UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2018

Or

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

For the transition period from              to

Commission File Number 001-36295

Egalet Corporation

(Exact Name of Registrant as Specified in Its Charter)

Registrant’s telephone number, including area code: (610) 833-4200

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act: None

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.:

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

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.

Common Stock, $0.001 par value                                 Shares outstanding as of May 10, 2018: 52,881,201

TABLE OF CONTENTS

Unless otherwise indicated or the context otherwise requires, references to the “Company”, “we”, “us” and “our” refer to Egalet Corporation and its subsidiaries. The Egalet logo is our trademark and Egalet is our registered trademark. All other trade names, trademarks and service marks appearing in this Quarterly Report on Form 10-Q are the property of their respective owners. We have assumed that the reader understands that all such terms are source-indicating. Accordingly, such terms, when first mentioned in this Quarterly Report on Form 10-Q, appear with the trade name, trademark or service mark notice and then throughout the remainder of this Quarterly Report on Form 10-Q without the trade name, trademark or service mark notices for convenience only and should not be construed as being used in a descriptive or generic sense. Unless otherwise indicated, all statistical information provided about our business in this report is as of March 31, 2018.

PART I

ITEM 1.  FINANCIAL STATEMENTS

Egalet Corporation and Subsidiaries

Consolidated Balance Sheets

(in thousands, except share and per share data)

See accompanying notes to unaudited consolidated financial statements.

 Egalet Corporation and Subsidiaries

Consolidated Statements of Operations (Unaudited)

(in thousands, except share and per share data)

See accompanying notes to unaudited consolidated financial statements.

Egalet Corporation and Subsidiaries

Consolidated Statements of Comprehensive Loss (Unaudited)

(in thousands)

See accompanying notes to unaudited consolidated financial statements.

Egalet Corporation and Subsidiaries

Consolidated Statements of Cash Flows (Unaudited)

(in thousands)

See accompanying notes to unaudited consolidated financial statements.

Egalet Corporation and Subsidiaries

Notes to Unaudited Consolidated Financial Statements

1. Organization and Description of the Business

Organization and Business Overview

Egalet Corporation (the “Company”) is a fully integrated specialty pharmaceutical company manufacturing and commercializing innovative treatments for pain and other conditions. Given the need for acute and chronic pain products and the issue of prescription abuse, the Company is focused on bringing non-narcotic and abuse-deterrent (“AD”) formulations of opioids to patients and healthcare providers. The Company is currently marketing SPRIX® (ketorolac tromethamine) Nasal Spray (“SPRIX Nasal Spray”), OXAYDO® (oxycodone HCI, USP) tablets for oral use only—CII (“OXAYDO”) and ARYMO® ER (morphine sulfate) extended-release (“ER”) tablets, for oral use CII (“ARYMO ER”).

SPRIX Nasal Spray is a nonsteroidal anti-inflammatory drug indicated in adult patients for the short‑term (up to five days) management of moderate to moderately severe pain that requires analgesia at the opioid level.  OXAYDO is an immediate release (“IR”) oxycodone product designed to discourage abuse via snorting, indicated for the management of acute and chronic pain severe enough to require an opioid analgesic and for which alternative treatments are inadequate.ARYMO ER is an ER morphine product formulated with AD properties and approved for the management of pain severe enough to require daily, around-the-clock, long-term opioid treatment and for which alternative treatment options are inadequate. ARYMO ER is the Company’s first product developed using its proprietary Guardian™ Technology.

The Company also has a pipeline of products developed using Guardian Technology with respect to which it may look to partner. The Company plans to continue to grow revenues of its three commercial products, explore business development opportunities and leverage its proprietary Guardian Technology.

Liquidity and Substantial Doubt in Going Concern 

The accompanying financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. The Company has incurred recurring operating losses since inception. As of March 31, 2018, the Company had an accumulated deficit of $305.8 million and will need to improve cash generated from product sales and may require additional capital to fund its commercialization strategies for SPRIX Nasal Spray, OXAYDO and ARYMO ER.  The Company anticipates operating losses to continue for the foreseeable future due to, among other things, costs related to its commercial infrastructure.  

As of March 31, 2018, and through the date of this report, the Company was not in compliance with certain Nasdaq Global Market listing requirements. The Company’s outstanding 5.50% convertible notes in the principal amount of $24.6 million contain redemption features in the event the Company is not able to maintain its Nasdaq Global Market listing. The Company’s outstanding 6.50% convertible notes in the principal amount of $23.9 million contain redemption features in the event the Company is not able to maintain any Nasdaq listing. Refer to Note 7 – Long Term Debt for further information. These factors, in combination with others described above, raise substantial doubt about the ability of the Company to continue as a going concern within one year after the date that these financial statements are issued. The financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.  The Company continues to seek other sources of capital and alternatives, such as contemplating a reverse stock split, to maintain its listing on the Nasdaq. However, if the Company is unable to raise sufficient capital or maintain its Nasdaq listing to prevent the redemption of its convertible notes, the Company will not have sufficient liquidity to fund its business operations for at least the next year following the date that the financial statements are issued.  Accordingly, management has concluded that substantial doubt exists with respect to the Company’s ability to continue as a going concern within one year after the date that the financial statements are issued.

2. Summary of Significant Accounting Policies and Basis of Accounting

Basis of Presentation

The unaudited consolidated financial statements are prepared in conformity with United States (“U.S.”) generally accepted accounting principles (“GAAP”) for interim financial information. Certain information and footnotes normally included in consolidated financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) for quarterly reports on Form 10-Q. The Company’s consolidation policy requires the consolidation of entities where a controlling financial interest is held. All intercompany balances and transactions have been eliminated in consolidation.

The accompanying consolidated financial information at March 31, 2018 and the three months ended March 31, 2017 and 2018 is unaudited. The interim unaudited financial statements have been prepared on the same basis as the annual audited financial statements and, in the opinion of management, reflect all adjustments, which include only normal recurring adjustments, necessary for the fair presentation of the Company’s consolidated financial position as of March 31, 2018, the consolidated results of its operations and comprehensive loss for the three months ended March 31, 2017 and 2018, and consolidated cash flows for the three months ended March 31, 2017 and 2018, except, in each case, as described above under “Liquidity and Substantial Doubt in Going Concern.” The financial data and other information disclosed in these notes related to the three months ended March 31, 2017 and 2018 are not necessarily indicative of the results to be expected for the year ending December 31, 2018, any other interim periods or any future year or period. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and the notes thereto for the year ended December 31, 2017 filed on March 16, 2018 with the SEC.

The Company’s significant accounting policies are described in Note 2 of the Notes to the Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017. Since the date of those financial statements, there have been no changes to the Company’s significant accounting policies, except as described in Note 3 – Revenue from contracts with customers.

Recent Accounting Pronouncements

In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842). The new standard establishes a right-of-use (“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either financing or operating, with classification affecting the pattern of expense recognition in the income statement. ASU 2016-02 is effective for annual periods beginning after December 15, 2018, including interim periods within those annual periods, with early adoption permitted. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available. The Company is currently evaluating the impact that the standard will have on the financial statements, and has not yet determined what effect, if any, the impact of adoption will be.

In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10), Recognition and Measurement of Financial Assets and Financial Liabilities, which addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. ASU 2016-01 will be effective for annual periods and interim periods within those annual periods beginning after December 15, 2017 and early adoption is not permitted. The Company has adopted the standard in the current period and determined there to be no impact of the adoption in the three months ended March 31, 2018.

In May 2014, the FASB issued new guidance related to revenue recognition, ASU 2014-09, Revenue from Contracts with Customers, which outlines a comprehensive revenue recognition model and supersedes most current revenue recognition guidance. The new guidance requires an entity to recognize revenue upon transfer of goods or services to a customer at an amount that reflects the expected consideration to be received in exchange for those goods or services. ASU 2014-09 defines a five-step approach for recognizing revenue, which may require an entity to use more

judgment and make more estimates than under the current guidance. The new guidance became effective in calendar year 2018. Two methods of adoption are permitted: (a) full retrospective adoption, meaning the standard is applied to all periods presented; or (b) modified retrospective adoption, meaning the cumulative effect of applying the new guidance is recognized at the date of initial application as an adjustment to the opening retained earnings balance.

In March 2016, April 2016 and December 2016, the FASB issued ASU No. 2016-08, Revenue From Contracts with Customers:  Principal Versus Agent Considerations, ASU No. 2016-10, Revenue From Contracts with Customers:  Identifying Performance Obligations and Licensing, and ASU No. 2016-20, Technical Corrections and Improvements to Topic 606, Revenue From Contracts with Customers, respectively, which further clarify the implementation guidance on principal versus agent considerations contained in ASU No. 2014-09. In May 2016, the FASB issued ASU 2016-12 Revenue from Contracts with Customers, narrow-scope improvements and practical expedients which provides clarification on assessing the collectability criterion, presentation of sales taxes, measurement date for non-cash consideration and completed contracts at transition (collectively “ASC 606”). These standards are effective for the Company beginning in the first quarter of 2018.

The Company formed a task force that analyzed the Company’s customer contracts and the impacts the standard had on previously reported revenues and future revenues. Under ASC 606, the Company recognizes net product sales at the time it ships its products to its customers (primarily wholesalers and specialty pharmacies), rather than its historic policy of recognizing net product sales when prescriptions are dispensed to patients.  As a result, the Company now recognizes net product sales under such contracts earlier under ASC 606 than it would have recognized under the historic guidance.

The Company adopted the new standard effective January 1, 2018 using the modified retrospective approach. Refer to Note 3 — Revenue From Contracts with Customers for further details.

3. Revenue From Contracts with Customers

Adoption of ASC Topic 606, Revenue from Contracts with Customers

The Company adopted ASC 606 on January 1, 2018, using the modified retrospective method for all contracts not completed as of the date of adoption, referred to herein as the “new guidance”. The reported results as of, and for the three months ended March 31, 2018 reflect the application of ASC 606 guidance while the reported results as of, and for the three months ended March 31, 2017 were prepared under the guidance of ASC 605, Revenue Recognition (“ASC 605”), which is also referred to herein as "legacy GAAP" or the "previous guidance". The adoption of ASC 606 had a material impact on the Company’s consolidated financial position, results of operations and stockholders’ deficit as of the adoption date and for the three months ended March 31, 2018. The adoption of ASC 606 represents a change in accounting principle that will more closely align revenue recognition with the delivery of the Company's products to its customers and will provide financial statement readers with enhanced disclosures.

Financial Statement Impact of Adopting ASC 606

The cumulative effect of applying the new guidance to all contracts with customers for which all performance obligations were satisfied as of January 1, 2018, was recorded as an adjustment to accumulated deficit as of the adoption date. For contracts which were modified before the adoption date, the Company has not restated the contract for those modifications. Rather, the Company reflected the aggregate effect of all modifications when identifying the satisfied and unsatisfied performance obligations, determining the transaction price and allocating the transaction price, if necessary. As a result of applying the modified retrospective method in adopting the new revenue guidance, the following adjustments were made to accounts on the Company’s consolidated balance sheets as of January 1, 2018:

Under ASC 606, the Company recognizes net product sales at the time it ships its products to its customers (primarily wholesalers and specialty pharmacies), rather than the legacy GAAP policy of recognizing net product sales when prescriptions are dispensed to patients.  As a result, the adjustments reflect the recognition of all deferred revenue related to product shipped to the Company’s customers, but not yet dispensed to patients and the related decrease in inventory.  In addition, the Company recorded accrued expenses for patient discount programs, commercial and government rebates and a reduction in accounts receivable for estimated returns.  An adjustment to accumulated deficit was recorded for the net impact of the preceding adjustments as of January 1, 2018.

Revenue Recognition

Under ASC 606, revenue is recognized when, or as, performance obligations under the terms of a contract are satisfied, which occurs when control of the promised products or services is transferred to customers.  To recognize revenue pursuant to the provisions of ASC 606, the Company performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the Company satisfies a performance obligation. The Company only applies the five-step model to contracts when it is probable that the Company will collect substantially all the consideration it is entitled to in exchange for the goods or services it transfers to the customer. At contract inception, once the contract is determined to be within the scope of ASC 606, the Company assesses whether the goods or services promised within each contract are distinct to determine those that are performance obligations.

Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring products or services to a customer (“transaction price”). The Company then recognizes as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.  To the extent that the transaction price includes variable consideration, the Company estimates the amount of variable consideration that should be included in the transaction price to which the Company expects to be entitled after giving effect to returns, rebates, sales allowances and other variable elements with contracts between the Company and its customers.  Variable consideration is included in the transaction price if, in the Company’s judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur.  Estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of the Company’s anticipated performance under the contract and all information (historical, current and forecasted) that is reasonably available.  Sales taxes and other taxes collected on behalf of third parties are excluded from revenue.

When determining the transaction price of a contract, an adjustment is made if payment from a customer occurs either significantly before or significantly after performance, resulting in a significant financing component.  Applying the significant financing practical expedient, the Company does not assess whether a significant financing component exists if the period between when the Company performs its obligations under the contract and when the customer pays is one year or less.  None of the Company’s contracts contained a significant financing component as of March 31, 2018.

The Company’s existing contracts with customers contain only a single performance obligation, as such the entire transaction price is allocated to the single performance obligation.  Should future contracts contain multiple performance obligations, those would require an allocation of the transaction price based on the estimated relative standalone selling prices of the promised products or services underlying each performance obligation.  The Company determines standalone selling prices based on observable prices or a cost-plus margin approach when one is not available.

The Company’s performance obligations are to provide pharmaceutical products to several wholesalers or a single specialty pharmaceutical distributor.  All of the Company's performance obligations, and associated revenue, are generally

transferred to customers at a point in time. Revenue is recognized at the time the related performance obligation is satisfied by transferring control of a promised good to a customer, which is typically upon delivery.  Payments for invoices are generally due within 30 days of invoice date.

Disaggregation of Revenue

The following table summarizes revenue by revenue source for the three months ended March 31, 2018:

Reserves for Variable Consideration

Revenues from product sales are recorded at the transaction price, which includes estimates of variable consideration for which reserves are established and which result from returns, rebates and sales allowances that are offered within or impacted by contracts between the Company and its customers. Where appropriate, these estimates take into consideration a range of possible outcomes which are probability-weighted for relevant factors such as the Company’s historical experience, current contractual requirements, specific known market events and trends, industry data and forecasted customer buying and payment patterns.  Overall, these reserves reflect the Company’s best estimates of the amount of consideration to which it is entitled based on the terms of the contract as of the date of determination.  The amount of variable consideration which is included in the transaction price may be constrained, and is included in the net sales price only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue recognized will not occur in a future period.  Actual amounts of consideration ultimately received may differ from the Company’s estimates.  If actual results in the future vary from the Company’s estimates, the Company adjusts these estimates, which would affect net product revenue and earnings in the period such variances become known.

Product Returns   

Consistent with industry practice, the Company generally offers customers a limited right of return for its products. The Company estimates the amount of its product sales that may be returned by its customers and records this estimate as a reduction of revenue in the period the related product revenue is recognized.  The Company estimates product return liabilities using the expected value method based on its historical sales information and other factors that it believes could significantly impact its expected returns, including product recalls and expirations, of which it becomes aware. These factors include its estimate of actual and historical return rates for non-conforming product and open return requests.

Specialty Pharmacy Fees 

The Company pays certain specialty pharmaceutical distributor fees based on a contractually determined rate. The Company records the fees on shipment to the distributor and recognizes the fees as a reduction of revenue in the same period the related revenue is recognized.

Wholesaler Fees

The Company pays certain pharmaceutical wholesalers fees based on a contractually determined rate. The Company accrues the fees on shipment to the respective wholesalers and recognizes the fees as a reduction of revenue in the same period the related revenue is recognized.

Prompt Pay Discount

The Company offers cash discounts to its customers, generally 2% of the sales price, as an incentive for prompt payment. The Company estimates for cash discounts using the mostly likely amount method by reducing accounts

receivable by the prompt pay discount amount. The discount is recognized as a reduction of revenue in the same period as the related revenue.

Patient Discount Programs

The Company offers co-pay discount programs for SPRIX Nasal Spray, OXAYDO and ARYMO ER to patients, in which patients receive a co-pay discount on their prescriptions. The Company estimates the total amount that will be redeemed using the expected value method based on the quantity of product shipped. The Company recognizes the discount as a reduction of revenue in the same period as the related revenue.

Commercial and Government Rebates

The Company contracts with various private and government payor organizations, primarily insurance companies and pharmacy benefit managers, for the payment of rebates with respect to utilization of its products.  The Company estimates these rebates using the expected value method and records such estimates in the same period the related revenue is recognized, resulting in a reduction of net product sales and the establishment of an accrued expense.

The following table summarizes activity in each of the net product sales allowance and reserve categories for the three months ended March 31, 2018:

Impact of New Revenue Guidance on Financial Statement Line Items

The following table compares the Company’s reported consolidated balance sheets and statement of operations, as of and for the three months ended March 31, 2018 to the pro-forma amounts had the previous guidance been in effect:

Under ASC 606, the Company recognizes net product sales at the time it ships its products to its customers (primarily wholesalers and specialty pharmacies), rather than the legacy GAAP policy of recognizing net product sales when prescriptions are dispensed to patients.  As a result, the adjustments reflect the accrual of deferred revenue related to product shipped to the Company’s customers, but not yet dispensed to patients and the related increase in inventory for deferred cost of goods sold.  In addition, the Company would not have accrued expenses for patient discount programs, commercial and government rebates or a reduction in accounts receivable for estimated returns until the product was dispensed to patients.  The adjustment to accumulated deficit represents the net impact of these items.

Amounts reported on certain line items within net cash used in operating activities on the consolidated statement of cash flows changed as a result of the adoption of ASU 2014-09, but there was no change in the reported amounts of total operating, investing and financing cash flow.

Transaction Price Allocated to Future Performance Obligations

ASC 606 requires that the Company disclose the aggregate amount of transaction price that is allocated to performance obligations that have not yet been satisfied as of March 31, 2018. The guidance provides certain practical expedients that limit this requirement including performance obligations that are part of a contract that has an original expected duration of one year or less. All of the Company’s contracts are eligible for the practical expedient provided by ASC 606, therefore the Company elected not to disclose any remaining performance obligations.

Contract Balances from Contracts with Customers

When the Company receives consideration from a customer, or such consideration is unconditionally due from a customer prior to the transfer of goods or services to the customer under the terms of a contract, the Company records a contract liability. Contract liabilities are recognized as revenue after control of the products is transferred to the customer

and all revenue recognition criteria have been met. The Company classifies contract liabilities as deferred revenue. The Company had no deferred revenue as of January 1, 2018 or March 31, 2018. 

Contract assets primarily relate to rights to consideration for goods or services transferred to the customer when the right is conditional on something other than the passage of time.  Contract assets are transferred to accounts receivable when the rights become unconditional.  The Company had no contract assets as of January 1, 2018 or March 31, 2018.

Costs to Obtain and Fulfill a Contract

The Company accounts for shipping and handling activities related to contracts with customers as costs to fulfill the promise to transfer the associated products. When shipping and handling costs are incurred after a customer obtains control of the products, the Company also has elected to account for these as costs to fulfill the promise and not as a separate performance obligation. Shipping and handling costs, associated with the distribution of finished products to customers, are expensed as incurred and are recorded in costs of goods sold in the accompanying consolidated statements of operations. The Company expenses incremental costs of obtaining a contract with a customer (for example, commissions) when incurred as the period of benefit is less than one year.

4. Investments

Marketable Securities

Marketable securities consisted of the following at December 31, 2017: 

Marketable securities consisted of the following as of March 31, 2018:

The fair value of marketable securities as of March 31, 2018 with a maturity of less than one year is $40.8 million.  There were no marketable securities with a maturity of greater than one year as of March 31, 2018.

At March 31, 2018, the Company held six marketable securities that were in a continuous loss position for less than one year and two marketable securities that were in a continuous loss position for one to two years.  The unrealized losses are immaterial in amount and are the result of current economic and market conditions and the Company has determined that no other than temporary impairment exists at March 31, 2018.

5. Inventory

Inventory is stated at the lower of cost or market using actual cost net of reserve for excess and obsolete inventory. The following represents the components of inventory at December 31, 2017 and March 31, 2018:

6. Intangible Assets

The following represents the balance of the intangible assets at December 31, 2017:

The following represents the balance of the intangible assets at March 31, 2018:

There was no impairment to intangible assets in the three months ended March 31, 2017 and 2018.

Collaboration and License Agreement with Acura Pharmaceuticals, Inc. (“Acura”)

In January 2015, the Company entered into a Collaboration and License Agreement with Acura to commercialize OXAYDO™ (oxycodone hydrochloride) tablets containing Acura’s Aversion® Technology (the “OXAYDO License Agreement”). The Company paid Acura an upfront payment of $5.0 million in January 2015 and a $2.5 million milestone payment in October 2015 as a result of the first commercial sale of OXAYDO.  The Company also incurred transaction costs of $172,000 associated with the OXAYDO License Agreement.  Refer to Note 13 — Acquisitions and License and Collaboration Agreements for additional details.

During the three months ended March 31, 2017 and 2018, the Company recognized amortization expense of $269,000 and $275,000, respectively, related to the OXAYDO product rights intangible asset.

Purchase Agreement with Luitpold Pharmaceuticals, Inc. (“Luitpold”)

In January 2015, the Company entered into and consummated the transactions contemplated by the Purchase Agreement with Luitpold to purchase SPRIX Nasal Spray (the “SPRIX Purchase Agreement”).  Pursuant to the SPRIX Purchase Agreement, the Company acquired specified assets and liabilities associated with SPRIX (ketorolac tromethamine) Nasal Spray for a purchase price of $7.0 million. The Company recorded an intangible asset of $4.6 million related to this transaction.  Refer to Note 13 — Acquisitions and License and Collaboration Agreements for additional details.

During the three months ended March 31, 2017 and 2018, the Company recognized amortization expense of $234,000 and 252,000, respectively, related to the SPRIX Nasal Spray product rights intangible asset.

In-Process Research and Development (“IP R&D”)

In connection with the acquisition of Egalet A/S, the Company recognized an IP R&D asset related to the drug delivery platform specifically designed to help deter physical abuse of pain medications, the Guardian Technology. Through December 31, 2017, the IP R&D was considered an indefinite-lived intangible asset and was assessed for impairment annually or more frequently if impairment indicators existed.  Following the approval of ARYMO ER in January 2017, the Company began to amortize the intangible asset over a useful life of five years. 

 During the three months ended March 31, 2018, the Company recognized amortization expense of $9,000 related to the IP R&D intangible asset.

7. Long-Term Debt

5.50% Convertible Notes Due 2020 (the “5.50% Notes”)

In April and May 2015, the Company issued through a private placement $61.0 million in aggregate principal amount of the 5.50% Notes. Interest on the 5.50% Notes is payable semi-annually in arrears on April 1 and October 1 of each year and commenced on October 1, 2015.

The 5.50% Notes are general, unsecured and unsubordinated obligations and rank senior in right of payment to all of the Company’s indebtedness that is expressly subordinated in right of payment to the 5.50% Notes.  The 5.50% Notes rank equal in right of payment to the Company’s existing and future indebtedness and other liabilities that are not so subordinated.  The 5.50% Notes are effectively subordinated to any of the Company’s future secured indebtedness to the extent of the value of the assets securing such indebtedness, and rank structurally junior to all indebtedness and other liabilities incurred by the Company’s subsidiaries, including trade payables. The 5.50% Notes rank equal in right of the payment to the 13% Notes (as defined below).

The Company may not redeem the 5.50% Notes prior to maturity. The 5.50% Notes are convertible prior to maturity, subject to certain conditions described below, into shares of the Company’s common stock, par value $0.001 per share (“Common Stock”) at an initial conversion rate of 67.2518 shares per $1,000 principal amount of the 5.50% Notes (equivalent to an initial conversion price of approximately $14.87 per share of Common Stock).  This conversion rate is subject to adjustment upon the occurrence of certain specified events but will not be adjusted for accrued and unpaid interest.   The Company will satisfy the conversion obligation by paying or delivering, as the case may be, cash, shares of the Company’s Common Stock or a combination thereof, at the Company’s election.

Holders may convert all or any portion of their 5.50% Notes, in multiples of $1,000 principal amount, at their option at any time prior to the close of business on the business day immediately preceding January 1, 2020 only under the following circumstances:

On or after January 1, 2020 until the close of business on the second scheduled trading day immediately preceding the maturity date (April 1, 2020), holders may convert all or any portion of their 5.50% Notes, in multiples of $1,000 principal amount, at the option of the holder regardless of the foregoing circumstances.

Upon conversion, the Company will pay or deliver, as the case may be, 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, and an interest make-whole payment in shares of the common stock, if applicable. If the Company satisfies the conversion obligation solely in cash or through payment and delivery, as the case may be, of a combination of cash and shares of the Company’s Common Stock, the amount of cash and shares of Common Stock, if any, due upon conversion will be based on a daily conversion value calculated on a proportionate basis for each trading day in a 50 trading day observation period.

In addition, following certain corporate events that occur prior to the maturity date, the Company will increase the conversion rate for a holder who elects to convert its 5.50% Notes in connection with such a corporate event in certain circumstances.  Holders will not receive any additional cash payment or additional shares representing accrued and unpaid interest, if any, upon conversion of a note, except in limited circumstances. Instead, interest will be deemed to be paid in full, rather than cancelled, extinguished or forfeited from the consideration paid to the holders upon conversion of a 5.50% Note. 

On or after the date that is six months after the last date of original issuance of the 5.50% Notes, if the last reported sale price of the Company’s Common Stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending within the five trading days immediately preceding a conversion date is greater than or equal to the conversion price for the 5.50% Notes on each applicable trading day, the Company will, in addition to the other consideration payable or deliverable in connection with such conversion, make an interest make-whole payment to the converting holder equal to the sum of the present value of the remaining scheduled payments of interest that would have been made on the 5.50% Notes to be converted had such notes remained outstanding from the conversion date through April 1, 2018, computed using a discount rate equal to 2%. The Company will pay any interest make-whole payment by delivering shares of the Company’s Common Stock valued at 95% of the simple average of the daily volume weighted average price for the 10 trading days ending on and including the trading day immediately preceding the conversion date.  Notwithstanding the foregoing, the number of shares the Company may deliver in connection with a conversion of the 5.50% Notes, including those delivered in connection with an interest make-whole payment, will not exceed 77.3395 shares of Common Stock per $1,000 principal amount of 5.50% Notes, subject to adjustment.  The Company will not be required to make any cash payments in lieu of any fractional shares or have any further obligation to deliver any shares of Common Stock or pay any cash in excess of the threshold described above. In addition, if in connection with any conversion the conversion rate is adjusted, then such holder will not receive the interest make-whole payment with respect to such 5.50% Note.

Certain provisions in the 5.50% Notes could require accelerated payment of principal and interest.  The 5.50% Notes provide that the delisting of the Company’s Common Stock from the Nasdaq Global Market would constitute a “fundamental change” under the 5.50% Notes, which would entitle the holder, at the holder’s option, to require the Company to repurchase for cash all or any portion of such holder’s 5.50% Notes at a repurchase price equal to 100% of the principal amount thereof, plus accrued and unpaid interest thereon.  On November 24, 2017, the Company received a notice from the Nasdaq that the Company was not in compliance with Nasdaq's Listing Rule 5450(b)(2)(A) (the "Rule"), as the minimum market value of the Company’s Common Stock had been below $50.0 million for 30 consecutive business days. Further, on March 8, 2018, the Company received a notice from Nasdaq that since the minimum closing bid price for the Company’s Common Stock had been below $1.00 for 30 consecutive business days, the Company did not meet the minimum closing bid price requirement in the Rule.  Refer to Note 1- Organization and Description of the Business for further details.

The Company accounts for convertible debt instruments by recording the liability and equity components of the convertible debt separately. The liability is computed based on the fair value of a similar debt instrument that does not include the conversion option. The liability component includes both the value of the embedded interest make-whole derivative and the carrying value of the 5.50% Notes.  The equity component is computed based on the total debt

proceeds less the fair value of the liability component. The equity component is also recorded as debt discount and amortized as interest expense over the expected term of the 5.50% Notes, using the effective interest method.

The liability component of the 5.50% Notes on the date of issuance was computed as $41.6 million, including the value of the embedded interest make-whole derivative of $0.9 million and the carrying value of the 5.50% Notes of $40.6 million. Accordingly, the equity component on the date of issuance was $19.4 million.  The discount on the 5.50% Notes is being amortized to interest expense over the term of the 5.50% Notes, using the effective interest method. 

The conversion criteria for the 5.50% Notes have not been met at March 31, 2018.  Should the 5.50% Notes become convertible, management will determine whether the intent is to settle in cash, which would result in the liability component of the 5.50% Notes being classified as a current liability and the equity component being presented as redeemable equity if the liability is considered current.

Transaction costs of $4.1 million related to the issuance of the 5.50% Notes are allocated to the liability and equity components in proportion to the allocation of the proceeds and accounted for as debt discount and equity issuance costs, respectively. Approximately $1.3 million of this amount was allocated to equity and the remaining $2.8 million was recorded as debt discount at issuance.

In September 2016, in connection with the issuance of the 13% Notes (as defined below), the Company and its subsidiaries entered into supplemental indentures with the trustee for the 5.50% Notes pursuant to which the Company’s subsidiaries became guarantors under the indenture guaranteeing the 5.50% Notes.

In December 2017, the Company exchanged, with certain existing 5.50% Noteholders, $36.4 million in principal amount of the 5.50% Notes for (i) approximately $23.9 million of the Company’s new 6.50% Notes, (ii) a warrant exercisable for 3.5 million shares of the Company’s Common Stock and (iii) payments, in cash, of all accrued but unpaid interest as of the closing of the 5.50% Notes exchanged in the transaction.  This exchange was accounted for as a debt extinguishment and the gain on debt extinguishment of $13.2 million, inclusive of the make-whole payments and write-off of deferred financing fees, is reflected in the Company’s consolidated statements of operations during the year ended December 31, 2017. 

The following table summarizes how the issuance of the 5.50% Notes is reflected in the Company’s consolidated balance sheets at December 31, 2017 and March 31, 2018:

6.50% Convertible Notes Due 2024 (the “6.50% Notes”)

In December 2017, the Company entered into exchange agreements (the “Exchange Agreements”) with certain holders (the “Holders”) of the Company’s 5.50% Notes pursuant to which the Holders agreed to exchange, in the aggregate, approximately $36.4 million of outstanding principal amount of the 5.50% Notes for, in the aggregate, (i) approximately $23.9 million of the Company’s new 6.50% Notes, (ii) a warrant exercisable for 3.5 million shares of the Company’s Common Stock at an exercise price of $0.01 per share and (iii) payments, in cash, of all accrued but unpaid interest as of the closing on the 5.50% Notes exchanged in the transaction (the “Exchange”).  At the closing of the Exchange, 2.5 million warrants were exercised.  The remaining 1.0 million warrants were exercised in January 2018.

The Company consummated the Exchange in reliance upon the exemption from registration provided by Section 4(a)(2) under the Securities Act of 1933, as amended (the “Securities Act”) and pursuant to an indenture (the “Indenture”), dated December 27, 2017, by and among the Company, the subsidiary guarantors party thereto as of the date thereof, and The Bank of New York Mellon, as trustee (the “Trustee”).

The 6.50% Notes will pay interest semiannually in arrears on January 1 and July 1 of each year commencing July 1, 2018 at a rate of 6.50% per year, which rate is subject to adjustment in accordance with the terms of the Indenture and as described below.  The 6.50% Notes are general unsecured obligations of the Company and rank equally in right of payment with all of its other existing and future senior unsecured indebtedness and senior in right of payment to all of its existing and future subordinated indebtedness. The 6.50% Notes will mature on December 31, 2024, unless earlier repurchased, redeemed or converted in accordance with the terms of the Indenture prior to such date. Subject to certain conditions, on or after January 1, 2021, the Company may redeem for cash all or a part of the 6.50% Notes.  The 6.50% Notes will be convertible at any time until the close of business on the business day immediately preceding the maturity date.  Upon conversion and subject to certain conditions, holders of the 6.50% Notes will receive shares of the Company’s Common Stock at an initial conversion rate of 749.6252 shares of Common Stock per $1,000 principal amount of 6.50% Notes, which is equivalent to an initial conversion price of approximately $1.33 per share, and is subject to adjustment under the terms of the Indenture. Similar to the 5.50% Notes, the 6.50% Notes will provide for an interest make-whole payment in connection with conversions that occur prior to January 1, 2021.  For any Conversion Date that occurs prior to the close of business on the business day immediately preceding January 1, 2021, the Company shall, in addition to the other consideration payable or deliverable in connection with any conversion of Notes, make an interest make-whole payment in cash or in shares of Common Stock, at the Company’s election, to such converting Holder equal to the sum of the present value of the remaining scheduled payments of interest that would have been made on the Notes to be converted had such Notes remained outstanding from the Conversion Date through January 1, 2021. The present values will be computed using a discount rate equal to 2% by a U.S. nationally recognized independent investment banking firm.

If an event of default (as defined in the Indenture) occurs and is continuing (other than specified events of bankruptcy or insolvency with respect to the Company), the Trustee or the holders of at least 25% in aggregate principal amount of the outstanding 6.50% Notes may declare all the outstanding 6.50% Notes to be due and payable immediately. If an event of default relating to specified events of bankruptcy or insolvency with respect to the Company occurs, all the outstanding 6.50% Notes will immediately become due and payable without any declaration or other act on the part of the trustee or any holders of the 6.50% Notes.  Notwithstanding the foregoing, the Indenture provides that, to the extent the Company elects, the sole remedy for an event of default relating to certain failures by the Company to comply with certain reporting covenants in the Indenture will, for the first 180 days after such event of default, consist exclusively of the right to receive additional interest on the 6.50% Notes.

In addition, the Indenture required the Company to use its reasonable best efforts to (i) seek stockholder approval of an amendment to the Company’s Third Amended & Restated Certificate of Incorporation, as amended, in order to increase the amount of authorized shares available for issuance thereunder, and (ii) upon such approval, to reserve from such amount the number of shares that may be issued in respect of the 6.50% Notes and any other securities issued in connection with the Exchange.  In February 2018, the Company held a special meeting of stockholders (the “Special Meeting”) and received stockholder approval of an amendment to the Company’s Third Amended and Restate Certificate of Incorporation (the “Charter Amendment”) to increase authorized shares by 200,000,000 additional shares. Refer to Footnote 8- Stockholders’ Equity for further details. The Exchange Agreements also provide that, for a period of nine months, the Company will not enter into additional exchange transactions with the other holders of the 5.50% Notes the economic terms of which, taken is a whole, are more favorable to the 5.50% Note holders than the December 2017 Exchange.  

Certain provisions in the 6.50% Notes could require accelerated payment of principal and interest.  The 6.50% Notes provide that the delisting of the Company’s Common Stock from the Nasdaq exchange would constitute a “fundamental change” under the 6.50% Notes, which would entitle the holder, at the holder’s option, to require the Company to repurchase for cash all or any portion of such holder’s 6.50% Notes at a repurchase price equal to 100% of the principal amount thereof, plus accrued and unpaid interest thereon.  On November 24, 2017, the Company received a notice from The Nasdaq Stock Market ("Nasdaq") that it was not in compliance with Nasdaq Global Market’s Listing Rule 5450(b)(2)(A) (the "Rule"), as the minimum market value of our Common Stock had been below $50 million for 30 consecutive business days. Further, on March 8, 2018, the Company received a notice from Nasdaq that since the minimum closing bid price for the Company’s Common Stock had been below $1.00 for 30 consecutive business days, it did not meet the minimum closing bid price requirement in the Rule.  The Company has the option to move to the Nasdaq Capital Market if it is delisted from the Nasdaq Global Market, provided it meets the minimum listing requirements for the Nasdaq Capital Market at the time of the move.  The move from the Nasdaq Global Market to the

Nasdaq Capital Market would not be considered a fundamental change under the 6.50% Notes.   Refer to Note 1- Organization and Description of the Business for further details.

At the date of Exchange, December 27, 2017, the Company did not have sufficient unissued authorized shares to cover the conversion of the outstanding 6.50% Notes and as a result was required to account for the bifurcated conversion feature as a derivative liability which results in a debt discount on the 6.50% Notes.  The fair value of the derivative liability for the conversion feature at the date of Exchange was determined to be approximately $15.0 million and was classified as a liability in the Company’s consolidated balance sheet as of December 31, 2017, with subsequent changes to fair value recorded through earnings at each reporting period on the Company’s consolidated statements of operations and comprehensive loss as change in fair value of derivative liabilities.  

As a result of the Charter Amendment, as of March 31, 2018, the Company had reserved sufficient shares of its Common Stock to satisfy the conversion provisions of the 6.50% Notes and accordingly, the conversion feature is considered indexed to the Company’s Common Stock and the fair value of the conversion feature at the date of approval, $12.5 million, was reclassified from a liability into stockholders' equity during the three months ended March 31, 2018. 

The conversion criteria for the 6.50% Notes have not been met at March 31, 2018.  Should the 6.50% Notes become convertible, management will determine whether the intent is to settle in cash which would result in the liability component of the 6.50% Notes being classified as a current liability and the equity component being presented as redeemable equity if the liability is considered current.

Transaction costs of $1.7 million were incurred related to the issuance of the 6.50% Notes are accounted for as debt discount.

The following table summarizes how the issuance of the 6.50% Notes is reflected in the Company’s consolidated balance sheets at December 31, 2017 and March 31, 2018:

13% Senior Secured Notes (the “13% Notes”)

In August 2016, the Company completed the initial closing (the “Initial Closing”) of its offering (the “Offering”) of up to $80.0 million aggregate principal amount of its 13% Notes and entered into an indenture (the “Indenture”) governing the 13% Notes with the guarantors party thereto (the “Guarantors”) and U.S. Bank National Association, a national banking association, as trustee (the “Trustee”) and collateral agent (the “Collateral Agent”). 

The Company issued $40.0 million aggregate principal amount of the 13% Notes at the Initial Closing, and issued an additional $40.0 million aggregate principal amount upon the FDA’s approval of ARYMO™ ER in January 2017 (the “Second Closing”).  Net proceeds from the Initial Closing and Second Closing were $37.2 million and $38.3 million, respectively, after deducting the estimated Offering expenses payable by the Company in connection with the Initial Closing and Second Closing. The 13% Notes were sold only to qualified institutional buyers within the meaning of Rule 144A under the Securities Act of 1933, as amended.

The Company has used and will use the net proceeds from the 13% Notes and the Royalty Rights (as defined below) to repay all outstanding obligations to Hercules under the Loan Agreement with Hercules, to support the commercialization of ARYMO ER and for general corporate purposes.

Prior to the Second Closing, interest on the 13% Notes accrued at a rate of 13% per annum and was payable semi-annually in arrears on March 20 and September 20 of each year (each, a “Payment Date”) commencing on March 20, 2017. On each Payment Date commencing on March 20, 2018, the Company was required to also pay an installment of principal of the 13% Notes pursuant to a straight-line fixed amortization schedule. Following the Second Closing in January 2017, in lieu of the straight-line fixed amortization schedule, on each Payment Date commencing on March 20, 2018, the Company will pay an installment of principal on the 13% Notes in an amount equal to 15% (or 17% if certain sales targets are not met) of the aggregate net sales of OXAYDO, SPRIX Nasal Spray, ARYMO ER and, if approved, Egalet-002 for the two consecutive fiscal quarterly period most recently ended, less the amount of interest payable on the 13% Notes on such Payment Date.

The 13% Notes are senior secured obligations of the Company and will be equal in right of payment to all existing and future pari passu indebtedness of the Company (including the Company’s outstanding 5.50% Notes due 2020), will be senior in right of payment to all existing and future subordinated indebtedness of the Company, will have the benefit of a security interest in the 13% Notes collateral and will be junior in lien priority in respect of any collateral that secures any first priority lien obligations incurred, which includes intellectual property (“IP”), from time to time in accordance with the Indenture. Following the Second Closing, the stated maturity date of the 13% Notes became September 30, 2033. Upon the occurrence of a Change of Control, subject to certain conditions, or certain Asset Sales events (each, as defined in the Indenture), holders of the 13% Notes may require the Company to repurchase for cash all or part of their 13% Notes at a repurchase price equal to 101.00% of the principal amount of the 13% Notes to be repurchased, plus accrued and unpaid interest to the date of repurchase.

The Company may redeem the 13% Notes at its option, in whole or in part from time to time, prior to August 31, 2018, at a redemption price equal to 100.00% of the principal amount of the 13% Notes being redeemed, plus accrued and unpaid interest, if any, through the redemption date, plus a make-whole premium computed using a discount rate equal to the treasury rate in respect of such redemption date plus 100 basis points. The Company may redeem the 13% Notes at its option, in whole or in part from time to time, on or after August 31, 2018 at a redemption price equal to: (i) from and including August 31, 2018 to and including August 30, 2019, 109.00% of the principal amount of the 13% Notes to be redeemed, (ii) from and including August 31, 2019 to and including August 30, 2020, 104.50% of the principal amount of the 13% Notes to be redeemed, and (iii) from and including August 31, 2020 and thereafter, 100.00% of the principal amount of the 13% Notes to be redeemed, in each case, plus accrued and unpaid interest to the redemption date. In addition, prior to August 31, 2018, the Company may redeem, at its option, up to 35% of the aggregate principal amount of the 13% Notes with the proceeds of one or more public or private equity offerings at a redemption price equal to 113.50% of the aggregate principal amount of the 13% Notes to be redeemed, plus accrued and unpaid interest to the date of redemption in accordance with the Indenture; provided that at least 65% of the aggregate principal amount of 13% Notes issued under the Indenture remains outstanding immediately after each such redemption and provided further that each such redemption occurs within 90 days of the date of closing of each such equity offering.  No sinking fund is provided for the 13% Notes, which means that the Company is not required to periodically redeem or retire the 13% Notes.

The obligations of the Company under the Indenture and the 13% Notes are unconditionally guaranteed on a secured basis by the Guarantors. Under the terms of the Indenture, the Company may designate entities within its corporate structure as unrestricted subsidiaries, which entities will therefore not be guarantors provided that certain conditions set forth in the Indenture are met.

Pursuant to the Indenture, the Company and its restricted subsidiaries must also comply with certain affirmative covenants, such as furnishing financial statements to the holders of the 13% Notes, and negative covenants, including limitations on the following: the incurrence of debt; the issuance of preferred and/or disqualified stock; the payment of dividends, the repurchase of shares and under certain conditions making certain other restricted payments; the prepayment, redemption or repurchase of subordinated debt; the merger, amalgamation or consolidation involving the Company; engaging in certain transactions with affiliates; and the making of investments other than those permitted by the Indenture.

The Indenture governing the 13% Notes contains customary events of default with respect to the 13% Notes (including the Company’s failure to make any payment of principal or interest on the 13% Notes when due and payable),

and upon certain events of default occurring and continuing, the Trustee by notice to the Company, or the holders of at least 25% in principal amount of the outstanding 13% Notes by notice to the Company and the Trustee, may (subject to the provisions of the Indenture) declare 100% of the principal of and accrued and unpaid interest, if any, on all of the 13% Notes to be due and payable. Upon such a declaration of acceleration, such principal and accrued and unpaid interest, if any, as well as the then-applicable optional redemption premium under the Indenture, will be due and payable immediately. In the case of certain events of bankruptcy, insolvency or reorganization involving the Company or a Restricted Subsidiary (as defined in the Indenture), the 13% Notes will automatically become due and payable.

In connection with the Initial Offering in August 2016, the Company entered into royalty rights agreements with each of the 13% Notes Purchasers pursuant to which the Company sold to such Purchasers the right to receive, in the aggregate, a payment equal to 1.5% of the aggregate net sales of OXAYDO and SPRIX Nasal Spray from the Initial Closing through December 31, 2019, inclusive (the “Royalty Rights”).  Following the approval of ARYMO ER in January 2017, the Royalty Rights will continue through December 31, 2020 and include royalties of ARYMO ER as described below.

The Company also entered into separate royalty rights agreements with each of the Purchasers pursuant to which the Company sold to such Purchasers the right to receive 1.5% of the aggregate net sales of ARYMO ER payable from the date of first sale of ARYMO ER through December 31, 2020, inclusive.  The royalty rights agreements also include other terms and conditions customary in agreements of this type.

The Royalty Rights were determined to be a freestanding element with respect to the 13% Notes and the Company is accounting for the Royalty Rights obligation relating to future royalties as a debt instrument.  The Company has Royalty Rights obligations of $4.1 million and $3.7 million as of December 31, 2017 and March 31, 2018, respectively, which are classified within current and non-current debt in the consolidated balance sheets.

The Company incurred fees and legal expenses of $4.5 million in connection with the issuance of the 13% Notes, which have been recorded as a discount on the debt in the Company’s consolidated balance sheets and are amortized using the effective interest method. The Company calculated an effective interest rate of 15.2% as of March 31, 2018 based on its best estimate of future cash outflows.

The accounting for the 13% Notes requires the Company to make certain estimates and assumptions about the future net sales of OXAYDO, SPRIX Nasal Spray and ARYMO ER in the U.S. The estimates of the magnitude and timing of OXAYDO, SPRIX Nasal Spray and ARYMO ER net sales are subject to significant variability due to the recent product launch and the extended time period associated with the financing transaction, and are thus subject to significant uncertainty. Therefore, these estimates and assumptions are likely to change as the Company continues to gain experience marketing OXAYDO, SPRIX Nasal Spray and ARYMO ER, which may result in future adjustments to the portion of the debt that is classified as a current liability, the amortization of debt issuance costs and discount as well as the accretion of the interest expense. Any such adjustments could be material.  The fair value of the Royalty Rights associated with certain net product sales was estimated to be $5.0 million at the issuance of the 13% Notes using a probability-weighted present value analysis.

The following table summarizes how the issuance of the 13% Notes is reflected in the Company’s consolidated balance sheets at December 31, 2017 and March 31, 2018:

Current and non-current debt on the Company’s consolidated balance sheets at December 31, 2017 and March 31, 2018 includes the carrying value of the 5.50% Notes, 6.50% Notes and the 13% Notes, as well as $4.1 million and $3.7 million, respectively, for the Royalty Rights issued in connection with the 13% Notes. 

8. Stockholders’ Equity

At the Market Offering

In July 2015, the Company entered into a Controlled Equity Offering Sales Agreement (“2015 Sales Agreement”) with Cantor Fitzgerald & Co. (“Cantor”), under which the Company could, at its discretion, from time to time, sell shares of its Common Stock, for an aggregate offering price of up to $30.0 million. The Company provided Cantor with customary indemnification rights, and Cantor is entitled to a commission at a fixed rate of 3% of the gross proceeds per share sold.  Sales of the shares of Common Stock under the 2015 Sales Agreement have been and, if there are additional sales under the 2015 Sales Agreement, will be, made in transactions deemed to be “at the market offerings”, as defined in Rule 415 under the Securities Act of 1933, as amended. 

The Company has initiated sales of shares under the 2015 Sales Agreement at various times beginning in March 2017 and has sold an aggregate of 7,434,336 shares of Common Stock through March 31, 2018, resulting in gross proceeds of $8.5 million before deducting commissions of $254,000. The Company has sold an aggregate of 106,120 shares under the Sales Agreement during the period subsequent to March 31, 2018, resulting in gross proceeds of $77,000 before deducting commissions of $2,000.

July 2017 Equity Offering

On July 6, 2017, the Company entered into an underwriting agreement with Cantor relating to an underwritten public offering (the “July 2017 Equity Offering”) of 16,666,667 shares of the Company’s Common Stock and accompanying warrants to purchase 16,666,667 shares of Common Stock, at a combined public offering price of $1.80 per share and accompanying warrant, for gross proceeds of $30.0 million.  The net offering proceeds were $28.6 million after deducting underwriting discounts and commissions and offering-related costs of $1.4 million. Each warrant had an initial exercise price of $2.70, subject to adjustment in certain circumstances.  As of March 31, 2018, the warrants had an exercise price of $2.03. The shares of Common Stock and warrants were issued separately. The warrants may be exercised at any time on or after the date of issuance and will expire five years from the date of issuance.

The Company accounted for the warrants using ASC 480 – Distinguishing Liabilities from Equity and determined that the warrants were a freestanding financial instrument that are subject to liability classification.  Pursuant to the terms of the agreement, the Company could be required to settle the warrants in cash in the event of an acquisition of the Company, and as a result the warrants are required to be measured at fair value and reported as a liability in the Company’s consolidated balance sheet.  The warrant exercise price is subject to adjustment upon the issuance of certain equity securities at a price less than the exercise price of the warrants then in effect. 

The fair value of the warrants to purchase shares of the Company’s Common Stock in connection with the July 2017 Equity Offering was $9.7 million on the date of issuance, which was determined using a lattice model that takes into account various future financing scenarios and the impact of those scenarios on the fair value of the warrants.  The fair value of the warrants of $9.7 million on the date of issuance was recorded as a liability which will be marked to its estimated fair value at each reporting period. Refer to Footnote 9- Fair Value Measurements for further details.

Reclassification of the Derivative Liability

 In February 2018, the Company received shareholder approval to increase authorized shares by 200,000,000 additional shares.  Prior to this approval, the embedded conversion options in the 6.50% Notes were required to be separately accounted for as a derivative liability. Upon the shareholder approval to increase authorized shares, the Company had reserved sufficient shares of its Common Stock to satisfy the conversion provisions of the 6.50% Notes. The fair value of the derivative liability of $12.5 million was reclassified from a liability into stockholders’ equity during the three months ended March 31, 2018.

9. Fair Value Measurements

The Company measures certain assets and liabilities at fair value in accordance with ASC 820, Fair Value Measurements and Disclosures (“ASC 820”). ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability (the exit price) in an orderly transaction between market participants at the measurement date. The guidance in ASC 820 outlines a valuation framework and creates a fair value hierarchy in order to increase the consistency and comparability of fair value measurements and the related disclosures. In determining fair value, the Company maximizes the use of quoted prices and observable inputs. Observable inputs are inputs that market participants would use in pricing the asset or liability based on market data obtained from independent sources. The fair value hierarchy is broken down into three levels based on the source of inputs as follows:

The following fair value hierarchy table presents information about each major category of the Company’s financial assets and liabilities measured at fair value on a recurring basis: