irwd_Current_Folio_10Q

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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 September 30, 2018

 

OR

 

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

 

For the transition period from            to

Commission file number: 001-34620

IRONWOOD PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

 

Delaware

 

04-3404176

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification Number)

 

301 Binney Street

 

 

Cambridge, Massachusetts

 

02142

(Address of Principal Executive Offices)

 

(Zip Code)

 

(617) 621-7722

(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 every Interactive Data File required to be submitted 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 such files):  Yes ☒  No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 ☐

 

 

 

 

 

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 November 1, 2018, there were 140,082,377 shares of Class A common stock outstanding and 13,976,855 shares of Class B common stock outstanding.

 

 

 

 


 

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NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q, including the sections titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors”, contains forward-looking statements. All statements contained in this Quarterly Report on Form 10-Q other than statements of historical fact are forward-looking statements. Forward-looking statements include statements regarding our future financial position, business strategy, budgets, projected costs, plans and objectives of management for future operations. The words “may,” “continue,” “estimate,” “intend,” “plan,” “will,” “believe,” “project,” “expect,” “seek,” “anticipate” and similar expressions may identify forward-looking statements, but the absence of these words does not necessarily mean that a statement is not forward-looking. These forward-looking statements include, among other things, statements about:

 

·

the demand and market potential for our products in the countries where they are approved for marketing, as well as the revenues therefrom;

·

the timing, investment and associated activities involved in commercializing LINZESS® by us and Allergan plc in the U.S.;

 

·

the timing and execution of the launches and commercialization of CONSTELLA® in Europe and LINZESS in Japan;

 

·

the timing, investment and associated activities involved in developing, obtaining regulatory approval for, launching, and commercializing our products and product candidates by us and our partners worldwide;

 

·

our ability and the ability of our partners to secure and maintain adequate reimbursement for our products;

 

·

our ability and the ability of our partners and third parties to manufacture and distribute sufficient amounts of linaclotide active pharmaceutical ingredient, drug product and finished goods, as applicable, on a commercial scale;

 

·

our expectations regarding U.S. and foreign regulatory requirements for our products and our product candidates, including our post-approval development and regulatory requirements;

 

·

the ability of our product candidates to meet existing or future regulatory standards;

 

·

the safety profile and related adverse events of our products and our product candidates;

 

·

the therapeutic benefits and effectiveness of our products and our product candidates and the potential indications and market opportunities therefor;

 

·

our and our partners’ ability to obtain and maintain intellectual property protection for our products and our product candidates and the strength thereof, as well as Abbreviated New Drug Applications filed by generic drug manufacturers and potential U.S. Food and Drug Administration approval thereof, and associated patent infringement suits that we have filed or may file, or other action that we may take against such companies, and the timing and resolution thereof;

 

·

our and our partners’ ability to perform our respective obligations under our collaboration, license and other agreements, and our ability to achieve milestone and other payments under such agreements;

 

·

our plans with respect to the development, manufacture or sale of our product candidates and the associated timing thereof, including the design and results of pre-clinical and clinical studies;

 

·

the in-licensing or acquisition of externally discovered businesses, products or technologies, as well as partnering arrangements, including expectations relating to the completion of, or the realization of the expected benefits from, such transactions;

 

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·

our expectations as to future financial performance, revenues, expense levels, payments, cash flows, profitability, tax obligations, capital raising and liquidity sources, real estate needs and concentration of voting control, as well as the timing and drivers thereof, and internal control over financial reporting;

 

·

our ability to repay our outstanding indebtedness when due, or redeem or repurchase all or a portion of such debt, as well as the potential benefits of the note hedge transactions described herein;

 

·

inventory levels and write downs, or asset impairments, and the drivers thereof, and inventory purchase commitments;

 

·

our ability to compete with other companies that are or may be developing or selling products that are competitive with our products and product candidates;

 

·

the status of government regulation in the life sciences industry, particularly with respect to healthcare reform;

 

·

trends and challenges in our potential markets;

 

·

our ability to attract and motivate key personnel;

 

·

the proposed separation of the Company’s operations into two independent, publicly traded companies, including the completion and timing of the separation, the business and operations of each company and any benefits or costs of the separation, including the tax treatment;

 

·

the timing and benefits and costs associated with the termination of the lesinurad license agreement and the transition of the lesinurad franchise to AstraZeneca; and

 

·

other factors discussed elsewhere in this Quarterly Report on Form 10-Q.

 

Any or all of our forward-looking statements in this Quarterly Report on Form 10-Q may turn out to be inaccurate. These forward-looking statements may be affected by inaccurate assumptions or by known or unknown risks and uncertainties, including the risks, uncertainties and assumptions identified under the heading “Risk Factors” in this Quarterly Report on Form 10-Q. In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this Quarterly Report on Form 10-Q may not occur as contemplated, and actual results could differ materially from those anticipated or implied by the forward-looking statements.

 

You should not unduly rely on these forward-looking statements, which speak only as of the date of this Quarterly Report on Form 10-Q. Unless required by law, we undertake no obligation to publicly update or revise any forward-looking statements to reflect new information or future events or otherwise. You should, however, review the factors and risks we describe in the reports we will file from time to time with the U.S. Securities and Exchange Commission, or the SEC, after the date of this Quarterly Report on Form 10-Q.

 

NOTE REGARDING TRADEMARKS

 

LINZESS® and CONSTELLA® are trademarks of Ironwood Pharmaceuticals, Inc. ZURAMPIC® and DUZALLO® are trademarks of AstraZeneca AB. Any other trademarks referred to in this Quarterly Report on Form 10-Q are the property of their respective owners. All rights reserved.

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IRONWOOD PHARMACEUTICALS, INC.

QUARTERLY REPORT ON FORM 10-Q

FOR THE QUARTER ENDED SEPTEMBER 30, 2018

TABLE OF CONTENTS

 

June 30,

 

 

 

 

 

 

Page

 

 

 

 

 

PART I — FINANCIAL INFORMATION

 

 

Item 1. 

Financial Statements (unaudited)

 

 

 

Condensed Consolidated Balance Sheets as of September 30, 2018 and December 31, 2017

 

5

 

Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2018 and 2017

 

6

 

Condensed Consolidated Statements of Comprehensive Loss for the Three and Nine Months Ended September 30, 2018 and 2017

 

7

 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2018 and 2017

 

8

 

Notes to Condensed Consolidated Financial Statements

 

9

Item 2. 

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

 

46

Item 3. 

Quantitative and Qualitative Disclosures About Market Risk

 

67

Item 4. 

Controls and Procedures

 

68

 

 

 

 

 

PART II — OTHER INFORMATION

 

 

Item 1. 

Legal Proceedings

 

69

Item 1A. 

Risk Factors

 

70

Item 6. 

Exhibits

 

98

 

 

 

 

 

Signatures

 

100

 

 

 

 

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PART I — FINANCIAL INFORMATION

Item 1.  Financial Statements

Ironwood Pharmaceuticals, Inc.

Condensed Consolidated Balance Sheets

(In thousands, except share and per share amounts)

(unaudited)

 

 

 

 

 

 

 

 

 

September 30, 

 

December 31, 

 

    

2018

    

2017

ASSETS

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

Cash and cash equivalents

 

$

141,562

 

$

125,736

Available-for-sale securities

 

 

19,836

 

 

95,680

Accounts receivable, net

 

 

10,193

 

 

3,190

Related party accounts receivable, net

 

 

55,182

 

 

78,967

Inventory, net

 

 

76

 

 

735

Prepaid expenses and other current assets

 

 

21,699

 

 

7,288

Total current assets

 

 

248,548

 

 

311,596

Restricted cash

 

 

7,676

 

 

7,056

Property and equipment, net

 

 

16,161

 

 

17,274

Convertible note hedges

 

 

142,774

 

 

108,188

Intangible assets, net

 

 

 

 

159,905

Goodwill

 

 

785

 

 

785

Other assets

 

 

708

 

 

870

Total assets

 

$

416,652

 

$

605,674

LIABILITIES AND STOCKHOLDERS' (DEFICIT) EQUITY

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

Accounts payable and related party accounts payable, net

 

$

9,332

 

$

15,958

Accrued research and development costs

 

 

5,088

 

 

7,313

Accrued expenses and other current liabilities

 

 

44,958

 

 

38,237

Capital lease obligations

 

 

171

 

 

4,077

Current portion of deferred rent

 

 

247

 

 

195

Current portion of 2026 Notes

 

 

39,191

 

 

 —

Current portion of contingent consideration

 

 

74

 

 

247

Deferred revenue

 

 

13,521

 

 

 —

Total current liabilities

 

 

112,582

 

 

66,027

Deferred rent, net of current portion

 

 

6,113

 

 

5,449

Contingent consideration, net of current portion

 

 

 

 

31,011

Note hedge warrants

 

 

122,778

 

 

92,188

Convertible senior notes

 

 

261,355

 

 

249,193

2026 Notes, net of current portion

 

 

108,589

 

 

146,898

Other liabilities

 

 

2,530

 

 

5,060

Commitments and contingencies

 

 

 

 

 

 

Stockholders’ (deficit) equity:

 

 

 

 

 

 

Preferred stock, $0.001 par value, 75,000,000 shares authorized, no shares issued and outstanding

 

 

 

 

Class A common stock, $0.001 par value, 500,000,000 shares authorized and 139,805,308 and 136,465,526 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively

 

 

140

 

 

137

Class B common stock, $0.001 par value, 100,000,000 shares authorized and 13,976,855 shares issued and outstanding at September 30, 2018 and 13,983,762 shares issued outstanding at December 31, 2017

 

 

14

 

 

14

Additional paid-in capital

 

 

1,378,195

 

 

1,318,536

Accumulated deficit

 

 

(1,575,635)

 

 

(1,308,760)

Accumulated other comprehensive loss

 

 

(9)

 

 

(79)

Total stockholders’ (deficit) equity

 

 

(197,295)

 

 

9,848

Total liabilities and stockholders’ (deficit) equity

 

$

416,652

 

$

605,674

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

 

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Ironwood Pharmaceuticals, Inc.

Condensed Consolidated Statements of Operations

(In thousands, except per share amounts)

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30, 

 

September 30, 

 

 

    

2018

    

2017

    

2018

    

2017

 

Revenues:

 

 

 

 

 

 

 

 

 

 

 

 

 

Collaborative arrangements revenue

 

$

54,194

 

$

76,652

 

$

188,487

 

$

187,156

 

Product revenue, net

 

 

1,235

 

 

682

 

 

2,966

 

 

1,436

 

Sale of active pharmaceutical ingredient

 

 

10,257

 

 

9,491

 

 

24,494

 

 

15,476

 

Total revenues

 

 

65,686

 

 

86,825

 

 

215,947

 

 

204,068

 

Cost and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenues, excluding amortization of acquired intangible assets

 

 

4,616

 

 

6,080

 

 

11,288

 

 

10,113

 

Write-down of commercial supply and inventory to net realizable value and (settlement) loss on non-cancellable purchase commitments

 

 

(1,589)

 

 

71

 

 

247

 

 

167

 

Research and development

 

 

46,794

 

 

37,065

 

 

122,231

 

 

108,111

 

Selling, general and administrative

 

 

55,248

 

 

61,774

 

 

183,112

 

 

175,170

 

Amortization of acquired intangible assets

 

 

1,159

 

 

1,897

 

 

8,111

 

 

2,738

 

(Gain) loss on fair value remeasurement of contingent consideration

 

 

(33,519)

 

 

(628)

 

 

(31,045)

 

 

7,919

 

Restructuring expenses

 

 

10,282

 

 

 —

 

 

15,096

 

 

 —

 

Impairment of intangible assets

 

 

151,794

 

 

 —

 

 

151,794

 

 

 —

 

Total cost and expenses

 

 

234,785

 

 

106,259

 

 

460,834

 

 

304,218

 

Loss from operations

 

 

(169,099)

 

 

(19,434)

 

 

(244,887)

 

 

(100,150)

 

Other (expense) income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

(9,482)

 

 

(9,135)

 

 

(28,138)

 

 

(27,164)

 

Interest and investment income

 

 

741

 

 

601

 

 

2,154

 

 

1,492

 

Gain (loss) on derivatives

 

 

3,489

 

 

(4,329)

 

 

3,996

 

 

(1,191)

 

Loss on extinguishment of debt

 

 

 —

 

 

 —

 

 

 —

 

 

(2,009)

 

Other expense, net

 

 

(5,252)

 

 

(12,863)

 

 

(21,988)

 

 

(28,872)

 

Net loss

 

$

(174,351)

 

$

(32,297)

 

$

(266,875)

 

$

(129,022)

 

Net loss per share—basic and diluted

 

$

(1.14)

 

$

(0.22)

 

$

(1.75)

 

$

(0.87)

 

Weighted average number of common shares used in net loss per share—basic and diluted:

 

 

153,227

 

 

149,502

 

 

152,143

 

 

148,695

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Ironwood Pharmaceuticals, Inc.

Condensed Consolidated Statements of Comprehensive Loss

(In thousands)

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30, 

 

September 30, 

 

 

    

2018

    

2017

    

2018

    

2017

 

Net loss

 

$

(174,351)

 

$

(32,297)

 

$

(266,875)

 

$

(129,022)

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gains on available-for-sale securities

 

 

35

 

 

18

 

 

70

 

 

1

 

Total other comprehensive income

 

 

35

 

 

18

 

 

70

 

 

1

 

Comprehensive loss

 

$

(174,316)

 

$

(32,279)

 

$

(266,805)

 

$

(129,021)

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Ironwood Pharmaceuticals, Inc.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(unaudited)

 

 

 

 

 

 

 

 

 

 

Nine Months Ended

 

 

 

September 30, 

 

 

    

2018

    

2017

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net loss

 

$

(266,875)

 

$

(129,022)

 

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

 

 

 

 

 

 

 

Depreciation and amortization

 

 

4,847

 

 

6,602

 

Amortization of acquired intangible assets

 

 

8,111

 

 

2,738

 

Impairment of intangible assets

 

 

151,794

 

 

 —

 

(Gain) loss on disposal of property and equipment

 

 

(1,591)

 

 

703

 

Share-based compensation expense

 

 

32,762

 

 

25,116

 

Change in fair value of note hedge warrants

 

 

30,590

 

 

(9,494)

 

Change in fair value of convertible note hedges

 

 

(34,586)

 

 

10,685

 

Write-down of commercial supply and inventory to net realizable value and (settlement) loss on non-cancellable purchase commitments

 

 

247

 

 

167

 

Write-down of excess non-cancellable ZURAMPIC and DUZALLO sample purchase commitments

 

 

390

 

 

1,353

 

Gain on facility subleases

 

 

 —

 

 

(1,579)

 

Accretion of discount/premium on investment securities

 

 

(157)

 

 

31

 

Non-cash interest expense

 

 

13,044

 

 

11,918

 

Non-cash change in fair value of contingent consideration

 

 

(31,045)

 

 

7,919

 

Loss on extinguishment of debt

 

 

 —

 

 

2,009

 

Changes in assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable and related party accounts receivable

 

 

16,782

 

 

(15,229)

 

Prepaid expenses and other current assets

 

 

(13,164)

 

 

1,020

 

Inventory, net

 

 

(713)

 

 

1,081

 

Other assets

 

 

163

 

 

185

 

Accounts payable, related party accounts payable and accrued expenses

 

 

(2,766)

 

 

(6,659)

 

Accrued research and development costs

 

 

(2,225)

 

 

935

 

Deferred revenue

 

 

13,521

 

 

 —

 

Deferred rent

 

 

716

 

 

(2,018)

 

Net cash used in operating activities

 

 

(80,155)

 

 

(91,539)

 

Cash flows from investing activities:

 

 

 

 

 

 

 

Purchases of available-for-sale securities

 

 

(3,241)

 

 

(130,728)

 

Sales and maturities of available-for-sale securities

 

 

79,312

 

 

319,133

 

Purchases of property and equipment

 

 

(5,320)

 

 

(3,209)

 

Proceeds from sale of property and equipment

 

 

627

 

 

117

 

Net cash provided by investing activities

 

 

71,378

 

 

185,313

 

Cash flows from financing activities:

 

 

 

 

 

 

 

Proceeds from issuance of 2026 Notes, net of discount to lender

 

 

 —

 

 

146,250

 

Costs associated with issuance of 2026 Notes

 

 

 —

 

 

(235)

 

Proceeds from exercise of stock options and employee stock purchase plan

 

 

27,152

 

 

19,379

 

Payments on capital leases

 

 

(1,822)

 

 

(2,406)

 

Principal payments on PhaRMA notes

 

 

 —

 

 

(134,258)

 

Payments on contingent purchase price consideration

 

 

(107)

 

 

(15,058)

 

Net cash provided by financing activities

 

 

25,223

 

 

13,672

 

Net increase in cash, cash equivalents and restricted cash

 

 

16,446

 

 

107,446

 

Cash, cash equivalents and restricted cash, beginning of period

 

 

132,792

 

 

62,251

 

Cash, cash equivalents and restricted cash, end of period

 

$

149,238

 

$

169,697

 

 

 

 

 

 

 

 

 

Reconciliation of cash, cash equivalents, and restricted cash to the condensed consolidated balance sheets

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

141,562

 

$

162,640

 

Restricted cash

 

 

7,676

 

 

7,057

 

Total cash, cash equivalents, and restricted cash

 

$

149,238

 

$

169,697

 

 

 

 

 

 

 

 

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

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Ironwood Pharmaceuticals, Inc.

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

1. Nature of Business

 

Overview

 

Ironwood Pharmaceuticals, Inc. (the “Company”) is a commercial biotechnology company leveraging its proven development and commercial capabilities as it seeks to bring multiple medicines to patients. The Company is advancing innovative product opportunities in areas of large unmet need, based upon the Company’s target-to-disease approach to development and leveraging the Company’s core areas of expertise in gastrointestinal (“GI”) and primary care, as well as in guanylate cyclase (“GC”) pathways.

 

The Company’s first commercial product, linaclotide, is available to adult men and women suffering from irritable bowel syndrome with constipation (“IBS-C”), or chronic idiopathic constipation (“CIC”), in certain countries around the world. Linaclotide is available under the trademarked name LINZESS® to adult men and women suffering from IBS-C or CIC in the United States (the “U.S.”) and Mexico, and to adult men and women suffering from IBS-C in Japan. Linaclotide is available under the trademarked name CONSTELLA® to adult men and women suffering from IBS-C or CIC in Canada, and to adult men and women suffering from IBS-C in certain European countries. 

 

The Company and its partner Allergan plc (together with its affiliates, “Allergan”) began commercializing LINZESS in the U.S. in December 2012. Under the Company’s collaboration with Allergan for North America, total net sales of LINZESS in the U.S., as recorded by Allergan, are reduced by commercial costs incurred by each party, and the resulting amount is shared equally between the Company and Allergan. Allergan also has an exclusive license from the Company to develop and commercialize linaclotide in all countries other than China, Hong Kong, Macau, Japan and the countries and territories of North America (the “Allergan License Territory”). On a country-by-country and product-by-product basis in the Allergan License Territory, Allergan pays the Company a royalty as a percentage of net sales of products containing linaclotide as an active ingredient. In addition, Allergan has exclusive rights to commercialize linaclotide in Canada as CONSTELLA and in Mexico as LINZESS.

 

Astellas Pharma Inc. (“Astellas”), the Company’s partner in Japan, has an exclusive license to develop and commercialize linaclotide in Japan. In March 2017, Astellas began commercializing LINZESS for the treatment of adults with IBS-C in Japan, and in September 2018, Astellas began commercializing LINZESS for the treatment of adults with chronic constipation in Japan. The Company has a collaboration agreement with AstraZeneca AB (together with its affiliates, “AstraZeneca”), to co-develop and co-commercialize linaclotide in China, Hong Kong and Macau, with AstraZeneca having primary responsibility for the local operational execution. In December 2015, the Company and AstraZeneca filed for approval with the China Food and Drug Administration (“CFDA”) to market linaclotide in China.

 

The Company’s and Allergan’s linaclotide life cycle management strategy in the U.S. includes the objective of strengthening the clinical profile of linaclotide by obtaining additional abdominal symptom claims and expanding the clinical utility of linaclotide by demonstrating the pain-relieving effect of a delayed release formulation, through the advancement of MD-7246 (linaclotide delayed release) in all forms of IBS. The Company and Allergan are also continuing to explore ways to enhance the clinical profile of LINZESS by studying linaclotide in additional indications, populations and formulations to assess its potential to treat various conditions. In July 2018, the Company announced the initiation of a Phase IIIb trial evaluating the efficacy and safety of linaclotide 290 mcg on multiple abdominal symptoms in addition to pain, including bloating and discomfort, in adult patients with IBS-C.

 

The Company is advancing another GI development program, IW-3718, a gastric retentive formulation of a bile acid sequestrant for the potential treatment of persistent gastroesophageal reflux disease (“GERD”). The Company’s clinical research has demonstrated that reflux of bile from the intestine into the stomach and esophagus plays a key role in the ongoing symptoms of persistent GERD. IW-3718 is a novel formulation of a bile acid sequestrant designed to release in the stomach over an extended period of time, bind to bile that refluxes into the stomach, and potentially provide symptomatic relief in patients with persistent GERD. In June 2018, the Company initiated two Phase III clinical trials evaluating the safety and efficacy of IW-3718 in patients with persistent GERD.

 

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In June 2016, the Company closed a transaction with AstraZeneca (the “Lesinurad Transaction”) pursuant to which the Company received an exclusive license to develop, manufacture, and commercialize in the U.S. products containing lesinurad as an active ingredient (the “Lesinurad License”), including ZURAMPIC® and DUZALLO®. Lesinurad 200mg tablets were approved as ZURAMPIC by the U.S. Food and Drug Administration (“FDA”) in December 2015 for use in combination with a xanthine oxidase inhibitor for the treatment of hyperuricemia associated with uncontrolled gout (“uncontrolled gout”). In October 2016, the Company began commercializing ZURAMPIC in the U.S. The FDA approved DUZALLO, a fixed-dose combination product of lesinurad and allopurinol in August 2017 for the treatment of hyperuricemia associated with gout in patients who have not achieved goal serum uric acid levels with a medically appropriate daily dose of allopurinol alone. In October 2017, the Company began commercializing DUZALLO in the U.S. In January 2018, the Company commenced an initiative to evaluate the optimal mix of investments for the lesinurad franchise for uncontrolled gout, including DUZALLO and ZURAMPIC. As part of this effort, in 2018, the Company began re-allocating resources within the lesinurad franchise to systematically explore a more comprehensive marketing mix in select test markets (with paired controls), while continuing to build market presence for the lesinurad franchise across the country. In July 2018, the Company obtained and analyzed the results from the lesinurad franchise test markets. Data from the test markets did not meet expectations. In connection with the results, the Company’s Board of Directors determined on July 31, 2018 to terminate the lesinurad license agreement (Note 3).

 

The Company is also leveraging its pharmacological expertise in GC pathways gained through the discovery and development of linaclotide, a GC-C agonist, to develop and advance a pipeline of sGC stimulators, including praliciguat and olinciguat. The Company is advancing olinciguat, one of its lead clinical sGC stimulators in a Phase II trial for the potential treatment of sickle cell disease. In June 2018, the FDA granted Orphan Drug Designation to olinciguat for the treatment of patients with sickle cell disease. The Company is not pursuing additional clinical studies of olinciguat in achalasia at this time, and instead is focused on completing the ongoing Phase II trial of olinciguat in patients with sickle cell disease.  The Company is also advancing praliciguat, another of its lead clinical sGC stimulators, in Phase II trials, for the potential treatment of diabetic nephropathy and for the potential treatment of heart failure with preserved ejection fraction (“HFpEF”). In September 2018, the FDA granted Fast Track Designation for praliciguat for the treatment of patients with HFpEF.

 

In May 2018, the Company announced its intent, as authorized by its Board of Directors, to separate its sGC business from its commercial and GI business, resulting in two independent, publicly traded companies, Ironwood and a new company (“R&D Co”). Following the separation, Ironwood is expected to focus on accelerating growth of its in-market products, including LINZESS, and advance development programs targeting treatments for GI diseases and abdominal pain. The separated R&D Co. is expected to focus on the sGC pipeline development programs for the treatment of serious and orphan diseases. The separation is expected to be completed in the first half of 2019 and is anticipated to be tax-free.

 

The Company has periodically entered into co-promotion agreements to maximize its salesforce productivity. As part of this strategy, in August 2015, the Company and Allergan entered into an agreement for the co-promotion of VIBERZI® (eluxadoline) in the U.S., Allergan’s treatment for adults suffering from IBS with diarrhea (“IBS-D”). In January 2017, the Company and Allergan entered into a commercial agreement under which adjustments to the Company’s or Allergan’s share of the net profits under the share adjustment provision of the collaboration agreement for linaclotide in North America are eliminated, in full, in 2018 and all subsequent years. As part of this agreement, Allergan appointed the Company, on a non-exclusive basis, to promote CANASA® (mesalamine), approved for the treatment of ulcerative proctitis, and DELZICOL® (mesalamine), approved for the treatment of ulcerative colitis, in the U.S. for approximately two years. In December 2017, this agreement was amended to include and extend the promotion of VIBERZI through December 31, 2018 and discontinue the promotion of DELZICOL effective January 1, 2018.

 

These agreements are more fully described in Note 3, Goodwill and Intangible Assets, and Note 4, Collaboration, License, Co-Promotion and Other Commercial Agreements, to these condensed consolidated financial statements.

 

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In September 2016, the Company closed a direct private placement, pursuant to which the Company issued $150.0 million in aggregate principal amount of 8.375% notes due 2026 (the “2026 Notes”) on January 5, 2017 (the “Funding Date”). The Company received net proceeds of approximately $11.2 million from the 2026 Notes, after redemption of the PhaRMA Notes outstanding balance and accrued interest of approximately $135.1 million and deducting fees and expenses of approximately $3.7 million. The proceeds from the issuance of the 2026 Notes were used to redeem the outstanding principal balance of the 11% PhaRMA Notes due 2024 (the “PhaRMA Notes”) on the Funding Date. These transactions are more fully described in Note 9, Notes Payable, to these condensed consolidated financial statements.

 

Basis of Presentation

 

The accompanying condensed consolidated financial statements and the related disclosures are unaudited and have been prepared in accordance with accounting principles generally accepted in the U.S. Additionally, certain information and footnote disclosures normally included in the Company’s annual financial statements have been condensed or omitted. Accordingly, these interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017, which was filed with the Securities and Exchange Commission on February 22, 2018 (the “2017 Annual Report on Form 10-K”).

 

The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and, in the opinion of management, reflect all normal recurring adjustments considered necessary for a fair presentation of the Company’s financial position as of September 30, 2018, and the results of its operations for the three and nine months ended September 30, 2018 and 2017, and its cash flows for the nine months ended September 30, 2018 and 2017. The results of operations for the three and nine months ended September 30, 2018 and 2017 are not necessarily indicative of the results that may be expected for the full year or any other subsequent interim period.

 

Principles of Consolidation

 

The accompanying condensed consolidated financial statements include the accounts of Ironwood Pharmaceuticals, Inc. and its wholly owned subsidiaries. All intercompany transactions and balances are eliminated in consolidation.

 

Reclassifications and Revisions to Prior Period Financial Statements

 

Certain prior period financial statement items, such as Sale of Active Pharmaceutical Ingredient and Restricted Cash, have been reclassified to conform to current period presentation.

 

Use of Estimates

 

The preparation of condensed consolidated financial statements in accordance with U.S. generally accepted accounting principles requires the Company’s management to make estimates and judgments that may affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the amounts of revenues and expenses during the reported periods. On an on-going basis, the Company’s management evaluates its estimates, judgments and methodologies. Significant estimates and assumptions in the condensed consolidated financial statements include those related to revenue recognition, including returns, rebates, and other pricing adjustments; available-for-sale securities; inventory valuation, and related reserves; impairment of long-lived assets, including its acquired intangible assets and goodwill; initial valuation procedures for the issuance of convertible notes; fair value of derivatives; balance sheet classification of notes payable and convertible notes; income taxes, including the valuation allowance for deferred tax assets; research and development expenses; contingent consideration; contingencies and share-based compensation. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ materially from these estimates under different assumptions or conditions. Changes in estimates are reflected in reported results in the period in which they become known.

 

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Summary of Significant Accounting Policies

 

The Company’s significant accounting policies are described in Note 2, Summary of Significant Accounting Policies, in the 2017 Annual Report on Form 10-K. During the nine months ended September 30, 2018, the Company adopted the following additional significant accounting policies:

 

Revenue Recognition

Effective January 1, 2018, the Company adopted Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers (“ASC 606”) using the modified retrospective transition method. The adoption of ASC 606 represents a change in accounting principle that aims to more closely align revenue recognition with the delivery of the Company's services and will provide financial statement readers with enhanced disclosures. In accordance with ASC 606, the Company recognizes revenue when the customer obtains control of a promised good or service, in an amount that reflects the consideration which the Company expects to receive in exchange for the good or service.  The reported results for the three and nine months ended September 30, 2018 reflect the application of ASC 606 guidance, while the reported results for prior periods were prepared in accordance with ASC 605, Revenue Recognition (“ASC 605”). Upon adoption of ASC 606, the Company concluded that no cumulative adjustment to the accumulated deficit as of January 1, 2018 was necessary. There were no remaining or ongoing deliverables or unrecognized consideration as of December 31, 2017 that required an adjustment to accumulated deficit. The adoption of ASC 606 had no impact on the Company’s statement of operations, balance sheets, or statement of cash flows.

As part of the ASC 606 adoption, the Company has utilized certain practical expedients outlined in the guidance. These practical expedients include:

·

Expensing as incurred incremental costs of obtaining a contract, such as sales commissions, if the amortization period of the asset would be less than one year.

·

Recognizing revenue in the amount that the Company has the right to invoice, when consideration from the customer corresponds directly with the value to the customer of the Company’s performance completed to date.

·

For contracts that were modified before the beginning of the earliest reporting period presented in accordance with the pending content that links to this paragraph, an entity need not retrospectively restate the contract for those contract modifications in accordance with paragraphs ASC 606-10-25-12 through 25-13. Instead, an entity shall reflect the aggregate effect of all modifications that occur before the beginning of the earliest period presented in accordance with the pending content that links to this paragraph when: a. Identifying the satisfied and unsatisfied performance obligations b. Determining the transaction price and c. Allocating the transaction price to the satisfied and unsatisfied performance obligations.

Prior to the adoption of ASC 606, the Company recognized revenue when there was persuasive evidence that an arrangement existed, services had been rendered or delivery had occurred, the price was fixed or determinable, and collection was reasonably assured.

The Company’s revenues are generated primarily through collaborative arrangements and license agreements related to the research and development and commercialization of linaclotide, as well as co-promotion arrangements in the U.S. and product revenue related to the commercial sale of ZURAMPIC and DUZALLO in the U.S. The terms of the collaborative research and development, license, co-promotion and other agreements contain multiple performance obligations which may include (i) licenses, (ii) research and development activities, including participation on joint steering committees, (iii) the manufacture of finished drug product, active pharmaceutical ingredient (“API”), or development materials for a partner, which are reimbursed at a contractually determined rate, and (iv) co-promotion activities by the Company’s clinical sales specialists. Non-refundable payments to the Company under these agreements may include (i) up-front license fees, (ii) payments for research and development activities, (iii) payments for the manufacture of finished drug product, API, or development materials, (iv) payments based upon the achievement of certain milestones, (v) payments for sales detailing, promotional support services and medical education initiatives, and (vi) royalties on product sales. Additionally, the Company may receive its share of the net profits or bear its share of the net losses from the sale of linaclotide in the U.S. and for China, Hong Kong and Macau through its collaborations with Allergan and AstraZeneca, respectively. The Company has adopted a policy to recognize revenue net of tax withholdings, as applicable.

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Revenue recognition under ASC 606

Upon executing a revenue generating arrangement, the Company assesses whether it is probable the Company will collect consideration in exchange for the good or service it transfers to the customer. To determine revenue recognition for arrangements that the Company determines are within the scope of ASC 606, it performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the Company satisfies the performance obligations. The Company must develop assumptions that require significant judgment to determine the stand-alone selling price for each performance obligation identified in the contract. The assumptions that are used to determine the stand-alone selling price may include forecasted revenues, development timelines, reimbursement rates for personnel costs, discount rates and probabilities of technical and regulatory success.

Collaboration, License, Co-Promotion and Other Commercial Agreements

Upon licensing intellectual property to a customer, the Company determines if the license is distinct from the other performance obligations identified in the arrangement. The Company recognizes revenues from the transaction price, including non-refundable, up-front fees allocated to the license when the license is transferred to the customer if the license has distinct benefit to the customer. For licenses that are combined with other promises, the Company assesses the nature of the combined performance obligation to determine whether the combined performance obligation is satisfied over time or at a point in time. For performance obligations that are satisfied over time, the Company evaluates the measure of progress each reporting period and, if necessary, adjusts the measure of performance and related revenue recognition.

The Company’s license and collaboration agreements include milestone payments, such as development and other milestones. 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 at the inception of the agreement. 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, 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. The Company re-evaluates the probability of achievement of such milestones and any related constraint at each reporting period, and any adjustments are recorded on a cumulative catch-up basis.

Agreements that include the supply API or drug product for either clinical development or commercial supply at the customer’s discretion are generally considered as options. The Company assesses if these options provide a material right to its partner, and if so, they are accounted for as separate performance obligations. If the Company is entitled to additional payments when the customer exercises these options, any additional payments are recorded as revenue when the customer obtains control of the goods, which is typically upon shipment for sales of API and upon delivery for sales of drug product.

For agreements 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 when the related sales occur in accordance with the sales-based royalty exception under ASC 606-10-55-65.

Net Profit or Net Loss Sharing

In accordance with ASC 808 Topic, Collaborative Arrangements (“ASC 808”), the Company considered the nature and contractual terms of the arrangement and the nature of the Company’s business operations to determine the classification of payments under the Company’s collaboration agreements. While ASC 808 provides guidance on classification, the standard is silent on matters of separation, initial measurement, and recognition.  Therefore, the Company, consistent with its accounting policies prior to the adoption of ASC 606, applies the separation, initial measurement, and recognition principles of ASC 606 to its collaboration agreements.

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The Company’s collaborative arrangements revenues generated from sales of LINZESS in the U.S. are considered akin to sales-based royalties. In accordance with the sales-based royalty exception, the Company recognizes its share of the pre-tax commercial net profit or net loss generated from the sales of LINZESS in the U.S. in the period the product sales are earned, as reported by Allergan, and related cost of goods sold and selling, general and administrative expenses are incurred by the Company and its collaboration partner.  These amounts are partially determined based on amounts provided by Allergan and involve the use of estimates and judgments, such as product sales allowances and accruals related to prompt payment discounts, chargebacks, governmental and contractual rebates, wholesaler fees, product returns, and co-payment assistance costs, which could be adjusted based on actual results in the future. The Company is highly dependent on Allergan for timely and accurate information regarding any net revenues realized from sales of LINZESS in the U.S. in accordance with both ASC 808 and ASC 606, and the costs incurred in selling it, in order to accurately report its results of operations. If the Company does not receive timely and accurate information or incorrectly estimates activity levels associated with the collaboration at a given point in time, the Company could be required to record adjustments in future periods.

In accordance with ASC 606-10-55, Principal Agent Considerations, the Company records revenue transactions as net product revenue in its condensed consolidated statements of operations if it is deemed the principal in the transaction, which includes being the primary obligor, retaining inventory risk, and control over pricing. Given that the Company is not the primary obligor and does not have the inventory risks in the collaboration agreement with Allergan for North America, it records its share of the net profits or net losses from the sales of LINZESS in the U.S. on a net basis and presents the settlement payments to and from Allergan as collaboration expense or collaborative arrangements revenue, as applicable. The Company and Allergan settle the cost sharing quarterly, such that the Company’s statement of operations reflects 50% of the pre-tax net profit or loss generated from sales of LINZESS in the U.S.

Product revenue, net

Net product revenue is derived from sales of ZURAMPIC and DUZALLO (“the Lesinurad Products”) in the U.S. The Company sells the Lesinurad Products principally to a limited number of national wholesalers and selected regional wholesalers (the “Distributors”). The Distributors resell the Lesinurad Products to retail pharmacies and healthcare providers, who then sell to patients.

Net product revenue is recognized when the Distributor obtains control of the Company’s product, which occurs at a point in time, typically upon shipment of Lesinurad Products to the Distributor. When the Company performs shipping and handling activities after the transfer of control to the Distributor (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. 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.

The Company evaluates the creditworthiness of each of its Distributors to determine whether it is probable that a significant reversal in the amount of the cumulative revenue recognized will not occur. The Company calculates its net product revenue based on the wholesale acquisition cost that the Company charges its Distributors for the Lesinurad Products less variable consideration. The product revenue variable consideration consists of estimates relating to (i) trade discounts and allowances, such as invoice discounts for prompt payment and distributor fees, (ii) estimated government and private payor rebates, chargebacks and discounts, such as Medicaid reimbursements, (iii) reserves for expected product returns and (iv) estimated costs of incentives offered to certain indirect customers including patients. These estimates could be adjusted based on actual results in the period such variances become known.

Trade Discounts and Allowances:    The Company generally provides invoice discounts on sales of Lesinurad Products to its Distributors for prompt payment and pays fees for distribution services and for certain data that Distributors provide to the Company. Consistent with historical industry practice, the Company expects its Distributors to earn these discounts and fees, and accordingly deducts the full amount of these discounts and fees from its gross product revenues at the time such revenues are recognized.

 

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Rebates, Chargebacks and Discounts:    The Company contracts with Medicaid, other government agencies and various private organizations ("Third-party Payors") to allow for eligible purchases of the Lesinurad Products at partial or full reimbursement from such Third-party Payors. The Company estimates the rebates, chargebacks and discounts it will be obligated to provide to Third-party Payors and deducts these estimated amounts from its gross product revenue at the time the revenue is recognized. Based upon (i) the Company's contracts with these Third-party Payors, (ii) the government-mandated discounts applicable to government-funded programs, (iii) information obtained from the Company's Distributors and third-parties regarding the payor mix for Lesinurad Products and (iv) historical industry information regarding the payor mix for analog products, the Company estimates the rebates, chargebacks and discounts that it will be obligated to provide to Third-party Payors.

 

Product Returns:    The Company estimates the amount of Lesinurad Products that will be returned and deducts these estimated amounts from its gross revenue at the time the revenue is recognized. The Company's Distributors have the right to return unopened, unprescribed Lesinurad Products beginning six months prior to the labeled expiration date and ending twelve months after the labeled expiration date. The expiration date for the Lesinurad Products is at least 24 months after it has been converted into tablet form, which is the last step in the manufacturing process for Lesinurad Products and generally occurs within a few months before Lesinurad Products are delivered to the Company. The Company currently estimates product returns based on data provided to the Company by its Distributors and by other third parties, historical industry information regarding rates for similar pharmaceutical products, the estimated remaining shelf life of the Lesinurad Products previously shipped and currently being shipped to Distributors, and contractual agreements with the Company's Distributors intended to limit the amount of inventory they maintain.  Reporting from the Distributors includes Distributor sales and inventory held by Distributors, which provides the Company with visibility into the distribution channel in order to determine which products, if any, were eligible to be returned.

 

Other Incentives:    Incentives that 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.

 

Product revenue is recorded net of the trade discounts, allowances, rebates, chargebacks, discounts, product returns, and other incentives. Certain of these adjustments are recorded as an accounts receivable reserve.

 

Other

The Company produces linaclotide finished drug product, API and development materials for certain of its partners.

The Company recognizes revenue on linaclotide finished drug product, API and development materials when control have transferred to the partner, which generally occurs upon shipment for sales of API and upon delivery for sales of drug product, after the material has passed all quality testing required for collaborator acceptance. As it relates to development materials and API produced for Astellas, the Company is reimbursed at a contracted rate. Such reimbursements are considered as part of revenue generated pursuant to the Astellas license agreement and are presented as collaborative arrangements revenue. Any linaclotide finished drug product, API and development materials currently produced for Allergan for the U.S. or AstraZeneca for China, Hong Kong and Macau are recognized in accordance with the cost-sharing provisions of the Allergan and AstraZeneca collaboration agreements, respectively.

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Revenue recognition prior to the adoption of ASC 606

Agreements Entered into Prior to January 1, 2011

For arrangements that include multiple deliverables and were entered into prior to January 1, 2011, the Company followed the provisions of ASC Topic 605-25, Revenue Recognition—Multiple-Element Arrangements (‘‘ASC 605-25’’), in accounting for these agreements. Under ASC 605‑25, the Company was required to identify the deliverables included within the agreement and evaluate which deliverables represent separate units of accounting. Collaborative research and development and licensing agreements that contained multiple deliverables were divided into separate units of accounting when the following criteria were met:

·

Delivered element(s) had value to the collaborator on a standalone basis,

·

There was objective and reliable evidence of the fair value of the undelivered obligation(s), and

·

If the arrangement included a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) was considered probable and substantially within the Company’s control.

The Company allocated arrangement consideration among the separate units of accounting either on the basis of each unit’s respective fair value or using the residual method, and applied the applicable revenue recognition criteria to each of the separate units. If the separation criteria were not met, revenue of the combined unit of accounting was recorded based on the method appropriate for the last delivered item.

Agreements Entered into or Materially Modified on or after January 1, 2011 and prior to January 1, 2018

The Company evaluated revenue from multiple element agreements entered into on or after January 1, 2011 under ASU No. 2009‑13, Multiple-Deliverable Revenue Arrangements (“ASU 2009‑13”), or ASC 605, until the adoption of ASC 606.  The Company also evaluated whether amendments to its multiple element arrangements were considered material modifications that were subject to the application of ASU 2009‑13. This evaluation required management to assess all relevant facts and circumstances and to make subjective determinations and judgments.

When evaluating multiple element arrangements under ASU 2009‑13, the Company considered whether the deliverables under the arrangement represented separate units of accounting. This evaluation required subjective determinations and required management to make judgments about the individual deliverables and whether such deliverables were separable from the other aspects of the contractual relationship. In determining the units of accounting, management evaluated certain criteria, including whether the deliverables had standalone value, based on the consideration of the relevant facts and circumstances for each arrangement. Factors considered in this determination included the research, manufacturing and commercialization capabilities of the partner and the availability of relevant research and manufacturing expertise in the general marketplace. In addition, the Company considered whether the collaborator can use the license or other deliverables for their intended purpose without the receipt of the remaining elements, and whether the value of the deliverable was dependent on the undelivered items and whether there were other vendors that could provide the undelivered items.

The consideration received was allocated among the separate units of accounting using the relative selling price method, and the applicable revenue recognition criteria were applied to each of the separate units.

The Company determined the estimated selling price for deliverables using vendor‑specific objective evidence (“VSOE”) of selling price, if available, third‑party evidence (“TPE”) of selling price if VSOE was not available, or best estimate of selling price (“BESP”) if neither VSOE nor TPE was available.

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Up‑Front License Fees prior to January 1, 2018

When management believed the license to its intellectual property had stand-alone value, the Company generally recognized revenue attributed to the license upon delivery. When management believed the license to its intellectual property did not have stand‑alone value from the other deliverables to be provided in the arrangement, it was combined with other deliverables and the revenue of the combined unit of accounting was recorded based on the method appropriate for the last delivered item.

Milestones prior to January 1, 2018

At the inception of each arrangement that included pre-commercial milestone payments, the Company evaluated whether each pre-commercial milestone was substantive, in accordance with ASU No. 2010-17, Revenue Recognition—Milestone Method (“ASU 2010-17”), prior to the adoption of ASC 606. This evaluation included an assessment of whether (a) the consideration was commensurate with either (1) the entity’s performance to achieve the milestone, or (2) the enhancement of the value of the delivered item(s) as a result of a specific outcome resulting from the entity’s performance to achieve the milestone, (b) the consideration relates solely to past performance and (c) the consideration is reasonable relative to all of the deliverables and payment terms within the arrangement. The Company evaluated factors such as the scientific, clinical, regulatory, commercial and other risks that must be overcome to achieve the respective milestone, the level of effort and investment required and whether the milestone consideration is reasonable relative to all deliverables and payment terms in the arrangement in making this assessment. At December 31, 2017, the Company had no pre-commercial milestones that were deemed substantive.

Commercial milestones were accounted for as royalties and are recorded as revenue upon achievement of the milestone, assuming all other revenue recognition criteria are met.

Net Profit or Net Loss Sharing prior to January 1, 2018

In accordance with ASC 808 Topic, Collaborative Arrangements, and ASC 605‑45, Principal Agent Considerations, the Company considered the nature and contractual terms of the arrangement and the nature of the Company’s business operations to determine the classification of the transactions under the Company’s collaboration agreements. The Company recorded revenue transactions gross in the condensed consolidated statements of operations if it is deemed the principal in the transaction, which includes being the primary obligor and having the risks and rewards of ownership.

The Company recognized its share of the pre‑tax commercial net profit or net loss generated from the sales of LINZESS in the U.S. in the period the product sales are reported by Allergan and related cost of goods sold and selling, general and administrative expenses are incurred by the Company and its collaboration partner. These amounts were partially determined based on amounts provided by Allergan and involve the use of estimates and judgments, such as product sales allowances and accruals related to prompt payment discounts, chargebacks, governmental and contractual rebates, wholesaler fees, product returns, and co‑payment assistance costs, which could be adjusted based on actual results. For the periods covered in the condensed consolidated financial statements presented, there have been no material changes to prior period estimates of revenues, cost of goods sold or selling, general and administrative expenses associated with the sales of LINZESS in the U.S.

The Company records its share of the net profits or net losses from the sales of LINZESS in the U.S. on a net basis and presents the settlement payments to and from Allergan as collaboration expense or collaborative arrangements revenue, as applicable, as the Company is not the primary obligor and does not have the risks and rewards of ownership in the collaboration agreement with Allergan for North America. The Company and Allergan settle the cost sharing quarterly, such that the Company’s statement of operations reflects 50% of the pre‑tax net profit or loss generated from sales of LINZESS in the U.S.

Royalties on Product Sales prior to January 1, 2018

The Company received royalty revenues under certain of the Company’s license or collaboration agreements. The Company recorded these revenues as earned.

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Product Revenue, Net prior to January 1, 2018

 

As noted above, net product revenue is derived from sales of the Lesinurad Products in the U.S.

The Company recognized net product revenue from sales of the Lesinurad Products in accordance with ASC 605, when persuasive evidence of an arrangement exists, delivery has occurred and title of the product and associated risk of loss has passed to the customer, the price is fixed or determinable, and collection from the customer has been reasonably assured. ASC 605 required, among other criteria, that future returns could be reasonably estimated in order to recognize revenue.

The Company began commercializing ZURAMPIC in October 2016 and DUZALLO in October 2017 in the U.S. Initially, upon the product launch of each of the Lesinurad Products, the Company determined that it was not able to reliably make certain estimates, including returns, necessary to recognize product revenue upon delivery to Distributors. As a result, through September 30, 2017, the Company recorded net product revenue for the Lesinurad Products using a deferred revenue recognition model (sell-through). Under the deferred revenue model, the Company did not recognize revenue until the respective product was prescribed to an end-user. Accordingly, the Company recognized net product revenue when the Lesinurad Products were prescribed to the end-user, using estimated prescription demand and pharmacy demand from third party sources and the Company’s analysis of third party market research data, as well as other third-party information through September 30, 2017.

During the three months ended December 31, 2017, the Company concluded it had sufficient volume of historical activity and visibility into the distribution channel, in order to reasonably make all estimates required under ASC 605 to recognize product revenue upon delivery to the Distributor.  During the three months and year ended December 31, 2017, product revenue is recognized upon delivery of the Lesinurad Products to the Distributors.  The Company evaluated the creditworthiness of each of its Distributors to determine whether revenue can be recognized upon delivery, subject to satisfaction of the other requirements, or whether recognition was required to be delayed until receipt of payment. In order to conclude that the price is fixed or determinable, the Company must be able to (i) calculate its gross product revenue from the sales to Distributors and (ii) reasonably estimate its net product revenue. The Company calculated gross product revenue based on the wholesale acquisition cost that the Company charged its Distributors for ZURAMPIC and DUZALLO. The Company estimated its net product revenue by deducting from its gross product revenue (i) trade discounts and allowances, such as invoice discounts for prompt payment and distributor fees, (ii) estimated government and private payor rebates, chargebacks and discounts, such as Medicaid reimbursements, (iii) reserves for expected product returns and (iv) estimated costs of incentives offered to certain indirect customers including patients. These estimates could be adjusted based on actual results in the period such variances become known.

Other

The Company supplies linaclotide finished drug product, API and development materials for certain of its partners.

The Company recognized revenue on linaclotide finished drug product, API and development materials when the material had passed all quality testing required for collaborator acceptance, delivery had occurred, title and risk of loss had transferred to the partner, the price was fixed or determinable, and collection was reasonably assured.

 

New Accounting Pronouncements

 

From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (the “FASB”) or other standard setting bodies that are adopted by the Company as of the specified effective date. Except as set forth below, the Company did not adopt any new accounting pronouncements during the three and nine months ended September 30, 2018 and 2017 that had a material effect on its condensed consolidated financial statements.

 

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In May 2014, the FASB issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which supersedes the revenue recognition requirements in ASC 605, and most industry-specific guidance. The new standard requires that an entity recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. The update also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. In April 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers: Identifying Performance Obligations and Licensing (“ASU 2016-10”), which clarifies certain aspects of identifying performance obligations and licensing implementation guidance. In May 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers: Narrow-Scope Improvements and Practical Expedients (“ASU 2016-12”), related to disclosures of remaining performance obligations, as well as other amendments to guidance on collectability, non-cash consideration and the presentation of sales and other similar taxes collected from customers. The Company adopted these ASUs using the modified retrospective transition approach effective January 1, 2018. The adoption of these ASUs did not have a material impact on the Company’s financial position or results of operations; however, adoption did result in significant changes to the Company’s financial statement disclosures.

 

In February 2016, the FASB issued ASU No. 2016-02, Leases (“ASU 2016-02”), which supersedes the lease accounting requirements in ASC Topic 840, Leases, and most industry-specific guidance with ASC Topic 842, Leases. ASU 2016-02 requires the identification of arrangements that should be accounted for as leases by lessees. In general, for lease arrangements exceeding a 12-month term, these arrangements must now be recognized as assets and liabilities on the balance sheet of the lessee. Under ASU 2016-02, a right-of-use asset and lease obligation will be recorded for all leases, whether operating or financing, while the income statement will reflect lease expense for operating leases and amortization and 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. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. In July 2018, the FASB issued ASU No. 2018-10, Leases (Topic 842) (“ASU 2018-10”), Codification Improvements and ASU No. 2018-11, Leases (Topic 842), Targeted Improvements (“ASU 2018-11”), to provide additional guidance for the adoption of Topic 842. ASU 2018-10 clarifies certain provisions and corrects unintended applications of the guidance, such as the rate implicit in a lease, impairment of the net investment in a lease, lessee reassessment of lease classifications, lessor reassessment of lease term and purchase options, variable payments that depend on an index or rate and certain transition adjustments. The amendments in ASU 2018-11 allow for an additional transition method, whereby at the adoption date the entity recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption, while the comparative period disclosures continue recognition under ASC Topic 840. Additionally, ASU 2018-11 includes a practical expedient for separating contract components for lessors.  The Company is evaluating the potential impact that the adoption of ASU 2016-02, ASU 2018-10, and ASU 2018-11 may have on the Company’s financial position and results of operations. The Company’s analysis includes, but is not limited to, reviewing existing leases, reviewing other service agreements for embedded leases, establishing policies and procedures, assessing potential disclosures and evaluating the impact of adoption on the Company’s condensed consolidated financial statements. The Company anticipates adopting ASC Topic 842 using the additional transition method outlined in ASU 2018-11 as of January 1, 2019.

 

In October 2016, the FASB issued ASU No. 2016-16, Accounting for Income Taxes: Intra-Entity Asset Transfers of Assets Other than Inventory (“ASU 2016-16”). ASU 2016-16 eliminates the ability to defer the tax expense related to intra-entity asset transfers other than Inventory. Under the new standard, entities should recognize the income tax consequences on an intra-entity transfer of an asset other than inventory when the transfer occurs. ASU 2016-16 is effective for fiscal periods beginning after December 15, 2018. Early adoption is permitted. The Company continues to evaluate the potential impact that the adoption of ASU 2016-16 will have on the Company’s financial position or results of operations. The Company does not expect the adoption of ASU 2016-16 to have a material impact on the Company’s financial position or results of operations. 

 

In October 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230) Restricted Cash (“ASU 2016-18”), which requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents, and restricted cash or restricted cash equivalents. Therefore, amounts described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statement of cash flows. ASU 2016-18 is effective for fiscal years beginning after December 15, 2017, and interim periods within those years. The Company adopted this standard during

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the three months ended March 31, 2018. Adoption of this standard did not have a material impact on the Company’s financial position or results of operations.

 

As a result of adopting ASU 2016-18, the Company adjusted the condensed consolidated statements of cash flows from previously reported amounts as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Nine Months Ended

 

 

 

September 30, 2017

 

 

    

As previously reported

    

Adjustments

    

As adjusted

 

Cash flows from Operating Activities:

 

 

 

 

 

 

 

 

 

 

Net decrease (increase) in restricted cash related to lease obligations

 

$

1,190

 

$

(1,190)

 

$

 —

 

Net cash flows used in operating activities

 

 

(90,349)

 

 

(1,190)

 

 

(91,539)

 

Net change in cash, cash equivalents, and restricted cash

 

 

108,636

 

 

(1,190)

 

 

107,446

 

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

 

 

54,004

 

 

8,247

 

 

62,251

 

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

 

$

162,640

 

$

7,057

 

$

169,697

 

 

In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business (“ASU 2017-01”), to clarify the definition of a business by adding guidance to assist entities with evaluating whether transactions should be accounted for as acquisitions or disposals of assets versus businesses. ASU 2017-01 is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. The Company adopted this standard during the three months ended March 31, 2018. The adoption of this standard did not have a material impact on the Company’s financial position or results of operations.

 

In January 2017, the FASB issued ASU No. 2017-04, Intangibles—Goodwill and Other (Topic 350) (“ASU 2017-04”) to simplify the accounting for goodwill impairment by removing Step 2 of the goodwill impairment test. ASU 2017-04 is effective for fiscal years beginning after December 15, 2019. Early adoption is permitted. The Company is evaluating the potential impact that the adoption of ASU 2017-04 may have on the Company’s financial position and results of operations.

 

In May 2017, the FASB issued ASU No. 2017-09, Compensation—Stock Compensation (Topic 708) Scope of Modification Accounting (“ASU 2017-09”) which provides guidance that clarifies when changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. Adoption of ASU 2017-09 is required for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company adopted this standard during the three months ended March 31, 2018. The adoption of this standard did not have a material impact on the Company’s financial position and results of operations.

 

In June 2018, the FASB issued ASU No. 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting (“ASU 2018-07”). This ASU expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from non-employees, and as a result, the accounting for share-based payments to non-employees will be substantially aligned. ASU 2018-07 is effective for fiscal years beginning after December 15, 2-18, including interim periods within that fiscal year. Early adoption is permitted but not earlier than an entity’s adoption date of Topic 606. The Company is currently evaluating the potential impact that the adoption of ASU 2018-07 may have on the Company’s financial position and results of operations.

 

In July 2018, the FASB issued ASU 2018-09, Codification Improvements “(ASC 2018-09”). The amendments in ASU 2018-09 affect a wide variety of Topics in the FASB Codification and apply to all reporting entities within the scope of the affected accounting guidance. The Company has evaluated ASU 2018-09 in its entirety and determined that the amendments related to Topic 718-740, Compensation—Stock Compensation—Income Taxes, are the only provisions that currently apply to the Company. The amendments in ASU 2018-09 related to Topic 718-740, Compensation—Stock Compensation—Income Taxes, clarify that an entity should recognize excess tax benefits related to stock compensation transactions in the period in which the amount of the deduction is determined. The amendments in ASU 2018-09 related to Topic 718-740 are effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The Company does not expect the adoption of the new standard to have a material impact on the Company’s financial position or results of operations.

 

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In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework- Changes to the Disclosure Requirement for Fair Value Measurement (“ASU 2018-13”) which amends the disclosure requirements for fair value measurements. The amendments in ASU 2018-13 are effective for fiscal years beginning after December 15, 2019, with early adoption permitted. The Company is currently evaluating the potential impact that the adoption of ASU 2018-13 may have on the Company’s financial position and results of operations.

 

In August 2018, the FASB issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract (a consensus of the FASB Emerging Issues Task Force) (“ASU 2018-15)” which provides additional guidance on the accounting for costs of implementation activities performed in a cloud computing arrangement that is a service contract. The amendments in ASU 2018-15 are effective for fiscal years beginning after December 15, 2019, with early adoption permitted. The Company is currently evaluating the potential impact that the adoption of ASU 2018-15 may have on the Company’s financial position and results of operations.

 

 

 

2. Net Loss Per Share

 

Basic and diluted net loss per common share is computed by dividing net loss by the weighted average number of common shares outstanding during the period.

 

In June 2015, in connection with the issuance of approximately $335.7 million in aggregate principal amount of the 2022 Notes, the Company entered into convertible note hedge transactions (the “Convertible Note Hedges”). The Convertible Note Hedges are generally expected to reduce the potential dilution to the Company’s Class A common stockholders upon a conversion of the 2022 Notes and/or offset any cash payments the Company is required to make in excess of the principal amount of converted 2022 Notes in the event that the market price per share of the Company’s Class A common stock, as measured under the terms of the Convertible Note Hedges, is greater than the conversion price of the 2022 Notes (Note 9). The Convertible Note Hedges are not considered for purposes of calculating the number of diluted weighted average shares outstanding, as their effect would be antidilutive.

 

Concurrently with entering into the Convertible Note Hedges, the Company also entered into certain warrant transactions in which it sold note hedge warrants (the “Note Hedge Warrants”) to the Convertible Note Hedge counterparties to acquire 20,249,665 shares of the Company’s Class A common stock, subject to customary anti-dilution adjustments. The Note Hedge Warrants could have a dilutive effect on the Company’s Class A common stock to the extent that the market price per share of the Class A common stock exceeds the applicable strike price of such warrants (Note 9). The Note Hedge Warrants are not considered for purposes of calculating the number of diluted weighted averages shares outstanding, as their effect would be antidilutive.

 

The following potentially dilutive securities have been excluded from the computation of diluted weighted average shares outstanding as their effect would be anti-dilutive (in thousands):

 

 

 

 

 

 

 

 

 

Nine Months Ended

 

 

 

September 30, 

 

 

    

2018

    

2017

 

Options to purchase common stock

 

20,860

 

21,320

 

Shares subject to repurchase

 

97

 

93

 

Restricted stock units

 

3,238

 

2,205

 

Shares subject to issuance under Employee Stock Purchase Plan

 

59

 

74

 

Note hedge warrants

 

20,250

 

20,250

 

2022 Notes

 

20,250

 

20,250

 

 

 

64,754

 

64,192

 

 

 

3. Goodwill and Intangible Assets

 

The Company closed the Lesinurad Transaction on June 2, 2016 (the “Acquisition Date”) with AstraZeneca pursuant to which the Company received an exclusive license to develop, manufacture and commercialize in the U.S. products containing lesinurad as an active ingredient, including ZURAMPIC and DUZALLO. On August 2, 2018, the Company delivered to AstraZeneca a notice of termination of the lesinurad license agreement, which termination is made

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with respect to all products under the lesinurad license agreement and expected to be effective no later than 180 days from the notice (the “Effective Termination Date”).

 

In connection with the Lesinurad License, the Company is required to perform certain post-marketing activities required by the FDA. These post-marketing requirements for lesinurad are estimated to be less than $100.0 million over up to ten years from the Acquisition Date.

 

The Company concluded that the Lesinurad Transaction included inputs and processes that have the ability to create outputs and accordingly accounted for the transaction as a business combination in accordance with ASC 805. The purchase price consisted of the up-front payment to AstraZeneca of $100.0 million, which was made in June 2016, and the fair value of contingent consideration of approximately $67.9 million. In addition to the up-front payment, the Company will also pay a tiered royalty to AstraZeneca in the single-digits as a percentage of net sales of the Products in the U.S. through the Effective Termination Date of the Lesinurad License. During the year ended December 31, 2017, the Company paid a $15.0 million milestone to AstraZeneca related to the approval of DUZALLO by the FDA.

 

In connection with the Company’s revised forecast and subsequent notice of termination of the lesinurad license agreement, the Company reduced its projected revenue and net cash flow assumptions associated with the value of its developed technology – ZURAMPIC and developed technology – DUZALLO intangible assets.  Accordingly, the Company evaluated its developed technology – ZURAMPIC and developed technology – DUZALLO intangible assets for impairment.

 

As a result of the triggering event requiring an impairment assessment, the Company recorded an approximately $151.8 million impairment charge during the three months ended September 30, 2018 related to the write-down of the developed technology – ZURAMPIC and developed technology – DUZALLO intangible assets. The impairment assessment performed utilized the revised projected revenue and net cash flows assumed through the Effective Termination Date, resulting in an impairment of the full carrying value of the intangible assets. The impairment charge was recorded as impairment of intangible assets in the Company’s condensed consolidated statement of operations.

 

The Company tests its goodwill for impairment annually as of October 1st, or more frequently if events or changes in circumstances indicate an impairment may have occurred. As of September 30, 2018, there was no impairment of goodwill.

 

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4. Collaboration, License, Co-Promotion and Other Commercial Agreements

 

For the three and nine months ended September 30, 2018, the Company had linaclotide collaboration agreements with Allergan for North America and AstraZeneca for China, Hong Kong and Macau, as well as linaclotide license agreements with Astellas for Japan and with Allergan for the Allergan License Territory. The Company also had agreements with Allergan to co-promote VIBERZI in the U.S. and to promote CANASA in the U.S. The following table provides amounts included in the Company’s condensed consolidated statements of operations as collaborative arrangements revenue and sale of API attributable to transactions from these arrangements (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Collaborative Arrangements Revenue

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30, 

 

September 30, 

 

Collaborative Arrangements Revenue

 

2018

    

2017

 

2018

    

2017

 

Linaclotide Agreements:

 

 

 

 

 

 

 

 

 

 

 

 

 

Allergan (North America)

 

$

52,724

 

$

76,034

 

$

184,133

 

$

182,727

 

Allergan (Europe and other)

 

 

255

 

 

131

 

 

831

 

 

349

 

AstraZeneca (China, Hong Kong and Macau)

 

 

 —

 

 

 —

 

 

 —

 

 

208

 

Co-Promotion and Other Agreements:

 

 

 

 

 

 

 

 

 

 

 

 

 

Exact Sciences (Cologuard) (1)

 

 

 —

 

 

108

 

 

 —

 

 

2,544

 

Allergan (VIBERZI)

 

 

750

 

 

301

 

 

2,250

 

 

1,247

 

Other

 

 

465

 

 

78

 

 

1,273

 

 

81

 

Total collaborative arrangements revenue

 

$

54,194

 

$

76,652

 

$

188,487

 

$

187,156

 

Sale of API

 

 

 

 

 

 

Linaclotide Agreements:

 

 

 

 

 

 

 

 

 

 

 

 

 

Astellas (Japan)

 

$

9,501

 

$

9,491

 

$

23,738

 

$

15,476

 

Other (2)

 

 

756

 

 

 —

 

 

756

 

 

 —

 

Total sale of API

 

$

10,257

 

$

9,491

 

$

24,494

 

$

15,476

 


(1) In August 2016, the Company terminated the Exact Sciences Co-Promotion Agreement for Cologuard. Under the terms of the agreement, the Company continued to receive royalty payments through July 2017.

(2) During the three months ended September 30, 2018, the Company recorded approximately $0.8 million in revenue related to the sale of API to Allergan.

 

 

Accounts receivable, net and related party accounts receivable, net totaled approximately $64.7 million related to collaborative arrangements revenue and sale of API as of September 30, 2018, net of approximately $6.6 million related to related party accounts payable.

 

As of September 30, 2018, there were no impairment indicators for the accounts receivable recorded. During the three and nine months ended September 30, 2018, there was no significant unusual activity in accounts receivable.

 

Linaclotide Agreements

 

Collaboration Agreement for North America with Allergan

 

In September 2007, the Company entered into a collaboration agreement with Allergan to develop and commercialize linaclotide for the treatment of IBS-C, CIC and other GI conditions in North America. Under the terms of this collaboration agreement, the Company received a non-refundable, upfront licensing fee and shares equally with Allergan all development costs as well as net profits or losses from the development and sale of linaclotide in the U.S. The Company receives royalties in the mid-teens percent based on net sales in Canada and Mexico. Allergan is solely responsible for the further development, regulatory approval and commercialization of linaclotide in those countries and funding any costs. The collaboration agreement for North America also includes contingent milestone payments, as well as a contingent equity investment, based on the achievement of specific development and commercial milestones. At September 30, 2018, $205.0 million in license fees and all six development milestone payments had been received by the Company, as well as a $25.0 million equity investment in the Company’s capital stock (Note 12). The Company can also achieve up to $100.0 million in a sales-related milestone if certain conditions are met, which will be recognized as

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collaborative arrangements revenue when it is probable that a significant reversal of revenue would not occur and the associated constraints have been lifted.

 

As a result of the research and development cost-sharing provisions of the linaclotide collaboration for North America, the Company offset approximately $2.5 million and offset approximately $5.8 million in incremental research and development costs during the three and nine months ended September 30, 2018, respectively, and recognized an insignificant amount and approximately $0.5 million in research and development costs during the three and nine months ended September 30, 2017, respectively, to reflect the obligations of each party under the collaboration to bear half of the development costs incurred.

 

The Company and Allergan began commercializing LINZESS in the U.S. in December 2012. The Company receives 50% of the net profits and bears 50% of the net losses from the commercial sale of LINZESS in the U.S. Net profits or net losses consist of net sales of LINZESS to third-party customers and sublicense income in the U.S. less the cost of goods sold as well as selling, general and administrative expenses. LINZESS net sales are calculated and recorded by Allergan and may include gross sales net of discounts, rebates, allowances, sales taxes, freight and insurance charges, and other applicable deductions. If either party provided fewer calls on physicians in a particular year than it was contractually required to provide, such party’s share of the net profits would be adjusted as set forth in the collaboration agreement for North America. During the year ended December 31, 2017, these adjustments to the share of the net profits were reduced or eliminated in connection with the co-promotion activities under the Company’s agreement with Allergan to co-promote VIBERZI in the U.S., as described below in Agreement with Allergan for VIBERZI. Additionally, these adjustments to the share of the net profits are eliminated, in full, in 2018 and all subsequent years under the terms of the Company’s commercial agreement with Allergan entered into in January 2017 under which the Company promotes Allergan’s CANASA product, as described below in Commercial Agreement with Allergan. In May 2014, CONSTELLA became commercially available in Canada and in June 2014, LINZESS became commercially available in Mexico.

 

The Company evaluated this collaboration arrangement under ASC 606 and concluded that all development-period performance obligations had been satisfied as of September 2012. However, the Company has determined that there are three remaining commercial-period performance obligations, which include the sales detailing of LINZESS, participation in the joint commercialization committee, and approved additional trials. The consideration remaining includes cost reimbursements in the U.S., as well as commercial sales-based milestones and net profit and loss sharing payments based on net sales in the U.S. Additionally, the Company receives royalties in the mid-teens percent based on net sales in Canada and Mexico. Royalties, commercial sales-based milestones, and net profit and loss sharing payments will be recorded as collaborative arrangements revenue or expense in the period earned, in accordance with the sales-based royalty exception, as these payments relate predominately to the license granted to Allergan. The Company records royalty revenue in the period earned based on royalty reports from its partner, if available, or based on the projected sales and historical trends. The cost reimbursements received from Allergan during the commercialization period will be recognized as billed in accordance with the right-to-invoice exemption, as the Company’s right to consideration corresponds directly with the value of the services transferred during the commercialization period.

Under the Company’s collaboration with Allergan for North America, LINZESS net sales are calculated and recorded by Allergan and include gross sales net of discounts, rebates, allowances, sales taxes, freight and insurance charges, and other applicable deductions, as noted above. These amounts include the use of estimates and judgments, which could be adjusted based on actual results in the future. The Company records its share of the net profits or net losses from the sales of LINZESS in the U.S. on a net basis less commercial expenses, and presents the settlement payments to and from Allergan as collaboration expense or collaborative arrangements revenue, as applicable. This is in accordance with the Company’s policy, given that the Company is not the primary obligor and does not have the inventory risks in the collaboration agreement with Allergan for North America. The Company relies on Allergan to provide accurate and complete information related to net sales of LINZESS in accordance with U.S. GAAP in order to calculate its settlement payments to and from Allergan and record collaboration expense or collaborative arrangements revenue, as applicable. 

 

From time to time, in accordance with the terms of the collaboration with Allergan for North America, the Company engages an independent certified public accounting firm to review the accuracy of the financial reporting from Allergan to the Company. In connection with the most recent of such reviews, during the three months ended September 30, 2018, Allergan reported to the Company an approximately $59.3 million negative adjustment to LINZESS net sales. Such adjustment relates to the cumulative difference between certain previously estimated LINZESS gross-to-net sales

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reserves and allowances made by Allergan during the years ended December 31, 2015, 2016 and 2017, and actual subsequent payments made. This adjustment is primarily associated with estimated governmental and contractual rebates, as reported by Allergan. Accordingly, upon receiving this information from Allergan, the Company recorded a change in accounting estimate to reduce collaborative arrangements revenue by approximately $29.7 million during the three months ended September 30, 2018 related to the Company’s share of this adjustment.

 

The Company recognized collaborative arrangements revenue from the Allergan collaboration agreement for North America during the three and nine months ended September 30, 2018 and 2017 as follows (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30, 

 

September 30, 

 

 

    

2018

    

2017

    

2018

    

2017

 

Collaborative arrangements revenue related to sales of LINZESS in the U.S.

 

$

52,261

 

$

73,905

 

$

182,675

 

$

179,664

 

Royalty revenue

 

 

463

 

 

452

 

 

1,458

 

 

1,386

 

Other (1)

 

 

 —

 

 

1,677

 

 

 —

 

 

1,677

 

Total collaborative arrangements revenue

 

$

52,724

 

$

76,034

 

$

184,133

 

$

182,727

 

(1)Includes net profit share adjustments of approximately $1.7 million recorded during the three months ended September 30, 2017 related to a change in estimated selling expenses previously recorded.

 

The collaborative arrangements revenue recognized in the three and nine months ended September 30, 2018 and 2017 primarily represents the Company’s share of the net profits and net losses on the sale of LINZESS in the U.S.

 

The following table presents the amounts recorded by the Company for commercial efforts related to LINZESS in the U.S. in the three and nine months ended September 30, 2018 and 2017 (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30, 

 

September 30, 

 

 

    

2018

    

2017

    

2018

    

2017

 

Collaborative arrangements revenue related to sales of LINZESS in the U.S.(1)(2)

 

$

52,261

 

$

73,905

 

$

182,675

 

$

179,664

 

Selling, general and administrative costs incurred by the Company(1)

 

 

(10,915)

 

 

(10,457)

 

 

(33,556)

 

 

(34,062)

 

The Company’s share of net profit

 

$

41,346

 

$

63,448

 

$

149,119

 

$

145,602

 


(1)

Includes only collaborative arrangement revenue or selling, general and administrative costs attributable to the cost-sharing arrangement with Allergan for the three and nine months ended September 30, 2018 and 2017.

(2)

Certain of the unfavorable adjustments to the Company’s share of the LINZESS net profits were reduced or eliminated during the nine months ended September 30, 2017 in connection with the co-promotion activities under the Company’s agreement with Allergan to co-promote VIBERZI in the U.S., as described below in Agreement with Allergan for VIBERZI.

 

In May 2014, CONSTELLA became commercially available in Canada and in June 2014, LINZESS became commercially available in Mexico. In October 2015, Almirall and Allergan terminated the sublicense arrangement with respect to Mexico, returning the exclusive rights to commercialize CONSTELLA in Mexico to Allergan. CONSTELLA continues to be available to adult IBS-C patients in Mexico. The Company records royalties on sales of CONSTELLA in Canada and LINZESS in Mexico in the period earned. The Company recognized approximately $0.5 million and approximately $1.5 million of combined royalty revenues from Canada and Mexico during the three and nine months ended September 30, 2018, respectively. The Company recognized approximately $0.5 million and approximately $1.4 million of combined royalty revenues from Canada and Mexico during the three and nine months ended September 30, 2017, respectively.

 

License Agreement with Allergan (All countries other than the countries and territories of North America, China, Hong Kong, Macau, and Japan)

 

In April 2009, the Company entered into a license agreement with Almirall (the “European License Agreement”) to develop and commercialize linaclotide in Europe (including the Commonwealth of Independent States and Turkey) for the treatment of IBS-C, CIC and other GI conditions. In October 2015, Almirall transferred its exclusive license to develop and commercialize linaclotide in Europe to Allergan. In accordance with the European License

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Agreement, the Company granted Almirall a right to access its U.S. Phase III clinical trial data for the purposes of supporting European regulatory approval.  Additionally, the Company was required to participate on a joint development committee during linaclotide’s development period and is required to participate in a joint commercialization committee while linaclotide is commercially available. 

 

Additionally, in October 2015, the Company and Allergan separately entered into an amendment to the European License Agreement relating to the development and commercialization of linaclotide in Europe. Pursuant to the terms of the amendment, (i) certain sales-based milestones payable to the Company under the European License Agreement were modified to increase the total milestone payments such that, when aggregated with certain commercial launch milestones, they could total up to $42.5 million, (ii) the royalties payable to the Company during the term of the European License Agreement were modified such that the royalties based on sales volume in Europe begin in the mid-single digit percent and escalate to the upper-teens percent by calendar year 2019, and (iii) Allergan assumed responsibility for the manufacturing of linaclotide API for Europe from the Company, as well as the associated costs. The Company concluded that the 2015 amendment to the European License Agreement was not a modification to the linaclotide collaboration agreement with Allergan for North America.

 

In January 2017, concurrently with entering into the commercial agreement as described below in Commercial Agreement with Allergan, the Company and Allergan entered into an amendment to the European License Agreement. The European License Agreement, as amended (the “Allergan License Agreement”), extended the license to develop and commercialize linaclotide in all countries other than China, Hong Kong, Macau, Japan, and the countries and territories of North America. On a country-by-country and product-by-product basis in such additional territory, Allergan is obligated to pay the Company a royalty as a percentage of net sales of products containing linaclotide as an active ingredient in the upper-single digits for five years following the first commercial sale of a linaclotide product in a country, and in the low-double digits thereafter. The royalty rate for products in the expanded territory will decrease, on a country-by-country basis, to the lower-single digits, or cease entirely, following the occurrence of certain events. Allergan is also obligated to assume certain purchase commitments for quantities of linaclotide API under the Company’s agreements with third-party API suppliers. The amendment to the European License Agreement did not modify any of the milestones or royalty terms related to Europe.

The Company concluded that the 2017 amendment was a material modification to the European License Agreement; however, this modification did not have a material impact on the Company's condensed consolidated financial statements as there was no deferred revenue associated with the European License Agreement. The Company also concluded that the 2017 amendment to the European License Agreement was not a material modification to the linaclotide collaboration agreement with Allergan for North America. The Company’s conclusions on deliverables under ASC Topic 605-25, Revenue Recognition—Multiple-Element Arrangements (“ASC 605-25”) are described below in Commercial Agreement with Allergan.

The Company evaluated the European License Agreement under ASC 606. In evaluating the terms of the 2009 European License Agreement under ASC 606, the Company determined that there are no remaining performance obligations as of September 2012. However, the Company continues to be eligible to receive consideration in the form of commercial launch milestones, sales-based milestones, and royalties.

The commercial launch milestones, sales-based milestones and royalties under the European License Agreement have historically been recognized as revenue as earned. Under ASC 606, the Company will apply the sales-based royalty exception to royalties and sales-based milestones, as these payments relate predominantly to the license granted to Allergan (formerly Almirall). Accordingly, the royalties and sales-based milestones will be recorded as revenue in the period earned. The Company records royalties on sales of CONSTELLA in Europe in the period earned based on royalty reports from its partner, if available, or the projected sales and historical trends. The commercial launch milestones will be recognized as revenue when it is probable that a significant reversal of revenue would not occur and the associated constraint has been lifted.

Additionally, the Company evaluated the terms of the January 2017 amendment under ASC 606 and determined that it would be treated as a separate contract given that it adds a distinct good or service at an amount that reflects standalone selling price. The Company determined that all performance obligations in this amendment were satisfied in January 2017 when the license for the additional territory was transferred. The Company continues to receive royalties under this agreement, which are recorded in the period earned pursuant to the sales-based royalty exception, as they related predominantly to the license granted to Allergan.

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The Company recognized approximately $0.2 million and $0.8 million of royalty revenue during the three and nine months ended September 30, 2018, respectively, and an insignificant amount and approximately $0.3 million during the three and nine months ended September 30, 2017, respectively.

 

License Agreement for Japan with Astellas

 

In November 2009, the Company entered into a license agreement with Astellas, as amended, to develop and commercialize linaclotide for the treatment of IBS‑C, CIC and other GI conditions in Japan. Astellas is responsible for all activities relating to development, regulatory approval and commercialization in Japan as well as funding the associated costs and the Company is required to participate on a joint development committee over linaclotide’s development period. During the year ended December 31, 2017, the Company and Astellas entered into a commercial API supply agreement (the “Astellas Commercial Supply Agreement”). Pursuant to the Astellas Commercial Supply Agreement, the Company sells linaclotide API supply to Astellas at a contractually defined rate and recognizes related revenue as sale of API. Under the license agreement, the Company receives royalties which escalate based on sales volume, beginning in the low-twenties percent, less the transfer price paid for the API included in the product actually sold and other contractual deductions.

In 2009, Astellas paid the Company a non‑refundable, up‑front licensing fee of $30.0 million, which was recognized as collaborative arrangements revenue on a straight‑line basis over the Company’s estimate of the period over which linaclotide was developed under the license agreement in accordance with ASC 605. The development period was completed in December 2016 upon approval of LINZESS by the Japanese Ministry of Health, Labor and Welfare at which point all previously deferred revenue under the agreement was recognized.

The agreement also includes three development milestone payments that totaled up to $45.0 million, all of which were achieved and recognized as revenue through December 31, 2016 in accordance with ASC 605. The first milestone payment, consisting of $15.0 million upon enrollment of the first study subject in a Phase III study for linaclotide in Japan, was achieved in November 2014. The second milestone payment, consisting of $15.0 million upon filing of a New Drug Application (“NDA”) for linaclotide with the Japanese Ministry of Health, Labor and Welfare, was achieved in February 2016. The third development milestone payment consisting of $15.0 million upon approval of an NDA by the Japanese Ministry of Health, Labor and Welfare to market linaclotide in Japan was achieved in December 2016.

 

The Company has evaluated the terms of the 2009 License Agreement with Astellas under ASC 606 and has determined that there are no remaining performance obligations as of December 2016. However, there continues to be consideration in the form of royalties on sales of LINZESS in Japan under the 2009 License Agreement. Upon adoption of ASC 606, the Company concluded that the royalties on sales of LINZESS in Japan relate predominantly to the license granted to Astellas. Accordingly, the Company applies the sales-based royalty exception and records royalties on sales of LINZESS in Japan in the period earned based on royalty reports from its partner, if available, or the projected sales and historical trends.

 

Additionally, under the terms of the Astellas Commercial Supply Agreement, the Company continues to have an ongoing performance obligation to supply API. Upon adoption of ASC 606, product revenue is recognized when the customer obtains control of the Company’s product, which occurs at a point in time, typically upon shipment of the product to the customer. This results in earlier revenue recognition than the Company’s historical accounting.

 

The royalty on sales of LINZESS in Japan during each of the three and nine months ended September 30, 2018 and September 30, 2017 relating to the quarters in arrears did not exceed the transfer price of API sold and other contractual deductions during the periods. During the three and nine months ended September 30, 2017, the Company recognized approximately $9.5 million and $15.5 million, respectively, from the sale of API to Astellas under the license agreement and the Astellas Commercial Supply Agreement. During the three and nine months ended September 30, 2018, the Company recognized approximately $9.5 million and $23.7 million, respectively, from the sale of API to Astellas under the license agreement and the Astellas Commercial Supply Agreement. Additionally, the Company recorded approximately $13.5 million as deferred revenue as of September 30, 2018 related to API transactions with Astellas for API sales where control had not yet passed.

 

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Collaboration Agreement for China, Hong Kong and Macau with AstraZeneca

 

In October 2012, the Company entered into a collaboration agreement with AstraZeneca (the “AstraZeneca Collaboration Agreement”) to co‑develop and co‑commercialize linaclotide in China, Hong Kong and Macau (the “License Territory”). The collaboration provides AstraZeneca with an exclusive nontransferable license to exploit the underlying technology in the License Territory. The parties share responsibility for continued development and commercialization of linaclotide under a joint development plan and a joint commercialization plan, respectively, with AstraZeneca having primary responsibility for the local operational execution.

The parties agreed to an Initial Development Plan (“IDP”) which includes the planned development of linaclotide in China, including the lead responsibility for each activity and the related internal and external costs. The IDP indicates that AstraZeneca is responsible for a multinational Phase III clinical trial (the “Phase III Trial”), the Company is responsible for nonclinical development and supplying clinical trial material and both parties are responsible for the regulatory submission process. The IDP indicates that the party specifically designated as being responsible for a particular development activity under the IDP shall implement and conduct such activities. The activities are governed by a Joint Development Committee (“JDC”), with equal representation from each party. The JDC is responsible for approving, by unanimous consent, the joint development plan and development budget, as well as approving protocols for clinical studies, reviewing and commenting on regulatory submissions, and providing an exchange of data and information.

The AstraZeneca Collaboration Agreement will continue until there is no longer a development plan or commercialization plan in place, however, it can be terminated by AstraZeneca at any time upon 180 days’ prior written notice. Under certain circumstances, either party may terminate the AstraZeneca Collaboration Agreement in the event of bankruptcy or an uncured material breach of the other party. Upon certain change in control scenarios of AstraZeneca, the Company may elect to terminate the AstraZeneca Collaboration Agreement and may re‑acquire its product rights in a lump sum payment equal to the fair market value of such product rights.

 

In connection with the AstraZeneca Collaboration Agreement, the Company and AstraZeneca also executed a co-promotion agreement (the “Co-Promotion Agreement”), pursuant to which the Company utilized its existing sales force to co-promote NEXIUM® (esomeprazole magnesium), one of AstraZeneca’s products, in the U.S. The Co-Promotion Agreement expired in May 2014.

There are no refund provisions in the AstraZeneca Collaboration Agreement and the Co‑Promotion Agreement (together, the “AstraZeneca Agreements”).

Under the terms of the AstraZeneca Collaboration Agreement, the Company received a $25.0 million non‑refundable up-front payment upon execution. The Company is also eligible for $125.0 million in additional commercial milestone payments contingent on the achievement of certain sales targets. The parties will also share in the net profits and losses associated with the development and commercialization of linaclotide in the License Territory, with AstraZeneca receiving 55% of the net profits or incurring 55% of the net losses until a certain specified commercial milestone is achieved, at which time profits and losses will be shared equally thereafter.

Activities under the AstraZeneca Agreements were evaluated in accordance with ASC 605-25, to determine if they represented a multiple element revenue arrangement. The Company identified the following deliverables in the AstraZeneca Agreements:

·

an exclusive license to develop and commercialize linaclotide in the License Territory (the “License Deliverable”) (the deliverable was completed upon execution and all associated revenue was recognized as of December 31, 2016),

·

research, development and regulatory services pursuant to the IDP, as modified from time to time (the “R&D Services”),

·

JDC services,

·

obligation to supply clinical trial material, and

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·

co‑promotion services for AstraZeneca’s product (the “Co‑Promotion Deliverable”) (the deliverable was completed and all associated revenue was recognized as of December 31, 2013).

 

Under ASC 605, the License Deliverable is nontransferable and has certain sublicense restrictions. The Company determined that the License Deliverable had standalone value as a result of AstraZeneca’s internal product development and commercialization capabilities, which would enable it to use the License Deliverable for its intended purposes without the involvement of the Company. The remaining deliverables were deemed to have standalone value based on their nature and all deliverables met the criteria to be accounted for as separate units of accounting under ASC 605‑25. Factors considered in this determination included, among other things, whether any other vendors sell the items separately and if the customer could use the delivered item for its intended purpose without the receipt of the remaining deliverables.

 

The Company performs R&D Services and JDC services, and supplies clinical trial materials during the estimated development period. All consideration allocated to such services was being recognized as a reduction of research and development costs, using the proportional performance method, by which the amounts are recognized in proportion to the costs incurred in accordance with ASC 605. At the inception of the arrangement, the Company identified the supply of linaclotide drug product for commercial requirements and commercialization services as contingent deliverables under ASC 605 because these services are contingent upon the receipt of regulatory approval to commercialize linaclotide in the License Territory, and there were no binding commitments or firm purchase orders pending for commercial supply at the inception of the AstraZeneca Collaboration Agreement.

In August 2014, the Company and AstraZeneca, through the JDC, modified the IDP and development budget to include approximately $14.0 million in additional activities over the remaining development period, to be shared by the Company and AstraZeneca under the terms of the AstraZeneca Collaboration Agreement. These additional activities serve to support the continued development of linaclotide in the License Territory, including the Phase III Trial. Pursuant to the terms of the modified IDP and development budget, certain of the Company’s deliverables were modified, specifically the R&D Services and the obligation to supply clinical trial material. The modification did not, however, have a material impact on the Company’s condensed consolidated financial statements.

The total amount of the non‑contingent consideration allocable to the AstraZeneca Agreements was approximately $34.0 million (“Arrangement Consideration”) which includes the $25.0 million non‑refundable up-front payment and approximately $9.0 million representing 55% of the costs for clinical trial material supply services and research, development and regulatory activities allocated to the Company in the IDP or as approved by the JDC in subsequent periods.

The Company allocated the Arrangement Consideration to the non-contingent deliverables based on management’s best estimated selling price (“BESP”) of each deliverable using the relative selling price method, as the Company did not have vendor-specific objective evidence or third-party evidence of selling price for such deliverables. Of the total Arrangement Consideration, approximately $29.7 million was allocated to the License Deliverable, approximately $1.8 million to the R&D Services, approximately $0.1 million to the JDC services, approximately $0.3 million to the clinical trial material supply services, and approximately $2.1 million to the Co-Promotion Deliverable in the relative selling price model.

Because the Company shares development costs with AstraZeneca, payments from AstraZeneca with respect to both research and development and selling, general and administrative costs incurred by the Company prior to the commercialization of linaclotide in the License Territory are recorded as a reduction in expense, in accordance with the Company’s policy, which is consistent with the nature of the cost reimbursement. Development costs incurred by the Company that pertain to the joint development plan and subsequent amendments to the joint development plan, as approved by the JDC, are recorded as research and development expense as incurred. Payments to AstraZeneca are recorded as incremental research and development expense. As a result of the cost-sharing arrangements under the collaboration, the Company offset an insignificant amount and approximately $0.2 million in research and development costs during the three and nine months ended September 30, 2017 respectively.

In March 2017, the Company began providing supply of linaclotide drug product and certain commercialization-related services pursuant to the AstraZeneca Collaboration Agreement. During the three and nine months ended September 30, 2017, the Company recognized no revenue and approximately $0.2 million, respectively, as collaborative arrangements revenue related to linaclotide drug product, as this deliverable was no longer contingent.

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Upon the adoption of ASC 606, the Company reevaluated the AstraZeneca Agreements and, consistent with its conclusions under ASC 605, identified six performance obligations including the license, R&D services, JDC services, supply of clinical trial material, co-promotion services for NEXIUM, and the JCC services. The Company determined that the supply of linaclotide drug product for commercial requirements was an optional service at inception of the arrangement and did not provide a material right to AstraZeneca.

At the adoption date, the Company had fully satisfied its obligation to transfer the license and NEXIUM co-promotion services to AstraZeneca. The following remaining performance obligations are ongoing as of September 30, 2018:

·

research, development and regulatory services pursuant to the IDP, as modified from time to time (the R&D Services),

·

JDC services, and

·

obligation to supply clinical trial material, and

·

JCC services

Under ASC 606, the Company applied the contract modification practical expedient to the August 2014 amendment, which expanded the scope of the Company’s activities under the IDP and increased the development budget. This practical expedient allows an entity to reflect the aggregate effect of all modifications that occur before the beginning of the earliest period presented. The application of this practical expedient resulted in a total transaction price of approximately $34.0 million, which was allocable to the Company’s performance obligations on a relative standalone selling price (“SSP”) basis. 

Under ASC 606, amounts of consideration allocated to the license and NEXIUM co-promotion services would have been recognized in full prior to adoption as these performance obligations were satisfied in October 2012 and December 2013, respectively. Consideration allocated to the R&D Services will be recognized as such services are provided over the performance period using an output method based on full-time employee hours incurred. Consideration allocated to the JDC services are recognized ratably over the development period using a time-based, straight-line attribution model. Revenue from the supply of clinical trial material is recognized as the clinical trial material is delivered to the customer. During the three and nine months ended September 30, 2018, the Company offset  an insignificant amount and approximately $0.8 million, respectively, related to R&D Services and JDC services.

 

Upon commercialization, the Company’s only remaining performance obligation will be JCC services. During commercialization, the Company will be entitled to receive sales-based milestone payments from AstraZeneca. Additionally, the parties will share in the net profits and losses associated with the development and commercialization of linaclotide in the License Territory, with AstraZeneca receiving 55% of the net profits or incurring 55% of the net losses until a certain specified commercial milestone is achieved; from that point, profits and losses will be shared equally thereafter. Commercial sales-based milestones and net profit and loss sharing payments will be recorded as collaborative arrangements revenue or expense in the period earned, in accordance with the sales-based royalty exception, as these payments related predominately to the license granted to AstraZeneca. Any cost reimbursements received from AstraZeneca during the commercialization period will be recognized as billed in accordance with the right-to-invoice exemption, as the Company’s right to consideration corresponds directly with the value of the services transferred during the commercialization period.

 

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Co-Promotion and Other Agreements

 

Co-Promotion Agreement with Exact Sciences Corp. for Cologuard

 

In March 2015, the Company and Exact Sciences entered into an agreement to co-promote Exact Sciences’ Cologuard, the first and only FDA-approved noninvasive stool DNA screening test for colorectal cancer (the “Exact Sciences Co-Promotion Agreement”). The Exact Sciences Co-Promotion Agreement was terminated by the parties in August 2016. Under the terms of the non-exclusive Exact Sciences Co-Promotion Agreement, the Company’s sales team promoted and educated health care practitioners regarding Cologuard through July 2016. Exact Sciences maintained responsibility for all other aspects of the commercialization of Cologuard outside of the co-promotion. Under the terms of the Exact Sciences Co-Promotion Agreement, the Company was compensated primarily via royalties earned on the net sales of Cologuard generated from the healthcare practitioners on whom the Company called with such royalties payable through July 2017. There were no refund provisions in the Exact Sciences Co-Promotion Agreement.

 

During the three and nine months ended September 30, 2017, the Company recognized an insignificant amount and approximately $2.5 million, respectively, as collaborative arrangements revenue related to this arrangement in accordance with ASC 605 - 25.

 

The Company determined that the Exact Sciences Co-Promotion Agreement was completed prior to the adoption of ASC 606 and accordingly did not reevaluate the terms of the agreement.

Agreement with Allergan for VIBERZI

 

In August 2015, the Company and Allergan entered into an agreement for the co‑promotion of VIBERZI in the U.S., Allergan’s treatment for adults suffering from IBS‑D (the “VIBERZI Co‑Promotion Agreement”). Under the terms of the VIBERZI Co‑Promotion Agreement, the Company’s clinical sales specialists detailed VIBERZI to the same health care practitioners to whom they detail LINZESS. Allergan was responsible for all costs and activities relating to the commercialization of VIBERZI outside of the co‑promotion. The Company’s promotional efforts under the non-exclusive co-promotion began when VIBERZI became commercially available in December 2015. The VIBERZI Co-Promotion Agreement was effective through December 31, 2017.

 

Under the terms of the VIBERZI Co Promotion Agreement, the Company’s promotional efforts were compensated based on the volume of calls delivered by the Company’s sales force, with the terms of the agreement reducing or eliminating certain of the unfavorable adjustments to the Company’s share of net profits stipulated by the linaclotide collaboration agreement with Allergan for North America, provided that the Company provided a minimum number of VIBERZI calls on physicians.  The Company provided the minimum number of VIBERZI calls on physicians pursuant to the VIBERZI Co-Promotion Agreement, and was compensated with the elimination of certain of the unfavorable adjustments to the Company’s share of net profits stipulated by the linaclotide collaboration agreement with Allergan for North America for the years ending December 31, 2015, 2016 and 2017. In connection with these co-promotion activities, the net profit share adjustments payable to Allergan under the linaclotide collaboration agreement for North America were reduced by approximately $2.4 million and approximately $5.2 million during the three and nine months ended September 30, 2017, respectively. During the three and nine months ended September 30, 2017, the Company recognized approximately $0.3 million and approximately $1.2 million, respectively, in collaborative arrangements revenue related to the VIBERZI Co‑Promotion Agreement for the performance of medical education services.

 

In December 2017, the Company and Allergan entered into an amendment to the commercial agreement with Allergan (the “VIBERZI Amendment”), as described below, to include the VIBERZI promotional activities through December 31, 2018. Under the terms of the VIBERZI Amendment, the Company’s clinical sales specialists will continue detailing VIBERZI in the second position to the same health care practitioners to whom they detail LINZESS in the first position and provide certain medical education services. The Company has the potential to achieve a milestone payment of up to $7.5 million based on the net sales of VIBERZI during 2018, and will be compensated approximately $3.0 million over the term of the agreement for its medical education initiatives. The Company evaluated the VIBERZI Amendment in accordance with ASC 606 and determined that it would be treated as a separate contract because it adds a distinct good or service at an amount that reflects standalone selling price. The following performance obligations under the VIBERZI Amendment were identified:

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·

sales detailing of VIBERZI in either first or second position, and

·

medical education services

 

The sales-based milestone payment will be recognized as collaborative arrangements revenue when it is probable that a significant reversal of revenue would not occur and the associated constraint has been lifted. As of September 30, 2018, the Company determined the sales-based milestone payment was fully constrained. The consideration related to medical education events of approximately $3.0 million will be recognized over the period of performance that medical education services are provided.  During the three and nine months ended September 30, 2018, the Company recognized approximately $0.8 million and approximately $2.3 million, respectively, of collaborative arrangements revenue related to VIBERZI.

 

Commercial Agreement with Allergan

 

In January 2017, concurrently with entering into the amendment to the European License Agreement, the Company and Allergan entered into an agreement under which the adjustments to the Company’s or Allergan’s share of the net profits under the share adjustment provision of the collaboration agreement for linaclotide in North America relating to the contractually required calls on physicians in each year are eliminated, in full, in 2018 and all subsequent years (the “Commercial Agreement”). Pursuant to the Commercial Agreement, Allergan appointed the Company, on a non-exclusive basis, to promote CANASA, approved for the treatment of ulcerative proctitis, and DELZICOL, approved for the treatment of ulcerative colitis, in the U.S. for approximately two years through February 2019. Under the terms of the Commercial Agreement, the Company is obligated to perform third position sales details and offer samples of such products to gastroenterology prescribers who are on the then-current call panel for LINZESS to which the Company provides first or second position details. The Company purchases samples of CANASA and DELZICOL from Allergan at the actual manufacturing cost. On a product-by-product basis, Allergan pays the Company a royalty in the mid-teens on incremental sales of CANASA and DELZICOL above a mutually agreed upon sales baseline. Additionally, the Company may incur a detailing shortfall penalty if it fails to meet the annual target product detail amount in any calendar year.

 

In December 2017, the Company and Allergan entered into the VIBERZI Amendment to the Commercial Agreement, as described above, to include and extend the VIBERZI promotional activities through December 31, 2018 and discontinue the promotion of DELZICOL effective January 1, 2018. Accordingly, promotional activities for DELZICOL terminated on December 31, 2017 and, subject to the Company’s or Allergan’s rights of early termination, the promotional activities for CANASA will terminate on February 26, 2019. The share adjustment relief will, in the case of Allergan’s termination for convenience and certain other specified circumstances, survive termination of the commercial agreement. Under ASC 605, the Company concluded that the commercial agreement with Allergan, as amended, was not a material modification to the linaclotide collaboration agreement with Allergan for North America.

 

Activities under the Commercial Agreement with Allergan and the Allergan License Agreement were evaluated in accordance with ASC 605-25 upon execution, as the agreements were entered into concurrently, to determine if they represented a multiple element revenue arrangement.

 

The Company identified the following deliverables:

 

·

an exclusive license to develop and commercialize linaclotide in the Allergan License Territory, and

·

sales detailing services for CANASA and DELZICOL.

 

The exclusive license for the Allergan License Territory is nontransferable and has certain sublicense restrictions. The Company determined that Allergan had the internal product development and commercialization capabilities that would enable Allergan to use the license for its intended purposes without the involvement of the Company and, therefore, the license had standalone value. The deliverable for the sales detailing services for CANASA and DELZICOL was deemed to have standalone value based on the nature of the services, and all deliverables met the criteria to be accounted for as separate units of accounting under ASC 605-25. There was no allocable arrangement consideration at the inception of the arrangement, as the consideration is in the form of royalties and the elimination of a contingent liability. During each of the three and nine months ended September 30, 2017, the Company did not recognize royalty revenue related to the Commercial Agreement with Allergan to promote CANASA and DELZICOL.

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Upon adoption of ASC 606, the Company evaluated the commercial agreement and the amendment to the European License Agreement under the contract combination and contract modification guidance in ASC 606. The Company determined that the agreements should be accounted for as separate contracts because each agreement adds distinct goods or services at an amount that reflects standalone selling price. The Company concluded that the CANASA and DELZICOL sales detailing deliverable under ASC 605 was also considered a performance obligation in accordance with ASC 606. Accordingly, the Company records royalties on sales of CANASA and any estimated detailing shortfall penalty over the period of performance for the sales details; collaborative arrangements revenue is recognized when it is probable that a significant reversal of revenue would not occur and the associated constraint has been lifted. The Company estimates sales detailing royalties based on royalty reports from its partner, if available, or the projected sales and historical trends.  At the inception of the arrangement, the consideration associated with the agreement comprised of royalties and a sales detailing shortfall penalty are fully constrained. During each of the three and nine months ended September 30, 2018, the Company did not recognize royalty revenue related to the Commercial Agreement with Allergan for sales of CANASA. As discussed above, the Company’s obligation to perform sales detailing for DELZICOL was eliminated through the VIBERZI Amendment to the Commercial Agreement with Allergan.

 

The VIBERZI Amendment was effective as of January 1, 2018 and evaluated in accordance with ASC 606 as described above.

 

Other Collaboration and License Agreements

 

The Company has other collaboration and license agreements that are not individually significant to its business. Pursuant to the terms of one agreement, the Company was required to pay $7.5 million for development milestones, all of which had been paid as of September 30, 2018. The Company may also be required to pay up to $18.0 million for regulatory milestones, none of which had been paid as of September 30, 2018. The Company recorded approximately $5.0 million in research and development expense associated with the Company’s other collaboration and license agreements during the three and nine months ended September 30, 2018. The Company did not record any research and development expense associated with the Company’s other collaboration and license agreements during the three and nine months ended September 30, 2017. 

 

5. Fair Value of Financial Instruments

 

The tables below present information about the Company’s assets that are measured at fair value on a recurring basis as of September 30, 2018 and December 31, 2017 and indicate the fair value hierarchy of the valuation techniques the Company utilized to determine such fair value. In general, fair values determined by Level 1 inputs utilize observable inputs such as quoted prices in active markets for identical assets or liabilities. Fair values determined by Level 2 inputs utilize data points that are either directly or indirectly observable, such as quoted prices for similar instruments in active markets, interest rates and yield curves. Fair values determined by Level 3 inputs utilize unobservable data points in which there is little or no market data, which require the Company to develop its own assumptions for the asset or liability.

 

The Company’s investment portfolio includes fixed income securities that do not always trade on a daily basis. As a result, the pricing services used by the Company apply other available information as applicable through processes such as benchmark yields, benchmarking of like securities, sector groupings and matrix pricing to prepare valuations. In addition, model processes are used to assess interest rate impact and develop prepayment scenarios. These models take into consideration relevant credit information, perceived market movements, sector news and economic events. The inputs into these models may include benchmark yields, reported trades, broker-dealer quotes, issuer spreads and other relevant data. The Company validates the prices provided by its third-party pricing services by obtaining market values from other pricing sources and analyzing pricing data in certain instances. The Company also invests in certain reverse repurchase agreements which are collateralized by deposits in the form of Government Securities and Obligations for an amount not less than 102% of their principal amount. The Company does not record an asset or liability for the collateral as the Company is not permitted to sell or re-pledge the collateral. The collateral has at least the prevailing credit rating of U.S. Government Treasuries and Agencies. The Company utilizes a third-party custodian to manage the exchange of funds and ensure the collateral received is maintained at 102% of the reverse repurchase agreements principal amount on a daily basis.

 

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Table of Contents

The following tables present the assets and liabilities the Company has measured at fair value on a recurring basis (in thousands):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fair Value Measurements at Reporting Date Using

 

 

    

 

 

  

  

Quoted Prices in

    

Significant Other

    

Significant

 

 

 

 

 

 

 

Active Markets for

 

Observable

 

Unobservable

 

 

 

 

 

 

Identical Assets

 

Inputs

 

Inputs

 

 

 

September 30, 2018

 

 

(Level 1)

 

(Level 2)

 

(Level 3)

 

Assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Money market funds

 

$

116,037

 

 

$

116,037

 

$

 —

 

$

 —

 

Repurchase agreements

 

 

30,000

 

 

 

30,000

 

 

 —

 

 

 —

 

Available-for-sale securities: