SUPERNUS PHARMACEUTICALS, INC. - Quarter Report: 2017 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

 

FORM 10-Q

 

(Mark One)

 

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

 

For the quarterly period ended September 30, 2017

 

OR

 

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

 

For the transition period from                  to          

 

Commission File Number: 001-35518

 

SUPERNUS PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

 

 

(301) 838-2500

(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.  x Yes  o No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, 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).  x Yes  o No

 

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

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

 

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

 

The number of outstanding shares of the registrant’s common stock, par value $0.001 per share, as of the close of business on October 31, 2017 was 51,262,132.

 

 

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SUPERNUS PHARMACEUTICALS, INC.

FORM 10-Q — QUARTERLY REPORT

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2017

TABLE OF CONTENTS

 

	Page No.
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of September 30, 2017 (Unaudited) and December 31, 2016	1
Consolidated Statements of Operations for the three and nine months periods ended September 30, 2017 and 2016 (Unaudited)	2
Consolidated Statements of Comprehensive Income for the three and nine months periods ended September 30, 2017 and 2016 (Unaudited)	3
Consolidated Statements of Cash Flows for the nine months periods ended September 30, 2017 and 2016 (Unaudited)	4
Notes to Consolidated Financial Statements (Unaudited)	5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	20
Item 3. Quantitative and Qualitative Disclosures about Market Risk	31
Item 4. Controls and Procedures	32
PART II — OTHER INFORMATION
Item 1. Legal Proceedings	33
Item 1A. Risk Factors	36
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	36
Item 3. Defaults Upon Senior Securities	36
Item 4. Mine Safety Disclosures	36
Item 5. Other Information	36
Item 6. Exhibits	36
SIGNATURES	39

 

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PART I — FINANCIAL INFORMATION

 

Supernus Pharmaceuticals, Inc.

Consolidated Balance Sheets

(in thousands, except share amounts)

 

		September 30,			December 31,
		2017			2016
		(unaudited)
Assets
Current assets:
Cash and cash equivalents		$	81,924		$	66,398
Marketable securities		32,626			23,723
Accounts receivable, net		56,166			41,527
Inventories, net		14,947			16,801
Prepaid expenses and other current assets		5,667			2,955
Total current assets		191,330			151,404
Long term marketable securities		123,123			75,410
Property and equipment, net		4,688			4,344
Intangible assets, net		37,162			36,350
Other non-current assets		368			331
Deferred income taxes		28,807			41,729
Total assets		$	385,478		$	309,568
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable		$	6,262		$	8,055
Accrued sales deductions		59,772			41,943
Accrued expenses		26,892			27,427
Income taxes payable		6,489			7
Non-recourse liability related to sale of future royalties, current portion		5,254			3,101
Deferred licensing revenue		287			209
Total current liabilities		104,956			80,742
Deferred licensing revenue, net of current portion		1,221			1,501
Convertible notes, net		—			4,165
Non-recourse liability related to sale of future royalties, long term		22,702			27,289
Other non-current liabilities		4,936			4,002
Derivative liabilities		—			114
Total liabilities		133,815			117,813
Stockholders’ equity:
Common stock, $0.001 par value, 130,000,000 shares authorized at September 30, 2017 and December 31, 2016; 51,262,007 and 49,971,267 shares issued and outstanding at September 30, 2017 and December 31, 2016, respectively		51			50
Additional paid-in capital		291,841			276,127
Accumulated other comprehensive income (loss), net of tax		252			(134		)
Accumulated deficit		(40,481		)	(84,288		)
Total stockholders’ equity		251,663			191,755
Total liabilities and stockholders’ equity		$	385,478		$	309,568

 

See accompanying notes.

 

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Supernus Pharmaceuticals, Inc.

Consolidated Statements of Operations

(in thousands, except share and per share data)

 

 

		Three Months ended September 30,						Nine Months ended September 30,
		2017			2016			2017			2016
		(unaudited)						(unaudited)
Revenue
Net product sales		$	78,066		$	55,618		$	207,763		$	148,978
Royalty revenue		2,010			1,140			4,338			3,464
Licensing revenue		322			52			1,702			187
Total revenue		80,398			56,810			213,803			152,629
Costs and expenses
Cost of product sales		4,251			3,428			11,060			8,214
Research and development		12,980			7,868			33,405			29,539
Selling, general and administrative		40,825			25,675			104,141			76,956
Total costs and expenses		58,056			36,971			148,606			114,709
Operating income		22,342			19,839			65,197			37,920
Other income (expense)
Interest income		814			378			2,002			1,071
Interest expense		—			(202		)	(148		)	(577		)
Interest expense-nonrecourse liability related to sale of future royalties		(155		)	(1,004		)	(1,274		)	(3,564		)
Changes in fair value of derivative liabilities		—			125			76			349
Loss on extinguishment of debt		(91		)	—			(295		)	(382		)
Total other income (expense)		568			(703		)	361			(3,103		)
Earnings before income taxes		22,910			19,136			65,558			34,817
Income tax expense (benefit)		6,949			(42,690		)	21,932			(42,085		)
Net income		$	15,961		$	61,826		$	43,626		$	76,902
Earnings per share:
Basic		$	0.31		$	1.25		$	0.86		$	1.56
Diluted		$	0.29		$	1.18		$	0.82		$	1.48
Weighted-average number of common shares outstanding:
Basic		51,046,375			49,516,595			50,583,726			49,395,284
Diluted		53,628,389			51,974,435			53,227,433			51,615,334

 

See accompanying notes.

