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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

For the quarterly period ended September 30, 2018

OR

For the transition period from __________________ to _________________

Commission file number: 001-35902

 

Insys Therapeutics, Inc.

(Exact name of registrant as specified in its charter)

 

 

(480) 500-3127

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

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 Date File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes   ☑  No   ☐

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

 

 

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 October 30, 2018, the registrant had 74,269,661 shares of Common Stock ($0.01 par value) outstanding.

 

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INSYS THERAPEUTICS, INC.

FORM 10-Q

TABLE OF CONTENTS

 

 

 

 

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FORM 10-Q

GLOSSARY OF TERMS

The following glossary provides definitions for certain acronyms and terms used in our periodic filings with the United States Securities and Exchange Commission, including this Quarterly Report on Form 10-Q. These acronyms and terms are specific to our company, commonly used in our industry, or are otherwise frequently used throughout our filings, including this document.

 

 

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PART I:  FINANCIAL INFORMATION

ITEM 1. UNAUDITED FINANCIAL STATEMENTS

INSYS THERAPEUTICS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

 

 

See accompanying notes to unaudited condensed consolidated financial statements. 

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INSYS THERAPEUTICS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(In thousands, except share and per share data)

(unaudited)

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

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INSYS THERAPEUTICS, INC.

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

(In thousands, except share data)

(unaudited)

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

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INSYS THERAPEUTICS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(unaudited)

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

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INSYS THERAPEUTICS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Insys Therapeutics, Inc., which was incorporated in Delaware in June 1990, and our subsidiaries (collectively, “we,” “us,” and “our”) maintain headquarters in Chandler, Arizona.

We are a commercial-stage specialty pharmaceutical company that develops and commercializes innovative supportive care products. As of September 30, 2018, we have two marketed products: SUBSYS®, a proprietary sublingual fentanyl spray for BTCP in opioid-tolerant adult patients; and SYNDROS®, a proprietary, orally administered liquid formulation of dronabinol for the treatment of nausea and vomiting associated with cancer chemotherapy in patients who have failed to respond adequately to conventional antiemetic treatments and anorexia associated with weight loss in patients with AIDS.

The accompanying unaudited condensed consolidated financial statements are unaudited and have been prepared in accordance with U.S. GAAP, pursuant to rules and regulations of the SEC. Certain information and footnote disclosures have been condensed or omitted pursuant to such rules and regulations. In the opinion of management, the accompanying unaudited condensed consolidated financial statements include normal recurring adjustments that are necessary for a fair presentation of the results for the interim periods presented. These unaudited condensed consolidated financial statements should be read in conjunction with our audited consolidated financial statements and notes thereto for the fiscal year ended December 31, 2017, included in our Annual Report on Form 10-K. The results of operations for the three and nine months ended September 30, 2018 and 2017, are not necessarily indicative of results to be expected for the full fiscal year or any other periods.

The preparation of the unaudited condensed consolidated financial statements in conformity with U.S. GAAP requires management to make a number of estimates and judgments that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reported period. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition (which are affected by prescriptions dispensed, wholesaler discounts, patient discount programs, rebates, returns, and chargebacks), inventories, fair value of investments, legal liabilities and settlements, stock-based compensation expense, impairment, uncertain tax positions, and deferred tax valuation allowances. We base our estimates on historical experience and on various other assumptions that are believed by management to be reasonable under the circumstances. Actual results could materially differ from these estimates.

All significant intercompany balances and transactions have been eliminated in the accompanying unaudited condensed consolidated financial statements.

Liquidity

As of September 30, 2018, the Company had an accumulated deficit of $289.8 million as well as negative cash flows from operating activities for the nine months ended September 30, 2018.

While we have no outstanding debt and $113.0 million in cash and cash equivalents and investments as of September 30, 2018, the Company expects its negative cash flows from operating activities to continue.  However, management believes that our existing cash and cash equivalents and investments, together with interest thereon, will be sufficient to sustain operations for at least the next 12 months from the issuance of these unaudited condensed consolidated financial statements. As our research and development activities mature and develop over the next several years, the Company will likely require substantial funds to continue such activities, depending upon events that are difficult to predict at this time.  In addition, as the Company continues to contend with existing litigation (and resolve such proceedings as appropriate) and to fund other legal expenses related to our former employees, we may require additional funding. In this regard, management’s plans, in order to meet any additional operating cash flow requirements, include the pursuit of strategic alternatives related to our opioid-related assets, as well as financing activities such as public offerings and private placements of our common stock, preferred stock offerings, and issuances of debt and convertible debt instruments.

There are no assurances that such additional funding will be obtained and that the Company will succeed in its future operations. If the Company cannot successfully raise additional capital and implement its strategic development plan, its liquidity, financial condition and business prospects will be materially and adversely affected.

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Revision of Previously Issued Financial Statements for Correction of Immaterial Errors

During the three months ended September 30, 2018, we identified an error related to the accounting for uncertain income tax positions in the interim and annual financial statements for the year ended December 31, 2017. We determined that we had incorrectly applied the accounting guidance when implementing Accounting Standards Update (“ASU”) No. 2016-09, “Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” on January 1, 2017 by inadvertently omitting the impact on the unrecognized tax benefit (“UTB”) reserves for state taxes. In addition, we identified errors in the calculation of weighted average shares outstanding, which impacted net loss per share for the three and nine months ended September 30, 2017, and for the year ended December 31, 2017. We assessed the materiality of these errors on our prior annual financial statements, assessing materiality both quantitatively and qualitatively, in accordance with the SEC’s Staff Accounting Bulletin (“SAB”) No. 99 and SAB No. 108 and concluded that the errors were not material to our audited financial statements for the year ended December 31, 2017, the unaudited condensed consolidated financial statements for any of the quarterly periods within the year ended December 31, 2017, nor to the quarterly periods ended March 31, 2018 and June 30, 2018. However, the impact of these errors was material to the accompanying unaudited condensed consolidated financial statements. To correctly present uncertain income tax position liabilities, income tax expense (benefit), and net loss per share in the appropriate periods, management revised its previously issued consolidated balance sheet and statement of stockholders’ equity as of December 31, 2017, the consolidated statement of operations and comprehensive loss for the year ended December 31, 2017, the unaudited condensed consolidated statements of operations and comprehensive loss for the three and nine months ended September 30, 2017, and the unaudited condensed consolidated statements of cash flows for the nine months ended September 30, 2017. Certain amounts in prior periods as previously reported have been reclassified to conform to the current period presentation.

The following tables summarize the impact and financial statement line items impacted by the revision adjustments (in thousands, except per share data):

 

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Recently Adopted Accounting Pronouncements

 

    Effective January 1, 2018, we adopted the requirements of ASU No. 2014-09, “Revenue from Contracts with Customers (ASC Topic 606),” and all the related amendments (“new revenue standard”). The new revenue standard aims to achieve a consistent application of revenue recognition within the United States, resulting in a single revenue model to be applied by reporting companies under U.S. GAAP. Under the new model, recognition of revenue occurs when a customer

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obtains control of promised goods or services in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, the new revenue standard requires that reporting companies disclose the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. We used the modified retrospective transition method for all contracts that were not completed as of the adoption date. In addition, we have applied the practical expedient to contract modifications, as allowed by the SEC, but did not have any material contract modifications to be included in the initial adoption of ASC Topic 606. The comparative information for 2017 presented below has not been restated and continues to be reported under ASC Topic 605, “Revenue Recognition.” We recognize revenue when we transfer control of our products to our customers, as our contracts have a single performance obligation (delivery of our product to their preferred location). Our sales revenue from SUBSYS® continues to be recognized when product is delivered to wholesale pharmaceutical distributors and specialty retail pharmacies (collectively, our customers). In accordance with the new revenue standard, our sales revenue from SYNDROS® is now recognized when product is delivered to our customers, where revenue was previously deferred until the right of return no longer existed, which occurred at the earlier of the time SYNDROS® units were sold to health care facilities or dispensed through patient prescriptions, or the expiration of the right of return. It is common for our contracts to include product sales allowances (including returns, discounts and rebates) that can decrease the transaction price and are therefore considered to be variable consideration. In accordance with the new revenue standard, we estimate the amount of variable consideration promised in the contract using the expected value (probability weighted estimate) method. We do not have any significant extended payment terms as payment is received shortly after the point of sale. See Note 2, Revenue Recognition, for additional discussion of our revenue recognition policy and variable consideration estimates.  The impact of adopting the new revenue standard on our unaudited condensed consolidated financial statements is shown in the tables below.

The cumulative effect of the changes made to our January 1, 2018 unaudited condensed consolidated balance sheet for the adoption of the new revenue standard was as follows (in thousands):

 

 

The impact of adopting the new revenue standard on our unaudited condensed consolidated statements of operations and comprehensive loss was as follows (in thousands):

 

 

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The impact of adopting the new revenue standard on our unaudited condensed consolidated balance sheets, excluding the cumulative effect of adoption on January 1, 2018 disclosed previously, was as follows (in thousands):

 

 

Effective January 1, 2018, we adopted ASU No. 2016-01, “Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities,” and ASU No. 2018-03, “Technical Corrections and Improvements to Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” These standards amended the Financial Instruments topic of the ASC to address certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. The standard requires that unrealized gains and losses on investments in equity securities to be recognized in net income (loss). The adoption of this guidance did not have a material impact on our unaudited condensed consolidated financial statements.

Effective January 1, 2018, we adopted ASU No. 2016-15, “Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments.” The guidance clarifies how certain cash flow transactions are classified in the statement of cash flows. The adoption of this guidance did not have a material impact on our unaudited condensed consolidated financial statements.

Effective January 1, 2018, we adopted ASU No. 2016-16, “Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory.” Prior to January 1, 2018, U. S. GAAP prohibited the recognition of current and deferred income taxes for an intra-entity asset transfer until the asset was sold to an outside party, which was an exception to the principle of comprehensive recognition of current and deferred income taxes in U. S. GAAP. This guidance eliminates the exception for an intra-entity transfer of an asset other than inventory. The adoption of this guidance did not have a material impact on our unaudited condensed consolidated financial statements.

Effective January 1, 2018, we adopted ASU No. 2017-09, “Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting.” The ASU requires modification accounting to a share-based payment award unless all of the following are the same immediately before and after the change: the award’s fair value; the award’s vesting conditions; and the award’s classification as an equity instrument or a liability instrument. The adoption of this guidance did not have a material impact on our unaudited condensed consolidated financial statements.

Effective January 1, 2018, we adopted ASU No. 2018-05, “Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 (SEC Update).” The standard addresses any uncertainty or diversity of views in practice regarding the application of ASC Topic 740 in situations where a registrant did not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting under ASC Topic 740 for certain income tax effects of the 2017 Tax Cuts and Jobs Act (the “Act”) for the reporting period in which the Act was enacted. The Company recognized the provisional tax impacts of the Act in the fourth quarter of 2017. The Company completed its analysis of the Act, in conjunction with the completion of the Company's tax returns for 2017, and recorded a $0.7 million reduction of tax expense.

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In June 2018, the FASB issued ASU No. 2018-07, “Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting.”  The standard expands the scope of ASC Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees, and supersedes ASC Topic 505-50, “Equity – Equity Based Payments to Non-Employees.”  Previously, the fair value of share-based payment awards to nonemployees was determined by the measurement date, which was the earlier of the date at which a commitment for performance by the counterparty is reached or the date at which the counterparty’s performance is complete.  This concept caused significant differences in the accounting for share-based payment to nonemployees as compared to share-based payments to employees. Furthermore, the previous guidance required employers to revalue share-based payments to nonemployees at each reporting period if a measurement date could not be established, causing fluctuations in the resulting expense from period to period. The new standard eliminates the measurement date concept and requires the fair value of share-based payments to nonemployees to be measured on the grant date, consistent with share-based payments to employees.  We early adopted the standard during the three months ended June 30, 2018.  We remeasured the fair value of our equity-classified share-based payments to nonemployees for which a measurement date had not been established as of the adoption date of January 1, 2018.  Because we had previously remeasured our share-based payments to nonemployees at each reporting period, the adoption did not result in a cumulative effect adjustment to opening retained earnings.

Recent Accounting Pronouncements

In August 2018, the FASB issued ASU No. 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement,” to improve the effectiveness of disclosures. The amendments remove, modify, and add certain disclosure requirements in Topic 820, “Fair Value Measurement.” The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. The amendments are effective for fiscal years beginning after December 15, 2019. Early adoption is permitted, including adoption in an interim period. Furthermore, an entity is permitted to early adopt any removed or modified disclosures upon issuance of the update and delay adoption of the additional disclosures until their effective date.  We do not expect this amendment to have a material impact on our consolidated financial statements.

 

In March 2017, the FASB issued ASU No. 2017-08, “Receivables—Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities,” to amend the amortization period for certain purchased callable debt securities held at a premium. The ASU shortens the amortization period for the premium to the earliest call date. Under current U.S. GAAP, entities generally amortize the premium as an adjustment of yield over the contractual life of the instrument. The amendments should be applied on a modified retrospective basis and are effective for fiscal years beginning after December 15, 2018. Early adoption is permitted, including adoption in an interim period. We are currently evaluating the impact of this amendment on our consolidated financial statements.

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments effected by this ASU affect entities holding financial assets and net investment in leases that are not accounted for at fair value through net income and are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, and early adoption is permitted. ASU 2016-13 amends the impairment model to utilize an expected loss methodology in place of the currently used incurred loss methodology, which will result in the timelier recognition of losses. We do not expect this amendment to have a material impact on our consolidated financial statements.

In February 2016, the FASB issued ASU No. 2016-02, “Leases: (Topic 842),” to provide guidance on recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements, specifically differentiating between different types of leases. The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from all leases. The recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee have not significantly changed from previous U.S. GAAP guidance. There continues to be a differentiation between finance leases and operating leases. However, the principal difference from previous guidance is that the lease assets and lease liabilities arising from operating leases should be recognized in the balance sheet. The accounting applied by a lessor is largely unchanged from that applied under previous U.S. GAAP guidance. The amendments will be effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, and early adoption is permitted. Originally, entities were required to adopt ASU 2016-02 using a modified retrospective approach. In July 2018, the FASB issued ASU No. 2018-11“Leases: (Topic 842): Targeted Improvements,” which provides entities with an additional optional transition method of recognizing the cumulative effect of applying the new standard as an adjustment to beginning retained

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earnings in the year of adoption while continuing to present all prior periods under previous lease accounting guidance. In July 2018, the FASB also issued ASU No. 2018-10, “Codification Improvements to Topic 842, Leases,” which clarifies how to apply certain aspects of ASU 2016-02. We expect to adopt ASU 2018-10 and ASU 2018-11 on January 1, 2019, concurrent with the adoption of ASU 2016-02. We currently expect that most of our operating lease commitments will be subject to the update and recognized as right-of-use assets and operating lease liabilities upon adoption. We expect the standard to have a material impact on our assets and liabilities for the addition of right-of-use assets and lease liabilities, but we do not expect it to have a material impact to our results of operations or liquidity.

SUBSYS® was commercially launched in March 2012 and is monitored by an FDA-mandated REMS program known as the TIRF REMS. SYNDROS® was commercially launched in July 2017. We sell all of our products in the United States to our customers.  See Note 10, Product Lines, Concentration of Credit Risk and Significant Customers, for information on revenues disaggregated by product line and route to market.

To determine revenue recognition for contractual arrangements that we determine are within the scope of ASC Topic 606, we perform the following five steps: (i) identify each contract with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to our performance obligations in the contract; and (v) recognize revenue when (or as) we satisfy the relevant performance obligation. We only apply the five-step model to contracts when it is probable that we will collect the consideration we are entitled to in exchange for the goods we transfer to the customer. We recognize revenue from the sale of our commercially approved products, SUBSYS® and SYNDROS®, when we transfer control of our products to our customers, as our contracts have a single performance obligation (delivery of our product to their preferred location). Revenue is measured as the amount of consideration we expect to receive in exchange for transferring goods. Any shipping and handling activities that we perform, whether before or after a customer has obtained control of the products, are considered activities to fulfill our obligation to transfer the products, and are recorded as incurred within sales and marketing expenses.  We offer the following discounts to our customers:

Wholesaler and Retailer Discounts. We offer discounts to certain wholesale distributors and specialty retailers based on contractually determined rates. We record receivables due from the wholesalers and retailers net of these discounts upon shipment to the respective wholesale distributors and retail pharmacies.

Prompt Pay Discounts. We offer cash discounts to our customers, generally 2% of the sales price, as an incentive for prompt payment. We record receivables net of these cash discounts.

Stocking Allowances. We may offer discounts and extended payment terms, generally in the month of the initial commercial launch of a new product and on the first order made by certain wholesale distributors and retail pharmacies based on contractually determined rates. We record receivables due from the wholesalers and retailers net of these discounts upon shipment to the respective wholesale distributors and retail pharmacies. The extended payment terms are not greater than 12 months and therefore do not include a financing component.

As is customary in the pharmaceutical industry, it is common for our contracts to include product sales allowances that can decrease the transaction price and are therefore considered to be variable consideration. Product sales allowances, which include product returns, patient discount programs, rebates and chargebacks, are variable consideration and are based on amounts owed or to be claimed on the related sales. We estimate variable consideration when determining the transaction price using the expected value method. We assess whether variable consideration is constrained and only include estimated amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. Our estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on historical data, and take into consideration the terms of our agreements with customers and third-party payers and the levels of inventory within the distribution channels that may result in future discounts taken. In certain cases, such as patient assistance programs, our estimates are based on estimated utilization. If actual future results vary, we may need to adjust these estimates, which could have an effect on revenue in the period of adjustment. Our product sales allowances include:

Product Returns. We allow customers to return product for credit beginning six months prior to, and ending 12 months following, the product expiration date. SUBSYS® currently has a shelf life of 36 or 48 months from the date of manufacture, depending on the manufacture date, and SYNDROS® currently has a shelf life of 24 or 36 months from the date of manufacture, depending on the manufacture date. We have monitored actual return history since product launch, which provides us with a basis to reasonably estimate future product returns, taking into consideration the shelf life of product at the

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time of shipment, shipment and prescription trends, estimated distribution channel inventory levels and consideration of the introduction of competitive products.

Because of the shelf life of our products and our return policy of issuing credits on returned product that is within six months before, and up to 12 months following, the product expiration date, there may be a significant period of time between when the product is shipped and when we issue credits on returned products. Accordingly, we may have to adjust these estimates, which could have a material effect on net revenue and earnings in the period of adjustment. The allowance for product returns is included in accrued sales allowances. 

Patient Discount Programs. We offer discount card programs to patients, in which patients receive discounts on their prescriptions that are reimbursed by us to the retailer. We estimate the total amount that will be redeemed based on a percentage of actual redemptions applied to inventory in the distribution and retail channels. The allowance for patient discount programs is included in accrued sales allowances.

Rebates. We participate in certain rebate programs, which provide discounted prescriptions to qualified insured patients. Under these rebate programs, we pay a rebate to the third-party administrator of the program, generally two to three months after the quarter in which prescriptions subject to the rebate are filled. We estimate and accrue these rebates based on current and estimated future contract prices, historical and estimated future percentages of products prescribed to qualified patients and estimated levels of inventory in the distribution channel. The allowance for rebates is included in accrued sales allowances. 

Chargebacks. We provide discounts primarily to authorized users of the FSS of the General Services Administration under an FSS contract negotiated by the Department of Veterans Affairs and various organizations under Medicaid contracts and regulations. These organizations purchase products from the wholesale distributors at a discounted price, and the wholesale distributors then charge back to us the difference between the current retail price and the price the organization paid for the product. We estimate chargebacks based on estimated wholesaler inventory levels, current contract and estimated future prices and historical chargeback activity.

As of September 30, 2018, the majority of our accounts receivables were related to product sales. For the three and nine months ended September 30, 2018, the Company had no material bad-debt expense and there were no contract assets, contract liabilities or deferred contract costs recorded on the unaudited condensed consolidated balance sheets as of September 30, 2018.   

Our policy for short-term and long-term investments is to establish a high-quality portfolio that preserves principal, meets liquidity needs, avoids inappropriate concentrations, and delivers an appropriate yield in relationship to our investment guidelines and market conditions. Short-term and long-term investments consist of corporate and various government agency and municipal debt securities, commercial paper, as well as certificates of deposit that have maturity dates that are greater than 90 days. Certificates of deposit and commercial paper are carried at cost, which approximates fair value. We classify our marketable securities as available-for-sale in accordance with FASB ASC Topic 320, “Investments — Debt and Equity Securities.” Investments in debt securities that are classified as available-for-sale are carried at fair value with unrealized gains and losses reported in stockholders’ equity, net of related tax effects. There were no reclassifications on available-for-sale securities during the three and nine months ended September 30, 2018 and 2017. A decline in the market value of any available-for-sale security below cost that is deemed to be other than temporary results in impairment of the fair value of the investment. If we had unrealized gains and losses and declines in value judged to be other than temporary, we would have been required to include those changes in other income (expense) in the unaudited condensed consolidated statements of operations and comprehensive loss. Premiums and discounts are amortized or accreted over the life of the related available-for-sale security. The cost of securities sold is calculated using the specific identification method. At September 30, 2018, our certificates of deposit and commercial paper as well as our marketable securities have been recorded at an estimated fair value of $1,998,000, $79,719,000, and $12,451,000 in cash and cash equivalents, short-term and long-term investments, respectively. 

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Cash, cash equivalents and investments consisted of the following at September 30, 2018 (in thousands):

 

 

Cash, cash equivalents and investments consisted of the following at December 31, 2017 (in thousands):

 

 

The amortized cost and estimated fair value of the marketable securities by maturity, are shown below (in thousands):

 

 

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The following table shows the gross unrealized losses and the fair value of our investments, with unrealized losses that are not deemed to be other-than-temporarily impaired aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position (in thousands):

 

 

Marketable securities are reviewed quarterly for possible other than temporary impairment. This review includes an analysis of the facts and circumstances of each individual investment such as the severity of loss, the expectation for that security’s performance and the creditworthiness of the issuer. We did not have any unrealized gains or losses or decline in values judged to be other than temporary during the three and nine months ended September 30, 2018 and 2017.  

 

FASB ASC Topic 820, Fair Value Measurement, defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. It also establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

At September 30, 2018 and December 31, 2017, we held short-term and long-term investments, as discussed in Note 3, Short-Term and Long-Term Investments, that are required to be measured at fair value on a recurring basis. Except as discussed in Note 6, Property and Equipment, Net, we had no assets or liabilities measured at fair value on a nonrecurring basis at September 30, 2018 and December 31, 2017. Substantially all available-for-sale investments held by us at September 30, 2018 and December 31, 2017, have been valued based on Level 2 inputs. Available-for-sale securities classified within Level 2 of the fair value hierarchy are valued utilizing reports from an independent third-party public quotation service based on closing prices on the last business day of the period presented. In addition, we use the public quotation service to perform price testing by comparing quoted prices listed in reports provided by the asset managers that hold our investments to quotes listed through the public quotation service. These asset managers utilize an independent pricing source to obtain quotes for most fixed income securities and utilize internal procedures to validate the prices obtained. Our Level 3 asset represents an investment in convertible preferred stock that is not listed on any security exchange. The fair value of the preferred stock approximates its carrying value at September 30, 2018 and December 31, 2017.  

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Our assets and liabilities subject to the disclosure requirements of ASC Topic 820 at September 30, 2018, were as follows (in thousands):

 

 

Our assets and liabilities subject to the disclosure requirements of ASC Topic 820 at December 31, 2017, were as follows (in thousands):

 

 

The following table presents additional information about assets measured at fair value on a recurring basis and for which we utilize Level 3 inputs to determine fair value for the three and nine months ended September 30, 2018 and 2017 (in thousands):

 

 

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Inventories are stated at lower of cost or NRV. Cost, which includes amounts related to materials and costs incurred by our contract manufacturers, is determined on a first-in, first-out basis. Inventories are reviewed periodically for potential excess, dated or obsolete status. Management evaluates the carrying value of inventories on a regular basis, taking into account such factors as historical and anticipated future sales compared to quantities on hand, the price we expect to obtain for products in their respective markets compared with historical cost and the remaining shelf life of goods on hand.

The components of inventories, net of allowances, are as follows (in thousands):

 

 

As of September 30, 2018 and December 31, 2017, raw materials inventories consisted of raw materials used in the manufacture of the dronabinol API for SYNDROS® in our U.S.-based, state-of-the-art dronabinol manufacturing facility, the fentanyl API for SUBSYS®, and component parts and packaging materials used in the manufacture of both SUBSYS® and SYNDROS®. Work-in-process consisted of actual production costs, including facility overhead and tooling costs of in-process dronabinol, SUBSYS® and SYNDROS® products. Finished goods inventories consisted of finished SUBSYS® and SYNDROS® products and deferred SYNDROS® cost of revenue of $0 and $59,000 as of September 30, 2018 and December 31, 2017, respectively. There was no deferred SYNDROS® cost of revenue as of September 30, 2018, due to the adoption of ASC Topic 606 on January 1, 2018. Non-current raw materials and finished goods represent those inventories not expected to be consumed or sold within 12 months of the balance sheet date and are included in other assets in our unaudited condensed consolidated balance sheets. As of September 30, 2018 and December 31, 2017, all work-in-process inventory is expected to be used within 12 months of the balance sheet date and, therefore, is classified as current assets in our unaudited condensed consolidated balance sheets. We maintain an allowance for excess and obsolete inventory, as well as inventory where its cost is in excess of its NRV. Inventories at September 30, 2018 and December 31, 2017, were reported net of these reserves of $2,631,000 and $13,664,000, respectively. During the three and nine months ended September 30, 2018, we decreased these reserves by approximately $7,463,000 and $12,531,000, respectively, for the destruction of previously reserved product, partially offset by an increase to the reserves of approximately $495,000 and $1,498,000, respectively. During the three and nine months ended September 30, 2017, we increased these reserves by approximately $3,372,000 and $6,331,000, respectively.

Property and equipment are recorded at cost and depreciated using the straight-line method over their estimated useful lives; leasehold improvements are recorded at cost and depreciated using the straight-line method over the shorter of their estimated useful lives or remaining lease term. Maintenance and repairs that do not extend the life of assets are charged to expense when incurred. When property and equipment is disposed of, the related costs and accumulated depreciation are removed from the unaudited condensed consolidated balance sheets, and any gain or loss is reported in other income (expense) in the period the transaction takes place.  During the three and nine months ended September 30, 2018, we recorded losses on the disposal of property and equipment of $0 and $108,000, respectively.  There were no such charges during the three and nine months ended September 30, 2017.

Property and equipment are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted cash flows expected to be generated by the asset. If the carrying amount exceeds its estimated future undiscounted cash flows, an impairment charge is recognized by the amount by which the carrying amount exceeds the fair value of the asset.  The fair value is measured on a nonrecurring basis using unobservable (Level 3) inputs.  Impairment charges are reported in the period the impairment is identified.  During the three and nine months ended September 30, 2018, we recorded impairment charges in research and development of $0 and $1,487,000, respectively.  The charge during the nine months ended September 30, 2018 was the result of a decision to abandon a partially constructed device manufacturing machine with a cost of $1,487,000 and no associated depreciation, and was written down to its fair value of $0. There were no such charges during the three and nine months ended September 30, 2017.

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Legal Matters

Other than the matters that we have disclosed below, we from time to time become involved in various ordinary course legal and administrative proceedings, which include intellectual property, commercial, governmental and regulatory investigations, employee-related issues and private litigation, which we do not currently believe are either individually or collectively material.

We record accruals for contingencies when it is probable that a liability has been incurred and the amount can be reasonably estimated. These accruals are adjusted periodically as assessments change or additional information becomes available. If the reasonable estimate of a probable loss is a range, and no amount within the range is a better estimate, the minimum amount in the range is accrued. If a loss is not probable or a probable loss cannot be reasonably estimated, no liability is recorded. We have established reserves for certain of our legal matters. Our loss estimates are generally developed in consultation with outside counsel and outside accounting experts and are based on analyses of potential outcomes. As legal and governmental proceedings, disputes and investigations are inherently unpredictable and in part, beyond our control, unless otherwise indicated, we cannot reasonably predict the outcome of these legal proceedings, nor can we estimate the amount of loss, or range of loss, if any, that may result from these proceedings. While our liability in connection with certain claims cannot be currently estimated, the resolution in any reporting period of one or more of these matters could have a significant impact on our consolidated financial condition, results of operations, liquidity, and cash flows for that future period, and could ultimately have a material adverse effect on our consolidated financial position and could cause the market value of our common shares to decline. While we believe we have valid defenses in these matters, litigation and governmental and regulatory investigations are inherently uncertain, and we may in the future incur material judgments or enter into material settlements of claims.

Consistent with the practice of many publicly-traded companies, we have entered into, and continue to enter into, indemnity agreements with our executive officers and certain members of our board of directors.  These indemnity agreements broadly provide for us to advance expenses (including attorneys’ fees) incurred in connection with any legal proceeding, as well as indemnification for any and all expenses, actually and reasonably incurred, in connection with the investigation, defense, settlement or appeal of such a proceeding, in connection with matters related to their position. These indemnity agreements provide that the indemnitee shall repay all amounts so advanced if it shall ultimately be determined by final judicial decision from where there is no further right of appeal that the indemnitee is not entitled to be indemnified.

Government Proceedings

Like other companies in the pharmaceutical industry, we are subject to extensive regulation by national, state and local government agencies in the United States. As a result, interaction with government agencies occurs in the normal course of our operations. The following is a brief description of pending governmental investigations that we believe are potentially or actually material at this time. It is possible that criminal charges and substantial payments, fines and/or civil penalties or damages or exclusion from federal health care programs or other administrative actions, as well as a corporate integrity agreement, deferred prosecution or deferred exclusion agreement, or similar government mandated compliance document that institutes significant restrictions or obligations, could result for us from any government investigation or proceeding. In addition, even certain investigations that are not discussed below and which we do not deem to be material at this time could be determined to be material and could have a material adverse effect on our financial condition, results of operations and cash flows.

HHS Investigation. We received a subpoena, dated December 9, 2013, from the OIG in connection with an investigation of potential violations involving HHS programs. This subpoena was issued in connection with an investigation by the U.S. Attorney’s Office for the Central District of California and requested documents regarding our business, including the commercialization of SUBSYS®. We continue to cooperate with this investigation and have produced substantial documents in response to the subpoena and have provided other requested information.

On April 13, 2018, the United States intervened in part and declined to intervene in part in five lawsuits: United States ex rel. Guzman v. Insys Therapeutics, Inc. (CV 13-5861 JLS (AJWx)), United States ex rel Doe v. Insys Therapeutics, Inc. (CV 14-3488 JLS (AJWx)), United States ex rel. Andersson v. Insys Therapeutics, Inc. (CV 14-9179 JLS (AJWx), United States ex rel. Erickson v. Insys Therapeutics, Inc. (CV 16-2956 JLS (AJWx), and United States ex rel. Doe v. Insys Therapeutics, Inc. (CV 16-7937 JLS (AJWx)).  Qui tam lawsuits typically remain under seal (hence, usually unknown to the defendant) for some time while the government decides whether or not to intervene on behalf of a private qui tam plaintiff (known as a relator) and take the lead in the litigation. These lawsuits can involve significant monetary damages and penalties and award bounties to private plaintiffs who successfully bring the suits.

The States of California, Colorado, Indiana, Minnesota, New York, North Carolina, and Virginia (the “Plaintiff States”) elected to intervene in part and declined to intervene in part in United States ex rel. Guzman v. Insys Therapeutics, Inc. (CV 13-5861 JLS (AJWx)) and United States ex rel. Doe v. Insys Therapeutics, Inc. (CV 16-7937 JLS (AJWx)).  The States of

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Connecticut, Delaware, District of Columbia, Florida, Georgia, Illinois, Iowa, Louisiana, Maryland, Massachusetts, Michigan, Montana, Nevada, New Hampshire, New Jersey, New Mexico, Oklahoma, Rhode Island, Tennessee, Texas, Vermont, and Washington declined to intervene.  

The United States’ Complaint in Intervention, which was ordered unsealed on May 11, 2018, brings claims for False Claims Act: Presentation of False Claims pursuant to 31 U.S.C. § 3729(a)(1)(A), False Claims Act: Using False Statements to Get False Claims Paid pursuant to 31 U.S.C. § 3729(a)(1)(B), Payment by Mistake, and Unjust Enrichment. This case is currently stayed, and we continue to have ongoing discussion with respect to the DOJ Investigation (as discussed below).  The qui tam plaintiffs may pursue the claims in which either the United States or the above-mentioned states declined to intervene.

HIPAA Investigation. On September 8, 2014, we received a subpoena issued pursuant to HIPAA from the U.S. Attorney’s Office for the District of Massachusetts. The subpoena requested documents regarding SUBSYS®, including our sales and marketing practices related to this product. This investigation also relates to activities in our patient services hub. We continue to cooperate with this investigation and have produced a substantial number of documents in response to the subpoena and have provided other requested information.

DOJ Investigation and Agreement in Principle. We collectively refer to the HHS and HIPAA investigations discussed above as the “DOJ Investigation.” In connection with our cooperation, we have been engaged in discussions with the DOJ about these matters, including a resolution of potential liability exposure.

Management accrued, as of September 30, 2017, an aggregate of $150,000,000, which represented our best estimate of the minimum liability exposure that we expected to be paid out over five years in connection with the DOJ Investigation. This estimate reflected a minimum exposure at which management had determined a willingness to settle these matters. The accrual was recorded in accrued litigation award and settlements on our unaudited condensed consolidated balance sheets and as an operating expense on our unaudited condensed consolidated statements of operations and comprehensive loss.

On August 8, 2018, we announced that we reached an agreement in principle with the DOJ to settle the DOJ’s civil and criminal investigation into inappropriate sales and commercial practices by some former company employees.  Our initial estimate of the minimum liability exposure we previously accrued in connection with the DOJ Investigation of $150,000,000 expected to be paid over five years remains unchanged as of September 30, 2018, with the potential for contingency-based payments associated with certain events that, if they were to occur, management estimates would require additional payments ranging from $0 to $75,000,000. This agreement in principle is subject to the negotiation of final settlement documents with the government. We expect that a final settlement would include other material non-financial terms and conditions which will also be subject to negotiation, including criminal pleas by our subsidiary related to the actions of our former employees. Once executed, these agreements will require cooperation with the federal government’s prosecutions, enhancements to our compliance program, fulfillment of reporting and monitoring obligations, and management certifications, among other requirements.  In addition, compliance with the terms of these agreements will impose additional costs and burdens on us, including in the form of employee training, third party reviews, compliance monitoring, reporting obligations and management attention. More importantly, if we fail to comply with the final agreement with DOJ and OIG, the DOJ or OIG may impose substantial monetary penalties or exclude us from federal healthcare programs, including Medicare, Medicaid or the VA, which would have a material adverse effect on our business, financial condition and results of operations.  

Because other material, non-financial terms and conditions remain subject to the negotiation of final settlement documents, we cannot provide assurances as to the timing of the execution of final documentation and, like any pending negotiation, there is uncertainty as to the outcome.  Moreover, any such final settlement is likely to involve entry into final agreements, which will impose significant costs and burdens and obligations on our business operations and could materially and adversely affect our results of operations and financial conditions as we implement and adhere to such requirements.

At this time, the aforementioned accrual does not currently meet the more likely than not standard for tax deductibility; therefore, we have recognized no tax benefit for it in these unaudited condensed consolidated financial statements. It is possible that some or all of this accrual may meet the more likely than not standard in the future, at which time the benefit would be recognized.

SEC Investigation. On January 11, 2018, the SEC's Los Angeles Regional office requested that the Company voluntarily provide information on the Company's: (1) restatement of the Company’s interim unaudited condensed consolidated financial statements as of and for the quarters ended September 30, June 30, and March 31, 2016 and 2015, filed on April 7, 2017; (2) sales and marketing practices; and (3) compliance program, internal controls and enhancements thereto. The Company provided such information and cooperated with the SEC's investigation, including responding to requests or demands for documents and other information. On October 4, 2018, the SEC notified the Company in writing that it had concluded its

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investigation and, based on information as of the date of the notification, it does not intend to recommend an SEC enforcement action against the Company.

Health Care Professionals and Former Employees Related Investigations.

Investigations of Health Care Professionals. A number of health care practitioners who formerly interacted with our company are under investigation or have been charged in criminal proceedings. In addition to the below investigations that are specifically directed at us, we have received governmental agency requests for information, including subpoenas, from at least the following governmental bodies: the USAO and/or HHS OIG of California (Los Angeles), Central District of California, Colorado, Connecticut, Eastern District of Michigan, Eastern District of New York, Florida (Jacksonville), Kansas, Middle District of Florida, Middle District of Pennsylvania, New Hampshire, New Jersey, Northern District of California, Northern District of Texas, Rhode Island, Southern District of Alabama, Southern District of New York, Southern District of Ohio, Western District of New York, and the states of Arizona, Delaware, Maryland and New York, regarding specific health care professionals with which we have interacted with in those states. In addition, at least the following health care practitioners formerly interacting with our company have been charged as follows:

On or about June 23, 2015, a nurse practitioner located in Connecticut, who served on our speaker bureau in connection with our speaker programs designed to educate and promote product awareness and safety for external health care providers, pled guilty to violating the federal Anti-Kickback Statute in connection with payments of approximately $83,000 from us. 

On or about November 7, 2016, a health care professional located in Michigan who served on our speaker bureau pled guilty to healthcare fraud in connection, in part, with receiving payments from us.

On February 23, 2017, two Alabama health care professionals who served on our speaker bureau were convicted on 19 of 20 counts brought against them, which included charges related to distribution of a controlled substance, drug conspiracy, health care fraud conspiracy and money laundering.

On or about March 22, 2017, the U.S. Attorney’s Office for the District of New Hampshire filed an indictment against a physician assistant, who served on our speaker bureau, charging him with violating the federal Anti-Kickback Statute and conspiring to violate the federal Anti-Kickback Statute in connection with payments received for serving as an Insys promotional speaker. The physician assistant pled not guilty.

On or about October 20, 2017, a health care professional in Rhode Island, who served on our speaker bureau pled guilty to health care fraud and conspiracy to receive kickbacks in connection with payments of approximately $188,000 from us.

On or about March 14, 2018, the U.S. Attorney’s Office for the Southern District of New York filed an indictment against five health care professionals who served on our speaker bureau, charging them with conspiracy to violate the federal Anti-Kickback Statute, violation of the federal Anti-Kickback Statute, and conspiracy to commit honest services fraud, and charged certain of them with aggravated identity theft, false statements, and wrongful disclosure of individually identifiable health information.

On or about June 4, 2018, a Florida health care professional who served on our speaker bureau pled guilty to conspiracy to receive healthcare kickbacks in connection, in part, with receiving payments from us.

On or about June 28, 2018, an Ohio health care professional who served on our speaker bureau was indicted for violating the federal Anti-Kickback Statute in connection with receiving payments of more than $103,000 from us.

Investigations of Former Employees. A number of our former employees have been charged in criminal proceedings related to our federal investigations and the following is certain information related thereto.

On or about February 18, 2016, one of our former sales employees located in Alabama pled guilty to a conspiracy to violate the federal Anti-Kickback Statute in connection with two convicted Alabama health care professionals mentioned above. On or about April 23, 2018, the former sales employee was sentenced to six months’ home confinement.

On or about June 8, 2016, a former district sales manager in New York and a former sales representative in New Jersey were charged in a federal court in Manhattan, New York, with violating the federal Anti-Kickback Statute in connection with interacting with health care professionals who prescribed our product and served on our speaker bureau. On June 1, 2017, the former district sales manager was charged in a superseding indictment with additional charges of honest services wire fraud and aggravated identity theft in connection with falsifying sign-in sheets for our speaker programs. On or about March 16, 2018,

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records were unsealed indicating that the two former employees each pled guilty to the following counts contained in a superseding indictment: conspiracy to violate the Anti-Kickback Statue, violation of the Anti-Kickback Statue, violation of HIPAA, conspiracy to commit honest services wire fraud, and aggravated identity theft, and that the former sales representative also pled guilty to health care fraud.

On or about December 8, 2016, the U.S. Attorney’s Office for the District of Massachusetts issued an indictment against six former employees, including Michael L. Babich, our former President, CEO and director, on charges including racketeering conspiracy, conspiracy to commit mail fraud, conspiracy to commit wire fraud, conspiracy to violate the Anti-Kickback Statute and forfeiture (the “Original Indictment”).  On or about October 26, 2017, the U.S. Attorney’s Office for the District of Massachusetts issued a superseding indictment in connection with the Original Indictment and added charges against our former President, CEO and director, Dr. John N. Kapoor. After Dr. Kapoor’s indictment, he agreed to put his ownership of our common stock in a trust to be controlled independently, which was effective as of February 27, 2018.  The related voting trust agreement was filed with the SEC on a Current Report on Form 8-K on March 1, 2018. On September 11, 2018, the U.S. Attorney’s Office for the District of Massachusetts filed a second superseding indictment which contained one count of racketeering conspiracy for all the defendants.  This superseding indictment includes a request for forfeiture upon conviction of any interest or property acquired or maintained in violation of such charges, which expressly includes any and all shares of the Company’s common stock or options to purchase such stock, salaries, bonuses and other benefits.

As prescribed by the indemnity agreements we entered into with these former executives, we are responsible for any and all expenses, actually and reasonably incurred. We have recognized expenses associated with criminal and civil defense of Dr. Kapoor of approximately $8,500,000 and $19,500,000, respectively for the three and nine months ended September 30, 2018.  The Company is disputing the reasonableness of a portion of these expenses as they relate to the criminal defense and is analyzing the reasonableness of the civil defense expenses. We continue to accrue all of these costs in our unaudited condensed consolidated statements of operations and comprehensive loss.  As of September 30, 2018, the company has made cash payments of $5,600,000 related to these legal expenses incurred as part of Dr. Kapoor’s criminal defense.  If such disputed amounts are subsequently determined not to be due and payable, we would recognize a reversal of these expenses in a future period.  The reversal of these expenses could have a material impact on our unaudited condensed consolidated statements of operations and comprehensive loss.  If it is subsequently determined that all of these costs are reasonable, and the company is forced to pay the remaining balance, this could have a material adverse impact on our cash position and liquidity.

On or about February 8, 2017, a former district sales manager in the Northeast was charged in federal court in New Haven, Connecticut, with violating the federal Anti-Kickback Statute in connection with interacting with health care professionals who prescribed our product and served on our speaker bureau.

On April 5, 2017, the U.S. Attorney’s Office for the District of Massachusetts filed an information charging a former prior authorization specialist and manager of our patient services hub with one count of wire fraud conspiracy; the former employee pled guilty to that information on June 19, 2017.

On or about July 11, 2017, a former district sales manager pled guilty to conspiring to violate the federal Anti-Kickback Statute related to her activities in the Southern District of Alabama, as well as the Middle and Southern Districts of Florida, including in connection with the two convicted Alabama health care professionals mentioned above.

On or about May 30, 2018, a former specialty sales professional pled guilty to a second-degree charge of conspiracy to commit commercial bribery related to her activities in New Jersey.

Except as otherwise indicated, we understand that each of these indicted individuals have entered pleas of not guilty to the charges against them.

Given the ongoing investigations related to our company and former employees, as well as other individuals associated with our company, including health care professionals, it is possible that additional individual or company criminal charges and convictions and pleas could result from our ongoing federal and state government investigations and related proceedings and the foregoing disclosure and the disclosure below is merely intended to provide general insight into the comprehensive nature of the scope and breadth of investigations that are being conducted related to our company and is not, nor is it intended to be, an exhaustive listing of every charge, conviction or pleading in connection with our company.

Ongoing State-Related Investigations. We have received CIDs or subpoenas, as the case may be, from at least each of the following state’s Office of the Attorney General (or similarly named and authorized office) which have ongoing investigations directed at our company: Arizona, Colorado, Florida, Kansas, Kentucky, Maryland, Minnesota, Missouri, New Jersey, New York, North Carolina, Pennsylvania, Rhode Island, Virginia and Washington. Moreover, we have received an administrative subpoena from the California Insurance Commissioner. In addition, we understand that numerous physicians

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practicing within several of the aforementioned states have received subpoenas from certain state Attorney General or Department of Justice offices in connection with interactions with us. Generally, these CIDs and subpoenas request documents regarding SUBSYS®, including our sales and marketing practices related to SUBSYS® in the applicable state, as well as our patient services hub. We are cooperating with each of these investigations and have produced, or anticipate producing, documents in response to these CIDs, subpoenas and related requests for information from each office.

Resolved State-Related Investigations. Our company has resolved investigations conducted by certain states’ Office of the Attorney General (or similarly named and authorized office) as follows:

In connection with the investigation by the ODOJ, we entered into a settlement agreement with the ODOJ, referred to as an AVC, and made monetary payments totaling approximately $1,100,000. The AVC requires us to maintain certain controls and processes around our promotional and sales activity related to SUBSYS® in Oregon. This AVC expressly provides that we do not admit any violation of law or regulation. This settlement was reached as a result of our cooperation with the ODOJ's investigation and after producing documents in response to certain CIDs and related requests for information from the ODOJ. All monetary payments in connection with this settlement were made prior to December 31, 2015.

In connection with the investigation by the Illinois Office of the Attorney General, such office filed a complaint against us on behalf of the State of Illinois on August 25, 2016, in the Circuit Court of Cook County, Illinois, Chancery Division, asserting a claim for violation of the Illinois Consumer Fraud and Deceptive Business Practices Act in connection with the sales and marketing of SUBSYS®. On August 18, 2017, the Circuit Court of Cook County entered a Final Judgment and Consent Decree, which, among other things, provided for a monetary payment of $4,450,000 by Insys and requires us to maintain certain controls and processes around our promotional and sales activity related to SUBSYS® in Illinois. The Final Judgment and Consent Decree expressly provides that we do not admit any violation of law or regulation. All monetary payments in connection with this Final Judgment and Consent Decree were accrued in the unaudited condensed consolidated balance sheets as of June 30, 2017 and the payments in connection with this settlement were made prior to September 30, 2017.

In connection with the investigation by the State of New Hampshire, we entered into a settlement agreement with the State of New Hampshire referred to as an assurance of discontinuance, and made monetary payments totaling approximately $2,900,000 to the State of New Hampshire and a charitable contribution of $500,000 to be used by a New Hampshire charitable foundation in preventing or remediating problems related to abuse, misuse or misprescribing of opioid drugs. The assurance of discontinuance expressly provides that we do not admit any violation of law or regulation and requires us to maintain certain controls and processes around our promotional and sales activity related to SUBSYS® in New Hampshire. This settlement was reached as a result of our cooperation with the State of New Hampshire investigation and after producing documents in response to certain requests for information by the State of New Hampshire. These amounts were accrued in the consolidated balance sheet as of December 31, 2016 and the payments in connection with this settlement were made during the three months ended March 31, 2017.

In connection with the investigation by the State of Massachusetts, we entered into a settlement with the State of Massachusetts, which was entered by the Superior Court of the Commonwealth of Massachusetts in a Final Judgment by Consent on October 5, 2017. The Final Judgment by Consent provided for a monetary payment of $500,000 and requires us to maintain certain controls and processes around our promotional and sales activity related to Massachusetts. The Final Judgment by Consent expressly provides that we do not admit any liability or wrongdoing. The amount of the monetary payment was accrued in the unaudited condensed consolidated balance sheet as of September 30, 2017 and the payments in connection with this settlement were made during the three months ended December 31, 2017.

Ongoing Complaints filed in connection with State AG Investigations. Our Company has several ongoing legal proceedings related to complaints filed in connection with investigations conducted by certain states’ Office of the Attorney General (or similarly named and authorized office) as follows:

In connection with the investigation by the State of Arizona, on August 30, 2017, the Arizona Attorney General filed a complaint on behalf of the State of Arizona against us in the Maricopa County, Arizona Superior Court. The complaint asserts claims for violations of the Arizona Consumer Fraud Act in connection with the sales and marketing of SUBSYS® in Arizona and in connection with our patient services hub. The complaint seeks a permanent injunction preventing us from engaging in practices in violation of the Arizona Consumer Fraud Act, restitution to consumers and other persons, disgorgement of profits, civil penalties, and investigative costs. On or about November 10, 2017, we filed a motion to dismiss. On January 17, 2018, the Court dismissed, based upon preemption by the federal Sunshine Act, the State’s claim to the extent related to remedies that are based upon the payment and disclosure of speaker fees, but did not dismiss the rest of the complaint. The State filed a motion for leave to amend its complaint, which the Court granted. We filed our answer to the amended complaint on April 5, 2018.

In connection with the investigation by the State of New Jersey, on October 5, 2017, the New Jersey Attorney General, on behalf of the State of New Jersey, and the Acting Director of the New Jersey Division of Consumer Affairs filed a complaint

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against us in the Superior Court of New Jersey, Chancery Division, Middlesex Vicinage. The complaint asserts claims for violations of the New Jersey Consumer Fraud Act and for violations of the New Jersey False Claims Act in connection with the sales and marketing of SUBSYS® in New Jersey and in connection with our patient services hub. The complaint seeks a permanent injunction preventing us from engaging in practices in violation of the New Jersey Consumer Fraud Act, disgorgement of profits, civil penalties, treble damages for alleged violations of the New Jersey False Claims Act, and costs and attorneys’ fees. On November 16, 2017, the New Jersey Attorney General filed an Amended Complaint, which we moved to dismiss on January 8, 2018. The New Jersey Attorney General opposed our motion on March 28, 2018, and we replied. The Court held oral argument on the motion on June 18, 2018.

On December 21, 2017, Attorney General of the State of North Carolina filed a complaint in Wake County, North Carolina Superior Court against us. The complaint asserts claims related to alleged violations of the North Carolina Consumer Protection Act. On or about September 25, 2018, we moved to dismiss the complaint. The motion remains pending.

On February 1, 2018, the Attorney General of the State of New York, filed a complaint against us in the Supreme Court of the State of New York, County of New York. The complaint asserts claims related to alleged deceptive acts and practices. We moved to dismiss the complaint on April 18, 2018.  In response, on May 25, 2018, the New York Attorney General opposed our motion to dismiss and filed a cross-motion for partial summary judgment related to the State’s commercial bribery claim.  On June 29, 2018, we filed a reply in support of our motion to dismiss and opposed the State’s motion for partial summary judgment.  The Court conducted oral argument on the motions to dismiss and the cross-motion for summary judgement on October 4, 2018. The motion remains pending.

On February 5, 2018, the Consumer Protection Division, Office of the Attorney General of Maryland, filed a petition to enforce an administrative subpoena against us. The State voluntarily dismissed the action on September 5, 2018.  On September 6, 2018, however, the Consumer Protection Division, Office of the Attorney General of Maryland, filed a Statement of Charges against us with the Consumer Protection Division.  Insys filed its response to the Statement of Charges on October 17, 2018.

On May 30, 2018, the Attorney General of the State of Minnesota and the Minnesota Board of Pharmacy filed a complaint against us in the Hennepin County District Court, State of Minnesota.  The complaint asserts claims related to alleged deceptive acts and practices and consumer fraud, as well as claims under the Minnesota Wholesale Drug Distribution Licensing Act (Minn. Stat. § 151.461).  On August 28, 2018, Insys moved to dismiss the complaint.  On the same day, the Attorney General and the Board of Pharmacy filed a motion for temporary injunction.  The Court held oral argument on both the motion to dismiss and the motion for temporary injunction, and both motions remain pending. Also, on May 30, 2018, the Minnesota Board of Pharmacy filed an administrative action against us before the State of Minnesota Office of Administrative Hearings for the Board of Pharmacy, which seeks a determination regarding whether certain alleged conduct by Insys constitutes grounds for disciplinary action. The Office of Administrative Hearings has indicated that it will set a hearing in this matter for March or April 2019.

Multi-District Prescription Opioid Litigation. We have been named along with various other opioid manufacturers, opioid distributors, prescribers, pharmacies, and others in complaints focused on the national opioid epidemic filed by various cities, counties, states, Native American tribes, and third-party payers in many state and federal courts in Alabama, Arizona, Arkansas, California, Connecticut, Florida, Georgia, Indiana, Iowa, Kentucky, Louisiana, Maine, Maryland, Michigan, Minnesota, Mississippi, Missouri, Nebraska, New Hampshire, New Jersey, New Mexico, New York, Ohio, Oklahoma, Oregon, Pennsylvania, Rhode Island, South Carolina, Tennessee, Texas, Utah and West Virginia. We are involved in more than 600 of these cases, the majority of which have been consolidated into multi-district litigation (MDL No. 2804) in the Northern District of Ohio. Most of the cases in the multi-district litigation are presently stayed while the Court seeks to facilitate a resolution. On April 2, 2018, the United States filed a motion to participate in settlement discussions and as a friend of the court. Additionally, the Court set certain cases for a litigation track, and those cases will move forward toward trial, which is scheduled to commence on March 18, 2019.

We have also been named, along with various other opioid manufacturers and distributors, in putative class action complaints that seek to assert claims allegedly related to the national opioid epidemic on behalf of (1) purchasers of health insurance between 1996 and the present, and (2) children born addicted to opioids. Most of these cases have been consolidated into MDL No. 2804.  Finally, Insys has been named in at least one lawsuit in which a personal injury plaintiff sued Insys and other opioid manufacturers for harm allegedly caused by a tortfeasor who was addicted to opioids.

Congressional and Other Inquiries. Many federal agencies and branches are focused on the abuse of opioids in the United States and agencies such as the HHS have expressed their belief that the United States is in the midst of a prescription opioid abuse epidemic. Moreover, President Trump has declared the opioid crisis to be a public health emergency and has made it a priority to address this crisis.

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Members of our U.S. Congress have been conducting hearings and other inquiries into causes and solutions to the national opioid epidemic that have involved inquiries into our Company’s practices. For example, on March 28, 2017, the Ranking Member of the Committee on Homeland Security and Governmental Affairs of the United States Senate distributed a letter to five manufacturers of opioid products, including us, requesting documents and information intended to aid such committee in understanding the challenges industry practices pose to efforts to curb opioid addiction and stem rising prescription drug costs for the federal government. This letter requested documents regarding our business, including the commercialization of SUBSYS®. This inquiry continues and has resulted in at least four reports that mention or address our Company. We continue to cooperate with this inquiry.

Similarly, on August 2, 2018, bipartisan leaders of the House of Representatives Committee on Energy and Commerce sent letters to three manufacturers of opioid products, including us, requesting documents and information intended to aid such committee in investigating potential breakdowns in the controlled substances supply chain which may have contributed to the nation’s opioid epidemic.  This letter requested documents regarding our business, sales practices, and speaker programs.  We continue to cooperate with this inquiry.

With the exception of the investigations by the ODOJ, the State of New Hampshire, the State of Illinois, the State of Massachusetts, and the DOJ, which we have quantified above, we believe a loss from an unfavorable outcome of these federal and state governmental proceedings is reasonably possible and an estimate of the amount or range of loss from an unfavorable outcome is not determinable at these stages. We believe we have meritorious legal positions and will continue to represent our interests vigorously in these matters. However, responding to government investigations has and could continue to burden us with substantial legal costs in connection with defending any claims raised. Any potential resulting fines, restitution, damages and penalties, settlement payments, pleas or exclusion from federal health care programs or other administrative actions, as well as any related actions brought by stockholders or other third parties, could have a material adverse effect on our financial position, results of operations or cash flows. Additionally, these matters could also have a negative impact on our reputation and divert the attention of our management from operating our business.

Federal Securities Litigation and Derivative Complaints

Federal Securities Litigation. On or about February 2, 2016, a complaint (captioned Richard Di Donato v. Insys Therapeutics, Inc., et al., Case 2:16-cv-00302-NVW) was filed in the United States District Court for the District of Arizona against us and certain of our current and former officers. The complaint was brought as a purported class action on behalf of purchasers of our common stock between March 3, 2015 and January 25, 2016. In general, the plaintiffs allege that the defendants violated the anti-fraud provisions of the federal securities laws by making materially false and misleading statements regarding our business, operations and compliance with laws during the class period, thereby artificially inflating the price of our common stock. On June 3, 2016, the Court appointed Clark Miller to serve as lead plaintiff. On June 24, 2016, the plaintiff filed a first amended complaint naming a former employee of Insys Therapeutics, Inc. as an additional defendant and extending the class period. On December 22, 2016, the plaintiff filed a second amended complaint, primarily to add allegations relating to an indictment of Michael L. Babich and certain of our former employees announced on December 8, 2016, and to extend the class period from August 12, 2014 through December 8, 2016. On January 12, 2017, the defendants moved to dismiss the second amended complaint. Oral arguments were heard by the Court on July 28, 2017, and the Court granted the motion in part and denied it in part. The plaintiff subsequently moved for leave to further amend the complaint, which we opposed. The Court denied Plaintiff’s motion on March 31, 2018, and Insys filed its answer on April 15, 2018. The plaintiff seeks unspecified monetary damages and other relief. We continue to vigorously defend this matter.

On or about March 17, 2017, a complaint (captioned Kayd Currier v. Insys Therapeutics, Inc., et al., Case 1:17-cv-01954-PAC) was filed in the United States District Court for the Southern District of New York against us and certain of our current and former officers. The complaint was brought as a purported class action on behalf of purchasers of our securities between February 23, 2016, and March 15, 2017. In general, the plaintiffs allege that the defendants violated the anti-fraud provisions of the federal securities laws by making materially false and misleading statements regarding our business and financial results during the class period, thereby artificially inflating the price of our securities. On or about March 28, 2017, a second complaint making similar allegations (captioned Hans E. Erdmann v. Insys Therapeutics, Inc., et al., Case 1:17-cv-02225-PAC) was filed in the same Court. On May 31, 2017, the Court consolidated the first and second complaint and appointed lead counsel in the consolidated action. On July 31, 2017, the lead counsel filed a consolidated complaint. On October 11, 2017, the Court held a pre-motion conference, at which the Court granted leave to plaintiffs to again amend the complaint. The amendment was filed on October 27, 2017, and we moved to dismiss. The Court subsequently dismissed the complaint as to Santosh Vetticaden, our former Interim CEO and Chief Medical Officer, and otherwise denied our motion to dismiss.  Insys filed its answer on June 26, 2018. The plaintiffs in both actions seek unspecified monetary damages and other relief. We continue to vigorously defend this matter.

Derivative Litigation. On or about August 26, 2016, Gary Hirt and Precieux Art Jewelers Inc. filed a derivative complaint in the Court of Chancery of Delaware against members of our Board of Directors and Michael L. Babich. The plaintiffs allege, among other things, that the defendants breached their fiduciary duties by (a) knowingly overseeing the implementation of an

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illegal sales and marketing program, (b) consciously disregarding their duty of oversight of our compliance with laws and (c) trading on the basis of material non-public information. On November 8, 2016, the plaintiffs filed an amended derivative complaint, and on January 26, 2017, the plaintiffs supplemented the amended derivative complaint, primarily to add allegations relating to the indictment of Michael L. Babich and certain of our former employees announced on December 8, 2016. On November 22, 2016, the defendants moved to dismiss the action.

On or about February 2, 2017, Michael Bourque filed a derivative complaint in the Court of Chancery against members of our Board of Directors; Michael L. Babich; Franc Del Fosse, our General Counsel; and Sanga Emmanuel, our Vice President and Chief Compliance Officer. The Bourque derivative complaint contains similar claims as the other derivative complaint. All parties stipulated to consolidate the two actions, and the consolidated action is captioned In re Insys Therapeutics, Inc. Derivative Litigation, C.A. No. 12696-VCMR. Following the submission of motions for appointment as lead counsel, the Court held a hearing on March 23, 2017, and appointed counsel for Gary Hirt and Precieux Art Jewelers Inc. as lead counsel. Lead counsel is required to designate an operative complaint or file a consolidated complaint. The plaintiffs seek unspecified monetary damages and other relief derivatively on behalf of Insys Therapeutics, Inc.

On or about April 28, 2017, lead counsel filed a consolidated and amended complaint which maintained the original defendants this lead counsel had included in its original complaint and did not include any additional defendants included in the Bourque complaint. On May 31, 2017, we subsequently moved to stay or to dismiss the complaint and, on or about July 28, 2017, lead counsel filed an answering brief in opposition to our motion to stay or dismiss. On November 30, 2017, the Court granted our motion to stay but has required us to provide certain discovery to the plaintiffs. On February 8, 2018, in response to the plaintiffs’ motion to alter or clarify judgment, the Court ordered us to provide additional discovery to the plaintiffs. On March 16, 2018, the Court entered the parties’ stipulated proposed order implementing the Court’s ruling of February 8, 2018. We continue to vigorously defend this matter.

On or about June 5, 2018, Jim Soltau filed a derivative complaint (“the Soltau complaint”) in the United States District Court, District of Arizona (18-cv-01720-SPL), against members of our Board of Directors, former directors and officers, as applicable, John Kapoor, Michael Babich, Patrick Forteau, Brian Tambi, the Estate of Dr. Theodore Stanley, and former officers Darryl Baker and Santosh Vetticaden.  The plaintiff alleged, among other things, that these individuals breached their fiduciary duties as our officers and/or directors and are liable for unjust enrichment, waste of corporate assets, abuse of control, gross mismanagement, and violations of Sections 14(a), 10(b) and 20(a) of the Securities Exchange Act of 1934.  On July 20, 2018, Insys filed its answer to the complaint.  On September 12, 2018, the Court granted a motion to stay the case.  We continue to vigorously defend this matter.

On or about June 10, 2018, David Bennett filed a derivative complaint in the United States District Court, District of Arizona (18-cv-02170), against members of our Board of Directors, former directors and officers, as applicable, John Kapoor, Michael Babich, Patrick Forteau, Brian Tambi, the Estate of Dr. Theodore Stanley, and former officers Darryl Baker and Santosh Vetticaden.  This complaint contains similar claims as the Soltau complaint.  On August 10, 2018, the Soltau and Bennett cases were consolidated, and on September 12, 2018, the Court granted a motion to stay the case. We intend to vigorously defend this matter.

On August 6, 2018, Hamid Ravansari filed a derivative complaint in the United District Court, Southern District of New York (18-CV-07026) against members of our Board of Directors, former directors and officers, as applicable, John Kapoor, Michael Babich, Patrick Fourteau, Pierre Lapalme, Steven Meyer, Brian Tambi, the Estate of Dr. Theodore Stanley, and former officers Darryl Baker and Santosh Vetticaden. The plaintiffs allege, among other things, that these individuals breached their fiduciary duties as our officers and/or directors and are liable for unjust enrichment, abuse of control, gross mismanagement and waste of corporate assets. On October 29, 2018, Insys filed its answer to the complaint. We intend to vigorously defend this matter.

Paragraph IV Challenges

On or about August 2, 2017, we received a Paragraph IV Notice Letter from counsel for TEVA Pharmaceuticals USA (“TEVA USA”) related to SUBSYS® 0.4mg dose. The letter asserts that (i) the FDA received an ANDA from TEVA USA and (ii) that TEVA USA’s formulation does not infringe SUBSYS® patents and/or that our patents for SUBSYS® are invalid. On September 13, 2017, we filed suit in United States District Court for the District of Delaware, in which we allege patent infringement. On January 15, 2018, TEVA USA filed an answer and counterclaims, to which we have replied. We intend to represent our interests vigorously in this matter.

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On or about January 31, 2018, we received a Paragraph IV Notice Letter from counsel for TEVA USA related to SUBSYS® 0.1mg, 0.2mg, 0.6mg, 1.2mg and 1.6mg doses. The letter asserts that (i) the FDA received an ANDA from TEVA USA and (ii) that TEVA USA’s formulation does not infringe SUBSYS® patents and/or that our patents for SUBSYS® are invalid. We filed a patent infringement lawsuit against TEVA USA on March 16, 2018. TEVA USA filed its answer to our complaint and counterclaims, to which we have replied. We intend to represent our interests vigorously in this matter.

On or about July 10, 2018, we received a Paragraph IV Notice Letter from counsel for TEVA USA related to SUBSYS® 0.8mg dose.  The letter asserts that (i) the FDA received an ANDA from TEVA USA and (ii) that TEVA USA’s formulation does not infringe SUBSYS® patents and/or that our patents for SUBSYS® are invalid. We filed a patent infringement lawsuit against TEVA USA on August 23, 2018. We intend to represent our interests vigorously in this matter.

On September 26, 2018, we received two Paragraph IV Notice Letters from counsel for TEVA USA related to SUBSYS® 0.1mg, 0.2mg, 0.4mg, 0.6mg, 0.8mg, 1.2mg and 1.6mg doses.  The letter asserts that (i) the FDA received an ANDA from TEVA USA and (ii) that TEVA USA’s formulation does not infringe SUBSYS® patents and/or that our patents for SUBSYS® are invalid.  We intend to represent our interests vigorously in this matter.

General Litigation and Disputes

Kottayil vs. Insys Pharma, Inc. On September 29, 2009, Insys Pharma, Inc., our wholly owned subsidiary, and certain of our officers and the five directors who comprised the Insys Pharma board of directors as of June 2009, as well as their spouses, were named as defendants in a lawsuit in the Superior Court of the State of Arizona, Maricopa County, or the Arizona Superior Court, brought by Santosh Kottayil, Ph.D., certain of his family members and a trust of which Dr. Kottayil is the trustee. Dr. Kottayil formerly served as President, Chief Scientific Officer and a director of Insys Pharma, among other positions.

In February 2010, Insys Pharma and the other defendants answered and filed counter-claims to Dr. Kottayil’s amended complaint. The counter-claims include actions for breach of fiduciary duty, fraud and negligent misrepresentations and omissions with respect to the time during which Dr. Kottayil was employed at Insys Pharma. The counter-claims, among other relief, sought compensatory and punitive damages.

The trial commenced on December 1, 2014, with the evidence phase of the trial completed on January 29, 2015.

On June 8, 2015, the Court issued findings of fact and conclusions of law in its final trial ruling, which included a finding in favor of Kottayil and against Insys Pharma on Insys Pharma’s counterclaims of breach of fiduciary duty, fraud, and negligent misrepresentation.

On October 2, 2015, the Court denied Kottayil’s request to submit an application for attorneys’ fees for his defense of the Insys Pharma counterclaims, finding that the request was premature.

On or around November 1, 2015, we received a notice from Dr. Kottayil’s attorneys demanding indemnification for legal and other defense costs alleged to have been incurred in connection with Dr. Kottayil’s defense of the Insys Pharma counterclaims in the amount of $3,630,000. We responded to these demands by, among other things, requesting supporting documents and information from the plaintiffs’ counsel, which we have not received. On June 1, 2018, Dr. Kottayil filed a complaint in Superior Court in the State of Arizona in and for the County of Maricopa against Insys Pharma, Inc., our wholly owned subsidiary.  The complaint seeks indemnification in the amount of $3,630,000, plus interest.  On July 26, 2018, Insys moved to dismiss the complaint, which the Court granted.  Dr. Kottayil subsequently moved for reconsideration of the Court’s dismissal ruling.  The motion for reconsideration remains pending.  Because of the uncertainty surrounding the ultimate outcome, we have not accrued for this claim at this time; however, we believe that that it is reasonably possible that there may be a material loss associated with this claim and we currently estimate the range of the reasonably possible loss to be between $0 and the $3,630,000 claimed.

Insurance Litigation. On June 23, 2017, Aetna, Inc. and a subsidiary filed an action against us and a number of former employees in the Pennsylvania Court of Common Pleas, Philadelphia County (captioned Aetna Inc. v. Insys Therapeutics, Inc., Case No. 170602779). Plaintiffs bring claims against us for: (1) insurance fraud; (2) civil conspiracy; (3) common law fraud; (4) unjust enrichment; (5) negligent misrepresentation; and (6) negligence. Through all of the claims, Aetna seeks recovery of millions of dollars paid for SUBSYS® prescriptions that, allegedly, were not properly covered. It also seeks punitive damages, investigative expenses and costs of suit, reasonable attorneys’ fees and expenses, and prejudgment and post-judgment interest. Plaintiffs served their complaint on September 25, 2017. On October 25, 2017, we removed this matter to federal court. Aetna subsequently moved to remand the case to state court. On January 6, 2018, the district court denied Aetna’s motion to remand. We moved to dismiss Aetna’s claims. On August 24, 2018, the Court dismissed Aetna’s negligent misrepresentation and negligence claims and otherwise denied the motion to dismiss. We intend to vigorously defend this matter.

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On July 12, 2017, numerous subsidiaries of Anthem, Inc. filed a complaint in the U.S. District Court for the District Court for the District Court for the District of Arizona against us (captioned Blue Cross of California, Inc. d/b/a Anthem Blue Cross of California v. Insys Therapeutics, Inc., Case No. 2:17-cv-02286-DLR). Plaintiffs brought claims against us for: (1) violation of various state laws prohibiting deceptive, unfair, and unlawful business practices (i.e., consumer fraud); (2) fraud; (3) negligent misrepresentation; (4) unjust enrichment; and (5) civil conspiracy to commit fraud and unfair business practices. Through all of the claims, Anthem seeks recovery of more than $19,000,000 paid for SUBSYS® prescriptions that, allegedly, were not properly covered. It also seeks punitive damages and an injunction to prevent Insys from continuing to engage in the conduct underlying its claims. Plaintiffs served their complaint on July 14, 2017. On August 4, 2017, we filed an answer to such complaint. On February 2, 2018, Plaintiffs filed a motion for leave to file a second amended complaint and on February 16, 2018, we filed (i) an opposition to Plaintiff’s motion to file a second amended complaint and (ii) a motion to stay the case. On or about July 23, 2018, the Court granted Plaintiff’s motion to file a second amended complaint.  On August 8, 2018, the Court denied our motion to stay.  On September 14, 2018, we moved to dismiss Anthem’s second amended complaint and Anthem’s response is due on October 29, 2018. Discovery in this case is ongoing. We intend to vigorously defend this matter.

On October 31, 2017, we received correspondence from Horizon Blue Cross Blue Shield of New Jersey requesting reimbursement for allegedly fraudulently induced off-label purchases of SUBSYS® in connection with alleged claim value of approximately $4,400,000. In further correspondence, Horizon Blue Cross Blue Shield of New Jersey has identified in excess of $2,000,000 at issue. We intend to vigorously defend this matter.

On May 21, 2018, MSPA Claims I, LLC, MAO-MSO Recovery II, LLC, and MSP Recovery Claims, Series LLC filed a complaint in the United States District Court, Northern District of Ohio, against Insys Therapeutics, Inc.  Plaintiffs bring claims for violations of the Racketeer Influenced and Corrupt Organizations Act (“RICO”), common law fraud, and unjust enrichment.  Plaintiffs subsequently amended their complaint on August 22, 2018, and we moved to dismiss the complaint on September 25, 2018. We intend to vigorously defend this matter.

Markland. On July 1, 2016, Robert N. Markland, as the Personal Representative of the Estate of Carolyn S. Markland filed a complaint in the Circuit Court, Fourth Judicial Circuit, in and for Duval County, Florida, against Insys Therapeutics, Inc. The complaint states that it is a wrongful death products liability action brought pursuant to Section 768.16, et seq. under Florida law in connection with a death occurring in July 2014 and includes a claim of negligent marketing. The lawsuit seeks unspecified damages for past expenses and costs, pain and suffering and loss of consortium and earnings. On August 4, 2016, we removed this case to U.S. District Court in the Middle District of Florida. On September 2, 2016, we filed a motion to dismiss. The Court granted our motion on September 15, 2017. The plaintiff subsequently filed a notice of appeal, and the opening brief on appeal was filed on March 9, 2018. We filed our answering brief on May 24, 2018, and the reply brief was filed on July 9, 2018. We continue to vigorously defend this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Buchalter. On September 9, 2016, Jeffrey Buchalter filed a complaint in the Circuit Court for Anne Arundel County, Maryland, Case No. C-02-cv-16-002718, against Dr. William Tham, Physical Medicine & Pain Management Associates, Maryland Neurological Institute, various physician assistants, and Insys Therapeutics, Inc. Plaintiff’s complaint states it is a personal injury action against Insys related to negligent misrepresentation, failure to warn and fraud under state laws. The lawsuit seeks unspecified compensatory and punitive damages. We filed a motion to dismiss and on or about May 6, 2017, the Court denied the motion to dismiss. On March 22, 2018, Plaintiff filed a motion to file a second amended complaint, which, among other things, sought to add as defendants certain former Insys officers and employees.  The motion to file a second amended complaint was subsequently granted.  Insys filed its answer to the second amended complaint on June 20, 2018. We continue to vigorously defend this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Fuller. On or about March 23, 2017, Deborah Fuller & David Fuller, as Administrators Ad Prosequendum for the Estate of Sarah A. Fuller, deceased, and Deborah Fuller and David Fuller, individually, filed a complaint in the Superior Court of New Jersey Law Division, Middlesex County, Case No. L1859-17, against Vivienne Matalon, M.D., TLC Healthcare 2, LLC, Linden Care and Insys Therapeutics, Inc. The plaintiff’s complaint alleges negligence violations under the Wrongful Death Act pursuant to N.J.S.A 2A:31, et seq. and also brings claims for fraud and negligent misrepresentation. We filed a motion to dismiss the complaint on May 19, 2017, and the Court held oral argument on the motion on June 29, 2017. On July 27, 2017, the Court issued a ruling on the multi-party motion to dismiss. The Court dismissed some claims but denied the motion to dismiss on certain of plaintiffs’ claims. We answered the complaint, and, after plaintiffs dismissed the treating physician, on October 4, 2017, we removed the case to U.S. District Court for the District of New Jersey. Plaintiffs subsequently filed a motion to remand the case to state court on October 11, 2017. On January 19, 2018, the Magistrate Judge issued a Report and Recommendation, recommending that the District Court deny plaintiffs’ motion to remand. On February 5, 2018, the District Court adopted the Report and Recommendation. On February 6, 2018, plaintiffs filed a motion for leave to amend, seeking to add as defendants certain former Insys officers and a former employee. Insys filed its opposition to the motion for leave to

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amend on February 21, 2018. Consistent with our opposition, the Court denied plaintiffs’ motion as to the former employee and granted the motion as to the former officers.  Plaintiffs filed their first amended complaint on June 12, 2018.  On June 26, 2018, Insys moved to dismiss, in part, plaintiffs’ first amended complaint.  Plaintiffs filed a response in opposition to the motion on July 18, 2018, and the Court set a return date of August 6, 2018.  Plaintiffs subsequently stipulated to dismiss certain allegations and claims against Insys, and the motion to dismiss was withdrawn. We continue to vigorously defend this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Cantone. On or about June 15, 2017, we received service of a complaint filed by Angela Mistrulli Cantone and Philip L. Cantone in the State Court of South Carolina, County of Greenville, C.A. No.: 2017-CP-23 against Insys Therapeutics, Inc., Linden Care, LLC, Aathirayen Thiyagarajah, M.D. and Spine and Pain, LLC. The plaintiffs’ complaint alleges medical negligence, negligence, negligent misrepresentation, unjust enrichment, common law fraud, unfair and deceptive trade practices, aiding and abetting and loss of consortium.  We filed a motion to dismiss, which the Court denied. We filed our answer on November 14, 2017. We continue to vigorously defend this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Ballou. On or about September 1, 2017, Carey Ballou filed a complaint in the circuit Court of Johnson County, Kansas, Case No. 17CV05004, against Insys Therapeutics, Inc., Insys Pharma, Inc., Torgny Andersson, Mid-America Physiatrist, P.A., Steven Simon M.D., Donna Ruck, Pharma Consultants KC, LLC, AmerisourceBergen Corporation, and Morris & Dickson Co., LLC. The plaintiffs bring claims against Insys for negligence, common law fraud, negligent misrepresentation, unfair and deceptive trade practices, unjust enrichment, conspiracy, and aiding and abetting. On December 26, 2017, Plaintiff filed a second amended complaint, which added as defendants certain former officers and employees. Insys moved to dismiss the second amended complaint on February 26, 2018. On August 22, 2018, the Court held oral argument on the motion to dismiss.  The motion remains pending.  We intend to vigorously defend this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Whitham. On or about September 1, 2017, James “Mike” Whitham and Ashley Whitham filed a complaint in the Circuit Court of Johnson County, Kansas, Case No. 17CV05005, against Insys Therapeutics, Inc., Insys Pharma, Inc., Torgny Andersson, Mid-America Physiatrist, P.A., Steven Simon M.D., Donna Ruck, Pharma Consultants KC, LLC, AmerisourceBergen Corporation, and Morris & Dickson Co., LLC. The plaintiff brings claims against Insys for negligence, common law fraud, negligent misrepresentation, unfair and deceptive trade practices, unjust enrichment, loss of consortium, conspiracy, and aiding and abetting. On December 26, 2017, Plaintiff filed a second amended complaint, which added as defendants certain former officers and employees. Insys moved to dismiss the second amended complaint on February 26, 2018. On August 22, 2018, the Court held oral argument on the motion to dismiss.  The motion remains pending.  We intend to vigorously defend this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Hartsfield. On or about October 4, 2017, Cheryl Hartsfield filed a complaint in the Circuit Court of Pulaski County, Arkansas, Case No. 60CV-17-5581, against Insys Therapeutics, Inc., Linden Care, LLC, Mahmood Ahmad, and United Pain Care, Ltd. The plaintiff brings claims against Insys for common law fraud and deceit, breach of fiduciary duty, violations of the Arkansas deceptive trade practices act, civil conspiracy, acting in concert, and negligence. Insys filed its answer to the complaint on November 27, 2017. We intend to vigorously defend this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Jordan. On January 5, 2018, Bobby Ray Jordan, individually and as Special Administrator of the Estate of Doris L. Jordan, deceased, filed a complaint in the District Court of Leavensworth County, Kansas against Insys Therapeutics, Inc., Insys Pharma, Inc., Torgny Andersson, Mid-America Physiatrist, P.A., Steven Simon, M.D., Donna Ruck, Pharma Consultants KC, LLC, John N. Kapoor, Michael L. Babich, and Alec Burlakoff. The plaintiff brings claims against Insys for negligence, conspiracy to commit fraud and breach of fiduciary duty, negligent misrepresentation, unfair and deceptive trade practices, unjust enrichment, survival action, and wrongful death action. On January 31, 2018, Insys moved to consolidate this case with the Ballou and Witham actions, which the Court denied. On April 16, 2018, we moved to transfer venue to Johnson County, Kansas, and on May 14, 2018, we moved to dismiss the case.  The Court denied both motions. We intend to vigorously defend this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Mencucci. On February 23, 2018, Lisa Mencucci and Angelo Mencucci filed a complaint in the Superior Court of Providence, Rhode Island against Insys Therapeutics, Inc. and Jerrold Rosenberg, M.D. Plaintiffs bring claims against Insys for common law fraud, common law fraud and misrepresentation – punitive damages, conscious misrepresentation involving risk of physical harm, conscious misrepresentation involving risk of physical harm – punitive damages, Rhode Island General Law 9-1-2,  Rhode Island General Law 9-1-2 – punitive damages, negligent misrepresentation, negligent misrepresentation

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involving risk of physical harm, negligence, and violation of the Rhode Island Deceptive trade practices act. Our answer to the Complaint was filed on April 26, 2018. We intend to vigorously defend this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Hemmings. On March 21, 2018, William Hemmings filed a complaint in the United States District Court for the Northern District of Illinois against Insys Therapeutics, Inc. Plaintiff brings claims against Insys for negligence, fraud, and consumer fraud. On May 16, 2018, we filed an answer and a motion to dismiss.  The motion to dismiss is fully briefed and remains pending. We intend to vigorously defend this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Hampton. On March 8, 2018, Scott Hampton, as Heir, Executor and Personal Representative of the Estate of Diana Hampton, individually and on behalf of his minor children I.S. and S.M., filed a complaint in Clark County, Nevada District Court against Steven A. Holper and Insys Therapeutics, Inc. Plaintiffs bring claims against Insys for wrongful death: negligence, survivor action: negligence, wrongful death: intentional/reckless conduct, survivor’s action: intentional/reckless conduct, negligence, strict liability – defect in design – product liability, strict liability – failure to warn, and punitive damages. On April 16, 2018, Insys removed this case to the United States District Court for the District of Nevada. On April 17, 2018, the District Judge entered an Order to Show Cause why the case should not be remanded to state court, and subsequently remanded the case to state court.  On June 26, 2018, Insys moved to dismiss the case.  On June 29, 2018, plaintiffs sought leave to amend the complaint, which the court granted. Oral argument on the motion occurred on July 30, 2018, and the Court denied the motion.  Plaintiffs filed a second amended complaint on September 7, 2018 and Insys subsequently moved to dismiss the second amended complaint.  We intend to vigorously defend this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Munson. On April 4, 2018, Morgan Michelle Munson and Christopher Edward Munson filed a complaint in Duval County, Florida Circuit Court against Insys Therapeutics, Inc. and Linden Care, LLC. Plaintiffs bring claims against Insys for civil conspiracy, negligence, and aiding and abetting. On May 21, 2018, Insys removed the case to the United States District Court for the Middle District of Florida.  On June 12, 2018, plaintiffs filed a motion for leave to file amended complaint and to remand.  We filed our response in opposition on July 10, 2018. On November 6, 2018, the Court denied plaintiffs’ motion for leave to file amended complaint and to remand.  It also dismissed plaintiffs’ complaint without prejudice as a “shotgun” pleading.  The Court ordered plaintiffs to file an amended complaint by November 28, 2018 and ordered defendants to respond to the amended complaint by December 20, 2018.  We intend to vigorously defend this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Tisher/Starling.  On May 4, 2018, Herbert Tisher and Jane Tisher filed a complaint in the Superior Court of the State of Delaware against Insys Therapeutics, Inc., Compassionate Pain Management, LLC, Compassionate Diagnostics, LLC d/b/a Cutting Edge Treatment Center, and Eva C. Dickinson, M.D.  On July 3, 2018, the Complaint was amended to add as Plaintiffs James Starling, Jr. and Pamela Starling, and to remove as a Plaintiff Jane Tisher.  The Amended Complaint also added as defendants Michael J. Babich, Alec Burlakoff, Michael J. Gurry, Richard Simon, Sunrise Lee, Joseph A. Rowan, John N. Kapoor, Rodney Village Pharmacy LLC, Hometown Drug LLC, and Sanjana Company, LLC.  Plaintiffs bring claims against Insys for general negligence, negligent misrepresentation, common law fraud, aiding and abetting, unjust enrichment, and civil conspiracy.  We filed an answer to the amended complaint on August 31, 2018.  We continue to vigorously defend this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Kyle.  On May 10, 2018, Jeffrey A. Kyle and Polly Kyle filed a complaint in the State of New Hampshire Superior Court, Stratford, SS, against Christopher Clough, PA, Dr. John J. Schermerhorn, Dr. O’Connell’s Pain Care Centers, Inc., and Insys Therapeutics, Inc.  Plaintiffs bring claims against Insys for negligence and loss of consortium.  Insys filed its answer to the complaint on July 13, 2018.  On September 20, 2018, the Court dismissed the complaint against all the defendants.

Gruenspecht.  On June 14, 2018, Mark Gruenspecht filed a complaint in the Supreme Court of the State of New York, County of New York, against Upper East Side Pain Medicine, P.C., Gordon Freedman, M.D., and Insys Therapeutics, Inc.  Plaintiff brings a single untitled claim against Insys, asserting, among other things, that Insys’s conduct constituted fraud, deception, misrepresentation, wantonness, negligence, and gross negligence.  The complaint was served on June 27, 2018.  We filed a motion to dismiss the complaint on October 5, 2018. We continue to vigorously defend this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

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Hanson.  On July 10, 2018, Cynthia L. Hanson filed a complaint in the Circuit Court of Johnson County, Kansas against Insys Therapeutics, Inc., Insys Pharma, Inc., Torgny Andersson, Mid-America Physiatrist, P.A., Steven Simon, M.D., Donna Ruck, Pharma Consultants KC, LLC, AmerisourceBergen Corporation, and Morris & Dickson Co., LLC.  Plaintiff brings bring claims against Insys for negligence, conspiracy to commit fraud and breach of fiduciary duty, negligent misrepresentation, unfair and deceptive trade practices, unjust enrichment, survival action, and wrongful death action.  On July 23, 2018, we accepted service and we filed a motion to dismiss the complaint on September 21, 2018.  We continue to vigorously defend this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Kelly.  On July 18, 2018, Michael and Julie Kelly filed a complaint in the Common Pleas Court of Erie County, Ohio against Insys Therapeutics, Inc., Insys Pharma, Inc., and Insys Manufacturing, LLC.  Plaintiffs bring claims against Insys for negligence, negligent misrepresentation, strict products liability due to inadequate warning, strict products liability defective due to inadequate warning pursuant to Ohio Revised Code Section 2307.76, strict products liability defect due to design defect, strict products liability defective pursuant to Ohio Revised Code Section 2307.75, fraud, Ohio Consume Sales Practices Act pursuant to Ohio Revised Code Chapter 1345, false advertising, unjust enrichment, loss of consortium, negligent infliction of emotional distress, and punitive damages.  We were served with the complaint on July 30, 2018. On July 31, 2018, we removed the case to the Northern District of Ohio.  On September 21, 2018, we moved to dismiss the complaint. We continue to vigorously defend this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Mascio.  On July 31, 2018, Robin Mascio filed a complaint in the Supreme Court of the State of New York, County of New York, against Todd R. Schlifstein D.O., Jeffrey Goldstein M.D., Kathryn E. Moran P.A., Aja Snow P.A., Fountain Medical Group Holdings Inc., Fountain Medical Holdings Inc., EGA medical Management LLC, NACSIP Inc., NACSIP Inc. d/b/a Lake Mahopac Pharmacy & Surgical, Nagi Wissa, Dorvit Pharmacy Inc. d/b/a The Cure Pharmacy, Third Avenue Lerman Pharmaceutics, Inc., Vishi Pharmacy Corp. d/b/a The Cure Pharmacy, David Lerman, and Insys Therapeutics, Inc.  Plaintiff brings claims against Insys for fraud, negligent representation, lack of informed consent, and an unspecified claim that may be a claim for negligence and/or gross negligence.  Insys was served with the complaint on October 12, 2018.  We anticipate vigorously defending this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Wagner. On August 21, 2018, Dorrie Wagner filed a complaint in the County of Greenville, South Carolina Court of Common Pleas against Insys Therapeutics, Inc., John N. Kapoor, Michael L. Babich, Alec Burlakoff, Linden Care, LLLC, Aathirayen Thiyagarajah, M.D., Pain and Spine Consultants, PA and Spine and Pain, LLC. Plaintiff brings claims against Insys for general negligence, aiding and abetting, unjust enrichment, and for violations of the unfair and deceptive trade practices act. On September 10, 2018, plaintiffs filed a second complaint against the same defendants, which includes the same claims.  Insys filed its answer to the complaint on October 17, 2018.  We continue to vigorously defend this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Haddock.  On September 27, 2018, Insys received a demand letter from counsel for Iliana Haddock, asserting that Ms. Haddock has claims against Insys for negligence and alleged off-label promotion of SUBSYS®.  We anticipate vigorously defending this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Crownover.  On October 8, 2018, Michelle Crownover, Brandon Crownover, and Bailee, Makena, and Payton Crownover filed a complaint in the Franklin County, Ohio, Court of Common Pleas against Jimmy M. Henry, M.D., Midwest Pain Spine and Pain Consultants, LLC, Thomas Tadsen, Shaffer Pharmacy, Inc., Christopher Dinoffria, Avella of Columbus, Inc., and Insys Therapeutics, Inc.  Plaintiffs also included Aetna, Inc. and Anthem Blue Cross/Blue Shield as involuntary plaintiffs.  Plaintiffs bring claims against Insys for civil conspiracy, fraud, civil liability for criminal conduct, negligence, and loss of consortium.  We anticipate vigorously defending this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Tudhope.  On October 17, 2018, Carole Tudhope and John Tudhope filed a complaint in the Circuit Court of Jackson County, Missouri at Independence, against Insys Therapeutics, Inc.,  Insys Pharma, Inc., John N. Kapoor, Michael L. Babich, Alec Burlakoff, , Mid-America Physiatrist, P.A., Steven Simon, M.D., Gregory Buhler, D.O., Kathryn McConnaughey, Pharma Consultants KC, LLC, University of Kansas Hospital Authority d/b/a Cancer Center Pharmacy East, Amerisourcebergen Drug Corporation, and Morris & Dickson Co., LLC.  Plaintiffs bring claims against Insys for negligence, conspiracy to commit fraud and breach of fiduciary duty, negligent misrepresentation, unfair and deceptive trade practices,

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unjust enrichment, and loss of consortium.  We anticipate vigorously defending this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Perry.  On October 25, 2018, Colleen Perry filed a complaint in the State of New Hampshire Superior Court, Strafford, against Insys Therapeutics, Inc. Plaintiff brings a claim for fraud, consumer protection, and negligence.  We anticipate vigorously defending this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Cordes.  On or about November 2, 2018, Insys received a demand letter from counsel for Eleanor Cordes asserting that Ms. Cordes has claims against Insys for negligence, fraud, and consumer fraud.  We anticipate vigorously defending this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Farquhar.  On November 5, 2018, Timothy and Kelley Farquhar filed a complaint in the Circuit Court of Johnson County, Kansas against Insys Therapeutics, Inc., Insys Pharma, Inc., Torgny Andersson, Mid-America Physiatrists, P.A., Steven Simon, M.D., Donna Ruck, Pharma Consultants KC, LLC, AmerisourceBergen Drug Corp., Morris & Dickson Co., LLC, John N. Kapoor, Michael L. Babich, and Alex Burlakoff.  Plaintiff brings bring claims against Insys for negligence, conspiracy to commit fraud and breach a fiduciary duty, negligent misrepresentation, unfair and deceptive trade practices (Kansas Consumer Protection Act), unjust enrichment, and loss of consortium.  We anticipate vigorously defending this matter and based on currently available information, we do not believe any resolution of this matter, when taken individually, will have a material adverse effect on our business, financial position, or future results of operations.

Except as it pertains to (i) the final settlements addressed above, (ii) the accrual of $150,000,000 related to the DOJ Investigation, and (iii) the potential for damages in the federal securities litigation and derivative action that we believe could be covered by in whole or part our director and officers insurance policies (once we have met any applicable retainage requirement under the applicable policy), we believe that the probability of unfavorable outcome or loss related to all of the above litigation matters and an estimate of the amount or range of loss, if any, from an unfavorable outcome are not determinable at this time. We believe we have meritorious legal positions and will continue to represent our interests vigorously in these matters but the range of possible outcomes on these matters is very broad and, unless otherwise provided above, we are not able to provide a reasonable estimate of our potential liability, if any, nor are we able to predict the outcome of each litigation matter.

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The expense and time required to respond to each of these litigation matters and legal proceedings and related actions, defending any claims raised, and any resulting fines, restitution, damages and penalties, or settlement payments, as well as any related actions brought by shareholders or other third parties, could have a material impact on our reputation, business and financial condition and divert the attention of our management from operating our business.

Material Agreements

Aptar

In October 2015, we entered into an amended and restated supply, development and exclusive licensing agreement with Aptargroup, Inc. (“Aptar”), which, among other things, extended our exclusive supply rights to the current sublingual spray device currently utilized by SUBSYS®, as well any new device(s) jointly developed by the two companies for a period of seven years. In addition to extending the term, this amendment added certain minimum purchase commitments and requires certain tiered royalties as a percentage of net revenue to be paid by us ranging from less than one percent to the low single digits, commencing in March 2016 through the term of this agreement, from our sales of SUBSYS® and future products that use the Aptar spray device technology.

In January 2016, we assigned our rights, title, duties and obligations of supply, development and exclusive licensing agreement with Aptar from our parent to our manufacturing subsidiary as part of a corporate restructuring.

In April 2017, we, through our manufacturing subsidiary, entered into a further amendment to our Aptar supply, development and exclusive licensing agreement. This amendment effectively eliminates any prior minimum purchase obligations that had been set forth in the amendment dated October 30, 2015, and beginning in 2019, replaces them with a new annual flat fee of up to $500,000 if the quantity of devices purchased in a calendar year is less than one million devices. As a result, the cumulative effect related to this amendment reduces our aggregated purchase commitment with Aptar from $20,790,000 to $9,000,000 through December 21, 2022.

As of September 30, 2018, our remaining estimated annual contractual obligation under our agreement with Aptar was $7,500,000.

Renaissance

In April 2015, we entered into an amendment to our Renaissance manufacturing and supply agreement dated May 24, 2011, as amended, which extends our existing manufacturing and supply agreement to produce SUBSYS® until the end of 2020. In addition to extending the term, this amendment added certain minimum purchase commitments.

In January 2016, we assigned our rights, title, duties and obligations under our manufacturing and supply agreement with Renaissance from our parent to our manufacturing subsidiary as part of a corporate restructuring.

In April 2018, we, through our manufacturing subsidiary, entered into a further amendment to our Renaissance manufacturing and supply agreement. This amendment effectively eliminates any prior minimum purchase (and batch) obligations that had been set forth in the amendment dated July 2016 and replaces them with a new annual purchase commitment of $3,000,000 for the calendar year ended December 31, 2018, and $2,000,000 for the calendar years ending December 31, 2019 and 2020. As a result, the cumulative effect related to this amendment reduces our aggregated purchase commitment with Renaissance from $12,000,000 to $7,000,000 through December 31, 2020.  During the three months ended September 30, 2018, we reversed $77,000 of a previously recorded loss in cost of revenue in these unaudited condensed consolidated statements of operations and comprehensive loss for a portion of this commitment which represented firm, non-cancellable and unconditional purchase commitments for quantities in excess of our current forecasts for future demand.  During the three and nine months ended September 30, 2018, we recorded a loss of $0 and $1,195,000, respectively, in cost of revenue in these unaudited condensed consolidated statements of operations and comprehensive loss for a portion of this commitment which represented firm, non-cancellable and unconditional purchase commitments for quantities in excess of our current forecasts for future demand.

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As of September 30, 2018, our remaining estimated annual contractual obligation under our agreement with Renaissance was $4,125,000.

The following table sets forth our aggregate minimum purchase commitments and exclusive supply rights with Renaissance and Aptar under these agreements (in thousands):   

 

 

Amounts recognized in the unaudited condensed consolidated statements of operations and comprehensive loss with respect to our stock-based compensation plans were as follows (in thousands):

 

 

The following table summarizes stock option activity during the nine months ended September 30, 2018:

 

 

As of September 30, 2018, we expected to recognize $17,554,000 of stock-based compensation for outstanding options over a weighted-average period of 2.4 years.

 

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From time to time we grant restricted stock units to certain employees and directors. Restricted stock units are valued at the closing market price of our common stock on the day of grant and the total value of the units is recognized as expense ratably over the vesting period of the grants. The following table summarizes restricted stock unit activity during the nine months ended September 30, 2018:

 

 

As of September 30, 2018, we expected to recognize $3,780,000 of stock-based compensation for outstanding restricted stock units over a weighted-average period of 1.8 years.

Cash received from option exercises under all stock-based payment arrangements for the nine months ended September 30, 2018 and 2017 was $1,032,000 and $3,550,000, respectively. For the nine months ended September 30, 2018 and 2017, we recorded net reductions of $920,000 and $466,000, respectively, of our federal and state income tax liability, with an offsetting credit within income tax expense, resulting from the excess tax benefits of stock options. A full valuation allowance was recorded against these reductions during the nine months ended September 30, 2018.

 

Basic net loss per common share is computed by dividing the net loss allocable to the common stockholders by the weighted average number of common shares outstanding during the period. The diluted income per share further includes any common shares available to be issued upon exercise of outstanding stock options if such inclusion would be dilutive.

The following table sets forth the computation of basic and diluted net loss per common share (dollars in thousands, except per share amounts):

 

 

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As we have incurred a net loss for the nine months ended September 30, 2018 and 2017, basic and diluted per share amounts are the same, since the effect of potential common share equivalents is anti-dilutive. Anti-dilutive share equivalents included 5,778,022 and 5,578,530 outstanding restricted stock units and stock options as of September 30, 2018 and 2017, respectively.

We are engaged in the business of developing and selling pharmaceutical products. During the three and nine months ended September 30, 2018, we had two product lines, SUBSYS® and SYNDROS®. Our CODM evaluates revenues based on product lines.

The following tables summarize our net revenue by product line, as well as the percentage of revenue by route to market (in thousands):

 

  

 

 

All our products are sold in the United States of America. Product shipments to our three largest pharmaceutical wholesalers accounted for 32%, 16% and 11% of total shipments and product shipments to our two largest specialty pharmaceutical retailers accounted for 21% and 18 % of total shipments for the nine months ended September 30, 2018. Product shipments to our three largest pharmaceutical wholesalers accounted for 25%, 18%, and 11% of total shipments and product shipments to our two largest specialty pharmaceutical retailers accounted for 25% and 13% of total shipments for the nine months ended September 30, 2017. Our three largest pharmaceutical wholesalers’ accounts receivable balances accounted for 45%, 19%, and 13% of accounts receivable and our two largest specialty pharmaceutical retailers’ accounts receivable balances accounted for 14% and 14% of accounts receivable balance as of September 30, 2018. Three pharmaceutical wholesalers’ accounts receivable balances accounted for 44%, 18%, and 10% of accounts receivable balance as of December 31, 2017, and two specialty pharmaceutical retailers’ accounts receivable balances accounted for 13% and 12% of accounts receivable as of December 31, 2017.

On November 5, 2018, we announced that we have commenced a process to review strategic alternatives for our portfolio of opioid-related assets, including SUBSYS®, as well as formulations of buprenorphine and the combination of buprenorphine/naloxone. Our decision to pursue this process is consistent with our objective to become a leader in pharmaceutical cannabinoids and novel drug delivery systems and to continue shifting our focus away from opioids in our product pipeline. We anticipate that our company has a number of clinical and regulatory milestones to achieve over the next few quarters, including the completion of the CBD and epinephrine studies and filing the naloxone NDA, that are consistent with our objectives.

 

 

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

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and related notes included in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto as of and for the year ended December 31, 2017, and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations, both of which are contained in our Annual Report on Form 10-K for the year ended December 31, 2017.

 

Forward-Looking Statements

The information in this discussion contains forward-looking statements and information within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which are subject to the “safe harbor” created by those sections. The words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,” “would” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements that we make. The forward-looking statements are applicable only as of the date on which they are made, and we do not assume any obligation to update any forward-looking statements. All forward-looking statements in this Form 10-Q are made based on our current expectations, forecasts, estimates and assumptions, and involve risks, uncertainties and other factors that could cause results or events to differ materially from those expressed in the forward-looking statements. In evaluating these statements, you should specifically consider various factors, uncertainties and risks that could affect our future results or operations as described from time to time in our SEC reports, including those risks outlined under “Risk Factors” in Part I, Item 1A of our Form 10-K for the year ended December 31, 2017, and in Part II, Item 1A in this Form 10-Q. These factors, uncertainties and risks may cause our actual results to differ materially from any forward-looking statement set forth in this Form 10-Q. You should carefully consider these risks and uncertainties described and other information contained in the reports we file with or furnish to the SEC before making any investment decision with respect to our securities. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this cautionary statement. These forward-looking statements include, but are not limited to statements concerning:

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Some of the important factors that could cause our actual results to differ materially from those projected in any forward-looking statements include, but are not limited to, the following:

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Additionally, there may be other risks that are otherwise described from time to time in the reports that we file with the SEC. Any forward-looking statements in this report should be considered in light of various important factors, including the risks and uncertainties listed above, as well as others.

Overview

We are a commercial-stage specialty pharmaceutical company that develops and commercializes innovative supportive care products. As of September 30, 2018, we have two commercially marketed products:

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We market SUBSYS® and SYNDROS® through our U.S.-based field sales force focused on oncologists and supportive care physicians. Consistent with most pharmaceutical manufacturing companies, we sell SUBSYS® and SYNDROS® primarily to pharmaceutical wholesalers and collect sales proceeds from those wholesalers. For the nine months ended September 30, 2018, three of our largest wholesale customers accounted for 59% of product shipments. We also sell SUBSYS® and SYNDROS® directly to certain specialty pharmaceutical retailers who distribute our product. For the nine months ended September 30, 2018, two of our largest specialty pharmaceutical retailers accounted for 39% of product shipments. 

On November 5, 2018, we announced that we have commenced a process to review strategic alternatives for our portfolio of opioid-related assets, including SUBSYS®, as well as formulations of buprenorphine and the combination of buprenorphine/naloxone. Our decision to pursue this process is consistent with our objective to become a leader in pharmaceutical cannabinoids and novel drug delivery systems and to continue shifting our focus away from opioids in our product pipeline. We anticipate that our company has a number of clinical and regulatory milestones to achieve over the next few quarters, including the completion of the CBD and epinephrine studies and filing the naloxone NDA, that are consistent with our objectives.

All wholesaler and specialty pharmacies that fulfill SUBSYS® and SYNDROS® prescriptions are fully independent from us. For instance, we do not own or have any ownership stake in any pharmaceutical wholesaler or specialty pharmacy, nor do we have an option to acquire any wholesaler or specialty pharmacy. In addition, our relationships with every pharmacy that fulfills SUBSYS® and SYNDROS® prescriptions are non-exclusive in that each of these pharmacies may also fulfill prescriptions for other pharmaceutical manufacturers, including our competitors. For the nine months ended September 30, 2018, over 269 independent pharmacies have fulfilled at least one SUBSYS® prescription.

Our sales of, and revenue from, SUBSYS® and SYNDROS® depend in significant part on the coverage and reimbursement policies of third-party payers, including government payers, such as Medicare and Medicaid, and private health insurers. All third-party payers are sensitive to the cost of drugs, including our products, and consistently implement efforts to control these costs, which efforts include, but are not limited to, establishing excluded or preferred drug lists. SUBSYS® and SYNDROS® have been, and will continue to be, subject to these restrictions and impediments from third-party payers, particularly PBMs and private health insurers. We have in the past, either directly or through the use of qualified third-party entities such as large service providers or specialty pharmacies, facilitated assistance to patients in connection with obtaining insurance coverage for our products.

 

We focus a significant portion of our resources on our research and development efforts. In particular, we are developing product candidates in both cannabinoids and sublingual and intranasal sprays. Our most advanced product candidate is a buprenorphine sublingual spray. We believe this product candidate possesses unique pharmacological properties that may make it a safe and efficacious alternative to traditional opioids, especially outside of a hospital setting. On September 29, 2017, we filed an NDA with the FDA for this product candidate, and on December 6, 2017, the FDA accepted the filing.  On July 27, 2018, we received a Complete Response Letter from the FDA, indicating that, although the clinical development program demonstrated all three proposed doses of the product candidate were statistically significantly different than placebo in providing pain relief, some of the data suggested potential safety concerns. Given the attributes of our proprietary buprenorphine formulation for sublingual delivery, we continue to believe that this drug-device combination could bring value to the management of pain and will assess the next steps for this product.  Additionally, we continue to progress with our Cannabidiol Oral Solution, a CBD, and currently have four clinical development programs underway, including two Phase 2 and one Phase 3 clinical trials.

We produce the dronabinol API for SYNDROS® at our U.S.-based, state-of-the-art dronabinol manufacturing facility. While we believe that this facility has the capacity to supply sufficient commercial quantities of dronabinol API for SYNDROS® and support the continued development of our other dronabinol product candidates in the near-term, we have opened and expanded a second dronabinol manufacturing facility, which we anticipate will enable us to supply sufficient commercial quantities of dronabinol API for the anticipated commercialization of our proprietary dronabinol product candidates, if approved.

We have the capability to manufacture pharmaceutical CBD, an over 99.5% pure form of cannabidiol, in our Round Rock, Texas manufacturing facility.

Factors Affecting Our Performance

We believe that our performance and future success are dependent upon a number of factors, including our approved product sales, investments in our infrastructure and growth, our ability to successfully develop product candidates, and complete related regulatory processes. While each of these areas presents significant opportunities for us, they also pose significant risks and challenges that we must successfully address. In addition, our ability to ensure that our products, policies

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and practices adhere to the extensive national, state, and local regulations applicable to our industry is critical to our success. Finally, we believe that as our ongoing federal and state investigations and litigation proceedings have continued to accumulate, these challenges in the aggregate have led to significant legal costs and pressure on our business with respect to factors like reputational damage in the healthcare community and industry.

As management seeks to continue to provide insight into known material trends and uncertainties related to our net revenue and other factors affecting our performance, we note that the macro trend of the continuing and heightened publicity surrounding the national opioid epidemic continues to result in sensitivity by many health care professionals to prescribe opioids, pharmacies to dispense opioids, distributors to distribute opioids and third-party payors to cover opioid prescriptions, particularly those that are off-label. Third-party payers, such as insurance companies and regulatory and government agencies continue to scrutinize the indications and uses for which opioid prescriptions are being written and dispensed. In addition, we believe other high-profile initiatives, such as (i) President Trump’s declaration of the opioid crisis as a public health emergency, (ii) Congressional efforts to examine the causes of the opioid epidemic in public and (iii) states, cities and counties initiating multi-district litigation against manufacturers and distributors of opioids, have likely added to this sensitivity around opioid prescribing. Consequently, these current and potential future trends and events have affected and will likely continue to affect, the manner in which, and the situations when, opioids, including SUBSYS®, are being prescribed, dispensed and approved for coverage.

Our product, and the TIRF class in which it is classified, has experienced a significant downward trend for the past several years.  Based upon industry data available to us, since 2015, TIRF class prescriptions have declined approximately 75% and it is difficult to predict if this trend will continue or whether the prescriptions for this class of product will stabilize.  Our product, SUBSYS®, is declining at faster rate than the overall market and we have not been able to stabilize the trajectory of our revenue. We believe that the nature of the pricing on our branded products such as SUBSYS® (as well as SYNDROS®) has adversely affected our overall market share decline, and accordingly, our revenue generated from such products, especially since pharmaceutical product pricing has received significant governmental and media attention and we believe that migration to lower-cost generics has resulted from this focus.

In addition to the macro trends discussed above, our Company continues to have issues more specific to our business that have affected, and will likely continue to adversely affect, our net revenue and may be causing the decrease in overall market share for SUBSYS®. For instance, our Company has significant reputational issues primarily driven by ongoing state and federal investigations into our sales, marketing and other commercial practices, as well as criminal developments related thereto, and media reports covering such activity. We have had numerous former employees that have either been charged with or have pled guilty to criminal activity in connection with our sales, marketing, and other commercial practices. In addition, we had various health care professionals that previously interacted with our Company, either through our speaker bureau, as a prescriber, or both, that have either been charged with, or have pled guilty to or been convicted of, criminal activity in connection with our sales, marketing and other commercial practices. These developments, which may continue to worsen, have significantly and adversely affected our reputation within the healthcare industry and with some potential prescribers of our products.

As discussed above, we announced, on November 5, 2018, that we have commenced a process to review strategic alternatives for our portfolio of opioid-related assets, including SUBSYS®, as well as formulations of buprenorphine and the combination of buprenorphine/naloxone. Our decision to pursue this process is consistent with our objective to become a leader in pharmaceutical cannabinoids and novel drug delivery systems and to continue shifting our focus away from opioids in our product pipeline. We anticipate that our company has a number of clinical and regulatory milestones to achieve over the next few quarters, including the completion of the CBD and epinephrine studies and filing the naloxone NDA, that are consistent with our objectives.  

In response to the continuing decline in revenue, our management team has continued to examine potential cost reduction initiatives that could more closely align operating expenses with our reduced revenue.  On July 12, 2018, we eliminated 45 positions through headcount reduction and role consolidation. The headcount reduction included 30 employees, the majority of which were sales and marketing employees, and represented approximately 9% of our workforce at the time.  On and around November 1, 2018, we eliminated an additional 48 positions through further headcount reduction and role consolidation.  The headcount reduction included 36 employees, the majority of which were sales and marketing employees, and represented approximately 13% of our workforce at the time.  These reductions in our sales and marketing force may adversely affect the sales performance of our products.

Management may in the future need to take additional cost reduction measures to the extent that our revenue does not stabilize or decisions that management makes in connection with this strategic alternative process materially affect our liquidity and our primary revenue generating asset, SUBSYS®.  In addition, our company may need to seek liquidity from outside sources including debt and equity in order to continue to meet management’s operating plans and objectives and there can be no assurances that we will be able to do so at all or on terms that we believe are favorable to us.

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Approved Product Sales. Our operating results will depend significantly upon sales of approved products. During the nine months ended September 30, 2018, substantially all of our net revenues were generated from the sale of our approved product, SUBSYS®. We generated minimal revenues from the sale of SYNDROS® during the nine months ended September 30, 2018. Our results depend on prescription volume generally, which we believe is driven primarily by achievement of broad market acceptance and coverage by third-party payers, and effectiveness of the marketing and selling efforts with respect to SUBSYS® and SYNDROS®. Moreover, our gross margins improve on a unit-by-unit basis as we sell higher dosage strengths of our products. Importantly, the proportion of prescriptions written for repeat SUBSYS® patients was approximately 91% of prescriptions as of September 30, 2018. Generally, repeat SUBSYS® patients receive significantly higher doses of SUBSYS® on average than first-time patients, as patients are titrated from a starter dose of SUBSYS® to their effective dose in accordance with the TIRF REMS protocol.

According to IQVIA, a worldwide integrated information and technology health care service provider, the total market for TIRF products for the three months ended September 30, 2018, was approximately 6,000 prescriptions and we estimate SUBSYS® prescriptions were approximately 27% of the TIRF market in this period, compared to a total market for TIRF products of approximately 10,000 prescriptions and approximately 31% SUBSYS® market share for the three months ended September 30, 2017.

While we continue to sell directly into wholesalers and retail pharmacies for our revenue, the direct pressures discussed above related to the retail demand-side components of our business will likely result in our inability to grow full-year 2018 SUBSYS® revenue. In addition, for the same reasons, we anticipate that we will likely continue to experience future declines in SUBSYS® revenue for the remainder of 2018 when compared to prior quarters in 2017.

Third-Party Payer Interactions and Government Programs Associated with Reimbursement. Acceptance of our products by third-party payers is critical to the success of our business and financial condition. Our relationships with these third-party payers evolves on a regular basis and is often difficult to predict, but may be affected by the reputational issues discussed above. By way of example, from time to time, third-party payers modify which drugs they choose to reimburse. For instance, on or around August 1, 2014, ESI officially released its exclusion list of drugs which included SUBSYS®, effective January 1, 2015, in connection with its national preferred formulary. While SUBSYS® was removed from this list in 2017, other PBMs may take similar actions as a result of a number of factors, including migration to lower-cost generics, and these actions may have a material impact on our net revenue in the future. As we have in the past, we will continue working with PBMs to evaluate price increases and to communicate with managed care and health-system decision-makers to ensure a balanced approach, which takes into account the clinical performance and efficacy of our products. 

In addition, from time to time, our business may be affected by evolving or new governmental programs in the reimbursement landscape. For instance, CMS, which is part of the HHS, has instituted The Recovery Audit Program. The program’s mission is to identify and correct improper Medicare payments through the efficient detection and collection of overpayments made on claims of health care services provided to Medicare beneficiaries, and the identification of underpayments to providers so that CMS can implement actions that will prevent future improper payments in all 50 states. We are aware that in January 2016, certain specialty pharmacies received written correspondence from Humana indicating that as a result of a CMS audit, Humana was initiating a deletion of certain PDEs related to SUBSYS®, which will result in a reversal and recovery of identified claims paid to certain pharmacies. This audit by CMS may have been part of The Recovery Audit Program or a similar initiative of CMS. Based upon information available to us, all of these claims involve Medicare Part D patients whose prescriptions were in connection with off-label indications and related to approximately $5.6 million in SUBSYS® claims in the aggregate. Upon our inquiry for more information about these matters, Humana notified us that these deletions of certain PDEs resulting from the CMS audit also involve TIRF medications other than SUBSYS® and Humana intends to resolve these matters with the pharmacies. We believe that some affected pharmacies may alter their processes and or protocols related to dispensing off-label TIRF prescriptions to Medicare patients as a result of these and similar events. 

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Investments in Our Infrastructure and Growth. Our ability to increase our sales and to further penetrate our target market segments is dependent in part on our ability to invest in our infrastructure and in our sales and marketing efforts. In order to drive further growth, we may hire additional sales and marketing personnel and invest in marketing our products to our target physician prescriber base. While we would anticipate that any increase in sales force would result in increased product sales and net revenue, this would also lead to corresponding increases in our operating expenses. Conversely, a decrease in sales force may lead to decreased product sales, net revenue, and operating expenses. As of September 30, 2018, we had 112 full-time sales and marketing personnel, as compared to 197 full-time sales and marketing personnel at September 30, 2017. We have constructed and expanded a second dronabinol manufacturing facility, which we anticipate will supply us with sufficient commercial quantities of dronabinol API for the commercialization of our proprietary dronabinol product candidates, if approved. This second facility has, and will continue to, increase our operating expenses.

Product Development and Related Regulatory Processes. Our operating results will also depend significantly on our research and development activities and related regulatory developments. Our research and development expenses were $43.2 million and $46.6 million for the nine months ended September 30, 2018 and 2017, respectively. As of September 30, 2018, we had 53 full-time research and development personnel, as compared to 60 full-time research and development personnel at September 30, 2017. We expect research and development expenses to fluctuate with the timing of our planned preclinical studies and clinical trials for our product candidates, particularly our proprietary cannabinoid product candidates and sublingual spray product candidates. We do not expect to realize net revenues from all of these research and development initiatives in the near term and may never realize net revenues from these investments. Due to the risks inherent in conducting preclinical studies and clinical trials, the regulatory approval process and the costs of preparing, filing and prosecuting patent applications, our development completion dates and costs will vary significantly for each product candidate and are very difficult to estimate. The lengthy process of seeking regulatory approvals and the subsequent compliance with applicable regulations require the expenditure of substantial additional resources. Any failure by us to obtain, or any delay in obtaining, regulatory approvals or acceptable DEA classifications for our product candidates could cause our research and development expenditures to increase significantly and in turn, have a material adverse effect on our results of operations.

In addition, dronabinol and CBD are subject to the DEA’s production and procurement quota scheme. The DEA establishes annually an aggregate quota for the amount of dronabinol and CBD that may be produced in the United States based on the DEA’s estimate of the quantity needed to meet legitimate scientific and medicinal needs. This limited aggregate amount of dronabinol and CBD that the DEA allows to be produced in the United States each year is allocated among individual companies, who must submit applications annually to the DEA for individual production and procurement quotas. We are required to obtain an annual quota from the DEA in order to manufacture and produce dronabinol and CBD. The DEA may adjust aggregate production quotas and individual production and procurement quotas from time to time during the year and has substantial discretion in deciding whether or not to make such adjustments. For 2018, we were originally allocated what we believe is a sufficient quantity of dronabinol and CBD to meet our currently anticipated production and testing needs through 2018; however, due to a discrepancy in the interpretations of how to account for in-process CBD materials in connection with our quota limitations, we will likely need additional amounts of CBD for both 2018 (and future years) to implement our business plan and there is no certainty we will receive what we believe is the appropriate adjustments to our CBD quota.  We are actively working with the DEA to resolve this matter; however, if we fail to resolve this matter and it is determined that we failed to stay within DEA quota guidelines, this could affect our clinical timelines and/or subject us to potential remedial actions by DEA including but not limited to fines, future restrictions and/or loss of registration.

Legal Expenses. As our ongoing federal and state investigations and litigation proceedings have continued to accumulate, these challenges have led to significant legal costs and expenses, which have had, and will continue to have, a material adverse effect on our financial condition and results of operations. It is difficult to predict such legal costs, and in many ways these costs are not within our control. For instance, consistent with the practice of many publicly-traded companies, we have entered into, and continue to enter into, indemnity agreements with our executive officers and certain members of our board of directors.  These indemnity agreements broadly provide for us to advance expenses (including attorneys’ fees) incurred in connection with any legal proceeding, as well as indemnification for any and all expenses, actually and reasonably incurred, in connection with the investigation, defense, settlement or appeal of such a proceeding, in connection with matters related to their position. As has been previously disclosed, two of our former executive officers, who have indemnity agreements with us based upon their prior employment and membership on our board of directors, have been criminally charged. Our satisfaction of our obligations pursuant to these executives’ indemnity agreements, as well as the payment of legal fees for other former employees in connection with these legal proceedings, has resulted in significant expense. Moreover, our board of directors has been subject to securities class action and derivative cases which has resulted, and may in the future result, in significant and continuing legal costs and expenses related to separate legal counsel for individuals. The Company continues to analyze, and in some instances dispute the reasonableness of a portion of, the costs and expenses associated with the defense and representation of Dr. Kapoor. If such disputed amounts are subsequently determined not to be due and payable, we would recognize a reversal of these expenses in a future period.  The reversal of these expenses could have a material impact on our unaudited condensed consolidated statements of operations and comprehensive loss.  If it is subsequently

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determined that all of these costs are reasonable, and the company is forced to pay the remaining balance, this could have a material adverse impact on our cash position and liquidity.

Cost Savings Initiatives.  As a result of the declining TIRF market, combined with the DOJ Investigation and other legal matters, we have implemented a number of cost savings initiatives.  Some of these initiatives include prioritizing research and development projects, reducing discretionary spending, and renegotiating long-term commitment contracts.  On July 12, 2018, we eliminated 45 positions through headcount reduction and role consolidation. The headcount reduction included 30 employees, the majority of which were sales and marketing employees, and represented approximately 9% of our workforce at the time.  The affected employees received certain severance benefits, for which we incurred a one-time severance-related charge totaling approximately $0.3 million recorded within sales and marketing expenses during the nine months ended September 30, 2018.  On and around November 1, 2018, we eliminated an additional 48 positions through further headcount reduction and role consolidation.  The headcount reduction included 36 employees, the majority of which were sales and marketing employees, and represented approximately 13% of our workforce at the time. We may also incur other charges or cash expenditures not currently contemplated due to events that may occur as a result of, or associated with, the headcount reduction.  We expect to continue to incur losses from operations, and we may take additional actions to reduce our immediate cash expenditures. Although management has been successful in renegotiating long-term contracts and reducing expenses, there can be no assurance that we will be successful or that any needed financing will be available in the future at terms acceptable to the Company.

Basis of Presentation 

Net Revenue

We sell SUBSYS® and SYNDROS® in various dosing packages to wholesale pharmaceutical distributors and specialty retail pharmacies (collectively, our customers), on a wholesale basis. Sales to our customers are subject to specified rights of return. We recognize revenue when we transfer control of our products to our customers, as our contracts have a single performance obligation (delivery of our product to their preferred location). Net revenue is measured as the amount of consideration we expect to receive in exchange for transferring goods.

Cost of Revenue, Gross Profit and Gross Margin

Cost of revenue consists primarily of materials, third-party manufacturing costs, freight in, direct and indirect personnel costs, and other overhead costs based on units dispensed through patient prescriptions. Also, included in cost of revenue are charges for reserves for excess, dated, or obsolete commercial inventories and production manufacturing variances.

Gross profit is net revenue less cost of revenue. Gross margin is gross profit expressed as a percentage of net revenue.

Sales and Marketing Expenses

Our sales and marketing expenses consist primarily of salaries, commissions, benefits, travel, consulting fees, costs of obtaining prescription and market data, and market research studies related to SUBSYS® and SYNDROS®. As of September 30, 2018, we had 112 full-time sales and marketing personnel as compared to 197 full-time sales and marketing personnel at September 30, 2017. Because we use an incentive-based compensation model for our sales professionals, we expect our sales and marketing expenses to fluctuate from period to period based on changes in net revenue.

Research and Development Expenses

Research and development expenses consist of costs associated with our preclinical studies and clinical trials, and other expenses related to our drug development efforts. Our research and development expenses consist primarily of:

Our recent research and development efforts have been focused primarily on our cannabidiol, naloxone, dronabinol, buprenorphine, and epinephrine programs. As of September 30, 2018, we had 53 full-time research and development personnel

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as compared to 60 full-time research and development personnel at September 30, 2017. We expect research and development expenses to fluctuate with the timing of our planned preclinical studies and clinical trials for our product candidates. We determine which research and development projects to pursue, as well as the level of funding available for each project, based on the scientific, preclinical and clinical results of each product candidate, as well as the related regulatory action and the risk adjusted economic benefit to the Company.

The following table provides a breakdown of our research and development expenses during the nine months ended September 30, 2018 and 2017 (in millions):

 

 

General and Administrative Expenses

Our general and administrative expenses consist primarily of:

As of September 30, 2018 and 2017, we had 53 full-time general and administrative personnel. We expect general and administrative expense to fluctuate with market changes.

Legal Expenses

Our legal expenses consist primarily of salaries and related costs for legal personnel and professional fees for legal services.  We expect legal expense to fluctuate due to timing of litigation and legal defense activities. See “Factors Affecting Our Performance – Legal Expenses” for additional information.  

Income Tax Expense (Benefit)

We account for income taxes based upon an asset and liability approach. Deferred tax assets and liabilities represent the future tax consequences of the differences between the financial statement carrying amounts of assets and liabilities versus the tax basis of assets and liabilities. Under this method, deferred tax assets are recognized for deductible temporary differences, and operating loss and tax credit carryforwards. Deferred tax liabilities are recognized for taxable temporary differences. Deferred tax assets are reduced by a valuation allowance when, in our opinion, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The impact of tax rate changes on deferred tax assets and liabilities is recognized in the year that the change is enacted. We also account for the uncertainty in income taxes by utilizing a comprehensive model for the recognition, measurement, presentation, and disclosure in financial statements of any uncertain tax positions that have been taken or are expected to be taken on an income tax return.

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During the three months ended September 30, 2018, we identified an error related to the accounting for the uncertain income tax positions in 2017. We assessed the materiality of these errors on our prior annual financial statements, assessing materiality both quantitatively and qualitatively, in accordance with the SEC’s Staff Accounting Bulletin (“SAB”) No. 99 and SAB No. 108 and concluded that the errors were not material to our audited financial statements for the year ended December 31, 2017, the unaudited condensed consolidated financial statements for any of the quarterly periods within the year ended December 31, 2017, nor to the quarterly periods ended March 31, 2018 and June 30, 2018. However, the impact of these errors was material to the accompanying unaudited condensed consolidated financial statements. To correctly present uncertain income tax position liabilities, income tax expense (benefit), and net loss per share in the appropriate periods, management revised its previously issued consolidated balance sheet and statement of stockholders’ equity as of December 31, 2017, the consolidated statement of operations and comprehensive loss for the year ended December 31, 2017, the unaudited condensed consolidated statements of operations and comprehensive loss for the three and nine months ended September 30, 2017, and the unaudited condensed consolidated statements of cash flows for the nine months ended September 30, 2017. See Note 1, Nature of Business and Basis of Presentation, of the Notes to our Unaudited Condensed Consolidated Financial Statements for additional information.  

Significant Accounting Policies and Estimates

Significant changes to our accounting policies as a result of adopting ASC Topic 606 are discussed in Note 1 and Note 2 of the Notes to our Unaudited Condensed Consolidated Financial Statements. Significant changes to our accounting policies as a result of adopting ASU 2018-07 are discussed in Note 1.  There were no other changes in our significant accounting policies and estimates during the nine months ended September 30, 2018, from those set forth in “Note 2, Significant Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2017.

Results of Operations

Comparison of Three Months Ended September 30, 2018 to Three Months Ended September 30, 2017

The following table presents certain selected consolidated financial data for the three months ended September 30, 2018 and 2017, expressed as a percentage of net revenue:

 

 

Net Revenue. Net revenue decreased $12.4 million, or 40.4%, to $18.3 million for the three months ended September 30, 2018, compared to $30.7 million for the three months ended September 30, 2017. The decrease in net revenue was primarily attributable to a 49.4% decrease in SUBSYS® shipments to our customers for the three months ended September 30, 2018 primarily due to reduced demand for SUBSYS®, as compared to the three months ended September 30, 2017, partially offset

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by a 7.3% increase in net sales price due to changes in mix of prescribed dosages and changes in provisions for wholesaler discounts, patient discounts, rebates, and returns, as well as price increases in August 2017 and January 2018. Provisions for patient discounts, wholesaler discounts, rebates, and returns were $1.1 million, $2.1 million, $4.2 million, and $1.8 million, respectively, for the three months ended September 30, 2018, compared to $1.9 million, $3.5 million, $7.2 million, and $5.6 million, respectively, for the three months ended September 30, 2017. The decrease in product sales allowances was primarily attributable to lower sales of SUBSYS® and a decrease in product returns during the three months ended September 30, 2018 as compared to the three months ended September 30, 2017. As described in “Factors Affecting Our Performance”, the continuing sensitivity by some health care professionals to prescribe, and pharmacies to dispense, opioids, scrutiny by third-party payers and governmental agencies, ongoing state and federal investigations, and media reports related thereto, will likely result in our inability to grow full-year SUBSYS® revenue for the remainder of 2018 when compared to 2017. In addition, for the same reasons, we anticipate that we will experience future declines in SUBSYS® revenue for the remainder of 2018 when compared to prior quarters in 2017.

Cost of Revenue, Gross Profit and Gross Margin. Cost of revenue decreased $5.1 million to $2.4 million for the three months ended September 30, 2018, compared to $7.5 million for the three months ended September 30, 2017. The decrease in cost of revenue was primarily attributable to the decrease in sales of SUBSYS® during the three months ended September 30, 2018. Gross profit decreased $7.2 million to $16.0 million for the three months ended September 30, 2018, compared to $23.2 million for the three months ended September 30, 2017, due primarily to the decrease in sales of SUBSYS®. Gross margin for the three months ended September 30, 2018 was approximately 87% compared to approximately 76% for the three months ended September 30, 2017. The increase in gross margin was primarily due to a decrease in product returns and excess and obsolete inventory reserves.

Sales and Marketing Expense. Sales and marketing expense decreased $5.4 million to $7.4 million for the three months ended September 30, 2018, compared to $12.8 million for the three months ended September 30, 2017. The decrease in sales and marketing expense was primarily due to lower sales of SUBSYS® and decreases in personnel costs resulting from the headcount reductions and role consolidations in July 2018 as a part of our cost savings initiatives.

Research and Development Expense. Research and development expense decreased $5.1 million to $14.5 million for the three months ended September 30, 2018, compared to $19.6 million for the three months ended September 30, 2017. The decrease in research and development expense was primarily due to timing of clinical and development expenses and decreases in personnel costs.

General and Administrative Expense. General and administrative expense decreased $2.4 million to $8.9 million for the three months ended September 30, 2018, compared to $11.3 million for three months ended September 30, 2017.  The decrease in general and administrative expense was primarily due to a decrease in stock-based compensation costs.

Legal Expense. Legal expense increased $11.6 million to $16.0 million for the three months ended September 30, 2018, compared to $4.4 million for the three months ended September 30, 2017.  The increase was due to increases in legal expense incurred in connection with various ongoing government investigations and prosecutions of our former employees, and other legal proceedings.  See “Factors Affecting our Performance – Legal Expenses” for additional information.

Charges Related to Litigation Award and Settlements. There were no material charges related to litigation award and settlements for the three months ended September 30, 2018. Charges related to litigation award and settlements for the three months ended September 30, 2017 represent an accrual of $150.0 million in connection with the DOJ Investigation and interest expense of $0.8 million in connection with the settlement with Dr. Kottayil.  See Note 7, Commitments and Contingencies, of the Notes to our Unaudited Condensed Consolidated Financial Statements for additional information.  

Income Tax Expense (Benefit). Income tax expense was $0.2 million for the three months ended September 30, 2018, representing an effective tax rate of (0.5)%, as compared to a benefit of $(9.0) million for the three months ended September 30, 2017, representing an effective tax rate of 5.2%. The change in the effective rate for the period ended September 30, 2018, compared with the same period in the previous year, was primarily due to the full valuation allowance in the three months ended September 30, 2018. As of September 30, 2018, we had approximately $76.0 million of federal NOLs, and $272.9 million of state NOLs.

We record valuation allowances to reduce the book value of our deferred tax assets to amounts that are estimated on a more likely than not basis to be realized. We established a full valuation allowance for deferred taxes during the period ended December 31, 2017, and maintain a full valuation allowance as of the current quarter. The establishment of a valuation

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allowance does not impact cash, nor does it preclude us from using our tax credits, loss carryforwards and other deferred tax assets in the future.

We had unrecognized tax benefits of approximately $8.0 million as of September 30, 2018, primarily associated with tax positions taken in prior years. No significant penalties and approximately $1.0 million of interest are included in income taxes and accounted for on the balance sheet related to unrecognized tax positions.

 

Comparison of Nine Months Ended September 30, 2018 to Nine Months Ended September 30, 2017

The following table presents certain selected consolidated financial data for the nine months ended September 30, 2018 and 2017, expressed as a percentage of net revenue:

 

Net Revenue. Net revenue decreased $43.5 million, or 39.8%, to $65.7 million for the nine months ended September 30, 2018, compared to $109.2 million for the nine months ended September 30, 2017. The decrease in net revenue was primarily attributable to a 43.0% decrease in SUBSYS® shipments to our customers for the nine months ended September 30, 2018 primarily due to reduced demand for SUBSYS®, as compared to the nine months ended September 30, 2017, and a 1.1% decrease in net sales price due to changes in mix of prescribed dosages and changes in provisions for wholesaler discounts, patient discounts, rebates, and returns, partially offset by price increases in August 2017 and January 2018. Provisions for patient discounts, wholesaler discounts, rebates, and returns were $3.9 million, $7.7 million, $16.6 million, and $10.0 million, respectively, or for the nine months ended September 30, 2018, compared to $8.9 million, $11.2 million, $23.1 million, and $6.6 million, respectively, for the nine months ended September 30, 2017. The decrease in product sales allowances (other than for product returns) was primarily attributable to lower sales of SUBSYS® during the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017, partially offset by a $3.4 million increase in product returns. As described in “Factors Affecting Our Performance”, the continuing sensitivity by some health care professionals to prescribe, and pharmacies to dispense, opioids, scrutiny by third-party payers and governmental agencies, ongoing state and federal investigations, and media reports related thereto, will likely result in our inability to grow full-year SUBSYS® revenue for the remainder of 2018 when compared to 2017. In addition, for the same reasons, we anticipate that we will experience future declines in SUBSYS® revenue for the remainder of 2018 when compared to prior quarters in 2017.

Cost of Revenue, Gross Profit and Gross Margin. Cost of revenue decreased $7.8 million to $8.2 million for the nine months ended September 30, 2018, compared to $16.0 million for the nine months ended September 30, 2017. The decrease in cost of revenue was primarily attributable to the decrease in sales of SUBSYS® during the nine months ended September 30, 2018. Gross profit decreased $35.7 million to $57.5 million for the nine months ended September 30, 2018, compared to $93.2 million for the nine months ended September 30, 2017, due primarily to the decrease in sales of SUBSYS®. Gross margin for

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the nine months ended September 30, 2018 was 88%, compared to approximately 85% for the nine months ended September 30, 2017.

Sales and Marketing Expense. Sales and marketing expense decreased $16.3 million to $25.5 million for the nine months ended September 30, 2018, compared to $41.8 million for the nine months ended September 30, 2017. The decrease in sales and marketing expense was primarily due to lower sales of SUBSYS® and decreases in personnel costs resulting from the headcount reductions and role consolidations in July 2018 as a part of our cost savings initiatives.

Research and Development Expense. Research and development expense decreased $3.4 million to $43.2 million for the nine months ended September 30, 2018, compared to $46.6 million for the nine months ended September 30, 2017. The decrease in research and development expense was primarily due to timing of clinical and development expenses and decreases in personnel costs.

General and Administrative Expense. General and administrative expense decreased $2.6 million to $29.3 million for the nine months ended September 30, 2018, compared to $31.9 million for the nine months ended September 30, 2017. The decrease in general and administrative expense was primarily due to a decrease in stock-based compensation costs.

Legal Expense. Legal expense increased $21.5 million to $37.5 million for the nine months ended September 30, 2018, compared to $16.0 million for the nine months ended September 30, 2017.  The increase was due to increases in legal expense incurred in connection with various ongoing government investigations and prosecutions of our former employees, and other legal proceedings. See “Factors Affecting our Performance – Legal Expenses” for additional information.

Charges Related to Litigation Award and Settlements. Charges related to litigation award and settlements for the nine months ended September 30, 2018 were $0.8 million. Charges related to litigation award and settlements for the nine months ended September 30, 2017 represent an accrual of $150.0 million in connection with the DOJ Investigation, $4.5 million in connection with the investigation by the State of Illinois, and interest expense of $0.8 million in connection with the settlement with Dr. Kottayil.  See Note 7, Commitments and Contingencies, of the Notes to our Unaudited Condensed Consolidated Financial Statements for additional information.

Income Tax Expense (Benefit). Income tax expense was $0.5 million for the nine months ended September 30, 2018, representing an effective tax rate of (0.6)%, as compared to a benefit of $(16.1) million for the nine months ended September 30, 2017, representing an effective tax rate of 8.2%. The change in the effective rate for the period ended September 30, 2018, compared with the same period in the previous year was primarily due to the full valuation allowance in the nine months ended September 30, 2018. As of September 30, 2018, we had approximately $76.0 million of federal NOLs, and $272.9 million of state NOLs.

We record valuation allowances to reduce the book value of our deferred tax assets to amounts that are estimated on a more likely than not basis to be realized. We established a full valuation allowance for deferred taxes during the period ended December 31, 2017, and maintain a full valuation allowance as of the current quarter. The establishment of a valuation allowance does not impact cash, nor does it preclude us from using our tax credits, loss carryforwards and other deferred tax assets in the future.

We had unrecognized tax benefits of approximately $8.0 million as of September 30, 2018, primarily associated with tax positions taken in prior years. No significant penalties and approximately $1.0 million of interest are included in income taxes and accounted for on the balance sheet related to unrecognized tax positions.

Liquidity and Capital Resources

Sources of Liquidity

Current operations are financed principally with existing cash on hand, investments in marketable securities and cash flows from operations.

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Cash Flows 

The following table shows a summary of our cash flows for the periods indicated (in millions):

 

 

Cash Flows from Operating Activities. Net cash used in operating activities was $48.7 million and $49.4 million for the nine months ended September 30, 2018 and 2017, respectively. The net cash used during the nine months ended September 30, 2018 primarily reflects the net loss for the period driven by a reduction in SUBSYS® net sales, adjusted in part by depreciation and amortization, stock-based compensation expense, and an impairment loss on property and equipment. The net cash used during the nine months ended September 30, 2017 primarily reflects the net loss for the period driven by a reduction in SUBSYS® net sales, adjusted in part by depreciation and amortization and stock-based compensation expense, and is also impacted by changes in working capital and payments in connection with the settlement of the investigations by the States of New Hampshire and Illinois, and the settlement with Dr. Kottayil.

Cash Flows from Investing Activities. Net cash provided by investing activities was $35.7 million for the nine months ended September 30, 2018, and consists primarily of the net sale and maturity of investments, partially offset by purchases of property and equipment. Net cash used in investing activities of $23.8 million for the nine months ended September 30, 2017 consists primarily of the purchase of investments and property and equipment.

Cash Flows from Financing Activities. Net cash provided by financing activities was $1.8 million and $4.4 million for the nine months ended September 30, 2018 and 2017. During the nine months ended September 30, 2018, we received proceeds from the exercise of stock options of $1.1 million and proceeds from shares issued under our employee stock purchase plan of $0.7 million. During the nine months ended September 30, 2017, we received proceeds from the exercise of stock options of $3.6 million and proceeds from shares issued under our employee stock purchase plan of $0.8 million.

We invoice pharmaceutical wholesalers and specialty pharmaceutical retailers upon delivery of SUBSYS® and SYNDROS®. To date, our customers have typically paid us 30 to 60 days from their applicable invoice dates. 

Our cash flows for 2018 and beyond will depend on a variety of factors, including sales of SUBSYS® and SYNDROS®, regulatory approvals, investments in manufacturing and production, capital equipment, research and development, general and administrative expenses, strategic alternatives related to our opioid-related assets, and legal costs and expenses associated with litigation proceedings and settlements.

Funding Requirements

We believe that our cash and cash equivalents and investments, together with interest thereon, will be sufficient to fund our operations for at least the next 12 months from the issuance date of these unaudited condensed consolidated financial statements. As our research and development activities mature and develop over the next several years, the Company will likely require substantial additional funds to continue such activities, depending upon events that are difficult to predict at this time. In addition, as the Company continues to contend with existing litigation (and resolve such proceedings as appropriate) and fund other legal expenses related to our former employees, we may require additional funding.   In this regard, management’s plans, in order to meet any additional operating cash flow requirements, include the pursuit of potential strategic alternatives related to our opioid-related assets, as well as financing activities such as public offerings and private placements of our common stock, preferred stock offerings, and issuances of debt and convertible debt instruments.

In the ordinary course of business, we are involved in litigation, claims, government inquiries, investigations, charges and proceedings. Refer to Note 7, Commitments and Contingencies, to the Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q. The legal fees and expenses required to

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successfully defend ourselves and our former executives against pending and future litigation, criminal trials and investigations has, and will likely continue to, materially impact cash flows. In addition, the uncertainty of the timing of a final settlement with the DOJ (and the payments associated therewith), will likely impact our liquidity and may require us to sell investments before the recovery of their amortized cost basis or raise capital at potentially unfavorable terms or rates, particularly when aggregated with other potential state and multi-district litigation investigation settlements that may occur in the future, as well as potential future settlements related to ongoing litigation with insurance payers or other third parties.

Because of the numerous risks and uncertainties associated with the commercialization of SUBSYS®, SYNDROS® and the development of our other product candidates, outcomes of litigation or liabilities for indemnification, and the pursuit of strategic alternatives related to our opioid-related assets discussed elsewhere in this quarterly report, we are unable to predict the amounts of increased capital outlays and operating expenditures associated with our current anticipated product introduction, clinical trials and preclinical studies. The timing and amounts of our funding requirements will depend on numerous factors, including but not limited to:

We cannot be sure that our existing cash and cash equivalents or investments will continue to be adequate to fund our operations, or that additional financing will be available when needed, or that, if available, financing will be obtained on terms favorable to us or our stockholders. Having insufficient funds may require us to delay, scale back or eliminate some or all of our research or development programs or to relinquish greater or all rights to product candidates at an earlier stage of development or on less favorable terms than we would otherwise choose. If we raise additional funds by issuing equity or convertible securities, substantial dilution to existing stockholders will likely result. If we raise additional funds by incurring new debt obligations, the terms of the debt will likely require significant cash payment obligations as well as covenants and specific financial ratios that may restrict our ability to operate our business.

Contractual Obligations

In April 2018, we, through our manufacturing subsidiary, entered into a further amendment to our Renaissance manufacturing and supply agreement. This amendment effectively eliminates any prior minimum purchase (and batch) obligations that had been set forth in the amendment dated July 2016, and replaces them with a new annual purchase commitment of $3,000,000 for the calendar year ended December 31, 2018, and $2,000,000 for the calendar years ending December 31, 2019 and 2020. As a result, the cumulative effect related to this amendment reduces our aggregated purchase commitment with Renaissance from $12,000,000 to $7,000,000 through December 31, 2020.

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Off-Balance Sheet Arrangements

During the nine months ended September 30, 2018, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements.

Recently Adopted Accounting Pronouncements

Refer to Note 1 to the Unaudited Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q.

 

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

At September 30, 2018, $13.6 million of our cash equivalent investments was in money market securities that are reflected as cash equivalents because all original maturities are within 90 days. Money market securities may consist of commercial paper, Federal agency discount notes and money market funds. We believe our interest rate risk with respect to these investments is limited due to the short-term duration of these arrangements and the yields earned, which approximate current interest rates.

Our policy for our short-term and long-term investments is to establish a high-quality portfolio that preserves principal, meets liquidity needs, avoids inappropriate concentrations and delivers an appropriate yield in relationship to our investment guidelines and market conditions. Our investment portfolio, consisting of fixed income securities that we hold on an available-for-sale basis, was approximately $94.0 million as of September 30, 2018, and $136.4 million as of December 31, 2017. These securities, like all fixed income instruments, are subject to interest rate risk and would likely decline in value if market interest rates increase. We have the ability to hold our fixed income investments until maturity and, therefore, we would not expect to recognize any material adverse impact in income or cash flows if market interest rates increase.

The following table provides information about our available-for-sale securities that are sensitive to changes in interest rates. We have aggregated our available-for-sale securities for presentation purposes since they are all very similar in nature (dollar amounts in millions):

Interest Rate Sensitivity

Principal Amount by Expected Maturity as of September 30, 2018

 

 

We have not entered into derivative financial instruments. We do not have operations outside of the U.S. and accordingly, we have not been susceptible to significant risk from changes in foreign currencies.

During the normal course of business, we could be subjected to a variety of market risks, examples of which include, but are not limited to, interest rate movements and foreign currency fluctuations, as we discussed above, and collectability of accounts receivable. We continuously assess these risks and have established policies and procedures to protect against the adverse effects of these and other potential exposures. Although we do not anticipate any material losses in these risk areas, no assurance can be made that material losses will not be incurred in these areas in the future.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our President and Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act), as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of such date, our disclosure controls and procedures were effective.

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Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarterly period ended September 30, 2018, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

We believe that a control system, no matter how well designed and operated, cannot provide absolute assurance that the objectives of the control system are met, and no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within any company have been detected.

 

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PART II OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The information contained in Note 7 to the Unaudited Condensed Consolidated Financial Statements is incorporated herein by reference. 

ITEM 1A. RISK FACTORS

You should carefully consider the risks described in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2017, as well as other factors discussed herein under “Forward-Looking Statements” in Part I, Item 2 “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Our business, financial condition and results of operations could be adversely affected by any of the risks and uncertainties described therein. Below we have provided material updates and changes to our risk factors disclosed in Part I, Item 1A, in our Annual Report on Form 10-K.

Our principal stockholder has placed his shares in an independently controlled trust and depending upon the results of his criminal trial in 2019, his ownership stake may be subject to forfeiture or compelled divestiture.

Effective as of February 27, 2018, our company entered into a voting trust agreement with Dr. John N. Kapoor (“Kapoor”) (and certain of his beneficiaries) and an independent trustee.  During the term of this voting trust, Kapoor (and certain of his beneficiaries) will not have control over voting decisions (except under limited circumstances) over the shares of the Company’s common stock beneficially owned by Kapoor and the beneficiaries.  As of the effective date of the voting trust agreement, the shares subject to the trust represented approximately 59% of the outstanding shares of common stock of the Company. Until the voting trust agreement is terminated, the shares subject to the trust shall generally be voted on any matter by the trustee as directed by an independent voting committee (the “Voting Committee”) whose members meet certain independence standards with respect to Kapoor.  If at any time the shares subject to the trust represent less than 40% of the outstanding shares of common stock of the Company, such shares shall be voted on any matter by the trustee in the same proportion that the shares of the Company’s common stock that are not subject to the trust are voted on such matter, which is commonly referred to as “mirror voting.”  

By virtue of this trust, the Voting Committee can and will be able to effectively control the election of the members of our Board of Directors, our management and our affairs and prevent corporate transactions, such as mergers, consolidations or the sale of all or substantially all of our assets, that may be favorable from our standpoint or that of our other stockholders or cause a transaction that we or our other stockholders may view as unfavorable. In addition, pursuant to an exception included in the voting trust agreement, Kapoor retains a veto right which permits him to veto change of control transactions.  Accordingly, this concentration of ownership may harm the market price of our common stock by:

 

 

 

The existence and nature of this voting trust could be viewed negatively by third parties and have a negative impact on our stock price. Moreover, if Kapoor’s ownership falls below 40% of the outstanding shares and the shares subject to the trust are now subject to “mirror voting,” it is possible that a group of shareholders representing a relatively small percentage of ownership in the company could work together to effectively control key decisions. Finally, in the event of Kapoor’s passing, we cannot assure you as to how these shares will be distributed and subsequently voted.

In addition, Kapoor is currently in the midst of a criminal trial as result of his indictment on or about October 26, 2017 by the U.S. Attorney’s Office for the District of Massachusetts, as superseded on September 11, 2018 by a second superseding indictment.  This indictment provides that upon conviction, the government could seek forfeiture of Kapoor’s ownership interest in the Company.  Furthermore, depending upon the outcome of the trial, mandatory or permissive exclusion under OIG rules and regulations may prevent Kapoor from participating in government programs which would result in a requirement by OIG for Kapoor to divest his ownership in the Company.  Finally, depending upon the outcome of the trial, NASDAQ could require Kapoor to divest his ownership in order for the Company to continue to be listed on the exchange.

 

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If we fail to finalize our agreement in principle with the DOJ or comply with the final terms contained in the final written agreements with the DOJ and OIG, our results of operations and financial condition will be materially and adversely affected.  In addition, even if we finalize such documentation with the federal government, the additional costs and burden to comply with the terms of such documents and the risks that exist if we fail to comply with such documents, such as exclusion from federal health care programs, are significant and present significant risk to our company. Finally, we will also have additional financial payments and requirements associated with settlements with state authorities and offices of attorneys general which will result in significant costs and burdens for our company.

On August 8, 2018, we announced that we reached an agreement in principle with the DOJ to settle the DOJ’s civil and criminal investigation into inappropriate sales and commercial practices by some former company employees.  This agreement in principle is subject to the negotiation of final settlement documents with the government which will include other material non-financial terms and conditions which will also be subject to negotiation including criminal pleas by our subsidiary related to the actions of our former employees.

Once executed, these agreements will require cooperation with the federal government’s prosecutions, enhancements to our compliance program, fulfillment of reporting and monitoring obligations, and management certifications, among other requirements.  In addition, compliance with the terms of these agreements will impose additional costs and burdens on us, including in the form of employee training, third party reviews, compliance monitoring, reporting obligations and management attention. More importantly, if we fail to comply with the final agreement with DOJ and OIG, the DOJ or OIG may impose substantial monetary penalties or exclude us from federal healthcare programs, including Medicare, Medicaid or the VA, which would have a material adverse effect on our business, financial condition and results of operations.  Furthermore, we will also have additional financial payments and requirements associated with settlements with state authorities and offices of state attorneys general which will result in significant costs and burdens for our company and we may be subject to new and unanticipated third-party claims and shareholder lawsuits in connection with all of these settlements with governmental authorities.

Annual DEA quotas on the amount of dronabinol and CBD allowed to be produced in the United States and our specific allocation of dronabinol and CBD by the DEA could significantly limit the production of SYNDROS® and our CBD product candidates for which we seek to obtain regulatory approval as well as significantly delay the clinical development of our CBD product candidates.

Dronabinol and CBD are subject to the DEA’s production and procurement quota scheme. The DEA establishes annually an aggregate quota for the amount of dronabinol and CBD that may be produced in the United States based on the DEA’s estimate of the quantity needed to meet legitimate scientific and medicinal needs. This limited aggregate amount of dronabinol and CBD that the DEA allows to be produced in the United States each year is allocated among individual companies, who must submit applications annually to the DEA for individual production and procurement quotas. We are required to obtain an annual quota from the DEA in order to manufacture and produce dronabinol and CBD. The DEA may adjust aggregate production quotas and individual production and procurement quotas from time to time during the year and has substantial discretion in deciding whether or not to make such adjustments. In the future, we may need additional amounts of dronabinol and CBD to implement our business plan and there is no certainty we will receive what we believe is the appropriate adjustments to our quotas.  In addition, compliance with DEA quota requirements and restrictions can be complicated and, like any regulation, are subject to interpretations of the DEA’s rules and regulations that may not always be clear.  Ultimately, if we fail to stay with DEA quota guidelines we could be subject to potential actions by DEA including but not limited to fines, future restrictions and/or loss of registration.  See “Factors Affecting Our Performance - Product Development and Related Regulatory Processes” for additional information.

We face potential exposure on various fronts, including securities class actions and derivative cases, as well as product and other liability exposure, and our existing and future insurance coverage may be inadequate to cover any successful claims brought against us, or settlements which we choose to resolve, which could result in substantial liability that could materially and adversely affect our financial condition and results of operations.

All of the activities of our organization, including our board of directors’ oversight of management, the commercial use of our products, including any prior misdeeds of our former employees, and the clinical use of our product candidates expose us to the risk of liability claims and government sanctions and penalties. These risks are often varied and difficult to predict even in situations where we have continuing and protracted litigation since such litigation inherently unpredictable.  For instance, our company and board of directors currently face several securities class action and derivative cases and our directors and officers (“D&O”) insurance carrier has disputed the policy period into which certain matters should be placed or, in some instances, whether their policy applies.   

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In addition, because SUBSYS® is an opioid, we face significant risk of product liability for this product even though this product is approved for commercial sale by the FDA and manufactured in facilities licensed and regulated by the FDA. Our products and product candidates are designed to affect important bodily functions and processes, but side effects, manufacturing defects, misuse or abuse associated with SUBSYS®, SYNDROS®, or our product candidates could result in injury to a patient or even death. For example, because our sublingual spray technology is designed to be self-administered by patients, it is possible that a patient could fail to follow instructions and as a result apply a dose in a manner that results in injury or death. In addition, SUBSYS® is an opioid pain reliever that contains fentanyl, and SYNDROS® is a synthetic cannabinoid, which are both regulated “controlled substances” under the CSA and could result in harm to patients relating to its potential for abuse. In addition, a liability claim may be brought against us even if our products or product candidates merely appear to have caused an injury or because our commercial activities are alleged to have impaired a prescriber’s ability to independently act in the best interest of the patient. Product liability claims may be brought against us by consumers, health care providers, pharmaceutical companies or others selling or otherwise coming into contact with our products or product candidates, among others. If we cannot successfully defend ourselves against product liability claims, we will incur substantial liabilities. In addition, regardless of merit or eventual outcome, product liability claims may result in:

 

 

 

 

 

 

 

 

Finally, we face other legal challenges for which we may not have any insurance coverage at all and which may entail settlement payments or litigation judgments that could individually, or in the aggregate, have a materially adverse effect on our financial condition and results of operations. For instance, we have disputes with insurance carriers regarding claims of insurance fraud by our former employees and we have investigations by federal and state governmental authorities for the alleged prior misconduct of our former employees.

With the assistance of a reputable and prominent insurance broker, we have attempted to maintain insurance coverage for our organization, which we believed to have appropriate aggregate coverage limits consistent with market practice at the time we obtained coverage. We also carry excess product liability insurance coverage that was determined to be appropriate. However, identifying appropriate coverage is difficult to manage and to predict and it is likely our historic and future insurance coverage will not be sufficient to cover all of our expenses or losses related to existing claims and cover us for any expenses or losses we may suffer. Moreover, insurance coverage is becoming increasingly expensive and has provisions that limit that coverage under certain circumstances that may apply to our company. For instance, as a result of the risks associated with marketing opioids, particularly as a result of the opioid epidemic, many insurance companies are limiting or eliminating certain policy coverage of opioids.  In addition, in the future, we may not be able to maintain insurance coverage at a reasonable cost, in sufficient amounts or upon adequate terms to protect us against losses due to, among other things, the challenges we have had with respect to the commercial activities of former employees and the past legal actions that our company has endured or may endure in the future. If we determine that it is prudent to increase our product liability coverage, we may be unable to obtain this increased product liability insurance on commercially reasonable terms or at all and insurance providers are increasingly putting limitations around coverage of opioid products and may not be willing to issue coverage at all. Large judgments have been awarded in class action, multi-district, and individual lawsuits related to opioids and we anticipate that significant judgements or settlements will occur in the future. A large successful product liability claim, or a series of smaller successful claims, brought against us could cause our stock price to decline and, if judgments or settlements exceed our insurance coverage or result in significant dollar amounts, could decrease our cash and have a material adverse effect our business, results of operations and financial condition.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.

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ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.

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ITEM 6. EXHIBITS

 

 

 

+     Management contract or compensatory plan or arrangement. 

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INSYS THERAPEUTICS, INC.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

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Exhibit 31.1

CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER

PURSUANT TO RULES 13a-14(a) AND 15d-14(a)

OF THE SECURITIES EXCHANGE ACT OF 1934

I, Saeed Motahari, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2018 of Insys Therapeutics, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

 

 

Exhibit 31.2

CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER

PURSUANT TO RULES 13a-14(a) AND 15d-14(a)

OF THE SECURITIES EXCHANGE ACT OF 1934

I, Andrew G. Long, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q for the quarterly period ended September 30, 2018 of Insys Therapeutics, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and

5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting.

 

 

 

Exhibit 32

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report on Form 10-Q of Insys Therapeutics, Inc. (the “Company”), for the quarter ended September 30, 2018, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), each of the undersigned, Saeed Motahari, principal executive officer of the Company, and Andrew G. Long, principal financial officer of the Company, hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that, to his knowledge:

(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

(2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

 

Dated November 9, 2018