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Table of Contents


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2019
OR
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
incorporation or organization)
 
 
(I.R.S. Employer
Identification No.)
 
 
 
 
1550 East Gude Drive
Rockville 
MD
20850
(Address of principal executive offices)
 
 
(Zip Code)
(301838-2500
(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.   Yes   No
Indicate by check mark whether the registrant has submitted electronically pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes 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.
Large accelerated filer

Accelerated filer 
 
 
 
 
Non-accelerated filer
Smaller reporting company 
 
 
 
 
 
 
Emerging growth company
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).   Yes   No
Securities registered pursuant to Section 12(b) of the Exchange Act
Title of each class
 
Outstanding at October 31, 2019
 
Trading Symbol
 
Name of each exchange on which registered
Common Stock, $0.001 par value per share
 
52,462,936
 
SUPN
 
The Nasdaq Global Market

 


Table of Contents


SUPERNUS PHARMACEUTICALS, INC.
FORM 10-Q — QUARTERLY REPORT
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2019
 
Page No.
 
 

 

2

Table of Contents


PART I — FINANCIAL INFORMATION

Supernus Pharmaceuticals, Inc.
Condensed Consolidated Balance Sheets
(in thousands, except share data)
 
September 30,
 
December 31,
 
2019
 
2018
 
(unaudited)
 
 
Assets
 
 
 
Current assets
 
 
 
Cash and cash equivalents
$
116,889

 
$
192,248

Marketable securities
179,808

 
163,770

Accounts receivable, net
86,699

 
102,922

Inventories, net
25,504

 
25,659

Prepaid expenses and other current assets
18,182

 
8,888

Total current assets
427,082

 
493,487

Long term marketable securities
596,442

 
418,798

Property and equipment, net
9,977

 
4,095

Intangible assets, net
26,101

 
31,368

Lease assets
18,780

 

Deferred income taxes
27,953

 
29,683

Other assets
574

 
380

 
 
 
 
Total assets
$
1,106,909

 
$
977,811

 
 
 
 
Liabilities and stockholders’ equity
 
 
 
Current liabilities
 
 
 
Accounts payable
$
3,090

 
$
3,195

Accrued product returns and rebates
98,050

 
107,063

Accrued expenses and other current liabilities
40,800

 
36,535

Income taxes payable
4,818

 
12,377

Nonrecourse liability related to sale of future royalties, current portion
2,959

 
2,183

Total current liabilities
149,717

 
161,353

Convertible notes, net
341,163

 
329,462

Nonrecourse liability related to sale of future royalties, long term
20,305

 
22,575

Lease liabilities, long term
27,256

 

Other liabilities
11,211

 
11,398

Total liabilities
549,652

 
524,788

 
 
 
 
Stockholders’ equity
 
 
 
Common stock, $0.001 par value; 130,000,000 shares authorized; 52,462,936 and 52,316,583 shares issued and outstanding as of September 30, 2019 and December 31, 2018, respectively
52

 
52

Additional paid-in capital
383,525

 
369,637

Accumulated other comprehensive earnings (loss), net of tax
7,261

 
(3,158
)
Retained earnings
166,419

 
86,492

Total stockholders’ equity
557,257

 
453,023

 
 
 
 
Total liabilities and stockholders’ equity
$
1,106,909

 
$
977,811



See accompanying notes.

3

Table of Contents

Supernus Pharmaceuticals, Inc.
Condensed Consolidated Statements of Earnings
(in thousands, except share and per share data)
 
Three Months ended September 30,
 
Nine Months ended
September 30,
 
2019
 
2018
 
2019
 
2018
 
(unaudited)
 
(unaudited)
Revenues
 
 
 
 
 
 
 
Net product sales
$
100,034

 
$
100,227

 
$
285,491

 
$
286,377

Royalty revenues
2,106

 
2,769

 
6,818

 
5,836

Licensing revenues

 

 

 
750

Total revenues
102,140

 
102,996

 
292,309

 
292,963

 
 
 
 
 
 
 
 
Costs and expenses
 
 
 
 
 
 
 
Cost of goods sold
4,819

 
4,207

 
12,547

 
11,168

Research and development
16,943

 
20,422

 
49,307

 
59,368

Selling, general and administrative
40,649

 
40,892

 
122,700

 
117,838

 
 
 
 
 
 
 
 
Total costs and expenses
62,411

 
65,521

 
184,554

 
188,374

 
 
 
 
 
 
 
 
Operating earnings
39,729

 
37,475

 
107,755

 
104,589

 
 
 
 
 
 
 
 
Other income (expenses), net
(139
)
 
(1,104
)
 
(1,180
)
 
(3,180
)
 
 
 
 
 
 
 
 
Earnings before income taxes
39,590

 
36,371

 
106,575

 
101,409

 
 
 
 
 
 
 
 
Income tax expense
10,730

 
8,360

 
26,648

 
16,309

Net earnings
$
28,860

 
$
28,011

 
$
79,927

 
$
85,100

 
 
 
 
 
 
 
 
Earnings per share
 
 
 
 
 
 
 
Basic
$
0.55

 
$
0.54

 
$
1.53

 
$
1.64

Diluted
$
0.54

 
$
0.52

 
$
1.48

 
$
1.57

 
 
 
 
 
 
 
 
Weighted-average shares outstanding
 
 
 
 
 
 
 
Basic
52,453,384

 
52,227,630

 
52,392,232

 
51,897,240

Diluted
53,805,838

 
54,239,847

 
53,898,486

 
54,098,330

 
 
 
 
 
 
 
 






See accompanying notes.

4

Table of Contents

Supernus Pharmaceuticals, Inc.
Condensed Consolidated Statements of Comprehensive Earnings
(in thousands)
 
Three Months ended September 30,

Nine Months ended
September 30,
 
2019
 
2018
 
2019
 
2018
 
(unaudited)
 
(unaudited)
 
 
 
 
 
 
 
 
Net earnings
$
28,860


$
28,011

 
$
79,927

 
$
85,100

Other comprehensive earnings (loss)





 
 
 
 
Unrealized gain (loss) on marketable securities, net of tax
1,337


8

 
10,419

 
(3,364
)
Other comprehensive earnings (loss)
1,337


8

 
10,419

 
(3,364
)
 





 
 
 
 
Comprehensive earnings
$
30,197


$
28,019

 
$
90,346

 
$
81,736




































See accompanying notes.

5

Table of Contents


Supernus Pharmaceuticals, Inc.
Condensed Consolidated Statements of Changes in Stockholders’ Equity
Three and Nine Months ended September 30, 2019
(unaudited, in thousands, except share data)

j
Common Stock
 
Additional 
Paid-in Capital
 
Accumulated Other
Comprehensive
Earnings (Loss)
 
Retained
Earnings
 
Total
Stockholders’
Equity
 
Shares
 
Amount
 
 
 
 
Balance, December 31, 2018
52,316,583

 
$
52

 
$
369,637

 
$
(3,158
)
 
$
86,492

 
$
453,023

Share-based compensation

 

 
3,287

 

 

 
3,287

Exercise of stock options
57,665

 

 
783

 

 

 
783

Net earnings

 

 

 

 
18,340

 
18,340

Unrealized gain on marketable securities, net of tax

 

 

 
4,585

 

 
4,585

Balance, March 31, 2019
52,374,248

 
52

 
373,707

 
1,427

 
104,832

 
480,018

 
 
 
 
 
 
 
 
 
 
 
 
Share-based compensation

 

 
4,022

 

 

 
4,022

Issuance of ESPP shares
48,950

 

 
1,377

 

 

 
1,377

Exercise of stock options
25,838

 

 
263

 

 

 
263

Net earnings

 

 

 

 
32,727

 
32,727

Unrealized gain on marketable securities, net of tax

 

 

 
4,497

 

 
4,497

Balance, June 30, 2019
52,449,036

 
52

 
379,369

 
5,924

 
137,559

 
522,904

 
 
 
 
 
 
 
 
 
 
 
 
Share-based compensation

 

 
3,914

 

 

 
3,914

Exercise of stock options
13,900

 

 
242

 

 

 
242

Net earnings

 

 

 

 
28,860

 
28,860

Unrealized gain on marketable securities, net of tax

 

 

 
1,337

 

 
1,337

Balance, September 30, 2019
52,462,936

 
52

 
383,525

 
7,261

 
166,419

 
557,257

 
 
 
 
 
 
 
 
 
 
 
 















See accompanying notes.

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Supernus Pharmaceuticals, Inc.
Condensed Consolidated Statements of Changes in Stockholders’ Equity (continued)
Three and Nine Months ended September 30, 2018
(unaudited, in thousands, except share data)

 
Common Stock
 
Additional 
Paid-in Capital
 
Accumulated Other
Comprehensive
Earnings (Loss)
 
Retained
Earnings
 
Total
Stockholders’
Equity
 
Shares
 
Amount
 
 
 
 
Balance, December 31, 2017
51,314,850

 
$
51

 
294,999

 
(747
)
 
(26,823
)
 
267,480

Cumulative-effect of adoption of ASC 606

 

 

 

 
2,322

 
2,322

Balance, January 1, 2018
51,314,850

 
51

 
294,999

 
(747
)
 
(24,501
)
 
269,802

Share-based compensation

 

 
2,635

 

 

 
2,635

Exercise of stock options
319,141

 
1

 
2,857

 

 

 
2,858

Equity component of convertible notes issuance, net of tax

 

 
56,215

 

 

 
56,215

Purchases of convertible note hedges, net of tax

 

 
(70,137
)
 

 

 
(70,137
)
Issuance of warrants

 

 
65,688

 

 

 
65,688

Net earnings

 

 

 

 
26,352

 
26,352

Unrealized loss on marketable securities, net of tax

 

 

 
(1,544
)
 

 
(1,544
)
Balance, March 31, 2018
51,633,991

 
52

 
352,257

 
(2,291
)
 
1,851

 
351,869

 
 
 
 
 
 
 
 
 
 
 
 
Share-based compensation

 

 
3,068

 

 

 
3,068

Issuance of ESPP shares
34,676

 

 
1,184

 

 

 
1,184

Exercise of stock options
510,667

 

 
5,462

 

 

 
5,462

Net earnings

 

 

 

 
30,737

 
30,737

Unrealized loss on marketable securities, net of tax

 

 

 
(1,828
)
 

 
(1,828
)
Balance, June 30, 2018
52,179,334

 
52

 
361,971

 
(4,119
)
 
32,588

 
390,492

 
 
 
 
 
 
 
 
 
 
 
 
Share-based compensation

 

 
2,597

 

 

 
2,597

Exercise of stock options
77,679

 

 
828

 

 

 
828

Net earnings

 

 

 

 
28,011

 
28,011

Unrealized gain on marketable securities, net of tax

 

 

 
8

 

 
8

Balance, September 30, 2018
52,257,013

 
52

 
365,396

 
(4,111
)
 
60,599

 
421,936





See accompanying notes.

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Supernus Pharmaceuticals, Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
 
Nine Months ended September 30,
 
2019
 
2018
 
(unaudited)
Cash flows from operating activities
 
 
 
Net earnings
$
79,927

 
$
85,100

 
 
 
 
Adjustments to reconcile net earnings to net cash provided by operating activities:
 
 
 
Depreciation and amortization
5,029

 
5,371

Noncash operating lease cost
2,600

 

Amortization of deferred financing costs and debt discount
11,701

 
8,052

Amortization of premium/discount on marketable securities
(3,189
)
 
(1,825
)
Noncash interest expense
4,331

 
3,096

Noncash royalty revenue
(5,028
)
 
(4,300
)
Share-based compensation expense
11,223

 
8,300

Deferred income tax benefit
(1,689
)
 
(6,233
)
Changes in operating assets and liabilities:
 
 
 
Accounts receivable
16,344

 
(10,687
)
Inventories
155

 
(6,976
)
Prepaid expenses and other current assets
(4,236
)
 
(2,778
)
Other noncurrent assets
(141
)
 
(342
)
Accounts payable
(334
)
 
3,066

Accrued product returns and rebates
(9,013
)
 
17,627

Accrued expenses and other current liabilities
1,120

 
5,966

Income taxes payable
(7,559
)
 
(7,390
)
Other liabilities
(1,903
)
 
90

Net cash provided by operating activities
99,338

 
96,137

 
 
 
 
Cash flows from investing activities
 
 
 
Purchases of marketable securities
(361,121
)
 
(491,654
)
Sales and maturities of marketable securities
184,467

 
45,271

Purchases of property and equipment
(707
)
 
(748
)
Deferred legal fees
(1
)
 
(679
)
Net cash used in investing activities
(177,362
)
 
(447,810
)
 
 
 
 
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
2,665

 
10,331

Net cash provided by financing activities
2,665

 
375,187

 
 
 
 
Net change in cash and cash equivalents
(75,359
)
 
23,514

Cash and cash equivalents at beginning of year
192,248

 
100,304

Cash and cash equivalents at end of period
$
116,889

 
$
123,818

 
 
 
 
Supplemental cash flow information
 
 
 
Cash paid for interest on convertible notes
$
2,516

 
$

Income taxes paid
$
35,933

 
$
29,930

 
 
 
 
Noncash investing and financing activities
 
 
 
Deferred legal fees and fixed assets included in accounts payable and accrued expenses
$
495

 
$
280

Property and equipment acquired under build-to-suit lease transaction
$

 
$
2,304

Interest capitalized during construction period for build-to-suit lease transaction
$

 
$
44

Facility lease financing obligation
$

 
$
2,347

See accompanying notes.

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Supernus Pharmaceuticals, Inc.
Notes to Condensed Consolidated Financial Statements (unaudited)
1.
Organization and Business
Supernus Pharmaceuticals, Inc. (the Company) was incorporated in Delaware and commenced operations in 2005. The Company is a 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 opportunities in the CNS market.
The Company launched Oxtellar XR and Trokendi XR for the treatment of epilepsy in 2013, launched Trokendi XR for the prophylaxis of migraine headache in adolescents and adults in April 2017, and launched Oxtellar XR with an expanded indication to include monotherapy for partial seizures in January 2019.
2.
Summary of Significant Accounting Policies
Basis of Presentation
The Company’s condensed consolidated financial statements include the accounts of Supernus Pharmaceuticals, Inc., Supernus Europe Ltd., Biscayne Neurotherapeutics, Inc. and its wholly-owned subsidiary, Biscayne Neurotherapeutics Australia Pty 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 condensed 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 condensed 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 most recent Annual Report on Form 10-K for the year ended December 31, 2018, filed with the SEC.
In management’s opinion, the condensed consolidated financial statements include all normal and recurring adjustments necessary for a fair presentation of the Company’s financial position, results of operations and cash flows. The results of operations for any interim period are not necessarily indicative of the Company’s future quarterly or annual results.
The Company, which is primarily located in the United States (U.S.), operates in one operating segment.
Use of Estimates
The Company bases its estimates on: historical experience; various forecasts; information received from its service providers; and other assumptions that the Company believes are reasonable under the circumstances. Actual results could differ materially from the Company’s estimates. The Company evaluates the methodologies employed in its estimates on an ongoing basis.
Revenue Recognition
The Company recognizes revenue when physical control of goods or provision of services are transferred to the Company’s customers in an amount that reflects the consideration the Company expects to receive in exchange for those goods or services. The Company does not adjust revenue for any financing effects in transactions where the Company expects the period between the transfer of the goods or services and collection to be less than one year.
There were no contract assets or liabilities recorded as of September 30, 2019.
Revenue from Product Sales
The Company’s customers, who are primarily pharmaceutical wholesalers and distributors, purchase product to fulfill orders from retail pharmacy chains and independent pharmacies of varying size and purchasing power. The Company recognizes gross revenue when its products are physically received by its customers after shipment from a third party fulfillment center. Customers take control of the products, including title and ownership, upon physical receipt of our products at the customers' facilities.

9

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Product sales are recorded net of various forms of variable consideration, including: estimated liability for rebates; an estimated liability for future product returns; and an estimated allowance for discounts. These are collectively considered "sales deductions."
As described below, variability in the net transaction price for the Company’s products arises primarily from sales deductions and significant judgment is required in estimating sales deductions. In making these estimates, the Company considers: historical experience; product price increases; current contract prices under applicable programs; unbilled claims; processing time lags; and inventory levels in the distribution channel. The Company adjusts its estimates of revenue either when the most likely amount of consideration it expects to receive changes, or when the consideration becomes fixed.
If actual results in the future vary from the estimates, the Company adjusts these estimates. These adjustments could materially affect net product sales and earnings in the period that such adjustments are recorded.
Sales Deductions
The Company records product sales net of the following sales deductions:
Rebates:  Rebates are discounts which the Company pays under either public sector or private sector health care programs. Public sector rebate programs encompass: various Medicaid drug rebate programs; Medicare coverage gap programs; and programs covering public health service institutions and government entities. All federal employees and agencies purchase drugs under the Federal Supply Schedule. Private sector rebate programs include: contractual agreements with managed care providers, under which the Company pays fees to gain access to that provider’s patient drug formulary; and Company sponsored programs, under which the Company defrays or eliminates patient co-payment charges that the patient would otherwise pay to their managed care provider.
Rebates paid under public sector programs are generally mandated under law, whereas private sector rebates are generally contractually negotiated by the Company with managed care providers.
Rebates are owed upon dispensing our product to a patient; i.e., filling a prescription. The accrual balance for rebates consists of three components. First, because rebates are generally invoiced and paid quarterly in arrears, the accrual balance consists of an estimate of the amount expected to be incurred for prescriptions dispensed in the current quarter. Second, the accrual balance also includes an estimate for known or estimated prior quarters’ unpaid rebates, to cover prescriptions dispensed in past quarters, but for which no invoice has been received. Third, the accrual balance includes an estimate for rebates that will be prospectively owed, for prescriptions filled in future quarters. This pertains to product that has been sold to wholesalers or distributors, and which resides either as wholesaler/distributor inventory, or as inventory held at pharmacies.
The Company’s estimates of expected rebate claims vary by program and by type of customer, because the period from the date at which the prescription is filled to the date the Company receives and pays the invoice varies substantially. For each of its products, the Company bases its estimates of expected rebate claims on multiple factors, including historical levels of deductions; contractual terms with managed care providers; actual and anticipated changes in product price; prospective changes in managed care fee for service contracts; prospective changes in co-pay assistance programs; and anticipated changes in program utilization rates (i.e., patient participation rates under a specific program). The Company records an estimated liability for rebates at the time the customer takes title to the product (i.e., at the time of sale to wholesalers/distributors), and records this liability as a reduction to gross product sales and an increase in Accrued product returns and rebates in current liabilities on its condensed consolidated balance sheets.
The sensitivity of the Company’s estimates varies by program and by type of customer. If actual rebates vary from estimated amounts, the Company will adjust the balances of such accrued rebates to reflect actual experience with respect to these programs. These changes could materially affect the estimated liability balance, net product sales and earnings in the period of adjustment.
Returns:  Sale of the Company’s products are not subject to a general right of return. However, the Company will accept return of product that is damaged or defective when shipped from its third party fulfillment center. In addition, the Company will accept return of expired product six months prior to and up to 12 months subsequent to the product’s expiry date. Expired or defective returned product cannot be re-sold and is therefore destroyed. Product that has been used to fill patient prescriptions is no longer subject to any right of return.
The Company records an estimated liability for product returns at the time the customer takes title to the product (i.e., at time of sale) as a reduction to gross product sales and an increase in Accrued product returns and rebates

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in current liabilities on the condensed consolidated balance sheets. The Company estimates the liability for returns based on the actual returns experience for its two commercial products, in conjunction with industry experience for return of similar products (i.e., ambient temperature storage for oral formulations). Because the Company’s products have not reached maturity, the return rate of its products has and is expected to continue to vary.
The Company’s products have a shelf life of 48 months from date of manufacture. Because of the extended shelf life, coupled with its return policy, there typically is a significant time lag between the time at which the product is sold and when the Company issues credit on expired product. Because the Company’s policy generally permits product returns to be processed at current wholesaler price rather than historical acquisition price, the Company’s estimated liability for product returns is affected by price increases taken subsequent to the date of sale. Therefore, price increase(s) taken during the current period increase(s) the liability for product returns because they affect the estimated liability for product returns for both sales made in the current period as well as sales made in prior periods.
When the Company adjusts its estimates for product returns, either favorably or unfavorably, this adjustment affects the estimated liability, product sales and earnings in the period of adjustment.
Sales discounts:  Distributors and wholesalers of the Company's pharmaceutical products are generally offered various forms of consideration, including allowances, service fees and prompt payment discounts for distributing our products. Distributor and wholesaler allowances and service fees arise from contractual agreements and are estimated as a percentage of the price at which the Company sells product to them. In addition, distributor and wholesaler are offered a prompt pay discount for payment within a specified period.
The Company accounts for these discounts at the time of sale, as a reduction to gross product sales, and records these amounts as a valuation allowance against Accounts receivable on the condensed consolidated balance sheets.
Customer orders are generally fulfilled within a few days of receipt, resulting in minimal order backlog. There are no minimum product purchase requirements.
License Revenues
License and Collaboration Agreements
The Company has entered into collaboration agreements to commercialize both Oxtellar XR and Trokendi XR outside of the U.S., which agreements include 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 executed between the Company and its licensee.
Milestones are a form of variable consideration that are recognized when either the underlying events have transpired (i.e., event-based milestone) or when the sales-based targets have been met by the collaborative partner (i.e., sales-based milestone). Both types of milestone payments are nonrefundable. The Company evaluates whether achieving the milestone is considered probable and estimates the amount of the milestone to be included in the transaction price using the most likely amount method. The value of the associated milestone is not included in the transaction price if it is probable that a significant revenue reversal would occur. This estimation is based on management’s judgment, including assessing factors that are outside of the Company’s influence, such as: likelihood of regulatory success; availability of third party information; and expected time period until achievement of the event. These factors are evaluated based on the specific facts and circumstances.
Event-based milestones are recognized in the period that the related event, such as regulatory approval, occurs. 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 success of a third-party are not considered probable until the specified event occurs. Sales-based milestones are recognized as revenue only when the sales-based target is achieved. Revenue is recognized from the satisfaction of performance obligations in the amount billable to the customer.
No guaranteed minimum amounts are owed to the Company related to license and collaboration agreements.

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Royalty Revenues
The Company recognizes noncash royalty revenue for amounts earned pursuant to a royalty agreement with United Therapeutics Corporation (United Therapeutics), which agreement includes 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 17, Commitments and Contingencies). Accordingly, the Company records noncash royalty revenue based on estimated product sales by United Therapeutics, in which sales of United Therapeutics' product results 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, a subsidiary of Takeda Pharmaceutical Company Ltd), based on net product sales of Shire’s product, Mydayis, in the current period. Royalty revenue is only recognized when the underlying product sale by Shire occurs. The Shire arrangement also includes Shire's right to use the Company’s intellectual property as a functional license.
There are no guaranteed minimum amounts owed to the Company related to any royalty revenue agreement.
Research and Development Expense
Research and development expenditures are expensed as incurred. These expenses include: salaries, benefits and share-based compensation; contract research and development services provided by third parties; costs for preclinical and clinical studies; the cost of acquiring or manufacturing clinical trial material; regulatory costs; facilities costs; depreciation expense and other allocated expenses; and license fees and milestone payments related to in-licensed products and technologies. Assets acquired that are used for research and development and that have no future alternative use are expensed as in-process research and development.
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 the Company’s behalf. In recording service fees, the Company estimates the time period over which the related services are performed and compares the level of effort expended through the end of each period with the cumulative expenses recorded and payments made for such services. As appropriate, the Company accrues additional service fees, or defers any nonrefundable 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 adjusts its accrued expenses, or its deferred advance payments, accordingly. If the Company subsequently determines that it no longer expects the services associated with a nonrefundable advance payment to be rendered, the remaining portion of that advance payment is charged to expense in the period in which such determination is made.
Share-Based Compensation
The Company recognizes share-based compensation expense over the service period using the straight-line method. Employee share-based compensation is measured based on estimated fair value as of the grant date. The Company uses the Black-Scholes option-pricing model in calculating the fair value of option grants as of the grant date. The Company uses the following assumptions for estimating fair value of option grants:
Fair Value of Common Stock—The fair value of the common stock underlying the option grants is determined based on observable market prices of the Company’s common stock.
Expected Volatility—Volatility is a measure of the amount by which the Company’s share price has fluctuated (i.e., historical volatility) or is expected to fluctuate (i.e., expected volatility) during a period. Beginning in the first quarter of 2019, the Company began using the historical volatility of its common stock to measure expected volatility for future option grants. Prior to the first quarter of 2019, volatility was estimated using the volatility of the common stock of several public entities of similar size, complexity, and stage of development, as well as taking into consideration the Company’s actual volatility since the Company’s IPO in 2012.
Dividend Yield—The Company has never declared or paid dividends, and has no plans to do so in the foreseeable future.
Expected Term—This is the period of time during which options are expected to remain unexercised. Options have a maximum contractual term of ten years. Beginning in the first quarter of 2019, the Company began estimating the average expected life of stock options using its historical experience. Prior to the first quarter of 2019, the Company determined the

12

Table of Contents


average expected life of stock options according to the “simplified method”, as described in Staff Accounting Bulletin 110, which is the mid-point between the vesting date and the end of the contractual term.
Risk-Free Interest Rate—This is the U.S. Treasury Note rate as of the week each option grant is issued, with a term that most closely resembles the expected term of the option.
Expected Forfeiture Rate—Forfeitures are accounted for as they occur.
Self-insurance Liabilities
As of January 1, 2019, the Company self-insures its employee medical insurance liability. The self-insurance liability is undiscounted and is determined actuarially. It is based on claims filed, historical and industry claims experience, and an estimate of claims incurred but not yet paid. The Company has established stop-loss amounts that limit the Company’s further exposure after a claim reaches the designated stop-loss threshold, which effectively transfers any additional liability to a third party. The stop-loss limit for self-insured employee medical claims is $150,000 per employee per year.
The Company recorded self-insurance liability of approximately $500,000 as of September 30, 2019 in Accrued expenses and other current liabilities on the condensed consolidated balance sheets.
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 $11.3 million and $32.5 million in advertising costs for the three and nine months ended September 30, 2019, respectively, and approximately $11.6 million and $30.5 million in advertising costs for the three and nine months ended September 30, 2018, respectively. These expenses are recorded in Selling, general and administrative in the condensed consolidated statements of earnings.
Recently Issued Accounting Pronouncements
Accounting Pronouncements Adopted
In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-02, “Leases (Topic 842)” and its related amendments (New Lease Standard). The New Lease Standard requires a lessee to recognize a right-of-use lease asset and a corresponding lease liability on the balance sheet. The Company adopted the New Lease Standard on January 1, 2019 using the modified retrospective method, which applies the provision of the New Lease Standard at the effective date without adjusting comparative periods presented. In addition, the Company elected the package of practical expedients permitted under the transition guidance within the New Lease Standard which, among other things, allows the Company to carry forward the historical lease classification.
The adoption of the New Lease Standard resulted in the recognition of lease assets and lease liabilities for operating leases as of January 1, 2019 of approximately $4.0 million. Financial reporting for periods on or after January 1, 2019 are presented under the new guidance. Prior period amounts are not adjusted and continue to be reported in accordance with previous guidance. The standard did not materially impact the Company’s condensed consolidated net earnings and had no impact on cash flows (see Note 14, Leases).
New Accounting Pronouncements Not Yet Adopted
In June 2016, the FASB issued ASU 2016-13, Financial Instruments—Credit Losses (Topic 326), which requires credit losses on financial assets measured on an amortized cost basis to be presented at the net amount expected to be collected, rather than based on incurred losses. Further, credit losses on available-for-sale debt securities should be recorded through an allowance for credit losses, limited to the amount by which fair value is below amortized cost. The new standard also requires enhanced disclosure of credit risk associated with respective assets. The standard is effective for fiscal years beginning after December 15, 2019, for interim and annual periods within those years, with early adoption permitted. The Company is currently assessing the impact of this new standard and expects the adoption of the guidance will not have a material impact on its condensed consolidated financial statements.

In August 2018, the FASB issued ASU 2018-15, Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, which aligns the requirements for capitalizing implementation costs incurred

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in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). This ASU also requires the entity to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement, which includes reasonably certain renewals. The standard is effective for the Company in the year ending December 31, 2020, with early adoption permitted. The Company is currently assessing the impact of this new standard and expects the adoption of the guidance will not have a material impact on its condensed consolidated financial statements.

In November 2018, the FASB issued ASU 2018-18, Clarifying the Interaction Between Topic 808 and Topic 606, which clarifies when transactions between participants in a collaborative arrangement are within the scope of the FASB’s revenue standard, Topic 606. The standard is effective for the Company in the year ending December 31, 2020, with early adoption permitted. The Company is currently assessing the impact of this new standard and expects the adoption of the guidance will not have a material impact on its condensed 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 arm's length market participants.
The Company reports assets and liabilities measured at fair value using a three level fair value hierarchy that prioritizes the inputs used to measure fair value. 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 as of 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 (e.g., interest rates; yield curves); and inputs that are derived principally from or corroborated by observable market data by correlation or other means (i.e., 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.
Financial Assets
The Company’s financial assets that are required to be measured at fair value on a recurring basis are as follows, in thousands of dollars:
 
 
 
Fair Value Measurements at
September 30, 2019
(unaudited)
 
Total Fair
Value at
September 30,
2019
 
Quoted Prices
in Active Markets
for Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
Assets:
 
 
 
 
 
Cash and cash equivalents
$
116,889

 
$
116,889

 
$

Marketable securities
 
 
 
 
 
Corporate debt securities
179,643

 
247

 
179,396

Municipal debt securities
165

 

 
165

Long term marketable securities
 
 
 
 
 
Corporate debt securities
585,446

 
456

 
584,990

U.S. government agency debt securities
10,996

 

 
10,996

Other noncurrent assets
 
 
 
 
 
Marketable securities - restricted (SERP)
378

 
1

 
377

Total assets at fair value
$
893,517

 
$
117,593

 
$
775,924



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Fair Value Measurements at
December 31, 2018
 
Total Fair
Value at
December 31,
2018
 
Quoted Prices
in Active Markets
for Identical Assets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
Assets:
 
 
 
 
 
Cash and cash equivalents
$
192,248

 
$
192,248

 
$

Marketable securities
 
 
 
 
 
Corporate debt securities
163,770

 
245

 
163,525

Long term marketable securities
 
 
 
 
 
Corporate debt securities
415,650

 
445

 
415,205

U.S. government agency and municipal debt securities
3,148

 

 
3,148

Other noncurrent assets
 
 
 
 
 
Marketable securities - restricted (SERP)
326

 
1

 
325

Total assets at fair value
$
775,142

 
$
192,939

 
$
582,203


Level 1 assets include cash held at banks, certificates of deposit, money market funds, and investment grade corporate debt securities.
Level 2 assets include commercial paper, investment grade corporate and U.S. government agency, state and municipal debt securities, other fixed income securities and SERP (Supplemental Executive Retirement Plan) assets. 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 fair value of the restricted marketable securities is recorded in Other assets on the condensed consolidated balance sheets.
No amount was recorded for level 3 assets as of September 30, 2019.
The carrying amounts of other financial instruments, including accounts receivable, accounts payable and accrued expenses approximate fair value due to their short-term maturities.
Unrestricted available-for-sale marketable securities held by the Company are as follows, in thousands of dollars:
 
September 30,
2019
 
December 31, 2018
 
(unaudited)
 
 
Corporate and U.S. government agency and municipal debt securities
 
 
 
Amortized cost
$
766,570

 
$
586,726

Gross unrealized gains
9,756

 
55

Gross unrealized losses
(76
)
 
(4,213
)
Total fair value
$
776,250

 
$
582,568


The contractual maturities of the unrestricted available-for-sale marketable securities held by the Company are as follows, in thousands of dollars:
 
September 30,
2019
 
(unaudited)
Less than 1 year
$
179,808

1 year to 2 years
194,063

2 years to 3 years
201,889

3 years to 4 years
200,490

Greater than 4 years

Total
$
776,250


The Company has not experienced any other-than-temporary losses on its marketable securities.

15

Table of Contents


Financial Liabilities
The following table sets forth the Company’s financial liabilities that are not carried at fair value, in thousands of dollars:
 
September 30, 2019
 
December 31, 2018
 
(unaudited)
 
 
 
 
 
Carrying Value
 
Fair Value (Level 2)
 
Carrying Value
 
Fair Value (Level 2)
2023 Notes
$
341,163

 
$
374,828

 
$
329,462

 
$
375,834


The fair value is estimated based on actual trade information as well as quoted prices provided by bond traders.
4.
Inventories
Inventories consist of the following, in thousands of dollars:
 
September 30,
2019
 
December 31,
2018
 
(unaudited)
 
 
Raw materials
$
5,271

 
$
5,742

Work in process
7,050

 
7,275

Finished goods
13,183

 
12,642

Total
$
25,504

 
$
25,659


5.
Property and Equipment
Property and equipment consists of the following, in thousands of dollars:
 
September 30,
2019
 
December 31,
2018
 
(unaudited)
 
 
Lab equipment and furniture
$
9,526

 
$
8,995

Leasehold improvements
8,884

 
2,731

Software
2,225

 
2,181

Computer equipment
1,334

 
1,313

Construction-in-progress
338

 
94

 
22,307

 
15,314

Less accumulated depreciation and amortization
(12,330
)
 
(11,219
)
Total
$
9,977

 
$
4,095


Depreciation and amortization expense on property and equipment was approximately $0.4 million and $1.1 million for the three and nine months ended September 30, 2019, respectively, modestly lower than the approximately $0.6 million and $1.5 million for the three and nine months ended September 30, 2018, respectively.
The Company performs its annual impairment assessment of its property and equipment in the fourth quarter, or earlier if impairment indicators exist. As of September 30, 2019, there were no identified indicators of impairment.
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 Company amortizes those costs over the useful life of the respective patents.

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The following sets forth the gross carrying amount and related accumulated amortization of the intangible assets, in thousands of dollars:
 
Weighted-
Average Life
 
September 30,
2019
 
December 31,
2018
 
(unaudited)
Capitalized patent defense costs
3.26 - 7.51 years
 
$
43,375

 
$
44,724

Less accumulated amortization
 
 
(17,274
)
 
(13,356
)
Total
 
 
$
26,101

 
$
31,368


Amortization expense on intangible assets was approximately $1.3 million and $3.9 million for the three and nine months ended September 30, 2019, respectively, essentially unchanged as compared to $1.3 million and $3.9 million for the three and nine months ended September 30, 2018, respectively.
The Company performs its annual impairment assessment of its intangible assets in the fourth quarter, or earlier, if impairment indicators exist. As of September 30, 2019, there were no identified indicators of impairment.
7.
Accrued Expenses and Other Current Liabilities
Accrued expenses and other current liabilities consist of the following, in thousands of dollars:
 
September 30,
2019
 
December 31,
2018
 
(unaudited)
 
 
Accrued clinical trial costs (1)
$
17,332

 
$
14,034

Accrued compensation
12,820

 
13,546

Accrued professional fees
4,003

 
3,706

Lease liabilities, current
3,145

 

Other accrued expenses
3,500

 
5,249

Total
$
40,800

 
$
36,535


________________________________________________________________
(1) Includes clinical supply and research manufacturing costs.
8.
Accrued Product Returns and Rebates
Accrued product returns and rebates consist of the following, in thousands of dollars:
 
September 30,
2019
 
December 31,
2018
 
(unaudited)
 
 
Accrued product rebates
$
76,758

 
$
85,003

Accrued product returns
21,292

 
22,060

Total
$
98,050

 
$
107,063


9.
Convertible Senior Notes Due 2023
The 0.625% Convertible Senior Notes Due 2023 (2023 Notes), which were issued in March 2018, bear interest at an annual rate of 0.625%, payable semi-annually in arrears on April 1 and October 1 of each year. The 2023 Notes will mature on April 1, 2023, unless earlier converted or repurchased by the Company. The Notes are being amortized to interest expense at an effective interest rate of 5.41% over the contractual term of the 2023 Notes. The Company may not redeem the 2023 Notes at its option before maturity.
The 2023 Notes were issued pursuant to an 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 does not contain any financial or operating covenants or restrictions on the payment of dividends, the issuance of other indebtedness, or the issuance or repurchase of securities by the Company.

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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. In the event of conversion, if converted in cash, the holders would forgo all future interest payments, any unpaid accrued interest and the possibility of further stock price appreciation.
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.
Contemporaneous with the issuance of the 2023 Notes, the Company also entered into separate privately negotiated convertible note hedge transactions (collectively, the Convertible Note Hedge Transactions) with each of the call spread counterparties. The Company issued 402,500 convertible note hedge options. 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 to 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.
Concurrently with entering into the Convertible Note Hedge Transactions, the Company also entered into separate privately negotiated warrant transactions (collectively, the Warrant Transactions) with each of the call spread counterparties. 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, and is subject to adjustment.
The Convertible Note Hedge Transactions are expected to reduce the potential dilution of 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. 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.
The liability component of the 2023 Notes consists of the following, in thousands of dollars:
 
September 30,
2019
 
December 31,
2018
 
(unaudited)
 
 
Principal amount of the 2023 Notes
$
402,500

 
$
402,500

Debt discount
(76,434
)
 
(76,434
)
Deferred financing costs
(8,452
)
 
(8,452
)
Accretion of debt discount and deferred financing costs
23,549

 
11,848

Total carrying value
$
341,163

 
$
329,462


No 2023 Notes have been converted as of September 30, 2019.
10.
Other Income (Expenses)
Other income (expenses) consist of the following, in thousands of dollars:
 
Three Months ended September 30,
 
Nine Months ended
September 30,
 
2019
 
2018
 
2019
 
2018
 
(unaudited)
 
(unaudited)
Interest income
$
5,523

 
$
4,461

 
$
15,657

 
$
9,331

Interest expense
(4,546
)
 
(4,374
)
 
(13,425
)
 
(9,415
)
Interest expense on nonrecourse liability related to sale of future royalties
(1,116
)
 
(1,191
)
 
(3,412
)
 
(3,096
)
 
 
 
 
 
 
 
 
Total
$
(139
)
 
$
(1,104
)
 
$
(1,180
)
 
$
(3,180
)


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Interest expense includes noncash interest expense related to amortization of deferred financing costs and amortization of the debt discount in the amount of $4.0 million and $11.7 million for the three and nine months ended September 30, 2019, respectively, as compared to $3.7 million and $8.1 million respectively, for the three and nine months ended September 30, 2018.
11.
Share-Based Payments
Share-based compensation expense is as follows, in thousands of dollars:
 
Three Months ended
September 30,

Nine Months ended
September 30,
 
2019
 
2018
 
2019
 
2018
 
(unaudited)
 
(unaudited)
Research and development
$
680

 
$
469

 
$
1,954

 
$
1,421

Selling, general and administrative
3,234

 
2,128

 
9,269

 
6,879

Total
$
3,914

 
$
2,597

 
$
11,223

 
$
8,300


The following table summarizes stock option and SAR activities:
 
Number of
Options
 
Weighted-
Average
Exercise Price
 
Weighted-
Average
Remaining
Contractual
Term (in years)
Outstanding, December 31, 2018
3,916,963

 
$
19.98

 
7.10
Granted
867,135

 
$
36.63

 
 
Exercised
(97,403
)
 
$
13.23

 
 
Forfeited
(48,449
)
 
$
35.73

 
 
Outstanding, September 30, 2019 (unaudited)
4,638,246

 
$
23.07

 
6.91
 
 
 
 
 
 
As of December 31, 2018:
 
 
 
 
 
Vested and expected to vest
3,916,963

 
$
19.98

 
7.10
Exercisable
1,889,947

 
$
12.47

 
5.96
 
 
 
 
 
 
As of September 30, 2019:
 
 
 
 
 
Vested and expected to vest
4,638,246

 
$
23.07

 
6.91
Exercisable
2,595,276

 
$<