Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following is a discussion and analysis of the consolidated operating results, financial condition, liquidity and cash flows of our company as of and for the periods presented below. The following discussion and analysis should be read in conjunction with the audited consolidated financial statements and the related notes thereto included in Item 8 under the heading “Financial Statements and Supplementary Data.” This discussion contains forward-looking statements that are based on the beliefs of our management, as well as assumptions made by and information currently available to, our management. Actual results could differ materially from those discussed in or implied by forward-looking statements. These risks, uncertainties and other factors include among others, those identified under the “Special Note About Forward-Looking Statements,” above and described in greater detail elsewhere in this Annual Report on Form 10-K, particularly in Item 1A, “Risk Factors.”
In this section, we generally discuss the results of our operations for the year ended December 31, 2020 compared to the year ended December 31, 2019. For a discussion of the year ended December 31, 2019 to the year ended December 31, 2018, please refer to Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2019, filed with the SEC on March 16, 2020, which discussion is hereby incorporated herein by reference.
Overview
We are a bio-pharmaceutical company that focuses primarily on developing, manufacturing, marketing and selling technically-challenging generic and proprietary injectable, inhalation, and intranasal products as well as insulin API products. We currently manufacture and sell over 20 products.
We are currently developing a portfolio of 13 generic abbreviated new drug applications, or ANDAs, three biosimilar insulin product candidates and four proprietary product candidates, which are in various stages of development and target a variety of indications. Five of the ANDAs and one NDA are currently on file with the FDA.
Our largest products by net revenues currently include Primatene Mist ® , enoxaparin sodium injection, phytonadione, lidocaine jelly and sterile solution, and naloxone hydrochloride injection. In the fourth quarter of 2018, we launched our over-the-counter product Primatene Mist ® . In July 2019, we began a national digital, radio, and television campaign for our over-the-counter product Primatene Mist ® , which will continue throughout 2021. During the second quarter of 2020, we launched our epinephrine injection, USP 30mg/mL multiple dose vial product. In December 2020, the FDA granted approval of our glucagon for injection emergency kit, 1mg, and we launched this product in the first quarter of 2021.
To complement our internal growth and expertise, we have made several strategic acquisitions of companies, products and technologies. These acquisitions collectively have strengthened our core injectable and inhalation product technology infrastructure by providing additional manufacturing, marketing, and research and development capabilities, including the ability to manufacture raw materials, API and other components for our products.
Included in these acquisitions are marketing authorizations for 33 products in the UK, Ireland, Australia, and New Zealand, representing 11 different injectable chemical entities from UCB Pharma GmbH. We are in the process of transferring the manufacturing of these products to our facilities in California, which will require approvals from the UK Medicines and Healthcare products Regulatory Agency before we can relaunch the products.
In July 2018, our Chinese subsidiary, ANP, completed a private placement of its common equity interest and received approximately $56.3 million of cash proceeds. We have retained approximately 58% of the equity interest in ANP following the private placement. ANP’s net income or loss after July 2, 2018, is attributed to us in accordance with our equity interest of approximately 58% in ANP.
COVID-19 Pandemic
In March 2020, the World Health Organization declared the outbreak of a novel coronavirus, or COVID-19, as a pandemic, which continues to spread throughout the world, including locations where we operate, such as the United
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States, China and France. We have been actively monitoring the COVID-19 pandemic and its impact globally. Currently, our production facilities in all of our locations continue to operate as they had prior to the COVID-19 pandemic with few changes, other than for enhanced safety measures intended to prevent the spread of the virus.
As a result of the COVID-19 pandemic, during the first half of 2020, sales of Primatene Mist ® and certain hospital products increased, while sales of certain products frequently used in elective procedures, such as Cortrosyn ® and lidocaine products, decreased. During the second half of 2020, sales of these products returned to levels closer to those experienced prior to the COVID-19 pandemic. Also, some of our ongoing clinical trials have experienced short-term interruptions in the recruitment of patients due to the COVID-19 pandemic, as hospitals prioritize their resources towards the COVID-19 pandemic and governments impose travel restrictions. Additionally, some clinical trials experienced increased expenses due to new protocols to protect participants from COVID-19.
It is not possible at this time to estimate the complete impact that COVID-19 could have on our business, including our customers and suppliers, as the impact will depend on future developments, which are highly uncertain and cannot be predicted. Infections may resurge or become more widespread and the limitation on our ability to travel and timely sell and distribute our products, as well as any closures or supply disruptions, may be extended for longer periods of time, all of which would have a negative impact on our business, financial condition and operating results.
