10-Q 1 nbix-10q_20180331.htm 10-Q nbix-10q_20180331.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2018

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 0-22705

 

NEUROCRINE BIOSCIENCES, INC.

(Exact name of registrant as specified in its charter)

 

 

Delaware

 

33-0525145

(State or other jurisdiction of
incorporation or organization)

 

(IRS Employer
Identification No.)

 

 

 

12780 El Camino Real,
San Diego, California

 

92130

(Address of principal executive office)

 

(Zip Code)

 

(858) 617-7600

(Registrant’s telephone number, including area code)

Not Applicable

(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 check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T 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, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act:

 

Large accelerated filer

 

 

Accelerated filer

Non-accelerated filer

(Do not check if a smaller reporting company)

 

Smaller reporting company

Emerging growth company

 

 

 

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes      No  

The number of outstanding shares of the registrant’s common stock, par value $0.001 per share, was 89,897,863 as of April 25, 2018.

 

 

 


 

NEUROCRINE BIOSCIENCES, INC.

FORM 10-Q INDEX

 

 

 

PAGE

PART I. FINANCIAL INFORMATION

 

 

 

 

 

ITEM 1: Financial Statements

 

3

 

 

 

Condensed Consolidated Balance Sheets as of March 31, 2018 and December 31, 2017

 

3

 

 

 

Condensed Consolidated Statements of Operations and Comprehensive Loss for the three months ended March 31, 2018 and 2017

 

4

 

 

 

Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2018 and 2017

 

5

 

 

 

Notes to the Condensed Consolidated Financial Statements

 

6

 

 

 

ITEM 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

21

 

 

 

ITEM 3: Quantitative and Qualitative Disclosures About Market Risk

 

28

 

 

 

ITEM 4: Controls and Procedures

 

28

 

 

 

PART II. OTHER INFORMATION

 

 

 

 

 

ITEM 1: Legal Proceedings

 

29

 

 

 

ITEM 1A: Risk Factors

 

29

 

 

 

ITEM 5: Other Information

 

44

 

 

 

ITEM 6: Exhibits

 

45

 

 

 

Signatures

 

46

 

2


PART I. FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS

NEUROCRINE BIOSCIENCES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share information)

(unaudited)

 

 

 

March 31,

2018

 

 

December 31,

2017

 

ASSETS

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

175,311

 

 

$

254,712

 

Short-term investments, available for sale

 

 

285,168

 

 

 

261,217

 

Accounts receivable, net

 

 

44,624

 

 

 

31,127

 

Other current assets

 

 

8,613

 

 

 

7,863

 

Total current assets

 

 

513,716

 

 

 

554,919

 

Property and equipment, net

 

 

11,825

 

 

 

10,811

 

Long-term investments, available for sale

 

 

276,319

 

 

 

247,361

 

Restricted cash

 

 

4,500

 

 

 

4,500

 

Total assets

 

$

806,360

 

 

$

817,591

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

Accounts payable and accrued liabilities

 

$

45,650

 

 

$

53,520

 

Current portion of cease-use liability

 

 

 

 

 

62

 

Current portion of deferred gain on sale of real estate

 

 

731

 

 

 

731

 

Other current liabilities

 

 

85

 

 

 

113

 

Total current liabilities

 

 

46,466

 

 

 

54,426

 

Deferred gain on sale of real estate

 

 

7,860

 

 

 

8,043

 

Deferred revenue

 

 

10,231

 

 

 

10,231

 

Deferred rent

 

 

3,107

 

 

 

3,135

 

Convertible senior notes

 

 

374,209

 

 

 

369,618

 

Total liabilities

 

 

441,873

 

 

 

445,453

 

Commitments and contingencies

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

 

Preferred stock, $0.001 par value; 5,000,000 shares authorized; no shares

   issued and outstanding

 

 

 

 

 

 

Common stock, $0.001 par value; 220,000,000 shares authorized; issued and

   outstanding shares were 89,882,062 as of March 31, 2018 and 88,793,903

   as of December 31, 2017

 

 

90

 

 

 

89

 

Additional paid-in capital

 

 

1,608,778

 

 

 

1,572,765

 

Accumulated other comprehensive loss

 

 

(3,697

)

 

 

(1,850

)

Accumulated deficit

 

 

(1,240,684

)

 

 

(1,198,866

)

Total stockholders’ equity

 

 

364,487

 

 

 

372,138

 

Total liabilities and stockholders’ equity

 

$

806,360

 

 

$

817,591

 

 

See accompanying notes to the condensed consolidated financial statements.

3


NEUROCRINE BIOSCIENCES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(in thousands, except per share data)

(unaudited)

 

 

 

Three Months Ended

March 31,

 

 

 

2018

 

 

2017

 

Revenues:

 

 

 

 

 

 

 

 

Product sales, net

 

$

71,086

 

 

$

 

Total revenues

 

 

71,086

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

Cost of product sales

 

 

950

 

 

 

 

Research and development

 

 

48,947

 

 

 

51,882

 

Sales, general and administrative

 

 

58,636

 

 

 

28,050

 

Total operating expenses

 

 

108,533

 

 

 

79,932

 

Loss from operations

 

 

(37,447

)

 

 

(79,932

)

Other (expense) income:

 

 

 

 

 

 

 

 

Deferred gain on real estate

 

 

201

 

 

 

879

 

Interest expense

 

 

(7,504

)

 

 

 

Investment income, net

 

 

2,932

 

 

 

727

 

Total other (expense) income

 

 

(4,371

)

 

 

1,606

 

Net loss

 

$

(41,818

)

 

$

(78,326

)

Net loss per common share:

 

 

 

 

 

 

 

 

Basic and diluted

 

$

(0.47

)

 

$

(0.90

)

Shares used in the calculation of net loss per common share:

 

 

 

 

 

 

 

 

Basic and diluted

 

 

89,526

 

 

 

87,283

 

Other comprehensive loss:

 

 

 

 

 

 

 

 

Net loss

 

$

(41,818

)

 

$

(78,326

)

Net unrealized (losses) gains on available-for-sale securities

 

 

(1,847

)

 

 

83

 

Comprehensive loss

 

$

(43,665

)

 

$

(78,243

)

 

See accompanying notes to the condensed consolidated financial statements.

4


NEUROCRINE BIOSCIENCES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

 

 

 

Three Months Ended

March 31,

 

 

 

2018

 

 

2017

 

CASH FLOWS FROM OPERATING ACTIVITIES

 

 

 

 

 

 

 

 

Net loss

 

$

(41,818

)

 

$

(78,326

)

Adjustments to reconcile net loss to net cash used in operating activities:

 

 

 

 

 

 

 

 

Depreciation and amortization

 

 

786

 

 

 

489

 

Gain on sale of assets, net

 

 

(201

)

 

 

(879

)

Amortization of debt issuance costs

 

 

326

 

 

 

 

Amortization of debt discount

 

 

4,265

 

 

 

 

Deferred rent

 

 

(28

)

 

 

(114

)

Amortization of premiums on investments

 

 

512

 

 

 

269

 

Non-cash share-based compensation expense

 

 

19,879

 

 

 

8,976

 

Change in operating assets and liabilities:

 

 

 

 

 

 

 

 

Accounts receivable

 

 

(13,497

)

 

 

(779

)

Other current assets

 

 

(750

)

 

 

 

Accounts payable and accrued liabilities

 

 

(7,870

)

 

 

(6,927

)

Cease-use liability

 

 

(62

)

 

 

(66

)

Other liabilities

 

 

(28

)

 

 

 

Net cash used in operating activities

 

 

(38,486

)

 

 

(77,357

)

CASH FLOWS FROM INVESTING ACTIVITIES

 

 

 

 

 

 

 

 

Purchases of investments

 

 

(139,354

)

 

 

(57,877

)

Sales and maturities of investments

 

 

84,086

 

 

 

116,085

 

Proceeds from sales of property and equipment

 

 

18

 

 

 

 

Purchases of property and equipment

 

 

(1,800

)

 

 

(1,362

)

Net cash (used in) provided by investing activities

 

 

(57,050

)

 

 

56,846

 

CASH FLOWS FROM FINANCING ACTIVITIES

 

 

 

 

 

 

 

 

Issuance of common stock

 

 

16,135

 

 

 

1,531

 

Net cash provided by financing activities

 

 

16,135

 

 

 

1,531

 

Net decrease in cash, cash equivalents and restricted cash

 

 

(79,401

)

 

 

(18,980

)

Cash, cash equivalents and restricted cash at beginning of the period

 

 

259,212

 

 

 

88,150

 

Cash, cash equivalents and restricted cash at end of the period

 

$

179,811

 

 

$

69,170

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

See accompanying notes to the condensed consolidated financial statements.

5


NEUROCRINE BIOSCIENCES, INC.

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

Description of Business. Neurocrine Biosciences, Inc. (the Company or Neurocrine) was incorporated in California in 1992 and reincorporated in Delaware in 1996. The Company discovers, develops and commercializes innovative and life-changing pharmaceuticals, in diseases with high unmet medical needs, through its novel research and development (R&D) platform, focused on neurological and endocrine based diseases and disorders. In April 2017, the Company received approval from the United States Food and Drug Administration (FDA) for INGREZZA® (valbenazine), a vesicular monoamine transporter 2 (VMAT2) inhibitor for the treatment of tardive dyskinesia. The Company’s three lead late-stage clinical programs are elagolix, a gonadotropin-releasing hormone (GnRH) antagonist for women’s health that is partnered with AbbVie Inc. (AbbVie), INGREZZA for Tourette syndrome, and opicapone, a highly-selective catechol-O-methyltransferase inhibitor for the treatment of Parkinson’s disease.

Basis of Presentation. The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (GAAP) for interim financial information and with the instructions of the Securities and Exchange Commission (SEC) on Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and disclosures required by GAAP for complete financial statements. In the opinion of management, the condensed consolidated financial statements include all adjustments necessary, which are of a normal and recurring nature, for the fair presentation of the Company’s financial position and of the results of operations and cash flows for the periods presented. The accompanying unaudited condensed consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries.

These financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2017 included in the Company’s Annual Report on Form 10-K filed with the SEC. The results of operations for the interim period shown in this report are not necessarily indicative of the results that may be expected for any other interim period or for the full year. The balance sheet at December 31, 2017 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete financial statements.

Impact of Recently Issued Accounting Standards. In May 2014 the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes all existing revenue recognition requirements, including most industry-specific guidance. This new standard amends the guidance for the recognition of revenue from contracts with customers to transfer goods and services. The FASB subsequently issued additional, clarifying standards to address issues arising from implementation of the new revenue recognition standard. The Company adopted this new standard as of January 1, 2018 using the modified retrospective method. The adoption of the new revenue standards did not change the Company’s revenue recognition. As the Company did not identify any accounting changes that impacted the amount of reported revenues with respect to product revenues, or revenue from collaboration and license agreements, no adjustment to retained earnings was required upon adoption. See below for discussion of the Company’s Revenue Recognition policy.

In February 2016, the FASB issued ASU 2016-02 Leases. This update amends the current accounting guidance for lease transactions. Under the new guidance, a lessee will be required to recognize both assets and liabilities for any leases in excess of twelve months. Additionally, certain qualitative and quantitative disclosures will also be required in the financial statements. The Company is required to adopt this new guidance beginning in 2019 and early adoption is permitted. The Company’s lease for its corporate headquarters is subject to this new guidance and the Company is in the process of determining the impact of the adoption of this update will have on its condensed consolidated financial statements is ongoing.

In November 2016, the FASB issued ASU 2016-18, “Statement of Cash Flows (Topic 230): Restricted Cash”, which clarifies the presentation of restricted cash and restricted cash equivalents in the statements of cash flows. Under this ASU, restricted cash and restricted cash equivalents are included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts presented on the statements of cash flows. This ASU is intended to reduce diversity in practice in the classification and presentation of changes in restricted cash on the statement of cash flows. This ASU requires that the statement of cash flows explain the change in total cash and equivalents and amounts generally described as restricted cash or restricted cash equivalents when reconciling the beginning-of-period and end-of-period total amounts. This ASU also requires a reconciliation between the total of cash and equivalents and restricted cash presented on the statement of cash flows and the cash and equivalents balance presented on the balance sheet. This amended guidance was retrospectively adopted on January 1, 2018 and required that cash, cash equivalents and restricted cash reported on the Condensed Consolidated Statements of Cash Flows now includes restricted cash of $4.5 million and $5.1 million as of March 31, 2018 and 2017, respectively, as well as previously reported cash and cash equivalents.

6


Use of Estimates. The preparation of the condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and the accompanying notes. Actual results could differ from those estimates.

Inventory. Inventory is stated at the lower of cost or estimated net realizable value. The Company currently uses actual costing to determine the cost basis for its inventory. Inventory is valued on a first-in, first-out basis and consists primarily of third-party manufacturing costs. The Company capitalizes inventory costs associated with its products upon regulatory approval when, based on management’s judgment, future commercialization is considered probable and the future economic benefit is expected to be realized; otherwise, such costs are expensed.

Prior to FDA approval of INGREZZA, all costs related to its manufacturing were charged to research and development expense in the period incurred. At March 31, 2018 and December 31, 2017, the Company’s physical inventory included active pharmaceutical product (API) that had been produced prior to FDA approval of INGREZZA and accordingly has no cost basis as the cost associated with producing this material was expensed rather than capitalized in accordance with authoritative guidance. Additionally, manufacturing of bulk drug product, finished bottling and other labeling activities that occurred post FDA approval are included in the inventory value at March 31, 2018 and December 31, 2017.

The Company provides reserves for potential excess, dated or obsolete inventory based on an analysis of forecasted demand compared to quantities on hand and any firm purchase orders, as well as product shelf life. To date, the Company has determined that such reserves are not required.

Cost of Product Sales. Cost of product sales consists of third-party manufacturing costs, transportation and freight, and indirect overhead costs associated with the manufacture and distribution of INGREZZA. Cost of product sales may also include period costs related to certain inventory manufacturing services, inventory adjustment charges as well as manufacturing variances. A significant portion of the cost of producing the product sold to date was expensed as R&D prior to the Company’s New Drug Application (NDA) approval for INGREZZA and therefore is not included in the cost of product sales during this period.

Accounts Receivable. Accounts receivable are recorded net of customer allowances for prompt payment discounts, chargebacks, and any allowance for doubtful accounts. The Company estimates the allowance for doubtful accounts based on existing contractual payment terms, actual payment patterns of its customers and individual customer circumstances. To date, the Company has determined that an allowance for doubtful accounts is not required.

Research and Development Expenses. R&D expenses consist primarily of salaries, payroll taxes, employee benefits, and share-based compensation charges, for those individuals involved in ongoing R&D efforts; as well as scientific contractor fees, development milestones from in-licensed collaboration agreements, preclinical and clinical trial costs, R&D facilities costs, laboratory supply costs, and depreciation of scientific equipment. All such costs are charged to R&D expense as incurred. These expenses result from the Company’s independent R&D efforts as well as efforts associated with collaborations and in-licensing arrangements. In addition, the Company funds R&D at other companies and research institutions under agreements, which are generally cancelable. The Company reviews and accrues clinical trial expenses based on work performed, which relies on estimates of total costs incurred based on patient enrollment, completion of patient studies and other events. The Company follows this method since reasonably dependable estimates of the costs applicable to various stages of a research agreement or clinical trial can be made. Accrued clinical costs are subject to revisions as trials progress. Revisions are charged to expense in the period in which the facts that give rise to the revision become known.

7


Revenue Recognition. Effective January 1, 2018, the Company adopted Topic 606, using the modified retrospective method, which it elected to apply to all contracts.   As the Company did not identify any revenue recognition differences when comparing the revenue recognition criteria under Topic 606 to the requirements under previous criteria with respect to product revenues, or revenue from collaboration and license agreements, no cumulative effect adjustment to retained earnings was necessary upon adoption. See the Company’s Annual Report on Form 10-K filed with the SEC for the year ended December 31, 2017 for a detailed description of the Company’s accounting policy under Topic 605 which was effective for periods prior to January 1, 2018.  The Company’s revenues for the first quarter of 2018, had the Company continued to account for revenue recognition under Topic 605, would not have differed by a significant amount from those reported under Topic 606.

Under Topic 606, the Company recognizes revenues when its customers obtain control of its products or services in an amount that reflects the consideration it expects to receive from its customers in exchange for those products or services. To determine revenue recognition, the Company performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the Company satisfies the performance obligation. The Company only applies the five-step model to contracts when it is probable that the entity will collect the consideration it is entitled to in exchange for the goods or services it transfers to the customer.  At contract inception, once the contract is determined to be within the scope of Topic 606, the Company assesses the goods or services promised within each contract and determines those that are performance obligations, and assesses whether each promised good or service is distinct.  The Company then recognizes as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.

If the consideration promised under the contract includes a variable amount, the Company must estimate the consideration it expects to receive for transferring the good or service to the customer. There are two methods for determining the amount of variable consideration: (i) the expected value method, which is the sum of probability-weighted amounts in a range of possible consideration amounts, and; (ii) the mostly likely amount method, which identifies the single most likely amount in a range of possible consideration amounts. Performance milestone payments represent a form of variable consideration.

Product Sales, Net.  The Company’s product sales consist of U.S. sales of INGREZZAINGREZZA was approved by the FDA on April 11, 2017 and the Company commenced shipments of INGREZZA to select pharmacies (SPs) and a select distributor (SD), or collectively, its customers, in late April 2017. The SPs dispense product to a patient based on the fulfillment of a prescription and the SD sells product to government facilities, long-term care pharmacies or in-patient hospital pharmacies. The Company’s agreements with the SPs and SD provide for transfer of title to the product at the time the product is delivered to the SP or SD. In addition, except for limited circumstances, the SPs and SDs have no right of product return to the Company. Product sales are recognized when the customer obtains control of the Company’s product, typically upon delivery to the customer.

Revenue from product sales are recorded at the net sales price (transaction price), which includes an estimate of variable consideration for which reserves are established and which results from contractual discounts, returns, chargebacks, rebates, co-pay assistance and other allowances relating to the Company’s sales of its products.  These reserves are based on the amounts earned or to be claimed on the related sales and are classified as reductions of accounts receivable (if the amount is payable to the customer) or a current liability (if the amount is payable to a party other than a customer).  Where appropriate, these estimates take into consideration a range of possible outcomes that are probability-weighted for relevant factors such as the Company’s historical experience, current contractual and statutory requirements, specific known market events and trends, industry data and forecasted customer buying and payment patterns.  Overall, these reserves reflect the Company’s best estimates of the amount of consideration to which it is entitled based on the terms of the contract.  The amount of variable consideration that is included in the transaction price may be constrained, and is included in the net sales price only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue recognized will not occur in a future period.  Actual amounts of consideration ultimately received may differ from the Company’s estimates.  If actual results in the future vary from the Company’s estimates, the Company will adjust these estimates, which would affect net product revenue and earnings in the period such variances become known. The following are the Company’s significant categories of sales discounts and allowances:

Trade Discounts and Allowances: The Company generally provides customers with discounts that include prompt payment discounts, discounts for providing sales data, and other off-invoice discounts that are explicitly stated in the Company’s contracts and are recorded as a reduction of revenue in the period the related product revenue is recognized.  

Product Returns: The Company offers customers limited product return rights for damages and shipment errors provided it is within a very limited period after the original shipping date as set forth in the applicable individual distribution agreement. The Company does not allow product returns for product that has been dispensed to a patient or for drug expiration. The Company receives real-time shipping reports and inventory reports from the customers and has the ability to control the amount of product that is sold to the customers. Product returns to date have not been significant and the Company has not considered it necessary to record a reserve for product returns.

8


Government Rebates: The Company is subject to discount obligations under state Medicaid programs and Medicare prescription drug coverage gap program.  The Company estimates its Medicaid and Medicare prescription drug coverage gap rebates based upon a range of possible outcomes that are probability-weighted for the estimated payor mix. These reserves are recorded in the same period the related revenue is recognized, resulting in a reduction of product revenue and the establishment of a current liability that is included in accrued expenses on the condensed consolidated balance sheet.   The Company’s liability for these rebates consists of invoices received for claims from prior quarters that have not been paid or for which an invoice has not yet been received, estimates of claims for the current quarter, and estimated future claims that will be made for product that has been recognized as revenue, but remains in the distribution channel inventories at the end of each reporting period.

Provider Chargebacks and Discounts: Chargebacks for fees and discounts to providers represent the estimated obligations resulting from contractual commitments to sell products to qualified healthcare providers at prices lower than the list prices charged to customers who directly purchase the product from the Company.  Customers charge the Company for the difference between what they pay for the product and the ultimate selling price to the qualified healthcare providers.  These reserves are established in the same period that the related revenue is recognized, resulting in a reduction of product revenue and accounts receivable.  Chargeback amounts are generally determined at the time of resale to the qualified healthcare provider by customers, and the Company generally issues credits for such amounts following the customer’s notification to the Company of the resale.  Reserves for chargebacks consist of credits that the Company expects to issue for units that remain in the distribution channel inventories at each reporting period end that the Company expects will be sold to qualified healthcare providers.

Co-Payment Assistance: The Company offers co-payment assistance to commercially insured patients meeting certain eligibility requirements. The calculation of the accrual for co-pay assistance is based on an estimate of claims and the cost per claim that the Company expects to receive associated with product that has been recognized as revenue, but remains in the distribution channel inventories at the end of each reporting period.

Shipping and handling costs related to the Company’s product sales are included in selling, general and administrative expenses.

Collaborative Research and Development Agreements The Company enters into collaboration and licensing agreements that are within the scope of Topic 606, under which it licenses certain rights to its product candidates to third parties.  The terms of these arrangements typically include payment to the Company of one or more of the following: non-refundable, up-front license fees; development, regulatory and commercial milestone payments; payments for manufacturing supply services; and royalties on net sales of licensed products.  

In determining the appropriate amount of revenue to be recognized as the Company fulfills its obligations under each of its agreements, the Company performs the following steps: (i) identification of the promised goods or services in the contract; (ii) determination of whether the promised goods or services are performance obligations including whether they are distinct in the context of the contract; (iii) measurement of the transaction price, including the constraint on variable consideration; (iv) allocation of the transaction price to the performance obligations; and (v) recognition of revenue when (or as) the Company satisfies each performance obligation.  As part of the accounting for these arrangements, the Company must develop assumptions that require judgment to determine the stand-alone selling price for each performance obligation identified in the contract.  The Company uses key assumptions to determine the stand-alone selling price, which may include forecasted revenues, development timelines, reimbursement rates for personnel costs, discount rates and probabilities of technical and regulatory success.

Licenses of Intellectual Property:  If the license to the Company’s intellectual property is determined to be distinct from the other performance obligations identified in the arrangement, the Company recognizes revenues from non-refundable, up-front fees allocated to the license when the license is transferred to the licensee and the licensee is able to use and benefit from the license.  For licenses that are bundled with other promises, the Company utilizes judgment to assess the nature of the combined performance obligation to determine whether the combined performance obligation is satisfied over time or at a point in time and, if over time, the appropriate method of measuring progress for purposes of recognizing revenue from non-refundable, up-front fees.  The Company evaluates the measure of progress each reporting period and, if necessary, adjusts the measure of performance and related revenue recognition.

Milestone Payments:  At the inception of each arrangement that includes development, commercialization and regulatory milestone payments, the Company evaluates whether the milestones are considered probable of being reached and estimates the amount to be included in the transaction price using the most likely amount method.  If it is probable that a significant revenue reversal would not occur, the associated milestone value is included in the transaction price.  Milestone payments that are not within the control of the Company or the licensee, such as regulatory approvals, are not considered probable of being achieved until those approvals are received.  The transaction price is then allocated to each performance obligation on a relative stand-alone selling price basis, for which the Company recognizes revenue as or when the performance obligations under the contract are satisfied.  At the end of each subsequent reporting period, the Company re-evaluates the probability of achievement of such development milestones and any related constraint, and if necessary, adjusts its estimate of the overall transaction price.  Any such adjustments are recorded on a cumulative catch-up basis, which would affect milestone and license fees revenues and earnings in the period of adjustment.

9


Manufacturing Supply Services:  Arrangements that include a promise for future supply of drug substance or drug product for either clinical development or commercial supply at the licensee’s discretion are generally considered as options.  The Company assesses if these options provide a material right to the licensee and if so, they are accounted for as separate performance obligations.  

Royalties:  For arrangements that include sales-based royalties, including milestone payments based on the level of sales, and the license is deemed to be the predominant item to which the royalties relate, the Company recognizes revenue at the later of (i) when the related sales occur, or (ii) when the performance obligation to which some or all of the royalty has been allocated has been satisfied (or partially satisfied).  To date, the Company has not recognized any royalty revenue resulting from any of its out-licensing arrangements.

The Company receives payments from its licensees based on billing schedules established in each contract.  Up-front payments and fees are recorded as deferred revenue upon receipt or when due, and may require deferral of revenue recognition to a future period until the Company performs its obligations under these arrangements.  Amounts are recorded as accounts receivable when the Company’s right to consideration is unconditional. 

2. SIGNIFICANT COLLABORATIVE RESEARCH AND DEVELOPMENT AGREEMENTS

Mitsubishi Tanabe Pharma Corporation (Mitsubishi Tanabe). During 2015, the Company entered into a collaboration and license agreement with Mitsubishi Tanabe for the development and commercialization of INGREZZA for movement disorders in Japan and other select Asian markets. Mitsubishi Tanabe made an up-front license fee of $30 million and has agreed to make payments up to $85 million in development and commercialization event-based payments, payments for the manufacture of pharmaceutical products, and royalties on product sales in select territories in Asia. Under the terms of the agreement, Mitsubishi Tanabe is responsible for all third-party development, marketing and commercialization costs in Japan and other select Asian markets. The Company will be entitled to a percentage of sales of INGREZZA in Japan and other select Asian markets for the longer of ten years or the life of the related patent rights.

Under the terms of the Company’s agreement with Mitsubishi Tanabe, the collaboration effort between the parties to advance INGREZZA towards commercialization in Japan and other select Asian markets is governed by a joint steering committee and joint development committee with representatives from both the Company and Mitsubishi Tanabe. There are no performance, cancellation, termination or refund provisions in the agreement that would have a material financial consequence to the Company. The Company does not directly control when event-based payments will be achieved or when royalty payments will begin. Mitsubishi Tanabe may terminate the agreement at its discretion upon 180 days’ written notice to the Company. In such event, all INGREZZA product rights for Japan and other select Asian markets would revert to the Company.

The Company assessed this arrangement in accordance with Topic 606 and identified the following material promises under the  agreement: (i) INGREZZA technology license and existing know-how; and (ii) development activities to initiate a clinical trial of INGREZZA for Huntington’s chorea, at an estimated cost of approximately $12 million, should Mitsubishi Tanabe request. The Company has the option to participate on the joint steering committee, but since participation is at the Company’s option it was deemed to not be a material promise. The option for Mitsubishi Tanabe to engage the Company to manufacture and supply pharmaceutical products, not at a discount, was not considered a material right and therefore not a material promise.  Based on these assessments, the Company identified the license and the development activities as the only performance obligations at the inception of the agreement, which were both deemed to be distinct.

Under the terms of the agreement, in order to evaluate the appropriate transaction price, the Company determined that the up-front amount constituted the entirety of the consideration to be included in the transaction price and to be allocated to the performance obligations based on the Company’s best estimate of their relative stand-alone selling prices.  For the license, the stand-alone selling price was calculated using an income approach model and included the following key assumptions: the development timeline, revenue forecast, discount rate and probabilities of technical and regulatory success.  The relative selling price of the Company’s development activities to initiate a clinical trial of INGREZZA for Huntington’s chorea was based on an assessment of costs to perform the study, based upon the peer company analysis for similar studies.  The Company believes that a change in the assumptions used to determine its stand-alone selling price for the license most likely would not have a significant effect on the allocation of consideration received (or receivable) to the performance obligations.

At execution, the transaction price included only the $30 million up-front consideration received.  None of the development or regulatory milestones has been included in the transaction price, as all milestone amounts were fully constrained.  As part of its evaluation of the constraint, the Company considered numerous factors, including that receipt of the milestones is outside the control of the Company and contingent upon success in future clinical trials and the licensee’s efforts.  Any consideration related to sales-based milestones (including royalties) will be recognized when the related sales occur as they were determined to relate predominantly to the license granted to Mitsubishi Tanabe and therefore have also been excluded from the transaction price.  The Company will re-evaluate the transaction price in each reporting period and as uncertain events are resolved or other changes in circumstances occur.

10


To date, the Company has recognized revenue under this agreement of $19.8 million associated with the delivery of a technology license and existing know-how, and $15 million in development event-based payments resulting from Mitsubishi Tanabe’s initiation of Phase II/III development of INGREZZA in TD in Asia. In accordance with our continuing performance obligations, $10.2 million of the $30 million up-front payment is being deferred and recognized in future periods. Under the terms of the agreement, there is no general obligation to return the up-front payment for any non-contingent deliverable. No revenue was recognized under the Mitsubishi Tanabe agreement for the quarters ended March 31, 2018 or 2017.

AbbVie Inc. (AbbVie). In June 2010, the Company announced an exclusive worldwide collaboration with AbbVie, to develop and commercialize elagolix and all next-generation GnRH antagonists (collectively, GnRH Compounds) for women’s and men’s health. AbbVie made an upfront payment of $75 million and has agreed to make additional development and regulatory event-based payments of up to $480 million, of which $75 million has been earned to date, and up to an additional $50 million in commercial event-based payments.

Under the terms of the agreement, AbbVie is responsible for all third-party development, marketing and commercialization costs. The Company will be entitled to a percentage of worldwide sales of GnRH Compounds for the longer of ten years or the life of the related patent rights. AbbVie may terminate the collaboration at its discretion upon 180 days’ written notice to the Company. In such event, the Company would be entitled to specified payments for ongoing clinical development and related activities and all GnRH Compound product rights would revert to the Company.

The Company has evaluated the terms of this agreement under Topic 606 and has determined that there is one performance obligation, the exclusive worldwide license with rights to develop, manufacture and commercialize elagolixAt execution, the transaction price included only the $75 million up-front consideration received.  None of the development or regulatory milestones has been included in the transaction price, as all milestone amounts were fully constrained.  As part of its evaluation of the constraint, the Company considered numerous factors, including that receipt of the milestones is outside the control of the Company and contingent upon success in future clinical trials and the licensee’s efforts.  Any consideration related to sales-based milestones (including royalties) will be recognized when the related sales occur as they were determined to relate predominantly to the license granted to AbbVie and therefore have also been excluded from the transaction price.  The Company will re-evaluate the transaction price in each reporting period and as uncertain events are resolved or other changes in circumstances occur.

During 2017, event-based revenue of $30.0 million was recognized based on AbbVie’s NDA submission for elagolix in endometriosis being accepted as filed by the FDA. During 2016, event-based revenue of $15.0 million was recognized related to AbbVie’s initiation of Phase III development of elagolix in uterine fibroids. No revenue was recognized under the AbbVie agreement for the quarters ended March 31, 2018 or 2017.  

3. INVESTMENTS

Available-for-sale securities are carried at fair value, with the unrealized gains and losses reported in comprehensive loss. The amortized cost of debt securities in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization and accretion is included in investment income. Realized gains and losses and declines in value judged to be other-than-temporary, if any, on available-for-sale securities are included in investment income or expense. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in investment income.

Investments consist of the following (in thousands):

 

 

 

March 31,

2018

 

 

December 31,

2017

 

Commercial paper

 

$

41,993

 

 

$

75,362

 

Corporate debt securities

 

 

501,103

 

 

 

414,815

 

Securities of government sponsored entities

 

 

18,391

 

 

 

18,401

 

Total investments

 

$

561,487

 

 

$

508,578

 

 

11


The following is a summary of investments classified as available-for-sale securities (in thousands):

 

 

 

Contractual

Maturity

(in years)

 

Amortized

Cost

 

 

Gross

Unrealized

Gains(1)

 

 

Gross

Unrealized

Losses(1)

 

 

Aggregate

Estimated

Fair

Value

 

March 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Classified as current assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial paper

 

Less than 1

 

$

42,105

 

 

$

 

 

$

(112

)

 

$

41,993

 

Corporate debt securities

 

Less than 1

 

 

236,818

 

 

 

 

 

 

(1,127

)

 

 

235,691

 

Securities of government-sponsored entities

 

Less than 1

 

 

7,501

 

 

 

 

 

 

(17

)

 

 

7,484

 

Total short-term available-for-sale securities

 

 

 

$

286,424

 

 

$

 

 

$

(1,256

)

 

$

285,168

 

Classified as non-current assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

1 to 2

 

$

267,756

 

 

$

 

 

$

(2,344

)

 

$

265,412

 

Securities of government-sponsored entities

 

1 to 2

 

 

11,004

 

 

 

 

 

 

(97

)

 

 

10,907

 

Total long-term available-for-sale securities

 

 

 

$

278,760

 

 

$

 

 

$

(2,441

)

 

$

276,319

 

December 31, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Classified as current assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial paper

 

Less than 1

 

$

75,396

 

 

$

1

 

 

$

(35

)

 

$

75,362

 

Corporate debt securities

 

Less than 1

 

 

178,776

 

 

 

 

 

 

(400

)

 

 

178,376

 

Securities of government-sponsored entities

 

Less than 1

 

 

7,503

 

 

 

 

 

 

(24

)

 

 

7,479

 

Total short-term available-for-sale securities

 

 

 

$

261,675

 

 

$

1

 

 

$

(459

)

 

$

261,217

 

Classified as non-current assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Corporate debt securities

 

1 to 2

 

$

237,749

 

 

$

 

 

$

(1,310

)

 

$

236,439

 

Securities of government-sponsored entities

 

1 to 2

 

 

11,004

 

 

 

 

 

 

(82

)

 

 

10,922

 

Total long-term available-for-sale securities

 

 

 

$

248,753

 

 

$

 

 

$

(1,392

)

 

$

247,361

 

 

(1)

Unrealized gains and losses are included in other comprehensive loss.

The following table presents gross unrealized losses and fair value for those available-for-sale investments that were in an unrealized loss position as of March 31, 2018 and December 31, 2017, aggregated by investment category and length of time that individual securities have been in a continuous loss position (in thousands):

 

 

 

Less Than 12 Months

 

 

12 Months or Greater

 

 

Total

 

 

 

Estimated

Fair

Value

 

 

Unrealized

Losses

 

 

Estimated

Fair

Value

 

 

Unrealized

Losses

 

 

Estimated

Fair

Value

 

 

Unrealized

Losses

 

March 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial paper

 

$

41,993

 

 

$

(112

)

 

$

 

 

$

 

 

$

41,993

 

 

$

(112

)

Corporate debt securities

 

 

481,836

 

 

 

(3,409

)

 

 

19,267

 

 

 

(62

)

 

 

501,103

 

 

 

(3,471

)

Securities of government-sponsored entities

 

 

10,907

 

 

 

(97

)

 

 

7,484

 

 

 

(17

)

 

 

18,391

 

 

 

(114

)

Total

 

$

534,736

 

 

$

(3,618

)

 

$

26,751

 

 

$

(79

)

 

$

561,487

 

 

$

(3,697

)

December 31, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Commercial paper

 

$

62,602

 

 

$

(35

)

 

$

 

 

$

 

 

$

62,602

 

 

$

(35

)

Corporate debt securities

 

 

386,728

 

 

 

(1,660

)

 

 

28,087

 

 

 

(50

)

 

 

414,815

 

 

 

(1,710

)

Securities of government-sponsored entities

 

 

10,922

 

 

 

(82

)

 

 

7,479

 

 

 

(24

)

 

 

18,401

 

 

 

(106

)

Total

 

$

460,252

 

 

$

(1,777

)

 

$

35,566

 

 

$

(74

)

 

$

495,818

 

 

$

(1,851

)

 

The primary objective of the Company’s investment portfolio is to enhance overall returns in an efficient manner while maintaining safety of principal, prudent levels of liquidity and acceptable levels of risk. The Company’s investment policy limits interest-bearing security investments to certain types of instruments issued by institutions with primarily investment grade credit ratings and places restrictions on maturities and concentration by asset class and issuer.

12


The Company reviews the available-for-sale investments for other-than-temporary declines in fair value below cost basis each quarter and whenever events or changes in circumstances indicate that the cost basis of an asset may not be recoverable. This evaluation is based on a number of factors, including the length of time and the extent to which the fair value has been below the cost basis and adverse conditions related specifically to the security, including any changes to the credit rating of the security, and the intent to sell, or whether the Company will more likely than not be required to sell the security before recovery of its amortized cost basis. The assessment of whether a security is other-than-temporarily impaired could change in the future due to new developments or changes in assumptions related to any particular security. As of March 31, 2018 and December 31, 2017, the Company believed the cost bases for available-for-sale investments were recoverable in all material respects.

4. FAIR VALUE MEASUREMENTS

Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, a three-tier fair value hierarchy has been established, 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 include quoted prices for similar instruments in active markets and/or quoted prices for identical or similar instruments in markets that are not active near the measurement date; and

 

Level 3:

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

The Company classifies its cash equivalents and available for sale investments within Level 1 or Level 2. The fair value of the Company’s high quality investment grade corporate debt securities is determined using proprietary valuation models and analytical tools. These valuation models and analytical tools use market pricing or prices for similar instruments that are both objective and publicly available, including matrix pricing or reported trades, benchmark yields, broker/dealer quotes, issuer spreads, two-sided markets, benchmark securities, bids and/or offers. The Company did not reclassify any investments between levels in the fair value hierarchy during the three months ended March 31, 2018.

13


The Company’s assets which were measured at fair value on a recurring basis as of March 31, 2018 and December 31, 2017 were determined using the inputs described above and are as follows (in millions):

 

 

 

 

 

 

 

Fair Value Measurements Using

 

 

 

Carrying

Value

 

 

Quoted Prices

in Active

Markets for

Identical Assets

(Level 1)

 

 

Significant

Other

Observable

Inputs

(Level 2)

 

 

Significant

Unobservable

Inputs

(Level 3)

 

March 31, 2018:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Classified as current assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and money market funds

 

$

147.4

 

 

$

147.4

 

 

$

 

 

$

 

Commercial paper

 

 

69.9

 

 

 

 

 

 

69.9

 

 

 

 

Securities of government-sponsored entities

 

 

7.5

 

 

 

 

 

 

7.5

 

 

 

 

Corporate debt securities

 

 

235.7

 

 

 

 

 

 

235.7

 

 

 

 

Subtotal

 

 

460.5

 

 

 

147.4

 

 

 

313.1

 

 

 

 

Classified as long-term assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and money market funds

 

 

1.5

 

 

 

1.5

 

 

 

 

 

 

 

Certificates of deposit

 

 

3.0

 

 

 

3.0

 

 

 

 

 

 

 

Securities of government-sponsored entities

 

 

10.9

 

 

 

 

 

 

10.9

 

 

 

 

Corporate debt securities

 

 

265.4

 

 

 

 

 

 

265.4

 

 

 

 

Total

 

 

741.3

 

 

 

151.9

 

 

 

589.4

 

 

 

 

Less cash, cash equivalents and restricted cash

 

 

(179.8

)

 

 

(151.9

)

 

 

(27.9

)

 

 

 

Total investments

 

$

561.5

 

 

$

-

 

 

$

561.5

 

 

$

 

December 31, 2017:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Classified as current assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and money market funds

 

$

170.2

 

 

$

170.2

 

 

$

 

 

$

 

Commercial paper

 

 

159.9

 

 

 

 

 

 

159.9

 

 

 

 

Securities of government-sponsored entities

 

 

7.5

 

 

 

 

 

 

7.5

 

 

 

 

Corporate debt securities

 

 

178.4

 

 

 

 

 

 

178.4

 

 

 

 

Subtotal

 

 

516.0

 

 

 

170.2

 

 

 

345.8

 

 

 

 

Classified as long-term assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and money market funds

 

 

1.5

 

 

 

1.5

 

 

 

 

 

 

 

Certificates of deposit

 

 

3.0

 

 

 

3.0

 

 

 

 

 

 

 

Securities of government-sponsored entities

 

 

10.9

 

 

 

 

 

 

10.9

 

 

 

 

Corporate debt securities

 

 

236.4

 

 

 

 

 

 

236.4

 

 

 

 

Total

 

 

767.8

 

 

 

174.7

 

 

 

593.1

 

 

 

 

Less cash, cash equivalents and restricted cash

 

 

(259.2

)

 

 

(174.6

)

 

 

(84.6

)

 

 

 

Total investments

 

$

508.6

 

 

$

0.1

 

 

$

508.5

 

 

$

 

 

5. CONVERTIBLE SENIOR NOTES

On May 2, 2017, the Company completed a private placement of $517.5 million in aggregate principal amount of 2.25% convertible senior notes due 2024 (2024 Notes) and entered into an indenture agreement (2024 Indenture) with respect to the 2024 Notes. The 2024 Notes accrue interest at a fixed rate of 2.25% per year, payable semiannually in arrears on May 15 and November 15 of each year, beginning on November 15, 2017. The 2024 Notes mature on May 15, 2024. The net proceeds from the issuance of the 2024 Notes were approximately $502.8 million, after deducting commissions and the offering expenses payable by the Company.

Holders of the 2024 Notes may convert the 2024 Notes at any time prior to the close of business on the business day immediately preceding May 15, 2024, only under the following circumstances:

 

(i)

during any calendar quarter commencing after the calendar quarter ending on September 30, 2017 (and only during such calendar quarter), if the last reported sale price of the Company’s common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than 130% of the conversion price on each applicable trading day;

14


 

(ii)

during the five business-day period immediately after any five consecutive trading-day period (the ‘‘measurement period’’) in which the trading price (as defined in the 2024 Indenture) per $1,000 principal amount of the 2024 Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price of the Company’s common stock and the conversion rate on each such trading day;

 

(iii)

upon the occurrence of specified corporate events, including a merger or a sale of all or substantially all of the Company’s assets; or

 

(iv)

if the Company calls the 2024 Notes for redemption, until the close of business on the business day immediately preceding the redemption date.

On or after January 15, 2024, until the close of business on the scheduled trading day immediately preceding May 15, 2024, holders may convert their 2024 Notes at any time.

Upon conversion, holders will receive the principal amount of their 2024 Notes and any excess conversion value, calculated based on the per share volume-weighted average price for each of the 30 consecutive trading days during the observation period (as more fully described in the 2024 Indenture). For both the principal and excess conversion value, holders may receive cash, shares of the Company’s common stock or a combination of cash and shares of the Company’s common stock, at the Company’s option.

It is the Company’s intent and policy to settle conversions through combination settlement, which essentially involves repayment of an amount of cash equal to the “principal portion” and delivery of the “share amount” in excess of the principal portion in shares of common stock or cash. In general, for each $1,000 in principal, the “principal portion” of cash upon settlement is defined as the lesser of $1,000, and the conversion value during the 25-day observation period as described in the indenture for the notes. The conversion value is the sum of the daily conversion value which is the product of the effective conversion rate divided by 25 days and the daily volume weighted average price (VWAP) of the Company’s common stock. The “share amount” is the cumulative “daily share amount” during the observation period, which is calculated by dividing the daily VWAP into the difference between the daily conversion value (i.e., conversion rate x daily VWAP) and $1,000.

The initial conversion rate for the 2024 Notes is 13.1711 shares of common stock per $1,000 principal amount, which is equivalent to an initial conversion price of approximately $75.92 per share of the Company’s common stock. The conversion rate will be subject to adjustment in some events but will not be adjusted for any accrued and unpaid interest. The initial conversion price of the 2024 Notes represents a premium of approximately 42.5% to the closing sale price of $53.28 per share of the Company’s common stock on the NASDAQ Global Select Market on April 26, 2017, the date that the Company priced the private offering of the 2024 Notes.

In the event of conversion, holders would forgo all future interest payments, any unpaid accrued interest and the possibility of further stock price appreciation. Upon the receipt of conversion requests, the settlement of the 2024 Notes will be paid pursuant to the terms of the 2024 Indenture. In the event that all of the 2024 Notes are converted, the Company would be required to repay the $517.5 million in principal value and any conversion premium in any combination of cash and shares of its common stock (at the Company’s option).

Prior to May 15, 2021, the Company may not redeem the 2024 Notes. On or after May 15, 2021, the Company may redeem for cash all or part of the 2024 Notes if the last reported sale price (as defined in the 2024 Indenture) of the Company’s common stock has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading-day period ending on, and including, the trading day immediately before the date which the Company provides notice of redemption. The redemption price will equal the sum of (i) 100% of the principal amount of the 2024 Notes being redeemed, plus (ii) accrued and unpaid interest, including additional interest, if any, to, but excluding, the redemption date. No sinking fund is provided for the 2024 Notes.

If the Company undergoes a fundamental change, as defined in the 2024 Indenture, subject to certain conditions, holders of the 2024 Notes may require the Company to repurchase for cash all or part of their 2024 Notes at a repurchase price equal to 100% of the principal amount of the 2024 Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date. In addition, if a ‘‘make-whole fundamental change’’ (as defined in the 2024 Indenture) occurs prior to January 15, 2024, the Company will, in certain circumstances, increase the conversion rate for a holder who elects to convert its notes in connection with the make-whole fundamental change.

The 2024 Notes are the Company’s general unsecured obligations that rank senior in right of payment to all of its indebtedness that is expressly subordinated in right of payment to the 2024 Notes, and equal in right of payment to the Company’s unsecured indebtedness.

15


The fair value of the 2024 Notes is estimated utilizing market quotations from an over-the-counter trading market. As of March 31, 2018, the fair value approximated 131.25 percent of the face principal amount of the 2024 Notes.

While the 2024 Notes are currently classified on the Company’s consolidated balance sheet at March 31, 2018 and December 31, 2017 as long-term, the future convertibility and resulting balance sheet classification of this liability will be monitored at each quarterly reporting date and will be analyzed dependent upon market prices of the Company’s common stock during the prescribed measurement periods. In the event that the holders of the 2024 Notes have the election to convert the 2024 Notes at any time during the prescribed measurement period, the 2024 Notes would then be considered a current obligation and classified as such.

Under current accounting guidance, an entity must separately account for the liability and equity components of convertible debt instruments (such as the 2024 Notes) that may be settled entirely or partially in cash upon conversion in a manner that reflects the issuer’s economic interest cost. The liability component of the instrument was valued in a manner that reflects the market interest rate for a similar nonconvertible instrument at the date of issuance. The initial carrying value of the liability component of $368.3 million was calculated using a 7.5% assumed borrowing rate. The equity component of $149.2 million, representing the conversion option, was determined by deducting the fair value of the liability component from the par value of the 2024 Notes and is recorded in additional paid-in capital on the consolidated balance sheet at the issuance date. That equity component is treated as a discount on the liability component of the 2024 Notes, which is amortized over the seven year term of the 2024 Notes using the effective interest rate method. The equity component is not re-measured as long as it continues to meet the conditions for equity classification.

The Company allocated the total transaction costs of approximately $14.7 million related to the issuance of the 2024 Notes to the liability and equity components of the 2024 Notes based on their relative values. Transaction costs attributable to the liability component are amortized to interest expense over the seven-year term of the 2024 Notes, and transaction costs attributable to the equity component are netted with the equity component in stockholders’ equity.

The 2024 Notes do not contain any financial or operating covenants or any restrictions on the payment of dividends, the issuance of other indebtedness or the issuance or repurchase of securities by the Company. The 2024 Indenture contains customary events of default with respect to the 2024 Notes, including that upon certain events of default, 100% of the principal and accrued and unpaid interest on the 2024 Notes will automatically become due and payable.

Debt, net of discounts and deferred financing costs at March 31, 2018 and December 31, 2017, consisted of the following (in thousands):

 

 

 

March 31,

2018

 

 

December 31,

2017

 

Principal

 

$

517,500

 

 

$

517,500

 

Deferred financing costs

 

 

(9,326

)

 

 

(9,652

)

Debt discount, net

 

 

(133,965

)

 

 

(138,230

)

Net carrying amount

 

$

374,209

 

 

$

369,618

 

 

6. SHARE-BASED COMPENSATION

The compensation expense related to the Company’s share-based compensation arrangements has been included in the condensed consolidated statements of comprehensive loss as follows (in thousands):

 

 

 

Three Months Ended

March 31,

 

 

 

2018

 

 

2017

 

General and administrative

 

$

7,256

 

 

$

5,453

 

Research and development

 

 

12,623

 

 

 

3,523

 

Total share-based compensation expense

 

$

19,879

 

 

$

8,976

 

 

The fair value of equity instruments that vest based on continued employee service is recognized and amortized on a straight-line basis over the requisite service period. For restricted stock units (RSUs) with performance-based vesting requirements (PRSUs), no expense is recorded until the performance condition is probable of being achieved. During the three months ended March 31, 2018, the Company recorded a non-recurring share-based compensation charge of $7.7 million related to the modification of certain options and RSUs.

16


As of March 31, 2018, total unrecognized estimated compensation cost related to non-vested stock options and non-vested RSUs, that vest over a given service period, granted prior to that date was $67.7 million and $62.0 million, respectively, which is expected to be recognized over a weighted average period of approximately 3.2 and 3.3 years, respectively. Additionally, the Company has approximately 0.4 million PRSUs outstanding. As of March 31, 2018, total unrecognized estimated compensation cost related to these PRSUs was $21.5 million and will be recognized over the expected performance period once the achievement of performance conditions becomes probable.

During the three months ended March 31, 2018 and 2017, stock options to purchase approximately 0.7 million and 0.3 million shares of the Company’s common stock were exercised, respectively. The cash received by the Company from stock option exercises during the three months ended March 31, 2018 and 2017 was approximately $16.1 million and $1.5 million, respectively. The Company also issued approximately 0.4 million and 0.3 million shares of common stock pursuant to the vesting of RSUs during each of the three months ended March 31, 2018 and 2017.

Stock Option Assumptions

The Company granted stock options to purchase approximately 0.8 million and 1.4 million shares of the Company’s common stock during the three months ended March 31, 2018 and 2017, respectively. These stock options generally vest monthly over a four-year period. The exercise price of all stock options granted during the three months ended March 31, 2018 and 2017 was equal to the closing price of the Company’s common stock on the date of grant. The estimated fair value of each stock option granted was determined on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for the stock option grants:

 

 

 

Three Months Ended

March 31,

 

 

 

2018

 

 

2017

 

Risk-free interest rate

 

2.4%

 

 

2.0%

 

Expected volatility of common stock

 

60.6%

 

 

58.1%

 

Dividend yield

 

0.0%

 

 

0.0%

 

Expected option term

 

4.7 years

 

 

5.8 years

 

 

The Black-Scholes option-pricing model incorporates various and highly sensitive assumptions including expected volatility, expected term and interest rates. The expected volatility is based on the historical volatility of the Company’s common stock over the most recent period commensurate with the estimated expected term of the Company’s stock options. The expected option term is estimated based on historical experience as well as the status of the employee. For example, directors and officers have a longer expected option term than all other employees. The risk-free rate for periods within the contractual life of the option is based upon observed interest rates appropriate for the expected term of the Company’s employee stock options. The Company has never declared or paid dividends and has no plans to do so in the foreseeable future. For the three months ended March 31, 2018 and 2017, share-based compensation expense related to stock options was $13.6 million and $5.7 million, respectively.

Restricted Stock Units

During the three months ended March 31, 2018 and 2017, the Company granted approximately 0.5 million and 0.4 million RSUs, respectively, that vest annually over a four-year period. Additionally, during the three months ended March 31, 2018, the Company granted approximately 0.2 million PRSUs. No PRSUs were granted during 2017. The Company’s PRSUs vest based on the achievement of pre-defined Company-specific performance criteria and expire approximately four to five years from the grant date. Expense recognition for PRSUs commences when attainment of the performance based criteria is probable. The fair value of RSUs and PRSUs is estimated based on the closing sale price of the Company’s common stock on the date of grant. For the three months ended March 31, 2018 and 2017, the aggregate share-based compensation expense related to RSUs and PRSUs was $6.3 million and $3.3 million, respectively.

17


7. STOCKHOLDERS’ EQUITY

Shelf Registration Statements

In February 2017, the Company filed an automatic shelf registration statement which immediately became effective by rule of the SEC. For so long as the Company continues to satisfy the requirements to be deemed a well-known seasoned issuer, this shelf registration statement allows the Company to issue an unlimited number of securities from time to time. As of March 31, 2018, the Company had not sold any securities under this shelf registration statement.

The specific terms of future offerings, if any, under this shelf registration statements would be established at the time of such offerings.

8. REAL ESTATE

In December 2007, the Company closed the sale of its facility and associated real property for a purchase price of $109 million. Concurrent with the sale, the Company retired the entire $47.7 million in mortgage debt previously outstanding with respect to the facility and associated real property, and received cash of $61.0 million net of transaction costs and debt retirement.

Upon the closing of the sale of the facility and associated real property, the Company entered into a lease agreement (Lease) whereby it leased back for an initial term of 12 years its corporate headquarters comprised of two buildings located at 12790 El Camino Real (Front Building) and 12780 El Camino Real (Rear Building) in San Diego, California. The Company also entered into a series of lease amendments (Amendments), beginning in late 2008 through 2011, through which it vacated the Front Building, but continues to occupy the Rear Building. The ultimate result of this real estate sale was a net gain of $39.1 million which was deferred in accordance with authoritative guidance. The Company recognized $0.2 million and $0.9 million of the deferred gain during the three-month periods ending March 31, 2018 and 2017, and will recognize the remaining $8.6 million of the deferred gain on a straight-line basis over the amended Lease term which will expire at the end of 2029.

During 2017, the Company entered into an amendment to extend the current term of the Lease through December 31, 2029 (Term Amendment). Under the Term Amendment, the Company reduced its base rental rate by approximately 8% and will continue to pay base annual rent (subject to an annual fixed percentage increase), plus a 3.5% annual management fee, property taxes and other normal and necessary expenses associated with the Lease such as utilities, repairs and maintenance. Certain incentives were included in the Term Amendment, including approximately $13.1 million in various tenant improvement allowances, three months of rent abatement, and a reduction in the required security deposit amount from $4.7 million to $3.0 million. In lieu of a cash security deposit, Wells Fargo Bank, N.A. issued on the Company’s behalf a letter of credit in the amount of $3.0 million, which is secured by a deposit of equal amount with the same bank and is included in restricted cash on the Company’s condensed consolidated financial statements. The Company also has the right to extend the Lease for two consecutive ten-year terms as well as a right of first offer for future rental of adjacent office space owned by the landlord.

Historically, the Company had one sublease agreement for approximately 16,000 square feet of the Rear Building. This sublease resulted in approximately $0.3 million of rental income during the three months ended March 31, 2018 with this sublease rental income being recorded as an offset to rent expense. The income generated under this sublease is lower than the Company’s financial obligation under the Lease for the Rear Building, as determined on a per square foot basis. Consequently, at the inception of such a sublease, or in association with an amendment to such sublease, the Company is required to record a cease-use liability for the net present value of the estimated difference between the expected income to be generated under the sublease and future subleases and the Lease obligation over the remaining term of the Lease for the space that is occupied by the subtenant. The Company has reoccupied the space at the conclusion of the sublease in March 2018. The sublease termination resulted in reversal of cease use expense of approximately $0.5 million during the second quarter of 2017.

The following table sets forth changes to the accrued cease-use liability during the three months ended March 31, 2018 and 2017 (in thousands):

 

 

 

Three Months Ended

March 31,

 

 

 

2018

 

 

2017

 

Beginning balance

 

$

62

 

 

$

853

 

Change in estimate

 

 

 

 

 

 

Payments

 

 

(62

)

 

 

(66

)

Ending balance

 

$

 

 

$

787

 

 

18