TESARO, Inc.
TESARO, Inc. (Form: 10-Q, Received: 08/08/2017 16:57:23)

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

(Mark One)

 

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

 

For the quarterly period ended June 30, 2017

 

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 001-35587

 

TESARO, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware

 

27-2249687

(State or Other Jurisdiction of

 

(I.R.S. Employer

Incorporation or Organization)

 

Identification No.)

 

 

 

1000 Winter Street

 

 

Waltham, Massachusetts

 

02451

(Address of Principal Executive Offices)

 

(Zip Code)

 

(339) 970-0900

(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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer ☒

 

Accelerated filer ☐

 

 

 

Non-accelerated filer ☐

 

Smaller reporting company ☐

(Do not check if a smaller reporting company)

 

 

 

 

 

Emerging growth company ☐

 

 

 

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

 

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

 

As of August 3, 2017, there were 54,180,974 shares of the registrant’s Common Stock, par value $0.0001 per share, outstanding.

 

 

 

 


 

Table of Contents

TESARO, INC.

FORM 10-Q
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2017

 

TABLE OF CONTENTS

 

 

 

Page No.

PART I.  

FINANCIAL INFORMATION

 

Item 1.  

Financial Statements (unaudited)

3

 

Condensed Consolidated Balance Sheets as of December 31, 2016 (as revised) and June 30, 2017

3

 

Condensed Consolidated Statements of Operations and Comprehensive Loss for the three and six  months ended June 30, 2016 (as revised) and 2017

4

 

Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2016 (as revised) and 2017

5

 

Notes to Condensed Consolidated Financial Statements

6

Item 2.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

24

Item 3.  

Quantitative and Qualitative Disclosures About Market Risk

40

Item 4.  

Controls and Procedures

40

 

 

 

PART II.  

OTHER INFORMATION

 

Item 1.  

Legal Proceedings

41

Item 1A.  

Risk Factors

41

Item 6.  

Exhibits

43

 

 

 

SIGNATURES  

44

 

 

CERTIFICATIONS

 

 

2

 


 

Table of Contents

PART I FINANCIAL INFORMATIO N

 

Item 1. Financial Statements .

 

TESARO, INC.

 

Condensed Consolidated Balance Sheet s

 

( all amounts in 000’s, except share and per share data )

(Unaudited)

 

 

 

 

 

 

 

 

 

    

December 31,

    

June 30,

    

 

 

2016

 

2017

 

 

 

 

(as revised)

 

 

 

 

Assets

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

785,877

 

$

507,941

 

Accounts receivable

 

 

6,195

 

 

23,149

 

Inventories

 

 

14,700

 

 

28,285

 

Other current assets

 

 

10,515

 

 

23,045

 

Total current assets

 

 

817,287

 

 

582,420

 

 

 

 

 

 

 

 

 

Intangible assets, net

 

 

12,877

 

 

44,408

 

Property and equipment, net

 

 

6,640

 

 

9,958

 

Restricted cash

 

 

1,694

 

 

2,522

 

Other assets

 

 

3,795

 

 

6,087

 

Total assets

 

$

842,293

 

$

645,395

 

 

 

 

 

 

 

 

 

Liabilities and stockholders’ equity

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Accounts payable

 

$

5,236

 

$

45

 

Accrued expenses

 

 

68,700

 

 

99,589

 

Deferred revenue, current

 

 

95

 

 

95

 

Other current liabilities

 

 

2,978

 

 

2,701

 

Total current liabilities

 

 

77,009

 

 

102,430

 

 

 

 

 

 

 

 

 

Convertible notes, net

 

 

131,775

 

 

137,447

 

Deferred revenue, non-current

 

 

305

 

 

258

 

Other non-current liabilities

 

 

5,086

 

 

5,346

 

Total liabilities

 

 

214,175

 

 

245,481

 

 

 

 

 

 

 

 

 

Commitments and contingencies (Notes 10 and 12)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

 

 

Preferred stock, $0.0001 par value; 10,000,000 shares authorized at both December 31, 2016 and June 30, 2017; no shares issued or outstanding at both December 31, 2016 and June 30, 2017

 

 

 

 

 

Common stock, $0.0001 par value; 100,000,000 shares authorized at both December 31, 2016 and June 30, 2017; 53,621,679 and 54,165,714 shares issued and outstanding at December 31, 2016 and June 30, 2017, respectively

 

 

 5

 

 

 5

 

Additional paid-in capital

 

 

1,604,798

 

 

1,664,997

 

Accumulated other comprehensive loss

 

 

(2,924)

 

 

(2,543)

 

Accumulated deficit

 

 

(973,761)

 

 

(1,262,545)

 

Total stockholders’ equity

 

 

628,118

 

 

399,914

 

Total liabilities and stockholders’ equity

 

$

842,293

 

$

645,395

 

 

See accompanying notes to condensed consolidated financial statements.

 

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Table of Contents

TESARO, INC.

 

Condensed Consolidated Statements of Operation s and Comprehensive Loss

 

( all amounts in 000’s, except per share data )

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

    

2016

    

2017

    

2016

    

2017

    

 

 

 

(as revised)

 

 

 

 

 

(as revised)

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Product revenue, net

 

$

1,242

 

$

28,829

 

$

1,518

 

$

30,968

 

License, collaboration and other revenues

 

 

34,568

 

 

635

 

 

34,592

 

 

1,569

 

Total revenues

 

 

35,810

 

 

29,464

 

 

36,110

 

 

32,537

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of sales – product

 

 

234

 

 

3,620

 

 

313

 

 

4,064

 

Cost of sales – intangible asset amortization

 

 

463

 

 

2,979

 

 

927

 

 

3,469

 

Research and development

 

 

50,138

 

 

71,400

 

 

102,847

 

 

137,522

 

Selling, general and administrative

 

 

36,218

 

 

92,979

 

 

66,367

 

 

162,241

 

Acquired in-process research and development

 

 

4,000

 

 

7,000

 

 

8,000

 

 

7,000

 

Total expenses

 

 

91,053

 

 

177,978

 

 

178,454

 

 

314,296

 

Loss from operations

 

 

(55,243)

 

 

(148,514)

 

 

(142,344)

 

 

(281,759)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

(4,120)

 

 

(4,426)

 

 

(8,101)

 

 

(8,693)

 

Interest income

 

 

209

 

 

959

 

 

311

 

 

1,800

 

Loss before income taxes

 

 

(59,154)

 

 

(151,981)

 

 

(150,134)

 

 

(288,652)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Provision for income taxes

 

 

 —

 

 

78

 

 

 —

 

 

132

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(59,154)

 