The COVID-19 pandemic has and will continue to adversely affect global economies and financial markets, resulting in an economic downturn that could affect demand for our products and impact our operating results. Even after the COVID-19 pandemic has subsided, we may continue to experience an adverse impact to our business as a result of the continued global economic impact of the pandemic. We cannot anticipate all of the ways in which health epidemics such as COVID-19 could adversely impact our business. We will continue to monitor the impact of COVID-19 on all aspects of our business. See Item 1A, “Risk Factors” for further discussion of the possible impact of the COVID-19 pandemic on our business.
Business Segments
As of December 31, 2020, our performance is assessed and resources are allocated based on the following two reportable segments: (1) finished pharmaceutical products and (2) API products. The finished pharmaceutical products segment manufactures markets and distributes Primatene Mist ® , enoxaparin, naloxone, phytonadione, lidocaine, as well as various other critical and non-critical care drugs. The API segment manufactures and distributes RHI API and porcine insulin API for external customers and internal product development. Information reported herein is consistent with how it is reviewed and evaluated by our chief operating decision maker. Factors used to identify our segments include markets, customers and products.
For more information regarding our segments, see “Part II – Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Segment Reporting Information.”
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Results of Operations
Year ended December 31, 2020 compared to year ended December 31, 2019
Net revenues
Year Ended December 31,
Change
2020
2019
Dollars
%
(in thousands)
Net revenues
Finished pharmaceutical products
$
331,368
$
302,000
$
29,368
10
%
API
18,478
20,357
(1,879)
(9)
%
Total net revenues
$
349,846
$
322,357
$
27,489
9
%
Cost of revenues
Finished pharmaceutical products
$
179,723
$
165,424
$
14,299
9
%
API
26,783
25,010
1,773
7
%
Total cost of revenues
$
206,506
$
190,434
$
16,072
8
%
Gross profit
$
143,340
$
131,923
$
11,417
9
%
as % of net revenues
41
%
41
%
The increase in net revenues of finished pharmaceutical products for 2020 was primarily due to the following changes:
Year Ended December 31,
Change
2020
2019
Dollars
%
(in thousands)
Finished pharmaceutical products net revenues
Primatene Mist ®
$
51,725
$
18,065
$
33,660
186
%
Enoxaparin
48,681
42,695
5,986
14
%
Phytonadione
42,646
45,786
(3,140)
(7)
%
Lidocaine
41,113
46,013
(4,900)
(11)
%
Naloxone
33,416
34,761
(1,345)
(4)
%
Epinephrine
23,799
13,885
9,914
71
%
Other finished pharmaceutical products
89,988
100,795
(10,807)
(11)
%
Total finished pharmaceutical products net revenues
$
331,368
$
302,000
$
29,368
10
%
The increase in sales of Primatene Mist ® for the year ended December 31, 2020 was a result of the continued success of our nationwide digital, television and radio campaign, which will continue throughout 2021. Additionally, sales of Primatene Mist ® increased as we increased our distribution channels, selling online on Amazon and to Kroger, the largest grocery store chain in the United States starting in the third quarter of 2020. The increase in sales of enoxaparin was primarily due to an increase in unit volume, as a result of a competitor leaving the market. The increase in sales of epinephrine was primarily due to the launch of our epinephrine injection, USP 30mg/30mL multiple dose vial product in the second quarter of 2020. During the second and fourth quarters of 2020, we experienced lower demand for certain products which are frequently used in elective procedures, including lidocaine products and some products such as Cortrosyn ® which are included in other finished pharmaceutical products. We attribute these declines in products used in elective procedures to a nationwide decline in such procedures by hospitals and individuals in response to the COVID-19 pandemic. These declines were partially offset by a $5.9 million increase in sales of sodium bicarbonate, included in other finished pharmaceutical products, as we were able to utilize the new production line approved by the FDA earlier in the year to meet strong market demand. We saw lower volume of several other finished pharmaceutical products including calcium chloride, dextrose and atropine, as a competitor who experienced shortages in 2019 returned to the market in 2020.
We anticipate that sales of naloxone and enoxaparin will continue to fluctuate in the future as a result of changing levels of competition.
Sales of API primarily depend on the timing of customer purchases. We anticipate that sales of API will continue to fluctuate and may decrease due to the inherent uncertainties related to sales to MannKind Corporation pursuant to our supply agreement with them. In addition, most of our API sales are denominated in euros, and the fluctuation in the
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value of euros versus the U.S. dollar has had, and will continue to have, an impact on API sales revenues in the near term.
