Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Please read the following discussion in conjunction with Item 1A. (“Risk Factors”) and our audited consolidated financial statements included elsewhere in this annual report. Some of the statements in the following discussion are forward-looking statements. See the discussion about forward-looking statements on page 1 of this Annual Report on Form 10-K.
This section of this Form 10-K generally discusses 2020 and 2019 items and year-to-year comparisons between 2020 and 2019. Discussions of 2018 items and year-to-year comparisons between 2019 and 2018 that are not included in this Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019 , filed with the SEC on February 27, 2020.
Executive Overview
ANI Pharmaceuticals, Inc. and its consolidated subsidiaries, ANIP Acquisition Company and ANI Pharmaceuticals Canada Inc. (together, “ANI,” the “Company,” “we,” “us,” or “our”) is an integrated specialty pharmaceutical company focused on delivering value to our customers by developing, manufacturing, and marketing high quality branded and generic prescription pharmaceuticals. We focus on niche and high barrier to entry opportunities, including controlled substances, oncology products (anti-cancer), hormones and steroids, and complex formulations. Our three pharmaceutical manufacturing facilities, of which two are located in Baudette, Minnesota and one is located in Oakville, Ontario, are together capable of producing oral solid dose products, as well as semi-solids, liquids and topicals, controlled substances, and potent products that must be manufactured in a fully-contained environment.
Our strategy is to use our assets to develop, acquire, manufacture, and market branded and generic specialty prescription pharmaceuticals. While generic products tend to have higher margins than branded products, margins decrease as the number of companies offering a generic form of a branded drug increases. To address this downward pressure on prices of generic products, we actively seek to acquire new drug products. By executing on this and other strategies, we believe we will be able to continue to grow our business, expand and diversify our product portfolio, and create long-term value for our investors.
In 2018, our subsidiary, ANI Pharmaceuticals Canada Inc. (“ANI Canada”), acquired all the issued and outstanding equity interests of WellSpring Pharma Services Inc. (“WellSpring”), a Canadian company that performs contract development and manufacturing of pharmaceutical products. In conjunction with the transaction, we acquired WellSpring’s pharmaceutical manufacturing facility, laboratory, and offices, its current book of commercial business, as well as an organized workforce. In addition, we acquired the ANDAs for three previously-commercialized generic products, the approved ANDAs for two generic products that had yet to be commercialized at the time of the acquisition, the development package for one generic product, a license, supply, and distribution agreement for a generic product with an ANDA that is pending approval, and certain manufacturing equipment required to manufacture one of the products. We also acquired the ANDAs for 23 previously-marketed generic products and API for four of the acquired products. During the 2018 year, we launched 11 products.
In addition, in December 2018, we refinanced our $125.0 million Credit Agreement by entering into an amended and restated Senior Secured Credit Facility (the “Credit Facility”) for up to $265.2 million. The principal new feature of the Credit Facility was a $118.0 million Delayed Draw Term Loan (the “DDTL”), which could only be drawn on in order to pay down the Company’s remaining 3.0% Convertible Senior Notes, which matured in December 2019. The Credit Facility also extended the maturity of the $72.2 million secured term loan (the “Term Loan”) to December 2023. In addition, the Credit Facility increased the previous $50.0 million line of credit (the “Revolver”) to $75.0 million.
In 2019, we entered into an agreement with Teva Pharmaceutical Industries Ltd. to purchase a basket of ANDAs for 35 previously-marketed generic drug products. We also acquired from Coeptis Pharmaceuticals, Inc. seven development stage generic products. During the 2019 year, we launched six products.
40
Table of Contents
Additionally, on November 29, 2019, we exercised our option to borrow $118.0 million pursuant to the DDTL feature under the existing Credit Facility and the proceeds were used to repay the outstanding 3% Convertible Senior Notes, which matured on December 1, 2019.
In 2020, we acquired the U.S. portfolio of 23 generic products, including 10 commercial products at the time of the acquisition, from Amerigen Pharmaceuticals, Ltd. During the 2020 year, we launched ten products.
Recent Developments
On March 8, 2021, ANI Pharmaceuticals, Inc. (“Parent”) entered into an Agreement and Plan of Merger (the “Merger Agreement”) by and among Parent, Nile Merger Sub LLC, a Delaware limited liability company and a wholly-owned subsidiary of Parent (“Merger Sub”), Novitium Pharma LLC, a Delaware limited liability company (“Novitium”), Esjay LLC, a Delaware limited liability company (“Esjay”), Chali Properties, LLC, a New Jersey limited liability company (“Chali”), Chad Gassert, Muthusamy Shanmugam, and Thorappadi Vijayaraj (collectively, the “Key Persons”, and Muthusamy Shanmugam and Thorappadi Vijayaraj, together with Esjay and Chali, the “Principal Members”) and Shareholder Representative Services LLC, a Colorado limited liability company, as the representative of the equity holders of Novitium.
Upon the terms and subject to the conditions set forth in the Merger Agreement, Merger Sub will merge with and into Novitium, with Novitium surviving the merger as a wholly-owned subsidiary of Parent (the “Merger”). The closing of the Merger (the “Closing”) will occur (a) within five business days after all of the conditions to the Closing set forth in the Merger Agreement are satisfied or waived or (b) at such other time, date and place as may be agreed by Parent and Novitium, subject to the completion of a minimum period.
The Merger consideration will consist of a combination of (i) an estimated cash amount of $89.5 million, subject to various adjustments and expected to be financed in part by a $25.0 million Private Investment in Public Equity (“PIPE Investment”) (as defined below) and in part by new debt financing, (ii) an aggregate of 2,466,667 shares of Parent common stock, and (iii) up to $46.5 million in contingent future earn-out payments.
We will finance the transaction with a new $340.0 million Senior Secured Credit Facility (the “Facility”), consisting of a $300.0 million term loan and a $40.0 million revolving credit facility, the issuance of approximately $74.0 million in equity to the sellers, and a $25.0 million PIPE Investment by Ampersand Capital Partners. The new debt financing will be secured by substantially all the assets of ANI and its subsidiaries and used for the cash portion of the acquisition and to refinance ANI’s existing senior credit facilities.
Concurrently with the execution of the Merger Agreement, on March 8, 2021, Parent entered into an Equity Commitment and Investment Agreement (the “Investment Agreement”) with Ampersand 2020 Limited Partnership (the “PIPE Investor”), an affiliate of Ampersand Capital Partners, pursuant to which we agreed to issue and sell to the PIPE Investor, and the PIPE Investor agreed to purchase, 25,000 shares of our Series A Convertible Preferred Stock (the “PIPE Shares”), for a purchase price of $1,000 per share and an aggregate purchase price of $25.0 million, in a private placement (the “PIPE Investment”).
The completion of the Merger transaction is subject to various closing conditions, including approval by ANI stockholders of the issuance of ANI common stock in connection with the Merger. For more information about the pending Merger transaction, please see the Form 8-K filed on March 9, 2021 by ANI Pharmaceuticals, Inc. , which is incorporated by reference herein.
Fiscal 2020 Developments
Asset Acquisitions
In July 2020, we acquired an ANDA and certain related inventories from a private company for total consideration of $4.3 million. The transaction was funded using cash on hand.
41
Table of Contents
In May 2020, we entered into an agreement with a private company to purchase an ANDA and API for one currently marketed generic drug product and certain API for $0.2 million. The transaction was funded using cash on hand.
