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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number: 001-35006 
 
http://api.tenkwizard.com/cgi/image?quest=1&rid=23&ipage=12539603&doc=13
SPECTRUM PHARMACEUTICALS, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
 
93-0979187
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
11500 South Eastern Avenue, Suite 240
Henderson, Nevada
 
89052
(Address of principal executive offices)
 
(Zip Code)
(702) 835-6300
(Registrant’s telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
¨
  
Accelerated filer
 
ý
Non-accelerated filer
 
¨
  
Smaller reporting company
 
¨
 
 
 
 
Emerging Growth Company
 
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
As of October 31, 2018, 106,913,392 shares of the registrant’s common stock were outstanding.



Table of Contents

SPECTRUM PHARMACEUTICALS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2018
TABLE OF CONTENTS
Item
 
Page
 
PART I. FINANCIAL INFORMATION
 
Item 1.
Condensed Consolidated Financial Statements (unaudited):
 
 
 
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
 
PART II. OTHER INFORMATION
 
Item 1.
Item 1A.
Item 6.
 
Items 2 through 5 of Part II have been omitted because they are not applicable with respect to the current reporting period.

SPECTRUM PHARMACEUTICALS, INC. ®, FUSILEV®, FOLOTYN®, ZEVALIN®, MARQIBO®, BELEODAQ® , EVOMELA®, and ROLONTIS® are registered trademarks of Spectrum Pharmaceuticals, Inc. and its affiliates. QAPZOLA, KHAPZORY™, REDEFINING CANCER CARE™ and the Spectrum Pharmaceuticals’ logos are trademarks owned by Spectrum Pharmaceuticals, Inc. Any other trademarks are the property of their respective owners.



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Table of Contents

PART I: FINANCIAL INFORMATION
ITEM 1: CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SPECTRUM PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except share and par value amounts)
(Unaudited)

September 30,
2018
 
December 31,
2017
ASSETS

 

Current assets:

 

Cash and cash equivalents
$
166,541

 
$
227,323

Marketable securities
54,014

 
248

Accounts receivable, net of allowance for doubtful accounts of $71 and $71, respectively
29,485

 
32,260

Other receivables
5,131

 
2,133

Inventories
3,979

 
5,715

Prepaid expenses and other assets
8,300

 
10,067

Total current assets
267,450

 
277,746

Property and equipment, net of accumulated depreciation
437

 
589

Intangible assets, net of accumulated amortization
116,273

 
137,159

Goodwill
18,091

 
18,162

Other assets
10,376

 
53,783

Total assets
$
412,627

 
$
487,439

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

Current liabilities:

 

Accounts payable and other accrued liabilities
$
57,633

 
$
58,117

Accrued payroll and benefits
7,744

 
9,261

Deferred revenue

 
3,872

FOLOTYN development liability
211

 
275

Convertible senior notes
35,357

 
38,224

Total current liabilities
100,945

 
109,749

FOLOTYN development liability, less current portion
11,905

 
12,111

Deferred revenue, less current portion

 
315

Acquisition-related contingent obligations
5,555

 
6,272

Deferred tax liabilities
1,447

 
1,438

Other long-term liabilities
5,997

 
6,215

Total liabilities
125,849

 
136,100

Commitments and contingencies

 

Stockholders’ equity:

 

Preferred stock, $0.001 par value; 5,000,000 shares authorized; no shares issued and outstanding

 

Common stock, $0.001 par value; 300,000,000 shares authorized; 106,060,681 and 100,742,735 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively
106

 
100

Additional paid-in capital
840,681

 
837,347

Accumulated other comprehensive (loss) income
(3,342
)
 
15,999

Accumulated deficit
(550,667
)
 
(502,107
)
Total stockholders’ equity
286,778

 
351,339

Total liabilities and stockholders’ equity
$
412,627

 
$
487,439


See accompanying notes to these unaudited condensed consolidated financial statements.

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SPECTRUM PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share amounts)
(Unaudited)
 
 
Three Months Ended
September 30,

Nine Months Ended
September 30,
 
2018

2017

2018

2017
Revenues:







Product sales, net
$
24,556


$
31,234


$
76,419


$
88,235

License fees and service revenue
712


5,161


3,511


11,562

Total revenues
$
25,268


$
36,395


$
79,930


$
99,797

Operating costs and expenses:







Cost of sales (excluding amortization of intangible assets)
6,472


12,179


19,891


31,618

Cost of service revenue






4,221

Selling, general and administrative
19,837


18,527


67,393


55,052

Research and development
21,060


13,815


60,442


43,760

Amortization of intangible assets
6,923


6,928


20,804


20,718

Total operating costs and expenses
54,292


51,449


168,530


155,369

Loss from operations
(29,024
)

(15,054
)

(88,600
)

(55,572
)
Other (expense) income:







Interest expense, net
(12
)

(2,014
)

(484
)

(6,196
)
Change in fair value of contingent consideration related to acquisitions
1,200


(2,942
)

717


(3,236
)
Other (expense) income, net
(40,880
)

251


17,583


901

Total other (expense) income
(39,692
)

(4,705
)

17,816


(8,531
)
Loss before income taxes
(68,716
)

(19,759
)

(70,784
)

(64,103
)
(Provision) benefit for income taxes
(2
)

1,466


(8
)

1,412

Net loss
$
(68,718
)

$
(18,293
)

$
(70,792
)

$
(62,691
)
Net loss per share:







Basic
$
(0.66
)

$
(0.22
)

$
(0.69
)

$
(0.78
)
Diluted
$
(0.66
)
 
$
(0.22
)
 
$
(0.69
)
 
$
(0.78
)
Weighted average shares outstanding:







Basic
104,106,295

 
83,463,153

 
102,571,850

 
80,177,370

Diluted
104,106,295

 
83,463,153

 
102,571,850

 
80,177,370

See accompanying notes to these unaudited condensed consolidated financial statements.


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SPECTRUM PHARMACEUTICALS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)
(Unaudited)
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Net loss
$
(68,718
)
 
$
(18,293
)
 
$
(70,792
)
 
$
(62,691
)
Other comprehensive (loss) income:

 

 

 

Unrealized loss on available-for-sale securities, net of income tax benefit of $2,068 and $2,068, for the three and nine months ended September 30, 2017

 
5,047

 

 
3,903

Cumulative effect of ASU 2016-01 adoption on January 1, 2018 for unrealized gains on equity securities, net of income tax; recorded as a reclassification to “accumulated deficit” (see Note 3(a))

 


(17,211
)


Foreign currency translation adjustments
(254
)
 
405

 
(2,130
)
 
1,349

Other comprehensive (loss) income
(254
)
 
5,452

 
(19,341
)
 
5,252

Total comprehensive loss
$
(68,972
)
 
$
(12,841
)
 
$
(90,133
)
 
$
(57,439
)
See accompanying notes to these unaudited condensed consolidated financial statements.


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SPECTRUM PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
 
Nine Months Ended
September 30,
 
2018

2017
Cash Flows From Operating Activities:
 
 
 
Net loss
$
(70,792
)
 
$
(62,691
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
Depreciation and amortization
21,000

 
20,965

Stock-based compensation
13,197

 
10,201

Accretion of debt discount on 2018 Convertible Notes, recorded to interest expense (Note 13)
1,558

 
4,236

Amortization of deferred financing costs on 2018 Convertible Notes, recorded to interest expense (Note 13)
178

 
491

Unrealized loss (gains) from transactions denominated in foreign currency
17

 
(18
)
Change in cash surrender value of corporate-owned life insurance policy
(5
)
 
(266
)
Deferred tax liabilities
9

 
154

Income tax recognition on unrealized gain for available-for-sale securities

 
(2,068
)
Unrealized gains on marketable securities (Note 3(a))
(17,716
)
 

Change in fair value of contingent consideration related to the Talon and EVOMELA acquisitions (Note 9)
(717
)
 
3,236

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
3,252

 
2,143

Other receivables
(3,002
)
 
(88
)
Inventories
2,862

 
554

Prepaid expenses
(2,362
)
 
972

Other assets
4,890

 
183

Accounts payable and other accrued obligations
(457
)
 
(2,954
)
Accrued payroll and benefits
(1,517
)
 
(1,343
)
FOLOTYN development liability
(270
)
 
(704
)
Deferred revenue

 
(483
)
Other long-term liabilities
(218
)
 
1,523

Net cash used in operating activities
(50,093
)

(25,957
)
Cash Flows From Investing Activities:
 
 
 
Proceeds from redemption of corporate-owned life insurance policy
4,130

 

Payment for corporate-owned life insurance premiums

 
(601
)
Redemption of mutual funds

 
(1
)
Purchases of property and equipment
(46
)
 
(412
)
Net cash provided by (used in) investing activities
4,084

 
(1,014
)
Cash Flows From Financing Activities:
 
 
 
Proceeds from employees for exercises of stock options
7,843

 
3,051

Proceeds from sale of stock under our employee stock purchase plan
734

 
406

Proceeds from employees, for our remittance to tax authorities, upon vesting of restricted stock and exercises of stock options
4,645

 

Payments to tax authorities upon employees' surrender of restricted stock at vesting and exercises of stock options
(27,686
)
 
(1,476
)
Proceeds from sale of common stock under an at-the-market sales agreement (Note 17)

 
113,966

Net cash (used in) provided by financing activities
(14,464
)
 
115,947

Effect of exchange rates on cash and equivalents
(309
)
 
270

Net (decrease) increase in cash and cash equivalents
(60,782
)
 
89,246

Cash and cash equivalents—beginning of period
227,323

 
158,222

Cash and cash equivalents—end of period
$
166,541

 
$
247,468

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for income taxes
$
38

 
$
10

Cash paid for interest
$
558

 
$
1,513


See accompanying notes to these unaudited condensed consolidated financial statements.

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Spectrum Pharmaceuticals, Inc.
 
Notes to Condensed Consolidated Financial Statements
(all tabular amounts presented in thousands, except share, per share, per unit, and number of years)
(Unaudited)
1. DESCRIPTION OF BUSINESS, BASIS OF PRESENTATION, AND OPERATING SEGMENT
(a) Description of Business
Spectrum Pharmaceuticals, Inc. (“Spectrum”, the “Company”, “we”, “our”, or “us”) is a biopharma company, with a primary strategy comprised of acquiring, developing, and commercializing a broad and diverse pipeline of late-stage clinical and commercial products. We have an in-house clinical development organization with regulatory and data management capabilities, in addition to commercial infrastructure and a field-based sales force for our marketed products. Currently, we have six approved oncology/hematology products (FUSILEV, FOLOTYN, ZEVALIN, MARQIBO, BELEODAQ, and EVOMELA) that target different types of cancer including: non-Hodgkin’s lymphoma (“NHL”), advanced metastatic colorectal cancer, acute lymphoblastic leukemia, and multiple myeloma (“MM”).
We also have two drugs in mid-to-late stage development (in Phase 2 or Phase 3 clinical trials):
poziotinib, a novel pan-HER inhibitor used in the treatment of patients with a variety of solid tumors, including breast and lung cancer; and
ROLONTIS for chemotherapy-induced neutropenia.
(b) Basis of Presentation
Interim Financial Statements
The interim financial data for the three and nine months ended September 30, 2018 and 2017, respectively, is unaudited, and is not necessarily indicative of our operating results for a full year. In the opinion of our management, the interim data includes normal and recurring adjustments necessary for a fair presentation of our financial results for the three and nine months ended September 30, 2018 and 2017. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with United States (“U.S.”) generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to the U.S. Securities and Exchange Commission (“SEC”) rules and regulations relating to interim financial statements. The accompanying Condensed Consolidated Financial Statements should be read in conjunction with our audited Consolidated Financial Statements and Notes thereto included within our Annual Report on Form 10-K for the fiscal year ended December 31, 2017 (filed with the SEC on March 7, 2018).
Principles of Consolidation
The accompanying Condensed Consolidated Financial Statements have been prepared in accordance with GAAP and with the rules and regulations of the SEC. These financial statements include the financial position, results of operations, and cash flows of Spectrum and its subsidiaries, all of which are wholly-owned (except for Spectrum Pharma Canada (“SPC”), as discussed below). All inter-company accounts and transactions among these legal entities have been eliminated in consolidation.
Variable Interest Entity
We own fifty-percent of SPC, a legal entity organized in Quebec, Canada in January 2008. Some of our clinical studies are conducted through this “variable interest entity” (as defined under applicable GAAP). We fund all of SPC’s operating costs, and since we assume all risks and rewards for this entity, we meet the criteria as being its “primary beneficiary” (as defined under applicable GAAP). Accordingly, SPC’s balance sheets and statements of operations are included in our Condensed Consolidated Financial Statements as if it were a wholly-owned subsidiary for all periods presented.
(c) Operating Segment

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Table of Contents
Notes to Condensed Consolidated Financial Statements
(all tabular amounts presented in thousands, except share, per share, per unit, and number of years)
(Unaudited)


We operate in one reportable operating segment that is focused exclusively on developing and marketing oncology and hematology drug products. For the three and nine months ended September 30, 2018 and 2017, all of our revenue and related expenses were solely attributable to these activities. Substantially all of our assets (excluding cash held in certain foreign bank accounts and ZEVALIN distribution rights for ex-U.S. territories - see Note 3(f)) are held in the U.S.
2. USE OF ESTIMATES AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The preparation of financial statements in conformity with GAAP requires our management to make informed estimates and assumptions that affect our reported amounts of assets, liabilities, revenues, and expenses. These amounts may materially differ from the amounts ultimately realized and reported due to the inherent uncertainty of any estimate or assumption. On an on-going basis, our management evaluates its most critical estimates and assumptions, including those related to: (i) gross-to-net revenue adjustments; (ii) the timing of revenue recognition; (iii) the collectability of customer accounts; (iv) whether the cost of our inventories can be recovered; (v) the recoverability of our reported goodwill and intangible assets; (vi) the realization of our tax assets and estimates of our tax liabilities; (vii) the likelihood of payment and value of contingent liabilities; (viii) the fair value of our investments; (ix) the valuation of our stock options and the periodic expense recognition of stock-based compensation; and (x) the potential outcome of our ongoing or threatened litigation.
Our accounting policies and estimates that most significantly impact the presented amounts within our Condensed Consolidated Financial Statements are further described below:
(i) Revenue Recognition
Impact of the Adoption of the New Revenue Recognition Standard: ASU No. 2014-09, Revenue from Contracts with Customers (“Topic 606”), became effective for us on January 1, 2018. Our disclosure within the below sections to this footnote reflects our updated accounting policies that are affected by this new standard. We applied the “modified retrospective” transition method for open contracts for the implementation of Topic 606; this resulted in the recognition of an aggregate $4.7 million, net of tax, decrease to our January 1, 2018 “accumulated deficit” on our accompanying Condensed Consolidated Balance Sheets for the cumulative impact of applying this new standard. We made no adjustments to our previously-reported total revenues, as those periods continue to be presented in accordance with our historical accounting practices under Topic 605, Revenue Recognition (“Topic 605”). See Notes 4, 5, and 19 for additional quantitative and qualitative revenue disclosures in accordance with Topic 606.
Required Elements of Our Revenue Recognition: Revenue from our (a) product sales, (b) out-license arrangements, and (c) service arrangements is recognized under Topic 606 in a manner that reasonably reflects the delivery of our goods and/or services to customers in return for expected consideration and includes the following elements:
(1)
we ensure that we have an executed contract(s) with our customer that we believe is legally enforceable;
(2)
we identify the “performance obligations” in the respective contract;
(3)
we determine the “transaction price” for each performance obligation in the respective contract;
(4)
we allocate the transaction price to each performance obligation; and
(5)
we recognize revenue only when we satisfy each performance obligation.
    These five elements, as applied to each of our revenue categories, are summarized below:
(a) Product Sales: We sell our products to pharmaceutical wholesalers/distributors (i.e., our customers), except for our U.S. sales of ZEVALIN in which case the end-user (i.e., clinic or hospital) is our customer. Our wholesalers/distributors in turn sell our products directly to clinics, hospitals, and private oncology-based practices. Revenue from our product sales is recognized as physical delivery of product occurs (when our customer obtains control of the product), in return for agreed-upon consideration.
Our gross product sales (i.e., delivered units multiplied by the contractual price per unit) are reduced by our corresponding gross-to-net (“GTN”) estimates using the “expected value” method, resulting in our reported “product sales, net” in the accompanying Condensed Consolidated Statements of Operations, reflecting the amount we ultimately expect to realize in net cash proceeds, taking into account our current period gross sales and related cash receipts, and the subsequent cash disbursements on these sales that we estimate for the various GTN categories discussed below. These estimates are based upon

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Table of Contents
Notes to Condensed Consolidated Financial Statements
(all tabular amounts presented in thousands, except share, per share, per unit, and number of years)
(Unaudited)


information received from external sources (such as written or oral information obtained from our customers with respect to their period-end inventory levels and sales to end-users during the period), in combination with management’s informed judgments. Due to the inherent uncertainty of these estimates, the actual amount incurred (of some, or all) of product returns, government chargebacks, prompt pay discounts, commercial rebates, Medicaid rebates, and distribution, data, and GPO administrative fees may be materially above or below the amount estimated, then requiring prospective adjustments to our reported net product sales.
These GTN estimate categories are each discussed below:
Product Returns Allowances: Our FUSILEV, MARQIBO, and BELEODAQ customers are contractually permitted to return purchased products beginning at its expiration date and within six months thereafter. Our EVOMELA customers are permitted to return purchased product beginning at six months prior to its expiration date, and within 12 months thereafter (as well as for overstock inventory, as determined by end-users). ZEVALIN and FOLOTYN returns for expiry are not contractually permitted. Returns outside of this aforementioned criteria are not customarily allowed. We estimate expected product returns for our allowance based on our historical return rates. Returned product is typically destroyed, since substantially all returns are due to expiry and cannot be resold.
Government Chargebacks: Our products are subject to pricing limits under certain federal government programs (e.g., Medicare and 340B Drug Pricing Program). Qualifying entities (i.e., end-users) purchase products from our customers at their qualifying discounted price. The chargeback amount we incur represents the difference between our contractual sales price to our customer, and the end-user’s applicable discounted purchase price under the government program. There may be significant lag time between our reported net product sales and our receipt of the corresponding government chargeback claims from our customers.
Prompt Pay Discounts: Discounts for prompt payment are estimated at the time of sale, based on our eligible customers’ prompt payment history and the contractual discount percentage.
Commercial Rebates: Commercial rebates are based on (i) our estimates of end-user purchases through a group purchasing organization (“GPO”), (ii) the corresponding contractual rebate percentage tier we expect each GPO to achieve, and (iii) our estimates of the impact of any prospective rebate program changes made by us.
Medicaid Rebates: Our products are subject to state government-managed Medicaid programs, whereby rebates are issued to participating state governments. These rebates arise when a patient treated with our product is covered under Medicaid, resulting in a discounted price for our product under the applicable Medicaid program. Our Medicaid rebate accrual calculations require us to project the magnitude of our sales, by state, that will be subject to these rebates. There is a significant time lag in us receiving rebate notices from each state (generally several months or longer after our sale is recognized). Our estimates are based on our historical claim levels by state, as supplemented by management’s judgment.
Distribution, Data, and GPO Administrative Fees: Distribution, data, and GPO administrative fees are paid to authorized wholesalers/distributors of our products (except for U.S. sales of ZEVALIN) for various commercial services including: contract administration, inventory management, delivery of end-user sales data, and product returns processing. These fees are based on a contractually-determined percentage of our applicable sales.
(b) License Fees: Our out-license arrangements allow licensees to market our product(s) in certain territories for a specific term (representing the out-license of “functional intellectual property”). These arrangements may include one or more of the following forms of consideration: (i) upfront license fees, (ii) sales royalties, (iii) sales milestone-achievement fees, and (iv) regulatory milestone-achievement fees. We recognize revenue for each based on the contractual terms that establish our right to collect payment once the performance obligation is achieved, as follows:
(1) Upfront License Fees: We determine whether upfront license fees are earned at the time of contract execution (i.e., when rights transfer to the customer) or over the actual (or implied) contractual period of the out-license. As part of this determination, we evaluate whether we have any other requirements to provide substantive services that are inseparable from the performance obligation of the license transfer. Our customers’ “distinct” rights to licensed “functional intellectual property” at the time of contract execution results in concurrent revenue recognition of all upfront license fees (assuming that there are no other performance obligations at contract execution that are inseparable from this license transfer).


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Table of Contents
Notes to Condensed Consolidated Financial Statements
(all tabular amounts presented in thousands, except share, per share, per unit, and number of years)
(Unaudited)


(2) Royalties: Under the “sales-or-usage-based royalty exception” we recognize revenue in the same period that our
licensees complete product sales in their territory for which we are contractually entitled to a percentage-based royalty receipt.

(3) Sales Milestones: Under the “sales-or-usage-based royalty exception” we recognize revenue in full within the period that our licensees achieve annual or aggregate product sales levels in their territories for which we are contractually entitled to a specified lump-sum receipt.

(4) Regulatory Milestones: Under the terms of the respective out-license, regulatory achievements may either be our responsibility, or that of our licensee.

When our licensee is responsible for the achievement of the regulatory milestone, we recognize revenue in full (for the contractual amount due from our licensee) in the period that the approval occurs (i.e., when the “performance obligation” is satisfied by our customer) under the “most likely amount” method. This revenue recognition remains “constrained” (i.e., not recognized) until regulatory approval occurs, given its inherent uncertainty and the requirement of a significant revenue reversal not being probable if achievement does not occur. At each reporting period, we re-evaluate the probability of milestone achievement and the associated revenue constraint; any resulting adjustments would be recorded on a cumulative catch-up basis, thus reflected in our financial statements in the period of adjustment.

When we are responsible for the achievement of a regulatory milestone, the “relative selling price method” is applied for purposes of allocating the transaction price to our performance obligations. In such case, we consider (i) the extent of our effort to achieve the milestone and/or the enhancement of the value of the delivered item(s) as a result of milestone achievement and (ii) if the milestone payment is reasonable relative to all of the deliverables and payment terms (including other potential milestone consideration) within the arrangement. We have historically assessed the contractual value of these milestones upon their achievement to be identical to the allocation of value of our performance obligations and thus representing the “transaction price” for each milestone at contract inception. We recognize this revenue in the period that the regulatory approval occurs (i.e., when we complete the “performance obligation”) under the “most likely amount” method, and revenue recognition is otherwise “constrained” until regulatory approval occurs, given its inherent uncertainty and the requirement of a significant revenue reversal not being probable if achievement does not occur. At each reporting period, we re-evaluate the probability of milestone achievement and the associated revenue constraint; any resulting adjustments would be recorded on a cumulative catch-up basis, thus reflected in our financial statements in the period of adjustment.
(c) Service Revenue: We receive fees under certain arrangements for (i) sales and marketing services, (ii) supply chain services, (iii) research and development services, and (iv) clinical trial management services.
Our rights to receive payment for these services may be established by (1) a fixed-fee schedule that covers the term of the arrangement, so long as we meet ongoing performance obligations, (2) our completion of product delivery in our capacity as a procurement agent, (3) the successful completion of a phase of drug development, (4) favorable results from a clinical trial, and/or (5) regulatory approval events.
We consider whether revenue associated with these service arrangements is reportable each period, based on our completed services or deliverables (i.e., satisfied “performance obligations”) during the reporting period, and the terms of the arrangement that contractually result in fixed payments due to us. The promised service(s) within these arrangements are distinct and explicitly stated within each contract, and our customer benefits from the separable service(s) delivery/completion. Further, the nature of the promise to our customer as stated within the respective contract is to deliver each named service individually (not a transfer of combined items to which the promised goods or services are inputs), and thus are separable for revenue recognition.
(ii) Cash and Cash Equivalents
Cash and cash equivalents consist of bank deposits and highly liquid investments with maturities of three months or less from the purchase date.

10


Table of Contents
Notes to Condensed Consolidated Financial Statements
(all tabular amounts presented in thousands, except share, per share, per unit, and number of years)
(Unaudited)


(iii) Marketable Securities
Our marketable securities consist of our holdings in equity securities (beginning January 1, 2018 - see Note 3(a)), mutual funds, and bank certificates of deposit (“Bank CDs”). Beginning January 1, 2018, our realized and unrealized (losses) gains on marketable securities are included in “Other (expense) income, net” on the accompanying Condensed Consolidated Statements of Operations. Prior to January 1, 2018, our unrealized (losses) gains were included in “other comprehensive (loss) income” on our accompanying Condensed Consolidated Statements of Comprehensive Loss.
(iv) Accounts Receivable
Our accounts receivable are derived from our product sales and license fees (our service revenue is recorded in “other receivables”), and do not bear interest. The allowance for doubtful accounts is management’s best estimate of the amount of probable credit losses in our existing accounts receivable. Account balances are charged off against the allowance after appropriate collection efforts are exhausted.
(v) Inventories
We value our inventory at the lower of (i) the actual cost of its purchase or manufacture, or (ii) its net realizable value. Inventory cost is determined on the first-in, first-out method. We regularly review our inventory quantities in process of manufacture and on hand. When appropriate, we record a provision for obsolete and excess inventory to derive its new cost basis, which takes into account our sales forecast by product and corresponding expiry dates of each product lot.
Manufacturing costs of drug products that are pending U.S. Food and Drug Administration (“FDA”) approval are expensed through “research and development,” on the accompanying Condensed Consolidated Statements of Operations (rather than being capitalized to “inventories”).
(vi) Property and Equipment
Our property and equipment is stated at historical cost, and is depreciated on a straight-line basis over an estimated useful life that corresponds with its designated asset category. We evaluate the recoverability of “long-lived assets” (which includes property and equipment) whenever events or changes in circumstances in our business indicate that the asset’s carrying amount may not be recoverable through our on-going operations.
(vii) Goodwill and Intangible Assets
Our goodwill represents the excess of our business acquisition cost over the estimated fair value of the net assets acquired in the corresponding transaction. Goodwill has an indefinite accounting life and is therefore not amortized. Instead, goodwill is evaluated for impairment on an annual basis (as of each October 1st), unless we identify impairment indicators that would require earlier testing.
We evaluate the recoverability of indefinite-lived intangible assets at least annually, or whenever events or changes in our business indicate that an intangible asset’s (whether indefinite or definite-lived) carrying amount may not be recoverable. Such circumstances could include, but are not limited to the following:
(a)
a significant decrease in the market value of an asset;
(b)
a significant adverse change in the extent or manner in which an asset is used; or
(c)
an accumulation of costs significantly in excess of the amount originally expected for the acquisition of an asset.
Intangible assets with finite useful lives are amortized over their estimated useful lives on a straight-line basis. We review these assets for potential impairment if/when facts or circumstances suggest that the carrying value of these assets may not be recoverable.
(viii) Stock-Based Compensation

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Table of Contents
Notes to Condensed Consolidated Financial Statements
(all tabular amounts presented in thousands, except share, per share, per unit, and number of years)
(Unaudited)


Stock-based compensation expense for equity awards granted to our employees and members of our Board of Directors is recognized on a straight-line basis over each award’s vesting period. Recognized compensation expense is net of an estimated forfeiture rate, representing the percentage of awards that are expected to be forfeited prior to vesting, though is ultimately adjusted for actual forfeitures. We use the Black-Scholes option pricing model to determine the fair value of stock options (as of the date of grant) that have service conditions for vesting. We use the Monte Carlo valuation model to value equity awards (as of the date of grant) that have combined market conditions and service conditions for vesting.
The recognition of stock-based compensation expense and the initial calculation of stock option fair value requires uncertain assumptions, including (a) the pre-vesting forfeiture rate of the award, (b) the expected term that the stock option will remain outstanding, (c) our stock price volatility over the expected term (and that of our designated peer group with respect to certain market-based awards), and (d) the prevailing risk-free interest rate for the period matching the expected term.
With regard to (a)-(d): We estimate forfeiture rates based on our employees’ overall forfeiture history, which we believe will be representative of future results. We estimate the expected term of stock options granted based on our employees’ historical exercise patterns, which we believe will be representative of their future behavior. We estimate the volatility of our common stock on the date of grant based on the historical volatility of our common stock for a look-back period that corresponds with the expected term. We estimate the risk-free interest rate based upon the U.S. Department of the Treasury yields in effect at award grant, for a period equaling the expected term of the stock option.
(ix) Foreign Currency Translation
Our foreign subsidiaries’ separate financial statements are stated in their functional currencies (i.e., local operating currencies). To create the accompanying Condensed Consolidated Financial Statements, we translate the assets and liabilities of our subsidiaries to U.S. dollars at the rates of exchange in effect at the reported balance sheet date; revenues and expenses are translated using the monthly average exchange rates during the reported period. Unrealized gains and losses from these translations are included in “accumulated other comprehensive (loss) income” in the Condensed Consolidated Balance Sheets.
We record foreign currency-based transactions (i.e., when not denominated in the functional currency of our transacting legal entity) at the prevailing exchange rate on the date of the transaction. Resulting unrealized foreign exchange gains and losses from these unsettled transactions are included in “accumulated other comprehensive (loss) income” in the Condensed Consolidated Balance Sheets.
All unrealized foreign exchange gains and losses associated with our intercompany loans are included in “accumulated other comprehensive (loss) income” in the Condensed Consolidated Balance Sheets, as these loans with our foreign subsidiaries are not expected to be settled in the “foreseeable future.”
(x) Basic and Diluted Net Loss per Share
We calculate basic and diluted net loss per share using the weighted average number of common shares outstanding during the periods presented. In periods of a net loss, basic and diluted loss per share are the same. For the diluted earnings per share calculation, we adjust the weighted average number of common shares outstanding to include only dilutive stock options, warrants, and other common stock equivalents outstanding during the period.
(xi) Income Taxes
Deferred tax assets and liabilities are recorded based on the estimated future tax effects of temporary differences between the tax basis of assets and liabilities and amounts reported in the financial statements, as well as operating losses and tax credit carry forwards using enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. Realization of deferred tax assets is dependent upon future earnings, the timing and amount of which are uncertain.
We have recorded a valuation allowance to reduce our deferred tax assets, because we believe that, based upon a weighting of positive and negative factors, it is more likely than not that these deferred tax assets will not be realized. If/when we were to determine that our deferred tax assets are realizable, an adjustment to the corresponding valuation allowance would increase our net income in the period that such determination was made.

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Table of Contents
Notes to Condensed Consolidated Financial Statements
(all tabular amounts presented in thousands, except share, per share, per unit, and number of years)
(Unaudited)


In the event that we are assessed interest and/or penalties from taxing authorities that have not been previously accrued, such amounts would be included in “(provision) benefit for income taxes” within the Condensed Consolidated Statements of Operations for the period in which we received the notice.
(xii) Research and Development Costs
Our research and development costs are expensed as incurred (see Note 15(c)), or as certain milestone payments become contractually due to our licensors, as triggered by the achievement of clinical or regulatory events.
(xiii) Fair Value Measurements
We determine measurement-date fair value based on the proceeds that would be received through the sale of the asset, or that we would pay to settle or transfer the liability, in an orderly transaction between market participants. We utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible. Fair value measurements are based on a three-tier hierarchy that prioritizes the inputs used to measure fair value. These tiers include the following:
Level 1: Quoted prices (unadjusted) in active markets for identical assets or liabilities that are publicly accessible at the measurement date.
Level 2: Observable prices that are based on inputs not quoted on active markets, but that are corroborated by market data. These inputs may include quoted prices for similar assets or liabilities or quoted market prices in markets that are not active to the general public.
Level 3: Unobservable inputs are used when little or no market data is available.
3. BALANCE SHEET ACCOUNT DETAIL
The composition of selected financial statement captions that comprise the accompanying Condensed Consolidated Balance Sheets are summarized below:
(a) Cash and Cash Equivalents and Marketable Securities
As of September 30, 2018 and December 31, 2017, our “cash and cash equivalents” were held with major financial institutions. Our “marketable securities” primarily relate to our equity holdings in CASI (as defined below).
We maintain cash balances in excess of federally insured limits with reputable financial institutions. To a limited degree, the Federal Deposit Insurance Corporation and other third parties insure these investments. However, these investments are not insured against the possibility of a complete loss of earnings or principal and are inherently subject to the credit risk related to the continued credit worthiness of the underlying issuer and general credit market risks. We manage such risks in our portfolio by investing in highly liquid, highly-rated instruments, and limit investing in long-term maturity instruments.
Our investment policy requires that purchased investments in marketable securities may only be in highly-rated instruments, which are primarily U.S. treasury bills or treasury-backed securities, and also limits our investments in securities of any single issuer (excluding any debt or equity securities received from our strategic partners in connection with an out-license arrangement, as discussed in Note 10).
 
The carrying amount of our equity securities, money market funds, and Bank CDs approximates their fair value (utilizing “Level 1” or “Level 2” inputs – see Note 2(xiii)) because of our ability to immediately convert these instruments into cash with minimal expected change in value.
The following is a summary of our presented “cash and cash equivalents” and “marketable securities”:

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Table of Contents
Notes to Condensed Consolidated Financial Statements
(all tabular amounts presented in thousands, except share, per share, per unit, and number of years)
(Unaudited)


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Cost
 
Foreign Currency Translation
 
Gross
Unrealized
Gains*
 
Gross
Unrealized
Losses
 
Estimated
Fair
Value
 
Cash and Cash
Equivalents
 
Marketable Securities
September 30, 2018
 
 

 
 
 
 
 
 
 
 
 
 
Equity securities* (see Note 3(g) and Note 10)
$
8,710

 
$
(1,920
)
 
$
47,138

 
$

 
$
53,928

 
$

 
$
53,928

Bank deposits
22,256

 

 

 

 
22,256

 
22,256

 

Money market funds
144,285

 

 

 

 
144,285

 
144,285

 

Bank certificates of deposits
87

 

 

 

 
87

 

 
87

Total cash and cash equivalents and marketable securities
$
175,338

 
$
(1,920
)
 
$
47,138

 
$

 
$
220,556

 
$
166,541

 
$
54,015

December 31, 2017
 
 

 
 
 
 
 
 
 
 
 
 
Bank deposits
$
10,965

 
$

 
$

 
$

 
$
10,965

 
$
10,965

 
$

Money market funds
216,358

 

 

 

 
216,358

 
216,358

 

Bank certificates of deposits
248

 

 

 

 
248

 

 
248

Total cash and cash equivalents and marketable securities
$
227,571

 
$

 
$

 
$

 
$
227,571

 
$
227,323

 
$
248

* Beginning January 1, 2018, under the new requirements of ASU 2016-01, Recognition and Measurement of Financial Assets and Liabilities, the unrealized (losses) gains on our CASI Pharmaceuticals, Inc. (NASDAQ: CASI) (“CASI”) equity securities are recognized as a (decrease) increase to “other (expense) income, net” on the Consolidated Statements of Operations (rather than through “other comprehensive (loss) income” on the Consolidated Statements of Comprehensive Loss). Our adoption of ASU 2016-01 on January 1, 2018, resulted in a $17.2 million cumulative-effect adjustment, net of income tax, recorded as a decrease to “accumulated other comprehensive (loss) income” and a decrease to “accumulated deficit” on the accompanying Condensed Consolidated Balance Sheets. Our recognized unrealized loss on these equity securities for the three months ended September 30, 2018 was $40.9 million and our recognized unrealized gain on these equity securities for the nine months ended September 30, 2018 was $17.7 million, as reported in “other (expense) income, net” on the accompanying Condensed Consolidated Statements of Operations.
As of September 30, 2018, none of our securities were in an unrealized loss position.
(b) Property and Equipment, net of Accumulated Depreciation
“Property and equipment, net of accumulated depreciation” consists of the following: 
 
September 30, 2018
 
December 31, 2017
Computer hardware and software
$
3,076

 
$
2,994

Laboratory equipment
635

 
630

Office furniture
212

 
218

Leasehold improvements
2,938

 
2,938

Property and equipment, at cost
6,861

 
6,780

(Less): Accumulated depreciation
(6,424
)
 
(6,191
)
Property and equipment, net of accumulated depreciation
$
437

 
$
589

Depreciation expense (included within “total operating costs and expenses” in the accompanying Condensed Consolidated Statements of Operations) for the three and nine months ended September 30, 2018 and 2017, was $0.1 million, $0.1 million, $0.2 million, and $0.2 million, respectively.
New Accounting Standard for Leases, effective January 1, 2019
In February 2016, the FASB issued ASU 2016-02, which amends the FASB Accounting Standards Codification and creates Topic 842, Leases (“Topic 842”). The new topic supersedes Topic 840, Leases and requires additional disclosures regarding our lease arrangements, as well as our presentation of lease assets and lease liabilities (including those for operating leases) on the balance sheet at the present value of lease payments not yet paid, and for us to subsequently apply the “effective

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Table of Contents
Notes to Condensed Consolidated Financial Statements
(all tabular amounts presented in thousands, except share, per share, per unit, and number of years)
(Unaudited)


interest rate” method” to reduce the lease liability, while amortizing the right-of-use asset for straight-line expense recognition over the lease term.
Topic 842 is effective for us beginning January 1, 2019, and mandates a “modified retrospective” transition method. We are currently assessing the quantitative impact this guidance will have on our consolidated financial statements. However, we presently do not have any capital lease arrangements, or any active contracts that would contain an “embedded lease”. Our current operating lease arrangements affected by this “gross-up” presentation are limited to (1) our executive, administrative, and research and development office facilities and (2) certain office equipment.

(c) Inventories
“Inventories” consists of the following: 
 
September 30, 2018
 
December 31, 2017
Raw materials
$
1,870

 
$
1,077

Work-in-process
2,569

 
2,551

Finished goods
1,515

 
5,187

(Less:) Non-current portion of inventories included within "other assets" *
(1,975
)
 
(3,100
)
Inventories
$
3,979

 
$
5,715

* The “non-current” portion of inventories is presented within “other assets” in the accompanying Condensed Consolidated Balance Sheets at September 30, 2018 and December 31, 2017, respectively. This value of $2 million at September 30, 2018 represents product that we expect to sell beyond September 30, 2019, and the value at December 31, 2017 represented product that we expected to sell beyond December 31, 2018.
(d) Prepaid Expenses and Other Assets
“Prepaid expenses and other assets” consists of the following:
 
September 30, 2018
 
December 31, 2017
Other miscellaneous prepaid operating expenses
$
7,186

 
$
3,389

Prepaid insurance
131

 
645

Research and development supplies
983

 
1,883

Key employee life insurance - cash surrender value

 
4,150

Prepaid expenses and other assets
$
8,300

 
$
10,067

(e) Other Receivables
“Other receivables” consists of the following:
 
September 30, 2018
 
December 31, 2017
Other miscellaneous receivables (including Medicaid rebate credits and royalty receivables)
$
1,147

 
$
1,152

Income tax receivable
632

 
665

Insurance receivable
1,458

 
53

CASI note - short term
1,523

 

Reimbursements due from development partners for incurred research and development expenses
371

 
263

Other receivables
$
5,131

 
$
2,133

(f) Intangible Assets and Goodwill
Intangible assets, net of accumulated amortization and impairment charges consists of the following: 

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Table of Contents
Notes to Condensed Consolidated Financial Statements
(all tabular amounts presented in thousands, except share, per share, per unit, and number of years)
(Unaudited)


 
 
 
September 30, 2018
 
Historical
Cost
 
Accumulated
Amortization
 
Foreign
Currency
Translation
 
Impairment
 
Net Amount
 
Full
Amortization
Period
(months)
 
Remaining
Amortization
Period
(months)
MARQIBO IPR&D (NHL and other novel indications)
$
17,600

 
$

 
$

 
$

 
$
17,600

 
n/a
 
n/a
EVOMELA distribution rights
7,700

 
(1,481
)
 

 

 
6,219

 
156
 
126
BELEODAQ distribution rights
25,000

 
(7,969
)
 

 

 
17,031

 
160
 
109
MARQIBO distribution rights
26,900

 
(20,420
)
 

 

 
6,480

 
81
 
21
FOLOTYN distribution rights (1)
118,400

 
(63,918
)
 

 

 
54,482

 
152
 
50
ZEVALIN distribution rights – U.S.
41,900

 
(40,163
)
 

 

 
1,737

 
123
 
6
ZEVALIN distribution rights – ex-U.S.
23,490

 
(17,913
)
 
(3,132
)
 

 
2,445

 
96
 
18
FUSILEV distribution rights (2)
16,778

 
(9,618
)
 

 
(7,160
)
 

 
56
 
0
FOLOTYN out-license (3)
27,900

 
(16,598
)
 

 
(1,023
)
 
10,279

 
110
 
46
Total intangible assets
$
305,668

 
$
(178,080
)
 
$
(3,132
)
 
$
(8,183
)
 
$
116,273

 
 
 
 
 
(1)
Beginning June 2016, we adjusted the amortization period of our FOLOTYN distribution rights to November 2022 from March 2025, representing the period through which we expect to have patent protection from generic competition.

(2)
On February 20, 2015, the United States District Court for the District of Nevada found the patent covering FUSILEV to be invalid, which was upheld on appeal. On April 24, 2015, Sandoz began to commercialize a generic version of FUSILEV. This represented a “triggering event” under applicable GAAP in evaluating the value of our FUSILEV distribution rights as of March 31, 2015, resulting in a recognized $7.2 million impairment charge (non-cash) in 2015. We accelerated amortization expense recognition in 2015 for the then remaining net book value of FUSILEV distribution rights.

(3)
On May 29, 2013, we amended our FOLOTYN collaboration agreement with Mundipharma. As a result of the amendment, Europe and Turkey were excluded from Mundipharma’s commercialization territory, and their royalty rates and milestone payments to us were modified. This constituted a change under which we originally valued the FOLOTYN out-license as part of business combination accounting, resulting in a recognized impairment charge (non-cash) of $1 million in 2013.

 
 
 
December 31, 2017

Historical
Cost
 
Accumulated
Amortization
 
Foreign
Currency
Translation
 
Impairment
 
Net Amount
MARQIBO IPR&D (NHL and other novel indications)
$
17,600

 
$

 
$

 
$

 
$
17,600

EVOMELA distribution rights
7,700

 
(1,037
)
 

 

 
6,663

BELEODAQ distribution rights
25,000

 
(6,563
)
 

 

 
18,437

MARQIBO distribution rights
26,900

 
(17,182
)
 

 

 
9,718

FOLOTYN distribution rights
118,400

 
(54,111
)
 

 

 
64,289

ZEVALIN distribution rights – U.S.
41,900

 
(37,557
)
 

 

 
4,343

ZEVALIN distribution rights – ex-U.S.
23,490

 
(17,232
)
 
(2,471
)
 

 
3,787

FUSILEV distribution rights
16,778

 
(9,618
)
 

 
(7,160
)
 

FOLOTYN out-license
27,900

 
(14,555
)
 

 
(1,023
)
 
12,322

Total intangible assets
$
305,668

 
$
(157,855
)
 
$
(2,471
)
 
$
(8,183
)
 
$
137,159


Intangible asset amortization expense recognized during the three and nine months ended September 30, 2018 and 2017, was $6.9 million, $6.9 million, $20.8 million and $20.7 million, respectively.

Estimated intangible asset amortization expense for the remainder of 2018 and the five succeeding fiscal years and thereafter is as follows:

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Table of Contents
Notes to Condensed Consolidated Financial Statements
(all tabular amounts presented in thousands, except share, per share, per unit, and number of years)
(Unaudited)



Years Ending December 31,
 
Remainder of 2018
$
6,923

2019
25,084

2020
19,754

2021
18,266

2022
15,882

2023
2,467

2024 and thereafter
10,297

 
$
98,673

“Goodwill” consists of the following, by source:
 
September 30, 2018
 
December 31, 2017
Acquisition of Talon (MARQIBO distribution rights)
$
10,526

 
$
10,526

Acquisition of ZEVALIN ex-U.S. distribution rights
2,525

 
2,525

Acquisition of Allos (FOLOTYN distribution rights)
5,346

 
5,346

Foreign currency exchange translation effects
(306
)
 
(235
)
Goodwill
$
18,091

 
$
18,162

(g) Other Assets
“Other assets” consists of the following: 
 
September 30, 2018
 
December 31, 2017
Equity securities (see Note 10)*
$

 
$
37,530

Key employee life insurance – cash surrender value
6,382

 
10,737

Inventories - non-current portion
1,975

 
3,100

CASI note - long term (see Note 10)

 
1,517

Income tax receivable**
668

 
668

Research & development supplies and other
1,351

 
231

Other assets
$
10,376

 
$
53,783

* As of March 31, 2018, we reclassified our presentation of these equity securities from this account caption to “marketable securities” on our accompanying Condensed Consolidated Balance Sheets - (see Note 3(a)).
** This value represents the non-current portion of the refundable alternative minimum tax credit that is expected to be received over the next few years (see Note 16).
(h) Accounts Payable and Other Accrued Liabilities

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Table of Contents
Notes to Condensed Consolidated Financial Statements
(all tabular amounts presented in thousands, except share, per share, per unit, and number of years)
(Unaudited)


“Accounts payable and other accrued liabilities” consists of the following:
 
September 30, 2018
 
December 31, 2017
Trade accounts payable and other accrued liabilities
$
35,535

 
$
33,648

Accrued rebates
8,228

 
7,990

Accrued product royalty
3,992

 
4,339

Allowance for returns
4,715

 
4,045

Accrued data and distribution fees
2,701

 
4,305

Accrued GPO administrative fees
244

 
296

Accrued inventory management fee
428

 
1,126

Allowance for chargebacks
1,790

 
2,368

Accounts payable and other accrued liabilities
$
57,633

 
$
58,117

Amounts presented within “accounts payable and other accrued liabilities” in the accompanying Condensed Consolidated Balance Sheets for our categories of GTN estimates (see Note 2(i)) were as follows:

Commercial/Medicaid Rebates and Government Chargebacks
 
Distribution, Data, Inventory and
GPO Administrative Fees
 
Product Return Allowances
Balance as of December 31, 2016
$
9,817

 
$
5,146

 
$
2,309

Add: provisions
106,647

 
20,104

 
2,807

(Less): credits or actual allowances
(106,106
)
 
(19,523
)
 
(1,071
)
Balance as of December 31, 2017
10,358

 
5,727

 
4,045

Add: provisions
47,130

 
10,425

 
1,207

(Less): credits or actual allowances
(47,470
)
 
(12,779
)
 
(537
)
Balance as of September 30, 2018
$
10,018

 
$
3,373

 
$
4,715

(i) Deferred Revenue
Deferred revenue (current and non-current) consists of the following:

September 30, 2018
 
December 31, 2017
EVOMELA deferred revenue
$

 
$
3,819

ZEVALIN out-license in India territory (see Note 15(b)(iii))

 
368

Deferred revenue*
$

 
$
4,187

* On January 1, 2018, we reclassified the deferred revenue related to our EVOMELA product sales and our ZEVALIN out-license in the India territory of $3.8 million and $0.4 million, respectively. These amounts were included in the $4.7 million aggregate decrease to “accumulated deficit” on January 1, 2018, in accordance with the adoption of Topic 606 (see Note 2(i)).
(j) Other Long-Term Liabilities
“Other long-term liabilities” consists of the following:
 
September 30, 2018
 
December 31, 2017
Accrued executive deferred compensation
$
5,764

 
$
5,928

Deferred rent (non-current portion)
1

 
52

Clinical study holdback fees, non-current
56

 
59

Other tax liabilities
176

 
176

Other long-term liabilities
$
5,997

 
$
6,215

 

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Table of Contents
Notes to Condensed Consolidated Financial Statements
(all tabular amounts presented in thousands, except share, per share, per unit, and number of years)
(Unaudited)



4. GROSS-TO-NET PRODUCT SALES
The below table presents a GTN (see Note 2(i)) product sales reconciliation for the accompanying Condensed Consolidated Statements of Operations:
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Gross product sales
$
46,052

 
187.5
 %
 
$
66,517

 
213.0
 %
 
$
139,703

 
182.8
 %
 
$
192,443

 
218.1
 %
Commercial rebates and government chargebacks
(17,272
)
 
(70.3
)%
 
(28,075
)
 
(89.9
)%
 
(50,355
)
 
(65.9
)%
 
(85,400
)
 
(96.8
)%
Data and distribution fees, GPO fees, and inventory management fees
(3,415
)
 
(13.9
)%
 
(5,864
)
 
(18.8
)%
 
(10,509
)
 
(13.8
)%
 
(15,503
)
 
(17.6
)%
Prompt pay discounts
(420
)
 
(1.7
)%
 
(455
)
 
(1.5
)%
 
(1,133
)
 
(1.5
)%
 
(1,143
)
 
(1.3
)%
Product returns
(389
)
 
(1.6
)%
 
(889
)
 
(2.8
)%
 
(1,287
)
 
(1.7
)%
 
(2,162
)
 
(2.5
)%
Product sales, net
$
24,556

 
100.0
 %
 
$
31,234

 
100.0
 %
 
$
76,419

 
100.0
 %
 
$
88,235

 
100.0
 %

5. COMPOSITION OF TOTAL REVENUE
The below table presents our net product sales by geography for the three and nine months ended September 30, 2018 and 2017:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
United States
$
22,131

 
90.1
%
 
$
29,184

 
93.4
%
 
$
66,676

 
87.3
%
 
$
82,049

 
93.0
%
International:
 
 
 
 
 
 
 
 


 


 


 


Europe/Canada
2,425

 
9.9
%
 
2,050

 
6.6
%
 
8,319

 
10.9
%
 
6,186

 
7.0
%
Asia Pacific

 
%
 

 
%
 
1,424

 
1.9
%
 

 
%
Total International
2,425

 
9.9
%
 
2,050

 
6.6
%
 
9,743

 
12.7
%
 
6,186

 
7.0
%
Product sales, net
$
24,556

 
100.0
%
 
$
31,234

 
100.0
%
 
$
76,419

 
100.0
%
 
$
88,235

 
100.0
%
 

The below table presents our net sales by product for the three and nine months ended September 30, 2018 and 2017:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
FOLOTYN
$
11,341

 
46.2
%
 
$
11,576

 
37.1
%
 
$
35,742

 
46.8
%
 
$
32,031

 
36.3
%
EVOMELA
6,850

 
27.9
%
 
10,503

 
33.6
%
 
20,763

 
27.2
%
 
26,862

 
30.4
%
BELEODAQ
3,212

 
13.1
%
 
3,399

 
10.9
%
 
8,628

 
11.3
%
 
9,666

 
11.0
%
ZEVALIN
1,463

 
6.0
%
 
2,737

 
8.8
%
 
6,125

 
8.0
%
 
7,881

 
8.9
%
MARQIBO
1,121

 
4.6
%
 
1,227

 
3.9
%
 
3,163

 
4.1
%
 
5,369

 
6.1
%
FUSILEV
569

 
2.3
%
 
1,792

 
5.7
%
 
1,998

 
2.6
%
 
6,426

 
7.3
%
Product sales, net
$
24,556

 
100.0
%
 
$
31,234

 
100.0
%
 
$
76,419

 
100.0
%
 
$
88,235

 
100.0
%
 
The below table presents our license fees and service revenue by source for the three and nine months ended September 30, 2018 and 2017:

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Table of Contents
Notes to Condensed Consolidated Financial Statements
(all tabular amounts presented in thousands, except share, per share, per unit, and number of years)
(Unaudited)


 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Out-license of FOLOTYN in all countries except the United States, Canada, Europe, and Turkey: royalties (Note 14)
$
712

 
100.0
%
 
$
5,148

 
99.7
%

1,504


42.8
%

5,530


47.8
%
Out-license of ZEVALIN: recognition of milestone achievement, upfront cash receipt and subsequent royalties for Asia and certain other territories, excluding China (Note 11)

 
%
 

 
%

2,001


57.0
%

1,245


10.8
%
Out-license of ZEVALIN: amortization of upfront cash receipt related to India territory (Note 15(b)(iii)) and other

 
%
 
13

 
0.3
%

6


0.2
%

37


0.3
%
Out-license of ZEVALIN, FOLOTYN, BELEODAQ, MARQIBO: upfront cash receipt and subsequent royalties for the Canada territory (Note 15(b)(xiv))

 
%
 

 
%



%

3


%
Sales and marketing contracted services (Note 12)

 
%
 

 
%



%

4,747


41.1
%
License fees and service revenues
$
712

 
100.0
%
 
$
5,161

 
100.0
%

$
3,511


100.0
%

$
11,562


100.0
%


6. STOCK-BASED COMPENSATION
We report our stock-based compensation expense (inclusive of our incentive stock plan, employee stock purchase plan, and 401(k) contribution matching program) in the accompanying Condensed Consolidated Statements of Operations, based on the assigned department of the recipient. Stock-based compensation expense, included within “total operating costs and expenses” for the three and nine months ended September 30, 2018 and 2017, was as follows (see Note 18 for a discussion of certain immaterial corrections affecting the presented 2017 amounts below):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Cost of sales
$
80

 
$
68

 
$
146

 
$
150

Selling, general and administrative
3,151

 
2,398

 
10,673

 
8,523

Research and development
755

 
529

 
2,378

 
1,528

Total stock-based compensation
$
3,986

 
$
2,995

 
$
13,197

 
$
10,201

 
7. NET LOSS PER SHARE
Net loss per share was computed by dividing net loss by the weighted average number of common shares outstanding for the three and nine months ended September 30, 2018 and 2017:
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Weighted average shares outstanding - basic and diluted
104,106,295

 
83,463,153

 
102,571,850

 
80,177,370

Net loss
$
(68,718
)
 
$
(18,293
)
 
$
(70,792
)
 
$
(62,691
)
Net loss per share – basic and diluted
$
(0.66
)
 
$
(0.22
)
 
$
(0.69
)
 
$
(0.78
)
The below outstanding securities for the three and nine months ended September 30, 2018, were excluded from the calculation above because their impact under the “treasury stock method” and “if-converted method” would have been anti-dilutive due to our net loss per share in each respective period, as summarized below:

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Table of Contents
Notes to Condensed Consolidated Financial Statements
(all tabular amounts presented in thousands, except share, per share, per unit, and number of years)
(Unaudited)


 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
2018 Convertible Notes
3,403,659

 
10,454,799


3,403,659


10,454,799

Common stock options
3,702,092

 
3,144,969


4,175,866


1,504,155

Restricted stock awards
1,751,876

 
2,025,661


1,751,876


2,025,661

Restricted stock units
245,214

 
217,206


245,214


217,206

Common stock warrants

 
111,441




32,833

Employee stock purchase plan shares
21,033


50,474


21,033


50,474

Total
9,123,874

 
16,004,550

 
9,597,648

 
14,285,128

 

8. FAIR VALUE MEASUREMENTS
The table below summarizes certain asset and liability fair values that are included within our accompanying Condensed Consolidated Balance Sheets, and their designations among the three fair value measurement categories (see Note 2(xiii)):
 
September 30, 2018
Fair Value Measurements
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Assets:

 

 

 

 
Bank certificates of deposits
$

 
$
87

 
$

 
$
87

 
Money market funds

 
144,285

 

 
144,285

 
Equity securities (Note 10)
53,928

 

 

 
53,928

 
Mutual funds

 
88

 

 
88

 
Deferred compensation investments (life insurance cash surrender value (Note 3(g))

 
6,382

 

 
6,382

*

$
53,928

 
$
150,842

 
$

 
$
204,770

 
Liabilities:

 

 

 

 
Deferred executive compensation liability (Note 15(f))
$

 
$
6,536

 
$

 
$
6,536

*
Drug development liability (Note 14)

 

 
12,116

 
12,116

 
Talon CVR (Note 9(a))

 

 
5,555

 
5,555

 
 
$

 
$
6,536

 
$
17,671

 
$
24,207

 
 
 
December 31, 2017
Fair Value Measurements
 
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Assets:

 

 

 

 
Bank certificates of deposits
$

 
$
248

 
$

 
$
248

 
Money market funds

 
216,358

 

 
216,358

 
Equity securities (Note 10)
37,530

 

 

 
37,530

 
Mutual funds

 
59

 

 
59

 
Deferred compensation investments (life insurance cash surrender value (Note 3(g))

 
14,887

 

 
14,887

*

$
37,530

 
$
231,552

 
$

 
$
269,082

 
Liabilities:

 

 

 

 
Deferred executive compensation liability (Note 15(f))
$

 
$
11,038

 
$

 
$
11,038

*
Drug development liability (Note 14)

 

 
12,386

 
12,386

 
Talon CVR (Note 9(a))

 

 
6,210

 
6,210

 
Corixa Liability (Note 15(b)(i))

 

 
62

 
62

 

$

 
$
11,038

 
$
18,658

 
$
29,696

 
* The reported amount of “deferred compensation investments” is based on the cash surrender value of employee life insurance policies at period-end, while the reported amount of “deferred executive compensation liability” is based on the period-end market value of investments selected by plan participants.

21


Table of Contents
Notes to Condensed Consolidated Financial Statements
(all tabular amounts presented in thousands, except share, per share, per unit, and number of years)
(Unaudited)


We did not have any transfers between “Level 1” and “Level 2” (see Note 2(xiii)) measurement categories for any periods presented.
The table below summarizes the 2017 and 2018 activity of our liabilities that are valued with unobservable inputs:
 
Fair Value Measurements of
Unobservable Inputs (Level 3)
Balance as of December 31, 2016
$
14,445

FOLOTYN development liability (see Note 14)
(744
)
Talon CVR fair value adjustment - MARQIBO (see Note 9(a))
4,957

Balance as of December 31, 2017
18,658

FOLOTYN development liability (see Note 14)
(270
)
Talon CVR fair value adjustment - MARQIBO (see Note 9(a))
(655
)
Corixa Liability (see Note 15(b)(i))
(62
)
Balance as of September 30, 2018
$
17,671

Our carrying amounts of financial instruments such as cash equivalents, accounts receivable, prepaid expenses, accounts payable, and accrued liabilities, excluding acquisition-related contingent obligations, approximate their related fair values due to their short-term nature.

9. BUSINESS COMBINATIONS AND CONTINGENT CONSIDERATION
(a) Acquisition of Talon Therapeutics, Inc.
Overview of Talon Acquisition
On July 17, 2013, we purchased all of the outstanding shares of common stock of Talon Therapeutics, Inc. (“Talon”). Through the acquisition of Talon, we gained worldwide rights to MARQIBO. The Talon purchase consideration consisted of (i) an aggregate upfront cash amount of $11.3 million, (ii) issuance of 3 million shares of our common stock, then equivalent to $26.3 million (based on a closing price of $8.77 per share on July 17, 2013), and (iii) the issuance of a contingent value right (“CVR”) initially valued at $6.5 million.
The CVR was valued using a valuation model that probability-weights expected outcomes (ranging from 50% to 100%) and discounts those amounts to their present value, using an appropriate discount rate (these represent unobservable inputs and are therefore classified as Level 3 inputs – see Note 2 (xiii)). The CVR has a maximum payout of $195 million if all sales and regulatory approval milestones are achieved, as summarized below:
 
$5 million upon the achievement of net sales of MARQIBO in excess of $30 million in any calendar year
$10 million upon the achievement of net sales of MARQIBO in excess of $60 million in any calendar year
$25 million upon the achievement of net sales of MARQIBO in excess of $100 million in any calendar year
$50 million upon the achievement of net sales of MARQIBO in excess of $200 million in any calendar year
$100 million upon the achievement of net sales of MARQIBO in excess of $400 million in any calendar year
$5 million upon receipt of marketing authorization from the FDA regarding Menadione Topical Lotion

    
Talon CVR Fair Value as of September 30, 2018 and December 31, 2017
The CVR fair value will continue to be evaluated on a quarterly basis. Current and future changes in its fair value results from the likelihood and timing of milestone achievement and/or the corresponding discount rate applied thereon. Adjustments to CVR fair value are recognized within “change in fair value of contingent consideration related to acquisitions” in the accompanying Condensed Consolidated Statements of Operations. 

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Table of Contents
Notes to Condensed Consolidated Financial Statements
(all tabular amounts presented in thousands, except share, per share, per unit, and number of years)
(Unaudited)


 
Fair Value
of Talon
CVR
December 31, 2017
$
6,210

Fair value adjustment for the nine months ended September 30, 2018
(655
)
September 30, 2018
$
5,555

(b) Acquisition of Rights to EVOMELA and Related Contingent Consideration
Overview of Acquisition of Rights to EVOMELA
In March 2013, we completed the acquisition of exclusive global development and commercialization rights to Captisol-enabled®, propylene glycol-free MELPHALAN (which we branded as “EVOMELA”) for use as a conditioning treatment prior to autologous stem cell transplant for patients with MM. We acquired these rights from CyDex pharmaceuticals, Inc. (“Cydex”) a wholly-owned subsidiary of Ligand Pharmaceuticals Inc. (“Ligand”) for an initial license fee of $3 million, and assumed responsibility for EVOMELA’s then-ongoing clinical and regulatory development program. We accounted for this transaction as a business combination, which required that assets acquired and liabilities assumed be recognized on the balance sheet at their fair values as of the transaction date.
We are required to pay Ligand additional amounts up to an aggregate of $60 million upon the achievement of annual net sales thresholds (exclusive of the $6 million milestone payment triggered in March 2016, as discussed below), however, we do not expect to achieve these sales thresholds based on our estimated market size for this product and our projected market share at the time of the acquisition and to date. We also must pay Ligand royalties of 20% on our net sales of EVOMELA in all territories.
Our EVOMELA royalty obligation and sales-based milestones are jointly treated as part of an “executory contract” (as defined under GAAP) that is connected with an at-market supply agreement for Captisol that was executed concurrently with this acquisition (requiring the continuing involvement of CyDex). As a result, our royalty obligation and sales-based milestone arrangements are treated as separate transactions, distinct from the consideration for the EVOMELA rights. Our royalty expenses are reported through “cost of sales” in our Condensed Consolidated Statements of Operations in the same period of our recognized revenue for the product sale.
Consideration Transferred
The acquisition-date fair value of the consideration transferred consisted of the following:
 
 
Cash consideration
$
3,000

Ligand contingent consideration
4,700

Total purchase consideration
$
7,700

Fair Value Estimate of Asset Acquired and Liability Assumed
The total purchase consideration is allocated to the acquisition of the net tangible and intangible assets based on their estimated fair values as of the transaction date. The allocation of the total purchase price to the net assets acquired is as follows:
EVOMELA IPR&D rights
$
7,700

We estimated the fair value of the in-process research and development using the income approach. The income approach uses valuation techniques to convert future net cash flows to a single present value (discounted) amount.  We applied our net cash flow projections for EVOMELA over 10 years and a discount rate of 25%, taking into account our estimates of future incremental earnings that may be achieved upon regulatory approval and commercialization of the product(s). The fair value of the Ligand Contingent Consideration (as defined below) liability was determined using the probability of success and the discounted cash flow method of the income approach (representing unobservable “Level 3” inputs (see Note 2(xiii)) for regulatory and sales-based milestones due to Ligand upon achievement).
 
In March 2016, the FDA approved EVOMELA, triggering a $6 million milestone payment to Ligand (“Ligand Contingent Consideration”) that was paid in April 2016. “EVOMELA IPR&D” of $7.7 million was reclassified in April 2016 to

23


Table of Contents
Notes to Condensed Consolidated Financial Statements
(all tabular amounts presented in thousands, except share, per share, per unit, and number of years)
(Unaudited)


“EVOMELA distribution rights” that is reported within “Intangible assets, net of accumulated amortization” in the accompanying Condensed Consolidated Balance Sheets as of September 30, 2018 (see Note 3(f)). Amortization related to this intangible asset commenced on April 1, 2016.
(c) Allos Acquisition
We acquired Allos Therapeutics, Inc. (“Allos”) in September 2012 for cash consideration of $205.2 million and assumed its FOLOTYN distribution rights (see Note 14). We accounted for this transaction as a business combination, which required that assets acquired and liabilities assumed be reported on our balance sheet at their fair values as of the transaction date. We have no ongoing contingent consideration obligations from this transaction.
10. OUT-LICENSE OF MARQIBO, ZEVALIN, & EVOMELA IN CHINA TERRITORY
Overview of CASI Out-License
In September 2014, we executed three perpetual out-license agreements for ZEVALIN, MARQIBO, and EVOMELA (“CASI Out-Licensed Products”) with CASI, a publicly-traded biopharmaceutical company (NASDAQ: CASI) with a primary focus on the China market (collectively, the “CASI Out-License”). Under the CASI Out-License, we received CASI common stock and a secured promissory note; CASI gained the exclusive rights to distribute these drug products in greater China (which includes Taiwan, Hong Kong and Macau).
CASI is responsible for the development and commercialization of these drugs, including the submission of import drug registration applications to regulatory authorities and conducting any confirmatory clinical studies in greater China. We will provide CASI with future commercial supply of the CASI Out-Licensed Products under typical market terms.

Our Ownership in CASI at September 30, 2018

Under certain conditions that expired in December 2017, we had a right to purchase additional shares of CASI common stock in order to maintain our post-investment ownership percentage. During 2017 and 2016, we acquired an additional 1.5 million and 4.6 million CASI common shares at par value, respectively. Our aggregate holding of 11.5 million common shares as of September 30, 2018 represented an approximate 12.36% ownership in CASI, with a fair market value of $53.9 million (see Note 3(a)).

Proceeds Received from CASI in 2014
The proceeds we received in 2014, and its fair value on the CASI Out-License execution date, consisted of the following:
CASI common stock (5.4 million shares)
$
8,649

(a)
CASI secured promissory note, net of fair value discount ($1.5 million face value and 0.5% annual coupon)
1,310

(b)
Total consideration received, net of fair value discount
$
9,959

(c)

(a)
Value determined based on the September 17, 2014 closing price of 5.4 million shares of CASI common stock on the NASDAQ Capital Market of $1.60 per share.

(b)
Value estimated using the terms of the $1.5 million promissory note, the application of a synthetic debt rating based on CASI’s publicly-available financial information, and the prevailing interest yields on similar public debt securities as of September 17, 2014. This full balance was reclassified beginning December 31, 2017 to “other assets” (presented within non-current assets on the accompanying Condensed Consolidated Balance Sheets) from “other receivables” (presented within current assets) due to an amended maturity date of September 17, 2019.
(c)
Presented within “license fees and service revenue” in the Consolidated Statements of Operations for the year ended December 31, 2015 (see below).
In addition, CASI will be responsible for paying any royalties or milestones that we are obligated to pay to our third-party licensors resulting from the achievement of certain milestones and/or sales of CASI Out-Licensed Products, but only to the extent of the greater China portion of such royalties or milestones.


24


Table of Contents
Notes to Condensed Consolidated Financial Statements
(all tabular amounts presented in thousands, except share, per share, per unit, and number of years)
(Unaudited)


License Fee Revenue Recognized in 2015

The $9.7 million value of the upfront proceeds (undiscounted, and net of certain foreign exchange adjustments) from CASI were recognized in 2015 within “license fees and service revenue” on our Consolidated Statements of Operations. The delayed timing of this revenue recognition corresponded with the execution of certain supply agreements with CASI for ZEVALIN, MARQIBO, and EVOMELA. These agreements allow CASI to procure CASI Out-Licensed Products directly from approved third parties, and in such case, do not require our future involvement for its commercial supply.
11. OUT-LICENSE OF ZEVALIN IN CERTAIN EX-U.S. TERRITORIES
In November 2015, we entered into an out-license agreement with Mundipharma AG (“Mundipharma”) for its commercialization of ZEVALIN in Asia (excluding India and greater China), Australia, New Zealand, Africa, the Middle East, and Latin America (including the Caribbean). In return, we received $18 million (comprised of $15 million received in December 2015 and $3 million received in January 2016). Of these proceeds, $15 million was recognized and reported within “license fees and service revenue” in the fourth quarter of 2015, and the remaining $3 million payment was recognized in full by June 30, 2017.
In April 2018, we received $2 million due to Mundipharma’s achievement of a specified sales milestone which was recognized in the first quarter of 2018 and reported within “license fees and service revenue” on our accompanying Condensed Consolidated Statements of Operations for the nine months ended September 30, 2018 (see Note 5). Mundipharma is required to reimburse us for our payment of royalties due to Bayer Pharma AG (“Bayer”) from its ZEVALIN sales - see Note 15(b)(ii).
 
12. CO-PROMOTION ARRANGEMENT WITH EAGLE PHARMACEUTICALS
In November 2015, we executed an agreement with Eagle Pharmaceuticals, Inc. (“Eagle”) whereby designated members of our sales force concurrently marketed up to six of Eagle’s products (along with our products). This arrangement was in return for fixed monthly payments (aggregating $12.8 million) and variable sales-based milestones from Eagle over an 18 month contract term from January 1, 2016 through June 30, 2017 (the “Eagle Agreement”). On July 1, 2017, our sales force ceased marketing Eagle products and the Eagle Agreement expired under its terms.
The fixed receipts from Eagle for our sales activities, as well as reimbursements of third-party marketing services, are recognized within “license fees and service revenue” on our accompanying Condensed Consolidated Statements of Operations, and was $4.7 million for the nine months ended September 30, 2017. No sales-based milestones were achieved.
An allocation of costs for our sales personnel that were dedicated to the Eagle Agreement are reported within “cost of service revenue” on our accompanying Condensed Consolidated Statements of Operations, as are reimbursed costs for Eagle marketing activities; these were an aggregate $4.2 million for the nine months ended September 30, 2017.

13. CONVERTIBLE SENIOR NOTES

Overview of Convertible Notes and Conversion Hedge
On December 17, 2013, we entered into an agreement for the sale of $120 million aggregate principal amount of 2.75% Convertible Senior Notes (equaling 120,000 notes, denominated in $1,000 principal units) due December 2018 (the “2018 Convertible Notes”). As of September 30, 2018 and December 31, 2017, $35.8 million and $40.6 million of principal of the 2018 Convertible Notes was outstanding, respectively, due to our open market purchases discussed below, as well as $4.7 million of principal value, converted by a holder in July 2018 into 451,300 common shares.
The 2018 Convertible Notes are convertible into shares of our common stock at a conversion rate of 95 shares per $1,000 principal units, equating to 3.4 million common shares if fully converted at September 30, 2018. The in-the-money conversion price is equivalent to $10.53 per common share. The conversion rate and conversion price is subject to adjustment under certain limited circumstances. The 2018 Convertible Notes bear interest at a rate of 2.75% per year, payable semiannually in arrears on June 15 and December 15 of each year. The 2018 Convertible Notes will mature and become payable on December 15, 2018, subject to earlier conversion into common stock at the holders’ option.
The sale of the 2018 Convertible Notes closed on December 23, 2013 and we received net proceeds of $115.4 million, after deducting banker and professional fees of $4.6 million. We used a portion of these net proceeds to simultaneously enter into “bought call” and “sold warrant” transactions with Royal Bank of Canada (collectively, the “Conversion Hedge”). We

25


Table of Contents
Notes to Condensed Consolidated Financial Statements
(all tabular amounts presented in thousands, except share, per share, per unit, and number of years)
(Unaudited)


recorded the Conversion Hedge on a net cost basis of $13.1 million, as a reduction to “additional paid-in capital” in our accompanying Condensed Consolidated Balance Sheets. Under applicable GAAP, the Conversion Hedge transaction has not been (and is not expected to be) marked-to-market through earnings or comprehensive income.
On and after June 15, 2018, and until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert all, or a portion, of their 2018 Convertible Notes. Our stockholders’ approved “flexible settlement” our Annual Meeting of Stockholders on June 29, 2015, though on September 27, 2018, we elected to exclusively settle any and all conversions with our common stock. However, if the holders of our 2018 Convertible Notes do not elect to convert, our December 2018 obligation to repay the remaining principal amount of $35.8 million in cash, plus any accrued and unpaid interest, will remain unchanged.
We entered into Conversion Hedge transactions in December 2013 to reduce the potential dilution to our stockholders and/or offset any cash payments that we are required to make in excess of the principal amount, upon conversion of the 2018 Convertible Notes (in the event that the market price of our common stock is greater than the conversion price). The strike price of the “bought call” is equal to the conversion price and conversion rate of the 2018 Convertible Notes (at such time, it matched the 11.4 million common shares into which the holders could convert the 2018 Convertible Notes); the strike price of our “sold warrant” is $14.03 per share of our common stock, and is also for 11.4 million common shares (reduced by the partial unwinding of these instruments, as discussed above).
Open Market Purchases of 2018 Convertible Notes and Conversion Hedge Unwind in December 2016 and October 2017
In December 2016, we completed two open market purchases of our 2018 Convertible Notes, aggregating 9,963 note units (equivalent to $10 million principal value) for $9 million in cash. We recognized an aggregate loss of $25 thousand on the retirement of these 2018 Convertible Notes (based on their carrying value under GAAP), which is included in “other income (expense), net” on the Consolidated Statements of Operations for the year ended December 31, 2016. Concurrent with these two open market purchases in December 2016, we unwound a portion of our previously sold warrants and previously purchased call options (which were part of our Conversion Hedge described below) for aggregate net proceeds of $21 thousand. We recorded a corresponding net increase to “additional paid-in capital” in the Consolidated Balance Sheets as of December 31, 2016.
In October 2017, we completed an additional open market purchase of our 2018 Convertible Notes, aggregating 69,472 note units (equivalent to $69.5 million principal value) for $27.3 million in cash and 5.4 million newly-issued shares of our common stock, then worth $73 million. We recognized a loss of $0.8 million on the retirement of these 2018 Convertible Notes (based on their carrying value under GAAP), which was included in “other (expense) income, net” on the Consolidated Statements of Operations for the year ended December 31, 2017.
Concurrent with this open market purchase in October 2017, we also unwound a portion of the previously sold warrants and previously purchased call options that were part of our Conversion Hedge for aggregate net proceeds of $5.8 million. We recorded a corresponding net increase to “additional paid-in capital” in the Consolidated Balance Sheets as of December 31, 2017.
Carrying Value and Fair Value of 2018 Convertible Notes at September 30, 2018 and December 31, 2017
The carrying value of the 2018 Convertible Notes as of September 30, 2018 and December 31, 2017, is summarized as follows: 
 
September 30, 2018
 
December 31, 2017
Principal amount
$
35,815

 
$
40,565

(Less): Unamortized debt discount (amortized through December 2018)
(412
)
 
(2,101
)
(Less): Debt issuance costs
(46
)
 
(240
)
Carrying value
$
35,357

 
$
38,224



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Table of Contents
Notes to Condensed Consolidated Financial Statements
(all tabular amounts presented in thousands, except share, per share, per unit, and number of years)
(Unaudited)


As of September 30, 2018 and December 31, 2017, the estimated aggregate fair value of the 2018 Notes is $55.8 million and $74.3 million, respectively. These estimated fair values represent a Level 2 measurement (see Note 2(xiii)), based upon the 2018 Convertible Notes quoted bid price at each date in a thinly-traded market.
Components of Interest Expense on 2018 Convertible Notes
The following table sets forth the components of interest expense recognized in the accompanying Condensed Consolidated Statements of Operations for the 2018 Convertible Notes for the three and nine months ended September 30, 2018 and 2017

Three months ended September 30,
 
Nine months ended September 30,

2018
 
2017
 
2018
 
2017
Contractual coupon interest expense
$
246

 
$
757

 
$
798

 
$
2,270

Amortization of debt issuance costs
56

 
170

 
178

 
491

Accretion of debt discount
491

 
1,442

 
1,558