NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1 — Business and Basis of Presentation
Business:
Akorn, Inc., together with its wholly-owned subsidiaries (collectively “Akorn,” the “Company,” “we,” “our” or “us”) is a specialty generic pharmaceutical company that develops, manufactures and markets generic and branded prescription pharmaceuticals, branded as well as private-label over-the-counter consumer health products and animal health pharmaceuticals. We are an industry leader in the development, manufacturing and marketing of specialized generic pharmaceutical products in alternative dosage forms. We focus on difficult-to-manufacture sterile and non-sterile dosage forms including, but not limited to, ophthalmics, injectables, oral liquids, otics, topicals, inhalants and nasal sprays.
Akorn is a Louisiana corporation founded in 1971 in Abita Springs, Louisiana. In 1997, we relocated our corporate headquarters to the Chicago, Illinois area and currently maintain our principal corporate offices in Lake Forest, Illinois. We operate pharmaceutical manufacturing facilities in Decatur, Illinois; Somerset, New Jersey; Amityville, New York; Hettlingen, Switzerland; and Paonta Sahib, Himachal Pradesh, India. We also operate a central distribution warehouse in Gurnee, Illinois and additional distribution facilities in Amityville, New York and Decatur, Illinois. Our research and development (“R&D”) centers are located in Vernon Hills, Illinois; Copiague, New York and Cranbury, New Jersey. In the fourth quarter of 2016, we moved our previous R&D center in Warminster, Pennsylvania to Cranbury, New Jersey. We also have other corporate offices in Ann Arbor, Michigan and Gurgaon, Haryana, India.
During the three month periods ended
March 31, 2017
and 2016, the Company reported results for
two
reportable segments: Prescription Pharmaceuticals and Consumer Health. For further detail concerning our reportable segments please see Part I, Item 1, Note 10 - “
Segment Information.”
Our common shares are traded on The NASDAQ Global Select Market under the ticker symbol AKRX. Our principal corporate office is located at 1925 West Field Court, Suite 300, Lake Forest, Illinois 60045 with telephone number (847) 279-6100.
Basis of Presentation
:
The Company’s financial statements have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP") for interim financial information and accordingly do not include all the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments of a normal and recurring nature considered necessary for a fair presentation have been included in these financial statements. Operating results for the three month period ended
March 31, 2017
are not necessarily indicative of the results that may be expected for the full year. For further information, refer to the consolidated financial statements and footnotes for the year ended
December 31, 2016
, included in the Company’s Annual Report on Form 10-K filed on March 1, 2017.
The Company has considered the accounting and disclosure of events occurring after the balance sheet date of
March 31, 2017
through the filing date of this Form 10-Q.
Certain prior-period amounts such as the provision and allowance components of net trade receivables and gross sales to net revenue adjustments have been reclassified to conform to current-period presentation.
Note 2 — Summary of Significant Accounting Policies
Consolidation:
The accompanying condensed consolidated financial statements include the accounts of Akorn, Inc. and its wholly-owned domestic and foreign subsidiaries. All inter-company transactions and balances have been eliminated in consolidation, and the financial statements of Akorn India Private Limited ("AIPL") and Akorn AG (formerly "Excelvision AG" or "Hettlingen") have been translated from Indian Rupees and Swiss Francs, respectively, to U.S. Dollars based on the currency translation rates in effect either during the period or as of the date of consolidation, as applicable. The Company has no involvement with variable interest entities.
Use of Estimates:
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ materially from those estimates.
Significant estimates and assumptions for the Company may relate to the allowances for chargebacks, rebates and administrative fees, product returns, coupons, promotions and doubtful accounts, as well as the reserve for slow-moving and obsolete inventories, the carrying value and lives of intangible assets, the useful lives of fixed assets, the carrying value of deferred income tax assets and liabilities, the assumptions underlying share-based compensation, accrued but unreported employee benefit costs and assumptions underlying the accounting for business combinations.
Going Concern:
In connection with the preparation of the financial statements as of and for the three month period ended March 31, 2017, the Company conducted an evaluation as to whether there were conditions and events, considered in the aggregate, which raised substantial doubt as to the entity's ability to continue as a going concern within one year after the date of the issuance, or the date of availability, of the financial statements to be issued, noting that there did not appear to be evidence of substantial doubt of the entity's ability to continue as a going concern.
Revenue Recognition:
Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the sales price is fixed or determinable, and collectability is reasonably assured. Revenue from product sales are recognized when title and risk of loss have passed to the customer.
Provision for estimated chargebacks, rebates, discounts, managed care rebates, product returns and doubtful accounts is made at the time of sale and is analyzed and adjusted, if necessary, at each balance sheet date.
Freight:
The Company records amounts billed to customers for shipping and handling as revenue, and records shipping and handling expense related to product sales as cost of sales.
Cash and Cash Equivalents:
The Company considers all unrestricted, highly liquid investments with maturity of three months or less when acquired, to be cash and cash equivalents.
Accounts Receivable:
Trade accounts receivable are stated at their net realizable value. The nature of the Company’s business involves, in the ordinary course, significant judgments and estimates relating to chargebacks, coupon redemption, product returns, rebates, discounts given to customers and allowances for doubtful accounts. Depending on the products, the customers, the specific terms of national supply contracts and the particular arrangements with the Company’s wholesaler customers, rebates, chargebacks and other credits are recorded as deductions to the Company’s trade accounts receivable.
Unless otherwise noted, the provisions and allowances for the following customer deductions are reflected in the accompanying condensed consolidated financial statements as reductions of revenues and trade accounts receivable, respectively.
Chargebacks
:
The Company enters into contractual agreements with certain third parties such as retailers, hospitals, group-purchasing organizations (“GPOs”) and managed care organizations to sell certain products at predetermined prices. Similarly, we maintain an allowance for rebates and discounts related to billbacks, wholesaler fee for service contracts, GPO administrative fees, government programs, prompt payment and other adjustments with certain customers. Most of the parties have elected to have these contracts administered through wholesalers that buy the product from the Company and subsequently sell it to these third parties. As noted elsewhere, these wholesalers represent a significant percentage of the Company’s gross sales. When a wholesaler sells products to one of these third parties that are subject to a contractual price agreement, the difference between the price paid to the Company by the wholesaler and the price under the specific contract is charged back to the Company by the wholesaler. This process typically takes four to six weeks, but for some products may extend to twelve weeks. The Company tracks sales and submitted chargebacks by product number and contract for each wholesaler. Utilizing this information, the Company estimates a chargeback percentage for each product and records an allowance as a reduction to gross sales when the Company records its sale of the products. The Company reduces the chargeback allowance when a chargeback request from a wholesaler is processed. Actual chargebacks processed by the Company can vary materially from period to period based upon actual sales volume through the wholesalers. However, the Company’s provision for chargebacks is fully reserved for at the time revenues are recognized.
Management obtains product inventory reports from certain wholesalers to aid in analyzing the reasonableness of the chargeback allowance and to monitor whether wholesaler inventory levels do not significantly exceed customer demand. The Company assesses the reasonableness of its chargeback allowance by applying a product chargeback percentage that is based on a combination of historical activity and future price and mix expectations to the quantities of inventory on hand at the wholesalers according to wholesaler inventory reports. In addition, the Company estimates the percent of gross sales generated through direct and indirect sales channels and the percent of contract vs. non-contract revenue in the period, as these each affect the estimated reserve calculation. In accordance with its accounting policy, the Company also estimates the percent of wholesaler inventory that will ultimately be sold to third parties that are subject
to contractual price agreements based on a trend of such sales through wholesalers. The Company uses this percentage estimate until historical trends indicate that a revision should be made. On an ongoing basis, the Company evaluates its actual chargeback rate experience, and new trends are factored into its estimates each quarter as market conditions change.
For the three month period ended March 31, 2017, the Company incurred a chargeback provision of
$280.2 million
, or
41.2%
of gross sales of
$680.5 million
, compared to
$219.4 million
, or
37.0%
of gross sales of
$593.4 million
in the prior year period. We note that the dollar and percent increase in the comparative period was the result of gross sales increases and product mix shifts to products with higher chargeback expense percentages. The Company ensures that this rate as a percent of gross sales is reasonable through inspection of contractual obligations, review of historical trends and evaluation of recent activity. Furthermore, other events that could materially alter chargeback rates include: changes in product pricing as a result of competitive market dynamics or negotiations with customers, changes in demand for specific products due to external factors such as competitor supply position or consumer preferences, customer shifts in buying patterns from direct to indirect through wholesalers, which could either individually or in aggregate increase or decrease the chargeback rate depending on the direction and velocity of the change(s).
To better understand the impact of changes in chargeback reserve based on circumstances that are not fully outside the Company’s control, for instance, the ratio of sales subject to chargeback to indirect sales, the Company performs a sensitivity analysis. Holding all other assumptions constant, for a
119
basis point (“BP”) change in the ratio of sales subject to chargeback to indirect sales would increase the chargeback reserve by
$0.5 million
or decrease the chargeback reserve by
$1.0 million
depending on the change in the direction of the ratio. Fundamentally, the BP change calculation is determined based on the six month trend of the average ratio of sales subject to chargeback to indirect sales. Due to the competitive generic pharmaceutical industry and our recent experience with wholesalers’ strategy and shifts in contracted and non-contracted indirect sales, we believe that the six month trend of the proportion of direct to indirect sales provides a representative basis for sensitivity analysis.
Starting with the second quarter of 2016, the Company determined that in order to more closely align with internal analysis of associated reserves it would adjust the allowances disclosure to separately report rebates from chargebacks and rebates for both net trade accounts receivable and gross sales adjustments and to consolidate administrative fees and others with rebates for purposes of reporting gross sales to net revenue reserves. As a result, the first quarter 2016 information has been recast to reflect this disclosure change.
Rebates, Administrative Fees and Others
: The Company maintains an allowance for rebates, administrative fees and others, related to contracts and other rebate programs that it has in place with certain customers. Rebates, administrative fees and other percentages vary by product and by volume purchased by each eligible customer. The Company tracks sales by product number for each eligible customer and then applies the applicable rebate, administrative fees and other percentage, using both historical trends and actual experience to estimate its rebates, administrative fees and others allowances. The Company reduces gross sales and increases the rebates, administrative fees and others allowance by the estimated rebates, administrative fees and others amounts when the Company sells its products to eligible customers. The Company reduces the rebate allowance when it processes a customer request for a rebate. At each balance sheet date, the Company analyzes the allowance for rebates, administrative fees and others against actual rebates processed and makes adjustments as appropriate. The amount of actual rebates processed can vary materially from period to period as discussed below.
The allowances for rebates, administrative fees and others further takes into consideration price adjustments which are 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 shelf-stock adjustment credit may be 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.
Similar to rebates, the reserve for administrative fees and others represents those amounts processed related to contracts and other fee programs which have been in place with certain entities, but they are settled through cash payment to these entities and accordingly are accounted for as a current liability. Otherwise, administrative fees and others operate similarly to rebates.
For the three month period ended March 31, 2017 the Company recorded a rebates, administrative fees and others provision of
$124.4 million
, or
18.3%
of gross sales of
$680.5 million
, compared to
$88.3 million
, or
14.9%
of gross sales of
$593.4 million
in the prior year period. We note that the dollar and percent increase from the comparative period was the result of gross sales increases and product mix shifts to products with higher rebates, administrative fees and others expense percentages. The Company ensures that this rate as a percent of gross sales is reasonable through inspection of contractual obligations, review of historical trends and evaluation of recent activity. Furthermore, other events that could materially alter rebates, administrative fees and others rates include: changes in product pricing as a result of competitive market dynamics or negotiations with customers, changes in demand for specific products due to external factors such as competitor supply position or consumer preferences, customer shifts in buying patterns from direct to indirect through wholesalers, which could either individually or in aggregate increase or decrease the rebate rate depending on the direction and velocity of the change(s).
To better understand the impact of changes in reserves for rebates, administrative fees and others based on circumstances that are not fully outside the Company’s control, for instance, the proportion of direct to indirect sales subject to rebates, administrative fees and others, the Company performs a sensitivity analysis. Holding all other assumptions constant, for a
119
BP change in the ratio of sales subject to rebates, administrative fees and others to indirect sales would increase the reserve for rebates, administrative fees and others by
$0.2 million
or decrease the same reserve by
$0.2 million
depending on the direction of the change in the ratio. Fundamentally, the BP change calculation is determined based on the six month trend of the average ratio of sales subject to rebates, administrative fees and others to indirect sales. Due to the competitive generic pharmaceutical industry and our recent experience with wholesalers’ strategy and shifts in contracted and non-contracted indirect sales, we believe the six month trend of the average ratio of sales subject to rebates, administrative fees and others to indirect sales provides a representative basis for sensitivity analysis.
Sales Returns:
Certain of the Company’s products are sold with the customer having the right to return the product within specified periods. Provisions are made at the time of sale based upon historical experience. Historical factors such as one-time recall events as well as pending new developments like comparable product approvals or significant pricing movement that may impact the expected level of returns are taken into account to determine the appropriate reserve estimate at each balance sheet date. As part of the evaluation of the reserve required, the Company considers actual returns to date that are in process, the expected impact of any product recalls and the amount of wholesaler’s inventory to assess the magnitude of unconsumed product that may result in sales returns to the Company in the future. The sales returns level can be impacted by factors such as overall market demand and market competition and availability for substitute products which can increase or decrease the pull through for sales of the Company’s products and ultimately impact the level of sales returns.
For the three month period ended March 31, 2017, the Company incurred a return provision of
$8.4 million
, or
1.2%
of gross sales of
$680.5 million
, compared to
$4.3 million
, or
0.7%
of gross sales of
$593.4 million
in the prior year period. We note that the dollar increase and percent decrease in the comparative period was the result of gross sales increases and product mix shifts to products with higher return rates. The Company ensures that this rate as a percent of gross sales is reasonable through inspection of historical trends and evaluation of recent activity. Furthermore, other events that could materially alter return rates include: acquisitions and integration activities that consolidate dissimilar contract terms and could decrease the return rate as typically the Company purchases smaller entities with less contracting power and integrates those product sales to Akorn contracts; and consumer demand shifts by products, which could either increase or decrease the return rate depending on the product or products specifically demanded and ultimately returned.
To better understand the impact of changes in return reserve based on certain circumstances, the Company performs a sensitivity analysis. Holding all other assumptions constant, for an average
1.0
month change in the lag from the time of sale to the time the product return is processed, this change would result in an increase of
$1.8 million
or decrease of
$1.5 million
in return reserve expense if the lag increases or decreases, respectively. The average
1.0
month change in the lag from the time of sale to the time the product return is processed was determined based on the average variances of the last six-month historical activities. Due to the change in the volume and type of products sold by the Company in the recent past, we have determined that the lag calculation provides a reasonable basis for sensitivity analysis.
Allowance for Coupons, Promotions and Co-Pay discount cards:
The Company issues coupons from time to time that are redeemable against certain of our Consumer Health products. Upon release of coupons into the market, the Company records an estimate of the dollar value of coupons expected to be redeemed. This estimate is based on historical experience and is adjusted as needed based on actual redemptions. In addition to couponing, from time to time the Company authorizes various retailers to run in-store promotional sales of its products. Upon receiving confirmation that a promotion was run, the Company accrues an estimate of the dollar amount expected to be owed back to the retailer. This estimate is then adjusted to
actual upon receipt of an invoice from the retailer. Additionally, the Company provides consumer co-pay discount cards, administered through outside agents to provide discounted products when redeemed. Upon release of the cards into the market, the Company records an estimate of the dollar value of co-pay discounts expected to be utilized. This estimate is based on historical experience and is adjusted as needed based on actual experience.
Doubtful Accounts:
Provisions for doubtful accounts, which reflect trade receivable balances owed to the Company that are believed to be uncollectible, are recorded as a component of selling, general and administrative ("SG&A") expenses. In estimating the allowance for doubtful accounts, the Company considers its historical experience with collections and write-offs, the credit quality of its customers and any recent or anticipated changes thereto, and the outstanding balances and past due amounts from its customers. Note that in the ordinary course of business, and consistent with our peers, we may from time to time offer extended payment terms to our customers as an incentive for new product launches or in other circumstances in accordance with standard industry practices. These extended payment terms do not represent a significant risk to the collectability of accounts receivable as of the period-end and are evaluated in accordance with
Accounting Standards Codification
("ASC")
605 - Revenue Recognition
as applicable. Accounts are considered past due when they remain uncollected beyond the due date specified in the applicable contract or on the applicable invoice, whichever is deemed to take precedence.
Advertising and Promotional Allowances to Customers:
The Company routinely sells its over-the-counter Consumer Health products to major retail drug chains. From time to time, the Company may arrange for these retailers to run in-store promotional sales of the Company’s products. The Company reserves an estimate of the dollar amount owed back to the retailer for these promotions, recording the amount as a reduction to revenue at the later of the date which the revenue is recognized or the date the sales incentive is offered. When the actual invoice for the sales promotion is received from the retailer, the Company adjusts its estimate accordingly. Advertising and promotional expenses paid to customers are expensed as incurred in accordance with
ASC 605-50 - Customer Payments and Incentives
.
Inventories:
Inventories are stated at the lower of cost and net realizable value ("NRV") (see Note 5 -
Inventories, net
). The Company maintains an allowance for slow-moving and obsolete inventory as well as inventory where the cost is in excess of its NRV. For finished goods inventory, the Company estimates the amount of inventory that may not be sold prior to its expiration or is slow-moving based upon recent sales activity by unit and wholesaler inventory information. The Company also analyzes its raw material and component inventory for slow-moving items and NRV.
The Company capitalizes inventory costs associated with its products prior to regulatory approval when, based on management judgment, future commercialization is considered probable and future economic benefit is expected to be realized. The Company assesses the regulatory approval process and where the product stands in relation to that approval process including any known constraints or impediments to approval. The Company also considers the shelf life of the product in relation to the product timeline for approval.
Property, Plant and Equipment:
Property, plant and equipment is stated at cost, less accumulated depreciation. Depreciation is provided using the straight-line method in amounts considered sufficient to amortize the cost of the assets to operations over their estimated useful lives.
Intangible Assets:
Intangible assets consist primarily of goodwill, which is carried at its initial value, In-Process Research and Development ("IPR&D"), which is accounted for as an indefinite-lived intangible asset, subject to impairment testing until completion or abandonment of the project, and product licensing costs, trademarks and other such costs, which are capitalized and amortized on a straight-line basis over their useful lives, normally ranging from
one year
to
thirty years
. The Company regularly assesses its amortizable intangible assets for impairment based on several factors, including estimated fair value and anticipated cash flows. If the Company incurs additional costs to renew or extend the life of an intangible asset, such costs are added to the remaining unamortized cost of the asset, if any, and the sum is amortized over the extended remaining life of the asset. Goodwill is tested for impairment annually or more frequently if changes in circumstances or the occurrence of events suggest that impairment may exist. The Company uses widely accepted valuation techniques to determine the fair value of its reporting units used in its annual goodwill impairment analysis. The Company’s valuation is primarily based on qualitative and quantitative assessments regarding the fair value of the reporting unit relative to its carrying value. The Company models the fair value of the reporting unit based on projected earnings and cash flows of the reporting unit.
Impairments of IPR&D are recorded in R&D expenses in the Consolidated Statements of Comprehensive Income, while all other impairments of intangible assets are recorded in impairment of intangible assets line.
Net Income Per Common Share:
Basic net income per common share is based upon the weighted average common shares outstanding. Diluted net income per common share is based upon the weighted average number of common shares outstanding,
including the dilutive effect, if any, of stock options, restricted stock and convertible securities using the treasury stock and if converted methods. Anti-dilutive shares are excluded from the computation of diluted net income per share.
Income Taxes:
Income taxes are accounted for under the asset and liability method. Deferred income tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities, and net operating loss and other tax credit carry-forwards. These items are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The Company records a valuation allowance to reduce the deferred income tax assets to the amount that is more likely than not to be realized.
Fair Value of Financial Instruments:
The Company applies
ASC 820 - Fair Value Measurement
, which establishes a framework for measuring fair value and clarifies the definition of fair value within that framework.
ASC 820 - Fair Value Measurement
defines fair value as an exit price, which is the price that would be received for an asset or paid to transfer a liability in the Company’s principal or most advantageous market in an orderly transaction between market participants on the measurement date. The fair value hierarchy established in
ASC 820 - Fair Value Measurement
generally requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Observable inputs reflect the assumptions that market participants would use in pricing the asset or liability and are developed based on market data obtained from sources independent of the reporting entity. Unobservable inputs reflect the entity’s own assumptions based on market data and the entity’s judgments about the assumptions that market participants would use in pricing the asset or liability, and are to be developed based on the best information available in the circumstances.
The valuation hierarchy is composed of three levels. The classification within the valuation hierarchy is based on the lowest level of input that is significant to the fair value measurement. The levels within the valuation hierarchy are described below:
|
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-
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Level 1
—Assets and liabilities with unadjusted, quoted prices listed on active market exchanges. Inputs to the fair value measurement are observable inputs, such as quoted prices in active markets for identical assets or liabilities. The carrying value of the Company‘s cash and cash equivalents and the portion of the value of the Nicox S.A. ("Nicox") shares which are available to be traded on the exchange are considered Level 1 assets.
|
|
|
|
|
-
|
Level 2
—Inputs to the fair value measurement are determined using prices for recently traded assets and liabilities with similar underlying terms, as well as directly or indirectly observable inputs, such as interest rates and yield curves that are observable at commonly quoted intervals. The Company has no Level 2 assets or liabilities in any of the periods presented.
|
|
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-
|
Level 3
—Inputs to the fair value measurement are unobservable inputs, such as estimates, assumptions, and valuation techniques when little or no market data exists for the assets or liabilities. The portion of the fair valuation of the available-for-sale investment held in shares of Nicox stock that is subject to a lock-up provision is considered a Level 3 asset. The additional consideration payable as a result of prior years' divestitures and other insignificant contingent amounts are considered Level 3 liabilities.
|
The following table summarizes the basis used to measure the fair values of the Company’s financial instruments (amounts in thousands):
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
|
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Fair Value Measurements at Reporting Date, Using:
|
|
Description
|
March 31, 2017
|
|
Quoted Prices
in Active
Markets for
Identical Items
(Level 1)
|
|
Significant
Other
Observable
Inputs
(Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
Cash and cash equivalents
|
$
|
307,425
|
|
|
$
|
307,425
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
Available-for-sale securities
|
1,310
|
|
|
1,268
|
|
|
—
|
|
|
42
|
|
|
Total assets
|
$
|
308,735
|
|
|
$
|
308,693
|
|
|
$
|
—
|
|
|
$
|
42
|
|
|
|
|
|
|
|
|
|
|
|
Purchase consideration payable
|
$
|
4,994
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
4,994
|
|
|
Total liabilities
|
$
|
4,994
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
4,994
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Description
|
December 31, 2016
|
|
Quoted Prices
in Active
Markets for
Identical Items
(Level 1)
|
|
Significant
Other
Observable
Inputs
(Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
Cash and cash equivalents
|
$
|
200,772
|
|
|
$
|
200,772
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
Available-for-sale securities
|
1,106
|
|
|
1,074
|
|
|
—
|
|
|
32
|
|
|
Total assets
|
$
|
201,878
|
|
|
$
|
201,846
|
|
|
$
|
—
|
|
|
$
|
32
|
|
|
|
|
|
|
|
|
|
|
|
Purchase consideration payable
|
$
|
4,994
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
4,994
|
|
|
Total liabilities
|
$
|
4,994
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
4,994
|
|
As of
March 31, 2017
, the Company was carrying available-for-sale investments in shares of Nicox stock fair valued at
$1.3 million
. In 2014, the Company acquired Nicox stock fair valued at
$12.5 million
, consisting of an original cost basis of
$10.8 million
, discounted to reflect certain lockup provisions preventing immediate sale of the underlying shares received, and
$1.7 million
unrealized
gain
from the original costs basis of
$10.8 million
. From 2014 through 2016, the Company sold available-for-sale Nicox stock with a total original cost basis of
$9.2 million
and realized immaterial losses through these sales. During the three month period ended
March 31, 2017
, the Company did not sell any available-for-sale securities, and as of
March 31, 2017
, recorded
$0.2 million
unrealized
loss
on the investment. An immaterial amount of the remaining
$1.3 million
of securities were subject to certain lockup provisions and as such, the fair value of that portion of the investment was estimated using observable and unobservable inputs to discount for lack of marketability.
The remaining purchase consideration payable is principally comprised of amounts owed relating to various prior years' divestitures, at fair value as determined based on the underlying contracts and the Company’s subjective evaluation of the additional consideration obligation estimate.
Stock-Based Compensation:
Stock-based compensation cost is estimated at grant date based on the fair value of the award, and the cost is recognized as expense ratably over the vesting period. The Company uses the Black-Scholes model for estimating the grant date fair value of stock options. Determining the assumptions to be used in the model is highly subjective and requires judgment. The Company uses an expected volatility that is based on the historical volatility of its common stock. The expected life assumption is based on historical employee exercise patterns and employee post-vesting termination behavior. The risk-free interest rate for the expected term of the option is based on the average market rate on U.S. Treasury securities of similar term in effect during the quarter in which the options were granted. The dividend yield reflects the Company’s historical experience as well as future expectations over the expected term of the option. The Company estimates forfeitures at the time of grant and revises the estimate in subsequent periods, as necessary, if actual forfeitures differ from initial estimates.
Note 3 — Stock Options, Employee Stock Purchase Plan and Restricted Stock
The Company maintains equity compensation plans that allow the Company’s Board of Directors to grant stock option and other equity awards to eligible employees, officers, directors and consultants. As of
March 31, 2017
, the active plan from which new awards could be granted was the Akorn, Inc. 2014 Stock Option Plan ("the 2014 Plan"), which was approved by shareholders at the Company's 2014 Annual Meeting of Shareholders on May 2, 2014 and subsequently amended by proxy vote of the Company’s shareholders on December 16, 2016. The 2014 Plan reserved
7.5 million
shares for issuance upon the grant of stock options, restricted stock units (“RSUs”), or various other instruments to directors, employers and consultants. The 2014 Plan replaced the Amended and Restated Akorn, Inc. 2003 Stock Option Plan (the “2003 Plan”), which expired on November 6, 2013, although previously granted awards remain outstanding under the 2003 Plan.
The Company uses the single-award method for allocating compensation cost related to stock options to each period. The following table sets forth the components of the Company’s share-based compensation expense for the three month periods ended
March 31, 2017
and
2016
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
|
2017
|
|
2016
|
|
Stock options
|
$
|
3,314
|
|
|
$
|
2,049
|
|
|
Employee stock purchase plan
|
262
|
|
|
—
|
|
|
Restricted stock units
|
1,133
|
|
|
872
|
|
|
Total stock-based compensation expense
|
$
|
4,709
|
|
|
$
|
2,921
|
|
Stock Option awards
From time to time, the Company grants stock option awards to certain employees and directors. The weighted-average assumptions used in estimating the grant date fair value of the stock options granted under the 2014 Plan during the three -month periods ended
March 31, 2017
and
2016
, respectively, along with the weighted-average grant date fair values, are set forth in the table below:
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
|
2017
|
|
2016
|
|
Expected volatility
|
50
|
%
|
|
47
|
%
|
|
Expected life (in years)
|
4.8
|
|
|
4.8
|
|
|
Risk-free interest rate
|
1.75
|
%
|
|
1.26
|
%
|
|
Dividend yield
|
—
|
|
|
—
|
|
|
Fair value per stock option
|
$
|
9.25
|
|
|
$
|
9.95
|
|
|
Forfeiture rate
|
8
|
%
|
|
8
|
%
|
The table below sets forth a summary of stock option activity within the 2014 Plan and the 2003 Plan for the three month period ended
March 31, 2017
:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Number of
Options
(in thousands)
|
|
Weighted
Average
Exercise Price
|
|
Weighted
Average
Remaining
Contractual
Term (Years)
|
|
Aggregate
Intrinsic Value
(in thousands) (1)
|
|
Outstanding at December 31, 2016
|
4,766
|
|
|
$
|
27.27
|
|
|
5.03
|
|
$
|
5,714
|
|
|
Granted
|
66
|
|
|
21.28
|
|
|
|
|
|
|
Exercised
|
(88
|
)
|
|
12.68
|
|
|
|
|
|
|
Forfeited
|
(38
|
)
|
|
31.83
|
|
|
|
|
|
|
Outstanding at March 31, 2017
|
4,706
|
|
|
$
|
27.43
|
|
|
4.89
|
|
$
|
7,034
|
|
|
Exercisable at March 31, 2017
|
1,688
|
|
|
$
|
25.09
|
|
|
3.46
|
|
$
|
5,800
|
|
(1) The Aggregate Intrinsic Value for stock options outstanding and exercisable is defined as the difference between the market value of the Company’s common stock as of the date indicated and the exercise price of the stock options. Stock options for which the exercise price exceeded the market price have been omitted. Fluctuations in the intrinsic value of both outstanding and exercisable options may result from changes in underlying stock price and the timing and volume of option grants, exercises and forfeitures.
During the three month period ended
March 31, 2017
,
0.1 million
stock options were exercised resulting in cash payments to the Company of
$1.1 million
. These stock option exercises generated tax deductible expense of
$0.8 million
. During the three month period ended
March 31, 2016
,
no
stock options were exercised.
Restricted Stock Unit awards
From time to time, the Company has granted RSUs to certain executives, employees and directors. During 2016, the Company adopted a new Long-Term Incentive Plan for salaried, non-executive employees. That plan called for annual grants of RSUs to all such eligible employees, and the first such grants took place on July 1, 2016. These grants were calculated based on the average pay by employee class and vest
25%
per year on each of the first
four
anniversaries of the grant date. All RSUs are valued at the closing market price of the Company’s common stock on the day of grant and the total value of the units is recognized as expense ratably over the vesting period of the grants.
During the three month period ended
March 31, 2017
, there were no grants of new RSU awards, and no existing RSUs either vested or were released to holders. Set forth below is a summary of non-vested RSU activity during the three month period ended
March 31, 2017
:
|
|
|
|
|
|
|
|
|
|
|
Number of Units
(in thousands)
|
|
Weighted Average Per Share
Grant Date Fair Value
|
|
Non-vested at December 31, 2016
|
416
|
|
$
|
31.52
|
|
|
Granted
|
—
|
|
$
|
—
|
|
|
Vested
|
—
|
|
$
|
—
|
|
|
Forfeited
|
(6)
|
|
$
|
29.50
|
|
|
Non-vested at March 31, 2017
|
410
|
|
$
|
31.55
|
|
Employee Stock Purchase Plan
The 2016 Akorn, Inc. Employee Stock Purchase Plan (the “ESPP”) permits eligible employees to acquire shares of the Company’s common stock through payroll deductions. The ESPP has been structured to qualify under Section 423 of the Internal Revenue Code (“IRC”). Employees who elect to participate in the ESPP may withhold from
1%
to
15%
of eligible wages toward the purchase of stock. Shares will be purchased at a
15%
discount off the lesser of the market price at the beginning or the ending of the applicable offering period. The ESPP is designed with two offering periods each year, one running from January 1st to December 31st and the other running from July 1st to December 31st. In a given year, employees may enroll in either offering period, but not both. Per IRC rules, annual purchases per employee are limited to
$25,000
worth of stock, valued as of the beginning of the offering period. Accordingly, with the
15%
discount, employees may withhold no more than
$21,250
per year toward the purchase of stock under the ESPP. Employees are further limited to purchasing no more than
15,000
shares of stock per year. A total of
2.0 million
shares of the Company’s stock have been set aside for issuance under the ESPP. The ESPP was approved by vote of the Company’s shareholders on December 16, 2016.
The initial offering period under the ESPP began in January 2017 and is scheduled to run through the end of the year. During the quarter ended
March 31, 2017
, participants contributed approximately
$0.9 million
through payroll deductions toward the future purchase of shares under the ESPP.
Note 4 — Accounts Receivable, Sales and Allowances
The nature of the Company’s business inherently involves, in the ordinary course, significant amounts and substantial volumes of transactions and estimates relating to allowances for product returns, chargebacks, rebates, doubtful accounts and discounts given to customers. This is typical of the pharmaceutical industry and is not necessarily specific to the Company. Depending on the product, the end-user customer, the specific terms of national supply contracts and the particular arrangements with the Company’s wholesaler customers, certain rebates, chargebacks and other credits are deducted from the Company’s accounts receivable. The process of claiming these deductions depends on wholesalers reporting to the Company the amount of deductions that were earned under the terms of the respective agreement with the end-user customer (which in turn depends on the specific end-user customer, each having its own pricing arrangement, which entitles it to a particular deduction). This process can lead to partial payments to the Company against outstanding invoices as the wholesalers take the claimed deductions at the time of payment.
With the exception of the provision for doubtful accounts, which is reflected as part of selling, general and administrative expense, the provisions for the following customer reserves are reflected as a reduction of revenues in the accompanying condensed consolidated statements of comprehensive income. Additionally, with the exception of administrative fees and others, which is included as a current liability, the ending reserve balances are included in trade accounts receivable, net in the Company’s condensed consolidated balance sheets.
In the quarter ended June 30, 2016, the Company determined that in order to more closely align with internal analysis of associated reserves it would adjust the allowances disclosure to separately report rebates from chargebacks and rebates for both net trade accounts receivable and gross sale adjustments and to consolidate administrative fees and others with rebates for purposes of reporting gross sales to net revenues. As a result, information as of and for the three month period ended March 31, 2016 has been recast to reflect this disclosure change.
Net trade accounts receivable consists of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
2017
|
|
December 31,
2016
|
|
Gross accounts receivable (1)
|
$
|
462,013
|
|
|
$
|
519,175
|
|
|
Less reserves for:
|
|
|
|
|
Chargebacks
|
(77,472
|
)
|
|
(80,360
|
)
|
|
Rebates
|
(93,449
|
)
|
|
(97,935
|
)
|
|
Product returns
|
(45,660
|
)
|
|
(43,689
|
)
|
|
Discounts and allowances
|
(10,293
|
)
|
|
(12,389
|
)
|
|
Advertising and promotions
|
(641
|
)
|
|
(688
|
)
|
|
Doubtful accounts
|
(816
|
)
|
|
(960
|
)
|
|
Trade accounts receivable, net
|
$
|
233,682
|
|
|
$
|
283,154
|
|
(1) The reduction in the Gross accounts receivable balance as of
March 31, 2017
when compared to the December 31, 2016 balance is due to higher Gross sales in the last two months of the fourth quarter of 2016 compared to the last two months of the first quarter of 2017.
For the three month periods ended
March 31, 2017
and
2016
, the Company recorded the following adjustments to gross sales (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
|
|
2017
|
|
2016
|
|
Gross sales
|
|
$
|
680,534
|
|
|
$
|
593,392
|
|
|
Less adjustments for:
|
|
|
|
|
|
Chargebacks (1)
|
|
(280,160
|
)
|
|
(219,376
|
)
|
|
Rebates, administrative and other fees (1)
|
|
(124,378
|
)
|
|
(88,348
|
)
|
|
Product returns
|
|
(8,418
|
)
|
|
(4,286
|
)
|
|
Discounts and allowances
|
|
(12,922
|
)
|
|
(11,954
|
)
|
|
Advertising, promotions and others
|
|
(1,236
|
)
|
|
(1,081
|
)
|
|
Revenues, net
|
|
$
|
253,420
|
|
|
$
|
268,347
|
|
(1) The increases in chargebacks and rebates, administrative and other fees for the three month periods ended
March 31, 2017
as compared to the same period in
2016
, were primarily due to product, customer mix, price erosion and volume declines. The price erosion and volume declines were due to increased industry pricing pressure and the competitive nature of our business.
Note 5 — Inventories, Net
The components of inventories are as follows (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
2017
|
|
December 31,
2016
|
|
Finished goods
|
$
|
73,918
|
|
|
$
|
73,027
|
|
|
Work in process
|
10,819
|
|
|
14,719
|
|
|
Raw materials and supplies
|
87,588
|
|
|
87,047
|
|
|
Inventories, net
|
$
|
172,325
|
|
|
$
|
174,793
|
|
The Company maintains an allowance for excess and obsolete inventory, as well as inventory for which its cost is in excess of its net realizable value. Inventory at
March 31, 2017
and
December 31, 2016
was reported net of these reserves of
$27.6 million
and
$33.5 million
, respectively.
Note 6 — Property, Plant and Equipment, Net
Property, plant and equipment, net consist of the following (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
2017
|
|
December 31,
2016
|
|
Land and land improvements
|
$
|
17,645
|
|
|
$
|
17,410
|
|
|
Buildings and leasehold improvements
|
93,106
|
|
|
88,825
|
|
|
Furniture and equipment
|
168,482
|
|
|
160,546
|
|
|
Sub-total
|
279,233
|
|
|
266,781
|
|
|
Accumulated depreciation
|
(113,322
|
)
|
|
(108,425
|
)
|
|
Property, plant and equipment in service, net
|
$
|
165,911
|
|
|
$
|
158,356
|
|
|
Construction in progress
|
86,745
|
|
|
80,048
|
|
|
Property, plant and equipment, net
|
$
|
252,656
|
|
|
$
|
238,404
|
|
At
March 31, 2017
and
December 31, 2016
, property, plant and equipment, net, with a net carrying value of
$68.9 million
and
$65.1 million
, respectively, was located outside the United States at the Company’s manufacturing facilities in India and Switzerland.
The Company recorded depreciation expense of
$5.4 million
and
$6.0 million
during the three month periods ended
March 31, 2017
and
2016
, respectively.
Note 7 — Goodwill and Other Intangible Assets, Net
The following table provides a summary of the activity in goodwill by segment for the three month period ended
March 31, 2017
(in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Consumer
Health
|
|
Prescription
Pharmaceuticals
|
|
Total
|
|
Balances at December 31, 2016
|
$
|
16,717
|
|
|
$
|
267,576
|
|
|
$
|
284,293
|
|
|
Currency translation adjustments
|
—
|
|
|
738
|
|
|
738
|
|
|
Acquisitions
|
—
|
|
|
—
|
|
|
—
|
|
|
Impairments
|
—
|
|
|
—
|
|
|
—
|
|
|
Dispositions
|
—
|
|
|
—
|
|
|
—
|
|
|
Balances at March 31, 2017
|
$
|
16,717
|
|
|
$
|
268,314
|
|
|
$
|
285,031
|
|
The following table sets forth the major categories of the Company’s intangible assets as of
March 31, 2017
and December 31, 2016, and the weighted average remaining amortization period as of
March 31, 2017
and December 31, 2016 (dollar amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
Amount (1)
|
|
Accumulated
Amortization
|
|
Reclass-ifications
|
|
Gross Impairment
|
|
Net
Balance
|
|
Wtd Avg Remaining
Amortization Period
(years)
|
|
March 31, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
Product licensing rights
|
$
|
746,906
|
|
|
$
|
(197,563
|
)
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
549,343
|
|
|
10.4
|
|
IPR&D
|
173,757
|
|
|
—
|
|
|
—
|
|
|
(225
|
)
|
|
173,532
|
|
|
N/A - Indefinite lived
|
|
Trademarks
|
16,000
|
|
|
(4,559
|
)
|
|
—
|
|
|
—
|
|
|
11,441
|
|
|
18.0
|
|
Customer relationships
|
4,225
|
|
|
(1,863
|
)
|
|
—
|
|
|
—
|
|
|
2,362
|
|
|
9.1
|
|
Other intangibles
|
11,235
|
|
|
(4,755
|
)
|
|
—
|
|
|
—
|
|
|
6,480
|
|
|
5.9
|
|
|
$
|
952,123
|
|
|
$
|
(208,740
|
)
|
|
$
|
—
|
|
|
$
|
(225
|
)
|
|
$
|
743,158
|
|
|
|
|
December 31, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Product licensing rights
|
$
|
790,143
|
|
|
$
|
(182,901
|
)
|
|
$
|
9,400
|
|
|
$
|
(52,637
|
)
|
|
$
|
564,005
|
|
|
10.5
|
|
IPR&D
|
187,007
|
|
|
—
|
|
|
(9,400
|
)
|
|
(3,850
|
)
|
|
173,757
|
|
|
N/A - Indefinite lived
|
|
Trademarks
|
16,000
|
|
|
(4,244
|
)
|
|
—
|
|
|
—
|
|
|
11,756
|
|
|
18.0
|
|
Customer relationships
|
6,290
|
|
|
(3,863
|
)
|
|
—
|
|
|
—
|
|
|
2,427
|
|
|
9.3
|
|
Other intangibles
|
11,235
|
|
|
(4,326
|
)
|
|
—
|
|
|
—
|
|
|
6,909
|
|
|
6.0
|
|
|
$
|
1,010,675
|
|
|
$
|
(195,334
|
)
|
|
$
|
—
|
|
|
$
|
(56,487
|
)
|
|
$
|
758,854
|
|
|
|
The Company recorded amortization expense of
$15.5 million
and
$16.5 million
during the three month periods ended
March 31, 2017
and 2016, respectively.
(1) Differences in the Gross Amounts between periods are due to either impairment of assets or the write down of fully amortized assets.
Note 8 — Financing Arrangements
Term Loans
Concurrent with the closing of its acquisition of Hi-Tech (the “Hi-Tech Acquisition”), Akorn, Inc. and its wholly-owned domestic subsidiaries (the "Akorn Loan Parties") entered into a
$600.0 million
Term Facility (the “Existing Term Facility”) pursuant to a Loan Agreement dated April 17, 2014 (the “Existing Term Loan Agreement”) between Akorn Loan Parties as borrowers, certain other lenders and JPMorgan Chase Bank, N.A. ("JPMorgan") acting as administrative agent. The Company may increase the loan amount up to an additional
$150.0 million
, or more, provided certain financial covenants and other conditions are satisfied. The proceeds received pursuant to the Existing Term Loan Agreement were used to finance the Hi-Tech Acquisition. Additionally and concurrent with the closing of its acquisition of VersaPharm, the Akorn Loan Parties entered into a
$445.0 million
Incremental Facility Joinder Agreement (the “Incremental Term Loan Facility”) pursuant to a Loan Agreement (the “Incremental Term Loan Agreement”) dated August 12, 2014 between Akorn Loan Parties as borrowers and JPMorgan as lender and administrative agent for certain other lenders. The proceeds received pursuant to the Incremental Term Loan Agreement were used to finance the VersaPharm acquisition. The Existing Term Facility and Incremental Term Loan Facility are collectively the “Term Loans” or the “Term Loan Agreements.”
The Term Loans are secured by all of the assets of the Akorn Loan Parties, including springing control of the Company’s primary deposit account pursuant to a deposit account control agreement.
Prior to February 16, 2016, the Term Loan Agreements required quarterly principal repayment equal to
0.25%
of the initial aggregate loan amount beginning with the second full quarter following the closing date of the Existing Term Loan Agreement, with a final payment of the remaining principal balance due at maturity
seven
years from the date of closing of the Existing Term Loan Agreement. The Company was also able to prepay all or a portion of the remaining outstanding principal amount under the Term Loan Agreements at any time, or from time to time, subject to prior notice to the lenders and payment of applicable fees. Prepayment of principal was required should the Company incur any indebtedness not permitted under the Term Loan Agreements, or effect the sale, transfer or disposition of any property or asset, other than in the ordinary course of business. On February 16, 2016, the Company made a voluntary prepayment of its Existing Term Facility of
$200.0 million
which settled all future quarterly principal repayments of the Term Loan Agreements as denoted above until the date of the maturity of the Term Loan Agreements or April 16, 2021, although future voluntary principal repayments are permitted. As of
March 31, 2017
, outstanding debt under the Term Loans was
$831.9 million
and the Company was in full compliance with all
applicable covenants which included customary limitations on indebtedness, distributions, liens, acquisitions, investments, and other activities.
On May 20, 2015, the Company modified the Term Loan Agreements with JPMorgan and certain other lenders to remedy certain covenant defaults related to the fiscal year 2014 financial restatement by incurring nominal charges affected through a temporary interest rate increase and an upfront payment.
Prior to November 13, 2015, interest accrued based, at the Company’s election, on an adjusted prime/federal funds rate or an adjusted LIBOR (“Eurodollar Loan”) rate, plus a margin of
2.50%
for ABR Loans, and
3.50%
for Eurodollar Loans. Each such margin would decrease by
0.25%
in the event of the Company’s senior debt to EBITDA ratio for any quarter falling to
2.25
:
1.00
or below. During an event of default, as defined in the Term Loan Agreements, any interest rate would have been increased by
2.00%
per annum. Per the Term Loan Agreements, the interest rate on LIBOR loans could not fall below
4.50%
.
On November 13, 2015, the Company again modified the Term Loan Agreements with JPMorgan and certain other lenders to remedy certain remaining covenant defaults related to the FY 2014 financial restatement by incurring additional charges affected through a temporary interest rate increase and an upfront payment. During 2016, the Company incurred an additional
$5.1 million
of financing costs related to the 2014 restatement process that ended on May 10, 2016, and carried a deferred financing fees balance of
$21.5 million
at December 31, 2016.
During the three month period ended
March 31, 2017
, the Company amortized
$1.3 million
of the Term Loans-related costs, resulting in
$20.2 million
remaining balance of deferred financing fees at
March 31, 2017
. The Company will amortize this balance using the effective interest method over the life of the Term Loan Agreements.
Subsequent to November 13, 2015, interest accrues based, at the Company’s election, on an adjusted prime/federal funds rate (“ABR Loan”) or an adjusted LIBOR (“Eurodollar Loan”) rate, plus a margin of
4.00%
for ABR Loans, and
5.00%
for Eurodollar Loans. As of the date of the filing of this Form 10-Q until the maturity of the Term Loans, the Company's spread will be based upon the Ratings Level applicable on such date as documented below. As of the period ended
March 31, 2017
, the Company was a Ratings Level I for the Term Loan Agreements.
|
|
|
|
|
|
|
|
Ratings Level
|
Index Ratings
(Moody’s/S&P)
|
Eurodollar Spread
|
ABR Spread
|
|
Level I
|
B1/B+ or higher
|
4.25%
|
3.25%
|
|
Level II
|
B2/B
|
4.75%
|
3.75%
|
|
Level III
|
B3/B- or lower
|
5.50%
|
4.50%
|
For the three month periods ended
March 31, 2017
and 2016, the Company recorded interest expense of
$10.9 million
and
$10.8 million
, respectively in relation to the Term Loans.
JPMorgan Credit Facility
On April 17, 2014, the Akorn Loan Parties entered into a Credit Agreement (the “JPM Credit Agreement”) with JPMorgan as administrative agent, and Bank of America, N.A., as syndication agent for certain other lenders (at closing, Bank of America, N.A. and Wells Fargo Bank, N. A.) for a
$150.0 million
revolving credit facility (the “JPM Revolving Facility”).
Subject to other conditions in the JPM Credit Agreement, advances under the JPM Revolving Facility will be made in accordance with a borrowing base consisting of the sum of the following:
|
|
|
|
(a)
|
85%
of eligible accounts receivable;
|
|
|
|
|
a.
|
65%
of the lower of cost or market value of eligible raw materials and work in process inventory, valued on a first in first out basis, and
|
|
|
|
|
b.
|
85%
of the orderly liquidation value of eligible raw materials and work in process inventory, valued on a first in first out basis;
|
|
|
|
|
a.
|
75%
of the lower of cost or market value of eligible finished goods inventory, valued on a first in first out basis, and
|
|
|
|
|
b.
|
85%
of the orderly liquidation value of eligible finished goods inventory, valued on a first in first out basis up to
85%
of the liquidation value of eligible inventory (or
75%
of market value finished goods inventory); and
|
|
|
|
|
(d)
|
Less any reserves deemed necessary by the administrative agent, and allowed in its permitted discretion.
|
The total amount available under the JPM Revolving Facility includes a
$10.0 million
letter of credit facility.
Under the terms of the JPM Credit Agreement, if availability under the JPM Revolving Facility falls below
12.5%
of commitments or
$15.0 million
for more than
30
consecutive days, the Company may be subject to cash dominion, additional reporting requirements, and additional covenants and restrictions. The Company may seek additional commitments to increase the maximum amount of the JPM Revolving Facility to
$200.0 million
.
Unless cash dominion is exercised by the lenders in connection with the JPM Revolving Facility, the Company will be required to repay the JPM Revolving Facility upon its expiration
five
years from issuance, subject to permitted extension, and will pay interest on the outstanding balance monthly based, at the Company’s election, on an adjusted prime/federal funds rate (“ABR”) or an adjusted LIBOR (“Eurodollar”), plus a margin determined in accordance with the Company’s consolidated fixed charge coverage ratio (EBITDA to fixed charges) as follows:
|
|
|
|
|
|
|
Fixed Charge
Coverage Ratio
|
Revolver ABR
Spread
|
Revolver
Eurodollar
Spread
|
|
Category 1
> 1.50 to 1.0
|
0.50%
|
1.50%
|
|
Category 2
> 1.25 to 1.00 but
< 1.50 to 1.00
|
0.75%
|
1.75%
|
|
Category 3
< 1.25 to 1.00
|
1.00%
|
2.00%
|
In addition to interest on borrowings, the Company will pay an unused line fee of
0.25%
per annum on the unused portion of the JPM Revolving Facility.
During an event of default, as defined in the JPM Credit Agreement, any interest rate will be increased by
2.00%
per annum.
The JPM Revolving Facility is secured by all of the assets of the Akorn Loan Parties, including springing control of the Company’s primary deposit account pursuant to a Deposit Account Control Agreement. The financial covenants require the Akorn Loan Parties to maintain the following on a consolidated basis:
|
|
|
|
(a)
|
Minimum Liquidity, as defined in the JPM Credit Agreement, of not less than (a)
$120.0 million
plus (b)
25%
of the JPM Revolving Facility commitments during the three month period preceding the June 1, 2016 maturity date of the Company’s senior convertible notes.
|
|
|
|
|
(b)
|
Ratio of EBITDA to fixed charges of no less than
1.00
to 1.00 (measured quarterly for the trailing
4
quarters).
|
As of
March 31, 2017
the Company was in full compliance with all covenants applicable to the JPM Revolving Facility.
The Company may use any proceeds from borrowings under the JPM Revolving Facility for working capital needs and for the general corporate purposes of the Company and its subsidiaries. At
March 31, 2017
, there were no outstanding borrowings and
one
outstanding letter of credit in the amount of
$2.2 million
under the JPM Revolving Facility. Availability under the facility as of
March 31, 2017
was
$147.8 million
.
The JPM Credit Agreement places customary limitations on indebtedness, distributions, liens, acquisitions, investments, and other activities of the Akorn Loan Parties in a manner designed to protect the collateral while providing flexibility for growth and the historic business activities of the Company and its subsidiaries.
Aggregate cumulative maturities of long-term obligations (including the Term Loans and the JPM Revolving Facility) as of
March 31, 2017
are:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(In thousands)
|
2017
|
|
2018
|
|
2019
|
|
2020
|
|
Thereafter
|
|
Maturities of debt
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
831,938
|
|
Note 9 — Earnings Per Share
Basic net income per common share is based upon the weighted average number of common shares outstanding during the period. Diluted net income per common share is based upon the weighted average number of common shares outstanding, including the dilutive effect, if any, of potentially dilutive securities using the treasury stock method. Additionally, For the three month period ended March 31, 2016, the earnings per share amount was calculated using the if-converted method to account for the dilutive impact of the Convertible Notes. The Convertible Notes matured in the quarter ended June 30, 2016.
The Company’s potentially dilutive shares consist of: (i) vested and unvested stock options that are in-the-money, (ii) unvested RSUs, and (iii) for the three month period ended March 31, 2016, shares potentially issuable upon conversion of the Notes.
A reconciliation of the earnings per share data from a basic to a fully diluted basis is detailed below (amounts in thousands, except per share data):
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
|
2017
|
|
2016
|
|
Net income
|
$
|
41,027
|
|
|
$
|
41,886
|
|
|
Convertible debt income adjustments, net of tax
|
—
|
|
|
604
|
|
|
Net income adjusted for convertible debt as used for diluted earnings per share
|
$
|
41,027
|
|
|
$
|
42,490
|
|
|
Net income per share:
|
|
|
|
|
Basic
|
$
|
0.33
|
|
|
$
|
0.35
|
|
|
Diluted (1)
|
$
|
0.33
|
|
|
$
|
0.34
|
|
|
Shares used in computing net income per share:
|
|
|
|
|
|
|
Weighted average basic shares outstanding
|
124,421
|
|
|
119,516
|
|
|
Dilutive securities:
|
|
|
|
|
Stock option and unvested RSUs
|
245
|
|
|
1,172
|
|
|
Shares issuable upon conversion of the notes
|
—
|
|
|
4,933
|
|
|
Total dilutive securities
|
245
|
|
|
6,105
|
|
|
Weighted average diluted shares outstanding
|
124,666
|
|
|
125,621
|
|
|
|
|
|
|
|
Shares subject to stock options omitted from the calculation of income per share as their effect would have been anti-dilutive
|
4,093
|
|
|
2,430
|
|
|
|
|
|
(1)
|
As a result of the Company's expectation that it would likely settle all future note conversions in shares of the Company's common stock, the diluted income from continuing operations per share calculation for the periods prior to the complete conversion of the convertible debt on June 1, 2016, included the dilutive effect of convertible debt and was offset by the exclusion of interest expense and deferred financing fees related to the convertible debt of
$0.6 million
, after-tax for the three month period ended March 31, 2016.
|
Note 10 — Segment Information
During the three month periods ended
March 31, 2017
and 2016, the Company reported results for the following
two
reportable segments:
- Prescription Pharmaceuticals
- Consumer Health
The Company’s Prescription Pharmaceuticals segment principally consists of generic and branded prescription pharmaceuticals products which span a broad range of indications as well as a variety of dosage forms including: sterile ophthalmics, injectables and inhalants, and non-sterile oral liquids, topicals and nasal sprays. The Company’s Consumer Health segment principally consists of animal health and OTC products, both branded and private label. OTC products include, but are not limited to, a suite of products for the treatment of dry eye sold under the TheraTears
®
brand name.
Financial information about the Company’s reportable segments is based upon internal financial reports that aggregate certain operating information. The Company’s Chief Operating Decision Maker (“CODM”), as defined in
ASC 280 - Segment Reporting
, who is also the CEO, oversees operational assessments and resource allocations based upon the results of the Company’s reportable segments, which have available and discrete financial information.
Selected financial information by reportable segment is presented below (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
|
2017
|
|
2016
|
|
Revenues, net:
|
|
|
|
|
Prescription Pharmaceuticals
|
$
|
237,379
|
|
|
$
|
250,749
|
|
|
Consumer Health
|
16,041
|
|
|
17,598
|
|
|
Total revenues, net
|
253,420
|
|
|
268,347
|
|
|
|
|
|
|
|
Gross Profit:
|
|
|
|
|
|
|
Prescription Pharmaceuticals
|
141,319
|
|
|
154,635
|
|
|
Consumer Health
|
7,813
|
|
|
8,382
|
|
|
Total gross profit
|
149,132
|
|
|
163,017
|
|
|
|
|
|
|
|
Operating expenses
|
74,299
|
|
|
75,438
|
|
|
|
|
|
|
|
Operating income
|
74,833
|
|
|
87,579
|
|
|
Other expense
|
(9,507
|
)
|
|
(21,007
|
)
|
|
|
|
|
|
|
Income before income taxes
|
$
|
65,326
|
|
|
$
|
66,572
|
|
The Company manages its business segments to the gross profit level and manages its operating and other costs on a company-wide basis. Inter-segment activity at the gross profit level is minimal. The Company does not have discrete assets by segment, as certain manufacturing and warehouse facilities support more than one segment, and therefore does not report assets by segment. Financial information including revenues and gross profit from external customers by product or product line is not provided as to do so would be impracticable.
Note 11 – Share Repurchases
In July 2016, the Company announced that the Board of Directors authorized a stock repurchase program (the "Stock Repurchase Program") pursuant to which the Company may repurchase up to
$200.0 million
of the Company’s common stock. The shares may be repurchased in open market transactions at prevailing market prices, in privately negotiated transactions or others, including accelerated stock repurchase arrangements, pursuant to a Rule 10b5-1 repurchase plan or by other means in accordance with federal securities laws. The timing and the amount of any repurchases will be determined by the Company’s management based on its evaluation of market conditions, capital allocation alternatives, and other factors. There is no guarantee as to the number of shares that will be repurchased, and the repurchase program may be suspended or discontinued at any time without notice and at the Company's discretion, and at this time no estimate to the effect on the results of the Company due to the Stock Repurchase Program can be made.
The Company did
no
t repurchase any shares during the three month period ended
March 31, 2017
, and had
$155.0 million
remaining under the repurchase authorization.
Companies incorporated under Louisiana law are subject to the Louisiana Business Corporation Act ("LBCA"). Provisions of the LBCA eliminate the concept of treasury stock and require that shares repurchased by a company are to be treated as authorized but unissued shares instead of treasury stock. As a result, all stock repurchases are presented as a reduction to issued and outstanding shares of common stock, the stated par value of common stock and retained earnings.
Note 12 — Commitments and Contingencies
The Company is subject to certain due-course complaints and claims arising out of its business, typically brought by competitors, suppliers, customers and others. In accordance with
ASC 450 - Contingencies
, the Company records reserves when loss is probable and the amount of loss can be reasonably estimated. As such, the Company believes that it has provided adequate reserves and that any matters currently pending will not materially affect the condensed, consolidated financials of the Company as of the period end.
The Company has entered into strategic business agreements for the development and marketing of finished dosage form pharmaceutical products with various pharmaceutical development companies.
Each strategic business agreement includes a future payment schedule for contingent milestone payments and in certain strategic business agreements, minimum royalty payments. The Company will be responsible for contingent milestone payments and minimum royalty payments to these strategic business partners based upon the occurrence of future events. Each strategic business agreement defines the triggering event of its future payment schedule, such as meeting product development progress timelines, successful product testing and validation, successful clinical studies, various FDA and other regulatory approvals and other factors as negotiated. None of the contingent milestone payments or minimum royalty payments are individually material to the Company.
The Company is engaged in various supply agreements with third parties which obligate the Company to purchase various active pharmaceutical ingredients ("API") or finished products at contractual minimum levels. None of these agreements are individually or in aggregate material to the Company. Further, the Company does not believe at this time that any of the purchase obligations represent levels above that of normal business demands.
The table below summarizes contingent potential milestone payments due to strategic partners in the years 2017 and beyond, assuming all such contingencies occur (in thousands):
|
|
|
|
|
|
|
|
Year ending December 31,
|
Amount
|
|
2017
|
$
|
5,247
|
|
|
2018
|
9,392
|
|
|
2019
|
70
|
|
|
2020 and Beyond
|
800
|
|
|
Total
|
$
|
15,509
|
|
Legal Proceedings
The Company is a party to legal proceedings and potential claims arising in the ordinary course of our business. The amount, if any, of ultimate liability with respect to such matters cannot be determined, but despite the inherent uncertainties of litigation, management of the Company believes that the ultimate disposition of such proceedings and exposure will not have a material adverse impact on the financial condition, results of operations, or cash flows of the Company. Set forth below are material updates to legal proceedings of the Company.
As previously disclosed in various reports filed with the SEC, on March 4, 2015, a purported class action complaint was filed entitled
Yeung v. Akorn, Inc., et al.
, in the federal district court of Northern District of Illinois, No. 15-cv-1944. The complaint alleged that the Company and
three
of its officers violated the federal securities laws in connection with matters related to its accounting and financial reporting in the wake of its acquisitions of Hi-Tech Pharmaceutical Co., Inc. and VersaPharm, Inc. A second, related case entitled
Sarzynski v. Akorn, Inc., et al.
, No. 15-cv-3921, was filed on May 4, 2015 making similar allegations. On August 24, 2015, the two cases were consolidated and a lead plaintiff appointed in
In re Akorn, Inc. Securities Litigation.
On July 5, 2016, the lead plaintiff group filed a consolidated amended complaint making similar allegations against the Company and an officer and former officer of the Company. The consolidated amended complaint seeks damages on behalf of the putative class. On August 9, 2016, the defendants filed a motion to dismiss the case. On March 6, 2017, the court denied the motion to dismiss and the defendants subsequently filed an answer to the consolidated
amended complaint on March 27, 2017. The case is now in the discovery phase, and no trial date has been scheduled.
As previously disclosed in various reports filed with the SEC, the Company’s Board of Directors also received shareholder demand letters and
four
shareholder derivative lawsuits have been filed alleging breaches of fiduciary duty in connection with the Company’s accounting for its acquisition and the restatement of its financials.
Two
of the derivative lawsuits,
Safriet v. Rai, et al.,
No. 15-cv-7275, and
Glaubach v. Rai, et al
., No. 15- 11129, which were filed in the U.S. District Court for the Northern District of Illinois, had been stayed pending anticipated rulings on the defendants’ motion to dismiss in
In re Akorn, Inc. Securities Litigation.
The two cases have been consolidated into a single action and the stay lifted. Plaintiffs in the consolidated action have not yet filed or designated a consolidated complaint.
As previously disclosed in various reports filed with the SEC,
Fera Pharmaceuticals, LLC v. Akorn Inc., Sean Brynjelsen, and Michael Stehn
, in the United States District Court for the Southern District of New York, Case No. 12-cv-07692-LLS. Fera Pharmaceuticals, LLC (“Fera”) filed this action on September 12, 2012. The defendants in the case are the Company, one former employee of the Company, Sean Brynjelsen, and a current employee of the Company, Michael Stehn. The amended complaint generally alleges that the Company breached certain terms of a contract manufacturing supply agreement by, among other things, failing to manufacture Fera’s products, raising the manufacturing cost, and impermissibly terminating the contract. In addition, Fera alleges that the Company misappropriated Fera’s trade secrets in order to manufacture Erythromycin and Bacitracin for its own benefit. The counts in the amended complaint are for (1) breach of contract, (2) misappropriation of trade secrets, (3) fraudulent inducement, and (4) declaratory and injunctive relief. Fera seeks
$135 million
in compensatory damages, an additional, unspecified amount in punitive damages, and injunctive relief restraining the Company from selling the products at issue in the case. The Company filed a counterclaim against Fera and certain affiliates, as well as Perrigo Company of Tennessee and Perrigo Company plc, asserting violations of Sections 1 and 2 of the Sherman Act and tortious interference with business relations. The case is still in the discovery phase, with fact discovery expected to close approximately at the end of May 2017, and expert discovery expected to be completed by September 1, 2017. The court has indicated it would like the trial to commence in mid-October 2017, but has not entered a scheduling order to that effect.
As previously disclosed in various reports filed with the SEC,
State of Louisiana v. Abbott Laboratories, Inc., et al.
The Louisiana Attorney General filed suit, Number 624,522, Nineteenth Judicial District Court, Parish of East Baton Rouge, including Hi-Tech Pharmacal and other defendants, in Louisiana state court. Louisiana’s complaint alleges that the defendants violated Louisiana state laws in connection with Medicaid reimbursement for certain vitamins, dietary supplements, and DESI products that were allegedly ineligible for reimbursement. The defendants filed exceptions of no cause of action and no right of action in response to Louisiana’s amended complaint. In a judgment entered on October 2, 2015, the trial court sustained the defendants’ exception of no right of action, which dismissed all of Louisiana’s claims. Louisiana sought appellate review of the court’s decision by filing an application for supervisory writs, as well as an appeal pending in the First Circuit Court of Appeal in Louisiana. On October 21, 2016, the First Circuit Court of Appeal affirmed the trial court’s judgment in part, reversed it in part, and remanded the case for further proceedings. Specifically, the First Circuit affirmed the dismissal of
four
of the
six
causes of action pled in Louisiana’s amended complaint, but reversed the dismissal with respect to the two remaining statutory claims. On December 22, 2016, the First Circuit denied Louisiana’s application for rehearing with respect to the First Circuit’s affirmance. On January 20, 2017, Louisiana filed an application for certiorari in the Louisiana Supreme Court as to the portion of the First Circuit’s decision affirming the trial court’s judgment. On January 23, 2017, the defendants filed an application for certiorari in the Louisiana Supreme Court as to the portion of the First Circuit’s decision reversing the trial court’s judgment. On March 13, 2017, the Louisiana Supreme Court denied both writ applications. On March 31, 2017, the trial court judge entered an order permitting Defendants to respond to the State’s First Amended Petition on or before May 11, 2017. There are presently no other scheduled dates in the proceeding.
In addition to the foregoing matters, Akorn has received shareholder demands for legal action to be taken against certain of the Company’s directors and officers based on alleged breaches of fiduciary duties and other misconduct in connection with the Company’s restatement of financial results and other matters. Akorn’s Board of Directors formed a special committee that conducted an inquiry into the demand allegations and provided its conclusions and recommendations to the Board.
On April 7, 2017, a jury in the State Court of Houston County in the State of Georgia reached a verdict of
$20.5 million
in damages against Akorn, Inc. in the product liability case
Ann Pope and Anthony Pope v. Horatio V. Cabasares, M.D., Horatio V. Cabasares, M.D., P.C. Houston Healthcare Systems, Inc., Akorn Sales, Inc., and Akorn, Inc.
in which plaintiff claimed Akorn provided inadequate labeling on its product methylene blue. The Company maintains sufficient product liability insurance coverage for the defense costs and expenses as well as the verdict related to this case. Further, on April 27, 2017, Akorn filed a motion for a new trial and intends to appeal, thereby challenging liability as well as the compensatory and punitive damage awards.
The legal matters discussed above and others could result in losses, including damages, fines and civil penalties, and criminal charges, which could be substantial. We record accruals for these contingencies to the extent that we conclude that a loss is both probable and reasonably estimable. Regarding the aforementioned labeling verdict related to methylene blue, the Company recorded a reasonable estimate of the liability less than the verdict amount (for which a corresponding insurance receivable is also recorded). Regarding the other matters disclosed above, the Company has determined that liabilities associated with these legal matters are reasonably possible but they cannot be reasonably estimated.
Given the nature of the litigation and investigations and the complexities involved, the Company is unable to reasonably estimate a possible loss for such matters until the Company knows, among other factors, (i) what claims, if any, will survive dispositive motion practice, (ii) the extent of the claims, including the size of any potential class, particularly when damages are not specified or are indeterminate, (iii) how the discovery process will affect the litigation, (iv) the settlement posture of the other parties to the litigation and (v) any other factors that may have a material effect on the litigation or investigation. However, we could incur judgments, enter into settlements or revise our expectations regarding the outcome of certain matters, and such developments could have a material adverse effect on our results of operations in the period in which the amounts are accrued and/or our cash flows in the period in which the amounts are paid.
Note 13 — Customer, Supplier and Product Concentration
Customer Concentrations
A significant percentage of the Company’s sales are to
three
wholesale drug distributors: AmerisourceBergen Corporation; Cardinal Health, Inc. and McKesson Corporation. These three wholesalers (the “Big 3 Wholesalers”) are all distributors of the Company’s products, as well as suppliers of a broad range of health care products.
The following table sets forth the percentage of the Company’s gross and net sales for the three month periods ended
March 31, 2017
and 2016, and gross accounts receivable as of
March 31, 2017
and December 31, 2016, attributable to the Big 3 Wholesalers:
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
Big 3 Wholesalers combined
:
|
2017
|
|
2016
|
|
Percentage of gross sales
|
79%
|
|
76%
|
|
Percentage of net revenues
|
64%
|
|
62%
|
|
|
|
|
|
|
|
|
|
March 31,
2017
|
|
December 31,
2016
|
|
Percentage of gross trade accounts receivable
|
83%
|
|
84%
|
If sales to any of the Big 3 Wholesalers were to diminish or cease, the Company believes that the end users of its products would have little difficulty obtaining the Company’s products either directly from the Company or from another distributor.
No other customers accounted for more than 10% of gross sales, net revenues or gross trade receivables for the indicated dates and periods.
Supplier Concentrations
The Company requires a supply of quality raw materials and components to manufacture and package pharmaceutical products for its own use and for third parties with which it has contracted. The principal components of the Company’s products are active and inactive pharmaceutical ingredients and certain packaging materials. Certain of these ingredients and components are available from only a single source and, in the case of certain of the Company’s abbreviated new drug applications and new drug applications, only one supplier of raw materials has been identified. Because FDA approval of drugs requires manufacturers to specify their proposed suppliers of active ingredients and certain packaging materials in their applications, FDA approval of any new supplier would be required if active ingredients or such packaging materials were no longer available from the specified supplier. The qualification of a new supplier could delay the Company’s development and marketing efforts. In addition, certain of the pharmaceutical products marketed by the Company are manufactured by a partnered third party manufacturer, which serves as the Company’s sole source of that finished product. If for any reason the Company is unable to obtain sufficient quantities of any of the raw materials or components required to produce and package
its products, it may not be able to manufacture its products as planned, which could have a material adverse effect on the Company’s business, financial condition and results of operations. Likewise, if the Company’s manufacturing partners experience any similar difficulties in obtaining raw materials or in manufacturing the finished product, the Company’s results of operations would be negatively impacted.
No
individual supplier represented 10% or more of the Company’s purchases in either of the three month periods ended
March 31, 2017
or 2016.
Product Concentrations
In the three month periods ended
March 31, 2017
and 2016,
one
Prescription Pharmaceutical product represented approximately
19%
and
18%
, respectively of the Company’s total net sales revenue. The Company attempts to minimize the risk associated with product concentrations by continuing to acquire and develop new products to add to its existing portfolio.
Note 14 — Income Taxes
The following table sets forth information about the Company’s income tax provision for the periods indicated (dollar amounts in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
March 31,
|
|
|
2017
|
|
2016
|
|
Income before income taxes
|
$
|
65,326
|
|
|
$
|
66,572
|
|
|
Income tax provision
|
24,299
|
|
|
24,686
|
|
|
Net income
|
$
|
41,027
|
|
|
$
|
41,886
|
|
|
|
|
|
|
|
Income tax provision as a percentage of income before income taxes
|
37.2
|
%
|
|
37.1
|
%
|
During the three month periods ended
March 31, 2017
and 2016, the Company recorded an income tax provision of
$24.3 million
and
$24.7 million
, or
37.2%
and
37.1%
of income before income taxes, respectively. The Company anticipates that its effective tax rate will for the year 2017 will be approximately
37.5%
. The income tax provision rate in the current year was increased in comparison to the prior year due to losses at the Company’s Indian and Swiss subsidiaries.
As of
March 31, 2017
, the Company could not conclude that it was more likely than not that tax benefits from certain of these net operating losses would be realized. Accordingly, as of
March 31, 2017
, the Company increased its valuation allowance to
$11.2 million
for certain of the losses at its Indian subsidiary and the entire amount of the loss at its Swiss subsidiary, compared to a valuation allowance of
$9.9 million
as of December 31, 2016.
In accordance with ASC 740-10-25,
Income Taxes - Recognition
, the Company reviews its tax positions to determine whether it is “more likely than not” that its tax positions will be sustained upon examination, and if any tax positions are deemed to fall short of that standard, the Company establishes reserves based on the financial exposure and the likelihood that its tax positions would not be sustained. Based on its evaluations, the Company determined that it would not recognize tax benefits on
$1.4 million
and
$1.3 million
related to uncertain tax positions as of
March 31, 2017
and December 31, 2016, respectively. If recognized, of the
$1.4 million
of uncertain tax positions as of March 31, 2017,
$1.2 million
of these tax positions will impact the Company’s effective rate with the remaining
$0.2 million
affecting goodwill.
Note 15 – Related Party Transactions
During the three month periods ended
March 31, 2017
and 2016, the Company obtained legal services totaling
$0.5 million
and
$0.4 million
, of which
$0.3 million
and
$0.1 million
was payable as of
March 31, 2017
and 2016, respectively, to Polsinelli PC, a law firm for which the spouse of the Company’s Executive Vice President, General Counsel and Secretary is an attorney and shareholder.
The Company also paid legal services totaling
$0.1 million
during the three month period ended March 31, 2017 to Segal McCambridge Singer & Mahoney, a firm for which the brother in law of the Company's Executive Vice President, General Counsel and Secretary is a partner.
Note 16 – Recently Issued and Adopted Accounting Pronouncements
Recently Issued Accounting Pronouncements
In November 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standard Update ("ASU")
No.
2016-18,
Statement of Cash Flows (Topic 230): Restricted Cash (a consensus of the FASB Emerging Issues Task Force)
, which addresses classification and presentation of changes in restricted
cash on the statement of cash flows. The standard requires an entity’s reconciliation of the beginning-of-period and end-of-period total amounts shown on the statement of cash flows to include in cash and cash equivalents amounts generally described as restricted cash and restricted cash equivalents. The ASU does not define restricted cash or restricted cash equivalents, but an entity will need to disclose the nature of the restrictions. The ASU is effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2017. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim period, adjustments should be reflected at the beginning of the fiscal year that includes that interim period. Entities should apply this ASU using a retrospective transition method to each period presented.
The Company is currently evaluating the impact that
ASU 2016-18
will have on its statement of financial position or financial statement disclosures.
In August 2016, the FASB issued
ASU 2016-15,
Statement of Cash Flows (Topic 230) Classification of Certain Cash Receipts and Cash Payments
. This standard amends and adjusts how cash receipts and cash payments are presented and classified in the statement of cash flows.
ASU 2016-15
is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years and will require adoption on a retrospective basis unless impracticable. If impracticable the Company would be required to apply the amendments prospectively as of the earliest date possible. The Company is currently evaluating the impact that
ASU 2016-15
will have on its statement of financial position or financial statement disclosures.
In February 2016, the FASB issued
ASU 2016-02
-
Leases,
which establishes a comprehensive new lease accounting model. The new standard clarifies the definition of a lease and causes lessees to recognize leases on the balance sheet as a lease liability with a corresponding right-of-use asset for leases with a lease term of more than one year.
ASU 2016-02
is effective for financial statements issued for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. The new standard requires a modified retrospective transition for capital or operating leases existing at or entered into after the beginning of the earliest comparative period presented in the financial statements, but it does not require transition accounting for leases that expire prior to the date of initial application. Upon adoption, the operating leases reporting in Note 9 - Leasing Arrangements, will be reported on the statement of financial position as gross-up assets and liabilities. The Company is currently evaluating the impact that
ASU 2016-02
will have on its statement of financial position or financial statement disclosures.
Revenue Recognition Related ASUs:
In February 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standard Update ("ASU")
No.
2017-05 - Other Income—Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets.
The amendments in this ASU address the recognition of gains and losses on the transfer (i.e., sale) of nonfinancial (and in substance nonfinancial) assets to counterparties other than customers. The ASU conforms the derecognition guidance on nonfinancial assets with the model for transactions in the new revenue standard (ASC 606, as amended). The amendments are effective at the same time as the new revenue standard. For public entities that means annual periods beginning after December 15, 2017 and interim periods therein.
In December 2016, the FASB issued
ASU 2016-20,
Technical Corrections and Improvements to Topic 606, Revenue from Contracts with Customers.
The amendments in this ASU affect narrow aspects of the guidance in
ASU 2014-09
, which is not yet effective. The amendments in this ASU address loan guarantee fees, impairment testing of contract costs, provisions for losses on construction-type and production-type contracts, and various disclosures. The effective date and transition requirements for the amendments are the same as the effective date and transition requirements for Topic 606 (and any other Topic amended by
ASU 2014-09
).
ASU 2015-14
,
Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date
, defers the effective date of
ASU 2014-09
by one year.
In May 2016, the FASB issued
ASU 2016-12 - Narrow-Scope Improvements and Practical Expedients
. This standard amends the guidance in
ASU 2014-09
to specifically provide a practical expedient for reflecting contract modifications at transition. The effective date for
ASU 2016-12
is the same as the effective date for
ASU 2014-09
,
ASU 2015-14
,
ASU
2016-08
and
ASU 2016-10
.
In April 2016, the FASB issued
ASU 2016-10 - Revenue from Contracts with Customers (Topic 606) — Identifying Performance Obligations and Licensing
. This standard amends the guidance in
ASU 2014-09
and
ASU 2016-08
specifically related to identifying performance obligations and accounting for licenses of intellectual property. The effective date for
ASU 2016-10
is the same as the effective date for
ASU 2014-09
,
ASU 2015-14
and
ASU 2016-08
.
In March 2016, the FASB issued
ASU 2016-08 - Revenue from Contracts with Customers: Principal versus Agent Considerations
. The amendments of this standard are intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations. The effective date for
ASU 2016-08
is the same as the effective date for
ASU 2014-09
and
ASU 2015-14
.
In August 2015, the FASB issued
ASU No. 2015-14 - Revenue from Contracts with Customers (Topic 606) - Deferral of the Effective Date
, which defers the effective date of
ASU 2014-09
for one year and permits early adoption as early as the original effective date of
ASU 2014-09
. The new revenue standard may be applied retrospectively to each prior period presented or retrospectively with the cumulative effect recognized as of the date of adoption.
In May 2014, FASB issued
ASU 2014-09 - Revenue from Contracts with Customers
, which provides guidance for revenue recognition.
ASU 2014-09
affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets and supersedes the revenue recognition requirements in
ASC 605 - Revenue Recognition
, and most industry-specific guidance. This ASU also supersedes some cost guidance included in
ASC 605-35 - Revenue Recognition-Construction-Type and Production-Type Contracts
. The standard’s core principle is to recognize revenue when promised goods or services are transferred to customers in an amount that reflects the consideration to which an entity expects to be entitled for those goods or services. The ASU defines a five step process to achieve this core principle and, in doing so, more judgment and estimates may be required within the revenue recognition process than are required under existing U.S. GAAP. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. The Company may adopt the new standard under the full retrospective approach or the modified retrospective approach, as permitted under the standard. Early adoption of the standard is not permitted. This ASU and related updates are effective for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period.
We have completed an initial review of the contracts for our three largest customers to determine the impact that
ASU 2014-09
and its subsequent updates through December 31, 2016 will have on the Company's consolidated financial statements or financial statement disclosures upon adoption. Based on our preliminary review, we believe that the timing and measurement of revenue for these customers will be similar to our current revenue recognition. However, this view is preliminary and could change based on the detailed analysis associated with the conversion and implementation phases of our
ASU 2014-09
project. We will complete our assessment during 2017, and will include other significant wholesale and retail customers as part of the review.
Recently Adopted Accounting Pronouncements
In January 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standard Update ("ASU")
No.
2017-04 - Intangibles—Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment
. This ASU simplifies the subsequent measurement of goodwill, the FASB eliminated Step 2 from the goodwill impairment test. Under the amendments in this ASU, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, an entity should consider income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if applicable. The FASB also eliminated the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. Therefore, the same impairment assessment applies to all reporting units. An entity is required to disclose the amount of goodwill allocated to each reporting unit with a zero or negative carrying amount of net assets. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. A public business entity that is an SEC filer should adopt the amendments in this Update for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017.
ASU 2017-04
was early adopted by the Company for the year beginning January 1, 2017 and did not have a material impact on the Company's condensed consolidated financial statements or financial statement
disclosures.
In January 2017, the FASB issued
ASU
2017-01 - Business Combinations (Topic 805): Clarifying the Definition of a Business.
This standard changes the definition of a business to assist entities with evaluating when a set of transferred assets and activities is a business. The amendments in this ASU provide a screen to determine when a set is not a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. This screen reduces the number of transactions that need to be further evaluated. If the screen is not met, the amendments in this ASU (1) require that to be considered a business, a set must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output and (2) remove the evaluation of whether a market participant could replace missing elements. The amendments provide a framework to assist entities in evaluating whether both an input and a substantive process are present. The framework includes two sets of criteria to consider that depend on whether a set has outputs. Although outputs are not required for a set to be a business, outputs generally are a key element of a business; therefore, the FASB has developed more stringent criteria for sets without outputs. Lastly, the amendments in this Update narrow the definition of the term output so that the term is consistent with how outputs are described in Topic 606.
The ASU is effective for public business entities for
annual periods beginning after December 15, 2017, including interim periods within those periods. The amendments in this Update should be applied prospectively on or after the effective date. No disclosures are required at transition. Early application of the amendments in this Update is allowed as follows: (1) for transactions for which the acquisition date occurs before the issuance date or effective date of the amendments, only when the transaction has not been reported in financial statements that have been issued or made available for issuance and (2) for transactions in which a subsidiary is deconsolidated or a group of assets is derecognized that occur before the issuance date or effective date of the amendments, only when the transaction has not been reported in financial statements that have been issued or made available for issuance.
ASU 2017-01
was early adopted by the Company for the year beginning January 1, 2017 and did not have a material impact on the Company's condensed consolidated financial statements or financial statement disclosures.
In July 2015, the FASB issued
ASU 2015-11
-
Inventory. ASU 2015-11 simplifies the measurement of inventory by requiring inventory to be measured at the lower of cost and net realizable value
.
ASU 2015-11
is effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years.
ASU 2015-11
was adopted by the Company for the year beginning January 1, 2017 and did not have a material impact on the Company's condensed consolidated financial statements or financial statement disclosures.
In August 2014, the FASB issued
ASU 2014-15 - Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern
, to provide guidance on management’s responsibility in evaluating whether there is substantial doubt about a company’s ability to continue as a going concern and to provide related footnote disclosures.
ASU 2014-15
is effective for financial statements issued for fiscal years ending after December 15, 2016, and interim periods thereafter.
ASU 2014-15 - Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern
was adopted by the Company for the year ending December 31, 2016. In connection with the preparation of the financial statements for the three month period ended
March 31, 2017
, the Company conducted an evaluation as to whether there were conditions and events, considered in the aggregate, which raised substantial doubt as to the entity's ability to continue as a going concern within one year after the date of the issuance, or the date of availability, of the financial statements to be issued, noting that there did not appear to be evidence of substantial doubt of the entity's ability to continue as a going concern.
In March 2016, the FASB issued
ASU 2016-09 - Compensation - Stock Compensation
, which simplifies the accounting for the tax effects related to stock based compensation, including adjustments to how excess tax benefits and a company's payments for tax withholdings should be classified, amongst other items.
ASU 2016-09
is effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years with early adoption permitted.
ASU 2016-09
was early adopted by the Company for the year beginning January 1, 2016 and resulted in various effects, most notably a reduction in income tax expense of
$11.4 million
due to stock option exercises in the year ended December 31, 2016.
In November 2015, the FASB issued
ASU 2015-17 - Balance Sheet Classification of Deferred Taxes
to simplify the presentation of deferred income taxes.
ASU 2015-17 - Balance Sheet Classification of Deferred Taxes
requires that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position.
ASU 2015-17 - Balance Sheet Classification of Deferred Taxes
is effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years.
ASU 2015-17 - Balance Sheet Classification of Deferred Taxes
was early adopted by the Company for the year beginning January 1, 2016 resulting in the reclassification of the current portion of deferred tax assets to non-current deferred tax assets for the years ended December 31, 2016 and 2015.
In September 2015, the FASB issued
ASU 2015-16 - Business Combinations
.
ASU 2015-16 - Business Combinations
simplifies the accounting for measurement-period adjustments by requiring adjustments to provisional amounts in a business combination to be recognized in the reporting period in which the adjustment amounts are determined and eliminates the requirement to retrospectively account for those adjustments.
ASU 2015-16 - Business Combinations
requires an entity to present separately on the face of the income statement or disclose in the notes the amount recorded in current-period earnings that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date.
ASU 2015-16 - Business Combinations
was adopted by the Company for the year beginning January 1, 2016 and did not have a material impact on the Company's condensed consolidated financial statements or financial statement disclosures.
In April 2015, the FASB issued
ASU 2015-03 - Interest - Imputation of Interest
, which simplifies the presentation of debt issuance costs by requiring that debt issuance costs be presented in the balance sheet as a direct deduction from the carrying amount of debt liability, consistent with debt discounts or premiums.
ASU 2015-03
is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years.
ASU 2015-03
was adopted by the Company for the year beginning January 1, 2016 resulting in the reclassification of the deferred financing fees to the respective face value of debt outstanding for the year ended December 31, 2016.
Note 17 – Subsequent Events
Merger Agreement
On April 24, 2017, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Fresenius Kabi AG, a German stock corporation (“Parent”), Quercus Acquisition, Inc., a Louisiana corporation and a wholly owned subsidiary of Parent (“Merger Sub”) and, solely for purposes of Article VIII thereof, Fresenius SE & Co. KGaA, a German partnership limited by shares. The Merger Agreement, which has been adopted by the Board of Directors of the Company, provides for the merger of Merger Sub with and into the Company (the “Merger”), with the Company surviving the Merger as a wholly owned subsidiary of Parent.
Subject to the terms and conditions set forth in the Merger Agreement, at the effective time of the Merger (the “Effective Time”), each of the Company’s issued and outstanding shares of common stock, no par value per share (the “Shares”) (other than Shares owned by the Company or by Parent, Merger Sub or any direct or indirect wholly owned subsidiary of the Company or of Parent (other than Merger Sub) immediately prior to the Effective Time), will be converted into the right to receive
$34.00
in cash per Share (the “Merger Consideration”), without interest.
Completion of the Merger is subject to customary closing conditions, including (1) the approval of the Merger Agreement by the affirmative vote of the holders of at least a majority of all outstanding Shares (the “Shareholder Approval”), (2) there being no judgment or law enjoining or otherwise prohibiting the consummation of the Merger and (3) the expiration of the waiting period applicable to the Merger under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended. The obligation of each of the Company and Parent to consummate the Merger is also conditioned on the other party’s representations and warranties being true and correct (subject to certain materiality exceptions) and the other party having performed in all material respects its obligations under the Merger Agreement.
The Merger Agreement contains representations and warranties and covenants of the parties customary for a transaction of this nature. Among other things, Parent has agreed to promptly take all actions necessary to obtain antitrust approval of the Merger, including (i) entering into consent decrees or undertakings with a regulatory authority, (ii) divesting or holding separate any assets or businesses of Parent or the Company, (iii) terminating existing contractual relationships or entering into new contractual relationships, (iv) effecting any other change or restructuring of Parent or the Company and (v) defending through litigation any claim asserted by a regulatory authority that would prevent the closing of the Merger.
Until the earlier of the termination of the Merger Agreement and the Effective Time, the Company has agreed to operate its business in the ordinary course of business in all material respects and has agreed to certain other operating covenants and to not take certain specified actions prior to the consummation of the Merger, as set forth more fully in the Merger Agreement. The Company has also agreed to convene and hold a meeting of its shareholders for the purpose of obtaining the Shareholder Approval. In addition, the Merger Agreement requires that, subject to certain exceptions, the Board recommend that the Company’s shareholders approve the Merger Agreement.
Shareholder Derivative and Class Action Complaint in Connection with the Merger
On May 2, 2017 a shareholder derivative and class action complaint for breach of fiduciary duties in connection with the Merger was filed entitled
Robert J. Shannon, Jr., et. al. v. Fresenius Kabi AG et. al. No. 2017-CH-06322
in the Circuit Court of Cook County, Illinois, Chancery Division. The complaint seeks injunctive relief. Defendants intend to vigorously defend this case.