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10-Q
INSYS THERAPEUTICS, INC. filed this Form 10-Q on 08/05/2016
Entire Document
 
insy20160630_10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q 

 (Mark One)

[X]

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES                            

EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2016

 

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: 001-35902

 

Insys Therapeutics, Inc.

(Exact name of registrant as specified in its charter)

 

Delaware

51-0327886

(State or other jurisdiction of incorporation

or organization)

(IRS Employer Identification No.)

  

  

1333 S. Spectrum Blvd, Suite 100, Chandler, Arizona

85286

(Address of principal executive offices)

(Zip Code)

 

(480) 500-3127

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

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 a checkmark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Date File required to be submitted and posted 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 and post such files).

 

Yes ☑     No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 
 

 

 

Large accelerated filer

 

Accelerated filer

Non-accelerated filer

 

Smaller reporting company

(Do not check if a smaller reporting company)

 

 

 

  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes ☐     No ☑

 

As of July 29, 2016, the registrant had 71,595,156 shares of Common Stock ($0.01 par value) outstanding.

 



 
 

 

 

INSYS THERAPEUTICS, INC.

FORM 10-Q

 

TABLE OF CONTENTS

 

 

 

 

PAGE

NO.

PART I

FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Unaudited Financial Statements:

 

 

 

Condensed Consolidated Balance Sheets as of June 30, 2016 and December 31, 2015

1

 

 

Condensed Consolidated Statements of Income and Comprehensive Income for the Three and Six Months Ended June 30, 2016 and 2015

2

  

  

Condensed Consolidated Statements of Stockholders’ Equity for the Six Months Ended June 30, 2016

3

 

 

Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2016 and 2015

4

 

 

Notes to Unaudited Condensed Consolidated Financial Statements

5

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

18

  

  

  

  

  

Item 3

Quantitative and Qualitative Disclosures About Market Risk

30

 

 

 

 

 

Item 4.

Controls and Procedures

30

 

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

 

 

Item 1.

Legal Proceedings

31

 

 

 

 

 

Item1A.

Risk Factors

31

 

 

 

 

  

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

31

  

  

  

  

  

Item 3.

Defaults Upon Senior Securities

32

  

  

  

  

  

Item 4.

Mine Safety Disclosures

32

  

  

  

  

  

Item 5.

Other Information

32

  

  

  

  

 

Item 6.

Exhibits

32

 

 

 

 

 

SIGNATURES

33

 

 

 

 

 

EXHIBIT INDEX

34

 

 
 

 

 

Form 10-Q

GLOSSARY OF TERMS

 

The following glossary provides definitions for certain acronyms and terms used in our periodic filings with the United States Securities and Exchange Commission, including this Quarterly Report on Form 10-Q. These acronyms and terms are specific to our company, commonly used in our industry, or are otherwise frequently used throughout our filings, including this document.

 

Abbreviated Term

  

Defined Term

  

  

  

ANDA

 

Abbreviated New Drug Application

API

 

Active pharmaceutical ingredient

Aptar

 

AptarGroup, Inc.

ATRA

 

American Taxpayer Relief Act of 2012

AUC

 

Area under the curve

AVC

 

Assurance of Voluntary Compliance

BTCP

 

Breakthrough cancer pain

Catalent

 

Catalent Pharma Solutions, LLC

CBD

 

Synthetic cannabidiol

cGMP

 

Current Good Manufacturing Practices

CID

 

Civil Investigative Demand

CINV

 

Chemotherapy-induced nausea and vomiting

CMS

 

Centers for Medicare & Medicaid Services

CRO

 

Contract Research Organization

CSA

 

Federal Controlled Substances Act of 1970

DEA

 

U.S. Drug Enforcement Administration

DPT

 

DPT Lakewood, LLC

ERP

 

Enterprise Resource Planning

ESI

 

Express Scripts, Inc.

FDA

 

U.S. Food and Drug Administration

FDCA

 

Federal Food, Drug, and Cosmetic Act

FSS

 

Federal Supply Schedule

GAAP

 

Generally Accepted Accounting Principles

GAO

 

Government Accountability Office

GCP

 

Good Clinical Practices

GI

 

Gastrointestinal

GLP

 

Good Laboratory Practices

HHS

 

U.S. Department of Health and Human Services

HIPAA

 

Health Insurance Portability and Accountability Act of 1996

HITECH

 

Health Information Technology for Economic and Clinical Health Act of 2009

IMS

 

IMS Health

IND

 

Investigational New Drug Application

Insys Pharma

 

Insys Pharma, Inc.

Insys Therapeutics

 

Insys Therapeutics, Inc.

IPO

 

Initial public offering

IPR

 

Inter Partes Review

IRB

 

Institutional Review Board

JOBS Act

 

Jumpstart Our Business Startups Act of 2012

MMA

 

Medicare Prescription Drug, Improvement, and Modernization Act of 2003

Mylan

 

Mylan Pharmaceuticals, Inc.

NDA

 

New Drug Application

NeoPharm

 

NeoPharm, Inc.

NOL

 

Net operating loss carryforward

NRV

 

Net Realizable Value

NSAID

 

Non-steroidal anti-inflammatory drug

Orange Book

 

FDA's Approved Drug Products with Therapeutic Equivalence Evaluations

ODOJ

 

Oregon Department of Justice

  

 
 

 

 

PBM

 

Pharmacy Benefit Managers

PDEs

 

Prescription Drug Events

PDMA

 

Prescription Drug Marketing Act

PDUFA

 

Prescription Drug User Fee Act

PK

 

Pharmacokinetics

PPACA

 

Patient Protection and Affordable Care Act of 2010, as amended by the Health Care and Education Reconciliation Act of 2010

QSR

 

FDA's Quality System Regulation

REMS

 

Risk Evaluation and Mitigation Strategy

RLD

 

Reference listed drug

SEC

 

U.S. Securities and Exchange Commission

THC

 

Delta-9-tetrahydrocannabinol

TIRF

 

Transmucosal immediate-release fentanyl

TIRF REMS

 

Transmucosal immediate release fentanyl risk evaluation and mitigation strategy

USAO

 

United States Attorney Office

USPTO

 

United States Patent and Trademark Office

VC

 

Vomiting center

 

 
 

 

 

Part I:  FINANCIAL INFORMATION

 

Item 1.      UNAUDITED Financial Statements

  

INSYS THERAPEUTICS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

 

   

June 30, 2016

(unaudited)

   

December 31, 2015

 

 
                 

Assets

               

Current Assets:

               

Cash and cash equivalents

  $ 69,290     $ 79,515  

Short-term investments

    89,081       79,576  

Accounts receivable, net of allowances of $6,590 and $7,180 at June 30, 2016 and December 31, 2015, respectively

    41,049       48,459  

Inventories

    29,215       41,715  

Prepaid expenses and other assets

    5,359       3,973  

Total current assets

    233,994       253,238  

Property and equipment, net

    39,930       38,382  

Long-term investments

    35,339       43,219  

Deferred income tax assets

    18,615       16,331  

Other assets

    10,170       26  

Total assets

  $ 338,048     $ 351,196  
                 

Liabilities and Stockholders' Equity

               

Current Liabilities:

               

Accounts payable and accrued expenses

  $ 22,200     $ 36,354  

Accrued compensation

    9,104       10,225  

Accrued sales allowances

    30,419       32,713  

Accrued litigation award

    9,567       9,567  

Total current liabilities

    71,290       88,859  

Uncertain income tax position

    7,471       8,635  

Total liabilities

    78,761       97,494  
                 

Commitments and contingencies

    -       -  
                 

Stockholders' Equity:

               

Preferred stock (par value $0.01 per share; 10,000,000 shares authorized; 0 shares issued and outstanding as of June 30, 2016 and December 31, 2015)

    -       -  

Common stock (par value $0.01 per share; 100,000,000 shares authorized; 71,574,365 and 71,907,858 shares issued and outstanding as of June 30, 2016 and December 31, 2015, respectively)

    716       719  

Additional paid in capital

    244,299       245,736  

Unrealized gain (loss) on available-for-sale securities

    84       (152 )

Notes receivable from stockholders

    (21 )     (21 )

Retained earnings

    14,209       7,420  

Total stockholders' equity

    259,287       253,702  
                 

Total liabilities and stockholders' equity

  $ 338,048     $ 351,196  

 

See accompanying notes to unaudited condensed consolidated financial statements. 

 

 
1

 

 

INSYS THERAPEUTICS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(In thousands, except share and per share data)

(unaudited)

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2016

   

2015

   

2016

   

2015

 
                                 

Net revenue

  $ 67,121     $ 77,633     $ 129,083     $ 148,403  

Cost of revenue

    6,273       8,305       10,911       14,680  

Gross profit

    60,848       69,328       118,172       133,723  

Operating expenses:

                               

Sales and marketing

    19,691       21,986       39,491       42,902  

Research and development

    22,889       17,796       43,424       28,398  

General and administrative

    13,924       15,284       28,622       28,530  

Charges related to litigation award

    -       2,304       -       10,304  

Total operating expenses

    56,504       57,370       111,537       110,134  

Operating income

    4,344       11,958       6,635       23,589  
                                 

Other income:

                               

Interest income

    256       105       481       230  

Other income (expense), net

    (5 )     30       44       30  

Total other income

    251       135       525       260  
                                 

Income before income taxes

    4,595       12,093       7,160       23,849  

Income tax expense

    240       4,779       371       8,512  
                                 

Net income

    4,355       7,314       6,789     $ 15,337  

Unrealized gain (loss) on available-for-sale securities

    70       (21 )     236       7  

Total comprehensive income

  $ 4,425     $ 7,293     $ 7,025     $ 15,344  
                                 

Net income per common share:

                               

Basic

  $ 0.06     $ 0.10     $ 0.09     $ 0.22  

Diluted

  $ 0.06     $ 0.10     $ 0.09     $ 0.20  

Weighted average common shares outstanding

                               

Basic

    71,543,809       71,517,442       71,567,949       71,217,137  

Diluted

    74,053,550       75,478,649       74,281,838       75,255,048  

 

See accompanying notes to unaudited condensed consolidated financial statements.  

 

 
2

 

 

INSYS THERAPEUTICS, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

(In thousands, except share data)

(unaudited)

 

   

Common Stock

   

Additional

Paid in

   

Unrealized

Gain (Loss) on Available-For-Sale

   

Notes

Receivable

From

   

Retained

         
   

Shares

   

Amount

   

Capital

   

Securities

   

Stockholders

   

Earnings

   

Total

 

Balance at December 31, 2015

    71,907,858     $ 719     $ 245,736     $ (152 )   $ (21 )   $ 7,420     $ 253,702  

Exercise of stock options

    376,985       4       2,119       -       -       -       2,123  

Issuance of common stock- employee stock purchase plan

    132,597       1       1,575       -       -       -       1,576  

Excess tax benefits on stock options and awards

    -       -       389       -       -       -       389  

Stock based compensation - stock options and awards

    -       -       10,572       -       -       -       10,572  

Unrealized gain on available-for-sale securities

    -       -       -       236       -       -       236  

Repurchase of common stock

    (843,075 )     (8 )     (16,092 )     -       -       -       (16,100 )

Net income

    -       -       -       -       -       6,789       6,789  

Balance at June 30, 2016

    71,574,365     $ 716     $ 244,299     $ 84     $ (21 )   $ 14,209     $ 259,287  

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 
3

 

 

INSYS THERAPEUTICS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(unaudited)

 

   

Six Months Ended June 30,

 
   

2016

   

2015

 

Cash flows from operating activities:

               

Net income

  $ 6,789     $ 15,337  

Adjustments to reconcile net income to net cash provided by operating activities:

               

Depreciation and amortization

    3,023       2,457  

Stock-based compensation

    10,572       7,947  

Deferred income tax benefit

    (2,284 )     (1,513 )

Loss on disposal of assets

    -       41  

Excess tax benefits on stock options and awards

    (389 )     (7,416 )

Amortization of investment (premium) discount

    1,266       473  

Changes in operating assets and liabilities:

               

Accounts receivable

    7,410       (12,606 )

Inventories

    2,355       (772 )

Prepaid expenses and other assets

    (1,384 )     (424 )

Accounts payable, accrued expenses and other current liabilities

    (18,346 )     29,042  

Net cash provided by operating activities

    9,012       32,566  
                 

Cash flows from investing activities:

               

Purchase of investments

    (42,398 )     (47,419 )

Proceeds from sales of investments

    4,348       11,270  

Proceeds from maturities of investments

    35,396       12,613  

Purchases of property and equipment

    (4,571 )     (8,106 )

Net cash (used in) investing activities

    (7,225 )     (31,642 )
                 

Cash flows from financing activities:

               

Proceeds from issuance of common stock

    1,576       1,478  

Excess tax benefits on stock options and awards

    389       7,416  

Proceeds from exercise of stock options

    2,123       6,111  

Repurchase of common stock

    (16,100 )     -  

Net cash (used in) provided by financing activities

    (12,012 )     15,005  
                 

Change in cash and cash equivalents

    (10,225 )     15,929  
                 

Cash and cash equivalents, beginning of period

    79,515       58,106  
                 

Cash and cash equivalents, end of period

  $ 69,290     $ 74,035  
                 

Supplemental cash flow disclosures:

               

Cash paid for interest expense

  $ -     $ -  

Cash paid for income taxes

  $ 6,624     $ 3,350  

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

 
4

 

   

INSYS THERAPEUTICS, INC.

 

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1.       Nature of Business and Basis of Presentation

 

Insys Therapeutics, Inc., which was incorporated in Delaware in June 1990, and our subsidiaries (collectively, “we,” “us,” and “our”) maintain headquarters in Chandler, Arizona.

 

We are a commercial-stage specialty pharmaceutical company that develops and commercializes innovative supportive care products. We have one marketed product: Subsys, a proprietary sublingual fentanyl spray for BTCP in opioid-tolerant adult patients.

 

The accompanying condensed consolidated financial statements are unaudited and have been prepared in accordance with U.S. GAAP, pursuant to rules and regulations of the SEC. Certain information and footnote disclosures have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the accompanying condensed consolidated financial statements include normal recurring adjustments that are necessary for a fair presentation of the results for the interim periods presented. These condensed consolidated financial statements should be read in conjunction with our audited consolidated financial statements and notes thereto for the fiscal year ended December 31, 2015 included in our Annual Report on Form 10-K. The results of operations for the three and six months ended June 30, 2016 and 2015 are not necessarily indicative of results to be expected for the full fiscal year or any other periods.

 

The preparation of the condensed consolidated financial statements in conformity with U.S. GAAP requires management to make a number of estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to revenue recognition (which is affected by prescriptions dispensed, wholesaler discounts, patient discount programs, rebates and chargebacks), inventories, stock-based compensation expense, and deferred tax valuation allowances. We base our estimates on historical experience and on various other assumptions that are believed by management to be reasonable under the circumstances. Actual results may materially differ from these estimates.

 

Certain prior period amounts have been reclassified to conform with current period presentation.

 

All significant intercompany balances and transactions have been eliminated in the accompanying unaudited condensed consolidated financial statements.

  

Recent Accounting Pronouncements

 

In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-13 Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The amendments affect entities holding financial assets and net investment in leases that are not accounted for at fair value through net income, and are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. ASU 2016-13 amends the impairment model to utilize an expected loss methodology in place of the currently used incurred loss methodology, which will result in the more timely recognition of losses. We are currently evaluating the impact of this amendment on our financial statements.

 

In May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, to clarify certain core recognition principles including collectability, sales tax presentation, noncash consideration, contract modifications and completed contracts at transition and disclosures no longer required if the full retrospective transition method is adopted. The effective date and transition requirements for these amendments are the same as the effective date and transition requirements of ASU 2014-09 (discussed below). We are currently evaluating the impact of this amendment on our financial statements.

 

In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, to clarify the following two aspects of Topic 606: 1) identifying performance obligations, and 2) the licensing implementation guidance. The effective date and transition requirements for these amendments are the same as the effective date and transition requirements of ASU 2014-09 (discussed below). We are currently evaluating the impact of this amendment on our financial statements.

  

 
5

 

 

In March 2016, the FASB issued ASU No. 2016-09, Compensation-Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, to reduce complexity in accounting standards involving several aspects of the accounting for employee share-based payment transactions, including (1) the income tax consequences, (2) classification of awards as either equity or liabilities, and (3) classification on the statement of cash flows. The amendments will be effective for financial statements issued for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years, and early adoption is permitted. Amendments related to the timing of when excess tax benefits are recognized, minimum statutory withholding requirements, forfeitures, and intrinsic value should be applied using a modified retrospective transition, amendments related to the presentation of employee taxes paid on the statement of cash flows when an employer withholds shares to meet the minimum statutory withholding requirement should be applied retrospectively, amendments requiring recognition of excess tax benefits and tax deficiencies in the income statement and the practical expedient for estimating expected term should be applied prospectively, and amendments related to the presentation of excess tax benefits on the statement of cash flows can be applied using either a prospective transition method or a retrospective transition method. An entity that elects early adoption must adopt all of the amendments in the same period. We are currently evaluating the impact of this amendment on our financial statements.

 

In March 2016, the FASB issued ASU No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations, to clarify the implementation guidance on principal versus agent considerations and address how an entity should assess whether it is the principal or the agent in contracts that include three or more parties. The effective date and transition requirements for these amendments are the same as the effective date and transition requirements of ASU 2014-09 (discussed below). We are currently evaluating the impact of this amendment on our financial statements.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases: (Topic 842), to provide guidance on recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements, specifically differentiating between different types of leases. The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from all leases. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee have not significantly changed from previous GAAP. There continues to be a differentiation between finance leases and operating leases. However, the principal difference from previous guidance is that the lease assets and lease liabilities arising from operating leases should be recognized in the balance sheet. The accounting applied by a lessor is largely unchanged from that applied under previous GAAP. The amendments will be effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, and early adoption is permitted. In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. The modified retrospective approach includes a number of optional practical expedients that entities may elect to apply. These practical expedients relate to the identification and classification of leases that commenced before the effective date, initial direct costs for leases that commenced before the effective date, and the ability to use hindsight in evaluating lessee options to extend or terminate a lease or to purchase the underlying asset. An entity that elects to apply the practical expedients will, in effect, continue to account for leases that commence before the effective date in accordance with previous GAAP unless the lease is modified, except that lessees are required to recognize a right-of-use asset and a lease liability for all operating leases at each reporting date based on the present value of the remaining minimum rental payments that were tracked and disclosed under previous GAAP. We are currently evaluating the impact of this amendment on our financial statements.

 

In January 2016, the FASB issued ASU No. 2016-01, Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, which amended the Financial Instruments topic of the Accounting Standards Codification to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The amendments will be effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years, and early adoption is not permitted. These amendments should be applied by means of a cumulative-effect adjustment to the balance sheet as of the beginning of the fiscal year of adoption. The amendments related to equity securities without readily determinable fair values (including disclosure requirements) should be applied prospectively to equity investments that exist as of the date of adoption. We are currently evaluating the impact of this amendment on our financial statements.

  

 
6

 

 

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which will supersede nearly all existing revenue recognition guidance under U.S. GAAP. The core principle of ASU 2014-09 is to recognize revenues when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. ASU 2014-09 defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP. As amended by the FASB in July 2015, the standard is effective for annual periods beginning after December 15, 2017, and interim periods therein, using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption (which includes additional footnote disclosures). We are currently evaluating the impact of the pending adoption of ASU 2014-09 on our consolidated financial statements and have not yet determined the method by which we will adopt the standard in 2018.

 

In July 2015, the FASB issued guidance that requires entities to measure most inventory at the lower of cost and NRV, thereby simplifying the current guidance under which an entity must measure inventory at the lower of cost or market. Under the new guidance, inventory is measured at the lower of cost and NRV, which eliminates the need to determine replacement cost and evaluate whether it is above the ceiling (NRV) or below the floor (NRV less a normal profit margin). The guidance defines NRV as the “estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.” The guidance is effective for annual periods beginning after December 15, 2016, and interim periods therein. Early application is permitted. We are currently evaluating the impact of adoption of this guidance on our financial position and results of operations.

   

2.        Revenue Recognition

 

We recognize revenue from the sale of Subsys. Revenue is recognized when (i) persuasive evidence of an arrangement exists, (ii) delivery has occurred and title has passed, (iii) the price is fixed or determinable and (iv) collectability is reasonably assured.

  

Subsys was commercially launched in March 2012 and is monitored by an FDA mandated REMS program known as the TIRF REMS. We sell Subsys in the United States to wholesale pharmaceutical distributors and directly to retail pharmacies, collectively our customers, subject to rights of return within a period beginning six months prior to, and ending 12 months following, product expiration. Subsys currently has a shelf life of 36 months from the date of manufacture. We record revenue for Subsys at the time the customer receives the shipment.

 

We recognize estimated product sales allowances as a reduction of product sales in the same period the related revenue is recognized. Product sales allowances are based on amounts owed or to be claimed on the related sales. These estimates take into consideration the terms of our agreements with customers and third-party payors and the levels of inventory within the distribution channels that may result in future discounts taken. In certain cases, such as patient assistance programs, we recognize the cost of patient discounts as a reduction of revenue based on estimated utilization. If actual future results vary, we may need to adjust these estimates, which could have an effect on product revenue in the period of adjustment. Our product sales allowances include:

 

Product Returns. We allow customers to return product for credit beginning six months prior to, and ending 12 months following, the product expiration date. The shelf life of Subsys is currently 36 months from the date of manufacture. We have monitored actual return history since product launch, which provides us with a basis to reasonably estimate future product returns, taking into consideration the shelf life of product at the time of shipment, shipment and prescription trends, estimated distribution channel inventory levels, and consideration of the introduction of competitive products.

 

Because of the shelf life of our products and our return policy of issuing credits on returned product that is within six months before and up to 12 months after the product expiration date, there may be a significant period of time between when the product is shipped and when we issue credits on returned product. Accordingly, we may have to adjust these estimates, which could have an effect on product sales and earnings in the period of adjustment. The allowance for product returns is included in accrued sales allowances. 

 

Wholesaler and Retailer Discounts.    We offer discounts to certain wholesale distributors and specialty retailers based on contractually determined rates. We accrue the discount as a reduction of receivables due from the wholesalers and retailers upon shipment to the respective wholesale distributors and retail pharmacies.

 

Prompt Pay Discounts.    We offer cash discounts to our customers, generally 2.0% of the sales price, as an incentive for prompt payment. We account for cash discounts by reducing accounts receivable by the full amount.

 

 Patient Discount Programs.    We offer discount card programs to patients for Subsys in which patients receive discounts on their prescriptions that are reimbursed to the retailer. We estimate the total amount that will be redeemed based on a percentage of actual redemption applied to inventory in the distribution and retail channel. The allowance for patient discount programs is included in accrued sales allowances.

 

 
7

 

 

Rebates.    We participate in certain rebate programs, which provide discounted prescriptions to qualified insured patients. Under these rebate programs, we pay a rebate to the third-party administrator of the program, generally two to three months after the quarter in which prescriptions subject to the rebate are filled. We estimate and accrue these rebates based on current contract prices, historical and estimated future percentages of products sold to qualified patients and estimated levels of inventory in the distribution channel. The allowance for rebates is included in accrued sales allowances. 

  

Chargebacks.    We provide discounts primarily to authorized users of the FSS of the General Services Administration under an FSS contract negotiated by the Department of Veterans Affairs and various organizations under Medicaid contracts and regulations. These organizations purchase products from the wholesale distributors at a discounted price, and the wholesale distributors then charge back to us the difference between the current retail price and the price the organization paid for the product. We estimate and accrue chargebacks based on estimated wholesaler inventory levels, current contract prices and historical chargeback activity. Estimated chargebacks are recognized as a reduction of revenue in the same period the related revenue is recognized. The allowance for chargebacks is included as a reduction to accounts receivable. 

  

 

3.

Short-Term and Long-Term Investments 

 

Our policy for short-term and long-term investments is to establish a high-quality portfolio that preserves principal, meets liquidity needs, avoids inappropriate concentrations and delivers an appropriate yield in relationship to our investment guidelines and market conditions. Short-term and long-term investments consist of corporate and various government agency and municipal debt securities, as well as certificates of deposit that have maturity dates that are greater than 90 days. Certificates of deposit are carried at cost which approximates fair value. We classify our marketable securities as available-for-sale in accordance with FASB Accounting Standards Codification Topic 320, Investments — Debt and Equity Securities. Available-for-sale securities are carried at fair value with unrealized gains and losses reported in stockholders’ equity. A decline in the market value of any available-for-sale security below cost that is deemed to be other than temporary, results in impairment of the fair value of the investment. We did not have any realized gains or losses or decline in values judged to be other than temporary during the three and six months ended June 30, 2016. If we had realized gains and losses and declines in value judged to be other than temporary, we would have been required to include those changes in other income/expense in the condensed consolidated statements of income and comprehensive income. Premiums and discounts are amortized or accreted over the life of the related available-for-sale security. The cost of securities sold is calculated using the specific identification method. At June 30, 2016, our certificates of deposit as well as our marketable securities have been recorded at an estimated fair value of $755,000, $89,081,000 and $35,339,000 in cash and cash equivalents, short-term and long-term investments, respectively. 

  

Investments consisted of the following at June 30, 2016 (in thousands):

 

   

Cost

   

Unrealized

Gains

   

Unrealized

Losses

   

Other-

Than-

Temporary

Impairment

Losses

   

Fair

Value

   

Cash and

Cash Equivalents

   

Short-term

Investments

     

Long-term

Investments

 

Cash

  $ 40,571     $ -     $ -     $ -     $ 40,571     $ 40,571     $ -       $ -  

Money market securities

    27,964       -       -       -       27,964       27,964       -         -  

Certificates of deposit

    26,600       -       -       -       26,600       -       18,467         8,133  

Marketable securities:

                                                                 

Corporate securities

    35,048       27       (6 )     -       35,069       -       26,102         8,967  

Federal agency securities

    16,592       3       (1 )     -       16,594       -       10,594         6,000  

Municipal securities

    46,851       63       (2 )     -       46,912       755       33,918         12,239  

Total marketable securities

    98,491       93       (9 )     -       98,575       755       70,614         27,206  
                                                         

`

       
    $ 193,626     $ 93     $ (9 )   $ -     $ 193,710     $ 69,290     $ 89,081       $ 35,339  

 

 
8

 

 

Investments consisted of the following at December 31, 2015 (in thousands):

  

   

Cost

   

Unrealized

Gains

   

Unrealized

Losses

   

Other-

Than-

Temporary

Impairment

Losses

   

Fair

Value

   

Cash and

Cash

Equivalents

   

Short-term

Investments

   

Long-term

Investments

 

Cash

  $ 55,987     $ -     $ -     $ -     $ 55,987     $ 55,987     $ -     $ -  

Money market securities

    20,373       -       -       -       20,373       20,373       -       -  

Certificates of deposit

    26,223       -       -       -       26,223       -       16,637       9,586  

Marketable securities:

                                                               

Corporate securities

    27,186       -       (68 )     -       27,118       1,621       19,181       6,316  

Federal agency securities

    18,823       -       (65 )     -       18,758       -       10,129       8,629  

Municipal securities

    53,870       16       (35 )     -       53,851       1,534       33,629       18,688  

Total marketable securities

    99,879       16       (168 )     -       99,727       3,155       62,939       33,633  
                                                                 
    $ 202,462     $ 16     $ (168 )   $ -     $ 202,310     $ 79,515     $ 79,576     $ 43,219  

 

 The amortized cost and estimated fair value of the marketable securities at June 30, 2016, by maturity, are shown below (in thousands):

 

   

June 30, 2016

   

December 31, 2015

 
   

Amortized Cost

   

Fair Value

   

Amortized Cost

   

Fair Value

 

Marketable securities:

                               

Due in one year or less

  $ 71,342     $ 71,368     $ 66,148     $ 66,094  

Due after one year through 5 years

    27,149       27,207       33,731       33,633  

Due after 5 years through 10 years

    -       -       -       -  

Due after 10 years

    -       -       -       -  
                                 
    $ 98,491     $ 98,575     $ 99,879     $ 99,727  

 

The following table shows the gross unrealized losses and the fair value of our investments, with unrealized losses that are not deemed to be other-than-temporarily impaired aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at June 30, 2016 (in thousands):

 

   

June 30, 2016

   

December 31, 2015

 
   

Less Than 12 Months

   

Greater Than 12 Months

   

Less Than 12 Months

   

Greater Than 12 Months

 
   

Fair Value

   

Unrealized Loss

   

Fair Value

   

Unrealized Loss

   

Fair Value

   

Unrealized Loss

   

Fair Value

   

Unrealized Loss

 

Marketable securities:

                                                               

Corporate securities

  $ 14,577     $ (6 )   $ -     $ -     $ 25,137     $ (68 )   $ -     $ -  

Federal agency securities

    6,566       (1 )     -       -       18,759       (65 )     -       -  

Municipal securities

    8,626       (2 )     -       -       22,981       (35 )     -       -  
                                                                 
    $ 29,769     $ (9 )   $ -     $ -     $ 66,877     $ (168 )   $ -     $ -  

 

As of June 30, 2016, we have concluded that all the unrealized losses on our marketable securities are temporary in nature. Marketable securities are reviewed quarterly for possible other-than-temporary impairment. This review includes an analysis of the facts and circumstances of each individual investment such as the severity of loss, the expectation for that security’s performance and the creditworthiness of the issuer. Additionally, we do not intend to sell, and it is not probable that we will be required to sell, any of the securities before the recovery of their amortized cost basis.

 

4.     Fair Value Measurement

 

FASB ASC No. 820, “Fair Value Measurement,” defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. It also establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

 

Level 1:

Observable inputs such as quoted prices in active markets;

 

Level 2:

Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and

  

  

Level 3:

Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

 

 
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At June 30, 2016, we held short-term and long-term investments, as discussed in Note 3, that are required to be measured at fair value on a recurring basis.  Our Level 2 assets consist of available-for-sale securities that are valued utilizing reports from third-party asset managers that hold our investments, showing closing prices on the last business day of the period presented. These asset managers utilize an independent pricing source to obtain quotes for most fixed income securities, and utilize internal procedures to validate the prices obtained. In addition, we use an independent third-party to perform price testing, comparing a sample of quoted prices listed in the asset managers’ reports to quotes listed through a public quotation service.  Our Level 3 asset represents a long-term corporate convertible promissory note and a warrant to purchase shares issued in connection with the convertible promissory note. The note is not listed on any security exchange. The fair value of the convertible promissory note and warrant approximate their carrying values at June 30, 2016.

 

Our investments measured at fair value on a recurring basis subject to the disclosure requirements of ASC 820 at June 30, 2016 and December 31, 2015 were as follows (in thousands):

 

   

Fair Value Measurement at Reporting Date

 
   

June 30, 2016

   

Quoted

Prices in

active

Markets

(Level 1)

   

Significant

Other

Observable

Inputs

(Level 2)

   

Significant

Unobservable

Inputs

(Level 3)

 

Marketable securities:

                               

Corporate securities

  $ 35,069     $ -     $ 34,569     $ 500  

Federal agency securities

    16,594       -       16,594       -  

Municipal securities

    46,912       -       46,912       -  
                                 

Total assets measured at fair value

  $ 98,575     $ -     $ 98,075     $ 500  

 

 

   

Fair Value Measurement at Reporting Date

 
   

December 31, 2015

   

Quoted

Prices in

active

Markets

(Level 1)

   

Significant

Other

Observable

Inputs

(Level 2)

   

Significant

Unobservable

Inputs

(Level 3)

 

Marketable securities:

                               

Corporate securities

  $ 27,118     $ -     $ 27,118     $ -  

Federal agency securities

    18,758       -       18,758       -  

Municipal securities

    53,851       -       53,851       -  
                                 

Total assets measured at fair value

  $ 99,727     $ -     $ 99,727     $ -  

 

 
10

 

 

The following table presents additional information about assets measured at fair value on a recurring basis and for which we utilize Level 3 inputs to determine fair value (in thousands):

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2016

   

2015

   

2016

   

2015

 

Convertible note

                               

Balance, beginning of period

  $ -     $ -     $ -     $ -  

Change in fair value

    -       -       -       -  

Purchases

    500       -       500       -  
                                 

Balance, end of period

  $ 500     $ -     $ 500     $ -  

 

 

5.        Inventories

 

Inventories are stated at lower of cost or market. Cost, which includes amounts related to materials and costs incurred by our contract manufacturers, is determined on a first-in, first-out basis. Inventories are reviewed periodically for potential excess, dated or obsolete status. Management evaluates the carrying value of inventories on a regular basis, taking into account such factors as historical and anticipated future sales compared to quantities on hand, the price we expect to obtain for products in their respective markets compared with historical cost and the remaining shelf life of goods on hand.

 

The components of inventories, net of allowances, are as follows (in thousands):  

 

   

June 30,

2016

   

December 31,

2015

 

Finished goods

  $ 14,200     $ 28,216  

Work-in-process

    7,128       7,018  

Raw materials and supplies

    7,887       6,481  

Total inventories

    29,215       41,715  

Plus: non-current finished goods

    10,145       -  
    $ 39,360     $ 41,715  

 

As of June 30, 2016 and December 31, 2015, raw materials inventories consisted of raw materials used in the manufacture of the API in our U.S.-based, state-of-the-art dronabinol manufacturing facility and component parts and packaging materials used in the manufacture of Subsys. Work-in-process consists of actual production costs, including facility overhead and tolling costs of in-process dronabinol and Subsys products. Finished goods inventories consisted of finished Subsys products. Non-current finished goods represent those inventories not expected to be sold within 12 months of the balance sheet date and are included in other assets in our condensed consolidated unaudited balance sheets. As of June 30, 2016, all work-in-process inventory is expected to be used within 12 months of the balance sheet date and, therefore, is classified as current inventory. We maintain an allowance for excess and obsolete inventory, as well as inventory where its cost is in excess of its net realizable value. Inventory at June 30, 2016 and December 31, 2015 were reported net of these reserves of $1.4 million and $0.1 million, respectively.

 

6.       Commitments and Contingencies

 

Legal Matters

 

Other than the matters that we have disclosed below, we from time to time become involved in various ordinary course legal and administrative proceedings, which include intellectual property, commercial, governmental and regulatory investigations, employee related issues and private litigation, which we do not currently believe are either individually or collectively material.

 

As legal and governmental proceedings are inherently unpredictable and, in part, beyond our control, unless otherwise indicated, we cannot currently reasonably predict the outcome of these legal proceedings, nor can we estimate the amount of loss, or range of loss, if any, that may result from these proceedings. A future adverse outcome in any of these proceedings could have a material adverse effect on our business, financial condition, results of operations and cash flows, and could cause the market value of our common stock to decline.

 

 
11

 

 

Government Proceedings

 

Like other companies in the pharmaceutical industry, we are subject to extensive regulation by national, state and local government agencies in the United States. As a result, interaction with government agencies occurs in the normal course of our operations. The following is a brief description of pending governmental investigations which we believe are potentially material at this time. It is possible that criminal charges and substantial payments, fines and/or civil penalties or damages could result from any government investigation or proceeding, as well as a corporate integrity agreement or similar government mandated compliance document, whether we deem an investigation to be material or not at this time.

 

Department of Health and Human Services Investigation. We received a subpoena, dated December 9, 2013, from the Office of Inspector General of the Department of Health and Human Services, or HHS, in connection with an investigation of potential violations involving HHS programs. The subpoena was issued in connection with an investigation by the U.S. Attorney’s Office for the Central District of California. The subpoena requests documents regarding our business, including the commercialization of Subsys. We are cooperating with this investigation and have produced documents in response to the subpoena and have provided other requested information.

 

HIPPA Investigation. On September 8, 2014, we received a subpoena issued pursuant to HIPPA from the U.S. Attorney’s Office for the District of Massachusetts. The subpoena requests documents regarding Subsys, including our sales and marketing practices related to this product. We are cooperating with this investigation and have produced documents in response to the subpoena and have provided other requested information.

 

On or about June 23, 2015, a nurse practitioner located in Connecticut, who served on our speaker bureau in connection with our speaker programs designed to educate and promote product awareness and safety for external health care providers, pled guilty to violating the federal Anti-Kickback Statute in connection with payments of approximately $83,000 from us. On or about February 18, 2016, one of our former sales employees located in Alabama pled guilty to a conspiracy to violate the federal Anti-Kickback Statute in regards to two Alabama health care professionals who prescribed our product Subsys. Those two Alabama health care professionals served on our speaker bureau in connection with our speaker programs designed to educate and promote product awareness and safety for external health care providers. We continue to assess these matters to ensure we have an effective compliance program.

 

State Related Investigations. We have received CIDs from each of the Office of the Attorney General of the State of Arizona, Illinois and the Commonwealth of Massachusetts and ODOJ and we have also received a subpoena from the Office of the Attorney General of the State of Florida and the Chief Consumer Protection and Antitrust Division of the State of New Hampshire. In addition, we understand that numerous physicians practicing in New Jersey have received subpoenas from the Department of Justice of the State of New Jersey in connection with these physicians’ interactions with our company. These CIDs and subpoenas request documents regarding Subsys, including our sales and marketing practices related to Subsys in the applicable state, as well as our patient services hub. We are cooperating with each of these investigations and have produced documents in response to these CIDs and related requests for information from each office.

 

In connection with the investigation by the ODOJ we have entered into a settlement agreement with the ODOJ referred to as an AVC, and have made monetary payments totaling approximately $1,100,000. The AVC requires us to maintain certain controls and processes around our promotional and sales activity related to Subsys in Oregon. This AVC expressly provides that we do not admit any violation of law or regulation. This settlement was reached as result of our cooperation with the ODOJ's investigation and after producing documents in response to certain CIDs and related requests for information from the ODOJ. All monetary payments in connection with this settlement were made prior to December 31, 2015.

 

Investigations of Physicians. In addition to the above investigations that are specifically directed at our company, we have received governmental agency requests for information, including subpoenas, from the USAO of Connecticut, Eastern District of Michigan, Florida (Jacksonville), Kansas, New Hampshire, Rhode Island, Southern District of New York, Southern District of Alabama and Western District of New York regarding specific physicians that we have interacted with in those states.

 

Opioid Litigation. Many federal and governmental agencies are focused on the abuse of opioids in the United States and agencies such as the HHS have expressed their belief that the United States is in the midst of a prescription opioid abuse epidemic. Common prescription drugs that contain opioids are drugs such as oxycodone, hydrocodone and fentanyl. Our product, Subsys, is a fentanyl-based product in the TIRF class. Certain stakeholders in the healthcare community, regulatory bodies and governmental agencies may associate us with, or determine that we are a part of, this perceived opioid abuse epidemic. Like all TIRF products, our product is part of the mandatory TIRF REMS program which is designed “to ensure informed risk-benefit decisions before initiating treatment, and while patients are treated to ensure appropriate use of TIRF medicines” and “to mitigate the risk of misuse, abuse, addiction, overdose and serious complications due to medication errors with the use of TIRF medicines.” Nevertheless, from time to time, we may be included in litigation or investigations that are directed at the abuse of opioids in the United States. For example, in May 2014, Santa Clara and Orange Counties in California filed a complaint in state court in Orange County, California against numerous pharmaceutical manufacturers alleging claims related to opioid marketing practices, including false advertising, unfair competition, and public nuisance. Despite the fact that we are not named specifically in the complaint and this lawsuit was recently stayed, we have received a preservation notice letter from the Office of the County Counsel for the County of Santa Clara. From time to time, we may be included in these types of litigations as a result of the fact that we market an opioid product.  

 

 
12

 

 

With the exception of the ODOJ investigation which we have quantified above, we believe a loss from an unfavorable outcome of these governmental proceedings is reasonably possible and an estimate of the amount or range of loss from an unfavorable outcome is not determinable at these stages.  We believe we have meritorious legal positions and will continue to represent our interests vigorously in these matters.  However, responding to government investigations has and could continue to burden us with substantial legal costs in connection with defending any claims raised. Any potential resulting fines, restitution, damages and penalties, settlement payments, pleas or exclusion from federal health care programs or other administrative actions, as well as any related actions brought by shareholders or other third parties, could have a material adverse effect on our financial position, results of operations or cash flows.  Additionally, these matters could also have a negative impact on our reputation and divert the attention of our management from operating our business.

 

Federal Securities Litigation

 

On or about February 2, 2016, a complaint (captioned Richard Di Donato v. Insys Therapeutics, Inc., Case 2:16-cv-00302-NVW) was filed in the Arizona District Court, against us and certain of our current and former officers. This complaint was brought as a purported class action, on behalf of purchasers of our common stock between March 3, 2015 and January 25, 2016. In general, the plaintiffs allege that the defendants violated federal securities laws by making intentionally false and misleading statements regarding our business and operations, therefore artificially inflating the price of our common stock. The plaintiffs seek unspecified monetary damages and other relief. We intend to vigorously defend this claim.

 

General Litigation and Disputes

 

Kottayil vs. Insys Pharma, Inc. On September 29, 2009, Insys Pharma, Inc., our wholly owned subsidiary, and certain of our officers and the five directors who comprised the Insys Pharma board of directors as of June 2009, as well as their spouses, were named as defendants in a lawsuit in the Superior Court of the State of Arizona, Maricopa County, or the Arizona Superior Court, brought by Santosh Kottayil, Ph.D., certain of his family members and a trust of which Dr. Kottayil is the trustee. Dr. Kottayil formerly served as President, Chief Scientific Officer and a director of Insys Pharma, among other positions. The complaint brought a cause of action for statutory and common law appraisal of Dr. Kottayil’s Insys Pharma common stock. The cause of action for appraisal relates to a reverse stock split that Insys Pharma effected in June 2009, which resulted in Dr. Kottayil’s ownership position becoming a fractional share of Insys Pharma common stock. Following the reverse stock split, Insys Pharma cancelled all resulting fractional shares, including the fractional share held by Dr. Kottayil, and offered a cash payment in lieu of the fractional shares. The complaint also brought causes of action for breach of fiduciary duty, fraud and negligent misrepresentation in the defendants’ dealings with Dr. Kottayil on the subject of his compensation and stock ownership in Insys Pharma. In January 2010, the plaintiffs added claims seeking to rescind Dr. Kottayil’s assignment to Insys Pharma of his interest in all of the fentanyl and dronabinol patent applications previously assigned to Insys Pharma and to recover the benefits of those interests. Dr. Kottayil was seeking, among other relief, the fair value of his Insys Pharma common stock as of June 2, 2009, compensatory and punitive damages, and rescission of all assignments to Insys Pharma of his interest in the patent applications, as well as attorneys’ fees, costs and interest.

 

In February 2010, Insys Pharma and the other defendants answered and filed counter-claims to Dr. Kottayil’s amended complaint. The counter-claims include actions for breach of fiduciary duty, fraud and negligent misrepresentations and omissions with respect to the time during which Dr. Kottayil was employed at Insys Pharma. The counter-claims, among other relief, sought compensatory and punitive damages.

   

On January 29, 2014, the plaintiffs filed a second amended complaint in the Arizona Superior Court in which Insys Therapeutics, Inc. was also named as defendant in this lawsuit. This amended complaint filed by plaintiffs re-alleged substantially the same claims set forth in the prior complaint, except that plaintiffs also alleged that they were entitled to rescissory damages, added our majority stockholder, a private trust, as a defendant to the breach of fiduciary duty claim and revised their fraud claim against the Insys Pharma director defendants.

 

 
13

 

  

The trial commenced on December 1, 2014 with the evidence phase of the trial completed on January 29, 2015.

 

On June 8, 2015, the court issued findings of fact and conclusions of law in its final trial ruling. Specifically, the court found (i) in favor of Insys Pharma, our majority stockholder, a private trust and four of the Insys Pharma directors who were on the board in July 2008 on plaintiffs’ claim for breach of fiduciary duty arising out of transactions the board approved in July 2008, (ii) found in favor of plaintiffs and against Insys Pharma, Inc., our majority stockholder, a private trust and three of the Insys Pharma directors who were on the board in June 2009 on plaintiffs’ claims under Delaware law and for breach of fiduciary duties arising out of the reverse stock split the board approved in June 2009 in the amount of $7,317,450, along with pre-judgment and post-judgment interest and court costs, (iii) found in favor of two of the Insys Pharma directors who were on the Insys Pharma board as of June 2009 and against plaintiffs on plaintiffs’ breach of fiduciary duty claims, (iv) found in favor of Insys Pharma and against plaintiff (Kottayil) on his claim for rescission of the patent application assignments that he entered in favor of Insys Pharma before and after his employment terminated, (v) found in favor of Insys Therapeutics, Inc. and against plaintiff on plaintiffs' claims of successor liability and fraudulent transfer, and (vi) found in favor of Kottayil and against Insys Pharma on Insys Pharma’s counterclaims of breach of fiduciary duty, fraud, and negligent misrepresentation.

 

On October 2, 2015, the court entered a final judgment, awarding plaintiffs the amount of $7,317,450, along with pre-judgment interest from June 2, 2009, and post-judgment interest, from October 2, 2015, at the rate of 4.25% per annum, compounded quarterly and taxable costs in the amount of $93,163. On the same date, the court denied Kottayil’s request to submit an application for attorneys’ fees for his defense of the Insys Pharma counterclaims, finding that the request was premature.

 

 As a result of the final ruling, we have accrued $9,567,000 at June 30, 2016, including $2,249,000 of estimated pre-and post-judgement interest. The final outcome of the appeal could cause the estimates to vary materially from the final award.

 

On October 20, 2015, plaintiffs appealed the foregoing judgment and on November 4, 2015, Insys Pharma and the other defendants against whom judgment was entered filed a notice of cross-appeal. The appeal and cross-appeal remain pending before the Court of Appeals for the State of Arizona. 

   

On or around November 1, 2015 we received a notice from the Plaintiff’s attorneys demanding indemnification for legal and other defense costs alleged to have been incurred in connection with Dr. Kottayil’s defense of the Insys Pharma counterclaims in the amount of $3,630,000. We responded to these demands by, among other things, requesting for supporting documents and information from the Plaintiffs’ counsel which we have not received yet. Accordingly, we are still in the process of assessing the merit of such claims as well as evaluating the basis for the costs claimed. Because of the uncertainty surrounding the ultimate outcome we have not accrued for this claim at this time; however, we believe that that it is reasonably possible that there may be a material loss associated with this claim and we currently estimate the range of the reasonably possible loss to be between $0 and the $3,630,000 claimed.  

 

As of August 1, 2016, Plaintiffs have filed opening and reply and cross response briefs and we have filed our answering and cross-appeal brief and our reply in support of our cross-appeal. We intend to request an oral argument, after which the court may set a hearing date.

 

Except as it pertains to the $9,567,000 accrued for the dispute with Dr. Kottayil and the potential for damages in the Federal Securities litigation that we believe should be sufficiently covered by our director and officers insurance policies (once we have met any applicable retainage requirement under the applicable policy), we believe that the probability of unfavorable outcome or loss related to all of the above litigation matters and an estimate of the amount or range of loss, if any, from an unfavorable outcome are not determinable at this time. We believe we have meritorious legal positions and will continue to represent our interests vigorously in these matters but the range possible outcomes on these matters is very broad and we are not able to provide a reasonable estimate of our potential liability, if any, nor are we able to predict the outcome of each litigation matter. Responding to each of these litigation matters, defending any claims raised, and any resulting fines, restitution, damages and penalties, or settlement payments as well as any related actions brought by shareholders or other third parties, could have a material impact on our reputation, business and financial condition and divert the attention of our management from operating our business.

 

 
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Wayne Automatic Fire Sprinklers. On or about January 26, 2016, Wayne Automatic Fire Sprinklers, Inc. (“Wayne”), which installs, repairs, and monitors fire sprinkler and fire alarm systems throughout Florida and provides health insurance benefits to its employees and covered dependents through its self-funded health benefit plan, filed a complaint in the Circuit Court of the Ninth Judicial Circuit in and for Orange County, Florida. Wayne is seeking injunctive relief and damages in excess of $75,000, exclusive of interest, costs and attorneys’ fees, against Insys Therapeutics, Inc., Gessler Clinic, P.A., Edward Lubin, M.D., UMR, Inc. and OptumRx, Inc., as defendants, for claims based under the Florida Racketeer Influenced and Corrupt Organization Act pursuant to section 895.03(3), Florida Statutes, the Florida Civil Remedies for Criminal Practices Act pursuant to section 772.103(3), Florida Statutes, the Florida Deceptive and Unfair Trade Practices Act under sections 501.201-501.203, Florida Statutes, common law fraud, and civil conspiracy, as well as breach of contract against UMR and OptumRx. We believe that the amount of any anticipated resolution of this matter will not be material to our financial results. 

 

Markland.  On July 1, 2016, Robert N. Markland, as the Personal Representative of the Estate of Carolyn S. Markland filed a complaint in the Circuit Court, Fourth Judicial Circuit, in and for Duval County Florida against our parent, Insys Therapeutics, Inc. The complaint states it is wrongful death products liability action brought pursuant to Section 768.16, et seq. under Florida law in connection with a death occurring in July 2014 and includes a claim of negligent marketing. The lawsuit seeks unspecified damages for past expenses and costs, pain and suffering and loss of consortium and earnings.  On August 4, 2016, we removed this case to federal district court in the Middle District of Florida. We intend to vigorously defend this matter and based on currently available information, we do not believe any resolution of this matter will have a material adverse effect on the Company's business, financial position, or future results of operations.

 

Material Agreements

 

In April 2015, we entered into an amendment to our manufacturing and supply agreement with DPT, which extends our existing manufacturing and supply agreement to produce Subsys until the end of 2020. In addition to extending the term, this amendment added certain minimum purchase commitments.

 

In October 2015, we entered into an amended and restated supply, development & exclusive licensing agreement with Aptar which, among other things, extended our exclusive supply rights to the current sublingual device, currently utilized by Subsys, as well any new device(s) jointly developed by the two companies for a period of seven years. In addition to extending the term, this amendment added certain minimum purchase commitments and requires certain tiered royalties as a percentage of net revenue to be paid by us ranging from less than one percent to the low single digits, commencing in March 2016 through the term of this agreement, from our sales of Subsys and future products that use the Aptar spray device technology. 

 

In January 2016, we assigned our rights, title, duties and obligations of our manufacturing and supply agreement with DPT and our supply, development & exclusive licensing agreement with Aptar from our parent to our manufacturing subsidiary as part of a corporate restructuring.

 

In July 2016, we, through our manufacturing subsidiary, entered into a further amendment to our DPT manufacturing and supply agreement dated May 24, 2011. This amendment effectively eliminates any prior minimum purchase (and batch) obligations that had been set forth in this agreement and replaces it with a new annual purchase commitment of $4,000,000 per calendar year commencing January 1, 2017 through December 31, 2020. As a result, the cumulative effect related to this amendment reduces our aggregated minimum purchase commitments with DPT from $49,740,000 to $16,000,000.

 

The following table sets forth our aggregate minimum purchase commitments with DPT and Aptar under these agreements (in thousands):   

 

Years ending December 31,

       

Remainder of 2016

    1,790  

2017

    6,000  

2018

    7,500  

2019

    8,410  

2020

    8,550  

Thereafter

    4,330  

Total

  $ 36,580  

 

 
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7.       Stock-based Compensation  

 

Amounts recognized in the condensed consolidated statements of income and comprehensive income with respect to our stock-based compensation plans were as follows (in thousands):  

 

   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2016

   

2015

   

2016

   

2015

 

Research and development

  $ 1,063     $ 448     $ 3,424     $ 789  

General and administrative

    3,883       3,779       7,148       7,158  

Total cost of stock-based compensation

  $ 4,946     $ 4,227     $ 10,572     $ 7,947  

 

As of June 30, 2016, we expected to recognize $48,200,100 of stock-based compensation for outstanding options over a weighted-average period of 3.0 years.

 

The following table summarizes stock option activity as of December 31, 2015 and for the six months ended June 30, 2016:

 

                   

Weighted

         
           

Weighted

   

Average

   

Aggregate

 
           

Average

   

Remaining

   

Intrinsic

 
   

Number of

   

Exercise

   

Contractual

   

Value

 
   

Shares

   

Price

   

Term (in years)

   

(in millions)

 

Vested and exercisable as of December 31, 2015

    3,772,736     $ 6.91                  
                                 

Outstanding as of December 31, 2015

    7,138,089     $ 12.33                  

Granted

    2,124,393     $ 14.91                  

Cancelled

    (435,423 )   $ 16.90                  

Exercised

    (376,985 )   $ 5.63                  
                                 

Outstanding as of June 30, 2016

    8,450,074     $ 13.04       7.9     $ 32.4  
                                 

Vested and exercisable as of June 30, 2016

    4,131,635     $ 8.40       6.7     $ 28.1  

 

Cash received from option exercises under all share-based payment arrangements for the six months ended June 30, 2016 and 2015 was $2,123,000 and $6,111,000, respectively. For the six months ended June 30, 2016 and 2015, we recorded net reductions of $389,000 and $7,416,000, respectively, of our federal and state income tax liability, with an offsetting credit to additional paid-in capital, resulting from the excess tax benefits of stock options.

  

8.     Net Income per Share

 

Basic net income per common share is computed by dividing the net income allocable to the common stockholders by the weighted average number of common shares outstanding during the period. The diluted income per share further includes any common shares available to be issued upon exercise of outstanding stock options if such inclusion would be dilutive.

 

 
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The following table sets forth the computation of basic and diluted net income per common share (dollars in thousands, except per share amounts):

 

   

Three Months Ended

   

Six Months Ended

 
   

June 30,

   

June 30,

 
   

2016

   

2015

   

2016

   

2015

 
                                 

Historical net income per share - Basic

                               

Numerator:

                               

Net income

  $ 4,355     $ 7,314     $ 6,789     $ 15,337  

Denominator:

                               

Weighted average number of common shares outstanding

    71,543,809       71,517,442       71,567,949       71,217,137  

Basic net income per common share

  $ 0.06     $ 0.10     $ 0.09     $ 0.22  
                                 

Historical net income per share - Diluted

                               

Numerator:

                               

Net income

  $ 4,355     $ 7,314     $ 6,789     $ 15,337  

Denominator:

                               

Weighted average number of common shares outstanding

    71,543,809       71,517,442       71,567,949       71,217,137  

Effect of dilutive stock options

    2,509,741       3,961,207       2,713,889       4,037,911  

Weighted average number of common shares outstanding

    74,053,550       75,478,649       74,281,838       75,255,048  

Diluted net income per common share

  $ 0.06     $ 0.10     $ 0.09     $ 0.20  

 

Anti-dilutive share equivalents included 5,067,070 and 1,274,490 outstanding stock options as of June 30, 2016 and 2015, respectively.

 

9.     Product Lines, Concentration of Credit Risk and Significant Customers

 

We are engaged in the business of developing and selling pharmaceutical products. In 2016, we have one product line, Subsys. Our chief operating decision-maker evaluates revenues based on product lines.

 

The following tables summarize our net revenue by product line, as well as the percentages of revenue by route to market (in thousands):

 

   

Net Revenue by Product Line

 
   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2016

   

2015

   

2016

   

2015

 

Subsys

  $ 67,121     $ 76,700     $ 129,083     $ 147,240  

Dronabinol SG Capsule

    -       933       -       1,163  

Total net revenue

  $ 67,121     $ 77,633     $ 129,083     $ 148,403  

 

   

Percent of Revenue by Route to Market

 
   

Three Months Ended June 30,

   

Six Months Ended June 30,

 
   

2016

   

2015

   

2016

   

2015

 

Pharmaceutical wholesalers

    69 %     99 %     71 %     99 %

Specialty pharmaceutical retailers

    31 %     1 %     29 %     1 %
      100 %     100 %     100 %     100 %

 

All our products are sold in the United States of America.

  

Product shipments to four pharmaceutical wholesalers accounted for 18%, 17%, 16%, and 13% of total shipments and product shipments to one specialty pharmaceutical retailer accounted for 29% of total shipments for the six months ended June 30, 2016. Product shipments to four pharmaceutical wholesalers accounted for 33%, 20%, 18% and 15% of total shipments for the six months ended June 30, 2015. Four pharmaceutical wholesalers’ accounts receivable balances accounted for 23%, 18%, 15%, and 14% of gross accounts receivable and one specialty pharmaceutical retailers’ accounts receivable balance accounted for 20% of gross accounts receivable balance as of June 30, 2016. Four pharmaceutical wholesalers’ accounts receivable balances accounted for 35%, 20%, 18% and 12% of gross accounts receivable as of June 30, 2015.

 

 
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto as of and for the year ended December 31, 2015 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K.

 

Forward-Looking Statements

 

The information in this discussion contains forward-looking statements and information within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”), which are subject to the “safe harbor” created by those sections. These forward-looking statements include, but are not limited to, statements concerning our strategy, future operations, future financial position, future revenues, projected costs, prospects, and the factors affecting our future performance; plans and objectives of management; that ESI and other PBM formulary changes relative to Subsys may have a material impact on future net revenue; our intent to file an IND application for the treatment of epilepsy with cannabidiol in 2016; the sufficiency of our manufacturing capacity; the beneficial attributes of our dronabinol product candidates; that sales and marketing and research and development costs will be our largest categories of expenses; that sales and marketing expenses will fluctuate on changes in Subsys net revenue; our likely inability to grow full-year 2016 Subsys revenue at similar levels compared to 2015; that we will experience future declines in Subsys revenue for the remainder of 2016 when compared to prior quarters in 2015; our development of different dronabinol delivery systems; our anticipated timing of the commercial launch of Syndros; the source and sufficiency of our liquidity our capital resources to fund our operations; possible capital raising transactions we may pursue; that research and development and operating costs will increase; that our investments in our sales and research and development infrastructure will result in increased sales; accounting estimates and the impact of new or recently issued accounting pronouncements; that cash flows from operations will increase as a result of any increased sales of Subsys; trends in restrictions and impediments relating to reimbursement policies imposed by pharmacy benefit managers; the impact of pending litigation and our strategy relating thereto; our exposure to interest rate changes and market risks relating to our investments. The words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,” “should,” “could,” “predicts,” “potential,” “continue,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements that we make. The forward-looking statements are applicable only as of the date on which they are made, and we do not assume any obligation to update any forward-looking statements. All forward-looking statements in this Form 10-Q are made based on our current expectations, forecasts, estimates and assumptions, and involve risks, uncertainties and other factors that could cause results or events to differ materially from those expressed in the forward-looking statements. In evaluating these statements, you should specifically consider various factors, uncertainties and risks that could affect our future results or operations as described from time to time in our SEC reports, including those risks outlined under “Risk Factors” in Item 1A of our Form 10-K for the year ended December 31, 2015. These factors, uncertainties and risks may cause our actual results to differ materially from any forward-looking statement set forth in this Form 10-Q. You should carefully consider these risk and uncertainties described and other information contained in the reports we file with or furnish to the SEC before making any investment decision with respect to our securities. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this cautionary statement. Some of the important factors that could cause our actual results to differ materially from those projected in any forward-looking statements including, but are not limited to, the following:

 

 

 

the impact of ongoing regulatory review of Subsys and other product candidates that receive regulatory approval;

 

our dependence on sales of Subsys;

 

market acceptance, including by third-party payors, of our products;

  

the unpredictability and regulation surrounding the reimbursement of Subsys;

 

the success of our sales and marketing strategies;

 

 
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our ability to manage growth in our business;

  manufacturing failures;
  challenges relating to our operation of a second dronabinol manufacturing facility;
  our limited manufacturing capabilities and our reliance on third parties in our product supply chain;
  delays in manufacturing or interruption of our sublingual spray delivery system;
  competition;
  our ability to achieve and maintain adequate levels of third-party payor and reimbursement coverage for sales of our products;
  our reliance on wholesale pharmaceutical distributors for sales of our products through to the retail distribution channel;
  our reliance on third parties for the performance of services relating to Subsys, including invoicing, storage and transportation;
  our ability to develop a pipeline of product candidates;
  our failure to obtain or maintain Schedule III classification for our dronabinol product candidates;
  failure of our clinical trials to demonstrate acceptable levels of safety and efficacy;
  expenses, delays, changes and terminations that could adversely affect the design and implementation of our clinical trials;
  reliance on third parties to conduct and oversee our clinical trials;
  acceptance by the FDA our data from our clinical trials conducted outside the United States;
  risks and uncertainties associated with starting materials sourced from India;
  our ability to meet Section 505(b)(2) regulatory approval pathways or requirements for our product candidates;
  annual DEA quotas on the amount of dronabinol allowed to be produced in the United States;
  our failure to successfully acquire, develop or market additional product candidates;
  our ability to retain key management and other personnel;
  misconduct and improper activities by our employees, prescribing physicians and other persons involved in the marketing and distribution of our products;
  our ability to utilize our net operating loss and research and development tax credit carryforwards;
  the adverse impacts of strategic transactions;
  our exposure to product liability claims;
  our ability to comply with environmental laws relating to our use of hazardous materials;
  security system failures;
  natural disasters;
  our significant operating expenses and need for potential additional funding;
  our failure to comply with federal and state healthcare laws, including fraud and abuse and health information privacy and security laws;
  undesirable side effects of our products and the potential for post-approval regulatory action relating to such side effects;
  the impact of changes in policies and funding resulting from healthcare reform measures, including the impact on the funding, staffing and leadership of the FDA and other agencies;
  the impact of future sales of our common stock or securities convertible into our common stock;
  heightened attention on the use of opioids, including government litigation, changes in policies, and legislation at the federal and local level;
  our ability to obtain and enforce patent rights or other intellectual property rights that cover our products and product candidates;
  costs of litigation and our ability to protect our intellectual property rights;
  our exposure to litigation relating to infringement suits against us;
  our exposure to claims that our employees or independent contractors have wrongfully used or disclosed to us trade secrets of their other clients or former employers;
  our compliance with the procedural, document submission, fee payment and other requirements needed to apply for patents;
  control over the Company by its founder, Executive Chairman and principal stockholder;
  fluctuation in the price of our common stock;
  our ability to maintain and improve our financial controls and related compliance with SEC and stock exchange listing standards;
  lack of, or inaccurate, published research about us;

 

 
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the impact of future sales of our common stock or securities convertible into our common stock;

 

the effect of anti-takeover provisions in our charter documents and under Delaware law;

 

the impact of our exemptions from certain Nasdaq independence rules because of our status as a “controlled company”; and

 

our intention to not pay dividends in the foreseeable future.

 

  Additionally, there may be other risks that are otherwise described from time to time in the reports that we file with the SEC. Any forward-looking statements in this report should be considered in light of various important factors, including the risks and uncertainties listed above, as well as others.

  

Overview

 

 We are a commercial-stage specialty pharmaceutical company that develops and commercializes innovative supportive care products. We have one marketed product and one discontinued product:

 

 

Subsys — a proprietary, single-use product that delivers fentanyl, an opioid analgesic, for transmucosal absorption underneath the tongue, offered in 100, 200, 400, 600, 800, 1,200 and 1,600 mcg dosages. Subsys is approved for the treatment of BTCP in opioid-tolerant patients. We received FDA approval for Subsys in January 2012 and commercially launched Subsys in March 2012.

 

 

• 

Dronabinol SG Capsule — a dronabinol soft gelatin capsule that is a generic equivalent to Marinol, an approved second-line treatment for CINV and anorexia associated with weight loss in patients with AIDS, offered in 2.5, 5.0 and 10.0 milligram dosages. We received FDA approval for Dronabinol SG Capsule in August 2011. We commercially launched Dronabinol SG Capsule through our former exclusive distribution partner, Mylan Pharmaceuticals, Inc., in December 2011. We do not have any current plans to manufacture or market this product in the future.

  

We market Subsys through our U.S.-based field sales force focused on supportive care physicians. We utilize an incentive-based sales model that employs a pay structure where a significant component of the compensation paid to sales representatives is in the form of potential bonuses based on sales performance.

 

Consistent with most pharmaceutical manufacturing companies, we sell Subsys primarily to pharmaceutical wholesalers and collect sales proceeds from those wholesalers. We do not own or have any ownership stake in any pharmaceutical wholesaler, nor do we have an option to acquire any wholesaler. For the six months ended June 30, 2016, sales to our four largest wholesale customers accounted for 64% of gross revenue. We also sell Subsys directly to specialty pharmaceutical retailers. For the six months ended June 30, 2016, direct sales to specialty pharmaceutical retailers accounted for 29% of gross revenue. We distribute Subsys through both specialty and traditional retail pharmacies. All pharmacies that fulfill Subsys prescriptions are fully independent. We do not own or have an ownership stake in any pharmacy and do not possess an option to acquire any pharmacy. Our relationships with every pharmacy that fulfills Subsys prescriptions are non-exclusive, in that each of these pharmacies may also fulfill prescriptions for other pharmaceutical manufacturers. For the six months ended June 30, 2016, nearly 800 independent pharmacies have fulfilled at least one Subsys prescription.

  

Our sales of, and revenue from, Subsys depend in significant part on the coverage and reimbursement policies of third-party payers, including government payers, such as Medicare and Medicaid, and private health insurers. All third-party payers are sensitive to the cost of drugs and consistently implement efforts to control these costs, which efforts include, but are not limited to, establishing excluded or preferred drug lists. Subsys has been, and will likely continue to be, subject to these restrictions and impediments from third-party payers, particularly PBMs and private health insurers. We provide administrative reimbursement support assistance, in large part through our insurance reimbursement support hub, which provides administrative support assistance to help patients coordinate with their insurance companies.

 

We are also developing other product candidates, such as dronabinol line extensions and sublingual spray product candidates. Our most advanced potential cannabinoid line extension is Syndros. This product candidate has demonstrated more rapidly detectable blood levels and a more reliable absorption profile than Marinol in our clinical studies. We believe these attributes may ultimately increase patient compliance because of more rapid onset of action and less dose-to-dose variability, which we believe will allow us to further penetrate and potentially expand the market for the medical use of dronabinol. In August 2015, the FDA accepted for filing the NDA for Syndros. In July 2016, we obtained FDA approval of Syndros. Syndros is currently awaiting scheduling by the DEA. We anticipate launching Syndros in the second half of 2016.

 

 
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We produce the API for Syndros at our U.S.-based, state-of-the-art dronabinol manufacturing facility. While we believe that this facility has the capacity to supply sufficient commercial quantities of dronabinol API for our initial launch quantities of Syndros, if approved, and support the continued development of our other dronabinol product candidates in the near-term, we have opened a second dronabinol manufacturing facility, which we anticipate will enable us to supply sufficient commercial quantities of dronabinol API for the anticipated commercialization of our proprietary dronabinol product candidates, if approved.

 

We have the capability to manufacture pharmaceutical CBD, an over 99.5% pure form of cannabidiol, in our Round Rock, Texas manufacturing facility. On April 23, 2015, we announced that we had commenced dosing of epilepsy patients in a Phase I PK study in pediatric subjects. We intend to file an IND application with the FDA for the treatment of epilepsy.

 

Factors Affecting Our Performance

 

We believe that our performance and future success are dependent upon a number of factors, including our approved product sales, investments in our infrastructure and growth, and our ability to successfully develop product candidates and complete related regulatory processes. In addition, our ability to ensure that our products, policies and practices adhere to the extensive national, state and local regulations applicable to our industry is critical to our success, particularly as our operations and product opportunities continue to grow at a rapid pace. While each of these areas presents significant opportunities for us, they also pose significant risks and challenges that we must successfully address.  

  

Approved Product Sales.    Our operating results will depend significantly upon our, and any of our third-party distributors’, sales of approved products. During the six months ended June 30, 2016, all of our net revenues were generated from the sale of our approved product, Subsys. We will not generate any revenue from the sale of our discontinued Dronabinol SG Capsule in future periods. Our results will depend on prescription volume generally, which we believe will be driven primarily by achievement of broad market acceptance and coverage by third-party payors and effectiveness of the marketing and selling efforts with respect to Subsys. Moreover, our gross margins improve on a unit-by-unit basis as we sell higher dosage strengths of our products. Importantly, the proportion of prescriptions written for repeat Subsys patients has continued to increase since July 2012 from 50% of prescriptions to approximately 92% of prescriptions as of June 30, 2016. Generally, repeat Subsys patients receive significantly higher doses of Subsys on average than first-time patients as patients are titrated from a starter dose of Subsys to their effective dose in accordance with the TIRF REMS protocol.

 

According to Symphony Health Systems, the total market for TIRF products for the three months ended June 30, 2016 was approximately 21,000 prescriptions and we estimate Subsys prescriptions were approximately 44% of the TIRF market, compared to a total market of approximately 30,000 prescriptions and approximately 45% Subsys market share for the three months ended June 30, 2015.

 

The continuing and heightened publicity surrounding the national opioid epidemic continues to result in sensitivity by some healthcare professionals to prescribe, and pharmacies to dispense, opioids. In part, this sensitivity by healthcare professionals and pharmacies is the result of third-party payers, such as insurance companies, and regulatory and government agencies increasingly scrutinizing the indications and uses for which healthcare professionals are prescribing, and pharmacies are dispensing, opioids. Moreover, ongoing state and federal investigations into our sales, marketing and other commercial practices and developments and media reports that may arise in connection with such investigations may negatively affect our relationships with healthcare professionals and pharmacies and their prescribing or dispensing habits.  Consequently, these current and potential future events have and will likely continue to affect the manner in which, and the situations when, Subsys is being prescribed, dispensed and approved for coverage. While we continue to sell directly into wholesalers and retail pharmacies for our revenue, the direct pressures discussed above related to the retail demand-side components of our business will likely result in our inability to grow full-year 2016 Subsys revenue at similar levels when compared to 2015. In addition, we anticipate that we will experience future declines in Subsys revenue for the remainder of 2016 when compared to prior quarters in 2015.

 

 
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Third Party Payer Interactions and Government Programs Associated with Reimbursement. Our interaction with third-party payers is critical to the success of our business and financial condition. Our relationships with these third-party payers evolves on a regular basis and is often difficult to predict. By way of example, from time to time, third-party payers modify which drugs they choose to reimburse. For instance, on or around August 1, 2014, ESI officially released its exclusion list of drugs, effective January 1, 2015, in connection with its national preferred formulary. Our product, Subsys, was included on this exclusion list. ESI is a large PBM that administers prescription drug benefits for employers and health plans and runs large mail-order pharmacies. While ESI, like most PBMs, has an exception process that physicians may pursue to have an off-formulary, medically necessary drug covered for patients, this decision will make it difficult for many patients covered through an ESI administered plan to have Subsys covered by insurance. The ESI formulary change did not have a material impact on our net revenue during the three and six months ended June 30, 2016; however, other PBMs may take similar actions and this action by ESI may have a material impact on our net revenue in the future. As we have in the past, we will continue working with other PBMs to evaluate price increases and to communicate with managed care and health-system decision-makers to ensure a balanced approach, which takes into account the clinical performance and efficacy of our products. 

 

In addition, from time to time, our business may be affected by evolving or new governmental programs in the reimbursement landscape. For instance, CMS, which is part of the HHS, has instituted The Recovery Audit Program. The program’s mission is to identify and correct improper Medicare payments through the efficient detection and collection of overpayments made on claims of health care services provided to Medicare beneficiaries, and the identification of underpayments to providers so that CMS can implement actions that will prevent future improper payments in all 50 states. We are aware that in January 2016, certain specialty pharmacies received written correspondence from Humana indicating that as a result of a CMS audit, Humana was initiating a deletion of certain PDEs related to Subsys which will result in a reversal and recovery of identified claims paid to certain pharmacies. This audit by CMS may have been part of The Recovery Audit Program or a similar initiative of CMS. Based upon information available to us, all of these claims involve Medicare Part D patients whose prescriptions were in connection with off-label indications and related to approximately $5.6 million in Subsys claims in the aggregate. Upon our inquiry for more information about these matters, Humana notified us that these deletions of certain PDEs resulting from the CMS audit also involve TIRF medications other than Subsys and Humana intends to resolve these matters with the pharmacies. We believe that some affected pharmacies may alter their processes and or protocols related to dispensing off label TIRF prescriptions to Medicare patients as a result of these and similar events. 

  

Investments in Our Infrastructure and Growth.    Our ability to increase our sales and to further penetrate our target market segments is dependent in part on our ability to invest in our infrastructure and in our sales and marketing efforts. In order to drive further growth, we may hire additional sales and marketing personnel and invest in marketing our products to our target physician prescriber base. For example, as of June 30, 2016, we had 335 full-time sales and marketing personnel. This will lead to corresponding increases in our operating expenses, although we anticipate that these investments will result in increased product sales and net revenue. In addition, we have constructed a second dronabinol manufacturing facility, which we anticipate will supply us with sufficient commercial quantities of dronabinol API for the commercialization of our proprietary dronabinol product candidates, if approved. This second facility will also increase our operating expenses.

 

Product Development and Related Regulatory Processes.    Our operating results will also depend significantly on our research and development activities and related regulatory developments. Our research and development expenses were $43.4 million and $28.4 million for the six months ended June 30, 2016 and 2015, respectively. As of June 30, 2016, we had 78 full-time research and development personnel. We expect research and development expenses to increase as we continue our planned preclinical studies and clinical trials for our product candidates, particularly our proprietary cannabinoid product candidates, including Syndros, and sublingual spray product candidates. We do not expect to realize net revenues from all of these research and development initiatives in the near term and may never realize net revenues from these investments. Due to the risks inherent in conducting preclinical studies and clinical trials, the regulatory approval process and the costs of preparing, filing and prosecuting patent applications, our development completion dates and costs will vary significantly for each product candidate and are very difficult to estimate. The lengthy process of seeking regulatory approvals and the subsequent compliance with applicable regulations require the expenditure of substantial additional resources. Any failure by us to obtain, or any delay in obtaining, regulatory approvals or acceptable DEA classifications for our product candidates, in particular those related to Syndros, could cause our research and development expenditures to increase significantly and, in turn, have a material adverse effect on our results of operations.

 

Basis of Presentation 

 

Net Revenue

 

We sell Subsys in packages of various sized single-dose units in dosage strengths of 100, 200, 400, 600, 800, 1,200 and 1,600 mcg, to wholesale pharmaceutical distributors and retail pharmacies, collectively, our customers, on a wholesale basis. Sales to our customers are subject to specified rights of return. We record revenue for Subsys at the time the customer receives the shipment.

 

 
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Cost of Revenue, Gross Profit and Gross Margin

 

Cost of revenue consists primarily of materials, third-party manufacturing costs, freight in, indirect personnel costs, and other overhead costs based on units dispensed through patient prescriptions. Also included in cost of revenue are charges for reserves for excess, dated or obsolete commercial inventories and production manufacturing variances.

  

Gross profit is net revenue less cost of revenue. Gross margin is gross profit expressed as a percentage of net revenue.

 

Sales and Marketing Expenses

 

Our sales and marketing expenses consist primarily of salaries, commissions, benefits, consulting fees, costs of obtaining prescription and market data, and market research studies related to Subsys. As of June 30, 2016, we had 335 full-time sales and marketing personnel. We expect that the number of our sales and marketing personnel will remain steady in the immediate future and may increase as any subsequently approved products are commercialized. We expect our sales and marketing expenses, along with our research and development expenses, to be our largest categories of operating expenses for the foreseeable future. In addition, because we use an incentive-based compensation model for our sales professionals, we expect our sales and marketing expenses to fluctuate from period to period based on changes in Subsys net revenue. We will also incur expenses directly related to the launch of Syndros, which we anticipate will be in the second half of 2016.

 

Research and Development Expenses

 

Research and development expenses consist of costs associated with our preclinical studies and clinical trials, and other expenses related to our drug development efforts. Our research and development expenses consist primarily of:

 

 

external research and development expenses incurred under agreements with third-party CROs and investigative sites, third-party manufacturers and consultants;

 

 

employee-related expenses, which include salaries, benefits and stock-based compensation for the personnel involved in our preclinical and clinical drug development activities; and

 

 

facilities, depreciation and other allocated expenses, equipment and laboratory supplies.

 

To date, our research and development efforts have been focused primarily on our fentanyl, dronabinol and cannabidiol programs. As of June 30, 2016, we had 78 full-time research and development personnel. We expect research and development expenses to increase as we continue our planned preclinical studies and clinical trials for our product candidates. We determine which research and development projects to pursue, as well as the level of funding available for each project, based on the scientific and preclinical and clinical results of each product candidate and related regulatory action.

 

 
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The following table provides a breakdown of our research and development expenses during the six months ended June 30, 2016 and 2015 (in millions):

 

   

Six Months Ended

 
   

June 30,

 
   

2016

   

2015

 

Cannabidiol

  $ 8.4     $ 10.3  

Buprenorphine