Valeritas Holdings Inc. - FORM 10-Q

Valeritas Holdings Inc. - FORM 10-Q - November 10, 2016

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EX-32.2 - EX-32.2 - Valeritas Holdings Inc.	d258676dex322.htm
EX-32.1 - EX-32.1 - Valeritas Holdings Inc.	d258676dex321.htm
EX-31.2 - EX-31.2 - Valeritas Holdings Inc.	d258676dex312.htm
EX-31.1 - EX-31.1 - Valeritas Holdings Inc.	d258676dex311.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2016

☐	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 333-198807

Valeritas Holdings, Inc.

(Exact name of Registrant as specified in its charter)


Delaware		46-5648907
(State or other jurisdiction of incorporation or organization)		(I. R. S. Employer Identification No.)

750 Route 202 South, Suite 600 Bridgewater, NJ		08807
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (908) 927-9920

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, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 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 ☒

The number of shares outstanding of the registrant’s common stock as of November 9, 2016 was 12,727,741.

VALERITAS HOLDINGS, INC.


Part I – Financial Information

Item 1.	Unaudited Condensed Consolidated Financial Statements
	Condensed Consolidated Statements of Operations	3
	Condensed Consolidated Balance Sheets	4
	Condensed Consolidated Statement of Stockholders’ Deficit	5
	Condensed Consolidated Statements of Cash Flows	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	30
Item 4.	Controls and Procedures	31

Part II – Other Information

Item 1.	Legal Proceedings	32
Item 1A.	Risk Factors	32
Item 6.	Exhibits	33

Signatures		34

Forward Looking Statements

This Quarterly Report on Form 10-Q contains “forward looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. See “Forward-Looking Statements” in Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations for additional information.

Part I – Financial Information

Item 1.

Financial Statements

Valeritas Holdings, Inc.

Condensed Consolidated Statements of Operations

(Unaudited)

(Dollars in thousands, except share and per share amounts)


	Quarter Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Revenue, net	$	4,860		$	4,739		$	14,754		$	13,494
Cost of goods sold		3,132			4,119			9,589			11,143

Gross margin		1,728			620			5,165			2,351

Operating expense:
Research and development		1,188			1,519			3,635			5,140
Selling, general and administrative		7,997			9,908			24,547			36,458
Restructuring (note 7)		198			—			2,361			—

Total operating expense		9,383			11,427			30,543			41,598

Operating loss		(7,655	)		(10,807	)		(25,378	)		(39,247	)

Other income (expense), net:
Other income		121			—			121			—
Interest expense		(1,596	)		(3,688	)		(10,602	)		(12,380	)
Costs associated with aborted 2015 IPO (note 10)		—			—			—			(3,978	)
Change in fair value of derivatives		(27	)		—			(662	)		443

Total other income (expense), net		(1,502	)		(3,688	)		(11,143	)		(15,915	)

Loss before income taxes		(9,157	)		(14,495	)		(36,521	)		(55,162	)

Income tax expense		—			—			—

Net loss	$	(9,157	)	$	(14,495	)	$	(36,521	)	$	(55,162	)

Net loss per share of common shares outstanding – basic and diluted (note 16)	$	(0.72	)	$	—		$	(4.35	)	$	—

Weighted average common shares outstanding – basic and diluted (note 16)		12,679,521			—			8,385,262			—

See accompanying notes to unaudited condensed consolidated financial statements.

Valeritas Holdings, Inc.

Condensed Consolidated Balance Sheets

(Unaudited)

(Dollars in thousands, except share and per share amounts)


	September 30, 2016			December 31, 2015
Assets
Current assets:
Cash and cash equivalents	$	15,529		$	2,789
Accounts receivable, net		3,329			3,142
Other receivables		126			493
Inventories, net (note 4)		10,119			10,784
Deferred cost of goods sold		867			863
Prepaid expense and other current assets		824			735

Total current assets		30,794			18,806
Property and equipment, net (note 5)		11,048			12,091
Other assets		153			279

Total assets	$	41,995		$	31,176

Liabilities and stockholders’ deficit
Current liabilities:
Current portion of long-term debt, related parties (note 8)	$	—		$	69,107
Current portion of capital lease obligation		—			26
Accounts payable		2,884			7,419
Accrued expense and other current liabilities (note 6)		6,382			5,931
Deferred revenue		1,968			1,895
Derivative liabilities (note 9)		335			—

Total current liabilities		11,569			84,378
Long-term debt, related parties (note 8)		57,418			—
Deferred rent liability		89			143

Total liabilities		69,076			84,521
Commitments and Contingencies (Note 12)
Stockholders’ deficit (note 1 and note 15)
Common stock, $0.001 par value, 300,000,000 shares authorized; 12,727,741 and 1,631,738 shares issued and outstanding at September 30, 2016 and December 31, 2015, respectively		13			2
Additional paid-in capital		387,299			324,525
Accumulated deficit		(414,393	)		(377,872	)

Total stockholders’ deficit		(27,081	)		(53,345	)

Total liabilities and stockholders’ deficit	$	41,995		$	31,176

See accompanying notes to unaudited condensed consolidated financial statements.

Valeritas Holdings, Inc.

Consolidated Statements of Stockholders’ Deficit

(Unaudited)

(Dollars in thousands, except share data)


	Common Stock				Additional						Total
	Shares		Amount		Paid-in Capital			Accumulated Deficit			Stockholders’ Deficit
Balance—December 31, 2015		1,631,738	$	2	$	324,525		$	(377,872	)	$	(53,345	)
Share-based compensation expense		—		—		3,072			—			3,072
Issuance of common stock as a result of the exercise of warrants by related party (note 15)		1,407,476		1		8,932			—			8,933
Issuance of common stock, net of expense to related party (note 15)		1,110,613		1		5,818			—			5,819
Conversion of accrued interest to Common Stock by related parties (note 15)		2,450,160		3		17,931			—			17,934
Issuance of common stock in private placement offering, net of expense (note 15)		5,079,000		5		23,693			—			23,698
Recapitalization for reverse merger (note 15)		1,000,004		1		(1	)		—			—
Shares issued for restricted stock compensation (note 13)		48,750		—		293			—			293
Cancellation of warrants previously classified as derivative liabilities (note 9)		—		—		3,036			—			3,036
Net loss		—		—		—			(36,521	)		(36,521	)

Balance—September 30, 2016		12,727,741	$	13	$	387,299		$	(414,393	)	$	(27,081	)

See accompanying notes to unaudited condensed consolidated financial statements.

Valeritas Holdings, Inc.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(Dollars in thousands)


	Nine Months Ended September 30,
	2016			2015
Operating activities
Net loss	$	(36,521	)	$	(55,162	)
Adjustments to reconcile net loss to net cash used in operating activities:
Depreciation and amortization of property and equipment		1,212			1,251
Amortization of financing costs		4,396			3,299
Noncash interest expense		6,206			9,083
Share-based compensation expense		3,365			4,596
Costs associated with aborted 2015 IPO		—			3,978
Change in fair value of derivative liabilities		662			(443	)
Gain on sale of property and equipment		(121	)		—
Changes in:
Accounts receivable		(187	)		(810	)
Other receivables		367			(156	)
Inventories		665			(903	)
Deferred cost of goods sold		(4	)		(65	)
Prepaid expense and other current assets		(89	)		552
Other assets		126			9
Accounts payable		(4,535	)		3,555
Accrued expense		451			283
Deferred revenue		73			206
Deferred rent liability		(53	)		(39	)

Net cash used in operating activities		(23,987	)		(30,766	)

Investing activities

Proceeds from sale of property and equipment		121			—
Acquisition of property and equipment		(171	)		(921	)

Net cash used in investing activities		(50	)		(921	)

Financing activities
Repayment of capital lease		(26	)		(115	)
Investor capital contributions (note 1)		—			17,982
Proceeds from issuance of private company Series AB Preferred Stock ($5,819 and $1,706 received from related party, respectively)		5,819			3,016
Proceeds from issuance of common stock ($20,000 received from a related party)(note 1)		25,395			—
Costs associated with investor capital contributions		—			(173	)
Debt restructuring costs		(355	)		—
Offering costs		(1,431	)		(2,418	)
Proceeds from exercise of warrants by a related party		7,375			—

Net cash provided by financing activities		36,777			18,292

Net (decrease)/ increase in cash and cash equivalents		12,740			(13,395	)
Cash and cash equivalents—beginning of period		2,789			20,944

Cash and cash equivalents—end of period	$	15,529		$	7,549

Supplemental disclosures of cash flow information
Interest paid	$	—		$	—
Reclassification of derivative liability upon exercise of warrants	$	1,557		$	—
Cancellation of derivative liability	$	3,036		$	—
Issuance of derivative liabilities for PPO warrants	$	226		$	—
Conversion of interest and fees and write off of remaining debt discounts	$	17,934		$	—
Issuance of Series AB Preferred Stock warrants	$	4,000		$	—

See accompanying notes to unaudited condensed financial statements.

Valeritas Holdings, Inc.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

1. Nature of Operations and Organization

Valeritas Holdings, Inc. (formerly Cleaner Yoga Mat, Inc.) was incorporated in Florida on May 9, 2014 and was previously engaged in the sale of sanitizing solutions for Yoga and Pilates studios as well of conventional gyms of all sizes. Valeritas Holdings, Inc. was then reincorporated in Delaware on May 3, 2016.

As used in these Notes, the terms “Valeritas” and the “private company” refer to the business of Valeritas, Inc. prior to the 2016 Merger, the term “Valeritas Holdings, Inc.” or the “Company” refers to the combination of Valeritas and Valeritas Holdings, Inc. after giving retrospective effect to the recapitalization under the 2016 Merger.

Valeritas was incorporated in the state of Delaware on December 27, 2007 when it was converted into a Delaware Corporation from a Delaware limited liability company, which was formed on August 2, 2006 and changed its name from Valeritas LLC. The Company is a commercial-stage medical technology company focused on developing innovative technologies to improve the health and quality of life of people with Type 2 diabetes. The Company designed its first commercialized product, the V-Go Disposable Insulin Delivery device, or V-Go, to help patients with Type 2 diabetes who require insulin to achieve and maintain their target blood glucose goals. V-Go is a small, discreet, easy-to-use wearable and completely disposable insulin delivery device that a patient adheres to his or her skin every 24 hours. V-Go enables patients to closely mimic the body’s normal physiologic pattern of insulin delivery throughout the day and to manage their diabetes with insulin without the need to plan a daily routine around multiple daily injections.

2016 Reverse Merger and Recapitalization

On May 3, 2016, pursuant to an Agreement and Plan of Merger and Reorganization (the “Merger Agreement”), by and among Valeritas Holdings, Inc., Valeritas Acquisition Corp., a Delaware corporation and a direct wholly owned subsidiary of Valeritas Holdings, Inc. (the “Acquisition Subsidiary”) and Valeritas, Inc., Acquisition Subsidiary was merged with and into Valeritas, with Valeritas being the surviving entity and as a wholly owned subsidiary of Valeritas Holdings, Inc. (the “2016 Merger”). Immediately prior to the 2016 Merger, all shares of common stock, Series D Preferred Stock, Series AA Preferred Stock, and shares underlying common stock options and shares underlying the warrants were canceled without consideration. Concurrent with the 2016 merger, the shares of Valeritas private company Series AB Preferred Stock were canceled and each share of private company Series AB Preferred Stock of Valeritas was replaced with 0.23856 shares of common stock of Valeritas Holdings, Inc.

Upon the closing of the Merger, under the terms of a split-off agreement and a general release agreement, Valeritas Holdings, Inc. transferred all of its pre-Merger operating assets and liabilities to its wholly owned special purpose subsidiary (“Split-Off Subsidiary”), and transferred all of the outstanding shares of capital stock of Split-Off Subsidiary to the pre-Merger majority stockholder of Valeritas Holdings, Inc. (the “Split-Off”), in consideration of and in exchange for (i) the surrender and cancellation of 40,486,000 shares of Valeritas Holdings, Inc. common stock held by such stockholder (which will be cancelled and will resume the status of authorized but unissued shares of Valeritas Holdings, Inc. common stock) and (ii) certain representations, covenants and indemnities.

The Merger is being accounted for as a “reverse merger,” and Valeritas is deemed to be the accounting acquirer in the reverse merger. The historical financial statements of the Valeritas Holding, Inc. prior to the 2016 Merger have been replaced with the historical financial statements of Valeritas.

Amounts for Valeritas historical (pre-merger) common stock, preferred stock, warrants, and stock options including share and per share amounts have been retroactively adjusted using their respective exchange ratio in these financial statements, unless otherwise disclosed. Any amounts funded in connection with the original issuance of the common stock, Series D Preferred Stock and Series AA Preferred Stock have been retrospectively adjusted and accounted for as capital contributions as those classes of Valeritas stock did not receive common shares of Valeritas Holdings, Inc. in connection with the 2016 Merger. All shares of Valeritas private company Series AB Preferred Stock have been retrospectively adjusted to common stock of Valeritas Holdings, Inc. based upon the exchange ratio noted above.

2. Liquidity, Uncertainties and Going Concern

The Company is subject to a number of risks similar to those of early stage commercial companies, including dependence on key individuals, the difficulties inherent in the development of a commercial market, the potential need to obtain additional capital necessary to fund the development of its products, and competition from larger companies. The Company expects that its sales performance and the resulting operating income or loss, as well as the status of each of its new product development programs, will significantly impact its cash requirements.

The Company has incurred losses each year since inception and has experienced negative cash flows from operations in each year since inception. As of September 30, 2016, the Company had $15.5 million in cash and cash equivalents and an accumulated deficit of $414.4 million. The Company’s restructured Term Loan includes a liquidity covenant whereby the Company must maintain a cash balance greater than $5.0 million. The Company’s cash balance will not be sufficient to satisfy the Company’s operations for the next 12 months from September 30, 2016 or maintain its liquidity covenant, which raises substantial doubt about the Company’s ability to continue as a going concern. The Company estimates that the cash balance will be sufficient to satisfy the Company’s operations into mid-first quarter of 2017.

The Company expects that its actual sales performance and the resulting operating income or loss, as well as the status of each of its new product development programs, will significantly impact their cash management. The Company intends to maintain compliance with the liquidity covenant and fund future operations by raising additional capital. There can be no assurances that financing will be available on terms acceptable to the Company, or at all. If the Company is unable to raise capital prior to achieving sustained profitability from operations, there could be a material adverse effect on our business, results of operations and financial condition.

3. Basis of Presentation and Significant Accounting Policies

Basis of Presentation

The accompanying unaudited consolidated financial statements were prepared using generally accepted accounting principles for interim financial information and the instructions to Form 10-Q and Article 8 of Regulation S-X. Accordingly, these unaudited condensed consolidated financial statements do not include all information or notes required by generally accepted accounting principles for annual financial statements and should be read in conjunction in Valeritas Holdings, Inc.’s 2015 annual consolidated financial statements included within the Form 8-K/A filed by the Company on May 16, 2016.

The preparation of the unaudited condensed consolidated financial statements in conformity with these accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements; and the reported amounts of expenses during the reported period. Ultimate results could differ from the estimates of management.

In the opinion of management, the unaudited condensed consolidated financial statements included herein contain all adjustments necessary to present fairly the Company’s financial position and the results of its operations and cash flows for the interim periods presented. Such adjustments are of a normal recurring nature. The results of operations for the three and nine months ended September 30, 2016 may not be indicative of results for the full year.

Significant Accounting Policies

There have been no material changes to the significant accounting policies previously disclosed in Valeritas Holdings, Inc.’s 2015 annual consolidated financial statements included within the Form 8-K/A filed by the Company on May 16, 2016.

Recent Accounting Pronouncements

In April, 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers: Identifying performance obligations and licensing, effective January 1, 2018, to reduce the cost and complexity of applying the guidance on identifying promised goods or services around identifying performance obligations and implementation guidance on determining whether an entity’s promise to grant a license provides a customer with either a right to use the entity’s intellectual property (which is satisfied at a point in time) or a right to access the entity’s intellectual property (which is satisfied over time). The Company has not yet selected a transition method nor have they determined the effect of the standard on its ongoing financial reporting, if any.

In February 2016, the FASB issued ASU No. 2016-02, Leases. ASU 2016-2 sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e. lessees and lessors). The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether or not the lease effectively finances a purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method (finance lease) or on a straight line basis over the term of the lease (operating lease). A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than 12 months regardless of their classification. Leases with a term of 12 months or less will be accounted for similar to existing guidance for operating leases today. ASU 2016-2 supersedes the existing guidance on accounting for leases in “Leases (Topic 840).” The provisions of ASU 2016-2 are effective for fiscal years, and interim reporting periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted and the provisions are to be applied using a modified retrospective approach. We are in the process of evaluating the impact of adoption on our consolidated financial statements.

In March, 2016, the FASB issued ASU No 2016-09, Improvements to Employee Share-Based Payment Accounting. This ASU contains amendments intended to simplify various aspects of share-based payment accounting and presentation in the financial statements, including the income tax consequences, classification of awards as either equity or liabilities, treatment of forfeitures and statutory tax withholding requirements, and classification in the statement of cash flows. The new standard is effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. Early adoption of this standard is permitted. The amendments requiring recognition in the income statement of excess tax benefits and tax deficiencies resulting from settlements arising after the date of adoption of the new standard should be applied prospectively. Changes relating to classification of excess tax benefits and tax deficiencies in the statement of cash flows may be applied either prospectively or retrospectively. All other amendments are to be applied retrospectively. We have not elected early adoption of this standard. We are currently evaluating the impact this new standard will have on our financial statements.

4. Inventory

Inventory, net at September 30, 2016 and December 31, 2015 consists of:


*(Dollars in thousands)*	September 30, 2016		December 31, 2015
Raw materials	$	1,156	$	1,587
Work in process		711		2,659
Finished goods		8,252		6,538

Total	$	10,119	$	10,784

Cost is determined on a first in, first out, or FIFO, basis and includes material costs, labor and applicable overhead. The Company reviews its inventory for excess or obsolescence and writes down inventory that has no alternative uses to its net realizable value. The inventory reserves at September 30, 2016 and December 31, 2015 were $1.7 million and $2.3 million, respectively.

5. Property and Equipment

Property and equipment consisted of the following at September 30, 2016 and December 31, 2015:


*(Dollars in thousands)*	Useful lives		September 30, 2016			December 31, 2015
Machinery and equipment		5-10	$	10,583		$	10,594
Computers and software		3		1,338			1,312
Leasehold improvements		6-10		212			212
Office equipment		5		89			89
Furniture and fixtures		5		206			206
Construction in process				4,794			4,931

Total				17,222			17,344
Accumulated depreciation				(6,174	)		(5,253	)

Property and equipment, net			$	11,048		$	12,091

Depreciation and amortization expense for the three months and nine months ended September 30, 2016 were $0.4 million and $1.2 million, respectively. Depreciation and amortization expense for the three months and nine months ended September 30, 2015 were $0.5 million and $1.3 million, respectively.

6. Accrued Expenses and Other Current Liabilities

Accrued expenses and other current liabilities consist of the following:


(Dollars in thousands)	September 30, 2016		December 31, 2015
Compensation	$	2,183	$	2,932
Restructuring costs (note 7)		1,044		—
Marketing services		841		863
Distribution agreements and managed care costs		1,143		867
Professional fees		672		623
Franchise taxes		52		263
Travel expenses		153		144
Manufacturing overhead		132		46
Other accruals		162		193

Total accrued expenses and other current liabilities	$	6,382	$	5,931

7. Restructuring

In February 2016, as part of a restructuring plan, the Company underwent a labor force reduction. The total restructuring costs are expected to be $2.7 million and consists of $1.2 million severance expense and $1.5 million of retention bonuses. The retention bonuses were scheduled to be paid in two installments over the 12 months following the commencement of the restructuring plan. Employees entitled to the retention must remain employed with the Company in good standing for at least 6 months after each installment payment. Otherwise, employees are obligated to repay the entire bonus received for that installment.

The Company accrues the retention bonus monthly on a straight line basis through the retention period. See below for all activity during the nine months ended September 30, 2016:


*(Dollars in thousands)*	Severance Accrual			Retention Bonus Accrual			Total
December 31, 2015 Balance		—			—			—
Restructuring in February, 2016	$	1,217		$	—			1,217

Accruals for retention bonus		—			1,126			1,126

Payments		(766	)		(533	)		(1,299	)

September 30, 2016 Balance	$	451		$	593		$	1,044

8. Debt

At September 30, 2016 and December 31, 2015, the Company had the following debt outstanding:


*(Dollars in thousands)*	September 30, 2016			December 31, 2015
Senior Secured Debt, net	$	50,000		$	50,000
Prepayment fee		—			2,438
Issuance costs		(220	)		(301	)
Payment-in-kind (PIK) interest		2,379			10,956

Total Senior Secured Debt, net		52,159			63,093

Other Note Payable, net		5,000			4,210
Payment-in-kind (PIK) interest		259			1,804

Total Other Note Payable, net		5,259			6,014

Total debt	$	57,418		$	69,107

Total debt, long-term	$	57,418		$	—
Total debt, short-term	$	—		$	69,107

Presentation

On May 23, 2013, the Company entered into the Term Loan of $50 million with Capital Royalty Group (“CRG”), structured as a senior secured loan with a six-year term (the “Term Loan” or the “Senior Secured Debt”). In 2015, the Company did not meet the minimum revenue covenant of $50 million contained in the Term Loan agreement. Also, the Company did not meet the capital financing targets and was not able to maintain adequate operating cash and working capital all of which triggered the occurrence of a Material Adverse Change as stipulated within the Term Loan agreement. The Company entered into a series of forbearance agreements as described below, which extended the repayment terms through May 3, 2016. Due to the covenant failures and an associated cross-default covenant in the $5.0 million senior subordinated note or the WCAS Note or the Other Note Payable to WCAS Capital Partners IV, L.P., or WCAS, that refers to defaults on other debt instruments held by the Company, both debt balances were being presented as short-term debt in the Company’s consolidated balance sheet at December 31, 2015.

Concurrently with the closing of the 2016 Merger on May 3, 2016, the Company restructured its Term Loan and WCAS Note, which extended the payment term of respective principal balance of $50 million and $5 million to March 31, 2021 and September 8, 2021, respectively. As such, the Company has classified the principal balances of debt as long-term at September 30, 2016.

During the quarter and nine month periods ended September 30, 2016, the Company incurred non-cash interest expense of $1.6 million and $10.6 million, respectively. During the quarter and nine month periods ended September 30, 2015, the Company incurred non-cash interest expense of $3.7 million and $12.4 million, respectively.

Senior Secured Debt

The Term Loan is secured by substantially all of the Company’s assets, including its material intellectual property. The Term Loan bore interest at 11% per annum and compounds annually. Until the third anniversary of the Term Loan, the Company had the option to pay quarterly interest of 7.5% in cash and 3.5% paid-in-kind, or PIK, interest which is added to the aggregate principal amount of the Term Loan on the last day of each quarter. Thereafter, interest on the Term Loan was payable only in cash. The Term Loan contained a minimum revenue covenant, which was $50.0 million for 2015.

The events of default, described previously, has led the Company to enter into a series of forbearance agreements with CRG. The initial forbearance agreement was entered on May 18, 2015 and has subsequently been amended five times. The forbearance agreements, as amended entered in 2015, contained a number of terms and conditions in exchange for CRG’s agreement to forbear. The forbearance agreement imposed an interest rate at the default interest rate of 15% per annum and a prepayment premium of 4% on the aggregate outstanding balance on the date of the repayment. As of December 31, 2015, the parties deferred the forbearance expiration date again to January 22, 2016. The forbearance agreements entered in 2015 and 2016 were accounted as troubled debt restructuring (“TDR”). There was no gain associated with the TDR, however the modified effective interest rate was applied prospectively.

On January 22, 2016, the Company and CRG amended the forbearance agreement to extend the forbearance period to March 31, 2016. As part of the terms within the forbearance agreement, dated January 29, 2016, the Company issued warrants to CRG exercisable into 16,000,000 shares of private company Series AB Preferred Stock of the Valeritas at $1.25 per share. The warrant had a term of one year. The warrant fair value at the date of issuance was determined to be $4.0 million, using Black Scholes option pricing model (see note 9 below). The warrant was accounted for as a debt discount and amortized through to May 3, 2016, when the Term Loan was restructured.

On March 25, 2016, the Company and CRG amended the forbearance agreement to extend the expiration of the forbearance period to April 30, 2016 and included a number of events that could trigger an earlier expiration of the forbearance agreement. This did not result in any restructuring gain or loss and the modified effective interest rate was applied prospectively.

Concurrently with the closing of the 2016 Merger on May 3, 2016, the Company restructured the Term Loan. CRG converted its outstanding accrued interest and prepayment premium of $16.5 million into 8,609,824 shares of private company Series AB preferred stock and 4,649,859 shares of private company common stock (see Other Note Payable for additional conversions during 2016). The private company Series AB shares were then converted into 2,053,959 of the Company’s common stock upon the 2016 Merger and all private company shares of common stock were canceled upon the 2016 Merger. The principal balance was restated as $50 million with interest rate charged at 11% per annum, which is PIK interest through June 30, 2018 and then both PIK and cash interest thereafter. The provisions of the restructured Term Loan require quarterly interest payments during the term of the loan, which are set to commence on June 30, 2018. The repayment of principal on amounts borrowed under the Term Loan is scheduled to be completed on March 31, 2021.

The restructured Term Loan agreement contains a financial covenant, which requires the Company to maintain a minimum cash balance of $5.0 million. As of September 30, 2016, the Company was in compliance with the financial covenant in the restructured Term Loan agreement, as we held cash and cash equivalents of $15.5 million.

Warrant

In 2014, the Company issued warrants to CRG to purchase 177,347 shares of Valeritas common stock exercisable at $0.013 per share. On February 27, 2015, Valeritas issued warrants to purchase 1,802 shares of Valeritas common stock with the same exercise price and terms to those issued in 2014. Valeritas recorded the loan net of original issuance discount calculated fair value of the issued warrants. On January 29, 2016, Valeritas issued CRG additional warrants to acquire 16,000,000 private company Series AB shares at exercise price of $1.25, which would have converted to 3,816,960 shares of common stock in the public company. The fair value of the warrant at the date of issuance is determined to be $4.0 million, which Valeritas recorded as additional debt discount and a derivative liability.

All of the Valeritas common stock and preferred stock warrants issued to CRG were cancelled or exercised during the nine months ended September 30, 2016. The forbearance agreements entered into during 2015 and 2016, triggered a TDR and accelerated the timing of repayment of the Term Loan to January 22, 2016 which was extended during 2016 through May 3, 2016. The Company accelerated the amortization of the debt discount associated with the private company common stock warrants through January 22, 2016 and accelerated the amortization of the debt discount associated with Valeritas Series AB preferred stock warrants through May 3, 2016. As such, all discounts associated with warrants issued in connection with the Term Loan were fully amortized at May 3, 2016.

Financing costs

The Company recorded the Term Loan net of deferred financing costs paid directly to the creditor (and therefore treated as a discount to the debt) of $500 relating to the lender finance fee of 1%. The discount related to the issuance costs is being amortized over the term of the loan using the effective interest method. The forbearance agreements entered into during 2015 accelerated the timing of repayment of the Term Loan to January 22, 2016. The Company accelerated the amortization of the debt discount to coincide with the forbearance period. The carrying amount of the debt discount relating to the original deferred financing costs was fully amortized at September 30, 2016.

In connection with the restructuring of the Term Loan on May 3, 2016, the Company incurred costs of $0.2 million which were recorded as a discount to the Term Loan balance and will be amortized through the term of the loan using the effective interest rate method. At September 30, 2016, $0.2 million of the restructured debt discount remained.

Lenders Put Option

Upon a change in control or certain asset sales, the Term Loan was to be prepaid in an amount equal to the outstanding principal balance plus accrued and unpaid interest, taking into account a prepayment premium that started at 5% of the balance and decreased to 0% over time. The Company determined that the prepayment feature qualified as an embedded derivative requiring bifurcation from the debt. On May 23, 2014, the derivative was initially valued at $0.6 million and recorded as a long term liability within “derivative liabilities” in the Company’s consolidated balance sheet with a corresponding discount on the Term Loan. Upon default of the Term Loan, the Lenders called for immediate repayment of the Term Loan including a 4% prepayment penalty. As such, the derivative liability associated with the Term Loan prepayment provision was considered to be extinguished and the prepayment penalty in the amount of $2.4 million was accrued at December 31, 2015. The full prepayment penalty accrued at December 31, 2015 as well as the additional prepayment fee accrued during 2016 prior to the restructuring was included in the interest and fees that were converted into private company common shares and Series AB preferred stock upon the restructuring. As such, the full prepayment fee was extinguished on May 3, 2016.

The original issue discount for the prepayment feature was being amortized over the term of the loan using the effective interest method. The forbearance agreements entered into during 2015 and 2016, triggered a TDR and accelerated the timing of repayment of the Term Loan to January 22, 2016 and the remaining original issue discount was fully amortized in the first quarter of 2016.

Other Note Payable

In 2011, the Company issued a $5.0 million senior subordinated note, or the WCAS Note or the Other Note Payable, to WCAS Capital Partners IV, L.P., or WCAS. Amounts due under the WCAS Note originally bore interest at 10% per annum, payable semi-annually. On May 23, 2013, the WCAS Note was amended such that the note then bore interest at 12% per annum, and all interest accrues as compounded PIK interest and is added to the aggregate principal amount of the loan semi-annually. The then outstanding principal amount of the note, including accrued PIK interest, is due in full in September 2021. The Company may pay off the WCAS Note at any time without penalty.

Concurrently with the closing of the 2016 Merger on May 3, 2016, the Company restructured its WCAS Note. WCAS converted its outstanding accrued interest and fees of $2.1 million to 1,660,530 shares of private company Series AB preferred stock, which were then converted into 396,201 shares of common stock of the Company upon the merger. At the time of the debt restructuring, $0.7 million of remaining in debt issuance costs was extinguished and recorded against equity as the lender is also a shareholder of the Company, resulting in a net charge of $1.4 million to equity for the senior subordinated note (see Senior Secured Debt for additional conversions during 2016).

The principal balance was restated at $5.0 million with 10% per annum payable entirely as paid-in-kind interest and debt maturity date set at September 8, 2021. No interest payments are required during the term of the loan. The principal balance and any interest accrued during the term of the loan are due on the maturity date.

9. Derivative Liability

Private Company Series AB Preferred Stock Warrants

On January 29, 2016, Valeritas, Inc. issued CRG warrants to acquire 16,000,000 Series AB Preferred Stock of the private company at an exercise price of $1.25 with term of one year from the date of issuance. The warrants were accounted as derivative liability at fair value as the warrant for Series AB embodies a conditional obligation for the Company to repurchase its shares at a deemed liquidation event.

The fair value of the warrant at the date of issuance is $4.0 million based on the Black-Scholes option pricing model. Key assumptions used to apply this model upon issuance were as follows:


	January 29, 2016			Weighted Average Upon Exercise and Cancellation
Dividend yield		—			—
Expected volatility		80.0	%		80.0	%
Risk-free rate of return		0.47	%		0.61	%
Expected term (years)		1.0			0.80
Fair Value per share	$	0.25		$	0.30

Through April of 2016, CRG exercised warrants to acquire 5,900,000 shares of Series AB Preferred Stock of the private company (1,407,476 common shares of Valeritas, Holdings, Inc. post recapitalization) for gross proceeds of $7.4 million. The fair value of exercised warrants of $1.6 million was reclassified from derivative liability to additional paid in capital. On May 3, 2016, the Company cancelled any outstanding warrants to acquire private company Series AB Preferred Stock. The remaining derivative liability balance of $3.0 million was reclassified from derivative liability to additional paid in capital upon cancellation of the unexercised warrants.

The activities of the private company Series AB warrants are as follows:


	Number of shares			Weighted average exercise price		Weighted average remaining life
Outstanding and exercisable—December 31, 2015		—			—		—
Warrants issued in conjunction with private company Series AB financing		16,000,000		$	1.25
Warrants cancelled		(10,100,000	)	$	1.25		—
Warrants exercised		(5,900,000	)	$	1.25		—

Outstanding and exercisable—September 30, 2016		—			—		—

Placement Agent Warrants

The Company also issued 83,120 warrants to acquire common stock to the placement agents in the private placement offering that was conducted as part of the 2016 Merger (“PPO”). The warrants are accounted as a derivative liability at fair value as the warrant exercise price is subject to adjustment upon additional issuances of equity securities at a price per share lower than the exercise price of the warrants.

The fair value of the warrant at the date of issuance and at September 30, 2016 was estimated to be $0.3 million, based on the Black-Scholes option pricing model. Key assumptions used to apply this model were as follows:


	May 3, 2016			September 30, 2016
Dividend yield		—			—
Expected volatility		84.9	%		83.6	%
Risk-free rate of return		1.22	%		1.21	%
Expected term (years)		5.0			4.6
Fair Value per share	$	3.20		$	4.03

The activities of the common stock warrants are as follows:


	Number of shares		Weighted average exercise price		Weighted average remaining life
Outstanding and exercisable—December 31, 2015		—		—		—
Warrants issued in conjunction with public share offering		83,120	$	5.00		5.0 years
Warrants exercised		—		—

Outstanding and exercisable—September 30, 2016		83,120	$	5.00		4.6 years

10. Offering and acquisition related costs

The Company had capitalized deferred offering costs, which primarily consisted of direct incremental legal and accounting fees relating to the Initial Public Offering (IPO). In 2015, the offering was terminated. The previously capitalized deferred offering costs and additional costs incurred through to the termination of the IPO, aggregated to $4.0 million were expensed in the first quarter of 2015.

11. Fair Value Measurements

The Company determines the fair values of its financial instruments based upon the fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Below are the three levels of inputs that may be used to measure fair value:

•

Level 1—Quoted prices in active markets for identical assets or liabilities that the Company has the ability to access at the measurement date.

•

Level 2—Observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

•

Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The Company uses the market approach technique to value its financial instruments and there were no changes in valuation techniques during 2016 or 2015. The Company’s financial instruments consist primarily of cash and cash equivalents, short-term investments, accounts receivable, accounts payable and accrued liabilities, debt instruments and derivative liabilities. For accounts receivable, accounts payable and accrued liabilities, the carrying amounts of these financial instruments as of September 30, 2016 and December 31, 2015 were considered representative of their fair values due to their short term to maturity. Cash equivalents are carried at cost which approximates their fair value. The fair value of the Term Loan and WCAS note approximate their carrying value as of September 30, 2016 and December 31, 2015.

The following tables set forth the Company’s financial assets and liabilities that were measured at fair value on a recurring basis as of September 30, 2016. No financial assets or liabilities were measured at fair value on a recurring basis at December 31, 2015.


	Fair Value as of September 30, 2016
*(Dollars in thousands)*	Total		Level 1		Level 2		Level 3
Derivative Liability - Warrant	$	335	$	—	$	—	$	335

Total	$	335	$	—	$	—	$	335

The Company’s derivative liabilities are classified within Level 3 because they are valued with an option pricing model, where certain inputs to the model are unobservable and reflect the Company’s assumptions as to what market participants would use.

The warrants were valued using the Black Scholes option pricing model (refer to note 9). The life of the warrant is equal to the weighted average remaining contractual life of the warrants. The volatility utilized is based upon the volatilities observed from publicly traded companies that are comparable to the Company. To date, the Company has not declared or paid dividends to any of its shareholders so the assumed dividend rate is zero. The short term risk-free rate utilized is the yield on US Treasury STRIPS corresponding to the life of the warrant.

The following table presents the Company’s liabilities measured at fair value using significant unobservable inputs (Level 3), as of September 30, 2016:


*(Dollars in Thousands)*
Balance, December 31, 2015	$	—
Issuance of private company Series AB preferred warrant		4,000
Increase for fair value adjustment of warrant liability		662
Decrease for fair value adjustment of exercised warrant		(1,557	)
Cancelled warrants		(3,036	)
Issuance of common stock warrant in PPO		266

Balance, September 30, 2016		335

Concurrent with the closing of the 2016 Merger on May 3, 2016, the Company restructured its Term Loan and WCAS Note that extended the payment term of respective principal balance of $50 million and $5 million to March 31, 2021 and September 8, 2021. All warrants for private company common stock, Series D and private company Series AB there were outstanding on May 3, 2016 were cancelled.

12. Commitments and Contingencies

Operating Leases

The Company leases buildings in Shrewsbury, Massachusetts and Bridgewater, New Jersey and equipment under operating lease agreements, expiring through 2017. In addition to rental expense, the Company is obligated to pay costs of insurance, taxes, repairs and maintenance pursuant to the terms of the leases. The rental payments include the minimum rentals plus common area maintenance charges. Some of the leases include renewal options. Rental expense under operating leases amounted to $0.3 million and $0.4 million for the three months ended September 30, 2016 and 2015, respectively. Rental expense under operating leases amounted to $1.0 million and $1.0 million for the nine months ended September 30, 2016 and 2015, respectively.

At September 30, 2016, the Company had the following minimum lease commitments:


*(Dollars in thousands)*
Year ending December 31:
2016	$	354
2017		1,020
2018		121

	$	1,495

Licensing Agreement

Pursuant to a formation agreement, dated as of August 22, 2006 (the Formation Agreement), BioValve and BTI Technologies Inc. (BTI), a wholly owned subsidiary of BioValve, contributed to Valeritas, LLC all of their right, title and interest in and to all of the assets, properties and rights of BioValve and BTI to the extent related to BioValve’s drug delivery/medical device initiative, consisting of patents and equipment, hereafter referred to as the Device Assets (Device Assets).

On August 22, 2008, the Formation Agreement was amended and the Company agreed to pay BioValve an amount equal to 9% of any cash upfront license or signing fees and any cash development milestone payments received by the Company in connection with licenses or grants of third party rights to the use in development or commercialization of the Rapid Infuser Technology. In certain circumstances the Company would owe 10% of such payments received. As of September 30, 2016 and December 31, 2015, no amounts were owed under this agreement. Although the Company believes the intellectual property rights around this technology have value, the technology licensed under this agreement is not used in the V-Go or any current products under development.

13. Stock-Based Compensation

Stock Options and Restricted Stock

Total stock-based compensation expense related to stock options and restricted stock was $0.9 million and $1.0 million for the quarter ended September 30, 2016 and 2015, respectively. Total stock-based compensation expense related to stock options and restricted stock was $3.4 million and $4.6 million for the nine months ended September 30, 2016 and 2015, respectively.

On March 7, 2016, the Company dissolved Valeritas Holdings, LLC. As a result of the dissolution, the 2008 Employee Equity Compensation Plan was terminated and all options outstanding thereunder were cancelled. On May 3, 2016, the 2014 Employee Equity Compensation Plan (the “2014 Plan”) was terminated and all options outstanding thereunder were cancelled. As a result of the cancellation of the plans, the Company recognized a one-time expense of $1.6 million during 2016. The 2016 Employee Equity Compensation plan was established concurrently with the 2016 Merger.

2016 Employee Equity Compensation Plan Stock option activity for the nine months ended September 30, 2016 was as follows:


	Shares			Weighted- Average Exercise Price (in dollars per share)		Weighted- Average Contractual Life (in years)		Aggregate Intrinsic Value
Options outstanding at December 31, 2015		—		$	—		—		—
Granted		1,955,800			5.03		10.0 years		—
Exercised		—			—		—		—
Forfeited / Cancelled		(63,000	)		5.00		—		—
Expired		—			—		—		—

Options outstanding at September 30, 2016		1,892,800		$	5.03		9.62 years	$	1,834,776

The fair value of the options at the date of issuance was estimated to be $7.1 million, based on the Black-Scholes option pricing model. Key assumptions used to apply this model upon issuance were as follows:


	Weighted Average on Grant Date
Dividend yield		—
Expected volatility		84.79	%
Risk-free rate of return		1.41	%
Expected term (years)		6.13
Fair Value per share	$	3.61

During the second and third quarters of 2016, the Company issued restricted stock awards to employees and key consultants. The grants vest on the first, second and third anniversaries of the original grant date. We recognize compensation expense on all of these awards on a straight-line basis over the vesting period. The fair value of the award is determined based on the market value of the underlying stock price at the grant date.

The amount of time-based restricted stock compensation recognized during a period is based on the value of the portion of the awards that are ultimately expected to vest. Forfeitures are required to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. We currently expect, based on historical analysis, an annual forfeiture rate of approximately 22%. This assumption is reviewed periodically and the rate is adjusted as necessary. Ultimately, the actual expense recognized over the vesting period will only be for those awards that vest. Restricted stock award activity for the nine months ended September 30, 2016 is as follows:


	Time-Based Restricted Stock Awards
Non-vested awards outstanding at December 31, 2015		—
Awards granted		453,550
Awards vested		(48,750	)
Awards forfeited		(9,300	)

Non-vested awards outstanding at September 30, 2016		395,500

The fair value of the awards on the date of issuance was estimated to be $2.3 million and $1.3 million remains in unrecognized compensation related to these awards.

14. Related Party Transactions

On September 8, 2011, the Company issued the WCAS Note to WCAS, a private company Series D Preferred shareholder (See discussion of “Other Note Payable” in note 8). Certain affiliates of WCAS are also common stock shareholders as of September 30, 2016. Upon restructuring of the Company’s debt, WCAS converted $2.1 million of outstanding interest into 1,660,530 shares of Series AB Preferred Stock, which was converted to 396,201 shares of common stock of the Company.

During the nine months ended September 30, 2016, CRG participated in additional private company Series AB financing as well as exercised its private company Series AB warrants to acquire additional 10,276,030 shares of private company Series AB Preferred Stock (2,518,089 shares of Valeritas Holdings, Inc. common stock after the 2016 Merger) of the Company for gross amount of $12.8 million. CRG converted its outstanding accrued interest and prepayment premium of approximately $16.5 million into 8,609,824 shares of private company Series AB preferred stock and 4,649,859 shares of private company common stock. The private company Series AB shares were then converted into 2,053,959 shares of the Company’s common stock upon the 2016 Merger and all shares of the private company stock were canceled upon the 2016 Merger. Upon the closing of the 2016 Merger, the aggregate CRG shares of Series AB Preferred Stock were exchanged for 5,487,766 shares of common stock in Valeritas Holdings, Inc. CRG also took part in the PPO, contributing additional $20.0 million for 4,000,000 shares common stock of Valeritas Holdings. The aggregate common shares of Valeritas Holdings, Inc. held by CRG upon closing of the 2016 Merger were 9,487,763.

15. Stockholders’ Deficit

In connection with the 2016 Merger and the retrospective application of the recapitalization of the Company, the par value of each share of common stock of Valeritas Holdings, Inc. of $0.001 and the authorized 300,000,000 shares of common stock and 10,000,000 shares of blank check preferred stock of Valeritas Holdings, Inc. became the capital structure of the Company.

Concurrently with the closing of the 2016 Merger, and as a condition to the 2016 Merger, the Company closed a private placement offering (the “Private Placement”) of approximately 5 million shares of common stock of Valeritas Holdings at a purchase price of $5.00 per share, for proceeds of approximately $24.0 million, net of financing costs. Existing investors of the Company invested $20.0 million of the Private Placement. The pre-2016 Merger stockholders of the Company retained an aggregate of 1,000,004 shares of common stock.

Prior to the 2016 Merger and recapitalization, Valeritas, Inc. recognized the following preferred stock transactions in the private company shares:

Series AB Convertible Preferred Stock

The Company issued 4,655,430 shares of private company Series AB Preferred Stock (converted into 1,110,613 shares of common stock of Valeritas Holdings, Inc. as part of the 2016 Merger) on January 29, 2016 for gross proceeds of $5.8 million. During February, March and April of 2016, CRG exercised warrants with respect to 5,900,000 shares of private company Series AB Preferred Stock of Valeritas (converted into 1,407,476 shares of common stock of Valeritas Holdings, Inc. after the 2016 Merger) for gross proceeds of $7.4 million and $1.6 million of derivative liabilities. As of September 30, 2016, all shares of private company Series AB Preferred Stock outstanding was converted to common shares of Valeritas Holdings, Inc. All remaining derivative liabilities associated with the Series AB warrants were reclassified to equity upon cancellation.

Any amounts funded in connection with the original issuance of the shares of private company common stock, Series D Preferred Stock and Series AA Preferred Stock have been retrospectively adjusted and accounted for as capital contributions as holders of shares of those classes of Valeritas, Inc. stock did not receive common shares of Valeritas Holdings, Inc. in connection with the 2016 Merger.

Debt Conversion

CRG converted its outstanding accrued interest and prepayment premium of approximately $16.5 million into 8,609,824 shares of private company Series AB preferred stock and 4,649,859 shares of private company common stock. The shares of private company Series AB preferred stock were then converted into 2,053,959 shares of the Company’s common stock upon the 2016 Merger and all shares of the private company common stock were canceled upon the 2016 Merger.

Concurrently with the closing of the 2016 Merger on May 3, 2016, the Company restructured the WCAS Note. WCAS converted its outstanding accrued interest and fees of $2.1 million into 1,660,530 shares of private company Series AB Preferred Stock which were then converted into 396,201 shares of common stock of the Company upon the 2016 Merger. At the time of the debt restructuring, $0.7 million of remaining in debt issuance costs was extinguished and recorded against equity as the lender is also a stockholder of the Company resulting in a net charge of $1.4 million to equity for the Term Loan.

16. Net Loss Per Share

Basic net loss per share excludes the effect of dilution and is computed by dividing the net loss attributable to common stockholders by the weighted-average number of shares of common stock outstanding less the weighted-average number of shares subject to repurchase during the period.

Diluted net loss per share is computed by giving effect to all potential shares of common stock, including stock options and warrants to the extent dilutive. Basic net loss per share was the same as diluted net loss per share for the quarters and nine months ended September 30, 2016 and 2015 as the inclusion of all potential common shares outstanding would have an anti-dilutive effect.

The following awards were not included in the computation of weighted average common shares for the quarter and nine months ended September 30, 2016 and 2015:


	Quarter Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016		2015
Dilutive stock options		1,892,800		—		1,892,800		—
Warrants		83,120		—		83,120		—
Restricted stock		395,500		—		395,500		—

Total		2,371,420		—		2,371,420		—

As described in note 1 and Note 15, all outstanding Series AA Preferred Stock, Series D Preferred Stock and common stock were retired and cancelled prior to the 2016 Merger without consideration. They are therefore being excluded in the calculation of the net loss per share calculation included in these financial statements which have been retrospectively adjusted for the recapitalization of the Company. The weighted average common shares in 2016 and 2015 reflect the outstanding private company Series AB Preferred Stock of the private company as converted at the conversion ratio of 0.23856.

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following management’s discussion and analysis should be read in conjunction with the historical financial statements and the related notes thereto contained in this report. The management’s discussion and analysis contains forward-looking statements, such as statements of our plans, objectives, expectations and intentions. Any statements that are not statements of historical fact are forward-looking statements. When used, the words “believe,” “plan,” “intend,” “anticipate,” “target,” “estimate,” “expect” and the like, and/or future tense or conditional constructions (“will,” “may,” “could,” “should,” etc.), or similar expressions, identify certain of these forward-looking statements. These forward-looking statements are subject to risks and uncertainties, including those under “Risk Factors” in this Report, that could cause actual results or events to differ materially from those expressed or implied by the forward-looking statements. The Company’s actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of several factors. The Company does not undertake any obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this report.

Valeritas Holdings, Inc. (formerly Cleaner Yoga Mat, Inc.), was incorporated in Florida on May 9, 2014 and was previously engaged in the sale of sanitizing solutions for Yoga and Pilates studios as well of conventional gyms of all sizes. Valeritas Holdings, Inc. was then reincorporated in Delaware on May 3, 2016 as part of the 2016 Merger (as defined below).

On May 3, 2016, our wholly-owned subsidiary, Valeritas Acquisition Corp., a corporation formed in the State of Delaware on May 3, 2016 or the Acquisition Sub, merged with and into Valeritas, Inc., a corporation incorporated on August 26, 2008 in the state of Delaware or Valeritas or the private company. Pursuant to this transaction or the 2016 Merger in which Valeritas was the surviving entity and became our wholly-owned subsidiary, we discontinued our pre-2016 Merger business and continued the existing business operations of Valeritas as a publicly-traded company under the name Valeritas Holdings, Inc.

In connection with the 2016 Merger and pursuant to a Split-Off Agreement, we transferred our pre-2016 Merger assets and liabilities to our pre-2016 Merger majority stockholder in exchange for the surrender by her and cancellation of 40,486,000 shares of our common stock. In addition, all of the outstanding stock of Valeritas was converted into shares of our common stock.

The 2016 Merger is being accounted for as a “reverse merger,” and Valeritas is deemed to be the accounting acquirer in the reverse merger, because the shareholders of Valeritas effectively control the combined companies as a result of the 2016 Merger. As such, the historical financial statements of Valeritas Holding, Inc. prior to the 2016 Merger has been replaced with the historical financial statements of Valeritas.

Amounts for Valeritas historical (pre-merger) common stock, preferred stock, warrants, and stock options including share and per share amounts have been retroactively adjusted using their respective exchange ratio in these financial statements, unless otherwise disclosed. As such, all shares of Valeritas, Inc. common stock, Series D Preferred Stock and Series AA Preferred Stock have been eliminated in the historical results, beginning with the earliest period presented. Any amounts funded in connection with the original issuance of the common stock, Series D Preferred Stock and Series AA Preferred Stock have been retrospectively adjusted and accounted for as capital contributions as holders of shares of these classes of Valeritas stock did not receive common shares of Valeritas Holdings, Inc. in connection with the 2016 Merger. All shares of Valeritas private company Series AB Preferred Stock have been retrospectively adjusted to common stock of Valeritas Holdings, Inc. based upon the exchange ratio noted above.

The following discussion highlights Valeritas’s results of operations and the principal factors that have affected our financial condition as well as our liquidity and capital resources for the periods described, and provides information that management believes is relevant for an assessment and understanding of the statements of financial condition and results of operations presented herein. The following discussion and analysis are based on Valeritas’s unaudited financial statements contained in this Report, which we have prepared in accordance with accounting principles generally accepted in the United States. You should read the discussion and analysis together with such financial statements and the related notes thereto.

Basis of Presentation

The audited financial statements of Valeritas for the fiscal years ended December 31, 2015 and 2014 contained in the Form 8-K/A filed with the U.S. Securities and Exchange Commission by the Company on May 16, 2016, and the unaudited financial statements of Valeritas for the three and nine months ended September 30, 2016 and 2015 contained herein include a summary of our significant accounting policies and should be read in conjunction with the discussion below. In the opinion of management, all material adjustments necessary to present fairly the results of operations for such periods have been included in the unaudited financial statements for the three and nine months ended September 30, 2016 and 2015. All such adjustments are of a normal recurring nature.

Executive Summary

Company Background and Strategy

We are a commercial-stage medical technology company focused on developing innovative technologies to improve the health and quality of life of people with Type 2 diabetes. We designed our first commercialized product, the V-Go Disposable Insulin Delivery device, or V-Go, to help patients with Type 2 diabetes who require insulin to achieve and maintain their target blood glucose goals. V-Go is a small, discreet and easy-to-use disposable insulin delivery device that a patient adheres to his or her skin every 24 hours. V-Go enables patients to closely mimic the body’s normal physiologic pattern of insulin delivery throughout the day and to manage their diabetes with insulin without the need to plan a daily routine around multiple daily injections.

We currently focus on the treatment of patients with Type 2 diabetes—a pervasive and costly disease that, according to the 2014 National Diabetes Statistics Report released by the U.S. Centers for Disease Control and Prevention, or CDC, currently affects between 90% and 95% of the approximately 22 million U.S. adults diagnosed with diabetes. The CDC estimates that the combined direct medical and drug costs and indirect lost productivity costs of diabetes in the United States are approximately $245 billion annually. We believe the majority of the 12.8 million U.S. adults treating their Type 2 diabetes with more than one daily oral anti-diabetic drug, or OAD, or an injectable diabetes medicine can benefit from V-Go’s innovative approach to Type 2 diabetes management. Our near-term market consists of the approximately 5.8 million of these patients who currently take insulin, which includes 4.6 million patients who have not been able to achieve their target blood glucose goal.

We commenced commercial sales of V-Go in the United States during 2012. In the second half of 2012, we began hiring sales representatives in selected U.S. markets. At the end of 2015, our sales team covered 63 territories primarily within the East, South, Midwest and Southwest regions of the United States. Since launching V-Go, the total number of prescriptions for, and the number of patients using, V-Go have increased each year.

2016 Third Quarter Executive Summary

In the third quarter of 2016 as compared to the third quarter of 2015, our revenue increased 2.6% to $4.9 million, gross margin increased from 13.1 % to 35.6%, and our net loss decreased 36.8% to $9.2 million. The following key factors should be considered when reviewing our results of operations, financial condition and liquidity for the periods discussed:

•

Our revenue has been impacted by a reduction in our field sales force, which was the result of Company restructuring efforts during February of 2016. In terms of representatives on the ground, we started the third quarter with 29 filled territories and had an average of 30 filled territories in the quarter (compared to an average of 58 filled territories in the third quarter of 2015. The net growth in revenue was primarily the result of higher average net pricing in 2016, supported by our executed increase in our gross price charged to distributors.

•

We have significantly increased the gross margins for our product by creating manufacturing efficiencies and by implementing cost effective processes in our product development.

In obtaining additional financing through our recent offering, we will look to grow our sales force and expand into new markets during 2017, which should continue the Company’s revenue growth.

Results of Operations

Results of Operations for the Three Months Ended September 30, 2016 and 2015

The following is a comparison of revenue and expense categories for the three months ended September 30, 2016 and 2015:


*(Dollars in thousands)*	Quarter Ended September 30,						Change
*(Dollars in thousands)*	2016			2015			$			%
Revenue, net	$	4,860		$	4,739			121			2.6
Cost of goods sold		3,132			4,119			(987	)		(24.0	)

Gross margin		1,728			620			1,108			178.7

Operating expense:
Research and development		1,188			1,519			(331	)		(21.8	)
Selling, general and administrative		7,997			9,908			(1,911	)		(19.3	)
Restructuring		198			—			198			100.0

Total operating expense		9,383			11,427			(2,044	)		(17.9	)
Operating loss		(7,655	)		(10,807	)		3,152			29.2

Other income (expense), net:
Other income, net		121			—			121			100.0
Interest expense		(1,596	)		(3,688	)		2,092			(56.7	)
Change in fair value of derivatives		(27	)		—			(27	)		(100.0	)

Total other income (expense), net		(1,502	)		(3,688	)		2,186			(59.3	)

Loss before income taxes		(9,157	)		(14,495	)		5,338			(36.8	)

Income tax expense		—			—			—			—

Net loss	$	(9,157	)	$	(14,495	)		5,338			(36.8	)

Results of Operations for the Nine Months Ended September 30, 2016 and 2015

The following is a comparison of revenue and expense categories for the nine months ended September 30, 2016 and 2015:


*(Dollars in thousands)*	Nine Months Ended September 30,						Change
*(Dollars in thousands)*	2016			2015			$			%
Revenue, net	$	14,754		$	13,494			1,260			9.3
Costs of goods sold		9,589			11,143			(1,554	)		(13.9	)

Gross Margin		5,165			2,351			2,814			119.7
Operating expense:
Research and development		3,635			5,140			(1,505	)		(29.3	)
Selling, general and administrative		24,547			36,458			(11,911	)		(32.7	)
Restructuring		2,361			—			2,361			100.0

Total operating expense		30,543			41,598			(11,055	)		(26.6	)

Operating loss
Other income (expense), net:
Interest expense		(10,602	)		(12,381	)		1,779			(14.4	)
Other income		121			—			121			100.0
IPO costs written off		—			(3,978	)		3,978			100.0
Change in fair value of derivatives		(662	)		443			(1,105	)		(249.4	)

Total other income (expense), net		(11,143	)		(15,915	)		4,772			(30.0	)

Net loss before tax expense	$	(36,521	)	$	(55,162	)		18,641			(33.8	)
Tax expense		—			—			—			—

Net loss	$	(36,521	)	$	(55,162	)		18,641			(33.8	)

Revenue

We generate revenue from sales of V-Go to third-party wholesalers and medical supply distributors that take delivery and ownership of V-Go and, in turn, sell it to retail pharmacies or directly to patients with Type 2 diabetes. V-Go 30-day packages are sold to wholesalers and distributors at wholesale acquisition cost (WAC) and the Company reports net revenue after taking into consideration sales deductions as described in the Company’s financial statements. Our revenue is generated in the United States, and we view our operations as one operating segment. Financial information is reviewed on a consolidated basis to allow management to make decisions regarding resource allocations and assess performance.

Revenue increased by 2.6% to $4.9 million in the third quarter of 2016 from $4.7 million in the third quarter of 2015. In February of 2016, the Company completed a restructuring of the business, one result of which was a significant reduction to the field sales force. In terms of sales representatives on the ground, we started the quarter with 29 filled territories and had an average of 30 filled territories in the quarter (compared to an average of 58 filled territories in the third quarter of 2015). This reduction drove a 6.4% drop in the volume of V-Go prescribed to patients in the third quarter of 2016 compared with the same period in 2015. The net revenue increase in 2016 was driven by higher average net prices realized compared with the same comparable quarterly period in 2015. Although the Company implemented an 8.0% WAC price increase during the latter part of the fourth quarter of 2015, our realized net price increased compared with the same period in 2015 grew by 9.5%. This incremental growth was driven primarily by a lower mix of patients utilizing our co-pay card program and a corresponding increase through our contracted managed care providers, resulting in a higher average realized net price.

On a year to date basis, our revenue increased by 9.3% to $14.8 million in the first nine months of 2016 from $13.5 million in the first nine months of 2015. In January of 2016, the Company initiated a restructuring of the business, one result of which was a significant reduction to the field sales force post January of 2016. Despite this reduction, the volume of V-Go prescribed and sold to patients during the first nine months of 2016 remained relatively flat, decreasing by 0.1% compared with the same period in 2015. The net revenue increase in 2016 was driven by higher average net prices realized compared with the same comparable period in 2015. Although the Company implemented an 8.0% WAC price increase during the latter part of the fourth quarter of 2015, our realized net price increased 9.5% compared with the same period in 2015. This incremental growth was driven primarily by a lower mix of patients utilizing our co-pay card program and a corresponding increase through our contracted managed care providers, resulting in a higher average realized net price.

Gross Margin

Cost of goods sold includes raw materials, labor costs, manufacturing overhead expenses and reserves for anticipated scrap and inventory obsolescence. We currently manufacture V-Go and the EZ Fill accessory in cleanrooms at a contract manufacturing organization, or CMO, in Southern China. We also have a relationship with a separate CMO that performs our final inspection and packaging functions. Any single-source components and suppliers are managed through our global supply chain operation. We continually work with our manufacturing CMO to refine our manufacturing processes and production lines to improve efficiencies and reduce labor cost. These improvements represent the primary drivers in the current year reduction in cost of goods sold per unit.

Our gross margin as a percentage of revenues for the quarter ended September 30, 2016 was 35.6%, compared to 13.1% during the quarter ended September 30, 2015. The increase in our gross margin is due to manufacturing efficiencies, implementation of cost effective processes in our product development and the impact of our net price increase.

Our gross margin as a percentage of revenues for the nine month period ended September 30, 2016 was 35.0%, compared to 17.4% during the nine month period ended September 30, 2015. The increase in our gross margin is due to manufacturing efficiencies, implementation of cost effective processes in our product development and the impact of our net price increase.

We expect our overall gross margin, which is calculated as revenue less cost of goods sold for a given period, to fluctuate in future periods as a result of varying manufacturing output as we strive to reduce near-term inventory levels. In the future, planned changes in and improvements to our manufacturing processes and expenses, as well as increases in production volume up to our current capacity are expected to further improve our gross margins.

Research and Development

Our research and development activities primarily consist of activities associated with our core technologies and processes engineering as well as research programs associated with products under development. These expenses in 2016 are primarily related to employee compensation, including salary, fringe benefits, share-based compensation and contract employee expenses.

Total research and development expenses decreased by 21.8% to $1.2 million in the third quarter of 2016 from $1.5 million in the third quarter of 2015. The decrease of $0.3 million was primarily comprised of reduced employee-related expenses resulting from our February 2016 restructuring efforts, and to a lesser extent lower external service spending related to our ongoing projects and contract labor costs.

Total research and development expenses decreased by 29.3% to $3.6 million in the nine month period ended September 30, 2016 from $5.1 million in the nine month period ended September 30, 2015. The decrease of $1.5 million was primarily comprised of reduced employee related expenses resulting from our February 2016 restructuring efforts, and to a lesser extent lower external service spending related to our ongoing projects and contract labor costs.

We expect our research, development and engineering expenses to increase from current levels as we initiate and advance our development projects, including the prefill V-Go.

Selling, General and Administrative

Selling, general and administrative expenses consist primarily of salary, fringe benefits and share-based compensation for our executive, financial, marketing, sales, business development, regulatory affairs and administrative functions. Other significant expenses include product demonstration samples, trade show expenses, professional fees for our contracted customer support center, external legal counsel, independent auditors and other consultants, insurance, facilities and information technologies expenses. We expect our selling, general and administrative expenses to increase as our business expands.

Our selling, general and administrative expenses decreased 19.3% in the quarter ended September 30, 2016 to $8.0 million as compared to $9.9 million in the quarter ended September 30, 2015. This decrease was driven primarily by the impact of our Company restructuring efforts executed in February, 2016 which reduced our field sales force. The remaining savings was realized by lower non-headcount sales and marketing expenditures. The remaining savings was attributed to our planned reduction in the use of external consulting services used to assist with our marketing initiatives and other professional services.

Our selling, general and administrative expenses decreased 32.7% in the nine month period ended September 30, 2016 to $24.5 million as compared to $36.5 million in the nine month period ended September 30, 2015. This decrease was driven primarily by the impact of our Company restructuring efforts executed in February, 2016 which significantly reduced our field sales force. This reduction in employee related costs was partially offset by a non-cash charge of $1.6 million during 2016 for stock based compensation expenses resulting from the cancellation of the Company’s stock option plans. The remaining savings was attributed to our planned reduction in the use of external consulting services used to assist with our marketing initiatives and other professional services.

Other Income (Expense), Net

Other income (expense), net primarily consists of interest expense and amortization of debt discount associated with our loan agreements with Capital Royalty Partners and WCAS Capital Partners IV, L.P. See “—Indebtedness” below for more information. Also included are costs related to our financing activities in 2016 and 2015.

Interest expense decreased 56.7% during the quarter ended September 30, 2016 to $1.6 million as compared to $3.7 million during the same period in 2015. The decrease was attributable to a restructuring of the Company Term Loan with CRG and the note payable with WCAS on May 3, 2016. The debt restructuring resulted in a lower restructured principal balance and lower interest rates in the third quarter of 2016 compared with the same period in 2015. The restructured interest rate decreased from 15% per annum in 2015 to 11% in 2016.

Interest expense decreased 14.4% during the nine months ended September 30, 2016 to $10.6 million as compared to $12.4 million during the same period in 2015. The decrease was attributable to a restructuring of the Company Term Loan with CRG and the note payable with WCAS on May 3, 2016. The debt restructuring resulted in a lower restructured principal balance and lower interest rates in the first nine months of 2016 compared with the same period in 2015. The restructured interest rate decreased from 15% per annum in 2015 to 11% on the Senior Secured Debt and 10% on the other note payable in 2016.

During the first nine months of 2015, we expensed $4.0 million of previously capitalized deferred offering costs incurred from an Initial Public Offering (IPO) effort terminated in March of 2015.

The decrease in fair value of derivatives of $0.6 million during the nine months ended September 30, 2016 compared with the increase in fair value of $0.4 million during the same period ended September 30, 2015 is primarily caused by fluctuations in period end valuations of our derivative liabilities. We held different derivative instruments during each period as well.

Liquidity and Capital Resources

The Company expects that its actual sales performance and the resulting operating income or loss, as well as the status of each of its new product development programs, will significantly impact their cash management. The Company intends to maintain compliance with this liquidity covenant and fund future operations by raising additional capital. There can be no assurances that financing will be available on terms acceptable to the Company, or at all. If the Company is unable to raise additional capital prior to achieving sustained profitability from operations, there could be a material adverse effect on our business, results of operations and financial condition.

The following table shows a summary of our cash flows for the nine months ended September 30, 2016 and 2015:


	Nine Months Ended September 30,
*(Dollars in thousands)*	2016			2015
Net cash provided by (used in):
Operating activities	$	(23,987	)	$	(30,766	)
Investing activities		(50	)		(921	)
Financing activities		36,777			18,292

Total	$	12,740		$	(13,395	)

Operating Activities

The decrease in net cash used in operating activities for nine months ended September 30, 2016 as compared to the nine months ended September 30, 2015 was primarily associated with increased product revenue and lower cost of goods sold as a result of manufacturing efficiencies. In addition, since 2015, operating expense benefited from the Company’s restructuring implemented in February, 2016 as well as internal efforts and improvements in managing cash flows.

Investing Activities

Net cash used in investing activities for the nine months ended September 30, 2016 and 2015 was primarily related to purchases of capital equipment for our production lines. The use of cash in both 2016 and 2015 was related to augmenting the already existing production lines and corresponding capacity with our CMO built during prior years.

Financing Activities

Net cash provided by financing activities for the nine months ended September 30, 2016 was the result of gross proceeds from our common stock financing rounds, which raised $25.4 million and exercise of Series AB warrants of $7.4 million. Net cash provided by financing activities for the first nine months of 2015 was primarily the result of gross proceeds from the Series D, Series AA and Series AB Financing of $2.8 million, $15.2 million and $3.0 million respectively. These proceeds were partially offset by issuance costs of $2.6 million in aggregate.

Indebtedness

Senior Secured Debt

On May 23, 2013, the Company entered into the Term Loan of $50 million with Capital Royalty Group or CRG, structured as a senior secured loan with a six-year term or the Term Loan or the Senior Secured Debt. The Term Loan is secured by substantially all of the Company’s assets, including its material intellectual property. The Term Loan bore interest at 11% per annum and compounded annually. Until the third anniversary of the Term Loan, the Company had the option to pay quarterly interest of 7.5% in cash and 3.5% paid-in-kind, or PIK, interest which is added to the aggregate principal amount of the Term Loan on the last day of each quarter. Thereafter, interest on the Term Loan was payable only in cash. The Term Loan contained a minimum revenue covenant, which was $50.0 million for 2015.

The events of default, described previously, has led the Company to enter into a series of forbearance agreements with CRG. The initial forbearance agreement was entered into on May 18, 2015 and was subsequently amended five times. The forbearance agreements, as amended in 2015, contained a number of terms and conditions in exchange for CRG’s agreement to forbear. The forbearance agreement imposed an interest rate at the default interest rate of 15% per annum and a prepayment premium of 4% on the aggregate outstanding balance on the date of the repayment. As of December 31, 2015, the parties deferred the forbearance expiration date again to January 22, 2016. The forbearance agreements entered in 2015 and 2016 were accounted as troubled debt restructuring or TDR. There was no gain associated with the TDR, however the modified effective interest rate was applied prospectively.

On January 22, 2016, the Company and CRG amended the forbearance agreement to extend the forbearance period to March 31, 2016. As part of the terms within the forbearance agreement, dated January 29, 2016, the Company issued warrants to CRG exercisable into 16,000,000 shares of private company Series AB Preferred Stock of the private company at $1.25 per share. The warrant had a term of one year. The warrant fair value at the date of issuance was determined to be $4.0 million, using Black Scholes option pricing model. The warrant was accounted for as a debt discount and amortized through to May 3, 2016, when the Term Loan was restructured.

Concurrently with the closing of the 2016 Merger on May 3, 2016, the Company restructured its Term Loan. CRG converted its outstanding accrued interest and prepayment premium of $16.5 million into 8,609,824 shares of private company Series AB preferred stock and 4,649,859 shares of private company common stock (see “Other Note Payable” for additional conversions during 2016). The private company shares of Preferred Stock shares were then converted into 2,053,959 shares of the Company’s common stock upon the 2016 Merger and all private company common shares were canceled upon the 2016 Merger. The principal balance was restated as $50 million with interest rate charged at 11% per annum, which is PIK interest through June 30, 2018 and then both PIK and cash interest thereafter. The restructured Term Loan agreement requires quarterly interest payments during the term of the loan, which are set to commence on June 30, 2018. The repayment of principal on amounts borrowed under the Senior Secured Debt is scheduled to be completed on March 31, 2021.

The restructured Senior Secured Debt Agreement contains a financial covenant that requires the Company to maintain a minimum cash balance of $5.0 million. As of September 30, 2016, we were in compliance with the financial covenant in the restructured Term Loan agreement, as we held cash and cash equivalents of $15.5 million.

Other Note Payable

Concurrently with the closing of the 2016 Merger on May 3, 2016, the Company restructured its WCAS Note. WCAS converted its outstanding accrued interest and fees of $2.1 million into 1,660,530 shares of private company Series AB Preferred Stock, which were then converted into 396,201 shares of common stock of the Company upon the 2016 Merger. At the time of the debt restructuring, $0.7 million of remaining in debt issuance costs was extinguished and recorded against equity as the lender is also a stockholder of the Company, resulting in a net charge of $1.4 million to equity for the Term Loan (see “Senior Secured Debt” for additional conversions during 2016).

The principal balance was restated as $5.0 million with 10% per annum payable entirely as paid-in-kind interest and debt maturity date set at September 8, 2021. No interest payments are required during the term of the loan. The principal balance and any interest accrued during the term of the loan are due on the maturity date.

2016 Debt Restructuring

We restructured our outstanding debt in connection with the 2016 Merger. As part of this restructuring, we renegotiated our Term Loan with CRG, with such amended and restated term loan referred to as the Revised Term Loan, and the WCAS Note, with such amended and restated note referred to as the Revised WCAS Note. Pursuant to such negotiations, of the total amount of interest, fees, and expenses accrued as of immediately prior to the 2016 Merger equal to $18,650,267, $5,812,324 was converted into shares of Valeritas’s common stock and $12,837,943 was converted into shares of Valeritas’s Series AB Preferred Stock, each at a conversion price equal to $1.25 per share. These shares of Series AB Preferred Stock issued to CRG and WCAS as a result of such conversion were subsequently exchanged for shares of our common stock as part of the 2016 Merger.

Revised Term Loan

The material aspects of the Revised Term Loan are as follows:

•

The Revised Term Loan will mature and the principal and all accrued paid-in-kind interest will amortize in a single bullet payment, in March, 2021, the twentieth quarterly payment date following the consummation of the 2016 Merger.

•

Interest on the Revised Term Loan will accrue at a rate of 11% per annum paid quarterly. Interest is payable, in our discretion, as eight percent cash interest and three percent paid-in-kind interest; provided, however, that before the eighth quarterly payment date, interest will be payable, in our discretion, in its entirety as paid-in-kind interest. All cash interest will otherwise be paid quarterly. During any period in which an event of default has occurred and is continuing, the interest rate will increase by four percent, per annum, and payable entirely in cash. Through September 30, 2016 the Company recognized $1.0 million in paid-in-kind interest.

•

The Revised Term Loan is secured by a first priority security interest and right of payment in all of our current global assets, accounts and proceeds, or those to be acquired.

•

All existing defaults under the Term Loan have been permanently waived.

•

We may, in our discretion, repay the Revised Term Loan in whole or in part without any penalty or prepayment fees.

•

The Revised Term Loan includes only one financial liquidity operating covenant, which requires that we maintain an end-of-day cash balance greater than $5 million.

Revised WCAS Note

The material aspects of the Revised WCAS Note are as follows:

•

The Revised WCAS Note will mature and the principal and all accrued paid-in-kind interest will amortize in a single bullet payment, on September 8, 2021.

•

The Revised WCAS Note will accrue interest at a rate of 10% per annum payable entirely as paid-in-kind interest.

•

Pursuant to the Subordination Agreement, WCAS’s right to payment under the Revised WCAS Note is subject to CRG’s payment of the Revised Term Loan.

•

All existing defaults under the WCAS Note have been permanently waived.

Contractual Obligations

The following summarizes our significant contractual obligations as of September 30, 2016:


	Payment Due by Period
*(Dollars in thousands)*	Total		Less than 1 Year		1 to 3 Years		3 to 5 Years		More than 5 Years
Purchase commitments(1)	$	3,021	$	3,021	$	—	$	—	$	—
Operating lease obligations(2)		1,495		955		540		—		—
Senior secured debt(3)		52,379		—		—		52,379		—
Other Note Payable(4)		5,259		—		—		5,259		—
Severance payment (5)		451		451

Total	$	62,605	$	4,427	$	540	$	57,638	$	—

(1)	Represents purchase commitments with suppliers for raw materials and finished goods.

(2)	Represents operating lease commitments for office and manufacturing space in Shrewsbury, Massachusetts and Bridgewater, New Jersey and small office equipment.

(3)	Represents Term Loan agreement with Capital Royalty Partners for $50.0 million, including accrued interest through September 30, 2016.

(4)	Represents a $5.0 million Other Note Payable to WCAS Capital Partners IV, L.P., including accrued interest through September 30, 2016.

(5)	Represents severance payments due to former employees as part of our restructuring, which occurred in the first quarter of 2016.

Related Party Transactions

We transact business with certain parties related to the Company, primarily with key stakeholders with the intent of managing working capital through additional debt or equity financing.

Critical Accounting Policies and Use of Estimates

Our management’s discussion and analysis of financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States, or U.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, as well as the reported revenue and expenses during the reporting periods. These items are monitored and analyzed by us for changes in facts and circumstances, and material changes in these estimates could occur in the future. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Changes in estimates are reflected in reported results for the period in which they become known. Actual results may differ materially from these estimates under different assumptions or conditions.

While our significant accounting policies are more fully described in the notes to our consolidated financial statements included elsewhere in this filing, we believe that the following accounting policies are critical to the process of making significant judgments and estimates in the preparation of our consolidated financial statements and understanding and evaluating our reported financial results.

Revenue Recognition

Our revenue is primarily generated from the sales in the United States of V-Go to third-party wholesalers and medical supply distributors that, in turn, sell it to retail pharmacies or directly to patients.

We recognize revenue when persuasive evidence of an arrangement exists, delivery has occurred and title passed, the price is fixed or determinable, and collectability is reasonably assured. These criteria are applied as follows:

•

The evidence of an arrangement generally consists of contractual arrangements with our third-party wholesalers and medical supply distributors.

•

Transfer of title and risk and rewards of ownership are passed upon shipment of product to distributors. However, due to uncertainty of customer returns and insufficient historical data that would enable us to estimate returns, we do not consider this element to have been achieved until the prescription has been dispensed to the patient.

•

The selling prices are fixed and agreed upon based on the contracts with wholesalers and medical supply distributors, the customer and contracted insurance payers, if applicable. For sales to customers associated with insurance providers with whom we do not have a contract, we recognize revenue upon collection of cash at which time the price is determinable. Provisions for discounts and rebates to wholesalers, medical suppliers and payers are established as a reduction to revenue in the same period the related sales are recorded.

•

We consider the overall creditworthiness and payment history of the wholesalers and medical suppliers in concluding whether collectability is reasonably assured.

We have entered into agreements with wholesalers, distributors and third-party payers throughout the United States. These agreements may include product discounts or rebates payable by us to third-party payers upon dispensing V-Go to patients. Additionally, these agreements customarily provide such wholesalers and medical supply distributors with rights to return purchased products within a specific timeframe, as well as prior to such timeframe if the product is damaged in the normal course of business. Our wholesaler and medical supply distributor customers can generally return purchased product during a period that begins six months prior to the purchased V-Go’s expiration date and ends one year after the expiration date. Each V-Go’s expiration date is determined by adding 36 months to the date of manufacture. Returns are no longer honored after delivery to the patient. Therefore, with respect to each unit of V-Go sold, we record revenue when a patient takes possession of the product.

Revenue from product sales is recorded net of adjustments for managed care rebates, wholesale distributions fees, cash discounts, and prompt pay discounts, all of which are established at the time of sale. In order to prepare our consolidated financial statements, we are required to make estimates regarding the amounts earned or to be claimed on the related product sales, including the following:

•

managed care rebates, which are based on the estimated end user payer mix and related contractual rebates; and

•

distribution fees and prompt pay discounts, which are recorded based on specified payment terms, and which vary by customer.

We believe our estimates related to managed care rebates distribution fees and prompt pay discounts do not have a higher degree of estimation complexity or uncertainty as the related amounts are settled within a relatively short period of time.

We are currently unable to reasonably estimate future returns due to lack of sufficient historical return data for V-Go. Accordingly, we invoice our customers, record deferred revenue equal to the gross invoice sales price less estimated cash discounts and distribution fees, and record a related deferred cost of goods sold. We defer recognition of revenue and the related cost of goods sold on shipments of V-Go until a customer’s right of return no longer exists, which is once we receive evidence that the product has been distributed to patients based on our analysis of third-party information. When we believe we have sufficient historical data to develop reasonable estimates of expected returns based upon historical returns, we plan to recognize product sales upon shipment to wholesalers and medical supply distributors.

Inventories

Inventories consists of raw materials, work in process and finished goods, which are valued at the lower of cost or market. Cost is determined on a first in, first out, or FIFO, basis and includes material costs, labor and applicable overhead. We perform a review regarding our excess or obsolete inventory and write down any inventory that has no alternative uses to its net realizable value. Economic conditions, customer demand and changes in purchasing and distribution can affect the carrying value of inventory. As circumstances warrant, we record lower of cost or market inventory adjustments. In some instances, these adjustments can have a material effect on the financial results of an annual or interim period. In order to determine such adjustments, we evaluate the age, inventory turns and estimated fair value of product inventory by stage of completion and record an adjustment if estimated market value is below cost.

Impairment of Long-Lived Assets

We assess the impairment of long-lived assets, on an ongoing basis and whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Our impairment review process is based upon an estimate of future undiscounted cash flow. Factors we consider that could trigger an impairment review include the following:

•

significant underperformance relative to expected historical or projected future operating results,

•

significant changes in the manner of our use of the acquired assets or the strategy for our overall business

•

significant negative industry or economic trends

•

significant technological changes, which would render equipment and manufacturing processes obsolete

Recoverability of assets that will continue to be used in our operations is measured by comparing the carrying value to the future net undiscounted cash flows expected to be generated by the asset or asset group. Future undiscounted cash flows include estimates of future revenues, driven by market growth rates, and estimated future costs. There were no impairment charges recorded during the nine month periods ended September, 2016 and 2015.

Share-Based Compensation

We measure the cost of awards of equity instruments based on the grant date fair value of the awards. That cost is recognized on a straight-line basis over the period during which the employee is required to provide service in exchange for the entire award.

The fair value of stock options on the date of grant is calculated using the Black-Scholes option pricing model, based on key assumptions such as the fair value of common stock, expected volatility and expected term. Our estimates of these important assumptions are primarily based on third-party valuations, historical data, peer company data and our judgment regarding future trends and other factors.

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

Interest Rate Risk

We are exposed to financial market risks in the ordinary course of our business. Our cash and cash equivalents include cash in readily available checking and money market accounts, as well as certificates of deposit. These securities are not dependent on interest rate fluctuations that may cause the principal amount of these assets to fluctuate. Additionally, the interest rate on our outstanding indebtedness is fixed and is therefore not subject to changes in market interest rates.

Inflation Risk

Inflation generally affects us by increasing our cost of labor and pricing of contracts. We do not believe that inflation has had a material effect on our business, financial condition, or results of operations.

Recently Issued Accounting Standards

In April, 2016, the FASB issued ASU No. 2016-10, Revenue from Contracts with Customers: Identifying performance obligations and licensing, to reduce the cost and complexity of applying the guidance on identifying promised goods or services around identifying performance obligations and implementation guidance on determining whether an entity’s promise to grant a license provides a customer with either a right to use the entity’s intellectual property (which is satisfied at a point in time) or a right to access the entity’s intellectual property (which is satisfied over time. The Company has not yet selected a transition method nor have they determined the effect of the standard on our consolidated financial statements.

Off-Balance Sheet Arrangements

We did not engage in any “off-balance sheet arrangements” (as that term is defined in Item 303(a)(4)(ii) of Regulation S-K) as of September 30, 2016.

Item 4.

Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer (“CEO”), Chief Financial Officer (“CFO) and our Corporate Controller (our principal executive officer and principal financial officer, respectively) to allow for timely decisions regarding required disclosure. Our CEO, CFO and our Corporate Controller have concluded that our disclosure controls and procedures were not effective as of September 30, 2016. However, the Company’s management team has initiated certain measures designed to improve the effectiveness of the Company’s disclosure controls and procedures. These measures, include, but are not limited to, the recruitment and hiring of a Chief Financial Officer and the hiring and onboarding of an Accounting Manager with experience in annual and quarterly reporting for a public company pursuant to U.S. securities laws, which were both completed during 2016 as well as the implementation of additional review and approval processes. In designing and evaluating the disclosure controls and procedures, our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurances of achieving the desired control objectives, and management necessarily is required to apply its judgment in designing and evaluating the controls and procedures. On an on-going basis, we will review and document our disclosure controls and procedures and our internal control over financial reporting and we may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business.

There were no changes in the Company’s internal control over financial reporting during its most recently completed fiscal quarter that have materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting, as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act. As a result of the consummation of a reverse merger with Valeritas, Inc. completed on May 3, 2016, Valeritas Holdings, Inc. implemented a new management team. Our new management has not yet conducted a formal evaluation of our internal control over financial reporting.

Part II – Other Information

Item 1.

Legal Proceedings

There are currently no ongoing litigation matters. Refer to Note 12 – “Commitments and Contingencies,” to the condensed consolidated financial statements in Part I, Item 1 of this Form 10-Q.

Item 1A.

Risk Factors

Although we are not required to include risk factors in our Form 10-Q because we are a smaller reporting company, we believe the following risk factors are important to highlight in addition to other risk factors as listed in our prior SEC reports.

We have incurred significant losses since our inception and anticipate that we will continue to incur significant losses for the foreseeable future. These factors raise substantial doubt about our ability to continue as a going concern.

Since our inception in 2006, we have incurred significant net losses. Our recurring losses from operations raise substantial doubt about our ability to continue as a going concern, and as a result our independent registered public accounting firm included an explanatory paragraph in its reports on our consolidated financial statement for the fiscal year ended December 31, 2015. Substantial doubt about our ability to continue as a going concern may create negative reactions to the price of the common shares of our stock and we may have a more difficult time obtaining financing.

As of September 30, 2016, the Company had $15.5 million in cash and cash equivalents and an accumulated deficit of $414.4 million. To date, we have financed our operations primarily through sales of our preferred stock, debt financings and limited sales of our product. We have devoted substantially all of our resources to the research, development and engineering of our product, the commercial launch of V-Go, the development of a sales and marketing team and the assembly of a management team to lead our business. The Company estimates that the cash balance will be sufficient to satisfy the Company’s operations into mid-first quarter of 2017.

To implement our business strategy we need to, among other things, increase sales of our product with our existing sales and marketing infrastructure, fund ongoing research, development and engineering activities, and obtain regulatory clearance in other markets outside the U.S. and European Union or approval to commercialize our products currently under development. We expect our expenses to increase as we pursue these objectives. The extent of our future operating losses and the timing of profitability are highly uncertain, especially given that we only recently commercialized V-Go, which makes predicting our sales more difficult. Any additional operating losses will have an adverse effect on our stockholders’ equity/(deficit), and we cannot assure you that we will ever be able to achieve or sustain profitability.

Any failure to maintain effective internal control over our financial reporting could materially adversely affect us.

Section 404 of the Sarbanes-Oxley Act of 2002 requires us to include in our annual reports on Form 10-K an assessment by management of the effectiveness of our internal control over financial reporting. In addition, at such time, if any, as we are an “accelerated filer” or a “large accelerated filer,” and no longer an “emerging growth company,” our independent registered public accounting firm will have to attest to and report on management’s assessment of the effectiveness of such internal control over financial reporting. As a result of the consummation of the merger with Valeritas, Inc. completed on May 3, 2016, we have implemented a new management team. Our new management has not yet conducted a formal evaluation of our internal control over financial reporting and has not been able to make an assessment on whether the internal controls over financial reporting are effective. Based upon the last evaluation conducted as of September 30, 2016, our management concluded that our disclosure controls and procedures were not effective as of such date to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in rules and forms of the U.S. Securities and Exchange Commission.

While we intend to diligently and thoroughly document, review, test and improve our internal control over financial reporting in order to ensure compliance with Section 404, management may not be able to conclude that our internal control over financial reporting is effective. Furthermore, even if management were to reach such a conclusion, if at that time an attestation report of our independent registered public accounting firm is required and such firm is not satisfied with the adequacy of our internal control over financial reporting, or if the independent auditors interpret the requirements, rules or regulations differently than we do, then they may decline to attest to management’s assessment or may issue a report that is qualified. Any of these events could result in a loss of investor confidence in the reliability of our financial statements, which in turn could negatively affect the price of our common stock.

In particular, we must perform system and process evaluation and testing of our internal control over financial reporting to allow management and (if required in the future) our independent registered public accounting firm to report on the effectiveness of our internal control over financial reporting, as required by Section 404. Our compliance with Section 404 may require that we incur substantial accounting expense and expend significant management efforts. We currently do not have an internal audit group, and we will need to retain the services of additional accounting and financial staff or consultants with appropriate public company experience and technical accounting knowledge to satisfy the ongoing requirements of Section 404. We intend to review the effectiveness of our internal controls and procedures and make any changes management determines appropriate, including to achieve compliance with Section 404 by the date on which we are required to so comply.

Item 6.

Exhibits


31.1		Certification of Chief Executive Officer (Principal Executive Officer) pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated November 10, 2016.

31.2		Certification of Chief Financial Officer (Principal Financial Officer) pursuant to Rule 13a-14(a)/15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002, dated November 10, 2016.

32.1		Certification of Chief Executive Officer (Principal Executive Officer) pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated November 10, 2016.

32.2		Certification of Chief Financial Officer (Principal Financial Officer) pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, dated November 10, 2016.

101		The following materials from Valeritas Holdings Inc.’s Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2016 formatted in XBRL (Extensible Business Reporting Language): (i) Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2016 and September 30, 2015, (ii) Condensed Consolidated Statements of Financial Position at September 30, 2016 and December 31, 2015, (iii) Condensed Consolidated Statement of Shareholders’ Equity at September 30, 2016 and December 31, 2015, (iv) Condensed Consolidated Statements of Cash Flows for the nine months ended September 30, 2016 and September 30, 2015 and (v) Notes to Condensed Consolidated Financial Statements.

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Valeritas Holdings, Inc.

(Registrant)

/s/ John Timberlake

John Timberlake

Chief Executive Officer, Chief Commercial Officer and President

Principal Executive Officer

/s/ Erick Lucera

Erick Lucera

Chief Financial Officer

Principal Financial Officer

Dated: November 10, 2016

Large accelerated filer

Accelerated filer

Non-accelerated filer

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Smaller reporting company