News Column

FURIEX PHARMACEUTICALS, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations

May 9, 2014

Forward-looking Statements

This Form 10-Q includes forward-looking statements. All statements other than statements of historical facts are forward-looking statements, including any projections of milestones, royalties or other financial items, any statements of the plans and objectives of management for future operations, any statements concerning research and development, clinical development timelines, regulatory approvals, commercialization and marketing, proposed new compounds, or licensing or collaborative arrangements, any statements regarding future economic conditions or performance, and any statement of assumptions underlying any of the foregoing. In some cases, forward-looking statements can be identified by the use of terminology such as "believes", "might", "will", "expects", "plans", "anticipates", "estimates", "potential" or "continue", or the negative thereof or other comparable terminology. Although we believe that the expectations reflected in the forward-looking statements contained in this Form 10-Q are reasonable, there can be no assurance that such expectations or any of the forward-looking statements will prove to be correct, and actual results could differ materially from those projected or assumed in the forward-looking statements. Our future financial condition and results of operations, as well as any forward-looking statements, are subject to inherent risks and uncertainties, including the risk factors set forth in "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2013.

About Furiex Pharmaceuticals



We are a drug development company that collaborates with pharmaceutical and biotechnology companies to increase the value of their drug candidates by applying an accelerated approach to drug development, which we believe expedites research and development decision-making and can shorten drug development timelines. We share the risk with our collaborators by conducting and financing drug development programs, and in exchange, we share the potential rewards, receiving milestone and royalty payments for successful out-licensed drug candidates. This business model has generated a diversified product portfolio and pipeline with multiple therapeutic candidates, including one Phase III-ready asset, one compound in Phase III development, one compound which is with a partner pending regulatory approval in Japan, and four products on the market.

The Company's operations are headquartered in Morrisville, North Carolina. Our website address is www.furiex.com. Information on our website is not incorporated herein by reference. We make available free of charge through our website press releases, Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after we have electronically filed with, or furnished to, the Securities and Exchange Commission.

Our Business Strategy



Our strategy is to in-license and develop novel early stage drug candidates that address medical conditions with significant unmet need. We invest in innovative early stage drug candidates whose targets have scientific or clinical validation, and in disease areas that have a relatively straightforward path to regulatory approval. We leverage our extensive drug development expertise to implement efficient and high quality development programs that accelerate time to market. We progress drug candidates to key value inflection points and typically form strategic collaborations with commercial pharmaceutical companies in exchange for milestone payments and royalties. We subject each potential drug candidate we consider to a rigorous review process by our due diligence team, which has expertise in all aspects of drug development, as well as in intellectual property and commercial assessment. This approach has enabled us to build a diversified portfolio of drug candidates and commercialized products that offer value to patients, our investors and collaborators.

Our Portfolio



We have exclusive license rights to eluxadoline (MuDelta), which is in Phase III development, and to JNJ-Q2, which is Phase III-ready. We also have rights with respect to trelagliptin (SYR-472), which is with a partner pending regulatory approval in Japan, and to four products that are out-licensed and commercialized by collaborators, for which we are eligible to receive worldwide sales-based royalty and sales-based milestone payments. The commercialized products in the alogliptin family (i.e., Nesina and its fixed dose combination products) are currently marketed in Japan, the United States and certain countries in the EU and Asia, and Priligy is currently marketed outside of the United States, we have no further development obligations for any of these products or trelagliptin.

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Compounds in Clinical Development

Eluxadoline 1 (MuDelta) for diarrhea-predominant irritable bowel syndrome

Diarrhea-predominant irritable bowel syndrome affects approximately 28 million patients in the United States and the five major European Union countries, and is characterized by chronic abdominal pain and frequent diarrhea. Studies have demonstrated that IBS-d is associated with work absenteeism, high medical costs and low quality of life. We believe the market for prescription treatments for IBS-d is underserved due to the limited number of available treatments and the adverse side effects associated with those treatments.

Eluxadoline is a novel, orally active, investigational agent in Phase III development, with combined mu opioid receptor agonist and delta opioid receptor antagonist activity. The compound's dual opioid activity is designed to treat the symptoms of IBS-d, without causing the constipating side effects that occur with mu opioid agonists. Eluxadoline acts locally in the gut and has very low oral bioavailability, thus limiting the potential for systemic side effects, such as sedation. The FDA has granted Fast Track designation to the eluxadoline IBS-d program. Fast Track is a process for facilitating the development and expediting the review of drugs to treat serious diseases and fill unmet medical needs, with the goal of bringing important new drugs to patients earlier. More than 2,500 subjects have received eluxadoline across the Phase I, II and III programs.

