Vanda Pharmaceuticals Inc. - Quarter Report: 2013 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

For the quarterly period ended September 30, 2013

or

For the transition period from                      to                     

Commission File Number: 001-34186

VANDA PHARMACEUTICALS INC.

(Exact name of registrant as specified in its charter)

(202) 734-3400

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    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.

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

As of October 31, 2013, there were 33,190,106 shares of the registrant’s common stock issued and outstanding.

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Vanda Pharmaceuticals Inc.

Quarterly Report on Form 10-Q

For the Quarter Ended September 30, 2013

INDEX

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Part I — FINANCIAL INFORMATION

Item 1. Financial Statements (Unaudited)

VANDA PHARMACEUTICALS INC.

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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VANDA PHARMACEUTICALS INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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VANDA PHARMACEUTICALS INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS (Unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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VANDA PHARMACEUTICALS INC.

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY (Unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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VANDA PHARMACEUTICALS INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

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VANDA PHARMACEUTICALS INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

1. Business Organization and Presentation

Business organization

Vanda Pharmaceuticals Inc. (Vanda or the Company) is a biopharmaceutical company focused on the development and commercialization of products for the treatment of central nervous system disorders. Vanda commenced its operations in 2003. Vanda’s product portfolio includes tasimelteon, a product for the treatment of circadian rhythm sleep disorders, which is currently in clinical development for Non-24-Hour Disorder (Non-24) and for which a New Drug Application (NDA) is under review by the U.S. Food and Drug Administration (FDA), Fanapt^®, a product for the treatment of schizophrenia, the oral formulation of which is currently being marketed and sold in the U.S. by Novartis Pharma AG (Novartis), and VLY-686, a small molecule neurokinin-1 receptor (NK-1R) antagonist.

Basis of presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all the information and footnotes required by GAAP for complete financial statements and should be read in conjunction with the Company’s consolidated financial statements for the year ended December 31, 2012 included in the Company’s annual report on Form 10-K. The financial information as of September 30, 2013 and for the three and nine months ended September 30, 2013 and 2012 is unaudited, but in the opinion of management, all adjustments, consisting only of normal recurring accruals, considered necessary for a fair statement of the results of these interim periods have been included. The condensed consolidated balance sheet data as of December 31, 2012 was derived from audited financial statements but does not include all disclosures required by GAAP.

The results of the Company’s operations for any interim period are not necessarily indicative of the results that may be expected for any other interim period or for a full fiscal year. The financial information included herein should be read in conjunction with the consolidated financial statements and notes in the Company’s annual report on Form 10-K for the year ended December 31, 2012.

Use of estimates

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

Recent accounting pronouncements

On January 1, 2013, Vanda adopted changes issued by the Financial Accounting Standards Board (FASB) for the reporting of amounts reclassified out of accumulated other comprehensive income. The changes require an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required to be reclassified in its entirety to net income. For other amounts that are not required to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures that provide additional detail about those amounts. Adoption of these changes did not have a material impact on the condensed consolidated financial statements.

In July 2013, the FASB issued Accounting Standard Update (ASU) 2013-11, Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists. This new standard requires the netting of unrecognized tax benefits against a deferred tax asset for a loss or other carryforward that would apply in settlement of the uncertain tax positions. Under the new standard, unrecognized tax benefits will be netted against all available same-jurisdiction loss or other tax carryforwards that would be utilized, rather than only against carryforwards that are created by the unrecognized tax benefits. The Company does not expect that the new standard will have a material impact on the condensed consolidated financial statements.

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2. Earnings per Share

Basic earnings per share (EPS) is calculated by dividing the net income (loss) by the weighted average number of shares of common stock outstanding. Diluted EPS is computed by dividing the net income (loss) by the weighted average number of shares of common stock outstanding, plus potential outstanding common stock for the period. Potential outstanding common stock includes stock options and shares underlying Restricted Stock Units (RSUs), but only to the extent that their inclusion is dilutive.

The following table presents the calculation of basic and diluted net loss per share of common stock for the three and nine months ended September 30, 2013 and 2012:

The Company incurred net losses for the three and nine months ended September 30, 2013 and 2012 causing inclusion of any potentially dilutive securities to have an anti-dilutive effect, resulting in dilutive loss per share and basic loss per share attributable to common stockholders being equivalent.

3. Marketable Securities

The Company did not hold any available-for-sale marketable securities as of September 30, 2013.

The following is a summary of the Company’s available-for-sale marketable securities as of December 31, 2012:

4. Fair Value Measurements

Authoritative guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include:

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The Company did not hold any marketable securities as of September 30, 2013. Marketable securities classified in Level 1 and Level 2 at December 31, 2012 consist of available-for-sale marketable securities. The valuation of Level 1 instruments is determined using a market approach, and is based upon unadjusted quoted prices for identical assets in active markets. The valuation of investments classified in Level 2 also is determined using a market approach based upon quoted prices for similar assets in active markets, or other inputs that are observable for substantially the full term of the financial instrument. Level 2 securities include certificates of deposit, commercial paper and corporate notes that use as their basis readily observable market parameters.

As of September 30, 2013, the Company did not hold any assets that are required to be measured at fair value on a recurring basis.

As of December 31, 2012, the Company held certain assets that are required to be measured at fair value on a recurring basis, as follows:

The Company also has financial assets and liabilities, not required to be measured at fair value on a recurring basis, which primarily consist of cash and cash equivalents, accounts receivable, restricted cash, accounts payable and accrued liabilities, the carrying value of which materially approximate their fair values.

5. Prepaid Expenses and Other Current Assets

The following is a summary of the Company’s prepaid expenses and other current assets as of September 30, 2013 and December 31, 2012:

6. Intangible Asset

The following is a summary of the Company’s intangible asset as of September 30, 2013:

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The following is a summary of the Company’s intangible asset as of December 31, 2012:

In May 2009, the Company announced that the FDA had approved the New Drug Application (NDA) for Fanapt^®. As a result of this approval, the Company met a milestone under its original sublicense agreement with Novartis which required the Company to make a license payment of $12.0 million to Novartis. The $12.0 million is being amortized on a straight-line basis over the remaining life of the U.S. patent for Fanapt^®, which the Company expects to last until May 2017. This includes the Hatch-Waxman extension that provides patent protection for drug compounds for a period of five years to compensate for time spent in development and a six-month pediatric term extension. Fanapt^® has qualified for the full five-year patent term Hatch-Waxman extension and the Company expects that Fanapt^® will be eligible for six months of pediatric exclusivity. This term is the Company’s best estimate of the life of the patent; if, however, the pediatric extension is not granted, the intangible asset will be amortized over a shorter period.

The intangible asset is being amortized over its estimated useful economic life using the straight-line method. Amortization expense was $0.4 million for the three months ended September 30, 2013 and 2012 and $1.1 million for the nine months ended September 30, 2013 and 2012. The Company capitalized and began amortizing the asset immediately following the FDA approval of the NDA for Fanapt^®.

The following is a summary of the future intangible asset amortization schedule as of September 30, 2013:

7. Accrued Liabilities

The following is a summary of the Company’s accrued liabilities as of September 30, 2013 and December 31, 2012:

8. Deferred Revenue

The following is a summary of changes in total deferred revenue for the nine months ended September 30, 2013:

The following is a summary of changes in total deferred revenue for the nine months ended September 30, 2012:

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The Company entered into an amended and restated sublicense agreement with Novartis in October 2009, pursuant to which Novartis has the right to commercialize and develop Fanapt^® in the U.S. and Canada. Under the amended and restated sublicense agreement, the Company received an upfront payment of $200.0 million in December 2009. The Company and Novartis established a Joint Steering Committee (JSC) following the effective date of the amended and restated sublicense agreement. The Company concluded that the JSC constitutes a deliverable under the amended and restated sublicense agreement and that revenue related to the upfront payment will be recognized ratably over the term of the JSC; however, the delivery or performance has no term as the exact length of the JSC is undefined. As a result, the Company deems the performance period of the JSC to be the life of the U.S. patent of Fanapt^®, which the Company expects to last until May 2017. This includes the Hatch-Waxman extension that provides patent protection for drug compounds for a period of five years to compensate for time spent in development and a six-month pediatric term extension. Fanapt^® has qualified for the full five-year patent term Hatch-Waxman extension and the Company expects that Fanapt^® will be eligible for six months of pediatric exclusivity. This term is the Company’s best estimate of the life of the patent. Revenue related to the upfront payment will be recognized ratably from the date the amended and restated sublicense agreement became effective (November 2009) through the expected life of the U.S. patent for Fanapt^® (May 2017).

9. Income Taxes

Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The fact that the Company has historically generated net operating losses (NOLs) serves as strong evidence that it is more likely than not that deferred tax assets will not be realized in the future. Therefore, the Company has a full valuation allowance against all deferred tax assets as of September 30, 2013 and December 31, 2012. Changes in ownership may limit the amount of NOL carryforwards that can be utilized in the future to offset taxable income.

10. Commitments and Contingencies

Operating leases

The following is a summary of the minimum annual future payments under operating leases as of September 30, 2013:

The minimum annual future payments for operating leases consists of the lease for office space for the Company’s headquarters located in Washington, D.C., which expires in 2023.

In July 2011, the Company entered into an office lease with Square 54 Office Owner LLC (the Landlord) for its current headquarters, consisting of 21,400 square feet at 2200 Pennsylvania Avenue, N.W. in Washington, D.C. (the Lease). Under the Lease, rent payments were abated for the first 12 months, and the Landlord will provide the Company with an allowance of $1.9 million for leasehold improvements. As of September 30, 2013, the Company had received the full allowance. Subject to the prior rights of other tenants in the building, the Company has the right to renew the Lease for five years following the expiration of its original term. The Company has the right to sublease or assign all or a portion of the premises, subject to standard conditions. The Lease may be terminated early by the Company or the Landlord upon certain conditions.

As a result of the Company’s relocation from its former headquarters office space in Rockville, Maryland to Washington, D.C., the Company provided notice in the fourth quarter of 2011 to the landlord that it was terminating the Rockville lease effective June 30, 2013. As a result, the Company recognized an expense of $0.7 million in the year ended December 31, 2011 related to a lease termination penalty, of which $0.6 million was included as research and development expense in the consolidated statement of operations for the year ended December 31, 2011 and $0.1 million was included as general and administrative expense in the consolidated statement of operations for the year ended December 31, 2011. In the first quarter 2012, the Company ceased using the Rockville, Maryland location and, as a result, recognized additional rent expense of $0.8 million, of which $0.6 million was included as research and development expense in the consolidated statement of operations for the year ended December 31, 2012 and $0.2 million was included as general and administrative expense in the consolidated statement of operations for the year ended December 31, 2012. The rent expense of

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$0.8 million for the year ended December 31, 2012, consisted of a lease exit liability of $1.3 million for the remaining lease payments net of the reversal of the deferred rent liability of $0.5 million related to the Rockville lease.

The following is a summary of the Company’s lease exit activity for the nine months ended September 30, 2013, the year ended December 31, 2012 and the year ended December 31, 2011:

Rent expense under operating leases, including lease exit costs, was $0.3 million and $0.2 million for the three months ended September 30, 2013 and 2012, respectively. Rent expense under operating leases, including lease exit costs, was $0.8 million and $1.8 million for the nine months ended September 30, 2013 and 2012, respectively.

Consulting fees

The Company has engaged a regulatory consultant to assist the Company’s efforts to prepare, file and obtain FDA approval of an NDA for tasimelteon. As a result of the FDA acceptance of the NDA filing for tasimelteon for the treatment of Non-24, the Company made a milestone payment of $0.5 million to the regulatory consultant during the three months ended September 30, 2013. The payment was included as research and development expense in the consolidated statement of operations for the three and nine months ended September 30, 2013. Pursuant to the agreement and subject to certain conditions, the Company would be obligated to make a milestone payment of $2.0 million in the event the tasimelteon NDA is approved by the FDA. In addition to consulting fees and milestone payments, the Company is obligated to reimburse the consultant for ordinary and necessary business expenses incurred in connection with the engagement. The Company may terminate the engagement at any time upon prior notice; however, subject to certain conditions, the Company would remain obligated to make the milestone payment if the milestone is achieved following such termination.

Guarantees and indemnifications

The Company has entered into a number of standard intellectual property indemnification agreements in the ordinary course of its business. Pursuant to these agreements, the Company indemnifies, holds harmless, and agrees to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally the Company’s business partners or customers, in connection with any U.S. patent or any copyright or other intellectual property infringement claim by any third party with respect to the Company’s products. The term of these indemnification agreements is generally perpetual from the date of execution of the agreement. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited. Since inception, the Company has not incurred costs to defend lawsuits or settle claims related to these indemnification agreements. The Company also indemnifies its officers and directors for certain events or occurrences, subject to certain conditions.

License agreements

The Company’s rights to develop and commercialize its products and product candidates are subject to the terms and conditions of licenses granted to the Company by other pharmaceutical companies.

Tasimelteon. In February 2004, the Company entered into a license agreement with Bristol-Myers Squibb (BMS) under which the Company received an exclusive worldwide license under certain patents and patent applications, and other licenses to intellectual property, to develop and commercialize tasimelteon. In partial consideration for the license, the Company paid BMS an initial license fee of $0.5 million. Pursuant to the license agreement, the Company would be obligated to make future milestone payments to BMS of up to $37.0 million in the aggregate. The Company made a milestone payment to BMS of $1.0 million under the license agreement in 2006 relating to the initiation of its first Phase III clinical trial for tasimelteon. The Company made a milestone payment of $3.0 million during the three months ended September 30, 2013 relating to the FDA acceptance of the NDA filing for tasimelteon in the treatment of Non-24. The payment was included as research and development expense in the consolidated statement of operations for the three

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and nine months ended September 30, 2013. The Company will incur milestone obligations of $8.0 million in the event that the tasimelteon NDA is approved by the FDA and $25.0 million in the event that sales of tasimelteon reach a certain agreed upon sales threshold. Additionally, the Company would be obligated to make royalty payments based on net sales of tasimelteon which, as a percentage of net sales, are in the low teens. The Company is also obligated under the license agreement to pay BMS a percentage of any sublicense fees, upfront payments and milestone and other payments (excluding royalties) that the Company receives from a third party in connection with any sublicensing arrangement, at a rate which is in the mid-twenties. The Company is obligated to use commercially reasonable efforts to develop and commercialize tasimelteon and to meet certain milestones in initiating and completing certain clinical work.

Under the license agreement, the Company was required to enter into a development and commercialization agreement with a third party for tasimelteon. If the Company had not entered into such an agreement with respect to certain major market countries by a certain deadline, then BMS would have had the option to develop and commercialize tasimelteon itself in those countries not covered by a development and commercialization agreement on certain pre-determined terms (the “BMS Option”). However, the license agreement was amended in April 2013 to add a process that would allow BMS, prior to such deadline, to waive such right to develop and commercialize tasimelteon in those countries not covered by a development and commercialization agreement. Subsequent to the execution of the April 2013 amendment, BMS provided the Company with formal written notice that it irrevocably waived the BMS Option to exercise the right to reacquire any or all rights to any product (as defined in the license agreement) containing tasimelteon, or to develop or commercialize any such product, in the countries not covered by a development and commercialization agreement.

Either party may terminate the tasimelteon license agreement under certain circumstances, including a material breach of the agreement by the other. In the event that BMS has not exercised its option to reacquire the rights to tasimelteon and the Company terminates the license, or if BMS terminates the license due to the Company’s breach, all rights licensed and developed by the Company under the license agreement will revert or otherwise be licensed back to BMS on an exclusive basis.

Fanapt^®. The Company acquired exclusive worldwide rights to patents and patent applications for Fanapt^® (iloperidone) in 2004 through a sublicense agreement with Novartis. A predecessor company of sanofi-aventis, Hoechst Marion Roussel, Inc. (HMRI), discovered Fanapt^® and completed early clinical work on the product. In 1996, following a review of its product portfolio, HMRI licensed its rights to the Fanapt^® patents and patent applications to Titan Pharmaceuticals, Inc. (Titan) on an exclusive basis. In 1997, soon after it had acquired its rights, Titan sublicensed its rights to Fanapt^® on an exclusive basis to Novartis. In June 2004, the Company acquired exclusive worldwide rights to these patents and patent applications, as well as certain Novartis patents and patent applications to develop and commercialize Fanapt^®, through a sublicense agreement with Novartis. In partial consideration for this sublicense, the Company paid Novartis an initial license fee of $0.5 million and was obligated to make future milestone payments to Novartis of less than $100.0 million in the aggregate (the majority of which were tied to sales milestones), as well as royalty payments to Novartis at a rate which, as a percentage of net sales, was in the mid-twenties. In November 2007, the Company met a milestone under the sublicense agreement relating to the acceptance of its filing of the NDA for Fanapt^® for the treatment of schizophrenia and made a milestone payment of $5.0 million to Novartis. As a result of the FDA’s approval of the NDA for Fanapt^® in May 2009, the Company met an additional milestone under the sublicense agreement, which required the Company to make a payment of $12.0 million to Novartis.

