SEC Filing - Supernus Pharmaceuticals

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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 June 30, 2019



☐	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)

(301) 838-2500

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ 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

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SUPERNUS PHARMACEUTICALS, INC.

FORM 10-Q — QUARTERLY REPORT

FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2019



	Page No.
PART I — FINANCIAL INFORMATION
Item 1. Unaudited Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2019 and December 31, 2018	3
Condensed Consolidated Statements of Earnings for the three and six month periods ended June 30, 2019 and 2018	4
Condensed Consolidated Statements of Comprehensive Earnings for the three and six month periods ended June 30, 2019 and 2018	5
Condensed Consolidated Statements of Changes in Stockholders' Equity for the three and six month periods ended June 30, 2019 and 2018	6
Condensed Consolidated Statements of Cash Flows for the six month periods ended June 30, 2019 and 2018	8
Notes to Condensed Consolidated Financial Statements	9
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	24
Item 3. Quantitative and Qualitative Disclosures about Market Risk	37
Item 4. Controls and Procedures	37
PART II — OTHER INFORMATION
Item 1. Legal Proceedings	37
Item 1A. Risk Factors	37
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	38
Item 3. Defaults Upon Senior Securities	38
Item 4. Mine Safety Disclosures	38
Item 5. Other Information	38
Item 6. Exhibits	39
SIGNATURES	40

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PART I — FINANCIAL INFORMATION

Supernus Pharmaceuticals, Inc.

Condensed Consolidated Balance Sheets

(in thousands, except share data)



	June 30,		December 31,
	2019		2018
	(unaudited)
Assets
Current assets
Cash and cash equivalents	$	87,344	$	192,248
Marketable securities	171,222		163,770
Accounts receivable, net	84,564		102,922
Inventories, net	26,024		25,659
Prepaid expenses and other current assets	21,757		8,888
Total current assets	390,911		493,487
Long term marketable securities	593,754		418,798
Property and equipment, net	4,028		4,095
Intangible assets, net	28,787		31,368
Lease assets	19,639		—
Deferred income taxes	25,975		29,683
Other assets	581		380

Total assets	$	1,063,675	$	977,811

Liabilities and stockholders’ equity
Current liabilities
Accounts payable	$	4,081	$	3,195
Accrued product returns and rebates	95,934		107,063
Accrued expenses and other current liabilities	38,614		36,535
Income taxes payable	2,674		12,377
Non-recourse liability related to sale of future royalties, current portion	2,668		2,183
Total current liabilities	143,971		161,353
Convertible notes, net	337,210		329,462
Non-recourse liability related to sale of future royalties, long term	21,100		22,575
Lease liabilities, long term	27,535		—
Other liabilities	10,955		11,398
Total liabilities	540,771		524,788

Stockholders’ equity
Common stock, $0.001 par value, 130,000,000 shares authorized 52,449,036 and 52,316,583 shares issued and outstanding as of June 30, 2019 and December 31, 2018, respectively	52		52
Additional paid-in capital	379,369		369,637
Accumulated other comprehensive earnings (loss), net of tax	5,924		(3,158		)
Retained earnings	137,559		86,492
Total stockholders’ equity	522,904		453,023

Total liabilities and stockholders’ equity	$	1,063,675	$	977,811

See accompanying notes.

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Supernus Pharmaceuticals, Inc.

Condensed Consolidated Statements of Earnings

(in thousands, except share and per share data)



	Three Months ended June 30,					Six Months ended June 30,
	2019		2018			2019			2018
	(unaudited)					(unaudited)
Revenues
Net product sales	$	102,358	$	97,030		$	185,457		$	186,150
Royalty revenues	2,337		1,758			4,712			3,067
Licensing revenues	—		750			—			750
Total revenues	104,695		99,538			190,169			189,967

Costs and expenses
Cost of product sales	4,044		3,683			7,728			6,961
Research and development	16,970		20,038			32,364			38,946
Selling, general and administrative	41,083		40,097			82,051			76,946

Total costs and expenses	62,097		63,818			122,143			122,853

Operating earnings	42,598		35,720			68,026			67,114

Other income (expenses), net	148		(1,864		)	(1,041		)	(2,076		)

Earnings before income taxes	42,746		33,856			66,985			65,038

Income tax expense	10,019		3,119			15,918			7,949
Net earnings	$	32,727	$	30,737		$	51,067		$	57,089

Earnings per share
Basic	$	0.62	$	0.59		$	0.98		$	1.10
Diluted	$	0.61	$	0.57		$	0.95		$	1.06

Weighted-average shares outstanding
Basic	52,385,590		51,919,894			52,361,149			51,729,243
Diluted	53,912,977		54,203,308			53,947,834			54,021,941

See accompanying notes.

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Supernus Pharmaceuticals, Inc.

Condensed Consolidated Statements of Comprehensive Earnings

(in thousands)



	Three Months ended June 30,					Six Months ended June 30,
	2019		2018			2019		2018
	(unaudited)					(unaudited)

Net earnings	$	32,727	$	30,737		$	51,067	$	57,089
Other comprehensive earnings (loss)
Unrealized gain (loss) on marketable securities, net of tax	4,497		(1,828		)	9,082		(3,372		)
Other comprehensive earnings (loss)	4,497		(1,828		)	9,082		(3,372		)

Comprehensive earnings	$	37,224	$	28,909		$	60,149	$	53,717

See accompanying notes.

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Supernus Pharmaceuticals, Inc.

Condensed Consolidated Statements of Changes in Stockholders’ Equity

Three and Six Month Periods ended June 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		Additional Paid-in Capital		Accumulated Other Comprehensive Earnings (Loss)			Retained Earnings		Total Stockholders’ Equity
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

See accompanying notes.

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Supernus Pharmaceuticals, Inc.

Condensed Consolidated Statements of Changes in Stockholders’ Equity

Three and Six Month Periods ended June 30, 2018

(unaudited, in thousands, except share data)



	Common Stock			Additional Paid-in Capital			Accumulated Other Comprehensive Loss			Retained Earnings (Accumulated Deficit)			Total Stockholders’ Equity
	Shares	Amount		Additional Paid-in Capital			Accumulated Other Comprehensive Loss			Retained Earnings (Accumulated Deficit)			Total Stockholders’ Equity
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, net of tax	—	—		56,215			—			—			56,215
Purchase 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

See accompanying notes.

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Supernus Pharmaceuticals, Inc.

Condensed Consolidated Statements of Cash Flows

(in thousands)



	Six Months ended June 30,
	2019			2018
	(unaudited)
Cash flows from operating activities
Net earnings	$	51,067		$	57,089

Adjustments to reconcile net earnings to net cash provided by operating activities:
Realized loss on sales of securities	(93		)	—
Depreciation and amortization	3,355			3,487
Amortization of operating lease assets	1,230			—
Amortization of deferred financing costs and debt discount	7,748			4,307
Amortization of premium/discount on marketable securities	(1,625		)	(1,835		)
Non-cash interest expense	2,851			1,905
Non-cash royalty revenue	(3,368		)	(2,780		)
Share-based compensation expense	7,309			5,703
Deferred income tax (benefit) provision	861			(395		)
Changes in operating assets and liabilities:
Accounts receivable	18,439			(7,776		)
Inventories	(365		)	(4,376		)
Prepaid expenses and other current assets	(3,581		)	(8,060		)
Other non-current assets	(140		)	(342		)
Accounts payable	886			(3,838		)
Accrued product returns and rebates	(11,129		)	1,701
Accrued expenses and other current liabilities	(1,307		)	2,964
Income taxes payable	(9,703		)	(15,938		)
Other non-current liabilities	(755		)	1,873
Net cash provided by operating activities	61,680			33,689

Cash flows from investing activities
Purchases of marketable securities	(264,926		)	(491,655		)
Sales and maturities of marketable securities	96,165			19,466
Purchases of property and equipment	(245		)	(557		)
Deferred legal fees	(1		)	(401		)
Net cash used in investing activities	(169,007		)	(473,147		)

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	2,423			9,503
Net cash provided by financing activities	2,423			374,359

Net change in cash and cash equivalents	(104,904		)	(65,099		)
Cash and cash equivalents at beginning of year	192,248			100,304
Cash and cash equivalents at end of period	$	87,344		$	35,205

Supplemental cash flow information
Cash paid for interest on convertible notes	$	1,258		$	—
Income taxes paid	$	24,795		$	29,279
Cash paid for amounts included in the measurement of lease liabilities
Operating cash flows from operating leases	$	2,704		$	2,707

Non-cash investing and financing activities
Deferred legal fees included in accounts payable and accrued expenses	$	280		$	480
Lease assets and tenant receivable obtained for new operating leases	$	31,727		$	—

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 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 for 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 June 30, 2019.

Revenue from Product Sales

The Company’s products are distributed to its customers through a third party fulfillment center. 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 received by its customers after shipment from the fulfillment center. Customers take control of the products, including title and ownership, upon physical receipt of our products at their facilities.

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Product sales are recorded net of various forms of variable consideration, including: estimated rebates; an estimated liability for future product returns and discounts; (collectively, “sales deductions”).

As described below, variability in the net transaction price for the Company’s products arises primarily from sales deductions. 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 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

Sales deductions are primarily comprised of: estimated rebates; an estimated liability for future product returns and discounts. 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. Third, the accrual balance includes an estimate for rebates that will be prospectively owed, for prescriptions filled in future quarters, that is, for product which has been sold to wholesalers or distributors, and which resides either as wholesaler/distributor inventory, or is held as inventory at pharmacies.

The Company’s estimates of expected rebate claims vary by program and by type of customer, because of the period from the date on which the prescription is filled to the date the Company receives and pays the invoice varies, 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). 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.

The sensitivity of the Company’s estimates varies by program and by type of customer. If actual rebates vary from estimated amounts, the Company may need to 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. Product that has been used to fill patient prescriptions is no longer subject to any 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.

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 in current liabilities. 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

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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 estimated liability for product returns is also affected by price increases taken subsequent to the date of sale. 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. The Company’s policy generally permits product returns to be processed at current wholesaler price rather than historical acquisition price. Therefore, price increase(s) taken during the current period increase(s) the liability for product returns because it affects 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 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, they 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.

Customer orders are generally fulfilled within a few days of receipt, resulting in minimal order backlog. Open purchase orders for products from customers are expected to be fulfilled within the next 12 months. 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 been achieved (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 non-refundable. The Company evaluates whether achieving the milestones 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 can involve management’s judgment that includes assessing factors that are outside of the Company’s influence, such as: likelihood of regulatory success; availability of third party information; and expected duration of time until achievement of 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 when the sales-based target is achieved. Revenue is recognized from the satisfaction of performance obligations in the amount billable to the customer.

Revenue associated with future milestones will be recognized when the related event occurs or the sales-based target is achieved. No guaranteed minimum amounts are owed to the Company related to license and collaboration agreements.

Royalty Revenues

The Company recognizes non-cash 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

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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 non-cash royalty revenue based on estimated product sales by United Therapeutics, in which sales of United Therapeutics' product, result in payments made from United Therapeutics to HC Royalty in connection with these agreements.

Royalty revenue also includes royalty amounts received from collaboration partners, including from Shire Plc (Shire) (now 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.

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 non-refundable advance payments until the related services are performed. If the actual timing of the performance of services or the level of effort varies from the estimate, the Company 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 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

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after a claim reaches the designated stop-loss threshold. 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 June 30, 2019 in Accrued expenses and other current liabilities in 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 $11.2 million and $21.2 million in advertising costs for the three and six month periods ended June 30, 2019, respectively, and approximately $11.1 million and $19.0 million in advertising costs for the three and six month periods ended 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, allowed 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 does not expect the adoption of the guidance to 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, etc.); and inputs that are derived principally from or corroborated by observable market data by correlation or other means (i.e., market corroborated inputs).

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•	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 June 30, 2019 (unaudited)
	Total Fair Value at June 30, 2019		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)
Assets:
Cash and cash equivalents	$	87,344	$	87,344	$	—
Marketable securities
Corporate debt securities	171,222		247		170,975
Long term marketable securities
Corporate debt securities	558,755		454		558,301
U.S. government agency debt securities	34,999		—		34,999
Other non-current assets
Marketable securities - restricted (SERP)	387		1		386
Total assets at fair value	$	852,707	$	88,046	$	764,661



			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 debt securities	3,148		—		3,148
Other non-current 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 and government debt securities.

Level 2 assets include the SERP (Supplemental Executive Retirement Plan) assets, commercial paper and investment grade corporate and U.S. government agency debt securities and other fixed income securities. Level 2 securities are valued using third-party pricing sources that apply applicable inputs and other relevant data in their models to estimate fair value. The fair value of the restricted marketable securities is recorded in Other assets in the condensed consolidated balance sheets.

No amount was recorded for level 3 assets as of June 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.

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Financial Liabilities

The following table sets forth the Company’s financial liabilities that are not carried at fair value, in thousands of dollars:



	June 30, 2019				December 31, 2018
	(unaudited)
	Carrying Value		Fair Value (Level 2)		Carrying Value		Fair Value (Level 2)
2023 Notes	$	337,210	$	392,689	$	329,462	$	375,834

The fair value is estimated based on actual trade information as well as quoted prices provided by bond traders.

Unrestricted available-for-sale marketable securities held by the Company are as follows, in thousands of dollars:



	June 30, 2019			December 31, 2018
	(unaudited)
Corporate and U.S. government agency debt securities
Amortized cost	$	757,206		$	586,726
Gross unrealized gains	7,966			55
Gross unrealized losses	(196		)	(4,213		)
Total fair value	$	764,976		$	582,568

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



	June 30, 2019
	(unaudited)
Less than 1 year	$	171,222
1 year to 2 years	192,488
2 years to 3 years	200,597
3 years to 4 years	200,669
Greater than 4 years	—
Total	$	764,976

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


4.	Inventories

Inventories consist of the following, in thousands of dollars:



	June 30, 2019		December 31, 2018
	(unaudited)
Raw materials	$	4,953	$	5,742
Work in process	7,527		7,275
Finished goods	13,544		12,642
Total	$	26,024	$	25,659

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5.	Property and Equipment

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



	June 30, 2019			December 31, 2018
	(unaudited)
Lab equipment and furniture	$	9,133		$	8,995
Leasehold improvements	3,163			2,731
Software	2,212			2,181
Computer equipment	1,289			1,313
Construction-in-progress	193			94
	15,990			15,314
Less accumulated depreciation and amortization	(11,962		)	(11,219		)
Total	$	4,028		$	4,095

Depreciation and amortization expense on property and equipment was approximately $0.4 million and $0.7 million for the three and six month periods ended June 30, 2019, respectively, and approximately $0.5 million and $0.9 million for the three and six month periods ended June 30, 2018, respectively.

The Company performs its annual impairment assessment in the fourth quarter, or earlier if impairment indicators exist. As of June 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.

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



	Weighted- Average Life	June 30, 2019			December 31, 2018
	(unaudited)
Capitalized patent defense costs	3.51 - 7.76 years	$	44,755		$	44,724
Less accumulated amortization		(15,968		)	(13,356		)
Total		$	28,787		$	31,368

Amortization expense on intangible assets was approximately $1.3 million and $2.6 million for the three and six month periods ended June 30, 2019, respectively, essentially unchanged as compared to $1.3 million and $2.6 million for the three and six month periods ended June 30, 2018, respectively.

The Company performs its annual impairment assessment in the fourth quarter, or earlier, if impairment indicators exist. As of June 30, 2019, there were no identified indicators of impairment.

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7.	Accrued Expenses and Other Current Liabilities

Accrued expenses and other current liabilities consist of the following, in thousands of dollars:



	June 30, 2019		December 31, 2018
	(unaudited)
Accrued clinical trial and clinical supply costs	$	17,398	$	14,034
Accrued compensation	11,339		13,546
Accrued professional fees	3,703		3,706
Lease liabilities and related accrued interest, current	3,357		—
Accrued interest expense	629		650
Accrued product costs	13		38
Other accrued expenses	2,175		4,561
Total	$	38,614	$	36,535


8.	Accrued Product Returns and Rebates

Accrued product returns and rebates consist of the following, in thousands of dollars:



	June 30, 2019		December 31, 2018
	(unaudited)
Accrued rebates	$	74,362	$	85,003
Accrued product returns	21,572		22,060
Total	$	95,934	$	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 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.

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 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.

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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 generally reduce the potential dilution with respect to the Company’s common stock upon conversion of the 2023 Notes and/or offset any potential cash payments the Company is required to make in excess of the principal amount of converted 2023 Notes, as the case may be. 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:



	June 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	19,596			11,848
Total carrying value	$	337,210		$	329,462

No 2023 Notes were converted as of June 30, 2019.


10.	Other Income (Expenses)

Other income (expenses) consist of the following, in thousands of dollars:



	Three Months ended June 30,						Six Months ended June 30,
	2019			2018			2019			2018
	(unaudited)						(unaudited)
Interest income	$	5,453		$	3,664		$	10,134		$	4,870
Interest expense	(4,169		)	(4,324		)	(8,879		)	(5,041		)
Interest expense-nonrecourse liability related to sale of future royalties	(1,136		)	(1,204		)	(2,296		)	(1,905		)

Total	$	148		$	(1,864	)	$	(1,041	)	$	(2,076	)

Interest expense includes non-cash interest expense related to amortization of deferred financing costs and debt discount in the amount of $3.9 million and $7.7 million for the three and six month periods ended June 30, 2019, respectively, and $3.7 million and $4.3 million respectively, for the three and six month periods ended June 30, 2018.

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11.	Share-Based Payments

Share-based compensation expense is as follows, in thousands of dollars:



	Three Months ended June 30,				Six Months ended June 30,
	2019		2018		2019		2018
	(unaudited)				(unaudited)
Research and development	$	700	$	534	$	1,274	$	952
Selling, general and administrative	3,322		2,534		6,035		4,751
Total	$	4,022	$	3,068	$	7,309	$	5,703

The following table summarizes stock options 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 (unaudited)	840,435		$	36.76
Exercised (unaudited)	(83,503	)	$	12.53
Forfeited (unaudited)	(28,024	)	$	36.13
Outstanding, June 30, 2019 (unaudited)	4,645,871		$	23.05	7.15

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 June 30, 2019:
Vested and expected to vest (unaudited)	4,645,871		$	23.05	7.15
Exercisable (unaudited)	2,593,729		$	15.48	5.98


12.	Earnings per Share

Basic earnings per share (EPS) is calculated using the weighted-average number of common shares outstanding. Diluted EPS is calculated using the weighted-average number of common shares outstanding, including the dilutive effect of the Company’s stock option grants, stock appreciation rights (SAR), warrants, employee stock purchase plan (ESPP) awards and the 2023 Notes, as determined per the treasury stock method.

Effect of Convertible Notes and Related Convertible Note Hedges and Warrants

In connection with the issuance of the 2023 Notes, the Company entered into Convertible Note Hedge and Warrant transactions as described further in Note 9, Convertible Senior Notes Due 2023. The collective impact of the Convertible Note Hedges and Warrants effectively eliminates any economic dilution that may occur from the actual conversion of the 2023 Notes between the conversion price of $59.33 per share and the strike price of the Warrants of $80.9063 per share.

The Convertible Notes and Related Convertible Note Hedges and Warrants are excluded in the calculation of diluted EPS because their inclusion would be anti-dilutive. The denominator of the diluted earnings per share calculation excludes additional shares related to the 2023 Notes and Warrants since the average price of the Company's common stock was less than the conversion price of the 2023 Notes of $59.33 per share and the strike price of the Warrants of $80.9063 per share. Prior to actual conversion, the Convertible Note Hedges are not considered for purposes of the calculation of diluted earnings per share, as their effects would be anti-dilutive.

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In addition to the above described effect of the convertible notes and the related convertible note hedges and warrants, the Company also excluded the common stock equivalents for outstanding stock-based awards in the calculation of diluted EPS because their inclusion would be anti-dilutive:



	Three Months ended June 30,		Six Months ended June 30,
	2019	2018	2019	2018
	(unaudited)		(unaudited)
Stock options	1,030,370	137,565	300,342	184,760

The following table sets forth the computation of basic and diluted EPS for the three and six month periods ended June 30, 2019 and 2018, in thousands of dollars, except share and per share amounts:



	Three Months ended June 30,				Six Months ended June 30,
	2019		2018		2019		2018
	(unaudited)				(unaudited)
Numerator, in thousands:
Net earnings used for calculation of basic and diluted EPS	$	32,727	$	30,737	$	51,067	$	57,089

Denominator:
Weighted average shares outstanding, basic	52,385,590		51,919,894		52,361,149		51,729,243

Effect of dilutive potential common shares:
Stock options and SAR	1,527,387		2,283,414		1,586,685