AVADEL PHARMACEUTICALS PLC - Quarter Report: 2016 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

———————

FORM 10-Q

———————

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

For the quarterly period ended: June 30, 2016

———————

FLAMEL TECHNOLOGIES S.A.

(Exact name of registrant as specified in its charter)

———————

Parc Club du Moulin à Vent
33, avenue du Docteur Georges Levy
69200, Vénissieux France

 (Address of Principal Executive Office and Zip Code)

+33 472 78 34 34

 (Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

———————

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 þ 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes þ No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

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

The number of shares of the registrant’s common stock outstanding at August 3, 2016 was 41,241,254.

TABLE OF CONTENTS

Forward-Looking Statements

This quarterly report on Form 10-Q includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934 (Exchange Act). The words “will,” “may,” “believe,” “expect,” “anticipate,” “estimate,” “project” and similar expressions, and the negatives thereof, identify forward-looking statements, each of which speaks only as of the date the statement is made. In particular, information appearing under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” includes forward-looking statements.

Although we believe that our forward-looking statements are based on reasonable assumptions within the bounds of our knowledge of our business and operations, our business is subject to significant risks and there can be no assurance that actual results of our research, development and commercialization activities and our results of operations will not differ materially from our expectations.

More information on factors that could cause actual results or events to differ materially from those anticipated is included from time to time in our reports filed with the Securities and Exchange Commission (SEC), including our annual report on Form 10-K for the year ended December 31, 2015, in particular under the captions “Forward-Looking Statements” and “Risk Factors.”

All forward-looking statements speak only as of the date of this report and are expressly qualified in their entirety by the cautionary statements included or referenced in or incorporated by reference into this report. Except as is required by law, we expressly disclaim any obligation to publicly release any revisions to forward-looking statements to reflect events after the date of this report.

PART I – FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

FLAMEL TECHNOLOGIES S.A.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF LOSS

(In thousands, except per share data)

See accompanying notes to condensed consolidated financial statements.

FLAMEL TECHNOLOGIES S.A.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(In thousands)

See accompanying notes to condensed consolidated financial statements.

FLAMEL TECHNOLOGIES S.A.

UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except per share data)

See accompanying notes to condensed consolidated financial statements.

FLAMEL TECHNOLOGIES S.A.

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

See accompanying notes to condensed consolidated financial statements.

FLAMEL TECHNOLOGIES S.A.

NOTES TO THE UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share data)

NOTE 1 : Summary of Significant Accounting Policies

Nature of Operations. Flamel Technologies S.A. (“Flamel,” the “Company,” “we” or “us”) is organized as a Société Anonyme, a form of corporation under the laws of The Republic of France. The Company was founded in 1990. Flamel is a specialty pharmaceutical company utilizing core competencies in drug delivery and formulation development to create safer and more efficacious pharmaceutical products to address unmet medical needs and/or reduce overall healthcare costs. The Company has a business model consisting of:

Flamel is headquartered in Lyon, France and has operations in St. Louis, Missouri, United States, and Dublin, Ireland.

Proposed Reincorporation as an Irish Public Limited Company (plc).  At our shareholders meeting on August 10, 2016, our shareholders approved resolutions to change our jurisdiction of incorporation from France to Ireland.  Based on such approval, we intend to give effect to this reincorporation on December 31, 2016 by merging with and into our wholly owned Irish corporate subsidiary, Avadel Pharmaceuticals Limited (the “Merger”).  Prior to completing the Merger, Avadel Pharmaceuticals Limited will re-register as an Irish public limited company, or plc, and at the time of the Merger and thereafter our shareholders (and holders of our American Depositary Shares (ADSs)) will own shares (or ADSs, as applicable) in a company known as Avadel Pharmaceuticals plc.  Our definitive proxy statement filed with the Securities and Exchange Commission on July 5, 2016 contains additional information about the proposed reincorporation.

Basis of Presentation. The Condensed Consolidated Balance Sheet as of December 31, 2015, which is derived from the prior year 2015 audited consolidated financial statements, and the interim unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP), the requirements of Form 10-Q and Article 10 of Regulation S-X and, consequently, do not include all information or footnotes required by U.S. GAAP for complete financial statements or all the disclosures normally made in an annual report on Form 10-K. Accordingly, the unaudited condensed consolidated financial statements included herein should be read in conjunction with the audited consolidated financial statements and footnotes included in the Company’s 2015 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 15, 2016.