In October 2009, Vanda entered into an amended and restated sublicense agreement with Novartis, which amended and restated the June 2004 sublicense agreement. Pursuant to the amended and restated sublicense agreement, Novartis has exclusive commercialization rights to all formulations of Fanapt^® in the U.S. and Canada. Novartis began selling Fanapt^® in the U.S. during the first quarter of 2010. Novartis is responsible for the further clinical development activities in the U.S. and Canada, including the development of a long-acting injectable (or depot) formulation of Fanapt^®. In October 2012, Novartis informed Vanda that it had determined to cease the development of the long-acting injectable (or depot) formulation of Fanapt^®. Pursuant to the amended and restated sublicense agreement, Vanda received an upfront payment of $200.0 million and is eligible for additional payments totaling up to $265.0 million upon Novartis’ achievement of certain commercial and development milestones for Fanapt^® in the U.S. and Canada. Based on the current sales performance of Fanapt^® in the U.S. and the decision by Novartis to cease development of the long-acting

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injectable (or depot) formulation of Fanapt^®, Vanda expects that some or all of these commercial and development milestones will not be achieved by Novartis. Vanda also receives royalties, which, as a percentage of net sales, are in the low double-digits, on net sales of Fanapt^® in the U.S. and Canada. Vanda retains exclusive rights to Fanapt^® outside the U.S. and Canada and Vanda has exclusive rights to use any of Novartis’ data for Fanapt^® for developing and commercializing Fanapt^® outside the U.S. and Canada. At Novartis’ option, Vanda will enter into good faith discussions with Novartis relating to the co-commercialization of Fanapt^® outside of the U.S. and Canada or, alternatively, Novartis will receive a royalty on net sales of Fanapt^® outside of the U.S. and Canada. Novartis has chosen not to co-commercialize Fanapt^® with Vanda in Europe and certain other countries and will instead receive a royalty on net sales in those countries. These include, but are not limited to, the countries in the European Union as well as Switzerland, Norway, Liechtenstein and Iceland. Vanda has entered into agreements with the following partners for the commercialization of Fanapt^® in the countries set forth below:

In August 2012, the Israeli Ministry of Health granted market approval for Fanapt^® for the treatment of schizophrenia. In November 2012, Vanda was notified that Fanapt^® had been granted market approval in Argentina for the treatment of schizophrenia. In October 2013, the Mexican Federal Commission for Protection Against Sanitary Risks (COFEPRIS) granted market approval for Fanapt^® for the treatment of schizophrenia.

VLY-686. In April 2012, the Company entered into a license agreement with Eli Lilly and Company (Lilly) pursuant to which the Company acquired an exclusive worldwide license under certain patents and patent applications, and other licenses to intellectual property, to develop and commercialize an NK-1R antagonist, VLY-686, for all human indications. The patent describing VLY-686 as a new chemical entity expires in April 2023, except in the U.S., where it expires in June 2024 absent any applicable patent term adjustments.

Pursuant to the license agreement, the Company paid Lilly an initial license fee of $1.0 million and will be responsible for all development costs. The initial license fee was recognized as research and development expense in the consolidated statement of operations for the nine months ended September 30, 2012. Lilly is also eligible to receive additional payments based upon achievement of specified development and commercialization milestones as well as tiered-royalties on net sales at percentage rates up to the low double digits. These milestones include $4.0 million for pre-NDA approval milestones and up to $95.0 million for future regulatory approval and sales milestones. Vanda is obligated to use its commercially reasonable efforts to develop and commercialize VLY-686.

Either party may terminate the license agreement under certain circumstances, including a material breach of the license agreement by the other. In the event that Vanda terminates the license agreement, or if Lilly terminates due to Vanda’s breach or for certain other reasons set forth in the license agreement, all rights licensed and developed by Vanda under the license agreement will revert or otherwise be licensed back to Lilly on an exclusive basis, subject to payment by Lilly to the Company of a royalty on net sales of products that contain VLY-686.

Future milestone payments. No amounts were recorded as liabilities nor were any future contractual obligations relating to the license agreements included in the consolidated financial statements as of September 30, 2013 because the criteria for recording the future milestone payments have not yet been met. These criteria include the successful outcome of future clinical trials, regulatory filings, favorable FDA regulatory approvals, growth in product sales and other factors.

Research and development and marketing agreements

In the course of its business, the Company regularly enters into agreements with clinical organizations to provide services relating to clinical development and clinical manufacturing activities under fee service arrangements. The Company’s current agreements for clinical services may be terminated on no more than 60 days’ notice without incurring additional charges, other than charges for work completed but not paid for through the effective date of termination and other costs incurred by the Company’s contractors in closing out work in progress as of the effective date of termination.

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11. Common Stock

In August 2013, the Company completed a public offering of 4,680,000 shares of common stock at a price to the public of $11.14 per share. Net cash proceeds from the public offering were $48.6 million, after deducting the underwriting discounts and commissions and offering expenses.

12. Employee Stock-Based Compensation

Compensation costs for all stock-based awards to employees and directors are measured based on the grant date fair value of those awards and recognized over the period during which the employee or director is required to perform service in exchange for the award. The Company generally recognizes the expense over the award’s vesting period.

The fair value of stock options granted is amortized using the accelerated attribution method. The fair value of RSUs awarded is amortized using the straight-line method. As stock-based compensation expense recognized in the consolidated statements of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. Forfeitures are required to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

Total employee stock-based compensation expense related to stock-based awards for the three and nine months ended September 30, 2013 and 2012 was comprised of the following:

The fair value of each option award is estimated on the date of grant using the Black-Scholes-Merton option pricing model that uses the assumptions noted in the following table. Expected volatility rates are based on the historical volatility of the Company’s publicly traded common stock and other factors. The weighted average expected term of stock options granted is based on the simplified method as the options meet the “plain vanilla” criteria required by authoritative guidance. Significant changes in the market prices of the Company’s common stock in recent years has made historical data less reliable for the purpose of estimating future vesting, exercise, and employment behavior. The simplified method provides a more reasonable approach for estimating the weighted average expected term for options granted in 2013 and 2012. The risk-free interest rates are based on the U.S. Treasury yield for a period consistent with the expected term of the option in effect at the time of the grant. The Company has not paid dividends to its stockholders since its inception (other than a dividend of preferred share purchase rights, which was declared in September 2008) and does not plan to pay dividends in the foreseeable future.

Assumptions used in the Black-Scholes-Merton option pricing model for employee and director stock options granted during the nine months ended September 30, 2013 and 2012 were as follows:

As of September 30, 2013, the Company had two equity incentive plans, the Second Amended and Restated Management Equity Plan (the 2004 Plan) and the 2006 Equity Incentive Plan (the 2006 Plan). There were 670,744 shares subject to outstanding options granted under the 2004 Plan as of September 30, 2013, and no

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additional options will be granted under this plan. As of September 30, 2013, there were 8,995,930 shares of common stock reserved for issuance under the 2006 Plan, of which 5,332,870 shares were subject to outstanding options and RSUs granted to employees and non-employees and 2,213,524 shares remained available for future grant.

The Company has granted two types of options, option awards with service conditions (service option awards) and options with service and performance conditions (performance option awards). Service option awards are subject to terms and conditions established by the compensation committee of the board of directors. Service option awards have 10-year contractual terms and all service option awards granted prior to December 31, 2006, service option awards granted to new employees, and certain service option awards granted to existing employees vest and become exercisable on the first anniversary of the grant date with respect to the 25% of the shares subject to service option awards. The remaining 75% of the shares subject to the service option awards vest and become exercisable monthly in equal installments thereafter over three years. Certain service option awards granted to existing employees after December 31, 2006 vest and become exercisable monthly in equal installments over four years. The initial service option awards granted to directors upon their election vest and become exercisable in equal monthly installments over a period of four years, while the subsequent annual service option awards granted to directors vest and become exercisable in equal monthly installments over a period of one year. Certain service option awards to executives and directors provide for accelerated vesting if there is a change in control of the Company. Certain service option awards to employees and executives provide for accelerated vesting if the respective employee’s or executive’s service is terminated by the Company for any reason other than cause or permanent disability. There were 151,250 performance option awards outstanding with unrecognized stock-based compensation costs of $0.3 million at June 30, 2013. In July 2013, the performance option awards vested upon the acceptance by the FDA of the Company’s tasimelteon NDA (the Vesting Event). The Vesting Event for the performance option awards resulted in the recognition of additional stock-based compensation expense of $0.3 million for the three months and nine months ended September 30, 2013. As of September 30, 2013, there was $2.1 million of unrecognized compensation costs related to unvested service option awards expected to be recognized over a weighted average period of 1.6 years. None of the service option awards or performance option awards are classified as a liability as of September 30, 2013.

A summary of option activity for the 2004 Plan for the nine months ended September 30, 2013 follows:

A summary of option activity for the 2006 Plan for the nine months ended September 30, 2013 follows:

Proceeds from the exercise of stock options amounted to $1.1 million for the nine months ended September 30, 2013.

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An RSU is a stock award that entitles the holder to receive shares of the Company’s common stock as the award vests. The fair value of each RSU is based on the closing price of the Company’s stock on the date of grant. The Company has granted two types of RSUs, RSUs with service conditions (service RSUs) and RSUs with service and performance conditions (performance RSUs). The service RSUs vest in four equal annual installments provided that the employee remains employed with the Company. There were 48,750 performance RSUs outstanding with unrecognized stock-based compensation costs of $0.2 million at June 30, 2013. In July 2013, the performance RSUs vested upon the Vesting Event. The Vesting Event for the performance RSUs resulted in the recognition of additional stock-based compensation expense of $0.2 million for the three months and nine months ended September 30, 2013. As of September 30, 2013, there was $2.4 million of unrecognized compensation costs related to unvested service RSUs expected to be recognized over a weighted average period of 1.7 years. None of the service RSUs or performance RSUs are classified as a liability as of September 30, 2013.

A summary of RSU activity for the 2006 Plan for the nine months ended September 30, 2013 follows:

The vesting date fair value for the 48,750 shares underlying performance RSUs that vested but are unissued during the nine months ended September 30, 2013 was $0.4 million. The vesting date fair value for the 152,436 shares underlying RSUs that vested during the nine months ended September 30, 2013 was $0.6 million. In order for certain employees to satisfy the minimum statutory employee tax withholding requirements related to the issuance of common stock underlying certain of RSUs that vested and settled during the nine months ended September 30, 2013, the Company withheld 49,520 shares of common stock and paid employee payroll withholding taxes of $0.2 million relating to the vesting and settlement of the RSUs.

13. Legal Matters

On June 24, 2013, a securities class action complaint was filed in the United States District Court for the District of Columbia, naming the Company and certain of its officers as defendants. The complaint, filed on behalf of purported stockholders of the Company, seeks to assert violations of Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, in connection with allegedly false and misleading statements and alleged omissions regarding the Company’s Phase III trial results for tasimelteon and other disclosures between December 18, 2012 and June 18, 2013 (the “Class Period”). The plaintiff seeks to represent a class comprised of purchasers of the Company’s common stock during the Class Period and seeks damages, costs and expenses and such other relief as determined by the Court. A similar complaint was filed on July 8, 2013.

The Company’s management believes that Vanda has meritorious defenses and intends to defend these lawsuits vigorously. The Company does not anticipate that this litigation will have a material adverse effect on its business, results of operations or financial condition. However, these lawsuits are subject to inherent uncertainties, the actual cost may be significant, and the Company may not prevail. The Company believes it is entitled to coverage under its relevant insurance policies, subject to a retention, but coverage could be denied or prove to be insufficient.

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

Cautionary Note Regarding Forward-Looking Statements

Various statements throughout this report are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements may appear throughout this report. Words such as, but not limited to, “believe,” “expect,” “anticipate,” “estimate,” “intend,” “plan,” “project,” “target,” “goal,” “likely,” “will,” “would,” and “could,” or the negative of these terms and similar expressions or words, identify forward-looking statements. Forward-looking statements are based upon current expectations that involve risks, changes in circumstances, assumptions and uncertainties. Important factors that could cause actual results to differ materially from those reflected in our forward-looking statements include, among others:

All written and verbal forward-looking statements attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this section. We caution investors not to rely too heavily on the forward-looking statements we make or that are made on our behalf. We undertake no obligation, and specifically decline any obligation, to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

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We encourage you to read Management’s Discussion and Analysis of Financial Condition and Results of Operations as well as our unaudited condensed consolidated financial statements contained in this quarterly report on Form 10-Q. In addition, you should refer to Item 1A of Part I of our annual report on Form 10-K for the fiscal year ended December 31, 2012, and Item 1A of Part II of this quarterly report on Form 10-Q for a discussion of other important factors that may cause our actual results to differ materially from those expressed or implied by our forward-looking statements. The information in this report should be read together with other reports and documents that we file with the Securities and Exchange Commission (SEC) from time to time, including Forms 10-Q, 8-K and 10-K, which may supplement, modify, supersede or update those risk factors. As a result of these factors, we cannot assure you that the forward-looking statements in this report will prove to be accurate. Furthermore, if our forward-looking statements prove to be inaccurate, the inaccuracy may be material. In light of the significant uncertainties in these forward-looking statements, you should not regard these statements as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified time frame, or at all.

Overview

We are a biopharmaceutical company focused on the development and commercialization of products for the treatment of central nervous system disorders. We believe that each of our products will address a large market with significant unmet medical needs. Our product portfolio includes tasimelteon, a product for the treatment of circadian rhythm sleep disorders, which is currently in clinical development for Non-24-Hour Disorder (Non-24) and for which a New Drug Application (NDA) is under review by the U.S. Food and Drug Administration (FDA), Fanapt^®, a product for the treatment of schizophrenia, the oral formulation of which is currently being marketed and sold in the U.S. by Novartis Pharma AG (Novartis), and VLY-686, a small molecule neurokinin-1 receptor (NK-1R) antagonist.

In December 2012 and January 2013, we announced positive results for two Phase III studies for tasimelteon in the treatment of Non-24. The SET Phase III study demonstrated that tasimelteon was able to entrain the master body clock as measured by melatonin and cortisol circadian rhythms. Tasimelteon was also shown to significantly improve clinical symptoms across a number of sleep and wake measures. These results provided robust evidence of direct and clinically meaningful benefits to patients with Non-24. The RESET Phase III study demonstrated the maintenance effect of 20 milligrams (mg) of tasimelteon to entrain melatonin and cortisol circadian rhythms in individuals with Non-24. Patients treated with tasimelteon maintained their clinical benefits while patients receiving placebo showed significant deterioration in measures of nighttime sleep, daytime naps and timing of sleep. In May 2013, we submitted an NDA to the FDA for tasimelteon for the treatment of Non-24. In July 2013, we announced that the FDA accepted the filing and granted a priority review classification to our NDA for tasimelteon for the treatment of Non-24 in the totally blind. The FDA determined the action target date under the Prescription Drug User Fee Act (PDUFA-V) to be January 31, 2014. The FDA scheduled a Peripheral and Central Nervous System Drugs Advisory Committee meeting on November 14, 2013 for the review of our NDA for tasimelteon, proposed trade name HETLIOZ^TM, for the treatment of Non-24 in the totally blind. As a result of the FDA accepting the NDA filing for tasimelteon, we incurred costs of $4.0 million in the three and nine months ended September 30, 2013, including a $3.0 million milestone obligation under our license agreement with Bristol-Meyers Squibb (BMS), a $0.5 million milestone obligation under a regulatory consulting agreement and non-cash stock-based compensation expense of $0.3 million for performance-based stock options and $0.2 million for performance-based restricted stock unit (RSU) awards. In January 2013, we reported top-line results of the Phase IIb/III clinical study (MAGELLAN) in Major Depressive Disorder (MDD), investigating the efficacy and safety of tasimelteon as a monotherapy in the treatment of patients with MDD. The clinical study did not meet the primary endpoint of change from baseline in the Hamilton Depression Scale (HAMD-17) after eight weeks of treatment as compared to placebo. As a result, all activities have been discontinued related to the MDD indication for tasimelteon. We incurred $19.1 million in research and development costs for the nine months ended September 30, 2013 directly attributable to our development of tasimelteon.

In December 2012, the European Medicines Agency’s (EMA) Committee for Medicinal Products for Human Use (CHMP) issued a negative opinion recommending against approval of Fanaptum™ (oral iloperidone tablets) for the treatment of schizophrenia in adult patients in the European Union. The CHMP was of the opinion that the benefits of Fanaptum™ did not outweigh its risks and recommended against marketing authorization. We initiated an appeal of this opinion and requested a re-examination of the decision by the CHMP, but withdrew our Marketing Authorization Application in the first quarter of 2013 because the additional clinical data requested by the CHMP would not have been available in the timeframe allowed by the EMA’s Centralized Procedure. We

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intend to reassess our European regulatory strategy for Fanaptum™ once the results from the Relapse Prevention Study in Patients with Schizophrenia (REPRIEVE) being conducted by Novartis become available. We incurred $0.4 million in research and development costs for the nine months ended September 30, 2013 directly attributable to our development of Fanapt^®.

In the second half of 2013, we plan to initiate a proof of concept study for VLY-686 in treatment resistant pruritus in atopic dermatitis. We incurred $1.5 million in research and development costs for the nine months ended September 30, 2013 directly attributable to our development of VLY-686.

Since we began operations in March 2003, we have devoted substantially all of our resources to the in-licensing and clinical development of our products. Our ability to generate revenue and achieve profitability largely depends on our ability, alone or with others, to complete the development of our products, and to obtain the regulatory approvals for and to manufacture, market and sell our products, including tasimelteon for the treatment of Non-24 and Novartis’ ability to successfully commercialize Fanapt^® in the U.S. The results of our operations will vary significantly from year-to-year and quarter-to-quarter and depend on a number of factors, including risks related to our business, risks related to our industry, and other risks which are detailed in “Risk Factors” reported in Item 1A of Part I of our annual report in Form 10-K for the year ended December 31, 2012 and Item 1A of Part II of this quarterly report on Form 10-Q.

Revenues

Our revenues are derived primarily from our amended and restated sublicense agreement with Novartis and include an upfront payment, product sales and future milestone and royalty payments. Revenues are considered both realizable and earned when the following four conditions are met: (i) persuasive evidence of an arrangement exists, (ii) the arrangement fee is fixed or determinable, (iii) delivery or performance has occurred, and (iv) collectability is reasonably assured. Revenue related to the $200.0 million upfront payment is being recognized ratably on a straight-line basis from the date the amended and restated sublicense agreement became effective (November 2009) through the expected life of the U.S. patent for Fanapt^® which we expect to last until May 2017. This includes the Hatch-Waxman extension that extends patent protection for drug compounds for a period of five years to compensate for time spent in development and a six-month pediatric term extension. Fanapt^® has qualified for the full five-year patent term Hatch-Waxman extension and we expect that Fanapt^® will be eligible for six months of pediatric exclusivity. We recognize revenues from Fanapt^® royalties and commercial and development milestones from Novartis when realizable.

Research and development expenses

Research and development expenses consist primarily of fees for services provided by third parties in connection with the clinical trials, costs of contract manufacturing services, milestone payments made under licensing agreements prior to regulatory approval, costs of materials used in clinical trials and research and development, costs for regulatory consultants and filings, depreciation of capital resources used to develop products, related facilities costs, and salaries, other employee-related costs and stock-based compensation for research and development personnel. We expense research and development costs as they are incurred for products in the development stage, including manufacturing costs and milestone payments made under license agreements prior to FDA approval. Upon and subsequent to FDA approval, manufacturing and milestone payments made under license agreements are capitalized. Milestone payments are accrued when it is deemed probable that the milestone event will be achieved. Costs related to the acquisition of intellectual property are expensed as incurred if the underlying technology is developed in connection with our research and development efforts and has no alternative future use.

We incurred research and development expenses in the aggregate of $22.0 million for the nine months ended September 30, 2013 including employee stock-based compensation expense of $1.2 million. Milestone payments relating to research and development activities are accrued when it is deemed probable that the milestone event will be achieved. As a result of the FDA acceptance of our NDA for tasimelteon for the treatment of Non-24 in July 2013, we incurred milestone obligations of $3.5 million for the three and nine months ended September 30, 2013 including a $3.0 million milestone obligation under our license agreement with BMS and a $0.5 million milestone obligation under a regulatory consulting agreement.

We will be obligated to make a milestone payment of $8.0 million to BMS under the license agreement for tasimelteon in the event our NDA for tasimelteon for the treatment of Non-24 is approved by the FDA. Upon

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and subsequent to FDA approval, milestone payments made under license agreements are capitalized. In addition, we will be obligated to make a milestone payment of $2.0 million under a regulatory consulting agreement in the event our NDA for tasimelteon for the treatment of Non-24 is approved by the FDA. The FDA determined the action target date under the Prescription Drug User Fee Act (PDUFA-V) to be January 31, 2014. The FDA scheduled a Peripheral and Central Nervous System Drugs Advisory Committee meeting on November 14, 2013 for the review of the Company’s NDA for tasimelteon, proposed trade name HETLIOZ^TM, for the treatment of Non-24 in the totally blind. We expect to incur significant research and development expenses as we continue to develop our products and product candidates. We expect to incur licensing costs in the future that could be substantial, as we continue our efforts to develop our products.

The following table summarizes the costs of our product development initiatives for the three and nine months ended September 30, 2013 and 2012. Included in this table are the research and development expenses recognized in connection with the clinical development of tasimelteon, Fanapt^® and VLY-686:

General and administrative expenses

General and administrative expenses consist primarily of salaries, other related costs for personnel, including employee stock-based compensation, related to executive, finance, accounting, information technology, marketing, medical affairs and human resource functions. Other costs include facility costs not otherwise included in research and development expenses and fees for marketing, medical affairs, legal, accounting and other professional services. General and administrative expenses also include third party expenses incurred to support business development, marketing and other business activities. We incurred general and administrative expenses of $14.7 million for the nine months ended September 30, 2013, including employee stock-based compensation expense of $2.1 million.

Employee stock-based compensation expense

Total employee stock-based compensation expense related to stock-based awards for the three and nine months ended September 30, 2013 and 2012 was comprised of the following:

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Critical Accounting Policies

The preparation of our condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of our financial statements, as well as the reported revenues and expenses during the reported periods. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

There have been no significant changes in our critical accounting policies including estimates, assumptions and judgments as described in Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our annual report on Form 10-K for the year ended December 31, 2012.

Recent Accounting Pronouncements

See Note 1 to the condensed consolidated financial statements included in Part I of this quarterly report on Form 10-Q for information on recent accounting pronouncements.

Results of Operations

We anticipate that our results of operations will fluctuate for the foreseeable future due to several factors, including any possible payments made or received pursuant to license or collaboration agreements, progress of our research and development efforts, the timing and outcome of clinical trials and related possible regulatory approvals and our and our partners’ ability to successfully commercialize our products. Our limited operating history makes predictions of future operations difficult or impossible. Since our inception, we have incurred significant losses resulting in an accumulated deficit of $303.7 million as of September 30, 2013. Our total stockholders’ equity was $50.0 million as of September 30, 2013, and reflects net proceeds of $48.6 million from the public offering of common stock completed in August 2013.

Three months ended September 30, 2013 compared to three months ended September 30, 2012

Revenues. Total revenues increased by $0.4 million, or 5%, to $8.7 million for the three months ended September 30, 2013 compared to $8.3 million for the three months ended September 30, 2012. Revenues for both quarterly periods include licensing revenue of $6.8 million representing amortization of deferred revenue from straight-line recognition of the up-front license fee of $200.0 million received from Novartis for Fanapt^® in 2009. Revenues for the three months ended September 30, 2013 included royalty revenue of $2.0 million from Novartis based on quarterly sales of Fanapt^® by Novartis compared to $1.5 million for the three months ended September 30, 2012.

Intangible asset amortization. Intangible asset amortization was $0.4 million for the three months ended September 30, 2013 and 2012. Intangible amortization relates to the capitalized intangible asset of $12.0 million resulting from the Fanapt^® milestone payment to Novartis in 2009.

Research and development expenses. Research and development expenses decreased by $2.2 million, or 22%, to $8.0 million for the three months ended September 30, 2013 compared to $10.2 million for the three months ended September 30, 2012. Expenses were lower for the three months ended September 30, 2013 as a result of completion of the tasimelteon Non-24 and MDD efficacy studies, partially offset by milestone obligations of $3.5 million incurred in the three months ended September 30, 2013 as a result of the FDA acceptance of our NDA for tasimelteon for the treatment of Non-24 in July 2013. The SET-3201 efficacy study in Non-24 was completed in the fourth quarter of 2012 and the RESET-3203 efficacy study in Non-24 and the MAGELLAN-2301 efficacy study in MDD were both completed in the first quarter of 2013.

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The following table discloses the components of research and development expenses reflecting all of our project expenses for the three months ended September 30, 2013 and 2012:

Total direct costs decreased by $2.2 million, or 22%, to $7.7 million for the three months ended September 30, 2013 compared to $9.9 million for the three months ended September 30, 2012 reflecting lower costs as a result of the completion of the tasimelteon Non-24 and MDD efficacy studies, partially offset by milestone obligations of $3.5 million incurred in the three months ended September 30, 2013 as a result of the FDA acceptance of our NDA for tasimelteon for the treatment of Non-24 in July 2013.

Clinical trials costs decreased by $6.4 million, or 94%, to $0.4 million for the three months ended September 30, 2013 compared $6.8 million for the three months ended September 30, 2012 as a result of the completion of the tasimelteon Non-24 and MDD efficacy studies.

Contract research and development, consulting, materials and other direct costs increased by $3.9 million, or 217%, to $5.7 million for the three months ended September 30, 2013 compared to $1.8 million for the three months ended September 30, 2012 primarily as a result of milestone obligations of $3.5 million incurred in the three months ended September 30, 2013 as a result of the FDA acceptance of our NDA for tasimelteon for the treatment of Non-24 in July 2013.

Salaries, benefits and related costs decreased by $0.4 million, or 27%, to $1.1 million for the three months ended September 30, 2013 compared to $1.5 million for the three months ended September 30, 2012 as costs for three months ended September 30, 2012 included severance costs associated with the termination of our Chief Medical Officer.

Employee stock-based compensation expense increased by $0.5 million to $0.4 million for the three months ended September 30, 2013 compared to a credit of $0.1 million for the three months ended September 30, 2012. The credit for the three months ended September 30, 2012 resulted from the reversal of expense from the cancellation of equity awards due to the termination of our Chief Medical Officer.

General and administrative expenses. General and administrative expenses increased by $2.6 million, or 84%, to $5.7 million for the three months ended September 30, 2013 compared to $3.1 million for the three months ended September 30, 2012.

The following table discloses the components of our general and administrative expenses for the three months ended September 30, 2013 and 2012:

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Salaries, benefits and related costs increased by $0.5 million, or 63%, to $1.3 million for the three months ended September 30, 2013 compared to $0.8 million for the three months ended September 30, 2012 primarily due to increases in our employee headcount.

Employee stock-based compensation expense increased by $0.4 million, or 57%, to $1.1 million for the three months ended September 30, 2013 compared to $0.7 million for the three months ended September 30, 2012 primarily as a result of stock-based compensation expense recorded in the three months ended September 30, 2013 related to performance-based stock options and RSUs which vested upon the FDA acceptance of our NDA for tasimelteon for the treatment of Non-24 in July 2013.

Marketing, medical affairs, legal, accounting and other professional expenses increased by $1.7 million, or 213%, to $2.5 million for the three months ended September 30, 2013 compared to $0.8 million for the three months ended September 30, 2012 primarily due to increased market development expenses associated with tasimelteon.

Nine months ended September 30, 2013 compared to nine months ended September 30, 2012

Revenues. Total revenues increased by $0.3 million, or 1%, to $25.1 million for the nine months ended September 30, 2013 compared to $24.8 million for the nine months ended September 30, 2012. Revenues for both periods includes licensing revenue of $20.0 million representing amortization of deferred revenue from straight-line recognition of the up-front license fee of $200.0 million received from Novartis for Fanapt^® in 2009. Revenues for the nine months ended September 30, 2013 included royalty revenue of $5.1 million from Novartis based on year-to-date sales of Fanapt^® by Novartis compared to $4.8 million for the nine months ended September 30, 2012.

Intangible asset amortization. Intangible asset amortization was $1.1 million for the nine months ended September 30, 2013 and 2012. Intangible amortization relates to the capitalized intangible asset of $12.0 million resulting from the Fanapt^® milestone payment to Novartis in 2009.

Research and development expenses. Research and development expenses decreased by $12.8 million, or 37%, to $22.0 million for the nine months ended September 30, 2013 compared to $34.8 million for the nine months ended September 30, 2012. Expenses were lower for the nine months ended September 30, 2013 as a result of completion of the tasimelteon Non-24 and MDD efficacy studies partially offset by milestone obligations of $3.5 million incurred in the three months ended September 30, 2013 as a result of the FDA acceptance of our NDA for tasimelteon for the treatment of Non-24 in July 2013. The SET-3201 efficacy study in Non-24 was completed in the fourth quarter of 2012 and the RESET-3203 efficacy study in Non-24 and the MAGELLAN-2301 efficacy study in MDD were both completed in the first quarter of 2013.

The following table discloses the components of research and development expenses reflecting all of our project expenses for the nine months ended September 30, 2013 and 2012:

Total direct costs decreased by $12.1 million, or 37%, to $21.0 million for the nine months ended September 30, 2013 compared to $33.1 million for the nine months ended September 30, 2012 as a result of the completion of the tasimelteon Non-24 and MDD efficacy studies.

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Clinical trials costs decreased by $15.4 million, or 71%, to $6.4 million for the nine months ended September 30, 2013 compared $21.8 million for the nine months ended September 30, 2012 as a result of the completion of the tasimelteon Non-24 and MDD efficacy studies.

Contract research and development, consulting, materials and other direct costs increased by $3.5 million, or 54%, to $10.0 million for the nine months ended September 30, 2013 compared to $6.5 million for the nine months ended September 30, 2012 primarily as a result of milestone obligations of $3.5 million incurred in the three months ended September 30, 2013 as a result of the FDA acceptance of our NDA for tasimelteon for the treatment of Non-24 in July 2013.

Salaries, benefits and related costs decreased by $0.3 million, or 8%, to $3.4 million for the nine months ended September 30, 2013 compared to $3.7 million for the nine months ended September 30, 2012 as costs for nine months ended September 30, 2012 included severance costs associated with the termination of our Chief Medical Officer.

Employee stock-based compensation expense increased by $0.2 million, or 20%, to $1.2 million for the nine months ended September 30, 2013 compared to $1.0 million for the nine months ended September 30, 2012. Expense for the nine months ended September 30, 2012 reflects the reversal of expense from the cancellation of equity awards due to the termination of our Chief Medical Officer.

Indirect project costs decreased by $0.7 million, or 41%, to $1.0 million for the nine months ended September 30, 2013 compared to $1.7 million for the nine months ended September 30, 2012 primarily as a result of the lease exit liability and accelerated depreciation related to our former headquarters lease in Rockville, Maryland that was recognized in the nine months ended September 30, 2012.

General and administrative expenses. General and administrative expenses increased by $4.0 million, or 37%, to $14.7 million for the nine months ended September 30, 2013 compared to $10.7 million for the nine months ended September 30, 2012.

The following table discloses the components of our general and administrative expenses for the nine months ended September 30, 2013 and 2012:

Salaries, benefits and related costs increased by $0.8 million, or 35%, to $3.1 million for the nine months ended September 30, 2013 compared to $2.3 million for the nine months ended September 30, 2012 primarily due to increases in our employee headcount.

Employee stock-based compensation expense decreased by $0.1 million, or 5%, to $2.1 million for the nine months ended September 30, 2013 compared to $2.2 million for the nine months ended September 30, 2012.

Marketing, medical affairs, legal, accounting and other professional expenses increased by $3.7 million, or 103%, to $7.3 million for the nine months ended September 30, 2013 compared to $3.6 million for the nine months ended September 30, 2012 primarily due to increased market development expenses associated with tasimelteon.

Other expenses decreased by $0.3 million, or 12%, to $2.3 million for the nine months ended September 30, 2013 compared to $2.6 million for the nine months ended September 30, 2012 primarily as a result of the lease exit liability and accelerated depreciation related to our former headquarters lease in Rockville, Maryland that was recognized in the first quarter of 2012.

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Other income. Other income decreased by $0.4 million, or 80%, to $0.1 million for the nine months ended September 30, 2013 compared to $0.5 million for the nine months ended September 30, 2012 primarily due to income from a legal settlement we recognized in the nine months ended September 30, 2012 related to a lawsuit filed against one of our stockholders. While we did not participate in the lawsuit proceedings, we received a portion of the settlement.

Liquidity and Capital Resources

In August 2013, we completed a public offering of 4,680,000 shares of common stock at a price to the public of $11.14 per share. Net cash proceeds from the public offering were $48.6 million, after deducting the underwriting discounts and commissions and offering expenses.

As of September 30, 2013, our total cash and cash equivalents and marketable securities was $142.2 million, including net proceeds from the public offering of common stock completed in August 3013, compared to $120.4 million at December 31, 2012. Our cash and cash equivalents are deposits in operating accounts and highly liquid investments with an original maturity of 90 days or less at date of purchase and consist of time deposits, investments in money market funds with commercial banks and financial institutions, and commercial paper of high-quality corporate issuers. Our marketable securities consist of investments in government sponsored enterprises and commercial paper.

Our liquidity resources as of September 30, 2013 and December 31, 2012 are summarized as follows:

As of September 30, 2013 we maintained all of our cash and cash equivalents in two financial institutions. Deposits held with these institutions may exceed the amount of insurance provided on such deposits, but we do not anticipate any losses with respect to such deposits.

We expect to continue to incur substantial expenses relating to our research and development and regulatory efforts as we pursue FDA approval of an NDA for tasimelteon in Non-24. Additionally, we expect to incur substantial expenses in preparation of a potential commercial launch of tasimelteon in Non-24. We must receive regulatory approval to launch any of our products commercially. If tasimelteon is approved by the FDA for the treatment of Non-24, we expect to incur substantial commercial expenses. In order to receive such approval, the appropriate regulatory agency must conclude that our clinical data establish safety and efficacy and that tasimelteon and the manufacturing facilities meet all applicable regulatory requirements. We cannot be certain that we will establish sufficient safety and efficacy data to receive regulatory approval for any of our products or that our products and the manufacturing facilities will meet all applicable regulatory requirements.

Because of the uncertainties discussed above, the costs to advance our research and development projects are difficult to estimate and may vary significantly. We expect that our existing funds will be sufficient to fund our currently planned operations. Our future capital requirements and the adequacy of our available funds will depend on many factors, primarily including the scope and costs of our commercial, manufacturing and process development activities and the magnitude of our discovery, preclinical and clinical development programs.

We may need or desire to obtain additional capital to finance our operations through debt, equity or alternative financing arrangements. We may also seek capital through collaborations or partnerships with other companies. The issuance of debt could require us to grant liens on certain of our assets that may limit our flexibility. If we raise additional capital by issuing equity securities, the terms and prices for these financings may be much more favorable to the new investors than the terms obtained by our existing stockholders. These financings also may significantly dilute the ownership of our existing stockholders. If we are unable to obtain

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additional financing, we may be required to reduce the scope of our future activities which could harm our business, financial condition and operating results. There can be no assurance that any additional financing required in the future will be available on acceptable terms, if at all.

Cash Flow

The following table summarizes our cash flows for the nine months ended September 30, 2013 and 2012:

In assessing cash used in operating activities, we consider several principal factors: (i) net loss for the period; (ii) adjustments for non-cash charges including stock-based compensation expense, amortization of intangible assets and depreciation and amortization of property and equipment; and (iii) the extent to which receivables, accounts payable and other liabilities, or other working capital components increase or decrease.

Net cash used in operating activities was $27.4 million for the nine months ended September 30, 2013, a reduction of $3.7 million from net cash used in operating activities of $31.1 million for the nine months ended September 30, 2012. The decrease in net cash used for operating activities of $3.7 million resulted from a reduction in the net loss of $8.7 million which was partially offset by a reduction of $0.4 million in non-cash charges, a cash contribution of $1.8 million for tenant improvements that was received from the landlord for the nine months ended September 30, 2012, and a net reduction of $2.9 million in the working capital components that provided operating cash flow in the nine months ended September 30, 2013 and 2012.

Net cash provided by investing activities of $31.4 million for the nine months ended September 30, 2013 resulted from proceeds from maturities of marketable securities. Net cash provided by investing activities of $47.7 million for the nine months ended September 30, 2012 consisted of net purchases, sales and maturities of marketable securities of $49.7 million reduced by purchases of property and equipment.

Net cash provided by financing activities of $49.4 million for the nine months ended September 30, 2013 reflects the net proceeds of $48.6 million received from the public offering of 4,680,000 shares of common stock completed in August 2013.

Off-balance sheet arrangements

We have no off-balance sheet arrangements, as defined in Item 303(a) (4) of the Securities and Exchange Commission’s Regulation S-K.

Contractual obligations and commitments

The following is a summary of our non-cancellable long-term contractual cash obligations as of September 30, 2013:

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Operating leases

Our commitments related to operating leases represent the minimum annual payments for the operating lease for our headquarters located in Washington, D.C., which expires in 2023.

In July 2011, we entered into an office lease with Square 54 Office Owner LLC (the Landlord) for our current headquarters, consisting of 21,400 square feet at 2200 Pennsylvania Avenue, N.W. in Washington, D.C. (the Lease). Under the Lease, rent payments were abated for the first 12 months. The Landlord will provide us with an allowance of $1.9 million for leasehold improvements. As of September 30, 2013, we had received the full allowance. Subject to the prior rights of other tenants in the building, we have the right to renew the Lease for five years following the expiration of its original term. We also have the right to sublease or assign all or a portion of the premises, subject to standard conditions. The Lease may be terminated early by us or the Landlord upon certain conditions.

As a result of our relocation from our former headquarters office space in Rockville, Maryland to Washington, D.C., we provided notice in the fourth quarter of 2011 to the landlord that we were terminating the Rockville lease effective June 30, 2013. As a result, we recognized an expense of $0.7 million in the year ended December 31, 2011 related to a lease termination penalty, of which $0.6 million was included as research and development expense in the consolidated statement of operations for the year ended December 31, 2011 and $0.1 million was included as general and administrative expense in the consolidated statement of operations for the year ended December 31, 2011. In the first quarter of 2012, we ceased using the Rockville, Maryland location and, as a result, recognized additional rent expense of $0.8 million, of which $0.6 million was included as research and development expense in the consolidated statement of operations for the year ended December 31, 2012 and $0.2 million was included as general and administrative expense in the consolidated statement of operations for the year ended December 31, 2012. The rent expense of $0.8 million for the year ended December 31, 2012, consisted of a lease exit liability of $1.3 million for the remaining lease payments net of the reversal of the deferred rent liability of $0.5 million related to the Rockville lease.

The following is a summary of lease exit activity for the nine months ended September 30, 2013, the year ended December 31, 2012 and the year ended December 31, 2011:

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

Interest rates

Our exposure to market risk is currently confined to our cash and cash equivalents, marketable securities and restricted cash. We currently do not hedge interest rate exposure. We have not used derivative financial instruments for speculation or trading purposes. Because of the short-term maturities of our cash and cash equivalents and marketable securities, we do not believe that an increase in market rates would have any significant impact on the realized value of our investments.

Marketable securities

We deposit our cash with financial institutions that we consider to be of high credit quality and purchase marketable securities which are generally investment grade, liquid, short-term fixed income securities and money-market instruments denominated in U.S. dollars. Our marketable securities consist of certificates of deposit, commercial paper, corporate notes and U.S. government agency notes.

Effects of inflation

Inflation has not had a material impact on our results of operations.

Item 4. Controls and Procedures.

Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (Exchange Act)) as of September 30, 2013. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective as of September 30,2013, the end of the period covered by this quarterly report, to ensure that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.