In January 2020, we completed the acquisition of the U.S. portfolio of 23 generic products and API and finished goods related to certain of those products from Amerigen Pharmaceuticals, Ltd. ("Amerigen") for a purchase consideration of $56.8 million and up to $25.0 million in contingent payments over the next three years. The product portfolio at the time of the acquisition included ten commercial products, three approved products with launches pending, four filed products and four in-development products as well as a license to commercialize two approved products. The transaction was funded using cash on hand and $15.0 million in borrowings under our $75.0 million Revolver.
Product Launches
During 2020, we launched the following products. Refer to our website at www.anipharmaceuticals.com for further information on the products, including indications/treatments.
Product
Launch Date
Aminocaproic Acid Tablets USP 500mg
December 2020
Mexiletine Hydrochloride Capsules USP, 150mg, 200mg, and 250mg
June 2020
Omega-3-Acid Ethyl Esters Capsules, 1 gram
April 2020
Polyethylene Glycol 3350, 17g/Packet (PEG-3350)
April 2020
Dextroamphetamine Saccharate, Amphetamine Aspartate Monohydrate, Dextroamphetamine Sulfate and Amphetamine Sulfate Extended-Release Capsules 5 mg, 10 mg, 15 mg, 20 mg, 25 mg, and 30 mg
April 2020
Memantine Hydrochloride Extended-Release Capsules 7 mg, 14 mg, 21 mg, and 28 mg
March 2020
Sulfamethoxazole and Trimethoprim Oral Suspension USP 200 mg/40 mg per 5 mL
February 2020
Tolterodine Extended-Release Capsules, 2mg and 4 mg
February 2020
Potassium Citrate Extended-Release Tablets USP 10m Eq and 15 mEq
January 2020
Paliperidone Extended-Release Tablets, 1.5 mg, 3 mg, 6 mg, and 9 mg
January 2020
Cortrophin Gel Re-commercialization Update
In April 2020, the Food and Drug Administration (“FDA”) issued a Refusal to File (“RTF”) letter for our Supplemental New Drug Application (“sNDA”) for Cortrophin Gel. Since this time, our efforts have been focused on the preparation of a complete resubmission of the sNDA. We immediately retained a prominent regulatory consulting firm to support our efforts and augment the capabilities of our internal Cortrophin development team. In addition, we restructured the composition of the internal team. We have performed a comprehensive review of the original sNDA filing and prepared an internal gap assessment. The resultant remediation activities are currently in-progress and we currently anticipate re-submitting the sNDA in the second quarter of 2021.
In addition, in the third quarter of 2019, we began purchasing materials that are intended to be used commercially in anticipation of FDA approval of Cortrophin Gel and the resultant product launch. Under U.S. GAAP, we cannot capitalize these pre-launch purchases of materials as inventory prior to FDA approval, and accordingly, they are charged to expense in the period in which they are incurred. We expect these pre-launch purchases of material to increase significantly in the future as we build raw materials, API and finished goods for the expected launch of this product.
Management Transition
On May 10, 2020, our former President and Chief Executive Officer, Arthur S. Przybyl, departed the Company. Our Board of Directors retained an executive search firm to lead the search for a new President and Chief Executive Officer. In August 2020, we announced that Nikhil Lalwani was named our President and Chief Executive Officer and his employment was effective September 8, 2020, at which time he also joined our Board of Directors.
42
Table of Contents
COVID-19 Impact
We continue to closely monitor the impact of the novel coronavirus (“COVID-19”) pandemic on our business and the geographic regions where we operate. During the three months ended June 30, 2020, per IQVIA/IMS data, total market generic and brand prescriptions in the United States declined when compared to each of the previous calendar quarters during the trailing 12 months. The decline was in part attributable to the COVID-19 pandemic, including but not limited to negative impacts from “shelter-in-place” and quarantine orders in certain states, restrictions on travel, the prohibition of elective medical procedures, and the related downstream impact of the global economic activity during this period. The decline in prescriptions due to the COVID-19 pandemic negatively impacted our generic and brand net revenues during the three months ended June 30, 2020. During the three month periods ending September 30, 2020 and December 31, 2020, IQVIA/IMS data indicates both brand and generic total market prescription volume increased when compared to the three month period ended June 30, 2020, in part due to the easing of COVID-19 related restrictions. However, total market prescription volume did not increase to pre-pandemic levels during this period. We have not experienced a significant impact to our manufacturing operations; however, we have seen minor disruptions to our supply chain from the COVID-19 pandemic during 2020. Our manufacturing facilities in Baudette, Minnesota and Oakville, Ontario have remained open throughout the pandemic and have operated in accordance with local, state and national safety guidelines. The pandemic has not impacted our access to capital and has not significantly impacted our use of funds, including but not limited to capital expenditures, spend on research and development activities and business development opportunities.
We are unable to predict the impact that the COVID-19 pandemic will have on our future financial condition, results of operations and cash flows due to numerous uncertainties. These uncertainties include the scope, severity and duration of the pandemic, the level of success of continued actions taken to contain the pandemic or mitigate its impact, including the availability of vaccines, and the direct and indirect economic effects of the pandemic and containment measures, among others. The outbreak of COVID-19 in many countries, including the United States and Canada, has had a significant adverse impact on global economic activity and has contributed to significant volatility and negative pressure in financial markets. As a result, the COVID-19 pandemic has negatively impacted almost every industry, either directly or indirectly. Further, the impacts of a potential worsening of global economic conditions and the continued disruptions to, and volatility in, the credit and financial markets, pharmaceutical supply chains, patient access to healthcare as well as other unanticipated consequences remain unknown.
General
Year Ended
December 31,
(in thousands)
2020
2019
Net revenues
$
208,475
$
206,547
Operating expenses
Cost of sales (exclusive of depreciation and amortization)
87,157
63,154
Research and development
16,001
19,806
Selling, general, and administrative
64,986
55,843
Depreciation and amortization
44,638
44,612
Cortrophin pre-launch charges
11,263
6,706
Intangible asset impairment charge
446
75
Operating (loss)/income
(16,016)
16,351
Interest expense, net
(9,452)
(12,966)
Other expense, net
(494)
(228)
(Loss)/income before benefit for income taxes
(25,962)
3,157
Benefit for income taxes
3,414
2,937
Net (loss)/income
$
(22,548)
$
6,094
43
Table of Contents
The following table sets forth, for the periods indicated, items in our consolidated statements of operations as a percentage of net revenues.
Year Ended
December 31,
2020
2019
Net revenues
100.0
%
100.0
%
Operating expenses
Cost of sales (exclusive of depreciation and amortization)
41.8
%
30.6
%
Research and development
7.7
%
9.6
%
Selling, general, and administrative
31.2
%
27.0
%
Depreciation and amortization
21.4
%
21.6
%
Cortrophin pre-launch charges
5.4
%
3.2
%
Intangible asset impairment charge
0.2
%
—
%
Operating (loss)/income
(7.7)
%
8.0
%
Interest expense, net
(4.5)
%
(6.3)
%
Other expense, net
(0.2)
%
(0.1)
%
(Loss)/income before benefit for income taxes
(12.4)
%
1.6
%
Benefit for income taxes
1.6
%
1.4
%
Net (loss)/income
(10.8)
%
3.0
%
Results of Operations for the Years Ended December 31, 2020 and 2019
Year Ended December 31,
(in thousands)
2020
2019
Change
% Change
Generic pharmaceutical products
$
147,257
$
128,729
$
18,528
14.4
%
Branded pharmaceutical products
47,960
63,767
(15,807)
(24.8)
%
Contract manufacturing
9,221
11,139
(1,918)
(17.2)
%
Royalty and other income
4,037
2,912
1,125
38.6
%
Total net revenues
$
208,475
$
206,547
$
1,928
0.9
%
We derive substantially all of our revenues from sales of generic and branded pharmaceutical products, contract manufacturing, and contract services, which include product development services, laboratory services, and royalties on net sales of certain products.