 

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Supernus Pharmaceuticals, Inc.

Consolidated Statements of Comprehensive Income

(in thousands)

 

 

		Three Months ended September 30,						Nine Months ended September 30,
		2017			2016			2017			2016
		(unaudited)						(unaudited)
Net income		$	15,961		$	61,826		$	43,626		$	76,902
Other comprehensive income (loss):
Unrealized net gain (loss) on marketable securities, net of tax		36			(422		)	386			615
Other comprehensive income (loss):		36			(422		)	386			615
Comprehensive income		$	15,997		$	61,404		$	44,012		$	77,517

 

See accompanying notes.

 

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Supernus Pharmaceuticals, Inc.

Consolidated Statements of Cash Flows

(in thousands)

 

 

		Nine Months ended September 30,
		2017			2016
		(unaudited)
Cash flows from operating activities
Net income		$	43,626		$	76,902
Adjustments to reconcile net income to net cash provided by operating activities:
Loss on extinguishment of debt		295			382
Change in fair value of derivative liability		(76		)	(349		)
Depreciation and amortization		6,462			1,728
Amortization of deferred financing costs and debt discount		50			226
Non-cash interest expense, net/interest (income), net		(342		)	286
Non-cash interest expense on non-recourse liability related to sale of future royalties		1,274			3,564
Non-cash royalty revenue		(3,708		)	(3,464		)
Share-based compensation expense		6,447			4,454
Deferred income tax provision		13,314			(42,377		)
Changes in operating assets and liabilities:
Accounts receivable		(14,639		)	(10,312		)
Inventories		1,854			(4,866		)
Prepaid expenses and other current assets		(2,712		)	1,060
Accounts payable		(1,312		)	(1,629		)
Accrued sales deductions		17,829			12,900
Accrued expenses		2,769			2,503
Income taxes payable		6,482			811
Deferred licensing revenue		(202		)	195
Other non-current liabilities		894			(140		)
Net cash provided by operating activities		78,305			41,874
Cash flows from investing activities
Purchases of marketable securities		(78,938		)	(31,194		)
Sales and maturities of marketable securities		23,052			22,398
Purchases of property, plant and equipment		(1,273		)	(1,302		)
Deferred legal fees		(10,130		)	(12,224		)
Net cash used in investing activities		(67,289		)	(22,322		)
Cash flows from financing activities
Proceeds from issuance of common stock		4,510			1,255
Net cash provided by financing activities		4,510			1,255
Net increase in cash and cash equivalents		15,526			20,807
Cash and cash equivalents at beginning of period		66,398			33,498
Cash and cash equivalents at end of period		$	81,924		$	54,305
Supplemental cash flow information:
Cash paid for interest		$	134		$	247
Noncash financial activity:
Conversion of convertible notes and interest make-whole		$	4,546		$	2,138
Deferred legal fees included in accounts payable and accrued expenses		$	1,337		$	7,920

 

See accompanying notes.

 

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Supernus Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

For the Nine Months ended September 30, 2017 and 2016

(unaudited)

 

1.  Organization and Business

 

Supernus Pharmaceuticals, Inc. (the Company) was incorporated in Delaware and commenced operations in 2005. The Company is a specialty pharmaceutical company focused on developing and commercializing products for the treatment of central nervous system (CNS) diseases. The Company markets two products, Oxtellar XR for the treatment of epilepsy and Trokendi XR for the treatment of migraine and epilepsy, and has several proprietary product candidates in clinical development that address the psychiatry market.

 

The Company launched Oxtellar XR and Trokendi XR in 2013 for the treatment of epilepsy and launched Trokendi XR for the prophylaxis of migraine in adolescents and adults in April 2017.

 

2.  Summary of Significant Accounting Policies

 

Basis of Presentation

 

The Company’s consolidated financial statements include the accounts of Supernus Pharmaceuticals, Inc. and Supernus Europe Ltd., collectively referred to herein as “Supernus” or “the Company.” All significant intercompany transactions and balances have been eliminated in consolidation. The Company’s unaudited consolidated financial statements have been prepared in accordance with the requirements of the U.S. Securities and Exchange Commission (SEC) for interim financial information.

 

As permitted under Generally Accepted Accounting Principles in the United States (U.S. GAAP), certain notes and other information have been omitted from the interim unaudited consolidated financial statements presented in this Quarterly Report on Form 10-Q. Therefore, these financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K for the year ended December 31, 2016 filed with the SEC.

 

In the opinion of management, the consolidated financial statements reflect all adjustments necessary to fairly present the Company’s financial position, results of operations, and cash flows for the periods presented. These adjustments are of a normal recurring nature.  The Company currently operates in one business segment.

 

The results of operations for the three and nine months ended September 30, 2017 are not necessarily indicative of the Company’s future financial results.

 

Marketable Securities

 

Marketable securities consist of investments in U.S. Treasury bills and notes, certificates of deposit, various U.S. governmental agency debt securities, corporate and municipal bonds and other fixed income securities. The Company places all investments with government, industrial, or financial institutions whose debt is rated as investment grade. The Company classifies all available-for-sale marketable securities with maturities greater than one year from the balance sheet date as non-current assets.

