Item 7. Management’s Discussion and Analysis
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read together with Item 6, “Selected Financial Data” and the consolidated financial statements and the related notes included in Item 8 of this Annual Report on Form 10-K. This discussion contains forward-looking statements related to future events and our future financial performance that are based on current expectations and subject to risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those set forth in Part I—Item 1A. “Risk Factors” and “Cautionary Note Regarding Forward Looking Statements.” included in this Annual Report on Form 10-K.
Overview
Our Business
We are an established leader and fully integrated provider of innovative imaging diagnostics, targeted therapeutics, and artificial intelligence solutions to Find, Fight and Follow serious medical conditions. Clinicians use our imaging agents and products across a range of imaging modalities, including echocardiography and nuclear imaging. We believe that the resulting improved diagnostic information enables healthcare providers to better detect and characterize, or rule out, disease, potentially achieving improved patient outcomes, reducing patient risk and limiting overall costs for payers and the entire healthcare system.
Our commercial products are used by cardiologists, nuclear physicians, radiologists, internal medicine physicians, technologists and sonographers working in a variety of clinical settings. We sell our products to radiopharmacies, PMFs, integrated delivery networks, hospitals, clinics and group practices.
We sell our products globally and operate our business in two reportable segments, which are further described below:
• U.S. Segment produces and markets our medical imaging agents and products throughout the U.S. In the U.S., we primarily sell our products to radiopharmacies, PMFs, integrated delivery networks, hospitals, clinics and group practices.
• International Segment operations consist of direct distribution in Canada and Puerto Rico, as well as third-party distribution relationships in Europe, Canada, Australia, Asia-Pacific and Latin America and our EXINI business in Sweden.
We are in the process of evaluating our operating and reporting structure. We anticipate this evaluation, which we expect to complete during 2021, may result in a change to our existing operating segment reporting structure.
Progenics Acquisition
On June 19, 2020, we completed the Progenics Acquisition. Progenics is an oncology company focused on developing and commercializing innovative targeted medicines and artificial intelligence to Find, Fight and Follow cancer. Progenics’ portfolio of products and product candidates includes, among other things, therapeutic agents designed to target cancer (AZEDRA, 1095 and PSMA TTC), diagnostic imaging agents designed to target PSMA for prostate cancer (PyL and 1404), RELISTOR for OIC, AI imaging technologies and leronlimab being developed for HIV infection and COVID-19 applications. Progenics’ current revenue is generated from two principal sources: first, royalties, development and commercial milestones from strategic partnerships, including royalties from Bausch from sales of RELISTOR; and second, AZEDRA sales.
Holdings issued 26,844,877 shares of Holdings common stock and 86,630,633 CVRs to former Progenics stockholders in connection with the Progenics Acquisition. Holdings also assumed 34,000 in-the-money Progenics stock options and 6,507,342 out-of-the-money Progenics stock options, each converted into Replacement Stock Options at an exchange ratio of 0.31.
Key Factors Affecting Our Results
Our 2021 financial performance will reflect full year results of the Progenics business, whereas current year only incorporated results since the June 19, 2020 acquisition date. We also expect that the anticipated approval and launch of PyL during fiscal year 2021 may result in increased revenues.
Our business and financial performance have been, and continue to be, affected by the following:
COVID-19 Pandemic
The global COVID-19 pandemic has had, and will continue to have, a material impact on our business. Towards the end of the first quarter of 2020 we began to experience, and through the date of this filing we are continuing to experience, impacts to our business and operations related to the COVID-19 pandemic, including the impact of stay-at-home mandates and advisories, and a decline in the volume of procedures and treatments using our products. For example, there has been a reduction in the number of
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echocardiograms performed in 2020 (approximately 31.5 million) as compared to the number performed in 2019 (approximately 35.1 million), in each case, according to a third party source. In addition, there has been a substantial reduction in pulmonary ventilation studies in which our Xenon is used because of institutional concerns and professional society guidelines relating to the possible spread of COVID-19 to technicians and other patients, given that Xenon is both inhaled and exhaled by the patient. As a result, Xenon sales have decreased. We expect Xenon sales to continue to be at reduced levels so long as COVID-19 precautions remain in place. We cannot predict the magnitude or duration of the pandemic’s impact on our business.
As a result of the COVID-19 pandemic, we undertook a thorough analysis of all of our discretionary expenses. In the first quarter of 2020 we implemented certain cost reduction initiatives. For most of the second quarter of 2020, we reduced our work week from five days to four days and reduced the pay for our personnel by varying amounts, depending on level of seniority.
We can give no assurances that we will not have to take additional cost reduction measures if the pandemic continues to adversely affect the volume of procedures and treatments using our products.
During the second quarter of 2020, Progenics also implemented certain cost reduction initiatives, and new enrollment in the Phase 2 trial of 1095 in mCRPC patients was paused to minimize the risk to subjects and healthcare providers during the pandemic. New enrollment in that study restarted in October 2020.
GE Healthcare, our development and commercialization partner for flurpiridaz F 18, also delayed enrollment in the second Phase 3 clinical trial because of the pandemic and resumed enrollment in the third quarter of 2020.
While we are currently unable to estimate the impact of COVID-19 on our overall 2020 operations and financial results, we ended the fourth quarter of 2020 with $79.6 million of cash and cash equivalents. With our available liquidity and prudent expense management, we believe we will be able to maintain a state of preparedness to resume full business activities to support our customers as external conditions allow, although we can give no assurances that we will have sufficient liquidity if the pandemic continues to adversely affect the volume of procedures and treatments using our products for an extended period of time.
Anticipated Continued Growth of DEFINITY and Expansion of Our Ultrasound Microbubble Franchise
We believe the market opportunity for our ultrasound microbubble enhancing agent, DEFINITY, continues to be significant. DEFINITY has been our fastest growing and highest margin commercial product. We anticipate DEFINITY sales will continue to grow in the future. As we continue to educate the physician and healthcare provider community about the benefits and risks of DEFINITY, we believe we will be able to continue to grow the appropriate use of DEFINITY in suboptimal echocardiograms. In a U.S. market with three echocardiography ultrasound enhancing agents approved by the FDA, we estimate that DEFINITY had over 80% of the market as of December 31, 2020.
As we continue to pursue expanding our microbubble franchise, our activities include:
• Patents - We continue to actively pursue additional patents in connection with DEFINITY and DEFINITY RT, both in the U.S. and internationally. In the U.S. for DEFINITY we now own a total of four Orange Book-listed method of use patents, one of which expires in 2035 and three of which expire in 2037, as well as additional manufacturing patents that are not Orange Book-listed expiring in 2021, 2023 and 2037. In the U.S. for DEFINITY RT, we now own a total of five Orange Book-listed patents, including a composition of matter patent which expires in 2035. Outside of the U.S., while our original DEFINITY patent protection and regulatory exclusivity have generally expired, we are currently prosecuting additional DEFINITY and DEFINITY RT patents to obtain similar patent protection as in the U.S. The Orange Book-listed patents include a patent on the use of VIALMIX RFID which expires in 2037; additional VIALMIX RFID patent applications have been submitted in major markets throughout the world.
