as determined in accordance 16SD\1213749.2with Code Section 409A and any Treasury Regulations and other guidance issued thereunder. To the extent applicable, this Agreementshall be interpreted in accordance with Code Section 409A and Department of Treasury regulations and other interpretive guidanceissued thereunder.(ii)If the Executive is a “specified employee” (as defined in Section 409A of the Code), as determinedby the Company in accordance with Section 409A of the Code, on the date of the Executive’s Separation from Service, to the extentthat the payments or benefits under this Agreement are subject to Section 409A of the Code and the delayed payment or distribution ofall or any portion of such amounts to which Executive is entitled under this Agreement is required in order to avoid a prohibiteddistribution under Section 409A(a)(2)(B)(i) of the Code, then such portion deferred pursuant to this Section 9(o)(ii) shall be paid ordistributed to Executive in a lump sum on the earlier of (A) the date that is six (6)-months following Executive’s Separation fromService, (B) the date of Executive’s death or (C) the earliest date as is permitted under Section 409A of the Code. Any remainingpayments due under the Agreement shall be paid as otherwise provided herein.(iii)To the extent applicable, this Agreement shall be interpreted in accordance with the applicableexemptions from Section 409A of the Code. If Executive and the Company determine that any payments or benefits payable under thisAgreement intended to comply with Sections 409A(a)(2), (3) and (4) of the Code do not comply with Section 409A of the Code,Executive and the Company agree to amend this Agreement, or take such other actions as Executive and the Company deem reasonablynecessary or appropriate, to comply with the requirements of Section 409A of the Code and the Treasury Regulations thereunder (andany applicable transition relief) while preserving the economic agreement of the parties. To the extent that any provision in thisAgreement is ambiguous as to its compliance with Section 409A of the Code, the provision shall be read in such a manner that nopayments payable under this Agreement shall be subject to an “additional tax” as defined in Section 409A(a)(1)(B) of the Code.(iv)Any reimbursement of expenses or in-kind benefits payable under this Agreement shall be made inaccordance with Treasury Regulation Section 1.409A-3(i)(1)(iv) and shall be paid on or before the last day of Executive’s taxable yearfollowing the taxable year in which Executive incurred the expenses. The amount of expenses reimbursed or in-kind benefits payable inone year shall not affect the amount eligible for reimbursement or in-kind benefits payable in any other taxable year of Executive’s, andExecutive’s right to reimbursement for such amounts shall not be subject to liquidation or exchange for any other benefit.(v)In the event that the amounts payable under Sections 4(b)(ii) and (iii) and 4(c)(ii), (iii) and (iv) aresubject to Section 409A of the Code and the timing of the delivery of Executive’s Release could cause such amounts to be paid in one oranother taxable year, then notwithstanding the payment timing set forth in such sections, such amounts shall not be payable until thelater of (A) the payment date specified in such Section or (B) the first business day of the taxable year following Executive’s Separationfrom Service.(Signature Page Follows) 17SD\1213749.2 18SD\1213749.2IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first set forth above.ZOGENIX, INC.By: Name: Title: EXECUTIVE Richard Scott ShivelySIGNATURE PAGE TO EMPLOYMENT AGREEMENTSD\1213749.2EXHIBIT AGENERAL RELEASE OF CLAIMS[The language in this Release may change based on legal developments and evolving best practices; this form is provided as anexample of what will be included in the final Release document.]This General Release of Claims (“Release”) is entered into as of this _____ day of ________, ____, between Richard ScottShively (“Executive”), and Zogenix, Inc., a Delaware corporation (the “Company”) (collectively referred to herein as the “Parties”).WHEREAS, Executive and the Company are parties to that certain Employment Agreement effective as of November [ l ],2012 (the “Agreement”);WHEREAS, the Parties agree that Executive is entitled to certain severance benefits under the Agreement, subject toExecutive’s execution of this Release; andWHEREAS, the Company and Executive now wish to fully and finally to resolve all matters between them.NOW, THEREFORE, in consideration of, and subject to, the severance benefits payable to Executive pursuant to theAgreement, the adequacy of which is hereby acknowledged by Executive, and which Executive acknowledges that he or she would nototherwise be entitled to receive, Executive and the Company hereby agree as follows:1.General Release of Claims by Executive.(a)Executive, on behalf of himself or herself and his or her executors, heirs, administrators, representativesand assigns, hereby agrees to release and forever discharge the Company and all predecessors, successors and their respective parentcorporations, affiliates, related, and/or subsidiary entities, and all of their past and present investors, directors, shareholders, officers,general or limited partners, employees, attorneys, agents and representatives, and the employee benefit plans in which Executive is orhas been a participant by virtue of his or her employment with or service to the Company (collectively, the “Company Releasees”),from any and all claims, debts, demands, accounts, judgments, rights, causes of action, equitable relief, damages, costs, charges,complaints, obligations, promises, agreements, controversies, suits, expenses, compensation, responsibility and liability of every kindand character whatsoever (including attorneys’ fees and costs), whether in law or equity, known or unknown, asserted or unasserted,suspected or unsuspected (collectively, “Claims”), which Executive has or may have had against such entities based on any events orcircumstances arising or occurring on or prior to the date hereof or on or prior to the date hereof, arising directly or indirectly out of,relating to, or in any other way involving in any manner whatsoever Executive’s employment by or service to the Company or thetermination thereof, including any and all claims arising under federal, state, orSD\1213749.2local laws relating to employment, including without limitation claims of wrongful discharge, breach of express or implied contract,fraud, misrepresentation, defamation, or liability in tort, and claims of any kind that may be brought in any court or administrativeagency including, without limitation, claims under Title VII of the Civil Rights Act of 1964, as amended, 42 U.S.C. Section 2000, etseq.; the Americans with Disabilities Act, as amended, 42 U.S.C. § 12101 et seq.; the Rehabilitation Act of 1973, as amended, 29 U.S.C.§ 701 et seq.; the Age Discrimination inEmployment Act, as amended, 29 U.S.C. Section 621, et seq. (the “ADEA”); the Equal Pay Act, as amended, 29 U.S.C. Section206(d); regulations of the Office of Federal Contract Compliance, 41 C.F.R. Section 60, et seq.; the Family and Medical Leave Act, asamended, 29 U.S.C. § 2601 et seq.; the Fair Labor Standards Act of 1938, as amended, 29 U.S.C. § 201 et seq.; the EmployeeRetirement Income Security Act, as amended, 29 U.S.C. § 1001 et seq.; and the California Fair Employment and Housing Act,California Government Code Section 12940, et seq.Notwithstanding the generality of the foregoing, Executive does not release the following claims:(i) Claims for unemployment compensation or any state disability insurance benefits pursuant to the terms ofapplicable state law;(ii)Claims for workers’ compensation insurance benefits under the terms of any worker’s compensationinsurance policy or fund of the Company;(iii)Claims pursuant to the terms and conditions of the federal law known as COBRA;(iv)Claims for indemnity under the bylaws of the Company, as provided for by California law or under anyapplicable insurance policy with respect to Executive’s liability as an employee, director or officer of the Company;(v)Claims based on any right Executive may have to enforce the Company’s executory obligations under theAgreement; and(vi)Claims Executive may have to vested or earned compensation and benefits. (b)EXECUTIVE ACKNOWLEDGES THAT HE OR SHE HAS BEEN ADVISED OF AND IS FAMILIARWITH THE PROVISIONS OF CALIFORNIA CIVIL CODE SECTION 1542, WHICH PROVIDES AS FOLLOWS:“A GENERAL RELEASE DOES NOT EXTEND TO CLAIMS WHICH THE CREDITOR DOES NOTKNOW OR SUSPECT TO EXIST IN HIS OR HER FAVOR AT THE TIME OF EXECUTING THE RELEASE,WHICH, IF KNOWN BY HIM OR HER, MUST HAVE MATERIALLY AFFECTED HIS OR HER SETTLEMENTWITH THE DEBTOR.”2SD\1213749.2BEING AWARE OF SAID CODE SECTION, EXECUTIVE HEREBY EXPRESSLY WAIVES ANY RIGHTS HE OR SHE MAYHAVE THEREUNDER, AS WELL AS UNDER ANY OTHER STATUTES OR COMMON LAW PRINCIPLES OF SIMILAREFFECT.(c)Executive acknowledges that this Release was presented to him or her on the date indicated above and thatExecutive is entitled to have [twenty-one (21)][forty-five (45)] days’ time in which to consider it. Executive further acknowledges thatthe Company has advised him or her that he or she is waiving his or her rights under the ADEA, and that Executive should consult withan attorney of his or her choice before signing this Release, and Executive has had sufficient time to consider the terms of this Release.Executive represents and acknowledges that if Executive executes this Release before [twenty-one (21)][forty-five (45)] days haveelapsed, Executive does so knowingly, voluntarily, and upon the advice and with the approval of Executive’s legal counsel (if any), andthat Executive voluntarily waives any remaining consideration period.(d)Executive understands that after executing this Release, Executive has the right to revoke it within seven(7) days after his or her execution of it. Executive understands that this Release will not become effective and enforceable unless theseven (7) day revocation period passes and Executive does not revoke the Release in writing. Executive understands that this Releasemay not be revoked after the seven (7) day revocation period has passed. Executive also understands that any revocation of this Releasemust be made in writing and delivered to the Company at its principal place of business within the seven (7) day period.(e)Executive understands that this Release shall become effective, irrevocable, and binding upon Executive onthe eighth (8th) day after his or her execution of it, so long as Executive has not revoked it within the time period and in the mannerspecified in clause (d) above. (f)Executive further understands that Executive will not be given any severance benefits under theAgreement unless this Release is effective on or before the date that is fifty-five (55) days following the date of Executive’stermination of employment.2.No Assignment. Executive represents and warrants to the Company Releasees that there has been no assignment orother transfer of any interest in any Claim that Executive may have against the Company Releasees. Executive agrees to indemnify andhold harmless the Company Releasees from any liability, claims, demands, damages, costs, expenses and attorneys’ fees incurred as aresult of any such assignment or transfer from Executive.3SD\1213749.23.Severability. In the event any provision of this Release is found to be unenforceable by an arbitrator or court ofcompetent jurisdiction, such provision shall be deemed modified to the extent necessary to allow enforceability of the provision as solimited, it being intended that the parties shall receive the benefit contemplated herein to the fullest extent permitted by law. If a deemedmodification is not satisfactory in the judgment of such arbitrator or court, the unenforceable provision shall be deemed deleted, and thevalidity and enforceability of the remaining provisions shall not be affected thereby.4.Interpretation; Construction. The headings set forth in this Release are for convenience only and shall not be used ininterpreting this Agreement. This Release has been drafted by legal counsel representing the Company, but Executive has participated inthe negotiation of its terms. Furthermore, Executive acknowledges that Executive has had an opportunity to review and revise theRelease and have it reviewed by legal counsel, if desired, and, therefore, the normal rule of construction to the effect that anyambiguities are to be resolved against the drafting party shall not be employed in the interpretation of this Release. Either party’s failureto enforce any provision of this Release shall not in any way be construed as a waiver of any such provision, or prevent that partythereafter from enforcing each and every other provision of this Release.5.Governing Law and Venue. This Release will be governed by and construed in accordance with the laws of the UnitedStates of America and the State of California applicable to contracts made and to be performed wholly within such State, and withoutregard to the conflicts of laws principles thereof. Any suit brought hereon shall be brought in the state or federal courts sitting in SanDiego County, California, the Parties hereby waiving any claim or defense that such forum is not convenient or proper. Each partyhereby agrees that any such court shall have in personam jurisdiction over it and consents to service of process in any manner authorizedby California law.6.Entire Agreement. This Release and the Agreement constitute the entire agreement of the Parties in respect of thesubject matter contained herein and therein and supersede all prior or simultaneous representations, discussions, negotiations andagreements, whether written or oral. This Release may be amended or modified only with the written consent of Executive and anauthorized representative of the Company. No oral waiver, amendment or modification will be effective under any circumstanceswhatsoever.7.Counterparts. This Release may be executed in multiple counterparts, each of which shall be deemed to be an originalbut all of which together shall constitute one and the same instrument.(Signature Page Follows)4SD\1213749.2IN WITNESS WHEREOF, and intending to be legally bound, the Parties have executed the foregoing Release as of the datefirst written above.EXECUTIVE ZOGENIX, INC. /s/ Richard Scott Shively By: /s/ Roger Hawley Print Name: Richard Scott Shively Print Name: Roger L. Hawley Title: Chief Executive Officer SD\1213749.2Exhibit 23.1Consent of Independent Registered Public Accounting FirmWe consent to the incorporation by reference in the Registration Statements (Form S-3 Nos. 333-179337, 333-185900 and 333-185901, and Form S-8 Nos.333-170875, and 333-181543) of Zogenix, Inc. and in the related Prospectuses of our reports dated March 15, 2013, with respect to the consolidated financialstatements and schedule of Zogenix, Inc., and the effectiveness of internal control over financial reporting of Zogenix, Inc. included in this Annual Report(Form 10-K) for the year ended December 31, 2012./s/ Ernst & Young LLPSan Diego, CaliforniaMarch 15, 2013Exhibit 31.1CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002I, Roger L. Hawley, certify that:1.I have reviewed this Annual Report on Form 10-K of Zogenix, Inc. for the fiscal year ended December 31, 2012;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 the statements made, in lightof the circumstances under which such statements were made, not misleading with respect to the period covered by this report;3.Based on my knowledge, the consolidated financial statements, and other financial information included in this report, fairly present in all material respects the financialcondition, 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 in Exchange 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, to ensure thatmaterial information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during theperiod 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 our supervision, to providereasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generallyaccepted accounting principles;c)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of thedisclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; andd)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (theregistrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internalcontrol over financial reporting; and5.The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditorsand 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 reasonably likely to adverselyaffect the registrant’s ability to record, process, summarize and report financial information; andb)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financialreporting. /s/ Roger L. HawleyRoger L. HawleyChief Executive OfficerDate: March 15, 2013Exhibit 31.2CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002I, Ann D. Rhoads, certify that:1.I have reviewed this Annual Report on Form 10-K of Zogenix, Inc. for the fiscal year ended December 31, 2012;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 the statements made, in lightof the circumstances under which such statements were made, not misleading with respect to the period covered by this report;3.Based on my knowledge, the consolidated financial statements, and other financial information included in this report, fairly present in all material respects the financialcondition, 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 in Exchange 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, to ensure thatmaterial information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during theperiod 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 our supervision, to providereasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generallyaccepted accounting principles;c)Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of thedisclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; andd)Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (theregistrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internalcontrol over financial reporting; and5.The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditorsand 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 reasonably likely to adverselyaffect the registrant’s ability to record, process, summarize and report financial information; andb)Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financialreporting. /s/ Ann D. RhoadsAnn D. RhoadsChief Financial OfficerDate: March 15, 2013Exhibit 32.1CERTIFICATIONPursuant 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)In connection with the Annual Report on Form 10-K of Zogenix, Inc. (the “Company”) for the period ended December 31, 2012, as filed with the Securities andExchange Commission on the date hereof (the “Report”), I, Roger L. Hawley, as Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, asadopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:1.The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and2.The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date:March 15, 2013 /s/ Roger L. Hawley Roger L. Hawley Chief Executive OfficerThe foregoing certification is being furnished solely to accompany the Report pursuant to 18 U.S.C. § 1350, and is not being filed for purposes of Section 18 of the SecuritiesExchange Act of 1934, as amended, and is not to be incorporated by reference into any filing of the Company, whether made before or after the date hereof, regardless of anygeneral incorporation language in such filing. A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by theCompany and furnished to the Securities and Exchange Commission or its staff upon request.Exhibit 32.2CERTIFICATIONPursuant 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)In connection with the Annual Report on Form 10-K of Zogenix, Inc. (the “Company”) for the period ended December 31, 2012, as filed with the Securities andExchange Commission on the date hereof (the “Report”), I, Ann D. Rhoads, as Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, asadopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that to my knowledge:1.The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and2.The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date:March 15, 2013 /s/ Ann D. Rhoads Ann D. Rhoads Chief Finacial OfficerThe foregoing certification is being furnished solely to accompany the Report pursuant to 18 U.S.C. § 1350, and is not being filed for purposes of Section 18 of the SecuritiesExchange Act of 1934, as amended, and is not to be incorporated by reference into any filing of the Company, whether made before or after the date hereof, regardless of anygeneral incorporation language in such filing. A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by theCompany and furnished to the Securities and Exchange Commission or its staff upon request.

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