SUPERNUS PHARMACEUTICALS, INC. - Quarter Report: 2018 June (Form 10-Q)

Table of Contents

 

 

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 June 30, 2018

 

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)

 

Delaware		20-2590184
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

 

1550 East Gude Drive, Rockville, MD		20850
(Address of principal executive offices)		(Zip Code)

 

(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 August 3, 2018 was 52,214,334.

 

 

 

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SUPERNUS PHARMACEUTICALS, INC.

FORM 10-Q — QUARTERLY REPORT

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2018

 

			Page No.
PART I — FINANCIAL INFORMATION
	Item 1. Financial Statements
	Consolidated Balance Sheets as of June 30, 2018 (Unaudited) and December 31, 2017		3
	Consolidated Statements of Earnings for the three and six month periods ended June 30, 2018 and 2017 (Unaudited)		4
	Consolidated Statements of Comprehensive Earnings for the three and six month periods ended June 30, 2018 and 2017 (Unaudited)		5
	Consolidated Statements of Cash Flows for the six month periods ended June 30, 2018 and 2017 (Unaudited)		6
	Notes to Consolidated Financial Statements (Unaudited)		7
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		25
	Item 3. Quantitative and Qualitative Disclosures about Market Risk		37
	Item 4. Controls and Procedures		37
PART II — OTHER INFORMATION
	Item 1. Legal Proceedings		38
	Item 1A. Risk Factors		38
	Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		38
	Item 3. Defaults Upon Senior Securities		39
	Item 4. Mine Safety Disclosures		39
	Item 5. Other Information		39
	Item 6. Exhibits		39
SIGNATURES			41

 

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PART I — FINANCIAL INFORMATION

 

Supernus Pharmaceuticals, Inc.

Consolidated Balance Sheets

(in thousands, except share amounts)

 

		June 30, 2018			December 31, 2017
		(unaudited)
Assets
Current assets
Cash and cash equivalents		$	35,205		$	100,304
Marketable securities		139,208			39,736
Accounts receivable, net		74,842			65,586
Inventories, net		20,680			16,304
Prepaid expenses and other current assets		14,581			6,521
Total current assets		284,516			228,451
Long term marketable securities		503,312			133,638
Property and equipment, net		4,897			5,124
Intangible assets, net		33,794			36,019
Other non-current assets		752			389
Deferred income taxes		25,528			20,843
Total assets		$	852,799		$	424,464
Liabilities and stockholders’ equity
Current liabilities
Accounts payable		$	2,943		$	6,844
Accrued sales deductions		70,044			68,343
Accrued expenses		29,288			27,305
Income taxes payable		—			15,938
Non-recourse liability related to sale of future royalties, current portion		1,659			4,283
Deferred licensing revenue		—			287
Total current liabilities		103,934			123,000
Deferred licensing revenue, net of current portion		—			1,149
Convertible notes, net		321,920			—
Non-recourse liability related to sale of future royalties, long term		23,867			22,258
Other non-current liabilities		12,586			10,577
Total liabilities		462,307			156,984
Stockholders’ equity
Common stock, $0.001 par value, 130,000,000 shares authorized at June 30, 2018 and December 31, 2017; 52,179,334 and 51,314,850 shares issued and outstanding at June 30, 2018 and December 31, 2017, respectively		52			51
Additional paid-in capital		361,971			294,999
Accumulated other comprehensive loss, net of tax		(4,119		)	(747		)
Retained earnings (accumulated deficit)		32,588			(26,823		)
Total stockholders’ equity		390,492			267,480
Total liabilities and stockholders’ equity		$	852,799		$	424,464

 

See accompanying notes.

 

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Supernus Pharmaceuticals, Inc.

Consolidated Statements of Earnings

(in thousands, except share and per share data)

 

		Three Months ended June 30,						Six Months ended June 30,
		2018			2017			2018			2017
		(unaudited)						(unaudited)
Revenue
Net product sales		$	97,030		$	73,328		$	186,150		$	129,697
Royalty revenue		1,758			1,179			3,067			2,328
Licensing revenue		750			1,322			750			1,380
Total revenue		99,538			75,829			189,967			133,405
Costs and expenses
Cost of product sales		3,683			3,861			6,961			6,809
Research and development		20,038			10,823			38,946			20,425
Selling, general and administrative		40,097			35,078			76,946			63,316
Total costs and expenses		63,818			49,762			122,853			90,550
Operating earnings		35,720			26,067			67,114			42,855
Other income (expense)
Interest income		3,664			656			4,870			1,187
Interest expense		(4,324		)	(58		)	(5,041		)	(147		)
Interest expense-nonrecourse liability related to sale of future royalties		(1,204		)	(160		)	(1,905		)	(1,119		)
Changes in fair value of derivative liabilities		—			23			—			76
Loss on extinguishment of debt		—			(103		)	—			(204		)
Total other income (expense)		(1,864		)	358			(2,076		)	(207		)
Earnings before income taxes		33,856			26,425			65,038			42,648
Income tax expense		3,119			9,057			7,949			14,983
Net earnings		$	30,737		$	17,368		$	57,089		$	27,665
Earnings per share:
Basic		$	0.59		$	0.34		$	1.10		$	0.55
Diluted		$	0.57		$	0.32		$	1.06		$	0.52
Weighted-average number of common shares outstanding:
Basic		51,919,894			50,530,968			51,729,243			50,345,830
Diluted		54,203,308			53,223,714			54,021,941			53,026,323