The unaudited condensed consolidated financial statements include the accounts of the Company, and reflect all adjustments (consisting only of normal recurring adjustments) that are, in the opinion of management, necessary for a fair presentation of the Company’s financial position, results of operations and cash flows for the dates and periods presented. All intercompany accounts and transactions have been eliminated. Results for interim periods are not necessarily indicative of the results to be expected during the remainder of the current year or for any future period.

Foreign Currency Translation. The reporting currency of the Company and its wholly-owned subsidiaries is the U.S. dollar. Each of the Company's non-U.S. subsidiaries and the parent entity uses local currency as their functional currency. Subsidiaries and entities that do not use the U.S. dollar as their functional currency translate 1) profit and loss accounts at the weighted average exchange rates during the reporting period, 2) assets and liabilities at period end exchange rates and 3) shareholders' equity accounts at historical rates. Resulting translation gains and losses are included as a separate component of shareholders' equity in Accumulated Other Comprehensive Loss. Assets and liabilities denominated in a currency other than the subsidiary's functional currency are translated to the subsidiary's functional currency at period end exchange rates. Resulting gains and losses are recognized in the Condensed Consolidated Statements of Loss.

Reclassifications and Immaterial Corrections of Prior Period Amounts. The accompanying condensed consolidated financial statements for prior periods contain certain reclassifications to conform to the presentation used in 2016. Additionally, the Company has identified certain immaterial errors related to prior reporting periods. The Company has assessed the impact of the errors on its prior period financial statements included in our December 31, 2015 Annual Report on Form 10-K and concluded that the errors were not material to those financial statements.

Although the effect of the errors was not material to any previously issued financial statements, the cumulative effect of correcting the errors would have been material for the period ended June 30, 2016.

Consequently, the Company has presented the effects of these errors and reclassifications on its prior period financial statements in the tables below.  In future filings the financial statements for comparative periods affected by these errors and reclassifications will be revised.

The impact of the above errors and reclassifications on previously presented line items for each comparative period presented is as follows:

In addition to the specific amounts identified within the tables above, the Company also changed the names of the previously-reported “Interest expense – changes in fair value of related party financing related contingent consideration” line on the condensed consolidated statement of income (loss) to “Other expense – changes in fair value of related party payable”, and the previously-reported “Long-term related party contingent consideration payable” line on the condensed consolidated balance sheet to “Long-term related party payable” to better reflect the underlying nature of certain royalty agreements in prior periods.

While the balance sheet revisions and reclassifications noted in the tables above impact their corresponding captions within the cash flows provided by (used in) operating activities section of the Company’s consolidated statements of cash flows in each period of 2015, there was no impact to the total net cash provided by (used in) operating activities in any of these periods.

Revenue. Revenue includes sales of pharmaceutical products, amortization of licensing fees, milestone payments for R&D achievements, and compensation for the execution of R&D activities.

Product Sales and Services

Revenue is generally realized or realizable and earned when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller’s price to the buyer is fixed or determinable, and collectability is reasonably assured. The Company records revenue from product sales when title and risk of ownership have been transferred to the customer, which is typically upon delivery to the customer and when the selling price is determinable. As is customary in the pharmaceutical industry, the Company’s gross product sales are subject to a variety of deductions in arriving at reported net product sales. These adjustments include estimates for product returns, chargebacks, payment discounts, rebates, and other sales allowances and are estimated based on analysis of historical data for the product or comparable products, as well as future expectations for such products.

For generic products and branded products sold in mature markets where the ultimate net selling price to customer is estimable, the Company recognizes revenues upon shipment to the wholesaler. For new product launches the Company recognizes revenue once sufficient data is available to determine product acceptance in the marketplace such that product returns may be estimated based on historical data and there is evidence of reorders and consideration is made of wholesaler inventory levels.

Prior to the second quarter 2016, the Company did not have sufficient historical data to estimate certain revenue deductions. As such, it could not accurately estimate the ultimate net selling price of its Éclat portfolio of products and as a result delayed revenue recognition until the wholesaler sold the product through to its customers.

During the second quarter of 2016, the Company determined that it has sufficient evidence, history, data and internal controls to estimate the ultimate selling price of its products upon shipment from its warehouse to its customers, the wholesalers.  Accordingly, it discontinued the sell through revenue approach and now recognizes revenue once the product is shipped from its warehouse. As a result of this change in accounting estimate, the Company recognized $5,981 in additional revenue, or $0.05 in additional diluted net earnings (loss) per share, for the three and six months ended June 30, 2016 that previously would have been deferred until sold by the wholesalers to the hospitals. 

License and Research Revenue

The Company’s license and research revenues consist of fees and milestone payments. Non-refundable fees where we have continuing performance obligations are deferred and are recognized ratably over our projected performance period. We recognize milestone payments, which are typically related to regulatory, commercial or other achievements by us or our licensees and distributors, as revenues when the milestone is accomplished and collection is reasonably assured.

NOTE 2 : Newly Issued Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09 “Revenue from Contracts with Customers” which supersedes the most current revenue recognition requirements. This ASU requires entities to recognize revenue in a way that depicts the transfer of goods or services to customers in an amount that reflects the consideration which the entity expects to be entitled to in exchange for those goods or services. Through May 2016, the FASB issued ASU 2016-08 “Principal versus Agent Considerations (Reporting Revenue Gross versus Net),” ASU 2016-10 “Identifying Performance Obligations and Licensing,” and ASU 2016-12, “Narrow-Scope Improvements and Practical Expedients,” which provide supplemental adoption guidance and clarification to ASU 2014-09, respectively. These ASUs will be effective for annual and interim periods beginning after December 15, 2017 with early adoption for annual and interim periods beginning after December 15, 2016 permitted and should be applied retrospectively to each prior reporting period presented or as a cumulative effect adjustment as of the date of adoption. The Company is currently evaluating this pronouncement to determine the impact of its adoption on its condensed consolidated financial statements.

In March 2016, the FASB issued ASU 2016-09 “Improvements to Employee Share-Based Payment Accounting” which amends Accounting Standards Codification (“ASC”) Topic 718 “Compensation – Stock Compensation”. This update simplifies several aspects of accounting for share-based payment awards to employees, including the accounting for income taxes, classification of awards as either equity or liabilities and classification in the statement of cash flows. The standard is effective for annual reporting periods beginning after December 15, 2016. The Company does not believe this standard will materially impact its condensed consolidated financial statements.

In February 2016, the FASB issued ASU 2016-02 “Leases” which supersedes ASC 840 “Leases” and creates a new topic, ASC 842 “Leases.” This update requires lessees to recognize on their balance sheet a lease liability and a lease asset for all leases, including operating leases, with a term greater than 12 months. The update also expands the required quantitative and qualitative disclosures surrounding leases. This update is effective for fiscal years beginning after December 15, 2018 and interim periods within those fiscal years, with earlier application permitted. This update will be applied using a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The Company is currently evaluating the effect of this update on its condensed consolidated financial statements.

In September 2015, the FASB issued ASU 2015-16 “Business Combinations” which requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. This ASU is effective for interim and annual reporting periods beginning after December 15, 2016, with the option to early adopt for financial statements that have not been issued. The Company early adopted the provisions of ASU 2015-16 for the year ended December 31, 2015 on a prospective basis.

In July 2015, the FASB issued ASU 2015-11 “Simplifying the Measurement of Inventory”, which requires an entity to measure inventory within the scope of this ASU at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The effective date for the standard is for fiscal years beginning after December 15, 2016, which for the Company is January 1, 2017. Early adoption is permitted. The new standard is to be applied prospectively. The Company does not expect ASU 2015-11 to have a material impact on its condensed consolidated financial statements.

NOTE 3 : Marketable Securities

The Company has investments in available-for-sale marketable equity securities which are recorded at fair market value and measured using quoted prices in their respective active market, thus representing a level 1 fair value measurement as defined in ASC 820. Unrealized gains and losses are recorded as other comprehensive income (loss) in shareholders’ equity, net of income tax effects.

