UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

☒Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended June 30, 2016

 

OR

 

☐Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period from                to               .

 

Commission File Number: 001-36375

 

Corium International, Inc.

(Exact name of registrant as specified in its charter)

 

 

Corium International, Inc.
235 Constitution Drive
Menlo Park, California 94025

(Address of principal executive offices and zip code)

 

(650) 298-8255

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes ☒ No ☐

 

Indicate by check mark whether the Registrant has submitted electronically 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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes ☒ No ☐

 

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

 

 

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

 

As of August 9, 2016, there were approximately 22,359,011 shares of the Registrant’s Common Stock outstanding.

 

 

 

 

 

TABLE OF CONTENTS

 

 

 

PART I

 

ITEM 1.FINANCIAL STATEMENTS

 

CORIUM INTERNATIONAL, INC.

CONDENSED BALANCE SHEETS

(in thousands, except share amounts)

(Unaudited)

 

 

See accompanying notes to condensed financial statements.

 

 

 

CORIUM INTERNATIONAL, INC.

CONDENSED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(in thousands, except share and per share data)

(Unaudited)

 

 

See accompanying notes to condensed financial statements

 

CORIUM INTERNATIONAL, INC.

Condensed Statement of Stockholders’ Equity

(in thousands, except share data)

(Unaudited)

 

 

See accompanying notes to condensed financial statements.

 

 

CORIUM INTERNATIONAL, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(in thousands)

(Unaudited)

 

 

 

See accompanying notes to condensed financial statements.

 

 

CORIUM INTERNATIONAL, INC.

Notes to the Condensed Financial Statements

 

1.    Organization, Description of Business and Summary of Significant Accounting Policies

 

Organization

 

Corium International, Inc., a Delaware corporation (the “Company”), is a commercial-stage biopharmaceutical company focused on the development, manufacture and commercialization of specialty pharmaceutical products that leverage the Company’s broad experience with advanced transdermal and transmucosal delivery systems.

 

In the normal course of business, the Company enters into collaborative agreements with partners to develop and manufacture products based on the Company’s drug delivery technologies and product development expertise. Revenues consist of net sales of products manufactured, royalties and profit-sharing payments based on sales of such products by partners, and product development fees for research and development activities under collaboration agreements with partners. The Company is also engaged in the research and development of its own proprietary transdermal drug delivery products using its Corplex and MicroCor technologies.

 

The Company’s fiscal year ends on September 30.  References to “fiscal” refer to the years ended September 30.

 

Basis of Presentation

 

The accompanying unaudited condensed financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) and follow the requirements of the Securities and Exchange Commission (the “SEC”) for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by U.S. GAAP can be condensed or omitted. The interim balance sheet as of June 30, 2016 and the statements of operations and comprehensive loss for the three and nine months ended June 30, 2016 and 2015, statement of stockholders’ equity for the nine months ended June 30, 2016 and statements of cash flows for the nine months ended June 30, 2016 and 2015 are unaudited. The unaudited interim financial statements have been prepared on the same basis as the annual financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments necessary to present fairly the Company’s financial position as of June 30, 2016 and its results of operations for the three and nine months ended June 30, 2016 and 2015 and cash flows for the nine months ended June 30, 2016 and 2015. The financial data and the other financial information contained in these notes to the financial statements related to the three and nine month periods are also unaudited. The results of operations for the nine months ended June 30, 2016 are not necessarily indicative of the results to be expected for the year ending September 30, 2016 or for any future annual or interim period. The balance sheet as of September 30, 2015 has been derived from the audited financial statements at that date but does not include all of the information required by U.S. GAAP for complete financial statements.

 

The accompanying condensed financial statements and related financial information should be read in conjunction with the audited financial statements and the related notes thereto for the year ended September 30, 2015 included in the Company’s Annual Report on Form 10-K, which was filed with the SEC on December 16, 2015.

 

There have been no material changes to the significant accounting policies previously disclosed in the Company’s audited financial statements for the year ended September 30, 2015.

 

Use of Estimates

 

Estimates and assumptions are required to be used by management in the preparation of financial statements in conformity with U.S. GAAP that affect the reported amounts of assets, liabilities, and disclosures of contingent assets

and liabilities at the date of the financial statements and the reported amounts of operating revenues and operating expenses during the reporting period. Those estimates and assumptions affect revenue recognition, deferred revenues, impairment of long-lived assets, determination of fair value of stock-based awards and other debt- and equity-related instruments, accounting for clinical trials and accounting for income taxes. As future events and their effects cannot be determined with precision, actual results could differ from those estimates.

 

Concentration of Credit Risk

 

Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash and cash equivalents and accounts receivable. The Company maintains its cash and cash equivalents with a single domestic financial institution that is well capitalized. The Company provides credit, in the normal course of business, to its partners and performs credit evaluations of such partners.

 

For the three and nine months ended June 30, 2016, three partners accounted for 84% and 85% of the Company’s revenues and 84% of accounts receivable as of June 30, 2016. For the three and nine months ended June 30, 2015, four partners accounted for 87% and 88% of the Company’s revenues. As of September 30, 2015, three partners accounted for 84% of accounts receivable.

 

Restricted Cash

 

The Company’s restricted cash consists of cash maintained in a separate deposit account to secure a letter of credit issued by a bank to the landlord pursuant to a lease agreement for the Company’s new corporate headquarters. The Company has classified the restricted cash as noncurrent on the condensed balance sheet.

 

Facility Lease

 

On February 12, 2016, the Company entered into a lease agreement pursuant to which the Company agreed to lease approximately 48,240 square feet of space in Fremont, California, which was intended to replace the Company’s current headquarters. Subject to certain conditions, the lease agreement provided for a term of ten years. The lease agreement provided for annual base rent of $72,360 per month for the first twelve months, $110,952 per month for the next twelve months with rent increasing by approximately 3% annually thereafter.   In addition, the lease provided that the landlord will reimburse the Company for up to $2.4 million in tenant improvements. On July 29, 2016, the Company exercised its termination right under Section 4.2 of the lease by providing the landlord with written notice to terminate the lease agreement effective immediately.  For further details, see Note 14.

 

Comprehensive Income (Loss)

 

For the three and nine months ended June 30, 2016 and 2015, the Company did not recognize any other comprehensive income (loss) and, therefore, the net loss and comprehensive loss was the same for all periods presented.

 

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers, (Topic 606)” (“ASU 2014-09”). This ASU affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards. The guidance in this ASU supersedes the revenue recognition requirements in Topic 605, Revenue Recognition and most industry-specific guidance. The core principle of the guidance is that an entity should recognize revenue upon the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new guidance also includes a set of disclosure requirements that will provide users of financial statements with comprehensive information about the nature, amount, timing, and uncertainty of revenue and cash flows

arising from a reporting organization’s contracts with customers.  In August 2015, the Financial Accounting Standards Board issued ASU No. 2015-14, “Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date”, which defers the effective date of ASU 2014-09 by one year. This ASU is effective for annual reporting periods, and interim periods within those years, beginning after December 15, 2017 for public companies and permits the use of either the retrospective or cumulative effect transition method, with early adoption permitted as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within those annual periods. In April 2016, the FASB issued ASU 2016-10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing” which further clarifies guidance related to identifying performance obligations and licensing implementation guidance contained in ASU 2014-09. In May 2016, the FASB issued ASU 2016-12, “Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients” which addresses narrow-scope improvements to the guidance on collectibility, noncash consideration, and completed contracts at transition and provides a practical expedient for contract modifications at transition and an accounting policy election related to the presentation of sales taxes and other similar taxes collected from customers. We are currently evaluating the effect, if any, these ASUs may have on our future financial position, results of operations and cash flows.

In February 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) ("ASU 2016-02"), which supersedes existing guidance on accounting for leases in "Leases (Topic 840)" and generally requires all leases to be recognized in the statement of financial position. The provisions of ASU 2016-02 are effective for annual reporting periods beginning after December 15, 2018. Early adoption is permitted. The provisions of this ASU are to be applied using a modified retrospective approach. We are currently evaluating the effect that this ASU will have on our future financial position, results of operations and cash flows.

In March 2016, the FASB issued ASU 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). ASU 2016-09 modifies U.S. GAAP by requiring the following, among others: (1) all excess tax benefits and tax deficiencies are to be recognized as income tax expense or benefit on the income statement (excess tax benefits are recognized regardless of whether the benefit reduces taxes payable in the current period); (2) excess tax benefits are to be classified along with other income tax cash flows as an operating activity in the statement of cash flows; (3) in the area of forfeitures, an entity can still follow the current U.S. GAAP practice of making an entity-wide accounting policy election to estimate the number of awards that are expected to vest or may instead account for forfeitures when they occur; and (4) classification as a financing activity in the statement of cash flows of cash paid by an employer to the taxing authorities when directly withholding shares for tax withholding purposes. ASU 2016-09 is effective for annual periods beginning after December 15, 2016. Early adoption is permitted. We are currently evaluating the effect that this ASU will have on our future financial position, results of operations and cash flows.

 

2.  Fair Value Measurements

 

Financial assets and liabilities are recorded at fair value. Except as noted below, the carrying values of the Company’s financial instruments, including cash equivalents, accounts receivable, and accounts payable, approximated their fair values due to the short period of time to maturity or repayment.

 

Assets and liabilities recorded at fair value on a recurring basis in the balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair values. Fair value is defined as the exchange price that would be received for an asset, or an exit price that would be paid to transfer a liability, in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The authoritative guidance on fair value measurements establishes a three-tier fair value hierarchy for disclosure of fair value measurements as follows:

 

Level I —Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date;

 

Level II —Inputs are observable, unadjusted quoted prices in active markets for similar assets or liabilities, unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related assets or liabilities; and

 

Level III —Unobservable inputs that are significant to the measurement of the fair value of the assets or liabilities that are supported by little or no market data.

 

The Company did not have any transfers between Level I, II and III of the fair value hierarchy during the nine months ended June 30, 2016.  The Company’s policy for determining transfers between levels occurs at the end of the reporting period when circumstances in the underlying valuation criteria change and result in transfer between levels.

 

The Company’s financial assets that are measured at fair value on a recurring basis by level within the fair value hierarchy are as follows (in thousands):

 

 

 

 

The following financial liabilities have carrying values that differ from their fair value as estimated by the Company based on market quotes for instruments with similar terms and remaining maturities (Level III valuation) (in thousands):

 

 

 

 

 

 

 

 

 

3.  Inventories

 

Inventories consist of the following (in thousands):

 

 

 

 

4. Long-Term Debt

 

Outstanding long-term debt consists of the following (in thousands):

 

 

On July 13, 2012, the Company completed a $35.0 million term loan agreement with CRG, a structured debt and equity investment management firm. In August 2012 and December 2012, the Company drew down $29.0 million and $6.0 million under this agreement. On November 14, 2014, the agreement was amended to, among other things, increase the principal amount available under the term loan by $10.0 million, extend the interest-only period to June 30, 2018, and extend the maturity from June 30, 2017 to June 30, 2019. The amended agreement provides for a maximum borrowing of $45.0 million, excluding PIK notes, as defined below. The amended agreement requires interest to be paid quarterly at a simple annual rate of 15%, and all outstanding principal be repaid in four equal quarterly payments beginning on June 30, 2018, with interest continuing to accrue on the unpaid principal at a simple annual rate of 15%. In addition, the amended agreement contains a provision whereby the Company can, at each quarterly payment due date prior to June 30, 2018, choose to convert that portion of each quarterly interest obligation equal to 3.5% of the then-outstanding principal into additional notes (payment-in-kind (“PIK”) notes). Amounts outstanding under the term loan agreement are collateralized by all of the Company’s assets. The amended agreement also provides for a prepayment penalty, the amount of which varies with the date on which prepayment is made, if the Company chooses to repay principal prior to June 30, 2018 or upon other specified events, including a change of control. On December 4, 2014, the Company borrowed the remaining $10.0 million of principal provided for in the amended agreement. As of June 30, 2016 and September 30, 2015, the Company had converted $5.7 million and $4.4 million of interest into PIK notes, each of which added to the then-outstanding principal, and is included in the balances shown as of those dates. As of June 30, 2016, the principal amount outstanding under the term loan agreement, including all PIK notes, was $50.7 million.

 

The term loan agreement was amended in November 2015 to modify the financial covenants for minimum annual revenues (beginning with the 12 months ended June 30, 2016) and minimum liquidity, with which the Company has been in continuous compliance since the inception of the loan.

 

5.  Collaboration and Partner Arrangements

 

The Company has recognized the following revenues from its collaboration and partner agreements (in thousands):

 

 

Included in total revenues above are royalties and profit sharing, which totaled $0.5 million and $1.7 million for the three and nine months ended June 30, 2016, compared to $0.6 million and $1.8 million for the corresponding periods in 2015.

 

In 2005, the Company entered into a multi-faceted collaboration arrangement with The Procter & Gamble Company, or P&G. The relationship includes a world-wide license to P&G for the use of certain of the Company's technologies for products in specific fields. The Company is entitled to receive milestone payments for each qualifying product that the Company develops for P&G.  In the three and nine months ended June 30, 2016, the Company received a $1.1 million milestone payment from P&G for the approval of the U.S. commercial launch of a product developed by the Company.  For the three and nine months ended June 30, 2015, the Company received a $0.5 million milestone payment for the commercial launch of the same product outside of the U.S.

 

6.  Warrants

 

The Company issued warrants to purchase shares of the Company's capital stock as part of several transactions from fiscal 2008 through fiscal 2013. The warrants were recorded as equity instruments at the date of their issuances based on the terms of the warrants.

 

As of June 30, 2016 and September 30, 2015, warrants to purchase 51,386 shares of common stock, on an as-converted basis, were outstanding with a weighted-average exercise price of $9.26 per share.  All of the common stock warrants are exercisable at any time up to ten years from issuance.  These warrants expire at various dates between December 2020 and November 2021.  The fair value of these warrants was recorded in stockholders’ equity upon issuance.

 

7.  Convertible Preferred Stock, Common Stock and Stockholders' Equity

 

Convertible Preferred Stock

 

The Company was authorized to issue up to 5.0 million shares of preferred stock as of June 30, 2016 and September 30, 2015 with a par value of $0.001 per share.  No preferred stock was outstanding as of those dates.

 

Common Stock

 

The Company was authorized to issue up to 150.0 million shares of common stock as of June 30, 2016 and September 30, 2015 with a par value of $0.001 per share. As of June 30, 2016, there were 22,359,011 shares of common stock outstanding and as of September 30, 2015, there were 22,160,991 shares of common stock outstanding.

 

Controlled Equity Offering

 

In December 2015, the Company entered into a Controlled Equity OfferingSM Sales Agreement with Cantor Fitzgerald & Co., as agent (“Cantor Fitzgerald”), pursuant to which the Company may offer and sell, from time to time through Cantor Fitzgerald, shares of its common stock, par value $0.001 per share, with aggregate proceeds of up to $20.0 million.  The offer and sale of these shares will be made pursuant to a shelf registration statement on Form S-3 and the related prospectus (File No. 333-204025) filed by the Company with the SEC on May 8, 2015 and declared effective by the SEC on May 21, 2015, as supplemented by a prospectus supplement dated and filed with the SEC on December 30, 2015. The Company will pay Cantor Fitzgerald a commission of 3.0% of the aggregate gross proceeds from any shares sold by Cantor Fitzgerald. Since its inception in December 2015, the Company has not sold any shares under this sales agreement.

 

8.  Stock-Based Compensation

 

Equity Incentive Plans

 

As of June 30, 2016 and September 30, 2015, the Company had three equity incentive plans, all of which are sponsored by the Company. On March 19, 2014, the Company's board of directors approved the adoption of the 2014 Equity Incentive Plan (the "2014 Plan"). Under the 2014 Plan, the Company had initially reserved a total of 1.0 million shares of common stock plus the remaining unissued shares under the Company's 2012 Equity Incentive Plan (the "2012 Plan"), which was adopted in November 2012 and was replaced by the 2014 Plan. The 2014 Plan provides for the grant of incentive stock options (ISOs), nonstatutory stock options (NSOs), stock appreciation rights, restricted stock awards, restricted stock unit awards, stock bonus awards, performance-based stock awards, and other forms of equity compensation, all of which may be granted to employees (including officers), non-employee directors and consultants of the Company. The Company also sponsored the 2002 Stock Option Plan that expired in 2012.

 

On January 1 of each year during the ten-year term of the 2014 Plan, the number of shares of common stock issuable under the 2014 Plan will be automatically increased by an amount equal to 4% of the number of shares of common stock outstanding as of the preceding December 31, or such lesser number agreed to by the Company’s board of directors. On January 11, 2016 and January 16, 2015, the Company’s board of directors authorized an increase of 888,776 and 722,834 shares to be added to the total number of shares of common stock issuable under the 2014 Plan. As of June 30, 2016 and September 30, 2015, the Company had reserved 4,562,600 and 3,745,373 shares of common stock for issuance pursuant to the Corium Plans and had 1,156,780 and 830,396 shares of common stock available for grant pursuant to the 2014 Plan. The term “Corium Plans” refers to the 2014 Plan, the 2012 Plan and the 2002 Stock Option Plan.

 

The exercise price of each option granted under the Corium Plans is required to be no less than the fair market value of the Company's common stock on the date of the grant. The maximum term of the options is ten years and the vesting period is typically four years. The restricted stock unit awards granted under the 2014 Plan vest over a four-year period.

 

A summary of activity under the Corium Plans during the nine months ended June 30, 2016 is as follows:

 

 

All outstanding stock options under the Corium Plans as of June 30, 2016 have an exercise price between $2.12 and $14.12 per share.

 

The weighted-average fair value of the stock options granted for the nine months ended June 30, 2016 were estimated using the Black-Scholes option-pricing model with the following assumptions:

 

 

 

Expected Term — The expected term represents the period that the stock-based awards are expected to be outstanding before exercise or cancellation. As the Company's historical share exercise experience has not yet provided a reasonable basis upon which to estimate expected term because of a lack of sufficient data points, the Company estimated the expected term by using the midpoint between the vesting commencement date and the contractual expiration period of the stock-based awards.

 

Risk-Free Interest Rate —The risk-free interest rate is based on the constant maturity yields of U.S. Treasury notes with remaining maturities similar to the expected term.

 

Expected Volatility —Because the Company has limited information on the volatility of its common stock due to a lack of significant trading history and limited historical data regarding the volatility of its common stock, the expected volatility used is based on the volatility of a group of comparable publicly-traded companies. In evaluating comparability, the Company considered factors such as industry, stage of life cycle and size. The Company will continue to analyze the historical stock price volatility and term assumptions as more historical data for the Company's common stock becomes available.

 

Expected Dividend Rate —The Company has never paid any dividends, does not plan to pay dividends in the foreseeable future, and, therefore, uses an expected dividend rate of zero in the valuation model.

 

2014 Employee Stock Purchase Plan

 

On March 19, 2014, the Company's board of directors approved the adoption of the 2014 Employee Stock Purchase Plan (the "2014 ESPP"). The 2014 ESPP is intended to qualify as an "employee stock purchase plan" under Section 423 of the Internal Revenue Code of 1986 with the purpose of providing employees with an opportunity to purchase the Company's common stock through accumulated payroll deductions.

 

On January 1 of each year during the ten-year term of the plan, the number of shares issuable under the 2014 ESPP can be increased by an amount equal to up to 1% of the number of shares of common stock and common stock equivalents outstanding as of the preceding December 31, or a lesser number as agreed to by the Company’s board of directors. On January 11, 2016 and January 16, 2015, the Company’s board of directors reserved an additional 257,631 and 181,994 shares of common stock for issuance pursuant to the 2014 ESPP. No more than 4.0 million shares may be issued over the ten-year term of the 2014 ESPP without the consent of the Company's stockholders. Shares subject to purchase rights granted under the Company's 2014 ESPP that terminate without having been exercised in full will not reduce the number of shares available for issuance under the Company's 2014 ESPP. As of June 30, 2016 and September 30, 2015, there were 503,689 and 372,529 shares of common stock available for issuance pursuant to the 2014 ESPP.

For the three and nine months ended June 30, 2016, the Company recorded stock-based compensation expense of $79,000 and $217,000, compared to $86,000 and $362,000 for the corresponding periods in 2015 related to the 2014 ESPP. For the nine months ended June 30, 2016 and 2015, the Company issued 126,471 and 119,465 shares of common stock to employees related to the 2014 ESPP.

The fair value of the purchase rights granted under the 2014 ESPP for the offering period beginning May 20, 2016 were estimated by applying the Black-Scholes option-pricing model to each of the four purchase periods in the offering period using the following assumptions:

 

 

Fair Value of Common Stock —The fair market value of the Company’s common stock on the first day of each offering period, or $3.79 for the offering period commencing May 20, 2016.

Grant Price  — 85% of the fair market value of the Company’s common stock on the first day of each offering period, or $3.22 for the offering period commencing May 20, 2016.

Expected Terms —The expected terms are based on the end dates of the four purchase periods of each ESPP offering period, which are six, twelve, eighteen and twenty-four months from the commencement of each new offering period.

Expected Volatility —The expected volatility is based on the historical volatility of the Company’s common stock over the expected term.

Risk-Free Interest Rate —The risk-free interest rate is based on the constant maturity yields of U.S. Treasury notes with remaining maturities similar to each expected term.

Expected Dividend Rate —The Company has never paid any dividends, does not plan to pay dividends in the foreseeable future, and, therefore, uses an expected dividend rate of zero in the valuation model.

 

Stock-Based Compensation Expense

 

Employee stock-based compensation expense for the three and nine months ended June 30, 2016 and 2015 is classified in the condensed statements of operations and comprehensive loss as follows (in thousands):

 

 

As of June 30, 2016, there was a total of $5.8 million of unrecognized employee stock-based compensation expense, net of estimated forfeitures, related to unvested awards under the Corium Plans, which is expected to be recognized on a straight-line basis over a weighted-average period of approximately 2.4 years.

 

9.  Product Recall Liability

 

In fiscal 2008 and fiscal 2010, Allergan, plc, formerly known as Actavis, Inc. (“Actavis”) issued two voluntary recalls of certain lots and strengths of Fentanyl TDS manufactured by the Company and sold and distributed at that time by Actavis in the United States. The Company and Actavis negotiated financial settlements for these two recalls, and the Company accrued amounts related to these settlements in fiscal 2009 and 2011. These recall liabilities were subsequently reduced through various mechanisms per the terms of the settlement agreements.

 

In October 2012, the Company reached a revised settlement related to the two recalls, which provided for a total and combined remaining liability of $5.0 million as of the settlement date. The revised liability will be repaid through quarterly payments in arrears based on a percentage of the average of the total net revenues recorded by the Company in those prior periods related to Fentanyl TDS. These quarterly payments have been paid to Actavis since July 1, 2013 and will continue through April 1, 2017. To the extent that the revised settlement liability has not been fully repaid as of April 1, 2017, the remaining liability, if any, will be converted into the most recent form of capital stock issued by the Company in connection with a financing, at the price per share of that financing. The revised liability does not accrue interest.

 

The Company made settlement payments of $0.2 million during the three months ended June 30, 2016 and 2015 and $0.6 million and $0.5 million during the nine months ended June 30, 2016 and 2015.

 

 

10.  Net Loss and Net Loss per Share Attributable to Common Stockholders

 

The following table sets forth the computation of the Company's basic and diluted net loss per share attributable to common stockholders during the three and nine months ended June 30, 2016 and 2015 (in thousands, except share and per share data):

 

 

The following outstanding shares of common stock equivalents were excluded from the computation of the diluted net loss per share attributable to common stockholders for the periods presented because including them would have been antidilutive:

 

 

 

11.  Income Taxes

 

The Company did not record a provision for Federal income taxes for the three and nine months ended June 30, 2016 because it expects to generate a net operating loss for the year ending September 30, 2016. The income tax expense of $3,000 and $2,000 for the nine months ended June 30, 2016 and 2015 represents minimum statutory payments due in the states in which the Company is subject to taxation. The Company’s deferred tax assets continue to be fully offset by a valuation allowance.

 

12.  Segment and Enterprise-Wide Information

 

The Company’s chief operating decision maker is its President and Chief Executive Officer. The President and Chief Executive Officer reviews the Company’s operating results on an aggregate basis for purposes of allocating resources and evaluating financial performance. The Company has one business activity and there are no segment managers who are held accountable for operations or operating results for levels or components.  Accordingly, the Company has a single reporting segment and operating unit structure.

 

All of the Company’s revenues are derived from partners located primarily in North America and all long-lived assets are located in the United States.

 

13. Termination Charges

 

In June 2016, the Company approved and initiated a reduction in its workforce of employees and contractors to align resources with its current clinical development priorities.  In particular, the reduction was implemented to maximize the Company’s ability to pursue its lead clinical program in Alzheimer’s disease, which is on an accelerated development pathway based on recent regulatory guidance.  The reduction affected approximately 17% of the

Company’s total workforce, including employees and contractors. In accordance with ASC 420, Exit or Disposal Cost Obligations, the Company recorded as expense $0.3 million for the three and nine months ended June 30, 2016, which represents one-time termination benefits, comprised principally of severance and benefit continuation costs. As of June 30, 2016, the Company recorded a liability of $0.2 million related to these termination costs, which reflects payments made for the three months ended June 30, 2016 of $0.1 million.  The balance of the liability is expected to be paid out prior to December 31, 2016.  

 

14. Subsequent Events

 

On July 29, 2016, the Company exercised its termination right under Section 4.2 of the lease by providing the landlord of the Company’s leased property in Fremont, California, with written notice to terminate the Fremont, California lease agreement dated February 12, 2016 effective immediately because the underlying premises were not delivered to the Company in accordance with the terms of the lease.  The lease agreement provided for an initial term of approximately ten years and comprised approximately 48,240 square feet of space, which premises were intended to replace the Company’s current headquarters in Menlo Park, California. 

 

 

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

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the (1) unaudited condensed financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q, and (2) the audited financial statements and notes thereto and management’s discussion and analysis of financial condition and results of operations for the fiscal year ended September 30, 2015 included in the Annual Report on Form 10-K for the year ended September 30, 2015, and filed with SEC on December 16, 2015. This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”). These statements are often identified by the use of words such as “believe,” “may,” “will,” “potentially,” “estimate,” “continue,” “anticipate,” “intend,” “could,” “would,” “project,” “plan,” “expect,” “seek” and similar expressions or variations. Such forward‑looking statements may include, but are not limited to, our plans and strategy for our business, and are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by the forward‑looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified herein, and those discussed in the section titled “Risk Factors”, set forth in Part II, Item 1A of this Quarterly Report on Form 10-Q and in our other SEC filings. We disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. Our fiscal year ends September 30. Throughout this discussion and analysis, references to “fiscal,” “fiscal year” or “fiscal years” refer to years ended September 30.

 

Company Overview

 

We are a commercial-stage biopharmaceutical company focused on the development, manufacture and commercialization of specialty pharmaceutical products that leverage our broad experience with advanced transdermal and transmucosal delivery systems. We have multiple proprietary programs in preclinical and clinical development focusing primarily on the treatment of neurological disorders, with two lead programs in Alzheimer’s disease. We have developed and are the sole commercial manufacturer of seven prescription drug and consumer products for our marketing partners. We have two proprietary transdermal platforms: Corplex for small molecules and MicroCor, a biodegradable microstructure technology for small molecules and biologics, including vaccines, peptides and proteins.  Our late-stage pipeline includes a contraceptive patch co-developed with Agile Therapeutics that is currently in Phase 3 trials, and additional transdermal products that are being developed with other partners.

 

We have built significant know-how and experience in the development, scale-up and manufacture of complex specialty products, and have formed relationships with our partners that include both the development of new product formulations and our manufacture of the resulting products. All of our current commercial products are distributed, promoted and marketed by our partners. Our partners include The Procter & Gamble Company (“P&G”), Endo Pharmaceuticals, Inc., formerly Par Pharmaceutical, Inc. (“Endo”), Teva Pharmaceuticals USA, Inc. (“Teva”), Agile Therapeutics, Inc. (“Agile”) and Aequus Pharmaceuticals, Inc. (“Aequus”), as well as several other multinational pharmaceutical companies. Most of these entities have substantially greater financial and operating resources than we do, including global operations. We have never had, nor do we currently have, our own sales force or marketing capabilities. We do not control the market prices that our marketing partners set for our products and, consequently, we do not control the market shares or rates of adoption for our current products.

 

Our partnership with Teva began in 2004, with Teva’s predecessor, Barr Laboratories. Together with Barr, we developed a clonidine Transdermal Delivery Systems (“TDS”), which Teva commercially launched in 2010. Teva currently sells Clonidine TDS throughout North America.  Effective August 2, 2016, Teva divested Clonidine TDS to Mayne Pharma Inc. (“Mayne”), together with our agreements with Teva relating to the product, as a result of a Federal Trade Commission (“FTC”) consent order in which Teva agreed to divest the product in connection with Teva’s acquisition of the generic business of Allergan, plc (formerly Actavis) (“Allergan”).

 

Our partnership with Par, which was acquired by Endo, is likewise the result of an FTC-mandated divestiture of Fentanyl TDS from Actavis, Inc. in connection with the merger of Actavis with Watson Pharmaceuticals. We began the development of Fentanyl TDS with Abrika LLLP in May 2002, and Abrika was subsequently acquired by Actavis in 2007. Actavis commercially launched Fentanyl TDS in 2007. Endo currently sells Fentanyl TDS throughout the United States. 

 

Our partnership with P&G began in 2005 with the development of the various products under the Crest Whitestrips label, which P&G commercially launched in 2009. P&G currently sells Crest Whitestrips in North America and internationally.

 

The following table identifies: (1) products we have developed that are marketed by our partners, (2) products we have developed with our partners that are in clinical trials and that our partners have permitted us to disclose, (3) products in our proprietary pipeline, and (4) products currently awaiting FDA approval.

 

 

In addition to commercialized products, we have a number of products in late stages of development. One of these products is Twirla, which is a combination hormonal contraceptive patch designed to deliver two hormones, ethinyl estradiol and levonorgestrel, at levels comparable to low-dose oral contraceptives, through the skin in an easy-to-use format over seven days.

   

We are developing several additional products utilizing our proprietary technologies that we advanced into human clinical trials during 2015 and 2016.  We are actively pursuing two product candidates for the transdermal treatment of Alzheimer’s disease, incorporating donepezil and memantine, the two most commonly-prescribed drugs already approved by the FDA for this disease. The donepezil and memantine candidates first entered into Phase 1 clinical trials in the fourth fiscal quarter of 2015, and we announced successful results for several donepezil and memantine clinical trials throughout 2016. In late April 2016, we received positive feedback from the FDA on our pre-Investigational New Drug submission that outlined our proposed bioequivalence regulatory pathway for Corplex Donepezil. Also, in July 2015, we reported positive interim topline results from a Phase 2a trial for our MicroCor hPTH(1-34) product candidate, which utilizes our MicroCor technology to deliver parathyroid hormone, a peptide for treating osteoporosis that is currently available only in an injectable form that requires refrigeration.

 

In April 2015, we entered into an agreement with Aequus to develop new transdermal products with an initial focus on neurological disorders. The first project under this collaboration is a multi-day transdermal formulation of aripiprazole, a drug already approved by the FDA for the treatment of a variety of conditions, including schizophrenia, major depressive disorder, bipolar I disorder and irritability associated with autistic disorder in pediatric patients. Aequus initiated a Phase 1 bioavailability clinical trial for this product in the fourth calendar quarter of 2015, and reported positive results in the first calendar quarter of 2016. We also have ongoing feasibility agreements with several pharmaceutical and biotechnology companies involving our Corplex and MicroCor technologies, and are currently in active discussions with other parties for additional feasibility and partnering projects.

Components of Statements of Operations

 

Revenues

 

During the three and nine months ended June 30, 2016 and 2015, we recognized revenues in three categories: product revenues, contract research and development revenues, and other revenues.

 

Product Revenues —Product revenues consist of product sales to our partners and royalties and profit sharing from products that have been sold by our partners. Clonidine TDS, Fentanyl TDS and Crest Whitestrips provided all of our product revenues during the three and nine months ended June 30, 2016 and 2015.

 

Our product revenues from Clonidine TDS consisted of revenues from the sale of products manufactured and shipped to Teva, along with profit sharing from the net profits earned by Teva on the product. For the nine months ended June 30, 2016, product revenues related to Clonidine TDS remained consistent with those of the same period in 2015. On August 2, 2016, Teva completed the acquisition of the generic business of Allergan, which resulted in a divestiture of the Clonidine TDS product to Mayne, which could impact our revenues for this product for the remainder of fiscal 2016 and beyond. Based on purchase orders and forecasts provided by Mayne, product sales of Clonidine TDS are expected to increase for the remainder of fiscal 2016 compared to the same period in 2015. It is difficult, however, to predict the impact this divestiture may have on our results of operations, if any, until the transition period is complete. If Mayne is less effective in its commercialization of the product than Teva, it may result in a loss of market share or reduced pricing, either of which could result in a decrease in our revenues from the product. 

 

Our product revenues from Fentanyl TDS consisted of revenues from the sale of products manufactured and shipped to Par, a wholly owned subsidiary of Endo.  Product revenues related to Fentanyl TDS declined for the nine months ended June 30, 2016, compared to the same period in 2015. This decline was a result of continued marketplace competition as well as a June 2015 amendment to our agreements with Par, which amended the pricing and payment provisions and other business terms. The amended terms also include the elimination of the royalty obligations on future purchase orders and establish mutually agreeable transfer pricing. Based on purchase orders and forecasts provided by Endo, revenues from Fentanyl TDS for the fourth fiscal quarter of 2016 are anticipated to decline compared to revenues for the quarter ended June 30, 2016. We expect that our full-year product revenues from Fentanyl TDS will be lower in fiscal 2016 as compared with fiscal 2015. 

 

Product revenues from Crest Whitestrips consisted of revenues from the sale of products manufactured and shipped to P&G. Revenues increased for the nine months ended June 30, 2016, compared to the same period in 2015 as a result of increased demand for current products and the launch of a new product. We expect product sales from P&G to increase in fiscal 2016, as compared to fiscal 2015, as demand for current products increases and as new products may be launched.

 

Contract Research and Development Revenues —We also generate revenues from agreements with our partners for the research, development and scale-up activities of new products. The terms of our agreements with these partners may include nonrefundable upfront payments, partial or complete reimbursement of research and development costs, and milestone payments. Contract research and development revenues decreased for the nine months ended June 30, 2016, compared to the same period in 2015.  We expect our revenues from contract research and development to continue to decline until we enter into new product programs with new or existing partners.  Our contract research and development revenues for the nine months ended June 30, 2016 were primarily derived from our development activities related to Twirla, our development of new products for P&G, and our co-development arrangements for other new drug products.

 

Other Revenues —Other revenues consist primarily of income derived from certain aspects of our arrangements with our partners, whereby a portion of the revenues received under these agreements is treated for accounting purposes as rental income from embedded leases associated with these relationships and from license

revenue earned primarily from our agreement with P&G, whereby we receive milestone payments upon commercial launch approval of each new product developed by us using our intellectual property.  Other revenues have not been, and are not expected to be, a significant portion of our revenues.

 

Costs and Expenses

 

Cost of Product Revenues —The primary components of our cost of product revenues are materials, personnel costs, depreciation, facilities costs, other overhead costs, and infrastructure expenses associated with the manufacturing of our products. Our manufacturing overhead costs are significant, and are currently allocated among our products at rates consistent with current unit production volumes. As the number of units we manufacture increases, our overhead costs should increase less rapidly due to economies of scale, resulting in lower per-unit costs associated with higher unit production volumes. Conversely, if total unit production volumes decrease, the cost of product revenues, measured as a percentage of product revenues, may increase as we lose economies of scale, unless offset by other savings.

 

Cost of Contract Research and Development Revenues —We incur expenses related to our contract research and development revenues from our partner-funded and co-funded product development agreements. These expenses consist primarily of personnel costs, materials, supplies, and overhead costs. We expense all contract research and development costs, including costs to be subsequently reimbursed under development contracts, in the periods in which they are incurred. Our costs of contract research and development revenues will fluctuate depending on the timing and stage of our various partner programs. In certain cases, contract research and development costs exceed contract research and development revenues, either due to timing differences between expenses and revenues or due to the nature of the underlying contracts. We enter into certain research and development arrangements that we do not expect to be profitable because we expect the long-term benefits of those arrangements to outweigh the short-term costs. Furthermore, we have entered, and expect to continue to enter, into other research and development arrangements in which we will share the costs of development (co-development) with our partner, resulting in our costs significantly exceeding our revenues on such projects.

 

Research and Development Expenses —Research and development expenses include costs incurred to develop our proprietary products using our transdermal drug delivery technologies. These costs consist of personnel costs, materials and supplies, overhead and facility costs, preclinical and nonclinical development costs, clinical trial and related clinical manufacturing costs, contract services, and other outside costs. We expense all research and development costs in the periods in which they are incurred. We expect our research and development expenses to increase in future periods as we continue to invest in research and development activities related to clinical development of our proprietary pipeline, as well as other future development programs.  See “Results of Operations” below for more detailed discussion of research and development expenses.

 

General and Administrative Expenses —General and administrative expenses consist primarily of personnel costs, including stock-based compensation, for employees in our administration, finance, business development, human resources and information technology functions. Other expenses include professional fees for accounting and legal services, and costs of consultants and other outside services. We expect that our general and administrative expenses will increase with growth in our revenues and the continued development of our product pipeline.

 

Interest Income— Interest income consists primarily of interest earned on our cash and cash equivalents balances.

 

Interest Expense— Interest expense consists primarily of the interest charges associated with our long-term debt and our capital lease obligations. Our interest expense is paid periodically in cash, except when an allowable portion of the interest due is converted at our election into payment-in-kind (“PIK”) notes. For further discussion, see “Liquidity and Capital Resources—Description of Certain Indebtedness.”

 

Results of Operations

 

Comparison of the Three Months Ended June 30, 2016 and 2015

 

 

Revenues

 

Product revenues increased $1.0 million, or 15%, for the three months ended June 30, 2016 compared to the same period in 2015. The increase was primarily driven by a $1.2 million increase in product revenues because we shipped a greater number of units of Clonidine TDS , and a $0.6 million increase in product revenues from Crest Whitestrips.  The increases are partially offset by a $0.8 million decrease in Fentanyl TDS product revenues resulting from a decline in the number of units shipped, along with changes to our product pricing and the elimination of royalties on future purchase orders. 

 

Contract research and development revenues decreased $1.5 million, or 43%, for the three months ended June 30, 2016 compared to the same period in 2015. The decrease in contract research and development revenues was primarily a result of a $1.1 million decrease in revenues related to the suspension of development activities for a new product with an existing partner, and a $0.8 million decrease in revenues from our co-development programs related to the timing of milestone payments for one development program.  The decreases were partially offset by an increase of $0.3 million in revenues related to development programs with P&G. 

 

Other revenues increased $0.6 million, or 71%, for the three months ended June 30, 2016 compared to the same period in 2015.  The increase in other revenues was primarily a result of a $1.1 million milestone payment received during the three months ended June 30, 2016 from P&G for the U.S. commercial launch approval of a product developed by us.  For the three months ended June 30, 2015, we received a $0.5 million milestone payment for the commercial launch of the same product outside the U.S.

 

Cost of Product Revenues

 

Cost of product revenues increased $0.6 million, or 14%, for the three months ended June 30, 2016 compared to the same period in 2015, primarily as a result of a $0.5 million increase in raw materials associated with the higher number of Clonidine TDS units shipped. The percentage increase in cost of product revenues was primarily related to the percentage increase in product revenues, with the difference in the percentage increases arising as a result of changes to our product mix.

 

Cost of Contract Research and Development Revenues

 

Cost of contract research and development revenues decreased $1.3 million, or 33%, for the three months ended June 30, 2016 compared to the same period in 2015, primarily as a result of a $1.0 million decrease in costs related to our development programs with an existing partner, one of which was discontinued by our partner in fiscal 2015, a $0.3 million decrease in costs related to our co-development programs, and a $0.2 million decrease in costs related to Twirla.  The decreases in cost of contract research and development revenues were partially offset by a $0.3 million increase related to our various MicroCor feasibility programs.

 

While cost of contract research and development revenues decreased 33% for the three months ended June 30, 2016 compared to the same period in 2015, contract research and development revenues decreased by 43%.  The differences between contract research and development revenues and contract research and development costs are a function of the specific project activities undertaken in any given period, as well as the proportion of the expenses that are attributable to co-funded development programs. In addition, revenue recognition policies may restrict the recognition of certain revenues, while costs continue to be incurred in full, or, in some cases, may accelerate the recognition of revenues. As a result of these revenue timing and expense composition differences, any or all of our contract research and development projects may not be profitable in certain periods, but may be profitable in others. This relationship between changes in revenue and changes in related costs also reflects the increased activity under co-development programs where development costs are shared with our partner and, during periods of higher development activities, will result in higher costs which may not be reflected in revenues.

 

Research and Development Expenses

 

Research and development expenses increased $2.0 million, or 58%, for the three months ended June 30, 2016 compared to the same period in 2015, reflecting increased investment in our proprietary programs.  This increase was primarily as a result of a $2.4 million increase in research and development funding for our product development programs for Alzheimer’s, including the advancement of several optimized formulation candidates through preclinical evaluation, and ongoing Phase 1 clinical studies for both Donepezil TDS and Memantine TDS.  The increased investment was partially offset by a $0.5 million decrease in research and development spending on the MicroCor PTH and MicroCor-related projects as we completed our Phase 2a clinical study of MicroCor PTH during fiscal 2015.

 

General and Administrative Expenses

 

General and administrative expenses increased $0.3 million, or 10%, for the three months ended June 30, 2016 compared to the same period in 2015, primarily as a result of an increase of $0.3 million in legal and consulting fees.