$

(152,059)

 

$

(150,134)

 

$

(288,784)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss per share applicable to common stockholders - basic and diluted

 

$

(1.29)

 

$

(2.82)

 

$

(3.46)

 

$

(5.36)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted-average number of common shares used in net loss per share applicable to common stockholders - basic and diluted

 

 

45,808

 

 

53,982

 

 

43,387

 

 

53,834

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive loss:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net loss

 

$

(59,154)

 

$

(152,059)

 

$

(150,134)

 

$

(288,784)

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain (loss) on pension obligation

 

 

1

 

 

46

 

 

(98)

 

 

91

 

Foreign currency translation adjustments

 

 

 —

 

 

255

 

 

 —

 

 

290

 

Other comprehensive income (loss)

 

 

1

 

 

301

 

 

(98)

 

 

381

 

Comprehensive loss

 

$

(59,153)

 

$

(151,758)

 

$

(150,232)

 

$

(288,403)

 

 

See accompanying notes to condensed consolidated financial statements.

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TESARO, INC.

 

Condensed Consolidated Statements of Cash Flow s

 

( all amounts in 000’s )

(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended June 30,

 

 

    

2016

    

2017

    

 

 

 

(as revised)

 

 

 

 

Operating activities

 

 

 

 

 

 

 

Net loss

 

$

(150,134)

 

$

(288,784)

 

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

 

 

 

 

 

 

 

Acquired in-process research and development

 

 

8,000

 

 

7,000

 

Depreciation and amortization expense

 

 

1,479

 

 

4,931

 

Stock-based compensation expense

 

 

21,146

 

 

41,909

 

Non-cash interest expense

 

 

5,082

 

 

5,672

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable

 

 

1,152

 

 

(16,954)

 

Inventories

 

 

(7,275)

 

 

(6,959)

 

Other assets

 

 

(2,112)

 

 

(10,950)

 

Accounts payable

 

 

5,859

 

 

(5,146)

 

Accrued expenses

 

 

6,506

 

 

19,746

 

Deferred revenues

 

 

417

 

 

(46)

 

Other liabilities

 

 

(49)

 

 

94

 

Net cash used in operating activities

 

 

(109,929)

 

 

(249,487)

 

 

 

 

 

 

 

 

 

Investing activities

 

 

 

 

 

 

 

Acquisition of product candidate and technology licenses and milestone payments

 

 

(8,000)

 

 

(42,000)

 

Purchase of property and equipment

 

 

(590)

 

 

(4,309)

 

Change in restricted cash

 

 

 —

 

 

(846)

 

Net cash used in investing activities

 

 

(8,590)

 

 

(47,155)

 

 

 

 

 

 

 

 

 

Financing activities

 

 

 

 

 

 

 

Proceeds from sale of common stock, net of issuance costs

 

 

204,969

 

 

(8)

 

Proceeds from exercise of stock options and Employee Stock Purchase Plan

 

 

3,608

 

 

18,348

 

Net cash provided by financing activities

 

 

208,577

 

 

18,340

 

 

 

 

 

 

 

 

 

Effect of exchange rate changes on cash and cash equivalents

 

 

 —

 

 

366

 

Increase (decrease) in cash and cash equivalents

 

 

90,058

 

 

(277,936)

 

Cash and cash equivalents at beginning of period

 

 

230,146

 

 

785,877

 

Cash and cash equivalents at end of period

 

$

320,204

 

$

507,941

 

 

 

 

 

 

 

 

 

Non-cash investing and financing activities

 

 

 

 

 

 

 

Stock option exercise proceeds receivable as of period end

 

$

2,875

 

$

35

 

Leasehold improvement assets funded by lessor

 

$

 —

 

$

585

 

Purchase of property and equipment - cash not paid as of period end

 

$

139

 

$

118

 

 

 

 

 

 

 

 

 

Supplemental disclosure of cash flow information

 

 

 

 

 

 

 

     Cash paid for interest

 

$

3,019

 

$

3,019

 

 

See accompanying notes to condensed consolidated financial statements.

 

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TESARO, INC.

 

Notes to Condensed Consolidated Financial Statement s

(Unaudited)

 

1.  Description of Business

 

TESARO, Inc., or the Company or TESARO, was incorporated in Delaware on March 26, 2010 and commenced operations in May 2010.  Headquartered in Waltham, Massachusetts, TESARO is an oncology-focused biopharmaceutical company dedicated to improving the lives of cancer patients.  TESARO acquires, in-licenses, develops, and commercializes oncology products and product candidates.  As part of its business strategy, the Company intends to continue to in-license or acquire additional product candidates across various stages of development.  The Company operates in one segment.  The Company is subject to a number of risks, including, but not limited to, dependence on key individuals, regulatory and manufacturing risks, risks associated with intellectual property, the need to develop additional commercially viable products, competition from other companies, many of which are larger and better capitalized, and the need to obtain adequate additional financing to fund the development and potential commercialization of its product candidates and further its in-licensing and acquisition activities.

 

On September 1, 2015, the Company’s first commercial product, VARUBI® (rolapitant), was approved by the United States Food and Drug Administration, or FDA, in combination with other antiemetic agents in adults for the prevention of delayed nausea and vomiting associated with initial and repeat courses of emetogenic cancer chemotherapy, including, but not limited to, highly emetogenic chemotherapy.  The Company commenced sales of VARUBI in November 2015.  On March 27, 2017, the FDA approved the Company’s second commercial product, ZEJULA TM (niraparib), for the maintenance treatment of women with recurrent epithelial ovarian, fallopian tube, or primary peritoneal cancer who are in a complete or partial response to platinum-based chemotherapy.  The Company commenced sales of ZEJULA in the United States in April 2017.  On April 26, 2017, the European Commission approved VARUBY® (oral rolapitant tablets) for the prevention of delayed nausea and vomiting associated with highly and moderately emetogenic cancer chemotherapy in adults.  The Company commenced sales of VARUBY in Europe in May 2017.

 

The Company has incurred significant operating losses since inception and has relied on its ability to fund its operations through private and public equity and debt financings and to a lesser extent through product sales and license and collaboration arrangements.  Management expects operating losses and negative operating cash flows to continue for the foreseeable future.  As the Company continues to incur losses, the transition to profitability is dependent upon the successful development, approval, and commercialization of its products and product candidates and the achievement of a level of revenues adequate to support its cost structure.  The Company believes that its currently available funds in addition to cash generated from sales of its products will be sufficient to fund the Company’s operations through at least the next 12 months from the issuance of this Quarterly Report on Form 10-Q.  Management’s belief with respect to its ability to fund operations is based on estimates that are subject to risks and uncertainties.  If actual results are different from management’s estimates, the Company may need to seek additional funding.

 

2.  Basis of Presentation and Significant Accounting Policies

 

Basis of Presentation

 

The accompanying condensed consolidated financial statements are unaudited and have been prepared by TESARO in conformity with accounting principles generally accepted in the United States of America, or GAAP.  Certain amounts in the prior period financial statements have been reclassified to conform to the presentation of the current period financial statements.  See “New Accounting Pronouncements - Recently Adopted” below for discussion of the Company’s adoption of new revenue recognition guidance retroactive to January 1, 2015.  Otherwise, these reclassifications had no significant effects on the previously reported net loss.

 

The Company’s condensed consolidated financial statements reflect the operations of the Company and its wholly-owned subsidiaries.  All significant intercompany balances and transactions have been eliminated in consolidation.  The Company currently operates in one business segment, which is the identification, acquisition, development and commercialization of oncology-related therapeutics, and has a single reporting and operating unit structure.

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Certain information and footnote disclosures normally included in the Company’s annual financial statements have been condensed or omitted.  These interim financial statements, in the opinion of management, reflect all normal recurring adjustments necessary for a fair presentation of the Company’s financial position and results of operations for the interim periods ended June 30, 2016 and 2017.

 

The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full fiscal year.  These interim financial statements should be read in conjunction with the audited financial statements as of and for the year ended December 31, 2016 and the notes thereto, which are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.  The significant accounting policies used in preparation of these condensed consolidated financial statements for the three and six months ended June 30, 2017 are consistent with those discussed in Note 2 to the consolidated financial statements in the Company’s 2016 Annual Report on Form 10-K and are updated below as necessary.

 

Use of Estimates

 

The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, other comprehensive income (loss) and the related disclosures.  On an ongoing basis, management evaluates its estimates, including estimates related to net product revenues, license, collaboration and other revenues, accrued clinical trial and manufacturing development expenses, stock-based compensation expense, inventory and intangible assets and related amortization.  Significant estimates in these condensed consolidated financial statements include estimates made in connection with accrued research and development expenses, stock-based compensation expense, revenue, valuation of convertible notes, intangible assets and related amortization.  The Company bases its estimates on historical experience, known trends and other market-specific or other relevant factors that it believes to be reasonable under the circumstances.  Actual results may differ from those estimates or assumptions.

 

Fair Value of Financial Instruments

 

The Company is required to disclose information on all assets and liabilities reported at fair value that enables an assessment of the inputs used in determining the reported fair values.  The fair value hierarchy prioritizes valuation inputs based on the observable nature of those inputs.  The fair value hierarchy applies only to the valuation inputs used in determining the reported fair value of the investments and is not a measure of investment credit quality.  The hierarchy defines three levels of valuation inputs:

 

Level 1 inputs      Quoted prices in active markets for identical assets or liabilities

 

Level 2 inputs      Observable inputs other than Level 1 inputs, including quoted prices in active markets for similar assets or liabilities and quoted prices for identical assets or liabilities in markets that are not active

 

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

 

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The following table presents information about the Company’s financial assets and liabilities that have been measured at fair value as of December 31, 2016 and June 30, 2017 and indicates the fair value hierarchy of the valuation inputs utilized to determine such fair value (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2016

 

Description

    

Balance Sheet Classification

    

Total

    

Level 1

    

Level 2

    

Level 3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

Cash and cash equivalents

 

$

766,186

 

$

766,186

 

$

 —

 

$

 —

 

Total assets

 

 

 

$

766,186

 

$

766,186

 

$

 —

 

$

 —

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2017

 

Description

    

Balance Sheet Classification

    

Total

    

Level 1

    

Level 2

    

Level 3

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

Cash and cash equivalents

 

$

471,335

 

$

471,335

 

$

 

$

 

Total assets

 

 

 

$

471,335

 

$

471,335

 

$

 —

 

$

 —

 

 

The carrying amounts of accounts payable and accrued expenses approximate their fair values due to their short-term maturities.

 

In September 2014, the Company issued $201.3 million aggregate principal amount of 3.00% convertible senior notes due October 1, 2021, or the Convertible Notes.  Interest is payable semi-annually in arrears on April 1 and October 1 of each year.  As of June 30, 2017, the carrying value of the Convertible Notes, net of unamortized discount and debt issuance costs, was $137.4 million and the estimated fair value of the principal amount was $824.6 million.  The Convertible Notes are discussed in more detail in Note 5, “Convertible Notes”.

 

Revenue Recognition

 

Effective January 1, 2017, the Company adopted Accounting Standards Codification, or ASC, Topic 606, Revenue from Contracts with Customers , using the full retrospective transition method.  Under this method, the Company will revise its consolidated financial statements for the years ended December 31, 2015 and 2016, and applicable interim periods within those years, as if Topic 606 had been effective for those periods.  This standard applies to all contracts with customers, except for contracts that are within the scope of other standards, such as leases, insurance, collaboration arrangements and financial instruments.  Under Topic 606, an entity recognizes revenue when its customer obtains control of promised goods or services, in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services.  To determine revenue recognition for arrangements that an entity determines are within the scope of Topic 606, the entity performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation.  The Company only applies the five-step model to contracts when it is probable that the entity will collect the consideration it is entitled to in exchange for the goods or services it transfers to the customer.  At contract inception, once the contract is determined to be within the scope of Topic 606, the Company assesses the goods or services promised within each contract and determines those that are performance obligations, and assesses whether each promised good or service is distinct.  The Company then recognizes as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.  For a complete discussion of accounting for net product revenue and license, collaboration and other revenues, see Note 11, “Revenue Recognition”.

 

Intangible Assets

 

The Company maintains definite-lived intangible assets related to milestone payments made to third parties subsequent to regulatory approval for acquired and in-licensed product candidates.  These assets are amortized over their remaining useful lives, which are generally estimated to be the remaining patent life.  If the Company’s estimate of the product’s useful life is shorter than the remaining patent life, then the shorter period is used.  Intangible assets are amortized using the economic consumption method if anticipated future revenues can be reasonably estimated.  The straight-line method is used when future revenues cannot be reasonably estimated, with a cumulative catch-up of

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amortization expense for milestone payments that do not result in additional intellectual property rights and/or incremental cashflows.  Amortization expense is recorded as a component of cost of sales in the condensed consolidated statements of operations.

 

The Company assesses its intangible assets for impairment if indicators are present or changes in circumstance suggest that impairment may exist.  Events that could result in an impairment, or trigger an interim impairment assessment, include the receipt of additional clinical or nonclinical data regarding one of the Company’s drug candidates or a potentially competitive drug candidate, changes in the clinical development program for a drug candidate or new information regarding potential sales for the drug.   If impairment indicators are present or changes in circumstance suggest that impairment may exist, the Company performs a recoverability test by comparing the sum of the estimated undiscounted cash flows of each intangible asset to its carrying value on the condensed consolidated balance sheet.  If the undiscounted cash flows used in the recoverability test are less than the carrying value, the Company would determine the fair value of the intangible asset and recognize an impairment loss if the carrying value of the intangible asset exceeds its fair value.

 

New Accounting Pronouncements - Recently Adopted

 

In May 2014, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, No. 2014-09, which amends the guidance for accounting for revenue from contracts with customers.  This ASU supersedes the revenue recognition requirements in ASC Topic 605, Revenue Recognition , and creates a new Topic 606, Revenue from Contracts with Customers .  In 2015 and 2016, the FASB issued additional ASUs related to Topic 606 that delayed the effective date of the guidance and clarified various aspects of the new revenue guidance, including principal versus agent considerations, identifying performance obligations, and licensing, and they include other improvements and practical expedients.  The Company adopted this new standard on January 1, 2017 using the full retrospective transition method, and has elected to use the following practical expedients that are permitted under the rules of the adoption, which have been applied consistently to all contracts within all reporting periods presented:

 

·

For completed contracts that had variable consideration, the Company has used the transaction price   at the date the contract was completed rather than estimating variable consideration amounts in the comparative reporting periods.  Therefore, the Company did not need to estimate its discounts, returns, chargebacks, rebates, co-pay assistance and other allowances on product sales made in the comparative reporting periods.

 

·

For all reporting periods presented before January 1, 2017, the Company has not disclosed the amount of the transaction price allocated to the remaining performance obligations or an explanation of when the Company expects to recognize that amount as revenue.

 

Impact of Adoption

 

The Company, as a result of adopting Topic 606 on January 1, 2017, has revised its comparative financial statements for the prior year as if Topic 606 had been effective for that period.  As a result, the following financial statement line items for fiscal year 2016 were affected.

 

 

 

 

 

 

 

 

 

 

 

Condensed Consolidated Statements of Operations and Comprehensive Loss

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended June 30, 2016
(in thousands, except per share data)

 

    

As revised
under Topic 606

    

As originally
reported under
Topic 605

    

Effect of change

Product revenue, net

 

$

1,242

 

$

1,436

 

$

(194)

License, collaboration and other revenues

 

 

34,568

 

 

35,125

 

 

(557)

Cost of sales – product

 

 

234

 

 

238

 

 

(4)

Loss from operations

 

 

(55,243)

 

 

(54,496)

 

 

(747)

Net loss

 

 

(59,154)

 

 

(58,407)

 

 

(747)

Net loss per share applicable to common stockholders - basic and diluted

 

$

(1.29)

 

$

(1.28)

 

$

(0.01)

 

 

 

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Six months ended June 30, 2016
(in thousands, except per share data)

 

    

As revised
under Topic 606

    

As originally
reported under
Topic 605

    

Effect of change

Product revenue, net

 

$

1,518

 

$

1,609

 

$

(91)

License, collaboration and other revenues

 

 

34,592

 

 

35,259

 

 

(667)

Cost of sales – product

 

 

313

 

 

314

 

 

(1)

Loss from operations

 

 

(142,344)

 

 

(141,587)

 

 

(757)

Net loss

 

 

(150,134)

 

 

(149,377)

 

 

(757)

Net loss per share applicable to common stockholders - basic and diluted

 

$

(3.46)

 

$

(3.44)

 

$

(0.02)

 

 

 

 

 

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31, 2016  (in thousands)

 

    

As revised
under Topic 606

    

As originally
reported under
Topic 605

    

Effect of change

Accounts receivable

 

$

6,195

 

$

5,343

 

$

852

Other current assets

 

 

10,515

 

 

8,919

 

 

1,596

Accrued expenses

 

 

68,700

 

 

68,271

 

 

429

Deferred revenue, current

 

 

95

 

 

288

 

 

(193)

Deferred revenue, non-current

 

 

305

 

 

 —

 

 

305

Customer deposit

 

 

 —

 

 

15,000

 

 

(15,000)

Accumulated deficit

 

$

(973,761)

 

$

(990,668)

 

$

16,907

 

 

 

 

 

 

 

 

 

 

 

Condensed Consolidated Statement of Cash Flows

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six months ended June 30, 2016 (in thousands)

 

    

As revised
under Topic 606

    

As originally
reported under
Topic 605

    

Effect of change

Net loss

 

$

(150,134)

 

$

(149,377)

 

$

(757)

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

 

 

 

 

 

 

 

 

 

Accounts receivable

 

 

1,152

 

 

169

 

 

983

Other assets

 

 

(2,112)

 

 

(2,296)

 

 

184

Accrued expenses

 

 

6,506

 

 

6,421

 

 

85

Deferred revenues

 

 

417

 

 

912

 

 

(495)

Cash and cash equivalents at beginning of period

 

 

230,146

 

 

230,146

 

 

 —

Cash and cash equivalents at end of period

 

$

320,204

 

$

320,204

 

$

 —

 

The most significant change above relates to the Company’s license, collaboration and other revenues and the impact of the potential payment to Zai Lab (Shanghai) Co., Ltd., or Zai Lab, upon exercise of the option to co-market niraparib in China, Hong Kong and Macao, or the China Territories.  Under Topic 605, even though the Company believed it was remote that this option would be exercised, the Company had concluded that the contract price was not fixed or determinable under the revenue recognition criteria and accordingly no revenue had been previously recognized. Therefore, the upfront, non-refundable license fee of $15.0 million received by the Company in the fourth quarter of 2016 was deferred and recorded as a customer deposit as of December 31, 2016.  Under Topic 606, the Company determined the probability is remote that it will exercise the option and accordingly, the potential future payments to Zai Lab have no impact on the transaction price.  Further, the Company evaluated this option to co-market niraparib under Topic 606 and concluded that this option is not a repurchase right and accordingly recognized revenue in 2016 for the transaction price received as and when the performance obligations under this agreement were satisfied by the Company.  For further discussion of the adoption of this standard, see Note 11, “Revenue Recognition” and Note 12, “License and Collaboration Arrangements”.

 

In January 2017, the FASB issued ASU No. 2017-01, which clarifies the definition of a business.  To be considered a business (instead of an asset), an acquisition would have to include an input and a substantive process that together significantly contribute to the ability to create outputs.  The new guidance provides a framework to evaluate

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when an input and a substantive process are present (including for early stage companies that have not generated outputs).  To be a business without outputs, there will now need to be an organized workforce.  The new guidance narrows the definition of the term “outputs” to be consistent with how it is described in Topic 606.  Under the final definition, an output is the result of inputs and substantive processes that provide goods or services to customers, other revenue, or investment income, such as dividends and interest.  The new guidance is effective on a prospective basis for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted.  The Company elected to early adopt this ASU effective January 1, 2017.  The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements, although this guidance could impact its accounting conclusions for certain future transactions, such as in-licensing agreements.

 

New Accounting Pronouncements – Recently Issued

 

In May 2017, the FASB issued ASU No. 2017-09, which clarifies when a change to the terms or conditions of a share-based payment award must be accounted for as a modification.  The new guidance requires modification accounting if the fair value, vesting condition or the classification of the award is not the same immediately before and after a change to the terms and conditions of the award.  This ASU is effective on a prospective basis beginning on January 1, 2018, with early adoption permitted.  The Company does not expect this new guidance to have a material impact on its consolidated financial statements.

 

 

3.  Net Loss per Share

 

Basic and diluted net loss per common share is calculated by dividing net loss applicable to common stockholders by the weighted-average number of common shares outstanding during the period, without consideration of common stock equivalents.  The Company’s potentially dilutive shares, which include outstanding stock options,  Employee Stock Purchase Plan awards, unvested restricted stock units, or RSUs, and shares issuable upon conversion of the Convertible Notes, are considered to be common stock equivalents and are only included in the calculation of diluted net loss per share when their effect is dilutive.

 

The following table presents amounts that were excluded from the calculation of diluted net loss per share, due to their anti-dilutive effect (in thousands):

 

 

 

 

 

 

 

 

 

Three and Six Months Ended June 30,

 

 

    

2016

    

2017

 

Outstanding stock options

 

7,080

 

7,204

 

Unvested restricted stock units

 

587

 

1,158

 

Shares issuable upon conversion of Convertible Notes

 

 —

 

3,932

 

 

 

7,667

 

12,294

 

 

In September 2014, the Company issued Convertible Notes, which provide in certain situations for the conversion of the outstanding principal amount of the Convertible Notes into shares of the Company’s common stock at a predefined conversion rate.  See Note 5, “Convertible Notes”, for additional information.  In conjunction with the issuance of the Convertible Notes, the Company entered into capped call option transactions, or Capped Calls, with certain counterparties.  The Capped Calls are expected generally to reduce the potential dilution, and/or offset, to an extent, the cash payments the Company may choose to make in excess of the principal amount, upon conversion of the Convertible Notes.

 

As provided by the terms of the indenture underlying the Convertible Notes, the Company has a choice to settle the conversion obligation for the Convertible Notes in cash, shares or any combination of the two.  The Company currently intends to settle the par value of the Convertible Notes in cash and any excess conversion premium in shares.  Accordingly, the par value of the Convertible Notes will not be included in the calculation of diluted net income per share, but the dilutive effect of the conversion premium will be considered in the calculation of diluted net income per share using the treasury stock method.  The share figures in the table above represent the estimated incremental shares that would be issued, after consideration of the Capped Calls, assuming conversion of all of the outstanding Convertible Notes as of June 30, 2016 and 2017.

 

 

 

 

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4. Inventories

 

The following table presents inventories as of December 31, 2016 and June 30, 2017 (in thousands):

 

 

 

 

 

 

 

 

 

 

December 31,

 

June 30,

 

    

2016

    

2017

Raw materials

 

$

13,263

 

$

19,742

Work in process

 

 

584

 

 

7,083

Finished goods

 

 

853

 

 

1,460

Total inventories

 

$

14,700

 

$

28,285

 

 

 

 

 

 

Inventories are related to the Company’s approved products, VARUBI and ZEJULA.  If future sales of VARUBI or ZEJULA are less than expected, the Company may be required to write down the value of such inventories.

 

 

 

5.  Convertible Notes

 

On September 29, 2014, in a registered underwritten public offering, the Company completed the issuance of $201.3 million aggregate principal amount of Convertible Notes.  In conjunction with the sale of the Convertible Notes, the Company used $20.8 million of the net proceeds to enter into separate Capped Calls.

 

The Convertible Notes bear interest at a rate of 3.00% per annum, payable semi-annually on April 1 and October 1, and will be convertible into cash, shares of the Company’s common stock or a combination of cash and shares of the Company’s common stock, at the Company’s election.  The Convertible Notes will mature on October 1, 2021, unless earlier converted or repurchased in accordance with their terms.  Prior to the close of business on the business day immediately preceding April 1, 2021, the Convertible Notes will be convertible only upon the occurrence of certain events and during certain periods as discussed below, and thereafter, at any time until the close of business on the second scheduled trading day immediately preceding the maturity date.  The initial conversion price of the Convertible Notes is approximately $35.13 per share of common stock at an initial conversion rate of 28.4627 shares of the Company’s common stock per $1,000 principal amount of Convertible Notes.

 

The conversion rate is subject to adjustment from time to time upon the occurrence of certain events, including, but not limited to, the issuance of stock dividends and payment of cash dividends.  At any time prior to the close of business on the business day immediately preceding April 1, 2021, holders may convert their Convertible Notes at their option only under the following circumstances:

 

(1)

during any calendar quarter commencing after the calendar quarter ending on December 31, 2014 (and only during such calendar quarter), if the closing sale price of the Company’s common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter in which the conversion occurs is greater than 130% of the conversion price on each applicable trading day;

 

(2)

during the five business day period after any ten consecutive trading day period, or the measurement period, in which the trading price per $1,000 principal amount of the Convertible Notes for each trading day of the measurement period was less than 98% of the product of the closing sale price of the Company’s common stock and the conversion rate on each such trading day; or

 

(3)

upon the occurrence of specified corporate events.

 

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As of June 30, 2017, the carrying value of the Convertible Notes, net of unamortized discount and debt issuance costs, was $137.4 million and the estimated fair value of the principal amount was $824.6 million.  As provided by the terms of the indenture underlying the Convertible Notes, the Company has a choice to settle the conversion obligation for the Convertible Notes in cash, shares or any combination of the two.  The Company currently intends to settle the par value of the Convertible Notes in cash and any excess conversion premium in shares.  

 

The following table presents total interest expense recognized related to the Convertible Notes during the three and six months ended June 30, 2016 and 2017 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

    

2016

    

2017

    

2016

    

2017

Contractual interest expense

 

$

1,509

 

$

1,509

 

$

3,019

 

$

3,019

Amortization of debt discount

 

 

2,461

 

 

2,779

 

 

4,775

 

 

5,394

Amortization of debt issuance costs

 

 

150

 

 

136

 

 

307

 

 

279

Total interest expense

 

$

4,120

 

$

4,424

 

$

8,101

 

$

8,692

 

6.  Stock-Based Compensation

 

The Company maintains several equity compensation plans, including the TESARO, Inc. 2012 Omnibus Incentive Plan, or the 2012 Incentive Plan, the TESARO, Inc. 2010 Stock Incentive Plan, or the 2010 Incentive Plan, the TESARO, Inc. 2015 Non-Employee Director Stock Incentive Plan, or the 2015 Director Plan, and the TESARO, Inc. 2012 Employee Stock Purchase Plan, or the 2012 ESPP.

 

On April 27, 2012, the stockholders of the Company approved the 2012 Incentive Plan, which had been previously adopted by the board of directors.  Upon effectiveness of the 2012 Incentive Plan, the Company ceased making awards under the 2010 Incentive Plan.  The 2012 Incentive Plan initially allowed the Company to grant awards for up to 1,428,571 shares of common stock plus the number of shares of common stock available for grant under the 2010 Incentive Plan as of the effectiveness of the 2012 Incentive Plan (an additional 6,857 shares) plus the number of shares of common stock related to awards outstanding under the 2010 Incentive Plan that terminate by expiration, forfeiture, cancellation, cash settlement or otherwise.  The number of shares available for grants of awards under the 2012 Incentive Plan is increased automatically on January 1 by a number of shares of common stock equal to the lesser of 4% of the shares of common stock outstanding at such time or the number of shares determined by the Company’s board of directors.  Most recently, on January 1, 2016 and 2017, the number of shares authorized for issuance under the 2012 Incentive Plan was increased by 1,611,191 shares and 2,144,867 shares, respectively.  Awards under the 2012 Incentive Plan may include the following award types: stock options, which may be either incentive stock options or nonqualified stock options; stock appreciation rights; restricted stock; RSUs; dividend equivalent rights; performance shares; performance units; cash-based awards; other stock-based awards, including unrestricted shares; or any combination of the foregoing.  The exercise price of stock options granted under the 2012 Incentive Plan is equal to the closing price of a share of the Company’s common stock on the grant date.

 

On May 14, 2015, the stockholders of the Company approved the 2015 Director Plan, which had been previously adopted by the board of directors in order to have a plan in addition to the 2012 Incentive Plan for purposes of granting awards to non-employee directors.  The 2015 Director Plan allows the Company to grant awards for up to 500,000 shares of common stock.  Awards under the 2015 Director Plan may include the following award types: stock options; stock appreciation rights; restricted stock; RSUs; unrestricted stock; or any combination of the foregoing.  The exercise price of stock options granted under the 2015 Director Plan is equal to the closing price of a share of the Company’s common stock on the grant date.  On May 11, 2016, the Company’s stockholders approved an amendment to the 2015 Director Plan that limits the maximum number of shares of stock subject to awards granted in any calendar year to any non-employee director of the Company to 50,000 shares and affirms that 500,000 shares are reserved for issuance under the 2015 Director Plan.

 

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The following table presents stock-based compensation expense as reflected in the Company’s condensed consolidated statements of operations and comprehensive loss (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

    

2016

    

2017

    

2016

    

2017

Research and development

 

$

4,479

 

$

7,862

 

$

8,222

 

$

14,987

Selling, general and administrative

 

 

7,206

 

 

15,646

 

 

12,924

 

 

26,922

Total stock-based compensation expense

 

$

11,685

 

$

23,508

 

$

21,146

 

$

41,909

 

Stock Options

 

The following table presents a summary of the Company’s stock option activity and related information:

 

 

 

 

 

 

 

 

 

 

 

Weighted-average

 

 

 

 

exercise price per

 

 

Shares

 

share

Outstanding at December 31, 2016

 

6,978,621

 

$

40.65

Granted

 

661,657

 

 

162.65

Exercised

 

(373,078)

 

 

43.65

Cancelled

 

(62,837)

 

 

50.38

Outstanding at June 30, 2017

 

7,204,363

 

$

51.62

 

 

 

 

 

 

Vested at June 30, 2017

 

3,779,553

 

$

28.34

 

At June 30, 2017, there was approximately $142.6 million of unrecognized compensation cost related to unvested stock options, which the Company expects to recognize over a remaining weighted-average period of 2.5 years.

 

Restricted Stock Units

 

The following table presents a summary of the Company’s RSU activity and related information:

 

 

 

 

 

 

 

 

 

    

    

    

Weighted-average

 

 

 

 

 

grant date fair

 

 

 

Shares

 

value per share

 

Unvested restricted stock units at December 31, 2016

 

760,123

 

$

58.55

 

Granted

 

566,446

 

 

169.31

 

Vested

 

(150,162)

 

 

46.51

 

Forfeited

 

(18,473)

 

 

85.74

 

Unvested restricted stock units at June 30, 2017

 

1,157,934

 

$

113.86

 

 

At June 30, 2017, there was approximately $118. 5 million of unrecognized compensation cost related to unvested RSUs, which the Company expects to recognize over a remaining weighted-average period of 3.2   years. 

 

In July 2016, the Company issued 15,000 RSUs with service and performance conditions to certain employees,   of which 5,073 vested during the three months ended June 30, 2017. Vesting of these awards is contingent on the occurrence of certain milestone events and fulfillment of any remaining service condition.  As a result, the related compensation cost is recognized as an expense when achievement of the milestone is considered probable.  The Company recognized $0.5 million of related expense during the six months ended June 30, 2017.

 

ESPP

 

Under the Company’s 2012 ESPP, an aggregate of 275,000 shares of common stock have been reserved for issuance pursuant to purchase rights granted to the Company’s employees or to employees of the Company’s designated subsidiaries.  As of June 30, 2017, 176,561 shares remained available for issuance.  During the six months ended June 30, 2016 and 2017, the Company issued 25,225 and 17,684 shares under the 2012 ESPP, and recognized approximately $0.5 million and $1.0 million in related stock-based compensation expense, respectively.

 

 

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7.  Common Stock Transactions

 

In March 2016, the Company sold 4,404,658 shares of common stock in a private placement offering at a price of $35.19 per share, to certain accredited investors, including funds affiliated with three of its directors and current investors, resulting in gross proceeds of approximately $155.0 million.  The price per share was equal to the volume weighted average price for the ten-day period ending on March 17, 2016.  There were no placement agents used for this financing.  The sale and issuance of the shares of common stock in the private placement was made in reliance on the exemption afforded by Section 4(a)(2) under the Securities Act of 1933 and Regulation D promulgated under the Securities Act.

 

In April 2016, the Company sold 1,130,198 shares of common stock to Johnson & Johnson Innovation – JJDC, Inc., or JJDC, at a price per share of $44.24, for an aggregate purchase price of approximately $50.0 million.  The price per share was equal to the volume weighted average price for the five-day period ending on April 4, 2016.  There were no placement agents used, or any underwriting discounts or commissions paid in connection with the transaction.  The sale and issuance of the shares of common stock was made in reliance on the exemption afforded by Section 4(a)(2) under the Securities Act of 1933 and Regulation D promulgated under the Securities Act.

 

8.  Income Taxes

 

Deferred tax assets and deferred tax liabilities are determined based on temporary differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.  A valuation allowance is recorded against deferred tax assets if it is more likely than not that some portion or all of the deferred tax assets will not be realized.

 

The Company does not recognize a tax benefit for uncertain tax positions unless it is more likely than not that the position will be sustained upon examination by tax authorities, including resolution of any related appeals or litigation processes, based on the technical merits of the position.  The tax benefit that is recorded for these positions is measured at the largest amount of cumulative benefit that has greater than a 50 percent likelihood of being realized upon ultimate settlement.  Deferred tax assets that do not meet these recognition criteria are not recorded and the Company recognizes a liability for uncertain tax positions that may result in tax payments.  If such unrecognized tax benefits were realized and not subject to valuation allowances, the entire amount would impact the tax provision.  As of June 30, 2017, the Company’s uncertain tax positions were subject to valuation allowances.

 

The Company recorded provisions for income taxes for the three and six months ended June 30, 2017 of $0.1 million and $0.1 million, respectively.  The provision for income taxes consists of current tax expense, which relates primarily to the Company’s subsidiary operations in foreign tax jurisdictions.

 

 

9. Intangible Assets

 

The following table presents intangible assets as of December 31, 2016 and June 30, 2017 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

December 31,

 

June 30,

 

 

 

 

    

2016

    

2017

    

Estimated useful life

Acquired and in-licensed rights

 

$

15,000

 

$

50,000

 

8-13

Years

Less accumulated amortization

 

 

(2,123)

 

 

(5,592)

 

 

 

Total intangible assets, net

 

$

12,877

 

$

44,408

 

 

 

 

The increase in acquired and in-licensed rights as of June 30, 2017 was due to a milestone of $25.0 million paid to Merck Sharp & Dohme Corp., a subsidiary of Merck & Co., Inc., or Merck, which was triggered by the FDA approval of ZEJULA on March 27, 2017, and a milestone of $10.0 million paid to OPKO Health, Inc., which was triggered by the first commercial sale of VARUBY in Europe in May 2017.

 

The Company recorded $0.5 million and $3.0 million in amortization expense related to intangible assets during the three months ended June 30, 2016 and 2017, respectively, and $0.9 million and $3.5 million during the six months ended June 30, 2016 and 2017, respectively.  Estimated future amortization expense for intangible assets as of June 30, 2017 is $2.5 million for the remainder of 2017, $5.0 million per year for 2018, 2019, 2020, and 2021, and $21.8 million thereafter.

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10.  Commitments and Contingencies

 

The Company leases approximately 150,000 square feet of office space in Waltham, Massachusetts under a non-cancelable operating lease agreement.  The Company also leases office space in several locations throughout Europe.  The Company recognizes rental expense on a straight-line basis over the respective lease term including any free rent periods and tenant allowances. 

 

Future minimum rental commitments under the Company’s leased properties as of June 30, 2017 were $3.1 million for the remainder of the year ending December 31, 2017 and $6.9 million, $6.9 million, $3.6 million, $0.3 and $0.1 million for the years ending December 31, 2018, 2019, 2020, 2021 and 2022, respectively.  

 

The Company has entered into agreements with certain vendors for the provision of services, including services related to data management, clinical and commercial operation support and diagnostic test development, that the Company is not able to terminate for convenience under its contracts, and thus avoid any and all future obligations to the vendors.  Under such agreements, the Company is contractually obligated to make certain minimum payments to the vendors, with the exact amounts in the event of termination to be based on the timing of the termination and the exact terms of the agreement.

 

The Company has certain obligations under licensing agreements with third parties that are contingent upon achieving various development, regulatory and commercial milestones.  Pursuant to these license agreements, the Company is required to make milestone payments if certain development, regulatory and commercial sales milestones are achieved, and may have certain additional research funding obligations.  Also, pursuant to the terms of each of these license agreements, when and if commercial sales of a product commence, the Company will pay royalties to its licensors on net sales of the respective products.

 

Legal Proceedings

 

The Company may periodically become subject to legal proceedings and claims arising in connection with ongoing business activities, including claims or disputes related to patents that have been issued or that are pending in the field of research on which the Company is focused.  The Company is not a party to any material litigation and does not have contingency reserves established for any litigation liabilities.

 

11. Revenue Recognition

 

Product Revenue, Net

 

The Company sells its products principally to a limited number of specialty distributors and specialty pharmacy providers, or collectively, its Customers.  These Customers subsequently resell the Company’s products to health care providers and patients.  In addition to distribution agreements with Customers, the Company enters into arrangements with health care providers and payors that provide for government-mandated and/or privately-negotiated rebates, chargebacks and discounts with respect to the purchase of the Company’s products.

 

Revenues from product sales are recognized when the Customer obtains control of the Company’s product, which occurs at a point in time, typically upon delivery to the Customer.  When the Company performs shipping and handling activities after the transfer of control to the Customer (e.g., when control transfers prior to delivery), they are considered as fulfillment activities, and accordingly, the costs are accrued for when the related revenue is recognized.  Taxes collected from Customers relating to product sales and remitted to governmental authorities are excluded from revenues.  The Company expenses incremental costs of obtaining a contract as and when incurred if the expected amortization period of the asset that the Company would have recognized is one year or less.

 

Reserves for Variable Consideration

 

Revenues from product sales are recorded at the net sales price (transaction price), which includes estimates of variable consideration for which reserves are established and which result from discounts, returns, chargebacks, rebates, co-pay assistance and other allowances that are offered within contracts between the Company and its Customers, health care providers, payors and other indirect customers relating to the Company’s sales of its products.  These reserves are

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

 

Trade Discounts and Allowances:  The Company generally provides Customers with discounts which include incentive fees that are explicitly stated in the Company’s contracts and are recorded as a reduction of revenue in the period the related product revenue is recognized.  In addition, the Company receives sales order management, data and distribution services from certain Customers.  To the extent the services received are distinct from the Company’s sale of products to the Customer, these payments are classified in selling, general and administrative expenses in the condensed consolidated statements of operations and comprehensive loss of the Company.

 

Product Returns:  Consistent with industry practice, the Company generally offers Customers a limited right of return for product that has been purchased from the Company based on the product’s expiration date, which lapses upon shipment to a patient.  The Company estimates the amount of its product sales that may be returned by its Customers and records this estimate as a reduction of revenue in the period the related product revenue is recognized.  The Company currently estimates product return liabilities using available industry data and its own historical sales information, including its visibility into the inventory remaining in the distribution channel.  The Company has not received any returns to date and believes that returns of its products will be minimal.

 

Provider Chargebacks and Discounts:  Chargebacks for fees and discounts to providers represent the estimated obligations resulting from contractual commitments to sell products to qualified healthcare providers at prices lower than the list prices charged to Customers who directly purchase the product from the Company.  Customers charge the Company for the difference between what they pay for the product and the ultimate selling price to the qualified healthcare providers.  These reserves are established in the same period that the related revenue is recognized, resulting in a reduction of product revenue and accounts receivable.  Chargeback amounts are generally determined at the time of resale to the qualified healthcare provider by Customers, and the Company generally issues credits for such amounts within a few weeks of the Customer’s notification to the Company of the resale.  Reserves for chargebacks consist of credits that the Company expects to issue for units that remain in the distribution channel inventories at each reporting period end that the Company expects will be sold to qualified healthcare providers, and chargebacks that Customers have claimed but for which the Company has not yet issued a credit.

 

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

 

Payor Rebates:  The Company contracts with various private payor organizations, primarily insurance companies and pharmacy benefit managers, for the payment of rebates with respect to utilization of its products.  The Company estimates these rebates and records such estimates in the same period the related revenue is recognized, resulting in a reduction of product revenue and the establishment of a current liability.

 

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Other Incentives:     Other incentives which the Company offers include voluntary patient assistance programs, such as co-pay assistance programs, which are intended to provide financial assistance to qualified commercially insured patients with prescription drug co-payments required by payors.  The calculation of the accrual for co-pay assistance is based on an estimate of claims and the cost per claim that the Company expects to receive associated with product that has been recognized as revenue, but remains in the distribution channel inventories at the end of each reporting period.

 

To date, the Company’s sources of product revenue have been U.S. sales of ZEJULA and the oral formulation of VARUBI, and limited sales of VARUBY in Europe.  Total net product revenue was $1.2 million and $28.8 million for the three months ended June 30, 2016 and 2017, respectively.  These totals included $1.2 million and $2.9 million from sales of VARUBI/VARUBY, respectively, and zero and $25.9 million from sales of ZEJULA, respectively.  Total net product revenue was $1.5 million and $31.0 million for the six months ended June 30, 2016 and 2017, respectively.  These totals included $1.5 million and $5.0 million from sales of VARUBI/VARUBY, respectively, and zero and $25.9 million from sales of ZEJULA, respectively. The following table summarizes activity in each of the product revenue allowance and reserve categories for the six months ended June 30, 2016 (as revised) and 2017 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

    

Chargebacks,
discounts and
fees

    

Government
and other
rebates

    

Returns

    

Total

Balance at December 31, 2015

 

$

813

 

$

422

 

$

 8

 

$

1,243

Provision related to current period sales

 

 

602

 

 

368

 

 

 2

 

 

972

Adjustment related to prior period sales

 

 

 —

 

 

 —

 

 

 —

 

 

 —

Credit or payments made during the period

 

 

(605)

 

 

(209)

 

 

 —

 

 

(814)

Balance at June 30, 2016

 

$

810

 

$

581

 

$

10

 

$

1,401

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2016

   

$

177

   

$

1,312

    

$

18

  

$

1,507

Provision related to current period sales

 

 

3,251

 

 

3,264

 

 

73

 

 

6,588

Adjustment related to prior period sales

 

 

 —

 

 

62

 

 

 —

 

 

62

Credit or payments made during the period

 

 

(2,730)

 

 

(2,343)

 

 

 —

 

 

(5,073)

Balance at June 30, 2017

 

$

698

 

$

2,295

 

$

91

 

$

3,084

 

 

License, Collaboration and Other Revenues

 

The Company enters into out-licensing agreements which are within the scope of Topic 606, under which it licenses certain rights to its product candidates to third parties.  The terms of these arrangements typically include payment to the Company of one or more of the following: non-refundable, up-front license fees; development, regulatory and commercial milestone payments; payments for manufacturing supply services the Company provides through its contract manufacturers; and royalties on net sales of licensed products.  Each of these payments results in license, collaboration and other revenues, except for revenues from royalties on net sales of licensed products, which are classified as royalty revenues.

 

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

 

Licenses of Intellectual Property:   If the license to the Company’s intellectual property is determined to be distinct from the other performance obligations identified in the arrangement, the Company recognizes revenues from non-refundable, up-front fees allocated to the license when the license is transferred to the licensee and the licensee is able to use and benefit from the license.  For licenses that are bundled with other promises, the Company utilizes judgment to assess the nature of the combined performance obligation to determine whether the combined performance

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obligation is satisfied over time or at a point in time and, if over time, the appropriate method of measuring progress for purposes of recognizing revenue from non-refundable, up-front fees.  The Company evaluates the measure of progress each reporting period and, if necessary, adjusts the measure of performance and related revenue recognition.

 

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

 

Manufacturing Supply Services:  Arrangements that include a promise for future supply of drug substance or drug product for either clinical development or commercial supply at the licensee’s discretion are generally considered as options.  The Company assesses if these options provide a material right to the licensee and if so, they are accounted for as separate performance obligations.  If the Company is entitled to additional payments when the licensee exercises these options , any additional payments are recorded in license, collaboration and other revenues when the licensee obtains control of the goods, which is upon delivery.

 

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

 

The Company receives payments from its licensees based on billing schedules established in each contract.  Up-front payments and fees are recorded as deferred revenue upon receipt or when due, and may require deferral of revenue recognition to a future period until the Company performs its obligations under these arrangements.  Amounts are recorded as accounts receivable when the Company’s right to consideration is unconditional. The Company does not assess whether a contract has a significant financing component if the expectation at contract inception is such that the period between payment by the licensees and the transfer of the promised goods or services to the licensees will be one year or less.

 

The following table presents changes in the Company’s contract assets and liabilities during the six months ended June 30, 2016 (as revised) and 2017 (in thousands):