We acquired exclusive license rights to develop and commercialize eluxadoline under our existing development and license agreement with Janssen Pharmaceutica NV, or Janssen. Under the agreement, Janssen may receive up to $45.0 million in regulatory milestone payments and, if approved for marketing, up to $75.0 million in sales-based milestone payments and sales-based royalties increasing from the mid- to upper-single digit percentages as sales volume increases. Royalties are to be paid for a period of ten years after the first commercial sale or, if later, the expiration of the last valid patent claim or the expiration of patent exclusivity.

We completed a large multicenter randomized-double-blind Phase II Proof-of-Concept trial in patients with IBS-d in 2011; the study demonstrated that eluxadoline has a favorable efficacy and safety profile. The results are published in a paper entitled "Eluxadoline Benefits Patients With Irritable Bowel Syndrome With Diarrhea in a Phase 2 Study" (Dove et al. Gastroenterology 2013; 145:329-338).

Our Phase III program consisted of two randomized, double-blind, placebo controlled pivotal studies (studies 3001 and 3002), which have been designed to evaluate the efficacy and safety of eluxadoline in patients with IBS-d. The studies completed enrollment in July 2013, and randomized a total of 2,428 subjects; each study had three treatment arms: placebo, 75 mg twice a day and 100 mg twice a day. Both trials have the same overall design and efficacy endpoints capturing both the 12-week FDA endpoint as well as the 26-week European Medicines Agency (EMA) efficacy endpoints. These endpoints have been formally agreed with the FDA and EMA and are aligned respectively with the 2012 FDA guidance and the 2013 EMA draft guidance for clinical trial evaluation of new medicines for irritable bowel syndrome. Efficacy analyses were completed for both studies in late January 2014, but study 3001 is ongoing for the purpose of monitoring safety for a total of 52 weeks. Study 3001 is expected to complete safety monitoring in July 2014.

On February 4, 2014, we announced top-line results indicating that the two pivotal Phase III clinical trials (studies 3001 and 3002) evaluating the efficacy and safety of eluxadoline in the treatment of diarrhea-predominant irritable bowel syndrome met both the FDA and the EMA formally agreed-upon primary endpoints of composite response based on simultaneous improvements in stool consistency and abdominal pain. The primary efficacy endpoint was a composite response evaluated over the initial 12 weeks of double-blind treatment for FDA evaluation, and over 26 weeks of double-blind treatment for EMA evaluation. Response rates were compared based on patients who met the daily composite response criteria (improvement in pain and stool consistency) for at least 50% of the days from weeks 1 to 12 and weeks 1 to 26. A patient must have met both of the following criteria on any given day to be a daily responder:

? Daily stool consistency response: Bristol stool score <5, or the absence of a bowel movement; and ? Daily pain response: worst abdominal pain scores in the past 24 hours improved by ?30% compared to baseline (average of week prior to randomization).



Primary Analysis Study 3002 (intention-to-treat analysis):

Patients receiving eluxadoline demonstrated statistically significantly higher responder rates for the following composite primary endpoints:

? For the FDA composite endpoint (response over weeks 1-12), the responder rates were 29.6% for eluxadoline 100 mg, 28.9% for eluxadoline 75 mg and 16.2% for placebo ( p <0.001 both doses); and ? For the EMA composite endpoint (response over weeks 1-26), the responder rates were 32.7% for 100 mg, 30.4% for 75 mg and 20.2% for placebo ( p < 0.001 both doses). 1 United States Adopted Names Council (USAN) adopted, International Nonproprietary Names (INN) approval pending. 15



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Primary Analysis Study 3001 (intention-to-treat analysis):

Patients receiving eluxadoline demonstrated statistically significantly higher response rates for the following primary composite endpoints:

? For the FDA composite endpoint (response over weeks 1-12), the responder rates were 25.1% for eluxadoline 100 mg (p =0.004), 23.9% for eluxadoline 75 mg (p =0.014) and 17.1% for placebo; and ? For the EMA composite endpoint (response over weeks 1-26), the responder rates were 29.3% for 100 mg (p <0.001), 23.4% for 75 mg (p =0.112) and 19.0% for placebo.



Pooled Phase III Efficacy Analysis: Data pooled from studies 3001 and 3002 for the composite primary endpoints from the two studies demonstrated a differential effect between active and placebo. For the FDA endpoint, the differential effects were 9.5% and 10.3% for 75 and 100 mg respectively. Similarly, for the EMA 26 week endpoint, the differential effects were 7.2% and 11.5% for the 75 and 100 mg respectively. All p values were

Eluxadoline had a favorable tolerability and safety profile in the trials. The most commonly reported side effects across the two studies were constipation (8.3% for 100 mg eluxadoline, 7.4% for 75 mg eluxadoline vs. 2.4% for placebo) and nausea (7.3% for 100 mg eluxadoline, 7.8% for 75 mg eluxadoline vs. 4.8% placebo). Sporadic elevations of liver enzymes (>3XULN) were seen in both the active and placebo arms, with a difference between active and placebo less than 0.5%, all of which resolved. There were infrequent adjudicated events of mild pancreatitis involving five patients who received eluxadoline (0.3% of those treated with the compound). Three of these subjects reported heavy alcohol consumption, one patient was noted to have biliary sludge, a known risk factor for pancreatitis, and one subject experienced transient sphincter of Oddi spasm, which is a known opiate class effect associated with pancreatitis.

We have completed a series of Phase I ADME (absorption, distribution, metabolism, elimination) studies for eluxadoline. Based on these results, we do not anticipate any significant changes in the target product profile. We have also completed a QT study, which evaluated the effect of eluxadoline on cardiac electrical conduction, and obtained a favorable result of no increase in the QT interval at the doses tested. We completed a study in hepatically impaired patients which showed increased levels in this population, and may result in labeling cautions around use of eluxadoline in severe hepatic impairment. We have recently completed a nasal insufflation abuse liability study in opiate users that was requested by the FDA, and which was presented at The American College of Neuropsychopharmacology meeting in December 2013. Top-line results showed that: (1) eluxadoline was not liked any more than placebo and was liked significantly less than oxycodone (the positive control); and (2) eluxadoline was significantly disliked compared with both oxycodone and placebo. We also completed an oral abuse study for eluxadoline. Top-line study results indicate that as with the prior nasal study, there is low potential for abuse liability via the oral route.

We believe that the program is on track for New Drug Application submission by the end of the third quarter of 2014.

Recent events:



An abstract with Phase III trial results for eluxadoline was accepted for a late breaker presentation at the Digestive Diseases Week scientific meeting. The presentation, entitled "Eluxadoline for the Treatment of Diarrhea-Predominant Irritable Bowel Syndrome: Results of 2 Randomized, Double-blind, Placebo-Controlled Phase III Clinical Trials of Efficacy and Safety" was given by Dr. Anthony Lembo, Associate Professor, Harvard Medical School (Beth Israel Deaconess Medical Center) on May 6, 2014.

JNJ-Q2 for skin and lung infections

Community-acquired bacterial pneumonia, or CABP, and acute bacterial skin and skin structure infections, or ABSSSI, are important public-health concerns due to increasing drug resistance of established antibiotics to causative pathogens. Due to the emerging resistance to established antibiotics, there is a large unmet need for antibiotics such as JNJ-Q2 that cover a broad range of pathogens, including resistant Staphylococcus ("Staph") and Streptococcus ("Strep"). Bacterial infections are a major cause of morbidity and mortality. Global microbiological surveillance suggests that approximately 40% of Staph infections in the U.S., Latin America and Asia Pacific are methicillin-resistant Staphylococcus "Staph" aureus, or MRSA.

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JNJ-Q2 is a novel, broad-spectrum fluoroquinolone antibiotic that is Phase III-ready for two indications: ABSSSI and CABP. JNJ-Q2 has a low propensity to cause drug-resistance in vitro and has potent activity against two important drug-resistant pathogens: MRSA and drug-resistant Streptococcus pneumonia. In addition, JNJ-Q2 is highly active against other common and difficult to treat bacteria, including those that are gram-positive, atypical and anaerobic, as well as some gram negative bacteria. This broad bactericidal spectrum gives JNJ-Q2 an advantage over many other antibiotics, which do not reliably treat polymicrobial skin and wound infections or such a wide variety of respiratory pathogens. JNJ-Q2 is active against resistant pathogens that might be used in bioterrorism and also against drug-resistant gonorrhea. It can be dosed both intravenously and orally, differentiating it from many other MRSA treatments that are only dosed intravenously.

We acquired exclusive license rights to develop and commercialize JNJ-Q2 under our existing development and license agreement with Janssen. Under the agreement, Janssen may receive up to $50.0 million in regulatory milestone payments, and if approved for marketing, up to $75.0 million in sales-based milestone payments and sales-based royalties increasing from the mid- to upper-single digit percentages as sales volume increases. Royalties would be paid for a period of ten years after the first commercial sale or, if later, the expiration of the last valid patent claim or the expiration of patent exclusivity.

In February 2013, the FDA granted JNJ-Q2 a Qualified Infectious Disease Product and Fast Track designation. These designations should enable us and/or any future collaborator with respect to the compound to benefit from certain incentives for the development of new antibiotics, including priority review and additional five-year market exclusivity, as provided under the Generating Antibiotic Incentives Now (GAIN) Act, which is incorporated within the FDA Safety and Innovation Act of 2012.

We have forecasted minimal expenditures for this compound in 2014.

Marketed Products



Nesina® (alogliptin) for Type-2 diabetes

Type-2 diabetes is the most common form of diabetes and has reached worldwide epidemic proportions. The global healthcare expenditures to treat and prevent diabetes and its complications were estimated at $471.0 billion in 2012. By 2030, this number is projected to exceed $595.0 billion. In addition to diet and exercise, diabetic patients often require multiple medicines to help manage their condition.

Nesina is the trade name for alogliptin and is marketed by Takeda Pharmaceuticals Company Limited, or Takeda. Nesina is a highly selective, orally-active dipeptidyl peptidase-4, or DPP-4, inhibitor that slows the inactivation of hormones known as incretins (glucagon-like peptide-1 and glucose-dependent insulinotropic peptide), which play a major role in regulating blood sugar levels. Approximately 9,000 patients with Type-2 diabetes have been treated with Nesina in 14 randomized, double-blind, controlled clinical trials. Pivotal trials demonstrated that Nesina was well-tolerated when given as a single daily dose and it significantly improved glycemic control in Type-2 diabetes patients without raising the incidence of hypoglycemia. Additionally, Nesina has been shown to enhance glycemic control when used in combination with other commonly prescribed diabetes drugs.

Nesina has been marketed in Japan since 2010, in the United States since mid-2013 and in certain countries in Europe (Vipidia™) since early 2014. It is also being marketed as a fixed-dose combination with Actos® in Japan (Liovel®), the United States (Oseni®) and certain countries in Europe (Incresync™), and as a fixed dose combination with metformin in the United States (Kazano®) and certain countries in Europe (Vipdomet™). Oseni is the only marketed fixed-dose combination of a DPP4-inhibitor and a thiazolidinedione (i.e., Actos). Alogliptin monotherapy is also approved and marketed in the People's Republic of China and Australia.

Takeda completed two large randomized clinical studies in 2013, which provide rigorous data supporting the long-term safety and efficacy of alogliptin. Results from the ENDURE study, which were presented at the 2013 Scientific Sessions of the American Diabetes Association (Del Prato, S. et al. 2013), demonstrated that alogliptin (25 mg) in addition to metformin offered superior durability of glycemic control at two years with notably fewer hypoglycemic episodes and no negative impact on weight compared to a sulphonylurea (glipizide). Furthermore, when given in combination with metformin, significantly more patients treated with alogliptin achieve target hemoglobin A1C of ? 7% versus with glipizide in combination with metformin. Also, in 2013, Takeda published the results of the EXAMINE study in the New England Journal of Medicine (N Engl J Med 2013; 369:1327-1335). The EXAMINE study, which compared alogliptin to standard of care, is the first cardiovascular outcomes study of patients with Type-2 diabetes who are at high-risk for major adverse cardiac events (MACE) due to a recent history of acute coronary syndrome. These data demonstrate that alogliptin does not increase cardiovascular risk in Type-2 diabetes patients at high-risk for MACE compared with placebo, when added to usual therapy. The trial met its primary objective of demonstrating non-inferiority of cardiovascular risk based on a primary composite endpoint of cardiovascular death, nonfatal myocardial infarction and nonfatal stroke. Rates of hypoglycemia, malignancy, pancreatitis, serum aminotransferase elevations and of serious adverse events were similar for the alogliptin and placebo groups.

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We have no further financial obligations under our agreement with Takeda. Under this agreement, we will be entitled to receive up to $33.0 million in sales-based milestone payments plus royalty payments on worldwide sales of Nesina and alogliptin combination products at royalty rates of 7% to 12% in the U.S., 4% to 8% in Europe and Japan and 3% to 7% in regions other than the United States, Europe or Japan. Royalty payments are subject to a reduction of up to 0.5% for a portion of payments by Takeda to a licensor for intellectual property related to Nesina (except in Japan, where there is currently no intellectual property that would cause such a reduction). Royalties are to be paid for the longer of ten years following the first commercial sale or two years following the expiration of the last to expire patent. Royalties for sales of Nesina combination products are based on an agreed-upon percent of product sales in the U.S. and on the proportion of Nesina's average sales price compared to that of the combination product in territories outside of the U.S.

Recent events:



On March 29, 2014, Takeda presented sub-analyses from the global EXAMINE study in a poster session at the American College of Cardiology's scientific meetings in Washington, DC. These sub-analyses specifically demonstrated no effect on rates of cardiovascular mortality, no increase in sudden cardiac death and similar rates of hospitalization with heart failure. Furthermore, alogliptin neither induced new onset heart failure nor worsened heart failure outcomes in patients with a history of heart failure.

Alogliptin has recently been launched in South Korea, Mexico and Austria.

Priligy® (dapoxetine) for premature ejaculation

Premature ejaculation is a common type of sexual dysfunction. It is associated with lower sexual satisfaction in both men and their female partners, and can negatively impact a man's quality of life and interpersonal relationships. The reported percentage of men affected with premature ejaculation, or PE, at some point during their lives ranges from 4% to 30%, depending on the methodology and criteria used.

Priligy is the trade name for dapoxetine, a drug in tablet form that is the first and only oral medicine that is specifically indicated for the "on-demand" treatment of PE. It is a unique, short-acting, selective serotonin reuptake inhibitor, or SSRI, designed to be taken only when needed, one to three hours before sexual intercourse, rather than daily. It is the first oral medication to be approved for this condition. Priligy is approved in over 60 countries and currently marketed in over 30 countries in Europe, Asia-Pacific and Latin America.

Priligy has been studied in over 12,000 patients in clinical trials, including five randomized, placebo-controlled Phase III clinical trials involving more than 6,000 men with PE. Data from these randomized trials, as well as from a large post-marketing safety study (Mirone et al. European Urology, Aug 2103) have demonstrated favorable safety and benefit-risk profiles for Priligy.

In May 2012, we entered into a license agreement with Berlin-Chemie AG (Menarini Group), or Menarini, to commercialize Priligy in Europe, most of Asia, Africa, Latin America and the Middle East. This transaction became effective on July 30, 2012. We retain full development and commercialization rights in the U.S., Japan and Canada. We currently do not plan to develop Priligy in the United States because we do not believe that there is a clear regulatory path to NDA registration. We will continue to monitor the FDA's position on clinical development for this indication, and re-assess our strategy should circumstances change.

As of December 2013, we have received the $20.0 million in launch and regulatory milestones we were eligible to receive under our license agreement with Menarini. We remain eligible for up to $40.0 million in sales-based milestones, plus tiered royalties ranging from the mid-teens to mid-twenties in percentage terms.

We originally acquired patents for Priligy from Eli Lilly and Company, or Lilly, and are obligated to pay Lilly a royalty of 5.0% on annual sales in excess of $800.0 million. Under the terms of the license agreement with Menarini, Menarini will pay the portion of the royalties owed to Lilly in each country where Menarini is licensed to sell Priligy, where Lilly is eligible for payments, and where we are no longer eligible for payments from Menarini.

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Compound in Clinical Development by Collaborator

Trelagliptin for Type-2 diabetes

Trelagliptin (SYR-472) is part of the DPP-4 inhibitor portfolio that Takeda purchased from PPD and Syrrx in 2005. Trelagliptin has the same mechanism of action as alogliptin. However, in contrast to alogliptin, which is a once-daily oral therapy, trelagliptin is a once-weekly oral agent. Currently, all available DPP-4 inhibitors are dosed once-daily. A once-weekly treatment, such as trelagliptin, should provide patients with a convenient therapeutic alternative, and has the potential to improve treatment compliance.

Takeda has completed Phase III studies in Japan for treatment of Type-2 diabetes. In early March 2014, Takeda announced that it had submitted an NDA to the Japanese Ministry of Health, Labour and Welfare for trelagliptin succinate for the treatment for Type-2 diabetes. If trelagliptin is approved, we would be eligible to receive sales-based royalty payments and sales-based milestone payments based on global product sales at the same rates as for Nesina, as described above.

