1. Organization and Description of the Business

 

Egalet Corporation (the “Company”) is a fully integrated specialty pharmaceutical company developing, manufacturing and commercializing innovative treatments for pain and other conditions. The Company was incorporated in Delaware in August 2013 and until its initial public offering (“IPO”) in February 2014, had nominal assets and no operations. Egalet Limited (“Egalet UK”), incorporated in July 2010 in England and Wales, owned all of the Company’s current assets and operations and acquired them in July 2010 pursuant to an agreement to purchase the business and certain assets of Egalet A/S, which was founded under the laws of Denmark. This transaction was accounted for as a business combination. In November 2013, all of the issued and outstanding ordinary shares and preferred shares of Egalet UK were exchanged for an identical number of shares of common stock and preferred stock of the Company, which resulted in Egalet UK becoming a wholly-owned subsidiary of the Company. As Egalet UK and Egalet US Inc. are entities under common control, the consolidated financial statements reflect the historical carrying values of Egalet UK’s assets and liabilities and its results of operations as if they were consolidated for all periods presented. As a result of these transactions, the Company has a late-stage portfolio of product candidates that are being developed using the Company’s broad-based drug delivery platform specifically designed to resist manipulation, to prevent easy extraction and to discourage the abuse of medications via known routes of abuse, including chewing, snorting, and injecting.

 

On January 8, 2015, the Company announced the acquisition and license of two innovative pain products, SPRIX® (ketorolac tromethamine) Nasal Spray and OXAYDOTM (oxycodone HCl, USP) tablets for oral use only, —CII, both approved by the United States (“U.S.”) Food and Drug Administration (“FDA”) to treat pain. SPRIX Nasal Spray, a non-steroidal anti-inflammatory drug (NSAID), is indicated in adult patients for the short-term (up to five days) management of moderate to moderately severe pain that requires analgesia at the opioid level. OXAYDO is an immediate-release (“IR”) oral formulation of oxycodone HCl indicated for the management of acute and chronic moderate to severe pain where the use of an opioid analgesic is appropriate. OXAYDO is the first and only approved IR oxycodone product formulated to discourage abuse via snorting. In addition, using our proprietary Guardian™ Technology, the Company is developing a pipeline of clinical-stage, opioid-based product candidates, as well as a stimulant product candidate, that are specifically designed to deter abuse by physical and chemical manipulation.  The Company’s technology platform can be used with a broad range of opioids and non-opioids. The Company has patents and filed patent applications to protect its inventions covering both the Guardian technology and its products.

 

Liquidity

 

The Company has incurred recurring operating losses since inception. As of September 30, 2015, the Company had an accumulated deficit of $127.8 million and will require substantial additional capital to fund its research and development of its proprietary product candidates and commercial plans for SPRIX and OXAYDO. The Company reasonably expects that the net proceeds from the Company’s IPO, the Hercules term loan (see Note 6), the 5.50% Senior Convertible Notes (see Note 6), and the Follow-On Offering (see below), together with its pre-existing cash and cash equivalents, will enable it to fund its operating expenses and capital expenditure requirements through December 31, 2016. The Company anticipates operating losses to continue for the foreseeable future due to, among other things, costs related to research and development of its preclinical and clinical product candidates, and the development of its administrative organization. As the Company continues to incur losses, a transition to profitability is dependent upon the successful commercialization of its approved products, the successful development, approval and commercialization of its approved products and product candidates and the achievement of a level of revenue adequate to support the Company’s cost structure. The Company may never achieve profitability, and unless and until it does, the Company will continue to need to raise additional capital. Management intends to fund future operations through the sale of equity, debt financings or other sources, including potential additional collaborations, until profitability is achieved, if ever. There can be no assurances, however, that additional funding will be available on terms acceptable to the Company, or at all.

 

In January 2015, the Company entered into a Loan and Security Agreement, (“the Loan Agreement”), with Hercules Technology Growth Capital, Inc., (“Hercules”) and certain other lenders, pursuant to which the Company borrowed $15.0 million under a term loan.  Refer to Note 6 - Long term debt for additional information.

 

On April 1, 2015, the Company issued through a private placement $60.0 million in aggregate principal amount of 5.50% convertible senior notes due April 1, 2020 (the “5.50% Notes”). On May 6, 2015, the Company issued an additional $1.0 million in principal amount pursuant to the initial purchasers’ exercise of their 30-day over-allotment, for aggregate gross proceeds of $61.0 million.  Interest on the 5.50% Notes is payable semi-annually in arrears on April 1 and October 1 of each year, commencing October 1, 2015.  Refer to Note 6 - Long term debt for additional information.

 

On July 2, 2015, the Company entered into a sale agreement with Cantor Fitzgerald & Co. (“Cantor”) to offer shares of the Company’s common stock from time to time through Cantor, as the Company’s sales agent for the offer and sale of the shares, in an “at-the-market” offering.  The Company may offer and sell shares of common stock for an aggregate offering price of up to $30.0 million.

 

On July 31, 2015, the Company completed an underwritten public offering (the “Follow-On Offering”) of 7,666,667 shares of common stock (including the exercise in full of the underwriters’ option to purchase additional shares) at an offering price of $11.25 per share for gross proceeds of $86.3 million.  The net offering proceeds to the Company from the sale were $80.8 million, after deducting underwriting discounts and commissions of $5.2 million and offering costs of $293,000.

 

During the nine months ended September 30, 2015, the Company had cash outflows related to the purchase of SPRIX and license of OXAYDO of $8.1 million and $5.2 million, respectively.  With regards to OXAYDO, the Company also owes a $2.5 million milestone upon the earlier to occur of first commercial sale of OXAYDO or January 1, 2016.  Refer to Note 11 - Acquisitions and License and Collaboration Agreements for additional information.

 

2. Summary of Significant Accounting Policies and Basis of Accounting

 

Basis of Presentation

 

The unaudited consolidated financial statements are prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) for interim financial information. Certain information and footnotes normally included in consolidated financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for quarterly reports on Form 10-Q. The Company’s consolidation policy requires the consolidation of entities where a controlling financial interest is held. All intercompany balances and transactions have been eliminated in consolidation.

 

The accompanying consolidated financial information at September 30, 2015 and for the three and nine months ended September 30, 2014 and 2015 is unaudited. The interim unaudited financial statements have been prepared on the same basis as the annual audited financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary for the fair statement of the Company’s financial position as of September 30, 2015 and for the three and nine months ended September 30, 2014 and 2015. The financial data and other information disclosed in these notes related to the three and nine months ended September 30, 2014 and 2015 are not necessarily indicative of the results to be expected for the year ending December 31, 2015, any other interim periods or any future year or period. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto for the year ended December 31, 2014 filed on March 16, 2015 with the SEC.

 

The Company’s significant accounting policies are described in Note 2 of the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. Since the date of those financial statements, there have been no changes to the Company’s significant accounting policies, except where noted below.

 

Reclassification

 

Certain reclassifications were made to prior period amounts to conform to the current period presentation.

 

Marketable Securities, Available-for-Sale

 

Marketable securities consist of securities with original maturities greater than three months, and are comprised of securities issued by U.S. government agencies and corporate debt securities. Marketable securities have been classified as current assets in the accompanying Condensed Consolidated Balance Sheets based upon the nature of the securities and their intended use to fund operations.

 

Management determines the appropriate classification of securities at the time of purchase. The Company has classified its investment portfolio as available-for-sale in accordance with the Financial Accounting Standards Board (“FASB”) Standards Codification (“ASC”) 320, Investments—Debt and Equity Securities. The Company’s available-for-sale securities are carried at fair value with unrealized gains and losses reported in other comprehensive income (loss). Marketable securities are evaluated periodically for impairment. If it is determined that a decline of any investment is other than temporary, then the carrying amount of the investment is written down to fair value and the write-down is included in the statements of comprehensive income as a loss.

 

Fair Value Measurements

 

The carrying amounts reported in the Company’s consolidated financial statements for cash, accounts receivable, accounts payable and accrued liabilities approximate their respective fair values because of the short-term nature of these accounts.  The Company’s marketable securities are carried at fair value based on quoted market prices and other observable inputs.  The carrying value of the derivative liabilities are the estimated fair value of the liability as further described below.

 

Net Product Sales

 

The Company recognizes revenue in accordance with FASB ASC 605, Revenue Recognition, when the following criteria have been met: persuasive evidence of an arrangement exists; delivery has occurred and risk of loss has passed; the seller’s price to the buyer is fixed or determinable and collectability is reasonably assured.  The Company determines that persuasive evidence of an arrangement exists based on written contracts that define the terms of the arrangements.  Pursuant to the contract terms, the Company determines when title to products and associated risk of loss has passed on to the customer.  The Company assesses whether the price is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment.  The Company assesses collectability based primarily on the customer’s payment history and creditworthiness.

 

The Company sells SPRIX in the U.S. to a single specialty pharmaceutical distributor subject to rights of return. The Company has limited SPRIX sales history under the current distribution model and pricing, and the Company has determined that at this time it cannot reliably estimate expected returns of the product at the time of shipment. Accordingly, the Company defers recognition of revenue on product shipments of SPRIX until the right of return no longer exists, which occurs at the earlier of the time SPRIX units are dispensed through patient prescriptions or expiration of the right of return. Units dispensed are generally not subject to return, except in the rare cases where the product malfunctions or the product is damaged in transit. The Company calculates patient prescriptions dispensed using an analysis of third-party information. As of September 30, 2015, the Company had deferred revenue of $12.6 million related to sales of SPRIX to its specialty pharmaceutical distributor. In the event the related units are not dispensed pursuant to patient prescriptions prior to their expiration in April and May of 2016, they may be returned to the Company.

 

Related Party Revenue

 

During 2013, the Company entered into a collaborative research and license agreement with Shionogi, an investor in the Company. The terms of this agreement contain multiple deliverables which include (i) licenses; (ii) research and development activities and (iii) certain of the Company’s core technologies and improvements thereon.  The Company has adopted the provisions of Accounting Standards Update (“ASU”) 2009-13,”Multiple-Deliverable Revenue Arrangements,” which amends ASC 605-25. In accordance with ASU 2009-13, the Company considered whether the deliverables under the arrangement represent separate units of accounting. In determining the units of accounting, management evaluates certain criteria, including whether the deliverables have stand-alone value. Refer to Note 11 Acquisitions and License and Collaboration Agreements for further discussion of the Company’s accounting for the collaborative research and license agreement.

 

Deferred Revenue

 

The Company records deferred revenue when either: a sale of product has occurred, but revenue recognition criteria has not been met; or when payments are due under a collaborative research and license agreement but the revenue recognition criteria has not been met.  As of September 30, 2015, the deferred revenue balance consisted of $12.6 million for SPRIX product sales, all of which is classified as current, and $17.6 million related to the collaborative research and license agreement with Shionogi, $1.1 million of which is classified as current.

 

Product Sales Allowances

 

The Company recognizes product sales allowances as a reduction of product sales in the same period the related revenue is recognized. Product sales allowances are based on amounts owed or to be claimed on the related sales. These estimates take into consideration the terms of the Company’s agreements with customers and third-party payors that may result in future rebates or discounts taken. In certain cases, such as patient discount programs, the Company recognizes the cost of patient discounts as a reduction of revenue based on estimated utilization. If actual future results vary, the Company may need to adjust these estimates, which could have an effect on product revenue in the period of adjustment. The Company’s product sales allowances include:

 

Specialty Pharmacy Discounts. The Company offers a discount to a certain specialty pharmaceutical distributor based on a contractually determined rate. The Company accrues the discount on shipment to the respective distributor and recognizes the discount as a reduction of revenue in the same period the related revenue is recognized.

 

Prompt Pay Discounts. The Company offers cash discounts to its customers, generally 2% of the sales price, as an incentive for prompt payment. The Company accounts for cash discounts by reducing accounts receivable by the prompt pay discount amount and recognizes the discount as a reduction of revenue in the same period the related revenue is recognized.

 

Patient Discount Programs. The Company offers co-pay discount programs for SPRIX to patients, in which patients receive a co-pay discount on their prescriptions. The Company estimates the total amount that will be redeemed based on the quantity of product shipped and recognizes the discount as a reduction of revenue in the same period the related revenue is recognized.

 

Inventories and Cost of Sales

 

Inventories are stated at the lower of cost or market net of reserve for excess and obsolete inventory.  At September 30, 2015, inventory consisted of raw materials and deferred cost of goods.

 

Cost of sales includes the cost of inventory sold or reserved; manufacturing, manufacturing overhead and supply chain costs; product shipping and handling costs and product royalties.  The cost of sales associated with the deferred product revenues are recorded as deferred costs, which are included in inventory, until such time the deferred revenue is recognized.

 

Long Term Debt

 

Long term debt consists of the Loan Agreement with Hercules and certain other lenders, and the 5.50% Notes.

 

Pursuant to the Loan Agreement with Hercules, the Company borrowed $15.0 million in January 2015 under a term loan (see Note 6).  The term loan bears an interest rate per annum equal to the greater of either (i) 9.40% plus the prime rate as reported in The Wall Street Journal minus 3.25% or (ii) 9.40%.

 

On April 1, 2015, the Company issued through a private placement $60.0 million in aggregate principal amount of 5.50% convertible senior notes due April 1, 2020 (the “5.50% Notes”). On May 6, 2015, the Company issued an additional $1.0 million in principal amount pursuant to the initial purchasers’ exercise of their 30-day over-allotment, for aggregate gross proceeds of $61.0 million.  Interest on the 5.50% Notes is payable semi-annually in arrears on April 1 and October 1 of each year, commencing October 1, 2015. Refer to Note 6 - Long term debt for additional information.

 

Interest Make-Whole Derivative

 

The 5.50% Notes include an interest make-whole feature whereby if a noteholder converts any of the 5.50% Notes prior to April 1, 2018, subject to certain restrictions, they are entitled, in addition to the other consideration payable or deliverable in connection with such conversion, to an interest make-whole payment equal to the sum of the present value of the remaining scheduled payments of interest that would have been made on the notes to be converted had such notes remained outstanding from the conversion date through April 1, 2018, computed using a discount rate equal to 2%.  The Company has determined that this feature is an embedded derivative and have recognized the fair value of this derivative as a liability on the Company’s balance sheet, with subsequent changes to fair value recorded through earnings at each reporting period on the Company’s statements of operations and comprehensive loss as change in fair value of derivative liabilities.  The fair value of this embedded derivative was determined based on a binomial tree lattice model.

 

Common Stock Warrants

 

The Company issued warrants to Hercules in connection with the Loan Agreement with Hercules and certain other lenders.  The Company evaluated the warrants under ASC 480 - Distinguishing Liabilities from Equity and determined the warrants are classified as equity.  The fair value of the warrants on the date of grant was recorded as a debt discount.

 

Recent Accounting Pronouncements

 

On April 7, 2015, the FASB issued Accounting Standards Update (“ASU”) 2015-03,1 Interest — Imputation of Interest which changes the presentation of debt issuance costs in financial statements. Under the ASU, an entity presents such costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the costs is reported as interest expense.  The Company has adopted this standard during the current period and as a result reclassified $171,000 in deferred financing fees associated with the Hercules Loan Agreement to debt discount.

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, or ASU 2014-09, which converges the FASB and the International Accounting Standards Board standards on revenue recognition. Areas of revenue recognition that will be affected include, but are not limited to, transfer of control, variable consideration, allocation of transfer pricing, licenses, time value of money, contract costs and disclosures. In July 2015, the FASB decided to delay the effective date of the new revenue standard by one year. The FASB also agreed to allow entities to choose to adopt the standard as of the original effective date of January 1, 2017. The FASB decided, based on its outreach to various stakeholders and the forthcoming amendments to the new revenue standard, that a deferral is necessary to provide adequate time to effectively implement the new revenue standard. The new standard will be effective for the Company on January 1, 2018. The Company is currently evaluating the method of adoption and the potential impact that ASU 2014-09 may have on its financial position and results of operations.

 

In August 2014, the FASB issued ASU No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, to provide guidance on management’s responsibility in evaluating whether there is substantial doubt about a company’s ability to continue as a going concern and to provide related footnote disclosures.  ASU 2014-15 is effective for the Company for annual reporting periods beginning in 2016 and for interim reporting periods starting in the first quarter of 2017. The Company is currently evaluating the impact of the adoption of ASU 2014-15 on its financial statements.

 

3.  Investments

 

Marketable Securities

 

Marketable securities consisted of the following as of September 30, 2015:

 

 

The Company had no marketable securities at December 31, 2014.

 

The fair value of marketable securities with a maturity of less than one year is $63.7 million. All remaining securities have a maturity of one to two years.

 

4. Inventory

 

Inventory is stated at the lower of cost or market using actual cost net of reserve for excess and obsolete inventory. The following represents the components of inventory at September 30, 2015.  There was no inventory at December 31, 2014.

 

 

The deferred costs of sales will be recognized upon release of the product to patients.

 

5. Intangible Assets

 

The following represents the balance of the intangible assets at September 30, 2015:

 

 

The following represents the balance of the intangible assets at December 31, 2014:

 

 

There was no impairment to intangible assets recognized in the nine months ended September 30, 2014 and 2015.

 

Collaboration and License Agreement with Acura

 

In January 2015, the Company entered into a Collaboration and License Agreement with Acura Pharmaceuticals, Inc. (“Acura”) to commercialize OXAYDO™ (oxycodone hydrochloride) tablets containing Acura’s Aversion® Technology.  The Company paid Acura an upfront payment of $5.0 million in January 2015 and will pay a $2.5 million milestone on the earlier to occur of first commercial sale of OXAYDO or January 1, 2016.  The Company also incurred transaction costs of $172,000 associated with the deal.  Refer to Note 11 — Acquisitions and license and collaboration agreements for additional details.

 

During the three and nine months ended September 30, 2015, the Company recognized amortization expense of $274,000 and $797,000, respectively, related to the OXAYDO product right intangible.

 

Purchase Agreement with Luitpold

 

In January 2015, the Company entered into and consummated the transactions contemplated by the Purchase Agreement with Luitpold Pharmaceuticals, Inc. (“Luitpold”).  Pursuant to the Purchase Agreement, the Company acquired specified assets and liabilities associated with SPRIX (ketorolac tromethamine) Nasal Spray for a purchase price of $7.0 million.  The Company recorded an intangible asset of $4.6 million related to this transaction.  Refer to Note 11 for additional details.

 

During the three and nine months ended September 30, 2015, the Company recognized amortization expense of $231,000 and $672,000, respectively, related to the SPRIX product rights intangible asset.

 

In-Process Research and Development (“IP R&D”)

 

In connection with the acquisition of Egalet A/S, the Company recognized an IP R&D asset related to the drug delivery platform specifically designed to help deter physical abuse of pain medications. The IP R&D is considered an indefinite-lived intangible asset and is assessed for impairment annually or more frequently if impairment indicators exist. As of December 31, 2014 and September 30, 2015, the carrying value of IP R&D was $184,000, and $170,000, respectively.  The change in value was entirely due to fluctuation in foreign currency exchange rates.

 

6. Long-term Debt

 

Hercules Loan and Security Agreement

 

In January 2015, the Company entered into the Loan Agreement with Hercules and certain other lenders, pursuant to which the Company borrowed $15.0 million under a term loan.  The term loan bears an interest rate per annum equal to the greater of either (i) 9.40% plus the prime rate as reported in The Wall Street Journal minus 3.25% or (ii) 9.40%. Pursuant to the terms of the Loan Agreement, the Company will make interest-only payments for 12 months beginning on February 1, 2015, and then repay the principal balance of the loan in 30 equal monthly payments of principal and interest through the scheduled maturity date of July 1, 2018.  In connection with the Loan Agreement, the Company granted a security interest in substantially all of its assets, excluding intellectual property and certain new drug applications and related approvals, as collateral for the obligations under the Loan Agreement.

 

The Loan Agreement also contains representations and warranties, and indemnification in favor of Hercules. The Company is required to comply with various customary covenants, including, among others, restrictions on indebtedness, investments, distributions, transfers of assets and acquisitions.  The Loan Agreement contains several events of default, including, among others, payment defaults, breaches of covenants or representations, material impairment in the perfection of Hercules’ security interest or in the collateral and events related to bankruptcy or insolvency. Upon an event of default, Hercules may declare all outstanding obligations immediately due and payable, and Hercules may take such further actions as set forth in the Loan Agreement, including collecting or taking such other action with respect to the collateral pledged in connection with the Loan Agreement.

 

In connection with the Loan Agreement, the Company issued Hercules a warrant (the “Warrant”) to purchase $600,000 in shares of the Company’s common stock at an exercise price of $5.29 per share (or, approximately 113,421 shares of common stock).  The Warrant is considered a standalone instrument since it may be exercised separately from the Loan Agreement. The Warrant is exercisable for a period of five years beginning on the date of issuance and has a fair value of $328,610 that is included in stockholders’ equity. The fair value of the Warrant was recorded as a debt discount and was determined through the use of a Black Scholes calculation using the below assumptions:

 

 

On August 3, 2015, Hercules exercised the warrant in full, electing the net issuance option.  As a result, the Company issued 61,644 shares of the Company’s common stock to Hercules.

 

5.50% Convertible Senior Notes Due 2020

 

On April 1, 2015, the Company issued through a private placement $60.0 million in aggregate principal amount of the 5.50% Notes. On May 6, 2015, the Company issued an additional $1.0 million in principal amount pursuant to the initial purchasers’ exercise of their 30-day over-allotment for aggregate gross proceeds of $61.0 million.  Interest on the 5.50% Notes is payable semi-annually in arrears on April 1 and October 1 of each year, commencing October 1, 2015.

 

The 5.50% Notes are general, unsecured and unsubordinated obligations and will rank senior in right of payment to all of the Company’s indebtedness that is expressly subordinated in right of payment to the notes.  The 5.50% Notes rank equal in right of payment to the Company’s existing and future indebtedness and other liabilities that are not so subordinated.  The 5.50% Notes are effectively subordinated to any of the Company’s future secured indebtedness to the extent of the value of the assets securing such indebtedness, and rank structurally junior to all indebtedness and other liabilities incurred by the Company’s subsidiaries, including trade payables.

 

The 5.50% Notes are effectively junior to the $15.0 million principal amount of secured indebtedness outstanding under the Senior Secured Loan Agreement with Hercules and certain other lenders, to the extent of the value of the assets securing such indebtedness.

 

The Company may not redeem the 5.50% Notes prior to maturity. The 5.50% Notes are convertible prior to maturity, subject to certain conditions described below, into shares of the Company’s common stock at an initial conversion rate of 67.2518 shares per $1,000 principal amount of the 5.50% Notes (equivalent to an initial conversion price of approximately $14.87 per share of common stock).  This conversion rate is subject to adjustment upon the occurrence of certain specified events but will not be adjusted for accrued and unpaid interest.   The Company will satisfy the conversion obligation by paying or delivering, as the case may be, cash, shares of the Company’s common stock or a combination thereof, at the Company’s election.

 

Holders may convert all or any portion of their notes, in multiples of $1,000 principal amount, at their option at any time prior to the close of business on the business day immediately preceding January 1, 2020 only under the following circumstances:

 

 

 

 

On or after January 1, 2020 until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert all or any portion of their notes, in multiples of $1,000 principal amount, at the option of the holder regardless of the foregoing circumstances.

 

The conversion rate for the 5.50% notes is initially 67.2518 shares of common stock per $1,000 principal amount of notes (equivalent to an initial conversion price of approximately $14.87 per share of common stock), subject to adjustment.

 

Upon conversion, the Company will pay or deliver, as the case may be, cash, shares of common stock or a combination of cash and shares of the Company’s common stock, at the Company’s election, and an interest make-whole payment in shares of the common stock, if applicable. If the Company satisfies the conversion obligation solely in cash or through payment and delivery, as the case may be, of a combination of cash and shares common stock, the amount of cash and shares of common stock, if any, due upon conversion will be based on a daily conversion value calculated on a proportionate basis for each trading day in a 50 trading day observation period.

 

In addition, following certain corporate events that occur prior to the maturity date, the Company will increase the conversion rate for a holder who elects to convert its notes in connection with such a corporate event in certain circumstances.  Holders will not receive any additional cash payment or additional shares representing accrued and unpaid interest, if any, upon conversion of a note, except in limited circumstances. Instead, interest will be deemed to be paid by the cash, shares the Company’s common stock or a combination of cash and shares of the Company’s common stock paid or delivered, as the case may be, to the holders upon conversion of a note.

 

On or after the date that is six months after the last date of original issuance of the notes, if the last reported sale price of the Company’s common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending within the five trading days immediately preceding a conversion date is greater than or equal to the conversion price for the notes on each applicable trading day, the Company will, in addition to the other consideration payable or deliverable in connection with such conversion, make an interest make-whole payment to the converting holder equal to the sum of the present value of the remaining scheduled payments of interest that would have been made on the notes to be converted had such notes remained outstanding from the conversion date through April 1, 2018, computed using a discount rate equal to 2%. The Company will pay any interest make-whole payment by delivering shares of the Company’s common stock valued at 95% of the simple average of the daily volume weighted average price for the 10 trading days ending on and including the trading day immediately preceding the conversion date.  Notwithstanding the foregoing, the number of shares the Company may deliver in connection with a conversion of the notes, including those delivered in connection with an interest make-whole payment, will not exceed 77.3395 shares of common stock per $1,000 principal amount of notes, subject to adjustment.  The Company will not be required to make any cash payments in lieu of any fractional shares or have any further obligation to deliver any shares of common stock or pay any cash in excess of the threshold described above. In addition, if in connection with any conversion the conversion rate is adjusted, then such holder will not receive the interest make-whole payment with respect to such note.

 

The Company accounts for convertible debt instruments by recording the liability and equity components of the convertible debt separately. The liability is computed based on the fair value of a similar debt instrument that does not include the conversion option. The liability component includes both the value of the embedded interest make-whole derivative and the carrying value of the 5.50% Notes.  The equity component is computed based on the total debt proceeds less the fair value of the liability component. The equity component is also recorded as debt discount and amortized as interest expense over the expected term of the 5.50% Notes, using the effective interest method.

 

The liability component of the 5.50% Notes on the date of issuance was computed as $41.6 million, including the value of the embedded interest make-whole derivative of $0.9 million and the carrying value of the 5.50% Notes of $40.6 million. Accordingly, the equity component on the date of issuance was $19.4 million.  The discount on the 5.50% Notes is being amortized to interest expense over the term of the Notes, using the effective interest method.

 

The conversion criteria for the 5.50% Notes have not been met at September 30, 2015.  Should the Notes become convertible, management will determine whether the intent is to settle in cash which would result in the liability component of the convertible notes being classified as a current liability and the equity component being presented as redeemable equity if the liability is considered current.

 

Transaction costs of $4.1 million related to the issuance of the 5.50% Notes are allocated to the liability and equity components in proportion to the allocation of the proceeds and accounted for as debt discount and equity issuance costs, respectively. Approximately $1.3 million of this amount was allocated to equity and the remaining $2.8 million was recorded as debt discount.

 

The following table summarizes how the issuance of the 5.50% Notes is reflected in the Company’s balance sheet at September 30, 2015:

 

 

 

7.  Fair Value Measurements

 

The Company measures certain assets and liabilities at fair value in accordance with ASC 820, Fair Value Measurements and Disclosures. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (the exit price) in an orderly transaction between market participants at the measurement date. The guidance in ASC 820 outlines a valuation framework and creates a fair value hierarchy in order to increase the consistency and comparability of fair value measurements and the related disclosures. In determining fair value, the Company maximizes the use of quoted prices and observable inputs. Observable inputs are inputs that market participants would use in pricing the asset or liability based on market data obtained from independent sources. The fair value hierarchy is broken down into three levels based on the source of inputs as follows:

 

 

 

 

The following fair value hierarchy table presents information about each major category of our financial assets and liabilities measured at fair value on a recurring basis:

 

 

 

There were no financial liabilities subject to fair value measurement on a recurring basis at December 31, 2014.

 

The 5.50% Notes include an interest make-whole feature whereby if a noteholder converts any of the Notes prior to April 1, 2018, the Company will, in addition to the other consideration payable or deliverable in connection with such conversion, make an interest make-whole payment to the converting holder equal to the sum of the present value of the remaining scheduled payments of interest that would have been made on the notes to be converted had such notes remained outstanding from the conversion date through April 1, 2018, computed using a discount rate equal to 2%. The Company has determined that this feature is an embedded derivative and have recognized the fair value of this derivative as a liability in the Company’s balance sheet, with subsequent changes to fair value recorded through earnings at each reporting period on the Company’s statements of operations and comprehensive loss as change in fair value of derivative liabilities.  The fair value of this embedded derivative was determined based on a binomial tree lattice model.

 

The following tables set forth a summary of changes in the fair value of Level 3 liabilities for the nine months ended September 30, 2015:

 

 

As of September 30, 2015, the fair value and carrying value of our convertible debt, based on a valuation by a third party expert utilizing the binomial lattice tree model. This fair value measurement is based on significant inputs not observable in the market and thus represents a Level 3 measurement within the fair value hierarchy. The fair value measurement was based on several factors including:

 

 

The fair value and carrying value of the Company’s convertible debt at September 30, 2015 was as follows:

 

 

 

8. Net Loss Per Common Share

 

The following table sets forth the computation of basic and diluted net loss per share for the periods indicated:

 

 

The following outstanding securities at September 30, 2014 and 2015 have been excluded from the computation of diluted weighted shares outstanding, as they would have been anti-dilutive:

 

 

 

9. Stock-based Compensation

 

2013 Stock-Based Incentive Plan

 

In November 2013, the Company adopted its 2013 Stock-Based Incentive Plan (the “Plan”).  Pursuant to the Plan, the Company’s compensation committee is authorized to grant equity-based incentive awards to its board of directors, executive officers and other employees and service providers, including officers, employees and service providers of its subsidiaries and affiliates. The number of shares of common stock initially reserved for issuance under the Plan was 1,680,000, in the form of restricted stock and stock options.  A 2,000,000 share increase to shares reserved for issuance under the plan was authorized by the Company’s stockholders in June 2014.  The amount, terms of grants and exercisability provisions are determined by the board of directors or the Company’s chief executive officer. The term of the options may be up to 10 years, and options are exercisable in cash or as otherwise determined by the board of directors. All options vest over time as stipulated in the individual award agreements.

 

Shares Reserved for Future Issuance

 

As of September 30, 2015, the Company has reserved the following shares of common stock for issuance:

 

 

The estimated grant-date fair value of the Company’s share-based awards is amortized ratably over the awards’ service periods. Stock-based compensation expense recognized was as follows:

 

 

Stock Options Granted under the 2013 Stock-Based Incentive Plan

 

 

The intrinsic value of 1,219,721 options outstanding as of September 30, 2015 was $5.4 million, based on a per share price of $13.18, the Company’s closing stock price on that date, and a weighted-average exercise price of $8.82 per share.

 

The Company uses the Black-Scholes option-pricing model to estimate the fair value of stock options at the grant date. The Black-Scholes model requires the Company to make certain estimates and assumptions, including estimating the fair value of the Company’s common stock, assumptions related to the expected price volatility of the Company’s stock, the period during which the options will be outstanding, the rate of return on risk-free investments and the expected dividend yield for the Company’s stock.

 

The per-share weighted-average grant date fair value of the options granted to employees during the nine months ended September 30, 2015 was estimated at $6.99 per share on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:

 

 

The weighted-average valuation assumptions were determined as follows:

 

 

 

 

 

As of September 30, 2015, there was $6.0 million of total unrecognized compensation expense, related to unvested options granted under the Plan, which will be recognized over the weighted-average remaining period of 3.33 years.

 

Restricted stock

 

Upon consummation of the IPO, the Company granted an aggregate of 862,800 shares of restricted stock to its chief executive officer, chief financial officer, chief operating officer and senior vice president of research and development. On March 3, 2014, the Company granted an aggregate of 250,560 shares of restricted stock to three individuals who were providing research and development consulting services to the Company.  On May 1, 2014, the Company granted an aggregate of 257,800 shares of restricted stock to certain employees at a grant date fair value of $11.15 per share.  On August 5, 2014, the Company granted 25,000 shares of restricted stock to its chief medical officer.  On January 2, 2015 the Company granted 40,000 shares of restricted stock to its chief commercial officer.

 

A summary of the status of the Company’s restricted stock awards at September 30, 2015 and of changes in restricted stock awards outstanding under the Plan for the nine months ended September 30, 2015 is as follows:

 

 

For stock awards that vest subject to the satisfaction of service requirements, compensation expense is measured based on the fair value of the award on the date of grant and is recognized as expense on a straight-line basis (net of estimated forfeitures) over the requisite service period.  All restricted stock awards issued above vest over time as stipulated in the individual award agreements. In the event of a change in control, the unvested awards will be accelerated and fully vested immediately prior to the change in control. There are no performance based features or market conditions.

 

As of September 30, 2015, there was $5.7 million of total unrecognized compensation expense, related to restricted stock under the Plan, which will be recognized over the weighted-average remaining period of 1.64 years.

 

10.  Commitments and Contingencies

 

Employment Agreements

 

The Company has entered into employment agreements with its president and chief executive officer, chief financial officer, chief operating officer, chief medical officer, chief commercial officer and senior vice president of research and development, that provide for, among other things, salary, bonus and severance payments.

 

Legal Proceedings

 

As a result of the Company’s acquisition of SPRIX from Luitpold and in-license of OXAYDO from Acura in January 2015, the Company has been substituted or otherwise become subject to certain legal proceedings involving SPRIX and OXAYDO, which are further described below.

 

On August 10, 2012, Luitpold, the prior exclusive licensee of U.S. Patent No. 6,333,044 (the “‘044 patent”), filed a complaint in federal district court in New Jersey for infringement of the ‘044 patent against Amneal Pharmaceuticals, LLC et al. in response to Amneal’s  submission of ANDA No. 23-382 to the FDA for a generic version of SPRIX. Luitpold sought an injunction to prevent Amneal’s launch of a generic version of SPRIX.  On November 19, 2013, Luitpold and Amneal entered into a settlement and license agreement permitting Amneal to launch its generic product on or after March 25, 2018 subject to royalty payments.

 

On January 26, 2015, the Company was substituted for Luitpold as plaintiff in a patent litigation in federal district court in New Jersey against Apotex Corp. and Apotex, Inc. (collectively, “Apotex”), involving the SPRIX Nasal Spray. Apotex submitted ANDA No. 20-5486 to the FDA seeking approval for  a generic version of SPRIX. On July 11, 2014, Luitpold had filed a complaint for infringement of the ‘044 patent against Apotex, prompting a 30-month stay on the approval of Apotex’s ANDA by the FDA. On June 3, 2015, Apotex filed a Motion to Enforce Settlement alleging that Apotex, Luitpold and Recordati came to an agreement on the essential terms of a settlement prior to Egalet’s acquisition of SPRIX from Luitpold. Based on a thorough investigation, Egalet strongly denied Apotex’s allegations as baseless. A hearing on the motion will be set for the near future. Aside of this motion, the litigation is currently ongoing. The Company is aggressively defending its legal position to preserve the exclusivity of SPRIX in the market. As is the case with patent litigation, there is a risk that the ‘044 patent may be invalidated, unenforceable, not infringed or limited or narrowed in scope. The ‘044 Patent expires on December 25, 2018.

 

There were a number of generic challengers to OXAYDO (formerly Oxecta) during 2012 and 2013, including Watson Laboratories, Inc., Par Pharmaceuticals, Inc., Impax Laboratories, Inc., Sandoz, Inc., and Ranbaxy Laboratories, Ltd. In response, Acura filed a complaint for infringement of U.S. Patent No.7,510,726 (the “‘726 Patent”) against each generic challenger in federal district court in Delaware. As of November 2013, Acura resolved all claims at issue in each of the litigations: Watson amended its ANDA to a Paragraph III certification (i.e., launch at expiry of the patents) and the lawsuit was dismissed; Acura entered into a settlement agreement and consent judgment with Ranbaxy that its generic oxycodone HCl product does not infringe Acura’s patents; and Acura entered into settlement and license agreements with the remaining generic challengers allowing entry of a generic oxycodone HCl product on or after January 1, 2022.

 

On April 3, 2015, Purdue Pharma L.P., Purdue Pharmaceuticals L.P., and The P.F. Laboratories, Inc. (collectively, “Purdue”) sued Acura Pharmaceuticals, Inc. (“Acura”) and Egalet Corporation and Egalet US, Inc. (collectively, “Egalet”) in the U.S. District Court for the District of Delaware for patent infringement of U.S. Patent No. 8,389,007 (the “‘007 patent”) alleging that Acura’s and Egalet’s commercialization of OXAYDO will infringe the ‘007 patent. The Company is aggressively defending its legal position to preserve its right to market and sell OXAYDO.  The Company has reviewed Purdue’s assertion and, consistent with our answer filed on May 29, 2015, believe that the Company does not infringe a valid ‘007 patent.   As is the case with patent litigation, there is a risk that the Court may enjoin the making, using, selling and offering for sale OXAYDO and/or may find that OXAYDO infringes the ‘007 patent.

 

In addition, on February 20, 2015, Purdue has requested the U.S. Patent and Trademark Office (USPTO) to declare an interference between Purdue’s U.S. Patent Application Ser. Nos. 14/243,580 and 14/605,034 and Acura’s U.S. Patent Nos. 8,409,616, 8,637,540, 7,981,439, 7,510,726, and 7,201,920.  These patents, which have been exclusively licensed to the Company, cover OXAYDO. The USPTO denied Purdue’s request for interference as premature. However, Purdue may request an interference in the future.  The Company is reviewing Purdue’s assertions, but no response is due or requested at this time.

 

Based on the information currently available, the Company does not believe a loss is probable or reasonably estimable related to the above matters, and no accrual was recorded as of September 30, 2015

 

11. Acquisitions and License and Collaboration Agreements

 

License and Collaboration Agreement with Shionogi

 

In November 2013, the Company entered into a license and collaboration agreement with Shionogi, granting Shionogi an exclusive, royalty-bearing, worldwide license to develop, manufacture and commercialize abuse-deterrent hydrocodone-based product candidates using certain of the Company’s core technologies. The collaboration allows Shionogi to develop and commercialize an abuse-deterrent single-agent hydrocodone-based product and up to 20 different abuse-deterrent combination product candidates containing hydrocodone.

 

Under the terms of the agreement, the Company received an upfront payment of $10.0 million in 2013 and payment of $10.0 million in April 2015 upon submission of an investigational new drug (“IND”) application by Shionogi. The Company is eligible to receive regulatory milestone payments under the agreement as follows: (i) an additional $50.0 million upon successful achievement of specified regulatory milestones for the first licensed product candidate; (ii) up to $42.5 million upon successful achievement of specified regulatory milestones for a defined combination product candidate; (iii) up to $25.0 million upon successful achievement of specified regulatory milestones for a second product candidate (other than the defined combination product candidate); and (iv) up to $12.5 million upon successful achievement of specified regulatory milestones for further product candidates. In addition, the Company is eligible to receive up to an aggregate of $185.0 million based on successful achievement of specified net sales thresholds of licensed products.

 

The Company determined that the deliverables under the Shionogi agreement were: (i) the exclusive, royalty-bearing, worldwide license to its abuse-deterrent hydrocodone-based product candidates using certain of the Company’s core technologies, (ii) the research and development services to be completed by the Company and (iii) the Company’s obligation to serve on a joint committee. The license did not have standalone value to Shionogi and was not separable from the research and development services, because of the uncertainty of Shionogi’s ability to develop the product candidates without the research and development services of the Company during the transfer period and over the term of the agreement.

 

Due to the lack of standalone value for the license, research and development services and the joint committee obligation, the upfront and IND payment are being recognized ratably using the straight line method through November 2030, the expected term of the agreement. The Company recorded the $10.0 million upfront payment and subsequent $10.0 million IND payment as deferred revenue within its consolidated balance sheet as of September 30, 2015. For the nine months ended September 30, 2014 and 2015, the Company recognized revenue of $409,000 and $719,000, respectively, related to the amortization of deferred revenue.

 

Additionally, during the nine months ended September 30, 2014 and 2015, the Company recognized revenue of $685,000 and $642,000, respectively, related to certain development costs incurred under the Company’s collaborative research and license agreement

 

Collaboration and License Agreement with Acura

 

In January 2015, the Company entered into a Collaboration and License Agreement with Acura to commercialize OXAYDO™ (oxycodone hydrochloride) tablets containing Acura’s Aversion® Technology. OXAYDO (formerly known as Oxecta®) is currently approved by the FDA for marketing in the U.S. in 5 and 7.5 mg strengths, but was not actively marketed. Under the terms of the Collaboration and License Agreement, Acura transferred the approved new drug application (“NDA”) for OXAYDO to the Company and the Company was granted an exclusive license under Acura’s intellectual property rights for development and commercialization of OXAYDO worldwide (the “Territory”) in all strengths.

 

The Company paid Acura an upfront payment of $5.0 million in January 2015 and will pay a $2.5 million milestone on the earlier to occur of first commercial sale of OXAYDO or January 1, 2016.  In addition, Acura will be entitled to a one-time $12.5 million milestone payment when OXAYDO net sales reach a specified level of $150.0 million in a calendar year.

 

The Company has recorded a product rights intangible asset of $7.7 million related to the arrangement, which includes $172,000 of transaction costs related to the agreement.  The intangible asset is being amortized over a useful life of 7 years, which coincides with the patent protection of the product in the U.S.

 

In addition, Acura will receive from the Comany, a stepped royalty at percentage rates ranging from mid-single digits to double-digits on net sales during a calendar year based on OXAYDO net sales during such year.   In any calendar year in which net sales exceed a specified threshold, Acura will receive a double digit royalty on all OXAYDO net sales in that year. The Company’s royalty payment obligations commence on the first commercial sale of OXAYDO and expire, on a country-by-country basis, upon the expiration of the last to expire valid patent claim covering OXAYDO in such country (or if there are no patent claims in such country, then upon the expiration of the last valid claim in the U.S.).  Royalties will be reduced upon the entry of generic equivalents, as well for payments required to be made by Egalet to acquire intellectual property rights to commercialize OXAYDO, with an aggregate minimum floor.

 

Asset Purchase Agreement with Luitpold

 

In January 2015, the Company entered into and consummated the transactions contemplated by the Purchase Agreement with Luitpold.  Pursuant to the Purchase Agreement, the Company acquired specified assets and liabilities associated with SPRIX® (ketorolac tromethamine) Nasal Spray for a purchase price of $7.0 million, of which $315,000 was deposited into an escrow account to secure Luitpold’s indemnification obligations under the Purchase Agreement.  The Company concurrently purchased an additional $1.1 million of glassware, equipment and active pharmaceutical ingredient (“API”) from Luitpold, and agreed to purchase an additional $340,000 of API after closing within two business days of the release of such API from Luitpold’s supplier.

 

The Company accounted for the arrangement as a business combination and the purchase price has been preliminarily allocated to the acquisition date fair values as follows:

 

 

During the three months ended June 30, 2015, management determined that the allocation of the purchase price to inventory and the intangible should be adjusted based on the valuation of the acquired assets.  As a result, an adjustment was recorded to increase the allocation of the purchased price of the acquired finished goods inventory by $827,000 and increase the fair value of the intellectual property by $2.5 million.  These adjustments reduced goodwill related to the acquisition to $0.

 

The above estimated fair values of assets acquired are provisional and are based on the information that was available from the acquisition date through the nine months ended September 30, 2015 to estimate the fair value of assets acquired.  The Company believes that information provides a reasonable basis for estimating the fair values but the Company is waiting for additional information and analyses necessary to finalize all of the amounts listed above.  Thus, the provisional measurements of fair value reflected above are subject to change. Such changes could be significant.  The Company expects to finalize the valuation and complete the purchase price allocation as soon as practicable but no later than one year from the acquisition date.

 

The Company incurred $1.1 million of SPRIX acquisition-related costs, which were recorded as general and administrative expense in the consolidated statement of operations.

 

The following table presents supplemental pro forma information for the three and nine months ended September 30, 2014 as if the acquisition of SPRIX had occurred on January 1, 2014 (unaudited).  Due to the acquisition date of January 8, 2015, there is no material difference between the Company’s results presented in the consolidated statement of operations and the pro forma results for the three and nine months ended September 30, 2015:

 

 

 

12. Income Taxes

 

In accordance with ASC Topic No. 270 “Interim Reporting” and ASC Topic No. 740 “Income Taxes” (Topic No. 740) at the end of each interim period, the Company is required to determine the best estimate of its annual effective tax rate and then apply that rate in providing for income taxes on a current year-to-date (interim period) basis. For the three months ended September 30, 2014 and 2015, the Company recorded tax expense of $35,000 and $1,000, respectively.  For the nine months ended September 30, 2014 and 2015, the Company recorded tax expense of $84,000 and $4,000, respectively

 

As of December 31, 2014 and September 30, 2015, the Company had a non-current deferred tax liability of $25,000 and $27,000 respectively.  The deferred tax liability relates to an indefinite-lived intangible that was recorded in connection with the Danish IP R&D. The Company maintains a full valuation against all deferred tax assets as management has determined that it is not more likely than not that the Company will realize these future tax benefits.

 

13. Related-Party Transactions

 

Related Party Receivables

 

The Company has derived a portion of revenue for the three and nine months ended September 30, 2014 and 2015 under its license and collaboration agreement with Shionogi, who is also an investor in the Company. As of December 31, 2014 and September 30, 2015, related party receivables with Shionogi were $679,000 and $102,000, respectively and consisted entirely of revenue from development costs incurred under the Company’s collaborative research and license agreement.

 

Basis of Presentation

 

The unaudited consolidated financial statements are prepared in conformity with U.S. generally accepted accounting principles (“GAAP”) for interim financial information. Certain information and footnotes normally included in consolidated financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for quarterly reports on Form 10-Q. The Company’s consolidation policy requires the consolidation of entities where a controlling financial interest is held. All intercompany balances and transactions have been eliminated in consolidation.

 

The accompanying consolidated financial information at September 30, 2015 and for the three and nine months ended September 30, 2014 and 2015 is unaudited. The interim unaudited financial statements have been prepared on the same basis as the annual audited financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary for the fair statement of the Company’s financial position as of September 30, 2015 and for the three and nine months ended September 30, 2014 and 2015. The financial data and other information disclosed in these notes related to the three and nine months ended September 30, 2014 and 2015 are not necessarily indicative of the results to be expected for the year ending December 31, 2015, any other interim periods or any future year or period. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto for the year ended December 31, 2014 filed on March 16, 2015 with the SEC.

 

The Company’s significant accounting policies are described in Note 2 of the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. Since the date of those financial statements, there have been no changes to the Company’s significant accounting policies, except where noted below.

 

Reclassification

 

Certain reclassifications were made to prior period amounts to conform to the current period presentation.

 

Marketable Securities, Available-for-Sale

 

Marketable securities consist of securities with original maturities greater than three months, and are comprised of securities issued by U.S. government agencies and corporate debt securities. Marketable securities have been classified as current assets in the accompanying Condensed Consolidated Balance Sheets based upon the nature of the securities and their intended use to fund operations.

 

Management determines the appropriate classification of securities at the time of purchase. The Company has classified its investment portfolio as available-for-sale in accordance with the Financial Accounting Standards Board (“FASB”) Standards Codification (“ASC”) 320, Investments—Debt and Equity Securities. The Company’s available-for-sale securities are carried at fair value with unrealized gains and losses reported in other comprehensive income (loss). Marketable securities are evaluated periodically for impairment. If it is determined that a decline of any investment is other than temporary, then the carrying amount of the investment is written down to fair value and the write-down is included in the statements of comprehensive income as a loss.

 

Fair Value Measurements

 

The carrying amounts reported in the Company’s consolidated financial statements for cash, accounts receivable, accounts payable and accrued liabilities approximate their respective fair values because of the short-term nature of these accounts.  The Company’s marketable securities are carried at fair value based on quoted market prices and other observable inputs.  The carrying value of the derivative liabilities are the estimated fair value of the liability as further described below.

 

Net Product Sales

 

The Company recognizes revenue in accordance with FASB ASC 605, Revenue Recognition, when the following criteria have been met: persuasive evidence of an arrangement exists; delivery has occurred and risk of loss has passed; the seller’s price to the buyer is fixed or determinable and collectability is reasonably assured.  The Company determines that persuasive evidence of an arrangement exists based on written contracts that define the terms of the arrangements.  Pursuant to the contract terms, the Company determines when title to products and associated risk of loss has passed on to the customer.  The Company assesses whether the price is fixed or determinable based on the payment terms associated with the transaction and whether the sales price is subject to refund or adjustment.  The Company assesses collectability based primarily on the customer’s payment history and creditworthiness.

 

The Company sells SPRIX in the U.S. to a single specialty pharmaceutical distributor subject to rights of return. The Company has limited SPRIX sales history under the current distribution model and pricing, and the Company has determined that at this time it cannot reliably estimate expected returns of the product at the time of shipment. Accordingly, the Company defers recognition of revenue on product shipments of SPRIX until the right of return no longer exists, which occurs at the earlier of the time SPRIX units are dispensed through patient prescriptions or expiration of the right of return. Units dispensed are generally not subject to return, except in the rare cases where the product malfunctions or the product is damaged in transit. The Company calculates patient prescriptions dispensed using an analysis of third-party information. As of September 30, 2015, the Company had deferred revenue of $12.6 million related to sales of SPRIX to its specialty pharmaceutical distributor. In the event the related units are not dispensed pursuant to patient prescriptions prior to their expiration in April and May of 2016, they may be returned to the Company.

 

Related Party Revenue

 

During 2013, the Company entered into a collaborative research and license agreement with Shionogi, an investor in the Company. The terms of this agreement contain multiple deliverables which include (i) licenses; (ii) research and development activities and (iii) certain of the Company’s core technologies and improvements thereon.  The Company has adopted the provisions of Accounting Standards Update (“ASU”) 2009-13,”Multiple-Deliverable Revenue Arrangements,” which amends ASC 605-25. In accordance with ASU 2009-13, the Company considered whether the deliverables under the arrangement represent separate units of accounting. In determining the units of accounting, management evaluates certain criteria, including whether the deliverables have stand-alone value. Refer to Note 11 Acquisitions and License and Collaboration Agreements for further discussion of the Company’s accounting for the collaborative research and license agreement.

 

Deferred Revenue

 

The Company records deferred revenue when either: a sale of product has occurred, but revenue recognition criteria has not been met; or when payments are due under a collaborative research and license agreement but the revenue recognition criteria has not been met.  As of September 30, 2015, the deferred revenue balance consisted of $12.6 million for SPRIX product sales, all of which is classified as current, and $17.6 million related to the collaborative research and license agreement with Shionogi, $1.1 million of which is classified as current.

 

Product Sales Allowances

 

The Company recognizes product sales allowances as a reduction of product sales in the same period the related revenue is recognized. Product sales allowances are based on amounts owed or to be claimed on the related sales. These estimates take into consideration the terms of the Company’s agreements with customers and third-party payors that may result in future rebates or discounts taken. In certain cases, such as patient discount programs, the Company recognizes the cost of patient discounts as a reduction of revenue based on estimated utilization. If actual future results vary, the Company may need to adjust these estimates, which could have an effect on product revenue in the period of adjustment. The Company’s product sales allowances include:

 

Specialty Pharmacy Discounts. The Company offers a discount to a certain specialty pharmaceutical distributor based on a contractually determined rate. The Company accrues the discount on shipment to the respective distributor and recognizes the discount as a reduction of revenue in the same period the related revenue is recognized.

 

Prompt Pay Discounts. The Company offers cash discounts to its customers, generally 2% of the sales price, as an incentive for prompt payment. The Company accounts for cash discounts by reducing accounts receivable by the prompt pay discount amount and recognizes the discount as a reduction of revenue in the same period the related revenue is recognized.

 

Patient Discount Programs. The Company offers co-pay discount programs for SPRIX to patients, in which patients receive a co-pay discount on their prescriptions. The Company estimates the total amount that will be redeemed based on the quantity of product shipped and recognizes the discount as a reduction of revenue in the same period the related revenue is recognized.

 

Inventories and Cost of Sales

 

Inventories are stated at the lower of cost or market net of reserve for excess and obsolete inventory.  At September 30, 2015, inventory consisted of raw materials and deferred cost of goods.

 

Cost of sales includes the cost of inventory sold or reserved; manufacturing, manufacturing overhead and supply chain costs; product shipping and handling costs and product royalties.  The cost of sales associated with the deferred product revenues are recorded as deferred costs, which are included in inventory, until such time the deferred revenue is recognized.

 

Long Term Debt

 

Long term debt consists of the Loan Agreement with Hercules and certain other lenders, and the 5.50% Notes.

 

Pursuant to the Loan Agreement with Hercules, the Company borrowed $15.0 million in January 2015 under a term loan (see Note 6).  The term loan bears an interest rate per annum equal to the greater of either (i) 9.40% plus the prime rate as reported in The Wall Street Journal minus 3.25% or (ii) 9.40%.

 

On April 1, 2015, the Company issued through a private placement $60.0 million in aggregate principal amount of 5.50% convertible senior notes due April 1, 2020 (the “5.50% Notes”). On May 6, 2015, the Company issued an additional $1.0 million in principal amount pursuant to the initial purchasers’ exercise of their 30-day over-allotment, for aggregate gross proceeds of $61.0 million.  Interest on the 5.50% Notes is payable semi-annually in arrears on April 1 and October 1 of each year, commencing October 1, 2015. Refer to Note 6 - Long term debt for additional information.

 

Interest Make-Whole Derivative

 

The 5.50% Notes include an interest make-whole feature whereby if a noteholder converts any of the 5.50% Notes prior to April 1, 2018, subject to certain restrictions, they are entitled, in addition to the other consideration payable or deliverable in connection with such conversion, to an interest make-whole payment equal to the sum of the present value of the remaining scheduled payments of interest that would have been made on the notes to be converted had such notes remained outstanding from the conversion date through April 1, 2018, computed using a discount rate equal to 2%.  The Company has determined that this feature is an embedded derivative and have recognized the fair value of this derivative as a liability on the Company’s balance sheet, with subsequent changes to fair value recorded through earnings at each reporting period on the Company’s statements of operations and comprehensive loss as change in fair value of derivative liabilities.  The fair value of this embedded derivative was determined based on a binomial tree lattice model.

 

Common Stock Warrants

 

The Company issued warrants to Hercules in connection with the Loan Agreement with Hercules and certain other lenders.  The Company evaluated the warrants under ASC 480 - Distinguishing Liabilities from Equity and determined the warrants are classified as equity.  The fair value of the warrants on the date of grant was recorded as a debt discount.

 

Recent Accounting Pronouncements

 

On April 7, 2015, the FASB issued Accounting Standards Update (“ASU”) 2015-03,1 Interest — Imputation of Interest which changes the presentation of debt issuance costs in financial statements. Under the ASU, an entity presents such costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset. Amortization of the costs is reported as interest expense.  The Company has adopted this standard during the current period and as a result reclassified $171,000 in deferred financing fees associated with the Hercules Loan Agreement to debt discount.

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, or ASU 2014-09, which converges the FASB and the International Accounting Standards Board standards on revenue recognition. Areas of revenue recognition that will be affected include, but are not limited to, transfer of control, variable consideration, allocation of transfer pricing, licenses, time value of money, contract costs and disclosures. In July 2015, the FASB decided to delay the effective date of the new revenue standard by one year. The FASB also agreed to allow entities to choose to adopt the standard as of the original effective date of January 1, 2017. The FASB decided, based on its outreach to various stakeholders and the forthcoming amendments to the new revenue standard, that a deferral is necessary to provide adequate time to effectively implement the new revenue standard. The new standard will be effective for the Company on January 1, 2018. The Company is currently evaluating the method of adoption and the potential impact that ASU 2014-09 may have on its financial position and results of operations.

 

In August 2014, the FASB issued ASU No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern, to provide guidance on management’s responsibility in evaluating whether there is substantial doubt about a company’s ability to continue as a going concern and to provide related footnote disclosures.  ASU 2014-15 is effective for the Company for annual reporting periods beginning in 2016 and for interim reporting periods starting in the first quarter of 2017. The Company is currently evaluating the impact of the adoption of ASU 2014-15 on its financial statements.

 

Marketable securities consisted of the following as of September 30, 2015:

 

 

 

 

 

The following represents the balance of the intangible assets at September 30, 2015:

 

 

The following represents the balance of the intangible assets at December 31, 2014: