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UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2019

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934

 

FOR THE TRANSITION PERIOD FROM                  TO

 

Commission File No. 001-31298

 

LANNETT COMPANY, INC.

(Exact Name of Registrant as Specified in its Charter)

 

 

9000 State Road

Philadelphia, PA 19136

(215) 333-9000

(Address of principal executive offices and telephone number)

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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 x No o

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files). Yes x No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.  (Check one):

 

Large accelerated filer o		Accelerated filer x
Non-accelerated filer o		Smaller reporting company o
Emerging growth company o

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12B-12 of the Exchange Act).  Yes o No x

 

Indicate the number of shares outstanding of each class of the registrant’s common stock, as of the latest practical date.

 

 

 

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Table of Contents

 

		Page No.
PART I. FINANCIAL INFORMATION
ITEM 1.	FINANCIAL STATEMENTS (UNAUDITED)
	Consolidated Balance Sheets as of September 30, 2019 and June 30, 2019	3
	Consolidated Statements of Operations for the three months ended September 30, 2019 and 2018	4
	Consolidated Statements of Comprehensive Income/Loss for the three months ended September 30, 2019 and 2018	5
	Consolidated Statements of Changes in Stockholders’ Equity for the three months ended September 30, 2019 and 2018	6
	Consolidated Statements of Cash Flows for the three months ended September 30, 2019 and 2018	7
	Notes to Consolidated Financial Statements	8
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	31
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	41
ITEM 4.	CONTROLS AND PROCEDURES	41
PART II. OTHER INFORMATION
ITEM 1.	LEGAL PROCEEDINGS	41
ITEM 1A.	RISK FACTORS	41
ITEM 6.	EXHIBITS	44

 

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PART I.  FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

 

LANNETT COMPANY, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands, except share and per share data)

 

		(Unaudited)
		September 30, 2019			June 30, 2019
ASSETS
Current assets:
Cash and cash equivalents		$	101,008		$	140,249
Accounts receivable, net		173,109			164,752
Inventories		149,162			143,971
Prepaid income taxes		159			—
Assets held for sale		4,637			9,671
Other current assets		6,994			13,606
Total current assets		435,069			472,249
Property, plant and equipment, net		184,889			186,670
Intangible assets, net		427,253			411,229
Operating lease right-of-use assets		6,410			—
Deferred tax assets		110,396			109,305
Other assets		7,914			7,960
TOTAL ASSETS		$	1,171,931		$	1,187,413
LIABILITIES
Current liabilities:
Accounts payable		$	26,927		$	13,493
Accrued expenses		6,233			5,805
Accrued payroll and payroll-related expenses		12,347			19,924
Rebates payable		43,358			46,175
Royalties payable		16,597			16,215
Restructuring liability		1,167			2,315
Income taxes payable		—			2,198
Current operating lease liabilities		1,932			—
Short-term borrowings and current portion of long-term debt		66,845			66,845
Other current liabilities		3,652			3,652
Total current liabilities		179,058			176,622
Long-term debt, net		654,432			662,203
Long-term operating lease liabilities		5,626			—
Other liabilities		14,711			14,547
TOTAL LIABILITIES		853,827			853,372
Commitments and contingencies (Note 12)
STOCKHOLDERS’ EQUITY
Common stock ($0.001 par value, 100,000,000 shares authorized; 39,629,271 and 38,969,518 shares issued; 38,526,558 and 38,010,714 shares outstanding at September 30, 2019 and June 30, 2019, respectively)		40			39
Additional paid-in capital		314,645			317,023
Retained earnings		19,918			32,075
Accumulated other comprehensive loss		(661		)	(615		)
Treasury stock (1,102,713 and 958,804 shares at September 30, 2019 and June 30, 2019, respectively)		(15,838		)	(14,481		)
Total stockholders’ equity		318,104			334,041
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY		$	1,171,931		$	1,187,413

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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LANNETT COMPANY, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

(In thousands, except share and per share data)

 

		Three Months Ended September 30,
		2019			2018
Net sales		$	127,342		$	155,054
Cost of sales		77,656			87,690
Amortization of intangibles		7,028			8,223
Gross profit		42,658			59,141
Operating expenses:
Research and development expenses		8,940			9,810
Selling, general and administrative expenses		21,308			20,588
Restructuring expenses		1,388			1,022
Asset impairment charges		1,618			369,499
Total operating expenses		33,254			400,919
Operating income (loss)		9,404			(341,778		)
Other income (loss):
Loss on extinguishment of debt		(2,145		)	—
Investment income		729			379
Interest expense		(19,292		)	(21,433		)
Other		934			(296		)
Total other loss		(19,774		)	(21,350		)
Loss before income tax		(10,370		)	(363,128		)
Income tax expense (benefit)		1,787			(75,600		)
Net loss		$	(12,157	)	$	(287,528	)
Loss per common share:
Basic		$	(0.32	)	$	(7.65	)
Diluted (1)		$	(0.32	)	$	(7.65	)
Weighted average common shares outstanding:
Basic		38,309,267			37,586,327
Diluted (1)		38,309,267			37,586,327

 

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(1) See Note 14 “Loss Per Common Share” for details on calculation.

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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LANNETT COMPANY, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

(In thousands)

 

		Three Months Ended September 30,
		2019			2018
Net loss		$	(12,157	)	$	(287,528	)
Other comprehensive loss, before tax:
Foreign currency translation gain (loss)		(46		)	6
Total other comprehensive (loss) income, before tax		(46		)	6
Income tax related to items of other comprehensive (loss) income		—			—
Total other comprehensive (loss) income, net of tax		(46		)	6
Comprehensive loss		$	(12,203	)	$	(287,522	)

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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LANNETT COMPANY, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(UNAUDITED)

(In thousands)

 

		Common Stock					Additional						Accumulated Other						Total
		Shares Issued		Amount			Paid-In Capital			Retained Earnings			Comprehensive Loss			Treasury Stock			Stockholders’ Equity
Balance, June 30, 2019		38,970		$	39		$	317,023		$	32,075		$	(615	)	$	(14,481	)	$	334,041
Shares issued in connection with share-based compensation plans		660		1			235			—			—			—			236
Share-based compensation		—		—			4,459			—			—			—			4,459
Purchase of treasury stock		—		—			—			—			—			(1,357		)	(1,357		)
Other comprehensive income, net of tax		—		—			—			—			(46		)	—			(46		)
Purchase of capped call		—		—			(7,072		)	—			—			—			(7,072		)
Net loss		—		—			—			(12,157		)	—			—			(12,157		)
Balance, September 30, 2019		39,630		$	40		$	314,645		$	19,918		$	(661	)	$	(15,838	)	$	318,104

 

		Common Stock					Additional						Accumulated Other						Total
		Shares Issued		Amount			Paid-In Capital			Retained Earnings			Comprehensive Loss			Treasury Stock			Stockholders’ Equity
Balance, June 30, 2018		38,257		$	38		$	306,817		$	306,464		$	(515	)	$	(13,889	)	$	598,915
Shares issued in connection with share-based compensation plans		408		1			283			—			—			—			284
Share-based compensation		—		—			3,035			—			—			—			3,035
Purchase of treasury stock		—		—			—			—			—			(406		)	(406		)
Other comprehensive income, net of tax		—		—			—			—			6			—			6
ASC 606 adjustment, net of tax		—		—			—			(2,283		)	—			—			(2,283		)
Net loss		—		—			—			(287,528		)	—			—			(287,528		)
Balance, September 30, 2018		38,665		$	39		$	310,135		$	16,653		$	(509	)	$	(14,295	)	$	312,023

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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LANNETT COMPANY, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(In thousands)

 

		Three Months Ended September 30,
		2019			2018
OPERATING ACTIVITIES:
Net loss		$	(12,157	)	$	(287,528	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Depreciation and amortization		12,789			14,802
Deferred income tax benefit		(1,091		)	(77,698		)
Share-based compensation		4,459			3,035
Asset impairment charges		1,618			369,499
Loss (gain) on sale/disposal of assets		(1,298		)	37
Loss on extinguishment of debt		2,145			—
Amortization of debt discount and other debt issuance costs		4,008			4,539
Other noncash expenses		379			—
Changes in assets and liabilities which provided (used) cash:
Accounts receivable, net		(8,357		)	44,127
Inventories		(5,191		)	(9,842		)
Prepaid income taxes/income taxes payable		(2,193		)	14,386
Other assets		6,789			(2,149		)
Rebates payable		(2,817		)	(12,911		)
Royalties payable		382			(77		)
Restructuring liability		(1,148		)	205
Operating lease liability		(364		)	—
Accounts payable		13,434			(7,320		)
Accrued expenses		471			(1,253		)
Accrued payroll and payroll-related expenses		(7,577		)	2,872
Net cash provided by operating activities		4,281			54,724
INVESTING ACTIVITIES:
Purchases of property, plant and equipment		(4,033		)	(5,802		)
Proceeds from sale of property, plant and equipment		6,305			14,046
Proceeds from sale of outstanding loan to Variable Interest Entity (“VIE”)		—			5,600
Advance to VIE		(250		)	—
Purchases of intangible assets		(23,500		)	—
Net cash provided by (used in) provided by investing activities		(21,478		)	13,844
FINANCING ACTIVITIES:
Proceeds from issuance of long-term debt		86,250			—
Purchase of capped call		(7,072		)	—
Repayments of long-term debt		(96,566		)	(16,711		)
Proceeds from issuance of stock		236			284
Payment of deferred financing fees		(3,489		)	—
Purchase of treasury stock		(1,357		)	(406		)
Net cash used in financing activities		(21,998		)	(16,833		)
Effect on cash and cash equivalents of changes in foreign exchange rates		(46		)	6
NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		(39,241		)	51,741
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		140,249			98,586
CASH AND CASH EQUIVALENTS, END OF PERIOD		$	101,008		$	150,327
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid		$	15,316		$	16,716
Income taxes paid (refunded)		$	5,070		$	(12,282	)
Accrued purchases of property, plant and equipment		$	1,770		$	3,620

 

The accompanying notes are an integral part of the consolidated financial statements.

 

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LANNETT COMPANY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

 

Note 1.  Interim Financial Information

 

The accompanying unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“U.S. GAAP”) for the presentation of interim financial statements and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, the unaudited financial statements do not include all the information and footnotes necessary for a comprehensive presentation of the financial position, results of operations and cash flows for the periods presented.  In the opinion of management, the unaudited financial statements include all the normal recurring adjustments that are necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented.  Operating results for the three months ended September 30, 2019 are not necessarily indicative of the results that may be expected for the fiscal year ending June 30, 2020.  These unaudited financial statements should be read in combination with the other Notes in this section; “Management’s Discussion and Analysis of Financial Condition and Results of Operations” appearing in Item 2; and the Consolidated Financial Statements, including the Notes to the Consolidated Financial Statements, included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2019.  The Consolidated Balance Sheet as of June 30, 2019 was derived from audited financial statements.

 

Note 2.  The Business And Nature of Operations

 

Lannett Company, Inc. (a Delaware corporation) and its subsidiaries (collectively, the “Company” or “Lannett”) primarily develop, manufacture, package, market and distribute solid oral and extended release (tablets and capsules), topical, nasal and oral solution finished dosage forms of drugs that address a wide range of therapeutic areas.  Certain of these products are manufactured by others and distributed by the Company.

 

The Company operates pharmaceutical manufacturing plants in Carmel, New York and Seymour, Indiana.  The Company’s customers include generic pharmaceutical distributors, drug wholesalers, chain drug stores, private label distributors, mail-order pharmacies, other pharmaceutical manufacturers, managed care organizations, hospital buying groups, governmental entities and health maintenance organizations.

 

Note 3.  Summary of Significant Accounting Policies

 

Basis of Presentation

 

The Consolidated Financial Statements have been prepared in conformity with generally accepted accounting principles in the United States (“U.S. GAAP”).

 

Principles of consolidation

 

The Consolidated Financial Statements include the accounts of Lannett Company, Inc. and its wholly-owned subsidiaries.  All intercompany accounts and transactions have been eliminated.

 

Business Combinations

 

Acquired businesses are accounted for using the acquisition method of accounting, which requires that the assets acquired and liabilities assumed be recorded at the date of acquisition at their respective estimated fair values.  The fair values and useful lives assigned to each class of assets acquired and liabilities assumed are based on, among other factors, the expected future period of benefit of the asset, the various characteristics of the asset and projected future cash flows.  Significant judgment is employed in determining the assumptions utilized as of the acquisition date and for each subsequent measurement period.  Accordingly, changes in assumptions described above could have a material impact on our consolidated results of operations.

 

Reclassifications

 

Certain prior year amounts have been reclassified to conform to the current year financial statement presentation.

 

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Use of estimates

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Significant estimates and assumptions are required in the determination of revenue recognition and sales deductions for estimated chargebacks, rebates, returns and other adjustments including a provision for the Company’s liability under the Medicare Part D program.  Additionally, significant estimates and assumptions are required when determining the fair value of long-lived assets, including intangible assets, income taxes, contingencies and share-based compensation.

 

Because of the inherent subjectivity and complexity involved in these estimates and assumptions, actual results could differ from those estimates.

 

Foreign currency translation

 

The Consolidated Financial Statements are presented in U.S. Dollars, the reporting currency of the Company.  The financial statements of the Company’s foreign subsidiary are maintained in local currency and translated into U.S. dollars at the end of each reporting period.  Assets and liabilities are translated at period-end exchange rates, while revenues and expenses are translated at average exchange rates during the period.  The adjustments resulting from the use of differing exchange rates are recorded as part of stockholders’ equity in accumulated other comprehensive income (loss).  Gains and losses resulting from transactions denominated in foreign currencies are recognized in the Consolidated Statements of Operations under Other income (loss).  Amounts recorded due to foreign currency fluctuations are immaterial to the Consolidated Financial Statements.

 

Cash and cash equivalents

 

The Company considers all highly liquid investments with original maturities less than or equal to three months at the date of purchase to be cash and cash equivalents.  Cash and cash equivalents are stated at cost, which approximates fair value, and consist of bank deposits and certificates of deposit that are readily convertible into cash.  The Company maintains its cash deposits and cash equivalents at well-known, stable financial institutions.  Such amounts frequently exceed insured limits.

 

Allowance for doubtful accounts

 

The Company continuously monitors collections and payments from its customers and maintains a provision for estimated credit losses.  The Company determines its allowance for doubtful accounts by considering a number of factors, including the length of time balances are past due, the Company’s previous loss history, the customer’s current ability to pay its obligations to the Company and the condition of the general economy and the industry as a whole.  The Company writes off accounts receivable when they are determined to be uncollectible.

 

Inventories

 

Inventories are stated at the lower of cost or net realizable value by the first-in, first-out method.  Inventories are regularly reviewed and write-downs for excess and obsolete inventory are recorded based primarily on current inventory levels, expiration date and estimated sales forecasts.

 

Property, Plant and Equipment

 

Property, plant and equipment are stated at cost less accumulated depreciation.  Depreciation is computed on a straight-line basis over the assets’ estimated useful lives. Repairs and maintenance costs that do not extend the useful life of the asset are expensed as incurred.

 

Intangible Assets

 

Definite-lived intangible assets are stated at cost less accumulated amortization.  Amortization of definite-lived intangible assets is computed on a straight-line basis over the assets’ estimated useful lives which commences upon shipment of the product, generally for periods ranging from 10 to 15 years.  The Company continually evaluates the reasonableness of the useful lives of these assets.  Indefinite-lived intangible assets are not amortized, but instead are tested at least annually for impairment.  Costs to renew or extend the term of a recognized intangible asset are expensed as incurred.

 

Valuation of Long-Lived Assets, including Intangible Assets

 

The Company’s long-lived assets primarily consist of property, plant and equipment and definite and indefinite-lived intangible assets. Property, plant and equipment and definite-lived intangible assets are reviewed for impairment whenever events or changes in circumstances (“triggering events”) indicate that the carrying amount of the asset may not be recoverable.  If a triggering event is determined to have occurred, the asset’s carrying value is compared to the future undiscounted cash flows expected to be generated by the asset.  If the carrying value exceeds the undiscounted cash flows of the asset, then impairment exists.  Indefinite-lived intangible

 

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assets are tested for impairment at least annually during the fourth quarter of each fiscal year or more frequently if events or triggering events indicate that the asset might be impaired.

 

An impairment loss is measured as the excess of the asset’s carrying value over its fair value, which in most cases is calculated using a discounted cash flow model.  Discounted cash flow models are highly reliant on various assumptions which are considered Level 3 inputs, including estimates of future cash flows (including long-term growth rates), discount rates and the probability of achieving the estimated cash flows.

 

In-Process Research and Development

 

Amounts allocated to in-process research and development in connection with a business combination are recorded at fair value and are considered indefinite-lived intangible assets subject to impairment testing in accordance with the Company’s impairment testing policy for indefinite-lived intangible assets.  As products in development are approved for sale, amounts will be allocated to product rights and will be amortized over their estimated useful lives.  Definite-lived intangible assets are amortized over the expected lives of the related assets. The judgments made in determining the estimated fair value of in-process research and development, as well as asset lives, can materially impact our results of operations.  The Company’s fair value assessments are highly reliant on various assumptions which are considered Level 3 inputs, including estimates of future cash flows (including long-term growth rates), discount rates and the probability of achieving the estimated cash flows.

 

Segment Information

 

The Company operates in one reportable segment, generic pharmaceuticals.  As such, the Company aggregates its financial information for all products.  The table below identifies the Company’s net sales by medical indication for the three months ended September 30, 2019 and 2018.  The medical indication categories for the three months ended September 30, 2018 was reclassified to better align with industry standards and the Company’s peers.

 

(In thousands)		Three Months Ended September 30,
Medical Indication		2019			2018
Analgesic		$	1,884		$	1,829
Anti-Psychosis		28,034			10,889
Cardiovascular		21,606			21,770
Central Nervous System		19,257			14,286
Endocrinology		—			53,878
Gastrointestinal		16,962			17,594
Infectious Disease		11,895			4,480
Migraine		9,143			9,737
Respiratory/Allergy/Cough/Cold		2,707			3,584
Urinary		435			1,541
Other		9,861			10,805
Contract manufacturing revenue		5,558			4,661
Total		$	127,342		$	155,054

 

Customer, Supplier and Product Concentration

 

The following table presents the percentage of total net sales, for the three months ended September 30, 2019 and 2018, for one of the Company’s products, defined as products containing the same active ingredient or combination of ingredients, which accounted for at least 10% of net sales in any of those periods:

 

		2019		2018
Product 1		20	%	6	%
Product 2		—	%	35	%

 

The following table presents the percentage of total net sales, for the three months ended September 30, 2019 and 2018, for certain of the Company’s customers which accounted for at least 10% of net sales in any of those periods:

 

		2019		2018
Customer A		27	%	18	%
Customer B		25	%	29	%
Customer C		13	%	7	%

 

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The Company’s primary finished goods inventory supplier through March 23, 2019 was Jerome Stevens Pharmaceuticals, Inc. (“JSP”), in Bohemia, New York.  Purchases of finished goods inventory from JSP accounted for approximately 32% of the Company’s inventory purchases during the three months ended September 30, 2018.  There were no purchases of finished goods inventory from JSP in the first quarter of Fiscal 2020.

 

Revenue Recognition

 

On July 1, 2018, the Company adopted Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers, which superseded ASC Topic 605, Revenue Recognition.  Under ASC 606, the Company recognizes revenue when (or as) we satisfy our performance obligations by transferring a promised good or service to a customer at an amount that reflects the consideration the Company is expected to be entitled.  Our revenue consists almost entirely of sales of our pharmaceutical products to customers, whereby we ship product to a customer pursuant to a purchase order.  Revenue contracts such as these do not generally give rise to contract assets or contract liabilities because: (i) the underlying contracts generally have only a single performance obligation and (ii) we do not generally receive consideration until the performance obligation is fully satisfied.  The new revenue standard impacts the timing of the Company’s revenue recognition by requiring recognition of certain contract manufacturing arrangements to change from “upon shipment or delivery” to “over time”.  However, the recognition of these arrangements over time does not currently have a material impact on the Company’s consolidated results of operations or financial position. The Company adopted ASC 606 using the modified retrospective method.

 

When revenue is recognized, a simultaneous adjustment to gross sales is made for estimated chargebacks, rebates, returns, promotional adjustments and other potential adjustments.  These provisions are primarily estimated based on historical experience, future expectations, contractual arrangements with wholesalers and indirect customers and other factors known to management at the time of accrual.  Accruals for provisions are presented in the Consolidated Financial Statements as a reduction to gross sales with the corresponding reserve presented as a reduction of accounts receivable or included as rebates payable, depending on the nature of the reserve.

 

Provisions for chargebacks, rebates, returns and other adjustments require varying degrees of subjectivity.  While rebates generally are based on contractual terms and require minimal estimation, chargebacks and returns require management to make more subjective assumptions.  Each major category is discussed in detail below:

 

Chargebacks

 

The provision for chargebacks is the most significant and complex estimate used in the recognition of revenue. The Company sells its products directly to wholesale distributors, generic distributors, retail pharmacy chains and mail-order pharmacies. The Company also sells its products indirectly to independent pharmacies, managed care organizations, hospitals, nursing homes and group purchasing organizations, collectively referred to as “indirect customers.” The Company enters into agreements with its indirect customers to establish pricing for certain products. The indirect customers then independently select a wholesaler from which to purchase the products. If the price paid by the indirect customers is lower than the price paid by the wholesaler, the Company will provide a credit, called a chargeback, to the wholesaler for the difference between the contractual price with the indirect customers and the wholesaler purchase price. The provision for chargebacks is based on expected sell-through levels by the Company’s wholesale customers to the indirect customers and estimated wholesaler inventory levels. As sales to the large wholesale customers, such as Cardinal Health, AmerisourceBergen and McKesson increase (decrease), the reserve for chargebacks will also generally increase (decrease). However, the size of the increase (decrease) depends on product mix and the amount of sales made to indirect customers with which the Company has specific chargeback agreements. The Company continually monitors the reserve for chargebacks and makes adjustments when management believes that expected chargebacks may differ from the actual chargeback reserve.

 

Rebates

 

Rebates are offered to the Company’s key chain drug store, distributor and wholesaler customers to promote customer loyalty and increase product sales. These rebate programs provide customers with credits upon attainment of pre-established volumes or attainment of net sales milestones for a specified period. Other promotional programs are incentive programs offered to the customers. Additionally, as a result of the Patient Protection and Affordable Care Act (“PPACA”) enacted in the U.S. in March 2010, the Company participates in a new cost-sharing program for certain Medicare Part D beneficiaries designed primarily for the sale of brand drugs and certain generic drugs if their FDA approval was granted under a New Drug Application (“NDA”) or 505(b) NDA versus an abbreviated new drug application (“ANDA’).  Drugs purchased within the Medicare Part D coverage gap (commonly referred to as the “donut hole”) result in additional rebates. The Company estimates the reserve for rebates and other promotional credit programs based on the specific terms in each agreement when revenue is recognized. The reserve for rebates increases (decreases) as sales to certain wholesale and retail customers increase (decrease). However, since these rebate programs are not identical for all customers, the size of the reserve will depend on the mix of sales to customers that are eligible to receive rebates.

 

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Returns

 

Consistent with industry practice, the Company has a product returns policy that allows customers to return product within a specified time period prior to and subsequent to the product’s expiration date in exchange for a credit to be applied to future purchases. The Company’s policy requires that the customer obtain pre-approval from the Company for any qualifying return. The Company estimates its provision for returns based on historical experience, changes to business practices, credit terms and any extenuating circumstances known to management. While historical experience has allowed for reasonable estimations in the past, future returns may or may not follow historical trends. The Company continually monitors the reserve for returns and makes adjustments when management believes that actual product returns may differ from the established reserve. Generally, the reserve for returns increases as net sales increase.

 

Other Adjustments

 

Other adjustments consist primarily of “price adjustments, also known as “shelf-stock adjustments” and “price protections,” which are both credits issued to reflect increases or decreases in the invoice or contract prices of the Company’s products.  In the case of a price decrease, a credit is given for product remaining in customer’s inventories at the time of the price reduction.  Contractual price protection results in a similar credit when the invoice or contract prices of the Company’s products increase, effectively allowing customers to purchase products at previous prices for a specified period of time.  Amounts recorded for estimated shelf-stock adjustments and price protections are based upon specified terms with direct customers, estimated changes in market prices and estimates of inventory held by customers.  The Company regularly monitors these and other factors and evaluates the reserve as additional information becomes available.  Other adjustments also include prompt payment discounts and “failure-to-supply” adjustments.  If the Company is unable to fulfill certain customer orders, the customer can purchase products from our competitors at their prices and charge the Company for any difference in our contractually agreed upon prices.

 

Leases

 

On July 1, 2019, the Company adopted ASC Topic 842, Leases, which superseded ASC Topic 840, Leases.  Refer to the “Recent Accounting Pronouncements” section of this footnote for further discussion on the impact of the adoption.  Under ASC 842, when the Company enters into a new arrangement, it must determine, at the inception date, whether the arrangement is or contains a lease.  This determination generally depends on whether the arrangement conveys to the Company the right to control the use of an explicitly or implicitly identified asset for a period of time in exchange for consideration.  Control of an underlying asset is conveyed to the Company if the Company obtains the rights to direct the use of and to obtain substantially all of the economic benefits from using the underlying asset.  Once a lease has been identified, the Company must determine the lease term, the present value of lease payments and the classification of the lease as either operating or financing.

 

The lease term is determined to be the non-cancelable period including any lessee renewal options which are considered to be reasonably certain of exercise.  Our lease agreements do not contain any material residual value guarantees or material restrictive covenants

 

The present value of lease payments includes fixed and certain variable payments, less lease incentives, together with amounts probable of being owed by the Company under residual value guarantees and, if reasonably certain of being paid, the cost of certain renewal options and early termination penalties set forth in the lease arrangement.  To calculate the present value of lease payments, we use our incremental borrowing rate based on the information available at commencement date, as the rate implicit in the lease is generally not readily available.

 

In making the determination of whether a lease is an operating lease or a finance lease, the Company considers the lease term in relation to the economic life of the leased asset, the present value of lease payments in relation to the fair value of the leased asset and certain other factors.

 

Upon the commencement of the lease, the Company will record a lease liability and right-of-use (“ROU”) asset based on the present value of the future minimum lease payments over the lease term at commencement date.  The ROU asset also includes any lease payments made and excludes lease incentives and initial direct costs incurred.

 

For operating leases, a single lease cost is generally recognized in the Consolidated Statements of Operations on a straight-line basis over the lease term unless an impairment has been recorded with respect to a leased asset.  For finance leases, amortization expense and interest expense are recognized separately in the Consolidated Statements of Operations, with amortization expense generally recorded on a straight-line basis and interest expense recorded using the effective interest method.  Variable lease costs not initially included in the lease liability and ROU asset impairment charges are expensed as incurred.

 

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Cost of Sales, including Amortization of Intangibles

 

Cost of sales includes all costs related to bringing products to their final selling destination, which includes direct and indirect costs, such as direct material, labor and overhead expenses.  Additionally, cost of sales includes product royalties, depreciation, amortization and costs to renew or extend recognized intangible assets, freight charges and other shipping and handling expenses.

 

Research and Development

 

Research and development costs are expensed as incurred, including all production costs until a drug candidate is approved by the Food and Drug Administration (“FDA”).  Research and development expenses include costs associated with internal projects as well as costs associated with third-party research and development contracts.

 

Contingencies

 

Loss contingencies, including litigation-related contingencies, are included in the Consolidated Statements of Operations when the Company concludes that a loss is both probable and reasonably estimable.  Legal fees for litigation-related matters are expensed as incurred and included in the Consolidated Statements of Operations under the Selling, general and administrative expenses line item.

 

Restructuring Costs

 

The Company records charges associated with approved restructuring plans to remove duplicative headcount and infrastructure associated with business acquisitions or to simplify business processes.  Restructuring charges can include severance costs to eliminate a specified number of employees, infrastructure charges to vacate facilities and consolidate operations and contract cancellation costs. The Company records restructuring charges based on estimated employee terminations, site closure and consolidation plans. The Company accrues severance and other employee separation costs under these actions when it is probable that a liability exists and the amount is reasonably estimable.

 

Share-based Compensation

 

Share-based compensation costs are recognized over the vesting period, using a straight-line method, based on the fair value of the instrument on the date of grant less an estimate for expected forfeitures.  The Company uses the Black-Scholes valuation model to determine the fair value of stock options, the stock price on the grant date to value restricted stock and the Monte-Carlo simulation model to determine the fair value of performance-based shares.  The Black-Scholes valuation and Monte-Carlo simulation models include various assumptions, including the expected volatility, the expected life of the award, dividend yield and the risk-free interest rate as well as performance assumptions of peer companies.  These assumptions involve inherent uncertainties based on market conditions which are generally outside the Company’s control.  Changes in these assumptions could have a material impact on share-based compensation costs recognized in the consolidated financial statements.

 

Self-Insurance

 

The Company self-insures for certain employee medical and prescription benefits.  The Company also maintains stop loss coverage with third party insurers to limit its total liability exposure.  The liability for self-insured risks is primarily calculated using independent third-party actuarial valuations which take into account actual claims, claims growth and claims incurred but not yet reported.  Actual experience, including claim frequency and severity as well as health-care inflation, could result in different liabilities than the amounts currently recorded.  The liability for self-insured risks under this plan as of September 30, 2019 totaled $1.5 million and was not material to the financial position of the Company as of June 30, 2019.

 

Income Taxes

 

The Company uses the liability method to account for income taxes as prescribed by ASC 740, Income Taxes.  Deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences reverse.  Deferred tax expense (benefit) is the result of changes in deferred tax assets and liabilities.  Deferred income tax assets and liabilities are adjusted to recognize the effects of changes in tax laws or enacted tax rates in the period during which they are signed into law.  The factors used to assess the likelihood of realization are the Company’s forecast of future taxable income and available tax planning strategies that could be implemented to realize the net deferred tax assets.  Under ASC 740, Income Taxes, a valuation allowance is required when it is more likely than not that all or some portion of the deferred tax assets will not be realized through generating sufficient future taxable income.  Failure to achieve forecasted taxable income in applicable tax jurisdictions could affect the ultimate realization of deferred tax assets and could result in an increase in the Company’s effective tax rate on future earnings.

 

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The Company may recognize the tax benefit from an uncertain tax position claimed on a tax return only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position.  The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.  The authoritative accounting standards also provide guidance on de-recognition, classification, interest and penalties on income taxes, accounting in interim periods and requires increased disclosures.

 

On December 22, 2017, President Trump signed the Tax Cut and Jobs Act legislation (“2017 Tax Reform”) into law, which included a broad range of tax reform provisions affecting businesses, including corporate tax rates, business deductions and international tax provisions.  Many of these provisions significantly differ from the then-current U.S. tax law, resulting in pervasive financial reporting implications.  As a result of the new law, the SEC issued Staff Accounting Bulletin No. 118 (“SAB 118”) to address the application of U.S. GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed in reasonable detail to complete the accounting for certain income tax effects of 2017 Tax Reform.  SAB 118 requires registrants to report the tax effects of 2017 Tax Reform, inclusive of provisional amounts for which the accounting is incomplete but a reasonable estimate can be determined.  In the second quarter of Fiscal 2019, the Company finalized the provisional amounts without any further adjustments.

 

Earnings (Loss) Per Common Share

 

A dual presentation of basic and diluted earnings (loss) per common share is required on the face of the Company’s Consolidated Statement of Operations as well as a reconciliation of the computation of basic earnings (loss) per common share to diluted earnings (loss) per common share.  Basic earnings (loss) per common share excludes the dilutive impact of potentially dilutive securities and is computed by dividing net income (loss) by the weighted average number of shares outstanding during the period.  Beginning in the first quarter of Fiscal 2020, the Company’s diluted earnings (loss) per common share is computed using the “if-converted” method by dividing the adjusted “if-converted” net income by the adjusted weighted average number of shares of common stock outstanding during the period.  The adjusted “if-converted” net income is adjusted for interest expense and amortization of debt issuance costs, both net of tax, associated with the Company’s 4.50% Convertible Senior Notes due 2026.  The weighted average number of diluted shares is adjusted for the potential dilutive effect of the exercise of stock options, treats unvested restricted stock and performance-based shares as if it were vested, and assumes the conversion of the 4.50% Convertible Senior Notes.  Anti-dilutive securities are excluded from the calculation.  Dilutive shares are also excluded in the calculation in periods of net loss because the effect of including such securities would be anti-dilutive.

 

Comprehensive Income (Loss)

 

Comprehensive income (loss) includes all changes in equity during a period except those that resulted from investments by or distributions to the Company’s stockholders.  Other comprehensive income (loss) refers to gains and losses that are included in comprehensive income (loss), but excluded from income (loss) for all amounts are recorded directly as an adjustment to stockholders’ equity.

 

Recent Accounting Pronouncements

 

In February 2016, the FASB issued ASU 2016-02, Leases.  ASU 2016-02 requires an entity to recognize ROU assets and liabilities on its balance sheet for all leases with terms longer than 12 months.  Lessees and lessors are required to disclose quantitative and qualitative information about leasing arrangements to enable a user of the financial statements to assess the amount, timing and uncertainty of cash flows arising from leases.  ASU 2016-02 is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period and requires a modified retrospective application, with early adoption permitted.  The Company adopted ASU 2016-02 as of July 1, 2019 on a modified retrospective basis applying the guidance to leases existing as of this effective date.  The Company has determined that there was no cumulative-effect adjustment to beginning retained earnings on the consolidated balance sheet.  The Company will continue to report periods prior to July 1, 2019 in our financial statements under prior guidance as outlined in Topic 840.  Refer to Note 12 “Commitments” for additional information.

 

The Company’s adoption of ASU No. 2016-02 resulted in an increase in the Company’s assets and liabilities of $7.9 million at July 1, 2019.  The Company’s adoption of ASU No. 2016-02 did not have any impact to the Company’s consolidated statements of operations, or its consolidated statements of cash flows.  Further, there was no impact on the Company’s covenant compliance under its current debt agreements as a result of the adoption of ASU No. 2016-02.  The Company elected the package of practical expedients included in this guidance, which allowed it to not reassess: (i) whether any expired or existing contracts contain leases; (ii) the lease classification for any expired or existing leases; and, (iii) the initial direct costs for existing leases.  The Company does not recognize short-term leases of 12 months or less on its consolidated balance sheets and will recognize those lease payments in the consolidated statements of operations on a straight-line basis over the lease term.

 

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Note 4.  Restructuring Charges

 

Cody Restructuring Program

 

On June 29, 2018, the Company announced a restructuring plan with respect to Cody Labs (the “Cody Restructuring Plan”).  The plan focused on a more select set of opportunities which resulted in streamlined operations, improved efficiencies and a reduced cost structure.  The Company incurred approximately $2.5 million of severance and employee-related costs under this plan.  The restructuring activities under the Cody Restructuring Program are complete as of September 30, 2019.

 

The expenses associated with the Cody Restructuring Plan included in restructuring expenses during the three months ended September 30, 2019 and September 30, 2018 were as follows:

 

		Three Months Ended			Three Months Ended
(In thousands)		September 30, 2019			September 30, 2018
Employee separation costs		$	—		$	144
Facility closure costs		—			—
Total		$	—		$	144

 

A reconciliation of the changes in restructuring liabilities associated with the Cody Restructuring Plan from June 30, 2019 through September 30, 2019 is set forth in the following table:

 

(In thousands)		Employee Separation Costs			Facility Closure Costs			Total
Balance at June 30, 2019		$	108		$	—		$	108
Restructuring Charges		—			—			—
Payments		(108		)	—			(108		)
Balance at September 30, 2019		$	—		—			$	—

 

Cody API Restructuring Plan

 

In September 2018, the Company approved a plan to sell the active pharmaceutical ingredient manufacturing distribution business of Cody Labs (the “Cody API business”).  The Company was unable to sell the Cody API business as an ongoing operation and intended to sell the equipment and real estate utilized by the Cody API business upon receiving approval of the Company’s cocaine hydrochloride solution Section 505(b)(2) NDA application and to have Cody Labs cease all operations.  In June 2019, the Company approved the Cody API Restructuring Plan.  In connection with the Cody API Restructuring Plan, there has been a reduction of almost 70 positions at Cody Labs.  The restructuring activities under the Cody API Restructuring Plan are substantially complete as of September 30, 2019.  In the first quarter of Fiscal 2020, the Company completed the sale of a portion of the equipment associated with the Cody API business for $2.0 million.

 

The costs to implement the Cody API Restructuring Plan total approximately $6.0 million, including approximately $3.5 million of severance and employee-related costs and approximately $2.0 million of contract termination costs, as well as approximately $0.5 million of costs to be incurred in connection with moving equipment and other property to other Company-owned facilities that were originally anticipated to be incurred in connection with the Cody Restructuring Plan announced in June 2018.

 

The expenses associated with the Cody API Restructuring Plan included in restructuring expenses during the three months ended September 30, 2019 were as follows:

 

(In thousands)		Three Months Ended September 30, 2019
Employee separation costs		$	892
Facility closure costs		496
Total		$	1,388

 

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A reconciliation of the changes in restructuring liabilities associated with the Cody API Restructuring Plan from June 30, 2019 through September 30, 2019 is set forth in the following table:

 

(In thousands)		Employee Separation Costs			Contract Termination Costs			Facility Closure Costs			Total
Balance at June 30, 2019		$	2,207		$	—		$	—		$	2,207
Restructuring Charges		892			—			496			1,388
Payments		(1,932		)	—			(496		)	(2,428		)
Balance at September 30, 2019		$	1,167		$	—		—			$	1,167

 

2016 Restructuring Program

 

On February 1, 2016, in connection with the acquisition of Kremers Urban Pharmaceuticals Inc.( “KUPI”), the Company announced a plan related to the future integration of KUPI and the Company’s operations (the “2016 Restructuring Program”).  The plan focused on the closure of KUPI’s corporate functions and the consolidation of manufacturing, sales, research and development and distribution functions.  The restructuring activities under the 2016 Restructuring Program were completed as of March 31, 2019.  The Company incurred an aggregate of approximately $21.0 million in restructuring charges for actions that have been announced or communicated since the 2016 Restructuring Program began.  Of this amount, approximately $11.0 million related to employee separation costs, approximately $1.0 million relates to contract termination costs and approximately $9.0 million related to facility closure costs and other actions.

 

The expenses associated with the restructuring program included in restructuring expenses during the three months ended September 30, 2018 were as follows:

 

		Three
		Months Ended
(In thousands)		September 30, 2018
Employee separation costs		$	414
Facility closure costs		464
Total		$	878

 

Note 5.  Accounts Receivable

 

Accounts receivable consisted of the following components at September 30, 2019 and June 30, 2019:

 

(In thousands)		September 30, 2019			June 30, 2019
Gross accounts receivable		$	362,309		$	361,323
Less: Chargebacks reserve		(83,483		)	(89,567		)
Less: Rebates reserve		(31,473		)	(32,099		)
Less: Returns reserve		(53,992		)	(55,554		)
Less: Other deductions		(19,109		)	(18,128		)
Less: Allowance for doubtful accounts		(1,143		)	(1,223		)
Accounts receivable, net		$	173,109		$	164,752

 

For the three months ended September 30, 2019, the Company recorded a provision for chargebacks, rebates (including rebates presented as rebates payable), returns and other deductions of $207.9 million, $58.5 million, $3.7 million and $12.7 million, respectively.  For the three months ended September 30, 2018, the Company recorded a provision for chargebacks, rebates (including rebates presented as rebates payable), returns and other deductions of $277.9 million, $64.7 million, $7.3 million and $13.9 million, respectively.

 

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The following table identifies the activity and ending balances of each major category of revenue-related reserve for the three months ended September 30, 2019 and 2018:

 

Reserve Category (In thousands)		Chargebacks			Rebates			Returns			Other			Total
Balance at June 30, 2019		$	89,567		$	78,274		$	55,554		$	18,128		$	241,523
Current period provision		207,933			58,509			3,694			12,705			282,841
Credits issued during the period		(214,017		)	(61,952		)	(5,256		)	(11,724		)	(292,949		)
Balance at September 30, 2019		$	83,483		$	74,831		$	53,992		$	19,109		$	231,415

 

Reserve Category (In thousands)		Chargebacks			Rebates			Returns			Other			Total
Balance at June 30, 2018		$	153,034		$	82,502		$	43,059		$	20,021		$	298,616
Adjustment related to adoption of ASC 606		—			—			—			3,536			3,536
Current period provision		277,949			64,749			7,347			13,889			363,934
Credits issued during the period		(305,407		)	(76,626		)	(6,045		)	(13,146		)	(401,224		)
Balance at September 30, 2018		$	125,576		$	70,625		$	44,361		$	24,300		$	264,862

 

For the three months ending September 30, 2019 and 2018, as a percentage of gross sales the provision for chargebacks was 51.4% and 54.0%, the provision for rebates was 14.5% and 12.6%, the provision for returns was 0.9% and 1.4% and the provision for other adjustments was 3.1% and 2.7%, respectively.

 

On July 1, 2018, the Company adopted ASC 606 which resulted in a $3.2 million pre-tax adjustment to opening retained earnings and accounts receivable, of which $3.5 million related to “failure-to-supply” reserves offset by $0.3 million related to the timing of recognition of certain contract manufacturing arrangements.

 

The decrease in total reserves from June 30, 2019 to September 30, 2019 was mainly attributable to a $9.4 million rebate payment to the Department of Veteran’s Affairs related to pricing overcharges, of which $8.1 million was indemnified by UCB, the former parent company of KUPI.  See Note 11 “Legal, Regulatory Matters and Contingencies” for more information.  Historically, we have not recorded any material amounts in the current period related to reversals or additions of prior period reserves.  If the Company were to record a material reversal or addition of any prior period reserve amount, it would be separately disclosed.

 

Note 6.  Inventories

 

Inventories at September 30, 2019 and June 30, 2019 consisted of the following:

 

(In thousands)		September 30, 2019			June 30, 2019
Raw Materials		$	59,115		$	56,740
Work-in-process		14,359			18,988
Finished Goods		75,688			68,243
Total		$	149,162		$	143,971

 

During the three months ended September 30, 2019 and 2018, the Company recorded write-downs to net realizable value for excess and obsolete inventory of $3.5 million and $3.4 million, respectively.

 

Note 7.  Property, Plant and Equipment

 

Property, plant and equipment at September 30, 2019 and June 30, 2019 consisted of the following:

 

(In thousands)		Useful Lives		September 30, 2019			June 30, 2019
Land		—		$	1,783		$	1,783
Building and improvements		10 – 39 years		89,901			87,609
Machinery and equipment		5 – 10 years		158,555			156,166
Furniture and fixtures		5 – 7 years		3,110			3,105
Less accumulated depreciation				(89,182		)	(83,424		)
				164,167			165,239
Construction in progress				20,722			21,431
Property, plant and equipment, net				$	184,889		$	186,670

 

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Depreciation expense for the three months ended September 30, 2019 and 2018 was $5.8 million and $6.6 million, respectively.

 

In the first quarter of Fiscal 2019, the Company approved a plan to sell the Cody API business and performed a fair value analysis which resulted in a $29.9 million impairment of the Cody API property, plant and equipment assets.  The Company was unable to sell the Cody API business as an ongoing operation and intended to sell the equipment and real estate utilized by the Cody API business and to have Cody Labs cease all operations.  As such, Cody Labs’ property, plant and equipment totaling $6.7 million, were recorded in the assets held for sale caption in the Consolidated Balance Sheet as of June 30, 2019.  As of September 30, 2019, the Company has a remaining balance of $4.6 million recorded in the assets held for sale caption in the Consolidated Balance Sheet.  See Note 19 “Assets Held for Sale” for more information.

 

In the second quarter of Fiscal 2019, the Company ceased manufacturing functions at the Townsend Road facility and decided to sell the property.  The sale was finalized in the first quarter of Fiscal 2020 for total proceeds of $4.3 million.

 

Property, plant and equipment, net included amounts held in foreign countries in the amount of $1.0 million at September 30, 2019 and June 30, 2019.

 

Note 8.  Fair Value Measurements

 

The Company’s financial instruments recorded in the Consolidated Balance Sheets include cash and cash equivalents, accounts receivable, accounts payable, accrued expenses and debt obligations.  Included in cash and cash equivalents are certificates of deposit with maturities less than or equal to three months at the date of purchase and money market funds.  The carrying value of certain financial instruments, primarily cash and cash equivalents, accounts receivable, accounts payable and accrued expenses, approximate their estimated fair values based upon the short-term nature of their maturity dates.

 

The Company follows the authoritative guidance of ASC Topic 820 “Fair Value Measurements and Disclosures.”  Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.  The authoritative guidance also establishes a 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.  The Company’s financial assets and liabilities measured at fair value are entirely within Level 1 of the hierarchy as defined below:

 

Level 1 — Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.

 

Level 2 — Directly or indirectly observable inputs, other than quoted prices, such as quoted prices for similar assets or liabilities; quoted prices for identical or similar instruments in markets that are not active; or model-derived valuations whose inputs are observable or whose significant value drivers are observable.

 

Level 3 — Unobservable inputs that are supported by little or no market activity and that are material to the fair value of the asset or liability.  Financial instruments whose values are determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant judgment or estimation are examples of Level 3 assets and liabilities.

 

If the inputs used to measure the financial assets and liabilities fall within more than one level described above, the categorization is based on the lowest level input that is significant to the fair value measurement of the instrument.

 

Financial Instruments Disclosed, But Not Reported, at Fair Value

 

We estimate the fair value of our debt utilizing market quotations for debt that have quoted prices in active markets. Since our debt does not trade on a daily basis in an active market, the fair value estimates are based on market observable inputs based on borrowing rates currently available for debt with similar terms and average maturities (Level 2).  The estimated fair value of our term loan debt was approximately $656 million and $724 million as of September 30, 2019 and June 30, 2019, respectively.  The estimated fair value of our 4.5% Convertible Senior Notes was approximately $87 million as of September 30, 2019.  The difference between the principal amount of the 4.5% Convertible Senior Notes and its’ estimated fair value represents the equity conversion value premium.

 

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Note 9.  Goodwill and Intangible Assets

 

On August 17, 2018, JSP notified the Company that it would not extend or renew the JSP Distribution Agreement when the current term expired on March 23, 2019.  The Company determined that JSP’s decision represented a triggering event under U.S. GAAP to perform an analysis to determine the potential for impairment of goodwill. On October 4, 2018, the Company completed the analysis based on market data and concluded a full impairment of goodwill, totaling $339.6 million, was required.

 

Intangible assets, net as of September 30, 2019 and June 30, 2019, consisted of the following:

 

		Weighted		Gross Carrying Amount						Accumulated Amortization						Intangible Assets, Net
(In thousands)		Avg. Life (Yrs.)		September 30, 2019			June 30, 2019			September 30, 2019			June 30, 2019			September 30, 2019			June 30, 2019
Definite-lived:
Cody Labs import license		15		$	581		$	581		$	(434	)	$	(424	)	$	147		$	157
KUPI product rights		15		416,154			416,154			(104,519		)	(97,583		)	311,635			318,571
KUPI trade name		2		2,920			2,920			(2,920		)	(2,920		)	—			—
KUPI other intangible assets		15		19,000			19,000			(4,878		)	(4,562		)	14,122			14,438
Silarx product rights		15		10,000			10,000			(2,889		)	(2,722		)	7,111			7,278
Other product rights		13		30,192			26,579			(3,954		)	(4,243		)	26,238			22,336
Total definite-lived				$	478,847		$	475,234		$	(119,594	)	$	(112,454	)	$	359,253		$	362,780
Indefinite-lived:
KUPI in-process research and development		—		$	18,000		$	18,000		$	—		$	—		$	18,000		$	18,000
Silarx in-process research and development		—		18,000			18,000			—			—			18,000			18,000
Other product rights		—		32,000			12,449			—			—			32,000			12,449
Total indefinite-lived				68,000			48,449			—			—			68,000			48,449
Total intangible assets, net				$	546,847		$	523,683		$	(119,594	)	$	(112,454	)	$	427,253		$	411,229

 

For the three months ended September 30, 2019 and 2018, the Company recorded amortization expense of $7.0 million and $8.2 million, respectively.

 

In July 2019, the Company entered into a distribution and supply agreement with Cediprof, Inc.  The Company made an upfront payment of $20.0 million to distribute Levothyroxine Sodium Tablets USP, commencing no later than August 1, 2022, which is included within the “Other product rights” category of indefinite-lived intangible assets.  In August 2019, the Company entered into a distribution and supply agreement with Sinotherapeutics Inc. to distribute Posaconazole Delayed-Release Tablets 100mg.  The Company paid $2.0 million upon FDA approval of the product and $1.5 million upon the first commercial sale of the product, which is included within the “Other product rights” category of definite-lived intangible assets.

 

Future annual amortization expense consisted of the following as of September 30, 2019:

 

(In thousands) Fiscal Year Ending June 30,		Amortization Expense
2020		$	24,228
2021		32,304
2022		32,304
2023		32,304
2024		31,967
Thereafter		206,146
		$	359,253

 

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