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Overview



Our business to date has consisted solely of compound development and collaborative activities. Accordingly, we operate in one reportable business segment. Our revenues consist primarily of milestone and royalty payments from collaborators. For the three-month period ended March 31, 2013, our total revenue of $39.3 million consisted of a $25.0 million regulatory milestone from Takeda related to Nesina, a $5.0 million launch-based milestone payment from Menarini related to Priligy and $9.3 million of royalty revenue from the sale of Nesina and related combination products, as well as Priligy, by our collaborators. For the three-month period ended March 31, 2014, our total revenue of $6.4 million consisted of royalty revenue from the sale of Nesina and related combination products, as well as Priligy.

We incurred research and development expenses of $25.4 million and $14.3 million for the three-month periods ended March 31, 2013 and 2014, respectively. Our current research and development expenses are primarily related to the continued development of eluxadoline. We expense all research and development costs for our compounds and external collaborations as incurred.

For the three-month period ended March 31, 2013 we reported net income of $9.0 million. For the three-month period ended March 31, 2014 we reported a net loss of $13.1 million. Although we generated net income in the prior year first quarter, we have historically generated losses and there can be no assurances that we will generate income in future periods. We expect to continue to incur net losses unless revenues from all sources reach a level sufficient to support our on-going operations.

Our business is subject to various risks and uncertainties. See "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2013 for information on these risks and uncertainties.

We have prepared the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, or GAAP, and they include the accounts of Furiex Pharmaceuticals, Inc. and its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation. The preparation of financial statements in conformity with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Three Months Ended March 31, 2013 versus Three Months Ended March 31, 2014

The following table sets forth amounts from our consolidated financial statements for the three-month period ended March 31, 2013 compared to the three-month period ended March 31, 2014.

Three Months Ended March 31, (in thousands) 2013 2014 Revenue: Milestones $ 30,000 $ - Royalties 9,325 6,422 Total revenue 39,325 6,422 Research and development expenses 25,363 14,279



Selling, general and administrative expenses 3,873 3,554 Depreciation and amortization

22 8 Total operating expenses 29,258 17,841 Operating income (loss) 10,067 (11,419 ) Interest expense 1,100 1,627 Other income, net 90 1



Income (loss) before provision for income taxes 9,057 (13,045 ) Less provision for income taxes

91 6 Net income (loss) $ 8,966$ (13,051 )



Revenue. Total revenue decreased $32.9 million to $6.4 million in the first quarter of 2014 from the first quarter of 2013. This decrease was due to a $25.0 million regulatory milestone from Takeda with respect to the FDA approval of three new alogliptin-related products in January 2013 and a $5.0 million milestone from Menarini upon the launch of Priligy in France in March 2013. Royalty revenue of $6.4 million for the first quarter of 2014 related to the sale of Nesina and related combination products in Japan and the United States, and of Priligy in various countries outside the United States. The decrease in royalty revenue from the first quarter of 2013 related to lower net sales of Nesina in Japan for the three-month period ended March 31, 2014, in addition to a negative impact from the Yen/Dollar exchange rate.

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Expenses. Research and development, or R&D, expenses decreased $11.1 million to $14.3 million in the first quarter of 2014 from the first quarter of 2013. The decrease in R&D expense was due primarily to the completion of the efficacy analyses for both eluxadoline Phase III studies in late January 2014.

The following table sets forth amounts from our consolidated statements of operations for R&D expenses along with the dollar amount of the changes for the three-month period ended March 31, 2013 compared to the three-month period ended March 31, 2014.

Three Months Ended March 31, (in thousands) 2013 2014 $ Inc (Dec) R&D expense by project: Eluxadoline (MuDelta) $ 24,598$ 13,149$ (11,449 ) JNJ-Q2 6 6 - Other R&D expense 759 1,124 365 Total R&D expense $ 25,363$ 14,279$ (11,084 )



R&D expenses will likely fluctuate significantly from period to period for a variety of reasons, including the number of compounds under development, the stages of development and changes in development plans. The primary driver of the level of R&D expense during the current year was related to Phase III costs associated with the continued development of eluxadoline. The level and variability of quarterly R&D costs relate to the timing of specific activities associated with the on-going clinical trials.

Our forecasted total research and development expenses are expected to run between $21.0 million and $26.0 million for the remainder of 2014, comprised almost entirely of Phase III study costs, manufacturing costs, preparatory work in anticipation of the NDA submission for eluxadoline and a $10.0 million regulatory milestone to Janssen due upon acceptance of the NDA filing by the FDA.

Selling, general and administrative, or SG&A expenses, decreased $0.3 million to $3.6 million in the first quarter of 2014 from the first quarter of 2013. The decrease in SG&A expenses was due primarily to decreases in non-cash stock compensation expense of $1.0 million related to employee and consultant options, including the mark-to-market adjustment for non-vested consultant options, partially offset by additional restricted stock awards issued to employees and directors during 2013 and the first quarter of 2014.

Interest expense increased $0.5 million to $1.6 million in the first quarter of 2014 from the first quarter of 2013. The increase in interest expense was due to increased borrowings under the second amended loan agreement with Midcap Funding and Silicon Valley Bank in September 2013, in addition to a new $15.0 million loan with a related party as of September 2013.

Results of Operations. Net loss of $13.1 million in the first quarter of 2014 represents an approximate $22.0 million change from net income of $9.0 million in the first quarter of 2013. This change in our operating results resulted primarily from the $32.9 million decrease in revenue offset by the $11.1 million decrease in R&D expense, as described above.

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Liquidity and Capital Resources

As of March 31, 2014, we had $22.9 million of cash and cash equivalents. In addition, we had $6.4 million of accounts receivable, $11.7 million of accounts payable and accrued expenses and $15.3 million of short-term debt. The primary source of our current cash and cash equivalents has been from upfront, milestone and royalty payments received and proceeds from our credit facility and related party loan described below.

On August 18, 2011, we entered into a loan agreement with Midcap Funding III, LLC and Silicon Valley Bank. This initial borrowing in the amount of $10.0 million had a fixed interest rate of 10.25% per annum and was initially due August 1, 2015. On August 2, 2012, we entered into an amended loan agreement with Midcap Funding III, LLC, Midcap Funding RE Holdings, LLC and Silicon Valley Bank for an additional $30.0 million. This new agreement amended the prior agreement by resetting the maturity date to August 2, 2016 for a total amount of $40.0 million, bearing interest at a fixed rate of 10.00%. On September 30, 2013, we entered into a second amended loan agreement with Midcap Funding III, LLC, Midcap Funding V, LLC and Silicon Valley Bank which reset the outside maturity date to October 1, 2018, deferred payment of principal until May 2014, and increased the total amount of the loan to $42.0 million. This borrowing bears interest at a fixed rate of 10.00%. Interest accrues daily and is payable on the first day of the following month, in arrears. As part of this second amended agreement, we are required to maintain our primary deposit and investment accounts with Silicon Valley Bank, consisting of at least 50% of our total cash and cash equivalents balance.

On September 30, 2013, we entered into a loan agreement with Fredric N. Eshelman, the Company's chairman of the board and then a 27.5% stockholder. This $15.0 million borrowing bears interest at a fixed rate of 9.00%. Interest accrues daily and is payable on the first day of the following month, in arrears. This loan becomes due and payable on the earlier of January 1, 2019 or 91 days after the Midcap Funding LLC / Silicon Valley Bank loan has been paid in full. Principal payments of $166,667 on the Eshelman Loan Agreement begin on October 1, 2014, and continue on a monthly basis thereafter through and including the maturity date.

We have incurred losses and negative cash flows from operations since the spin-off and expect to continue to incur operating losses until revenues from all sources reach a level sufficient to support our on-going operations. As previously publicly disclosed, in April 2014 we entered into a definitive agreement to be acquired by Forest Labs, which we expect, subject to various closing conditions, should close in the second or third quarter of 2014. This agreement contains covenants restricting our business operations prior to closing or the agreement's termination, including limitations on our ability to raise additional capital other than up to $25.0 million of additional debt, which could constrain our liquidity. The remainder of this liquidity disclosure primarily addresses our liquidity as an independent entity. We believe our existing cash balance and anticipated revenue from our collaborators for marketed products are sufficient to fund ongoing essential operations into 2015. However, if we choose to advance eluxadoline through the FDA registration process, which would trigger a $10.0 million milestone payment to Janssen upon acceptance of the NDA filing by the FDA, and prepare to commercialize eluxadoline without a partner, we would need to raise additional capital through the issuance of debt, equity or other financing alternatives before the fourth quarter of 2014.

Our liquidity over the next 12 months could be materially affected by, among other things: our ability to raise additional funds through debt, equity, or other financing alternatives; costs related to our development and potential commercialization efforts; regulatory approval and commercialization of our compound candidates, which could affect selling, general and administrative expenses, milestone and royalty receipts; changes in regulatory compliance requirements; reliance on existing collaborators and potential need to enter into additional collaborative arrangements; or other factors described under the risk factors set forth in "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2013. Depending upon the success and timing of potential new collaborations or commercialization efforts and receipt of various milestone payments and royalties, it might be necessary to do one or more of the following in the next 12 months: (a) raise additional capital through equity or debt financings or from other sources; (b) reduce spending on research and development and/or commercialization of eluxadoline; or (c) restructure the Company's operations.

The timing and amount of any future expenses, trial completion dates and revenues related to our compounds are subject to significant uncertainty. We do not know if we will be successful in developing any of our compounds. The timing and amount of our research and development expenses will depend upon the costs associated with the present and potential future clinical trials and non-clinical studies of our compounds, any related expansion of our research and development organization, changes in regulatory requirements and manufacturing costs. There are numerous risks and uncertainties associated with the duration and cost of clinical trials and regulatory reviews, which vary significantly over the life of a program as a result of events arising during clinical development. For example, if the FDA, or another regulatory authority, were to require us or one of our collaborators to conduct clinical trials beyond those we currently anticipate to complete clinical development of a compound, or if we experience significant delays in enrollment in any of our clinical trials, we would be required to expend significant additional financial resources and time on the completion of clinical development. The timing and amount of revenues, if any, are dependent upon the success of the clinical trials as well as the commercial success of these products in the marketplace, all of which are subject to a variety of risks and uncertainties, including the ability to obtain reimbursement approval for our products and our ability to defend or enforce our patents related to Priligy.

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Our future capital requirements will depend on numerous factors, including, among others: the cost and expense of continuing the research and development activities of our existing compounds; new collaborative agreements that we might enter into in the future; progress of compounds in clinical trials as it relates to the cost of development and the receipt of future milestone payments, if any; the ability of us or our licensees and collaborators to obtain regulatory approval and successfully manufacture and market collaboration products; the continued or additional support by our collaborators or other third parties of research and development efforts and clinical trials; time required to gain regulatory approvals; the demand for our potential products, if and when approved; potential acquisitions of technology, compounds or businesses by us; and the costs of defending or prosecuting any patent opposition or litigation necessary to protect our proprietary technologies. In order to develop and obtain regulatory approval for and commercialize our potential compounds we might raise additional funds through equity or debt financings or from other sources, collaborative arrangements, the use of sponsored research efforts or other means. However, additional financing might not be available on acceptable terms, if at all, and such financing might only be available on terms dilutive or otherwise detrimental to our stockholders or our business.

For the three-month period ended March 31, 2014, net cash used in our operating activities was $9.2 million compared to net cash provided by operating activities of $9.5 million for the same period in 2013. The transition to net cash used in operating activities relates primarily to the decreased revenue associated with milestone and royalty payments from our collaborators, partially offset by the decrease in research and development expenditures previously described.

There were no significant investing activities for the three-month periods ended March 31, 2014 and 2013, respectively.

For the three-month period ended March 31, 2014 and 2013, our financing activities provided $2.9 million and $1.2 million in cash from the issuance of common stock related to stock option exercises during the period.

Contractual Obligations



In connection with the termination of the Merger Agreement under specified circumstances, including with respect to the Company's entry into an agreement with respect to a superior proposal and the board of directors of the Company changing its recommendation that stockholders vote in favor of the Merger Agreement, the Company is required to pay to Parent a termination fee equal to $41.0 million. In addition, in the event that the Merger Agreement is terminated under specified circumstances during the pendency of a publicly disclosed third-party proposal to acquire the Company, the Company is required to reimburse Parent for Parent's fees and expenses incurred in connection with the Merger Agreement up to an aggregate amount of $3.0 million, and, if the Company enters into an agreement for a third party to acquire the Company within 12 months of such termination, to pay to Parent the balance of the $41.0 million termination fee less any such reimbursed expenses. Other than the potential fees related to the Merger Agreement, there have been no significant changes to the Contractual Obligation table included in our Annual Report on Form 10-K for the year ended December 31, 2013.

Off-balance Sheet Arrangements

We have no off-balance sheet arrangements except for operating leases entered into in the normal course of business.

Critical Accounting Policies and the Use of Estimates

There have been no significant changes to our critical accounting policies or the use of estimates described in our Annual Report on Form 10-K for the year ended December 31, 2013.

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