2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Use of Estimates

 

The preparation of the Company’s financial statements requires it to make estimates and assumptions that impact the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities in the Company’s financial statements and accompanying notes. The most significant estimates in the Company’s financial statements relate to revenue recognition, including the estimates of units prescribed, discounts and allowances related to commercial sales of Xtampza, estimates utilized in the valuation of inventory, estimates of useful lives with respect to intangible assets, accounting for stock-based compensation, contingencies, intangible assets, tax valuation reserves and accrued expenses. The Company bases estimates and assumptions on historical experience when available and on various factors that it believes to be reasonable under the circumstances. The Company evaluates its estimates and assumptions on an ongoing basis. The Company’s actual results may differ from these estimates under different assumptions or conditions.

 

Fair Value Measurements

 

Disclosures of fair value information about financial instruments are required, whether or not recognized in the balance sheet, for financial instruments with respect to which it is practicable to estimate that value. The carrying amounts reported in the Company’s financial statements for cash and cash equivalents, accounts payable, term loan payable and accrued liabilities approximate their respective fair values because of the relative short‑term nature of these accounts.

Fair value measurements and disclosures describe the fair value hierarchy based on three levels of inputs, of which the first two are considered observable and the last unobservable, that may be used to measure fair value, as follows:

 

Level 1: Quoted prices in (unadjusted) active markets for identical assets or liabilities

Level 2: Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.

Level 3: Unobservable inputs that reflect the Company’s own assumptions about the assumptions market participants would use in pricing the asset or liability.

 

Transfers are calculated on values as of the transfer date. There were no transfers between Levels 1,  2 and 3 during the years ended December 31, 2016 and 2015.

 

The following tables present the Company’s financial instruments carried at fair value using the lowest level input applicable to each financial instrument at December 31, 2016 and 2015.

 

 

 

Concentration of Credit Risk

 

Financial instruments, which potentially subject the Company to significant concentration of credit risk, consist primarily of cash and cash equivalents and accounts receivable. The Company maintains deposits in federally insured financial institutions in excess of federally insured limits. Three customers comprised 10% or more of the Company’s accounts receivable balance as of December 31, 2016. These customers comprised 44%,  27% and 21% of the accounts receivable balance, respectively. Three customers comprised 10% or more of the Company’s revenue during the year ended December 31, 2016. These customers comprised 35%,  28% and 27% of revenue, respectively. The Company has not experienced any losses in such accounts and management believes that the Company is not exposed to significant credit risk due to the financial position of the financial institutions in which those deposits are held. The Company has no financial instruments with off‑balance sheet risk of loss.

 

Cash and Cash Equivalents

 

Cash and cash equivalents include cash in readily available checking and savings accounts and money market funds. The Company considers all highly liquid investments with an original maturity of three months or less from the date of purchase to be cash equivalents.

 

The Company’s cash equivalents, which consist of money market funds, are measured at fair value on a recurring basis. As of December 31, 2016 and 2015, the carrying amount of cash equivalents was $125,515 and $94,912, respectively, which approximates fair value and was determined based upon Level 1 inputs. Money market funds are valued using quoted market prices with no valuation adjustments applied. Accordingly, these securities are categorized as Level 1.

 

Inventory

 

Inventories are stated at the lower of cost or net realizable value. Inventory costs consist of costs related to the manufacturing of Xtampza, which are primarily the costs of contract manufacturing. The Company determines the cost of its inventories on a specific identification basis, and removes amounts from inventories on a first-in, first-out basis. If the Company identifies excess, obsolete or unsalable items, inventories are written down to their realizable value in the period in which the impairment is identified. These adjustments are recorded based upon various factors, including the level of product manufactured by the Company, the level of product in the distribution channel, current and projected demand for the foreseeable future and the expected shelf-life of the inventory components. Estimates of excess inventory consider various factors, including inventory levels, the level of product in the distribution channel, the Company’s projected sales of the product, as well as the remaining shelf lives of the product. The Company recorded such adjustments of $100 in the year ended December 31, 2016, which were recorded as a component of cost of product revenues. Inventories that are not expected to be used within one year are recorded as a non-current asset.

 

The Company outsources the manufacturing of Xtampza to a sole contract manufacturer that produces the finished product. In addition, the Company currently relies on a sole supplier for the active pharmaceutical ingredient for Xtampza. Accordingly, the Company has concentration risk associated with its commercial manufacturing of Xtampza.

 

Prior to the approval of Xtampza by the FDA in April 2016, the Company recorded all costs incurred related to the manufacturing of Xtampza as research and development expense. Subsequent to approval, the Company began capitalizing these costs as inventory as they are incurred.

 

The Company has capitalized $1,316 of inventory as of December 31, 2016. The Company expects sales of the capitalized units to occur during the next twelve months. The Company expects costs of product revenues to increase due to the expected increases in net product sales of Xtampza and the fact that the Company had expensed all manufacturing costs as research and development expense in periods prior to FDA approval of Xtampza. The impact on cost of product revenues as a result of inventory not capitalized prior to FDA approval is immaterial.

 

Property and Equipment

 

Property and equipment are recorded at historical cost. Maintenance and repair costs are expensed as incurred. Costs which materially improve or extend the lives of existing assets are capitalized. The Company provides for depreciation and amortization using the straight‑line method over the estimated useful lives of the assets, which are as follows:

 

 

Upon retirement or sale, the cost of assets disposed and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is recorded in the statements of operations.

 

Intangible Assets

 

Intangible assets that are deemed to have a definite life are amortized over their useful lives and are evaluated separately for impairment at least annually or whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable (See Note 7). Amortization of intangible assets is recognized on a straight-line basis and the useful life of the Company’s only intangible asset is approximately 3.7 years.

 

Restricted Cash

 

Restricted cash represents cash held in a depository account at a financial institution to collateralize a conditional stand‑by letter of credit related to the Company’s Canton, Massachusetts facility lease agreement. Restricted cash is reported as non‑current unless the restrictions are expected to be released in the next twelve months.

 

Revenue Recognition

 

Revenue for product sales is recognized when there is persuasive evidence of an arrangement, title and risk of loss have passed to the customer, when estimated provisions for chargebacks, rebates, sales incentives and allowances, distribution service fees, and returns are reasonably determinable, and when collectability is reasonably assured. Product revenue is recorded net of estimated chargebacks, rebates, sales incentives and allowance, distribution service fees, as well as estimated product returns.

 

The Company sells Xtampza in the United States principally to distributors and retailers (“customers”), which in turn sell the product to healthcare providers for the treatment of patients. The Company provides the right of return to its customers for unopened product for a limited time before and after its expiration date. Given the Company’s limited sales history for Xtampza and the inherent uncertainties in estimating product returns, the Company has determined that the shipments of Xtampza made to its customers thus far do not meet the criteria for revenue recognition at the time of shipment. Accordingly, the Company recognizes revenue when the product is sold-through to patients, provided all other revenue recognition criteria are met. The Company invoices its customers upon shipment of Xtampza and records accounts receivable, with a corresponding liability for deferred revenue equal to the gross invoice price, less any realized adjustments to the gross invoice price. The Company then recognizes revenue when Xtampza is sold-through, or when product is prescribed directly to the patient at which time the right of return has expired. Healthcare providers to whom distributors sell Xtampza hold limited inventory that is designated for patients, thereby limiting the risk of return.

 

Research and Development Costs

 

Research and development costs are charged to expense as incurred and consist of costs incurred to further the Company’s research and development activities including salaries and employee related costs, costs associated with market research and design, costs associated with conducting preclinical, clinical and regulatory activities including fees paid to third‑party professional consultants and service providers, costs incurred under clinical trial agreements, costs for laboratory supplies and laboratory equipment, costs to acquire, develop and manufacture preclinical study and clinical trial materials, facilities, depreciation and other expenses including allocated expenses for rent and maintenance of facilities. Government grants are recognized as a reduction of the qualifying cost being reimbursed.

 

Patent Costs

 

Costs related to filing and pursuing patent applications are recorded as selling, general and administrative expense as incurred since the recoverability of such expenditures is uncertain.

 

Advertising and Product Promotion Costs

 

Advertising and product promotion costs are included in selling, general and administrative expenses and were $16,328 in the year ended December 31, 2016. Advertising and product promotion costs are expensed as incurred.

 

Stock‑Based Compensation

 

The Company accounts for grants of stock options, restricted stock awards and restricted stock units to employees, including members of the board of directors, based on their grant date fair value and recognizes compensation expense over their vesting period. The Company estimates the fair value of stock options as of the date of grant using the Black‑Scholes option pricing model and restricted stock awards and restricted stock units based on the fair value of the underlying common stock as determined by management or the value of the services provided, whichever is more readily determinable.

 

Stock‑based compensation expense represents the cost of the grant date fair value of employee stock option grants recognized over the requisite service period of the awards (usually the vesting period) on a straight‑line basis, net of estimated forfeitures. The expense is adjusted for actual forfeitures as they occur.

 

For stock option grants with performance‑based milestones, the expense is recorded over the remaining service period after the point when the achievement of the milestone is probable or the performance condition has been achieved. For stock option grants with both performance‑based milestones and market conditions, expense is recorded over the derived service period after the point when the achievement of the performance‑based milestone is probable or the performance condition has been achieved.

 

The Company accounts for stock options and restricted stock awards to non‑employees using the fair value approach. Stock options and restricted stock awards to non‑employees are subject to periodic revaluation over their vesting terms. There were no non-employee grants in 2016 and there was one non-employee grant in 2015.

 

Income Taxes

 

The Company accounts for income taxes under the liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined on the basis of the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the years in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

 

The Company recognizes net deferred tax assets to the extent that the Company believes these assets are more likely than not to be realized. In making such a determination, management considers all available positive and negative evidence, including future reversals of existing taxable temporary differences, projected future taxable income, tax‑planning strategies and the absence of carryback available from results of recent operations. If management determines that the Company would be able to realize its deferred tax assets in the future, in excess of its net recorded amount, management would make an adjustment to the deferred tax asset valuation allowance, which would reduce the provision for income taxes.

 

The Company records uncertain tax positions on the basis of a two‑step process whereby (i) management determines whether it is more likely than not that the tax positions will be sustained on the basis of the technical merits of the position and (ii) for those tax positions that meet the more likely than not recognition threshold, management recognizes the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority. The Company will recognize interest and penalties related to uncertain tax positions within income tax expense. Any accrued interest and penalties will be included within the related tax liability. As of December 31, 2016 and 2015, the Company had no accrued interest or penalties related to uncertain tax positions and no amounts have been recognized in the Company’s statements of operations.

 

Net Loss per Common Share

 

Basic net loss per common share is calculated by dividing the net loss attributable to common shareholders by the weighted‑average number of shares of common stock outstanding during the period, without consideration for potentially dilutive securities. Diluted net loss per share is computed by dividing the net loss attributable to common shareholders by the weighted‑average number of shares of common stock and potentially dilutive securities outstanding for the period. For purposes of the diluted net loss per share calculation, stock options, warrants, redeemable convertible preferred stock and unvested restricted stock are considered potentially dilutive securities. Because the Company has reported a net loss for the years ended December 31, 2016,  2015 and 2014, diluted net loss per common share is the same as basic net loss per common share for those periods.

 

Diluted earnings per share is computed using the more dilutive of (i) the two‑class method, or (ii) the if‑converted method. The Company allocates earnings first to preferred shareholders based on dividend rights and then to common and preferred shareholders based on ownership interests. The weighted‑average number of common shares included in the computation of diluted earnings (loss) gives effect to all potentially dilutive common equivalent shares, including outstanding stock options, warrants, convertible redeemable preferred stock and the potential issuance of stock upon the conversion of the Company’s convertible notes. Common stock equivalent shares are excluded from the computation of diluted earnings (loss) per share if their effect is antidilutive.

 

Recently Issued Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, 2014-09 (ASC 606), Revenue from Contracts with Customers, which affects any entity that either enters into contracts with customers to transfer goods and services or enters into contracts for the transfer of nonfinancial assets. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers, which defers the effective date of ASU 2014-09 for all entities by one year. ASU 2014-09, which has been codified with the Accounting Standards Codification as Topic 606, is now effective for public companies for annual reporting periods beginning after December 15, 2017, including interim periods within those reporting periods. ASC 606 outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry-specific guidance. In addition, ASC 606 provides guidance on accounting for certain revenue-related costs including, but not limited to, when to capitalize costs associated with obtaining and fulfilling a contract. ASC 606 provides companies with two implementation methods. Companies can choose to apply the standard retrospectively to each prior reporting period presented (full retrospective application) or retrospectively with the cumulative effect of initially applying the standard as an adjustment to the opening balance of retained earnings of the annual reporting period that includes the date of initial application (modified retrospective application). Since ASU 2014-09 was issued, several additional ASUs have been issued and incorporated within ASC 606 to clarify various elements of the guidance. The Company anticipates that this standard will have a material impact on its consolidated financial statements with respect to inventory and deferred revenues and is continuing to assess all potential impacts of the standard, including evaluating the impact of each potential method of adoption on the Company’s consolidated financial statements and the impact to the pattern with which the Company will recognize revenue.

 

In August 2014, the FASB issued ASU No. 2014‑15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. ASU 2014‑15 requires management to evaluate, at each annual or interim reporting period, whether there are conditions or events that exist that raise substantial doubt about an entity’s ability to continue as a going concern within one year after the date the financial statements are issued and provide related disclosures. ASU 2014‑15 is effective for annual periods ending after December 15, 2016 and earlier application is permitted. The Company adopted this standard during the three months ended December 31, 2016. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

 

In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory. ASU 2015-11 applies to all inventory, except for inventory measured using the last-in, first-out method or the retail inventory method. The guidance allows an entity to measure inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The amendments in ASU 2015-11 are effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years, and may be applied prospectively with earlier adoption permitted. The Company adopted ASU 2015-11 during the three months ended June 30, 2016. The adoption of this ASU did not have a material impact on the Company’s consolidated balance sheets or statements of operations for the year ended and as of December 31, 2016.

 

In March 2016, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, 2016-09, Compensation – Stock Compensation (Topic 718 Improvements to Employee Share-Based Payment Accounting). ASU 2016-09 simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. Under this guidance, a company recognizes all excess tax benefits and tax deficiencies as income tax expense or benefit in the income statement. ASU 2016-09 is effective for public companies for annual reporting periods beginning after December 15, 2016, including interim periods within those annual reporting periods; however, early adoption is permitted. The Company has early adopted ASU 2016-09 for its year ended December 31, 2016. The adoption of ASU 2016-09 did not have a material impact on the Company’s effective tax rate.  In addition, the Company no longer calculates an estimate of expected forfeitures and began recongizing forfeitures as they occur. The recognition of forfeitures, as well as the cumulative-effect decrease to retained earnings with the offset to increase additional paid-in capital recognized upon adoption did not have a material impact on the Company’s consolidated balance sheets, statement of operations or cash flows for the year ended and as of December 31, 2016.

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). ASU 2016-02 most significantly impacts lessee accounting and disclosures. First, this guidance requires lessees to identify arrangements that should be accounted for as leases. Under ASU 2016-02, for lease arrangements exceeding a 12-month term, a right-of-use asset and lease obligation is recorded by the lessee for all leases, whether operating or financing, while the income statement will reflect lease expense for operating leases and amortization/interest expense for financing leases. The balance sheet amount recorded for existing leases at the date of adoption of ASU 2016-02 must be calculated using the applicable incremental borrowing rate at the date of adoption. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases today. In addition, ASU 2016-02 requires the use of the modified retrospective method, which will require adjustment to all comparative periods presented in the consolidated financial statements. This guidance is effective for public companies for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted for all entities. The Company has not chosen early adoption for this ASU and is currently evaluating its effect on the Company’s consolidated financial statements.