 

See accompanying notes.

 

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Supernus Pharmaceuticals, Inc.

Consolidated Statements of Comprehensive Earnings

(in thousands)

 

		Three Months ended June 30,						Six Months ended June 30,
		2018			2017			2018			2017
		(unaudited)						(unaudited)
Net earnings		$	30,737		$	17,368		$	57,089		$	27,665
Other comprehensive earnings (loss):
Unrealized (loss) gain on marketable securities, net of tax		(1,828		)	184			(3,372		)	350
Other comprehensive earnings (loss)		(1,828		)	184			(3,372		)	350
Comprehensive earnings		$	28,909		$	17,552		$	53,717		$	28,015

 

See accompanying notes.

 

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Supernus Pharmaceuticals, Inc.

Consolidated Statements of Cash Flows

(in thousands)

 

		Six Months ended June 30,
		2018			2017
		(unaudited)
Cash flows from operating activities
Net earnings		$	57,089		$	27,665
Adjustments to reconcile net earnings to net cash provided by operating activities:
Loss on extinguishment of debt		—			204
Change in fair value of derivative liability		—			(76		)
Depreciation and amortization		3,487			2,084
Amortization of deferred financing costs and debt discount		4,307			50
Amortization of premium/discount on marketable securities		(1,835		)	(327		)
Non-cash interest expense on non-recourse liability related to sale of future royalties		1,905			1,119
Non-cash royalty revenue		(2,780		)	(2,328		)
Share-based compensation expense		5,703			4,087
Deferred income tax provision (benefit)		(395		)	11,672
Changes in operating assets and liabilities:
Accounts receivable		(7,776		)	(9,630		)
Inventories		(4,376		)	178
Prepaid expenses and other current assets		(8,060		)	(1,791		)
Other non-current assets		(342		)	—
Accounts payable		(3,838		)	50
Accrued sales deductions		1,701			5,678
Accrued expenses		2,964			(1,283		)
Income taxes payable		(15,938		)	1,601
Deferred licensing revenue		—			(130		)
Other non-current liabilities		1,873			477
Net cash provided by operating activities		33,689			39,300
Cash flows from investing activities
Purchases of marketable securities		(491,655		)	(48,468		)
Sales and maturities of marketable securities		19,466			12,419
Purchases of property, plant and equipment		(557		)	(852		)
Deferred legal fees		(401		)	(9,224		)
Net cash used in investing activities		(473,147		)	(46,125		)
Cash flows from financing activities
Proceeds from issuance of convertible notes		402,500			—
Convertible notes issuance financing costs		(10,435		)	—
Proceeds from issuance of warrants		65,688			—
Purchases of convertible note hedges		(92,897		)	—
Proceeds from issuance of common stock		9,503			2,164
Net cash provided by financing activities		374,359			2,164
Net change in cash and cash equivalents		(65,099		)	(4,661		)
Cash and cash equivalents at beginning of year		100,304			66,398
Cash and cash equivalents at end of period		$	35,205		$	61,737
Supplemental cash flow information:
Cash paid for interest		$	—		$	134
Income taxes paid		$	29,279		$	1,710
Non-cash financial activity:
Conversion of convertible notes and interest make-whole		$	—		$	2,984
Deferred legal fees included in accounts payable and accrued expenses		$	480		$	1,884

 

See accompanying notes.

 

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Supernus Pharmaceuticals, Inc.

Notes to Consolidated Financial Statements

For the Six Months ended June 30, 2018 and 2017

(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 prophylaxis of migraine headache and treatment of epilepsy. The Company 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 headache 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, 2017, 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 earnings, and cash flows for the periods presented. These adjustments are of a normal recurring nature. The Company, which is primarily located in the United States (U.S.), operates in one operating segment.

 

The results of operations for the three and six months ended June 30, 2018 are not necessarily indicative of the Company’s future financial results.

 

Use of Estimates

 

The preparation of the Company’s consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, as well as related disclosure of contingent assets and liabilities. Actual results could differ materially from the Company’s estimates. To the extent that there are material differences between these estimates and actual results, the Company’s financial condition or operating results will be affected. The Company bases its estimates on historical experience or on various forecasts, including information received from its service providers and other assumptions that the Company believes are reasonable under the circumstances. The Company evaluates the methodology employed in its estimates on an ongoing basis.

 

Cash and Cash Equivalents

 

The Company considers all investments in highly liquid financial instruments with an original maturity of three months or less to be cash equivalents.

 

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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. Except for changes in fair value of equity securities which are recognized through net income, any unrealized holding gains or losses are reported, net of any reported tax effects, as accumulated other comprehensive earnings (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, with that reduction charged to earnings in that period. A new cost basis for the security is then established. Dividend and interest income is recognized when earned. The cost of securities sold is calculated using the specific identification method.

 

Concentration of Credit Risk

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash, cash equivalents, accounts receivable and marketable securities. The counterparties are various corporations and financial institutions of high credit standing, as described above.

 

Substantially all of the Company’s cash and cash equivalents are maintained in U.S. government agency debt and debt of well-known, investment grade, corporations. Deposits held with banks may exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and, therefore, management believes they bear minimal default risk.

 

The majority of our product sales are to wholesalers and distributors who, in turn sell the products to pharmacies, hospitals, and other customers.  Three wholesale pharmaceutical distributors collectively accounted for more than 90% of our total revenue for the six months ended June 30, 2018.

 

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.

 

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. The amortization period is based initially upon the remaining patent life and is adjusted, if necessary, for any subsequent settlements or other changes to the expected useful life of the patent. The carrying value of the patents is assessed for impairment annually during the fourth quarter of each year, or more frequently if impairment indicators exist.

 

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 value 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 require the recognition of an impairment charge equal to the excess of the carrying value of the long-lived asset over its estimated fair value.

 

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Deferred Financing Costs

 

Deferred financing costs consist of costs incurred by the Company in connection with the closing of the Company’s sale of $402.5 million of 0.625% Convertible Senior Notes due 2023 (the 2023 Notes) (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

 

The Company estimates preclinical study and clinical trial expenses based on the services performed pursuant to contracts with research institutions, clinical investigators, clinical research organizations (CROs) and other service providers that conduct activities on its 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, the Company accrues additional service fees or defers 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 accrued expenses or deferred advance payments accordingly. If the Company later determines that it no longer expects the services associated with a nonrefundable advance payment to be rendered, the remaining portion of that advance payment will be charged to expense in the period in which such determination is made.

 

Revenue Recognition

 

In May 2014, the Financial Accounting Standards Board (FASB) issued a comprehensive new standard, Accounting Standards Codification (ASC) 606, “Revenue from Contracts with Customers” and its related amendments, which amended revenue recognition principles. The Company adopted the new standard on January 1, 2018. While results for reporting periods beginning after January 1, 2018 are presented under the new guidance, prior period amounts are not adjusted and continue to be reported under the accounting standards in effect for the prior period. The accounting policy for revenue recognition for periods prior to January 1, 2018 is described in Note 2 of the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

 

		Three Months ended June 30,
		2018			2017
		(unaudited)			(unaudited)
Net Product Sales:
Trokendi XR		$	76,474		$	55,989
Oxtellar XR		20,556			17,339
Total Net Product Sales		97,030			73,328
Royalty Revenues		1,758			1,179
Licensing Revenue		750			1,322
Total Revenues		$	99,538		$	75,829

 

		Six Months ended June 30,
		2018			2017
		(unaudited)			(unaudited)
Net Product Sales:
Trokendi XR		$	147,029		$	97,998
Oxtellar XR		39,121			31,699
Total Net Product Sales		186,150			129,697
Royalty Revenues		3,067			2,328
Licensing Revenue		750			1,380
Total Revenues		$	189,967		$	133,405

 

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Revenue from Product Sales

 

Revenue from product sales is recognized when control of the Company’s products is transferred to the customer, which consists of wholesalers and pharmaceutical distributors. Product sales are recorded net of various forms of variable consideration, including estimated rebates paid to managed care plans, chargebacks, allowances, discounts, patient co-pay assistance and other deductions as well as estimated product returns (collectively, “sales deductions”). Variability in the transaction price for its products pursuant to its contracts with customers primarily arises from these amounts. Significant judgment is required in estimating sales deductions, considering historical experience, current contract prices under applicable programs, unbilled claims, processing time lags and inventory levels in the distribution channel. If actual results in the future vary from its estimates, the Company adjusts these estimates, which would affect net product sales and earnings in the period such variances become known.

 

The Company’s products are distributed through wholesalers and pharmaceutical distributors. Each of these wholesalers and distributors takes control of the product, including title and ownership to the product, upon physical receipt of the product and then distributes the Company’s 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, the Company may need to adjust the balances of such rebates to reflect its actual expenditures with respect to these programs, which would affect net product sales and earnings in the period of adjustment. Allowances for estimated rebates are recorded as current liabilities in Accrued Sales Deductions.