Hatch-Waxman Act - Even though our longest duration Orange Book-listed DEFINITY patent extends until March 2037, because our Orange Book-listed composition of matter patent expired in June 2019, we may face generic DEFINITY challengers in the near to intermediate term. Under the Hatch-Waxman Act, the FDA can approve Abbreviated New Drug Applications (“ANDAs”) for generic versions of drugs if the ANDA applicant demonstrates, among other things, that (i) its generic candidate is the same as the innovator product by establishing bioequivalence and providing relevant chemistry, manufacturing and product data, and (ii) the marketing of that generic candidate does not infringe an Orange Book-listed patent or that an Orange Book-listed patent is invalid. With respect to any Orange Book-listed patent covering the innovator product, the ANDA applicant must give a notice to the innovator (a “Notice”) that the ANDA applicant certifies that its generic candidate will not infringe the innovator’s Orange Book-listed patent or that the Orange Book-listed patent is invalid. The innovator can then challenge the ANDA applicant in court within 45 days of receiving that Notice, and FDA approval to commercialize the generic candidate will be stayed (that is, delayed) for up to 30 months (measured from the date on which a Notice is received) while the patent dispute between the innovator and the ANDA applicant is resolved in court. The 30
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month stay could potentially expire sooner if the courts determine that no infringement had occurred or that the challenged Orange Book-listed patent is invalid or if the parties otherwise settle their dispute.
As of the date of filing of this Annual Report on Form 10-K, we have not received any Notice from an ANDA applicant. If we were to (i) receive any such Notice in the future, (ii) bring a patent infringement suit against the ANDA applicant within 45 days of receiving that Notice, and (iii) successfully obtain the full 30 month stay, then the ANDA applicant would be precluded from commercializing a generic version of DEFINITY prior to the expiration of that 30 month stay period and, potentially, thereafter, depending on how the patent dispute is resolved. Solely by way of example and not based on any knowledge we currently have, if we received a Notice from an ANDA applicant in March 2021 and the full 30 month stay was obtained, then the ANDA applicant would be precluded from commercialization until at least September 2023. If we received a Notice some number of months in the future and the full 30 month stay was obtained, the commercialization date would roll forward in the future by the same calculation.
• DEFINITY RT - In November 2020, the FDA approved our supplemental new drug application (sNDA) for DEFINITY RT. DEFINITY RT is a modified formulation of DEFINITY that allows both storage and shipment at room temperature (DEFINITY’s previously approved formulation requires refrigerated storage). The modified formulation provides clinicians an additional choice and allows for greater utility of this formulation in broader clinical settings. We believe DEFINITY RT will become commercially available later in 2021, although that timing cannot be assured. Given its physical characteristics, we believe DEFINITY RT is also well-suited for inclusion in kits requiring microbubbles for other indications and applications (including in kits developed by third parties of the type described in the paragraph entitled New Clinical Applications below).
• VIALMIX RFID – In August 2020, we announced the FDA approved our sNDA for our next-generation activation device designed specifically for both DEFINITY and DEFINITY RT. The activation rate and time are controlled by VIALMIX RFID through the use of radio-frequency identification technology (“RFID”) to ensure reproducible activation of DEFINITY and DEFINITY RT. The RFID tag, which is affixed to the vial label, enables the DEFINITY or DEFINITY RT vial to be appropriately activated when utilized with the VIALMIX RFID activation device.
• New Clinical Applications - As we continue to look for other opportunities to expand our microbubble franchise, we are evaluating new indications and clinical applications beyond echocardiography and ultrasound enhancing agent imaging generally.
• In April 2019, we announced a strategic development and commercial collaboration with Cerevast Medical, Inc. (“Cerevast”) in which our microbubble will be used in connection with Cerevast’s ocular ultrasound device to improve blood flow in occluded retinal veins in the eye. Retinal vein occlusion is one of the most common causes of vision loss worldwide.
• In December 2019, we announced a strategic commercial supply agreement with CarThera for the use of our microbubbles in combination with SonoCloud, a proprietary implantable device in development for the treatment of recurrent glioblastoma. Glioblastoma is a lethal and devastating form of brain cancer with median survival of 15 months after diagnosis.
• In October 2020, we announced a strategic collaboration with Insightec Ltd. (“Insightec”) which will use our microbubbles in connection with Insightec’s transcranial guided focused ultrasound device for the treatment of glioblastoma as well as other neurodegenerative conditions.
• In-House Manufacturing - We have completed construction of specialized, in-house manufacturing capabilities at our North Billerica, Massachusetts facility for DEFINITY and, potentially, other sterile vial products. We believe the investment in these efforts will allow us to better control DEFINITY manufacturing and inventory, reduce our costs in a potentially more price competitive environment, and provide us with supply chain redundancy. We currently expect to make use of this in-house manufacturing capability in late 2021, although that timing cannot be assured.
• DEFINITY in China - In March 2020 in connection with our Chinese development and distribution arrangement with Double-Crane Pharmaceutical Company (“Double-Crane”), we filed an Import Drug License application with the National Medical Products Administration, or the NMPA, for the use of DEFINITY for the echocardiography indication. We believe this is an important milestone in our efforts to commercialize DEFINITY in China. Double-Crane is also in the process of analyzing the clinical results relating to the liver and kidney indications and will also work with us to prepare an Import Drug License application for those indications.
Integration of the Progenics Acquisition
The ultimate success of the Progenics Acquisition will depend on our ability to successfully combine the business of Progenics with our own and realize the anticipated benefits, including synergies, cost savings, innovation and operational efficiencies and revenue growth from the combination. If we are unable to achieve these objectives within the anticipated time frame, or at all, the
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anticipated benefits may not be realized fully or at all, or may take longer to realize than expected, and the value of our common stock may suffer.
Our combined business is now significantly larger and more complex than our business was immediately prior to the consummation of the Progenics Acquisition. Our ability to successfully manage this combined business will depend upon our ability to continue to integrate the two separate businesses and manage the combined business with its increased scale and scope, and increased costs and complexity.
We have incurred, and expect to continue to incur, substantial expenses in connection with the integration of the Progenics business with our own. There are a large number of processes, policies, procedures, operations, technologies and systems that have been, or must be, integrated, including purchasing, accounting and finance, sales, payroll, pricing, revenue management, marketing and benefits. The substantial majority of these costs have been, and will continue to be, non-recurring expenses related to the Progenics Acquisition, facilities and systems consolidation costs. We may also incur additional costs to maintain employee morale and to attract, motivate or retain management personnel or key employees.
Global Mo-99 Supply
We currently have Mo-99 supply agreements with Institute for Radioelements (“IRE”), running through December 31, 2022, and renewable by us on a year-to-year basis thereafter, and with NTP and ANSTO, running through December 31, 2021. We also have a Xenon supply agreement with IRE which runs through June 30, 2022, and which is subject to further extension.
Although we have a globally diverse Mo-99 supply with IRE in Belgium, NTP in South Africa, and ANSTO in Australia, we still face supplier and logistical challenges in our Mo-99 supply chain. The NTP processing facility had periodic outages in 2017, 2018 and 2019. When NTP was not producing, we relied on Mo-99 supply from both IRE and ANSTO to limit the impact of the NTP outages. In 2019 and 2020, ANSTO experienced multiple facility issues that resulted in ANSTO outages and volume limitations, during which time we relied on IRE and NTP to limit the impact of those outages and limitations. Because of the COVID-19 pandemic, we experienced challenges receiving regularly scheduled orders of Mo-99 from our global suppliers, particularly in the second quarter of 2020. We continue to manage these various supply chain challenges, but depending on reactor and processor schedules and operations, at times we have not been able to fill some or all of the demand for our TechneLite generators on certain manufacturing days. A prolonged disruption of service from one of our three Mo-99 processing sites or one of their main Mo-99-producing reactors could have a substantial negative effect on our business, results of operations, financial condition and cash flows.
We are also pursuing additional sources of Mo-99 from potential new producers to further augment our current supply. In November 2014, we entered into a strategic arrangement with SHINE for the future supply of Mo-99. Under the terms of the supply agreement, SHINE will provide Mo-99 produced using its proprietary LEU-solution technology for use in our TechneLite generators once SHINE’s facility becomes operational and receives all necessary regulatory approvals, which SHINE now estimates will occur in 2022. However, we cannot assure you that SHINE or any other possible additional sources of Mo-99 will result in commercial quantities of Mo-99 for our business, or that these new suppliers together with our current suppliers will be able to deliver a sufficient quantity of Mo-99 to meet our needs.
Inventory Supply
We obtain a substantial portion of our imaging agents from a third-party supplier. JHS is currently our sole source manufacturer of DEFINITY, NEUROLITE, Cardiolite and evacuation vials, the latter being an ancillary component for our TechneLite generators. We are currently seeking approval from certain foreign regulatory authorities for JHS to manufacture certain of our products. Until we receive these approvals, we will face continued limitations on where we can sell those products outside of the U.S.
In addition to JHS, we rely on SBL as our sole source manufacturer of DEFINITY RT. We have also completed construction of specialized, in-house manufacturing capabilities at our North Billerica, Massachusetts facility, which will also allow us to optimize our costs and reduce our supply chain risk. We can give no assurance as to when or if we will be successful in these efforts or that we will be able to successfully manufacture any additional commercial products at our North Billerica, Massachusetts facility.
Radiopharmaceuticals are decaying radioisotopes with half-lives ranging from a few hours to several days. These products cannot be kept in inventory because of their limited shelf lives and are subject to just-in-time manufacturing, processing and distribution, which takes place at our North Billerica, Massachusetts facility.
Research and Development Expenses
To remain a leader in the marketplace, we have historically made substantial investments in new product development, including, among other things, our flurpiridaz F 18 clinical development program, the expenses of which are now being borne by GE Healthcare. The Progenics Acquisition brings additional and substantial clinical development expense. The PyL NDA filed with the
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FDA on September 29, 2020, was accepted and granted priority review with PDUFA action date of May 28, 2021. For 1095, the ARROW Phase 2 study in mCRPC patients had been paused to minimize risk to subjects and healthcare providers during the pandemic, and new enrollment in that study restarted in October 2020. In addition, the Company’s development activities for PSMA AI are on-going. Our investments in these additional clinical activities will increase our operating expenses and impact our results of operations and cash flow, and we can give no assurances as to whether any of these clinical development candidates will be approved.
New Initiatives
In addition to integrating the new assets and programs resulting from the Progenics Acquisition, we continue to seek ways to further expand our portfolio of products and product candidates and how best to optimize the value of our current assets, evaluating a number of different opportunities to collaborate with others or to acquire or in-license additional products, product candidates, businesses and technologies to drive our future growth. As the Progenics Acquisition indicates, we are particularly interested in expanding our presence in oncology, in both radiotherapeutics and diagnostics. In May 2019, we commenced an initiative to build out our Pharma Services capabilities by entering into a strategic collaboration and license agreement with NanoMab, a privately-held biopharmaceutical company focusing on the development of next generation radiopharmaceuticals for cancer precision medicine. We believe this collaboration will provide the first broadly-available PD-L1 imaging biomarker research tool to pharmaceutical companies and academic centers conducting clinical trials on immuno-oncology treatments, including combination therapies. We have also expanded our Pharma Services offering to include PyL for pharmaceutical companies developing PSMA-targeted therapies and have entered into PyL clinical supply agreements with each of Regeneron, Bayer and POINT BioPharma for use of PyL in prostate cancer drug development programs. We can give no assurance as to when or if any of these Pharma Services collaborations will be successful or accretive to earnings.
In addition, as described above, we continue to expand our microbubble franchise. In October 2020, we announced a strategic collaboration with Insightec which will use our microbubbles in connection with Insightec’s transcranial guided focused ultrasound device for the treatment of glioblastoma as well as other neurodegenerative conditions. Glioblastoma is a lethal and devastating form of brain cancer with median survival of 15 months after diagnosis. Previously, we announced a strategic commercial supply agreement with CarThera for the use of our microbubbles in combination with SonoCloud, a proprietary implantable device in development for the treatment of recurrent glioblastoma. We also previously announced a strategic development and commercial collaboration with Cerevast in which our microbubbles will be used in connection with Cerevast’s ocular ultrasound device to improve blood flow in occluded retinal veins in the eye. Retinal vein occlusion is one of the most common causes of vision loss worldwide.
Results of Operations
The following is a summary of our consolidated results of operations:
Year Ended
December 31,
(in thousands) 2020 2019 2018
Revenues $ 339,410 $ 347,337 $ 343,374
Cost of goods sold 200,649 172,526 168,489
Gross profit 138,761 174,811 174,885
Operating expenses
Sales and marketing 40,901 41,888 43,159
General and administrative 69,270 61,244 50,167
Research and development 32,788 20,018 17,071
Total operating expenses 142,959 123,150 110,397
Operating (loss) income (4,198) 51,661 64,488
Interest expense 9,479 13,617 17,405
Loss on extinguishment of debt — 3,196 —
Other (income) loss (2,198) 6,221 (2,465)
(Loss) income before income taxes (11,479) 28,627 49,548
Income tax expense (benefit) 1,994 (3,040) 9,030
Net (loss) income $ (13,473) $ 31,667 $ 40,518
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Comparison of the Periods Ended December 31, 2020 and 2019
Revenues
Segment revenues are summarized by product as follows:
Year Ended
December 31, 2020 vs. 2019 2019 vs. 2018
(in thousands) 2020 2019 2018 Change
$ Change
% Change
$ Change
%
U.S.
DEFINITY $ 207,270 $ 211,777 $ 178,440 $ (4,507) (2.1) % $ 33,337 18.7 %
TechneLite 69,729 72,534 74,042 (2,805) (3.9) % (1,508) (2.0) %
Other nuclear 36,864 36,231 48,935 633 1.7 % (12,704) (26.0) %
Rebates and allowances (19,067) (16,553) (12,837) (2,514) 15.2 % (3,716) 28.9 %
Total U.S. Revenues 294,796 303,989 288,580 (9,193) (3.0) % 15,409 5.3 %
International
DEFINITY 6,046 5,731 4,633 315 5.5 % 1,098 23.7 %
TechneLite 16,512 14,058 24,816 2,454 17.5 % (10,758) (43.4) %
Other nuclear 22,060 23,574 25,349 (1,514) (6.4) % (1,775) (7.0) %
Rebates and allowances (4) (15) (4) 11 (73.3) % (11) 275.0 %
Total International Revenues 44,614 43,348 54,794 1,266 2.9 % (11,446) (20.9) %
Worldwide
DEFINITY 213,316 217,508 183,073 (4,192) (1.9) % 34,435 18.8 %
TechneLite 86,241 86,592 98,858 (351) (0.4) % (12,266) (12.4) %
Other nuclear 58,924 59,805 74,284 (881) (1.5) % (14,479) (19.5) %
Rebates and allowances (19,071) (16,568) (12,841) (2,503) 15.1 % (3,727) 29.0 %
Total Revenues $ 339,410 $ 347,337 $ 343,374 $ (7,927) (2.3) % $ 3,963 1.2 %
2020 vs. 2019
The decrease in U.S. segment revenues during the year ended December 31, 2020, as compared to the prior year is primarily due to COVID-19 related business losses which include a $4.5 million decrease in DEFINITY revenue and a $2.8 million decrease in TechneLite revenue. Additionally, rebates and allowances increased $2.5 million. Other nuclear revenue increased $0.6 million driven by the addition of Progenics revenue portfolio, which was nearly offset by a reduction in Xenon volume.
The increase in International segment revenues during the year ended December 31, 2020, as compared to the prior year is primarily due to a $2.5 million higher TechneLite revenue as a result of resolution of supplier disruptions and opportunistic incremental demand, partially offset by a decrease in revenue in other nuclear products driven by COVID-19 demand losses.
Rebates and Allowances
Estimates for rebates and allowances represent our estimated obligations under contractual arrangements with third parties. Rebate accruals and allowances are recorded in the same period the related revenue is recognized, resulting in a reduction to revenue and the establishment of a liability which is included in accrued expenses. These rebates and allowances result from performance-based offers that are primarily based on attaining contractually specified sales volumes and growth, Medicaid rebate programs for our products, administrative fees of group purchasing organizations and certain distributor related commissions. The calculation of the accrual for these rebates and allowances is based on an estimate of the third-party’s buying patterns and the resulting applicable contractual rebate to be earned over a contractual period.
An analysis of the amount of, and change in, reserves is summarized as follows:
(in thousands) Rebates and
Allowances
Balance, January 1, 2020 $ 6,985
Provision related to current period revenues 19,675
Adjustments relating to prior period revenues (604)
Payments or credits made during the period (16,706)
Balance, December 31, 2020 $ 9,350
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Gross Profit
Gross profit is summarized by segment as follows:
Year Ended
December 31, 2020 vs. 2019 2019 vs. 2018
(in thousands) 2020 2019 2018 Change
$ Change
% Change
$ Change
%
U.S. $ 127,778 $ 164,051 $ 161,760 $ (36,273) (22.1) % $ 2,291 1.4 %
International 10,983 10,760 13,125 223 2.1 % (2,365) (18.0) %
Total Gross profit $ 138,761 $ 174,811 $ 174,885 $ (36,050) (20.6) % $ (74) — %
2020 vs. 2019
The decrease in the U.S. segment gross profit for the year ended December 31, 2020, as compared to the prior year is primarily due to lower DEFINITY, TechneLite, and Xenon unit volumes due to COVID-19, amortization expense of assets acquired in the Progenics acquisition, a contract termination including a loss on disposal of assets and an asset impairment loss of $7.3 million on other nuclear products.
Sales and Marketing
Sales and marketing expenses consist primarily of salaries and other related costs for personnel in field sales, marketing and customer service functions. Other costs in sales and marketing expenses include the development and printing of advertising and promotional material, professional services, market research and sales meetings.
Sales and marketing expense is summarized by segment as follows:
Year Ended
December 31, 2020 vs. 2019 2019 vs. 2018
(in thousands) 2020 2019 2018 Change
$ Change
% Change
$ Change
%
U.S. $ 38,992 $ 39,672 $ 40,579 $ (680) (1.7) % $ (907) (2.2) %
International 1,909 2,216 2,580 (307) (13.9) % (364) (14.1) %
Total Sales and marketing $ 40,901 $ 41,888 $ 43,159 $ (987) (2.4) % $ (1,271) (2.9) %
2020 vs. 2019
The decrease in the U.S. segment sales and marketing expenses for the year ended December 31, 2020, as compared to the prior year period is primarily due to reduced marketing promotional programs, reduced travel due to COVID-19 impact and reduced hiring and lower employee related costs offset by market research and the addition of the Progenics business. The Progenics business contributed approximately $6.4 million of expense to the U.S. segment for the year ended December 31, 2020.
The decrease in the International segment sales and marketing expenses for the for the year ended December 31, 2020, as compared to the prior year period is primarily due to lower marketing promotional activities.
General and Administrative
General and administrative expenses consist of salaries and other related costs for personnel in executive, finance, legal, information technology and human resource functions. Other costs included in general and administrative expenses are professional fees for information technology services, external legal fees, consulting and accounting services as well as bad debt expense, certain facility and insurance costs, including director and officer liability insurance.
General and administrative expense is summarized by segment as follows:
Year Ended
December 31, 2020 vs. 2019 2019 vs. 2018
(in thousands) 2020 2019 2018 Change
$ Change
% Change
$ Change
%
U.S. $ 68,283 $ 60,752 $ 49,149 $ 7,531 12.4 % $ 11,603 23.6 %
International 987 492 1,018 495 100.6 % (526) (51.7) %
Total General and administrative $ 69,270 $ 61,244 $ 50,167 $ 8,026 13.1 % $ 11,077 22.1 %
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2020 vs. 2019
The increase in U.S. segment general and administrative expenses for the year ended December 31, 2020, as compared to the prior year is driven primarily by an increase in acquisition-related costs associated with the Progenics Acquisition and the addition of the Progenics business offset by lower medical insurance costs, travel with COVID-19 limitations and a gain on changes in fair value of contingent assets and liabilities. The Progenics business contributed approximately $5.5 million of expense to the U.S. segment for the year ended December 31, 2020.
The International segment general and administrative expenses increased for the year ended December 31, 2020, as compared to the prior year, driven primarily by the addition of the Progenics business and an insurance benefit received in 2019 which was partially offset by lower employee related costs in 2020. The Progenics business contributed approximately $0.4 million of expense to the International segment for the year ended December 31, 2020.
Research and Development
Research and development expenses relate primarily to the development of new products to add to our portfolio and costs related to our medical affairs, medical information and regulatory functions. We do not allocate research and development expenses incurred in the U.S. to our International segment.
Research and development expense is summarized by segment as follows:
Year Ended
December 31, 2020 vs. 2019 2019 vs. 2018
(in thousands) 2020 2019 2018 Change
$ Change
% Change
$ Change
%
U.S. $ 30,866 $ 19,352 $ 15,705 $ 11,514 59.5 % $ 3,647 23.2 %
International 1,922 666 1,366 1,256 188.6 % (700) (51.2) %
Total Research and development $ 32,788 $ 20,018 $ 17,071 $ 12,770 63.8 % $ 2,947 17.3 %
2020 vs. 2019
The increase in U.S. segment research and development expenses for the year ended December 31, 2020, as compared to the prior year is primarily driven by the addition of the Progenics business, including the PyL NDA filing fee, an in-process research and development (“IPR&D”) asset impairment loss of $2.7 million partially offset by clinical research expenses related to DEFINITY studies completing and lower employee related expenses. The Progenics business contributed approximately $17.2 million of expense to the U.S. segment for the year ended December 31, 2020.
The increase in the International segment research and development expenses for the year ended December 31, 2020, as compared to the prior year period is primarily driven by the addition of the Progenics business partially offset by regulatory costs related to Brexit matters. The Progenics business contributed approximately $1.3 million of expense to the International segment for the year ended December 31, 2020.
Interest Expense
Interest expense for the year ended December 31, 2020 decreased $4.1 million as compared to the prior year period due to the refinancing of our existing indebtedness in the second quarter of 2019 which reduced our underlying principal amount and decreased interest rates on our long-term debt offset by debt we assumed as part of the Progenics acquisition.
Loss on Extinguishment of Debt
During the year ended December 31, 2019, we incurred a $3.2 million loss on extinguishment of debt in connection with the refinancing of our existing indebtedness.
Other (Income) Loss
Other (income) loss changed by $8.4 million for the year ended December 31, 2020 as compared to the prior year, due to an increase in tax indemnification income primarily due to the reduction of indemnified receivables related to the release of our uncertain tax positions in the prior year offset by an arbitration award that occurred in the prior year.
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Income Tax Expense (Benefit)
Income tax expense (benefit) is summarized as follows:
Year Ended
December 31, 2020 vs. 2019 2019 vs. 2018
(in thousands) 2020 2019 2018 Change
$ Change
% Change
$ Change
%
Income tax expense (benefit) $ 1,994 $ (3,040) $ 9,030 $ 5,034 (165.6) % $ (12,070) (133.7) %
The income tax expense for the year ended December 31, 2020 was primarily due to the accrual of interest associated with uncertain tax positions and the impact of non-deductible acquisition costs, offset by the tax benefits on losses generated in the period, the recognition of the deferred tax asset on held for sale assets, and tax credits. In accordance with the Company’s accounting policy, the change in the tax liability, penalties and interest associated with these uncertain tax positions (net of any offsetting federal or state benefit) is recognized within income tax (benefit) expense. Contemporaneously, changes in the tax indemnification receivable are recognized within other loss (income) in the consolidated statement of operations. Accordingly, as these reserves change, adjustments are included in income tax (benefit) expense with an offsetting adjustment included in other loss (income). Assuming that the receivable from BMS continues to be considered recoverable by the Company, there will be no effect on net income and no net cash outflows related to these liabilities. Refer to Note 5, Income Taxes.
The income tax benefit for the year ended December 31, 2019 was primarily due to the release of tax contingency reserves as well as the release of the valuation allowance against our Canada deferred tax assets and tax benefits arising from stock compensation deductions, offset by tax expense on income generated in the period and the accrual of interest associated with uncertain tax positions.
We regularly assess our ability to realize our deferred tax assets. Assessing the realizability of deferred tax assets requires significant management judgment. In determining whether our deferred tax assets are more-likely-than-not realizable, we evaluate all available positive and negative evidence, and weigh the objective evidence and expected impact. We released the full valuation allowance recorded against our Canada deferred tax assets during the year ended December 31, 2018. We continue to record a valuation allowance against certain of our foreign net deferred tax assets and a small component of our domestic deferred tax assets.
Our effective tax rate for each reporting period is presented as follows:
Year Ended
December 31,
2020 2019 2018
Effective tax rate (17.4)% (10.6)% 18.2%
Our effective tax rate in fiscal 2020 differs from the U.S. statutory rate of 21% principally due to non-deductible acquisition costs and the accrual of interest on uncertain tax positions, offset by the benefit created by the recognition of the deferred tax asset on held for sale assets and tax credits.
The decrease in the effective income tax rate for the year ended December 31, 2020 as compared to the prior year period is primarily due to the large non-recurring benefit recorded in 2019 associated with the release of tax contingency reserves, non-deductible acquisition costs offset by the benefit created by the recognition of the deferred tax asset on held for sale assets. The 2020 effective tax rate is a tax expense recorded against a pre-tax loss, whereas the 2019 effective tax rate is a tax benefit recorded against pre-tax income.
Comparison of the Periods Ended December 31, 2019 and 2018
For a comparison of our results of operations for the fiscal years ended December 31, 2019 and December 31, 2018, see “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, filed with the SEC on February 25, 2020.
Liquidity and Capital Resources
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Cash Flows
The following table provides information regarding our cash flows:
Year Ended
December 31,
(in thousands) 2020 2019 2018
Net cash provided by operating activities $ 16,396 $ 80,384 $ 61,193
Net cash used in investing activities $ (4,912) $ (22,061) $ (19,132)
Net cash used in financing activities $ (21,861) $ (78,881) $ (4,668)
For a discussion of our liquidity and capital resources related to our cash flow activities for the fiscal year ended December 31, 2018, see “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our annual report on Form 10-K for the fiscal year ended December 31, 2019, filed with the SEC on February 25, 2020.
Net Cash Provided by Operating Activities
Net cash provided by operating activities of $16.4 million in the year ended December 31, 2020 was driven primarily by a net loss of $13.5 million, a net decrease of $22.4 million related to movements in our working capital accounts during the period and a net decrease of $2.0 million in the fair value of contingent assets and liabilities offset by $24.7 million of depreciation, amortization and accretion expense, stock-based compensation expense of $14.1 million, impairment of long-lived assets of $9.9 million and a loss on disposal of assets of $2.3 million. The overall decreases in cash from our working capital accounts were primarily driven by the increase in accounts receivable due to the Progenics Acquisition and increase in collection period as well as change in inventory related to the COVID-19 impact on products and the timing of payments and payments of accruals related to G&A expenses in connection with the Progenics Acquisition.
Net cash provided by operating activities of $80.4 million in the year ended December 31, 2019 was driven primarily by net income of $31.7 million plus $13.4 million of depreciation, amortization and accretion expense, changes in long-term income tax payable and other long-term liabilities of $13.2 million, stock-based compensation expense of $12.5 million, changes in long-term income tax receivable of $10.6 million, changes in deferred taxes of $9.7 million and debt extinguishment expense of $3.2 million. These net sources of cash were further increased by a net increase of $9.0 million related to movements in our working capital accounts during the period. The overall increases in cash from our working capital accounts were primarily driven by accrued expenses and the timing of purchases.
Net Cash Used in Investing Activities
Net cash used in investing activities during the year ended December 31, 2020 reflected $10.0 million in lending on a note receivable to Progenics prior to the acquisition and $12.5 million in capital expenditures offset by $17.6 million of acquired cash related to the Progenics Acquisition.
Net cash used in investing activities during the year ended December 31, 2019 reflected $22.1 million in capital expenditures.
Net Cash Used in Financing Activities
Net cash used in financing activities during the year ended December 31, 2020 is primarily attributable to the payments on long-term debt and other borrowings of $15.5 million related to the 2019 Term Facility and Royalty-Backed Loan (defined below), equity issuance costs related to the Progenics Acquisition of $3.8 million, and payments for minimum statutory tax withholding related to net share settlement of equity awards of $2.1 million.
Net cash used in financing activities during the year ended December 31, 2019 is primarily attributable to the net cash outflow of approximately $73.0 million in connection with the refinancing of our previous 2017 Facility, payments on long-term debt of $5.0 million related to the 2019 Term Facility and payments for minimum statutory tax withholding related to net share settlement of equity awards of $2.5 million. Starting in 2019, we require certain senior executives to cover tax liabilities resulting from the vesting of their equity awards pursuant to sell-to-cover transactions under 10b5-1 plans.
External Sources of Liquidity
In June 2019, we refinanced our 2017 $275.0 million five-year term loan facility with the 2019 Term Facility. In addition, we replaced our $75.0 million revolving facility with the 2019 Revolving Facility. The terms of the 2019 Facility are set forth in the Credit Agreement, dated as of June 27, 2019, by and among us, the lenders from time to time party thereto and Wells Fargo Bank, N.A., as administrative agent and collateral agent. We have the right to request an increase to the 2019 Term Facility or request the establishment of one or more new incremental term loan facilities, in an aggregate principal amount of up to $100.0 million, plus additional amounts, in certain circumstances.
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We are permitted to voluntarily prepay the 2019 Term Loans, in whole or in part, without premium or penalty. The 2019 Term Facility requires us to make mandatory prepayments of the outstanding 2019 Term Loans in certain circumstances. The 2019 Term Facility amortizes at 5.0% per year through September 30, 2022 and 7.5% thereafter, until its June 27, 2024 maturity date.
Under the terms of the 2019 Revolving Facility, the lenders thereunder agreed to extend credit to us from time to time until June 27, 2024 consisting of revolving loans in an aggregate principal amount not to exceed $200.0 million at any time outstanding. The 2019 Revolving Facility includes a $20.0 million sub-facility for the issuance of Letters of Credit. The 2019 Revolving Facility includes a $10.0 million sub-facility for Swingline Loans. The Letters of Credit, Swingline Loans and the borrowings under the 2019 Revolving Facility are expected to be used for working capital and other general corporate purposes.
Please refer to Note 13, “Long-Term Debt, Net, and Other Borrowings” for further details on the 2019 Facility.
On June 19, 2020, we amended our 2019 Credit Agreement (“the Amendment”) as a result of the impact of the COVID-19 pandemic on our business and operations and the near-term higher level of indebtedness resulting from our decision not to immediately repay the Progenics debt secured by the RELISTOR royalties following our Progenics Acquisition.
The Amendment provides for, among other things, modifications to our financial maintenance covenants. The covenant related to Total Net Leverage Ratio (as defined in the Amended Credit Agreement) has been waived from the date of the Amendment through December 31, 2020. The maximum total net leverage ratio and interest coverage ratio permitted by the financial covenant is displayed in the table below:
2020 Amended Credit Agreement
Period Total Net Leverage Ratio
Q1 2021 5.50 to 1.00
Q2 2021 3.75 to 1.00
Thereafter 3.50 to 1.00
Period Interest Coverage Ratio
Q4 2020 to Q1 2021 2.00 to 1.00
Thereafter 3.00 to 1.00
The Amendment also introduces a new financial covenant requiring Consolidated Liquidity (as defined in the Amended Credit Agreement) to be no less than $150.0 million. The Consolidated Liquidity covenant is tested on a continuing basis beginning on the date of the Amendment and ending on the date on which we deliver a compliance certificate for the fiscal quarter ending March 31, 2021. As of December 31, 2020, we were in compliance with all financial and other covenants under the Amendment.
For the period beginning on the date of the Amendment and ending on the Adjustment Date (as defined in the Amended Credit Agreement) for the fiscal quarter ending March 31, 2021, loans under the Amended Credit Agreement bear interest at LIBOR plus 3.25% or the Base Rate plus 2.25%. On and after the Adjustment Date for the fiscal quarter ending on March 31, 2021, loans bear interest at LIBOR plus a spread that ranges from 1.50% to 3.00% or the Base Rate plus a spread that ranges from 0.50% to 2.00%, in each case based on our Total Net Leverage Ratio.
The commitment fee applicable to the Revolving Facility is 0.50% until the Adjustment Date for the fiscal quarter ending March 31, 2021. On and after the Adjustment Date for the fiscal quarter ending on March 31, 2021, the commitment fee ranges from 0.15% to 0.40% based on our Total Net Leverage Ratio.
On June 19, 2020, as a result of the Progenics Acquisition, we assumed Progenics outstanding debt as of such date in the amount of $40.2 million. Progenics, through a wholly-owned subsidiary MNTX Royalties Sub LLC (“MNTX Royalties”), entered into a $50.0 million loan agreement (the “Royalty-Backed Loan”) with a fund managed by HealthCare Royalty Partners III, L.P. (“HCRP”) on November 4, 2016. Under the terms of the Royalty-Backed Loan, the lenders have no recourse to Progenics or any of its assets other than the right to receive royalty payments from the commercial sales of RELISTOR products owed under Progenics’ license agreement with Salix Pharmaceuticals, Inc., a wholly-owned subsidiary of Bausch. The RELISTOR royalty payments will be used to repay the principal and interest on the loan. The Royalty-Backed Loan bears interest at a per annum rate of 9.5% and matures on June 30, 2025. On June 22, 2020, HCRP waived the automatic acceleration of the Royalty-Backed Loan that otherwise would have been
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triggered by the consummation of the Progenics Acquisition and MNTX Royalties agreed not to prepay the loan until after December 31, 2020.
Under the terms of the loan agreement, payments of interest and principal, if any, are made on the last day of each calendar quarter out of RELISTOR royalty payments received since the immediately-preceding payment date. On each payment date, 50% of RELISTOR royalty payments received since the immediately-preceding payment date in excess of accrued interest on the loan are used to repay the principal of the loan, with the balance retained by us. Starting on September 30, 2021, all of the RELISTOR royalties received since the immediately-preceding payment date will be used to repay the interest and outstanding principal balance until the balance is fully repaid.
Our ability to fund our future capital needs will be affected by our ability to continue to generate cash from operations and may be affected by our ability to access the capital markets, money markets or other sources of funding, as well as the capacity and terms of our financing arrangements.
We may from time to time repurchase or otherwise retire our debt and take other steps to reduce our debt or otherwise improve our balance sheet. These actions may include prepayments of our term loans or other retirements or refinancing of outstanding debt, privately negotiated transactions or otherwise. The amount of debt that may be retired, if any, could be material and would be decided at the sole discretion of our Board of Directors and will depend on market conditions, our cash position and other considerations.
Funding Requirements
Our future capital requirements will depend on many factors, including:
• The level of product sales and the pricing environment of our currently marketed products, particularly DEFINITY and any additional products that we may market in the future, including decreased product sales resulting from the COVID-19 pandemic;
• Revenue mix shifts and associated volume and selling price changes that could result from contractual status changes with key customers and additional competition;
• The costs of acquiring or in-licensing, developing, obtaining regulatory approval for, and commercializing, new products, businesses or technologies, together with the costs of pursuing opportunities that are not eventually consummated;
• Our investment in the further clinical development and commercialization of products and development candidates, including the newly acquired Progenics assets AZEDRA, PyL, 1095, aBSI and PSMA AI;
• The costs of investing in our facilities, equipment and technology infrastructure;
• The costs and timing of establishing manufacturing and supply arrangements for commercial supplies of our products and raw materials and components;
• Our ability to have product manufactured and released from JHS and other manufacturing sites in a timely manner in the future;
• The costs of further commercialization of our existing products, particularly in international markets, including product marketing, sales and distribution and whether we obtain local partners to help share such commercialization costs;
• The extent to which we choose to establish collaboration, co-promotion, distribution or other similar arrangements for our marketed products;
• The legal costs relating to maintaining, expanding and enforcing our intellectual property portfolio, pursuing insurance or other claims and defending against product liability, regulatory compliance or other claims; and
• The cost of interest on any additional borrowings which we may incur under our financing arrangements.
Until we successfully become dual sourced for our principal products, we are vulnerable to future supply shortages. Disruption in our financial performance could also occur if we experience significant adverse changes in product or customer mix, broad economic downturns, adverse industry or company conditions or catastrophic external events, including pandemics such as COVID-19, natural disasters and political or military conflict. If we experience one or more of these events in the future, we may be required to further implement expense reductions, such as a delay or elimination of discretionary spending in all functional areas, as well as scaling back select operating and strategic initiatives.
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If our capital resources become insufficient to meet our future capital requirements, we would need to finance our cash needs through public or private equity offerings, debt financings, assets securitizations, sale-leasebacks or other financing or strategic alternatives, to the extent such transactions are permissible under the covenants of our Credit Agreement. Additional equity or debt financing, or other transactions, may not be available on acceptable terms, if at all. If any of these transactions require an amendment or waiver under the covenants in our Credit Agreement, which could result in additional expenses associated with obtaining the amendment or waiver, we will seek to obtain such a waiver to remain in compliance with those covenants. However, we cannot be assured that such an amendment or waiver would be granted, or that additional capital will be available on acceptable terms, if at all.
At December 31, 2020, our only current committed external source of funds is our borrowing availability under our 2019 Revolving Facility. We had $79.6 million of cash and cash equivalents at December 31, 2020. Our 2019 Facility, as amended, contains a number of affirmative, negative, reporting and financial covenants, in each case subject to certain exceptions and materiality thresholds. Incremental borrowings under the 2019 Revolving Facility, as amended, may affect our ability to comply with the covenants in the 2019 Facility, as amended, including the financial covenants restricting consolidated net leverage and interest coverage. Accordingly, we may be limited in utilizing the full amount of our 2019 Revolving Facility, as amended, as a source of liquidity.
In addition, in connection with the Progenics Acquisition, which we closed in June 2020, we incurred legal, accounting, financial advisory, consulting and printing fees, and transition, integration and other costs which we funded from our available cash and the available cash of Progenics. The CVRs we issued in the Progenics Acquisition entitle holders thereof to future cash payments of 40% of PyL net sales over (i) $100.0 million in 2022 and (ii) $150.0 million in 2023, which, if payable, we currently intend to fund from our then-available cash. In no event will our aggregate payments under the CVRs, together with any other non-stock consideration treated as paid in connection with the Progenics Acquisition, exceed 19.9% (which we estimate could be approximately $100.0 million) of the total consideration we pay in the Progenics Acquisition. Refer to Note 4, “Fair Value of Financial Instruments”, for further details on contingent consideration liabilities.
Based on our current operating plans, including our prudent expense management in response to the COVID-19 pandemic, we believe that our existing cash and cash equivalents, results of operations and availability under our 2019 Revolving Facility, as amended, will be sufficient to continue to fund our liquidity requirements for the foreseeable future.
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Contractual Obligations
Contractual obligations represent future cash commitments and liabilities under agreements with third parties and exclude contingent contractual liabilities for which we cannot reasonably predict future payment, including contingencies related to potential future development, financing, certain suppliers, contingent royalty payments and/or scientific, regulatory, or commercial milestone payments under development agreements. The following table summarizes our contractual obligations as of December 31, 2020:
Payments Due by Period
(in thousands) Total Less than
1 Year 1 - 3 Years 3 -5 Years More than
5 Years
Debt obligations (principal) $ 217,553 $ 20,452 $ 48,351 $ 148,750 $ —
Interest on debt obligations (a)
26,537 9,697 14,454 2,386 —
Operating lease obligations (b)
23,239 1,964 4,468 4,637 12,170
Purchase obligations (c)
6,198 4,132 2,066 — —
Finance lease obligations 525 231 294 — —
Fixed payments under license agreements (d)
733 164 328 203 38
Other long-term liabilities (e)(f)
— — — — —
Asset retirement obligations (g)
— — — — —
Total contractual obligations $ 274,785 $ 36,640 $ 69,961 $ 155,976 $ 12,208
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(a) Amounts relate to the estimated interest under our 2019 Term Facility and interest rate swaps based on interest rates in effect as of December 31, 2020 as well as future principal and interest, based upon estimated sales projections, under our Royalty-Backed Loan.
(b) Operating leases include minimum payments under leases for our facilities. Amounts exclude lease payments of $0.9 million associated with the Puerto Rico subsidiary that is classified as held for sale.
(c) Excludes purchase orders for inventory in the normal course of business.
(d) Does not include potential milestone or contractual payment obligations contingent upon the achievement or occurrence of future milestones or events under our license agreements, because they are contingent and the amounts and timing of such potential obligations are unknown or uncertain. We may be required to pay additional amounts up to approximately $90.6 million in contingent payments under our license agreements.
(e) Our other long-term liabilities in the consolidated balance sheet include unrecognized tax benefits and related interest and penalties. As of December 31, 2020, we had unrecognized tax benefits of $29.9 million, which included interest and penalties, classified as noncurrent liabilities. At this time, we are unable to make a reasonably reliable estimate of the timing of payments in individual years in connection with these tax liabilities; therefore, such amounts are not included in the above contractual obligation table.
(f) Our other long-term liabilities in the consolidated balance sheet also include the fair values of contingent consideration liabilities including CVRs and contingent consideration liabilities related to a previous acquisition completed by Progenics in 2013. We may be required to pay up to approximately $100.0 million related to the CVRs and approximately $85.0 million related to the contingent consideration. These contingent payments have been excluded from the above table due to uncertainty around the timing of the future cash outflows.
(g) We have excluded asset retirement obligations from the table above due to the uncertainty of the timing of the future cash outflows related to the decommissioning of our radioactive operations. As of December 31, 2020, the liability, which was approximately $14.3 million, including amounts recorded in liabilities held for sale was measured at the present value of the obligation expected to be incurred of approximately $26.9 million.
Off-Balance Sheet Arrangements
We are required to provide the U.S. Nuclear Regulatory Commission and Massachusetts Department of Public Health financial assurance demonstrating our ability to fund the decommissioning of our North Billerica, Massachusetts production facility upon closure, though we do not intend to close the facility. We have provided this financial assurance in the form of a $28.2 million surety bond.
Since inception, we have not engaged in any other off-balance sheet arrangements, including structured finance, special purpose entities or variable interest entities.
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Effects of Inflation
We do not believe that inflation has had a significant impact on our revenues or results of operations since inception. We expect our cost of product sales and other operating expenses will change in the future in line with periodic inflationary changes in price levels. Because we intend to retain and continue to use our property and equipment, we believe that the incremental inflation related to the replacement costs of those items will not materially affect our operations. However, the rate of inflation affects our expenses, such as those for employee compensation and contract services, which could increase our level of expenses and the rate at which we use our resources. While we generally believe that we will be able to offset the effect of price-level changes by adjusting our product prices and implementing operating efficiencies, any material unfavorable changes in price levels could have a material adverse effect on our financial condition, results of operations and cash flows.
Recent Accounting Standards
Refer to Note 2, “Summary of Significant Accounting Policies,” in the accompanying consolidated financial statements located under Item 8 of this Annual Report on Form 10-K for information regarding recently issued accounting standards that may have a significant impact on our business.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements require us to make estimates and judgments that affect our reported assets and liabilities, revenues and expenses, and other financial information. Actual results may differ materially from these estimates under different assumptions and conditions. In addition, our reported financial condition and results of operations could vary due to a change in the application of a particular accounting standard.
We believe the following represent our critical accounting policies and estimates used in the preparation of our financial statements.
Revenue from Contracts with Customers
Revenue is measured based on a consideration specified in a contract with a customer, and excludes any sales incentives and amounts collected on behalf of third parties. We recognize revenue when we satisfy our performance obligations by transferring control over products or services to our customers. The amount of revenue we recognize reflects the consideration to which we expect to be entitled to receive in exchange for these goods or services. To achieve this core principle, we apply the following five steps: (1) identify the contracts with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract; and (5) recognize revenue when (or as) we satisfy performance obligations.
We derive our revenues through arrangements with customers for product sales as well as licensing and royalty arrangements. We sell our products principally to hospitals and clinics, radiopharmacies, and distributors and we consider customer purchase orders, which in some cases are governed by master sales or group purchasing organization agreements, to be contracts with our customers. In addition to these arrangements, we also enter into licensing agreements under which we license certain rights to third parties. The terms of these arrangements typically include payment to us of one or more of the following: non-refundable, up-front license fees; development, regulatory and commercial milestone payments; and royalties on net sales of licensed products. We analyze various factors requiring management judgment when applying the five-step model to our contracts with customers.
Our product revenues are recorded at the net sales price (transaction price), which represents our sales price less estimates related to reserves which are established for items such as discounts, returns, rebates and allowances that may be provided for in certain contracts with our customers. Judgment is used in determining and updating our reserves on an on-going basis, and where appropriate, these estimates take into consideration a range of possible outcomes which are probability-weighted for relevant factors such as our historical experience, current contractual and statutory requirements, specific known market events and trends, industry data and forecasted customer buying and payment patterns. Overall, these reserves reflect the Company’s best estimates of the amount of consideration to which it is entitled based on the terms of the contract. Actual amounts of consideration ultimately received may differ from the Company’s estimates.
For our licensing and royalty arrangements, we use judgment in determining the number of performance obligations in a license agreement by assessing whether the license is distinct or should be combined with another performance obligation as well as the nature of the license. As part of the accounting for these arrangements, we develop assumptions that require judgment to determine the stand-alone selling price for each performance obligation identified in a contract. These key assumptions may include market conditions, reimbursement rates for personnel costs, development timelines and probabilities of regulatory success.
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Business Combinations
We account for business combinations using the acquisition method of accounting. We recognize the assets acquired and liabilities assumed in business combinations on the basis of their fair values at the date of acquisition. We assess the fair value of assets acquired, including intangible assets, and liabilities assumed using a variety of methods. Each asset acquired and liability assumed is measured at fair value from the perspective of a market participant. The method used to estimate the fair values of intangible assets incorporates significant assumptions regarding the estimates a market participant would make in order to evaluate an asset, including a market participant’s use of the asset and the appropriate discount rates. Acquired IPR&D is recognized at fair value and initially characterized as an indefinite-lived intangible asset, irrespective of whether the acquired IPR&D has an alternative future use. Any excess purchase price over the fair value of the net tangible and intangible assets acquired is allocated to goodwill. Transaction costs and restructuring costs associated with a business combination are expensed as incurred.
The fair values assigned to tangible and intangible assets acquired and liabilities assumed are based on our estimates and assumptions, as well as other information we have compiled, including valuations that utilize customary valuation procedures and techniques. If the actual results differ from the estimates and assumptions used in these estimates, it could result in a possible impairment of the intangible assets and goodwill, a required acceleration of the amortization expense of finite-lived intangible assets or the recognition of additional consideration, which would be expensed.
During the measurement period, which extends no later than one year from the acquisition date, we may record certain adjustments to the carrying value of the assets acquired and liabilities assumed with the corresponding offset to goodwill. After the measurement period, all adjustments are recorded in the consolidated statements of operations as operating expenses or income.
Intangible and Long-Lived Assets
We test intangible and long-lived assets for recoverability whenever events or changes in circumstances suggest that the carrying value of an asset or group of assets may not be recoverable. We measure the recoverability of assets to be held and used by comparing the carrying amount of the asset to future undiscounted net cash flows expected to be generated by the asset. If those assets are considered to be impaired, the impairment equals the amount by which the carrying amount of the assets exceeds the fair value of the assets. Any impairments are recorded as permanent reductions in the carrying amount of the assets. Long-lived assets, other than goodwill and other intangible assets, that are held for sale are recorded at the lower of the carrying value or the fair market value less the estimated cost to sell.
Intangible assets, consisting of trademarks, customer relationships, currently marketed products, licenses and developed technology are amortized in a method equivalent to the estimated utilization of the economic benefit of the asset.
Our IPR&D represents intangible assets acquired in a business combination that are used in research and development activities but have not yet reached technological feasibility, regardless of whether they have alternative future use. The primary basis for determining the technological feasibility or completion of these projects is whether we have obtained regulatory approval to market the underlying products in an applicable geographic region. Because obtaining regulatory approval can include significant risks and uncertainties, the eventual realized value of the acquired IPR&D projects may vary from their fair value at the date of acquisition. We classify IPR&D acquired in a business combination as an indefinite-lived intangible asset until the completion or abandonment of the associated research and development efforts. Upon completion of the associated research and development efforts, we will determine the useful life and begin amortizing the assets to reflect their use over their remaining lives. Upon permanent abandonment, we write-off the remaining carrying amount of the associated IPR&D intangible asset. We test our IPR&D assets at least annually or when a triggering event occurs that could indicate a potential impairment and we recognize any impairment loss in our consolidated statements of operations.