| Summary of Significant Accounting Policies | 2. Summary of Significant Accounting Policies
Basis of Presentation
The Company’s consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (U.S. GAAP).
The Company’s consolidated financial statements include the accounts of Supernus Pharmaceuticals, Inc., Supernus Europe Ltd., and Biscayne Neurotherapeutics, Inc. and its wholly-owned subsidiary, Biscayne Neurotherapeutics Australia Pty Ltd, collectively referred to herein as “Supernus” or “the Company.” All significant intercompany transactions and balances have been eliminated in consolidation. The financial results of Biscayne have been included in the consolidated financial statements from date of acquisition.
The Company has its principal business in the U.S. and operates in one operating segment.
Use of Estimates
The preparation of the Company’s consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, as well as related disclosure of contingent assets and liabilities. Actual results could differ materially from the Company’s estimates. To the extent that there are material differences between these estimates and actual results, the Company’s financial condition or operating results will be affected. The Company bases its estimates on: historical experience; various forecasts; information received from its service providers; and other assumptions that the Company believes are reasonable under the circumstances. The Company evaluates the methodology employed and the judgment and assumptions used in its estimates on an ongoing basis.
Cash and Cash Equivalents
The Company considers all investments in highly liquid financial instruments with an original maturity of three months or less to be cash equivalents.
Marketable Securities
Marketable securities consist of investments in U.S. Treasury bills and notes, certificates of deposit, various U.S. governmental agency debt securities, corporate and municipal bonds and other fixed income securities. The Company places all investments with government, industrial or financial institutions whose debt is rated as investment grade. The Company classifies all available-for-sale marketable securities with maturities greater than one year from the balance sheet date as non-current assets.
The Company’s investments are classified as available-for-sale and are carried at fair value. Any unrealized holding gains or losses on debt securities are reported net of any tax effects as a component of other comprehensive earnings (loss) in the consolidated statement of comprehensive earnings.
Declines in value judged to be other-than-temporary, if any, are included in consolidated statement of earnings. A decline in the market value of any available-for-sale security below cost that is deemed to be other-than-temporary results in a reduction in fair value, with that reduction charged to earnings in that period. A new cost basis for the security is then established.
Dividend and interest income is recognized when earned. Premiums and discounts on marketable securities are amortized and accreted, respectively, to maturity and included in interest income in the consolidated statement of earnings. Realized gains and losses are also included in interest income and are determined using the specific identification method for determining the cost of securities sold.
Accounts Receivable, Net
Accounts receivable are reported on the consolidated balance sheets at outstanding amounts due from customers, less an allowance for doubtful accounts and sales discounts and allowances. The Company extends credit without requiring collateral. The Company writes off uncollectible receivables when the likelihood of collection is remote. The Company evaluates the collectability of accounts receivable on a regular basis. An allowance, when needed, is based upon various factors including the financial condition and payment history of customers, an overall review of collections experience on other accounts, and economic factors or events expected to affect future collections experience. Payment terms for receivables are based on customary commercial terms and are generally less than one year.
The Company recorded approximately $0.1 million, zero and $0.4 million for doubtful accounts for the years ended December 31, 2018, 2017 and 2016, respectively. There was no receivable write-off recorded for the years ended December 31, 2018, 2017 and 2016.
The Company recorded an allowance of approximately $11.5 million and $8.9 million for expected sales discounts and allowances related to prompt pay discounts and contractual fee for service arrangements to pharmaceutical wholesalers and distributors, as of December 31, 2018 and December 31, 2017, respectively.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of cash, cash equivalents, accounts receivable and marketable securities. The counterparties are various corporations and financial institutions of high credit standing, as described above.
Substantially all of the Company’s cash and cash equivalents and marketable securities are maintained in U.S. government agency debt and debt of well-known, investment grade corporations. Deposits held with banks may exceed the amount of insurance provided on such deposits. Generally, these deposits may be redeemed upon demand and, therefore, these bear minimal default risk.
The following table includes the Company’s customers, who are pharmaceutical wholesalers and distributors, that represent more than 10% of total net product sales for the years ended December 31, 2018, 2017 and 2016.
Years Ended December 31,
2018
2017
2016
Customer A
33
%
30
%
29
%
Customer B
33
%
30
%
30
%
Customer C
32
%
37
%
37
%
98
%
97
%
96
%
The following table includes each major customer that represented more than 10% of accounts receivable, net as of December 31, 2018 and 2017:
December 31,
2018
2017
Customer A
46
%
46
%
Customer B
24
%
22
%
Customer C
27
%
28
%
97
%
96
%
Inventories
Inventories, which are recorded at the lower of cost or net realizable value, include materials, labor and other direct and indirect costs and are valued using the first-in, first-out method. The Company typically capitalizes inventories produced in preparation for commercial launches when the related product candidates have received regulatory approval and it is probable that the related costs will be recoverable through the commercial sale of the product.
Intangible Assets
Intangible assets consist of patent defense costs, which are deferred legal fees that have been incurred in connection with legal proceedings related to the defense of patents for Oxtellar XR and Trokendi XR. Patent defense costs will be charged to expense in the event of an unsuccessful outcome of the litigation. Patents are carried at cost less accumulated amortization, which is calculated on a straight line basis over the estimated useful lives of the patents. Amortization commences in the quarter after the costs are incurred. The amortization period is based initially upon the remaining patent life and is adjusted, if necessary, for any subsequent settlements or other changes to the expected useful life of the patent. The carrying value of the patents is assessed for impairment annually during the fourth quarter of each year, or more frequently if impairment indicators exist.
Impairment of Long‑Lived Assets
Long-lived assets consist primarily of property and equipment and patent defense costs. The Company assesses the recoverability of its long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If indications of impairment exist, projected future undiscounted cash flows associated with the asset are compared to the carrying value to determine whether the asset’s value is recoverable. Evaluating for impairment requires judgment, including the estimation of future cash flows, future growth rates and profitability, and the expected life over which cash flows will occur. Changes in the Company’s business strategy or adverse changes in market conditions could affect impairment analyses and require recognition of an impairment charge equal to the excess of the carrying value of the long-lived asset over its estimated fair value at the time at which that determination is made.
Deferred Financing Costs
Deferred financing costs were incurred by the Company in connection with the Company’s sale of $402.5 million of 0.625% Convertible Senior Notes due 2023 (2023 Notes). (See Note 9). The Company amortizes deferred financing costs over the term of the debt, using the effective interest method.
Preclinical Study and Clinical Trial Accruals
The Company estimates preclinical study and clinical trial expenses based on the services performed pursuant to contracts with research institutions, clinical investigators, clinical research organizations (CROs) and other service providers that conduct activities on our behalf. In recording service fees, the Company estimates the time period over which the related services will be performed and compares the level of effort expended through the end of each period to the cumulative expenses recorded and payments made for such services. As appropriate, the Company accrues additional service fees or defers any non-refundable advance payments until the related services are performed. If the actual timing of the performance of services or the level of effort varies from the estimate, the Company will adjust its accrued expenses or deferred advance payments accordingly. If the Company later determines that it no longer expects the services associated with a nonrefundable advance payment to be rendered, the remaining portion of that advance payment will be charged to expense in the period in which such determination is made.
Revenue Recognition
In accordance with ASC 606, “Revenue from Contracts with Customers,” the Company recognizes revenue when control of promised goods or services is transferred to the Company’s customers in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. (See Note 17 for disaggregation of revenue by nature.) The Company does not adjust revenue for effects of significant financing component for contracts where the Company expects the period between the transfer of the goods or service and collection to be less than one year.
Incremental costs for obtaining a contract include only those costs that the Company would not have incurred if the contract had not been obtained; e.g., sales commissions. As a practical expedient, the Company expenses incremental costs in obtaining a contract if the expected amortization period of the contract would have been a year or less, or if the amount is immaterial. These costs are recorded in Selling, general and administrative expenses in the consolidated statement of earnings. Costs to fulfill a contract are expensed as incurred and recorded in Cost of product sales in the consolidated statement of earnings. There were no contract assets or liabilities recorded as of January 1, 2018 or December 31, 2018.
Revenue from Product Sales
The Company’s products are distributed through a third party fulfillment center. The Company’s customers purchase product to fulfill orders from retail pharmacy chains and independent pharmacies of varying size and buying power. The Company’s customers take control of the products, including title and ownership, upon physical receipt of these products at their facilities.
The Company recognizes gross revenue when its products are shipped from its fulfillment center to its customers, who are primarily pharmaceutical wholesalers and distributors and the customers take control of the products. Product sales are recorded net of various forms of variable consideration, including estimated rebates, discounts, allowances, and an estimated liability for product returns (collectively, “sales deductions”).
Variability in the net transaction price for the Company’s products primarily arises from sales deductions, which require significant judgment. The Company considers: historical experience; current contract prices under applicable programs; unbilled claims; processing time lags; and inventory levels in the distribution channel in arriving at these estimates. The Company adjusts its estimates of revenue at the earlier of when the most likely amount of consideration it expects to receive changes or when the consideration becomes fixed.
If actual results in the future vary from estimates, the Company adjusts these estimates. These adjustments could materially affect net product sales and earnings in the period that such variances become known.
Sales Deductions
Sales deductions are primarily comprised of rebates, product returns and sales discounts and allowances. The Company records product sales net of the following sales deductions:
·
Rebates : Rebates are discounts which the Company pays under either private sector or public sector health care programs. Public sector rebate programs encompass: Medicaid Drug Rebate Programs; Medicare Coverage Gap Programs; and programs covering public health service institutions and government entities that purchase drugs under the Federal Supply Schedule, encompassing all federal employees and agencies. Private sector rebate programs include contractual agreements with managed care providers, under which the Company pays fees to gain access to that provider’s patient drug formulary and Company sponsored programs under which the Company defrays or eliminates patient co-payment charges that the patient would otherwise pay to their managed care provider. Rebates paid under public sector programs are generally mandated under law, whereas private sector rebates are generally contractually negotiated by the Company with managed care providers.
Rebates are owed upon dispensing product to a patient; i.e., filling a prescription. Our accrual balance consists of three components. First, because rebates are generally invoiced and paid quarterly in arrears, the accrual balance consists of an estimate of the amount expected to be incurred for prescriptions dispensed in the current quarter. Second, the accrual balance also includes accrual for known or estimated prior quarters’ unpaid rebates to cover prescriptions dispensed in past quarters. Third, the accrual balance includes an estimate for rebates that will be owed for prescriptions filled in future quarters; i.e., for product which has been sold to our customers, and which resides either as wholesaler/distributor inventory, or is held as inventory at pharmacies. This product will be used prospectively to fill prescriptions.
Because the period from the date on which the prescription is filled to the date the Company receives and pays the invoice varies, the Company’s estimates of expected rebate claims vary by program and by type of customer. For each of its products, the Company bases its estimates of expected rebate claims using multiple factors including historical levels of deductions; contractual terms with managed care providers; actual and anticipated changes in product price; prospective changes in managed care fee for service contractual agreements; prospective changes in co-pay assistance programs; and anticipated changes in program utilization rates (i.e., patient participation rates).
The sensitivity of the Company’s estimates can vary by program and by type of customer. If actual rebates vary from estimated amounts, the Company may need to adjust the balances of such rebates to reflect actual expenditures with respect to these programs. These changes could materially affect net product sales and earnings in the period of adjustment. The Company records an estimated liability for rebates at the time the customer takes title to the product (i.e., at the time of sale to wholesalers/distributors) as a reduction to gross product sales and an increase in Accrued Sales Deductions in current liabilities.
·
Returns: Sales of the Company’s products are not subject to a general right of return. Product that has been used to fill patient prescriptions is no longer subject to any right of return. However, the Company will accept the return of product that is damaged or defective when shipped from its warehouse. In addition, the Company will accept return of expired product six months prior to and up to 12 months subsequent to the product’s expiry date. Expired or defective returned product cannot be re-sold and are destroyed.
The Company estimates liability for returns based on the actual returns experience for its two commercial products, in conjunction with industry return experience for similar products; i.e., ambient temperature storage for oral formulations. Because the Company’s products have not reached maturity, the return rate of its products has and is expected to continue to vary. The Company records an estimated liability for product returns at the time the customer takes title to the product (i.e., at time of sale) as a reduction to gross product sales and an increase in Accrued Sales Deductions in current liabilities.
The Company’s estimated liability for product returns is also affected by price increases. The Company’s products have a shelf life of 36 to 48 months from date of manufacture. Because of the extended shelf life and its return policy, there typically is a significant time lag between the time at which the product is sold and when the Company issues credit on expired product. The Company’s policy permits product returns to be processed at current wholesaler price rather than historical price. Therefore, price increase(s) taken during the current period increases the provision for product returns and therefore affects its estimated liability for product returns for both sales made in the current period as well as sales made in prior periods. Accordingly, the Company may have to adjust its estimates, favorably or unfavorably, which would have an effect on product sales and earnings in the period of adjustment.
·
Sales discounts and allowances: Distributors and wholesalers of pharmaceutical products are generally offered various forms of consideration, including allowances, service fees and prompt payment discounts, as consideration for distributing products. Distributor and wholesaler allowances and service fees arise from contractual agreements and are estimated as a percentage of the price at which the Company sells product to them. In addition, they are offered a prompt pay discount for payment within a specified period.
The Company accounts for these discounts at the time of sale as a reduction to gross product sales and records these amounts as a reduction to Accounts Receivable.
Customer orders are generally fulfilled within a few days of receipt, resulting in minimal order backlog. Open purchase orders for products from customers are expected to be fulfilled within the next twelve months. There are no minimum product purchase requirements.
License Revenue
License and Collaboration Agreements
The Company has entered into collaboration agreements to commercialize both Oxtellar XR and Trokendi XR outside of the U.S., which involve the right to use the Company’s intellectual property as a functional license. These agreements generally include an up-front license fee and ongoing milestone payments upon the achievement of specific events. These agreements may also require minimum royalty payments based on in-country sales of products developed from the applicable intellectual property.
Up-front license fees are recognized once the license has been delivered to the customer.
Milestones are a form of variable consideration that are recognized when either the underlying events have been achieved (event-based milestone) or the sales-based targets have been met by the collaborative partner (sales-based milestone). Both types of milestone payments are non-refundable. The Company evaluates whether achieving the milestones is considered probable and estimates the amount to be included in the transaction price using the most likely amount method. This can involve management’s judgment that includes assessing factors that are outside of the Company’s influence, such as: likelihood of regulatory success; availability of third party information; and expected duration of time until achievement of event. These factors are evaluated based on the specific facts and circumstances. If it is probable that a significant revenue reversal would not occur, the value of the associated milestone is included in the transaction price.
Event-based milestones are recognized in the period that the related event, such as regulatory approval, occurs. Milestone payments that are not within the control of the Company, such as approval from regulatory authorities or where attainment of the specified event is dependent on the development activities of a third-party, are not considered probable of being achieved until the specified event occurs. Sales-based milestones are recognized as revenue when the target is achieved. Revenue is recognized from the satisfaction of performance obligations in the amount billable to the customer.
Revenue associated with future milestones will be recognized when the related event occurs or sales-based target is achieved.
There are no guaranteed minimum amounts owed to the Company related to license and collaboration agreements.
Royalty Revenue
The Company recognizes non-cash royalty revenue for royalty amounts earned pursuant to a royalty agreement with United Therapeutics Corporation that involves the right to use the Company’s intellectual property as a functional license. In 2014, the Company sold certain of these royalty rights to Healthcare Royalty Partners III, L.P. (HC Royalty) (see Note 16). Accordingly, the Company records non-cash royalty revenue based on estimated product sales of Orenitram by United Therapeutics that result in Royalty payments made from United Therapeutics to HC Royalty in connection with these agreements.
Royalty revenue also includes royalty amounts received from collaboration partners, including from Shire Plc (Shire), based on net product sales of Shire’s product, Mydayis, in the current period. Royalty revenue is only recognized when the underlying product sale by Shire occurs. The Shire arrangement also involves the right to use the Company’s intellectual property as a functional license.
There are no guaranteed minimum amounts owed to the Company related to royalty revenue agreements.
Cost of Product Sales
The cost of product sales consists primarily of materials, third-party manufacturing costs, freight and distribution costs, allocation of labor, quality control and assurance, and other manufacturing overhead costs.
Research and Development Costs
Research and development costs are expensed as incurred. Research and development costs consist primarily of: employee-related expenses, including salaries and benefits; share-based compensation expense; expenses incurred under agreements with CROs; fees paid to clinical investigators who are participating in our clinical trials; fees paid to consultants and other vendors that assist in the conduct of the Company’s clinical trials; the cost of acquiring and manufacturing clinical trial materials; the cost of manufacturing materials used in process validation, but only to the extent that those materials are manufactured prior to receiving regulatory approval and are not expected to be sold commercially; facilities costs that do not have an alternative future use; related depreciation and other allocated expenses; license fees for, and milestone payments related to, in-licensed products and technologies; and costs associated with animal testing activities and regulatory approvals. Assets acquired that are used for research and development and have no future alternative use are expensed as in-process research and development.
Advertising Expense
Advertising expense includes costs of promotional materials and activities, such as marketing materials, marketing programs and speaker programs. The costs of the Company’s advertising efforts are expensed as incurred.
The Company incurred approximately $43.3 million, $33.8 million and $21.9 million in advertising costs for the years ended December 31, 2018, 2017 and 2016, respectively. These expenses are recorded in Selling, general and administrative expenses in the consolidated statement of earnings.
Share‑Based Compensation
The Company recognizes share-based compensation expense over the service period using the straight-line method. Employee share-based compensation is measured based on estimated fair value as of the grant date. The Company uses the Black-Scholes option-pricing model in calculating the grant date fair value of option awards. The Company uses the following assumptions for estimating fair value of option grants:
Fair Value of Common Stock —The fair value of the common stock underlying the option grants was determined based on observable market prices of the Company’s common stock.
Expected Volatility —Volatility is a measure of the amount by which a variable such as a share price has fluctuated (historical volatility) or is expected to fluctuate (expected volatility) during a period. The Company has identified several public entities of similar size, complexity, and stage of development. Accordingly, historical volatility has been estimated using the volatility of the stock of these companies, as well as taking into consideration the Company’s actual volatility since our IPO in 2012. As the Company's historical experience is not sufficient to calculate volatility for the option grants, the Company will continue to use the guideline peer group volatility information until the historical volatility of its own common stock is sufficiently mature on its own to measure expected volatility for future option grants.
Dividend Yield —The Company has never declared or paid dividends, and has no plans to do so in the foreseeable future.
Expected Term —This is the period of time that the options granted are expected to remain unexercised. Options granted have a maximum term of ten years. The Company determines the average expected life of stock options according to the “simplified method” as described in Staff Accounting Bulletin 110, which is the mid‑point between the vesting date and the end of the contractual term. Over time, management will track actual experience with the option term, so that estimates will approximate actual experience.
Risk‑Free Interest Rate —This is the U.S. Treasury note rate during the week each option grant was issued during that year, with a term that most closely resembles the expected term of the option.
Expected Forfeiture Rate —Prior to 2017, the forfeiture rate was the estimated percentage of options granted that were anticipated to be forfeited or canceled before becoming fully vested. Following the Company's adoption of ASU 2016-09, " Compensation- Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting," at January 1, 2017, forfeitures are accounted for as they occur.
Income Taxes
The Company utilizes the asset and liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax reporting bases of assets and liabilities, and are measured using enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. When appropriate, valuation allowances are established to reduce deferred tax assets to the amounts expected to be realized.
The Company accounts for uncertain tax positions in its consolidated financial statements when it is more-likely-than-not that the position will be sustained upon examination by the tax authorities. Such tax positions must initially and subsequently be estimated as the largest amount of tax benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the tax authorities, assuming full knowledge of the position and relevant facts. The Company’s policy is to recognize any interest and penalties related to income taxes as income tax expense in the relevant period.
Recently Issued Accounting Pronouncements
Accounting Pronouncements Adopted in 2018
In May 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-09, “Revenue from Contracts with Customers, ” and has subsequently issued a number of amendments to ASU 2014-09. ASU 2014-09 and all the related amendments are codified in ASC 606, “Revenue from Contracts with Customers” (the New Revenue Standard). The New Revenue Standard provides a 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.
On January 1, 2018, the Company adopted the New Revenue Standard using the modified retrospective method and applied this method to those contracts which had not been completed as of January 1, 2018. While results for reporting periods beginning after January 1, 2018 are presented under the new guidance, prior period amounts were not adjusted and continue to be reported under the accounting standards in effect for the prior periods. The Company recognized the cumulative effect of initially applying the New Revenue Standard as an adjustment to the opening balance of retained earnings.
The impact of the adoption of the New Revenue standard was as follows:
December 31, 2017
As Reported
Adjustments
January 1, 2018
Accounts receivable, net
$
65,586
$
1,620
$
67,206
Deferred licensing revenue
287
(287)
—
Deferred licensing revenue, net of current portion
1,149
(1,149)
—
Deferred income taxes (asset)
20,843
(734)
20,109
Accumulated deficit
26,823
(2,322)
24,501
The Company recorded a decrease of $2.3 million to the accumulated deficit as of January 1, 2018 due to the cumulative impact of adopting the New Revenue Standard. The adoption of the New Revenue Standard resulted to the acceleration of both up-front licensing fees from license and collaboration agreements and the acceleration of royalties from sales of licensed product. Under the New Revenue Standard, up-front licensing fees are recognized when the license is delivered to the customer. Royalties from the sale of licensed product will be recognized as the underlying sales of product occur by the licensee. There were no changes in the timing of revenue recognition related to net product sales.
Adoption of the New Revenue Standard had no material impact on the Company’s consolidated financial statements.
In May 2017, the FASB issued ASU 2017-09, “Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting,” which clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions, or the classification of the award (as equity or liability) changes as a result of a change in terms or conditions. ASU 2017-09 is effective after December 15, 2017 for all annual periods, and interim periods within those annual periods, with early adoption permitted. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.
In August 2016, the FASB issued ASU No. 2016-15, “Classification of Certain Cash Receipts and Cash Payments. ” The standard eliminates diversity in the practice of how certain cash receipts and cash payments are presented and classified in the statement of cash flows. ASU 2016-15 is effective after December 15, 2017 for annual reporting periods and interim periods therein. The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.
In January 2017, the FASB issued ASU No. 2017-01, “Business Combination (Topic 805): Clarifying the Definition of a Business,” which clarifies the definition of a business to assist entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets or businesses. The standard introduces a screen for determining when assets acquired are not a business. The guidance requires that if substantially all of the fair value of gross assets acquired or disposed of is concen |
