Santarus 10Q 2008 Q3 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)


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

For the quarterly period ended September 30, 2008


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

For the transition period from to

Commission File Number: 000-50651

SANTARUS, INC.

(Exact name of registrant as specified in its charter)


Delaware (State or other jurisdiction of incorporation or organization)		33-0734433 (I.R.S. Employer Identification No.)


3721 Valley Centre Drive, Suite 400, San Diego, CA (Address of principal executive offices)		92130 (Zip Code)

(858) 314-5700
(Registrant’s telephone number, including area code)

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

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 the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.


Large accelerated filero	Accelerated filerþ	Non-accelerated filero	Smaller reporting companyo
	(Do not check if a smaller reporting company)

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

The number of outstanding shares of the registrant’s common stock, par value $0.0001 per share, as of September 30, 2008 was 51,528,133.

SANTARUS, INC.

FORM 10-Q — QUARTERLY REPORT
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2008

TABLE OF CONTENTS


	Page
	No.
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements		1
Condensed Balance Sheets (unaudited) as of September 30, 2008 and December 31, 2007		1
Condensed Statements of Operations (unaudited) for the three and nine months ended September 30, 2008 and 2007		2
Condensed Statements of Cash Flows (unaudited) for the nine months ended September 30, 2008 and 2007		3
Notes to Unaudited Condensed Financial Statements		4
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		13
Item 3. Quantitative and Qualitative Disclosures about Market Risk		28
Item 4. Controls and Procedures		29
PART II — OTHER INFORMATION
Item 1. Legal Proceedings		30
Item 1A. Risk Factors		31
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		53
Item 3. Defaults Upon Senior Securities		53
Item 4. Submission of Matters to a Vote of Security Holders		53
Item 5. Other Information		53
Item 6. Exhibits		54
SIGNATURES		55
EX-31.1
EX-31.2
EX-32

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

Santarus, Inc.

Condensed Balance Sheets

(unaudited)


	September 30,			December 31,
	2008			2007
Assets
Current assets:
Cash and cash equivalents	$	32,422,254		$	58,382,366
Short-term investments		1,995,620			6,295,380
Accounts receivable, net		12,460,301			9,680,667
Inventories, net		5,909,760			6,157,383
Other current assets		3,540,655			2,339,742

Total current assets		56,328,590			82,855,538

Long-term restricted cash		1,400,000			1,400,000
Long-term investments		3,896,935			—
Property and equipment, net		1,077,571			667,594
Intangible assets, net		11,625,000			—
Other assets		192,700			421,115

Total assets	$	74,520,796		$	85,344,247


Liabilities and stockholders’ equity
Current liabilities:
Accounts payable and accrued liabilities	$	42,359,386		$	37,354,912
Allowance for product returns		9,448,616			5,946,917
Current portion of deferred revenue		8,864,865			13,972,008

Total current liabilities		60,672,867			57,273,837

Deferred revenue, less current portion		3,632,299			12,722,007
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.0001 par value; 10,000,000 shares authorized at September 30, 2008 and December 31, 2007; no shares issued and outstanding at September 30, 2008 and December 31, 2007		—			—
Common stock, $0.0001 par value; 100,000,000 shares authorized at September 30, 2008 and December 31, 2007; 51,528,133 and 51,315,485 shares issued and outstanding at September 30, 2008 and December 31, 2007, respectively		5,153			5,132
Additional paid-in capital		322,979,548			319,342,022
Accumulated other comprehensive (loss) income		(404,732	)		52
Accumulated deficit		(312,364,339	)		(303,998,803	)

Total stockholders’ equity		10,215,630			15,348,403

Total liabilities and stockholders’ equity	$	74,520,796		$	85,344,247

See accompanying notes.

Santarus, Inc.

Condensed Statements of Operations

(unaudited)


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2008			2007			2008			2007
Revenues:
Product sales, net	$	28,105,282		$	19,527,196		$	71,474,636		$	55,354,207
Contract revenue		4,103,075			6,930,502			21,205,086			10,791,506

Total revenues		32,208,357			26,457,698			92,679,722			66,145,713
Costs and expenses:
Cost of product sales		1,924,035			1,782,295			5,320,007			5,092,583
License fees and royalties		3,619,146			2,733,808			9,717,337			7,749,590
Research and development		2,273,415			1,725,525			6,220,419			4,956,236
Selling, general and administrative		28,520,979			27,823,204			80,788,115			87,005,367

Total costs and expenses		36,337,575			34,064,832			102,045,878			104,803,776

Loss from operations		(4,129,218	)		(7,607,134	)		(9,366,156	)		(38,658,063	)
Interest and other income, net		177,264			705,352			1,000,620			2,383,993

Net loss	$	(3,951,954	)	$	(6,901,782	)	$	(8,365,536	)	$	(36,274,070	)


Basic and diluted net loss per share	$	(0.08	)	$	(0.13	)	$	(0.16	)	$	(0.71	)

Weighted average shares outstanding used to calculate basic and diluted net loss per share		51,528,133			51,274,685			51,410,762			50,966,842

See accompanying notes.

Santarus, Inc.

Condensed Statements of Cash Flows

(unaudited)


	Nine Months Ended
	September 30,
	2008			2007
Operating activities
Net loss	$	(8,365,536	)	$	(36,274,070	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization		834,115			423,456
Stock-based compensation		3,205,437			4,996,732
Changes in operating assets and liabilities:
Accounts receivable, net		(2,779,634	)		(5,476,012	)
Inventories, net		247,623			(164,695	)
Other current assets		(1,200,913	)		(705,214	)
Other assets		60,934			(4,255	)
Accounts payable and accrued liabilities		5,004,474			13,855,262
Allowance for product returns		3,501,699			963,010
Deferred revenue		(14,196,851	)		(5,791,506	)

Net cash used in operating activities		(13,688,652	)		(28,177,292	)

Investing activities
Purchase of short-term investments		(2,944,320	)		(3,727,891	)
Maturities of short-term investments		2,928,533			350,000
Long-term restricted cash		—			300,000
Purchases of property and equipment		(687,783	)		(632,187	)
Acquisition of intangible assets		(12,000,000	)		—

Net cash used in investing activities		(12,703,570	)		(3,710,078	)

Financing activities
Exercise of stock options		5,604			254,807
Issuance of common stock, net		426,506			1,293,254

Net cash provided by financing activities		432,110			1,548,061

Decrease in cash and cash equivalents		(25,960,112	)		(30,339,309	)
Cash and cash equivalents at beginning of the period		58,382,366			70,883,641

Cash and cash equivalents at end of the period	$	32,422,254		$	40,544,332


Supplemental disclosure of cash flow information:
Interest paid	$	33,700		$	9,636

See accompanying notes.

Santarus, Inc.

Notes to Condensed Financial Statements

(unaudited)

1. Organization and Business

Santarus, Inc. (“Santarus” or the “Company”) is a specialty pharmaceutical company focused on acquiring, developing and commercializing proprietary products that address the needs of patients treated by gastroenterologists or primary care physicians. Santarus was incorporated on December 6, 1996 as a California corporation and did not commence significant business activities until late 1998. On July 9, 2002, the Company reincorporated in the State of Delaware.

2. Basis of Presentation

The accompanying unaudited condensed financial statements have been prepared in accordance with U.S. generally accepted accounting principles related to the preparation of interim financial statements and the rules and regulations of the U.S. Securities and Exchange Commission related to a quarterly report on Form 10-Q. Accordingly, they do not include all of the information and disclosures required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements. The balance sheet at December 31, 2007 has been derived from the audited financial statements at that date but does not include all information and disclosures required by GAAP for complete financial statements. The interim financial statements reflect all adjustments which, in the opinion of management, are necessary for a fair presentation of the financial condition and results of operations for the periods presented. Except as otherwise disclosed, all such adjustments are of a normal recurring nature.

Operating results for the three and nine months ended September 30, 2008 are not necessarily indicative of the results that may be expected for any future periods. For further information, please see the financial statements and related disclosures included in the Company’s annual report on Form 10-K for the year ended December 31, 2007.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as well as disclosures of contingent assets and liabilities at the date of the financial statements. Estimates also affect the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

3. Revenue Recognition

The Company follows Staff Accounting Bulletin (“SAB”) No. 104,Revenue Recognition, and recognizes revenue when there is persuasive evidence that an arrangement exists, title has passed, the price is fixed or determinable, and collectibility is reasonably assured.

Product Sales, Net.The Company received approval from the U.S. Food and Drug Administration (“FDA”) to market Zegerid^® (omeprazole/sodium bicarbonate) Capsules in February 2006 for the treatment of heartburn and other symptoms associated with gastroesophageal reflux disease (“GERD”), treatment and maintenance of healing of erosive esophagitis and treatment of duodenal and gastric ulcers. The Company received approval from the FDA to market Zegerid (omeprazole/sodium bicarbonate) Powder for Oral Suspension for these same indications in 2004. In addition, Zegerid Powder for Oral Suspension is approved for the reduction of risk of upper gastrointestinal bleeding in critically ill patients, and is currently the only proton pump inhibitor (“PPI”) product approved for this indication. The Company commercially launched Zegerid Capsules in late March 2006 and launched Zegerid Powder for Oral Suspension 20 mg in late 2004 and the 40 mg dosage strength in early 2005.

The Company sells its Zegerid products primarily to pharmaceutical wholesale distributors. The Company is obligated to accept from customers the return of products that are within six months of their expiration date or up to 12 months beyond their expiration date. The Company authorizes returns for damaged products and exchanges for expired products in accordance with its return goods policy and procedures, and has established allowances for such amounts at the time of sale.

The Company recognizes revenue from product sales in accordance with SAB No. 104 and Statement of Financial Accounting Standard (“SFAS”) No. 48,Revenue Recognition When Right of Return Exists. Among its criteria for revenue recognition from sale transactions where a buyer has a right of return, SFAS No. 48 requires the amount of future returns to be reasonably estimable. The Company recognizes product sales net of estimated allowances for product returns, estimated rebates in connection with contracts relating to managed care, Medicaid, Medicare, and patient coupons, and estimated chargebacks from distributors, wholesaler fees and prompt payment and other discounts.

The Company establishes allowances for estimated product returns, rebates and chargebacks based primarily on the following qualitative and quantitative factors:

	•		the number of and specific contractual terms of agreements with customers;

	•		estimated levels of inventory in the distribution channel;

	•		estimated remaining shelf life of products;

	•		analysis of prescription data gathered by a third-party prescription data provider;

	•		direct communication with customers;

	•		historical product returns, rebates and chargebacks;

	•		anticipated introduction of competitive products or generics;

	•		anticipated pricing strategy changes by the Company and/or its competitors; and

	•		the impact of state and federal regulations.

In its analyses, the Company utilizes prescription data purchased from a third-party data provider to develop estimates of historical inventory channel pull-through. The Company utilizes a separate analysis which compares historical product shipments less returns to estimated historical prescriptions written. Based on that analysis, the Company develops an estimate of the quantity of product in the distribution channel which may be subject to various product return, rebate and chargeback exposures.

The Company’s estimates of product returns, rebates and chargebacks require management’s most subjective and complex judgment due to the need to make estimates about matters that are inherently uncertain. If actual future payments for returns, rebates, chargebacks and other discounts exceed the estimates the Company made at the time of sale, its financial position, results of operations and cash flows would be negatively impacted.

The Company’s allowance for product returns was $9.4 million as of September 30, 2008 and $5.9 million as of December 31, 2007. In order to provide a basis for estimating future product returns on sales to its customers at the time title transfers, the Company has been tracking its Zegerid products return history from the time of its first commercial product launch of Zegerid Powder for Oral Suspension 20 mg in late 2004, taking into consideration product expiration dating and estimated inventory levels in the distribution channel. The Company recognizes product sales at the time title passes to its customers, and the Company provides for an estimate of future product returns at that time based upon its historical product returns trends, analysis of product expiration dating and inventory levels in the distribution channel, and the other factors discussed above. There may be a significant time lag between the date the Company determines the estimated allowance and when it receives the product return and issues credit to a customer. Due to this time lag, the Company records adjustments to its estimated allowance over several periods, which can result in a net increase or a net decrease in its operating results in those periods. In 2007, based upon the Company’s review of additional product returns history gathered through the end of 2007 and analysis of product expiration dating and estimated inventory in the distribution channel, the Company increased its estimate for product returns to reflect actual experience accordingly. This change in estimate provided for potential product returns related to sales in prior periods and resulted in an increase to net loss of approximately $1.9 million in 2007.

The Company’s allowance for rebates, chargebacks and other discounts was $25.9 million as of September 30, 2008 and $21.0 million as of December 31, 2007. These allowances reflect an estimate of the Company’s liability for rebates due to managed care organizations under specific contracts, rebates due to various governmental organizations under Medicaid and Medicare contracts and regulations, chargebacks due to various organizations purchasing the Company’s products through federal contracts and/or group purchasing agreements, and other rebates and customer discounts due in connection with wholesaler fees and prompt payment and other discounts. The Company estimates its liability for rebates and chargebacks at each reporting period based on a combination of the qualitative and quantitative assumptions listed above. In each reporting period, the Company evaluates its outstanding contracts and applies the contractual discounts to the invoiced price of wholesaler shipments recognized. Although the total invoiced price of shipments to wholesalers for

the reporting period and the contractual terms are known during the reporting period, the Company projects the ultimate disposition of the sale (e.g. future utilization rates of cash payors, managed care, Medicaid, Medicare or other contracted organizations). This estimate is based on historical trends adjusted for anticipated changes based on specific contractual terms of new agreements with customers, anticipated pricing strategy changes by the Company and/or its competitors and the other qualitative and quantitative factors described above. There may be a significant time lag between the date the Company determines the estimated allowance and when the Company makes the contractual payment or issues credit to a customer. Due to this time lag, the Company records adjustments to its estimated allowance over several periods, which can result in a net increase or a net decrease in its operating results in those periods. To date, actual results have not materially differed from the Company’s estimates.

Contract Revenue.The Company recognizes contract revenue consistent with the provisions of SAB No. 104 and Emerging Issues Task Force (“EITF”) Issue No. 00-21,Revenue Arrangements with Multiple Deliverables. The Company analyzes each element of its licensing and co-promotion agreements to determine the appropriate revenue recognition. The Company recognizes revenue on upfront payments over the period of significant involvement under the related agreements unless the fee is in exchange for products delivered or services rendered that represent the culmination of a separate earnings process and no further performance obligation exists under the contract. The Company recognizes milestone payments upon the achievement of specified milestones if (1) the milestone is substantive in nature, and the achievement of the milestone was not reasonably assured at the inception of the agreement and (2) the fees are nonrefundable. Any milestone payments received prior to satisfying these revenue recognition criteria are recognized as deferred revenue. Sales milestones, royalties and co-promotion fees are recognized as revenue when earned under the agreements.

4. Stock-Based Compensation

For the three months ended September 30, 2008 and 2007 and the nine months ended September 30, 2008 and 2007, the Company recognized approximately $1.0 million, $1.7 million, $3.2 million and $5.0 million of total stock-based compensation, respectively, in accordance with SFAS No. 123 (revised 2004),Share-Based Payment, which is a revision of SFAS No. 123,Accounting for Stock-Based Compensation(“SFAS No. 123(R)”) and EITF Issue No. 96-18,Accounting for Equity Investments that are Issued to Other than Employees for Acquiring or in Conjunction with Selling Goods or Services.As of September 30, 2008, total unrecognized compensation cost related to stock options and employee stock purchase plan rights was approximately $7.3 million, and the weighted average period over which it was expected to be recognized was 2.3 years. In March 2008, the Company granted options to purchase 2,384,877 shares of its common stock in connection with annual option grants to all eligible employees. These stock options generally vest over a four-year period from the date of grant. Certain of these stock options for employees at or above the vice president level vest upon the attainment of specific financial performance targets. The measurement date of stock options containing performance-based vesting is the date the stock option grant is authorized and the specific performance goals are communicated. Compensation expense is recognized based on the probability that the performance criteria will be met. The recognition of compensation expense associated with performance-based vesting requires judgment in assessing the probability of meeting the performance goals, as well as defined criteria for assessing achievement of the performance-related goals. The continued assessment of probability may result in additional expense recognition or expense reversal depending on the level of achievement of the performance goals.

5. Comprehensive Income (Loss)

Comprehensive income (loss) consists of net income (loss) and other comprehensive income (loss). Other comprehensive income (loss) includes certain changes in stockholders’ equity that are excluded from net income (loss), specifically unrealized gains and losses on securities available-for-sale. Comprehensive income (loss) consists of the following:


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2008			2007			2008			2007
Net loss	$	(3,951,954	)	$	(6,901,782	)	$	(8,365,536	)	$	(36,274,070	)
Unrealized gain (loss) on investments		(116,388	)		1,928			(404,784	)		(131	)

Comprehensive loss	$	(4,068,342	)	$	(6,899,854	)	$	(8,770,320	)	$	(36,274,201	)

6. Net Loss Per Share

The Company calculates net loss per share in accordance with SFAS No. 128,Earnings Per Share. Basic loss per share is calculated by dividing the net loss by the weighted average number of common shares outstanding for the period, without consideration for common stock equivalents. Diluted loss per share is computed by dividing the net loss by the weighted average number of common share equivalents outstanding for the period determined using the treasury-stock method. For purposes of this calculation, common stock subject to repurchase by the Company, preferred stock, options and warrants are considered to be common stock equivalents and are only included in the calculation of diluted loss per share when their effect is dilutive. Potentially dilutive securities totaling 12.5 million and 8.8 million for the three months ended September 30, 2008 and 2007, respectively, and 11.9 million and 8.4 million for nine months ended September 30, 2008 and 2007, respectively, were excluded from the calculation of diluted loss per share because of their anti-dilutive effect.


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2008			2007			2008			2007
Numerator:
Net loss	$	(3,951,954	)	$	(6,901,782	)	$	(8,365,536	)	$	(36,274,070	)

Denominator:
Weighted average common shares outstanding		51,528,133			51,283,460			51,412,154			50,980,570
Weighted average unvested common shares subject to repurchase		—			(8,775	)		(1,392	)		(13,728	)

Denominator for basic and diluted net loss per share		51,528,133			51,274,685			51,410,762			50,966,842


Basic and diluted net loss per share	$	(0.08	)	$	(0.13	)	$	(0.16	)	$	(0.71	)

7. Segment Reporting

Management has determined that the Company operates in one business segment which is the acquisition, development and commercialization of pharmaceutical products.

8. Fair Value Measurements

Effective January 1, 2008, the Company adopted SFAS No. 157,Fair Value Measurements. SFAS No. 157 establishes a framework for measuring fair value in accordance with GAAP, clarifies the definition of fair value within that framework, and expands disclosures about the use of fair value measurements. It also responds to investors’ requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value and the effect of fair value measurements on earnings. SFAS No. 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value, and does not expand the use of fair value in any new circumstances. The adoption of SFAS No. 157 did not have a material impact on the Company’s condensed financial statements.

SFAS No. 157 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

The Company’s financial assets measured at fair value on a recurring basis subject to the disclosure requirements of SFAS No. 157 at September 30, 2008 are as follows:


	Fair Value Measurements at Reporting Date Using
	Quoted
	Prices in
	Active		Significant
	Markets for		Other		Significant
	Identical		Observable		Unobservable
	Assets		Inputs		Inputs
	(Level 1)		(Level 2)		(Level 3)		Total
Money market funds	$	10,698,270	$	—	$	—	$	10,698,270
U.S. government sponsored enterprise securities		—		8,786,898		—		8,786,898
Commercial paper		—		16,332,706		—		16,332,706
Municipal debt obligations		—		—		3,896,935		3,896,935

	$	10,698,270	$	25,119,604	$	3,896,935	$	39,714,809

All Level 3 assets held as of September 30, 2008 consist of municipal debt obligations with an auction rate reset mechanism issued by state municipalities. These auction rate securities are high-grade (AAA-rated) debt instruments with long-term maturity dates ranging from 2034 to 2042 and interest rates that are reset at short-term intervals (every 28 days) through auctions. Due to conditions in the global credit markets, in the nine months ended September 30, 2008, these securities, representing a par value of approximately $4.3 million, have experienced multiple failed auctions due to insufficient demand for the securities at auction. As a result, these affected securities are currently not liquid and the interest rates have been reset to predetermined higher rates. Due to the illiquid state of these investments, the Company has classified the balance of its auction rate securities as long-term investments in the condensed balance sheet as of September 30, 2008.

Typically the fair value of auction rate securities approximates par value due to the frequent resets through the auction process. While the Company continues to earn interest on its auction rate securities at the maximum contractual rates, these investments are not currently trading and therefore do not currently have a readily determinable market value. Accordingly, the estimated fair value of auction rate securities no longer approximates par value. The Company has used a discounted cash flow model to determine the estimated fair value of its investment in auction rate securities as of September 30, 2008. The assumptions used in preparing the discounted cash flow model include estimates for interest rates, timing and amount of cash flows and expected holding period of the auction rate securities. Based on this assessment of fair value, the Company recorded an unrealized loss of approximately $403,000 related to its auction rate securities as of September 30, 2008. Management believes this unrealized loss is primarily attributable to the limited liquidity of these investments and has no reason to believe that any of the underlying issuers are presently at risk of default.

In October 2008, the Company received an offer of Auction Rate Securities Rights (“Rights”) from its investment provider, UBS Financial Services, Inc., a subsidiary of UBS AG (“UBS”). The Company is assessing the offer of Rights and plans to make its determination prior to the November 14, 2008 expiration date of the offer. If accepted, the Rights will permit the Company to require UBS to purchase the Company’s auction rate securities at par value at any time during the period of June 30, 2010 through July 2, 2012. If the Company does not exercise its Rights, the auction rate securities will continue to accrue interest as determined by the auction process. If the Rights are not exercised before July 2, 2012 they will expire and UBS will have no further obligation to buy the Company’s auction rate securities. If the Company accepts the Rights, UBS will have the discretion to purchase or sell the Company’s auction rate securities at any time without prior notice so long as the Company receives a payment at par upon any sale or disposition. UBS will only exercise its discretion to purchase or sell the Company’s auction rate securities for the purpose of restructurings, dispositions or other solutions that will provide the Company with par value for its auction rate securities. As a condition to accepting the offer of Rights, the Company will be required to release UBS from all claims except claims for consequential damages relating to its marketing and sales of auction rate securities. The Company will also be required to agree not to serve as a class representative or receive benefits under any class action settlement or investor fund.

The following table provides a summary of changes in fair value of the Company’s Level 3 financial assets as of September 30, 2008:


	Three Months			Nine Months
	Ended			Ended
	September 30,			September 30,
	2008			2008
Municipal debt obligations:
Beginning balance	$	4,012,020		$	—
Transfers in		—			4,300,000
Unrealized loss included in other comprehensive loss		(115,085	)		(403,065	)

Ending balance as of September 30, 2008	$	3,896,935		$	3,896,935

9. Balance Sheet Details

Inventories, net consist of the following:


	September 30,			December 31,
	2008			2007
Raw materials	$	1,036,518		$	1,511,220
Finished goods		5,358,177			4,811,852

		6,394,695			6,323,072
Allowance for excess and obsolete inventory		(484,935	)		(165,689	)

	$	5,909,760		$	6,157,383

Inventories are stated at the lower of cost (FIFO) or market and consist of finished goods and raw materials used in the manufacture of the Company’s Zegerid Capsules and Zegerid Powder for Oral Suspension products. Also included in inventories are product samples of Glumetza^® (metformin hydrochloride extended release tablets) which the Company purchases from Depomed, Inc. (“Depomed”) under its promotion agreement. Inventories as of December 31, 2007 also included product samples of Naprelan^® (naproxen sodium) Controlled Release Tablets which the Company purchased from Victory Pharma, Inc. (“Victory”) under its co-promotion agreement, which was terminated effective as of October 1, 2008. The Company provides reserves for potentially excess, dated or obsolete inventories based on an analysis of inventory on hand and on firm purchase commitments, compared to forecasts of future sales.

Accounts payable and accrued liabilities consist of the following:


	September 30,		December 31,
	2008		2007
Accounts payable	$	4,508,853	$	5,179,954
Accrued compensation and benefits		5,270,481		5,359,756
Accrued rebates		23,051,007		19,478,658
Accrued royalties and milestones		3,244,146		3,363,914
Other accrued liabilities		6,284,899		3,972,630

	$	42,359,386	$	37,354,912

10. License Agreement

In May 2008, the Company achieved a $2.5 million regulatory milestone under its over-the-counter (“OTC”) license agreement with Schering-Plough Healthcare Products, Inc. (“Schering-Plough”). The regulatory milestone was earned upon FDA acceptance for filing of a new drug application (“NDA”) submitted by Schering-Plough for a Zegerid branded omeprazole/sodium bicarbonate OTC product in a 20 mg dosage strength of omeprazole. The Company received the $2.5 million nonrefundable payment in June 2008 and recognized the payment as contract revenue in the nine months ended September 30, 2008 due to the substantive nature of the milestone achieved.

11. Co-Promotion Agreements

On April 15, 2008, the Company provided notice to Otsuka America Pharmaceutical, Inc. (“Otsuka America”) of the Company’s intent to terminate their co-promotion agreement for Zegerid Capsules and Powder for Oral Suspension effective August 13, 2008, or earlier as the parties may mutually agree. On May 28, 2008, the Company and Otsuka America agreed to terminate the co-promotion agreement effective as of June 30, 2008. The Company and Otsuka America entered into the co-promotion agreement in October 2004 to co-promote Zegerid products in the U.S. through December 31, 2009, unless terminated earlier under amended terms agreed to in January 2006. Following the effective date of termination, there are no continuing financial commitments for either company, and the Company is no longer obligated to pay a high single-digit royalty on Zegerid net sales to Otsuka America. In addition, the Company amortized the remaining balance of the $15 million up-front payment previously received from Otsuka America in October 2004 and recognized approximately $5.7 million in contract revenue in the nine months ended September 30, 2008 associated with this amortization.

On May 6, 2008, the Company and C.B. Fleet Company, Incorporated (“Fleet”) entered into an amendment to their co-promotion agreement dated August 24, 2007 regarding the co-promotion by the Company of the Fleet^® Phospho-soda^® EZ-Prep^™ Bowel Cleansing System to gastroenterologists in the U.S. The amendment increased the maximum number of sales calls for which the Company was eligible to receive co-promotion fees from Fleet and specified the maximum number of sales calls on a monthly basis. The increase in the maximum number of sales calls increased the maximum amount of co-promotion fees that the Company was eligible to receive from approximately $3.0 million to approximately $4.8 million over the one-year term of the agreement. The co-promotion agreement expired in accordance with its terms on October 1, 2008.

On July 18, 2008, the Company and Victory mutually agreed to terminate their co-promotion agreement for Victory’s Naprelan prescription pharmaceutical products effective as of October 1, 2008. The Company and Victory entered into the co-promotion agreement in June 2007 to co-promote the Naprelan products in the U.S. through June 10, 2014, unless terminated earlier. The Company ended all promotional efforts under the agreement as of September 30, 2008, and Victory will pay to the Company any co-promotion fees due to the Company under the agreement through such period. Victory will also make a one-time, lump-sum payment to the Company on January 31, 2009, as a trailing royalty payment for the fiscal quarter ending December 31, 2008. In addition, Victory will purchase from Santarus a portion of the product samples on-hand.

12. Promotion Agreement with Depomed, Inc.

On July 21, 2008, the Company entered into a promotion agreement with Depomed granting the Company exclusive rights to promote Depomed’s Glumetza products in the U.S., including its territories and possessions and Puerto Rico (collectively, the “Territory”). Glumetza is a once-daily, extended-release formulation of metformin that incorporates patented drug delivery technology and is indicated as an adjunct to diet and exercise to improve glycemic control in adult patients with type 2 diabetes.

Under the promotion agreement, the Company is required to meet certain minimum promotion obligations during the term of the agreement. The Company began promoting the Glumetza products in October 2008, and for a period of one year from the promotion commencement date, the Company is required to deliver a minimum number of sales calls to potential Glumetza prescribers. Following the end of that one-year period, for a period of three years, the Company is required to make specified minimum sales force expenditures. In addition, during the term of the agreement, the Company is required to make certain minimum marketing, advertising, medical affairs and other commercial support expenditures.

Under the terms of the promotion agreement, the Company paid Depomed a $12.0 million upfront fee, and based on the achievement of specified levels of annual Glumetza net product sales, the Company may pay Depomed one-time sales milestones, totaling up to $16.0 million. The $12.0 million upfront fee has been capitalized and included in intangible assets and is being amortized to license fee expense over the estimated useful life of the asset on a straight-line basis through mid-2016. Total amortization expense for the three months ended September 30, 2008 was $375,000. Beginning in the fourth quarter of 2008, Depomed will pay the Company a fee ranging from 75% to 80% of the gross margin earned from all net sales of Glumetza products in the Territory, with gross margin defined as net sales less cost of goods and product-related fees paid to Biovail Laboratories. Depomed will continue to record revenue from the sales of Glumetza

products. The Company is responsible for all costs associated with its sales force and for all other sales and marketing-related expenses associated with its promotion of Glumetza products, including an initial commitment of $5.0 million in non-sales force advertising and promotional costs from signing through March 31, 2009. Depomed is responsible for overseeing product manufacturing and supply. A joint commercialization committee has been formed to oversee and guide the strategic direction of the Glumetza alliance. The promotion agreement will continue in effect until the expiration of the last-to-expire patent or patent application with a valid claim in the Territory covering a Glumetza product, unless terminated sooner. Subject to 90 days prior written notice to Depomed, the Company may terminate the promotion agreement at any time following the 18-month anniversary of the effective date of the agreement. Subject to notice to Depomed, the Company may also terminate the agreement immediately in other circumstances, such as loss of market exclusivity or in the event of certain regulatory or governmental actions or if Depomed fails to supply the Glumetza product as reasonably necessary to meet trade demand for a period of three months or longer. Subject to 60 days prior written notice to the Company, Depomed may terminate the agreement if the Company fails to meet its obligations with respect to minimum promotion obligations and fails to cure such breach within a specified time period. Depomed may also terminate the agreement on 180 days prior written notice if the Company fails to deliver certain required information related to forecasted sales force expenditures. Either party may terminate the agreement under certain other limited circumstances.

13. Long-Term Debt

On July 11, 2008, the Company entered into an Amended and Restated Loan and Security Agreement (the “Amended Loan Agreement”) with Comerica Bank (“Comerica”). The Amended Loan Agreement amends and restates the terms of the original Loan and Security Agreement entered into between the Company and Comerica in July 2006. As of September 30, 2008, the Company had not borrowed any amounts under the Amended Loan Agreement. The credit facility under the Amended Loan Agreement consists of a revolving line of credit, pursuant to which the Company may request advances in an aggregate outstanding amount not to exceed $25.0 million. Under the Amended Loan Agreement, the revolving loan bears interest, as selected by the Company, at either the variable rate of interest, per annum, most recently announced by Comerica as its “prime rate” plus 0.50% or the LIBOR rate (as computed in the Amended and Restated LIBOR Addendum to the Amended Loan Agreement) plus 3.00%. Interest payments on advances made under the Amended Loan Agreement are due and payable in arrears on the first calendar day of each month during the term of the Amended Loan Agreement. Amounts borrowed under the Amended Loan Agreement may be repaid and re-borrowed at any time prior to July 11, 2011. There is a non-refundable unused commitment fee equal to 0.50% per annum on the difference between the amount of the revolving line and the average daily balance outstanding thereunder during the term of the Amended Loan Agreement, payable quarterly in arrears. The Amended Loan Agreement will remain in full force and effect for so long as any obligations remain outstanding or Comerica has any obligation to make credit extensions under the Amended Loan Agreement.

Amounts borrowed under the Amended Loan Agreement are secured by substantially all of the Company’s personal property, excluding intellectual property. Under the Amended Loan Agreement, the Company is subject to certain affirmative and negative covenants, including limitations on the Company’s ability: to enter into certain change of control events; to convey, sell, lease, license, transfer or otherwise dispose of assets; to create, incur, assume, guarantee or be liable with respect to certain indebtedness; to grant liens; to pay dividends and make certain other restricted payments; and to make investments. In addition, under the Amended Loan Agreement the Company is required to maintain a balance of cash with Comerica in an amount of not less than $4.0 million and to maintain any other cash balances with either Comerica or another financial institution covered by a control agreement for the benefit of Comerica. The Company is also subject to specified financial covenants with respect to a minimum liquidity ratio and, in specified limited circumstances, minimum EBITDA requirements.

14. Contingencies

In September 2007, the Company filed a lawsuit in the United States District Court for the District of Delaware against Par Pharmaceutical, Inc. (“Par”) for infringement of U.S. Patent Nos. 6,645,988; 6,489,346; and 6,699,885, each of which is listed in the Approved Drug Products with Therapeutic Equivalence Evaluations (the “Orange Book”) for Zegerid Capsules. In December 2007, the Company filed a second lawsuit in the United States District Court for the District of Delaware against Par for infringement of U.S. Patent Nos. 6,645,988; 6,489,346; 6,699,885; and 6,780,882, each of which is listed in the Orange Book for Zegerid Powder for Oral Suspension. The University of Missouri, licensor of the patents, is a co-plaintiff in the litigation, and both lawsuits have been consolidated for all purposes. The lawsuits are in response to Abbreviated New Drug Applications (“ANDAs”) filed by Par with the FDA regarding Par’s intent to market generic

versions of the Company’s Zegerid Capsules and Zegerid Powder for Oral Suspension products prior to the July 2016 expiration of the asserted patents. Each complaint seeks a judgment that Par has infringed the asserted patents and that the effective date of approval of Par’s ANDA shall not be earlier than the expiration date of the asserted patents. Par has filed answers in each case, primarily asserting non-infringement, invalidity and/or unenforceability. Par has also filed counterclaims seeking a declaration in its favor on those issues. In addition, Par is seeking a declaration that U.S. Patent No. 5,840,737 (the “‘737 patent”) is not infringed, is invalid and/or is unenforceable. The ‘737 patent is one of six issued patents listed in the Orange Book for Zegerid Powder for Oral Suspension. The ‘737 patent is not one of the four patents listed in the Orange Book for Zegerid Capsules. The Company has moved to dismiss, or in the alternative, stay these claims due to a reissue proceeding involving the ‘737 patent currently pending before the U.S. Patent and Trademark Office (“PTO”). The Company and the University of Missouri also granted Par a covenant not to sue on the original ‘737 patent. The discovery phase of the lawsuits is continuing. A claim construction hearing is currently scheduled for November 2008. Trial is currently scheduled for July 2009.

The Company commenced each of the lawsuits within the applicable 45 day period required to automatically stay, or bar, the FDA from approving Par’s ANDAs for 30 months or until a district court decision that is adverse to the asserted patents, whichever may occur earlier. If the litigation is still ongoing after 30 months, the termination of the stay could result in the introduction of one or more generic products to Zegerid Capsules and/or Zegerid Powder for Oral Suspension prior to resolution of the litigation.

On July 15, 2008, the PTO issued U.S. Patent No. 7,399,772 (the “‘772 patent”), which is now listed in the Orange Book for both Zegerid Capsules and Zegerid Powder for Oral Suspension. In October 2008, the Company amended its complaint to add the ‘772 patent to the pending litigation with Par.

Although the Company intends to vigorously defend and enforce its patent rights, the Company is not able to predict the outcome of the litigation. Any adverse outcome in this litigation could result in one or more generic versions of Zegerid Capsules and/or Zegerid Powder for Oral Suspension being launched before the expiration of the listed patents in July 2016, which could adversely affect the Company’s ability to successfully execute its business strategy to maximize the value of Zegerid Capsules and Zegerid Powder for Oral Suspension and would likely negatively impact the Company’s financial condition and results of operations. An adverse outcome may also impact the patent protection for the products being commercialized pursuant to the Company’s strategic alliances with GlaxoSmithKline plc (“GSK”) and Schering-Plough, which in turn may impact the amount of, or the Company’s ability to receive, milestone payments and royalties under those agreements. In addition, even if the Company prevails, the litigation will be costly, time consuming and distracting to management, which could have a material adverse effect on the Company’s business.

In December 2007, the University of Missouri filed an Application for Reissue of the ‘737 patent with the PTO. It is not feasible to predict the impact that the reissue proceeding may have on the scope and validity of the ‘737 patent claims. If the claims of the ‘737 patent ultimately are narrowed substantially or invalidated by the PTO, the extent of the patent coverage afforded to the Company’s Zegerid family of products could be impaired, which could potentially harm the Company’s business and operating results.

15. Accounting Pronouncements

Adoption of Recent Accounting Pronouncements

In February 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment to FASB Statement No. 115. SFAS No. 159 allows certain financial assets and liabilities to be recognized, at the Company’s election, at fair market value, with any gains or losses for the period recorded in the statement of operations. SFAS No. 159 includes available-for-sale securities in the assets eligible for this treatment. Currently, the Company records the unrealized gains or losses for the period in comprehensive income (loss) and in the equity section of the balance sheet. SFAS No. 159 was effective for the Company on January 1, 2008. The Company did not elect to adopt the fair value option under SFAS No. 159 on any assets or liabilities not previously carried at fair value.

In June 2007, the EITF issued EITF Issue No. 07-3,Accounting for Nonrefundable Advance Payments for Goods or Services to be Used in Future Research and Development Activities. The consensus requires companies to defer and capitalize prepaid, nonrefundable research and development payments to third parties over the period that the research and development activities are performed or the services are provided, subject to an assessment of recoverability. EITF Issue No. 07-3 is effective for new contracts entered into beginning on January 1, 2008. The adoption of EITF Issue No. 07-3 did not have a material impact on the Company’s condensed financial statements.

Pending Adoption of Accounting Pronouncements

In November 2007, the EITF issued EITF Issue No. 07-1,Accounting for Collaborative Arrangements Related to the Development and Commercialization of Intellectual Property.Companies may enter into arrangements with other companies to jointly develop, manufacture, distribute, and market a product. Often the activities associated with these arrangements are conducted by the collaborators without the creation of a separate legal entity (that is, the arrangement is operated as a “virtual joint venture”). The arrangements generally provide that the collaborators will share, based on contractually defined calculations, the profits or losses from the associated activities. Periodically, the collaborators share financial information related to product revenues generated (if any) and costs incurred that may trigger a sharing payment for the combined profits or losses. The consensus requires collaborators in such an arrangement to present the result of activities for which they act as the principal on a gross basis and report any payments received from (made to) other collaborators based on other applicable GAAP or, in the absence of other applicable GAAP, based on analogy to authoritative accounting literature or a reasonable, rational, and consistently applied accounting policy election. EITF Issue No. 07-1 is effective for collaborative arrangements in place at the beginning of the annual period beginning after December 15, 2008. The Company does not expect the adoption of EITF Issue No. 07-1 to have a material impact on its financial statements.

In December 2007, the FASB issued SFAS No. 141(R),Business Combinations. SFAS No. 141(R) changes the requirements for an acquirer’s recognition and measurement of the assets acquired and liabilities assumed in a business combination, including the treatment of contingent consideration, pre-acquisition contingencies, transaction costs, in-process research and development and restructuring costs. In addition, under SFAS No. 141(R), changes in an acquired entity’s deferred tax assets and uncertain tax positions after the measurement period will impact income tax expense. This statement is effective for the Company with respect to business combination transactions for which the acquisition date is after December 31, 2008.

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

The following discussion contains forward-looking statements, which involve risks and uncertainties. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth below under the caption “Risk Factors.” The interim condensed financial statements and this Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the financial statements and notes thereto for the year ended December 31, 2007 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report onForm 10-K for the year ended December 31, 2007.

We are a specialty pharmaceutical company focused on acquiring, developing and commercializing proprietary products that address the needs of patients treated by gastroenterologists or primary care physicians. The primary focus of our current efforts is the commercialization of our proprietary, immediate-release proton pump inhibitor, or PPI, technology for the treatment of upper gastrointestinal, or GI, diseases and disorders, including gastroesophageal reflux disease, or GERD. In the U.S. prescription market, our commercial organization promotes our Zegerid^® (omeprazole/sodium bicarbonate) products to targeted gastroenterologists and primary care physicians. To further leverage our proprietary PPI technology and diversify our sources of revenue, we have entered into strategic alliances with Schering-Plough Consumer Healthcare Products, Inc., or Schering-Plough, for the U.S. and Canadian over-the-counter, or OTC, markets, and with Glaxo Group Limited, an affiliate of GlaxoSmithKline plc, or GSK, for prescription and OTC markets in up to 114 countries in Africa, Asia, the Middle-East, and Central and South America, as well as prescription markets in Puerto Rico and the U.S. Virgin Islands. In addition to our efforts related to our PPI technology, in October 2008, our commercial organization commenced promotion of Depomed Inc.’s, or Depomed’s, Glumetza^® (metformin hydrochloride extended release tablets) in the U.S. Glumetza is a once-daily, extended-release formulation of metformin that incorporates patented drug delivery technology and is indicated as an adjunct to diet and exercise to improve glycemic control in adult patients with type 2 diabetes. Our goal is to become a leading specialty pharmaceutical company, and we plan to continue to seek to maximize the value of our PPI technology, as well as expand our product portfolio through co-promotion, licensing or acquisition of marketed or late stage proprietary products.

Our Zegerid products are proprietary immediate-release formulations that combine omeprazole, a PPI, and one or more antacids and are currently marketed in capsule and powder for oral suspension dosage forms. These products were developed by us as the first immediate-release oral PPIs for the U.S. prescription market, and they have been approved by the U.S. Food and Drug Administration, or FDA, to treat or reduce the risk of a variety of upper GI diseases and disorders. According to IMS Health, an independent market research firm, the U.S. market for prescription PPI products had total sales of more than $14 billion during 2007. We believe our Zegerid products offer a differentiated treatment option for physicians and their patients and represent an attractive market opportunity.

Our Zegerid products are based on patented technology and utilize antacids, which raise the gastric pH and thus protect the PPI, omeprazole, from acid degradation in the stomach, allowing the omeprazole to be quickly absorbed into the bloodstream. Although other marketed oral PPIs enjoy widespread use due to their potent acid suppression, favorable safety profiles and once-a-day dosing, they are available only in delayed-release, enteric-coated formulations. While the enteric coatings protect delayed-release PPIs from acid degradation in the stomach, they also delay absorption until the delayed-release PPIs reach the alkaline environment of the small intestine, where the enteric coatings dissolve. Our immediate-release Zegerid products are not enterically coated and are designed to provide both rapid and continued nighttime and daytime acid control.

We received approval from the FDA to market Zegerid (omeprazole/sodium bicarbonate) Capsules in February 2006 for the treatment of heartburn and other symptoms associated with GERD, treatment and maintenance of healing of erosive esophagitis and treatment of duodenal and gastric ulcers. We received approval from the FDA to market Zegerid (omeprazole/sodium bicarbonate) Powder for Oral Suspension for these same indications in 2004. In addition, Zegerid Powder for Oral Suspension 40 mg is approved for the reduction of risk of upper GI bleeding in critically ill patients, and is currently the only PPI product approved for this indication. We received FDA approval of each of our new drug applications, or NDAs, for our Zegerid products within the initial 10-month period for FDA review under the policies of the Prescription Drug User Fee Act, or PDUFA. We commercially launched Zegerid Capsules 20 mg and 40 mg in late March 2006, and launched Zegerid Powder for Oral Suspension 20 mg in October 2004 and 40 mg in February 2005.

We have established a commercial organization that is targeting the highest PPI-prescribing physicians in the U.S., with a focus on approximately 26,000 office-based gastroenterologists and primary care physicians. We estimate that this group of physicians collectively wrote approximately one-third of the value of PPI prescriptions written in 2007. We believe our concentration on high-volume PPI prescribers enables us to effectively promote our products with a relatively focused sales and marketing organization. In connection with our Glumetza promotion agreement, we have also initiated sales calls with a targeted group of endocrinologists. Our field sales organization includes our own sales representatives and fully-dedicated contract sales representatives under our contract sales organization agreement with inVentiv Commercial Services, LLC, or inVentiv.

We also recently terminated a non-exclusive agreement with Otsuka America Pharmaceutical Inc., or Otsuka America, under which Otsuka America had been co-promoting Zegerid Capsules and Zegerid Powder for Oral Suspension to targeted U.S. physicians. We originally entered into the agreement in October 2004 and amended the terms of the agreement in January 2006. Under the agreement, we received a $15.0 million upfront payment from Otsuka America and paid Otsuka America a royalty on total U.S. net sales of Zegerid Capsules and Zegerid Powder for Oral Suspension. We agreed to terminate the co-promotion agreement effective as of June 30, 2008.

In January 2001, we entered into an exclusive, worldwide license agreement with the University of Missouri, under which we licensed rights to its patents and patent applications relating to specific formulations of immediate-release PPIs with antacids for treating upper GI diseases and disorders. This licensed technology forms the basis of our Zegerid family of products. We paid the University of Missouri an upfront licensing fee of $1.0 million in 2001 and a one-time $1.0 million milestone fee upon the filing of our first NDA in 2003. In July 2004, we paid a one-time $5.0 million milestone fee based upon the FDA’s approval of Zegerid Powder for Oral Suspension 20 mg, and we are required to make additional milestone payments to the University of Missouri upon initial commercial sale in specified territories outside the U.S., which may total up to $3.5 million in the aggregate. We are also required to make milestone payments based on first-time achievement of significant sales thresholds, up to a maximum of $86.3 million, the first of which is a $2.5 million milestone payment upon initial achievement of $100.0 million in annual calendar year sales, which includes sales by us, GSK and Schering-Plough. We are also obligated to pay royalties on net sales of our products and any products commercialized by GSK under our license and distribution agreements and Schering-Plough under our OTC license agreement.

In October 2006, we entered into a license agreement with Schering-Plough granting rights to develop, manufacture, market and sell Zegerid brand omeprazole products using our patented PPI technology for the OTC market in the U.S. and Canada. In November 2006, we received a $15.0 million upfront license fee. In August 2007, we received a $5.0 million milestone payment relating to progress on clinical product development strategy. In June 2008, we received a $2.5 million regulatory milestone relating to FDA acceptance for filing of an NDA submitted by Schering-Plough for a Zegerid branded omeprazole/sodium bicarbonate OTC product in a 20 mg dosage strength of omeprazole. We may receive an additional milestone payment of $20.0 million upon the achievement of a specified regulatory milestone and up to an additional $37.5 million in milestone payments upon the achievement of specified sales milestones. We will also receive low double-digit royalties, subject to adjustment in certain circumstances, on net sales of any OTC products sold by Schering-Plough under the license agreement. In turn, we will be obligated to pay royalties to the University of Missouri based on net sales of any OTC products sold by Schering-Plough. The license agreement will remain in effect as long as Schering-Plough is marketing products under the license agreement in the U.S. or Canada. Schering-Plough may terminate the agreement on 180 days prior written notice to us at any time. In addition, either party may terminate the agreement in the event of uncured material breach of a material obligation, subject to certain limitations, or in the event of bankruptcy or insolvency.

In August 2007, we entered into a co-promotion agreement with C.B. Fleet Company, Incorporated, or Fleet, which was subsequently amended in May 2008 to co-promote the Fleet^® Phospho-soda^® EZ-Prep^™ Bowel Cleansing System to our targeted gastroenterologists in the U.S. The Fleet product is a system for bowel preparation used prior to a medical procedure or examination, such as a colonoscopy. Under the terms of the agreement, Fleet paid us based on a set fee per sales call, subject to a minimum and maximum number of sales calls. We received co-promotion fees of approximately $4.8 million over the term of the agreement. The co-promotion agreement expired in accordance with its terms on October 1, 2008.

In November 2007, we entered into a license agreement and a distribution agreement with GSK granting GSK certain exclusive rights to commercialize prescription and OTC immediate-release omeprazole products in specified markets outside of the U.S., Europe, Australia, Japan and Canada and to distribute and sell Zegerid brand immediate-release omeprazole prescription products in Puerto Rico and the U.S. Virgin Islands, or USVI.

Under the license agreement, GSK is responsible for the development, manufacture and commercialization of prescription and OTC immediate-release omeprazole products for sale in up to 114 countries, outside of the U.S., Europe, Australia, Japan and Canada (including markets within Africa, Asia, the Middle-East and Central and South America). Under the distribution agreement, GSK began distributing, marketing and selling Zegerid brand prescription products in Puerto Rico and the USVI in February 2008. During an initial period following the execution of the distribution agreement, we are obligated to supply Zegerid products to GSK for sale in Puerto Rico and the USVI, and GSK will pay a specified transfer price covering our fully burdened costs. GSK bears all costs for its activities under the license and distribution agreements.

Under the license agreement, in December 2007, we received an $11.5 million upfront fee, and we receive tiered royalties, subject to reduction in certain circumstances, on net sales of any products sold under the license and distribution agreements. In turn, we are obligated to pay royalties to the University of Missouri based on net sales of any licensed products sold by GSK. GSK has an option to make a buy-out payment 20 years after the effective date of the agreements, after which time GSK’s royalty obligations generally would end. To support GSK’s initial launch costs, we agreed to waive the first $2.5 million of aggregate royalties payable under the license and distribution agreements. The term of the license agreement continues so long as GSK is obligated to pay royalties, and the term of the distribution agreement continues as long as GSK sells the products, unless the agreements are terminated earlier by either GSK or us under specified circumstances. GSK may terminate the license agreement or the distribution agreement on six months prior written notice at any time. We may terminate the license agreement on a country-by-country basis in the event that GSK fails to satisfy certain diligence obligations. In addition, either party may terminate the license agreement or the distribution agreement in the event of the other party’s uncured material breach or bankruptcy or insolvency.

In July 2008, we entered into a promotion agreement with Depomed granting us exclusive rights to promote Depomed’s Glumetza products in the U.S., including its territories and possessions and Puerto Rico, or collectively, the Territory. Glumetza is a once-daily, extended-release formulation of metformin that incorporates patented drug delivery technology and is indicated as an adjunct to diet and exercise to improve glycemic control in adult patients with type 2 diabetes. We began promotion of the Glumetza products in October 2008. Under the promotion agreement, we are required to meet certain minimum promotion obligations during the term of the agreement. For a period of one year from the date we began promoting the Glumetza products, we are required to deliver a minimum number of sales calls to potential Glumetza prescribers. Following the end of that one-year period, for a period of three years, we are required to make specified minimum sales force expenditures. In addition, during the term of the agreement, we are required to make certain minimum marketing, advertising, medical affairs and other commercial support expenditures.

Under the terms of the promotion agreement, we paid Depomed a $12.0 million upfront fee, and based on the achievement of specified levels of annual Glumetza net product sales, we may be required to pay Depomed one-time sales milestones, totaling up to $16.0 million. Beginning in the fourth quarter of 2008, Depomed will pay us a fee ranging from 75% to 80% of the gross margin earned from all net sales of Glumetza products in the Territory, with gross margin defined as net sales less cost of goods and product-related fees paid to Biovail Laboratories. Depomed will continue to record revenue from the sales of Glumetza products. We are responsible for all costs associated with our sales force and for all other sales and marketing-related expenses associated with our promotion of Glumetza products, including an initial commitment of $5.0 million in non-sales force advertising and promotional costs from signing through March 31, 2009. Depomed is responsible for overseeing product manufacturing and supply. A joint commercialization committee has been formed to oversee and guide the strategic direction of the Glumetza alliance. The promotion agreement will continue in effect until the expiration of the last-to-expire patent or patent application with a valid claim in the Territory covering a Glumetza product, unless terminated sooner. Subject to 90 days prior written notice to Depomed, we may terminate the Promotion Agreement at any time following the 18-month anniversary of the effective date of the agreement. Subject to notice to Depomed, we may also terminate the agreement immediately in other circumstances, such as loss of market exclusivity or in the event of certain regulatory or governmental actions or if Depomed fails to supply the Glumetza product as reasonably necessary to meet trade demand for a period of three months or longer. Subject to 60 days prior written notice to us, Depomed may terminate the agreement if we fail to meet our obligations with respect to minimum promotion obligations and fail to cure such breach within a specified time period. Depomed may also terminate the agreement on 180 days prior written notice if we fail to deliver certain required information related to forecasted sales force expenditures. Either party may terminate the agreement under certain other limited circumstances.

Also in July 2008, we and Victory Pharma, Inc., or Victory, mutually agreed to terminate our co-promotion agreement previously entered into in June 2007, pursuant to which we agreed to co-promote Naprelan^® (naproxen sodium) Controlled Release Tablets to targeted primary care physicians in the U.S. Under the terms of the co-promotion agreement, we received a co-promotion fee equal to slightly more than half of the net sales value of the prescriptions generated by our target physicians. We ended all promotional efforts under the agreement as of September 30, 2008, and Victory will pay us any co-promotion fees due to us under the agreement through such period. Victory will also make a one-time, lump-sum payment to us on January 31, 2009, as a trailing royalty payment for the fiscal quarter ending December 31, 2008. In addition, Victory is required to purchase from us a portion of the product samples on-hand.

We have incurred significant losses since our inception. We had an accumulated deficit of $312.4 million as of September 30, 2008. These losses have resulted principally from costs incurred in connection with license fees, research and development activities, including costs of clinical trial activities associated with our Zegerid products, commercialization activities and general and administrative expenses.

We expect to continue to incur significant expenditures as we support the commercialization of Zegerid Capsules and Zegerid Powder for Oral Suspension, promote Glumetza under our promotion agreement with Depomed, enhance our product portfolio through development and commercialization of acquired or internally developed proprietary products and fund our administrative support activities.

In February 2006, we entered into a committed equity financing facility, or CEFF, with Kingsbridge Capital Limited, or Kingsbridge, which may entitle us to sell and obligate Kingsbridge to purchase, from time to time over a period of three years, shares of our common stock for cash consideration up to the lesser of $75.0 million or 8,853,165 shares. The CEFF is subject to certain conditions and restrictions, including a minimum price for our common stock of $2.50. In connection with the CEFF, we entered into a common stock purchase agreement and registration rights agreement, and we also issued a warrant to Kingsbridge to purchase 365,000 shares of our common stock at a price of $8.2836 per share. The warrant is fully exercisable beginning after the six-month anniversary of the agreement for a period of five years thereafter. On February 3, 2006, we filed a resale shelf registration statement on Form S-3 with the Securities and Exchange Commission to facilitate Kingsbridge’s public resale of shares of our common stock which it may acquire from us from time to time in connection with our draw downs under the CEFF or upon the exercise of a warrant to purchase 365,000 shares of common stock that we issued to Kingsbridge in connection with the CEFF. The resale shelf registration statement was declared effective on February 13, 2006. In 2006, we completed four draw downs under the CEFF and have issued a total of 5,401,787 shares in exchange for aggregate gross proceeds of $36.5 million. We did not initiate any draw downs under the CEFF during 2007 or during the nine months ended September 30, 2008.

In July 2006, we entered into a loan agreement with Comerica Bank, or Comerica, which was subsequently amended in July 2008, pursuant to which we may request advances in an aggregate outstanding amount not to exceed $25.0 million. As of November 3, 2008, the date of this report, we have not borrowed any amounts under the loan agreement. Under the loan agreement, the revolving loan bears interest, as selected by us, at either the variable rate of interest, per annum, most recently announced by Comerica as its “prime rate” plus 0.50% or the LIBOR rate (as computed in the amended and restated LIBOR addendum to the amended loan agreement) plus 3.00%. Interest payments on advances made under the loan agreement are due and payable in arrears on the first calendar day of each month during the term of the loan agreement. Amounts borrowed under the loan agreement may be repaid and re-borrowed at any time prior to July 11, 2011. There is a non-refundable unused commitment fee equal to 0.50% per annum on the difference between the amount of the revolving line and the average daily balance outstanding thereunder during the term of the loan agreement, payable quarterly in arrears. The loan agreement will remain in full force and effect for so long as any obligations remain outstanding or Comerica has any obligation to make credit extensions under the loan agreement.

Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based on our condensed financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these condensed financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. We review our estimates on an on-going basis. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates under different assumptions or conditions. We believe the following accounting policies to be critical to the judgments and estimates used in the preparation of our financial statements.

Revenue Recognition

We follow Staff Accounting Bulletin, or SAB, No. 104,Revenue Recognition, and recognize revenue when there is persuasive evidence that an arrangement exists, title has passed, the price is fixed or determinable, and collectibility is reasonably assured.

Product Sales, Net.We sell our Zegerid products primarily to pharmaceutical wholesale distributors. We are obligated to accept from customers the return of products that are within six months of their expiration date or up to 12 months beyond their expiration date. We authorize returns for damaged products and exchanges for expired products in accordance with our return goods policy and procedures, and have established allowances for such amounts at the time of sale.

We recognize revenue from product sales in accordance with SAB No. 104 and Statement of Financial Accounting Standards, or SFAS, No. 48,Revenue Recognition When Right of Return Exists. Among its criteria for revenue recognition from sale transactions where a buyer has a right of return, SFAS No. 48 requires the amount of future returns to be reasonably estimable. We recognize product sales net of estimated allowances for product returns, estimated rebates in connection with contracts relating to managed care, Medicaid, Medicare, and patient coupons, and estimated chargebacks from distributors, wholesaler fees and prompt payment and other discounts.

We establish allowances for estimated product returns, rebates and chargebacks based primarily on the following qualitative and quantitative factors:

	•		the number of and specific contractual terms of agreements with customers;

	•		estimated levels of inventory in the distribution channel;

	•		estimated remaining shelf life of products;

	•		analysis of prescription data gathered by a third-party prescription data provider;

	•		direct communication with customers;

	•		historical product returns, rebates and chargebacks;

	•		anticipated introduction of competitive products or generics;

	•		anticipated pricing strategy changes by us and/or our competitors; and

	•		the impact of state and federal regulations.

In our analyses, we utilize prescription data purchased from a third-party data provider to develop estimates of historical inventory channel pull-through. We utilize a separate analysis which compares historical product shipments less returns to estimated historical prescriptions written. Based on that analysis, we develop an estimate of the quantity of product in the distribution channel which may be subject to various product return, rebate and chargeback exposures.

Our estimates of product returns, rebates and chargebacks require our most subjective and complex judgment due to the need to make estimates about matters that are inherently uncertain. If actual future payments for returns, rebates, chargebacks and other discounts exceed the estimates we made at the time of sale, our financial position, results of operations and cash flows would be negatively impacted.

Our allowance for product returns was $9.4 million as of September 30, 2008 and $5.9 million as of December 31, 2007. In order to provide a basis for estimating future product returns on sales to our customers at the time title transfers, we have been tracking our Zegerid products return history from the time of our first commercial product launch of Zegerid Powder for Oral Suspension 20 mg in late 2004, taking into consideration product expiration dating and estimated inventory levels in the distribution channel. We recognize product sales at the time title passes to our customers, and we provide for an estimate of future product returns at that time based upon our historical product returns trends, our analysis of product expiration dating and estimated inventory levels in the distribution channel, and the other factors discussed above. There may be a significant time lag between the date we determine the estimated allowance and when we receive the product return and issue credit to a customer. Due to this time lag, we record adjustments to our estimated allowance over several periods, which can result in a net increase or a net decrease in our operating results in those periods. In 2007, based upon our review of additional product returns history gathered through the end of 2007 and analysis of product expiration dating and inventory in the distribution channel, we increased our estimate for product returns to reflect actual experience accordingly. This change in estimate provided for potential product returns related to sales in prior periods and resulted in an increase to our net loss of approximately $1.9 million in 2007.

Our allowance for rebates, chargebacks and other discounts was $25.9 million as of September 30, 2008 and $21.0 million as of December 31, 2007. These allowances reflect an estimate of our liability for rebates due to managed care organizations under specific contracts, rebates due to various governmental organizations under Medicaid and Medicare contracts and regulations, chargebacks due to various organizations purchasing our products through federal contracts and/or group purchasing agreements, and other rebates and customer discounts due in connection with wholesaler fees and prompt payment and other discounts. We estimate our liability for rebates and chargebacks at each reporting period based on a combination of the qualitative and quantitative assumptions listed above. In each reporting period, we evaluate our outstanding contracts and apply the contractual discounts to the invoiced price of wholesaler shipments recognized. Although the total invoiced price of shipments to wholesalers for the reporting period and the contractual terms are known during the reporting period, we project the ultimate disposition of the sale (e.g. future utilization rates of cash payors, managed care, Medicaid, Medicare or other contracted organizations). This estimate is based on historical trends adjusted for anticipated changes based on specific contractual terms of new agreements with customers, anticipated pricing strategy changes by us and/or our competitors and the other qualitative and quantitative factors described above. There may be a significant time lag between the date we determine the estimated allowance and when we make the contractual payment or issue credit to a customer. Due to this time lag, we record adjustments to our estimated allowance over several periods, which can result in a net increase or a net decrease in our operating results in those periods. To date, actual results have not materially differed from our estimates.

Contract Revenue.We recognize contract revenue consistent with the provisions of SAB No. 104 and Emerging Issues Task Force, or EITF, Issue No. 00-21,Revenue Arrangements with Multiple Deliverables. We analyze each element of our licensing and co-promotion agreements to determine the appropriate revenue recognition. We recognize revenue on upfront payments over the period of significant involvement under the related agreements unless the fee is in exchange for products delivered or services rendered that represent the culmination of a separate earnings process and no further performance obligation exists under the contract. We recognize milestone payments upon the achievement of specified milestones if (1) the milestone is substantive in nature, and the achievement of the milestone was not reasonably assured at the inception of the agreement and (2) the fees are nonrefundable. Any milestone payments received prior to satisfying

these revenue recognition criteria are recognized as deferred revenue. Sales milestones, royalties and co-promotion fees are recognized as revenue when earned under the agreements. Certain elements of our licensing and co-promotion agreements are described below:

	•		In June 2008, we received a $2.5 million nonrefundable regulatory milestone relating to FDA acceptance for filing of an NDA submitted by Schering-Plough for a Zegerid branded omeprazole/sodium bicarbonate OTC product in a 20 mg dosage strength of omeprazole. In August 2007, we received a nonrefundable $5.0 million milestone payment from Schering-Plough relating to progress on clinical development strategy. We recognized the payments of $2.5 million and $5.0 million as contract revenue in the nine months ended September 30, 2008 and 2007, respectively, due to the substantive nature of the milestones achieved. In November 2006, we received a nonrefundable $15.0 million upfront license fee in connection with our license agreement with Schering-Plough. The $15.0 million upfront payment is being amortized to revenue on a straight-line basis over a 37-month period through the end of 2009, which represents the estimated period during which we have significant responsibilities under the agreement.

	•		In December 2007, we received a nonrefundable $11.5 million upfront payment in connection with our license and distribution agreements with GSK. To support GSK’s initial launch costs, we agreed to waive the first $2.5 million of aggregate royalties payable under the agreements. Of the total $11.5 million upfront payment, the $2.5 million in waived royalty obligations was recorded as deferred revenue and is being recognized as revenue as the royalties are earned. The remaining $9.0 million is being amortized to revenue on a straight-line basis over an 18-month period, which represents the estimated period we are obligated to supply Zegerid products to GSK for sale in Puerto Rico and the USVI under the distribution agreement.

	•		In October 2004, we received a nonrefundable $15.0 million upfront payment in connection with our co-promotion agreement with Otsuka America. The $15.0 million upfront payment was being amortized to revenue on a straight-line basis over the 63-month contractual term through the end of 2009. On May 28, 2008, we agreed to terminate the co-promotion agreement effective as of June 30, 2008. In connection with the termination, we amortized the remaining balance of the $15.0 million up-front payment previously received from Otsuka America in October 2004 and recognized approximately $5.7 million in contract revenue in the nine months ended September 30, 2008 associated with this amortization.

Inventories and Related Reserves

Inventories are stated at the lower of cost (FIFO) or market and consist of finished goods and raw materials used in the manufacture of our Zegerid Capsules and Zegerid Powder for Oral Suspension products. Also included in inventories are product samples of the Glumetza products which we purchase from Depomed under our promotion agreement. Inventories as of December 31, 2007 also included product samples of the Naprelan products which we purchased from Victory under our co-promotion agreement, which was terminated effective as of October 1, 2008. We provide reserves for potentially excess, dated or obsolete inventories based on an analysis of inventory on hand and on firm purchase commitments compared to forecasts of future sales.

Stock-Based Compensation

Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS No. 123 (revised 2004),Share-Based Payment, which is a revision of SFAS No. 123,Accounting for Stock-Based Compensation,or SFAS No. 123(R), using the modified prospective transition method. Under this transition method, compensation cost recognized for the three and nine months ended September 30, 2008 and 2007 included (a) compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation cost for all share-based payments granted subsequent to January 1, 2006, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R). Results for prior periods have not been restated.

We estimate the fair value of stock options and employee stock purchase plan rights granted using the Black-Scholes valuation model. This estimate is affected by our stock price, as well as assumptions regarding a number of complex and subjective variables. These variables include the expected volatility of our stock price, the expected term of the stock option, the risk-free interest rate and expected dividends. As the length of time our shares have been publicly traded is generally shorter than the expected life of the option, we consider the expected volatility of similar entities as well as our historical volatility since our initial public offering in April 2004 in determining our volatility factor. In evaluating similar entities, we consider factors such as industry, stage of development, size and financial leverage. In determining the expected life of the options, we use the “short-cut” method described in SAB No. 110. Under this method, the expected life is presumed to be the mid-point between the vesting date and the end of the contractual term. The Company will continue to use the “short-cut” method until it has sufficient historical exercise data to estimate the expected life of the options.

For options granted prior to January 1, 2006, we amortize the fair value on an accelerated basis. For options granted after January 1, 2006, we amortize the fair value on a straight-line basis over the requisite service period of the awards, which is generally the vesting period. Pre-vesting forfeitures were estimated to be approximately 0% for the three and nine months ended September 30, 2008 and 2007 as the majority of options granted contain monthly vesting terms.

We account for options issued to non-employees under SFAS No. 123(R) and EITF Issue No. 96-18,Accounting for Equity Investments that are Issued to Other than Employees for Acquiring or in Conjunction with Selling Goods or Services. As such, the value of options issued to non-employees is periodically remeasured as the underlying options vest.

The following table includes stock-based compensation recognized in accordance with SFAS No. 123(R) and EITF Issue No. 96-18 in our condensed statement of operations:


	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2008		2007		2008		2007
Cost of product sales	$	22,215	$	34,075	$	73,474	$	95,541
Research and development		122,674		142,314		357,119		394,189
Selling, general and administrative		875,233		1,481,569		2,774,844		4,507,002

Total	$	1,020,122	$	1,657,958	$	3,205,437	$	4,996,732

As of September 30, 2008, total unrecognized compensation cost related to stock options was approximately $7.3 million, and the weighted average period over which it was expected to be recognized was 2.3 years.

The above listing is not intended to be a comprehensive list of all of our accounting policies. In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP. There are also areas in which our management’s judgment in selecting any available alternative would not produce a materially different result. Please see our audited financial statements and notes thereto included in our annual report on Form 10-K, which contain accounting policies and other disclosures required by GAAP.

Results of Operations

Comparison of Three Months Ended September 30, 2008 and 2007

Product Sales, Net.Product sales, net were $28.1 million for the three months ended September 30, 2008 and $19.5 million for the three months ended September 30, 2007 and consisted of sales of Zegerid Capsules and Zegerid Powder for Oral Suspension. The $8.6 million increase in product sales, net was primarily attributable to an increase in the sales volume of Zegerid Capsules as well as increased average selling prices. For the three months ended September 30, 2008 as compared to the three months ended September 30, 2007, the amount of rebates, chargebacks and other discounts has grown primarily as a result of increased sales of our Zegerid products and increased utilization under contracts with various managed care organizations and governmental organizations relating to Medicaid and Medicare. Accordingly, reductions to revenue and corresponding increases to allowance accounts have likewise increased.

Contract Revenue.Contract revenue was $4.1 million for the three months ended September 30, 2008 and $7.0 million for the three months ended September 30, 2007. Contract revenue in each period consisted of license fee revenue from the amortization of the $15.0 million upfront fee received in November 2006 pursuant to our license agreement with Schering-Plough, and in the three months ended September 30, 2007, contract revenue also included license fee revenue from the $5.0 million milestone payment received from Schering-Plough. Contract revenue in three months ended September 30, 2008 also included license fee revenue from the amortization of the $11.5 million upfront fee received in 2007 pursuant to our license and distribution agreements with GSK as well as royalty revenue earned under these agreements. In addition, contract revenue in the three months ended September 30, 2008 included co-promotion fees earned under our co-promotion agreements with Victory and Fleet. Contract revenue in the three months ended September 30, 2007 also included co-promotion revenue from the amortization of the $15.0 million upfront fee received pursuant to our co-promotion agreement with Otsuka America which was terminated effective as of June 30, 2008.

Cost of Product Sales.Cost of product sales was $1.9 million for the three months ended September 30, 2008 and $1.8 million for the three months ended September 30, 2007, or approximately 7% and 9% of net product sales, respectively. Cost of product sales consists primarily of raw materials, third-party manufacturing costs, freight and indirect personnel and other overhead costs associated with the sales of our Zegerid products. Cost of product sales also includes reserves for excess, dated or obsolete commercial inventories based on an analysis of inventory on hand and on firm purchase commitments compared to forecasts of future sales. The decrease in our cost of product sales as a percentage of net product sales was primarily attributable to increased average selling prices for our capsule and powder products and certain fixed costs being applied to increased sales volumes.

License Fees and Royalties.License fees and royalties were $3.6 million for the three months ended September 30, 2008 and $2.7 million for the three months ended September 30, 2007. License fees and royalties consisted of royalties due to the University of Missouri based upon our net product sales as well as products sold by GSK under our license and distribution agreements. For the three months ended September 30, 2008, license fees and royalties also included an accrual of approximately $1.8 million related to a potential $2.5 million sales milestone due to the University of Missouri under our license agreement and license fee amortization from the $12.0 million upfront fee paid to Depomed under our promotion agreement entered into in July 2008. The $12.0 million upfront fee has been capitalized and is being amortized to license fee expense over the estimated useful life of the asset on a straight-line basis through mid-2016. For the three months ended September 30, 2007, license fees and royalties also included royalties due to Otsuka America based upon our net product sales. Following the termination of our co-promotion agreement effective as of June 30, 2008, we are no longer obligated to pay royalties to Otsuka America.

Research and Development.Research and development expenses were $2.3 million for the three months ended September 30, 2008 and $1.7 million for the three months ended September 30, 2007. The $548,000 increase in our research and development expenses was primarily attributable to development costs associated with a new swallowable tablet formulation we intend to add to our Zegerid family of branded prescription pharmaceutical products. This increase in research and development expenses was offset in part by a decrease in spending associated with Zegerid Capsules. Included in the three months ended September 30, 2007 was spending associated with our clinical trial evaluating the effects of morning dosing of each of Zegerid Capsules and delayed-release PPI brands, Protonix^® and Prevacid^®, on 24-hour gastric acid control in patients with symptoms of GERD. There were no expenses associated with this clinical trial in the three months ended September 30, 2008.

Selling, General and Administrative.Selling, general and administrative expenses were $28.5 million for the three months ended September 30, 2008 and $27.8 million for the three months ended September 30, 2007. The $697,000 increase in our selling, general and administrative expenses was primarily attributable to costs associated with sales training and advertising and promotional activities in preparation for the commencement of promotion of the Glumetza products under our promotion agreement with Depomed and an increase in legal fees primarily due to the patent infringement lawsuits we filed against Par Pharmaceutical, Inc. in 2007. These increases in costs were offset in part by a decrease in costs associated with our Zegerid advertising and promotional activities and our speaker programs and a decrease in stock-based compensation.

Interest and Other Income, Net.Interest and other income, net was $177,000 for the three months ended September 30, 2008 and $705,000 for the three months ended September 30, 2007. The $528,000 decrease was primarily attributable to lower interest income resulting from lower average cash balances and a lower rate of return on our cash, cash equivalents and short-term investments.

Comparison of Nine Months Ended September 30, 2008 and 2007

Product Sales, Net.Product sales, net were $71.5 million for the nine months ended September 30, 2008 and $55.3 million for the nine months ended September 30, 2007 and consisted of sales of Zegerid Capsules and Zegerid Powder for Oral Suspension. The $16.2 million increase in product sales, net was primarily attributable to an increase in the sales volume of Zegerid Capsules as well as increased average selling prices. For the nine months ended September 30, 2008 as compared to the nine months ended September 30, 2007, the amount of rebates, chargebacks and other discounts has grown primarily as a result of increased sales of our Zegerid products and increased utilization under contracts with various managed care organizations and governmental organizations relating to Medicaid and Medicare. Accordingly, reductions to revenue and corresponding increases to allowance accounts have likewise increased.

Contract Revenue.Contract revenue was $21.2 million for the nine months ended September 30, 2008 and $10.8 million for the nine months ended September 30, 2007. Contract revenue in each period consisted of co-promotion revenue from the amortization of the $15.0 million upfront fee received pursuant to our co-promotion agreement with Otsuka America and license fee revenue from the amortization of the $15.0 million upfront fee received in November 2006 pursuant to our license agreement with Schering-Plough. In connection with the termination of our co-promotion agreement with Otsuka America effective as of June 30, 2008, we amortized the remaining balance of the $15.0 million up-front payment and recognized approximately $5.7 million in contract revenue in the nine months ended September 30, 2008 associated with this amortization. In June 2008, we received a $2.5 million nonrefundable regulatory milestone relating to FDA acceptance for filing of an NDA submitted by Schering-Plough for a Zegerid branded omeprazole/sodium bicarbonate OTC product in a 20 mg dosage strength of omeprazole. In August 2007, we received a nonrefundable $5.0 million milestone payment from Schering-Plough relating to progress on clinical development strategy. We recognized the payments of $2.5 million and $5.0 million as contract revenue in the nine months ended September 30, 2008 and 2007, respectively, due to the substantive nature of the milestones achieved. Contract revenue in nine months ended September 30, 2008 also included license fee revenue from the amortization of the $11.5 million upfront fee received in 2007 pursuant to our license and distribution agreements with GSK as well as royalty revenue earned under these agreements. In addition, contract revenue in the nine months ended September 30, 2008 included co-promotion fees earned under our co-promotion agreements with Victory and Fleet.

Cost of Product Sales.Cost of product sales was $5.3 million for the nine months ended September 30, 2008 and $5.1 million for the nine months ended September 30, 2007, or approximately 7% and 9% of net product sales, respectively. Cost of product sales consists primarily of raw materials, third-party manufacturing costs, freight and indirect personnel and other overhead costs associated with the sales of our Zegerid products. Cost of product sales also includes reserves for excess, dated or obsolete commercial inventories based on an analysis of inventory on hand and on firm purchase commitments compared to forecasts of future sales. The decrease in our cost of product sales as a percentage of net product sales was primarily attributable to increased average selling prices and decreased manufacturing costs associated with our capsule and powder products and certain fixed costs being applied to increased sales volumes.

License Fees and Royalties.License fees and royalties were $9.7 million for the nine months ended September 30, 2008 and $7.8 million for the nine months ended September 30, 2007. License fees and royalties consisted of royalties due to the University of Missouri and Otsuka America based upon our net product sales as well as royalties due to the University of Missouri based upon products sold by GSK under our license and distribution agreements. Following the termination of our co-promotion agreement effective as of June 30, 2008, we are no longer obligated to pay royalties to Otsuka America. For the nine months ended September 30, 2008, license fees and royalties also included an accrual of approximately $1.8 million related to a potential $2.5 million sales milestone due to the University of Missouri under our license agreement and license fee amortization from the $12.0 million upfront fee paid to Depomed under our promotion agreement entered into in July 2008. The $12.0 million upfront fee has been capitalized and is being amortized to license fee expense over the estimated useful life of the asset on a straight-line basis through mid-2016.

Research and Development.Research and development expenses were $6.2 million for the nine months ended September 30, 2008 and $5.0 million for the nine months ended September 30, 2007. The $1.2 million increase in our research and development expenses was primarily attributable to development costs associated with a new swallowable tablet formulation we intend to add to our Zegerid family of branded prescription pharmaceutical products. This increase in research and development expenses was offset in part by a decrease in spending associated with Zegerid Capsules. Included in the nine months ended September 30, 2007 was spending associated with our clinical trial evaluating the effects of morning dosing of each of Zegerid Capsules and delayed-release PPI brands, Protonix and Prevacid, on 24-hour gastric acid control in patients with symptoms of GERD. There were no expenses associated with this clinical trial in the nine months ended September 30, 2008.

Research and development expenses have historically consisted primarily of costs associated with clinical trials of our products under development as well as clinical studies designed to further differentiate our Zegerid products from those of our competitors, development of and preparation for commercial manufacturing of our products, compensation and other expenses related to research and development personnel and facilities expenses. In the future, we may conduct additional clinical trials to further differentiate our Zegerid family of products, as well as conduct research and development related to any future products that we may in-license or otherwise acquire. We are unable to estimate with any certainty the research and development costs that we may incur in the future. We have also committed, in connection with the approval of our NDAs for Zegerid Powder for Oral Suspension, to evaluate the product in pediatric populations, including pharmacokinetic/pharmacodynamic, or PK/PD, and safety studies. Although we are currently focused primarily on advancing our Zegerid family of products, we anticipate that we will make determinations as to which development projects to pursue and how much funding to direct to each project on an ongoing basis in response to the scientific, clinical and commercial merits of each project.

Selling, General and Administrative.Selling, general and administrative expenses were $80.8 million for the nine months ended September 30, 2008 and $87.0 million for the nine months ended September 30, 2007. The $6.2 million decrease in our selling, general and administrative expenses was primarily attributable to a decrease in costs associated with our advertising and promotional activities and speaker programs related to our Zegerid products, a decrease in the number of sales representatives under our contract sales organization agreement with inVentiv and a decrease in stock-based compensation. These decreases in expenses were offset in part by an increase in legal fees primarily due to the patent infringement lawsuits we filed against Par Pharmaceutical, Inc. in 2007 and costs associated with sales training and advertising and promotional activities in preparation for the commencement of promotion of the Glumetza products under our promotion agreement with Depomed.

Interest and Other Income, Net.Interest and other income, net was $1.0 million for the nine months ended September 30, 2008 and $2.4 million for the nine months ended September 30, 2007. The $1.4 million decrease was primarily attributable to lower interest income resulting from lower average cash balances and a lower rate of return on our cash, cash equivalents and short-term investments.

Liquidity and Capital Resources

As of September 30, 2008, cash, cash equivalents and short-term investments were $34.4 million, compared to $64.7 million as of December 31, 2007, a decrease of $30.3 million. This decrease resulted primarily from our net loss for the nine months ended September 30, 2008, adjusted for non-cash stock-based compensation and changes in operating assets and liabilities, as well as our $12.0 million upfront payment to Depomed in July 2008. In addition, due to the illiquid state of our auction rate securities, we reclassified the fair value of these securities from short-term to long-term investments in the nine months ended September 30, 2008. The fair value of our auction rate securities was approximately $3.9 million in our condensed balance sheet as of September 30, 2008.

Our auction rate securities are high-grade (AAA-rated) municipal debt obligations with a long-term maturity and an interest rate that is reset in short-term intervals (every 28 days) through auctions. Due to conditions in the global credit markets, in the nine months ended September 30, 2008, these securities, representing a par value of approximately $4.3 million, have experienced multiple failed auctions due to insufficient demand for the securities at auction. As a result, these affected securities are currently not liquid and the interest rates have been reset to predetermined higher rates.

Typically the fair value of auction rate securities approximates par value due to the frequent resets through the auction process. While we continue to earn interest on our auction rate securities at the maximum contractual rates, these investments are not currently trading and therefore do not currently have a readily determinable market value. Accordingly, the estimated fair value of auction rate securities no longer approximates par value. We have used a discounted cash flowmodel to determine the estimated fair value of our investment in auction rate securities as of September 30, 2008. The assumptions used in preparing the discounted cash flow model include estimates for interest rates, timing and amount of cash flows and expected holding period of the auction rate securities. Based on this assessment of fair value, we recorded an unrealized loss of approximately $403,000 related to our auction rate securities as of September 30, 2008. We believe this unrealized loss is primarily attributable to the limited liquidity of these investments and have no reason to believe that any of the underlying issuers are presently at risk of default.

In October 2008, we received an offer of Auction Rate Securities Rights, or Rights, from our investment provider, UBS Financial Services, Inc., a subsidiary of UBS AG, or UBS. We are assessing the offer of Rights and plan to make our determination prior to the November 14, 2008 expiration date of the offer. If accepted, the Rights will permit us to require UBS to purchase our auction rate securities at par value at any time during the period of June 30, 2010 through July 2, 2012. If we do not exercise our Rights, the auction rate securities will continue to accrue interest as determined by the auction process. If the Rights are not exercised before July 2, 2012 they will expire and UBS will have no further obligation to buy our auction rate securities. If we accept the Rights, UBS will have the discretion to purchase or sell our auction rate securities at any time without prior notice so long as we receive a payment at par upon any sale or disposition. UBS will only exercise its discretion to purchase or sell our auction rate securities for the purpose of restructurings, dispositions or other solutions that will provide us with par value for our auction rate securities. As a condition to accepting the offer of Rights, we will be required to release UBS from all claims except claims for consequential damages relating to its marketing and sales of auction rate securities. We will also be required to agree not to serve as a class representative or receive benefits under any class action settlement or investor fund.

Net cash used in operating activities was $13.7 million for the nine months ended September 30, 2008 and $28.2 million for the nine months ended September 30, 2007. The primary use of cash was to fund our net losses for these periods, adjusted for non-cash expenses, including $3.2 million for the nine months ended September 30, 2008 and $5.0 million for the nine months ended September 30, 2007 in stock-based compensation, and changes in operating assets and liabilities. Significant working capital uses of cash for the nine months ended September 30, 2008 included decreases in deferred revenue and increases in accounts receivable. These working capital uses of cash were offset in part by an increase in the allowance for product returns and increases in accounts payable and accrued liabilities primarily driven by an increase in accrued rebates. For the nine months ended September 30, 2007, significant working capital sources of cash included increases in accounts payable and accrued liabilities primarily driven by an increase in accrued rebates. These working capital sources of cash were offset in part by increases in accounts receivable and a decrease in deferred revenue.

Net cash used in investing activities was $12.7 million for the nine months ended September 30, 2008 and $3.7 million for the nine months ended September 30, 2007 and included purchases and maturities of short-term investments and purchases of property and equipment. Additionally, for the nine months ended September 30, 2008, net cash used in investing activities consisted primarily of the acquisition of intangible assets in connection with our $12.0 million upfront payment to Depomed. For the nine months ended September 30, 2007, net cash used in investing activities was offset in part by a reduction in long-term restricted cash associated with a letter of credit agreement required by our facilities lease.

Net cash provided by financing activities was $432,000 for the nine months ended September 30, 2008 and $1.5 million for the nine months ended September 30, 2007 consisting of proceeds from the issuance of common stock under our employee stock purchase plan and the exercise of stock options.

While we support the commercialization of Zegerid Capsules and Zegerid Powder for Oral Suspension, promote Glumetza under our promotion agreement with Depomed, and as we continue to sponsor clinical trials and develop and manufacture our Zegerid products and pursue new product opportunities, we anticipate significant cash requirements for personnel costs for our own organization, as well as in connection with our contract sales agreement with inVentiv, advertising and promotional activities, capital expenditures, and investment in additional office space, internal systems and infrastructure.

We currently rely on OSG Norwich Pharmaceuticals, Inc. as our manufacturer of Zegerid Capsules and Patheon, Inc. as our manufacturer of Zegerid Powder for Oral Suspension. We also purchase commercial quantities of omeprazole, an active ingredient in our Zegerid products, from Union Quimico Farmaceutica, S.A. At September 30, 2008, we had finished goods and raw materials inventory purchase commitments of approximately $2.0 million.

The following summarizes our long-term contractual obligations, excluding potential sales-based royalty obligations and milestone payments under our agreements with the University of Missouri and Depomed, as of September 30, 2008:


	Payments Due by Period
			Less than
			One Year
			(Remainder		One to		Four to
Contractual Obligations	Total		of 2008)		Three Years		Five Years		Thereafter
	(in thousands)
Operating leases	$	6,355	$	442	$	4,876	$	1,037	$	—
Other long-term contractual obligations		452		208		190		54		—

Total	$	6,807	$	650	$	5,066	$	1,091	$	—

In addition to the obligations summarized above, we are responsible for certain ongoing minimum sales and marketing spending obligations in connection with our promotion agreement with Depomed, including an initial commitment of $5.0 million in non-sales force advertising and promotional costs from signing through March 31, 2009.

The amount and timing of cash requirements will depend on market acceptance of Zegerid Capsules and Zegerid Powder for Oral Suspension, the Glumetza products and any other products that we may market in the future, the resources we devote to researching, developing, formulating, manufacturing, commercializing and supporting our products, and our ability to enter into third-party collaborations.

In May 2005, we filed a universal shelf registration statement on Form S-3 with the Securities and Exchange Commission, which was declared effective in June 2005. The shelf registration statement expires on December 1, 2008. On August 22, 2005, we sold 7,350,000 shares of our common stock that were registered under the universal shelf registration statement. The universal shelf registration statement may permit us, from time to time, to offer and sell up to an additional approximately $43.8 million of equity or debt securities. However, there can be no assurance that we will be able to complete any such offerings of securities. Factors influencing the availability of additional financing include the progress of our commercial activities, investor perception of our prospects and the general condition of the financial markets, among others.

In February 2006, we entered into the CEFF which may entitle us to sell and obligate Kingsbridge to purchase, from time to time over a period of three years, shares of our common stock for cash consideration up to the lesser of $75.0 million or 8,853,165 shares, subject to certain conditions and restrictions. We filed a resale shelf registration statement on Form S-3 with the Securities and Exchange Commission to facilitate Kingsbridge’s public resale of shares of our common stock which it may acquire from us from time to time in connection with our draw downs under the CEFF or upon the exercise of a warrant to purchase 365,000 shares of common stock that we issued to Kingsbridge in connection with the CEFF. The resale shelf registration statement was declared effective in February 2006. In 2006, we completed four draw downs under the CEFF and have issued a total of 5,401,787 shares in exchange for aggregate gross proceeds of $36.5 million. We did not initiate any draw downs under the CEFF during 2007 or during the nine months ended September 30, 2008. Accordingly, the remaining commitment of Kingsbridge under the CEFF for the potential purchase of our common stock is equal to the lesser of $38.5 million in cash consideration or 3,451,378 shares (which shares would be priced at a discount ranging from 6% to 10% of the average market price during any future draw down), subject to certain conditions and restrictions. There can be no assurance that we will be able to complete any further draw downs under the CEFF. Factors influencing our ability to complete draw downs include conditions such as a minimum price of $2.50 for our common stock; the accuracy of representations and warranties made to Kingsbridge; the continued effectiveness of the shelf registration statement; and the continued listing of our stock on the Nasdaq Global Market.

In July 2006, we entered into our loan agreement with Comerica which was subsequently amended in July 2008, pursuant to which we may request advances in an aggregate outstanding amount not to exceed $25.0 million. As of November 3, 2008, the date of this report, we have not borrowed any amounts under the loan agreement. Under the loan agreement, the revolving loan bears interest, as selected by us, at either the variable rate of interest, per annum, most recently announced by Comerica as its “prime rate” plus 0.50% or the LIBOR rate (as computed in the amended and restated LIBOR addendum to the amended loan agreement) plus 3.00%. Interest payments on advances made under the loan agreement are due and payable in arrears on the first calendar day of each month during the term of the loan agreement. Amounts borrowed under the loan agreement may be repaid and re-borrowed at any time prior to July 11, 2011. There is a non-refundable unused commitment fee equal to 0.50% per annum on the difference between the amount of the revolving line and the average daily balance outstanding thereunder during the term of the loan agreement, payable quarterly in arrears. The loan agreement will remain in full force and effect for so long as any obligations remain outstanding or Comerica has any obligation to make credit extensions under the loan agreement.

Amounts borrowed under the loan agreement are secured by substantially all of our personal property, excluding intellectual property. Under the loan agreement, we are subject to certain affirmative and negative covenants, including limitations on our ability: to enter into certain change of control events; to convey, sell, lease, license, transfer or otherwise dispose of assets; to create, incur, assume, guarantee or be liable with respect to certain indebtedness; to grant liens; to pay dividends and make certain other restricted payments; and to make investments. In addition, under the loan agreement, we are required to maintain a balance of cash with Comerica in an amount of not less than $4.0 million and to maintain any other cash balances with either Comerica or another financial institution covered by a control agreement for the benefit of Comerica. We are also subject to specified financial covenants with respect to a minimum liquidity ratio and, in specified limited circumstances, minimum EBITDA requirements. We believe that we have currently met all of our obligations under the loan agreement.

We cannot be certain that our existing cash and marketable securities resources will be adequate to sustain our current operations. To the extent we require additional funding, we cannot be certain that such funding will be available to us on acceptable terms, or at all. For example, we may not be successful in obtaining collaboration agreements, or in receiving milestone or royalty payments under those agreements. In addition, if we raise additional funds through collaboration, licensing or other similar arrangements, it may be necessary to relinquish potentially valuable rights to our products or proprietary technologies, or grant licenses on terms that are not favorable to us. To the extent that we raise additional capital by issuing equity or convertible securities, our stockholders’ ownership will be diluted. Any debt financing we enter into may involve covenants that restrict our operations. If adequate funds are not available on terms acceptable to us at that time, our ability to continue our current operations or pursue new product opportunities would be significantly limited.

In addition, our results of operations could be materially affected by economic conditions generally, both in the U.S. and elsewhere around the world. Recently, concerns over inflation, energy costs, geopolitical issues, the availability and cost of credit, the U.S. mortgage market and a declining residential real estate market in the U.S. have contributed to increased volatility and diminished expectations for the economy and the markets going forward. These factors, combined with volatile oil prices, declining business and consumer confidence and increased unemployment, have precipitated an economic slowdown and fears of a possible recession or depression. Domestic and international equity markets have also been experiencing heightened volatility and turmoil. These events and the continuing market upheavals may have an adverse effect on us. In the event of a continuing market downturn, our results of operations could be adversely affected by those factors in many negative ways, including making it more difficult for us to raise funds if necessary, and our stock price may further decline. In addition, we maintain significant amounts of cash and cash equivalents at one or more financial institutions that are in excess of federally insured limits. Given the current instability of financial institutions, we cannot be assured that we will not experience losses on these deposits.

As of September 30, 2008, we did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts. As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.

Accounting Pronouncements

Adoption of Recent Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board, or FASB, issued SFAS No. 157,Fair Value Measurements. SFAS No. 157 establishes a framework for measuring fair value in accordance with GAAP, clarifies the definition of fair value within that framework, and expands disclosures about the use of fair value measurements. It also responds to investors’ requests for expanded information about the extent to which companies measure assets and liabilities at fair value, the information used to measure fair value and the effect of fair value measurements on earnings. SFAS No. 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value, and does not expand the use of fair value in any new circumstances. SFAS No. 157 was effective for us on January 1, 2008. The adoption of SFAS No. 157 did not have a material impact on our condensed financial statements.

In February 2007, the FASB issued SFAS No. 159,The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment to FASB Statement No. 115. SFAS No. 159 allows certain financial assets and liabilities to be recognized, at our election, at fair market value, with any gains or losses for the period recorded in the statement of operations. SFAS No. 159 includes available-for-sale securities in the assets eligible for this treatment. Currently, we record the unrealized gains or losses for the period in comprehensive income (loss) and in the equity section of the balance sheet. SFAS No. 159 was effective for us on January 1, 2008. We did not elect to adopt the fair value option under SFAS No. 159 on any assets or liabilities not previously carried at fair value.

Pending Adoption of Recent Accounting Pronouncements

In November 2007, the EITF issued EITF Issue No. 07-1,Accounting for Collaborative Arrangements Related to the Development and Commercialization of Intellectual Property.Companies may enter into arrangements with other companies to jointly develop, manufacture, distribute, and market a product. Often the activities associated with these arrangements are conducted by the collaborators without the creation of a separate legal entity (that is, the arrangement is operated as a “virtual joint venture”). The arrangements generally provide that the collaborators will share, based on contractually defined calculations, the profits or losses from the associated activities. Periodically, the collaborators share financial information related to product revenues generated (if any) and costs incurred that may trigger a sharing payment for the combined profits or losses. The consensus requires collaborators in such an arrangement to present the result of activities for which they act as the principal on a gross basis and report any payments received from (made to) other collaborators based on other applicable GAAP or, in the absence of other applicable GAAP, based on analogy to authoritative accounting literature or a reasonable, rational, and consistently applied accounting policy election. EITF Issue No. 07-1 is effective for collaborative arrangements in place at the beginning of the annual period beginning after December 15, 2008. We do not expect the adoption of EITF Issue No. 07-1 to have a material impact on our financial statements.

In December 2007, the FASB issued SFAS No. 141(R),Business Combinations. SFAS No. 141(R) changes the requirements for an acquirer’s recognition and measurement of the assets acquired and liabilities assumed in a business combination, including the treatment of contingent consideration, pre-acquisition contingencies, transaction costs, in-process research and development and restructuring costs. In addition, under SFAS No. 141(R), changes in an acquired entity’s deferred tax assets and uncertain tax positions after the measurement period will impact income tax expense. This statement is effective for us with respect to business combination transactions for which the acquisition date is after December 31, 2008.

Caution on Forward-Looking Statements

Any statements in this report and the information incorporated herein by reference about our expectations, beliefs, plans, objectives, assumptions or future events or performance that are not historical facts are forward-looking statements. You can identify these forward-looking statements by the use of words or phrases such as “believe,” “may,” “could,” “will,” “estimate,” “continue,” “anticipate,” “intend,” “seek,” “plan,” “expect,” “should,” or “would.” Among the factors that could cause actual results to differ materially from those indicated in the forward-looking statements are risks and uncertainties inherent in our business including, without limitation: our ability to increase market demand for, and sales of, our Zegerid^{^®}products, the Glumetza^® products and any other products that we or our strategic partners promote or market; the scope and validity of patent protection for our products and any other products that we or our strategic partners promote or market, including the outcome and duration of our patent infringement lawsuits against Par Pharmaceutical, Inc., and our and our strategic partners’ ability to commercialize products without infringing the patent rights of others; our dependence on a number of third parties, such as GSK, under our license and distribution agreements and Schering-Plough, under our OTC license agreement, whether these third party arrangements will result in payments to us on anticipated timeframes or at all and whether these arrangements will otherwise be successful; adverse side effects or inadequate therapeutic efficacy of our products or products we promote that could result in product recalls, market withdrawals or product liability claims; competition from other pharmaceutical or biotechnology companies and evolving market dynamics, including the impact of currently available generic PPI products and the introduction of additional generic or branded PPI products; our ability to further diversify our sources of revenue and product portfolio; other difficulties or delays relating to the development, testing, manufacturing and marketing of, and maintaining regulatory approvals for, our and our strategic partners’ products; fluctuations in quarterly and annual results; our ability to obtain additional financing as needed to support our operations or future product acquisitions; the impact of the recent turmoil in the financial markets; the potential for new legislation, regulatory proposals and managed care initiatives, particularly in light of the 2008 presidential and congressional elections and the potential agenda of any new administration, that may increase our costs of compliance and adversely affect our ability to market our products, obtain collaborators and raise capital; and other risks detailed below under Part II — Item 1A — Risk Factors.

Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee future results, events, levels of activity, performance or achievement. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, unless required by law.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Under the terms of our loan agreement with Comerica, the interest rate applicable to any amounts borrowed by us under the credit facility will be, at our election, indexed to either Comerica’s prime rate or the LIBOR rate. If we elect Comerica’s prime rate for all or any portion of our borrowings, the interest rate will be variable, which would expose us to the risk of increased interest expense if interest rates rise. If we elect the LIBOR rate for all or any portion of our borrowings, such LIBOR rate will remain fixed only for a specified, limited period of time after the date of our election, after which we will be required to repay the borrowed amount, or elect a new interest rate indexed to either Comerica’s prime rate or the LIBOR rate. The new rate may be higher than the earlier interest rate applicable under the loan agreement. As of November 3, 2008, the date of this report, we have not borrowed any amounts under the loan agreement. Accordingly, we currently believe that changes in such interest rates would not materially affect our market risk.

In addition to market risk related to our loan agreement with Comerica, we are exposed to market risk primarily in the area of changes in U.S. interest rates and conditions in the credit markets, particularly because the majority of our investments are in short-term marketable securities. We do not have any material foreign currency or other derivative financial instruments. All of our investment securities are classified as available-for-sale and therefore reported on the balance sheet at estimated market value. Our investment securities consist of high-grade auction rate securities, corporate debt securities and government agency securities. As of September 30, 2008, our investments included $3.9 million of high-grade (AAA-rated) auction rate securities issued by state municipalities. Our auction rate securities are debt instruments with a long-term maturity and an interest rate that is reset in short-term intervals through auctions. The conditions in the global credit markets have prevented many investors from liquidating their holdings of auction rate securities because the amount of securities submitted for sale has exceeded the amount of purchase orders for such securities. If there is insufficient demand for the securities at the time of an auction, the auction may not be completed and the interest rates may be reset to predetermined higher rates. When auctions for these securities fail, the investments may not be readily convertible to cash until a future auction of these investments is successful or they are redeemed or mature. If the credit ratings of the security issuers deteriorate and any decline in market value is determined to be other-than-temporary, we would be required to adjust the carrying value of the investment through an impairment charge.

Due to conditions in the global credit markets, in the nine months ended September 30, 2008, our auction rate securities, representing a par value of approximately $4.3 million, have experienced multiple failed auctions due to insufficient demand for the securities at auction. As a result, these affected securities are currently not liquid and the interest rates have been reset to predetermined higher rates. Due to the limited liquidity of these investments, we have recorded an unrealized loss of approximately $403,000 related to our auction rate securities and have classified the fair value of these securities as long-term investments as of September 30, 2008. To date, we have not recorded any realized gains or losses on our investment portfolio.

In the event we need to access the funds that are in an illiquid state, we will not be able to do so without the likely loss of principal, until a future auction for these investments is successful or they are redeemed by the issuer or they mature. If we are unable to sell these securities in the market or they are not redeemed, then we may be required to hold them to maturity. We do not believe we have a need to access these funds for operational purposes for the foreseeable future. We will continue to monitor and evaluate these investments on an ongoing basis for impairment. Based on our ability to access our cash, cash equivalents and other short-term investments, our expected operating cash flows, and our other sources of cash, we do not anticipate that the potential illiquidity of these investments will affect our ability to execute our current business plan.

Our results of operations could be materially affected by economic conditions generally, both in the U.S. and elsewhere around the world. Recently, concerns over inflation, energy costs, geopolitical issues, the availability and cost of credit, the U.S. mortgage market and a declining residential real estate market in the U.S. have contributed to increased volatility and diminished expectations for the economy and the markets going forward. These factors, combined with volatile oil prices, declining business and consumer confidence and increased unemployment, have precipitated an economic slowdown and fears of a possible recession or depression. Domestic and international equity markets have also been experiencing heightened volatility and turmoil. These events and the continuing market upheavals may have an adverse effect on us. In the event of a continuing market downturn, our results of operations could be adversely affected by those factors in many negative ways, including making it more difficult for us to raise funds if necessary, and our stock price may further decline. In addition, we maintain significant amounts of cash and cash equivalents at one or more financial institutions that are in excess of federally insured limits. Given the current instability of financial institutions, we cannot be assured that we will not experience losses on these deposits.

Item 4. Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls 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 of our management, including our chief executive officer and chief financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the quarter covered by this report. Based on the foregoing, our chief executive officer and chief financial officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level.

There has been no change in our internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

In September 2007, we filed a lawsuit in the United States District Court for the District of Delaware against Par Pharmaceutical, Inc., or Par, for infringement of U.S. Patent Nos. 6,645,988; 6,489,346; and 6,699,885, each of which is listed in the Approved Drug Products with Therapeutic Equivalence Evaluations, or the Orange Book, for Zegerid Capsules. In December 2007, we filed a second lawsuit in the United States District Court for the District of Delaware against Par for infringement of U.S. Patent Nos. 6,645,988; 6,489,346; 6,699,885; and 6,780,882, each of which is listed in the Orange Book for Zegerid Powder for Oral Suspension. The University of Missouri, licensor of the patents, is a co-plaintiff in the litigation, and both lawsuits have been consolidated for all purposes. The lawsuits are in response to Abbreviated New Drug Applications, or ANDAs, filed by Par with the FDA regarding Par’s intent to market generic versions of our Zegerid Capsules and Zegerid Powder for Oral Suspension products prior to the July 2016 expiration of the asserted patents. Each complaint seeks a judgment that Par has infringed the asserted patents and that the effective date of approval of Par’s ANDA shall not be earlier than the expiration date of the asserted patents. Par has filed answers in each case, primarily asserting non-infringement, invalidity and/or unenforceability. Par has also filed counterclaims seeking a declaration in its favor on those issues. In addition, Par is seeking a declaration that U.S. Patent No. 5,840,737, or the ‘737 patent, is not infringed, is invalid and/or is unenforceable. The ‘737 patent is one of six issued patents listed in the Orange Book for Zegerid Powder for Oral Suspension. The ‘737 patent is not one of the four patents listed in the Orange Book for Zegerid Capsules. We have moved to dismiss, or in the alternative, stay these claims due to a reissue proceeding involving the ‘737 patent currently pending before the PTO. We and the University of Missouri also granted Par a covenant not to sue on the original ‘737 patent. The discovery phase of the lawsuits is continuing. A claim construction hearing is currently scheduled for November 2008. Trial is currently scheduled for July 2009.

We commenced each of the lawsuits within the applicable 45 day period required to automatically stay, or bar, the FDA from approving Par’s ANDAs for 30 months or until a district court decision that is adverse to the asserted patents, whichever may occur earlier. If the litigation is still ongoing after 30 months, the termination of the stay could result in the introduction of one or more generic products to Zegerid Capsules and/or Zegerid Powder for Oral Suspension prior to resolution of the litigation.

On July 15, 2008, the PTO issued U.S. Patent No. 7,399,772, or the ‘772 patent, which is now listed in the Orange Book for both Zegerid Capsules and Zegerid Powder for Oral Suspension. In October 2008, we amended our complaint to add the ‘772 patent to the pending litigation with Par.

Although we intend to vigorously defend and enforce our patent rights, we are not able to predict the outcome of the litigation. Any adverse outcome in this litigation could result in one or more generic versions of Zegerid Capsules and/or Zegerid Powder for Oral Suspension being launched before the expiration of the listed patents in July 2016, which could adversely affect our ability to successfully execute our business strategy to maximize the value of Zegerid Capsules and Zegerid Powder for Oral Suspension and would likely negatively impact our financial condition and results of operations. An adverse outcome may also impact the patent protection for the products being commercialized pursuant to our strategic alliances with GSK and Schering-Plough, which in turn may impact the amount of, or our ability to receive, milestone payments and royalties under those agreements. In addition, even if we prevail, the litigation will be costly, time consuming and distracting to management, which could have a material adverse effect on our business.

In December 2007, the University of Missouri filed an Application for Reissue of the ‘737 patent with the PTO. It is not feasible to predict the impact that the reissue proceeding may have on the scope and validity of the ‘737 patent claims. If the claims of the ‘737 patent ultimately are narrowed substantially or invalidated by the PTO, the extent of the patent coverage afforded to our Zegerid family of products could be impaired, which could potentially harm our business and operating results.

In August 2006, an Indian company filed a pre-grant opposition to a pending Indian patent application that is licensed to us under our license agreement with the University of Missouri. A hearing was conducted in October 2007. In September 2008, the Indian Patent Office declined to grant a patent on the claims presented. As a result of the recent Indian Patent Office decision, we may not be able to obtain patent coverage for one or more of our Zegerid products in India.

Item 1A. Risk Factors

Certain factors may have a material adverse effect on our business, financial condition and results of operations, and you should carefully consider them. Accordingly, in evaluating our business, we encourage you to consider the following discussion of risk factors, which has been updated since the filing of our Annual Report on Form 10-K, in its entirety, in addition to other information contained in this report as well as our other public filings with the Securities and Exchange Commission.

In the near-term, the success of our business will depend on many factors, including:

•

whether we are able to increase market demand for, and sales of, our Zegerid^® (omeprazole/sodium bicarbonate) Capsules and Powder for Oral Suspension prescription products, including our ability to:

	o		achieve greater market acceptance of our products by our targeted primary care physicians and gastroenterologists;

	o		maintain adequate levels of reimbursement coverage for our products from third-party payors; and

	o		compete effectively within the gastrointestinal, or GI, and primary care fields, where we face competition from both branded and generic products, in many cases marketed by competitors with significantly more experience and resources;

	•		whether we are able to maintain patent protection for our products, including whether we are successful in the lawsuits we filed against Par Pharmaceutical, Inc., or Par, for infringement of patents covering our Zegerid Capsules and Zegerid Powder for Oral Suspension products;

	•		whether we are successful in generating revenue under our promotion arrangements and strategic alliances, including our promotion agreement with Depomed, Inc., or Depomed, for Glumetza^® (metformin hydrochloride extended release tablets), our over-the counter, or OTC, license agreement with Schering-Plough Healthcare Products, Inc., or Schering-Plough, and our license and distribution agreements with Glaxo Group Limited, an affiliate of GlaxoSmithKline plc, or GSK; and

	•		whether we will be able to further diversify our sources of revenue and product portfolio, including our ability to obtain additional financing to support the licensing or acquisition of new products.

Each of these factors, as well as other factors that may impact our business, are described in more detail in the following discussion. Although the factors highlighted above are among the most significant, any of the following factors could materially adversely affect our business or cause our actual results to differ materially from those contained in forward-looking statements we have made in this report and those we may make from time to time, and you should consider all of the factors described when evaluating our business.

Risks Related to Our Business and Industry

At this time, we are largely dependent on the commercial success of our Zegerid products and our immediate-release proton pump inhibitor, or PPI, technology, and we cannot be certain that we will be able to achieve commercial success with these products and technology.

We have invested a significant portion of our time and financial resources in the development and commercialization of our Zegerid family of prescription products, which are currently being marketed in capsule and powder for oral suspension dosage forms. These products are proprietary immediate-release formulations of omeprazole, a PPI, and are intended to treat or reduce the risk of a variety of upper GI diseases and disorders, including gastroesophageal reflux disease, or GERD. We anticipate that in the near term our ability to generate revenues will depend on the commercial success of our currently marketed products, which in turn, will depend on several factors, including our ability to:

•

successfully increase market demand for, and sales of, Zegerid Capsules and Zegerid Powder for Oral Suspension, through the promotional efforts of our own sales force, the contract sales representatives under our services agreement with inVentiv Commercial Services, LLC, or inVentiv, and any other promotional arrangements that we may later establish;

	•		successfully maintain patent protection for our Zegerid family of products, including whether we are successful in the lawsuits we filed against Par for infringement of patents covering our Zegerid Capsules and Zegerid Powder for Oral Suspension products;

	•		establish and maintain effective marketing programs and continue to build brand identity;

	•		obtain greater acceptance of the products by physicians, patients and third-party payors and obtain and maintain distribution at the retail level;

	•		establish and maintain agreements with wholesalers and distributors on commercially reasonable terms; and

	•		maintain commercial manufacturing capabilities as necessary to meet commercial demand for the products, as well as maintain commercial manufacturing arrangements with third-party manufacturers.

Our ability to generate revenue in the longer term will also depend on whether our strategic alliances with GSK and Schering-Plough will lead to the successful commercialization of additional omeprazole products using our patented PPI technology. In addition, our success may be impacted by the extent to which our promotion of other products detracts from our sales representatives’ effort to promote our Zegerid products. We also recently terminated our co-promotion agreement with Otsuka America Pharmaceutical, Inc., and we cannot be certain of the impact that the decrease in promotional support may have on our business.

We expect to incur significant costs as we continue to support the commercialization of Zegerid Capsules and Zegerid Powder for Oral Suspension. We have realized modest growth in sales of our Zegerid products to date relative to our expenses to date, including expenses associated with our commercial operations, and we may be unable to achieve greater market acceptance. For the nine months ended September 30, 2008, we recognized $71.5 million in Zegerid net product sales. In addition, as of September 30, 2008, we had an accumulated deficit of $312.4 million.

We cannot be certain that our continued marketing of Zegerid Capsules and Zegerid Powder for Oral Suspension will result in increased demand for, and sales of, our products or that we will receive any milestone payments or sales-based royalties from our strategic alliances with GSK and Schering-Plough. The potential demand for our currently marketed prescription products may also be negatively impacted by the availability of any OTC products developed and marketed by Schering-Plough in the U.S. pursuant to our strategic alliance. If we fail to successfully commercialize our prescription products or GSK and Schering-Plough fail to successfully commercialize products using our patented PPI technology or are significantly delayed in doing so, we may be unable to generate sufficient revenues to grow our business and attain and sustain profitability, and our business, financial condition and results of operations will be materially adversely affected.

In addition, even if our products continue to achieve market acceptance, we may not be able to maintain that market acceptance over time if new products or technologies are introduced that are more favorably received than our products, are more cost-effective or otherwise render our products obsolete.

If we are unable to maintain adequate levels of reimbursement for our Zegerid products on reasonable pricing terms, their commercial success may be severely hindered.

Our ability to sell our products may depend in large part on the extent to which reimbursement for the costs of our products is available from private health insurers, managed care organizations, government entities and others. Third-party payors are increasingly attempting to contain their costs. We cannot predict actions third-party payors may take, or whether they will limit the coverage and level of reimbursement for our products or refuse to provide any coverage at all. Reduced or partial reimbursement coverage could make our products less attractive to patients, suppliers and prescribing physicians and may not be adequate for us to maintain price levels sufficient to realize an appropriate return on our investment in our products or compete on price.

In many cases, insurers and other healthcare payment organizations encourage the use of less expensive alternative generic brands and OTC products through their prescription benefits coverage and reimbursement policies. The availability of generic prescription and OTC PPI products has created, and will continue to create, a competitive reimbursement environment for our prescription Zegerid branded products. Insurers and other healthcare payment organizations frequently make the generic or OTC alternatives more attractive to the patient by providing different amounts of reimbursement so that the net cost of the generic or OTC product to the patient is less than the net cost of a prescription branded product. Aggressive pricing policies by our generic or OTC product competitors and the prescription benefit policies of insurers could have a negative effect on our product revenues and profitability. Even though we are eligible to receive sales-based royalties on OTC products under our OTC license agreement with Schering-Plough, those potential revenues could be offset by the impact of lost sales of our prescription products to the extent the OTC products are preferred by customers over our current prescription products.

Many managed care organizations negotiate the price of medical services and products and develop formularies which establish pricing and reimbursement levels. Exclusion of a product from a formulary can lead to its sharply reduced usage in the managed care organization’s patient population. If our products are not included within an adequate number of formularies or adequate reimbursement levels are not provided, or if those policies increasingly favor generic or OTC products, our market share and gross margins could be negatively affected, as could our overall business and financial condition.

The competition among pharmaceutical companies to have their products approved for reimbursement also results in downward pricing pressure in the industry and in the markets where our products compete. In some cases, we aggressively discount our products in order to obtain reimbursement coverage, and we may not be successful in any efforts we take to mitigate the effect of a decline in average selling prices for our products. Declines in our average selling prices also reduce our gross margins.

In addition, managed care initiatives to control costs may influence primary care physicians to refer fewer patients to gastroenterologists and other specialists. Reductions in these referrals could have a material adverse effect on the size of our potential market and increase costs to effectively promote GI products.

Our account managers contact private health insurers, managed care organizations, government entities and other third-party payors, seeking reimbursement coverage for our products similar to that for branded delayed-release PPI products. The process for obtaining coverage can be lengthy and time-consuming, in some cases taking several months before a particular payor initially reviews our product, and we may ultimately be unsuccessful in obtaining coverage. Our competitors generally have larger account management organizations, as well as existing business relationships with third-party payors relating to their PPI products, as well as other portfolio products. Moreover, the current availability of generic and OTC delayed-release omeprazole products may make obtaining reimbursement coverage for our immediate-release products more difficult because our products also utilize omeprazole as an active ingredient. If we fail to successfully secure and maintain reimbursement coverage for our products on favorable terms or are significantly delayed in doing so, we will have difficulty achieving market acceptance of our products and our business will be materially adversely affected.

Our strategic partners, GSK and Schering-Plough, may not successfully commercialize products using our patented PPI technology.

In November 2007, we entered into a license agreement and a distribution agreement granting exclusive rights to GSK under our patented PPI technology to commercialize prescription and OTC products in up to 114 specified countries within Africa, Asia, the Middle-East, and Central and South America, and to distribute and sell Zegerid brand prescription products in Puerto Rico and the U.S. Virgin Islands. In October 2006, we entered into an OTC license agreement with Schering-Plough, pursuant to which we granted exclusive rights under our patented PPI technology to develop, manufacture, market and sell omeprazole products for the OTC market in the U.S. and Canada. Under these agreements, we depend on the efforts of GSK and Schering-Plough, and we have limited control over their commercialization efforts. For example, GSK and Schering-Plough may not commercialize products as fast as we would like or as fast as the market may expect and may not generate the level of sales that we would like. Any failures by GSK or Schering-Plough could have a negative impact on physician and patient impressions of our prescription products in the U.S. Even if GSK’s and Schering-Plough’s efforts are successful, we will only receive specified milestone payments and royalties on net sales and may not enjoy the same financial rewards as we would have had we developed and launched the products ourselves. Furthermore, the availability of products developed by Schering-Plough using our patented PPI technology for the U.S. OTC market could lead to decreased demand for our prescription products in the U.S.

We are also subject to risks associated with termination of our agreements with GSK and Schering-Plough. The GSK license and distribution agreements may be terminated by either party in the event of the other party’s uncured material breach or bankruptcy or insolvency. In addition, GSK may terminate the license and distribution agreements on six months prior written notice to us at any time. The Schering-Plough license agreement may be terminated by either party if the other party is in material breach of its material obligations under the agreement and has not cured the breach within 30 days notice, provided that the cure period for late payments is 15 days, and provided further that all alleged breaches are subject to dispute resolution provisions set forth in the agreement. In addition, Schering-Plough may terminate the agreement in its entirety on 180 days prior written notice to us at any time.

If GSK’s and Schering-Plough’s commercialization efforts are not successful, our ability to generate sufficient revenues to grow our business and attain and sustain profitability will be adversely affected.

The market for the GI pharmaceutical industry is intensely competitive and many of our competitors have significantly more resources and experience, which may limit our commercial opportunity.

The pharmaceutical industry is intensely competitive, particularly in the GI field, where currently marketed products are well-established and successful. Many of our competitors are large, well-established companies in the pharmaceutical field. Our competitors include, among others, AstraZeneca plc, Takeda Pharmaceutical Company Limited, Wyeth, Altana, Eisai Co., Ltd., Johnson & Johnson, Axcan Pharma Inc., Ferring Pharmaceuticals A/S, Merck & Co., Inc., Novartis AG, Salix Pharmaceuticals, Inc., Shire Pharmaceuticals Group plc and The Procter & Gamble Company, as well as several generic manufacturers. Many of these companies already offer products that target GERD and other GI diseases and disorders that we target. Given our relatively small size and the entry of our products into a market characterized by well-established drugs, we may not be able to compete effectively.

In addition, many of our competitors, either alone or together with their collaborative partners, may have significantly greater experience in:

	•		developing prescription and OTC drugs;

	•		undertaking preclinical testing and human clinical trials;

	•		formulating and manufacturing drugs;

	•		obtaining U.S. Food and Drug Administration, or FDA, and other regulatory approvals of drugs; and

	•		launching, marketing, distributing and selling drugs.

As a result, they may have a greater ability to undertake more extensive research and development, manufacturing, marketing and other programs. Many of these companies may succeed in developing products earlier than we do, completing the regulatory process and showing safety and efficacy of products more rapidly than we do or developing products that are more effective than our products. Additionally, many of our competitors have greater resources to conduct clinical studies differentiating their products, as compared to our limited resources. Further, the products they develop may be based on new and different technology and may exhibit benefits relative to our products.

Many of these companies with which we compete also have significantly greater financial and other resources than we do. Larger pharmaceutical companies typically have significantly larger field sales force organizations and invest significant amounts in advertising and marketing their products, including through the purchase of television advertisements and the use of other direct-to-consumer methods. As a result, these larger companies are able to reach a greater number of physicians and consumers and reach them more frequently than we can with our smaller sales organization. It is also possible that our competitors may be able to reduce their cost of manufacturing so that they can aggressively price their products and secure a greater market share to our detriment. In addition, our competitors may be able to attract and retain qualified personnel and to secure capital resources more effectively than we can. Any of these events could adversely affect our business.

Our Zegerid products compete with many other drug products focused on upper GI diseases and disorders, which could put downward pressure on pricing and market share and limit our ability to generate revenues.

Our Zegerid products compete with many prescription and OTC products, including:

Prescription Products:

	•		PPIs: AstraZeneca plc’s Prilosec^® and Nexium^®, Takeda Pharmaceutical Company Limited’s Prevacid^®, Wyeth’s and Altana’s Protonix^®, Johnson & Johnson’s and Eisai Co., Ltd.’s Aciphex^®, and generic delayed-release omeprazole and pantoprazole, among others; and

	•		Histamine-2 receptor antagonists: Merck & Co., Inc.’s Pepcid^®, GlaxoSmithKline plc’s Zantac^® and Tagamet^® and Braintree Laboratories, Inc.’s Axid^®, among others.

Over-the-Counter Products:

	•		PPIs: The Procter & Gamble Company’s Prilosec OTC^® and store brand delayed-release omeprazole OTC products;

	•		Histamine-2 receptor antagonists: Boehringer Ingelheim GmbH’s Zantac, GlaxoSmithKline plc’s Tagamet, and Johnson & Johnson’s and Merck & Co., Inc.’s Pepcid AC^® and Pepcid Complete^®, among others; and

	•		Antacids: Johnson & Johnson’s and Merck and Co., Inc.’s Mylanta^{^®}and Rolaids^®, Novartis AG’s Maalox^® and GlaxoSmithKline plc’s Gaviscon^® and Tums^®, among others.

In addition, various companies are developing new products, including new PPIs, such as Takeda’s dexlansoprazole compound under FDA review, motility agents, reversible acid inhibitors, cytoprotective compounds and products that act on the lower esophageal sphincter, or LES. We may face competition from these or other new products that have greater efficacy or other benefits relative to our products.

Many of the currently marketed competitive products are available as generic products. For example, generic delayed-release omeprazole products and generic delayed-release pantoprazole products are currently available in the U.S. market, and we anticipate that other generic delayed-release PPIs will enter the market. In addition, delayed-release omeprazole is available in a 20 mg dosage strength as a branded and store brand OTC product. We anticipate that other OTC PPI products will also enter the market. The existence of generic and OTC delayed-release PPI products could make it more difficult for branded prescription PPI products, including our Zegerid products, to gain or maintain market share and could cause prices for PPIs to drop, each of which could adversely affect our business. Moreover, the current availability of generic and OTC delayed-release omeprazole products may have an additional impact on demand and pricing for our immediate-release products because our products also utilize omeprazole as an active ingredient.

We may also face competition for our products from lower priced products from foreign countries that have placed price controls on pharmaceutical products. Proposed federal legislative changes may expand consumers’ ability to import lower priced versions of our products and competing products from Canada. Further, several states and local governments have implemented importation schemes for their citizens, and, in the absence of federal action to curtail such activities, we expect other states and local governments to launch importation efforts. The importation of foreign products that compete with our own products could negatively impact our business and prospects.

The promotional efforts of inVentiv, under our contract sales organization agreement, may not be successful in increasing market demand for, and sales of, our Zegerid prescription products.

To support the promotion of our Zegerid prescription products, we have entered into a contract sales organization agreement with inVentiv. Under our agreement with inVentiv, inVentiv is committed to provide up to a certain number of fully-dedicated contract sales representatives to promote our Zegerid products in the U.S. We are currently utilizing approximately 100 inVentiv representatives. Our agreement with inVentiv causes us to incur significant costs, and we cannot be sure that the efforts of the contract sales force will be successful.

Any revenues we receive from sales of our products generated by the inVentiv contract sales force will depend upon the efforts of contract sales representatives, which in many regards are not within our control. If we are unable to maintain our agreement with inVentiv or to effectively establish alternative arrangements to market our products more broadly than we can through our internal sales force, our business could be adversely affected.

We depend on a limited number of wholesaler customers for retail distribution of our products, and if we lose any of our significant wholesaler customers, our business could be harmed.

Our wholesaler customers include some of the nation’s leading wholesale pharmaceutical distributors, such as Cardinal Health, Inc., McKesson Corporation and AmerisourceBergen Corporation, and major drug chains. Sales to Cardinal, McKesson and AmerisourceBergen accounted for approximately 32%, 32% and 14%, respectively, of our annual revenues during 2007 and 31%, 27% and 15%, respectively, of our revenues for the nine months ended September 30, 2008. The loss of any of these wholesaler customers’ accounts or a material reduction in their purchases could harm our business, financial condition or results of operations. In addition, we may face pricing pressure from our wholesaler customers.

If we are unable to continue to manufacture our products on a commercial basis, our commercialization efforts will be materially harmed.

The quantities of our products that our suppliers are able to manufacture in the future may fail to meet our quality specifications or may not be sufficient to meet potential commercial demand. Any problems or delays experienced in the manufacturing process for Zegerid Capsules or Zegerid Powder for Oral Suspension may impair our ability to provide commercial quantities of the products, which would limit our ability to sell the products and would adversely affect our business. While we believe we ultimately could redesign our manufacturing processes or identify alternative suppliers in response to problems we may encounter as we manufacture our products, it could take significant time to do so and may require regulatory approval, and our products may not be available from alternate manufacturers at favorable prices.

We do not currently have any manufacturing facilities and instead rely on third-party manufacturers.

We have no manufacturing facilities, and we rely on third-party manufacturers to provide us with an adequate and reliable supply of our products on a timely basis. Our manufacturers must comply with U.S. regulations, including the FDA’s current good manufacturing practices, applicable to the manufacturing processes related to pharmaceutical products, and their facilities must be inspected and approved by the FDA and other regulatory agencies as part of their business. In addition, because several of our key manufacturers are located outside of the U.S., they must also comply with applicable foreign laws and regulations.

We have limited control over our third-party manufacturers, including with respect to regulatory compliance and quality assurance matters. Any delay or interruption of supply related to a third-party manufacturer’s failure to comply with regulatory or other requirements would limit our ability to make sales of our products. Any manufacturing defect or error discovered after products have been produced and distributed could result in even more significant consequences, including costly recall procedures, re-stocking costs, damage to our reputation and potential for product liability claims. With respect to any future products under development, if the FDA finds significant issues with any of our manufacturers during the pre-approval inspection process, the approval of those products could be delayed while the manufacturer addresses the FDA’s concerns, or we may be required to identify and obtain the FDA’s approval of a new supplier. This could result in significant delays before manufacturing of our products can begin, which in turn would delay commercialization of our products. In addition, the importation of pharmaceutical products into the U.S. is subject to regulation by the FDA, and the FDA can refuse to allow an imported product into the U.S. if it is not satisfied that the product complies with applicable laws or regulations.

We rely on Norwich Pharmaceuticals, Inc., located in New York, as the current sole third-party manufacturer of Zegerid Capsules. In addition, we rely on a single third-party manufacturer located outside of the U.S., Patheon Inc., for the supply of Zegerid Powder for Oral Suspension, and we are obligated under our supply agreement to purchase a significant portion of our requirements of this product from Patheon. We also currently rely on a single third-party supplier located outside of the U.S., Union Quimico Farmaceutica, S.A., or Uquifa, for the supply of omeprazole, which is an active pharmaceutical ingredient in each of our current Zegerid products. We are obligated under our supply agreement with Uquifa to purchase

all of our requirements of omeprazole from this supplier. We also currently have two approved suppliers for sodium bicarbonate, which is a key ingredient in our marketed powder for oral suspension and capsule products, and we rely on our third-party manufacturers to purchase the sodium bicarbonate. Additionally, we rely on single suppliers for certain excipients in our powder for oral suspension and capsule products. Any significant problem that our sole source manufacturers or suppliers experience could result in a delay or interruption in the supply to us until the manufacturer or supplier cures the problem or until we locate an alternative source of supply. In addition, because our sole source manufacturers and suppliers provide services to a number of other pharmaceutical companies, they may experience capacity constraints or choose to prioritize one or more of their other customers over us. In addition, to the extent GSK or Schering-Plough utilizes our suppliers, capacity at our suppliers may become further constrained.

Although alternative sources of supply exist, the number of third-party manufacturers with the manufacturing and regulatory expertise and facilities necessary to manufacture the finished forms of our pharmaceutical products or the active omeprazole and other key ingredients in our products on a commercial scale is limited, and it would take a significant amount of time to arrange for alternative manufacturers. Any new supplier of products or active pharmaceutical ingredients would be required to qualify under applicable regulatory requirements and would need to have sufficient rights under applicable intellectual property laws to the method of manufacturing such products or ingredients. The FDA may require us to conduct additional clinical trials, collect stability data and provide additional information concerning any new supplier before we could distribute products from that supplier. Obtaining the necessary FDA approvals or other qualifications under applicable regulatory requirements and ensuring non-infringement of third-party intellectual property rights could result in a significant interruption of supply and could require the new supplier to bear significant additional costs which may be passed on to us.

Our resources have been primarily focused on commercializing our Zegerid products, and we may be unable to expand our product portfolio or integrate new products successfully.

Our resources have been primarily focused on commercializing our Zegerid family of products. We also recently entered into a promotion agreement with Depomed to promote Depomed’s Glumetza^® (metformin hydrochloride extended release tablets). Our success will depend in part on our ability to further diversify our product portfolio and further leverage our commercial capabilities through co-promotion, in-licensing or acquisition of additional marketed or late stage proprietary products. We may not be able to identify appropriate licensing or acquisition opportunities to expand and diversify our pipeline of products. Even if we identify an appropriate product, competition for it may be intense. We may not be able to successfully negotiate the terms of a license or acquisition agreement on commercially acceptable terms. The negotiation of agreements to obtain rights to additional products or to acquire companies or their products or product lines could divert our management’s time and resources from other elements of our existing business. Moreover, we may be unable to finance the licensing or acquisition of a new product or an acquisition target. If we issue shares of our common stock or other securities in one or more significant acquisitions, our stockholders could suffer significant dilution of their ownership interests. We might also incur debt or experience a decrease in cash available for our operations, or incur contingent liabilities and amortization expenses relating to identifiable intangible assets, in connection with any future acquisitions.

We may not generate adequate revenues under our promotion agreement for Glumetza products to justify our level of promotional effort and expense under the agreement.

In July 2008, we entered into a promotion agreement with Depomed pursuant to which we agreed to promote Depomed’s Glumetza products in the U.S., including its territories and possessions and Puerto Rico. Under the terms of the promotion agreement, Depomed will pay us a fee ranging from 75% to 80% of the gross margin earned from all net sales of Glumetza products in the U.S., its territories and possessions and Puerto Rico, with gross margin defined as net sales less cost of goods and product-related fees paid to Biovail Laboratories. We paid Depomed a $12.0 million upfront fee, and based on the achievement of specified levels of annual Glumetza net product sales, we may be required to pay Depomed one-time sales milestones, totaling up to $16.0 million. We will also be responsible for all costs associated with our sales force and for all other sales and marketing-related expenses associated with our promotion of Glumetza products, including an initial commitment of $5.0 million in non-sales force advertising and promotional costs from signing through March 31, 2009. We began promotion of Glumetza products in October 2008.

Also in July 2008, we and Victory Pharma, Inc., or Victory, mutually agreed to terminate our co-promotion agreement previously entered into in June 2007, pursuant to which we agreed to co-promote Naprelan Controlled Release Tablets to our targeted primary care physicians in the U.S. Under the terms of the co-promotion agreement, we received a co-promotion fee equal to slightly more than half of the net sales value of the prescriptions generated by our target physicians. We ended all promotional efforts under the co-promotion agreement as of September 30, 2008, and Victory will pay us any co-promotion fees due to us under the agreement for our activities through such period. Victory will also make a one-time, lump-sum trailing royalty payment to us on January 31, 2009 for the fiscal quarter ending December 31, 2008. In addition, Victory is required to purchase from us a portion of the product samples on-hand.

In August 2007, we entered into a co-promotion agreement with C.B. Fleet Company Incorporated, or Fleet, which was subsequently amended in May 2008, pursuant to which we agreed to co-promote the Fleet Phospho-soda EZ-Prep Bowel Cleansing System to our targeted gastroenterologists in the U.S., in exchange for a set fee per sales call. The co-promotion agreement expired in accordance with its terms on October 1, 2008.

Our ability to generate adequate revenues under the Glumetza promotion agreement to justify the resources and the level of promotional effort we will have to expend is subject to a number of risks and uncertainties, including:

	•		our ability to increase market demand and sales of the Glumetza products;

	•		adverse side effects or inadequate therapeutic efficacy of the Glumetza products and any resulting product liability claims or product recalls;

	•		Depomed’s ability to ensure continued commercial supply of the Glumetza products; and

	•		the potential for termination of the promotion arrangement.

In addition, the promotion of the Glumetza products could detract from our sales representatives’ efforts to promote our Zegerid products and have an adverse impact on Zegerid sales. If our promotion efforts are not successful, our ability to generate sufficient revenues to grow our business and attain and sustain profitability may be adversely affected.

Our reporting and payment obligations under the Medicaid rebate program and other governmental purchasing and rebate programs are complex and may involve subjective decisions, and any failure to comply with those obligations could subject us to penalties and sanctions, which in turn could have a material adverse effect on our business and financial condition.

The regulations regarding reporting and payment obligations with respect to Medicaid reimbursement and rebates and other governmental programs are complex. Our calculations and methodologies are subject to review and challenge by the applicable governmental agencies, and it is possible that such reviews could result in material changes. In addition, because our processes for these calculations and the judgments involved in making these calculations involve subjective decisions and complex methodologies, these calculations are subject to the risk of errors. Any failure to comply with the government reporting and payment obligations could result in civil and/or criminal sanctions.

Regulatory approval for our currently marketed products is limited by the FDA to those specific indications and conditions for which we are able to support clinical safety and efficacy.

Any regulatory approval is limited to those specific diseases and indications for which our products are deemed to be safe and effective by the FDA. In addition to the FDA approval required for new formulations, any new indication for an approved product also requires FDA approval. If we are not able to obtain FDA approval for any desired future indications for our products, our ability to effectively market and sell our products may be reduced and our business will be adversely affected.

While physicians may choose to prescribe drugs for uses that are not described in the product’s labeling and for uses that differ from those tested in clinical studies and approved by the regulatory authorities, our regulatory approvals will be limited to those indications that are specifically submitted to the FDA for review. These “off-label” uses are common across medical specialties and may constitute an appropriate treatment for many patients in varied circumstances. Regulatory authorities in the U.S. generally do not regulate the behavior of physicians in their choice of treatments. Regulatory authorities do, however, restrict communications by pharmaceutical companies on the subject of off-label use. If our promotional activities fail to comply with these regulations or guidelines, we may be subject to warnings from, or enforcement action by, these authorities. In addition, our failure to follow FDA rules and guidelines relating to promotion and advertising may cause the FDA to delay its approval or refuse to approve a product, the suspension or withdrawal of an approved product from the market, recalls, fines, disgorgement of money, operating restrictions, injunctions or criminal prosecution, any of which could harm our business.

We are subject to ongoing regulatory review of our Zegerid products and any other products that we market.

Our Zegerid products and any other products that we market will continue to be subject to extensive regulation. These regulations impact many aspects of our operations, including the manufacture, labeling, packaging, adverse event reporting, storage, distribution, advertising, promotion and record keeping related to the products. The FDA also frequently requires post-marketing testing and surveillance to monitor the effects of approved products or place conditions on any approvals that could restrict the commercial applications of these products. For example, in connection with the approval of our NDAs for Zegerid Powder for Oral Suspension, we committed to commence clinical studies to evaluate the product in pediatric populations in 2005. We have not yet commenced any of the studies and, prior to doing so, will need to finalize study designs, including receiving FDA input on one of the proposed study designs, engage clinical research organizations and undertake other related activities. In addition, the subsequent discovery of previously unknown problems with the product may result in restrictions on the product, including withdrawal of the product from the market. If we fail to comply with applicable regulatory requirements, we may be subject to fines, suspension or withdrawal of regulatory approvals, product recalls, seizure of products, disgorgement of money, operating restrictions and criminal prosecution.

In addition to FDA restrictions on marketing of pharmaceutical products, several other types of state and federal laws have been applied to restrict certain marketing practices in the pharmaceutical industry in recent years. These laws include anti-kickback statutes and false claims statutes. The federal healthcare program anti-kickback statute prohibits, among other things, knowingly and willfully offering, paying, soliciting or receiving remuneration to induce or in return for purchasing, leasing, ordering or arranging for the purchase, lease or order of any healthcare item or service reimbursable under Medicare, Medicaid or other federally financed healthcare programs. This statute has been interpreted to apply to arrangements between pharmaceutical manufacturers on the one hand and prescribers, purchasers and formulary managers on the other. Violations of the anti-kickback statute are punishable by imprisonment, criminal fines, civil monetary penalties and exclusion from participation in federal healthcare programs. Although there are a number of statutory exemptions and regulatory safe harbors protecting certain common activities from prosecution or other regulatory sanctions, the exemptions and safe harbors are drawn narrowly, and practices that involve remuneration intended to induce prescribing, purchases or recommendations may be subject to scrutiny if they do not qualify for an exemption or safe harbor. Our practices may not in all cases meet all of the criteria for safe harbor protection from anti-kickback liability.

Federal false claims laws prohibit any person from knowingly presenting, or causing to be presented, a false claim for payment to the federal government, or knowingly making, or causing to be made, a false statement to have a false claim paid. Recently, several pharmaceutical and other healthcare companies have been prosecuted under these laws for allegedly inflating drug prices they report to pricing services, which in turn are used by the government to set Medicare and Medicaid reimbursement rates, and for allegedly providing free product to customers with the expectation that the customers would bill federal programs for the product. In addition, certain marketing practices, including off-label promotion, may also violate false claims laws. The majority of states also have statutes or regulations similar to the federal anti-kickback law and false claims laws, which apply to items and services reimbursed under Medicaid and other state programs, or, in several states, apply regardless of the payor. Sanctions under these federal and state laws may include civil monetary penalties, exclusion of a manufacturer’s products from reimbursement under government programs, criminal fines and imprisonment.

Because of the breadth of these laws and the narrowness of the safe harbors, it is possible that some of our business activities could be subject to challenge under one or more of such laws. Such a challenge could have a material adverse effect on our business, financial condition and results of operations.

In addition, as part of the sales and marketing process, pharmaceutical companies frequently provide samples of approved drugs to physicians. This practice is regulated by the FDA and other governmental authorities, including, in particular, requirements concerning record keeping and control procedures. Any failure to comply with the regulations may result in significant criminal and civil penalties as well as damage to our credibility in the marketplace.

We are subject to new legislation, regulatory proposals and managed care initiatives that may increase our costs of compliance and adversely affect our ability to market our products, obtain collaborators and raise capital.

There have been a number of legislative and regulatory proposals aimed at changing the healthcare system and pharmaceutical industry, including reductions in the cost of prescription products, changes in the levels at which consumers and healthcare providers are reimbursed for purchases of pharmaceutical products, proposals concerning reimportation of pharmaceutical products and proposals concerning safety matters. For example, in an attempt to protect against counterfeit drugs, the federal government and numerous states have enacted pedigree legislation. In particular, California has enacted legislation that requires development of an electronic pedigree to track and trace each prescription drug at the saleable unit level through the distribution system. California’s electronic pedigree requirement is scheduled to take effect in January 2011. Compliance with California and future federal or state electronic pedigree requirements will likely require an increase in our operational expenses and will likely be administratively burdensome. It is also possible that other proposals will be adopted, particularly in light of the 2008 presidential and congressional elections and the potential agenda of any new administration. As a result of new proposals, we may determine to change our current manner of operation, provide additional benefits or change our contract arrangements, any of which could harm our ability to operate our business efficiently, obtain collaborators and raise capital.

We face a risk of product liability claims and may not be able to obtain adequate insurance.

Our business exposes us to potential liability risks that may arise from the clinical testing of our products and the manufacture and sale of our Zegerid products and any other products we promote or otherwise commercialize. These risks exist even if a product is approved for commercial sale by the FDA and manufactured in facilities licensed and regulated by the FDA. Any product liability claim or series of claims brought against us could significantly harm our business by, among other things, reducing demand for our products, injuring our reputation and creating significant adverse media attention and costly litigation. Plaintiffs have received substantial damage awards in some jurisdictions against pharmaceutical companies based upon claims for injuries allegedly caused by the use of their products. Any judgment against us that is in excess of our insurance policy limits would have to be paid from our cash reserves, which would reduce our capital resources. Although we have product and clinical trials liability insurance with a coverage limit of $15.0 million, this coverage may prove to be inadequate. Furthermore, we cannot be certain that our current insurance coverage will continue to be available for our commercial or clinical trial activities on reasonable terms, if at all. Further, we may not have sufficient capital resources to pay a judgment, in which case our creditors could levy against our assets, including our intellectual property.

We rely on third parties to perform many necessary services for our commercial products, including services related to the distribution, 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 which are out of our direct control. For example, we rely on one third-party service provider to provide key services related to warehousing and inventory management, distribution, contract administration and chargeback processing, accounts receivable management and call center management, and, as a result, most of our inventory is stored at a single warehouse maintained by the service provider. We place substantial reliance on this provider as well as other third-party providers that perform services for us, including entrusting our inventories of products to their care and handling. If these third-party service providers fail to comply with applicable laws and regulations, fail to meet expected deadlines, or otherwise do not carry out their contractual duties to us, or encounter physical or natural damage at their facilities, our ability to deliver product to meet commercial demand would be significantly 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 by these service providers is insufficient, our ability to continue to market our products could be jeopardized or we could be subject to regulatory sanctions. We do not currently have the internal capacity to perform these important commercial functions, and we may not be able to maintain commercial arrangements for these services on reasonable terms.

Our reliance on third-party clinical investigators and clinical research organizations may result in delays in completing, or a failure to complete, clinical trials or we may be unable to use the clinical data gathered if they fail to comply with regulatory requirements or perform under our agreements with them.

As an integral component of our clinical development programs, we engage clinical investigators and clinical research organizations, or CROs, to enroll patients and conduct and manage our clinical studies. As a result, many key aspects of this process have been and will be out of our direct control. If the CROs and other third parties that we rely on for patient enrollment and other portions of our clinical trials fail to perform the clinical trials in a satisfactory manner and in compliance with applicable U.S. and foreign regulations, or fail to perform their obligations under our agreements with them, we could face significant delays in completing our clinical trials or we may be unable to rely in the future on the clinical data generated. For example, the FDA has inspected and will continue to inspect certain of our CROs’ operations and trial procedures and may issue notices of any observations of failure to comply with FDA-approved good clinical practices and other regulations. If our CROs or clinical investigators are unable to respond to such notices of observations in a satisfactory manner or otherwise resolve any issues identified by the FDA or other regulatory authorities, we may be unable to use the data gathered at those sites. To the extent a single CRO conducts clinical trials for us for multiple products, the CRO’s failure to comply with U.S. and foreign regulations could negatively impact each of the trials. If these clinical investigators and CROs do not carry out their contractual duties or obligations or fail to meet expected deadlines, or if the quality or accuracy of the clinical data they obtain is compromised due to their failure to adhere to our clinical protocols, regulatory requirements or for other reasons, our clinical trials may be extended, delayed or terminated, we may be required to repeat one or more of our clinical trials and we may be unable to obtain or maintain regulatory approval for or successfully commercialize our products.

Any products we develop in the future likely will require significant product and clinical development activities and ultimately may not be approved by the FDA, and any failure or delays associated with these activities or the FDA’s approval of such products would increase our costs and time to market.

We face substantial risks of failure inherent in developing pharmaceutical products. The pharmaceutical industry is subject to stringent regulation by many different agencies at the federal, state and international levels. Our products must satisfy rigorous standards of safety and efficacy before the FDA and any foreign regulatory authorities will approve them for commercial use.

Product development is generally a long, expensive and uncertain process. Successful development of product formulations depends on many factors, including our ability to select key components, establish a stable formulation, develop a product that demonstrates our intended safety and efficacy profile, and transfer from development stage to commercial-scale operations. Any delays we encounter during our product development activities would in turn adversely affect our ability to commercialize the product under development.

Once we have manufactured formulations of our products that we believe will be suitable for clinical testing, we then must complete our clinical testing, and failure can occur at any stage of testing. These clinical tests must comply with FDA and other applicable regulations. We may encounter delays or rejections based on our inability to enroll enough patients to complete our clinical trials. We may suffer significant setbacks in advanced clinical trials, even after showing promising results in earlier trials. The results of later clinical trials may not replicate the results of prior clinical trials. Based on results at any stage of clinical trials, we may decide to discontinue development of a product. We, or the FDA, may suspend clinical trials at any time if the patients participating in the trials are exposed to unacceptable health risks or if the FDA finds deficiencies in our applications to conduct the clinical trials or in the conduct of our trials. Moreover, not all products in clinical trials will receive timely, or any, regulatory approval.

Even if clinical trials are completed as planned, their results may not support our assumptions or our product claims. The clinical trial process may fail to demonstrate that our products are safe for humans or effective for their intended uses. Our product development costs will increase and our product revenues will be delayed if we experience delays in testing or regulatory approvals or if we need to perform more or larger clinical trials than planned. In addition, such failures could cause us to abandon a product entirely. If we fail to take any current or future product from the development stage to market, we will have incurred significant expenses without the possibility of generating revenues, and our business will be adversely affected.

We currently are developing a new tablet formulation as part of our Zegerid family of prescription products. The new formulation is a swallowable tablet that combines immediate-release omeprazole with a mix of buffers. We believe we have successfully completed our planned clinical study with the tablet and stability studies are ongoing. If the development program proceeds as currently planned, we expect to submit an NDA for the swallowable tablet to the FDA in the first quarter of 2009. Our objective is to have the new tablet formulation commercially available in the U.S. in the fourth quarter of 2009; however, completion of our development activities and timing of regulatory submission and approval are subject to a variety of risks and potential delays, including risks and delays associated with the new tablet formulation development activities, including difficulties and delays associated with product stability, clinical testing and the regulatory approval process. In addition, the new tablet formulation may not achieve the intended safety and efficacy profile. Any of these events could adversely affect our ability to commercialize the tablet formulation and the timing for commercial availability, which in turn could adversely affect our business.

If we are unable to attract and retain key personnel, our business will suffer.

We are a small company and, as of September 30, 2008, had 345 employees. Our success depends on our continued ability to attract, retain and motivate highly qualified management, clinical, manufacturing, product development, business development and sales and marketing personnel. We, as well as inVentiv, our contract sales provider, may not be able to recruit and retain qualified personnel in the future, particularly for sales and marketing positions, due to competition for personnel among pharmaceutical businesses, and the failure to do so could have a significant negative impact on our future product revenues and business results.

Our success depends on a number of key senior management personnel, particularly Gerald T. Proehl, our President and Chief Executive Officer. Although we have employment agreements with our executive officers, these agreements are terminable at will at any time with or without notice and, therefore, we cannot be certain that we will be able to retain their services. In addition, although we have a “key person” insurance policy on Mr. Proehl, we do not have “key person” insurance policies on any of our other employees that would compensate us for the loss of their services. If we lose the services of one or more of these individuals, replacement could be difficult and may take an extended period of time and could impede significantly the achievement of our business objectives.

Risks Related to Our Intellectual Property

The protection of our intellectual property rights is critical to our success and any failure on our part to adequately maintain such rights would materially affect our business.

We regard the protection of patents, trademarks and other proprietary rights that we own or license as critical to our success and competitive position. Laws and contractual restrictions, however, may not be sufficient to prevent unauthorized use or misappropriation of our technology or deter others from independently developing products that are substantially equivalent or superior to our products.

Patents. Our commercial success will depend in part on the patent rights we have licensed or will license and on patent protection for our own inventions related to the products that we market and intend to market. Our success also depends on maintaining these patent rights against third-party challenges to their validity, scope or enforceability. Our patent position is subject to uncertainties similar to other biotechnology and pharmaceutical companies. For example, the U.S. Patent and Trademark Office, or PTO, or the courts may deny, narrow or invalidate patent claims, particularly those that concern biotechnology and pharmaceutical inventions.

We may not be successful in securing or maintaining proprietary or patent protection for our products, and protection that we have and do secure may be challenged and possibly lost. Our competitors may develop products similar to ours using methods and technologies that are beyond the scope of our intellectual property rights. Other drug companies may challenge the scope, validity and enforceability of our patent claims and may be able to develop generic versions of our products if we are unable to maintain our proprietary rights. For example, although we believe that we have valid patent protection in the U.S. for our Zegerid products until at least 2016, depending on the outcome of our patent infringement suits against Par, described below, a generic version of Zegerid could be launched prior to the expiration of our patents. It is also possible that other generic drug makers will attempt to introduce generic versions of our Zegerid products prior to the expiration of our patents. We also may not be able to protect our intellectual property rights against third-party infringement, which may be difficult to detect.

To date, six U.S. patents have been issued relating to technology we license from the University of Missouri and several U.S. patent applications are pending. In addition to the U.S. patent coverage, several international patents have been issued, including in Australia, Canada, Mexico, New Zealand, Russia, Singapore, South Africa, and South Korea, as well as in countries within the European Patent Organization, and several international patent applications are pending, all of which are subject to the University of Missouri license agreement. The patents related specifically to our Zegerid products are and will be method and/or formulation patents and will not protect the use of the active pharmaceutical ingredients outside of the formulations covered by the patents and patent applications licensed to or owned by us. The issued claims in the international patents vary between the different countries and include claims covering pharmaceutical compositions combining PPIs with buffering agents and the use of these compositions in the manufacture of drug products for the treatment of GI disorders. The initial U.S. patent from the University of Missouri does not have corresponding international or foreign counterpart applications and there can be no assurance that we will be able to obtain foreign patent rights to protect each of our products in all foreign countries of interest. We consult with the University of Missouri in its pursuit of the patent applications that we have licensed, but the University of Missouri remains primarily responsible for prosecution of the applications. We cannot control the amount or timing of resources that the University of Missouri devotes on our behalf. It may not assign as great a priority to prosecution of patent applications relating to technology we license as we would if we were undertaking such prosecution ourselves. As a result of this lack of control and general uncertainties in the patent prosecution process, we cannot be sure that any additional patents will ever be issued. Issued patents generally require the payment of maintenance or similar fees to continue their validity. We rely on the University of Missouri to do this, subject to our obligation to provide reimbursement, and the University’s failure to do so could result in the forfeiture of patents not maintained.

In December 2007, the University of Missouri filed an Application for Reissue of U.S. Patent No. 5,840,737, or the ‘737 patent, with the PTO. The ‘737 patent is one of six issued patents listed in the Approved Drug Products with Therapeutic Equivalence Evaluations, or the Orange Book, for Zegerid Powder for Oral Suspension. The ‘737 patent is not one of the four patents listed in the Orange Book for Zegerid Capsules. It is not feasible to predict the impact that the reissue proceeding may have on the scope and validity of the ‘737 patent claims. If the claims of the ‘737 patent ultimately are narrowed substantially or invalidated by the PTO, the extent of the patent coverage afforded to our Zegerid family of products could be impaired, which could potentially harm our business and operating results.

Trade Secrets and Proprietary Know-how. We also rely upon unpatented proprietary know-how and continuing technological innovation in developing our products. Although we require our employees, consultants, advisors and current and prospective business partners to enter into confidentiality agreements prohibiting them from disclosing or taking our proprietary information and technology, these agreements may not provide meaningful protection for our trade secrets and proprietary know-how. Further, people who are not parties to confidentiality agreements may obtain access to our trade secrets or know-how. Others may independently develop similar or equivalent trade secrets or know-how. If our confidential, proprietary information is divulged to third parties, including our competitors, our competitive position in the marketplace will be harmed and our ability to successfully penetrate our target markets could be severely compromised.

Trademarks. Our trademarks are important to our success and competitive position. We have received U.S. and European Union, or EU, trademark registration for our corporate name, Santarus^®. We also have received trademark registration in the U.S., EU, Canada and Japan for our brand name, Zegerid^®, and have applied for trademark registration for various other names and logos. Any objections we receive from the PTO, foreign trademark authorities or third parties relating to our pending applications could require us to incur significant expense in defending the objections or establishing alternative names. There is no guarantee we will be able to secure any of our pending trademark applications with the PTO or comparable foreign authorities.

If we do not adequately protect our rights in our various trademarks from infringement, any goodwill that has been developed in those marks would be lost or impaired. We could also be forced to cease using any of our trademarks that are found to infringe upon or otherwise violate the trademark or service mark rights of another company, and, as a result, we could lose all the goodwill which has been developed in those marks and could be liable for damages caused by any such infringement or violation.

Par’s Paragraph IV certifications under the Hatch-Waxman Act related to Zegerid Capsules and Zegerid Powder for Oral Suspension and the related patent infringement litigation could adversely affect our financial condition and results of operations as it could result in the introduction of generic products prior to the expiration of the patents for Zegerid Capsules and Zegerid Powder for Oral Suspension, as well as in significant legal expenses and diversion of management time.

In September 2007, we filed a lawsuit in the United States District Court for the District of Delaware against Par for infringement of U.S. Patent Nos. 6,645,988; 6,489,346; and 6,699,885, each of which is listed in the Orange Book for Zegerid Capsules. In December 2007, we filed a second lawsuit in the United States District Court for the District of Delaware against Par for infringement of U.S. Patent Nos. 6,645,988; 6,489,346; 6,699,885; and 6,780,882, each of which is listed in the Orange Book for Zegerid Powder for Oral Suspension. The University of Missouri, licensor of the patents, is a co-plaintiff in the litigation, and both lawsuits have been consolidated for all purposes. The lawsuits are in response to Abbreviated New Drug Applications, or ANDAs, filed by Par with the FDA regarding Par’s intent to market generic versions of our Zegerid Capsules and Zegerid Powder for Oral Suspension products prior to the July 2016 expiration of the asserted patents. Each complaint seeks a judgment that Par has infringed the asserted patents and that the effective date of approval of Par’s ANDA shall not be earlier than the expiration date of the asserted patents. Par has filed answers in each case, primarily asserting non-infringement, invalidity and/or unenforceability. Par has also filed counterclaims seeking a declaration in its favor on those issues. In addition, Par is seeking a declaration that the ‘737 patent is not infringed, is invalid and/or is unenforceable. The ‘737 patent is one of six issued patents listed in the Orange Book for Zegerid Powder for Oral Suspension. The ‘737 patent is not one of the four patents listed in the Orange Book for Zegerid Capsules. We have moved to dismiss, or in the alternative, stay these claims due to a reissue proceeding involving the ‘737 patent currently pending before the PTO. We and the University of Missouri also granted Par a covenant not to sue on the original ‘737 patent. The discovery phase of the lawsuits is continuing. A claim construction hearing is currently scheduled for November 2008. Trial is currently scheduled for July 2009.

Third parties may choose to file patent infringement claims against us, which litigation would be costly, time consuming and distracting to management and could be materially adverse to our business.

The products we currently market, and those we may market in the future, may infringe patent and other rights of third parties. In addition, our competitors, many of which have substantially greater resources than us and have made significant investments in competing technologies or products, may seek to apply for and obtain patents that will prevent, limit or interfere with our ability to make, use and sell products either in the U.S. or international markets. Intellectual property litigation in the pharmaceutical industry is common, and we expect this to continue. In particular, intellectual property litigation among companies targeting the treatment of upper GI diseases and disorders is particularly common and may increase due to the large market for these products.

AstraZeneca plc, as well as other competitors and companies, including aaiPharma and Takeda Pharmaceutical Company Limited, hold various other patents relating to omeprazole and PPI products generally and could file an infringement suit claiming our current products infringe their patents. Our third-party manufacturers may also receive claims of infringement and could be subject to injunctions and temporary or permanent exclusionary orders in the U.S. or in the countries in which they are based. While we believe that we would have meritorious defenses to such claims, the outcome of any such litigation is uncertain and defending such litigation would be expensive, time-consuming and distracting to management.

If we or our third-party manufacturers or suppliers are unsuccessful in any challenge to our rights to manufacture, market and sell our products, we may be required to license the disputed rights, if the holder of those rights is willing, or to cease manufacturing and marketing the challenged products, or, if possible, to modify our products to avoid infringing upon those rights. If we or our third-party manufacturers or suppliers are unsuccessful in defending our rights, we could be liable for royalties on past sales or more significant damages, and we could be required to obtain and pay for licenses if we are to continue to manufacture and sell our products. These licenses may not be available and, if available, could require us to pay substantial upfront fees and future royalty payments. Any patent owner may seek preliminary injunctive relief in connection with an infringement claim, as well as a permanent injunction, and, if successful in the claim, may be entitled to lost profits from infringing sales, attorneys’ fees and interest and other amounts. Any damages could be increased if there is a finding of willful infringement. Even if we and our third-party manufacturers and suppliers are successful in defending an infringement claim, the expense, time delay and burden on management of litigation could have a material adverse effect on our business.

Our Zegerid products depend on technology licensed from the University of Missouri and any loss of our license rights would harm our business and seriously affect our ability to market our products.

Our Zegerid products are based on patented technology and technology for which patent applications are pending that we have exclusively licensed from the University of Missouri. A loss or adverse modification of our technology license from the University of Missouri would materially harm our ability to develop and commercialize our current Zegerid products and other products based on that licensed technology that we may attempt to develop or commercialize in the future. The University of Missouri may claim that new patents or new patent applications that result from new research performed by the University of Missouri are not part of the licensed technology.

The licenses from the University of Missouri expire in each country when the last patent for licensed technology expires in that country and the last patent application for licensed technology in that country is abandoned. In addition, our rights under the University of Missouri license are subject to early termination under specified circumstances, including our material and uncured breach of the license agreement or our bankruptcy or insolvency. Further, we are required to use commercially reasonable efforts to develop and sell products based on the technology we licensed from the University of Missouri to meet market demand. If we fail to meet these obligations in specified countries, after giving us an opportunity to cure the failure, the University of Missouri can terminate our license or render it nonexclusive with respect to those countries. To date, we believe we have met all of our obligations under the University of Missouri agreement. However, in the event that the University of Missouri is able to terminate the license agreement for one of the reasons specified in the license agreement, we would lose our rights to develop, market and sell our current Zegerid products and we would not be able to develop, market and sell future products based on those licensed technologies.

We may be subject to damages resulting from claims that we or our employees have wrongfully used or disclosed alleged trade secrets of their former employers or otherwise breached the terms of agreements with former employers.

Many of our employees were previously employed at other biotechnology or pharmaceutical companies, including our competitors or potential competitors. In addition, certain of our employees are parties to non-compete, non-solicitation and non-disclosure agreements with their prior employers. We may be subject to claims that these employees or we have inadvertently or otherwise breached these non-compete and non-solicitation agreements or used or disclosed trade secrets or other proprietary information of their former employers. Litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and be a distraction to management. If we fail in defending such claims, in addition to paying money claims, we may lose valuable intellectual property rights or personnel. A loss of key personnel or their work product could hamper or prevent our ability to commercialize products, which could severely harm our business.

Risks Related to Our Financial Results and Need for Financing

We have incurred significant operating losses since our inception, and we expect to incur significant additional operating losses and may not attain and sustain profitability.

The extent of our future operating losses and our ability to attain and sustain profitability are highly uncertain. We have been engaged in developing and commercializing drugs and have generated significant operating losses since our inception in December 1996. Our commercial activities and continued product development and clinical activities will require significant expenditures. For the nine months ended September 30, 2008, we recognized $71.5 million in net sales of our Zegerid products, and, as of September 30, 2008, we had an accumulated deficit of $312.4 million. We expect to incur additional operating losses and capital expenditures as we support the continued marketing of the Zegerid and Glumetza products and any other products we commercialize, and continue our product development and clinical research programs.

To the extent we need to raise additional funds in connection with the licensing or acquisition of new products or to continue our operations, we may be unable to raise capital when needed.

In February 2006, we entered into a committed equity financing facility, or CEFF, with Kingsbridge Capital Limited, or Kingsbridge, which may entitle us to sell and obligate Kingsbridge to purchase, from time to time over a period of three years, shares of our common stock for cash consideration up to the lesser of $75.0 million or 8,853,165 shares, subject to certain conditions and restrictions. We filed a resale shelf registration statement on Form S-3 with the Securities and Exchange Commission to facilitate Kingsbridge’s public resale of shares of our common stock which it may acquire from us from time to time in connection with our draw downs under the CEFF or upon the exercise of a warrant to purchase 365,000 shares of common stock that we issued to Kingsbridge in connection with the CEFF. The resale shelf registration statement was declared effective in February 2006. In 2006, we completed four draw downs under the CEFF and have issued a total of 5,401,787 shares in exchange for aggregate gross proceeds of $36.5 million. We did not initiate any draw downs under the CEFF during 2007 or in the nine months ended September 30, 2008. Accordingly, the remaining commitment of Kingsbridge under the CEFF for the potential purchase of our common stock is equal to the lesser of $38.5 million in cash consideration or 3,451,378 shares (which shares would be priced at a discount ranging from 6% to 10% of the average market price during any future draw down), subject to certain conditions and restrictions.

There can be no assurance that we will be able to complete any further draw downs under the CEFF. The CEFF is not currently available to us because our common stock is trading below the minimum price of $2.50 required by the CEFF. Other factors influencing our ability to complete draw downs include conditions such as the accuracy of representations and warranties made to Kingsbridge; our ability to maintain the effectiveness of the shelf registration statement; and the continued listing of our stock on the Nasdaq Global Market.

In July 2006, we entered into our loan agreement with Comerica Bank, or Comerica, which we subsequently amended in July 2008, pursuant to which we may request advances in an aggregate outstanding amount not to exceed $25.0 million. Amounts borrowed under the loan agreement may be repaid and re-borrowed at any time prior to July 11, 2011. As of August 4, 2008, the date of this report, we have not borrowed any amounts under the loan agreement. Our ability to borrow amounts under the loan agreement depends upon a number of conditions and restrictions, and we cannot be certain that we will satisfy all borrowing conditions at a time when we desire to borrow amounts under the loan agreement. For example, we have made comprehensive representations and warranties to Comerica as our lender, and all of these representations and warranties generally must be true and correct at the time of any proposed borrowing. Furthermore, we are subject to a number of affirmative and negative covenants, each of which must be satisfied at the time of any proposed borrowing. If we have not satisfied these various conditions, or an event of default otherwise has occurred, we may be unable to borrow amounts under the loan agreement, and may be required to repay any amounts previously borrowed. In addition, given the current financial market conditions, our ability to borrow under the loan agreement may be dependent on the financial solvency of banks in general, including Comerica.

Our quarterly financial results are likely to fluctuate significantly because our sales prospects are uncertain.

Our quarterly operating results are difficult to predict and may fluctuate significantly from period to period, particularly because the commercial success of, and demand for, our Zegerid products, as well as any other products we market are uncertain and therefore our sales prospects are uncertain. The level of our revenues, if any, and results of operations at any given time will be based primarily on the following factors:

	•		commercial success of Zegerid Capsules and Zegerid Powder for Oral Suspension and any products which may be commercialized by GSK or Schering-Plough pursuant to our strategic alliances;

	•		the outcome of, or other developments related to, our patent infringement suits against Par involving Zegerid Capsules and Zegerid Powder for Oral Suspension;

	•		our ability to generate revenues under our Glumetza promotion agreement;

	•		interruption in the manufacturing or distribution of our products;

	•		our ability to obtain regulatory approval for any future products we develop;

	•		results of our clinical trials and safety and efficacy of our products;

	•		timing of new product offerings, acquisitions, licenses or other significant events by us, GSK, Schering-Plough or our competitors;

	•		legislative changes affecting the products we may offer or those of our competitors; and

	•		the effect of competing technological and market developments.

It will continue to be difficult for us to forecast demand for our products with any degree of certainty. In addition, we expect to incur significant operating expenses as we continue to support the marketing of the Zegerid and Glumetza products. Accordingly, we may experience significant, unanticipated quarterly losses. Because of these factors, our operating results in one or more future quarters may fail to meet the expectations of securities analysts or investors, which could cause our stock price to decline significantly.

The CEFF that we entered into with Kingsbridge may not be available to us if we elect to make a draw down, may require us to make additional “blackout” or other payments to Kingsbridge, and may result in dilution to our stockholders.

In February 2006, we entered into a CEFF that entitles us to sell and obligates Kingsbridge to purchase, from time to time over a period of three years, shares of our common stock for cash consideration up to the lesser of $75.0 million or 8,853,165 shares, subject to certain conditions and restrictions. In 2006, we completed four draw downs under the CEFF and issued a total of 5,401,787 shares in exchange for aggregate gross proceeds of $36.5 million. We did not initiate any draw downs under the CEFF during 2007 or in the nine months ended September 30, 2008.

Kingsbridge will not be obligated to purchase additional shares under the CEFF unless certain conditions are met. For example, the CEFF is not currently available to us because our common stock is currently trading below the minimum price of $2.50 required by the CEFF. Other factors influencing our ability to complete draw downs include conditions such as the accuracy of representations and warranties made to Kingsbridge; compliance with laws; the continued effectiveness of the shelf registration statement; and the continued listing of our stock on the Nasdaq Global Market. In addition, Kingsbridge is permitted to terminate the CEFF if it determines that a material and adverse event has occurred affecting our business, operations, properties or financial condition and if such condition continues for a period of 10 days from the date Kingsbridge provides us notice of such material and adverse event. Moreover, our ability to fully utilize the CEFF as a source of future financings may be limited by the remaining maximum number of 3,451,378 shares issuable under the CEFF consistent with Nasdaq Global Market listing requirements (which shares would be priced at a discount ranging from 6% to 10% of the average market price during any future draw down). If we are unable to access funds through the CEFF, or if the CEFF is terminated by Kingsbridge, we may be unable to access capital on favorable terms or at all.

We are entitled in certain circumstances, to deliver a blackout notice to Kingsbridge to suspend the use of the shelf registration statement and prohibit Kingsbridge from selling shares thereunder. If we deliver a blackout notice in the 15 trading days following the settlement of a draw down, or if the shelf registration statement is not effective in circumstances not permitted by our agreement with Kingsbridge, then we must make a payment to Kingsbridge, or issue Kingsbridge additional shares in lieu of the payment, calculated on the basis of the number of shares held by Kingsbridge (exclusive of shares that Kingsbridge may hold pursuant to exercise of the Kingsbridge warrant) and the change in the market price of our common stock during the period in which the use of the shelf registration statement is suspended. If the trading price of our common stock declines during a suspension of the shelf registration statement, the blackout or other payment could be significant.

If we sell shares to Kingsbridge under the CEFF, or issue shares in lieu of a blackout payment, it will have a dilutive effective on the holdings of our current stockholders, and may result in downward pressure on the price of our common stock. For each draw down under the CEFF, we will issue shares to Kingsbridge at a discount of up to 10% from the volume weighted average price of our common stock. If we draw down amounts under the CEFF when our share price is decreasing, we will need to issue more shares to raise the same amount than if our stock price was higher. Issuances in the face of a declining share price will have an even greater dilutive effect than if our share price were stable or increasing, and may further decrease our share price.

Any future indebtedness under our loan agreement with Comerica could adversely affect our financial health.

Under our loan agreement with Comerica, we may incur a significant amount of indebtedness. Such indebtedness could have important consequences. For example, it could:

	•		impair our ability to obtain additional financing in the future for working capital needs, capital expenditures and general corporate purposes;

	•		increase our vulnerability to general adverse economic and industry conditions;

	•		make it more difficult for us to satisfy other debt obligations we may incur in the future;

	•		require us to dedicate a substantial portion of our cash flows from operations to the payment of principal and interest on our indebtedness, thereby reducing the availability of our cash flows to fund working capital needs, capital expenditures and other general corporate purposes;

	•		limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;

	•		place us at a disadvantage compared to our competitors that have less indebtedness; and

	•		expose us to higher interest expense in the event of increases in interest rates because our potential indebtedness under the loan agreement with Comerica may bear interest at a variable rate.

For a description of the loan agreement, see Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources.

Covenants in our loan agreement with Comerica may limit our ability to operate our business.

Under our loan agreement with Comerica, we are subject to specified affirmative and negative covenants, including limitations on our ability: to enter into certain change of control events; to convey, sell, lease, license, transfer or otherwise dispose of assets; to create, incur, assume, guarantee or be liable with respect to certain indebtedness; to grant liens; to pay dividends and make certain other restricted payments; and to make investments. In addition, under the loan agreement we are required to maintain a balance of cash with Comerica in an amount of not less than $4.0 million and to maintain any other cash balances with either Comerica or another financial institution covered by a control agreement for the benefit of Comerica. We are also subject to specified financial covenants with respect to a minimum liquidity ratio and, in specified limited circumstances, minimum EBITDA requirements.

If we default under the loan agreement because of a covenant breach or otherwise, all outstanding amounts could become immediately due and payable, which would negatively impact our liquidity and reduce the availability of our cash flows to fund working capital needs, capital expenditures and other general corporate purposes.

To service any future indebtedness and fund our working capital and capital expenditures, we will require a significant amount of cash. Our ability to generate cash depends on many factors beyond our control.

Our ability to make payments on any indebtedness will depend upon our future operating performance and on our ability to generate cash flow in the future, which is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. We cannot assure you that our business will generate sufficient cash flow from operations, or that future borrowings, including borrowings under our loan agreement with Comerica, will be available to us in an amount sufficient to enable us to pay any indebtedness or to fund our other liquidity needs.

Rises in interest rates could adversely affect our financial condition.

The interest rates applicable to any amounts we borrow under our loan agreement with Comerica will be indexed, at our election, to either Comerica’s prime rate or the LIBOR rate. If we elect Comerica’s prime rate for all or any portion of our borrowings, the interest rate will be variable. An increase in prevailing interest rates would have an immediate effect on the interest rates charged on our variable rate debt, if any. If prevailing interest rates or other factors result in higher interest rates on any debt we incur under the loan agreement, the increased interest expense could adversely affect our cash flow and our ability to service our debt. If we elect the LIBOR rate for all or any portion of our borrowings, such LIBOR rate will remain fixed only for a specified, limited period of time after the date of our election, after which we will be required to repay the borrowed amount, or elect a new interest rate indexed to either Comerica’s prime rate or the LIBOR rate. The new rate may be higher than the earlier interest rate applicable under the loan agreement. We cannot be certain that we will have sufficient cash flow from our operating activities or other resources to service our future debt obligations, if any, particularly in an environment of rising interest rates.

Our results of operations and liquidity needs could be materially affected by market fluctuations and economic downturn.

Negative conditions in the global credit markets may impair the liquidity of a portion of our investment portfolio.

Our investment securities consist of high-grade auction rate securities, corporate debt securities and government agency securities. As of September 30, 2008, our investments included $3.9 million of high-grade (AAA-rated) auction rate securities issued by state municipalities. Our auction rate securities are debt instruments with a long-term maturity and an interest rate that is reset in short-term intervals through auctions. The conditions in the global credit markets have prevented many investors from liquidating their holdings of auction rate securities because the amount of securities submitted for sale has exceeded the amount of purchase orders for such securities. If there is insufficient demand for the securities at the time of an auction, the auction may not be completed and the interest rates may be reset to predetermined higher rates. When auctions for these securities fail, the investments may not be readily convertible to cash until a future auction of these investments is successful or they are redeemed or mature. If the credit ratings of the security issuers deteriorate and any decline in market value is determined to be other-than-temporary, we would be required to adjust the carrying value of the investment through an impairment charge.

Due to conditions in the global credit markets, our auction rate securities, representing a par value of approximately $4.3 million, have experienced multiple failed auctions due to insufficient demand for the securities at auction. As a result, these affected securities are currently not liquid and the interest rates have been reset to the predetermined higher rates. Due to the limited liquidity of these investments, we have recorded an unrealized loss of approximately $403,000 related to our auction rate securities and have classified the fair value of these securities as long-term investments as of September 30, 2008. To date, we have not recorded any realized gains or losses on our investment portfolio.

Our short operating history makes it difficult to evaluate our business and prospects.

We were incorporated in December 1996 and have only been conducting operations with respect to our Zegerid family of products since January 2001. We commercially launched our first product in October 2004. Our operations to date have involved organizing and staffing our company, acquiring, developing and securing our technology, undertaking product development and clinical trials for our products and commercially launching Zegerid Powder for Oral Suspension and Zegerid Capsules. We have relatively limited experience selling and marketing our products, and we have not yet demonstrated an ability to attain and sustain profitability with our products. Consequently, any predictions about our future performance may not be as accurate as they could be if we had more experience successfully commercializing products.

Changes in, or interpretations of, accounting rules and regulations could result in unfavorable accounting charges or require us to change our compensation policies.

Accounting methods and policies for specialty pharmaceutical companies, including policies governing revenue recognition, expenses, accounting for stock options and in-process research and development costs are subject to further review, interpretation and guidance from relevant accounting authorities, including the Securities and Exchange Commission. Changes to, or interpretations of, accounting methods or policies in the future may require us to reclassify, restate or otherwise change or revise our financial statements, including those contained in this report.

In connection with the reporting of our financial condition and results of operations, we are required to make estimates and judgments which involve uncertainties, and any significant differences between our estimates and actual results could have an adverse impact on our financial position, results of operations and cash flows.

Our discussion and analysis of our financial condition and results of operations are based on our condensed financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these condensed financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. In particular, as part of our revenue recognition policy, our estimates of product returns, rebates and chargebacks require our most subjective and complex judgment due to the need to make estimates about matters that are inherently uncertain. Any significant differences between our actual results and our estimates under different assumptions or conditions could negatively impact our financial position, results of operations and cash flows.

Risks Related to the Securities Markets and Ownership of Our Common Stock

Our stock price may be volatile and you may not be able to sell your shares at an attractive price.

The market prices for securities of specialty pharmaceutical companies in general have been highly volatile and may continue to be highly volatile in the future. For example, during the year ended December 31, 2007, the trading prices for our common stock ranged from a high of $8.15 to a low of $1.90, and on September 30, 2008, the closing trading price for our common stock was $2.03. In addition, we have not paid cash dividends since our inception and do not intend to pay cash dividends in the foreseeable future. Furthermore, our loan agreement with Comerica prohibits us from paying dividends. Therefore, investors will have to rely on appreciation in our stock price and a liquid trading market in order to achieve a gain on their investment.

The trading price of our common stock may continue to fluctuate substantially as a result of one or more of the following factors:

	•		announcements concerning our commercial progress and activities, including sales trends, or concerning our product development programs, results of our clinical trials or status of our regulatory submissions;

	•		developments in our pending patent infringement suits against Par involving Zegerid Capsules and Zegerid Powder for Oral Suspension;

	•		the publication of prescription trend data concerning our products or competitive products;

	•		regulatory developments and related announcements in the U.S., including announcements by the FDA, and foreign countries;

	•		other disputes or developments concerning proprietary rights, including patents and trade secrets, litigation matters, and our ability to patent or otherwise protect our products and technologies;

	•		developments, including progress or delays, pursuant to our strategic alliances with GSK and Schering-Plough;

	•		conditions or trends in the pharmaceutical and biotechnology industries;

	•		fluctuations in stock market prices and trading volumes of similar companies or of the markets generally;

	•		changes in, or our failure to meet or exceed, investors’ and securities analysts’ expectations;

	•		announcements of technological innovations or new commercial products by us or our competitors;

	•		actual or anticipated fluctuations in our or our competitors’ quarterly or annual operating results;

	•		sales of large blocks of our common stock, including sales by Kingsbridge under the CEFF, our executive officers, directors or institutional investors;

	•		announcements concerning borrowings under the loan agreement, draw downs under the CEFF, takedowns under our existing universal shelf registration statement or other developments relating to the loan agreement, CEFF, universal shelf registration statement or our other financing activities;

	•		our entering into licenses, strategic partnerships and similar arrangements, or the termination of such arrangements;

	•		acquisition of products or businesses by us or our competitors;

	•		announcements made by, or events affecting, our strategic partners, our co-promotion partners, our contract sales force provider, our suppliers or other third parties that provide services to us;

	•		litigation and government inquiries; or

	•		economic and political factors, including wars, terrorism and political unrest.

Our stock price could decline and our stockholders may suffer dilution in connection with future issuances of equity or debt securities.

We believe that our current cash, cash equivalents and short-term investments will be sufficient to fund our current operations for at least the next 12 months; however, our projected revenue may decrease or our expenses may increase and that would lead to our cash resources being consumed earlier than we expect. Although we do not believe that we will need to raise additional funds to finance our current operations over the next 12 months, we may pursue raising additional funds in connection with licensing or acquisition of new products. Sources of additional funds may include funds generated through strategic collaborations or licensing agreements, or through equity, debt and/or royalty financing. To the extent we conduct substantial future offerings of equity or debt securities, such offerings could cause our stock price to decline. For example, we may issue additional shares of our common stock under our CEFF with Kingsbridge, we may issue securities under our existing universal shelf registration statement, or we may pursue alternative financing arrangements.

The exercise of outstanding options and warrants and future equity issuances, including future public offerings or future private placements of equity securities and any additional shares issued in connection with acquisitions, will also result in dilution to investors. The market price of our common stock could fall as a result of resales of any of these shares of common stock due to an increased number of shares available for sale in the market.

Future sales of our common stock by our stockholders may depress our stock price.

A concentrated number of stockholders hold significant blocks of our outstanding common stock. Sales by our current stockholders of a substantial number of shares, or the expectation that such sales may occur, could significantly reduce the market price of our common stock. Similarly, sales by Kingsbridge of any shares that we may sell to it under the CEFF from time to time or upon the exercise of the warrant to purchase 365,000 shares of common stock that we issued to Kingsbridge in connection with the CEFF, or the expectation that sales may occur, could significantly reduce the market price of our common stock. In addition, the holders of a substantial number of shares of common stock may have rights, subject to certain conditions, to require us to file registration statements to permit the resale of their shares in the public market or to include their shares in registration statements that we may file for ourselves or other stockholders. Moreover, certain of our executive officers have established programmed selling plans under Rule 10b5-1 of the Securities Exchange Act from time to time for the purpose of effecting sales of common stock, and other employees and affiliates, including our directors and executive officers, may choose to establish similar plans in the future. If any of our stockholders cause a large number of securities to be sold in the public market, the sales could reduce the trading price of our common stock. These sales also could impede our ability to raise future capital.

We may become involved in securities or other class action litigation that could divert management’s attention and harm our business.

The stock market has from time to time experienced significant price and volume fluctuations that have affected the market prices for the common stock of pharmaceutical and biotechnology companies. These broad market fluctuations may cause the market price of our common stock to decline. In the past, following periods of volatility in the market price of a particular company’s securities, securities class action litigation has often been brought against that company. In addition, over the last two years, several class action lawsuits have been filed against pharmaceutical companies alleging that the companies’ sales representatives have been misclassified as exempt employees under the Federal Fair Labor Standards Act and applicable state laws. Summary judgment has been granted on the outside sales exemption under California law in three cases, which are all on appeal to the United States Court of Appeals for the Ninth Circuit. Some of the cases pending have been conditionally certified under the Fair Labor Standards Act and other cases have not. We cannot be certain as to how the lawsuits will ultimately be resolved. Although we have not been the subject of these types of lawsuits, we may be targeted in the future. Litigation often is expensive and diverts management’s attention and resources, which could adversely affect our business.

We are exposed to increased costs and risks related to complying with recently enacted and proposed changes in laws and regulations, including costs and risks associated with compliance with Section 404 of the Sarbanes-Oxley Act of 2002.

Recently enacted and proposed changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and rules proposed by the Securities and Exchange Commission and by the Nasdaq Global Market, have resulted in increased costs to us. In particular, we incur additional administrative expense in connection with our compliance with Section 404 of the Sarbanes-Oxley Act, which requires management to report on, and our independent registered public accounting firm to attest to, our internal controls on an annual basis. As part of our compliance with Section 404, we also rely on the continued effectiveness and adequacy of the internal controls at our key service providers. In addition, the new rules could make it more difficult or more costly for us to obtain certain types of insurance, including directors’ and officers’ liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board, our board committees or as executive officers. We cannot predict or estimate the amount of the additional costs we may incur or the timing of such costs. If we, or the third party service providers on which we rely, fail to comply with any of these laws or regulations, or if our auditors cannot timely attest to our evaluation of our internal controls, we could be subject to regulatory scrutiny and a loss of public confidence in our corporate governance or internal controls, which could have an adverse effect on our business and our stock price.

Anti-takeover provisions in our organizational documents and Delaware law may discourage or prevent a change in control, even if an acquisition would be beneficial to our stockholders, which could adversely affect our stock price and prevent 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 may delay or prevent a change in control, discourage bids at a premium over the market price of our common stock and adversely affect the market price of our common stock and the voting and other rights of the holders of our common stock.

These provisions include:

	•		dividing our board of directors into three classes serving staggered three-year terms;

	•		prohibiting our stockholders from calling a special meeting of stockholders;

	•		permitting the issuance of additional shares of our common stock or preferred stock without stockholder approval;

	•		prohibiting our stockholders from making certain changes to our amended and restated certificate of incorporation or amended and restated bylaws except with 66 2/3% stockholder approval; and

	•		requiring advance notice for raising business matters or nominating directors at stockholders’ meetings.

We are also subject to provisions of the Delaware corporation law that, in general, prohibit any business combination with a beneficial owner of 15% or more of our common stock for five years unless the holder’s acquisition of our stock was approved in advance by our board of directors. Together, these charter and statutory provisions could make the removal of management more difficult and may discourage transactions that otherwise could involve payment of a premium over prevailing market prices for our common stock.

In addition, in November 2004, we adopted a stockholder rights plan, which was subsequently amended in April 2006. Although the rights plan will not prevent a takeover, it is intended to encourage anyone seeking to acquire our company to negotiate with our board prior to attempting a takeover by potentially significantly diluting an acquirer’s ownership interest in our outstanding capital stock. The existence of the rights plan may also discourage transactions that otherwise could involve payment of a premium over prevailing market prices for our common stock.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

Unregistered Sales of Equity Securities

Not applicable.

Issuer Purchases of Equity Securities

Not applicable.

Item 3. Defaults Upon Senior Securities

Not applicable.

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable.

Item 5. Other Information

Not applicable.

Item 6. Exhibits


Exhibit
Number		Description
3.1(1)		Amended and Restated Certificate of Incorporation

3.2(2)		Amended and Restated Bylaws

3.3(3)		Certificate of Designations for Series A Junior Participating Preferred Stock

4.1(3)		Form of Common Stock Certificate

4.2(4)		Amended and Restated Investors’ Rights Agreement, dated April 30, 2003, among us and the parties named therein

4.3(4)		Amendment No. 1 to Amended and Restated Investors’ Rights Agreement, dated May 19, 2003, among us and the parties named therein

4.4(4)*		Stock Restriction and Registration Rights Agreement, dated January 26, 2001, between us and The Curators of the University of Missouri

4.5(4)		Form of Common Stock Purchase Warrant

4.6(3)		Rights Agreement, dated as of November 12, 2004, between us and American Stock Transfer & Trust Company, which includes the form of Certificate of Designations of the Series A Junior Participating Preferred Stock of Santarus, Inc. as Exhibit A, the form of Right Certificate as Exhibit B and the Summary of Rights to Purchase Preferred Shares as Exhibit C

4.7(5)		First Amendment to Rights Agreement, dated as of April 19, 2006, between us and American Stock Transfer & Trust Company

4.8(6)		Warrant to Purchase Shares of Common Stock, dated February 3, 2006, issued by us to Kingsbridge Capital Limited

4.9(6)		Registration Rights Agreement, dated February 3, 2006, between us and Kingsbridge Capital Limited

10.1(7)		Amended and Restated Loan and Security Agreement, dated as of July 11, 2008, between us and Comerica Bank

10.2(7)		Amended and Restated LIBOR Addendum to Loan and Security Agreement, dated as of July 11, 2008, between us and Comerica Bank

31.1		Certification of Chief Executive Officer pursuant to Rules 13a-14 and 15d-14 promulgated under the Securities Exchange Act of 1934

31.2		Certification of Chief Financial Officer pursuant to Rules 13a-14 and 15d-14 promulgated under the Securities Exchange Act of 1934

32†		Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002


(1)		Incorporated by reference to the Quarterly Report on Form 10-Q of Santarus, Inc. for the quarter ended March 31, 2004, filed with the Securities and Exchange Commission on May 13, 2004.

(2)		Incorporated by reference to the Current Report on Form 8-K of Santarus, Inc., filed with the Securities and Exchange Commission on December 7, 2007.

(3)		Incorporated by reference to the Current Report on Form 8-K of Santarus, Inc., filed with the Securities and Exchange Commission on November 17, 2004.

(4)		Incorporated by reference to the Registration Statement on Form S-1 of Santarus, Inc. (Registration No. 333-111515), filed with the Securities and Exchange Commission on December 23, 2003, as amended.

(5)		Incorporated by reference to the Current Report on Form 8-K of Santarus, Inc., filed with the Securities and Exchange Commission on April 21, 2006.

(6)		Incorporated by reference to the Current Report on Form 8-K of Santarus, Inc., filed with the Securities and Exchange Commission on February 3, 2006.

(7)		Incorporated by reference to the Current Report on Form 8-K of Santarus, Inc., filed with the Securities and Exchange Commission on July 14, 2008.

*		Santarus, Inc. has been granted confidential treatment with respect to certain portions of this exhibit (indicated by asterisks), which portions have been omitted and filed separately with the Securities and Exchange Commission.

†		These certifications are being furnished solely to accompany this quarterly report pursuant to 18 U.S.C. Section 1350, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934 and are not to be incorporated by reference into any filing of Santarus, Inc., whether made before or after the date hereof, regardless of any general incorporation language in such filing.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Dated: November 3, 2008


		/s/ Debra P. Crawford

		Debra P. Crawford,
		Senior Vice President and
		Chief Financial Officer
		(Duly Authorized Officer and
		Principal Financial Officer)

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Santarus (SNTS) Inactive 10-Q2008 Q3 Quarterly report

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