MNKD 2017 Annual Report

Sales of Afrezza through Specialty Pharmacies - During the first quarter of 2017, the Company began selling Afrezza to a network of specialty pharmacies. Specialty pharmacies generally purchase product on demand. Title and risk of loss passes to the specialty pharmacies at shipment and our estimated returns are minimal. Therefore, the Company recognizes revenue for sales through specialty pharmacies at the time the product is shipped to the specialty pharmacies, net of Gross-to-net Adjustments as described below. For the year ended December 31, 2017, the net amount of revenue recognized from sales to specialty pharmacies was $0.5 million. For the years ended December 31, 2017 and 2016, Afrezza net revenue from commercial product sales consisted of $9.2 million and $1.9 million of net sales, respectively. As of December 31, 2017 and 2016, the ending balances for net deferred revenue, were $3.0 million and $3.4 million, on the Company’s consolidated balance sheets which are presented net of $1.5 million and $0.8 million in deferred gross-to-net adjustments, respectively. The December 31, 2016 deferred revenue balance includes $1.7 million of bulk insulin sales which is described more fully under the heading Revenue Recognition – Revenue – Other below. For the year ended December 31, 2017, shipments to three wholesale distributors represented 89% of total shipments. For the year ended December 31, 2016, the Company sold directly to ICS and Sanofi and for the year ended December 31, 2015 the Company sold directly to Sanofi. Gross-to-net Adjustments — Estimated gross-to-net adjustments for Afrezza include wholesaler distribution fees, prompt pay discounts, estimated rebates and chargebacks and patient discount and co-pay assistance programs, and are based on estimated amounts owed or to be claimed on the related sales. These estimates take into consideration the terms of the Company’s agreements with its customers and the levels of inventory within the distribution and retail channels that may result in future rebates or discounts taken. In certain cases, such as patient support programs, the Company recognizes the cost of patient discounts as a reduction of gross revenue based on estimated utilization. If actual future results vary, the Company may need to adjust these estimates, which could have an effect on product revenue in the period of adjustment. The Company records product sales deductions in the consolidated statements of operations at the time product revenue is recognized. At December 31, 2017 and 2016, year to date total gross-to-net adjustments were approximately $3.4 million and $0.8 million, which represents 27% and 30% of gross revenue from product sales, respectively. Gross-to-net items that are unpaid at the end of each period are presented in discounts and allowances for commercial product sales in accrued expense and other current liabilities. Wholesaler Distribution Fees — The Company pays distribution fees to certain wholesale distributors based on contractually determined rates. The Company accrues the distribution fees on shipment to the respective wholesale distributors and recognizes the distribution fees as a reduction of revenue in the same period the related revenue is recognized. Prompt Pay Discounts — The Company offers cash discounts to its customers, generally 2% of the sales price, as an incentive for prompt payment. The Company accounts for cash discounts by reducing accounts receivable and deferred revenue by the prompt pay discount amount (at the time of shipment to the wholesale distributor). The Company recognizes the cash discounts as a reduction of revenue in the same period the related revenue is recognized. Rebates and Chargebacks — Most of our rebates are contractual or legislatively mandated. Sales rebates include managed care, Medicare, Medicaid, and various other programs. The Company participates in federal and state government-managed Medicare and Medicaid rebate programs and, as such, is required to provide rebates under these programs. Chargebacks are discounts that occur when customers purchase directly from an intermediary wholesale purchaser. The Company accounts for these rebates and chargebacks by establishing an accrual based on contractual discount rates, expected utilization under each contract and an estimate of the amount of inventory in the distribution channel that will become subject to such rebates and chargebacks based on historical payor data provided by a third-party vendor along with additional data including forecasted participation rate. From that data, as well as input received from the commercial team, an estimated 88