Note 3. Summary of Significant Accounting Policies

(A) Principles of Consolidation

On January 1, 2018 MonoSol Rx, LLC (which previously consolidated MonoSol Rx, Inc. in 2017) was converted from a Delaware LLC into a Delaware corporation pursuant to a statutory conversion under the laws of the State of Delaware. The resulting entity is Aquestive Therapeutics, Inc. into which is consolidated its wholly-owned subsidiary MonoSol Rx, Inc.

These consolidated financial statements presented for periods earlier than January 1, 2018 include the accounts of the MonoSol Rx, LLC. and its wholly owned subsidiary, MonoSol Rx, Inc. Other than corporate formation activities, MonoSol Rx, Inc. has conducted no commercial, developmental or operational activities and has no customers or vendors.

(B) Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires the use of estimates and assumptions that affect the reported amounts of assets and liabilities, including disclosure of contingent assets and contingent liabilities, at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Significant items subject to estimates and assumptions include allowances for rebates from proprietary product sales, the allowance for sales returns, the useful lives of fixed assets, valuation of share-based compensation, and contingencies.

The Company considers all short-term, highly liquid investments purchased with original maturities of three months or less to be cash equivalents. These investments are carried at cost, which approximates fair value. At December 31, 2018 and 2017, the Company had no cash equivalents.

(D) Concentration of Credit Risk

Cash and cash equivalents are maintained at one federally insured financial institution. The Company has not experienced any losses in such accounts and management believes that the Company is not exposed to any credit risk due to the financial position of the banking institution.

(E) Trade Accounts Receivable

Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The Company grants credit to customers in the normal course of business, but generally does not require collateral or any other security to support its receivables. The Company’s credit terms generally range from 30 to 60 days, however some credit terms may reach 105 days, depending on the customer and type of invoice.

The Company evaluates the collectability of accounts receivable based on a combination of factors. In circumstances where a specific customer is unable to meet its financial obligations to the Company, a provision to the allowances for doubtful accounts is recorded against amounts due in order to reduce the net recognized receivable to the amount that is reasonably expected to be collected. For all other customers, a provision to the allowances for doubtful accounts is recorded based on factors including the length of time the receivables are past due, the current business environment and the Company’s historical experience. Provisions to the allowances for doubtful accounts are recorded to selling, general and administrative expenses. Account balances are charged off against the allowance when it is probable that the receivable will not be recovered. The allowance for doubtful accounts, associated with recoverability of accounts receivable, was $58 and $55 as of December 31, 2018 and 2017, respectively.

(F) Inventories

Inventories, consisting of purchased materials, direct labor and manufacturing overhead, are stated at the lower of cost, determined by the first-in, first-out method, or net realizable value, in accordance with ASU 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory. The Company regularly reviews its inventories for impairment and reserves are established when necessary.

At each balance sheet date, the Company evaluates inventories for excess quantities, obsolescence or shelf life expiration. This evaluation includes analysis of historical sales levels by product, projections of future demand, the risk of competitive obsolescence for products, general market conditions, and a review of the shelf life expiration dates for products. To the extent that management determines there are excess or obsolete inventory or quantities with a shelf life that is too near its expiration for the Company to reasonably expect that it can sell those products, or use them in production, prior to their expiration, the Company will adjust the carrying value to estimated net realizable value as necessary.

(G) Property and Equipment

Property and equipment are stated at cost. Depreciation and amortization is computed by the straight line method based on the estimated useful lives of the respective assets, as discussed below. Leasehold improvements are amortized over the lesser of the lease terms or the estimated useful lives of the assets. Maintenance and repair costs are charged to expense as incurred, and expenditures for major renewals and improvements are capitalized. Upon disposition of property and equipment, the related cost and accumulated depreciation and amortization are removed from the accounts, and any gain or loss is reflected in the accompanying Consolidated Statements of Operations and Comprehensive Loss.

(H) Intangible Assets

Intangible assets include the costs of acquired composition and process technologies and the costs of purchased patents used in the manufacture of orally soluble film. The Company amortizes these assets using the straight-line method over the shorter of their legal lives or estimated useful lives.

(I) Impairment of Long-Lived Assets

Long lived assets, such as property, plant, and equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require a long-lived asset or asset group to be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by that asset or asset group to its carrying amount. If the carrying amount of the long-lived asset or asset group is not recoverable on an undiscounted cash flow basis, an impairment is recognized to the extent that the carrying amount exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary.

(J) Revenue Recognition

Pursuant to FASB ASC Topic 605, Revenue Recognition, revenue is recognized when there is persuasive evidence of an agreement, title has been transferred or delivery has occurred, the price is fixed and determinable, and collection is reasonably assured.

Manufacture and Supply Revenue – The Company records revenues when products are shipped and title passes to the customers.

Co-development and Research Fees – Co-development and research fees are earned through performance of specific tasks, activities or completion of stages of development defined within a contractual arrangement with a customer. The nature of these performance obligations, broadly referred to as milestones or deliverables, are usually dependent on the scope and structure of the project as contracted, as well as the complexity of the product and the specific regulatory approval path necessary for that product. Accordingly, the duration of the Company’s research and development projects may range from several months to approximately three years. Although each contractual arrangement is unique, common milestones included in these arrangements include those for the performance of efficacy and other tests, reports of findings, formulation of initial prototypes, production of stability clinical and/or scale-up batches, and stability testing of those batches. Additional milestones may be established and linked to clinical results of the product submission and/or approval of the product by the FDA and the commercial launch of the product. Co-development and research fees are recognized when related milestones are completed and delivered and, in some cases, accepted by the customer.

License and Royalty Revenue – License revenue is recognized in accordance with the terms of the license agreement. The Company’s license revenues most commonly are non-refundable once collected and are typically recognized as revenue at the time that the transferred licensed rights can be utilized for the benefit of the licensee, subject to determinable pricing, performance contingencies and collectability assessments. In the event that a licensing agreement requires the Company to meet ongoing or future performance objectives that are other than inconsequential or perfunctory, licensing revenue may be recognized ratably, or in conjunction with its performance obligations, during the initial term of the license agreement. If a performance obligation, milestone, or contingency exists, revenue is deferred until such time that the contingencies are satisfied, or obligations are met. Payments received in excess of amounts earned are classified as deferred revenue until performance obligations are satisfied. Royalty revenue is recognized in accordance with contractual rates when they can be reasonably estimated based on reported sales data and when collection is reasonably assured. In the event that reasonable sales data is unavailable, revenue is recognized when royalty reports are received.

Collaborative Arrangements – A contractual arrangement falls within the scope of FASB ASC Subtopic 808-10, Collaborative Arrangements, if the arrangement requires the parties to be active participants and the arrangement exposes the parties to significant risks that are tied to the commercial success of the endeavor. Costs incurred and revenues generated on sales to third parties are reported in the Consolidated Statement of Operations based on the guidance in FASB ASC Subtopic 605-45, Revenue Recognition – Principal Agent Considerations. Revenue earned from collaboration partners as of December 31, 2018 and 2017 was not material.

Proprietary Product sales - Revenues from proprietary product sales are recorded when the goods are shipped and title passes to the customer, typically at time of delivery. At the time of sale, estimates for several revenue deductions are recorded. When estimating the impact of these revenue deductions from gross sales for a reporting period, knowledge of historical trends and judgmental estimates are required for each deduction. For sales of Sympazan, returns allowances and prompt pay discounts are estimated based on historical return rates if available, as well as on contractual terms, and these estimates are recorded as a reduction of receivables. Estimates affecting accrued liabilities include those related to wholesaler service fees, co-pay card redemption costs as well as Medicare, Medicaid and other rebates which are similarly based on historical results and contract terms.

Total reductions of proprietary product sales for these various estimated allowances in 2018 were $591, of which $104 affected Accounts receivable and $487 affected Accrued expenses at December 31, 2018. There were no related allowances and accruals at December 31, 2017, as Sympazan was launched in December 2018.

(K) Research and Development

Costs incurred in connection with research and development activities are expensed as incurred. Research and development expenses include (i) employee-related expenses, including salaries, benefits, travel and share-based compensation expense, (ii) external research and development expenses incurred under arrangements with third parties, such as contract research and contract manufacturing organizations, investigational sites and consultants, (iii) the cost of acquiring, developing and manufacturing clinical study materials, and (iv) costs associated with preclinical and clinical activities and regulatory operations. Non-refundable advance payments for goods and services that will be used in future research and development activities are expensed when the activity is performed or when the goods have been received, rather than when payment is made, in accordance with ASC 730, Research and Development.

(L) Income Taxes

From its founding through October 31, 2017, the Company was a limited liability company (“LLC”) treated as a partnership for income tax purposes. From November 1, 2017 through December 31, 2017, the LLC elected to be taxed as a C corporation. On January 1, 2018, the LLC was converted into a Delaware corporation and incorporated as Aquestive Therapeutics, Inc.

Income taxes are recorded in accordance with FASB ASC Topic 740 Income Taxes, or ASC 740, which provides for deferred taxes using an asset and liability approach. Income taxes have been calculated on a separate tax return basis. Certain activities and costs have been included in the tax returns filed by our predecessor company, MonoSol Rx, LLC. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases using enacted tax rates in effect for the year in which the differences are expected to affect taxable income. Tax benefits are recognized when it is more likely than not that a tax position will be sustained during an audit. Valuation allowances are provided if, based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.

Uncertain tax positions are accounted for in accordance with the provision of ASC 740. When uncertain tax positions exist, the tax benefit is recognized to the extent that the benefit will more likely than not be realized. The determination as to whether the tax benefit will more likely than not be realized is based upon the technical merits of the tax position, as well as consideration of the available facts and circumstances. To date, the Company has not had any significant uncertain tax positions.

(M) Share-Based Compensation

The Company records share-based compensation expenses for awards of stock options and restricted stock units (RSUs) under ASC 718, Compensation — Stock Compensation, and ASC 505-50, Equity-based Payments to Non-Employees. This standard establishes guidance for the recognition of expenses arising from the issuance of stock-based compensation awards at their fair value at the grant date. Stock-based compensation expense for stock option awards granted after January 1, 2018 is based on their fair value on the grant date using the Black-Scholes-Merton model. Key inputs and assumptions include the stock price at the grant date, exercise price, both the contractual and estimated expected term of the option, and estimates of stock price volatility, expected dividends and a risk-free interest rate. These assumptions require estimates and judgements and changes in those inputs could impact the amount of expenses that are charged to earnings. The Company recognizes compensation expense for the fair value of restricted stock unit and stock option awards over the requisite service period of the award. All excess tax benefits, taxes and tax deficiencies from stock-based compensation are included in the provision for income taxes in the Consolidated Statement of Operations.

For issuances of share-based compensation prior to the Company’s conversion from an LLC to a C Corporation, the Company recorded expenses arising from awards of performance units, also based on ASC 718, Compensation – Stock Compensation. Prior to 2018, the Company issued share-based payments under the terms of its Performance Unit Plans (the “PUP Plans”). The cost of employee services received in exchange for equity-based awards was also based on the grant-date fair value of the awards, and expense measurement was determinable based on the increase of the fair value from the date of grant to the date of settlement. However, unlike the 2018 awards of stock options and RSUs, expense recognition for awards granted under the Company’s PUP Plans was required to be delayed until achievement of specified performance conditions could be considered probable. None of these performance conditions were met, or could be considered probable as of December 31, 2017 and, accordingly, no expenses were recognizable as of that date.

Subsequent to the Company’s conversion from an LLC to a C Corp, on April 16, 2018, these Performance Unit Plans were formally terminated through actions of both the Board of Directors and the required approvals of certain plan participants. As a result, vesting of any then-unvested performance units was accelerated and the Company issued non-voting common shares to compensate the performance unit holders. In accordance with ASC 718, Compensation — Stock Compensation, the Company recorded a total charge to earnings representing the cost of this compensation totaling $27,298, consisting of $19,123 which relates to the estimated fair market value at the issuance date of the 4,922,353 non-voting common shares and $8,175 related to withholding taxes which the Company committed to pay on behalf of the performance unit holders. This compensation expense was estimated using an independent third-party valuation prepared in accordance with the American Institute of Certified Public Accountants Practice Aide, Valuation of Privately-Held Company Equity Securities Issued as Compensation. Key assumptions inherent in this valuation included a 34% discount for lack of marketability, 90% volatility, a weighted average cost of capital of 27.5%. If we had made different assumptions in determinations of fair value at either the initial grant dates of the performance units or at the time of issuance of the non-voting common shares issued in settlement of those grants, our equity-based compensation expense, net loss and net loss per share of common stock could have been significantly different. Immediately prior to the consummation of the IPO, all of the Company’s outstanding shares of non-voting common stock that had been issued in April 2018 were automatically converted to 4,922,353 shares of the voting common stock of the Company.

(N) Per Share Data

Basic net loss per common share is computed by dividing the net loss attributable to common shareholders by the weighted average number of shares of common stock outstanding during the period.

Diluted net income per common share is calculated by dividing net income available to common shareholders as adjusted for the effect of dilutive securities, if any, by the weighted average number of shares of common stock and dilutive common stock outstanding during the period. Potentially dilutive common shares include the shares of common stock issuable upon the exercise of outstanding stock options and warrants, the shares of issued but unvested RSUs and the purchase of shares from the Company’s employee stock purchase plan (using the treasury stock method). For all periods presented, potential common shares have been excluded from the calculation of EPS because their effect would be anti-dilutive.

(O) Comprehensive Loss

Comprehensive loss includes net loss as well as other changes in shareholders’ equity that may result from transactions and economic events other than those with shareholders. For December 31, 2017, the change in members’ (deficit) was from transactions and other events and circumstances other than those resulting from investments by members and distributions to members.

(P) Fair Value Measurements

Certain assets and liabilities are reported on a recurring basis at fair value. Fair value is defined 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. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. Financial assets and liabilities carried at fair value are to be classified and disclosed in one of the following three levels of the fair value hierarchy, of which the first two are considered observable and the last is considered unobservable:

Level 1 — Quoted prices in active markets for identical assets or liabilities. Cash and cash equivalents consisted of cash in bank checking and savings accounts and money market funds which are all Level 1 assets.

Level 2 — Observable inputs (other than Level 1 quoted prices), such as quoted prices in active markets for similar assets or liabilities, quoted prices in markets that are not active for identical or similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data. The Company currently has no Level 2 assets or liabilities.

Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to determining the fair value of the assets or liabilities, including pricing models, discounted cash flow methodologies and similar techniques. As of December 31, 2018, the Company has no level 3 assets or liabilities.

The Company’s Level 3 liabilities at December 31, 2017 consisted of warrants totaling $7,673. The Company’s warrant liability was stated at fair value based primarily on an independent third-party appraisal prepared as of the reported balance sheet dates consistent with generally-accepted valuation methods of the Uniform Standards of Professional Appraisal Practice, the American Society of Appraisers and the American Institute of Certified Public Accountants’ Accounting and Valuation Guide, Valuation of Privately-Held Company Equity Securities Issued as Compensation. See Note 12 for further information on the Company’s warrants.

The carrying amounts reported in the balance sheets for trade and other receivables, prepaid and other current assets, accounts payable, accrued expenses and deferred revenue approximate fair value based on the short-term maturity of these assets and liabilities.

(Q) Segment Information

Operating segments are defined as components of an entity about which separate discrete information is available for evaluation by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. The Company manages its operations as a single segment for purposes of assessing performance and making operating decisions.

(R) Deferred Offering Costs

Deferred Offering costs, consisting primarily of direct incremental legal, accounting and other fees relating to the IPO, were capitalized as incurred. As of December 31, 2017, deferred offering costs of $1,050 were included as a component of Other Assets. Upon completion of the Company’s IPO in July 2018, deferred offering costs of $5,232 were reclassified from Other Assets to Additional Paid in Capital in the accompanying balance sheet.

(S) Recent Accounting Pronouncements

As a public emerging growth company, the Company has elected to take advantage of the extended transition period afforded by Jumpstart Our Business Startups Act for the implementation of new or revised accounting standards and, as a result, the Company will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for public emerging growth companies.

From time to time, new accounting pronouncements are issued by the FASB and adopted by the Company as of the specified effective date. Unless otherwise discussed, the Company believes that the impact of recently issued standards that are not yet effective will not have a material impact on its financial position or results of operations upon adoption.

Recently Adopted Accounting Pronouncements:

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting. This guidance simplifies aspects of accounting for employee share-based payments, including income tax consequences, classification of awards as either equity or liabilities, and classifications within the statement of cash flows. This guidance was effective for annual periods beginning after December 15, 2017, with early adoption permitted. Under the Company’s now-terminated Performance Unit Plans (Note 14), vested grants were unable to be exercised prior to either a change in control of the Company or completion of an IPO, and as a result, expense recognition related to the settlement of these awards was deferred until the plans were formally terminated in April 2018 (Notes 3.(M) and 14).Because the Company is in a net operating loss position that requires provision of a full valuation allowance, there was no financial statement impact of adopting the ASU 2016-09 provisions regarding recognition of tax effects associated with share-based compensation.

Recent Accounting Pronouncements Not Adopted as of December 31, 2018:

In May 2014, the FASB issued Accounting Standards Update No 2014-09,“Revenue from Contracts with Customers” (ASU 2014-09) and has subsequently issued a number of amendments to ASU 2014-09. The new standard, as amended, provides a single comprehensive model to be used in the accounting for revenue arising from contracts with customers and supersedes current revenue recognition guidance, including industry specific guidance. The standard’s stated core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To achieve this core principle, ASU 2014-09, includes provisions within a five-step model that includes (1) identifying the contract with a customer, (2) identifying the performance obligation in the contract, (3) determining the transaction price, (4) allocating the transaction price to the performance obligations, and (5) recognizing when, or as, an entity satisfies a performance obligation. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

The new standard will be effective for us beginning January 1, 2019 and permits two methods of adoption: the full retrospective method, which requires the standard to be applied to each prior period presented, or the modified retrospective method, which requires the cumulative effect adoption to be recognized as an adjustment to opening retained earnings in the period of adoption. The Company will adopt the standard using the modified retrospective method.

The Company has completed an analysis of existing contracts with its customers and assessed the differences in accounting for such contracts under ASU 2014-09 compared with the current revenue accounting standards.

The Company concluded that the implementation of ASU 2014-09 will accelerate the timing of revenue recognition of its manufacturing and supply product sales, however, these changes are not expected to be material to the Company’s consolidated financial statements.

In addition, the Company further analyzed its existing collaborative licensing contracts and determined that for certain arrangements the identified performance obligation under the new standard will be satisfied over time as opposed to a point in time revenue recognition dictated by the current standard. The cumulative effect of initially applying the new revenue standard approximates $3,700 and will be recorded as an adjustment to the opening balance of retained earnings.

In January 2016, the FASB issued revised guidance governing accounting and reporting of financial instruments (ASU 2016-01) and in 2018 issued technical corrections (ASU 2018-03). This guidance requires that equity investments with readily determinable fair values that are classified as available-for-sale be measured at fair value with changes in value reflected in current earnings. This guidance also simplifies the impairment testing of equity investments without readily determinable fair values and alters certain disclosure requirements. ASU No. 2016-01, Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities, also provides guidance as to classification of the change in fair value of financial liabilities. These revised standards are effective for the Company for annual periods in fiscal years beginning after December 15, 2018. Adoption of this standard is not expected to have a material impact on the financial statements considering the lack of any such equity investments at the present time.

In February 2016, the FASB issued ASU No. 2016-02,Leases (Topic 842) which establishes a comprehensive new lease accounting model. The new standard: (i) clarifies the definition of a lease; (ii) requires a dual approach to lease classification similar to current lease classifications; and (iii) causes lessees to recognize leases on the balance sheet as a lease liability with a corresponding right-of-use asset for leases with a lease-term of more than twelve months. The new standard is effective for the Company for fiscal years and interim periods beginning after December 15, 2019 and requires modified retrospective application. Early adoption is permitted. The Company is currently evaluating the impact that the adoption of ASU 2016-02 will have on its consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326), amending existing guidance on the accounting for credit losses on financial instruments within its scope. The guidance introduces an expected loss model for estimating credit losses, replacing the incurred loss model. The new guidance also changes the impairment model for available-for-sale debt securities, requiring the use of an allowance to record estimated credit losses (and subsequent recoveries). The new guidance is effective for the Company beginning after December 15, 2020. The Company is currently evaluating the impact of adoption on its consolidated financial statements.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, providing guidance on the classification of certain cash receipts and payments in the statement of cash flows intended to reduce diversity in practice, including cash flows related to debt prepayment or extinguishment costs and contingent consideration that may be paid following a business combination. The guidance is effective for the Company for fiscal years beginning after December 31, 2019. Early adoption is permitted. The Company is currently evaluating the effect of the standard on its Consolidated Statement of Cash Flows.

In June 2018, the FASB issued ASU 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting, which aligns accounting for share-based payments issued to nonemployees to that of employees under the existing guidance of Topic 718, with certain exceptions. This update supersedes previous guidance for equity-based payments to nonemployees under Subtopic 505-50, Equity—Equity-Based Payments to Non-Employees. ASU 2018-07 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company does not expect ASU 2018-07 to have a material impact on its financial statements.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework. The purpose of the update is to improve the effectiveness of the fair value measurement disclosures that allows for clear communication of information that is most important to the users of financial statements. There were certain required disclosures that have been removed or modified. In addition, the update added the following disclosures: (i) changes in unrealized gains and losses for the period included in other comprehensive income (loss) for recurring Level 3 fair value measurements held at the end of the reporting period and (ii) the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. The standard will become effective for the Company for its periods beginning after December 15, 2019; early adoption is permitted. The Company is currently evaluating the impact of ASU 2018-13 on its consolidated financial statements.

Other pronouncements issued by the FASB or other authoritative accounting standards groups with future effective dates are either not applicable or not significant to the consolidated financial statements of the Company.