The value at cost, gross unrealized holding gains or losses, and fair value of the Company’s available-for-sale marketable securities are summarized below as of:

NOTE 4 : Inventories

The principal categories of inventories at June 30, 2016 and December 31, 2015 are as follows:  

NOTE 5 : Acquisitions

On February 5, 2016, the Company completed its acquisition of FSC Holdings, LLC (“FSC”), a Charlotte, North Carolina-based specialty pharmaceutical company dedicated to providing innovative solutions to unmet medical needs for pediatric patients, from Deerfield CSF, LLC, a Deerfield Management company (“Deerfield”), a related party.

This acquisition has been accounted for using the acquisition method of accounting and, accordingly, its results are included in the Company's condensed consolidated financial statements from the date of acquisition. Total consideration to acquire FSC is estimated to be $22,228, and was funded with a combination of the following, partially offset by $467 as a result of a net working capital settlement due from the seller:

The present value of these estimated discounted future cash flows for each of these items is reported in related party payable within the Company’s Condensed Consolidated Balance Sheet, and is further disclosed at Note 7 – Long-Term Related Party Payable.

During the first half of 2016, the Company determined its preliminary accounting for the FSC acquisition. As the Company completes its final accounting for the acquisition, future adjustments related to working capital, amortizable intangible assets, goodwill and deferred taxes could occur. The preliminary fair values assigned to the acquired assets and liabilities have been recognized as follows:

Goodwill resulting from the acquisition is largely attributable to the existing workforce of FSC, and is not expected to be deductible for tax purposes. Transaction expenses for legal and professional fees associated with the acquisition of FSC amounted to $76 during the three and six month period ended June 30, 2016 and are reported within the Selling, general and administrative expenses line in the Condensed Consolidated Statements of Loss. The useful lives on FSC acquired intangible assets range from seven to ten years.

After its acquisition on February 5, 2016, FSC contributed $1,761 and $2,637 to the Company's net sales for the three and six month periods ended June 30, 2016, respectively. Concurrently, the net impact of the FSC acquisition was a loss of $3,096 and $4,489 for the three and six month periods ended June 30, 2016, respectively.

Had the FSC acquisition been completed as of the beginning of 2015, the Company's unaudited pro forma net sales and net loss for the six months ended June 30, 2016 and 2015 would have been as follows:

NOTE 6 : Goodwill and Intangible Assets

The Company's amortizable and unamortizable intangible assets at June 30, 2016 and December 31, 2015 are as follows:

The Company recorded amortization expense related to amortizable intangible assets of $3,702 and $3,139 for the three months ended June 30, 2016 and 2015, respectively. The Company recorded amortization expense related to amortizable intangible assets of $7,216 and $6,282 for the six months ended June 30, 2016 and 2015, respectively. Accumulated amortization in the above tables includes an impairment charge of $7,171 which was recognized during the year ended December 31, 2012 relative to the “Acquired developed technology – Vazculep” intangible asset.

Amortizable intangible assets are amortized over their estimated useful lives, which range from three to ten years. Estimated amortization of intangible assets for the next five years is as follows:

The change in net goodwill during the six months ended June 30, 2016 is as follows:

NOTE 7 : Long-Term Related Party Payable

Long-term related party payable and related activity are reported at fair value and consist of the following at June 30, 2016 and December 31, 2015:

 The fair value of the warrants is estimated on a quarterly basis using a Black-Scholes option pricing model with the following assumptions as of June 30:

These Black-Scholes fair value measurements are based on significant inputs not observable in the market and thus represent a level 3 measurement as defined in ASC 820. The fair value of the warrant consideration is most sensitive to movement in the Company’s share price and expected volatility at the balance sheet date.

Expected term: The expected term of the options or warrants represents the period of time between the grant date and the time the options or warrants are either exercised or forfeited, including an estimate of future forfeitures for outstanding options or warrants. Given the limited historical data and the grant of stock options and warrants to a limited population, the simplified method has been used to calculate the expected life.

Expected volatility: The expected volatility is calculated based on an average of the historical volatility of the Company's stock price for a period approximating the expected term.

Risk-free interest rate: The risk-free interest rate is based on the U.S. Treasury yield curve in effect at the time of grant and a maturity that approximates the expected term.

