See accompanying notes to unaudited condensed consolidated financial statements

LIPOCINE INC.

Notes to Condensed Consolidated Financial Statements

(Unaudited)

The accompanying unaudited condensed consolidated financial statements included herein have been prepared by Lipocine Inc. (“Lipocine” or the “Company”) in accordance with the rules and regulations of the United States Securities and Exchange Commission (“SEC”). The unaudited condensed consolidated financial statements are comprised of the financial statements of Lipocine and its subsidiaries collectively referred to as the Company. In management's opinion, the interim financial data presented includes all adjustments (consisting solely of normal recurring items) necessary for fair presentation. All intercompany accounts and transactions have been eliminated. Certain information required by U.S. generally accepted accounting principles has been condensed or omitted in accordance with rules and regulations of the SEC. Operating results for the three and ninesix months ended SeptemberJune 30, 20182019 are not necessarily indicative of the results that may be expected for any future period or for the year endedending December 31, 2018.2019.

These unaudited condensed consolidated financial statements should be read in conjunction with the Company's audited consolidated financial statements and the notes thereto for the year ended December 31, 2017.2018.

The preparation of the unaudited condensed consolidated financial statements requires management to make estimates and assumptions relating to reporting of the assets and liabilities and the disclosure of contingent assets and liabilities to prepare these condensed consolidated financial statements and the reported amounts of revenues and expenses during the reporting period in conformity with U.S. generally accepted accounting principles. Actual results could differ from these estimates.

The Company believes that its existing capital resources, together with interest thereon, will be sufficient to meet its projected operating requirements through at least March 31, 2020. While the Company believes it has sufficient liquidity and capital resources to fund our projected operating requirements through at least March 31, 2020, the Company will need to raise additional capital at some point through the equity or debt markets or through out-licensing activities, before or after March 31, 2020, to support its operations, on-going clinical study for LPCN 1144, compliance with regulatory requirements and long-term research and development and commercialization of TLANDO, if we receive approval of TLANDO from the FDA. The Company has based this estimate on assumptions that may prove to be wrong, and the Company could utilize its available capital resources sooner than it currently expects. Additional clinical studies may be required to obtain approval of TLANDO and these studies would put additional demands on the Company’s limited capital resources. Further, the Company’s operating plan may change, and the Company may need additional funds to meet operational needs and capital requirements for product development, regulatory compliance, clinical trials and pre-commercialization activities sooner than planned. The Company may consume its capital resources more rapidly if the FDA approval for TLANDO is delayed or denied, or if the Company elects to pursue the build out of an internal sales force as part of the Company’s commercialization launch plan if TLANDO receives approval from the FDA. In addition, the Company’s capital resources may be consumed more rapidly if it pursues additional clinical studies for LPCN 1144, TLANDO XR (LPCN 1111) and LPCN 1148. Conversely, the Company’s capital resources could last longer if it reduces expenses, reduces the number of activities currently contemplated under our operating plan or if it terminates or suspends on-going clinical studies.

Basic earnings (loss) per share is calculated by dividing net income (loss) available to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings (loss) per share is based on the weighted average number of common shares outstanding plus, where applicable, the additional potential common shares that would have been outstanding related to dilutive options and unvested restricted stock units to the extent such shares are dilutive.

The following table sets forth the computation of basic and diluted earnings (loss) per share of common stock for the three and ninesix months ended SeptemberJune 30, 20182019 and 2017:2018:

The computation of diluted loss per share for the three and ninesix months ended SeptemberJune 30, 20182019 and 20172018 does not include the following stock options and unvested restricted stock units to purchase shares in the computation of diluted loss per share because these instruments were antidilutive:

The Company has classified its marketable investment securities as available-for-sale securities, all of which are debt securities. DebtThese securities are carried at fair value with unrealized holding gains and losses, net of the related tax effect, included in accumulated other comprehensive loss in stockholders’ equity until realized. Gains and losses on investment security transactions are reported on the specific-identification method. Dividend income is recognized on the ex-dividend date and interest income is recognized on an accrual basis. The amortized cost, gross unrealized holding gains, gross unrealized holding losses, and fair value for available-for-sale securities by major security type and class of security at SeptemberJune 30, 20182019 and December 31, 20172018 were as follows:

Maturities of debt securities classified as available-for-sale securities at SeptemberJune 30, 20182019 are as follows:

There were no sales of marketable investment securities during the three and ninesix months ended SeptemberJune 30, 20182019 and 20172018 and therefore no realized gains or losses. Additionally, $10.4$4.3 million of marketable investment securities matured during each of the three months ended June 30, 2019 and 2018. Also, $9.0 million and $8.4$16.6 million of marketable investment securities matured during the threesix months ended SeptemberJune 30, 20182019 and 2017, respectively. Also, $27.0 million and $29.7 million of marketable investment securities matured during the nine months ended September 30, 2018, and 2017, respectively. The Company determined there were no other-than-temporary impairments for the three and ninesix months ended SeptemberJune 30, 20182019 and 2017.2018.

The Company utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs to the extent possible. The Company determines fair value based on assumptions that market participants would use in pricing an asset or liability in the principal or most advantageous market. When considering market participant assumptions in fair value measurements, the following fair value hierarchy distinguishes between observable and unobservable inputs, which are categorized in one of the following levels:

All of the Company’s financial instruments are valued using quoted prices in active markets or based on other observable inputs. For accrued interest income, prepaid and other current assets, accounts payable, and accrued expenses, the carrying amounts approximate fair value because of the short maturity of these instruments. The following table presents the placement in the fair value hierarchy of assets and liabilities that are measured at fair value on a recurring basis at SeptemberJune 30, 20182019 and December 31, 2017:2018:

The following methods and assumptions were used to determine the fair value of each class of assets and liabilities recorded at fair value in the balance sheets:

Cash equivalents: Cash equivalents primarily consist of highly-rated money market funds, commercial paper and treasury bills with original maturities to the Company of three months or less and are purchased daily at par value with specified yield rates. Cash equivalents related to money market funds and treasury bills are classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices or broker or dealer quotations for similar assets. Cash equivalents related to commercial paper are classified within Level 2 of the fair value hierarchy because they are valued using broker/dealer quotes, bids and offers, benchmark yields and credit spreads and other observable inputs.

Government bonds and notes:treasury bills: The Company uses a third-party pricing service to value these investments. United States Treasury bonds and notesbills are classified within Level 1 of the fair value hierarchy because they are valued using quoted market prices in active markets for identical assets and reportable trades. Other United States government agency bonds are classified within Level 2 of the fair value hierarchy because they are valued using broker/dealer quotes, bids and offers, benchmark yields and credit spreads and other observable inputs.

Corporate bonds, notes, and commercial paper: The Company uses a third-party pricing service to value these investments. The pricing service utilizes broker/dealer quotes, bids and offers, benchmark yields and credit spreads and other observable inputs.

The Company’s accounting policy is to recognize transfers between levels of the fair value hierarchy on the date of the event or change in circumstances that caused the transfer. There were no transfers into or out of Level 1 or Level 2 for the three and ninesix months ended SeptemberJune 30, 2018.2019.

On January 5, 2018, the Company entered into a Loan and Security Agreement (the “Loan and Security Agreement”) with Silicon Valley Bank (“SVB”) pursuant to which SVB agreed to lend the Company $10.0 million. The principal borrowed under the Loan and Security Agreement bears interest at a fixed interest rate equal to the Prime Rate, as reported in the money rates section of The Wall Street Journal or any successor publication representing the rate of interest per annum then in effect, plus one percent per annum (6.5% as of June 30, 2019), which interest is payable monthly. The loan matures on December 1, 2021. The Company iswas only required to make monthly interest payments until December 31, 2018, following which the Company will beis required to also make equal monthly payments of principal and interest for the remainder of the term. The Company will also be required to pay an additional final payment at maturity equal to $650,000 (the “Final Payment Charge”). The Final Payment Charge will be due on the scheduled maturity date and is being recognized as an increase to the principal balance with a corresponding charge to interest expense over the term of the facility using the effective interest method. At its option, the Company may prepay all amounts owed under the Loan and Security Agreement (including all accrued and unpaid interest and the Final Payment Charge), subject to a prepayment charge if the loan has been outstanding for less than two years, which prepayment charge is determined based on the date the loan is prepaid.

In connection with the Loan and Security Agreement, the Company granted to SVB a security interest in substantially all of the Company’s assets now owned or hereafter acquired, excluding intellectual property and certain other assets. In addition, as TLANDO was not approved by the FDA prior to May 31, 2018, the Company maintains $5.0 million of cash collateral at SVB as required under the Loan and Security Agreement until such time as TLANDO is approved by the FDA.

While any amounts are outstanding under the Loan and Security Agreement, the Company is subject to a number of affirmative and negative covenants, including covenants regarding dispositions of property, business combinations or acquisitions, incurrence of additional indebtedness and transactions with affiliates, among other customary covenants. The credit facility also includes events of default, the occurrence and continuation of which could cause interest to be charged at the rate that is otherwise applicable plus 5.0% and would provide SVB, as collateral agent, with the right to exercise remedies against the Company and the collateral securing the credit facility, including foreclosure against the property securing the credit facilities, including its cash. These events of default include, among other things, any failure by the Company to pay principal or interest due under the credit facility, a breach of certain covenants under the credit facility, the Company’s insolvency, a material adverse change, and one or more judgments against the Company in an amount greater than $100,000 individually or in the aggregate.

Principal payments on debt at SeptemberJune 30, 2018,2019, are as follows:

The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the statement of financial positionconsolidated balance sheet that sum to the total of the same such amounts shown in the statement of cash flows.

Amounts included in restricted cash represent those required to be set aside by the Loan and Security Agreement. The restriction will lapse if and when TLANDO is approved by the FDA.

The tax provision for interim periods is determined using an estimate of the Company’s effective tax rate for the full year adjusted for discrete items, if any, that are taken into account in the relevant period. Each quarter the Company updates its estimate of the annual effective tax rate, and if the estimated tax rate changes, the Company makes a cumulative adjustment.

At SeptemberJune 30, 20182019 and December 31, 2017,2018, the Company had a full valuation allowance against its deferred tax assets, net of expected reversals of existing deferred tax liabilities, as it believes it is more likely than not that these benefits will not be realized.

On March 29, 2012, the Company terminated its collaborative agreement with Solvay Pharmaceuticals, Inc. (later acquired by Abbott Products, Inc.) for TLANDO. As part of the termination, the Company reacquired the rights to the intellectual property from Abbott. All obligations under the prior license agreement have been completed except that Lipocine will owe Abbott a perpetual 1% royalty on net sales. Such royalties are limited to $1.0 million in the first two calendar years following product launch, after which period there is not a cap on royalties and no maximum aggregate amount. If generic versions of any such product are introduced, then royalties are reduced by 50%. The Company did not incur any royalties during the three or nineand six months ended SeptemberJune 30, 20182019 and 2017.2018.

The Company has entered into agreements with various contract organizations that conduct preclinical, clinical, analytical and manufacturing development work on behalf of the Company as well as a number of independent contractors, primarily clinical researchers, who serve as advisors to the Company. The Company incurred expenses of $887,000$1.4 million and $1.4 million,$880,000, respectively, for the three months ended SeptemberJune 30, 2019 and 2018 and 2017 and $2.5$2.8 million and $7.3$1.6 million, respectively, for the ninesix months ended SeptemberJune 30, 20182019 and 20172018 under these agreements and has recorded these expenses in research and development expenses.

On August 6, 2004, the Company assumed a non-cancelable operating lease for office space and laboratory facilities in Salt Lake City, Utah. On May 6, 2014, the Company modified and extended the lease through February 28, 2018. On2018, on February 8, 2018, the Company extended the lease through February 28, 2019. Additionally,2019 and on December 28, 2015,January 2, 2019, the Company entered into an operatingextended the lease for office space in Lawrenceville, New Jersey through January 31, 2018. The Company vacated the Lawrenceville, New Jersey office on January 31, 2018. February 28, 2020.

Future minimum lease payments under non-cancellable operating leases (with initial or remaining lease terms in excess of one year) as of SeptemberJune 30, 20182019 are:

The Company’s rent expense was $80,000$83,000 and $95,000$80,000 for the three months ended SeptemberJune 30, 2019 and 2018 and 2017, respectively,was $164,000 and $243,000 and $285,000$163,000 for the ninesix months ended SeptemberJune 30, 20182019 and 2017, respectively.2018.

In March 2017, the Company entered into a Controlled Equity Offering Sales Agreement (the “Sales Agreement”) with Cantor Fitzgerald & Co. (“Cantor”), to sell shares of our common stock, with aggregate gross sales proceeds of up to $20.0 million, from time to time, through an “at the market” (“ATM”), equity offering program, under which Cantor acts as sales agent. The shares of common stock to be sold under the Sales Agreement were originally sold and issued pursuant to the Company’s Registration Statement on Form S-3 (File No. 333-199093) (the “Prior Form S-3”), which was previously declared effective by the Securities and Exchange Commission, and the related prospectus and one or more prospectus supplements. On October 13, 2017, the Company filed a Form S-3 (File No. 333-220942) (the “New Form S-3”) to replace the ExistingPrior Form S-3.  The New Form S-3 has been declared effective by the Securities and Exchange Commission, and the Prior Form S-3 has been terminated.  The New Form S-3 registered the sale of up to $150.0 million of any combination of common stock, preferred stock, debt securities, warrants and units pursuant to a shelf registration statement.  The New Form S-3 also contains a prospectus pursuant to which we may sell, from time to time, shares of our common stock having an aggregate offering price of up to $25.0 million through Cantor as our sales agent, pursuant to the Sales Agreement.  On September 20, 2018, the Company filed a prospectus supplement in which the Company disclosed that as a result of the limitations of General Instruction I.B.6. of Form S-3, and in accordance with the terms of the Sales Agreement, the amount of shares of our common stock available for sale under the New Form S-3 is now limited to $10.8 millionone-third of the aggregate market value of our common equity held by non-affiliates of the Company over any rolling 12-month period. 

As of SeptemberJune 30, 2018,2019, we had sold an aggregate of 2,587,8775,977,560 shares at a weighted-average sales price of $4.32$3.06 per share under the ATM for aggregate gross proceeds of $11.2$18.3 million and net proceeds of $10.7$17.6 million, after deducting sales agent commissioncommissions and discounts and our other offering and accounting costs. During the three and nine months ended SeptemberJune 30, 2018, we2019, the Company sold an aggregate of 69,768149,037 shares at a weighted-average sales price of $1.40$1.95 per share under the ATM for aggregate gross proceeds of $98,000$290,000 and $91,000$281,000 in net proceeds. During the threesix months ended SeptemberJune 30, 2017, we2019, the Company sold an aggregate of 531,4002,992,504 shares at a weighted-average sales price of $4.34$2.18 per share under the ATM for aggregate gross proceeds of $2.3$6.5 million and $2.3$6.3 million in net proceeds. During the ninethree and six months ended SeptemberJune 30, 2017, we sold an aggregate of 2,518,1092018, the Company did not sell any shares at a weighted-average sales price of $4.40 per share under the ATM for aggregate gross proceeds of $11.1 million and $10.6 million in net proceeds.ATM.

On November 13, 2015, the Company and American Stock Transfer & Trust Company, LLC, as Rights Agent, entered into a Rights Agreement. Also on November 12, 2015, the board of directors of the Company authorized and the Company declared a dividend of one preferred stock purchase right (each a “Right” and collectively, the “Rights”) for each outstanding share of common stock of the Company. The dividend was payable to stockholders of record as of the close of business on November 30, 2015 and entitles the registered holder to purchase from the Company one one-thousandth of a fully paid non-assessable share of Series A Junior Participating Preferred Stock of the Company at a price of $63.96 per one-thousandth share (the “Purchase Price”). The Rights will generally become exercisable upon the earlier to occur of (i) 10 business days following a public announcement that a person or group of affiliated or associated persons has become an Acquiring Person (as defined below) or (ii) 10 business days (or such later date as may be determined by action of the board of directors prior to such time as any person or group of affiliated or associated persons becomes an Acquiring Person) following the commencement of, or announcement of an intention to make, a tender offer or exchange offer the consummation of which would result in the beneficial ownership by a person or group of 15% or more of the outstanding common stock of the Company. Except in certain situations, a person or group of affiliated or associated persons becomes an “Acquiring Person” upon acquiring beneficial ownership of 15% or more of the outstanding shares of common stock of the Company.

In general, in the event a person becomes an Acquiring Person, then each Right not owned by such Acquiring Person will entitle its holder to purchase from the Company, at the Right’s then current exercise price, in lieu of shares of Series A Junior Participating Preferred Stock, common stock of the Company with a market value of twice the Purchase Price.

In addition, if after any person has become an Acquiring Person, (a) the Company is acquired in a merger or other business combination, or (b) 50% or more of the Company’s assets, or assets accounting for 50% or more of its earning power, are sold, leased, exchanged or otherwise transferred (in one or more transactions), proper provision shall be made so that each holder of a Right (other than the Acquiring Person, its affiliates and associates and certain transferees thereof, whose Rights became void) shall thereafter have the right to purchase from the acquiring corporation, for the Purchase Price, that number of shares of common stock of the acquiring corporation which at the time of such transaction would have a market value of twice the Purchase Price.

The Company will be entitled to redeem the Rights at $0.001 per Right at any time prior to the time an Acquiring Person becomes such. The terms of the Rights are set forth in the Rights Agreement, which is summarized in the Company's Current Report on Form 8-K dated November 13, 2015. The rights plan was originally set to expire on November 12, 2018; however, on November 5, 2018 our Board of Directors approved an extension ofAmended and Restated Rights Agreement pursuant to which the expiration date was extended to November 5, 2021, unless the rights are earlier redeemed or exchanged by the Company.

The Company recognizes stock-based compensation expense for grants of stock option awards, restricted stock units and restricted stock under the Company’s Incentive Plan to employees and nonemployee members of the Company’s board of directors based on the grant-date fair value of those awards. The grant-date fair value of an award is generally recognized as compensation expense over the award’s requisite service period. In addition, the Company grants stock options to nonemployee consultants from time to time in exchange for services performed for the Company. Equity instruments granted to nonemployees are subject to periodic revaluation over their vesting terms.Company

The Company uses the Black-Scholes model to compute the estimated fair value of stock option awards. Using this model, fair value is calculated based on assumptions with respect to (i) expected volatility of the Company’s common stock price, (ii) the periods of time over which employees and members of the board of directors are expected to hold their options prior to exercise (expected term), (iii) expected dividend yield on the Common Stock, and (iv) risk-free interest rates. Stock-based compensation expense also includes an estimate, which is made at the time of grant, of the number of awards that are expected to be forfeited. This estimate is revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Stock-based compensation cost that has been expensed in the statements of operations amounted to $244,000$446,000 and $939,000,$454,000, respectively, for the three months ended September 30,June30, 2019 and 2018 and 2017$723,000 and $1.1 million and $2.2 million,$881,000, respectively, for the ninesix months ended SeptemberJune 30, 2019 and 2018, and 2017,is allocated as follows:

The Company did not issue anyissued 55,000 stock options during the three and six months ended SeptemberJune 30, 20182019 and 2017, and the Company issued 80,000 and 50,000 stock options during the ninethree and six months ended SeptemberJune 30, 2018 and 2017, respectively.2018. Additionally, the Company issued 287,00050,000 restricted stock units during the ninethree and six months ended September 30, 2017June 2019, and did not issue any restricted stock units during the three and ninesix months ended SeptemberJune 30, 2018 or the three months ended September 30, 2017.

2018.

Key assumptions used in the determination of the fair value of stock options granted are as follows:

Expected Term: The expected term represents the period that the stock-based awards are expected to be outstanding. Due to limited historical experience of similar awards, the expected term was estimated using the simplified method in accordance with the provisions of Staff Accounting Bulletin (“SAB”) No. 107,Share-Based Payment, for awards with stated or implied service periods. The simplified method defines the expected term as the average of the contractual term and the vesting period of the stock option. For awards with performance conditions, and that have the contractual term to satisfy the performance condition, the contractual term was used.

Risk-Free Interest Rate: The risk-free interest rate used was based on the implied yield currently available on U.S. Treasury issues with an equivalent remaining term.

Expected Dividend: The expected dividend assumption is based on management’s current expectation about the Company’s anticipated dividend policy. The Company does not anticipate declaring dividends in the foreseeable future.

Expected Volatility: Since the Company did not have sufficient trading history, the volatility factor was based on the average of similar public companies through August 2014. When selecting similar companies, the Company considered the industry, stage of life cycle, size, and financial leverage. Beginning in August 2014, the volatility factor is based on a combination of the Company's trading history since March 2014 and the average of similar public companies. Beginning in July 2017, the volatility factor is based solely on the Company’s trading history since March 2014.

For options granted during the three and nine months ended September 30, 2018 and 2017, the Company calculated the fair value of each option grant on the respective dates of grant using the following weighted average assumptions:

FASB ASC 718,Stock Compensation, requires the Company to recognize compensation expense for the portion of options that are expected to vest. Therefore, the Company applied estimated forfeiture rates that were derived from historical employee termination behavior. If the actual number of forfeitures differs from those estimated by management, additional adjustments to compensation expense may be required in future periods.

As of SeptemberJune 30, 2018,2019, there was $1.2 million$769,000 of total unrecognized compensation cost related to unvested share-based compensation arrangements granted under the Company’s stock plans.option plan. That cost is expected to be recognized over a weighted average period of 1.521.69 years and will be adjusted for subsequent changes in estimated forfeitures. Additionally, as of SeptemberJune 30, 2018,2019, there was $594,000$878,000 of total unrecognized compensation cost related to unvested restricted stock units that have either time-based or performance vesting.

In April 2014, the board of directors adopted the 2014 Stock and Incentive Plan ("2014 Plan") subject to shareholder approval which was received in June 2014. The 2014 Plan provides for the granting of nonqualified and incentive stock options, stock appreciation rights, restricted stock units, restricted stock and dividend equivalents. An aggregate of 1,000,000 shares are authorized for issuance under the 2014 Plan. Additionally, 271,906 remaining authorized shares under the 2011 Equity Incentive Plan ("2011 Plan") were issuable under the 2014 Plan at the time of the 2014 Plan adoption. Upon receiving shareholder approval in June 2016, the 2014 Plan was amended and restated to increase the authorized number of shares of common stock of the Company issuable under all awards granted under the 2014 Plan from 1,271,906 to 2,471,906. Additionally, upon receiving shareholder approval in June 2018, the 2014 Plan was further amended and restated to increase the authorized number of shares of common stock of the Company issuable under all awards granted under the 2014 Plan from 2,471,906 to 3,221,906. The board of directors, on an option-by-option basis, determines the number of shares, exercise price, term, and vesting period. Options granted generally have a ten-year contractual life. The Company issues shares of common stock upon the exercise of options with the source of those shares of common stock being either newly issued shares or shares held in treasury. An aggregate of 3,221,906 shares are authorized for issuance under the 2014 Plan, with 1,528,704853,117 shares remaining available for grant as of SeptemberJune 30, 2018.2019.