 

The Company’s investments are classified as available-for-sale and are carried at estimated fair value. Any unrealized holding gains or losses are reported, net of any tax effects reported, as accumulated other comprehensive income (loss), which is a separate component of stockholders’ equity.

 

Realized gains and losses, and declines in value judged to be other-than-temporary, if any, are included in consolidated results of operations. A decline in the market value of any available-for-sale security below cost that is deemed to be other-than-temporary results in a reduction in fair value, which is charged to earnings in that period, and a new cost basis for the security is established. Dividend and interest income is recognized when earned. The cost of securities sold is calculated using the specific identification method.

 

The Company established the Supernus Supplemental Executive Retirement Plan (SERP) for the sole purpose of receiving funds for executives from a previous SERP and providing a continuing deferral program under the Supernus SERP. As of September 30, 2017 and December 31, 2016, the fair value of the SERP was $313,000 and $275,000, respectively. The fair value of these assets is included within other non-current assets on the consolidated balance sheets. A corresponding non-current liability is also included in the consolidated balance sheets to reflect the Company’s obligation for the SERP. The Company has not made, and has no plans to make, contributions to the SERP. The securities are restricted in nature and can only be used for purposes of paying benefits under the SERP.

 

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Accounts Receivable, net

 

Accounts receivable are reported on the consolidated balance sheets at outstanding amounts, less an allowance for doubtful accounts and discounts. The Company extends credit without requiring collateral. The Company writes off uncollectible receivables when the likelihood of collection is remote. The Company evaluates the collectability of accounts receivable on a regular basis. An allowance, when needed, is based upon various factors including the financial condition and payment history of customers, an overall review of collections experience on other accounts, and economic factors or events expected to affect future collections experience.

 

The Company recorded an allowance for expected sales discounts of approximately $8.1 million and $5.6 million as of September 30, 2017 and December 31, 2016, respectively.

 

Inventories

 

Inventories, which are recorded at the lower of cost or market, include materials, labor, and other direct and indirect costs and are valued using the first-in, first-out method. The Company capitalizes inventories produced in preparation for commercial launches when it becomes probable that the related product candidates will receive regulatory approval and that the related costs will be recoverable through the commercial sale of the product.

 

Property and Equipment

 

Property and equipment are stated at cost. Upon retirement or sale, the cost of assets disposed of and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is credited or charged to operations. Repairs and maintenance costs are expensed as incurred. Depreciation and amortization are computed using the straight-line method over the following useful lives:

 

Computer equipment		3 years
Software		3 years
Lab equipment and furniture		5 - 10 years
Leasehold improvements		Shorter of lease term or useful life

 

Intangible Assets

 

Intangible assets consist of patent defense costs, which are deferred legal fees that have been incurred in connection with legal proceedings related to the defense of patents for Oxtellar XR and Trokendi XR. Patent defense costs will be charged to expense in the event of an unsuccessful outcome of the ongoing litigation. Patents are carried at cost less accumulated amortization, which is calculated on a straight-line basis over the estimated useful lives of the patents. Amortization commences in the quarter after the costs are incurred. This amortization period is based initially upon the remaining patent life and is adjusted, if necessary, for any settlements or other changes to the expected useful life of the patent. The carrying value of the patents are assessed for impairment annually during the fourth quarter of each year, or more frequently if impairment indicators exist. There were no indicators of impairment identified as of September 30, 2017.

 

Impairment of Long-Lived Assets

 

Long-lived assets consist primarily of property and equipment and patent defense costs. The Company assesses the recoverability of its long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If indications of impairment exist, projected future undiscounted cash flows associated with the asset are compared to the carrying amount to determine whether the asset’s value is recoverable. Evaluation of impairment requires judgment, including the estimation of future cash flows, future growth rates and profitability and the expected life over which cash flows will occur. Changes in the Company’s business strategy or adverse changes in market conditions could impact impairment analyses and could require the recognition of an impairment charge equal to the excess of the carrying value of the long-lived assets over its estimated fair value.

 

There were no indicators of impairment identified for the Company’s long-lived assets as of September 30, 2017.

 

Deferred Financing Costs

 

Deferred financing costs consist of financing costs incurred by the Company in connection with the issuance of the Company’s 7.50% Convertible Senior Secured Notes due 2019 (the Notes). The Company amortizes deferred financing costs over the term of the related debt using the effective interest method. When extinguishing debt, the related deferred financing costs are written off.

 

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Preclinical Study and Clinical Trial Accruals

 

We estimate preclinical study and clinical trial expenses based on the services performed pursuant to contracts with research institutions, clinical investigators, and clinical research organizations (CROs) that conduct these activities on our behalf. In recording service fees, the Company estimates the time period over which the related services will be performed and compares the level of effort expended through the end of each period to the cumulative expenses recorded and payments made for such services. As appropriate, we accrue additional service fees or defer any non-refundable advance payments until the related services are performed. If the actual timing of the performance of services or the level of effort varies from the estimate, the Company will adjust its accrual or deferred advance payment accordingly. If the Company later determines that it no longer expects the services associated with a nonrefundable advance payment to be rendered, the advance payment will be charged to expense in the period that such determination is made.

 

Revenue from Product Sales

 

Revenue from product sales is recognized when persuasive evidence of an arrangement exists; delivery has occurred and title to the product and associated risk of loss has passed to the customer; the price is fixed or determinable; collection from the customer has been reasonably assured; all performance obligations have been met; and returns and allowances can be reasonably estimated. Product sales are recorded net of estimated rebates, chargebacks, allowances, discounts, patient co-pay assistance and other deductions as well as estimated product returns (collectively, “sales deductions”).

 

Our products are distributed through wholesalers and pharmaceutical distributors. Each of these wholesalers and distributors takes title and ownership to the product upon physical receipt of the product and then distributes our products to pharmacies.

 

Sales Deductions

 

Allowances for estimated sales deductions are provided for the following:

 

·                  Rebates:  Rebates include mandated discounts under the Medicaid Drug Rebate Program, the Medicare coverage gap program, as well as negotiated discounts with commercial healthcare providers. Rebates are amounts owed after the final dispensing of product to a benefit plan participant has occurred and are based upon contractual agreements or legal requirements with the public sector (e.g., Medicaid) and with private sector benefit providers (e.g., commercial managed care providers). The allowance for rebates is based on statutory and contractual discount rates and expected claimed rebates based on a plan provider’s utilization.

 

Rebates are generally invoiced and paid quarterly in arrears so that the accrual balance consists of an estimate of the amount expected to be incurred for the current quarter’s activity, plus an accrual balance for known or estimated prior quarters’ unpaid rebates. If actual rebates vary from estimates, we may need to adjust balances of such rebates to reflect the actual expenditures of the Company with respect to these programs, which would affect revenue in the period of adjustment.

 

·                  Co-pay assistance:  Patients who pay in cash or have commercial healthcare insurance and meet certain eligibility requirements may receive co-pay assistance from the Company. The intent of this program is to reduce the patient’s out of pocket costs when filling a prescription. Liabilities for co-pay assistance are based on actual program participation as well as estimates of program activity using data provided by third-party administrators.

 

·                  Distributor/wholesaler deductions and discounts:  U.S. specialty distributors and wholesalers are offered various forms of consideration including allowances, service fees and prompt payment discounts as consideration for distributing our products. Distributor allowances and service fees arise from contractual agreements with distributors and are generally a percentage of the price at which the Company sells product to distributors and wholesalers. Wholesale customers are offered a prompt pay discount for payment within a specified period.

 

·                  Returns:  Sales of our products are not subject to a general right of return; however, the Company will accept product that is damaged or defective when shipped directly from our warehouse. The Company will accept expired product six months prior to and up to 12 months subsequent to its expiry date. Product that has been used to fill patient prescriptions is no longer subject to any right of return.

 

·                  Chargebacks:  Chargebacks are discounts that occur when contracted customers purchase directly from an intermediary distributor or wholesaler. Contracted customers, which currently consist primarily of Public Health Service institutions and federal government entities purchasing via the Federal Supply Schedule, generally purchase our product at a discounted price. The distributor or wholesaler, in turn, charges back the difference between the price initially paid by the distributor or wholesaler and the discounted price paid to the distributor or wholesaler by the customer. The allowance for distributor/wholesaler chargebacks is based on sales to contracted customers.

 

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Revenue Recognition of License Revenue

 

License and Collaboration Agreements

 

We have entered into collaboration agreements to commercialize both Oxtellar XR and Trokendi XR outside of the U.S. These agreements generally include an up-front license fee and ongoing milestone payments upon the achievement of specific events. We believe that when milestones meet all of the necessary criteria to be considered substantive, these should be recognized as revenue when achieved. As regards to up-front license fees, we have estimated the service period of the contract and are recognizing revenue on a straight-line basis over the respective service period.

 

Milestone Payments

 

Milestone payments on licensing agreements are recognized as revenue when the collaborative partner acknowledges completion of the milestone and substantive effort was necessary to achieve the milestone. Management may recognize milestone revenue in its entirety in the period in which the milestone is achieved only if the milestone meets all the criteria to be considered substantive. Substantive milestone payments are recognized upon achievement only if all of the following conditions are met:

 

·                  the milestone payments are non-refundable;

 

·                  achievement of the milestone involves a degree of risk and was not reasonably assured at the inception of the arrangement;

 

·                  substantive effort on the partner’s part is involved in achieving the milestone; and

 

·                  the amount of the milestone payment is reasonable in relation to the effort expended or the risk associated with achievement of the milestone.

 

Determination as to whether a payment meets the aforementioned conditions involves management’s judgment. If any of these conditions are not met, the resulting payment would not be considered a substantive milestone. Therefore, the resulting payment would be considered part of the consideration for the single unit of accounting and amortized over the appropriate period.

 

The Company recorded $0.3 million and $1.5 million of milestone revenue during the three and nine month periods ended September 30, 2017, respectively. No milestone revenue was recorded during the three and nine months ended September 30, 2016.

 

Royalty Revenue

 

We recognize non-cash royalty revenue for royalty amounts earned pursuant to a royalty agreement with United Therapeutics. In 2014, the Company sold certain of these royalty rights to Healthcare Royalty Partners III, L.P. (HC Royalty) (see Note 14). Accordingly, the Company records non-cash royalty revenue when payments are made from United Therapeutics to HC Royalty in connection with these agreements. Royalty revenue also includes royalty amounts received from collaboration partners, including from Shire Pharmaceuticals based on net product sales of Mydayis.

 

Cost of Product Sales

 

The cost of product sales consists primarily of materials, third-party manufacturing costs, freight and distribution costs, allocation of labor, quality control and assurance, and other manufacturing overhead costs.

 

Research and Development Costs

 

Research and development costs are expensed as incurred. Research and development costs consist primarily of: employee-related expenses, including salaries and benefits; share-based compensation expense; expenses incurred under agreements with CROs; fees paid to clinical investigators who are participating in our clinical trials; fees paid to consultants and other vendors that conduct the Company’s clinical trials; the cost of acquiring and manufacturing clinical trial materials; the cost of manufacturing materials used in process validation, to the extent that those materials are manufactured prior to receiving regulatory approval for those products and are not expected to be sold commercially; facilities costs that do not have an alternative future use; related depreciation and other allocated expenses; license fees for, and milestone payments related to in-licensed products and technologies; and costs associated with animal testing activities and regulatory approvals.

 

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Advertising Expense

 

The costs of the Company’s advertising efforts are expensed as incurred. The Company incurred approximately $9.6 million and $26.1 million in advertising costs for the three and nine months ended September 30, 2017 and approximately $4.9 million and $16.2 million in advertising costs for the three and nine months ended September 30, 2016, respectively. These expenses are recorded in the selling, general and administrative expense line of the Statement of Operations.

 

Share-Based Compensation

 

Employee share-based compensation is measured based on the estimated fair value on the grant date. The grant date fair value is calculated using the Black-Scholes option-pricing model, which requires the use of subjective assumptions including volatility, expected term, risk-free rate, and the fair value of the underlying common stock. The Company recognizes expense using the straight-line method.

 

The Company records the expense for stock option grants to non-employees based on the estimated fair value of the stock option using the Black-Scholes option-pricing model. The fair value of non-employee awards is re-measured at each reporting period. As a result, stock compensation expense for non-employee awards with vesting is affected by subsequent changes in the fair value of the Company’s common stock.

 

Income Taxes

 

The Company utilizes the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax reporting bases of assets and liabilities and are measured using enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. When appropriate, valuation allowances are established to reduce deferred tax assets to the amounts expected to be realized.

 

The Company accounts for uncertain tax positions in its consolidated financial statements when it is more-likely-than-not that the position will be sustained upon examination by the tax authorities. Such tax positions must initially and subsequently be measured as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the tax authority, assuming full knowledge of the position and relevant facts. The Company’s policy is to recognize any interest and penalties related to income taxes as income tax expense.

 

Recently Issued Accounting Pronouncements

 

Accounting Pronouncements Adopted in 2017

 

In March 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-09, “Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting.” The standard is intended to simplify several areas of accounting for share-based compensation arrangements, including the income tax impact, classification on the statement of cash flows and forfeitures. ASU 2016-09 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and early adoption is permitted. The Company adopted ASU 2016-09 on January 1, 2017 using the modified retrospective approach. As a result, the Company recorded a cumulative effect adjustment of $211,000 to increase the 2017 beginning of period additional paid-in capital balance, with an offset to accumulated deficit for historical forfeiture assumptions. Additionally, the Company recorded an opening balance sheet adjustment of $392,000 to increase its deferred tax asset, with an offset to accumulated deficit, primarily to recognize excess tax benefits (i.e. windfalls) from stock option exercises in prior years combined with the impact of the $211,000 adjustment to historical forfeiture expense.

 

New Accounting Pronouncements Not Yet Adopted

 

In August 2017, the FASB issued ASU 2017-12, “Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities.” ASU 2017-12 provides new guidance about income statement classification and eliminates the requirement to separately measure and report hedge ineffectiveness. The entire change in fair value for qualifying hedge instruments included in the effectiveness will be recorded in other comprehensive income (OCI) and amounts deferred in OCI will be reclassified to earnings in the same income statement line item in which the earnings effect of the hedged item is reported. This standard will be effective for the first annual period beginning after December 15, 2018, including interim periods within those periods.  Early adoption is permitted. The Company is currently assessing the impact that this standard will have on its consolidated financial statements, but does not expect it to have a material impact.

 

In July 2017, the FASB issued ASU 2017-11, “Earnings per share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception.” The amendments in Part I change the classification analysis of certain equity-linked financial instruments (embedded features) with down round features. When determining whether

 

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certain financial instruments should be classified as liabilities or equity instruments, a down round feature no longer precludes equity classification when assessing whether the instrument is indexed to an entity’s own stock. The amendments in Part II recharacterize the indefinite deferral of certain provisions of Topic 480 with a scope exception and do not have an accounting effect. The amendments in Part I of ASU 2017-11 are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted. The amendments in Part II of ASU 2017-11 do not require any transition guidance because those amendments do not have an accounting effect. The Company is currently assessing the impact that this standard will have on its consolidated financial statements, but does not expect it to have a material impact.

 

In May 2017, the FASB issued ASU 2017-09, “Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting,” which clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. ASU 2017-09 is effective for all annual periods, and interim periods within those annual periods, beginning after December 15, 2017, with early adoption permitted. The Company is currently evaluating the impact of adopting this standard on the consolidated financial statements and disclosures, but does not expect it to have a material impact.

 

In March 2017, the FASB issued ASU 2017-08, “Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities.” The amendments shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date. The amendments do not require an accounting change for securities held at a discount, as the discount continues to be amortized to maturity. ASU 2017-08 is effective for public business entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018 and early adoption is permitted. The amendments should be applied on a modified retrospective basis, with a cumulative-effect adjustment recorded directly to retained earnings as of the beginning of the period of adoption. The Company is currently assessing the impact that this standard will have on its consolidated financial statements.

 

In August 2016, the FASB issued ASU No. 2016-15, “Classification of Certain Cash Receipts and Cash Payments.” The standard eliminates diversity in the practice of how certain cash receipts and cash payments are presented and classified in the statement of cash flows under Topic 230, Statement of Cash Flows, and other Topics. ASU 2016-15 is effective for annual reporting periods, and interim periods therein, beginning after December 15, 2017. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” The standard requires a lessee to recognize assets and liabilities on the balance sheet for leases with lease terms greater than 12 months. ASU 2016-02 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018, and early adoption is permitted. We expect the ASU to have a material impact on our assets and liabilities due to the addition of previously classified operating leases, but we do not expect it to have a material impact on our cash flows or results of operations.

 

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers.” ASU 2014-09 will eliminate transaction-and industry-specific revenue recognition guidance under current U.S. GAAP and replace it with a principles-based approach for determining revenue recognition. ASU 2014-09 will require that companies recognize revenue based on the value of transferred goods or services as they occur in the contract. The ASU also will require additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2017, with early adoption being permitted for periods ending after December 15, 2016. The guidance permits two methods of adoption: full retrospective method (retrospective application to each prior reporting period presented) or modified retrospective method (retrospective application with the cumulative effect of initially applying the guidance recognized at the date of initial application and providing certain additional disclosures). The Company has not selected an adoption methodology.

 

Since ASU No. 2014-09 supersedes substantially all existing revenue recognition guidance affecting us under the current standard, it could impact revenue and cost recognition across our business processes. The Company’s project plan includes a three-phase approach to implementing this standard update. The Company is currently finalizing phase one, the assessment phase, of the project.  In the assessment phase, we held revenue recognition workshops with our commercial and finance groups and reviewed a sample of revenue arrangements across the business to initially identify a set of applicable qualitative revenue recognition changes related to the new standard. Phase two will include (a) establishing and documenting key accounting positions, (b) assessing the new disclosure requirements, business processes, and control impacts, and (c) beginning to assess the initial quantitative impacts resulting from the initial standard.  Phase three will include (a) finalizing any changes to accounting policies, (b) preparing new disclosures and implementing new business processes and controls as needed, and (c) quantifying the effect of adoption on opening retained earnings.

 

The Company continues to evaluate the impact of the new standard on the consolidated financial statements and related disclosures and additional differences may be identified as contracts with customers that will impact future periods are executed. The majority of

 

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the Company’s revenue consists of sales of products that represent a single performance obligation where control transfers at the point in time title and risk of loss pass to the customer. The adoption of the new ASU will most likely impact our revenue recognition practices on our product sales with regards to the accounting for variable considerations such as incentives and sales deductions and the related financial statement presentation.

 

In addition, the Company also has licensing and collaboration arrangements, where it receives milestone and royalty payments. The provisions of the new standard may impact the timing of revenue associated with these arrangements; i.e., may result in acceleration of revenue recognition based on the transfer of control. We expect that disclosures in the notes to the consolidated financial statements related to revenue recognition will be expanded in line with the requirements of the new standard to further describe the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers. The Company is in the process of assessing its accounting and forecasting considerations to ensure its ability to record, report, forecast, and analyze results under the new standard.

 

3.  Fair Value of Financial Instruments

 

The fair value of an asset or liability should represent the price that would be received to sell an asset or that would be paid to transfer a liability in an orderly transaction between market participants. Such transactions are assumed to occur in the principal or most advantageous market for the asset or liability. Accordingly, fair value is determined based on a hypothetical transaction at the measurement date, considered from the perspective of a market participant rather than from a reporting entity’s perspective.

 

The Company reports assets and liabilities that are measured at fair value using a three level fair value hierarchy that prioritizes the inputs used to measure fair value. This hierarchy maximizes the use of observable inputs and minimizes the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:

 

·                  Level 1—Inputs are unadjusted quoted prices in active markets for identical assets that the Company has the ability to access at the measurement date.

 

·                  Level 2—Inputs are quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability (interest rates, yield curves, etc.); and inputs that are derived principally from or corroborated by observable market data by correlation or other means (market corroborated inputs).

 

·                  Level 3—Unobservable inputs that reflect the Company’s own assumptions, based on the best information available, including the Company’s own data.

 

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In accordance with the fair value hierarchy described above, the following tables show the fair value of the Company’s financial assets and liabilities that are required to be measured at fair value, in thousands:

 

		Fair Value Measurements at
		September 30, 2017
		(unaudited)
								Significant
		Total Carrying			Quoted Prices			Other			Significant
		Value at			in Active			Observable			Unobservable
		September 30,			Markets			Inputs			Inputs
		2017			(Level 1)			(Level 2)			(Level 3)
Assets:
Cash and cash equivalents		$	81,924		$	81,924		$	—		$	—
Marketable securities		32,626			1,871			30,755			—
Long term marketable securities		123,123			698			122,425			—
Marketable securities - restricted (SERP)		313			—			313			—
Total assets at fair value		$	237,986		$	84,493		$	153,493		$	—
Liabilities:
Derivative liabilities		$	—		$	—		$	—		$	—

 

		Fair Value Measurements at
		December 31, 2016
								Significant
		Total Carrying			Quoted Prices			Other			Significant
		Value at			in Active			Observable			Unobservable
		December 31,			Markets			Inputs			Inputs
		2016			(Level 1)			(Level 2)			(Level 3)
Assets:
Cash and cash equivalents		$	66,398		$	66,398		$	—		$	—
Marketable securities		23,723			656			23,067			—
Long term marketable securities		75,410			—			75,410			—
Marketable securities - restricted (SERP)		275			—			275			—
Total assets at fair value		$	165,806		$	67,054		$	98,752		$	—
Liabilities:
Derivative liabilities		$	114		$	—		$	—		$	114

 

The fair value of the restricted marketable securities is included within other non-current assets in the consolidated balance sheets.

 

The Company’s Level 1 assets include cash held with banks, certificates of deposit, and money market funds.

 

Level 2 assets include the SERP assets, commercial paper and investment grade corporate bonds and other fixed income securities. Level 2 securities are valued using third-party pricing sources that apply applicable inputs and other relevant data into their models to estimate fair value.

 

Level 3 liabilities include the estimated fair value of the interest make-whole liability associated with the Notes, which are recorded as derivative liabilities. The “make-whole fundamental change” provision (as defined in the Indenture governing the Notes) expired on May 1, 2017.

 

The carrying amounts of other financial instruments, including accounts receivable, accounts payable and accrued expenses approximate fair value due to their short-term maturities.

 

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Unrestricted marketable securities held by the Company were as follows, in thousands:

 

At September 30, 2017 (unaudited):

 

Available for Sale		Amortized Cost			Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Corporate debt securities		$	155,713		286		(250	)	$	155,749

 

At December 31, 2016:

 

Available for Sale		Amortized Cost			Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Corporate debt securities		$	99,487		86		(440	)	$	99,133

 

The contractual maturities of the unrestricted available for sale marketable securities held by the Company were as follows, in thousands:

 

		September 30,
		2017
		(unaudited)
Less Than 1 Year		$	32,626
1 year to 2 years		38,121
3 years to 4 years		85,002
Greater Than 4 Years		—
Total		$	155,749

 

The Company has not experienced any other-than-temporary losses on its marketable securities and restricted marketable securities. The cost of securities sold is calculated using the specific identification method.

 

4. Inventories

 

Inventories consist of the following, in thousands:

 

		September 30,			December 31,
		2017			2016
		(unaudited)
Raw materials		$	2,178		$	2,091
Work in process		4,690			8,874
Finished goods		8,079			5,836
		$	14,947		$	16,801

 

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5.  Property and Equipment

 

Property and equipment consist of the following, in thousands:

 

		September 30,			December 31,
		2017			2016
		(unaudited)
Computer equipment		$	1,214		$	1,206
Software		1,966			1,807
Lab equipment and furniture		7,805			6,758
Leasehold improvements		2,729			2,642
Construction in progress		—			28
		13,714			12,441
Less accumulated depreciation and amortization		(9,026		)	(8,097		)
		$	4,688		$	4,344

 

Depreciation and amortization expense on property and equipment was approximately $0.3 million and $0.9 million for the three and nine months ended September 30, 2017, and approximately $0.3 million and $0.9 million for the three and nine months ended September 30, 2016, respectively.

 

6.  Intangible Assets

 

Intangible assets consist of patent defense costs, which are deferred legal fees incurred in conjunction with defending patents for Oxtellar XR and Trokendi XR.

 

The following sets forth the gross carrying amount and related accumulated amortization of the intangible asset, in thousands:

 

		Weighted-		September 30,			December 31,
		Average Life		2017			2016
		(unaudited)
Capitalized patent defense costs		5.9 - 10 years		$	43,978		$	37,633
Less accumulated amortization				(6,816		)	(1,283		)
				$	37,162		$	36,350

 

In March 2017, the Company entered into two settlements with various companies related to Trokendi XR patent litigation. The remaining unamortized capitalized patent defense cost for Trokendi XR is amortized through the settlement date of January 1, 2023.

 

Amortization expense related to intangible assets was approximately $4.1 million and $5.5 million for the three and nine months ended September 30, 2017, and approximately $0.3 million and $0.9 million for the three and nine months ended September 30, 2016, respectively.

 

There were no indicators of impairment identified.

 

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7.  Accrued Expenses

 

Accrued expenses are comprised of the following, in thousands:

 

		September 30,			December 31,
		2017			2016
		(unaudited)
Accrued compensation		$	13,870		$	9,145
Accrued professional fees		2,212			6,447
Accrued clinical trial and clinical supply costs		4,251			4,350
Accrued product costs		807			1,794
Accrued interest expense		—			61
Other accrued expenses		5,752			5,630
		$	26,892		$	27,427

 

8.   Convertible Senior Secured Notes

 

The table below summarizes activity related to the Notes from their issuance on May 3, 2013 through September 30, 2017, in thousands:

 

Gross proceeds		$	90,000
Initial value of interest make-whole derivative reported as debt discount		(9,270		)
Conversion option reported as debt discount and APIC		(22,336		)
Conversion of debt to equity - principal		(85,425		)
Conversion of debt to equity - accretion of debt discount and deferred financing costs		25,767
Accretion of debt discount and deferred financing costs		5,429
December 31, 2016 carrying value		4,165
Conversion of debt to equity - principal		(4,575		)
Conversion of debt to equity - accretion of debt discount and deferred financing costs		360
Accretion of debt discount and deferred financing costs		50
September 30, 2017 carrying value, unaudited		$	—

 

During the nine months ended September 30, 2017, approximately $4.6 million of the Notes were presented to the Company for conversion. Accordingly, the Company issued approximately 0.9 million shares of common stock in conversion of the principal amount of the Notes. As a result of the conversions, the Company incurred a loss of approximately $0.3 million on extinguishment of debt during the nine months ended September 30, 2017, which is included as a separate component of other income (expense) on the Consolidated Statement of Operations. During the nine months ended September 30, 2016, consequent to approximately $2.0 million in note conversions, the Company incurred a loss of approximately $0.4 million on extinguishment of debt.

 

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9. Summary Stockholders’ Equity

 

The following summary table provides details related to the activity in certain captions within Stockholders’ Equity for the nine months ended September 30, 2017, in thousands.

 

		Common Stock			Additional Paid-in Capital			Accumulated Deficit
		(unaudited)
Balance, December 31, 2016		$	50		$	276,127		$	(84,288	)
Cumulative-effect adjustment		—			211			181
Balance at January 1, 2017		50			276,338			(84,107		)
Share-based compensation		—			6,447			—
Issuance of ESPP shares		—			908
Exercise of stock options		—			3,602			—
Equity issued on note conversion		1			4,546			—
Net income		—			—			43,626
Balance, September 30, 2017		$	51		$	291,841		$	(40,481	)

 

10. Share-Based Payments

 

The Company has adopted the Supernus Pharmaceuticals, Inc. 2012 Equity Incentive Plan (the 2012 Plan), which is stockholder approved, and provides for the grant of stock options and certain other awards, including stock appreciation rights (SAR), restricted and unrestricted stock, stock units, performance awards, cash awards and other awards that are convertible into or otherwise based on the Company’s common stock, to the Company’s key employees, directors, and consultants and advisors. The 2012 Plan is administered by the Company’s Board of Directors and provides for the issuance of up to 8,000,000 shares of the Company’s Common Stock. Option awards are granted with an exercise price equal to the estimated fair value of the Company’s Common Stock at the grant date. Option awards granted to employees, consultants and advisors generally vest in four annual installments, starting on the first anniversary of the date of grant and have ten-year contractual terms. Option awards granted to the directors generally vest over a one year term.

 

Share-based compensation recognized related to the grant of employee and non-employee stock options, SAR, Employee Stock Purchase Plan (ESPP) awards and non-vested stock was as follows, in thousands:

 

		Three Months ended						Nine Months ended September 30,
		2017			2016			2017			2016
		(unaudited)						(unaudited)
Research and development		$	356		$	253		$	1,071		$	882
Selling, general and administrative		2,004			1,230			5,376			3,572
Total		$	2,360		$	1,483		$	6,447		$	4,454

 

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The following table summarizes stock option and SAR activity:

 

		Number of Options		Weighted- Average Exercise Price			Weighted- Average Remaining Contractual Term (in years)
Outstanding, December 31, 2016		3,644,088		$	10.25		7.59
Granted		1,074,955		$	25.88
Exercised		(383,588	)	$	9.39
Forfeited or expired		(66,797	)	$	17.07
Outstanding, September 30, 2017		4,268,658		$	14.15		7.59
As of December 31, 2016:
Vested and expected to vest		3,591,528		$	10.22		7.57
Exercisable		1,503,004		$	8.62		6.49
As of September 30, 2017:
Vested and expected to vest		4,268,658		$	14.15		7.59
Exercisable		1,961,784		$	9.30		6.40

 

11.  Earnings per Share

 

Basic income per common share is determined by dividing income attributable to common stockholders by the weighted-average number of common shares outstanding during the period, without consideration of common stock equivalents. Diluted income per share is computed by dividing the income attributable to common stockholders by the weighted-average number of common share equivalents outstanding for the period. The treasury stock method is used to determine the dilutive effect of the Company’s stock option grants, SAR, and potential ESPP awards, and the if-converted method is used to determine the dilutive effect of the Company’s Notes.

 

The following common stock equivalents were excluded in the calculation of diluted income per share because their effect would be anti-dilutive as applied to the income from continuing operations applicable to common stockholders for the three and nine months ended September 30, 2017 and 2016:

 

		Three Months ended September 30,				Nine Months ended September 30,
		2017		2016		2017		2016
		(unaudited)				(unaudited)
Stock options, stock appreciation rights, and ESPP awards		15,170		12,097		105,699		67,030

 

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