A significant portion of our customer shipments in any period relate to orders received and shipped in the same period, generally resulting in low product backlog relative to total shipments at any time. We had no significant backlog as of December 31, 2020. Historically, our backlog has not been a meaningful indicator in any given period of our ability to achieve any particular level of overall revenue or financial performance.
Gross Margins
Gross margins remained approximately the same compared to the prior period. We saw an increase in sales of Primatene Mist ® and launched epinephrine injection multiple dose vial, which are both higher-margin products. These increases in gross margins were offset by charges included in cost of revenue to adjust our inventory and related purchase commitments to their net realizable value. Additionally, the gross margin in 2019 benefited from a one-time $2.8 million amendment fee paid by MannKind, which temporarily increased gross margin as a percentage of revenue in 2019.
The cost of heparin, which is the starting material for enoxaparin, has increased and is expected to increase further, putting downward pressure on our gross margins. However, we believe that this trend will be offset by sales of our higher-margin products, such as Primatene Mist ® , and epinephrine multi dose vials, which were launched over the past few years and by glucagon which was launched in 2021. Additionally, we have not seen significant supply disruption due to the COVID-19 pandemic at this time, but we are carefully monitoring for any potential problems.
Selling, distribution, and marketing, and general and administrative
Year Ended December 31,
Change
2020
2019
Dollars
%
(in thousands)
Selling, distribution, and marketing
$
14,780
$
12,830
$
1,950
15
%
General and administrative
50,377
50,279
98
0
%
The increase in selling, distribution, and marketing expenses was primarily due to marketing and distribution expenses related to Primatene Mist ® , including the cost of a national digital, television and radio marketing campaign which began in July 2019. The increase in general and administrative expense was primarily due to an expense of $4.9 million relating to cash compensation and share-based compensation expense in connection with a separation agreement with a former executive during the second quarter of 2020. This was partially offset by a decrease in legal expenses as a result of the enoxaparin patent and antitrust litigation settlement reached in the second quarter of 2019.
We expect that selling, distribution and marketing expenses will increase due to the increase in marketing expenditures for Primatene Mist ® . We expect that general and administrative expenses will increase on an annual basis due to increased costs associated with ongoing compliance with public company reporting obligations. Legal fees may fluctuate due to the timing of patent challenges and other litigation matters.
Research and development
Year Ended December 31,
Change
2020
2019
Dollars
%
(in thousands)
Salaries and personnel-related expenses
$
27,156
$
27,503
$
(347)
(1)
%
Clinical trials
6,975
8,707
(1,732)
(20)
%
FDA fees
370
860
(490)
(57)
%
Testing, operating and lab supplies
13,630
15,640
(2,010)
(13)
%
Depreciation
10,119
8,591
1,528
18
%
Other expenses
8,979
7,552
1,427
19
%
Total research and development expenses
$
67,229
$
68,853
$
(1,624)
(2)
%
Clinical trial expense decreased due to the completion of one of our external studies in 2020 and the delay in other studies caused by COVID-19. The decrease in testing, operating and lab supplies was primarily due to a decrease in expenses at our ANP facility.
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Research and development costs consist primarily of costs associated with the research and development of our product candidates including the cost of developing APIs. We expense research and development costs as incurred.
We have made, and expect to continue to make, substantial investments in research and development to expand our product portfolio and grow our business. We expect that research and development expenses will increase on an annual basis due to increased clinical trial costs related to our biosimilar and inhalation product candidates. These expenditures will include costs of APIs developed internally as well as APIs purchased externally, the cost of purchasing reference listed drugs and the costs of performing the clinical trials. As we undertake new and challenging research and development projects, we anticipate that the associated costs will increase significantly over the next several quarters and years. Some of our ongoing clinical trials have experienced short term interruptions in the recruitment of patients due to the COVID-19 pandemic, as hospitals prioritize their resources towards the COVID-19 pandemic and governments impose travel restrictions. These conditions may in turn delay spending and delay the results of these trials.
Other income (expense), net
Year Ended December 31,
Change
2020
2019
Dollars
%
(in thousands)
Other income (expenses), net
$
(6,585)
$
59,389
$
(65,974)
NM
In June 2019, we recognized a gain of $59.9 million relating to our settlement of the enoxaparin patent and antitrust litigation with Momenta Pharmaceuticals, Inc. and Sandoz Inc. In December 2020, we recorded $12.8 million of expense in connection with the Aventis litigation. For more information regarding our litigations matters, see Note 20 to the consolidated financial statements. This was partially offset by $5.1 million relating to foreign currency gains in 2020.
Income tax provision
Year Ended December 31,
Change
2020
2019
Dollars
%
(in thousands)
Income tax provision
$
3,540
$
13,723
$
(10,183)
NM
Effective tax rate
76
%
23
%
Our tax rate is affected by recurring items, such as tax rates in non-U.S. jurisdiction as compared to notional U.S. federal statutory tax rate, and the relative amount of income or loss in those various jurisdictions. It is also impacted by certain items that may occur in any given period, but are not consistent from period to period.
For additional information on our income taxes, including information about the impact of the CARES Act, refer to Note 15 to the consolidated financial statements.
Liquidity and Capital Resources
Cash Requirements and Sources
We need capital resources to maintain and expand our business. We expect our cash requirements to increase significantly in the foreseeable future as we sponsor clinical trials for, seek regulatory approvals of, and develop, manufacture and market our current development-stage product candidates and pursue strategic acquisitions of businesses or assets. Our future capital expenditures include projects to upgrade, expand, and improve our manufacturing facilities in the United States, China, and France. Our cash obligations include the principal and interest payments due on our existing loans and lease payments, as described below and throughout this Annual Report on Form 10-K.
As of December 31, 2020, our foreign subsidiaries collectively held $20.1 million in cash and cash equivalents. Cash or cash equivalents held at foreign subsidiaries are not available to fund the parent company’s operations in the United States. We believe that our cash reserves, operating cash flows, and borrowing availability under our credit facilities will be sufficient to fund our operations for at least the next 12 months. We expect additional cash flows to be generated in the longer term from future product introductions, although there can be no assurance as to the receipt of regulatory
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approval for any product candidates that we are developing or the timing of any product introductions, which could be lengthy or ultimately unsuccessful.
We maintain a shelf registration statement on Form S-3 pursuant to which we may, from time to time, sell up to an aggregate of $250 million of our common stock, preferred stock, depositary shares, warrants, units, or debt securities. If we require or elect to seek additional capital through debt or equity financing in the future, we may not be able to raise capital on terms acceptable to us or at all. To the extent we raise additional capital through the sale of equity or convertible debt securities, the issuance of such securities will result in dilution to our stockholders. If we are required and unable to raise additional capital when desired, our business, operating results and financial condition may be adversely affected.
Working capital increased $2.3 million to $167.5 million at December 31, 2020, compared to $165.2 million at December 31, 2019.
Cash Flows from Operations
The following table summarizes our cash flows from operating, investing, and financing activities for the years ended December 31, 2020 and 2019.
Year Ended December 31,
2020
2019
(in thousands)
Statement of Cash Flow Data:
Net cash provided by (used in)
Operating activities
$
57,266
$
41,762
Investing activities
(36,415)
(50,527)
Financing activities
(2,246)
(3,783)
Effect of exchange rate changes on cash
352
(104)
Net increase (decrease) in cash, cash equivalents, and restricted cash
$
18,957
$
(12,652)
Sources and Use of Cash
Operating Activities
Net cash provided by operating activities was $57.3 million for the year ended December 31, 2020, which included net income of $1.1 million. Non-cash items comprised primarily of $21.5 million of depreciation and amortization, and $20.5 million of share-based compensation expense.
Additionally, for the year ended December 31, 2020, there was a net cash inflow from changes in operating assets and liabilities of $9.1 million, which resulted from an increase in accounts payable and accrued liabilities and a decrease in inventory, which was partially offset by an increase in accounts receivable. Accounts payable and accrued liabilities increased primarily due to the timing of payments. The decrease in inventory was a result of strong sales throughout the year and a decrease in purchases of raw materials of enoxaparin. The increase in accounts receivable was due to the timing of sales.
Net cash provided by operating activities was $41.8 million for the year ended December 31, 2019, which included net income of $46.5 million, primarily as a result of the receipt of the $59.9 million relating to the litigation settlement with Momenta Pharmaceuticals, Inc. and Sandoz Inc. Non-cash items were primarily comprised of $18.1 million of depreciation and amortization, and $17.3 million of share-based compensation expense.
Additionally, there was a net cash outflow from changes in operating assets and liabilities of $51.7 million which resulted from the decrease in accounts receivable, offset by an increase in inventory, as well as a decrease in accounts payable and accrued liabilities. The decrease in accounts receivable was due to the timing of sales. The increase in inventory was primarily due to increased purchases of raw materials and the production of finished goods for enoxaparin and Primatene Mist ® with an impact of $29.2 million and $9.3 million, respectively. We utilized deferred tax credits to offset a significant portion of the tax liability related to our 2019 U.S. federal and California state taxable income,
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resulting in only $4.6 million tax payments. Accounts payable and accrued liabilities decreased primarily due to the timing of payments.
Investing Activities
Net cash used in investing activities was $36.4 million for the year ended December 31, 2020, primarily as a result of $33.9 million in purchases of property, plant, and equipment, which included $11.5 million incurred in the United States, $2.9 million in France, and $19.5 million in China. Additionally, we purchased $1.1 million in short-term investments in 2020.
Net cash used in investing activities was $50.5 million for the year ended December 31, 2019, primarily as a result of $41.6 million in purchases of property, plant, and equipment, which included $11.3 million incurred in the United States, $6.8 million in France, and $23.5 million in China. Additionally, we purchased $8.8 million in short-term investments in 2019.
Financing Activities
Net cash used in financing activities was $2.2 million for the year ended December 31, 2020, primarily as a result of $24.4 million used to purchase treasury stock offset by $23.2 million in net proceeds from the settlement of share-based compensation awards under our equity plans. Additionally, we also made $8.4 million in principal payments on our long-term debt and received $7.5 million from borrowings on our lines of credit, of which $3.1 million was converted into an equipment loan during the year.
Net cash used in financing activities was $3.8 million for the year ended December 31, 2019, primarily as a result of $22.3 million used to purchase treasury stock, which was partially offset by the receipt of $18.3 million for the ANP private placement, and $3.4 million in net proceeds received from our equity plans. Additionally, we received $3.6 million from borrowings on an equipment line of credit, and made $6.8 million in principal payments on our long-term debt and lines of credit.
Debt and Borrowing Capacity
Our outstanding debt obligations are summarized as follows:
December 31,
2020
2019
Change
(in thousands)
Short-term debt and current portion of long-term debt
$
12,263
$
7,741
$
4,522
Long-term debt
34,186
39,394
(5,208)
Total debt
$
46,449
$
47,135
$
(686)
As of December 31, 2020, we had $56.0 million in unused borrowing capacity under revolving lines of credit and equipment lines of credit with Cathay Bank, East West Bank, and China Merchant Bank.
Lines of credit bear variable interest rates and are secured by inventory, accounts receivable, intangible assets, and equipment. The weighted average interest rates on lines of credit as of December 31, 2020 and 2019 were 3.8% and 4.0%, respectively. We have also entered into or refinanced certain mortgage and equipment loans with Cathay Bank and East West Bank, which bear variable or fixed interest rates and are secured by buildings and equipment. On certain loans with East West Bank, we have entered into fixed interest rate swap contracts to exchange the variable interests for fixed interest rates without the exchange of underlying notional debt amounts.
For more information regarding our outstanding indebtedness, see “Part II – Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Debt.”
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Operating Lease Obligations
As discussed in Note 18 to the consolidated financial statements, as of December 31, 2020 we had a total of $26.2 million of minimum rental payments under operating leases. Of that amount, $4.4 million is due within 12 months as of December 31, 2020.
Purchase obligations
We have certain purchase obligations under which we are required to make minimum payments for items including, but not limited to, inventory and pharmaceutical manufacturing and laboratory equipment. As of December 31, 2020, we had an aggregate amount of approximately $48.8 million. We anticipate that most of these commitments with a remaining term in excess of one year will be fulfilled by 2022.
Critical Accounting Policies
We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States, or GAAP. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates. To the extent that there are material differences between these estimates and actual results, our financial condition and results of operations will be affected. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies, which we discuss further below. While our significant accounting policies are more fully described in Note 2 to our audited consolidated financial statements, we believe that the following accounting policies are critical to the process of making significant judgments and estimates in the preparation of our audited consolidated financial statements.
Revenue Recognition
In 2018, we adopted ASC 606, Revenue from Contracts with Customers , or ASC 606, using the modified retrospective transition method. The adoption of ASC 606 did not have a material impact on our revenues recognition or on the consolidated financial statements and related disclosures. According to ASC 606, revenue is recognized at the time that our customers obtain control of the promised goods. Revenues derived from contract manufacturing services are recognized when third-party products are shipped to customers, after customers have accepted test samples of the products to be shipped. The results for the reporting period beginning after January 1, 2018, are presented in accordance with the new standard, although comparative information continues to be reported under the accounting standards and policies in effect for those periods.
Our net revenues consist principally of revenues generated from the sale of our pharmaceutical products. We also generate a small amount of revenues from contract manufacturing services. Generally, we recognize revenues at the time of product delivery to our customers. In some cases, revenues are recognized at the time of shipment when stipulated by the terms of the sale agreements. Revenues derived from contract manufacturing services are recognized when third-party products are shipped to customers, after the customer has accepted test samples of the products to be shipped.
The consideration we receive in exchange for our goods or services is only recognized when it is probable that a significant reversal will not occur. The consideration to which we expect to be entitled includes a stated list price, less various forms of variable consideration. We make significant estimates for related variable consideration at the point of sale, including chargebacks, rebates, product returns, other discounts and allowances.
Provision for estimated chargebacks, rebates, discounts, product returns and credit losses is made at the time of sale and is analyzed and adjusted, if necessary, at each balance sheet date.
If actual future payments for the discounts, returns, fees, rebates and chargebacks exceed the estimates we made at the time of sale, our financial position, results of operations and cash flows would be negatively impacted. As discussed under “Accrual for Product Returns” below, we are generally obligated to accept from our customers the return of pharmaceuticals that have reached or will soon reach their expiration dates. We establish reserves for such amounts
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based on historical experience and other information available at the time of sale, but the actual returns will not occur until several years after the sale. Although we believe that our estimates and assumptions are reasonable as of the date when made, actual results may differ significantly from these estimates. Our financial position, results of operations and cash flows may be materially and negatively impacted if actual returns exceed our estimated allowances for returns.
We establish allowances for estimated chargebacks, rebates and product returns based on a number of qualitative and quantitative factors, including:
● contract pricing and return terms of our agreements with customers;
● wholesaler inventory levels and turnover;
● historical chargeback and product return rates;
● shelf lives of our products, which is generally two years, as is the case with enoxaparin;
● direct communication with customers;
● anticipated introduction of competitive products or authorized generics; and
● anticipated pricing strategy changes by us and/or our competitors.
Provision for Chargebacks and Rebates
The provision for chargebacks and rebates is a significant estimate used in the recognition of revenue. Wholesaler chargebacks relate to sales terms under which we agree to reimburse wholesalers for differences between the gross sales prices at which we sell our products to wholesalers and the actual prices of such products that wholesalers resell them under our various contractual arrangements with third parties such as hospitals and group purchasing organizations in the United States. Rebates include primarily amounts paid to retailers, payers, and providers in the United States, including those paid to state Medicaid programs, and are based on contractual arrangements or statutory requirements. We estimate chargebacks and rebates using the expected value method at the time of sale to wholesalers based on wholesaler inventory stocking levels, historic chargeback and rebate rates, and current contract pricing.
The provision for chargebacks and rebates is reflected as a component of net revenues. The following table is an analysis of the chargeback and rebate provision:
Year Ended
December 31,
2020
2019
(in thousands)
Beginning balance
$
21,644
$
22,423
Provision for chargebacks and rebates
158,152
131,524
Credits and payments issued to third parties
(159,416)
(132,303)
Ending balance
$
20,380
$
21,644
Changes in the chargeback provision from period to period are primarily dependent on our sales to wholesalers, the level of inventory held by wholesalers, and the wholesalers’ customer mix. Changes in the rebate provision from period to period are primarily dependent on retailer’s and other indirect customers’ purchases. The approach that we use to estimate chargebacks and rebates has been consistently applied for all periods presented. Variations in estimates have been historically small. We continually monitor the provision for chargebacks and rebates and make adjustments when we believe that the actual chargebacks and rebates may differ from the estimates. The settlement of chargebacks and rebates generally occurs within 30 days to 60 days after the sale to wholesalers. Accounts receivable and/or accounts payable and accrued liabilities are reduced and/or increased by the chargebacks and rebate amounts depending on whether we have the right to offset with the customer. Of the provision for chargebacks and rebates as of December 31, 2020 and 2019, $16.4 million and $15.4 million were included in accounts receivable, net, on the consolidated balance sheets, respectively. The remaining provision as of December 31, 2020 and 2019, was $4.0 million and $6.2 million,
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which were included in accounts payable and accrued liabilities, respectively.
Accrual for Product Returns
We offer most customers the right to return qualified excess or expired inventory for partial credit; however, API product sales are generally non-returnable. Our product returns primarily consist of the returns of expired products from sales made in prior periods. Returned products cannot be resold. At the time product revenue is recognized, we record an accrual for product returns estimated using the expected value method. The accrual is based, in part, upon the historical relationship of product returns to sales and customer contract terms. We also assess other factors that could affect product returns including market conditions, product obsolescence and the introduction of new competition. Although these factors do not normally give our customers the right to return products outside of the regular return policy, we realize that such factors could ultimately lead to increased returns. We analyze these situations on a case-by-case basis and make adjustments to the product return reserve as appropriate.
The provision for product returns is reflected as a component of net revenues. The following table is an analysis of the product return liability:
Year Ended
December 31,
2020
2019
(in thousands)
Beginning balance
$
10,339
$
8,030
Provision for product returns
11,810
7,305
Credits issued to third parties
(7,945)
(4,996)
Ending balance
$
14,204
$
10,339
Of the provision for product returns as of December 31, 2020 and 2019, $10.2 million and $7.1 million were included in accounts payable and accrued liabilities on the consolidated balance sheets, respectively. The remaining provision as of December 31, 2020 and 2019, of $4.0 million and $3.2 million were included in other long-term liabilities, respectively. For the years ended December 31, 2020 and 2019, our aggregate product return rate was 1.4% and 1.1% of qualified sales, respectively.
Inventory
Inventories consist of currently marketed products and products manufactured under contract. Inventories are stated using the first-in, first-out method, on a consistent basis. Inventory is stated at the lower of cost and net realizable value. We adjust inventories to their net realizable value: (i) if a launch of a new product is delayed and inventory may not be fully utilized and could be subject to impairment, (ii) when a product is close to expiration and not expected to be sold, (iii) when a product has reached its expiration date, (iv) when a product is not expected to be sellable, and (v) when the estimated net realizable value is below cost. In determining the estimated net realizable value of an inventory item, we consider factors such as the forecasted average net selling price, the amount of inventory on hand, its remaining shelf life, its regulatory approval status, and current and expected market conditions, including management forecasts and levels of competition.
The largest adjustment to the net realizable value of our inventory has historically been related to enoxaparin. The adjustment of enoxaparin inventory to its net realizable value has been driven primarily by increases in the prices of heparin, the starting material for the production of the API in our enoxaparin product. Other cost increases relate to labor and overhead also impacted the cost of producing enoxaparin. Additionally, fluctuations in the forecasted average net selling price impact this estimate. The average net selling price has fluctuated due to competitor entries and exits from the market.
Impairment of Intangible and Long-Lived Assets
We review long-lived assets and definite-lived identifiable intangible assets or asset groups for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Such events and circumstances include decisions by the FDA regarding evidence of effectiveness of proprietary drug candidates or bioequivalence (sameness) of our generic product candidates as compared to the reference drug, communication with the
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regulatory agencies regarding the safety and efficacy of our products under review, the use of the asset in current research and development projects, any potential alternative uses of the asset in other research and development projects in the short-to-medium term, clinical trial results and research and development portfolio management options. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset or asset groups and its eventual disposition. If the sum of the expected future undiscounted cash flows is less than the carrying amount of the asset or asset groups, further impairment analysis is performed. An impairment loss is measured as the amount by which the carrying amount exceeds the fair value of the asset or asset groups (assets to be held and used) or fair value less cost to sell (assets to be disposed of). All of our impairments relate primarily to the isolated write-off of certain manufacturing equipment related to abandoned projects. Since we periodically assess our product candidates and make changes to product development plans, we incur impairment charges from time to time which can fluctuate significantly from period to period.
The indefinite-lived intangible asset, the Primatene ® trademark acquired in June 2008, and goodwill are tested for impairment annually, in the fourth quarter, or more frequently if indicators of impairment are present. An impairment loss is recorded if the asset’s fair value is less than its carrying value. We also periodically review the Primatene ® trademark to determine if events and circumstances continue to support an indefinite useful life. When we choose to perform a qualitative assessment, we evaluate economic, industry and company-specific factors as an initial step. If we determine it is more likely than not that the Primatene ® trademark is impaired or the fair value of a reporting unit is less than its carrying amount, further quantitative impairment process is then performed; otherwise, no further testing is required. If the life is no longer indefinite, the asset is tested for impairment, and the carrying value, after recognition of any impairment loss, is amortized over its remaining useful life. No impairment of indefinite-lived intangible asset and goodwill was recorded during the years ended December 31, 2020, 2019, or 2018, respectively.
Deferred Income Taxes
We utilize the liability method of accounting for income taxes under which deferred taxes are determined based on the temporary differences between the financial statements and the tax basis of assets and liabilities using enacted tax rates. A valuation allowance is recorded when it is more likely than not that the deferred tax assets will not be realized.
A number of years may elapse before an uncertain tax position for which we have established a tax reserve is audited and finally resolved. The number of years for which we can be subject to audit varies depending on the tax jurisdiction. While it is often difficult to predict the final outcome or the timing of the resolution of an audit, we believe that our reserves for uncertain tax benefits reflect the outcome of tax positions that is more likely than not to occur. The resolution of a matter could be recognized as an adjustment to our provision for income taxes and our effective tax rate in the period of resolution, and may also require a use of cash.
Share-Based Compensation
Options issued under our 2015 Equity Incentive Award Plan, or the 2015 Plan, and our Amended and Restated 2005 Equity Incentive Award Plan, or 2005 Plan, are granted at exercise prices equal to or greater than the fair value of the underlying common shares on the date of grant and vest based on continuous service. There have been no awards with performance conditions and no awards with market conditions. The options have a contractual term of five to ten years and generally vest over a three- to five-year period.
For awards issued prior to the listing of our common stock on The Nasdaq Global Select Market, or Nasdaq, the fair value of the common stock utilized in the fair value estimation of award arrangements has been determined by our board of directors, utilizing contemporaneous third-party valuations. Following the listing of our common stock on Nasdaq, we use the closing stock price as reported on Nasdaq on the grant date for the fair value of its stock.
We use the Black-Scholes option pricing model to determine the fair value of options awards. The Black-Scholes option pricing model has various inputs such as the common share price on the date of grant, exercise price, the risk-free interest rate, volatility, expected life and dividend yield, all of which are estimates. We used the risk free rate on U.S. Treasury securities at the time of grant for instruments with maturities commensurate with the expected term of the stock option. Starting in 2020, our volatility estimate was based on the weighted average historical volatility of our stock price since IPO. Prior to 2020, our volatility estimate was based on the weighted average historical volatility of our stock price and the stock price from a set of peer companies, since our shares did not have sufficient trading history. We consider factors such as stage of life cycle, competitors, size, market capitalization and financial leverage in the selection of
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similar entities. Our dividend yield was assumed to be 0%, because we have no plans to pay dividends. We estimate the expected term of options with consideration of vesting date, contractual term, and historical experience for employee exercise and post-vesting employment termination behavior after our common stock has been publicly traded. The expected term of “plain vanilla” options is estimated based on the midpoint between the vesting date and the end of the contractual term under the simplified method.
The fair value of each share-based compensation award is amortized into compensation expense on a straight-line basis between the grant date for the option and the vesting date net of expected forfeitures. We estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual numbers differ from such estimates. The change of any of these inputs could significantly impact the determination of the fair value of our options as well as significantly impact our results of operations.
Recent Accounting Pronouncements
In December 2019, the Financial Accounting Standards Board, or FASB, issued Accounting Standard Update, or ASU, No. 2019-12 Simplifying the Accounting for Income Taxes (Topic 740) , which simplifies various aspects related to accounting for income taxes. The amendment also improves consistent application of and simplify GAAP for other areas of Topic 740 by clarifying and amending existing guidance. The guidance is effective for our interim and annual reporting periods during the year ended December 31, 2021, with early adoption permitted. We are currently evaluating the impact that the adoption of this guidance will have on our consolidated financial statements and related disclosures.
Non-GAAP Financial Measures
We report our financial results in accordance with accounting principles generally accepted in the United States, or GAAP.
Off-Balance Sheet Arrangements
We do not have any relationships or financial partnerships with unconsolidated entities, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts.
Investment in China
In accordance with certain agreements between ANP and the Chinese government, in January 2010 and November 2012, we acquired certain land-use rights for $1.2 million and $1.3 million, respectively. As required by these agreements, we were committed to spend approximately $15.0 million in the related land development, which primarily included the construction of fixed assets according to a specific timetable. As of December 31, 2020, we have spent $19.5 million on such construction, fulfilling our commitment.
Government Regulation
Our products and facilities are subject to regulation by a number of federal and state governmental agencies. The FDA in particular, maintains oversight of the formulation, manufacture, distribution, packaging, and labeling of all of our products. The Drug Enforcement Administration, or DEA, maintains oversight over our products that are considered controlled substances.
In December 2020, our IMS facility in South El Monte, California was subject to an inspection by the DEA. The inspection was routine as part of the DEA surveillance program. Due to COVID-19 restrictions, much of the inspection is being performed off-site, by DEA inspectors (i.e. a “paper inspection”). The DEA has completed the inspection, including a thorough review of the requested documents and have found the facility to be in compliance.
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