Net revenues for the year ended December 31, 2020 were $208.5 million compared to $206.5 million for the same period in 2019, an increase of $1.9 million, or 0.9%, primarily as a result of the following factors:
● Net revenues for generic pharmaceutical products were $147.3 million during the year ended December 31, 2020, an increase of 14.4% compared to $128.7 million for the same period in 2019. The primary reasons for the increase are the January 2020 launches of Miglustat, Paliperidone, Penicillamine, Mixed Amphetamine Salts, Tolterodine, Bexarotene and other products acquired from Amerigen, the September 2019 launch of Vancomycin Oral Solution, the January 2020 launch of Potassium Citrate ER, and increased revenues of Candesartan. These increases were tempered by decreases in revenues of Ezetimibe Simvastatin, Erythromycin Ethylsuccinate (“EES”) , Esterified Estrogen with Methyltestosterone (“EEMT”) , Vancomycin Capsules, and Methazolamide. During the year ended December 31, 2020, and primarily during the second quarter ended June 30, 2020, the overall generic pharmaceutical product market and our generic revenue results were negatively impacted by the COVID-19 pandemic, including but not limited to effects from “shelter-in-place” orders and the prohibition of elective medical procedures. These actions resulted in a decline in generic prescriptions during the year ended December 31, 2020, primarily during the second quarter ended June 30, 2020, when compared to the year ended December 31, 2019.
● Net revenues for branded pharmaceutical products were $48.0 million during the year ended December 31, 2020, a decrease of 24.8% compared to $63.8 million for the same period in 2019. The primary reasons for the decrease were lower unit sales of Inderal LA, Inderal XL and InnoPran XL, as well as a decrease in sales of
44
Table of Contents
Arimidex and Atacand. During the year ended December 31, 2020, and primarily during the second quarter ended June 30, 2020, the overall brand pharmaceutical product market and our brand revenue results were negatively impacted by the COVID-19 pandemic, including but not limited to effects from “shelter-in-place” orders and the prohibition of elective medical procedures. These actions resulted in a decline in brand prescriptions during the year ended December 31, 2020, primarily during the second quarter ended June 30, 2020, when compared to the year ended December 31, 2019.
● Contract manufacturing revenues were $9.2 million during the year ended December 31, 2020, a decrease of 17.2% compared to $11.1 million for the same period in 2019, due to a decreased volume of orders from contract manufacturing customers in the period.
● Royalty and other were $4.0 million during the year ended December 31, 2020, an increase of $1.1 million from $2.9 million for the same period in 2019, primarily due to an increase in product development revenues earned by ANI Canada and an increase in royalty revenues.
Cost of Sales (Excluding Depreciation and Amortization)
Year Ended December 31,
(in thousands)
2020
2019
Change
% Change
Cost of sales (excl. depreciation and amortization)
$
87,157
$
63,154
$
24,003
38.0
%
Cost of sales consists of direct labor, including manufacturing and packaging, active and inactive pharmaceutical ingredients, freight costs, packaging components, and royalties related to profit-sharing arrangements. Cost of sales does not include depreciation and amortization expense, which is reported as a separate component of operating expenses on our consolidated statements of operations.
For the year ended December 31, 2020, cost of sales increased to $87.2 million from $63.2 million for the same period in 2019, an increase of $24.0 million or 38.0%, primarily as a result of increased volumes during 2020, including a shift in product mix toward generic products, a $4.3 million increase in cost of sales representing the excess of fair value over cost for inventory acquired in the Amerigen acquisition and subsequently sold during the period, a $4.6 million increase related to increased sales of products subject to profit-sharing arrangements, and 2020 inventory reserve charges of $5.6 million related to excess inventory on hand, expired product and discontinued projects. The increases were partially offset by the non-recurrence of the January 2019 royalty buy out from the Asset Purchase Agreement Amendment with Teva Pharmaceuticals USA, Inc. and the non-recurrence of the fourth quarter 2019 $4.6 million inventory reserve charge primarily related to the exit from the market of Methylphenidate Extended Release. Cost of sales, exclusive of the $4.3 million net impact related to excess of fair value over the cost of inventory sold during the period, as a percentage of net revenues increased to 39.7% during the year ended December 31, 2020, from 30.6% during same period in 2019, primarily as a result of the same factors previously discussed.
During the year ended December 31, 2020, we purchased 10% of our inventory from one supplier. In the year ended December 31, 2019, we purchased 13% of our inventory from one supplier.
Other Operating Expenses
Year Ended December 31,
(in thousands)
2020
2019
Change
% Change
Research and development
$
16,001
$
19,806
$
(3,805)
(19.2)
%
Selling, general, and administrative
64,986
55,843
9,143
16.4
%
Depreciation and amortization
44,638
44,612
26
0.1
%
Cortrophin pre-launch charges
11,263
6,706
4,557
68.0
%
Intangible asset impairment charge
446
75
371
494.7
%
Total other operating expenses
$
137,334
$
127,042
$
10,292
8.1
%
Other operating expenses consist of research and development costs, selling, general, and administrative expenses, depreciation and amortization, impairment charges, and Cortrophin pre-launch charges.
45
Table of Contents
For the year ended December 31, 2020, other operating expenses increased to $137.3 million from $127.0 million for the same period in 2019, an increase of $10.3 million, or 8.1%, primarily as a result of the following factors:
● Research and development expenses decreased from $19.8 million to $16.0 million, a decrease of 19.2%, primarily due to a decrease in expense related to the Cortrophin re-commercialization project, the non-recurrence of the $2.3 million of expense related to in-process research and development acquired from Coeptis during the year ended December 31, 2019 and the non-recurrence of 2019 expenses related to Bretylium Tosylate and Methylphenidate Extended Release projects. These decreases were tempered by the $3.8 million in-process research and development expense from the Amerigen acquisition in January 2020.
● Selling, general, and administrative expenses increased from $55.8 million to $65.0 million, an increase of 16.4%, primarily due to $6.5 million of termination benefit expenses related to the departure of our former President and CEO, comprised of $3.4 million of stock-based compensation expense and $3.1 million of expense for salary continuation, bonus, and fringe benefits, increased quality assurance and outside testing expenses, and increased headcount. We also incurred $0.8 million in recruitment and related legal charges associated with our CEO search. The increases were tempered by a decrease in legal fees.
● Depreciation and amortization expense was $44.6 million for the years ended December 31, 2020 and 2019. In 2020, the non-recurrence of amortization expense related to the January 2019 royalty buy out decreased amortization expense, and this decrease was offset by the amortization of the ANDAs and marketing and distribution rights acquired in January 2020 from Amerigen and the ANDA acquired in July 2020.
● As described in Note 13, Cortrophin Pre-Launch Charges , in the notes to the consolidated financial statements in Part II, Item 8. of this Annual Report on Form 10-K, we recognized Cortrophin pre-launch charges of $11.3 million in the year ended December 31, 2020. We recognized Cortrophin pre-launch charges of $6.7 million in the year ended December 31, 2019. We currently expect to incur total expense related to this activity of approximately $15.0-$20.0 million for 2021.
● We recognized an impairment charge of $0.4 million in relation to a marketing and distribution right intangible asset during the year ended December 31, 2020. We recognized an impairment charge of $75 thousand in relation to our Ranitidine product right intangible asset during the year ended December 31, 2019.
Other Expense, net
Year Ended December 31,
(in thousands)
2020
2019
Change
% Change
Interest expense, net
$
(9,452)
$
(12,966)
$
3,514
(27.1)
%
Other expense, net
(494)
(228)
(266)
116.7
%
Total other expense, net
$
(9,946)
$
(13,194)
$
3,248
(24.6)
%
For the year ended December 31, 2020, we recognized other expense, net of $9.9 million versus other expense, net of $13.2 million for the same period in 2019, a decrease of $3.2 million. Interest expense, net for 2020 consists primarily of interest expense on our Term Loan, DDTL, and Revolver. Interest expense, net for 2019 consists primarily of interest expense on our convertible debt, including amortization of related debt discount, and interest expense on borrowings under our Term Loan and DDTL. For the year ended December 31, 2020 and 2019, there was $0.1 million of interest capitalized into construction in progress. The decrease in expense in 2020 is due primarily to the non-recurrence of amortization of the debt discount related to the convertible debt, which matured and was repaid in November 2019. The decrease was tempered by increased borrowing rates on the Term Loan and DDTL and new borrowings under the Revolver.
46
Table of Contents
Benefit for Income Taxes
Year Ended December 31,
(in thousands)
2020
2019
Change
% Change
Benefit for income taxes
$
3,414
$
2,937
$
477
16.2
%
Our provision for income taxes consists of current and deferred components, which include changes in our deferred tax assets, our deferred tax liabilities, and our valuation allowance. We measure our deferred tax assets and liabilities using the tax rates that we believe will apply in the years in which the temporary differences are expected to be recovered or paid. See Note 11. Income Taxes, in the notes to the consolidated financial statements in Part II, Item 8. of this Annual Report on Form 10-K for further information.
For the year ended December 31, 2020, we recognized an income tax benefit of $3.4 million, an effective benefit rate of 13.1% of consolidated pre-tax losses reported in the period. Our effective tax rate for 2020 was impacted by changes in state tax rates due to our changing presence in certain states, certain non-deductible expenses, and the impact of current period stock-based compensation, among other items.
For the year ended December 31, 2019, we recognized an income tax benefit of $2.9 million, an effective benefit rate of 93.0% of consolidated pre-tax income reported in the period. Our effective tax rate for 2019 was impacted by the use of the research and experimental tax credit in the U.S., changes in state tax rates due to our changing presence in certain states, the release of ANI Canada’s net valuation allowance, application of our newly adopted transfer pricing policy to 2019 and to 2018, and the impact of current period awards of stock-based compensation, stock option exercises, disqualifying dispositions of incentive stock options, among other items.
Liquidity and Capital Resources
The following table highlights selected liquidity and working capital information from our consolidated balance sheets.
December 31,
December 31,
(in thousands)
2020
2019
Cash and cash equivalents
$
7,864
$
62,332
Accounts receivable, net
95,793
72,129
Inventories, net
60,803
48,163
Prepaid income taxes
—
1,076
Prepaid expenses and other current assets
5,861
3,995
Total current assets
$
170,321
$
187,695
Current debt, net of deferred financing costs
$
13,243
$
9,941
Accounts payable
11,261
14,606
Accrued expenses and other
2,456
2,362
Accrued royalties
6,407
5,084
Accrued compensation and related expenses
6,231
3,736
Current income taxes payable, net
3,906
—
Accrued government rebates
7,826
8,901
Returned goods reserve
27,155
16,595
Deferred revenue
80
451
Total current liabilities
$
78,565
$
61,676
On December 31, 2020, we had $7.9 million in unrestricted cash and cash equivalents. On December 31, 2019, we had $62.3 million in unrestricted cash and cash equivalents. We generated $15.3 million of cash from operations in the year ended December 31, 2020. In January 2020, we acquired the U.S. portfolio of 23 generic products and certain commercial and development inventory and materials from Amerigen Pharmaceuticals, Ltd., for which we have used $57.4 million in cash and could make future payments of up to $25.0 million in contingent profit share payments over
47
Table of Contents
the next three years. The contingent payments are earned if annual gross profit exceeds a minimum threshold and are earned on a subset of the acquired products. No payment was due to Amerigen for the fiscal year ended December 31, 2020. At the time of the acquisition, the acquired portfolio included 10 commercial products, three approved products with launches pending, four filed products, and four in-development products as well as a license to commercialize two approved products. The transaction was funded from cash on hand and $15.0 million of borrowings from our Revolver, of which $7.5 million was repaid in the second quarter 2020. In July 2020, we acquired an ANDA and certain inventories from a private company for total consideration of $4.3 million. The transaction was funded using cash on hand. During 2020, we incurred expenses of $11.3 million related to purchases of Cortrophin pre-launch inventory and expect to continue to incur related costs in 2021.
We generated $45.6 million of cash from operations in the year ended December 31, 2019. In June 2019, we acquired from Coeptis Pharmaceuticals, Inc. seven development stage generic products, as well as active pharmaceutical ingredient API and reference-listed drug inventory related to certain of the products for a payment of $2.3 million using cash on hand. In addition, we could make up to $12.0 million in payments for certain development and commercial milestones. In March 2019, we purchased from Teva Pharmaceutical Industries Ltd. a basket of ANDAs for 35 previously-marketed generic drug products for $2.5 million using cash on hand. In January 2019, we entered into the Asset Purchase Agreement Amendment, under which all royalty obligations the Company owed to Teva with respect to products associated with ten ANDAs under the original asset purchase agreements ceased being effective as of December 31, 2018. As consideration for the termination of such future royalty obligations, we paid Teva $16.0 million using cash on hand.
We are focused on expanding our business and product pipeline through collaborations, and also through acquisitions of products and companies. We are continually evaluating potential asset acquisitions and business combinations. To finance such acquisitions, we might raise additional equity capital, incur additional debt, or both.
Our working capital ratio, defined as total current assets divided by total current liabilities, is 2.2 as of December 31, 2020. We believe that our financial resources, consisting of current working capital, anticipated future operating cash flows, and $67.5 million of available borrowings under our Revolver as of December 31, 2020, will be sufficient to enable us to meet our working capital requirements and debt obligations for at least the next 12 months. If our assumptions underlying estimated revenue and expenses are wrong, or if our cash requirements change materially as a result of shifts in our business or strategy, we could require additional financing. If we are not profitable or do not generate cash from operations as anticipated and additional capital is needed to support operations, we may be unable to obtain such financing, or obtain it on favorable terms, in which case we may be required to curtail development of new products, limit expansion of operations, or accept financing terms that are not as attractive as desired.
Consolidation among wholesale distributors, chain drug stores, and group purchasing organizations has resulted in a smaller number of companies each controlling a larger share of pharmaceutical distribution channels. Our net revenues were concentrated among three customers representing 31%, 24%, and 19% of net revenues during the year ended December 31, 2020. As of December 31, 2020 accounts receivable from these three customers totaled approximately 81% of accounts receivable, net. As a result, negotiated payment terms with these customers have a material impact on our liquidity and working capital.
None of our products accounted for 10% or more of our net revenues in 2020 or 2019.
Sources and Uses of Cash
Debt Financing
Our amended and restated Senior Secured Credit Facility for up to $265.2 million consists of a $72.2 million Term Loan, a $118.0 million DDTL, and a $75.0 million Revolver. The Company had previously fully drawn on the Term Loan and DDTL, and i n March 2020, drew $15.0 million under the Revolver, of which $7.5 million was repaid during the year ended December 31, 2020. As of December 31, 2020, we had a $186.9 million outstanding balance on the Credit Facility. As of December 31, 2020, we had $67.5 million available for borrowing under the Revolver.
48
Table of Contents
We may at any time repay borrowings under the term loans, including the initial Term Loan and DDTL, and the Revolver without any premium or penalty, and we must repay all borrowings thereunder by December 27, 2023. We may use the proceeds of the Revolver for working capital and other general corporate purposes.
Amounts drawn under the Revolver, Term Loan, and DDTL bear an interest rate equal to, at our option, either a LIBOR rate plus 1.50% to 2.75% per annum, depending on our total leverage ratio or an alternative base rate plus an applicable base rate margin, which varies within a range of 0.50% to 1.75%, depending on our total leverage ratio. On the Revolver, we incur a commitment fee at a rate per annum that varies within a range of 0.25% to 0.50%, depending on our leverage ratio. We must comply with various customary financial and non-financial covenants under the Credit Facility. The primary financial covenants under the Credit Facility consist of a maximum total leverage ratio, which, as of December 31, 2020, is 3.25 to 1.00, and a minimum fixed charge coverage ratio which shall be greater than or equal to 1.25 to 1.00. The primary non-financial covenants under the Credit Agreement limit, subject to various exceptions, the Company’s ability to incur future indebtedness, to place liens on assets, to pay dividends or make other distributions on the Company’s capital stock, to repurchase the Company’s capital stock, to conduct acquisitions, to alter its capital structure and to dispose of assets.
Customer Payments
In addition to the financings in prior years, payments from customers are a significant source of cash in 2020, 2019, and 2018 and were our primary source of cash in 2020 and 2019.
Uses of Cash
Our primary cash requirements are to fund operations, including research and development programs and collaborations, to support general and administrative activities, to purchase equipment and machinery to expand our manufacturing capabilities as our product lines grow, and to expand our business and product pipeline through acquisitions of products and companies. We are continually evaluating potential asset acquisitions and business combinations. Our future capital requirements will depend on many factors, including, but not limited to:
● product mix and pricing for product sales and contract manufacturing;
● pricing and payment terms with customers;
● costs of raw materials and payment terms with suppliers;
● capital expenditures and equipment purchases to support product launches; and
● business and product acquisitions.
In the first quarter of 2020, we acquired the U.S. portfolio of 23 generic products and certain commercial and development inventory and materials from Amerigen Pharmaceuticals, Ltd., for which we have used $57.4 million in cash and could make future payments of up to $25.0 million in contingent profit share payments over the next three years. The contingent payments are earned if annual gross profit exceeds a minimum threshold and are earned on a subset of the acquired products. No payment was due to Amerigen for the fiscal year ended December 31, 2020. At the time of the acquisition, the acquired portfolio included ten commercial products, three approved products with launches pending, four filed products, and four in-development products as well as a license to commercialize two approved products. The transaction was funded using cash on hand and $15.0 million of borrowings from our Revolver, of which $7.5 million was repaid in the second quarter of 2020. In the third quarter of 2020, we acquired an ANDA and certain inventories from a private company for total consideration of $4.4 million. The transaction was funded using cash on hand. In 2020, we had $6.1 million of capital expenditures.
In the first quarter of 2019, we entered into the Asset Purchase Agreement Amendment, under which all royalty obligations the Company owed to Teva with respect to products associated with ten ANDAs under the original asset purchase agreements ceased being effective as of December 31, 2018. As consideration for the termination of such
49
Table of Contents
future royalty obligations, we paid Teva $16.0 million using cash on hand. Also in the first quarter of 2019, we purchased from Teva Pharmaceutical Industries Ltd. a basket of ANDAs for 35 previously-marketed generic drug products for $2.5 million in cash using cash on hand. In the second quarter or 2019, we acquired from Coeptis Pharmaceuticals, Inc. seven development stage generic products, as well as active pharmaceutical ingredient API and reference-listed drug inventory related to certain of the products for a payment of $2.3 million using cash on hand. In addition, we could pay up to $12.0 million in payments for certain development and commercial milestones. In 2019, we had $6.6 million of capital expenditures.
Discussion of Cash Flows
The following table summarizes the net cash and cash equivalents provided by/(used in) operating activities, investing activities and financing activities for the periods indicated:
Year Ended December 31,
(in thousands)
2020
2019
Operating Activities
$
15,267
$
45,631
Investing Activities
$
(68,322)
$
(27,549)
Financing Activities
$
(1,439)
$
1,250
Net Cash Provided by Operating Activities
Net cash provided by operating activities was $15.3 million for the year ended December 31, 2020, compared to $45.6 million provided by operating activities during the same period in 2019, a decrease of $30.3 million. The decrease was due to changes in working capital and the net loss during the year ended December 31, 2020, including payments made for Cortrophin pre-launch materials and increases to trade accounts receivable.
Net Cash Used in Investing Activities
Net cash used in investing activities for the year ended December 31, 2020 was $68.3 million, principally due to the January 2020 acquisition of 23 generic products and inventory and materials from Amerigen Pharmaceuticals, Ltd. for $57.4 million, cash payments for the July 2020 acquisition of an ANDA and certain inventories of $4.0 million, and $6.1 million of capital expenditures during the period.
Net Cash (Used In) / Provided by Financing Activities
Net cash used in financing activities was $1.4 million for the year ended December 31, 2020, principally due to net borrowings of $7.5 million on the Revolver and $0.6 million of proceeds from stock option exercises, offset by $8.0 million of maturity payments on the Term Loan and DDTL and $1.5 million of treasury stock purchased related to restricted stock vests.
Contractual Obligations
The following table summarizes our long-term contractual obligations and commitments as of December 31, 2020.
Payments Due by Period
Less than
More than
(in thousands)
Total
1 year
1-3 years
3-5 years
5 years
Long-term debt obligations (1)
$
186,946
$
13,691
$
173,255
$
—
$
—
Interest on long-term debt obligations (2)
21,595
7,767
13,828
—
—
Operating lease obligations
319
138
150
31
—
Purchase obligations (3)
7,089
5,471
1,616
2
—
Total
$
215,949
$
27,067
$
188,849
$
33
$
—
50
Table of Contents
(1) Represents our $65.9 million Term Loan due December 27, 2023, our $113.6 million Delayed Draw Term Loan due December 2023, and our $7.5 million Revolver due December 2023. (Note 3, Indebtedness, in the notes to the consolidated financial statements in Part II, Item 8. of this Annual Report on Form 10-K.)
(2) Represents interest due on our Term Loan, Delayed Draw Term Loan and Revolver and commitment fee due on our Revolver. Interest for the Term Loan and Delayed Draw Term Loan is calculated based on our payment schedule as prescribed in the Senior Secured Credit Facility (the “Credit Facility”) and using an estimated interest rate of 4.235%, which is the estimated interest rate on the Term Loan and Delayed Draw Term Loan as fixed by our interest rate swap. Interest on the Revolver is based on the recent 1-month LIBOR rate plus applicable spread per the Credit Facility, which is based on our leverage ratio. The commitment fee is estimated using the applicable rate per the Credit Facility, which is based on our leverage ratio.
(3) Purchase obligations primarily includes contractual obligations for inventory/material purchase minimums and service agreements.
Critical Accounting Estimates
This Management’s Discussion and Analysis of Financial Condition and Results of Operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”). The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. In our consolidated financial statements, estimates are used for, but not limited to, stock-based compensation, allowance for credit losses, accruals for chargebacks, government rebates, returns, and other allowances, allowance for inventory obsolescence, valuation of financial instruments and intangible assets, accruals for contingent liabilities, fair value of long-lived assets, deferred taxes and valuation allowance, and the depreciable lives of long-lived assets.
Our significant accounting policies are discussed in Note 1. Description of Business and Summary of Significant Accounting Policies, in the notes to the consolidated financial statements in Part II, Item 8. of this Annual Report on Form 10-K. On an ongoing basis, we evaluate these estimates and assumptions, including those described below. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. These estimates and assumptions form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates. Due to the estimation processes involved, the following summarized accounting policies and their application are considered to be critical to understanding our business operations, financial condition, and operating results.
Revenue Recognition
We recognize revenue using the following steps:
● Identification of the contract, or contracts, with a customer;
● Identification of the performance obligations in the contract;
● Determination of the transaction price, including the identification and estimation of variable consideration;
● Allocation of the transaction price to the performance obligations in the contract; and
● Recognition of revenue when we satisfy a performance obligation.
We derive our revenues primarily from sales of generic and branded pharmaceutical products. Revenue is recognized when our obligations under the terms of our contracts with customers are satisfied, which generally occurs when control of the products we sell is transferred to the customer. We estimate variable consideration after considering applicable information that is reasonably available. We generally do not have incremental costs to obtain or fulfill contracts that would otherwise not have been incurred. We do not adjust revenue for the promised amount of
51
Table of Contents
consideration for the effects of a significant financing component because our customers’ payment terms are generally fewer than 100 days.
Our revenue recognition accounting methodologies contain uncertainties because they require management to make assumptions and to apply judgment to estimate the amount of discounts, rebates, promotional adjustments, price adjustments, returns, chargebacks, and other potential adjustments, which are accounted for as reductions to revenue. We make these estimates based on historical experience. In addition, for our product development services revenue, we recognize revenue on a percentage of completion basis, which requires judgments related to how much work has been completed on various components our projects.
Revenue from Sales of Generic and Branded Pharmaceutical Products
Product sales consist of sales of our generic and brand pharmaceutical products. Our sole performance obligation in our contracts is to provide pharmaceutical products to customers. Our products are sold at pre-determined standalone selling prices and our performance obligation is considered to be satisfied when control of the product is transferred to the customer. Control is generally transferred to the customer upon delivery of the product to the customer, as our pharmaceutical products are generally sold on an FOB destination basis and because inventory risk and risk of ownership passes to the customer upon delivery. Payment terms for these sales are generally fewer than 100 days. We recognized $195.2 million and $192.5 million of revenue related to sales of generic and branded pharmaceutical products in 2020 and 2019, respectively.
Revenue from Distribution Agreements
From time to time, we enter into marketing and distribution agreements with third parties in which we sell products under ANDAs or NDAs owned or licensed by these third parties. These products are sold under our own label. We have assessed and determined that we control the products sold under these marketing and distribution agreements and therefore are the principal for sales under each of these marketing and distribution agreements. As a result, we recognize revenue on a gross basis when control has passed to the customer and we have satisfied our performance obligation. Under these agreements, we pay these third parties a specified percentage of the gross profit earned on sales of the products. These profit-sharing percentages are recognized in cost of sales in our consolidated statements of operations and are accrued in accrued royalties in our consolidated balance sheets until payment has occurred.
Chargebacks
As discussed in Note 1. Description of Business and Summary of Significant Accounting Policies, in the notes to the consolidated financial statements in Part II, Item 8. of this Annual Report on Form 10-K, we estimate the amount of chargebacks based our actual historical experience. A number of factors influence current period chargebacks by impacting the average selling price (“ASP”) of products, including customer mix, negotiated terms, volume of off-contract purchases, and wholesale acquisition cost (“WAC”).
If actual results were not consistent with our estimates, we could be exposed to losses or gains that could be material, as changes to chargeback estimates could cause an increase or decrease in revenue recognized during the year and increase or decrease accounts receivable. If there were a 10% change in the chargeback estimates throughout the year, our net revenues would be affected by $40.8 million for the year ended December 31, 2020.
Government Rebates
As discussed in Note 1. Description of Business and Summary of Significant Accounting Policies, in the notes to the consolidated financial statements in Part II, Item 8. of this Annual Report on Form 10-K, our estimates for government rebates are based upon several factors. Our estimates for Medicaid rebates are based upon our average manufacturer price, best price, product mix, levels of inventory in the distribution channel that we expect to be subject to Medicaid rebates, and historical experience, which are invoiced in arrears by state Medicaid programs. Our estimates for Medicare rebates are based on historical experience. While such experience has allowed for reasonable estimation in the past,
52
Table of Contents
history may not always be an accurate indicator of future rebate experience, and trends in Medicaid and Medicare enrollment and which products are covered by Medicaid and Medicare could change.
If actual results were not consistent with our estimates, we could be exposed to losses or gains that could be material, as changes to government rebate estimates could cause an increase or decrease in revenue recognized during the year and decrease or increase the government rebate reserve. If there were a 10% change in the government rebate estimates throughout the year, our net revenues would be affected by $1.4 million for the year ended December 31, 2020.
Returns
As discussed in Note 1. Description of Business and Summary of Significant Accounting Policies, in the notes to the consolidated financial statements in Part II, Item 8. of this Annual Report on Form 10-K, our estimate for returns is based upon our historical experience with actual returns. While such experience has allowed for reasonable estimation in the past, history may not always be an accurate indicator of future returns.
If actual results were not consistent with our estimates, we could be exposed to losses or gains that could be material, as changes to returns estimates could cause an increase or decrease in revenue recognized during the year and decrease or increase the returned goods reserve. If there were a 10% change in the returns estimates throughout the year, our net revenues would be affected by $3.0 million for the year ended December 31, 2020.
Administrative Fees and Other Rebates
As discussed in Note 1. Description of Business and Summary of Significant Accounting Policies, in the notes to the consolidated financial statements in Part II, Item 8. of this Annual Report on Form 10-K, we accrue for fees and rebates by product by wholesaler, at the time of sale based on contracted rates, ASPs, and on-hand inventory counts obtained from wholesalers.
If actual results were not consistent with our estimates, we could be exposed to losses or gains that could be material, as changes to these estimates could cause an increase or decrease in revenue recognized during the year and increase or decrease accounts receivable. If there were a 10% change in the administrative fees estimates throughout the year, our net revenues would be affected by $3.8 million for the year ended December 31, 2020.
Prompt Payment Discounts
As discussed in Note 1. Description of Business and Summary of Significant Accounting Policies, in the notes to the consolidated financial statements in Part II, Item 8. of this Annual Report on Form 10-K, we reserve for sales discounts based on invoices outstanding, assuming, based on past experience, that 100% of available discounts will be taken.
If customers do not take 100% of available discounts as we estimate, we could need to re-adjust our methodology for calculating the prompt payment discount reserve. If there were a 10% decrease in the prompt payment discounts estimates throughout the year, our net revenues would increase by $1.4 million for the year ended December 31, 2020.
Contract Manufacturing Product Sales Revenue
Contract manufacturing arrangements consist of agreements in which we manufacture a pharmaceutical product on behalf of third party. Our performance obligation is to manufacture and provide pharmaceutical products to customers, typically pharmaceutical companies. The contract manufactured products are sold at pre-determined standalone selling prices and our performance obligations are considered to be satisfied when control of the product is transferred to the customer. Control is transferred to the customer when the product leaves our dock to be shipped to the customer, as our pharmaceutical products are sold on an FOB shipping point basis and the inventory risk and risk of ownership passes to the customer at that time. Payment terms for these sales are generally fewer than two months. We estimate returns based on historical experience. Historically, we have not had material returns for contract manufactured products. We
53
Table of Contents
recognized $9.2 million and $11.1 million of revenue related to sales of contract manufactured products in 2020 and 2019, respectively.
Royalties from Licensing Agreements
From time to time, we enter into transition agreements with the sellers of products we acquire, under which we license to the seller the right to sell the acquired products. Therefore, we recognize the revenue associated with sales of the underlying products as royalties. Because these royalties are sales-based, we recognize the revenue when the underlying sales occur, based on sales and gross profit information received from the sellers. Upon full transition of the products and upon launching the products under our own labels, we recognize revenue for the products as sales of generic or branded pharmaceutical products, as described above.
Pursuant to a 2012 Tripartite Agreement (the “Tripartite Agreement”) between the Company, The Regents of the University of California (“The Regents”), and Cabaret Biotech Ltd., an Israeli corporation (“Cabaret”) (as assignee of Dr. Zelig Eshhar’s rights under the Tripartite Agreement), and subsequent amendments thereto and assignments thereof, we are entitled to receive a percentage of the milestone and sales royalty payments paid to Cabaret by Kite Pharma, Inc. (“Kite”), a subsidiary of Gilead Sciences, Inc., under a license agreement. Under such license agreement, Kite licensed from Dr. Eshhar and Cabaret the patent rights covered by the Tripartite Agreement and agreed to make certain payments to Cabaret based on, among other things, Kite’s sales of Yescarta®. Under the Tripartite Agreement, portions of these payments are to be distributed to The Regents and to us.
We record royalty income related to Yescarta® on an accrual basis utilizing our best estimate of royalties earned based upon information available in the public domain, our understanding of the various agreements governing the royalty, and other information received from time to time from the relevant parties. Generally, cash is received directly from Cabaret once a year. The agreements governing this royalty are subject to multiple litigations in multiple jurisdictions, including litigation between Cabaret and Kite, and separately, the Company and Cabaret. We recently became aware that the litigation between Cabaret and Kite was dismissed and are working with our counsel to determine the potential impact the resolution of that matter may have on our rights under the agreements. In addition, the Israeli Tax Authority has taken the position that any payments from Cabaret to us are subject to mandatory withholding tax. The Company and its tax counsel have disputed this position and are actively seeking to resolve the issue. The ultimate outcome of these matters, either individually or in the aggregate, may impact the amount of cash due to us, and may result in the termination of future payments or further claims that royalties received by us in the past be repaid.
Product Development Services Revenue
We provide product development services to customers, which are performed over time. These services primarily relate to the technical transfer of products to our facility in Oakville, Ontario. Technology transfer refers to the process required to move the manufacture of a product to a new manufacturing site and may include performance obligations such as formulation development, production of small-scale batches, process development, and analytical method development and validation. The duration of these technical transfer projects is generally 18 months to three years. Deposits received from these customers are recorded as deferred revenue until revenue is earned and recognized. For contracts with no deposits and for the remainder of contracts with deposits, we invoice customers as our performance obligations are satisfied. We recognize revenue on a proportional basis, which results in contract assets on our balance sheet. We recognized $1.9 million and $1.1 million of revenue related to product development services in 2020 and 2019, respectively.
Intangible Assets
As discussed in Note 1. Description of Business and Summary of Significant Accounting Policies, in the notes to the consolidated financial statements in Part II, Item 8. of this Annual Report on Form 10-K, our definite-lived intangible assets have a carrying value of $188.5 million as of December 31, 2020. These assets include ANDAs, NDAs and product rights, marketing and distribution rights, and a non-compete agreement. These intangible assets were originally recorded at fair value for business combinations and at relative fair value based on the purchase price for asset acquisitions and are stated net of accumulated amortization.
54
Table of Contents
The ANDAs, NDAs and product rights, marketing and distribution rights, and non-compete agreement are amortized over their remaining estimated useful lives, ranging from seven to 10 years, generally based on the straight-line method. The estimated useful lives directly impact the amount of amortization expense recorded for these assets on a quarterly and annual basis.
In addition, we test for impairment of definite-lived intangible assets when events or circumstances indicate that the carrying value of the assets may not be recoverable. Judgment is used in determining when these events and circumstances arise. If we determine that the carrying value of the assets may not be recoverable, judgment and estimates are used to assess the fair value of the assets and to determine the amount of any impairment loss. If the fair value of an intangible asset is determined to be lower than its carrying value, we could be exposed to an impairment charge that could be material.
In March 2018, we entered into an agreement with Appco Pharma, LLC (“Appco”), in which a potential generic product, Ranitidine, was to be developed and marketed. Per the agreement, we paid Appco a series of licensing fees in conjunction with certain development milestones. Ranitidine was launched in the third quarter of 2019, resulting in the final milestone payment of $80 thousand. The $80 thousand milestone payment was capitalized as an intangible asset and determined to have an estimated useful life of eight years. In September 2019, the FDA issued a public statement that some ranitidine medicines contain a nitrosamine impurity called N-nitrosdimethylamine (“NDMA”) at low levels. NDMA is classified as a probable human carcinogen (a substance that could cause cancer) based on results from laboratory tests and the cause of the presence of this impurity in the ranitidine products is not yet fully understood at this time. During the fourth quarter 2019, testing of the API used in our ranitidine drug product, as well as testing of the drug product itself, indicated a level of NDMA above acceptable thresholds and Appco initiated a voluntary recall. We elected to exit the market for Ranitidine and determined that the carrying value of the asset has been impaired. During the fourth quarter 2019, we recognized a full impairment of the remaining $75 thousand carrying value of the asset.
In April 2019, we entered into an agreement with Pharmaceutics International, Inc. (“PII”) and BAS ANDA LLC (“BAS”), under which a previously-commercialized product would be developed and marketed. Per the agreement, we may pay PII a series of licensing fees in conjunction with the achievement of certain development and commercial milestones. In the fourth quarter of 2019, the product was launched, triggering a $0.5 million payment due to PII. The payment was capitalized as an intangible asset. During the fourth quarter 2020, we recognized a full impairment of the remaining $0.4 million carrying value of the asset.
No events or circumstances arose in 2020 that indicated that the carrying value of any of our other definite-lived intangible assets may not be recoverable. If the fair value of an intangible asset is determined to be lower than its carrying value, we could be exposed to an impairment charge that could be material.
Goodwill
As discussed in Note 1. Description of Business and Summary of Significant Accounting Policies, in the notes to the consolidated financial statements in Part II, Item 8. of this Annual Report on Form 10-K, our goodwill balance relates to our 2013 merger with BioSante Pharmaceuticals, Inc. and the acquisition of WellSpring and represents the excess of the total purchase consideration over the fair value of acquired assets and assumed liabilities, using the purchase method of accounting. Goodwill is not amortized, but is subject to periodic review for impairment. As a result, the amount of goodwill is directly impacted by the estimates of the fair values of the assets acquired and liabilities assumed.
In addition, goodwill is reviewed annually, as of October 31, and whenever events or changes in circumstances indicate that the carrying amount of the goodwill might not be recoverable. Judgment is used in determining when these events and circumstances arise. We perform our review of goodwill on our one reporting unit. If we determine that the carrying value of the assets may not be recoverable, judgment and estimates are used to assess the fair value of the assets and to determine the amount of any impairment loss.
The carrying value of goodwill at December 31, 2020 was $3.6 million. We believe it is unlikely that there will be a material change in the future estimates or assumptions used to test for impairment losses on goodwill. However, if actual
55
Table of Contents
results are not consistent with our estimates or assumptions, we could be exposed to an impairment charge that could be material.
Stock-Based Compensation
Our Amended and Restated 2008 Stock Incentive Plan (the “2008 Plan”) includes stock options and restricted stock, which are awarded in exchange for employee and non-employee director services. In July 2016, we commenced administration of our Employee Stock Purchase Plan (“ESPP”). We recognize the estimated fair value of stock-based awards and classify the expense where the underlying salaries are classified.
On September 8, 2020, we granted stock options to our Chief Executive Officer, through an inducement grant outside of our 2008 Plan to induce him to accept employment with us (the “Inducement Grant”). The grant was made pursuant to inducement grants outside of our shareholder approved equity plan as permitted under the Nasdaq Stock Market listing rules.
The following table summarizes stock-based compensation expense incurred under the 2008 Plan, Inducement Grant, and 2016 Employee Stock Purchase Plan and included in our consolidated statements of operations:
Years Ended December 31,
(in thousands)
2020
2019
2018
Cost of sales
$
137
$
119
$
98
Research and development
597
785
787
Selling, general, and administrative
12,202
8,313
5,897
$
12,936
$
9,217
$
6,782
Stock-based compensation cost for stock options is determined at the grant date using an option pricing model and stock-based compensation cost for restricted stock is based on the closing market price of the stock at the grant date. The value of the award is recognized as expense on a straight-line basis over the employee’s requisite service period.
Valuation of stock awards requires us to make assumptions and to apply judgment to determine the fair value of the awards. These assumptions and judgments include estimating the future volatility of our stock price and dividend yields. Changes in these assumptions can affect the fair value estimate.
Changes in estimates could affect compensation expense within individual periods. If there were to be a 10% change in our stock-based compensation expense for the year, our Income before Benefit for Income Taxes would be affected by $1.3 million for the year ended December 31, 2020.
Income Taxes
We use the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that such tax rate changes are enacted.
We use a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. We have not identified any uncertain income tax positions that could have a material impact to the consolidated financial statements. We are subject to taxation in various U.S. jurisdictions and Canada and remain subject to examination by taxing jurisdictions for the years 1998 and all subsequent periods due to the availability of net operating loss carryforwards. To the extent we prevail in matters for which a liability has been established, or are required to pay amounts in excess of our established liability, our effective income tax rate in a given financial statement period could be materially affected. An unfavorable tax settlement generally would require use of our cash and may result in an increase in our effective income tax rate in
56
Table of Contents
the period of resolution. A favorable tax settlement may reduce our effective income tax rate and would be recognized in the period of resolution.
We consider potential tax effects resulting from discontinued operations and gains and losses included in other comprehensive income and record intra-period tax allocations, when those effects are deemed material. Our effective income tax rate is also affected by changes in tax law, our level of earnings, and the results of tax audits.
Although we believe that the judgments and estimates discussed herein are reasonable, actual results could differ, and we may be exposed to losses or gains that could be material .
Recent Accounting Pronouncements
Recent Accounting Pronouncements Not Yet Adopted
In November 2019, the Financial Accounting Standards Board (“FASB”) issued guidance simplifying the accounting for income taxes by removing the following exceptions: 1) exception to the incremental approach for intraperiod tax allocation when there is a loss from continuing operations and income or a gain from other items, 2) exception requirement to recognize a deferred tax liability for equity method investments when a foreign subsidiary becomes an equity method investment, 3) exception to the ability not to recognize a deferred tax liability for a foreign subsidiary when a foreign equity method investment becomes a subsidiary, and 4) exception to the general methodology for calculating income taxes in an interim period when a year-to-date loss exceeds the anticipated loss for the year. The amendments also simplify accounting for income taxes by doing the following: 1) requiring that an entity recognize a franchise tax or similar tax that is partially based on income as an income-based tax and account for any incremental amount incurred as a non-income-based tax, 2) requiring that an entity evaluate when a step up in the tax basis of goodwill should be considered part of the business combination in which the book goodwill was originally recognized and when it should be considered a separate transaction, 3) specifying that an entity is not required to allocate the consolidated amount of current and deferred tax expense to a legal entity that is not subject to tax in its separate financial statements, 4) requiring that an entity reflect the effect of an enacted change in tax laws or rates in the annual effective tax rate computation in the interim period that includes the enactment date, and 5) making minor Codification improvements for income taxes related to employee stock ownership plans and investments in qualified affordable housing projects accounted for using the equity method. The guidance is effective for reporting periods beginning after December 15, 2020, including interim periods within that fiscal year. Early adoption was permitted, including adoption in an interim period. We will adopt this guidance as of January 1, 2021. We expect that the adoption of this guidance will not have a material impact on our consolidated financial statements.
We have evaluated all other issued and unadopted Accounting Standards Updates and believe the adoption of these standards will not have a material impact on our consolidated statements of operations, comprehensive income, balance sheets, or cash flows.
Recently Adopted Accounting Pronouncements
In November 2018, the FASB issued guidance clarifying that certain transactions between collaborative arrangement participants should be accounted for as revenue under Accounting Standards Codification Topic 606 when the collaborative arrangement participant is a customer in the context of a unit of account. The guidance was effective for reporting periods beginning after December 15, 2019, including interim periods within that fiscal year. We adopted this guidance as of January 1, 2020. The adoption of this guidance did not have a material impact on our consolidated financial statements.
In August 2018, the FASB issued guidance amending the disclosure requirements on fair value measurements. The amendments add, modify, and eliminate certain disclosure requirements on fair value measurements. The guidance was effective for reporting periods beginning after December 15, 2019, including interim periods within that fiscal year. We adopted this guidance as of January 1, 2020. The adoption of this guidance did not have a material impact on our consolidated financial statements.
57
Table of Contents
In June 2016, the FASB issued guidance with respect to measuring credit losses on financial instruments, including trade receivables. The guidance eliminates the probable initial recognition threshold that was previously required prior to recognizing a credit loss on financial instruments. The credit loss estimate now reflects an entity's current estimate of all future expected credit losses. Under the previous guidance, an entity only considered past events and current conditions. In April 2019, the FASB further clarified the scope of the credit losses standard and addressed issues related to accrued interest receivable balances, recoveries, variable interest rates, and prepayment. In May 2019, the FASB issued further guidance to provide entities with an option to irrevocably elect the fair value option applied on an instrument-by-instrument basis for eligible financial instruments. We adopted this guidance as of January 1, 2020 using the modified retrospective method for all financial assets measured at amortized cost. Results for reporting periods beginning after January 1, 2020 are presented under the new guidance while prior period amounts continue to be reported in accordance with previously applicable GAAP. We recognized an $8 thousand decrease to retained earnings as of January 1, 2020 for the cumulative effect of adopting the new guidance.
Off-Balance Sheet Arrangements
As of December 31, 2020, we did not have any off-balance sheet arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K promulgated by the SEC.