Changes in Internal Control over Financial Reporting

There has been no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) of the Exchange Act) during the third quarter of 2013 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

On June 24, 2013, a securities class action complaint was filed in the United States District Court for the District of Columbia, naming the Company and certain of our officers as defendants. The complaint, filed on behalf of purported stockholders of the Company, seeks to assert violations of Section 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, in connection with allegedly false and misleading statements and alleged omissions regarding our Phase III trial results for tasimelteon and other disclosures between December 18, 2012 and June 18, 2013 (the “Class Period”). The plaintiff seeks to represent a class comprised of purchasers of our common stock during the Class Period and seeks damages, costs and expenses and such other relief as determined by the Court. A similar complaint was filed on July 8, 2013.

Our management believes that we have meritorious defenses and intends to defend this lawsuit vigorously. We do not anticipate that this litigation will have a material adverse effect on our business, results of operations or financial condition. However, this lawsuit is subject to inherent uncertainties, the actual cost may be significant, and we may not prevail. We believe we are entitled to coverage under our relevant insurance policies, subject to a retention, but coverage could be denied or prove to be insufficient.

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Item 1A. Risk Factors

Investing in our common stock involves a high degree of risk. You should consider carefully the risks and uncertainties described below, together with all of the other information in this report and our Annual Report on Form 10-K for the fiscal year ended December 31, 2012, including the consolidated financial statements and the related notes appearing herein and therein, with respect to any investment in shares of our common stock. If any of the following risks actually occurs, our business, financial condition, results of operations and future prospects would likely be materially and adversely affected. In that event, the market price of our common stock could decline and you could lose all or part of your investment.

Risks related to our business and industry

If the U.S. Food and Drug Administration (FDA) does not approve our New Drug Application (NDA) for tasimelteon for the treatment of Non-24-Hour Disorder (Non-24) or continued development of tasimelteon is significantly delayed or terminated, our business will be significantly harmed, and the market price of our stock could decline.

We commenced our Phase III program for tasimelteon for the treatment of Non-24 in the third quarter of 2010. In December 2012, we reported positive top-line results in a randomized, double-blind, multi-center, placebo-controlled Phase III trial (SET study) that enrolled 84 patients. In January 2013, we announced positive results for the second Phase III study of tasimelteon for the treatment of Non-24 (RESET study). In addition, we have two ongoing open-label safety studies for tasimelteon in treatment of Non-24. We met with the FDA in the first quarter of 2013 for a pre-NDA meeting regarding tasimelteon in the treatment of patients with Non-24 and submitted an NDA to the FDA in May 2013. In July 2013, we announced that the FDA accepted the filing and granted a priority review classification to our NDA for tasimelteon for the treatment of Non-24 in the totally blind. The FDA determined the action target date under the Prescription Drug User Fee Act (PDUFA-V) to be January 31, 2014. The FDA scheduled a Peripheral and Central Nervous System Drugs Advisory Committee meeting on November 14, 2013 for the review of our NDA for tasimelteon, proposed trade name HETLIOZ^TM, for the treatment of Non-24 in the totally blind. Any adverse developments or results or perceived adverse developments or results with respect to our regulatory submission, the advisory committee meeting or the tasimelteon Phase III program will significantly harm our business and could cause the market price of our stock to decline. Examples of such adverse developments include, but are not limited to:

We and our partners face heavy government regulation. FDA regulatory approval of our products is uncertain and we and our partners are also continually at risk of the FDA requiring us or them to discontinue marketing any products that have obtained, or in the future may obtain, regulatory approval.

The research, testing, manufacturing and marketing of products such as those that we have developed or that we or our partners are developing are subject to extensive regulation by federal, state and local government authorities, including the FDA. To obtain regulatory approval of such products, we or our partners must demonstrate to the satisfaction of the applicable regulatory agency that, among other things, the product is safe and effective for its intended use. In addition, we or our partners must show that the manufacturing facilities used to produce such products are in compliance with current Good Manufacturing Practices regulations or cGMP.

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The process of obtaining FDA and other required regulatory approvals and clearances can take many years and will require us and our partners, as applicable, to expend substantial time and capital. Despite the time and expense expended, regulatory approval is never guaranteed. The number of pre-clinical and clinical trials that will be required for FDA approval varies depending on the product, the disease or condition that the product is in development for, and the requirements applicable to that particular product. The FDA can delay, limit or deny approval of a product for many reasons, including that:

For example, if certain of our or our partners’ methods for analyzing trial data are not accepted by the FDA, we or our partners may fail to obtain regulatory approval for our products.

Moreover, the marketing, distribution and manufacture of approved products remain subject to extensive ongoing regulatory requirements. Failure to comply with applicable regulatory requirements could result in, among other things:

Any delay or failure to obtain regulatory approvals for our products will result in increased costs, could diminish competitive advantages that we may attain and would adversely affect the marketing and sale of our products. Other than Fanapt^® in the U.S., Israel and Argentina, we have not received regulatory approval to market any of our products in any jurisdiction.

Even following regulatory approval of our products, the FDA may impose limitations on the indicated uses for which such products may be marketed, subsequently withdraw approval or take other actions against us, our partners or such products that are adverse to our business. The FDA generally approves drugs for particular indications. An approval for a more limited indication reduces the size of the potential market for the product. Product approvals, once granted, may be withdrawn or modified if problems occur after initial marketing.

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We and our partners also are subject to numerous federal, state and local laws, regulations and recommendations relating to safe working conditions, laboratory and manufacturing practices, the environment and the use and disposal of hazardous substances used in connection with discovery, research and development work. In addition, we cannot predict the extent to which new governmental regulations might significantly impede the discovery, development, production and marketing of our products. We or our partners may be required to incur significant costs to comply with current or future laws or regulations, and we may be adversely affected by the cost of such compliance or the inability to comply with such laws or regulations.

We intend to seek regulatory approvals for our products in foreign jurisdictions, but we may not obtain any such approvals.

We intend to market our products in foreign jurisdictions. In order to market our products in foreign jurisdictions, we or our partners may be required to obtain separate regulatory approvals and to comply with numerous and varying regulatory requirements. The approval procedure varies among countries and jurisdictions and can involve additional trials, and the time required to obtain approval may differ from that required to obtain FDA approval. Additionally, the foreign regulatory approval process may include all of the risks associated with obtaining FDA approval. For all of these reasons, we or our partners may not obtain foreign regulatory approvals on a timely basis, if at all. Approval by the FDA does not ensure approval by regulatory authorities in other countries or jurisdictions, and approval by one foreign regulatory authority does not ensure approval by regulatory authorities in other foreign countries or jurisdictions or by the FDA. We or our partners may not be able to file for regulatory approvals and may not receive necessary approvals to commercialize our products in any market. The failure to obtain these approvals could harm our business materially.

Even after we or our partners obtain regulatory approvals of a product, acceptance of such product in the marketplace is uncertain and failure to achieve commercial acceptance will prevent or delay our ability to generate product revenues.

Even after obtaining regulatory approvals for the sale of our products, the commercial success of these products will depend, among other things, on their acceptance by physicians, patients, third-party payors and other members of the medical community as a therapeutic and cost-effective alternative to competing products and treatments. The degree of market acceptance of any product will depend on a number of factors, including the demonstration of its safety and efficacy, its cost-effectiveness, its potential advantages over other therapies, the reimbursement policies of government and third-party payors with respect to such product, our ability to attract and maintain corporate partners, including pharmaceutical companies, to assist in commercializing our products, receipt of regulatory clearance of marketing claims for the uses that we or our partners are developing and the effectiveness of our and our partners’ marketing and distribution capabilities. If our approved products fail to gain market acceptance, we may be unable to earn sufficient revenue to continue our business. If our approved products do not become widely accepted by physicians, patients, third-party payors and other members of the medical community, it is unlikely that we will ever become profitable on a sustained basis or achieve significant revenues.

If we fail to obtain the capital necessary to fund our research and development activities and commercialization efforts, we may be unable to continue operations or we may be forced to share our rights to commercialize our products with third parties on terms that may not be attractive to us.

Our activities will necessitate significant uses of working capital throughout 2013 and beyond. As of September 30, 2013, our total cash and cash equivalents and marketable securities were $142.2 million. In August 2013, we completed a public offering of 4,680,000 shares of our common stock resulting in net proceeds to us of $48.6 million after deducting underwriting discounts and commissions and other estimated offering expenses. Our long term capital requirements are expected to depend on many factors, including, among others:

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