$INSY Form 10-K

The information in this Annual Report on Form 10-K, or this Form 10-K, including this discussion in Management’s Discussion and Analysis of Financial Condition and Results of Operations, or MD&A, contains forward-looking statements and information within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, which are subject to the “safe harbor” created by those sections. All statements, other than statements of historical facts, included or incorporated in this Form 10-K could be deemed forward-looking statements, particularly statements about our plans, strategies and prospects under this MD&A heading and under the heading “Business.” In some cases, you can identify forward-looking statements by terminology such as “may,” “will,” “should,” “could,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” “continue,” “intend” or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these identifying words. All forward-looking statements in this Form 10-K are made based on our current expectations, forecasts, estimates and assumptions, and involve risks, uncertainties and other factors that could cause results or events to differ materially from those expressed in the forward-looking statements. In evaluating these statements, you should specifically consider various factors, uncertainties and risks that could affect our future results or operations as described from time to time in our SEC reports, including those risks outlined under the heading “Risk Factors” in Part I, Item 1A of this Form 10-K. These factors, uncertainties and risks may cause our actual results to differ materially from any forward-looking statement set forth in this Form 10-K. You should carefully consider the trends, risks and uncertainties described below and other information in this Form 10-K and subsequent reports filed with or furnished to the SEC before making any investment decision with respect to our securities. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this cautionary statement.

These forward-looking statements include, but are not limited to, statements concerning our strategy, future operations, future financial position, future revenues, projected costs, prospects and plans and objectives of management; PBM formulary changes relative to SUBSYS� or established for SYNDROS� (once commercially launched, if at all) may have a material impact on future net revenue; our intent to file an IND application for the treatment of epilepsy with cannabidiol; the sufficiency of our manufacturing capacity; the beneficial attributes of our dronabinol product candidates and delivery mechanisms; that our suppliers are equipped to supply us with our current and future chemical needs; that pending dronabinol candidates will default to Schedule II classification; that changes in healthcare laws will result in reduced Medicaid and Medicare payments for prescription drugs; that sales and marketing and research and development costs will be our largest categories of expenses; that sales and marketing expenses will fluctuate based on changes in SUBSYS� net revenue; our development of different dronabinol delivery systems; our anticipated timing of the commercial launch of SYNDROS�; our ability to obtain finalization of labeling by the FDA as the final approval prior to commercial launch of SYNDROS�; that we can maintain or even grow market share and net revenue for SUBSYS� and our strategies relating thereto; that we may pursue strategies relating to synthetic cannabidiol; our sales and marketing strategy for future products and delivery systems; that we may pursue strategic transactions such acquisitions or other companies, asset purchase out- or in-licensing of products, strategic partnerships, joint ventures, divestitures, business combinations and investments; our ability to obtain foundation materials and manufacture dronabinol in light of government quotas; our strategy of using Marinol as a reference drug in future drug approval applications; the expected pathway of drug applications we expect to file in the future; that physicians and payers will continue to gain familiarity about and accept the features of SUBSYS�; our plans and strategies for obtaining future international approvals; our plans and strategies to protect our intellectual property; our intention of not paying dividends; possible capital raising transactions we may pursue; that we may avail ourselves of certain Nasdaq governance provisions because of our status as a controlled company; that research and development and operating costs will increase; that our investments in our sales and research and development infrastructure will result in increased sales; accounting estimates and the impact of new or recently issued accounting pronouncements; that cash flows from operations will increase and/or stabilize as a result of sales of SUBSYS�; the source and sufficiency of our liquidity and capital resources to fund our operations; trends in restrictions and impediments relating to reimbursement policies imposed by PBMs; the impact of pending litigation and our strategy relating thereto; that we will not recognize revenue in the near term from current research and development initiatives; our exposure to interest rate changes and market risks related to our investment; and the potential impact of Section 382 limitations on our NOLs. The words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,” “would” and similar expressions are intended to identify

forward-looking statements, although not all forward-looking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements that we make. The forward-looking statements are applicable only as of the date on which they are made, and we do not assume any obligation to update any forward-looking statements.The following discussion and analysis of the results of operations and financial condition of Insys Therapeutics, Inc. for the years ended December 31, 2016 and 2015 should be read in conjunction with the consolidated financial statements and the notes thereto, and other financial information contained elsewhere in this Form 10-K.

Overview

We are a commercial-stage specialty pharmaceutical company that develops and commercializes innovative supportive care products. We have one commercially marketed product and one product awaiting final labeling approval by the FDA, prior to commercial launch, after receiving FDA approval in July 2016 and DEA scheduling in March 2017:

� SUBSYS� – a proprietary, single-use product that delivers fentanyl, an opioid analgesic, for transmucosal absorption underneath the tongue, offered in 100, 200, 400, 600, 800, 1,200 and 1,600 mcg dosages. SUBSYS� is approved for the treatment of BTCP in opioid-tolerant patients. We received FDA approval for SUBSYS� in January 2012 and commercially launched SUBSYS� in March 2012.

� SYNDROS� – a dronabinol oral solution that is equivalent to Marinol, an approved second-line treatment for CINV and anorexia associated with weight loss in patients with AIDS. We received FDA approval for SYNDROS� in July 2016. In March 2017, the DEA issued an interim final ruling that would result in SYNDROS� being placed in Schedule II of the CSA. We are currently awaiting the finalization of labeling by the FDA as the final approval prior to commercial launch.

We also have one discontinued product:

� Dronabinol SG Capsule – a dronabinol soft gelatin capsule that is a generic equivalent to Marinol, an approved second-line treatment for CINV and anorexia associated with weight loss in patients with AIDS, offered in 2.5, 5.0 and 10.0 milligram dosages. We received FDA approval for Dronabinol SG Capsule in August 2011. We commercially launched Dronabinol SG Capsule through our former exclusive distribution partner, Mylan Pharmaceuticals, Inc., in December 2011. We do not have any current plans to manufacture or market this product in the future.

We market SUBSYS� through our U.S.-based field sales force focused on supportive care physicians. Consistent with most pharmaceutical manufacturing companies, we sell and distribute SUBSYS� primarily to pharmaceutical wholesalers and collect sales proceeds from those wholesalers. For the year ended December 31, 2016, sales to our four largest wholesale customers accounted for 67% of gross revenue. We also sell SUBSYS� directly to certain specialty pharmaceutical retailers who distribute our product. For the year ended December 31, 2016 direct sales to specialty pharmaceutical retailers accounted for 33% of gross revenue. We do not own or have any ownership stake in any pharmaceutical wholesaler or specialty pharmacy, nor do we have an option to acquire any wholesaler or specialty pharmacy. All pharmacies that fulfill SUBSYS� prescriptions are fully independent. Our relationships with every pharmacy that fulfills SUBSYS� prescriptions are non-exclusive in that each of these pharmacies may also fulfill prescriptions for other pharmaceutical manufacturers, including our competitors. For the year ended December 31, 2016, over 920 independent pharmacies have fulfilled at least one SUBSYS� prescription.

Our sales of, and revenue from, SUBSYS� depend in significant part on the coverage and reimbursement policies of third-party payers, including government payers such as Medicare and Medicaid, and private health insurers. All third-party payers are sensitive to the cost of drugs and consistently implement efforts to control these costs, which efforts include, but are not limited to, establishing excluded or preferred drug lists. SUBSYS� has been, and will likely continue to be, subject to these restrictions and impediments from third-party payers, particularly PBMs and private health insurers. We provide administrative reimbursement support assistance, in large part through our

insurance reimbursement support hub, which provides administrative support assistance to help patients coordinate with their insurance companies.We are also developing other product candidates, such as cannabinoid line extensions and sublingual spray product candidates.

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

We have the capability to manufacture pharmaceutical CBD, an over 99.5% pure form of cannabidiol, in our Round Rock, Texas manufacturing facility. On April 23, 2015, we announced that we had commenced dosing of epilepsy patients in a Phase I PK study in pediatric subjects. We intend to file an IND application with the FDA for the treatment of epilepsy.

Factors Affecting Our Performance

We believe that our performance and future success are dependent upon a number of factors, including our approved product sales, investments in our infrastructure and growth, and our ability to successfully develop product candidates and complete related regulatory processes. In addition, our ability to ensure that our products, policies and practices adhere to the extensive national, state and local regulations applicable to our industry is critical to our success, particularly as our operations and product opportunities continue to grow at a rapid pace. While each of these areas presents significant opportunities for us, they also pose significant risks and challenges that we must successfully address.

Approved Product Sales. Our operating results will depend significantly upon our, and any of our third-party distributors’, sales of approved products. During the year ended December 31, 2016, all of our net revenues were generated from the sale of our approved product, SUBSYS�. We will not generate any revenue from the sale of our discontinued Dronabinol SG Capsule in future periods. Our results will depend on prescription volume generally, which we believe will be driven primarily by achievement of broad market acceptance and coverage by third-party payers and effectiveness of the marketing and selling efforts with respect to SUBSYS�. Moreover, our gross margins improve on a unit-by-unit basis as we sell higher dosage strengths of our products. Importantly, the proportion of prescriptions written for repeat SUBSYS� patients has continued to increase since July 2012 from 50% of prescriptions to approximately 92% of prescriptions as of December 31, 2016. Generally, repeat SUBSYS� patients receive significantly higher doses of SUBSYS� on average than first-time patients as patients are titrated from a starter dose of SUBSYS� to their effective dose in accordance with the TIRF REMS protocol.

According to IMS, the total market for TIRF products for the year ended December 31, 2016 was approximately 72,000 prescriptions and we estimate SUBSYS� prescriptions were approximately 43% of the TIRF market, compared to a total market for TIRF products of approximately 94,000 prescriptions and approximately 46% SUBSYS� market share for the year ended December 31, 2015.

The continuing and heightened publicity surrounding the national opioid epidemic continues to result in sensitivity by some healthcare professionals to prescribe, and pharmacies to dispense, opioids. In part, this sensitivity by healthcare professionals and pharmacies is the result of third-party payers, such as insurance companies, and regulatory and government agencies increasingly scrutinizing the indications and uses for which healthcare professionals are prescribing, and pharmacies are dispensing, opioids. Moreover, ongoing state and federal investigations into our sales, marketing and other commercial practices and developments and media reports that may arise in connection with such investigations may negatively affect our relationships with healthcare professionals and pharmacies and their prescribing or dispensing habits. Consequently, these current and potential future events have and will likely continue to affect the manner in which, and the situations when, SUBSYS� is being prescribed, dispensed and approved for coverage. While we continue to sell directly into wholesalers and retail pharmacies for

our revenue, the direct pressures discussed above related to the retail demand-side components of our business contributed to the decline in full-year 2016 SUBSYS� revenue when compared to 2015.Third-Party Payer Interactions and Government Programs Associated with Reimbursement. Our interaction with third-party payers is critical to the success of our business and financial condition. Our relationships with these third-party payers evolves on a regular basis and is often difficult to predict. By way of example, from time to time, third-party payers modify which drugs they choose to reimburse. For instance, on or around August 1, 2014, ESI officially released its exclusion list of drugs, effective January 1, 2015, in connection with its national preferred formulary. Other PBMs may take similar actions and these actions may have a material impact on our net revenue in the future. As we have in the past, we will continue working with PBMs to evaluate price increases and to communicate with managed care and health-system decision-makers to ensure a balanced approach, which takes into account the clinical performance and efficacy of our products.

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

Investments in Our Infrastructure and Growth. Our ability to increase our sales and to further penetrate our target market segments is dependent in part on our ability to invest in our infrastructure and in our sales and marketing efforts. In order to drive further growth, we may hire additional sales and marketing personnel and invest in marketing our products to our target physician prescriber base. For example, as of December 31, 2016, we had 274 full-time sales and marketing personnel. This will lead to corresponding increases in our operating expenses, although we anticipate that these investments will result in increased product sales and net revenue. In addition, we have constructed a second dronabinol manufacturing facility, which we anticipate will supply us with sufficient commercial quantities of dronabinol API for the commercialization of our proprietary dronabinol product candidates, if approved. This second facility will also increase our operating expenses.

Product Development and Related Regulatory Processes. Our operating results will also depend significantly on our research and development activities and related regulatory developments. Our research and development expenses were $75.4 million and $55.3 million for the years ended December 31, 2016 and 2015, respectively. As of December 31, 2016, we had 59 full-time research and development personnel. We expect research and development expenses to increase as we continue our planned preclinical studies and clinical trials for our product candidates, particularly our proprietary cannabinoid product candidates, including SYNDROS�, and sublingual spray product candidates. We do not expect to realize net revenues from all of these research and development initiatives in the near term and may never realize net revenues from these investments. Due to the risks inherent in conducting preclinical studies and clinical trials, the regulatory approval process and the costs of preparing, filing and prosecuting patent applications, our development completion dates and costs will vary significantly for each product candidate and are very difficult to estimate. The lengthy process of seeking regulatory approvals and the subsequent compliance with applicable regulations require the expenditure of substantial additional resources. Any failure by us to obtain, or any delay in obtaining, regulatory approvals or acceptable DEA classifications for our product candidates, in particular those related to SYNDROS�, could cause our research and development expenditures to increase significantly and, in turn, have a material adverse effect on our results of operations.

Basis of PresentationRevision of Previously issued Financial Statements for Correction of Immaterial Errors

During September 2016, we identified an error related to the accounting for the rebates component of our product sales allowances since 2014. We determined that we had miscalculated our rebate obligations on government payer and managed care contracts. In addition, we recorded out-of-period adjustments that resulted in an increase in operating expenses of $1,500,000 related to stock option modifications during the three months ended March 31, 2016 and a decrease in income tax expense of $834,000 related to the deductible interest expense portion of accrued litigation award and settlements recorded during 2016. We concluded that the errors were not material to previously issued annual financial statements. However, to correctly present net revenue, operating expenses and income tax expense in the appropriate annual period, management has revised the 2015 and 2014 financial statements. Refer to Note 2 of the Consolidated Financial Statements for a summary of the amounts and financial statement line items impacted by the revision. All amounts set forth in the discussion and analysis of the results of operations and financial condition for the years ended December 31, 2015 and 2014 have been adjusted to reflect these revisions.

Net Revenue

We sell SUBSYS� in packages of various sized single-dose units in dosage strengths of 100, 200, 400, 600, 800, 1,200 and 1,600 mcg, to wholesale pharmaceutical distributors and specialty retail pharmacies, collectively, our customers, on a wholesale basis. Sales to our customers are subject to specified rights of return. We record revenue for SUBSYS� at the time the customer receives the shipment.

Cost of Revenue, Gross Profit and Gross Margin

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

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

Sales and Marketing Expenses

Our sales and marketing expenses consist primarily of salaries, commissions, benefits, consulting fees, costs of obtaining prescription and market data, and market research studies related to SUBSYS�. As of December 31, 2016, we had 274 full-time sales and marketing personnel. We expect our sales and marketing expenses, along with our research and development expenses, to be our largest categories of operating expenses for the foreseeable future. In addition, because we use an incentive-based compensation model for our sales professionals, we expect our sales and marketing expenses to fluctuate from period to period based on changes in SUBSYS� net revenue. We will also incur expenses directly related to the launch of SYNDROS�, if finalization of labeling by the FDA is obtained.

Research and Development Expenses

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

� external research and development expenses incurred under agreements with third-party CROs and investigative sites, third-party manufacturers and consultants;

� employee-related expenses, which include salaries, benefits and stock-based compensation for the personnel involved in our preclinical and clinical drug development activities; and

� facilities, depreciation and other allocated expenses, equipment and laboratory supplies.

To date, our research and development efforts have been focused primarily on our fentanyl, dronabinol and cannabidiol programs. As of December 31, 2016, we had 59 full-time research and development personnel. We expect research and development expenses to increase as we continue our planned preclinical studies and clinical trials for our product candidates. We determine which research and development projects to pursue, as well as the level of funding available for each project, based on the scientific and preclinical and clinical results of each product candidate and related regulatory action.The following table provides a breakdown of our research and development expenses (in millions):

                                                     Years Ended December 31,
                                               2016               2015           2014
                                                              (As Revised)
   Cannabidiol                               $    15.3       $         16.3     $  5.8
   Buprenorphine                                   9.4                  3.4        3.4
   Fentanyl                                        4.5                  2.8        2.8
   LEP-ETU and IL-13                               2.3                  2.5        1.1
   Naloxone                                        3.0                  2.2        0.2
   Dronabinol                                      3.9                  6.3        1.6
   Ondansetron                                     1.2                  1.4        0.7
   Buprenorphine/Naloxone                          1.0                  4.6        0.8
   Sildenafil                                      0.6                  0.2        0.8
   Internal research and development costs        29.5                 15.9       15.9
   Other                                           3.2                  1.2          -
   Total research and development expenses   $    73.9       $         56.8     $ 33.1

Our general and administrative expenses consist primarily of salaries and related costs for personnel in executive, finance, accounting, business development and internal support functions. In addition, general and administrative expenses include facility costs not otherwise included in research and development expenses, and professional fees for legal, consulting and accounting services. As of December 31, 2016, we had 46 full-time general and administrative personnel. We expect general and administrative expense to modestly increase as a result of expanding our operating activities and the costs we incur operating as a public company. We expect these increases to include salaries and related expenses, legal and consultant fees, regulatory fees as new products are commercialized, accounting fees, director fees, increased directors’ and officers’ insurance premiums, fees for investor relations services, and enhanced business and accounting systems.

Charges Related to Litigation Award and Settlements

Charges related to litigation award and settlements for the year ended December 31, 2016 represent legal expense accruals of $3.4 million related to a settlement reached with the State of New Hampshire and $0.5 million in connection with the investigation by the State of Massachusetts. Charges related . . .