ACELRX PHARMACEUTICALS INC - Quarter Report: 2014 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

For the quarterly period ended September 30, 2014

or

For the transition period from              to             

Commission File Number: 001-35068

ACELRX PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

351 Galveston Drive

Redwood City, CA 94063

(650) 216-3500

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

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.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    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. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Exchange Act Rule 12b-2)    Yes  ¨    No  x

As of October 24, 2014, the number of outstanding shares of the registrant’s common stock was 43,707,390.

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ACELRX PHARMACEUTICALS, INC.

QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2014

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Unless the context indicates otherwise, the terms “AcelRx,” “AcelRx Pharmaceuticals,” “we,” “us” and “our” refer to AcelRx Pharmaceuticals, Inc. “ACELRX”, “NANOTAB” and “ACCELERATE, INNOVATE, ALLEVIATE” are U.S. registered trademarks owned by AcelRx Pharmaceuticals, Inc. This report also contains other trademarks and trade names that are the property of their respective owners.

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PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

AcelRx Pharmaceuticals, Inc.

Condensed Balance Sheets

(In thousands, except share data)

See notes to condensed financial statements.

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AcelRx Pharmaceuticals, Inc.

Condensed Statements of Comprehensive Income (Loss)

(Unaudited)

(In thousands, except share and per share data)

See notes to condensed financial statements.

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AcelRx Pharmaceuticals, Inc.

Condensed Statements of Cash Flows

(Unaudited)

(In thousands)

See notes to condensed financial statements.

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AcelRx Pharmaceuticals, Inc.

Notes to Condensed Financial Statements

(Unaudited)

1. Organization and Summary of Significant Accounting Policies

The Company

AcelRx Pharmaceuticals, Inc., or the Company or AcelRx, was incorporated in Delaware on July 13, 2005 as SuRx, Inc., and in January 2006, the Company changed its name to AcelRx Pharmaceuticals, Inc. The Company’s operations are based in Redwood City, California.

AcelRx is a specialty pharmaceutical company focused on the development and commercialization of innovative therapies for the treatment of acute and breakthrough pain. AcelRx intends to commercialize its product candidates in the United States and license the development and commercialization rights to its product candidates for sale outside of the United States through strategic partnerships and collaborations. On July 25, 2014, the U.S. Food and Drug Administration, or FDA, issued a Complete Response Letter, or CRL, for the Company’s new drug application, or NDA, for Zalviso™ (sufentanil sublingual tablet system), formerly known as ARX-01. The proposed indication for Zalviso is for the management of moderate-to-severe acute pain in adult patients in the hospital setting. Zalviso consists of sufentanil tablets delivered by the Zalviso System, a needle-free, handheld, patient-administered, pain management system (together, “Zalviso”). In the third quarter of 2014, the Company held a meeting with the FDA to discuss the Zalviso CRL received in July. During the meeting the Company discussed the resubmission of the Zalviso NDA and the steps necessary for the resubmission. In advance of resubmitting the Zalviso NDA, the Company has agreed with the FDA to submit protocols for the bench testing and a Human Factors Study for their review and comment. In the interim, the Company continues the preparation necessary to initiate the bench testing and Human Factors study in the near term. Subject to the timing of the FDA review and comment on the protocols, the adequacy of such protocols, and the results generated from the bench testing and Human Factors Study, the Company is targeting resubmission of the Zalviso NDA in the first quarter of 2015. However, if the FDA review of the protocols takes longer than expected, the timing of the filing of the NDA could be later than the first quarter of 2015.

In addition, in December 2013, the Company entered into a collaboration agreement with Grünenthal, a European-based pharmaceutical company, for the commercialization of Zalviso in Europe and Australia. The Marketing Authorization Application, or MAA, for Zalviso was filed by Grünenthal under the centralized procedure in the European Union, or EU, in July 2014.

The Company has incurred recurring operating losses and negative cash flows from operating activities since inception and expects to continue to incur negative cash flows in the future as it prepares for the commercial launch of Zalviso and continues its research and development activities. In previous years, prior to the commercial collaboration of Zalviso with Grünenthal, AcelRx was considered a development stage company.

The Company has one business activity, which is the development and commercialization of product candidates for the treatment of pain, and a single reporting and operating unit structure.

Basis of Presentation

The accompanying unaudited condensed financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the rules and regulations of the U.S. Securities and Exchange Commission, or SEC. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included.

Operating results for the three and nine months ended September 30, 2014, are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. The condensed balance sheet as of December 31, 2013, was derived from the Company’s audited financial statements as of December 31, 2013, included in the Company’s Annual Report on Form 10-K filed with the SEC. These financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2013, which includes a broader discussion of the Company’s business and the risks inherent therein.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the condensed financial statements and accompanying notes. Management evaluates its estimates on an ongoing basis including critical accounting

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policies. Estimates are based on historical experience and on various other market-specific and other relevant assumptions that the Company believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates.

Recently Issued Accounting Standards

In August 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. ASU 2014-15 will explicitly require management to assess an entity’s ability to continue as a going concern, and to provide related footnote disclosure in certain circumstances. The new standard will be effective for AcelRx beginning in fiscal 2017. Earlier adoption is permitted. The Company is currently evaluating the potential impact of the adoption of ASU 2014-15.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, issued as a new Topic, Accounting Standards Codification (ASC) Topic 606. The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. The core principle of the guidance is that a Company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU is effective for AcelRx beginning in fiscal 2017 and can be adopted by the Company either retrospectively or as a cumulative-effect adjustment as of the date of adoption. The Company is currently evaluating the effect that adopting this new accounting guidance will have on its results of operations, cash flows and financial position.

2. Investments and Fair Value Measurement

Investments

The Company classifies its marketable securities as available-for-sale and records its investments at fair value. Available-for-sale securities are carried at estimated fair value based on quoted market prices or observable market inputs of almost identical assets, with the unrealized holding gains and losses included in accumulated other comprehensive income. Marketable securities which have maturities beyond one year as of the end of the reporting period are classified as non-current.

The table below summarizes the Company’s cash, cash equivalents and investments (in thousands):

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As of September 30, 2014 and December 31, 2013, none of the available-for-sale securities held by the Company had material unrealized losses. There were no other-than-temporary impairments for these securities at September 30, 2014 or December 31, 2013. No gross realized gains or losses were recognized on the available-for-sale securities and, accordingly, there were no amounts reclassified out of accumulated other comprehensive income to earnings during the three and nine months ended September 30, 2014 and 2013.

As of September 30, 2014 and December 31, 2013, the contractual maturity of all investments held was less than one year.

Fair Value Measurement

The Company’s financial instruments consist of Level I and Level II assets and Level III liabilities. Level I securities include highly liquid money market funds and are valued based on quoted market prices. For Level II instruments, the Company estimates fair value by utilizing third party pricing services in developing fair value measurements where fair value is based on valuation methodologies such as models using observable market inputs, including benchmark yields, reported trades, broker/dealer quotes, bids, offers and other reference data. Such Level II instruments typically include U.S. treasury and U.S. government agency obligations. As of September 30, 2014 and December 31, 2013, the Company held, in addition to Level I and Level II assets, a contingent put option liability associated with the Company’s Amended and Restated Loan and Security Agreement, or the Amended Loan Agreement, with Hercules Technology II, L.P. and Hercules Technology Growth Capital, Inc., collectively referred to as Hercules, which amends and restates the loan and security agreement with Hercules dated as of June 29, 2011, or the Original Loan Agreement, and which was classified as a Level III liability. See Note 5 “Long-Term Debt,” for further description. The Company’s estimate of fair value of the contingent put option liability was determined by using a risk-neutral valuation model, wherein the fair value of the underlying debt facility is estimated both with and without the presence of the default provisions, holding all other assumptions constant. The resulting difference between the two estimated fair values is the estimated fair value of the default provisions, or the contingent put option. Changes to the estimated fair value of these liabilities are recorded in interest income and other income (expense), net in the condensed statements of comprehensive loss. The fair value of the underlying debt facility is estimated by calculating the expected cash flows in consideration of an estimated probability of default and expected recovery rate in default, and discounting such cash flows back to the reporting date using a risk-free rate. As of September 30, 2014 and December 31, 2013, the Company also held a Level III liability associated with warrants, or PIPE warrants, issued in connection with the Company’s private placement equity offering, completed in June 2012. The PIPE warrants are considered a liability and are valued using the Black-Scholes option-pricing model, the inputs for which include exercise price of the PIPE warrants, market price of the underlying common shares, expected term, volatility based on a group of the Company’s peers and the risk-free rate corresponding to the expected term of the PIPE warrants. Changes to any of the inputs can have a significant impact to the estimated fair value of the PIPE warrants.

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The following table sets forth the fair value of the Company’s financial assets and liabilities by level within the fair value hierarchy (in thousands):

The following table sets forth the assumptions used in the Black-Scholes option-pricing model to estimate the fair value of the PIPE warrants as of September 30, 2014:

The following table sets forth the assumptions used in the Black-Scholes option-pricing model to estimate the fair value of the PIPE warrants as of December 31, 2013:

The following tables set forth a summary of the changes in the fair value of the Company’s Level III financial liabilities for the three and nine months ended September 30, 2014 and September 30, 2013 (in thousands):

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3. Research Grant Agreement

In May 2011, AcelRx received a grant from the US Army Medical Research and Materiel Command, or USAMRMC, in which the USAMRMC granted $5.6 million to the Company in order to support the development of a new product candidate, ARX-04, a sufentanil tablet for the treatment of moderate-to-severe acute pain. Under the terms of the grant, the USAMRMC reimbursed the Company for development, manufacturing and clinical costs necessary to prepare for and complete the planned Phase 2 dose-finding trial in a study of acute moderate-to-severe pain, and to prepare to enter Phase 3 development. The grant gives the USAMRMC the option to extend the term of the grant and provide additional funding for the research. As of December 31, 2013, the full amount of the grant, $5.6 million, had been received and recognized as revenue.

Revenue is recognized based on expenses incurred by AcelRx in conducting research and development activities set forth in the agreement. Revenue attributable to the research and development performed under the USAMRMC grant was $548,000 and $1.9 million for the three and nine months ended September 30, 2013, respectively. There was no such revenue recognized for the three and nine months ended September 30, 2014.

4. Collaboration Agreement

On December 16, 2013, AcelRx and Grünenthal GmbH, or Grünenthal, entered into a Collaboration and License Agreement (the “License Agreement”) and related Manufacture and Supply Agreement (the “Manufacturing Agreement” and together with the License Agreement, the “Grünenthal Agreements”). The License Agreement grants Grünenthal rights to commercialize Zalviso in the EU, Switzerland, Liechtenstein, Iceland, Norway and Australia, for pain treatment within or dispensed by hospitals, hospices, nursing homes and other medically-supervised settings. Under the Supply Agreement, the Company will exclusively manufacture and supply Zalviso to Grünenthal for sale in their territories.

License Agreement

Under the terms of the License Agreement, Grünenthal has the exclusive right to commercialize Zalviso in their territories. The Company retains control of clinical development, and together with Grünenthal will be responsible for certain development activities. The Company will not receive separate payment for such development activities. Grünenthal is responsible for marketing approval applications and other regulatory filings relating to the sufentanil drug cartridge for Zalviso, while the Company is responsible for the CE Mark and other regulatory filings relating to the device portions.

The Company received an upfront non-refundable cash payment of $30.0 million in December 2013, and a milestone payment of $5.0 million related to the MAA submission in the third quarter of 2014. The Company is eligible to receive an additional $15.0 million milestone payment upon the approval of the MAA, if approved. If the MAA is approved, the Company is eligible to receive approximately $200.0 million in additional milestone payments, based upon successful regulatory and product development efforts ($28.5 million) and net sales target achievements ($171.5 million). Grünenthal will also make tiered royalty and supply and trademark fee payments in the mid-teens up to the mid-twenties percent range on net sales of Zalviso.

Unless earlier terminated, the License Agreement continues in effect until the expiration of the obligation of Grünenthal to make royalty and supply and trademark fee payments, which supply and trademark fee continues for so long as the Company continues to supply Zalviso to Grünenthal. The License Agreement is subject to earlier termination in the event the parties mutually agree, by a party in the event of an uncured material breach by the other party, upon the bankruptcy or insolvency of either party, or by Grünenthal for convenience.

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Manufacturing Agreement

Under the terms of the Manufacturing Agreement, the Company will manufacture and supply Zalviso exclusively for Grünenthal. The Company will supply Zalviso at the Company’s fully burdened manufacturing cost (as defined in the Manufacturing Agreement). The Manufacturing Agreement requires the Company to use commercially reasonable efforts to enter stand-by contracts with third party contract manufacturers to ensure continual supply of Zalviso and under certain conditions permits Grünenthal to use a third party back-up manufacturer to manufacture Zalviso for commercial sale in their territories.

Unless earlier terminated, the Manufacturing Agreement continues in effect until the later of the expiration of the obligation of Grünenthal to make royalty and supply and trademark fee payments or the end of any transition period for manufacturing obligations due to the expiration or termination of the License Agreement. The Manufacturing Agreement is subject to earlier termination in connection with certain termination events in the License Agreement, in the event the parties mutually agree, by a party in the event of an uncured material breach by the other party or upon the bankruptcy or insolvency of either party.

The Company identified the following four significant non-contingent performance deliverables under the agreements: 1) intellectual property (license), 2) the obligation to provide research and development services, 3) the significant and incremental discount on the manufacturing of Zalviso for commercial purposes, and 4) the obligation to participate on the joint steering committee. The Company developed best estimates of selling prices for each deliverable in order to allocate the non-contingent arrangement consideration to the four units of accounting.

The Company’s management determined the best estimate of selling price for the license based on Grünenthal’s estimated future cash flows arising from the arrangement. Embedded in the estimate were significant assumptions regarding regulatory expenses, revenue, including potential customer market for the product and product price, costs to manufacture the product and the discount rate. The Company’s management determined the best estimate of selling price of the research and development services and committee participation based on the nature and timing of the services to be performed and in consideration of personnel and other costs incurred in the delivery of the services. For the discount on manufacturing services, the Company’s management estimated the selling price based on the market level of contract manufacturing margin it could have received if it were engaged to supply products to a customer in a separate transaction.

The Agreements entitle the Company to receive additional payments upon the achievement of certain development and sales milestones. Based on ASC Topic 605-28, Revenue Recognition — Milestone Method, the Company evaluates contingent milestones at the inception of the agreement, and recognizes consideration that is contingent upon the achievement of a milestone in its entirety as revenue in the period in which the milestone is achieved only if the milestone is considered substantive in its entirety. Milestones are events which have the following characteristics: (i) they can be achieved based in whole or in part on either the Company’s performance or on the occurrence of a specific outcome resulting from the Company’s performance, (ii) there was substantive uncertainty at the date the agreement was entered into that the event would be achieved and, (iii) they would result in additional payments due to the Company. A milestone is considered substantive if the following criteria are met: (i) the consideration is commensurate with either (1) the entity’s performance to achieve the milestone, or (2) the enhancement of the value of the delivered item (s) as a result of a specific outcome resulting from the entity’s performance to achieve the milestone, (ii) the consideration relates solely to past performance and, (iii) the consideration is reasonable relative to all of the other deliverables and payment terms, including other potential milestone consideration, within the arrangement.

The substantive milestone payments will be recognized as revenue in their entirety upon the achievement of each substantive milestone. Based on the criteria noted above, the identified substantive milestones in the agreement pertain to post-approval product enhancements, expanded market opportunities and manufacturing efficiencies for Zalviso. Each of these potential achievements is based primarily on the Company’s performance and involves substantive uncertainty as achievement of these milestones requires future research, development and regulatory activities, which are inherently uncertain in nature. The Company determined that the consideration for each milestone was commensurate with the Company’s performance to achieve the milestone, including future research, development, manufacturing and regulatory activities and that the consideration is reasonable relative to all of the other deliverables and payments within the arrangement. Aggregate potential payments for these milestones total $28.5 million.

In addition to substantive milestones, two milestones associated with the Agreements were deemed not to be substantive. These milestones pertain to regulatory developments for Zalviso in Europe, which the Company’s management deemed to be not substantive due to the level of performance associated with future achievement of these milestones. Aggregate potential payments for these milestones total $20.0 million. When achieved, the value of these milestones will be allocated to the four separate units of accounting based on estimated selling prices and recognized as revenue in the period of achievement to the extent the services underlying the separate units of accounting have been performed. In July 2014, Grünenthal submitted a

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Marketing Authorization Application, or MAA, to the European Medicines Agency, or EMA, for Zalviso for the management of moderate-to-severe acute pain in adult patients in a medically supervised environment. Under the terms of the License Agreement with Grünenthal, the Company received a cash payment of $5.0 million for the MAA submission in the third quarter of 2014. The Company is eligible to receive an additional $15.0 million milestone payment upon the approval of the MAA.

The Agreements also include milestone payments related to specified net sales targets, totaling $171.5 million. The sales-based milestones do not meet the definition of a milestone under ASU 2010-17 because the achievement of these milestones is solely dependent on counter-party performance and not on any performance obligations of the Company.

The Company allocated the $30.0 million upfront fee across the four deliverables based on estimated selling prices and for the quarter ended December 31, 2013, recognized $27.4 million attributable to the license. The remaining $2.6 million was recorded as deferred revenue at December 31, 2013, to be recognized in future periods to the extent services are performed related to the other non-contingent performance deliverables under the agreements.

The Company recognized $4.8 million and $5.0 million, of previously deferred revenue related to research and development services under the collaboration agreement during the three and nine months ended September 30, 2014, respectively. As of September 30, 2014, the Company had a deferred revenue balance of $2.6 million. As mentioned above, the Company received a milestone payment of $5.0 million related to the MAA submission, of which $4.6 million was recognized during the three months ended September 30, 2014. There were no other milestone payments received or recognized under these Agreements during the three and nine months ended September 30, 2014.

5. Long-Term Debt

Hercules Loan and Security Agreements

In June 2011, AcelRx entered into a Loan and Security Agreement, or the Original Loan Agreement, with Hercules Technology II, L.P. and Hercules Technology Growth Capital, Inc., collectively referred to as Hercules, under which AcelRx borrowed $20.0 million in two tranches of $10.0 million each, represented by secured convertible term promissory notes, or collectively, the Original Notes. The Company’s obligations associated with the agreement were secured by a security interest in substantially all of its assets, other than its intellectual property.

The Company borrowed the first tranche of $10.0 million upon the closing of the transaction on June 29, 2011 and borrowed the second tranche of $10.0 million in December 2011. The interest rate for each tranche was 8.50%. In connection with the Original Loan Agreement, the Company issued Hercules seven-year warrants to purchase an aggregate of 274,508 shares of common stock at a price of $3.06 per share. See Note 6 “Warrants,” for further description.

On December 16, 2013, AcelRx entered into an Amended and Restated Loan and Security Agreement, or the Amended Loan Agreement, with Hercules, under which the Company may borrow up to $40.0 million in three tranches. These loans are represented by secured convertible term promissory notes, or collectively, the Amended Notes. The Amended Loan Agreement amends and restates the Original Loan Agreement, as noted above. The Company borrowed the first tranche of $15.0 million upon closing of the transaction on December 16, 2013 and the second tranche of $10.0 million on June 16, 2014. The Company used approximately $8.6 million of the proceeds from the first tranche to repay its obligations under the Original Loan Agreement. The Company recorded the new debt at an estimated fair value of $24.9 million and $14.3 million as of September 30, 2014 and December 31, 2013, respectively.

On September 24, 2014, the Company entered into an amendment, or the Amendment, to the Amended Loan Agreement with Hercules. The Amendment extends the time period under which the Company can draw down the third tranche, of up to $15.0 million, from March 15, 2015 to August 1, 2015, subject to the Company obtaining approval for Zalviso from the U.S. Food and Drug Administration.

The interest rate for each tranche will be calculated at a rate equal to the greater of either (i) 9.10% plus the prime rate as reported from time to time in The Wall Street Journal minus 5.25%, and (ii) 9.10%. Payments under the Amended Loan Agreement are interest only until April 1, 2015 (which will be extended until January 1, 2016 if the Company achieves the Milestone on or before April 1, 2015) followed by equal monthly payments of principal and interest through the scheduled maturity date on October 1, 2017 (which would be extended until January 1, 2018 if the Company achieves the Milestone on or prior to April 1, 2015), or the Loan Maturity Date. In addition, a final payment equal to $1.7 million will be due on the Loan Maturity Date, or such earlier date specified in the Amended Loan Agreement. The Company’s obligations under the Amended Loan Agreement are secured by a security interest in substantially all of its assets, other than its intellectual property.

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If the Company prepays the Amended Loan Agreement prior to maturity, it will pay Hercules a prepayment charge, based on a percentage of the then outstanding principal balance, equal to 3% if the prepayment occurs prior to December 16, 2014, 2% if the prepayment occurs after December 16, 2014, but prior to December 16, 2015, or 1% if the prepayment occurs after December 16, 2015.

Subject to certain conditions and limitations set forth in the Amended Loan Agreement, the Company has the right to convert up to $5.0 million of scheduled principal installments under the Notes into freely tradeable shares of the Company’s common stock, or Common Stock. The number of shares of Common Stock that would be issued upon conversion of the Amended Notes would be equal to the number determined by dividing (x) the product of (A) the principal amount to be paid in shares of Common Stock and (B) 103%, by (y) $9.30 (subject to certain proportional adjustments as provided for in the Amended Loan Agreement).

The Amended Loan Agreement includes customary affirmative and restrictive covenants, but does not include any financial maintenance covenants, and also includes standard events of default, including payment defaults, breaches of covenants following any applicable cure period, a material impairment in the perfection or priority of Hercules’ security interest or in the value of the collateral, and events relating to bankruptcy or insolvency. Upon the occurrence of an event of default, a default interest rate of an additional 5% may be applied to the outstanding loan balances, and Hercules may declare all outstanding obligations immediately due and payable and take such other actions as set forth in the Amended Loan Agreement.

In connection with the Amended Loan Agreement, the Company issued a warrant to each Lender which, collectively, are exercisable for an aggregate of 176,730 shares of Common Stock and each carry an exercise price of $6.79. See Note 6 “Warrants,” for further description.

Upon an event of default, including a change of control, Hercules has the option to accelerate repayment of the Amended Loan Agreement, including payment of any applicable prepayment charges, which range from 1%-3% of the outstanding loan balance and accrued interest, as well as a final payment fee of $1.7 million. This option is considered a contingent put option liability, as the holder of the loan may exercise the option in the event of default, and is considered an embedded derivative, which must be valued and separately accounted for in the Company’s financial statements. As the amendment of the loan agreement was considered an extinguishment, the contingent put option liability associated with the Original Loan Agreement, which had an estimated fair value of $32,000 at the time of the amendment, was written off as a part of the loss on extinguishment, and a new contingent put option liability was established. As of September 30, 2014 and December 31, 2013, the estimated fair value of the contingent put option liability was $325,000 and $334,000, respectively, which was determined by using a risk-neutral valuation model, wherein the fair value of the underlying debt facility is estimated both with and without the presence of the default provisions, holding all other assumptions constant. The resulting difference between the two estimated fair values is the estimated fair value of the default provisions, or the contingent put option. The fair value of the underlying debt facility is estimated by calculating the expected cash flows in consideration of an estimated probability of default and expected recovery rate in default, and discounting such cash flows back to the reporting date using a risk-free rate. The contingent put option liability was recorded as a debt discount to the loan and consequently a reduction to the carrying value of the loan. The contingent put option liability is revalued at the end of each reporting period and any change in the fair value is recognized in interest income and other income (expense), net in the condensed statements of comprehensive loss.

As of September 30, 2014 and December 31, 2013, the Company had outstanding borrowings under the Amended Loan Agreement of $25.0 million and $15.0 million, respectively. Interest expense related to the Amended Loan Agreement was $813,000 and $1.8 million for the three and nine months ended September 30, 2014, respectively, $231,000 and $504,000 of which represented amortization of the debt discount for the three and nine months ended September 30, 2014, respectively. Interest expense related to the Original Loan Agreement was $348,000 and $1.2 million for the three and nine months ended September 30, 2013, respectively, $85,000 and $290,000 of which represented amortization of the debt discount for the three and nine months ended September 30, 2013, respectively.

6. Warrants

Series A Warrants

In March 2007, the Company entered into an equipment financing agreement in which the Company issued immediately exercisable and fully vested warrants to purchase 2,500 shares of its Series A convertible preferred stock, or the Series A warrants, with an exercise price of $10.00 per share. The fair value of the Series A warrants on the date of issuance was $1,000, as determined using the Black-Scholes option-pricing model. This fair value was recorded as a convertible preferred stock warrant liability and as a deferred financing cost in other assets. The fair value was remeasured at the end of each reporting period. In connection with the IPO, the Series A warrants were automatically converted into warrants to purchase 3,425 shares of common stock. As a result of the conversion, these common stock warrants were no longer recorded as liabilities and were, therefore, no longer remeasured as of the end of each reporting period.

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As of September 30, 2014, warrants to purchase 3,425 shares of common stock had not been exercised and were still outstanding. These warrants expire in March 2017.

Pinnacle Warrants

In September 2008, the Company entered into a $12.0 million loan and security agreement with Pinnacle Ventures. In connection with this loan and security agreement, the Company issued immediately exercisable and fully vested warrants, or the Series B warrants, to purchase 56,250 shares of Series B convertible preferred stock with an exercise price of $16.00 per share which were ultimately converted into warrants to purchase 228,264 shares of common stock with an exercise price of $3.94 per share in connection with the Company’s initial public offering in 2011.

In February 2013, warrants to purchase 228,264 shares were net exercised, for 58,580 shares of common stock. As of September 30, 2014, no warrants to purchase shares of common stock issued to Pinnacle were outstanding.

Hercules Warrants

In connection with the Amended Loan Agreement, executed in December 2013, the Company issued warrants to Hercules which are exercisable for an aggregate of 176,730 shares of Common Stock and each carry an exercise price of $6.79 (the “Warrants”). Each Warrant may be exercised on a cashless basis. The Warrants are exercisable for a term beginning on the date of issuance and ending on the earlier to occur of five years from the date of issuance or the consummation of certain acquisitions of the Company as set forth in the Warrants. The number of shares for which the Warrants are exercisable and the associated exercise price are subject to certain proportional adjustments as set forth in the Warrants. The Company estimated the fair value of these warrants as of the issuance date to be $1.1 million, which was recorded as equity. The fair value of the warrants was calculated using the Black-Scholes option-valuation model, and was based on the strike price of $6.79, the stock price at issuance of $9.67, the five-year contractual term of the warrants, a risk-free interest rate of 1.55%, expected volatility of 71% and 0% expected dividend yield.

As of September 30, 2014, warrants to purchase 176,730 shares of common stock issued to Hercules had not been exercised and were still outstanding. These warrants expire in December 2018.

In connection with the Original Loan Agreement with Hercules, executed in June 2011, the Company issued warrants to Hercules to purchase an aggregate of 274,508 shares of common stock at a price of $3.06 per share.

During June and July 2013, warrants to purchase 274,508 shares were net exercised, for 183,404 shares of common stock.

2012 Private Placement Warrants

In connection with the Private Placement, completed in June 2012, the Company issued PIPE warrants to purchase up to 2,630,103 shares of common stock. The per share exercise price of the PIPE warrants was $3.40 which equals the closing consolidated bid price of the Company’s common stock on May 29, 2012, the effective date of the Purchase Agreement. The PIPE warrants issued in the Private Placement became exercisable six months after the issuance date, and expire on the five year anniversary of the initial exercisability date. Under the terms of the PIPE warrants, upon certain transactions, including a merger, tender offer, sale of all or substantially all of the assets of the Company or if a person or group shall become the owner of 50% of the Company’s issued and outstanding common stock, which is outside of the Company’s control, each PIPE warrant holder may elect to receive a cash payment in exchange for the warrant, in an amount determined by application of the Black-Scholes option-pricing model. Accordingly, the PIPE warrants were recorded as a liability at fair value, as determined by the Black-Scholes option-pricing model, and then marked to fair value each reporting period, with changes in estimated fair value recorded through interest income and other income (expense), net in the condensed statements of comprehensive loss. The Black-Scholes assumptions used to value the PIPE warrants are disclosed in Note 2.

Upon execution of the Purchase Agreement, the fair value of the PIPE warrants was estimated to be $5.8 million, which was recorded as a liability. As of September 30, 2014, the fair value of the PIPE warrants was estimated to be $4.3 million. As of December 31, 2013, the fair value of the PIPE warrants was estimated to be $13.1 million. The change in fair value for the three and nine months ended September 30, 2014, which was recorded as other income, was $6.4 million and $8.2 million, respectively. The change in fair value for the three and nine months ended September 30, 2013, recorded as other expense, was $2.4 million and $13.4 million, respectively.

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During the three and nine months ended September 30, 2014, PIPE warrants to purchase 135,000 shares were net exercised for 91,488 shares of common stock. As of September 30, 2014, PIPE warrants to purchase 1,359,514 shares of common stock issued in connection with the Private Placement had not been exercised and were outstanding. These warrants expire in November 2017.

7. Stock-Based Compensation

The Company recorded total stock-based compensation expense for stock options, stock awards and the 2011 Employee Stock Purchase Plan as follows (in thousands):

As of September 30, 2014 there were 1,160,866 shares available for grant, 5,313,236 options outstanding and 0 restricted stock units outstanding under the Company’s 2011 Equity Incentive Plan.

8. Net Loss per Share of Common Stock

The Company’s basic net loss per share of common stock is calculated by dividing the net loss by the weighted average number of shares of common stock outstanding for the period. The diluted net loss per share of common stock is computed by giving effect to all potential common stock equivalents outstanding for the period determined using the treasury stock method. For purposes of this calculation, options to purchase common stock and warrants to purchase common stock were considered to be common stock equivalents. In periods with a reported net loss, common stock equivalents are excluded from the calculation of diluted net loss per share of common stock if their effect is antidilutive.

During the three and nine months ended September 30, 2014, the PIPE warrants had a dilutive impact to net loss per share due to a lower share price at September 30, 2014, compared to the closing share price on June 30, 2014 and December 31, 2013. The decrease in share price created a lower Black-Scholes value and lower liability for the PIPE warrants, which resulted in other income during the three and nine months ended September 30, 2014. The calculation of diluted net loss per share requires that, to the extent the average market price of the underlying shares for the reporting period exceeds the exercise price of the PIPE warrants and the presumed exercise of such securities are dilutive to loss per share for the period, adjustments to net loss used in the calculation are required to remove the change in fair value of the PIPE warrants for the period. Likewise, adjustments to the denominator are required to reflect the related dilutive shares.

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The following table sets forth the computation of the Company’s basic and diluted net loss per share of common stock during the three and nine months ended September 30, 2014 and 2013 (in thousands, except for share and per share amounts):

The following outstanding shares of common stock equivalents were excluded from the computation of diluted net loss per share of common stock for the periods presented because including them would have been antidilutive:

9. Manufacturing Agreements

Patheon

In January 2013, the Company and Patheon Pharmaceuticals Inc., or Patheon, entered into a Manufacturing Services Agreement, or the Services Agreement, and a related Amended and Restated Capital Expenditure and Equipment Agreement, or the Capital Agreement, relating to the manufacture of sufentanil tablets, or the Product, for use with the Company’s Zalviso drug product.

Under the terms of the Services Agreement, the Company has agreed to purchase, subject to Patheon’s continued material compliance with the terms of the Services Agreement, all of its Product requirements for the United States, Canada and Mexico from Patheon during the Initial Term of the Services Agreement (as defined below), and at least eighty percent (80%) of its Product requirements for such territories after the Initial Term.

The term of the Services Agreement extends until December 31, 2017, or the Initial Term, and will automatically renew thereafter for periods of two years, unless terminated by either party upon eighteen months’ prior written notice; provided, however, that the Services Agreement may not be terminated without cause prior to the end of the Initial Term.

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The Company also entered into a Capital Expenditure and Equipment Agreement, or the Capital Agreement. Under the terms of the Capital Agreement, as amended in January 2014, the Company has made and continues to make certain modifications to Patheon’s Cincinnati facility. Property and equipment, net in the condensed balance sheet at September 30, 2014, includes $3.6 million related to certain modifications the Company is making at Patheon’s Cincinnati facility under the terms of the Capital Agreement.

Expenditures associated with the aforementioned agreements are primarily driven by the potential commercial requirements and demand for the Company’s products, none of which have been approved for commercialization; accordingly, the amounts and timing of such future expenditures cannot be determined at this time.

Grünenthal

On December 16, 2013, AcelRx and Grünenthal entered into a Collaboration and License Agreement (the “License Agreement”) and related Manufacture and Supply Agreement (the “Manufacturing Agreement” and together with the License Agreement, the “Grünenthal Agreements”). The License Agreement grants Grünenthal rights to commercialize Zalviso in the EU, Switzerland, Liechtenstein, Iceland, Norway and Australia, for pain treatment within or dispensed by hospitals hospices, nursing homes and other medically-supervised settings.

Under the terms of the Manufacturing Agreement, the Company will manufacture and supply Zalviso exclusively for Grünenthal. The Company will supply Zalviso at the Company’s fully burdened manufacturing cost (as defined in the Manufacturing Agreement). The Manufacturing Agreement requires the Company to use commercially reasonable efforts to enter stand-by contracts with third party contract manufacturers to ensure a continual supply of Zalviso and under certain conditions permits Grünenthal to use a third party back-up manufacturer to manufacture Zalviso for commercial sale in their territories.

Unless earlier terminated, the Manufacturing Agreement continues in effect until the later of the expiration of the obligation of Grünenthal to make royalty and supply and trademark fee payments or the end of any transition period for manufacturing obligations due to the expiration or termination of the License Agreement. The Manufacturing Agreement is subject to earlier termination in connection with certain termination events in the License Agreement, in the event the parties mutually agree, by a party in the event of an uncured material breach by the other party or upon the bankruptcy or insolvency of either party.

Under the Supply Agreement, the Company will exclusively manufacture and supply Zalviso to Grünenthal for commercial sale in their territories.

Expenditures associated with the aforementioned agreements are primarily driven by the potential commercial requirements and demand for the Company’s products, none of which have been approved for commercialization; accordingly, the amounts and timing of such future expenditures cannot be determined at this time.

10. Commitments and Contingencies

Operating Leases

In May 2014, the Company entered into an amendment, or the Lease Amendment, to that certain lease dated December 21, 2011, with Metropolitan Life Insurance Company, or the Existing Lease, for 13,787 square feet of space located at 301 Galveston Drive, Redwood City, California, or the Current Premises. Pursuant to the Lease Amendment, the term of the Existing Lease has been extended for a period of twenty (20) months and twenty-two (22) days and expiring January 31, 2018, or the Expiration Date, unless sooner terminated pursuant to the terms of the Existing Lease. In addition, the Lease Amendment included a new lease on an additional 12,106 square feet of office space, or the Expansion Space, which is adjacent to the current premises. The new lease for the Expansion Space has a term of 42 months commencing on August 1, 2014, and expiring on the Expiration Date. The Company has an option to extend the term of the Lease Amendment for an additional five years, which would commence upon the Expiration Date, at a market rate determined according to the Existing Lease.

Base rent payable under the Lease Amendment during the Extended Term for the Current Premises will be as follows:

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Base rent payable under the Lease Amendment for the Expansion Space, commencing August 1, 2014, will be as follows:

In addition, the Company will pay the Landlord specified percentages of certain operating expenses and taxes related to the leased facility incurred by the Landlord.

11. Subsequent Events

On October 1, 2014, a securities class action complaint was filed in the U.S. District Court for the Northern District of California against the Company and certain of its current and former officers. The complaint alleges that between December 2, 2013 and September 25, 2014, the Company and certain of its officers violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 in connection with statements related to the Company’s lead drug candidate, Zalviso. Specifically, the complaint alleges that the Company’s statements were false and misleading because the Company failed to disclose that the Instructions for Use for Zalviso were designed improperly and the Company did not submit to the FDA sufficient data to support the shelf life of the product. The complaint seeks unspecified damages, interest, attorneys’ fees, and other costs. The Company believes that it has meritorious defenses and intends to defend against this lawsuit vigorously.

From time to time, the Company may be involved in additional legal proceedings arising in the ordinary course of business.

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

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, which are subject to the “safe harbor” created by those sections. Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to them. In some cases you can identify forward-looking statements by words such as “may,” “will,” “should,” “could,” “would,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “projects,” “predicts,” “potential” and similar expressions intended to identify forward-looking statements. Examples of these statements include, but are not limited to, statements regarding: our new drug application, or NDA, submission to the U.S. Food and Drug Administration, or FDA, for Zalviso™ (sufentanil sublingual tablet system) and the Complete Response Letter, or CRL; the recent meeting held with the FDA to discuss the CRL including minutes, correspondence and briefing materials associated with the meeting; our submission of protocols for review and comment by the FDA; our plans to address certain issues raised in the CRL; our anticipated resubmission of the Zalviso NDA to the FDA, including the scope of the resubmission and the timing of the resubmission and FDA review time; the impact, if any, of the FDA’s review of the information included in the amendments to the NDA that were not previously reviewed; planned initiation of the Phase 3 clinical trial for ARX-04, and the therapeutic and commercial potential of our product candidates, including Zalviso and ARX-04; our ability to receive regulatory approval for Zalviso; any delays or inability to obtain and maintain regulatory approval of our product candidates, including Zalviso, in the United States and Europe; our ability to build an effective commercial organization; our ability to obtain sufficient financing to commercialize Zalviso and proceed with clinical development of ARX-04; the success, cost and timing of all product development activities and clinical trials, including the planned Phase 3 ARX-04 trial; potential milestones and royalty payments under the Grünenthal agreement; our anticipated timing for initiation or completion of our clinical trials for any of our product candidates, including the planned initiation of the Phase 3 clinical trial for ARX-04; the implications of interim or final results of our clinical trials; the progress of our research programs, including clinical testing; our future operating expenses; our future losses; our future expenditures for research and development; and the sufficiency of our cash resources. Our actual results could differ materially from those anticipated in these forward-looking statements for many reasons, including the risks faced by us and described in Part II, Item 1A of this Quarterly Report on Form 10-Q and our other filings with the SEC. You should not place undue reliance on these forward-looking statements, which apply only as of the date of this Quarterly Report on Form 10-Q. You should read this Quarterly Report on Form 10-Q completely and with the understanding that our actual future results may be materially different from those we expect. Except as required by law, we assume no obligation to update these forward-looking statements, whether as a result of new information, future events or otherwise.

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The following discussion and analysis should be read in conjunction with the unaudited financial statements and notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q and with the audited consolidated financial statements and related notes thereto included as part of our Annual Report on Form 10-K for the year ended December 31, 2013.

About AcelRx Pharmaceuticals

We are a specialty pharmaceutical company focused on the development and commercialization of innovative therapies for the treatment of acute and breakthrough pain. Our lead product candidate is Zalviso^TM, formerly known as ARX-01. Zalviso consists of sufentanil tablets delivered by the Zalviso System, a needle-free, handheld, patient-administered, pain management system (together, “Zalviso”).

On July 25, 2014, the U.S. Food and Drug Administration, or FDA, issued a Complete Response Letter, or CRL, for our New Drug Application, or NDA, for Zalviso. The CRL contains requests for additional information on the Zalviso System to ensure proper use of the device. The requests include submission of data demonstrating a reduction in the incidence of optical system errors, changes to the Instructions for Use for the device to address inadvertent dosing, among other items, and submission of additional data to support the shelf life of the product. In the third quarter of 2014, we held a meeting with the FDA to discuss the Zalviso CRL received in July. During the meeting we discussed the resubmission of the Zalviso NDA and the steps necessary for the resubmission. In advance of resubmitting our Zalviso NDA, we have agreed with the FDA to submit protocols for the bench testing and a Human Factors Study for their review and comment. In the interim, we continue the preparation necessary to initiate the bench testing and Human Factors study in the near term. Subject to the timing of the FDA review and comment on the protocols, the adequacy of such protocols, and the results generated from the bench testing and Human Factors Study, we are targeting resubmission of the Zalviso NDA in the first quarter of 2015. However, if the FDA review of the protocols takes longer than expected, the timing of the filing of the NDA could be later than the first quarter of 2015.

Zalviso

Zalviso is an investigational, pre-programmed, non-invasive, system to allow hospital patients with moderate-to-severe acute pain to self-dose with sublingual (sufentanil) tablets to manage their pain. Zalviso is designed to help address certain problems associated with post-operative intravenous patient-controlled analgesia, by offering:

Based on the successful results of our Phase 3 clinical program for Zalviso, we submitted an NDA for Zalviso in September 2013 and, in December 2013 we announced that the FDA accepted for filing the Zalviso NDA. As mentioned above, the FDA issued a CRL for Zalviso on July 25, 2014, and we are currently working to prepare, submit and finalize with the FDA the protocols required to address certain issues raised in the CRL.

The 505(b)(2) NDA submission for Zalviso is based on a development program that includes data from seven Phase 1 studies, three Phase 2 clinical trials, and three Phase 3 clinical trials. The Phase 3 trial program included two placebo-controlled efficacy and safety trials and one open-label active comparator trial, in which Zalviso was compared to IV PCA with morphine. To date, the Zalviso safety database includes more than 600 patients. Zalviso successfully achieved the primary efficacy endpoints for each of the Phase 2 and Phase 3 trials. A summary of the Phase 3 trials and results is as follows:

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In December 2013, we announced a commercial collaboration with Grünenthal, covering the territory of the European Union, certain other European countries and Australia for Zalviso for use in the management of moderate-to-severe acute pain within a hospital, hospice, nursing home or other medically supervised setting. We retain all rights in remaining countries, including the United States, Asia and Latin America.

In July 2014, Grünenthal filed a Marketing Authorization Application, or MAA, with the European Medicines Agency, or EMA, under the centralized procedure in the European Union, or EU, for Zalviso for the management of moderate-to-severe acute pain in adult patients in a medically-supervised environment.

Under the terms of the license agreement, we received an upfront cash payment of $30.0 million in December 2013, and in the third quarter of 2014, we received a milestone payment of $5.0 million related to the MAA submission. We are eligible to receive an additional $15.0 million milestone payment upon the approval of the MAA. After approval, we are eligible to receive approximately $200.0 million in additional milestone payments, based upon successful regulatory and product development efforts and net sales target achievements. Grünenthal will also make tiered royalty, supply and trademark fee payments in the mid-teens up to the twenty percent range, on net sales of Zalviso in the Grünenthal territory.

Grünenthal will be responsible for all commercial activities for Zalviso, including obtaining and maintaining pharmaceutical product regulatory approval in the Grünenthal territory. We will be responsible for obtaining and maintaining device regulatory approval in the Grünenthal territory and manufacturing and supply of Zalviso to Grünenthal for commercial sales.

ARX-04

We are also developing a Sufentanil Single-Dose Tablet, or ARX-04, for the treatment of moderate-to-severe acute pain to be administered by a healthcare professional to a patient in settings of acute pain, such as on the battlefield, in the emergency room or in ambulatory care facilities. In December 2013, we completed an End-of-Phase 2 Meeting with the FDA to identify a Phase 3 program pathway forward for evaluation of ARX-04. We have been notified by the Department of Defense that we have been offered a contract to provide funding for the development of ARX-04, including funding for the proposed Phase 3 studies. We are in the process of completing the initial contracting process with the DoD and are in negotiation to determine the amount and timing of the contract. Currently, we plan to defer the initiation of the trials until the contract is complete. However, if negotiations with the DoD become protracted, we may elect to initiate the first trial on our own rather than sustain additional delays. If current negotiations are successful, we believe the contract will provide significant funding for the development of ARX-04. Pending completion of the negotiation with the DoD for a contract to provide funding for the development of ARX-04, we plan to initiate the proposed ARX-04 Phase 3 program in the first quarter of 2015.

Phase 3 Program

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Phase 2 Clinical Study Results

In April 2013, we reported top-line data showing that the primary endpoint was achieved in a placebo-controlled, dose-finding, Phase 2 clinical trial of ARX-04 for acute pain. This trial randomized 101 patients following bunionectomy surgery in a 2:2:1 ratio to 30 mcg sufentanil, 20 mcg sufentanil or placebo treatment arms. Ninety-one percent of patients entering the trial completed the 12-hour trial period.

Results demonstrated that patients receiving 30 mcg sufentanil tablet doses, administered by a healthcare professional, no more frequently than once per hour, had significantly greater pain reduction as measured by Summed Pain Intensity Difference to baseline during the 12-hour trial period (SPID-12) than placebo-treated patients (p=0.003).

Adverse events, or AEs, reported in the trial were generally mild-to-moderate in nature, with two serious adverse events, or SAEs, of post-surgical infection reported, both of which were determined by the investigator to be unrelated to trial drug.

Research and development of ARX-04, including the Phase 2 trial and pre-Phase 3 development, was funded by a $5.6 million grant from the U.S. Army Medical Research and Materiel Command, or USAMRMC. As of December 31, 2013, we had recognized the full amount of the grant of $5.6 million.

ARX-02 and ARX-03

In addition to ARX-04, our product candidate pipeline consists of two other sufentanil-based product candidates. The Sufentanil Tablet Breakthrough Pain, or BTP, Management System, or ARX-02, is a pain management system for the treatment of cancer patients who suffer from BTP. The Sufentanil/Triazolam Tablet, or ARX-03, is a single, fixed-dose, combination drug product designed to provide mild sedation, anxiety reduction and pain relief for patients undergoing painful procedures in a physician’s office. We have successfully completed Phase 2 clinical trials for ARX-02 and ARX-03. Future development of ARX-02 and ARX-03 is contingent on funding from a corporate partnership or other external funding source.

Financial Overview

We have incurred net losses and generated negative cash flows from operations since inception and expect to incur losses in the future as we continue our research and development activities and pre-commercialization activities. As we pursue potential commercial development of Zalviso, subject to FDA approval, we expect the business aspects of our company to become more complex. In the future, we plan to add personnel and incur additional costs related to the maturation of our business and the potential commercialization of Zalviso, our lead product candidate. In addition, we believe that continued investment in research and development is critical to attaining our strategic objectives. In order to develop our product candidates as commercially viable therapeutics, we expect to expend significant resources for expertise in the manufacturing, regulatory affairs, clinical research and other aspects of pharmaceutical development.

To date, we have funded our operations primarily through the issuance of equity securities, borrowings, payments from our corporate collaboration and our research grants.

Our revenues to date have consisted primarily of revenues from our collaboration with Grünenthal and our research grant with the USAMRMC. We have recognized in full, as revenue, our $5.6 million grant from the USAMRMC as of December 31, 2013. There can be no assurance that we will produce other collaborative agreement revenues or receive additional funding from USAMRMC or other research-related grant awards in the future. We expect revenues to continue to fluctuate from period-to–period. There can be no assurance that our existing collaboration with Grünenthal will continue beyond the initial term, or that we will be able to meet the milestones specified in this agreement or that we will obtain marketing approval for our product candidates and subsequently generate revenue from those product candidates in excess of our operating expenses.

Our net income for the three months ended September 30, 2014 was $671,000 and our net loss for the nine months ended September 30, 2014 was $19.5 million. As of September 30, 2014, we had an accumulated deficit of $165.0 million. As of September 30, 2014, we had cash, cash equivalents and investments totaling $85.6 million compared to $103.7 million as of December 31, 2013.

In December 2013, we entered into an amended loan and security agreement, or the Amended Loan Agreement, with Hercules Technology II, L.P. and Hercules Technology Growth Capital, Inc., collectively referred to as Hercules, under which we may borrow up to $40.0 million in three tranches, represented by secured convertible promissory notes. The Amended Loan Agreement amends and restates the loan and security agreement with Hercules dated as of June 29, 2011, or

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the Original Loan Agreement. We borrowed the first tranche of $15.0 million upon closing of the transaction on December 16, 2013 and used approximately $8.6 million of the proceeds from the first tranche to repay our obligations under the Original Loan Agreement with Hercules. On June 16, 2014, we borrowed the second tranche of $10.0 million. On September 24, 2014, the Company entered into an amendment, or the Amendment, to the Amended Loan Agreement with Hercules. The Amendment extends the time period under which the Company can draw down the third tranche, of up to $15.0 million, from March 15, 2015 to August 1, 2015, subject to the Company obtaining approval for Zalviso from the U.S. Food and Drug Administration. The interest rate for each tranche will be calculated at a rate equal to the greater of either (i) 9.10% plus the prime rate as reported from time to time in The Wall Street Journal minus 5.25%, and (ii) 9.10%. Payments under the Amended Loan Agreement are interest only until April 1, 2015 (which will be extended until January 1, 2016, if we obtain Zalviso approval on or before April 1, 2015) followed by equal monthly payments of principal and interest through the scheduled maturity date on October 1, 2017 (which will be extended until January 1, 2018, if we obtain Zalviso approval on or prior to April 1, 2015), or the Loan Maturity Date. In addition, a final payment equal to $1.7 million will be due on the Loan Maturity Date, or such earlier date specified in the Amended Loan Agreement. Our obligations under the Amended Loan Agreement are secured by a security interest in substantially all of our assets, other than our intellectual property.

As of September 30, 2014, the outstanding principal owed to Hercules was $25.0 million.

Since our inception in July 2005, we have not generated any revenue from the sale of our products. As mentioned above, on July 25, 2014, the FDA issued a CRL for our NDA for Zalviso. We are currently working to prepare, submit and finalize with the FDA the protocols required to address certain issues raised in the CRL. In the third quarter of 2014, we held a meeting with the FDA to discuss the Zalviso CRL received in July. During the meeting we discussed the resubmission of the Zalviso NDA and the steps necessary for the resubmission. In advance of resubmitting our Zalviso NDA, we have agreed with the FDA to submit protocols for the bench testing and a Human Factors Study for their review and comment. In the interim, we continue the preparation necessary to initiate the bench testing and Human Factors study in the near term. Subject to the timing of the FDA review and comment on the protocols, the adequacy of such protocols, and the results generated from the bench testing and Human Factors Study, we are targeting resubmission of the Zalviso NDA in the first quarter of 2015. However, if the FDA review of the protocols takes longer than expected, the timing of the filing of the NDA could be later than the first quarter of 2015. The FDA confirmed that the planned resubmission will qualify as a Class 2 resubmission with a review period of six months. There is no guarantee that we will receive approval from the FDA on a timely basis, or at all, and there can be no guarantee that we will be able to produce product revenue in the foreseeable future, if ever.

Critical Accounting Estimates

The accompanying discussion and analysis of our financial condition and results of operations are based upon our financial statements and the related disclosures, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires us to make estimates, assumptions and judgments that affect the reported amounts in our financial statements and accompanying notes. 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 that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. To the extent that there are material differences between these estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected. Our critical accounting policies and estimates are detailed in our Annual Report on Form 10-K for the year ended December 31, 2013. There have been no significant changes in our critical accounting policies and estimates during the nine months ended September 30, 2014 from those previously disclosed in our Annual Report on Form 10-K.

Recently Issued Accounting Standards

In August 2014, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. ASU 2014-15 will explicitly require management to assess an entity’s ability to continue as a going concern, and to provide related footnote disclosure in certain circumstances. The new standard will be effective for AcelRx beginning in fiscal 2017. Earlier adoption is permitted. The Company is currently evaluating the potential impact of the adoption of ASU 2014-15.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, issued as a new Topic, Accounting Standards Codification, or ASC, Topic 606. The new revenue recognition standard provides a five-step analysis of transactions to determine when and how revenue is recognized. The core principle of the guidance is that a Company should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU is effective for AcelRx beginning in fiscal 2017 and can be adopted by us either retrospectively or as a cumulative-effect adjustment as of the date of adoption. We are currently evaluating the effect that adopting this new accounting guidance will have on our results of operations, cash flows and financial position.

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Results of Operations

Three and Nine Months Ended September 30, 2014 and 2013

Revenue

To date, we have not generated any commercial product revenue. We do not expect to receive any commercial sales revenue from any product candidates that we develop until we, or our collaborators, obtain regulatory approval and commercialize our products.

Collaboration Agreement

In December 2013, we announced a commercial collaboration with Grünenthal, covering the territory of the European Union, certain other European countries and Australia for Zalviso for potential use in pain treatment within or dispensed by a hospital, hospice, nursing home or other medically supervised setting. We retain all rights in remaining countries, including the United States, Asia and Central and South America.

Under the terms of the agreement, we received an upfront cash payment of $30.0 million in December 2013, and a milestone payment of $5.0 million related to the MAA submission in the third quarter of 2014. In the third quarter of 2014, we recognized $4.6 million of the $5.0 million. In addition, we recognized $264,000 related to our development work performed under the agreement in the third quarter of 2014. We are eligible to receive an additional $15.0 million milestone payment upon the approval of the MAA. After approval, we are eligible to receive approximately $200.0 million in additional milestone payments, based upon successful regulatory and product development efforts and net sales target achievements. Grünenthal will also make tiered royalty, supply and trademark fee payments in the mid-teens up to the mid-twenties percent range, on net sales of Zalviso in the Grünenthal territory.

Grünenthal will be responsible for all commercial activities for Zalviso, including obtaining and maintaining pharmaceutical product regulatory approval in the Grünenthal territory. We will be responsible for obtaining and maintaining device regulatory approval in the Grünenthal territory and manufacturing and supply of Zalviso to Grünenthal for commercial sales.

Research Grant

In May 2011, we received a grant award of $5.6 million from the USAMRMC for the development of ARX-04, a sufentanil tablet for the treatment of moderate-to-severe acute pain. Revenue related to this grant award was recognized as the related research and development expenses were incurred. As of December 31, 2013, we had completed all grant-supported research and development activities and the $5.6 million grant had been recognized in full.

Revenue for the three and nine months ended September 30, 2014, was $4.8 million and $5.0 million, respectively, which was primarily due to the recognition of the milestone payment for the MAA submission under our collaboration agreement with Grünenthal. Revenue for the three and nine months ended September 30, 2013, was $548,000 and $1.9 million, respectively, and was generated from our grant from the USAMRMC.

Research and Development Expenses

Conducting research and development is central to our business model. The majority of our operating expenses to date have been for research and development activities related to Zalviso. Research and development expenses included the following:

Product candidates in late stages of clinical development generally have higher development costs than those in earlier stages of clinical development, primarily due to the increased size and duration of late stage clinical trials. We will incur substantial future expenditures as we seek to continue development of Zalviso, including the requisite activities associated with preparing for the potential commercialization of Zalviso. In addition, we plan to continue to incur significant research and development expenses, including the expenses associated with the continued development of ARX-04. We do not plan to continue development of ARX-02 and ARX-03, unless additional funding or corporate partnership resources are available to support these programs.

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We track external development expenses on a program-by-program basis. Our development resources are shared among all of our programs. Compensation and benefits, facilities, depreciation, stock-based compensation, and development support services are not allocated specifically to projects and are considered research and development overhead. Below is a summary of our research and development expenses during the three and nine months ended September 30, 2014 and 2013 (in thousands):

Due to the inherently unpredictable nature of product development, development timelines and the probability of success, development costs can differ materially from expectations. While we are currently focused on advancing Zalviso and the continued development of ARX-04, our future research and development expenses will depend on the clinical success of each product candidate as well as ongoing assessments of the commercial potential of our product candidates. In addition, we cannot predict which product candidates may be subject to future collaborations, when these arrangements will be secured, if at all, and to what degree these arrangements would affect our development plans and capital requirements.

Total research and development expenses for the three and nine months ended September 30, 2014 and 2013 were as follows (in thousands, except percentages):

The $1.3 million decrease in research and development expenses during the three months ended September 30, 2014, as compared to the three months ended September 30, 2013, was primarily attributable to a decrease of $1.8 million related to our Zalviso development program mainly due to the FDA filing fee of $2.0 million for the Zalviso NDA in the third quarter of 2013, partially offset by a net increase of $0.5 million primarily due to increased personnel related expenses, including stock-based compensation.

The $4.7 million decrease in research and development expenses during the nine months ended September 30, 2014, as compared to the nine months ended September 30, 2013, was primarily attributable to a $6.6 million decrease related to our Zalviso Phase 3 clinical program, partially offset by an increase of $1.4 million related to personnel related expenses, including stock-based compensation, and an increase of $0.5 million related to our ARX-04 development program.

General and Administrative Expenses

General and administrative expenses consisted primarily of salaries, benefits and stock-based compensation for personnel in administration, finance, marketing and business development activities. Other significant expenses included legal expenses to pursue patent protection of our intellectual property, allocated facility costs and professional fees for general legal, audit and consulting services. We expect general and administrative expenses to continue to increase as we continue to build our corporate infrastructure in support of a pre-commercial organization and continue the development of our product candidates.

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Total general and administrative expenses for the three and nine months ended September 30, 2014 and 2013 were as follows (in thousands, except percentages):

General and administrative expenses increased over both comparative periods primarily due to increased market research activities related to our Zalviso development program and headcount-related expenses.

The $2.3 million increase in general and administrative expenses during the three months ended September 30, 2014, as compared to the three months ended September 30, 2013, was primarily due to an increase in market research and outside services of $1.1 million, primarily related to market research activities for Zalviso and an increase of $1.2 million, primarily in headcount-related expenses, consulting and professional services fees.

The $7.1 million increase in general and administrative expenses during the nine months ended September 30, 2014, as compared to the nine months ended September 30, 2013, was primarily due to an increase in market research and outside services of $4.1 million, primarily related to market research activities for Zalviso, an increase of $3.0 million, primarily in headcount-related expenses, including recruiting efforts, and consulting and other professional services fees.

Interest Expense

Interest expense consisted primarily of interest accrued or paid on our debt obligation agreements and amortization of debt discounts. Total interest expense for the three and nine months ended September 30, 2014 and 2013, was as follows (in thousands, except percentages):