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Note A - Description of Business, Basis of Presentation and Significant Transactions

9 Months Ended

Sep. 30, 2022

Notes to Financial Statements

Business Description and Basis of Presentation [Text Block]

A.	Description of Business, Basis of Presentation and Significant Transactions

Organization

KemPharm, Inc. (the "Company") is a biotechnology company focused on the discovery, development and commercialization of novel treatments for rare central nervous system ("CNS") and neurodegenerative diseases, lysosomal storage disorders and related treatment areas. The Company has a diverse product portfolio, combining a clinical-stage pipeline with new drug application ("NDA") stage and commercial assets. The Company's pipeline includes arimoclomol, an orally-delivered, first-in-class investigational product candidate for Niemann-Pick disease type C ("NPC"), and KP1077, which the Company is developing as a treatment for idiopathic hypersomnia ("IH"), a rare neurological sleep disorder, and narcolepsy. In addition, the U.S. Food and Drug Administration ("FDA") has approved AZSTARYS^®, formally referred to as KP415, a once-daily treatment for attention deficit hyperactivity disorder ("ADHD") in patients age six years and older containing the Company's prodrug, serdexmethylphenidate ("SDX"), which is being commercialized by Corium, Inc. ("Corium"), an affiliate of Gurnet Point Capital, L.P., in the U.S. The FDA has also approved APADAZ^®, an immediate-release combination product containing benzhydrocodone, the Company's prodrug of hydrocodone, and acetaminophen, which is being commercialized by KVK-Tech, Inc. in the U.S.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") for interim financial information and with the instructions to Form 10-Q and Rule 8-03 of Regulation S-X. Accordingly, they do not include all of the information and related notes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring adjustments) considered necessary for a fair presentation have been included in the accompanying financial statements. Operating results for the three and nine months ended September 30, 2022, are not necessarily indicative of the results that may be expected for the full year ending December 31, 2022.

This interim information should be read in conjunction with the audited financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2021, filed with the Securities and Exchange Commission (“SEC”) on March 31, 2022.

Basis of Presentation

The Company prepared the financial statements in accordance with U.S. GAAP and the rules and regulations of the United States Securities and Exchange Commission (the "SEC") and, in the Company's opinion, reflect all adjustments, including normal recurring items that are necessary.

Arimoclomol Acquisition

On May 15, 2022, the Company and KemPharm Denmark A/S (“KemPharm DK”), a newly formed Danish company and wholly-owned subsidiary of KemPharm, Inc., entered into an asset purchase agreement (the “Arimoclomol Purchase Agreement”) with Orphazyme A/S in restructuring, a Danish public limited liability company (“Orphazyme”). The Arimoclomol Purchase Agreement closed on May 31, 2022. Under the terms of the Arimoclomol Purchase Agreement, KemPharm DK purchased all of the assets and operations of Orphazyme related to arimoclomol and settled all of Orphazyme’s actual outstanding liabilities to its creditors with a cash payment of $12.8 million. In addition, KemPharm DK agreed to assume an estimated reserve liability of $5.2 million related to revenue generated from Orphazyme’s Early Access Program in France.

The Company accounted for the arimoclomol acquisition as an asset acquisition as the majority of the value of the assets acquired related to the arimoclomol acquired in-process research and development (“IPR&D”) asset. The intangible asset associated with IPR&D relates to arimoclomol. The estimated fair value of $17.7 million was determined using the excess earnings valuation method, a variation of the income valuation approach. The excess earnings valuation method estimates the value of an intangible asset equal to the present value of the incremental after-tax cash flows attributable to that intangible asset over its remaining economic life. Some of the more significant assumptions utilized in our asset valuations included the estimated i) net cash flows, including net revenues, cost of sales, research and development and other operating expenses, ii) the potential regulatory and commercial success rates, iii) market penetration and pricing assumptions, and iv) tax rates, and were based on our most recent strategic plan. The fair value using the excess earnings valuation method was determined using an estimated weighted average cost of capital of 42%, which reflects the risks inherent in future cash flow projections and represents a rate of return that a market participant would expect for this asset. This fair value measurement was based on significant inputs not observable in the market and thus represent Level 3 fair value measurement.

In accordance with Accounting Standards Codification, Subtopic 730-10-25, Accounting for Research and Development Costs, the up-front payments to acquire a new drug compound, as well as future milestone payments when paid or payable, are immediately expensed as acquired IPR&D in transactions other than a business combination provided that the drug has not achieved regulatory approval for marketing and, absent obtaining such approval, has no alternative future use. Therefore, the portion of the purchase price that was allocated to the IPR&D assets acquired was immediately expensed. Other assets acquired and liabilities assumed, were recorded at fair value. The company also recorded a $0.7 million income tax benefit for the three and nine months ended September 30, 2022, related to research and development credits that are expected to be realized from the local jurisdiction in Denmark.

The following represents the consideration paid and purchase price allocation for the acquisition of arimoclomol (in thousands):

Cash		$	12,800
Assumed reserve liability			5,200
Total consideration		$	18,000

Total consideration		$	18,000
Direct transaction costs associated with the acquisition (1)			1,290
Total purchase price to be allocated		$	19,290

Property and equipment, inventory and assembled workforce acquired		$	1,627
IPR&D (2)			17,663
Total allocated purchase price		$	19,290

(1) As a result of the asset acquisition accounting, the transaction costs associated with the acquisition should be included in the costs of the assets acquired and allocated amongst qualifying assets using the relative fair value basis. The transaction costs primarily included financial advisor fees and legal expenses.
(2) The primary asset acquired, the IPR&D asset, was expensed and the allocated transaction related costs were included with and expensed with this asset.

Underwriting Agreement

On January 8, 2021, the Company entered into an underwriting agreement (the “Underwriting Agreement”) with Roth Capital Partners, LLC (the “Underwriter” or "Roth"), to issue and sell 6,765,463 shares of common stock of the Company, pre-funded warrants to purchase 926,844 shares of common stock and warrants to purchase 7,692,307 shares of common stock at an exercise price per share of $6.50 in an underwritten public offering (the “Public Offering”) pursuant to a registration statement on Form S-1 (File No. 333-250945) and a related prospectus, in each case filed with the Securities and Exchange Commission (the “SEC”). The offering price to the public was $6.50 per share of common stock and accompanying warrant, representing a public offering price of $6.4999 per share of common stock and $0.0001 per related warrant. In addition, the Company granted the Underwriter an option to purchase, for a period of 45 days, up to an additional 1,153,846 shares of the Company’s common stock and/or warrants to purchase up to an additional 1,153,846 shares of the Company’s common stock.

On January 8, 2021, the Underwriter exercised its over-allotment option, in part, for warrants to purchase 754,035 shares of the Company’s common stock. Further on February 1, 2021, the Underwriter again exercised its over-allotment option to purchase 374,035 shares of common stock.

On January 12, 2021, the Company closed the Public Offering. The aggregate gross proceeds to the Company from the Public Offering, including over-allotment, totaled approximately $52.4 million, before deducting underwriting discounts and commissions and offering expenses payable by the Company.

On January 25, 2022, the Company filed an amendment to the registration statement on Form S-1 (File No. 333-250945) on Form S-3 covering the issuance of the shares of our common stock issuable upon the exercise of the warrants issued in the Public Offering and remaining unexercised as of the date of the amendment, which was declared effective on February 1, 2022.

Listing on the Nasdaq Stock Market

On January 7, 2021, the Company’s common stock was approved for listing on the Nasdaq Capital Market. The Company’s common stock began trading on the Nasdaq Capital Market on January 8, 2021, under the ticker symbol “KMPH”.

On October 19, 2021, the Company announced that its shares of common stock were approved for listing to the Nasdaq Global Select Market. Trading on the Nasdaq Global Select Market commenced effective with the open of business on October 19, 2021, under the Company’s ticker symbol, “KMPH”. The Company was previously listed on the Nasdaq Capital Market, following its uplisting to the exchange in January 2021.

Entry into 2021 ATM Agreement

On July 2, 2021, the Company entered into an equity distribution agreement (the "2021 ATM Agreement") with JMP Securities LLC ("JMP") and RBC Capital Markets, LLC ("RBCCM") under which the Company may offer and sell, from time to time at its sole discretion, shares of its common stock having an aggregate offering price of up to $75.0 million through JMP and RBCCM as its sales agents. The issuance and sale, if any, of common stock by the Company under the 2021 ATM Agreement will be made pursuant to a registration statement on Form S-3. JMP and RBCCM may sell the common stock by any method permitted by law deemed to be an “at the market offering” as defined in Rule 415 of the Securities Act of 1933, as amended. JMP and RBCCM will use commercially reasonable efforts to sell the common stock from time to time, based upon instructions from the Company (including any price, time or size limits or other customary parameters or conditions the Company may impose). The Company will pay JMP and RBCCM a commission equal to 3.0% in the aggregate of the gross sales proceeds of any common stock sold through JMP and RBCCM under the 2021 ATM Agreement. The Company filed a registration statement on Form S-3 covering the sale of the shares of its common stock up to $350.0 million, $75.0 million of which was allocated to the sales of the shares of common stock issuable under the 2021 ATM Agreement, which was declared effective on July 12, 2021. As of September 30, 2022, no shares have been issued or sold under the 2021 ATM Agreement.

Share Repurchase Program

On December 20, 2021, the Company initiated a share repurchase program (the "Share Repurchase Program") pursuant to which the Company may repurchase up to $50 million of shares of its common stock through December 31, 2023. Capital allocation to the Share Repurchase Program will be based on a variety of factors, including our business results, the receipt of royalties and sales milestones under the AZSTARYS License Agreement (refer to Note B), and potentially other sources of non-dilutive capital that may become available to the Company. Repurchases will be made in compliance with Rule 10b-18 of the Securities Exchange Act of 1934, as amended, subject to a variety of factors, including the market price of the Company’s common stock, general market and economic conditions and applicable legal requirements. The exact number of shares to be repurchased by the Company is not guaranteed and the program may be suspended, modified, or discontinued at any time without prior notice. The Company does not currently intend to retire the repurchased treasury shares, rather all repurchased treasury shares will remain authorized but unissued. As of September 30, 2022, the Company has repurchased 909,953 shares of its common stock for approximately $7.5 million under the Share Repurchase Program.