SUPERNUS PHARMACEUTICALS, INC. - Quarter Report: 2017 March (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 March 31, 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 May 2, 2017 was 50,282,397.

 

 

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SUPERNUS PHARMACEUTICALS, INC.

FORM 10-Q — QUARTERLY REPORT

FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2017

TABLE OF CONTENTS

 

	Page No.
PART I — FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2017 (Unaudited) and December 31, 2016	1
Consolidated Statements of Operations for the three month periods ended March 31, 2017 and 2016 (Unaudited)	2
Consolidated Statements of Comprehensive Income for the three month periods ended March 31, 2017 and 2016 (Unaudited)	3
Consolidated Statements of Cash Flows for the three month periods ended March 31, 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	19
Item 3. Quantitative and Qualitative Disclosures about Market Risk	27
Item 4. Controls and Procedures	27
PART II — OTHER INFORMATION
Item 1. Legal Proceedings	28
Item 1A. Risk Factors	31
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	31
Item 3. Defaults Upon Senior Securities	31
Item 4. Mine Safety Disclosures	31
Item 5. Other Information	31
Item 6. Exhibits	31
SIGNATURES	32

 

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PART I — FINANCIAL INFORMATION

 

Supernus Pharmaceuticals, Inc.

Consolidated Balance Sheets

(in thousands, except share amounts)

 

		March 31,			December 31,
		2017			2016
		(unaudited)
Assets
Current assets:
Cash and cash equivalents		$	59,599		$	66,398
Marketable securities		27,533			23,723
Accounts receivable, net		38,885			41,527
Inventories, net		19,167			16,801
Prepaid expenses and other current assets		4,573			2,955
Total current assets		149,757			151,404
Long term marketable securities		89,163			75,410
Property and equipment, net		4,342			4,344
Deferred legal fees		11,331			19,860
Intangible assets, net		29,450			16,490
Other non-current assets		350			331
Deferred income taxes		37,863			41,729
Total assets		$	322,256		$	309,568
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable		$	5,056		$	8,055
Accrued sales deductions		43,450			41,943
Accrued expenses		26,890			27,427
Accrued income taxes payable		1,675			7
Non-recourse liability related to sale of future royalties, current portion		4,645			3,101
Deferred licensing revenue		287			209
Total current liabilities		82,003			80,742
Deferred licensing revenue, net of current portion		1,365			1,501
Convertible notes, net		3,310			4,165
Non-recourse liability related to sale of future royalties, long term		25,555			27,289
Other non-current liabilities		3,936			4,002
Derivative liabilities		23			114
Total liabilities		116,192			117,813
Stockholders’ equity:
Common stock, $0.001 par value, 130,000,000 shares authorized at March 31, 2017 and December 31, 2016; 50,226,397 and 49,971,267 shares issued and outstanding at March 31, 2017 and December 31, 2016, respectively		50			50
Additional paid-in capital		279,792			276,127
Accumulated other comprehensive income (loss), net of tax		32			(134		)
Accumulated deficit		(73,810		)	(84,288		)
Total stockholders’ equity		206,064			191,755
Total liabilities and stockholders’ equity		$	322,256		$	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 March 31,
		2017			2016
		(unaudited)
Revenue
Net product sales		$	56,369		$	43,025
Royalty revenue		1,149			1,119
Licensing revenue		58			50
Total revenue		57,576			44,194
Costs and expenses
Cost of product sales		2,949			2,035
Research and development		9,601			10,562
Selling, general and administrative		28,238			25,160
Total costs and expenses		40,788			37,757
Operating income		16,788			6,437
Other income (expense)
Interest income		531			327
Interest expense		(90		)	(179		)
Interest expense-nonrecourse liability related to sale of future royalties		(959		)	(1,279		)
Changes in fair value of derivative liabilities		54			101
Loss on extinguishment of debt		(101		)	(382		)
Total other expense		(565		)	(1,412		)
Earnings before income taxes		16,223			5,025
Income tax expense		5,926			200
Net income		$	10,297		$	4,825
Earnings per share:
Basic		$	0.21		$	0.10
Diluted		$	0.19		$	0.08
Weighted-average number of common shares outstanding:
Basic		50,158,634			49,240,099
Diluted		52,764,442			51,152,072

 

See accompanying notes.

 

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Supernus Pharmaceuticals, Inc.

Consolidated Statements of Comprehensive Income

(in thousands)

 

		Three Months ended March 31,
		2017			2016
		(unaudited)
Net income		$	10,297		$	4,825
Other comprehensive income:
Unrealized net gain on marketable securities, net of tax		166			656
Other comprehensive income:		166			656
Comprehensive income		$	10,463		$	5,481

 

See accompanying notes.

 

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Supernus Pharmaceuticals, Inc.

Consolidated Statements of Cash Flows

(in thousands)

		Three Months ended March 31,
		2017			2016
		(unaudited)
Cash flows from operating activities
Net income		$	10,297		$	4,825
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Loss on extinguishment of debt		101			382
Change in fair value of derivative liability		(54		)	(101		)
Depreciation and amortization		741			429
Non-cash interest expense, net/interest (income), net		(313		)	155
Non-cash interest expense on non-recourse liability related to sale of future royalties		959			1,279
Non-cash royalty revenue		(1,149		)	(1,119		)
Share-based compensation expense		1,827			1,359
Deferred income tax benefit		4,258			—
Changes in operating assets and liabilities:
Accounts receivable		2,642			(4,744		)
Inventories		(2,366		)	(457		)
Prepaid expenses and other assets		(1,618		)	260
Accounts payable		(3,133		)	(1,691		)
Accrued sales deductions		1,507			1,903
Accrued expenses		(1,865		)	(6,017		)
Accrued income taxes payable		1,668			22
Deferred licensing revenue		(58		)	300
Other non-current liabilities		(86		)	73
Net cash provided by (used in) operating activities		13,358			(3,142		)
Cash flows from investing activities
Purchases of marketable securities		(22,193		)	(17,335		)
Sales and maturities of marketable securities		5,140			7,400
Purchases of property, plant and equipment		(300		)	(279		)
Deferred legal fees		(3,408		)	(436		)
Net cash used in investing activities		(20,761		)	(10,650		)
Cash flows from financing activities
Proceeds from issuance of common stock		604			124
Net cash provided by financing activities		604			124
Net change in cash and cash equivalents		(6,799		)	(13,668		)
Cash and cash equivalents at beginning of period		66,398			33,498
Cash and cash equivalents at end of period		$	59,599		$	19,830
Noncash financial activity:
Conversion of convertible notes and interest make-whole		$	1,023		$	2,138
Deferred legal fees included in accounts payable and accrued expenses		$	6,584		$	3,779

 

See accompanying notes.

 

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Supernus Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

For the Three Months ended March 31, 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, including neurological and psychiatric disorders. 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 commercialized Oxtellar XR and Trokendi XR in 2013. The Company launched Trokendi XR for the treatment of migraine 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 months ended March 31, 2017 are not necessarily indicative of the Company’s future financial results.

 

Marketable Securities

 

Marketable securities consist of investments in U.S. Treasuries, 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. Such securities 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 March 31, 2017 and December 31, 2016, the fair value of the SERP was $294,000 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

 

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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.

 

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 $5.3 million and $5.6 million as of March 31, 2017 and December 31, 2016, respectively.

 

Inventory

 

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 average 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

 

Deferred Legal Fees

 

Legal fees have been incurred in connection with legal proceedings related to the defense of patents for Oxtellar XR and Trokendi XR (see Note 6). Amortization of the deferred legal fees will begin upon successful outcome of the ongoing litigation. Deferred legal fees will be charged to expense in the event of an unsuccessful outcome of the ongoing litigation.

 

Intangible Assets

 

Intangible assets consist of deferred legal fees related to patents. Patents are carried at cost less accumulated amortization, which is calculated on a straight-line basis over the estimated useful lives of the patents. The carrying value of the patents and deferred legal fees 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 at March 31, 2017 or December 31, 2016.

 

Impairment of Long-Lived Assets

 

Long-lived assets consist primarily of patents defense costs, deferred legal fees, and property and equipment. 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. Evaluating for 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.

 

For the three months ended March 31, 2017 or year ended December 31, 2016, the Company determined that there was no impairment of the Company’s long-lived assets.

 

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Deferred Financing Costs

 

Deferred financing costs consist of financing costs incurred by the Company in connection with the closing of the Company’s 7.50% Convertible Senior Secured Notes due 2019 (the Notes) and Secured Notes Payable (see Note 8). 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.

 

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, 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, 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 will take title and ownership to the product upon physical receipt of the product and then distribute 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 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). The allowance for rebates is based on statutory and contractual discount rates and expected claimed rebates paid 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 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 and estimates of program redemption 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 purchase price paid by the 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.

 

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·                  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 the 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 known sales to contracted customers.

 

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. For 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 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.

 

There was no milestone revenue during the three months ended March 31, 2017 or 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.

 

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 primarily consist of employee-related expenses, including salaries and benefits; share-based compensation expense; expenses incurred under agreements with CROs, payments to investigators and consultants 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

 

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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.

 

Advertising Expense

 

The costs of the Company’s advertising efforts are expensed as incurred. The Company incurred approximately $6.7 million and $6.4 million in advertising costs for the three months ended March 31, 2017 and 2016, respectively, which 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

 

In August 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (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 March 2016, the FASB issued 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 forfeitures assumptions. Additionally, the Company recorded an opening balance sheet adjustment of $392,000 to increase our 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.

 

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.

 

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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. Entities can transition to the standard either retrospectively or as a cumulative effect adjustment as of the date of adoption. We are in the process of evaluating the potential revenue implications of the standard change, which may result in changes to our revenue recognition practices around license and collaboration agreements.

 

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 paid to transfer a liability in an orderly transaction between market participants. Such transactions to sell an asset or transfer a liability 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
		March 31, 2017
		(unaudited)
								Significant
		Total Carrying			Quoted Prices			Other			Significant
		Value at			in Active			Observable			Unobservable
		March 31,			Markets			Inputs			Inputs
		2017			(Level 1)			(Level 2)			(Level 3)
Assets:
Cash and cash equivalents		$	59,599		$	59,599		$	—		$	—
Marketable securities		27,533			656			26,877			—
Long term marketable securities		89,163			—			89,163			—
Marketable securities - restricted (SERP)		294			—			294			—
Total assets at fair value		$	176,589		$	60,255		$	116,334		$	—
Liabilities:
Derivative liabilities		$	23		$	—		$	—		$	23

 

		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, certificate of deposits, 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 fair value of the interest make-whole liability of the Notes was calculated using a binomial-lattice model with the following key assumptions as of March 31, 2017, unaudited:

 

Volatility		45%
Stock Price as of March 31, 2017		$31.30 per share
Credit Spread		900 bps
Term		1 month
Dividend Yield		0.0%

 

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Changes in the fair value of the interest make-whole liability are recognized as a component of other income (expense) in the Consolidated Statements of Operations. The following table presents information about the Company’s Level 3 liabilities as of March 31, 2017 and December 31, 2016 that are included in the non-current liabilities section of the Consolidated Balance Sheets, in thousands:

 

		Three Months ended
		March 31, 2017
		(unaudited)
Balance at December 31, 2016		114
Changes in fair value of derivative liabilities included in earnings		(54		)
Reduction due to conversion of debt to equity		(37		)
Balance at March 31, 2017		$	23

 

The carrying value, face value and estimated fair value of the Notes was approximately $3.3 million, $3.6 million and $21.2 million, respectively, as of March 31, 2017. The fair value was estimated based on actual trade information as well as quoted prices provided by bond traders, which would be characterized within Level 2 of the fair value hierarchy. This fair value amount gives recognition to the value of the interest make-whole liability and the value of the conversion option. Upon issuance these were accounted for as derivative liabilities and additional paid-in-capital, respectively.

 

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

 

 

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

 

At March 31, 2017 (unaudited):

 

Available for Sale		Amortized Cost			Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Corporate debt securities		$	116,883		135		(322	)	$	116,696

 

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:

 

		March 31,
		2017
		(unaudited)
Less Than 1 Year		$	27,533
1 year to 2 years		24,722
3 years to 4 years		64,441
Greater Than 4 Years		—
Total		$	116,696

 

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.

 

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4. Inventories

 

Inventories consist of the following, in thousands:

 

		March 31,			December 31,
		2017			2016
		(unaudited)
Raw materials		$	4,307		$	2,091
Work in process		9,399			8,874
Finished goods		5,461			5,836
		$	19,167		$	16,801

 

5.  Property and Equipment

 

Property and equipment consist of the following, in thousands:

 

		March 31,			December 31,
		2017			2016
		(unaudited)
Computer equipment		$	1,206		$	1,206
Software		1,876			1,807
Lab equipment and furniture		6,892			6,758
Leasehold improvements		2,722			2,642
Construction in progress		45			28
		12,741			12,441
Less accumulated depreciation and amortization		(8,399		)	(8,097		)
		$	4,342		$	4,344

 

Depreciation and amortization expense on property and equipment was approximately $302,000 and $287,000 for the three months ended March 31, 2017 and 2016, respectively.

 

6.  Deferred Legal Fees and Intangible Assets

 

Deferred legal fees have been incurred in connection with patents for Oxtellar XR and Trokendi XR. As of March 31, 2017 and December 31, 2016, the Company had deferred legal fees of $11.3 million and $19.9 million, respectively.

 

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

 

		Weighted-		March 31,			December 31,
		Average Life		2017			2016
		(unaudited)
Capitalized patent defense costs		5.9 - 11 years		$	31,172		$	17,773
Less accumulated amortization				(1,722		)	(1,283		)
				$	29,450		$	16,490

 

In March 2017, the Company entered into two settlements with various companies related to Trokendi XR patent litigation, at which time the Company reduced deferred legal fees by $12.6 million and transferred these amounts to intangible assets. The Company subsequently began amortizing the cost of litigation, and will continue to do so through the settlement date of January 1, 2023.

 

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The net book value of intangible assets was $29.5 million as of March 31, 2017 and $16.5 million as of December 31, 2016. The

increase in intangible assets reflects the settlement of lawsuits related to Trokendi XR during the first quarter of 2017.

 

Amortization expense on intangible assets was approximately $439,000 and $142,000 for the three months ended March 31, 2017 and 2016, respectively.

 

There were no indicators of impairment identified at March 31, 2017 or March 31, 2016.

 

7.  Accrued Expenses

 

Accrued expenses are comprised of the following, in thousands:

 

		March 31,			December 31,
		2017			2016
		(unaudited)
Accrued compensation		$	7,950		$	9,145
Accrued professional fees		6,409			4,350
Accrued clinical trial and clinical supply costs		5,509			5,919
Accrued product costs		1,398			1,794
Accrued sales and marketing expenses		605			528
Accrued interest expense		120			61
Other accrued expenses		4,899			5,630
		$	26,890		$	27,427

 

8.   Convertible Senior Secured Notes

 

The table below summarizes activity related to the Notes from issuance on May 3, 2013 through March 31, 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		(1,000		)
Conversion of debt to equity - accretion of debt discount and deferred financing costs		114
Accretion of debt discount and deferred financing costs		31
March 31, 2017 carrying value, unaudited		$	3,310

 

During the three month period ended March 31, 2017, approximately $1.0 million of the Notes were presented to the Company for conversion. Accordingly, the Company issued approximately 0.2 million shares of common stock in conversion of the principal amount of the Notes. The Company issued an additional 2,000 shares of common stock in settlement of the interest make-whole provision related to the converted Notes. As a result of the conversions, the Company incurred a loss of approximately $0.1 million on extinguishment of debt during the three months ended March 31, 2017, which is included as a separate component of other income (expense) on the Consolidated Statement of Operations. During the three month period ended March 31, 2016, as a result of 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 three month period ended March 31, 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		—			1,827			—
Exercise of stock options		—			604			—
Equity issued on note conversion		—			1,023			—
Net income		—			—			10,297
Balance, March 31, 2017		$	50		$	279,792		$	(73,810	)

 

During the three months ended March 31, 2017, the Company adopted ASU No. 2016-09, which simplifies several aspects of the accounting for share-based payments, including the Company’s election to eliminate the requirement to estimate the number of awards that are expected to be forfeit and, instead, account for forfeitures when they occur. The new standard requires the change to be adopted using the modified retrospective approach. As such, the Company recorded a cumulative effect adjustment of $211,000 to increase the 2017 beginning of period additional paid-in capital balances, with an offset to accumulated deficit for historical forfeitures assumptions. Additionally, the Company recorded an opening balance sheet adjustment of $392,000 to increase our 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.

 

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:

 

		March 31,
		2017			2016
		(unaudited)
Research and development		$	317		$	288
Selling, general and administrative		1,510			1,071
Total		$	1,827		$	1,359

 

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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 (unaudited)		1,028,525		$	25.30
Exercised (unaudited)		(64,901	)	$	9.31
Forfeited or expired (unaudited)		(4,575	)	$	17.38
Outstanding, March 31, 2017		4,603,137		$	13.62		7.92
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 March 31, 2017:
Vested and expected to vest (unaudited)		4,603,137		$	13.62		7.92
Exercisable (unaudited)		2,238,770		$	9.23		6.73

 

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 months ended

March 31, 2017 and 2016:

 

		Three Months ended March 31,
		2017		2016
		(unaudited)
Shares underlying Convertible Senior Secured Notes		—		—
Stock options, stock appreciation rights, and ESPP awards		223,273		179,162

 

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The following table sets forth the computation of basic and diluted net income per share for the three months ended March 31, 2017 and 2016, in thousands, except share and per share amounts:

 

		Three Months ended March 31,
		2017			2016
		(unaudited)
Numerator, in thousands:
Net income used for calculation of basic EPS		$	10,297		$	4,825
Interest expense on convertible debt		90			179
Changes in fair value of derivative liabilities		(54		)	(101		)
Loss on extinguishment of debt		101			382
Loss on extinguishment of outstanding debt,
as if converted		(320		)	(1,229		)
Total adjustments		(183		)	(769		)
Net income used for calculation of diluted EPS		$	10,114		$	4,056
Denominator:
Weighted average shares outstanding, basic		50,158,634			49,240,099
Effect of dilutive potential common shares:
Shares underlying Convertible Senior Secured Notes		683,743			1,383,472
Shares issuable to settle interest make-whole derivatives		7,012			71,537
Stock options and stock appreciation rights		1,915,053			456,964
Total potential dilutive common shares		2,605,808			1,911,973
Weighted average shares outstanding, diluted		52,764,442			51,152,072
Net income per share, basic		$	0.21		$	0.10
Net income per share, diluted		$	0.19		$	0.08

 

12. Income Taxes

 

The following table provides a comparative summary of our income tax expense and effective tax rate for the three months ended March 31, 2017 and 2016, in thousands:

 

		Three Months ended March 31,
		2017			2016
		(unaudited)
Income tax expense		$	5,926		$	200
Effective tax rate		36.5		%	4		%

 

The tax provision for the three months ended March 31, 2017, is attributed to the U.S. federal and state income. The increase in the income tax expense and the effective tax rate for the three months ended March 31, 2017 as compared to the same period in the prior year is primarily attributable to the release of the valuation allowance on the deferred tax asset during the third quarter of 2016.

 

13. Commitments and Contingencies

 

The Company has concurrent leases for office and lab space that extend through April 2020. The Company may elect to extend the term of the leases for an additional five-year term. The leases provide for a tenant improvement allowance of approximately $2.1 million in aggregate. During the three months ended March 31, 2017, $50,000 of the allowance was utilized. During the three months ended March 31, 2016, none of the allowance was utilized. As of March 31, 2017, $470,000 remains available for tenant improvements. Rent expense for the leased facilities and leased vehicles for the three months ended March 31, 2017 and March 31, 2016 was approximately $0.7 million in each period.

 

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