 

·                  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. Allowances for estimated co-pay are recorded as current liabilities in Accrued Sales Deductions.

 

·                  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. Allowances for estimated discounts are recorded as a deduction in Accounts Receivable, net, which is recorded under current assets.

 

·                  Returns:  Sales of the Company’s products are not subject to a general right of return; however, the Company will accept the return of product that is damaged or defective when shipped directly from our warehouse. The Company will also 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. Returned product (i.e., damaged, defective or expired) cannot be re-sold, therefore a right of return asset is not recorded. Allowances for estimated returns are recorded as current liabilities in Accrued Sales Deductions.

 

·                  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 Company’s products 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. Allowances for estimated chargebacks are recorded as current liabilities in Accrued Sales Deductions.

 

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Customer orders are generally fulfilled within a few days of receipt, resulting in minimal order backlog. Open purchase orders for products from customers are expected to be fulfilled within the next twelve months. There are no minimum product purchase requirements.

 

Incremental costs of obtaining a contract include only those costs that the Company would not have incurred if the contract had not been obtained, for example sales commissions. Costs of obtaining a contract that are incremental and recoverable are capitalized and amortized on a straight-line basis over the expected customer relationship period. As a practical expedient, the Company expenses costs to obtain a contract as incurred if the expected amortization period of the asset would have been a year or less or if the amount is immaterial. These costs are recorded in selling, general and administrative expenses in the consolidated statement of earnings. Costs to fulfill a contract are expensed as incurred and recorded in cost of product sales in the consolidated statement of earnings.

 

As of June 30, 2018, the Company had not capitalized any costs of obtaining any of its contracts and had not incurred any costs to fulfill any contracts.

 

License Revenue

 

License and Collaboration Agreements

 

The Company has entered into collaboration agreements to commercialize both Oxtellar XR and Trokendi XR outside of the United States which involve the right to use the Company’s intellectual property as a functional license. These agreements generally include an up-front license fee and ongoing milestone payments upon the achievement of specific events. These agreements may also require minimum royalty payments based on sales of products developed from the applicable intellectual property.

 

Up-front license fees are recognized once the license has been delivered to the customer.

 

Milestones are a form of variable consideration that are recognized when either the underlying events have been achieved (event-based milestone) or the sales-based targets have been met by the collaborative partner (sales-based milestone). Both types of milestone payments are non-refundable. The Company evaluates whether achieving the milestones is considered probable and estimates the amount to be included in the transaction price using the most likely amount method. This can involve management’s judgment that includes assessing factors that are outside of the Company’s influence, such as: likelihood of regulatory success; availability of third party information; and expected duration of time until achievement of event. These factors will be evaluated based on the specific facts and circumstances. If it is probable that a significant revenue reversal would not occur, the value of the associated milestone is included in the transaction price.

 

Event-based milestones are recognized in the period that the related event, such as regulatory approval, occurs. Sales-based milestones are recognized as revenue when the sales target is achieved. Milestone payments that are not within the control of the Company, such as approval from regulatory authorities or where attainment of the specified event is dependent on the development activities of a third-party, are not considered probable of being achieved until the specified event occurs. Revenue is recognized from the satisfaction of performance obligations in the amount billable to the customer.

 

The Company recorded $750,000 of milestone revenue for both the three and six months ended June 30, 2018 and $1.3 million of milestone revenue for both the three and six months ended June 30, 2017, respectively. Revenue associated with future milestones will be recognized when the related event occurs or sales-based target is achieved. There are no guaranteed minimum amounts owed to the Company related to license and collaboration agreements.

 

Royalty Revenue

 

The Company recognizes non-cash royalty revenue for royalty amounts earned pursuant to a royalty agreement with United Therapeutics that involves the right to use the Company’s intellectual property as a functional license. 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 based on estimated sales by United Therapeutics that result in payments 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 Plc (Shire) based on net product sales of Shire’s product, Mydayis. Royalty revenue is only recognized when the underlying sale occurs. The Shire arrangement also involves the right to use the Company’s intellectual property as a functional license and royalty revenue is recognized based on estimated net product sales by Shire in the current period.

 

There are no guaranteed minimum amounts owed to the Company related to royalty revenue agreements.

 

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For the three and six months ended June 30, 2018, revenue recognized from performance obligations related to prior periods (for example, due to changes in transaction price) was not material in the aggregate for Net Product Sales, License Revenue and Royalty Revenue.

 

Accounts Receivable, net

 

Accounts receivable are reported on the consolidated balance sheets at outstanding amounts due from customers, 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. All arrangements are payable no later than one year after the transfer of the product. The Company does not assess whether a contract has a significant financing component if the expectation at contract inception is such that the period between the transfer of the promised good to the customer and receipt of payment will be one year or less. There are no significant financing components.

 

The Company recorded no allowance for bad debt as of June 30, 2018 and December 31, 2017. There were no impairment losses on accounts receivable for the three and six months ended June 30, 2018 and June 30, 2017.

 

The Company recorded an allowance of approximately $9.3 million and $8.9 million for expected sales discounts, related to prompt pay discounts and contractual fee for service arrangements, to wholesalers and distributors as of June 30, 2018 and December 31, 2017, respectively.

 

There were no contract assets or liabilities recorded as of January 1, 2018 or June 30, 2018.

 

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, but only to the extent that those materials are manufactured prior to receiving regulatory approval 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.

 

Advertising Expense

 

Advertising expense includes costs of promotional materials and activities, such as marketing materials, marketing programs and speaker programs. The costs of the Company’s advertising efforts are expensed as incurred. The Company incurred approximately $11.1 million and $19.0 million in advertising costs for the three and six months ended June 30, 2018 and approximately $9.8 million and $16.5 million in advertising costs for the three and six months ended June 30, 2017, respectively. These expenses are recorded in the selling, general and administrative expense line item.

 

Share-Based Compensation

 

Employee share-based compensation is measured based on the estimated fair value as of 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 stock volatility, expected term, risk-free rate, and the fair value of the underlying common stock. The Company recognizes expense using the straight-line method.

 

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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 awards to non-employees 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, with those changes recorded in the relevant period.

 

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 in the relevant period.

 

Recently Issued Accounting Pronouncements

 

Accounting Pronouncements Adopted in 2018

 

In May 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-09, “Revenue from Contracts with Customers,” and has subsequently issued a number of amendments to ASU 2014-09, which provides a comprehensive model to be used in the accounting for revenue arising from contracts with customers and supersedes current revenue recognition guidance, including industry-specific guidance.

 

On January 1, 2018, the Company adopted ASC 606, “Revenue from Contracts with Customers” and all the related amendments (the New Revenue Standard) using the modified retrospective method applied to those contracts which had not been completed as of January 1, 2018. The Company recognized the cumulative effect of initially applying the New Revenue Standard as an adjustment to the opening balance of retained earnings.

 

The Company recorded a decrease of $2.3 million to the accumulated deficit of January 1, 2018 due to the cumulative impact of adopting the New Revenue Standard. The decrease resulted from the acceleration of both up-front licensing fees from license and collaboration agreements and the acceleration of royalties from sales of licensed product. Under the New Revenue Standard, up-front licensing fees will be recognized when the license is delivered to the customer and royalties from the sale of licensed product will be recognized as the underlying sales of product occur by the licensee. There were no changes in the timing of revenue recognition related to net product sales.

 

The comparative information has not been restated and continues to be reported under the accounting standards in effect for those periods, in thousands of dollars:

 

		December 31, 2017			Adjustments			January 1, 2018
		As Reported			(unaudited)			(unaudited)
Accounts receivable, net		$	65,586		$	1,620		$	67,206
Deferred licensing revenue		287			(287		)	—
Deferred licensing revenue, net of current portion		1,149			(1,149		)	—
Deferred income taxes (asset)		20,843			(734		)	20,109
Accumulated deficit		26,823			(2,322		)	24,501

 

Adoption of the New Revenue Standard had no material impact on the Company’s consolidated balance sheets or statements of earnings and had no impact on cash from or used in total operating, investing or financing activities on the Company’s consolidated statements of cash flows.

 

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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 adoption of this guidance did not have a material impact on the Company’s 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 adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.

 

New Accounting Pronouncements Not Yet Adopted

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842).” The standard requires a lessee to recognize a right-of-use asset and a lease liability 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. The Company is evaluating the impact that adopting this new standard will have on its consolidated financial statements. The Company expects the ASU to have a material impact on its consolidated balance sheet due to the recognition of assets and liabilities, principally for certain leases currently accounted for as operating leases. The Company does not expect the ASU to have a material impact on its cash flows or results of operations.

 

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 measurement 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.

 

The Company has evaluated all other ASUs issued through the date the consolidated financial statements were issued in this Quarterly Report on Form 10-Q and believes that no other ASUs will have a material impact on the Company’s consolidated financial statements.

 

3.  Fair Value of Financial Instruments

 

The fair value of an asset or liability represents 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 of dollars:

 

		Fair Value Measurements at
		June 30, 2018
		(unaudited)
								Significant
		Total Carrying			Quoted Prices			Other			Significant
		Value at			in Active			Observable			Unobservable
		June 30,			Markets			Inputs			Inputs
		2018			(Level 1)			(Level 2)			(Level 3)
Assets:
Cash and cash equivalents		$	35,205		$	35,205		$	—		$	—
Marketable securities		139,208			1,376			137,832			—
Long term marketable securities:
Corporate debt securities		500,173			689			499,484			—
Government debt securities		3,139			—			3,139			—
Other non-current assets:
Marketable securities - restricted (SERP)		356			1			355			—
Total assets at fair value		$	678,081		$	37,271		$	640,810		$	—

 

 

		Fair Value Measurements at
		December 31, 2017
								Significant
		Total Carrying			Quoted Prices			Other			Significant
		Value at			in Active			Observable			Unobservable
		December 31,			Markets			Inputs			Inputs
		2017			(Level 1)			(Level 2)			(Level 3)
Assets:
Cash and cash equivalents		$	100,304		$	100,304		$	—		$	—
Marketable securities		39,736			2,118			37,618			—
Long term marketable securities:
Corporate debt securities		132,477			448			132,029			—
Government debt securities		1,161			—			1,161			—
Other non-current assets:
Marketable securities - restricted (SERP)		335			—			335			—
Total assets at fair value		$	274,013		$	102,870		$	171,143		$	—

 

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 (Supplemental Executive Retirement Plan) assets, commercial paper and investment grade corporate and government debt securities and other fixed income securities. Level 2 securities are valued using third-party pricing sources that apply applicable inputs and other relevant data in their models to estimate fair value.

 

The carrying value, face value and estimated fair value of the 2023 Notes were approximately $321.9 million, $402.5 million and $491.0 million, respectively, as of June 30, 2018. 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.

 

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 of dollars:

 

At June 30, 2018 (unaudited):

 

Available for Sale		Amortized Cost			Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Corporate and government debt securities		$	647,253		12		(4,745	)	$	642,520

 

At December 31, 2017:

 

Available for Sale		Amortized Cost			Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Corporate and government debt securities		$	174,235		48		(909	)	$	173,374

 

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

 

		June 30,
		2018
		(unaudited)
Less Than 1 Year		$	139,208
1 year to 2 years		165,451
2 year to 3 years		169,167
3 years to 4 years		168,694
Greater Than 4 Years		—
Total		$	642,520

 

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 of dollars:

 

		June 30,			December 31,
		2018			2017
		(unaudited)
Raw materials		$	2,914		$	2,995
Work in process		6,142			8,873
Finished goods		11,624			4,436
		$	20,680		$	16,304

 

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5.  Property and Equipment

 

Property and equipment consist of the following, in thousands of dollars:

 

		June 30,			December 31,
		2018			2017
		(unaudited)
Lab equipment and furniture		$	8,804		$	8,331
Leasehold improvements		2,848			2,731
Software		2,122			2,004
Computer equipment		1,230			1,226
Construction in progress		140			178
		15,144			14,470
Less accumulated depreciation and amortization		(10,247		)	(9,346		)
		$	4,897		$	5,124

 

Depreciation and amortization expense on property and equipment was approximately $500,000 and $900,000 for the three and six months ended June 30, 2018, and approximately $300,000 and $600,000 for the three and six months ended June 30, 2017, respectively.

 

There were no indicators of impairment identified.

 

6.  Intangible Assets

 

Intangible assets consist of patent defense costs, which are 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 assets, in thousands of dollars:

 

		Weighted-		June 30,			December 31,
		Average Life		2018			2017
				(unaudited)
Capitalized patent defense costs		4.5 -8.75 years		$	44,546		$	44,185
Less accumulated amortization				(10,752		)	(8,166		)
				$	33,794		$	36,019

 

In March 2017, the Company entered into two settlements with various companies related to Trokendi XR patent litigation. The remaining unamortized aggregate capitalized patent defense costs for Trokendi XR have subsequently been amortized over the remaining useful life of the patents at issue, or January 1, 2023, which is the date the Company is obligated under the settlements to grant a non-exclusive license to the patents at issue.

 

Amortization expense on intangible assets was approximately $1.3 million and $2.6 million for the three and six months ended June 30, 2018, and approximately $1.0 million and $1.4 million for the three and six months ended June 30, 2017, respectively.

 

There were no indicators of impairment identified.

 

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7.  Accrued Expenses

 

Accrued expenses are comprised of the following, in thousands of dollars:

 

		June 30,			December 31,
		2018			2017
		(unaudited)
Accrued clinical trial and clinical supply costs		$	11,810		$	6,996
Accrued compensation		10,302			10,279
Accrued product costs		1,217			726
Accrued professional fees		1,912			2,890
Accrued interest expense		734			—
Other accrued expenses		3,313			6,414
		$	29,288		$	27,305

 

8.  Convertible Senior Notes

 

On March 14, 2018, the Company entered into a Purchase Agreement (the Purchase Agreement) with Jefferies LLC, J.P. Morgan Securities LLC and Cowen and Company, LLC, as the initial purchasers (collectively, the Initial Purchasers), in connection with the offering and sale of $350 million aggregate principal amount of 2023 Notes.  The Company also granted the Initial Purchasers an over-allotment option to purchase, within a 30-day period, up to an additional $52.5 million principal amount of additional 2023 Notes on the same terms and conditions, which the Initial Purchasers exercised in full on March 15, 2018.

 

On March 19, 2018, the sale of the 2023 Notes was settled and the 2023 Notes were issued pursuant to an Indenture, dated as of March 19, 2018 (the Indenture), between the Company and Wilmington Trust, National Association, as trustee.  The Indenture includes customary terms and covenants, including certain events of default upon which the 2023 Notes may be due and payable immediately. The Indenture governing the 2023 Notes does not contain any financial or operating covenants or any restrictions on the payment of dividends, the issuance of other indebtedness or the issuance or repurchase of securities by the Company.

 

The Company will pay interest on the 2023 Notes at an annual rate of 0.625%, payable semi-annually in arrears on April 1 and October 1 of each year, beginning on October 1, 2018. The 2023 Notes will mature on April 1, 2023, unless earlier converted or repurchased by the Company.

 

Noteholders may convert their 2023 Notes at their option only in the following circumstances: (1) during any calendar quarter commencing after the calendar quarter ending on June 30, 2018, if the last reported sale price per share of the Company’s common stock for each of at least 20 trading days (whether or not consecutive) during the 30 consecutive trading days ending on, and including the last trading day of the immediately preceding calendar quarter exceeds 130% of the conversion price, or a price of approximately $77.13 per share, on such trading day; (2) during the five consecutive business days immediately after any 10 consecutive trading day period (such 10 consecutive trading day period, the “measurement period”) in which the trading price per $1,000 principal amount of notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price per share of the Company’s common stock on such trading day and the conversion rate on such trading day; (3) upon the occurrence of certain corporate events or distributions on the Company’s common stock, as specified in the Indenture; and (4) at any time from, and including, October 1, 2022 until the close of business on the second scheduled trading day immediately before the maturity date. The Company will settle conversions by paying or delivering, as applicable, cash, shares of the Company’s common stock or a combination of cash and shares of the Company’s common stock, at its election, based on the applicable conversion rate. The initial conversion rate is 16.8545 shares per $1,000 principal amount of the 2023 Notes, which represents an initial conversion price of approximately $59.33 per share, and is subject to adjustment as specified in the Indenture.

 

If a “make-whole fundamental change” (as defined in the Indenture) occurs, then the Company will in certain circumstances increase the conversion rate for a specified period of time.  If a “fundamental change” (as defined in the Indenture) occurs, then noteholders may require the Company to repurchase their 2023 Notes at a cash repurchase price equal to the principal amount of the 2023 Notes to be repurchased, plus accrued and unpaid interest, if any.

 

The Company may not redeem the 2023 Notes at its option before maturity.

 

In the event of conversion, holders would forgo all future interest payments, any unpaid accrued interest and the possibility of further stock price appreciation. Upon the receipt of conversion requests, the settlement of the 2023 Notes will be paid pursuant to the

 

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terms of the Indenture. In the event that all of the 2023 Notes are converted, the Company would be required to repay the $402.5 million in principal value and any conversion premium in cash, shares or any combination of cash and shares of its common stock (at the Company’s option).

 

The 2023 Notes are the Company’s senior, unsecured obligations and will be equal in right of payment with the Company’s future senior, unsecured indebtedness, senior in right of payment to the Company’s future indebtedness that is expressly subordinated to the 2023 Notes and effectively subordinated to the Company’s future secured indebtedness, to the extent of the value of the collateral securing that indebtedness. The 2023 Notes will be structurally subordinated to all future indebtedness and other liabilities, including trade payables.

 

Convertible Notes Hedge and Warrant Transactions

 

In connection with the pricing of the 2023 Notes on March 14, 2018, and in connection with the exercise of the over-allotment option by the Initial Purchasers on March 15, 2018, the Company entered into separate privately negotiated convertible note hedge transactions (collectively, the Convertible Note Hedge Transactions) with each of the call spread counterparties. The Convertible Note Hedge Transactions cover, subject to customary anti-dilution adjustments substantially similar to those applicable to the 2023 Notes, the number of shares of the Company’s common stock underlying the 2023 Notes, as described above. The Company issued 402,500 convertible note hedge options, including options purchased on the exercise of the overallotment option. In the event that shares or cash are deliverable to holders of the 2023 Notes upon conversion at limits defined in the Indenture, counterparties to the convertible note hedges will be required to deliver up to approximately 6.8 million shares of the Company’s common stock or pay cash to the Company in a similar amount as the value that the Company delivers to the holders of the 2023 Notes based on a conversion price of $59.33 per share. The total cost of the convertible note hedge transactions was $92.9 million.

 

Concurrently with entering into the Convertible Note Hedge Transactions on each such date, the Company also entered into separate privately negotiated warrant transactions (collectively, the Warrant Transactions) with each of the call spread counterparties whereby the Company sold to the call spread counterparties warrants to purchase, subject to customary anti-dilution adjustments, up to the same number of shares of the Company’s common stock.

 

The Convertible Note Hedge Transactions and the Warrant Transactions are separate contracts entered into by the Company with the Call Spread Counterparties, are not part of the terms of the 2023 Notes and will not affect the noteholders’ rights under the 2023 Notes. Holders of the 2023 Notes will not have any rights with respect to the Convertible Note Hedge Transactions or the Warrant Transactions. The Company issued a total of 6,783,939 warrants. The warrants entitle the holder to one share per warrant at the strike price through 2023. The strike price of the Warrant Transactions will initially be $80.9063 per share of the Company’s common stock (subject to adjustment). The Company received proceeds of approximately $65.7 million from the sale of these warrants.

 

The Convertible Note Hedge Transactions are expected to reduce generally the potential dilution with respect to the Company’s common stock upon conversion of the 2023 Notes and/or offset any potential cash payments the Company is required to make in excess of the principal amount of converted 2023 Notes, as the case may be, upon any conversion of the 2023 Notes. The Warrant Transactions are intended to partially offset the cost to the Company of the purchased Convertible Note Hedge Transactions; however, the Warrant Transactions could have a dilutive effect with respect to the Company’s common stock to the extent that the market price per share of the Company’s common stock, as measured under the terms of the Warrant Transactions, exceeds the strike price of the warrants. As these transactions meet certain accounting criteria under ASC 815-40-25, the convertible note hedges and warrants are recorded in stockholders’ equity and are not accounted for as derivatives. The net cost incurred in connection with the convertible note hedges and warrant transactions was recorded as a reduction to additional paid-in capital in the consolidated balance sheet as of June 30, 2018.

 

In accordance with accounting guidance on embedded conversion features, the Company valued and bifurcated the conversion option associated with the 2023 Notes from the respective host debt instrument, which is referred to as debt discount, and initially recorded the conversion option of $76.4 million in additional paid-in capital on the consolidated balance sheet. The resulting debt discount on the 2023 Notes is being amortized to interest expense at an effective interest rate of 5.41% over the contractual term of the 2023 Notes.

 

The Company incurred approximately $10.4 million of debt financing costs. Approximately $2.0 million of this amount is allocated to the additional paid-in capital and the remaining $8.4 million is recorded as deferred costs and is being amortized to interest expense over the contractual term of the 2023 Notes.

 

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The liability component of the 2023 Notes consisted of the following, in thousands of dollars, unaudited:

 

		June 30,
		2018
Principal amount of the 2023 Notes		$	402,500
Debt discount		(76,434		)
Deferred financing costs		(8,453		)
Accretion of debt discount and deferred financing costs		4,307
June 30, 2018 carrying value		$	321,920

 

No 2023 Notes were converted in the six months ended June 30, 2018.

 

9.  Summary Stockholders’ Equity

 

The following summary table provides details related to the activity in certain captions within Stockholders’ Equity for the six month period ended June 30, 2018, in thousands of dollars:

 

		Common Stock			Additional Paid-in Capital			Retained Earnings (Accumulated Deficit)
		(unaudited)
Balance, December 31, 2017		$	51		$	294,999		$	(26,823	)
Cumulative-effect of adoption of ASC 606		—			—			2,322
Balance, January 1, 2018		51			294,999			(24,501		)
Share-based compensation		—			5,703			—
Issuance of ESPP shares		—			1,184			—
Exercise of stock options		1			8,319			—
Equity component of convertible notes issuance, net of tax		—			56,215			—
Purchases of convertible note hedges, net of tax		—			(70,137		)	—
Issuance of warrants		—			65,688			—
Net income		—			—			57,089
Balance, June 30, 2018		$	52		$	361,971		$	32,588

 

10.  Share-Based Payments

 

Stock Option Plans

 

The Company has adopted the Supernus Pharmaceuticals, Inc. 2012 Equity Incentive Plan, as amended (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, consultants and advisors. The 2012 Plan is administered by the Company’s Board of Directors and the Company’s Compensation Committee 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 equivalent annual installments, starting on the first anniversary of the date of the grant and have ten-year contractual terms. Option awards granted to the directors generally vest over a one year term and have ten year contractual terms.

 

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