Expected dividend yield: The Company has not distributed any dividends since its inception, and has no plan to distribute dividends in the foreseeable future.

At the closing date of the 2012 Éclat acquisition and at June 30, 2016, it was uncertain as to whether the Company would ultimately fulfill its obligation under these warrants using Company shares or cash. Accordingly, pursuant to the guidance of ASC 480, the Company determined that these warrants should be classified as a long-term liability. This classification as a long-term liability was further supported by the Company’s determination, pursuant to the guidance of ASC 815-40-15-7(i), that these warrants could also not be considered as being indexed to the Company’s own stock, on the basis that the exercise price for the warrants is determined in U.S. dollars, although the functional currency of the Company at the closing date of the Éclat acquisition was the Euro.

At June 30, 2016, the fair value of each related party payable listed in (b) through (e) above was estimated using a discounted cash flow model based on probability-adjusted annual net revenues or gross profit, as appropriate, of each of the specified Éclat and FSC products using an appropriate risk-adjusted discount rate ranging from 15% to 32%. These fair value measurements are based on significant inputs not observable in the market and thus represent a level 3 measurement as defined in ASC 820. Subsequent changes in the fair value of the acquisition-related contingent consideration payable, resulting primarily from management’s revision of key assumptions, will be recorded in the ‘Changes in fair value of related party contingent consideration’ line within the Company’s Condensed Consolidated Statements of Loss.

The Company has chosen to make a fair value election pursuant to ASC 825, “Financial Instruments” for its royalty agreements detailed in items (d) and (e) above. These financing-related liabilities are recorded at fair market value on the Condensed Consolidated Balance Sheets and the periodic change in fair market value is recorded as a component of “Other expense – change in fair value of related party payable” on the Condensed Consolidated Statements of Loss.

NOTE 8 : Income Taxes

The components of income (loss) before income taxes are as follows:

The items accounting for the difference between the income tax provision computed at the French statutory rate and the Company's effective tax rate are as follows:

The income tax provision for the three months ended June 30, 2016 and 2015 was $7,449 and $8,507, respectively. The decrease in the income tax provision for the three months ended June 30, 2016 is primarily the result of decreases in the amount of pre-tax income recorded in the United States and France, when compared to the same period in 2015. The decrease in the income tax provision for the three months ended June 30, 2016 would have been larger, but a tax benefit from stock-based compensation recorded in the same period in 2015 did not repeat in 2016.

The income tax provision for the six months ended June 30, 2016 and 2015 was $14,761 and $17,214, respectively. The decrease in the income tax provision for the six months ended June 30, 2016 is primarily the result of decreases in the amount of pre-tax income recorded in the United States and France, when compared to the same period in 2015. The decrease in the income tax provision for the six months ended June 30, 2016 would have been larger, but a tax benefit from stock-based compensation recorded in the same period in 2015 did not repeat in 2016 and the Company was required to record a valuation allowance against the net operating losses generated in France in 2016.

NOTE 9 : Other Assets and Liabilities

Various other assets and liabilities are summarized as follows:

NOTE 10 : Net Loss Per Share

Basic net loss per share is calculated using the weighted average number of shares outstanding during each period. The diluted net loss per share calculation includes the impact of dilutive equity compensation awards and contingent consideration warrants.

A reconciliation of basic and diluted net loss per share, together with the related shares outstanding in thousands is as follows:

Potential common shares of 6,596 and 6,634 were excluded from the calculation of weighted average shares for the three and six months ended June 30, 2016 and 2015, respectively, because their effect was considered to be anti-dilutive.

NOTE 11 : Comprehensive Income (Loss)

The following table shows the components of accumulated other comprehensive loss for the three and six months ended June 30, 2016 and 2015, net of tax effects:

The effect on the Company’s condensed consolidated financial statements of amounts reclassified out of accumulated other comprehensive loss was immaterial for all periods presented.

NOTE 12 : Shareholders’ Equity

The following table presents a reconciliation of the Company’s beginning and ending balances in shareholders’ equity for the six months ended June 30, 2016:

NOTE 13 : Company Operations by Product

The Company has determined that it operates in one segment, the development and commercialization of pharmaceutical products, including controlled-release therapeutic products based on its proprietary polymer based technology. The Company's Chief Operating Decision Maker is the CEO. The CEO and the Board review profit and loss information on a consolidated basis to assess performance and make overall operating decisions as well as resource allocations. All products are included in one segment because the majority of our products have similar economic and other characteristics, including the nature of the products and production processes, type of customers, distribution methods and regulatory environment.

The following table presents a summary of total revenues by these products:

NOTE 14 : Commitments and Contingencies

Litigation

The Company is subject to potential liabilities generally incidental to its business arising out of present and future lawsuits and claims related to product liability, personal injury, contract, commercial, intellectual property, tax, employment, compliance and other matters that arise in the ordinary course of business. The Company accrues for potential liabilities when it is probable that future costs (including legal fees and expenses) will be incurred and such costs can be reasonably estimated. At June 30, 2016 and December 31, 2015, there were no contingent liabilities with respect to any threat of litigation, arbitration or administrative or other proceeding that are reasonably likely to have a material adverse effect on the Company’s condensed consolidated financial position, results of operations, cash flows or liquidity.

Material Commitments

Other than commitments to Recipharm and for operating leases as disclosed in Note 12 - Contingent Liabilities and Commitments to the Company's consolidated financial statements included in Part II, Item 8 of the Company’s 2015 Annual Report, there were no other material commitments outside of the normal course of business. Material commitments in the normal course of business include long-term debt, and post-retirement benefit plan obligations which are disclosed in Note 7 - Long-Term Debt and Note 10 – Post-Retirement Benefit Plans, respectively, to the Company's consolidated financial statements included in Part II, Item 8 of the Company’s 2015 Annual Report and long-term contingent consideration payable as disclosed in Note 7 – Long-term Related Party Payable, to the Company's condensed consolidated financial statements included in Part I, Item 1 of this report.

ITEM 2.    MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management's Discussion and Analysis

(In thousands, except per share data)

(Unaudited)

You should read the discussion and analysis of our financial condition and results of operations set forth in this Item 2 together with our condensed consolidated financial statements and the related notes appearing elsewhere in this quarterly report on Form 10-Q. Some of the information contained in this discussion and analysis or set forth elsewhere in this quarterly report on Form 10-Q, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties, and reference is made to the “Cautionary Disclosure Regarding Forward-Looking Statements” set forth immediately following the Table of Content of the Company’s 2015 Annual Report on Form 10-K filed with the SEC on March 15, 2016 (the “2015 Annual Report”) for further information on the forward looking statements herein. In addition, you should read the “Risk Factors” section in Part I, Item 1A of the 2015 Annual Report for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis and elsewhere in this quarterly report.

Overview

We are a specialty pharmaceutical company utilizing core competencies in drug delivery and formulation to develop safer and more efficacious pharmaceutical products to address unmet medical needs and/or reduce overall healthcare costs. Flamel has a business model consisting of:

Flamel’s business model allows the Company to select, develop, seek approval for, and commercialize niche branded and generic products, initially targeted for the U.S. market. The Company is currently able to self-fund the development of most product development opportunities. On May 2, 2016, the company announced that the U.S. Food and Drug Administration (FDA) has approved the Company’s New Drug Application (NDA) for Akovaz™ (ephedrine sulfate), a drug administered parenterally as a pressor agent to address clinically important hypotension in surgical settings. The NDA, which is the first to receive approval from the FDA for ephedrine sulfate, was approved as scheduled on April 29, 2016. Flamel expects to launch Akovaz during the third quarter 2016 in a strength of 50mg/mL.

Strategy

The Company's business strategy is designed to drive overall sales and earnings growth while maintaining a return on invested capital at an appropriate premium above the Company's cost of capital. Our key areas of focus address the most significant opportunities and challenges facing the Company, including:

Each of the above products are currently or will be commercialized in the United States by Flamel’s subsidiary Éclat. These products were derived from the acquisition of Éclat, which has focused on pursuing FDA approvals through the 505(b)(2) regulatory pathway. Through our acquisition of Éclat we obtained marketing and licensing knowledge of the commercial and regulatory process in the U.S. and E.U. We believe this knowledge has enhanced our ability to identify product candidates for development, leverage new opportunities for the application of our drug delivery platforms, and license and market products in the U.S and E.U. The revenues from these UMD products are now generating cash flow which we can use to fund our second strategy, the development and commercialization of our drug delivery products.

Several products formulated using our proprietary drug delivery platforms are currently under various stages of development for possible marketing either by the Company and/or by partners via licensing/distribution agreements.

The key elements of our pipeline strategy include:

Key Business Trends and Highlights

In operating our business and monitoring our performance, we consider a number of performance measures, as well as trends affecting our industry as a whole, which include the following:

Highlights of our condensed consolidated results for the six months ended June 30, 2016 are as follows:

Critical Accounting Estimates

The Company’s condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America. To prepare these financial statements, management must make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, as well as the disclosures of contingent assets and liabilities. Actual results could be significantly different from these estimates.

Our significant accounting policies are described in Note 1 of the audited consolidated financial statements included in our 2015 Form 10-K. The SEC suggests companies provide additional disclosure on those accounting policies considered most critical. The SEC considers an accounting policy to be critical if it is important to our financial condition and results of operations and requires significant judgments and estimates on the part of management in its application. Our estimates are often based on complex judgments, probabilities and assumptions that management believes to be reasonable, but that are inherently uncertain and unpredictable. It is also possible that other professionals, applying reasonable judgment to the same facts and circumstances, could develop and support a range of alternative estimated amounts. For a complete discussion of our critical accounting policies, see the “Critical Accounting Policies” section of the MD&A in our 2015 Form 10-K. There were no significant changes to our critical accounting policies, with the exception of changes made to our revenue recognition policy disclosed below, during the six months ended June 30, 2016.

Revenue. Revenue includes sales of pharmaceutical products, amortization of licensing fees, milestone payments for R&D achievements, and compensation for the execution of R&D activities.

Product Sales and Services

Revenue is generally realized or realizable and earned when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the seller’s price to the buyer is fixed or determinable, and collectability is reasonably assured. The Company records revenue from product sales when title and risk of ownership have been transferred to the customer, which is typically upon delivery to the customer and when the selling price is determinable. As is customary in the pharmaceutical industry, the Company’s gross product sales are subject to a variety of deductions in arriving at reported net product sales. These adjustments include estimates for product returns, chargebacks, payment discounts, rebates, and other sales allowances and are estimated based on analysis of historical data for the product or comparable products, as well as future expectations for such products.

For generic products and branded products sold in mature markets where the ultimate net selling price to customer is estimable, the Company recognizes revenues upon shipment to the wholesaler. For new product launches the Company recognizes revenue once sufficient data is available to determine product acceptance in the marketplace such that product returns may be estimated based on historical data and there is evidence of reorders and consideration is made of wholesaler inventory levels.

Prior to the second quarter 2016, the Company did not have sufficient historical data to estimate certain revenue deductions. As such, it could not accurately estimate the ultimate net selling price of its Éclat portfolio of products and as a result delayed revenue recognition until the wholesaler sold the product through to its customers.

During the second quarter of 2016, the Company determined that it has sufficient evidence, history, data and internal controls to estimate the ultimate selling price of its products upon shipment from its warehouse to its customers, the wholesalers.  Accordingly, it discontinued the sell through revenue approach and now recognizes revenue once the product is shipped from its warehouse. As a result of this change in accounting estimate, the Company recognized $5,981 in additional revenue for the three and six months ended June 30, 2016 that previously would have been deferred until sold by the wholesalers to the hospitals.  The impact of this change is reflected as revenue in the Company’s Condensed Consolidated Statements of Loss for the periods reported.

License and Research Revenue

The Company’s license and research revenues consist of fees and milestone payments. Non-refundable fees where we have continuing performance obligations are deferred and are recognized ratably over our projected performance period. We recognize milestone payments, which are typically related to regulatory, commercial or other achievements by us or our licensees and distributors, as revenues when the milestone is accomplished and collection is reasonably assured.

Results of Operations

The following is a summary of our financial results (in thousands, except per share amounts) for the three months ended June 30, 2016 and 2015, respectively: