UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 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: 001-36375

Corium International, Inc.

(Exact name of registrant as specified in its charter)

Delaware		38-3230774
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)

Corium International, Inc.
235 Constitution Drive
Menlo Park, California 94025

(Address of principal executive offices and zip code)

(650) 298-8255

(Registrant’s telephone number, including area code)

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days: Yes ☒ No ☐

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). Yes ☒ No ☐

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


Large accelerated filer ☐		Accelerated filer ☐

Non-accelerated filer ☒ (Do not check if a smaller reporting company)		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 Act). Yes ☐ No ☒

As of August 7, 2018, there were approximately 36,250,261 shares of the Registrant’s Common Stock outstanding.

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TABLE OF CONTENTS

		Page
PART I. FINANCIAL INFORMATION		2

ITEM 1. FINANCIAL STATEMENTS		2
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		36
ITEM 4. CONTROLS AND PROCEDURES		36

PART II. OTHER INFORMATION		37

ITEM 1. LEGAL PROCEEDINGS		37
ITEM 1A. RISK FACTORS		37
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS		79
ITEM 3. DEFAULTS UPON SENIOR SECURITIES		79
ITEM 4. MINE SAFETY DISCLOSURES		79
ITEM 5. OTHER INFORMATION		79
ITEM 6. EXHIBITS		80
SIGNATURES		81

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PART I

ITEM 1.FINANCIAL STATEMENTS

CORIUM INTERNATIONAL, INC.

CONDENSED BALANCE SHEETS

(In thousands, except share and per share data)

(Unaudited)


	As of June 30,		As of September 30,
	2018		2017

ASSETS
Current assets:
Cash and cash equivalents	$	82,523	$	57,466
Accounts receivable		3,556		4,641
Unbilled accounts receivable		228		169
Inventories		1,686		2,300
Prepaid expenses and other current assets		924		982
Total current assets		88,917		65,558
Property and equipment, net		15,810		12,176
Intangible assets, net		7,404		7,117
TOTAL ASSETS	$	112,131	$	84,851
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	4,519	$	3,978
Accrued expenses and other current liabilities		6,860		6,411
Long-term debt, current portion		49		13,172
Recall liability, current portion		119		114
Deferred contract revenues, current portion		137		626
Total current liabilities		11,684		24,301
Convertible notes, net		70,021		—
Long-term debt, net of current portion		337		39,027
Recall liability, net of current portion		1,697		1,811
Deferred contract revenues, net of current portion		3,500		3,500
Total liabilities		87,239		68,639
Commitments and contingencies
Stockholders’ equity:
Common stock, par value of $0.001 per share, 150,000,000 shares authorized; 36,244,074 and 36,004,602 shares issued and outstanding as of June 30, 2018 and September 30, 2017		36		36
Additional paid-in capital		283,826		231,457
Accumulated deficit		(258,970)		(215,281)
Total stockholders’ equity		24,892		16,212
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	112,131	$	84,851

See accompanying notes to condensed financial statements.

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CORIUM INTERNATIONAL, INC.

CONDENSED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS

(In thousands, except share and per share data)

(Unaudited)


	Three Months Ended June 30,				Nine Months Ended June 30,
	2018		2017		2018		2017
Revenues:
Product revenues	$	5,901	$	5,906	$	18,512	$	16,301
Contract research and development revenues		1,529		1,936		7,813		5,320
Other revenues		240		267		720		801
Total revenues		7,670		8,109		27,045		22,422
Costs and operating expenses:
Cost of product revenues		3,507		3,935		10,806		10,892
Cost of contract research and development revenues		2,339		2,977		9,238		7,891
Research and development expenses		8,305		9,122		30,511		22,650
General and administrative expenses		3,325		3,284		10,728		9,288
Amortization of intangible assets		183		159		541		514
Loss on disposal of equipment		4		6		4		6
Total costs and operating expenses		17,663		19,483		61,828		51,241
Loss from operations		(9,993)		(11,374)		(34,783)		(28,819)
Interest income		332		77		617		149
Interest expense		(3,370)		(2,087)		(7,903)		(6,178)
Loss on extinguishment of long-term debt		—		—		(2,258)		—
Other income		640		—		640		—
Loss before income taxes		(12,391)		(13,384)		(43,687)		(34,848)
Income tax expense		—		—		2		2
Net loss and comprehensive loss	$	(12,391)	$	(13,384)	$	(43,689)	$	(34,850)
Net loss per share attributable to common stockholders, basic and diluted	$	(0.34)	$	(0.43)	$	(1.21)	$	(1.30)
Weighted-average shares used in computing net loss per share attributable to common stockholders, basic and diluted		36,214,740		31,457,702		36,144,746		26,784,678

See accompanying notes to condensed financial statements

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CORIUM INTERNATIONAL, INC.

Condensed Statement of Stockholders’ Equity

(In thousands, except share data)

(Unaudited)



				Additional				Total
	Common Stock			Paid-in		Accumulated		Stockholders’
	Shares	Amount		Capital		Deficit		Equity
Balance - September 30, 2017	36,004,602	$	36	$	231,457	$	(215,281)	$	16,212
Issuance of common stock under Employee Stock Purchase Plan	126,298		—		427		—		427
Issuance of common stock upon exercise of stock options	108,705		—		377		—		377
Issuance of common stock upon net exercise of common stock warrants	4,469		—		—		—		—
Equity component of convertible notes, net of issuance costs of $2.5 million	—		—		46,154		—		46,154
Warrant issued in connection with the convertible note offering	—		—		1,792		—		1,792
Stock-based compensation expense	—		—		3,619		—		3,619
Net loss and comprehensive loss	—		—		—		(43,689)		(43,689)
Balance - June 30, 2018	36,244,074	$	36	$	283,826	$	(258,970)	$	24,892

See accompanying notes to condensed financial statements.

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CORIUM INTERNATIONAL, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)


	Nine Months Ended June 30,
	2018		2017
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss and comprehensive loss	$	(43,689)	$	(34,850)
Adjustments to reconcile net loss to net cash used by operating activities:
Depreciation and amortization of property and equipment		703		801
Loss on disposal of equipment		4		6
Amortization of intangible assets		541		514
Noncash amortized debt discount and issuance costs on convertible notes		2,379		—
Noncash amortized debt discount and issuance costs on long-term debt and capital leases		172		285
Stock-based compensation expense		3,619		2,711
Issuance of payment-in-kind notes in lieu of cash interest payments		—		1,369
Loss on extinguishment of long-term debt		2,258		—
Other income		(640)		—
Changes in operating assets and liabilities:
Accounts receivable		1,085		(241)
Unbilled accounts receivable		(59)		86
Inventories		614		(97)
Prepaid expenses and other current assets		58		208
Accounts payable		199		2,530
Accrued expenses and other current liabilities		974		110
Deferred contract revenues		(489)		(234)
Recall liability		(109)		(351)
Net cash used by operating activities		(32,380)		(27,153)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment		(3,999)		(1,974)
Payments for patents and licensing rights		(828)		(813)
Net cash used by investing activities		(4,827)		(2,787)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the issuance of convertible notes		120,000		—
Payments for convertible notes issuance costs		(3,772)		—
Proceeds from issuance of common stock, net of issuance costs		—		56,136
Principal payments on long-term debt		(52,537)		(58)
Payments for long-term debt extinguishment costs		(2,231)		—
Principal payments on capital lease obligations		—		(73)
Proceeds from exercise of stock options		377		229
Proceeds from issuance of common stock under Employee Stock Purchase Plan		427		436
Net cash provided by financing activities		62,264		56,670
NET INCREASE IN CASH AND CASH EQUIVALENTS		25,057		26,730
CASH AND CASH EQUIVALENTS — Beginning of period		57,466		39,833
CASH AND CASH EQUIVALENTS — End of period	$	82,523	$	66,563

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest	$	3,434	$	4,524
Cash paid for income taxes	$	6	$	4
SUPPLEMENTAL DISCLOSURES OF NON-CASH INVESTING AND FINANCING ACTIVITIES:
Property and equipment purchases included in accounts payable	$	372	$	310
Warrant issued in connection with convertible note offering	$	1,792	$	—
Unpaid transaction costs associated with issuance of long-term debt	$	—	$	544

See accompanying notes to condensed financial statements.

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CORIUM INTERNATIONAL, INC.

Notes to the Condensed Financial Statements

1. Organization, Description of Business and Summary of Significant Accounting Policies

Organization

Corium International, Inc., a Delaware corporation (the “Company”), is a commercial-stage biopharmaceutical company focused on the development, manufacture and commercialization of specialty pharmaceutical products that leverage the Company’s broad experience with advanced transdermal and transmucosal delivery systems. The Company refers to its Transdermal Delivery Systems as “TDS.”

In the normal course of business, the Company enters into collaborative agreements with partners to develop and manufacture products based on the Company’s drug delivery technologies and product development expertise. Revenues consist of net sales of products manufactured, royalties and profit-sharing payments based on sales of such products by partners, and product development fees for research and development activities under collaboration agreements with partners. The Company is also engaged in the research and development of its own proprietary transdermal drug delivery products.

The Company’s fiscal year ends on September 30. References to “fiscal” refer to the years ended September 30.

Basis of Presentation

The accompanying unaudited condensed financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) and follow the requirements of the Securities and Exchange Commission (the “SEC”) for interim reporting. As permitted under those rules, certain footnotes or other financial information that are normally required by U.S. GAAP can be condensed or omitted. The interim balance sheet as of June 30, 2018, statements of operations and comprehensive loss for the three and nine months ended June 30, 2018 and 2017, statement of stockholders’ equity for the nine months ended June 30, 2018, and statements of cash flows for the nine months ended June 30, 2018 and 2017 are all unaudited. The unaudited interim financial statements have been prepared on the same basis as the annual financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments necessary to present fairly the Company’s financial position as of June 30, 2018, its results of operations for the three and nine months ended June 30, 2018 and 2017, and its cash flows for the nine months ended June 30, 2018 and 2017. The financial data and the other financial information contained in these notes to the financial statements related to the nine-month periods are also unaudited. The results of operations for the nine months ended June 30, 2018 are not necessarily indicative of the results to be expected for the year ending September 30, 2018 or for any future annual or interim period. The balance sheet as of September 30, 2017 has been derived from the audited financial statements at that date but does not include all of the information required by U.S. GAAP for complete financial statements.

The accompanying condensed financial statements and related financial information should be read in conjunction with the audited financial statements and the related notes thereto for the year ended September 30, 2017 included in the Company’s Annual Report on Form 10-K, which was filed with the SEC on December 29, 2017.

There have been no material changes to the significant accounting policies or recent accounting pronouncements previously disclosed in the Company’s audited financial statements for the year ended September 30, 2017.

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Liquidity

With the exception of fiscal 2013, the Company has incurred losses from operations since fiscal 2006 and has an accumulated deficit of $259.0 million as of June 30, 2018. The Company has financed its operations primarily through the proceeds from the sale of equity securities, and various debt and capital lease financings.

During the nine months ended June 30, 2018, the Company issued $120.0 million aggregate principal amount of convertible notes (the “Convertible Notes”) due in 2025 (see Note 4). The Company used the proceeds from the issuance of the Convertible Notes to prepay in full all outstanding borrowings, fees and other amounts due under the earlier term loan agreement with CRG, a structured debt and equity investment management firm. With the addition of the $61.5 million net proceeds arising from the issuance of the Convertible Notes and simultaneous retirement of the CRG indebtedness, the Company believes that its existing cash and cash equivalents will be sufficient to fund operations as currently planned beyond the next 12 months. Consequently, the Company believes there is no longer substantial doubt regarding its ability to continue as a going concern because the Company is no longer required to maintain compliance with covenants related to liquidity or revenues. The unaudited condensed financial statements as of June 30, 2018 have been prepared under the assumption that the Company will continue as a going concern for the next 12 months.

Use of Estimates

Estimates and assumptions are required to be used by management in the preparation of financial statements in conformity with U.S. GAAP that affect the reported amounts of assets, liabilities, and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of operating revenues and operating expenses during the reporting period. Those estimates and assumptions affect revenue recognition, deferred revenues, impairment of long-lived assets, determination of fair value of stock-based awards and other debt- and equity-related instruments, accounting for clinical trial expenses and accounting for income taxes. As future events and their effects cannot be determined with precision, actual results could differ from those estimates.

Concentration of Credit Risk

Financial instruments that potentially subject the Company to concentrations of credit risk consist of cash and cash equivalents and accounts receivable. The Company maintains its cash and cash equivalents with a single domestic financial institution that is well capitalized. The Company provides credit, in the normal course of business, to its partners and performs credit evaluations of such partners.

For both the three and nine months ended June 30, 2018, three partners accounted for 100% and 99% of the Company’s revenues and three partners accounted for 99% of accounts receivable as of June 30, 2018. For the three and nine months ended June 30, 2017, three partners accounted for 96% and 93% of the Company’s revenues. As of September 30, 2017, three partners accounted for 88% of accounts receivable.

Comprehensive Income (Loss)

For the three and nine months ended June 30, 2018 and 2017, the Company did not recognize any other comprehensive income (loss) and, therefore, the net loss and comprehensive loss was the same for all periods presented.

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Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) No. 2014-09, “Revenue from Contracts with Customers, (Topic 606)” (“ASU 2014-09”). This ASU affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards. The guidance in this ASU supersedes the revenue recognition requirements in Topic 605, “Revenue Recognition” and most industry-specific guidance. The core principle of the guidance is that an entity should recognize revenue upon the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new guidance also includes a set of disclosure requirements that will provide users of financial statements with comprehensive information about the nature, amount, timing, and uncertainty of revenue and cash flows arising from a reporting organization’s contracts with customers. In August 2015, the Financial Accounting Standards Board issued ASU No. 2015-14, “Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date,” which defers the effective date of ASU 2014-09 by one year. These ASUs are effective for annual reporting periods, and interim periods within those years, beginning after December 15, 2017 for public companies and permits the use of either the retrospective or modified retrospective method, with early adoption permitted as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within those annual periods. In April 2016, the FASB issued ASU 2016-10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing” which further clarifies guidance related to identifying performance obligations and licensing implementation guidance contained in ASU 2014-09. In May 2016, the FASB issued ASU 2016-12, “Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients” which addresses narrow-scope improvements to the guidance on collectibility, noncash consideration, and completed contracts at transition and provides a practical expedient for contract modifications at transition and an accounting policy election related to the presentation of sales taxes and other similar taxes collected from customers. In December 2016, the FASB issued ASU No. 2016-20, “Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers,” which clarifies areas for correction or improvement in the Accounting Standards Codification.

The Company will adopt the new revenue recognition standard effective October 1, 2018, utilizing the modified retrospective method. The Company is in the process of evaluating the impact the adoption of this standard will have on its financial statements and has performed an initial review of its major contracts with partners. Based on the initial reviews, the Company believes the adoption of the new standard will not have a significant quantitative impact on product revenues, as the timing of revenue recognition for product sales, profit sharing and royalties is not expected to significantly change. For the Company’s collaboration and partner arrangements, the consideration the Company is eligible to receive under these arrangements typically consists of nonrefundable upfront payments, reimbursement of research and development costs and milestone payments. The Company believes the adoption of the new standard will not have a significant quantitative impact on the revenue recognition of the reimbursement of research and development costs as the timing of the revenue recognition is not expected to significantly change. The Company continues to review the impact that this new standard will have on the timing of recognition for nonrefundable upfront payments and milestone payments as well as on its financial statement disclosures and has not made a determination on the impact to its financial statements. The Company is also evaluating changes to its accounting processes, internal controls and disclosures required to support the new standard.

In February 2016, the FASB issued ASU No. 2016-02, “Leases (Topic 842)” ("ASU 2016-02"), which supersedes existing guidance on accounting for leases in "Leases (Topic 840)" and generally requires separating leases into liability and asset components to be presented in the statement of financial position. Certain qualitative disclosures are also required to enable users of financial statements to understand the amount, timing, and uncertainty of cash flows arising from leases. The provisions of ASU 2016-02 are effective for annual reporting periods beginning after December 15, 2018; early adoption is permitted. The provisions of this ASU are to be applied using a modified retrospective approach. The Company is evaluating the effect that this ASU will have on the Company’s future financial position, results of operations or cash flows.

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In May 2017, the FASB issued ASU No. 2017-09, “Compensation-Stock Compensation (Topic 718) – Scope of Modification Accounting (Topic 718)”. This ASU clarifies when to account for a change to the terms or conditions of a share-based payment award as a modification, and provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting in Topic 718. An entity should account for the effects of a modification unless all three of the following conditions are met:

(1) The fair value (or calculated value or intrinsic value, if such an alternative measurement method is used) of the modified award is the same as the fair value (or calculated value or intrinsic value, if such an alternative measurement is used) of the original award immediately before the original award is modified. If the modification does not affect any of the inputs to the valuation technique that the entity uses to value the award, the entity is not required to estimate the value immediately before and after the modification.

(2) The vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified.

(3) The classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified.

This ASU is effective for annual periods beginning after December 15, 2017 and the Company will adopt the standard effective October 1, 2018. The adoption of this standard is not expected to have a material impact on the Company’s future financial position, results of operations or cash flows.

2. Fair Value Measurements

Financial assets and liabilities are recorded at fair value. Except as noted below, the carrying values of the Company’s financial instruments, including cash equivalents, accounts receivable, and accounts payable, approximated their fair values due to the short period of time to maturity or repayment.

Assets and liabilities recorded at fair value on a recurring basis in the balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair values. Fair value is defined as the exchange price that would be received for an asset, or an exit price that would be paid to transfer a liability, in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. The authoritative guidance on fair value measurements establishes a three-tier fair value hierarchy for disclosure of fair value measurements as follows:

Level I —Inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date;

Level II —Inputs that are observable, unadjusted quoted prices in active markets for similar assets or liabilities, unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related assets or liabilities; and

Level III —Unobservable inputs that are significant to the measurement of the fair value of the assets or liabilities that are supported by little or no market data.

The Company did not have any transfers between Levels I, II and III of the fair value hierarchy during the three and nine months ended June 30, 2018. The Company’s policy is to determine the need for transfers between levels at the end of the reporting period when circumstances in the underlying valuation criteria are evaluated for changes requiring transfer between levels.

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The Company’s financial assets that are measured at fair value on a recurring basis by level within the fair value hierarchy are as follows (in thousands):


	As of June 30, 2018
	Level I		Level II		Level III		Total
Financial Assets:
Money market funds	$	83,012	$	—	$	—	$	83,012


	As of September 30, 2017
	Level I		Level II		Level III		Total
Financial Assets:
Money market funds	$	57,928	$	—	$	—	$	57,928

The Company did not have any Level III liabilities as of September 30, 2017.

In March 2018, the Company issued $120.0 million aggregate principal amount of Convertible Notes due 2025 with embedded conversion features. The Company estimated the fair value of the liability component at issuance based on a hypothetical non-convertible debt instrument with a seven-year term, but with a fair market value interest rate derived from a Monte Carlo simulation of the coupon and conversion option outcomes of the Convertible Notes. The Company recorded $71.3 million as the gross fair value of the liability at issuance on March 5, 2018, with the balance of $48.7 million recorded to equity as additional paid-in capital, before issuance costs. The fair value of the liability component is based on unobservable inputs and is, therefore, a Level III liability. As of June 30, 2018, the carrying value of the Convertible Notes liability approximates the fair value, net of issuance costs allocated to it.

The carrying value of the Company’s long-term debt as of September 30, 2017 reflects the principal amount, adjusted for any unamortized debt issuance costs and discount. The long-term debt liability as of September 30, 2017 includes $51.8 million of adjusted debt principal relating to the then-outstanding term loan with CRG (see Note 4). The fair value of certain debt liabilities have been estimated by the Company based on market quotes for instruments with similar terms and remaining maturities. The following table lists both the carrying and fair values for such liabilities (in thousands):


	As of June 30, 2018
	Carrying		Fair
	Value		Value		Difference
Long-term debt	$	386	$	386	$	—


	As of September 30, 2017
	Carrying		Fair
	Value		Value		Difference
Long-term debt	$	52,199	$	55,888	$	3,689

3. Inventories

Inventories consist of the following (in thousands):


	As of June 30,		As of September 30,
	2018		2017
Raw materials	$	1,076	$	1,683
Work in process		386		264
Finished goods		224		353
Total inventories	$	1,686	$	2,300

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4. Debt

Long-Term Debt

Outstanding long-term debt consists of the following (dollars in thousands):


	As of June 30,		As of September 30,
	2018		2017
Term loan agreement expiring June 30, 2019, less unamortized issuance costs of $697 and unamortized discount of $27 as of September 30, 2017. See terms of the agreement below.	$	—	$	51,779
Notes payable to lessor for tenant improvements. The note calls for monthly payments of principal and interest of $6 at an interest rate of 7% and is due November 2024		386		420
Total		386		52,199
Less current portion		49		13,172
Long-term portion	$	337	$	39,027

Term Loan

Since 2012, the Company had borrowed $45.0 million from CRG, a structured debt and equity investment management firm, pursuant to a term loan agreement and subsequent amendments to such agreement. The amended agreement provided for a maximum borrowing of $45.0 million, excluding payment-in-kind (“PIK”) notes. The amended agreement required interest to be paid quarterly at a simple annual rate of 15%, and that all outstanding principal be repaid in four equal quarterly payments beginning on September 30, 2018, with interest continuing to accrue on the unpaid principal at a simple annual rate of 15%. In addition, the amended agreement contained a provision whereby the Company could, at each quarterly payment due date prior to June 30, 2018, choose to convert that portion of each quarterly interest obligation equal to 3.5% of the then-outstanding principal into PIK notes. Since inception of the amended agreement, the Company converted $7.5 million of interest into PIK notes, each of which were added to the then-outstanding principal. Amounts outstanding under the term loan agreement were collateralized by all of the Company’s assets.

The amended agreement also provided for a prepayment premium, the amount of which varied with the date on which prepayment was made if the Company chose to repay principal prior to December 31, 2018, or upon other specified events, including a change of control. For the period January 1, 2018 through December 31, 2018, the prepayment premium was equal to 3.25% of the aggregate value of the principal and PIK notes outstanding at the time of prepayment. An additional fee of 1.0% of the aggregate value of the principal and PIK notes outstanding was due at the time of repayment of the loan, whether paid early or upon the maturity date.

On March 5, 2018, the Company terminated the term loan agreement with CRG, as amended, and prepaid in full all outstanding borrowings, fees and other amounts due thereunder, in an aggregate amount of approximately $54.8 million plus accrued interest. This amount included total prepayment fees equal to 4.25% of the principal amount then outstanding. The loss on extinguishment of the debt was $2.3 million and is included in the Statement of Operations and Comprehensive Loss for the nine months ended June 30, 2018. The Company was in continuous compliance with the financial covenants from inception through termination of the loan.

Convertible Notes

In March 2018, the Company issued $120.0 million aggregate principal amount of Convertible Notes due 2025, which aggregate principal amount included the exercise in full by the initial purchaser of the Convertible Notes of an option to purchase $20.0 million of such Convertible Notes. The Convertible Notes are senior, unsecured obligations and accrue interest at an interest rate of 5.00% per year, payable in cash semi-annually in arrears on March 15 and September 15 of each year, beginning on September 15, 2018. The Convertible Notes have a maturity date of March 15, 2025, unless earlier converted or repurchased in accordance with their terms. The Company received $116.2 million in net proceeds from the sale of the Convertible Notes, after deducting payments for offering fees and expenses of $3.8 million.

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The Convertible Notes were issued pursuant to an indenture, dated as of March 5, 2018, by and between the Company and U.S. Bank National Association, as trustee (the “Indenture”). Pursuant to their terms, the Convertible Notes will be convertible into cash, shares of the Company’s common stock, or a combination of cash and shares of the Company’s common stock, at the Company’s election, as discussed in more detail below. The Convertible Notes have an initial conversion rate of 58.0552 shares of common stock per $1,000 principal amount, which is equivalent to an initial conversion price of approximately $17.22 per share of common stock. The conversion rate and the corresponding conversion price will be subject to adjustment upon the occurrence of certain events, including, but not limited to, stock splits and dividends, rights offerings, cash dividends, or a make-whole fundamental change (as described in the Indenture).

The Company may not redeem the Convertible Notes prior to March 15, 2022. The Company may redeem for cash all or any portion of the Convertible Notes, at its option, on or after March 15, 2022 if certain conditions are met, including, but not limited to, if the last reported sales price per share of the Company’s common stock has exceeded 130% of the conversion price for each of at least 20 trading days during the 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter.

Noteholders may convert their Convertible Notes at their option only in the following circumstances:

at any time during a calendar quarter after June 30, 2018, if the last reported sales price per share of the Company’s common stock exceeds 130% of the conversion price for each of at least 20 trading days during the 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter;

during the five consecutive business days immediately after any five consecutive trading day period (such five consecutive trading day period, referred to as the measurement period) in which the trading price per $1,000 principal amount of Convertible Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price per share of the Company’s common stock on such trading day and the conversion rate on such trading day;

upon the occurrence of certain corporate events or distributions on the Company’s common stock;

the Company calls the Convertible Notes for redemption; and

at any time from, and including, September 15, 2024 until the close of business on the scheduled trading day immediately before the maturity date.

The Convertible Notes are considered convertible debt with a cash conversion feature. The Company has separated the carrying value of the convertible debt into liability and equity components. The $71.3 million initial carrying amount of the liability component is based on the calculated fair value of a hypothetical non-convertible debt instrument with a seven-year term, but with a fair market value interest rate derived from a Monte Carlo simulation of the coupon and conversion option outcomes of the Convertible Notes. The $48.7 million gross carrying value of the equity component, which amount is also recorded as the initial debt discount, represents the standalone value of the conversion option, and was determined by Monte Carlo simulation. The carrying value of the Convertible Notes equals the aggregate par value of the Convertible Notes less the unamortized debt discount and unamortized debt issuance costs. The debt discount and debt issuance costs are being amortized to interest expense over the seven-year term of the Convertible Notes, using the effective interest rate method. The equity component will not be re-measured as long as it continues to meet the conditions for equity classification. The $46.2 million equity component of the Convertible Notes, which is net of $2.5 million in issuance costs allocated to it, is included in additional paid-in capital.

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In connection with the issuance of the Convertible Notes, the Company incurred $6.2 million of total debt issuance costs, primarily consisting of underwriting, legal and other professional fees, including a $2.4 million estimate of the fair value of a warrant issued to the initial purchaser (see Note 6), and allocated these costs to the liability and equity components in proportion to their respective carrying values. Of the total debt issuance costs, $3.7 million was allocated to the liability component and is recorded as a reduction of the Convertible Notes carrying value in the balance sheet, while the remaining $2.5 million was allocated to the equity component.

Debt discount and issuance costs totaling $52.4 million are being amortized to interest expense over the seven-year life of the Convertible Notes using the effective interest rate method. As of June 30, 2018, the interest rate was 5.00%, and the effective interest rate was 11.21%. Interest expense related to the Convertible Notes for the three and nine months ended June 30, 2018 was $3.4 million and $4.3 million, including $1.9 million and $2.4 million related to the amortization of the debt discount and issuance costs.

The table below summarizes the carrying value of the Convertible Notes as of June 30, 2018 (in thousands):


Gross proceeds	$	120,000
Portion of proceeds allocated to equity component (additional paid-in capital)		(48,671)
Debt issuance costs		(6,204)
Portion of issuance costs allocated to equity component (additional paid-in capital)		2,517
Amortization of debt discount and debt issuance costs		2,379
Carrying value of Convertible Notes	$	70,021

5. Collaboration and Partner Arrangements

The Company has recognized the following revenues from its collaboration and partner agreements (in thousands):


	Three Months Ended June 30,				Nine Months Ended June 30,
	2018		2017		2018		2017
Mayne	$	1,572	$	2,207	$	6,261	$	4,411
Par		—		—		—		363
P&G		5,149		4,406		14,942		12,519
Agile		949		1,154		5,605		4,014
Other		—		342		237		1,115
Total revenues	$	7,670	$	8,109	$	27,045	$	22,422

Included in revenues from Mayne is profit sharing, which totaled $0.2 million and $0.6 million for the three and nine months ended June 30, 2018, compared to $0.1 million and $0.7 million for the corresponding periods in fiscal 2017.

6. Warrants

The Company issued warrants to purchase shares of the Company's capital stock as part of several transactions occurring from fiscal 2008 through fiscal 2018. The warrants were recorded as equity instruments at the date of their issuances based on the terms of the warrants.

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On May 14, 2018 (the “Warrant Issuance Date”), the Company issued a warrant to purchase 350,000 shares of the Company’s common stock to Cantor Fitzgerald (the “Cantor Warrant”) in connection with its role as the initial purchaser of the Company’s offering of the Convertible Notes. The Cantor Warrant has a term of 7 years and a strike price of $17.22 per share. The Company estimated the value of the warrant to be $2.4 million as of a measurement date of March 31, 2018, and recorded that value as an adjustment to equity, and then further adjusted this estimate to the actual fair value of the warrant at issuance, which was $1.8 million as of the Warrant Issuance Date. The change in the value of the warrant from March 31, 2018 to the Warrant Issuance Date was recorded as other income in the Statements of Operations and Comprehensive Loss for the three and nine months ended June 30, 2018. The warrant was treated as an equity instrument, with its initial estimated value of $2.4 million recorded as an additional issuance cost associated with the offering of the Convertible Notes. The total Convertible Notes issuance costs of $6.2 million includes the warrant’s initial estimated value of $2.4 million. The Company estimated the fair value of this warrant as of May 14, 2018 using the Black-Scholes option pricing model with the following key assumptions:


Expected term (in years)	7.0
Risk-free interest rate	2.96	%
Expected volatility	70	%
Expected dividend rate	0	%

As of June 30, 2018 and September 30, 2017, warrants to purchase 382,380 and 51,386 shares of common stock were outstanding, with a weighted average exercise price of $16.55 and $9.26 per share. These common stock warrants have terms ranging from seven to ten years and are exercisable at any time within the terms. These warrants expire at various dates between December 2020 and May 2025. The fair value of these warrants was recorded in stockholders’ equity upon issuance.

During the nine months ended June 30, 2018, warrants to purchase 19,006 shares of common stock were net exercised, resulting in the issuance of 4,469 shares of common stock.

7. Convertible Preferred Stock, Common Stock and Stockholders' Equity

Convertible Preferred Stock

The Company was authorized to issue up to 5.0 million shares of preferred stock as of June 30, 2018 and September 30, 2017 with a par value of $0.001 per share. No preferred stock was outstanding as of those dates.

Common Stock

The Company was authorized to issue up to 150.0 million shares of common stock as of June 30, 2018 and September 30, 2017 with a par value of $0.001 per share. As of June 30, 2018, there were 36,244,074 shares of common stock outstanding and as of September 30, 2017, there were 36,004,602 shares of common stock outstanding.

Controlled Equity Offering

In December 2015, the Company entered into a Controlled Equity OfferingSM Sales Agreement with Cantor Fitzgerald & Co., as agent (“Cantor Fitzgerald”), pursuant to which the Company may offer and sell, from time to time through Cantor Fitzgerald, shares of its common stock, par value $0.001 per share, with aggregate proceeds of up to $20.0 million. The Company will pay Cantor Fitzgerald a commission of 3.0% of the aggregate gross proceeds from any shares of common stock sold by Cantor Fitzgerald. The Company has not sold any shares of common stock under this sales agreement. The offer and sale of these shares will require the filing of a new registration statement, or an amendment to an existing one, because the registration statement on Form S-3 that was filed by the Company with the SEC on May 8, 2015 (File No. 333-204025), including the related prospectus that covered the offer and sale of shares pursuant to the agreement with Cantor Fitzgerald, has expired.

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8. Stock-Based Compensation

Equity Incentive Plans

As of June 30, 2018 and September 30, 2017, the Company had three equity incentive plans, all of which are sponsored by the Company. On March 19, 2014, the Company’s board of directors approved the adoption of the 2014 Equity Incentive Plan (the "2014 Plan"), which is the only plan under which the Company can grant new awards. Under the 2014 Plan, the Company had initially reserved a total of 1.0 million shares of common stock plus the remaining unissued shares under the Company's 2012 Equity Incentive Plan (the "2012 Plan"), which was adopted in November 2012 and was replaced by the 2014 Plan. The 2014 Plan provides for the grant of incentive stock options (ISOs), nonstatutory stock options (NSOs), stock appreciation rights, restricted stock awards, restricted stock unit awards, stock bonus awards, performance-based stock awards, and other forms of equity compensation, all of which may be granted to employees (including officers), non-employee directors and consultants of the Company. The Company also sponsored the 2002 Stock Option Plan that expired in 2012. The term “Corium Plans” refers to the 2014 Plan, the 2012 Plan and the 2002 Stock Option Plan.

On January 1 of each year during the ten-year term of the 2014 Plan, the number of shares of common stock issuable under the 2014 Plan will be automatically increased by 4% of the number of shares of common stock outstanding as of the preceding December 31, unless a lesser number of shares is agreed to by the Company’s board of directors. On January 16, 2018 and January 10, 2017, the Company’s board of directors authorized an increase of 1,444,716 and 902,298 shares to be added to the total number of shares of common stock issuable under the 2014 Plan. As of June 30, 2018 and September 30, 2017, the Company had reserved 6,396,840 and 5,060,829 shares of common stock for issuance pursuant to the 2014 Plan. As of June 30, 2018 and September 30, 2017, the Company had 1,714,127 and 1,129,232 shares of common stock available for issuance pursuant to the 2014 Plan.

Stock Options

The exercise price of each stock option granted under the Corium Plans is required to be no less than the fair market value of the Company’s common stock on the date of the grant. The maximum term of stock options granted under the Corium Plans is ten years and the vesting period is typically four years.

A summary of stock option activity under the Corium Plans during the nine months ended June 30, 2018 is as follows:


		Weighted		Weighted Average
	Stock	Average		Remaining	Aggregate
	Options	Exercise		Contractual	Intrinsic Value
	Outstanding	Price		Life (Years)	(In thousands)
Balance - September 30, 2017	3,787,222	$	4.85	6.84	$	23,819
Options granted	811,050	$	11.59
Options exercised	(108,705)	$	3.47
Options forfeited / cancelled	(20,784)	$	7.48
Options expired	(445)	$	2.22
Balance - June 30, 2018	4,468,338	$	6.10	6.77	$	11,990

Options exercisable - June 30, 2018	3,085,519	$	5.01	5.92	$	10,193

Options vested and expected to vest - June 30, 2018	4,328,101	$	6.02	6.71	$	11,835

All outstanding stock options under the Corium Plans as of June 30, 2018 have an exercise price between $2.12 and $14.12 per share.

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The weighted-average fair value of the stock options granted for the nine months ended June 30, 2018 were estimated using the Black-Scholes option-pricing model with the following assumptions:


	Nine Months Ended
	June 30, 2018
Expected term (in years)	5.27		-	6.57
Risk-free interest rate	2.08	%	-	2.72	%
Expected volatility	67	%	-	73	%
Expected dividend rate			0	%

Expected Term — The expected term represents the period that the stock-based awards are expected to be outstanding before exercise or cancellation. As the Company's historical share exercise experience has not yet provided a reasonable basis upon which to estimate expected term because of a lack of sufficient data points, the Company estimated the expected term by using the midpoint between the vesting commencement date and the contractual expiration period of the stock-based awards.

Risk-Free Interest Rate — The risk-free interest rate is based on the constant maturity yields of U.S. Treasury notes with remaining maturities similar to the expected term.

Expected Volatility — Because the Company has insufficient information on the volatility of its common stock due to limited historical data regarding the volatility of its common stock, the expected volatility used is based on the volatility of a group of comparable publicly-traded companies. In evaluating comparability, the Company considered factors such as industry, stage of life cycle and size. The Company will continue to analyze the historical stock price volatility and term assumptions as more historical data for the Company's common stock becomes available.

Expected Dividend Rate — The Company has never paid any dividends, does not plan to pay dividends in the foreseeable future, and, therefore, uses an expected dividend rate of zero in the valuation model.

Restricted Stock Unit Awards

The fair value of restricted stock unit awards is determined on the grant date based on the fair market value of the Company’s common stock on the date of the grant. The restricted stock unit awards granted under the 2014 Plan have a maximum term of ten years and typically vest over a four-year period.

A summary of restricted stock unit award activity under the Corium Plans during the nine months ended June 30, 2018 is as follows:


		Weighted
		Average
	Number of	Grant Date
	Shares	Fair Value
Nonvested - September 30, 2017	144,375	$	6.44
Granted	70,000	$	11.59
Vested	(27,502)	$	5.50
Forfeited	—	$	—
Nonvested - June 30, 2018	186,873	$	8.51

As of June 30, 2018 and September 30, 2017, the Company had 214,375 and 144,375 restricted stock unit awards outstanding.

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2014 Employee Stock Purchase Plan

On March 19, 2014, the Company's board of directors approved the adoption of the 2014 Employee Stock Purchase Plan (the "2014 ESPP"), with 310,000 shares initially reserved for issuance. The 2014 ESPP is intended to qualify as an "employee stock purchase plan" under Section 423 of the Internal Revenue Code of 1986 with the purpose of providing employees with an opportunity to purchase the Company's common stock through accumulated payroll deductions.

On January 1 of each year during the ten-year term of the plan, the number of shares issuable under the 2014 ESPP will be automatically increased by 1% of the number of shares of common stock and common stock equivalents outstanding as of the preceding December 31, unless a lesser number of shares is agreed to by the Company’s board of directors. On January 16, 2018 and January 10, 2017, the Company’s board of directors reserved an additional 409,224 and 267,565 shares of common stock for issuance pursuant to the 2014 ESPP. No more than 4.0 million shares may be issued over the ten-year term of the 2014 ESPP without the consent of the Company's stockholders. Shares subject to purchase rights granted under the Company’s 2014 ESPP that terminate without having been exercised in full will not reduce the number of shares available for issuance under the Company’s 2014 ESPP. As of June 30, 2018 and September 30, 2017, there were 919,325 and 636,399 shares of common stock available for issuance pursuant to the 2014 ESPP.

For the three and nine months ended June 30, 2018, the Company recorded stock-based compensation expense related to the 2014 ESPP of $73,000 and $146,000 compared to $60,000 and $224,000 for the corresponding periods in fiscal 2017. For the nine months ended June 30, 2018 and 2017, the Company issued 126,298 and 134,855 shares of common stock to employees pursuant to the 2014 ESPP.

The fair value of the purchase rights granted under the 2014 ESPP for the current offering periods were estimated by applying the Black-Scholes option-pricing model to each of the four purchase periods in the offering period using the following assumptions:


	As of
	June 30, 2018
Fair value of common stock	$	4.82		–	$	8.51
Grant price	$	4.10		–	$	7.23
Expected term (in years)		0.5		–		2.0
Expected volatility		46	%	–		84	%
Risk-free interest rate		1.08	%	–		2.58	%
Expected dividend rate				0	%

Fair Value of Common Stock — The fair market value of the Company’s common stock on the first day of each offering period.

Grant Price — 85% of the fair market value of the Company’s common stock on the first day of the offering period.

Expected Term — The expected term is based on the end dates of the four purchase periods of each two year offering period, which are six, twelve, eighteen or twenty-four months from the commencement of each new offering period.

Expected Volatility — The expected volatility is based on the historical volatility of the Company’s common stock over each of the expected terms.

Risk-Free Interest Rate — The risk-free interest rate is based on the constant maturity yields of U.S. Treasury notes with remaining maturities similar to each expected term.

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Stock-Based Compensation Expense

Employee stock-based compensation expense for the three and nine months ended June 30, 2018 and 2017 is classified in the condensed statements of operations and comprehensive loss as follows (in thousands):


	Three Months Ended June 30,				Nine Months Ended June 30,
	2018		2017		2018		2017
Cost of product revenues	$	127	$	93	$	348	$	300
Cost of contract research and development revenues		96		61		266		169
Research and development		269		174		750		501
General and administrative		743		592		2,255		1,741
Total stock-based compensation	$	1,235	$	920	$	3,619	$	2,711

As of June 30, 2018, there was a total of $7.7 million of unrecognized employee stock-based compensation expense, net of estimated forfeitures, related to unvested stock-based awards under the Corium Plans, which is expected to be recognized on a straight-line basis over a weighted-average period of approximately 2.6 years.

9. Product Recall Liability

In fiscal 2008 and fiscal 2010, Actavis, Inc. (“Actavis”) issued two voluntary recalls of certain lots and strengths of Fentanyl TDS manufactured by the Company and sold and distributed at that time by Actavis in the United States. The Company and Actavis negotiated financial settlements for these two recalls, and the Company accrued amounts related to these settlements in fiscal 2009 and 2011. These recall liabilities were subsequently reduced through various mechanisms per the terms of the settlement agreements.

In October 2012, the Company reached a revised settlement related to the two recalls, which provided for a total and combined remaining liability of $5.0 million as of the settlement date. The revised liability will be repaid through quarterly payments in arrears based on a percentage of the average of the total net revenues recorded by the Company in those prior periods related to Fentanyl TDS, and may be pre-paid by the Company in its discretion. These quarterly payments have been paid to Actavis since July 1, 2013. In April 2017, the Company and Actavis mutually agreed to extend the provision for quarterly payments through April 1, 2019, and agreed that, to the extent that the revised settlement liability has not been fully repaid as of April 30, 2019, the remaining liability, if any, will be converted into the most recent form of capital stock issued by the Company in connection with a financing, at the price per share of that financing. The revised liability does not accrue interest.

During the three and nine months ended June 30, 2018, the Company made an immaterial amount of settlement payments to Actavis compared to $0.1 million and $0.3 million for the corresponding periods in fiscal 2017. The outstanding balance of the recall liability was $1.8 million and $1.9 million as of June 30, 2018 and September 30, 2017.

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10. Net Loss and Net Loss per Share Attributable to Common Stockholders

The following table sets forth the computation of the Company's basic and diluted net loss per share attributable to common stockholders during the three and nine months ended June 30, 2018 and 2017 (in thousands, except share and per share data):


	Three Months Ended				Nine Months Ended
	June 30,				June 30,
	2018		2017		2018		2017
Basic and diluted net loss per share
Net loss attributable to common stockholders, basic and diluted	$	(12,391)	$	(13,384)	$	(43,689)	$	(34,850)
Weighted-average shares used in computing net loss per share attributable to common stockholders, basic and diluted		36,214,740		31,457,702		36,144,746		26,784,678
Net loss per share attributable to common stockholders, basic and diluted	$	(0.34)	$	(0.43)	$	(1.21)	$	(1.30)

The following outstanding shares of common stock equivalents were excluded from the computation of the diluted net loss per share attributable to common stockholders for the periods presented because including them would have been antidilutive:


	Three Months Ended		Nine Months Ended
	June 30,		June 30,
	2018	2017	2018	2017
Convertible notes	6,968,641	—	6,968,641	—
Stock options to purchase common stock	4,468,338	4,058,134	4,468,338	4,058,134
Unvested restricted stock unit awards	186,873	102,500	186,873	102,500
Shares authorized under the 2014 ESPP	919,325	636,399	919,325	636,399
Common stock warrants	382,380	51,386	382,380	51,386

11. Income Taxes

The Company did not record a provision for Federal income taxes for the nine months ended June 30, 2018 because it expects to generate a net operating loss for the year ending September 30, 2018. The income tax expense of $2,000 for both the nine month periods ended June 30, 2018 and 2017 represents minimum statutory payments due in the states in which the Company is subject to taxation. The Company’s deferred tax assets continue to be fully offset by a valuation allowance.

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “2017 Tax Act”). The 2017 Tax Act makes broad and complex changes to the U.S. tax code and will affect the Company’s fiscal year ending September 30, 2018, including, but not limited to reducing the U.S. federal corporate tax rate from 35 percent to 21 percent and creating limitations on net operating losses (“NOLs”) generated after December 31, 2017. Because the Company’s fiscal years do not coincide with the federal tax year, Section 15 of the Internal Revenue Code requires that the Company’s fiscal year ending September 30, 2018 will have a blended corporate tax rate of 24.53 percent, which is based on the applicable tax rates in effect before and after December 31, 2017 weighted by the number of days in the Company’s 2018 fiscal year before and after December 31, 2017.

The SEC staff issued Staff Accounting Bulletin 118 (“SAB 118”), which provides guidance on accounting for the tax effects of the 2017 Tax Act. SAB 118 provides a measurement period that should not extend beyond December 22, 2018 for companies to complete the accounting under ASC 740, “Income Taxes.” In accordance with SAB 118, a company must reflect the income tax effects of those aspects of the 2017 Tax Act for which the accounting under ASC 740 is complete. To the extent that a company’s accounting for certain income tax effects of the 2017 Tax Act is incomplete but it is able to determine a reasonable estimate, it must record a provisional estimate in the financial statements. If a company is unable to determine such a provisional estimate, it should continue to apply ASC 740 on the basis of the provisions of the tax laws that were in effect immediately before the enactment of the 2017 Tax Act.

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Although the Company’s analysis of the 2017 Tax Act is incomplete, it does not currently have the necessary information available, prepared, or analyzed in sufficient detail to make reasonable estimates of the impact of the 2017 Tax Act on the Company’s financial statements, the Company expects there will be no impact on the Company’s financial statements due to the full valuation allowance applied to the Company’s deferred tax assets.

The 2017 Tax Act also limits the use of Net Operating Loss carryforwards (or “NOLs”) generated after December 31, 2017 to 80% of taxable income. The Company does not expect profitability in the near term, nor has it conducted an analysis on its NOLs generated to date, so the future impact of such NOL limitations is not yet known.

12. Segment and Enterprise-Wide Information

The Company’s chief operating decision maker is its President and Chief Executive Officer. The President and Chief Executive Officer reviews the Company’s operating results on an aggregate basis for purposes of allocating resources and evaluating financial performance. The Company has one business activity and there are no segment managers who are held accountable for operations or operating results for levels or components. Accordingly, the Company has a single reporting segment and operating unit structure.

All of the Company’s revenues are derived from partners conducting their business involving the Company’s products and services primarily in North America and all long-lived assets are located in the United States.

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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 the (1) unaudited condensed financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q, and (2) the audited financial statements and notes thereto and management’s discussion and analysis of financial condition and results of operations for the fiscal year ended September 30, 2017 included in the Annual Report on Form 10-K filed with SEC on December 29, 2017. This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These statements are often identified by the use of words such as “believe,” “may,” “will,” “potentially,” “estimate,” “continue,” “anticipate,” “intend,” “could,” “would,” “project,” “plan,” “expect,” “seek” and similar expressions or variations. Such forward‑looking statements may include, but are not limited to, our plans and strategy for our business, and are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by the forward‑looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified herein, and those discussed in the section titled “Risk Factors”, set forth in Part II, Item 1A of this Quarterly Report on Form 10-Q and in our other SEC filings. We disclaim any obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. Our fiscal year ends September 30. Throughout this discussion and analysis, references to “fiscal,” “fiscal year” or “fiscal years” refer to years ended September 30.

Company Overview

We are a commercial-stage biopharmaceutical company focused on the development, manufacture and commercialization of specialty pharmaceutical products that leverage our broad experience with advanced transdermal and transmucosal delivery systems, or TDS. We have multiple proprietary programs in preclinical and clinical development focusing primarily on the treatment of neurological disorders, with two lead programs in Alzheimer’s disease. We have developed and are the sole commercial manufacturer of seven prescription drug and consumer products for our marketing partners. We have two proprietary transdermal platforms: Corplex™ for small molecules and MicroCor®, a biodegradable microstructure technology for small molecules and biologics, including vaccines, peptides and proteins.

We have built significant know-how and experience in the development, scale-up and manufacture of complex specialty products, and have formed relationships with our partners that include both the development of new product formulations and our manufacture of the resulting products. Our partners include Mayne Pharma Inc., or Mayne, The Procter & Gamble Company, or P&G, Agile Therapeutics, or Agile, and Aequus Pharmaceuticals, Inc., or Aequus, as well as other pharmaceutical companies. All of our current commercial products are distributed, promoted and marketed by our partners.

The following table identifies: (1) products we have developed that are marketed by our partners, (2) products we have developed with our partners that are in clinical trials and that our partners have permitted us to disclose, (3) publicly disclosed clinical stage Central Nervous System, or CNS, products in our proprietary pipeline, including those in Bioequivalence, or BE trials, and (4) products currently awaiting Food and Drug Administration, or FDA, approval as part of a pending New Drug Application, or NDA, or an Abbreviated New Drug Application, or ANDA.


Partner	Product/Candidate	Application	Status
Mayne	Clonidine TDS	Hypertension	Marketed
Mayne	Fentanyl TDS	Pain	Marketed
P&G	Crest Whitestrips (5 Products)	Teeth Whitening	Marketed
Agile	Twirla	Contraception	NDA Filed
Self-funded	Donepezil TDS	Alzheimer's	BE Complete
Self-funded	Memantine TDS	Alzheimer's	Phase 1
Aequus	Aripiprazole TDS	Psychiatric Disorders	Phase 1
Mayne	ANDA	Motion Sickness	ANDA Filed

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In August 2016, Mayne acquired the commercial rights to the Clonidine Transdermal Delivery System, or Clonidine TDS, and the product-related agreements from Teva Pharmaceuticals USA, Inc., or Teva, as a result of a Federal Trade Commission, or FTC, consent order in which Teva agreed to divest the product in connection with Teva’s acquisition of the generic business of Allergan, plc, or Allergan. Mayne currently sells Clonidine TDS throughout the United States. Development of the product commenced in 2004, and it was commercially launched in 2010.

In March 2017, Mayne acquired the commercial rights to the Fentanyl TDS from Par Pharmaceuticals, or Par. Par had originally acquired the product as a result of an FTC-mandated divestiture of Fentanyl TDS from Actavis Inc., or Actavis, in connection with the merger of Actavis with Watson Pharmaceuticals, Inc. Mayne currently sells Fentanyl TDS throughout the United States. We began the development of Fentanyl TDS in May 2002, and the product was commercially launched in 2007.

Our partnership with P&G began in 2005 with the development of the various products under the Crest® Whitestrips label, the first of which was commercially launched in 2009. P&G currently sells Crest Whitestrips products globally.

In addition to commercialized products, we have a number of partner-funded and self-funded product candidates in various stages of development. One of these products is Twirla®, which is an investigational combination hormonal contraceptive transdermal patch designed to deliver two hormones, ethinyl estradiol and levonorgestrel, at levels comparable to low-dose oral contraceptives over seven days. Twirla incorporates the proprietary SkinFusion® adhesive technology designed by Agile. We are the exclusive manufacturer of this product for Agile.

In June 2017, Agile resubmitted its NDA with the results of an additional Phase 3 clinical trial that had been recommended by the FDA in 2013. On December 22, 2017, Agile disclosed that the FDA had issued a Complete Response Letter, or CRL, in response to the resubmission of its NDA, which stated that the FDA could not approve Agile’s NDA in its current form. Agile further disclosed that it met with the FDA in April 2018 to discuss the deficiencies in the Twirla NDA and the regulatory path for approval of Twirla, and that the FDA informed Agile that it continued to have significant concerns regarding the adhesion properties of Twirla in Agile’s clinical trials, and that Agile needed to address the Twirla in vivo adhesion properties by reformulating the transdermal system and conducting a formal adhesion study with the new formulation. In June 2018, Agile submitted a formal dispute resolution request to the FDA. The dispute pertains to the determination from the FDA’s reviewing Division of Bone, Reproductive and Urologic Products, or DBRUP, that concerns surrounding the in vivo adhesion properties of Twirla prevent its approval and cannot be addressed through Agile’s proposed patient compliance programs. In July 2018, Agile reported that the Office Director of the FDA’s Office of Drug Evaluation III, or ODEIII, has affirmed the position of DBRUP and denied their appeal of the CRL. In addition, Agile disclosed that it intends to appeal the ODEIII decision to the Office of New Drugs. We continue to work with Agile as it pursues the dispute resolution process for Twirla.

In addition to our partnered products, we are developing products utilizing our Corplex technology, some of which we advanced into human clinical trials during 2015 and 2016. Our two lead central nervous system product candidates are for the transdermal treatment of Alzheimer’s disease and incorporate the two most commonly-prescribed drugs already approved by the FDA for this disease: donepezil and memantine.

Our donepezil and memantine product candidates first entered into Phase 1 clinical trials in fiscal 2015, and we announced positive results for several donepezil and memantine clinical trials in fiscal 2016. In April 2016, we received positive feedback from the FDA on our pre-Investigational New Drug, or pre-IND, submission that outlined our proposed 505(b)(2) regulatory pathway for Corplex Donepezil based on a demonstration of bioequivalence, or BE. Specifically, the FDA advised us that if we can adequately demonstrate bioequivalence between Corplex Donepezil and oral Aricept in our planned bioequivalence studies, additional clinical efficacy studies would not be required. Bioequivalence clinical studies are designed to assess the biological equivalence of pharmaceutical products based on their pharmacokinetic, or PK, profiles, and are generally performed in healthy subjects. These studies are relatively short in duration and provide a development path that is generally less costly and more streamlined than typical clinical development programs, which require studies demonstrating safety and efficacy in patients with the disease.

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Additionally, in August 2016, after review of our pre-IND submission of Corplex Memantine, the FDA concurred with our development plans for this product, including our proposal for a pivotal study based on the demonstration of bioequivalence between the Corplex Memantine and oral Namenda XR® extended release capsules.

In fiscal 2016, we initiated our first bioequivalence study, which we previously referred to as our pilot BE study, for Corplex Donepezil, and we completed the study in April 2017. The first bioequivalence study was a six-month, three-period, randomized crossover study comparing the steady-state pharmacokinetic profiles of once-daily oral Aricept with two Corplex Donepezil transdermal patches that differed only in size. Based on the results of our earlier one-week Phase 1 PK study comparing Corplex Donepezil with oral Aricept, we projected that the maximum plasma concentration, or Cmax, and the area under the curve, or AUC, of plasma concentration of donepezil with the Corplex patch over the course of a week, at steady state, would be similar to the same measurements of oral Aricept. Data from the first BE study demonstrated that the smaller of the two Corplex Donepezil product candidates successfully met the statistical criteria for bioequivalence to oral Aricept based on the primary PK parameters of Cmax at steady state and AUC at steady state that had been previously established with the FDA. Both Corplex transdermal treatments were well tolerated, with favorable adhesion, skin safety and gastrointestinal side effect profiles after application of over 500 patches in the course of the study. For example, the incidence of treatment-related nausea in subjects on the smaller patch was more than six-fold lower than the incidence of nausea with oral Aricept.

In August 2017, we held an end of Phase 2 meeting with the FDA in which we reviewed the results from the first BE study. The FDA confirmed the choice of PK parameters and statistical testing approaches for the BE study and also confirmed our design of the planned supportive studies and other requirements for product registration. The FDA also indicated that it would consider whether the data from the first BE study could be sufficient for an NDA submission, and we provided additional data requested by the FDA during its review. However, due to uncertainty at that time as to the length or outcome of that review, we initiated dosing of our second BE study for Corplex Donepezil, which we have previously referred to as our pivotal BE study, in October 2017. The design of the second BE study was similar to the first BE study and was a single center, randomized, multiple dose, two-way crossover study in healthy volunteers, conducted at the same site as the first BE study. Dosing for this second BE study was completed in mid-February 2018. Following its review, the FDA provided positive feedback in mid-February, and we subsequently announced our intention to rely on the data from our successful first BE study for the planned NDA submission for Corplex Donepezil. We have completed treatments in all the ancillary studies required for the NDA filing and are planning to submit a Section 505(b)(2) NDA for this product candidate in the first quarter of calendar 2019.

We are currently focusing our resources and clinical development efforts on Corplex Donepezil, the highest priority of our proprietary programs. We are also pursuing development of several pipeline product candidates, including Corplex Memantine. We anticipate following the same bioequivalence-based development pathway for Corplex Memantine that we are following for Corplex Donepezil. In addition, we continue to perform preclinical development work on other proprietary pipeline products with a primary focus on developing innovative products for treatment of central nervous system diseases, and have identified several product candidates that have met our initial technical and commercial criteria for further development, including fingolimod for the treatment of relapsing and remitting multiple sclerosis and lidocaine for the non-opioid management of acute pain.

In April 2015, we entered into an agreement with Aequus to develop new transdermal products with an initial focus on neurological and psychiatric disorders. The first project under this collaboration is a multi-day transdermal formulation of aripiprazole, a drug already approved by the FDA for the treatment of a variety of psychiatric conditions. Aequus reported positive results from a single dose Phase 1 bioavailability clinical trial in the first calendar quarter of 2016 and, in April 2017, announced positive results from a follow-up repeat dose 28-day study to evaluate the bioavailability and safety of this product candidate. In addition, we have recently expanded our relationship with Aequus to include formulation and manufacturing of Aequus’ long-acting transdermal patch for nausea and vomiting in pregnancy.

We routinely enter into other feasibility and development agreements with pharmaceutical and biotechnology companies involving our transdermal technologies.

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Components of Statements of Operations

Revenues

During the nine months ended June 30, 2018 and 2017, we recognized revenues in three categories: product revenues, contract research and development revenues, and other revenues.

Product Revenues—Product revenues consisted of product sales to our partners and profit sharing from products that have been sold by our partners. Clonidine TDS, Fentanyl TDS and Crest Whitestrips provided all of our product revenues during the nine months ended June 30, 2018 and 2017.

Our product revenues from Clonidine TDS consisted of revenues from the sale of products we manufactured and shipped to Mayne, along with profit sharing from the net profits earned by Mayne on its sales of the product. For the nine months ended June 30, 2018, product revenues related to Clonidine TDS were similar to those for the same period in fiscal 2017. Although product revenues from Clonidine TDS in fiscal 2018 may be higher than fiscal 2017 revenues, product revenues beyond 2018 are expected to be adversely impacted by the longer term trend of increasing competition among generic drug marketers.

Our product revenues from Fentanyl TDS consisted of revenues from the sale of products we manufactured and shipped to Mayne following Mayne’s March 2017 acquisition of the product from Par, along with profit sharing from the net profits earned by Mayne on its sales of the product. Product revenues related to Fentanyl TDS increased for the nine months ended June 30, 2018, compared to the same period in fiscal 2017, as a result of an increase in the number of units shipped. There have been, and will likely continue to be, material variations in quantities of Fentanyl TDS ordered from quarter to quarter, and we expect that our product revenues from Fentanyl TDS in fiscal 2018 and beyond will be lower than fiscal 2017 as a result of continued pressure on market pricing and the timing of orders from Mayne.

Product revenues from Crest Whitestrips consisted of revenues from the sale of products manufactured and shipped to P&G. Revenues increased for the nine months ended June 30, 2018, compared to the same period in fiscal 2017, as a result of increased global demand for the current products. We expect product revenues from P&G to be higher in fiscal 2018, compared to fiscal 2017, as demand is expected to continue to increase. We have completed the expansion of our commercial manufacturing capacity and expect to be able to meet this increased demand during the fourth quarter of fiscal 2018 and beyond.

Contract Research and Development Revenues —We also generated revenues from agreements with our partners for the research, development and scale-up activities of new products. The terms of our agreements with these partners may include nonrefundable upfront payments, partial or complete reimbursement of research and development costs, and milestone payments. Contract research and development revenues increased for the nine months ended June 30, 2018, compared to the same period in fiscal 2017, due to increased development activities for Agile and P&G. We currently expect our revenues from contract research and development in fiscal 2018 to be roughly flat compared to fiscal 2017.

Other Revenues —Other revenues consisted primarily of income derived from certain aspects of our arrangements with our partners, whereby a portion of the revenues received under these agreements is treated for accounting purposes as rental income from embedded leases associated with these relationships. Other revenues have not been, and are not expected to be, a significant portion of our revenues.

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Costs and Expenses

Cost of Product Revenues —The primary components of our cost of product revenues are materials, personnel costs, depreciation, facilities costs, other overhead costs, and infrastructure expenses associated with the manufacturing of our products. Our manufacturing overhead costs are significant, and are allocated proportionately among our products at levels consistent with then-current unit production volumes. As the number of units we manufacture increases, our overhead costs should increase less rapidly due to economies of scale, resulting in lower per-unit costs associated with higher unit production volumes. Conversely, if total unit production volumes decrease, the cost of product revenues, measured as a percentage of product revenues, may increase as we lose economies of scale, unless offset by other savings. In addition, cost of product revenues varies with the mix of products sold.

Cost of Contract Research and Development Revenues —We incur expenses related to our contract research and development revenues from our partner-funded and co-funded product development agreements. These expenses consist primarily of personnel costs, materials, supplies, and overhead costs. We generally expense all contract research and development costs, including costs to be subsequently reimbursed under development contracts, in the periods in which they are incurred. Our costs of contract research and development revenues will fluctuate depending on the timing and stage of our various partner programs. In certain cases, contract research and development costs exceed contract research and development revenues, either due to timing differences between expenses and revenues or due to the nature of the underlying contracts. We enter into certain research and development arrangements that we do not expect to be profitable because we expect the long-term benefits of those arrangements to outweigh the short-term costs. Furthermore, we have entered, and expect to continue to enter, into other research and development arrangements in which we will share the costs of development (or co-development) with our partners, resulting in our costs significantly exceeding our revenues on such projects.

The differences between contract research and development revenues and contract research and development costs are a function of the specific project activities undertaken in any given period, as well as the proportion of the expenses that are attributable to co-funded development programs. In addition, revenue recognition policies may restrict or delay the recognition of certain revenues, while costs continue to be recognized in full, or, in some cases, may accelerate the recognition of revenues. As a result of these revenue timing and expense composition differences, any or all of our contract research and development projects may not be profitable in certain periods, but may be profitable in other periods. This relationship between changes in revenue and changes in related costs is also impacted by changes in the activity under co-development programs where development costs are shared with our partner. For example, during periods of higher development activities, co-development programs will result in higher costs, which may not be reflected to the same extent, if at all, in revenues.

Research and Development Expenses —Research and development expenses include costs incurred to develop our proprietary products using our transdermal drug delivery technologies. These costs consist primarily of personnel costs, materials and supplies, overhead and facility costs, preclinical and nonclinical development costs, clinical trial and related clinical manufacturing costs, contract services, and other outside costs. We expense all research and development costs in the periods in which they are incurred. We expect our research and development expenses to increase in future periods as we continue to invest in research and development activities related to clinical development of our proprietary pipeline, as well as other future development programs. See “Results of Operations” below for more detailed discussion of research and development expenses.

General and Administrative Expenses — General and administrative expenses consist primarily of personnel costs, including stock-based compensation, for employees in our administration, finance, business development, human resources and information technology functions. Other expenses include professional fees for accounting and legal services, and costs of consultants and other outside services. We expect that our general and administrative expenses will increase with growth in our revenues, increasing compliance activities related to the Sarbanes-Oxley Act, and the continued development of our product pipeline.

Interest Income— Interest income consists primarily of interest earned on our cash and cash equivalents balances.

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Interest Expense— Interest expense consists primarily of the interest charges associated with our Convertible Notes, long-term debt and our capital lease obligations. The interest expense related to the Convertible Notes consists of interest payable semi-annually in cash beginning on September 15, 2018 and the amortization of the related debt discount and issuance costs. The majority of our interest associated with the CRG term loan, which was terminated in March 2018, was paid quarterly in cash, except when an allowable portion of the interest due was converted at our election into payment-in-kind, or PIK, notes. Commencing in September 2017, we began paying all of the quarterly interest due on the CRG term loan in cash. For further discussion, see “Liquidity and Capital Resources—Description of Certain Indebtedness.”

Other Income—Other income consists of the change in the fair value of a warrant issued in connection with the Convertible Notes.

Results of Operations

Comparison of the Three Months Ended June 30, 2018 and 2017


	Three Months
	Ended June 30,				Change
(In thousands, except percentages)	2018		2017		$		%
Revenue:
Product revenues	$	5,901	$	5,906	$	(5)	—	%
Contract research and development revenues		1,529		1,936		(407)	(21)
Other revenues		240		267		(27)	(10)
Total revenues		7,670		8,109		(439)	(5)
Costs and operating expenses:
Cost of product revenues		3,507		3,935		(428)	(11)
Cost of contract research and development revenues		2,339		2,977		(638)	(21)
Research and development expenses		8,305		9,122		(817)	(9)
General and administrative expenses		3,325		3,284		41	1
Amortization of intangible assets		183		159		24	15
Loss on disposal of equipment		4		6		(2)	(33)
Total costs and operating expenses		17,663		19,483		(1,820)	(9)
Loss from operations		(9,993)		(11,374)		1,381	12
Interest income		332		77		255	331
Interest expense		(3,370)		(2,087)		(1,283)	(61)
Other income		640		—		640	NM
Loss before income taxes		(12,391)		(13,384)		993	7
Income tax expense		—		—		—	—
Net loss and comprehensive loss	$	(12,391)	$	(13,384)	$	993	7	%

Revenues

Product revenues were essentially unchanged for the three months ended June 30, 2018 compared to the same period in fiscal 2017. While revenues from Clonidine TDS decreased by $0.7 million, as no units were shipped in the three months ended June 30, 2018, revenues from Crest Whitestrips increased by $0.5 million due to increased global demand for these products and revenues from Fentanyl TDS increased by $0.2 million, as more units were shipped. We expect shipments of clonidine to resume in the three months ended September 30, 2018.

Contract research and development revenues decreased $0.4 million, or 21%, for the three months ended June 30, 2018 compared to the same period in fiscal 2017. This decrease was primarily driven by a decrease of $0.2 million in revenues related to development activities for Twirla, a $0.2 million decrease in revenues for a late-stage partnered development program and a $0.3 million decrease in revenues related to various partnered development activities. These decreases were partially offset by an increase of $0.3 million in revenues from P&G development activities associated with implementing the increase in production capacity for Crest Whitestrips.

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Cost of Product Revenues

Cost of product revenues decreased $0.4 million, or 11%, for the three months ended June 30, 2018 compared to the same period in fiscal 2017, primarily as a result of no Clonidine TDS units shipped during the period. While total product revenues remained constant, the total cost of product revenues decreased by 11% primarily due to changes in our product mix between the periods.

Cost of Contract Research and Development Revenues

Cost of contract research and development revenues decreased $0.6 million, or 21%, for the three months ended June 30, 2018 compared to the same period in fiscal 2017, primarily as a result of a $0.7 million decrease in costs related to a co-development program that has reached the clinical trial stage, and a $0.3 million decrease in costs related to our other partnered contract feasibility programs. These decreases were partially offset by a $0.5 million increase in costs from P&G development activities associated with the increase in production capacity for Crest Whitestrips.

Research and Development Expenses

Research and development expenses decreased $0.8 million, or 9%, for the three months ended June 30, 2018 compared to the same period in fiscal 2017, driven primarily by a $0.9 million decrease in expense for our lead Alzheimer’s program, Corplex Donepezil, primarily as a result of decreased expenses for our bioequivalence studies, and a $0.2 million decrease in expense for our other proprietary programs as we prioritized Corplex Donepezil ahead of our other clinical-stage programs. These decreases were partially offset by a $0.3 million increase in expense for preclinical development work on several proprietary feasibility programs.

General and Administrative Expenses

General and administrative expenses were approximately equal for the three months ended June 30, 2018 compared to the same period in fiscal 2017.

Interest Expense

Interest expense increased $1.3 million, or 61%, for the three months ended June 30, 2018 compared to the same period in fiscal 2017, primarily as a result of a $1.7 million increase in amortization of the debt discount and issuance costs related to the Convertible Notes. This increase was partially offset by a decrease of $0.4 million in interest expense due to the repayment of the CRG term loan in March 2018, at which time interest no longer continued to accrue on that loan. The annual interest rate of the $52 million CRG loan was 15%, and the coupon rate of the $120 million Convertible Notes is 5%.

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Comparison of the Nine Months Ended June 30, 2018 and 2017


	Nine Months
	Ended June 30,				Change
(In thousands, except percentages)	2018		2017		$		%
Revenue:
Product revenues	$	18,512	$	16,301	$	2,211	14	%
Contract research and development revenues		7,813		5,320		2,493	47
Other revenues		720		801		(81)	(10)
Total revenues		27,045		22,422		4,623	21
Costs and operating expenses:
Cost of product revenues		10,806		10,892		(86)	(1)
Cost of contract research and development revenues		9,238		7,891		1,347	17
Research and development expenses		30,511		22,650		7,861	35
General and administrative expenses		10,728		9,288		1,440	16
Amortization of intangible assets		541		514		27	5
Loss on disposal of equipment		4		6		(2)	(33)
Total costs and operating expenses		61,828		51,241		10,587	21
Loss from operations		(34,783)		(28,819)		(5,964)	(21)
Interest income		617		149		468	314
Interest expense		(7,903)		(6,178)		(1,725)	(28)
Loss on extinguishment of long-term debt		(2,258)		—		(2,258)	NM
Other income		640		—		640	NM
Loss before income taxes		(43,687)		(34,848)		(8,839)	(25)
Income tax expense		2		2		—	—
Net loss and comprehensive loss	$	(43,689)	$	(34,850)	$	(8,839)	(25)	%

Revenues

Product revenues increased $2.2 million, or 14%, for the nine months ended June 30, 2018 compared to the same period in fiscal 2017. The increase was primarily driven by a $1.5 million increase in revenues from Crest Whitestrips due to increased global demand for these products, a $0.6 million increase in revenues from Fentanyl TDS and a $0.1 million increase in revenues from Clonidine TDS as more units for these two products were shipped.

Contract research and development revenues increased $2.5 million, or 47%, for the nine months ended June 30, 2018 compared to the same period in fiscal 2017. This increase was driven by a $1.6 million increase in revenues related to development activities for Twirla, a $0.9 million increase in revenues from P&G development activities associated with the increase in production capacity for Crest Whitestrips, and a $0.6 million increase in revenues for a late-stage partnered development program. These increases were partially offset by a $0.3 million decrease in revenues related to various partnered development activities and a $0.3 million decrease in revenues from our co-development programs related to the timing of project activities.

Cost of Product Revenues

Cost of product revenues decreased $0.1 million, or 1%, for the nine months ended June 30, 2018 compared to the same period in fiscal 2017. While total product revenues increased by 14%, total cost of product revenues decreased by 1% due to changes in our product mix between the periods.

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Cost of Contract Research and Development Revenues

Cost of contract research and development revenues increased $1.3 million, or 17%, for the nine months ended June 30, 2018 compared to the same period in fiscal 2017, primarily as a result of a $1.9 million increase in costs related to the Twirla program, a $0.9 million increase in costs associated with the increased production capacity for P&G, and a $0.7 million increase in costs for a late-stage partnered development program. These increases were partially offset by a $1.9 million decrease in costs related to a co-development program and $0.2 million decrease in costs related to our various partnered contract feasibility programs.

While cost of contract research and development revenues increased 17% for the nine months ended June 30, 2018 compared to the same period in fiscal 2017, contract research and development revenues increased by 47%. The difference was primarily the result of the timing of project activities and corresponding milestone payments for one of our co-development programs.

Research and Development Expenses

Research and development expenses increased $7.9 million, or 35%, for the nine months ended June 30, 2018 compared to the same period in fiscal 2017, primarily driven by a $7.0 million increase in expense for our lead Alzheimer’s program, Corplex Donepezil, as we initiated the second BE study and several supportive clinical studies in the first quarter of fiscal 2018, and a $2.3 million increase in expense for preclinical development work on several proprietary feasibility programs. This increased investment was partially offset by a $1.4 million decrease in expense for our other proprietary programs as we prioritized Corplex Donepezil ahead of our other clinical-stage programs.

General and Administrative Expenses

General and administrative expenses increased $1.4 million, or 16%, for the nine months ended June 30, 2018 compared to the same period in fiscal 2017, primarily as a result of a $0.6 million increase in legal, consulting and outside services expenses, including one-time expenses related to the pursuit of alternative refinancing opportunities for the CRG term loan, and a $0.5 million increase in stock-based compensation expense.

Interest Expense

Interest expense increased $1.7 million, or 28%, for the nine months ended June 30, 2018 compared to the same period in fiscal 2017, primarily as a result of a $2.3 million increase in amortization of the debt discount and issuance costs related to the Convertible Notes. This increase was partially offset by a decrease of $0.6 million in interest expense due to the repayment of the CRG term loan in March 2018, at which time interest no longer continued to accrue on that loan. The annual interest rate of the $52 million CRG loan was 15%, and the coupon rate of the $120 million Convertible Notes is 5%.

Liquidity and Capital Resources

With the exception of fiscal 2013, we have incurred losses from operations since fiscal 2006 and have an accumulated deficit of $259.0 million as of June 30, 2018. We have financed our operations primarily through the proceeds from the sale of equity securities, and various debt and capital lease financings.

During the nine months ended June 30, 2018, we issued $120.0 million aggregate principal amount of Convertible Notes due in 2025 (see Note 4 to our financial statements included in this Quarterly Report on Form 10-Q). We used the proceeds from the issuance of the Convertible Notes to prepay in full all outstanding borrowings, fees and other amounts due under the earlier term loan agreement with CRG. With the addition of the $61.5 million net proceeds arising from the issuance of the Convertible Notes and simultaneous retirement of the CRG indebtedness, we believe that our existing cash and cash equivalents will be sufficient to fund operations as currently planned beyond the next 12 months. Consequently, we believe there is no longer substantial doubt regarding our ability to continue as a going concern because we are no longer required to maintain compliance with covenants related to liquidity or revenues. Our unaudited condensed financial statements as of June 30, 2018 included in this Quarterly Report on Form 10-Q have been prepared under the assumption that we will continue as a going concern for the next 12 months.

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Description of Certain Indebtedness — We have borrowed funds from a variety of sources, including Convertible Notes, a term loan with CRG, and notes payable with lessors for tenant improvements to our leased facilities.

Since 2012, we had borrowed $45.0 million from CRG pursuant to a term loan agreement and subsequent amendments thereto. The amended agreement provided for a maximum borrowing of $45.0 million, excluding payment-in-kind, or PIK, notes. The amended agreement required interest to be paid quarterly at a simple annual rate of 15%, and all outstanding principal be repaid in four equal quarterly payments beginning on September 30, 2018, with interest continuing to accrue on the unpaid principal at a simple annual rate of 15%. In addition, the amended agreement contained a provision whereby we could, at each quarterly payment due date on or prior to June 30, 2018, choose to convert that portion of each quarterly interest obligation equal to 3.5% of the then-outstanding principal into PIK notes. Since inception of the amended agreement, we converted $7.5 million of interest into PIK notes, each of which were added to the then-outstanding principal. Amounts outstanding under the term loan agreement were collateralized by all of our assets.

The amended agreement also provided for a prepayment premium, the amount of which varied with the date on which prepayment was made if we chose to prepay principal on or prior to December 31, 2018, or upon other specified events, including a change of control. For the period January 1, 2018 through December 31, 2018, the prepayment premium was equal to 3.25% of the aggregate value of the principal and PIK notes outstanding at the time of prepayment. An additional exit fee of 1.0% of the aggregate value of the principal and PIK notes outstanding was due at the time of repayment of the loan, whether paid early or upon the maturity date.

On March 5, 2018, we terminated the term loan agreement with CRG, as amended, and prepaid in full all outstanding borrowings, fees and other amounts due thereunder, in an aggregate amount of approximately $54.8 million plus accrued interest. This amount included total prepayment fees equal to 4.25% of the principal amount then outstanding. The loss on extinguishment of the CRG debt was $2.3 million and is included in our Statement of Operations and Comprehensive Loss for the three and nine months ended June 30, 2018 presented with our financial statements in this Current Report on Form 10-Q. We were in continuous compliance with the financial covenants from inception through termination of the CRG loan.

In March 2018, we issued $120.0 million aggregate principal amount of convertible senior notes due 2025, which aggregate principal amount included the exercise in full by the initial purchaser of the Convertible Notes of an option to purchase $20.0 million of such Convertible Notes. The Convertible Notes are senior, unsecured obligations and accrue interest at an interest rate of 5.00% per year, payable in cash semi-annually in arrears on March 15 and September 15 of each year, beginning on September 15, 2018. The Convertible Notes have a maturity date of March 15, 2025, unless earlier converted or repurchased in accordance with their terms. We received $116.2 million in net proceeds from the sale of the Convertible Notes, after deducting payments for offering fees and expenses of $3.8 million.

The Convertible Notes were issued pursuant to an indenture, dated as of March 5, 2018, by and between us and U.S. Bank National Association, as trustee, or the Indenture. Pursuant to their terms, the Convertible Notes will be convertible into cash, shares of our common stock, or a combination of cash and shares of our common stock, at our election, as discussed in more detail below. The Convertible Notes have an initial conversion rate of 58.0552 shares of common stock per $1,000 principal amount, which is equivalent to an initial conversion price of approximately $17.22 per share of common stock. The conversion rate and the corresponding conversion price will be subject to adjustment upon the occurrence of certain events, including but not limited to, stock splits and dividends, rights offerings, cash dividends, or a make-whole fundamental change (as described in the Indenture).

We may not redeem the Convertible Notes prior to March 15, 2022. We may redeem for cash all or any portion of the Convertible Notes, at our option, on or after March 15, 2022 if certain conditions are met, including, but not limited to, if the last reported sales price per share of our common stock has exceeded 130% of the conversion price for each of at least 20 trading days during the 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter.

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Noteholders may convert their Convertible Notes at their option only in the following circumstances:

at any time during a calendar quarter after June 30, 2018, if the last reported sales price per share of our common stock exceeds 130% of the conversion price for each of at least 20 trading days during the 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter;

during the five consecutive business days immediately after any five consecutive trading day period (such five consecutive trading day period, referred to as the measurement period) in which the trading price per $1,000 principal amount of Convertible Notes for each trading day of the measurement period was less than 98% of the product of the last reported sale price per share of our common stock on such trading day and the conversion rate on such trading day;

upon the occurrence of certain corporate events or distributions on our common stock;

we call the Convertible Notes for redemption; and

at any time from, and including, September 15, 2024 until the close of business on the scheduled trading day immediately before the maturity date.

We also have other credit facilities under which we have borrowed funds, including notes payable to lessors for tenant improvements of leased facilities. For further details, see Note 7 to our financial statements contained in our Annual Report on Form 10-K for the fiscal year ended September 30, 2017, which was filed with the SEC on December 29, 2017.

In connection with certain of our partner arrangements, our partners purchase equipment that we use in the production and development of their products. This reduces our need for financing and lowers the manufacturing cost of these products for those partners, but generally limits our ability to use this equipment for our own or other partners’ products.

Cash Flows

The following table summarizes our cash flows for the periods indicated (in thousands):


	Nine Months Ended June 30,
	2018		2017
Cash used by operating activities	$	(32,380)	$	(27,153)
Cash used by investing activities		(4,827)		(2,787)
Cash provided by financing activities		62,264		56,670

Cash Flows from Operating Activities — Cash used by operating activities for the nine months ended June 30, 2018 was $32.4 million, primarily driven by our net loss of $43.7 million, as we continued to generate negative cash flows from operations as a result of research and development spending in excess of cash flows provided by our commercial activities. Depreciation, amortization, stock-based compensation and other non-cash expenses, totaling $9.0 million, were all consistent with normal operations with the exception of the $2.2 million loss on extinguishment of long-term debt and the $0.6 million of other income. The $2.3 million in cash provided by changes in operating assets and liabilities as of June 30, 2018 compared to their balances as of September 30, 2017 was the result of offsetting sources and uses of cash, consisting primarily of:

$1.1 million in cash provided by a decrease in accounts receivable, primarily related to lower revenue for the three months ended June 30, 2018;

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$1.0 million in cash provided by an increase in accrued expenses and other current liabilities primarily related to the higher amount of clinical trial expenses accrued but not paid;

$0.6 million in cash provided by a decrease in inventory levels due primarily to the decreased production of generic products for the three months ended June 30, 2018; and

$0.2 million in cash provided by an increase in accounts payable, resulting primarily from increased research and development expenses, including clinical trial costs invoiced but not paid; partially offset by:

a $0.5 million use of cash from a decrease in deferred contract revenues as a result of the recognition of revenue related to upfront payments received from partners for development activities.

Cash used by operating activities for the nine months ended June 30, 2017 was $27.2 million, primarily driven by our net loss of $34.9 million, as we continued to generate negative cash flows from operations as a result of research and development spending in excess of cash flows provided by our commercial activities. Depreciation, amortization, stock-based compensation and other non-cash expenses, totaling $5.7 million, were all consistent with normal operations. The $2.0 million cash provided by net operating assets and liabilities was the result of offsetting sources and uses of cash, including:

$2.5 million in cash provided by an increase in accounts payable, resulting primarily from increased research and development expenses, including clinical trial costs, raw material purchases, and legal and professional fees invoiced but not paid as of June 30, 2017; and

$0.2 million in cash provided by a decrease in prepaid expenses and other current assets at June 30, 2017, compared to September 30, 2016, primarily related to monthly amortization of prepaid insurance balances, partially offset by:

a $0.3 million use of cash from a decrease in the recall liability, primarily reflecting the ongoing payments made on a quarterly basis to reduce this liability;

a $0.2 million use of cash from an increase in accounts receivable, primarily related to increased receivables outstanding at June 30, 2017 compared to September 30, 2016, as a result of increased contract research and development activities during the nine months ended June 30, 2017; and

a $0.2 million use of cash from a decrease in deferred contract revenues.

Cash Flows from Investing Activities — Cash used by investing activities for the nine months ended June 30, 2018 was $4.8 million, consisting of capital expenditures of $4.0 million for equipment and leasehold improvements to support operations, including the acquisition of a new production line for P&G, and expenditures of $0.8 million relating to the acquisition of patent and licensing rights.

Cash used by investing activities for the nine months ended June 30, 2017 was $2.8 million, consisting of capital expenditures of $2.0 million for equipment and leasehold improvements to support operations, and expenditures of $0.8 million relating to the acquisition of patent and licensing rights.

Cash Flows from Financing Activities — Cash provided by financing activities for the nine months ended June 30, 2018 was $62.3 million, consisting primarily of $120.0 million in cash provided by proceeds from the issuance of the Convertible Notes, $0.4 million in cash provided by proceeds from the issuance of common stock under our 2014 ESPP, and $0.4 million provided from the exercise of stock options. The cash provided by financing activities was partially offset by a $54.8 million use of cash for prepayment in full of all outstanding borrowings, fees and other amounts due under the CRG term loan, and a $3.8 million use of cash for payment of issuance costs associated with the Convertible Notes.

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Cash provided by financing activities for the nine months ended June 30, 2017 was $56.7 million, consisting primarily of $56.1 million in net proceeds from the issuance of common stock in connection with our two underwritten public offerings, $0.4 million in cash provided by proceeds from the issuance of common stock under our 2014 ESPP, and $0.2 million provided from the exercise of stock options.

Contractual Obligations

The following table summarizes our contractual obligations as of June 30, 2018 (in thousands):


	Payments Due by Period
	Less Than						More Than
Contractual Obligations:	1 Year		1 to 3 Years		3 to 5 Years		5 Years		Total
Convertible notes obligations	$	—	$	—	$	—	$	120,000	$	120,000
Interest on convertible notes obligations		6,167		12,000		12,000		12,000		42,167
Long-term debt obligations		49		108		124		105		386
Interest on long-term debt obligations		25		40		24		6		95
Operating lease obligations		1,411		2,185		1,329		1,205		6,130
Total contractual obligations	$	7,652	$	14,333	$	13,477	$	133,316	$	168,778

Off-Balance Sheet Arrangements

We have not entered into any off-balance sheet arrangements and do not have any holdings in variable interest entities.

Segment Information

We have one business activity and operate in one reportable segment.

Critical Accounting Policies and Estimates

Our condensed financial statements are prepared in accordance with U.S. GAAP. The preparation of these condensed financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, costs and expenses, and related disclosures. These estimates form the basis for judgments we make about the carrying values of our assets and liabilities, which are not readily apparent from other sources. We base our estimates and judgments on historical experience and on various other assumptions that we believe are reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates.

We believe that the assumptions and estimates associated with revenue recognition, income taxes, stock-based compensation, and other debt- and equity-linked instruments have the greatest potential impact on our condensed financial statements. Therefore, we consider these to be our critical accounting policies and estimates.

There have been no material changes to our critical accounting policies or estimates as compared to the critical accounting policies and estimates described in our Annual Report on Form 10-K for the fiscal year ended September 30, 2017.

Recent Accounting Pronouncements

Corium International, Inc. 10-Q