Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following is a discussion and analysis of the consolidated operating results, financial condition, liquidity and cash flows of our company as of and for the periods presented below. The following discussion and analysis should be read in conjunction with the audited consolidated financial statements and the related notes thereto included in Item 8 under the heading “Financial Statements and Supplementary Data.” This discussion contains forward-looking statements that are based on the beliefs of our management, as well as assumptions made by and information currently available to, our management. Actual results could differ materially from those discussed in or implied by forward-looking statements. These risks, uncertainties and other factors include among others, those identified under the “Special Note About Forward-Looking Statements,” above and described in greater detail elsewhere in this Annual Report on Form 10-K, particularly in Item 1A, “Risk Factors.”
In this section, we generally discuss the results of our operations for the year ended December 31, 2020 compared to the year ended December 31, 2019. For a discussion of the year ended December 31, 2019 to the year ended December 31, 2018, please refer to Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2019, filed with the SEC on March 16, 2020, which discussion is hereby incorporated herein by reference.
Overview
We are a bio-pharmaceutical company that focuses primarily on developing, manufacturing, marketing and selling technically-challenging generic and proprietary injectable, inhalation, and intranasal products as well as insulin API products. We currently manufacture and sell over 20 products.
We are currently developing a portfolio of 13 generic abbreviated new drug applications, or ANDAs, three biosimilar insulin product candidates and four proprietary product candidates, which are in various stages of development and target a variety of indications. Five of the ANDAs and one NDA are currently on file with the FDA.
Our largest products by net revenues currently include Primatene Mist®, enoxaparin sodium injection, phytonadione, lidocaine jelly and sterile solution, and naloxone hydrochloride injection. In the fourth quarter of 2018, we launched our over-the-counter product Primatene Mist®. In July 2019, we began a national digital, radio, and television campaign for our over-the-counter product Primatene Mist®, which will continue throughout 2021. During the second quarter of 2020, we launched our epinephrine injection, USP 30mg/mL multiple dose vial product. In December 2020, the FDA granted approval of our glucagon for injection emergency kit, 1mg, and we launched this product in the first quarter of 2021.
To complement our internal growth and expertise, we have made several strategic acquisitions of companies, products and technologies. These acquisitions collectively have strengthened our core injectable and inhalation product technology infrastructure by providing additional manufacturing, marketing, and research and development capabilities, including the ability to manufacture raw materials, API and other components for our products.
Included in these acquisitions are marketing authorizations for 33 products in the UK, Ireland, Australia, and New Zealand, representing 11 different injectable chemical entities from UCB Pharma GmbH. We are in the process of transferring the manufacturing of these products to our facilities in California, which will require approvals from the UK Medicines and Healthcare products Regulatory Agency before we can relaunch the products.
In July 2018, our Chinese subsidiary, ANP, completed a private placement of its common equity interest and received approximately $56.3 million of cash proceeds. We have retained approximately 58% of the equity interest in ANP following the private placement. ANP’s net income or loss after July 2, 2018, is attributed to us in accordance with our equity interest of approximately 58% in ANP.
COVID-19 Pandemic
In March 2020, the World Health Organization declared the outbreak of a novel coronavirus, or COVID-19, as a pandemic, which continues to spread throughout the world, including locations where we operate, such as the United
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States, China and France. We have been actively monitoring the COVID-19 pandemic and its impact globally. Currently, our production facilities in all of our locations continue to operate as they had prior to the COVID-19 pandemic with few changes, other than for enhanced safety measures intended to prevent the spread of the virus.
As a result of the COVID-19 pandemic, during the first half of 2020, sales of Primatene Mist® and certain hospital products increased, while sales of certain products frequently used in elective procedures, such as Cortrosyn® and lidocaine products, decreased. During the second half of 2020, sales of these products returned to levels closer to those experienced prior to the COVID-19 pandemic. Also, some of our ongoing clinical trials have experienced short-term interruptions in the recruitment of patients due to the COVID-19 pandemic, as hospitals prioritize their resources towards the COVID-19 pandemic and governments impose travel restrictions. Additionally, some clinical trials experienced increased expenses due to new protocols to protect participants from COVID-19.
It is not possible at this time to estimate the complete impact that COVID-19 could have on our business, including our customers and suppliers, as the impact will depend on future developments, which are highly uncertain and cannot be predicted. Infections may resurge or become more widespread and the limitation on our ability to travel and timely sell and distribute our products, as well as any closures or supply disruptions, may be extended for longer periods of time, all of which would have a negative impact on our business, financial condition and operating results.
The COVID-19 pandemic has and will continue to adversely affect global economies and financial markets, resulting in an economic downturn that could affect demand for our products and impact our operating results. Even after the COVID-19 pandemic has subsided, we may continue to experience an adverse impact to our business as a result of the continued global economic impact of the pandemic. We cannot anticipate all of the ways in which health epidemics such as COVID-19 could adversely impact our business. We will continue to monitor the impact of COVID-19 on all aspects of our business. See Item 1A, “Risk Factors” for further discussion of the possible impact of the COVID-19 pandemic on our business.
Business Segments
As of December 31, 2020, our performance is assessed and resources are allocated based on the following two reportable segments: (1) finished pharmaceutical products and (2) API products. The finished pharmaceutical products segment manufactures markets and distributes Primatene Mist®, enoxaparin, naloxone, phytonadione, lidocaine, as well as various other critical and non-critical care drugs. The API segment manufactures and distributes RHI API and porcine insulin API for external customers and internal product development. Information reported herein is consistent with how it is reviewed and evaluated by our chief operating decision maker. Factors used to identify our segments include markets, customers and products.
For more information regarding our segments, see “Part II – Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Segment Reporting Information.”
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Results of Operations
Year ended December 31, 2020 compared to year ended December 31, 2019
Net revenues
Year Ended December 31, Change
(in thousands)
Net revenues
Cost of revenues
as % of net revenues 41 % 41 %
The increase in net revenues of finished pharmaceutical products for 2020 was primarily due to the following changes:
Year Ended December 31, Change
(in thousands)
Finished pharmaceutical products net revenues
The increase in sales of Primatene Mist® for the year ended December 31, 2020 was a result of the continued success of our nationwide digital, television and radio campaign, which will continue throughout 2021. Additionally, sales of Primatene Mist® increased as we increased our distribution channels, selling online on Amazon and to Kroger, the largest grocery store chain in the United States starting in the third quarter of 2020. The increase in sales of enoxaparin was primarily due to an increase in unit volume, as a result of a competitor leaving the market. The increase in sales of epinephrine was primarily due to the launch of our epinephrine injection, USP 30mg/30mL multiple dose vial product in the second quarter of 2020. During the second and fourth quarters of 2020, we experienced lower demand for certain products which are frequently used in elective procedures, including lidocaine products and some products such as Cortrosyn® which are included in other finished pharmaceutical products. We attribute these declines in products used in elective procedures to a nationwide decline in such procedures by hospitals and individuals in response to the COVID-19 pandemic. These declines were partially offset by a $5.9 million increase in sales of sodium bicarbonate, included in other finished pharmaceutical products, as we were able to utilize the new production line approved by the FDA earlier in the year to meet strong market demand. We saw lower volume of several other finished pharmaceutical products including calcium chloride, dextrose and atropine, as a competitor who experienced shortages in 2019 returned to the market in 2020.
We anticipate that sales of naloxone and enoxaparin will continue to fluctuate in the future as a result of changing levels of competition.
Sales of API primarily depend on the timing of customer purchases. We anticipate that sales of API will continue to fluctuate and may decrease due to the inherent uncertainties related to sales to MannKind Corporation pursuant to our supply agreement with them. In addition, most of our API sales are denominated in euros, and the fluctuation in the
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value of euros versus the U.S. dollar has had, and will continue to have, an impact on API sales revenues in the near term.
A significant portion of our customer shipments in any period relate to orders received and shipped in the same period, generally resulting in low product backlog relative to total shipments at any time. We had no significant backlog as of December 31, 2020. Historically, our backlog has not been a meaningful indicator in any given period of our ability to achieve any particular level of overall revenue or financial performance.
Gross Margins
Gross margins remained approximately the same compared to the prior period. We saw an increase in sales of Primatene Mist® and launched epinephrine injection multiple dose vial, which are both higher-margin products. These increases in gross margins were offset by charges included in cost of revenue to adjust our inventory and related purchase commitments to their net realizable value. Additionally, the gross margin in 2019 benefited from a one-time $2.8 million amendment fee paid by MannKind, which temporarily increased gross margin as a percentage of revenue in 2019.
The cost of heparin, which is the starting material for enoxaparin, has increased and is expected to increase further, putting downward pressure on our gross margins. However, we believe that this trend will be offset by sales of our higher-margin products, such as Primatene Mist®, and epinephrine multi dose vials, which were launched over the past few years and by glucagon which was launched in 2021. Additionally, we have not seen significant supply disruption due to the COVID-19 pandemic at this time, but we are carefully monitoring for any potential problems.
Selling, distribution, and marketing, and general and administrative
Year Ended December 31, Change
(in thousands)
The increase in selling, distribution, and marketing expenses was primarily due to marketing and distribution expenses related to Primatene Mist®, including the cost of a national digital, television and radio marketing campaign which began in July 2019. The increase in general and administrative expense was primarily due to an expense of $4.9 million relating to cash compensation and share-based compensation expense in connection with a separation agreement with a former executive during the second quarter of 2020. This was partially offset by a decrease in legal expenses as a result of the enoxaparin patent and antitrust litigation settlement reached in the second quarter of 2019.
We expect that selling, distribution and marketing expenses will increase due to the increase in marketing expenditures for Primatene Mist®. We expect that general and administrative expenses will increase on an annual basis due to increased costs associated with ongoing compliance with public company reporting obligations. Legal fees may fluctuate due to the timing of patent challenges and other litigation matters.
Research and development
Year Ended December 31, Change
(in thousands)
Salaries and personnel-related expenses $ 27,156 $ 27,503 $ (347) (1) %
Clinical trial expense decreased due to the completion of one of our external studies in 2020 and the delay in other studies caused by COVID-19. The decrease in testing, operating and lab supplies was primarily due to a decrease in expenses at our ANP facility.
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Research and development costs consist primarily of costs associated with the research and development of our product candidates including the cost of developing APIs. We expense research and development costs as incurred.
We have made, and expect to continue to make, substantial investments in research and development to expand our product portfolio and grow our business. We expect that research and development expenses will increase on an annual basis due to increased clinical trial costs related to our biosimilar and inhalation product candidates. These expenditures will include costs of APIs developed internally as well as APIs purchased externally, the cost of purchasing reference listed drugs and the costs of performing the clinical trials. As we undertake new and challenging research and development projects, we anticipate that the associated costs will increase significantly over the next several quarters and years. Some of our ongoing clinical trials have experienced short term interruptions in the recruitment of patients due to the COVID-19 pandemic, as hospitals prioritize their resources towards the COVID-19 pandemic and governments impose travel restrictions. These conditions may in turn delay spending and delay the results of these trials.
Other income (expense), net
Year Ended December 31, Change
(in thousands)
In June 2019, we recognized a gain of $59.9 million relating to our settlement of the enoxaparin patent and antitrust litigation with Momenta Pharmaceuticals, Inc. and Sandoz Inc. In December 2020, we recorded $12.8 million of expense in connection with the Aventis litigation. For more information regarding our litigations matters, see Note 20 to the consolidated financial statements. This was partially offset by $5.1 million relating to foreign currency gains in 2020.
Income tax provision
Year Ended December 31, Change
(in thousands)
Effective tax rate 76 % 23 %
Our tax rate is affected by recurring items, such as tax rates in non-U.S. jurisdiction as compared to notional U.S. federal statutory tax rate, and the relative amount of income or loss in those various jurisdictions. It is also impacted by certain items that may occur in any given period, but are not consistent from period to period.
For additional information on our income taxes, including information about the impact of the CARES Act, refer to Note 15 to the consolidated financial statements.
Liquidity and Capital Resources
Cash Requirements and Sources
We need capital resources to maintain and expand our business. We expect our cash requirements to increase significantly in the foreseeable future as we sponsor clinical trials for, seek regulatory approvals of, and develop, manufacture and market our current development-stage product candidates and pursue strategic acquisitions of businesses or assets. Our future capital expenditures include projects to upgrade, expand, and improve our manufacturing facilities in the United States, China, and France. Our cash obligations include the principal and interest payments due on our existing loans and lease payments, as described below and throughout this Annual Report on Form 10-K.
As of December 31, 2020, our foreign subsidiaries collectively held $20.1 million in cash and cash equivalents. Cash or cash equivalents held at foreign subsidiaries are not available to fund the parent company’s operations in the United States. We believe that our cash reserves, operating cash flows, and borrowing availability under our credit facilities will be sufficient to fund our operations for at least the next 12 months. We expect additional cash flows to be generated in the longer term from future product introductions, although there can be no assurance as to the receipt of regulatory
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approval for any product candidates that we are developing or the timing of any product introductions, which could be lengthy or ultimately unsuccessful.
We maintain a shelf registration statement on Form S-3 pursuant to which we may, from time to time, sell up to an aggregate of $250 million of our common stock, preferred stock, depositary shares, warrants, units, or debt securities. If we require or elect to seek additional capital through debt or equity financing in the future, we may not be able to raise capital on terms acceptable to us or at all. To the extent we raise additional capital through the sale of equity or convertible debt securities, the issuance of such securities will result in dilution to our stockholders. If we are required and unable to raise additional capital when desired, our business, operating results and financial condition may be adversely affected.
Working capital increased $2.3 million to $167.5 million at December 31, 2020, compared to $165.2 million at December 31, 2019.
Cash Flows from Operations
The following table summarizes our cash flows from operating, investing, and financing activities for the years ended December 31, 2020 and 2019.
Year Ended December 31,
(in thousands)
Statement of Cash Flow Data:
Net cash provided by (used in)
Financing activities (2,246) (3,783)
Effect of exchange rate changes on cash 352 (104)
Sources and Use of Cash
Operating Activities
Net cash provided by operating activities was $57.3 million for the year ended December 31, 2020, which included net income of $1.1 million. Non-cash items comprised primarily of $21.5 million of depreciation and amortization, and $20.5 million of share-based compensation expense.
Additionally, for the year ended December 31, 2020, there was a net cash inflow from changes in operating assets and liabilities of $9.1 million, which resulted from an increase in accounts payable and accrued liabilities and a decrease in inventory, which was partially offset by an increase in accounts receivable. Accounts payable and accrued liabilities increased primarily due to the timing of payments. The decrease in inventory was a result of strong sales throughout the year and a decrease in purchases of raw materials of enoxaparin. The increase in accounts receivable was due to the timing of sales.
Net cash provided by operating activities was $41.8 million for the year ended December 31, 2019, which included net income of $46.5 million, primarily as a result of the receipt of the $59.9 million relating to the litigation settlement with Momenta Pharmaceuticals, Inc. and Sandoz Inc. Non-cash items were primarily comprised of $18.1 million of depreciation and amortization, and $17.3 million of share-based compensation expense.
Additionally, there was a net cash outflow from changes in operating assets and liabilities of $51.7 million which resulted from the decrease in accounts receivable, offset by an increase in inventory, as well as a decrease in accounts payable and accrued liabilities. The decrease in accounts receivable was due to the timing of sales. The increase in inventory was primarily due to increased purchases of raw materials and the production of finished goods for enoxaparin and Primatene Mist® with an impact of $29.2 million and $9.3 million, respectively. We utilized deferred tax credits to offset a significant portion of the tax liability related to our 2019 U.S. federal and California state taxable income,
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resulting in only $4.6 million tax payments. Accounts payable and accrued liabilities decreased primarily due to the timing of payments.
Investing Activities
Net cash used in investing activities was $36.4 million for the year ended December 31, 2020, primarily as a result of $33.9 million in purchases of property, plant, and equipment, which included $11.5 million incurred in the United States, $2.9 million in France, and $19.5 million in China. Additionally, we purchased $1.1 million in short-term investments in 2020.
Net cash used in investing activities was $50.5 million for the year ended December 31, 2019, primarily as a result of $41.6 million in purchases of property, plant, and equipment, which included $11.3 million incurred in the United States, $6.8 million in France, and $23.5 million in China. Additionally, we purchased $8.8 million in short-term investments in 2019.
Financing Activities
Net cash used in financing activities was $2.2 million for the year ended December 31, 2020, primarily as a result of $24.4 million used to purchase treasury stock offset by $23.2 million in net proceeds from the settlement of share-based compensation awards under our equity plans. Additionally, we also made $8.4 million in principal payments on our long-term debt and received $7.5 million from borrowings on our lines of credit, of which $3.1 million was converted into an equipment loan during the year.
Net cash used in financing activities was $3.8 million for the year ended December 31, 2019, primarily as a result of $22.3 million used to purchase treasury stock, which was partially offset by the receipt of $18.3 million for the ANP private placement, and $3.4 million in net proceeds received from our equity plans. Additionally, we received $3.6 million from borrowings on an equipment line of credit, and made $6.8 million in principal payments on our long-term debt and lines of credit.
Debt and Borrowing Capacity
Our outstanding debt obligations are summarized as follows:
December 31,
(in thousands)
As of December 31, 2020, we had $56.0 million in unused borrowing capacity under revolving lines of credit and equipment lines of credit with Cathay Bank, East West Bank, and China Merchant Bank.
Lines of credit bear variable interest rates and are secured by inventory, accounts receivable, intangible assets, and equipment. The weighted average interest rates on lines of credit as of December 31, 2020 and 2019 were 3.8% and 4.0%, respectively. We have also entered into or refinanced certain mortgage and equipment loans with Cathay Bank and East West Bank, which bear variable or fixed interest rates and are secured by buildings and equipment. On certain loans with East West Bank, we have entered into fixed interest rate swap contracts to exchange the variable interests for fixed interest rates without the exchange of underlying notional debt amounts.
For more information regarding our outstanding indebtedness, see “Part II – Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Debt.”
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Operating Lease Obligations
As discussed in Note 18 to the consolidated financial statements, as of December 31, 2020 we had a total of $26.2 million of minimum rental payments under operating leases. Of that amount, $4.4 million is due within 12 months as of December 31, 2020.
Purchase obligations
We have certain purchase obligations under which we are required to make minimum payments for items including, but not limited to, inventory and pharmaceutical manufacturing and laboratory equipment. As of December 31, 2020, we had an aggregate amount of approximately $48.8 million. We anticipate that most of these commitments with a remaining term in excess of one year will be fulfilled by 2022.
Critical Accounting Policies
We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States, or GAAP. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates. To the extent that there are material differences between these estimates and actual results, our financial condition and results of operations will be affected. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies, which we discuss further below. While our significant accounting policies are more fully described in Note 2 to our audited consolidated financial statements, we believe that the following accounting policies are critical to the process of making significant judgments and estimates in the preparation of our audited consolidated financial statements.
Revenue Recognition
In 2018, we adopted ASC 606, Revenue from Contracts with Customers, or ASC 606, using the modified retrospective transition method. The adoption of ASC 606 did not have a material impact on our revenues recognition or on the consolidated financial statements and related disclosures. According to ASC 606, revenue is recognized at the time that our customers obtain control of the promised goods. Revenues derived from contract manufacturing services are recognized when third-party products are shipped to customers, after customers have accepted test samples of the products to be shipped. The results for the reporting period beginning after January 1, 2018, are presented in accordance with the new standard, although comparative information continues to be reported under the accounting standards and policies in effect for those periods.
Our net revenues consist principally of revenues generated from the sale of our pharmaceutical products. We also generate a small amount of revenues from contract manufacturing services. Generally, we recognize revenues at the time of product delivery to our customers. In some cases, revenues are recognized at the time of shipment when stipulated by the terms of the sale agreements. Revenues derived from contract manufacturing services are recognized when third-party products are shipped to customers, after the customer has accepted test samples of the products to be shipped.
The consideration we receive in exchange for our goods or services is only recognized when it is probable that a significant reversal will not occur. The consideration to which we expect to be entitled includes a stated list price, less various forms of variable consideration. We make significant estimates for related variable consideration at the point of sale, including chargebacks, rebates, product returns, other discounts and allowances.
Provision for estimated chargebacks, rebates, discounts, product returns and credit losses is made at the time of sale and is analyzed and adjusted, if necessary, at each balance sheet date.
If actual future payments for the discounts, returns, fees, rebates and chargebacks exceed the estimates we made at the time of sale, our financial position, results of operations and cash flows would be negatively impacted. As discussed under “Accrual for Product Returns” below, we are generally obligated to accept from our customers the return of pharmaceuticals that have reached or will soon reach their expiration dates. We establish reserves for such amounts
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based on historical experience and other information available at the time of sale, but the actual returns will not occur until several years after the sale. Although we believe that our estimates and assumptions are reasonable as of the date when made, actual results may differ significantly from these estimates. Our financial position, results of operations and cash flows may be materially and negatively impacted if actual returns exceed our estimated allowances for returns.
We establish allowances for estimated chargebacks, rebates and product returns based on a number of qualitative and quantitative factors, including:
● contract pricing and return terms of our agreements with customers;
● wholesaler inventory levels and turnover;
● historical chargeback and product return rates;
● direct communication with customers;
● anticipated introduction of competitive products or authorized generics; and
● anticipated pricing strategy changes by us and/or our competitors.
Provision for Chargebacks and Rebates
The provision for chargebacks and rebates is a significant estimate used in the recognition of revenue. Wholesaler chargebacks relate to sales terms under which we agree to reimburse wholesalers for differences between the gross sales prices at which we sell our products to wholesalers and the actual prices of such products that wholesalers resell them under our various contractual arrangements with third parties such as hospitals and group purchasing organizations in the United States. Rebates include primarily amounts paid to retailers, payers, and providers in the United States, including those paid to state Medicaid programs, and are based on contractual arrangements or statutory requirements. We estimate chargebacks and rebates using the expected value method at the time of sale to wholesalers based on wholesaler inventory stocking levels, historic chargeback and rebate rates, and current contract pricing.
The provision for chargebacks and rebates is reflected as a component of net revenues. The following table is an analysis of the chargeback and rebate provision:
Year Ended
December 31,
(in thousands)
Credits and payments issued to third parties (159,416) (132,303)
Changes in the chargeback provision from period to period are primarily dependent on our sales to wholesalers, the level of inventory held by wholesalers, and the wholesalers’ customer mix. Changes in the rebate provision from period to period are primarily dependent on retailer’s and other indirect customers’ purchases. The approach that we use to estimate chargebacks and rebates has been consistently applied for all periods presented. Variations in estimates have been historically small. We continually monitor the provision for chargebacks and rebates and make adjustments when we believe that the actual chargebacks and rebates may differ from the estimates. The settlement of chargebacks and rebates generally occurs within 30 days to 60 days after the sale to wholesalers. Accounts receivable and/or accounts payable and accrued liabilities are reduced and/or increased by the chargebacks and rebate amounts depending on whether we have the right to offset with the customer. Of the provision for chargebacks and rebates as of December 31, 2020 and 2019, $16.4 million and $15.4 million were included in accounts receivable, net, on the consolidated balance sheets, respectively. The remaining provision as of December 31, 2020 and 2019, was $4.0 million and $6.2 million,
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which were included in accounts payable and accrued liabilities, respectively.
Accrual for Product Returns
We offer most customers the right to return qualified excess or expired inventory for partial credit; however, API product sales are generally non-returnable. Our product returns primarily consist of the returns of expired products from sales made in prior periods. Returned products cannot be resold. At the time product revenue is recognized, we record an accrual for product returns estimated using the expected value method. The accrual is based, in part, upon the historical relationship of product returns to sales and customer contract terms. We also assess other factors that could affect product returns including market conditions, product obsolescence and the introduction of new competition. Although these factors do not normally give our customers the right to return products outside of the regular return policy, we realize that such factors could ultimately lead to increased returns. We analyze these situations on a case-by-case basis and make adjustments to the product return reserve as appropriate.
The provision for product returns is reflected as a component of net revenues. The following table is an analysis of the product return liability:
Year Ended
December 31,
(in thousands)
Provision for product returns 11,810 7,305
Credits issued to third parties (7,945) (4,996)
Of the provision for product returns as of December 31, 2020 and 2019, $10.2 million and $7.1 million were included in accounts payable and accrued liabilities on the consolidated balance sheets, respectively. The remaining provision as of December 31, 2020 and 2019, of $4.0 million and $3.2 million were included in other long-term liabilities, respectively. For the years ended December 31, 2020 and 2019, our aggregate product return rate was 1.4% and 1.1% of qualified sales, respectively.
Inventory
Inventories consist of currently marketed products and products manufactured under contract. Inventories are stated using the first-in, first-out method, on a consistent basis. Inventory is stated at the lower of cost and net realizable value. We adjust inventories to their net realizable value: (i) if a launch of a new product is delayed and inventory may not be fully utilized and could be subject to impairment, (ii) when a product is close to expiration and not expected to be sold, (iii) when a product has reached its expiration date, (iv) when a product is not expected to be sellable, and (v) when the estimated net realizable value is below cost. In determining the estimated net realizable value of an inventory item, we consider factors such as the forecasted average net selling price, the amount of inventory on hand, its remaining shelf life, its regulatory approval status, and current and expected market conditions, including management forecasts and levels of competition.
The largest adjustment to the net realizable value of our inventory has historically been related to enoxaparin. The adjustment of enoxaparin inventory to its net realizable value has been driven primarily by increases in the prices of heparin, the starting material for the production of the API in our enoxaparin product. Other cost increases relate to labor and overhead also impacted the cost of producing enoxaparin. Additionally, fluctuations in the forecasted average net selling price impact this estimate. The average net selling price has fluctuated due to competitor entries and exits from the market.
Impairment of Intangible and Long-Lived Assets
We review long-lived assets and definite-lived identifiable intangible assets or asset groups for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Such events and circumstances include decisions by the FDA regarding evidence of effectiveness of proprietary drug candidates or bioequivalence (sameness) of our generic product candidates as compared to the reference drug, communication with the
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regulatory agencies regarding the safety and efficacy of our products under review, the use of the asset in current research and development projects, any potential alternative uses of the asset in other research and development projects in the short-to-medium term, clinical trial results and research and development portfolio management options. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset or asset groups and its eventual disposition. If the sum of the expected future undiscounted cash flows is less than the carrying amount of the asset or asset groups, further impairment analysis is performed. An impairment loss is measured as the amount by which the carrying amount exceeds the fair value of the asset or asset groups (assets to be held and used) or fair value less cost to sell (assets to be disposed of). All of our impairments relate primarily to the isolated write-off of certain manufacturing equipment related to abandoned projects. Since we periodically assess our product candidates and make changes to product development plans, we incur impairment charges from time to time which can fluctuate significantly from period to period.
The indefinite-lived intangible asset, the Primatene® trademark acquired in June 2008, and goodwill are tested for impairment annually, in the fourth quarter, or more frequently if indicators of impairment are present. An impairment loss is recorded if the asset’s fair value is less than its carrying value. We also periodically review the Primatene® trademark to determine if events and circumstances continue to support an indefinite useful life. When we choose to perform a qualitative assessment, we evaluate economic, industry and company-specific factors as an initial step. If we determine it is more likely than not that the Primatene® trademark is impaired or the fair value of a reporting unit is less than its carrying amount, further quantitative impairment process is then performed; otherwise, no further testing is required. If the life is no longer indefinite, the asset is tested for impairment, and the carrying value, after recognition of any impairment loss, is amortized over its remaining useful life. No impairment of indefinite-lived intangible asset and goodwill was recorded during the years ended December 31, 2020, 2019, or 2018, respectively.
Deferred Income Taxes
We utilize the liability method of accounting for income taxes under which deferred taxes are determined based on the temporary differences between the financial statements and the tax basis of assets and liabilities using enacted tax rates. A valuation allowance is recorded when it is more likely than not that the deferred tax assets will not be realized.
A number of years may elapse before an uncertain tax position for which we have established a tax reserve is audited and finally resolved. The number of years for which we can be subject to audit varies depending on the tax jurisdiction. While it is often difficult to predict the final outcome or the timing of the resolution of an audit, we believe that our reserves for uncertain tax benefits reflect the outcome of tax positions that is more likely than not to occur. The resolution of a matter could be recognized as an adjustment to our provision for income taxes and our effective tax rate in the period of resolution, and may also require a use of cash.
Share-Based Compensation
Options issued under our 2015 Equity Incentive Award Plan, or the 2015 Plan, and our Amended and Restated 2005 Equity Incentive Award Plan, or 2005 Plan, are granted at exercise prices equal to or greater than the fair value of the underlying common shares on the date of grant and vest based on continuous service. There have been no awards with performance conditions and no awards with market conditions. The options have a contractual term of five to ten years and generally vest over a three- to five-year period.
For awards issued prior to the listing of our common stock on The Nasdaq Global Select Market, or Nasdaq, the fair value of the common stock utilized in the fair value estimation of award arrangements has been determined by our board of directors, utilizing contemporaneous third-party valuations. Following the listing of our common stock on Nasdaq, we use the closing stock price as reported on Nasdaq on the grant date for the fair value of its stock.
We use the Black-Scholes option pricing model to determine the fair value of options awards. The Black-Scholes option pricing model has various inputs such as the common share price on the date of grant, exercise price, the risk-free interest rate, volatility, expected life and dividend yield, all of which are estimates. We used the risk free rate on U.S. Treasury securities at the time of grant for instruments with maturities commensurate with the expected term of the stock option. Starting in 2020, our volatility estimate was based on the weighted average historical volatility of our stock price since IPO. Prior to 2020, our volatility estimate was based on the weighted average historical volatility of our stock price and the stock price from a set of peer companies, since our shares did not have sufficient trading history. We consider factors such as stage of life cycle, competitors, size, market capitalization and financial leverage in the selection of
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similar entities. Our dividend yield was assumed to be 0%, because we have no plans to pay dividends. We estimate the expected term of options with consideration of vesting date, contractual term, and historical experience for employee exercise and post-vesting employment termination behavior after our common stock has been publicly traded. The expected term of “plain vanilla” options is estimated based on the midpoint between the vesting date and the end of the contractual term under the simplified method.
The fair value of each share-based compensation award is amortized into compensation expense on a straight-line basis between the grant date for the option and the vesting date net of expected forfeitures. We estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual numbers differ from such estimates. The change of any of these inputs could significantly impact the determination of the fair value of our options as well as significantly impact our results of operations.
Recent Accounting Pronouncements
In December 2019, the Financial Accounting Standards Board, or FASB, issued Accounting Standard Update, or ASU, No. 2019-12 Simplifying the Accounting for Income Taxes (Topic 740), which simplifies various aspects related to accounting for income taxes. The amendment also improves consistent application of and simplify GAAP for other areas of Topic 740 by clarifying and amending existing guidance. The guidance is effective for our interim and annual reporting periods during the year ended December 31, 2021, with early adoption permitted. We are currently evaluating the impact that the adoption of this guidance will have on our consolidated financial statements and related disclosures.
Non-GAAP Financial Measures
We report our financial results in accordance with accounting principles generally accepted in the United States, or GAAP.
Off-Balance Sheet Arrangements
We do not have any relationships or financial partnerships with unconsolidated entities, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts.
Investment in China
In accordance with certain agreements between ANP and the Chinese government, in January 2010 and November 2012, we acquired certain land-use rights for $1.2 million and $1.3 million, respectively. As required by these agreements, we were committed to spend approximately $15.0 million in the related land development, which primarily included the construction of fixed assets according to a specific timetable. As of December 31, 2020, we have spent $19.5 million on such construction, fulfilling our commitment.
Government Regulation
Our products and facilities are subject to regulation by a number of federal and state governmental agencies. The FDA in particular, maintains oversight of the formulation, manufacture, distribution, packaging, and labeling of all of our products. The Drug Enforcement Administration, or DEA, maintains oversight over our products that are considered controlled substances.
In December 2020, our IMS facility in South El Monte, California was subject to an inspection by the DEA. The inspection was routine as part of the DEA surveillance program. Due to COVID-19 restrictions, much of the inspection is being performed off-site, by DEA inspectors (i.e. a “paper inspection”). The DEA has completed the inspection, including a thorough review of the requested documents and have found the facility to be in compliance.
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Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
The following discussion provides forward-looking quantitative and qualitative information about our potential exposure to market risk. Market risk represents the potential loss arising from adverse changes in the value of financial instruments. The risk of loss is assessed based on the likelihood of adverse changes in fair values, cash flows or future earnings. We are exposed to market risk for changes in the market values of our investments (Investment Risk), the impact of interest rate changes (Interest Rate Risk), and the impact of foreign currency exchange changes (Foreign Currency Exchange Risk).
Investment Risk
We regularly review the carrying value of our investments and identify and recognize losses, for income statement purposes, when events and circumstances indicate that any declines in the fair values of such investments below our accounting basis are other than temporary. As of December 31, 2020, none of our investments experienced any declines in fair value that are other than temporary. We do not enter into investments for trading or speculative purposes.
As of December 31, 2020, we had $15.0 million deposited in seven banks located in China, $4.7 million deposited in one bank located in France, and $0.4 million deposited in one bank located in the United Kingdom. We also maintained $58.7 million in cash equivalents that include money market accounts as of December 31, 2020. Additionally, we maintain approximately $3.9 million in investment grade corporate bonds as of December 31, 2020. The remaining amounts of our cash equivalent as of December 31, 2020, are in non-interest bearing accounts.
As of December 31, 2019, we had $27.6 million deposited in seven banks located in China, $3.0 million deposited in one bank located in France, and $0.8 million deposited in one bank located in the United Kingdom. We also maintained $44.2 million in cash equivalents that include money market accounts as of December 31, 2019. Additionally, we maintain approximately $2.8 million in investment grade corporate bonds as of December 31, 2019. The remaining amounts of our cash equivalent as of December 31, 2019, are in non-interest bearing accounts.
Interest Rate Risk
Our primary exposure to market risk is interest-rate-sensitive investments and credit facilities, which are affected by changes in the general level of U.S. interest rates. Due to the nature of our short-term investments, we believe that we are not subject to any material interest rate risk with respect to our short-term investments.
As of December 31, 2020, we had $46.4 million in long-term debt and finance leases outstanding. Of this amount, $13.2 million had variable interest rates which were not locked-in through fixed interest rate swap contracts. The debt with variable interest rate exposure had a weighted-average interest rate of 4.4% at December 31, 2020. An increase in the index underlying these rates of 1% (100 basis points) would increase our annual interest expense on the debt with variable interest rate exposure by approximately $0.1 million per year.
As of December 31, 2019, we had $47.1 million in long-term debt and finance leases outstanding. Of this amount, $14.5 million had variable interest rates which were not locked-in through fixed interest rate swap contracts. The debt with variable interest rate exposure had a weighted-average interest rate of 4.7% at December 31, 2019.
Foreign Currency Exchange Risk
Our finished pharmaceutical products are primarily sold in the U.S. domestic market, and have little exposure to foreign currency price fluctuations. Our API manufacturing business in France is exposed to market risk related to changes in foreign currency exchange rates, because our insulin sales contracts are frequently denominated in euros, which are subject to fluctuations relative to the USD.
Our Chinese subsidiary, ANP, maintains its books of record in Chinese yuan. These books are remeasured into the functional currency of USD, using the current or historical exchange rates. The resulting currency remeasurement adjustments and other transactional foreign exchange gains and losses are reflected in our statement of operations.
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Our French subsidiary, AFP, maintains its books of record in euros. ANP’s Chinese subsidiaries maintain their book of record in Chinese yuan. AUK’s subsidiary, IMS UK, maintains its books of record in British pounds. These books of records are translated into USD using average exchange rates during the period. Assets and liabilities are translated at the rate of exchange prevailing on the balance sheet date. Equity is translated at the prevailing exchange rate at the date of the equity transactions. Translation adjustments are reflected in stockholders’ equity and are included as a component of other comprehensive income (loss).
We are also exposed to the potential earnings effects from intercompany foreign currency assets and liabilities that arise from normal trade receivables and payables and other intercompany loans.
As of December 31, 2020, a 10% unfavorable change in the exchange rate of the U.S. dollar strengthening against the foreign currencies to which we have exposure would result in approximately $4.8 million reduction of foreign currency gains, and approximately $5.6 million reduction in other comprehensive income.
As of December 31, 2020 and 2019, our foreign subsidiaries had cash balances denominated in foreign currencies in the amount of $10.1 million and $5.2 million, respectively.
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Item 8. Financial Statements and Supplementary Data.
Index to Amphastar Pharmaceuticals, Inc. Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm 95
Consolidated Balance Sheets 98
Consolidated Statements of Operations 99
Consolidated Statements of Comprehensive Income (Loss) 100
Consolidated Statements of Stockholders’ Equity 101
Consolidated Statements of Cash Flows 102
Notes to Consolidated Financial Statements 103
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Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors of Amphastar Pharmaceuticals, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Amphastar Pharmaceuticals, Inc. (the Company) as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive income (loss), stockholders' equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated March 15, 2021 expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidatedfinancial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
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Provision for chargebacks estimate
Inventory lower of cost or net realizable value estimate
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/s/ Ernst & Young LLP
We have served as the Company’s auditor since 1998.
Irvine, California
March 15, 2021
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AMPHASTAR PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
December 31, December 31,
ASSETS
Current assets:
Restricted short-term investments 2,200 2,290
Income tax refunds and deposits 385 311
Prepaid expenses and other assets 6,777 9,538
Finance lease right-of-use assets 612 887
Operating lease right-of-use assets 20,042 18,805
Goodwill and intangible assets, net 40,615 41,153
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued liabilities $ 95,504 $ 77,051
Current portion of long-term debt 12,263 7,741
Current portion of operating lease liabilities 3,357 3,175
Long-term reserve for income tax liabilities 4,709 3,425
Long-term debt, net of current portion 34,186 39,394
Deferred tax liabilities 741 867
Other long-term liabilities 13,212 9,433
Commitments and contingencies
Stockholders’ equity:
Accumulated other comprehensive loss (3,721) (4,687)
Total Amphastar Pharmaceuticals, Inc. stockholders’ equity 402,306 381,366
Total liabilities and stockholders’ equity $ 631,236 $ 586,971
See accompanying notes to consolidated financial statements.
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AMPHASTAR PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share data)
Year Ended December 31,
Operating expenses:
Income (loss) from operations 10,954 (39) (8,623)
Non-operating (expenses) income:
Total non-operating (expenses) income, net (6,317) 60,267 (1,303)
See accompanying notes to consolidated financial statements.
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AMPHASTAR PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
Year Ended December 31,
Foreign currency translation adjustment 1,121 (576) (1,957)
Change in pension obligations (155) (98) 44
See accompanying notes to consolidated financial statements.
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Amphastar Pharmaceuticals, Inc.
Consolidated Statements of Stockholders’ Equity
(in thousands, except share data)
Common Stock Accumulated Treasury Stock Total
Additional Other Amphastar Non-
See accompanying notes to consolidated financial statements.
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AMPHASTAR PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
Year Ended December 31,
Cash Flows From Operating Activities:
Loss on impairment and disposal of assets 240 1,036 1,429
Operating lease right-of-use asset amortization 3,653 3,011 —
Changes in reserve for uncertain tax positions 1,285 3,010 (464)
Changes in deferred taxes, net (162) 4,542 (1,414)
Changes in operating assets and liabilities:
Prepaid expenses and other assets (2,049) (3,604) 1,375
Income tax refunds, deposits, and payable, net (972) 591 3,849
Operating lease liabilities (3,597) (2,613) —
Accounts payable and accrued liabilities 20,609 (11,720) 29,159
Cash Flows From Investing Activities:
Proceeds from the sale of property, plant and equipment — — 245
Sale of intangible assets — — 4,400
Purchase of short-term investments (13,557) (8,815) (308)
Maturity of short-term investments 12,411 — 91
Payment of deposits and other assets (1,414) (157) 198
Cash Flows From Financing Activities:
Proceeds from the private placement of ANP — 18,298 38,036
Acquisition of additional ownership interest in ANP (106) — —
Proceeds from borrowing under lines of credit 1,238 — 347
Repayments under lines of credit — (347) —
Proceeds from issuance of long-term debt 6,283 3,570 8,431
Principal payments on long-term debt (8,401) (6,434) (5,705)
Effect of exchange rate changes on cash 352 (104) (274)
Noncash Investing and Financing Activities:
Operating lease right-of-use assets $ 4,819 $ 7,978 $ —
Equipment acquired under finance leases $ 61 $ 143 $ 14
Supplemental Disclosures of Cash Flow Information:
Interest paid, net of capitalized interest $ 2,199 $ 2,435 $ 2,376
See accompanying notes to consolidated financial statements
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AMPHASTAR PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Business
Amphastar Pharmaceuticals, Inc., a Delaware corporation (together with its subsidiaries, hereinafter referred to as the “Company”) is a bio-pharmaceutical company that develops, manufactures, markets, and sells generic and proprietary injectable, inhalation, and intranasal products, including products with high technical barriers to market entry. Additionally, the Company sells insulin active pharmaceutical ingredient, or API, products. Most of the Company’s products are used in hospital or urgent care clinical settings and are primarily contracted and distributed through group purchasing organizations and drug wholesalers. The Company’s insulin API products are sold to other pharmaceutical companies for use in their own products and are being used by the Company in the development of injectable finished pharmaceutical products. The Company’s inhalation product, Primatene Mist® is primarily distributed through drug retailers.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries, and are prepared in accordance with United States generally accepted accounting principles, or GAAP. All intercompany activity has been eliminated in the preparation of the consolidated financial statements. In the opinion of management, the accompanying consolidated financial statements include all adjustments necessary to present fairly the consolidated financial position, results of operations, and cash flows of the Company.
The Company’s subsidiaries include: (1) International Medication Systems, Limited, or IMS, (2) Armstrong Pharmaceuticals, Inc., or Armstrong, (3) Amphastar Nanjing Pharmaceuticals Inc., or ANP, (4) Nanjing Letop Biological Technology Co., Ltd., or Letop, (5) Nanjing Hanxin Pharmaceutical Technology Co., Ltd., or Hanxin, (6) Nanjing Hanxin Biomedical Testing Service Co., Ltd., or Hanxin Biomedical, (7) Nanjing Baixin Trading Co., Ltd., or Baixin, (8) Amphastar France Pharmaceuticals, S.A.S., or AFP, (9) Amphastar UK Ltd., or AUK, and (10) International Medication Systems (UK) Limited, or IMS UK.
In July 2018, the Company’s Chinese subsidiary, ANP, completed a private placement of its common equity interest to accredited investors and received approximately $56.3 million of cash proceeds, a portion of which was received in 2019. The Company has retained approximately 58% of the equity interest in ANP following the private placement and continues to consolidate the financial results of ANP with the Company’s results of operations. ANP’s net income after July 2, 2018, was attributed to the Company in accordance with the Company’s equity interest of approximately 58% in ANP.
COVID-19 Pandemic
The Company is subject to risks and uncertainties as a result of the novel coronavirus pandemic, or COVID-19. The complete extent of the impact of the COVID-19 pandemic on the Company’s business is highly uncertain and difficult to predict, as the information is constantly evolving. The Company considered the impact of COVID-19 on the assumptions and estimates used to determine the results reported and asset valuations as of December 31, 2020.
In March 2020, the World Health Organization declared the outbreak of a novel coronavirus, or COVID-19, as a pandemic, which continues to spread throughout the world, including locations where the Company operates, such as the United States, China and France. The Company has been actively monitoring the COVID-19 pandemic and its impact globally. In late January 2020, China implemented extensive curfews and travel restrictions to control the outbreak, and started easing these restrictions in March. Our business operations in China experienced a temporary disruption but resumed full operation in February 2020. In March 2020, France also implemented a stay-at-home order limiting movement and restricting travel, however, the Company was deemed to be an essential business and was not significantly impacted by the restrictions. In March 2020, the Governors of the States of California and Massachusetts declared a health emergency and issued orders to close all nonessential business; as a bio-pharmaceutical company, the
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AMPHASTAR PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Company was deemed to be an essential businesses. Subsequently, some but not all of the restrictions were lifted in China, France, and states where the Company operates, and most businesses were allowed to reopen. All of the Company’s production facilities continued to operate during the remainder of the year as they had prior to the COVID-19 pandemic with very little change, other than for enhanced safety measures intended to prevent the spread of the virus.
It is not possible at this time to estimate the complete impact that COVID-19 could have on the Company’s business, including its customers and suppliers, as the impact will depend on future developments, which are highly uncertain and cannot be predicted. Infections may resurge or become more widespread and the limitation on the Company’s ability to travel and timely sell and distribute its products, as well as any closures or supply disruptions, may be extended for longer periods of time, all of which would have a negative impact on the Company’s business, financial condition and operating results. The Company will continue to monitor the impact of COVID-19 on all aspects of its business.
Use of Estimates
The preparation of consolidated financial statements in accordance with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. The principal accounting estimates include: determination of allowances for credit losses, allowance for discounts, provision for chargebacks and rebates, provision for product returns, adjustment of inventory to their net realizable values, impairment of long-lived and intangible assets and goodwill, workers’ compensation liabilities, litigation reserves, stock price volatilities for share-based compensation expense, valuation allowances for deferred tax assets, and liabilities for uncertain income tax positions.
Foreign Currency
The functional currency of the Company, its domestic subsidiaries, its Chinese subsidiary ANP, and its U.K. subsidiary, AUK, is the USD. ANP maintains its books of record in Chinese yuan. These books are remeasured into the functional currency of USD using the current or historical exchange rates. The resulting currency remeasurement adjustments and other transactional foreign currency exchange gains and losses are reflected in the Company’s consolidated statements of operations.
The Company’s French subsidiary, AFP, maintains its book of record in euros. ANP’s other Chinese subsidiaries, maintain their books of record in Chinese yuan. AUK’s subsidiary, IMS UK, maintains its book of record in British pounds. These local currencies have been determined to be the subsidiaries’ respective functional currencies. These books of record are translated into USD using average exchange rates during the period. Assets and liabilities are translated at the rate of exchange prevailing on the balance sheet date. Equity is translated at the prevailing rate of exchange at the date of the equity transactions. Translation adjustments are reflected in stockholders’ equity and are included as a component of other accumulated comprehensive income (loss). The unrealized gains or losses of intercompany foreign currency transactions that are of a long-term investment nature are reported in other accumulated comprehensive income (loss). The unrealized gains and losses of intercompany foreign currency transactions that are of a long-term investment nature for the years ended December 31, 2020, 2019, and 2018 were a $3.0 million gain, a $0.7 million loss, and a $1.5 million loss, respectively.
Comprehensive Income (Loss)
For the years ended December 31, 2020, 2019 and 2018, the Company included its foreign currency translation gain (loss) and change in pension obligation of its defined benefit pension plan as part of its comprehensive income (loss). Income tax expense of $0.9 million was allocated to other comprehensive income for the year ended December 31, 2020. There was no material income tax provision (benefit) allocated to other comprehensive loss for the years ended December 31, 2019 and 2018.
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AMPHASTAR PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Shipping and Handling Costs
For the years ended December 31, 2020, 2019, and 2018, the Company included shipping and handling costs of approximately $4.3 million, $4.3 million, and $3.7 million, respectively, in selling, distribution and marketing expenses in the accompanying consolidated statements of operations.
Advertising Expense
Advertising expenses, primarily associated with Primatene Mist® are recorded as they are incurred, except for expenses related to the development of a major commercial or media campaign, which are expensed in the period in which commercial or campaign is first presented, and is reflected as a component of selling, distribution and marketing in the Company’s consolidated statement of operations. For the years ended December 31, 2020, 2019, and 2018, advertising cost was $5.8 million, $4.3 million, and $0.4 million, respectively.
Research and Development Costs
Research and development costs are charged to expense as incurred and consist of costs incurred to further the Company’s research and development activities. These include salaries and related employee benefits, costs associated with clinical trials, nonclinical research and development activities, regulatory activities, research-related overhead expenses and fees paid to external service providers.
The Company may produce or purchase inventories prior to or with the expectation of receiving marketing authorization in the near term, based on operational decisions about the most effective use of existing resources. This inventory is referred to as pre-launch inventory. It is the Company’s accounting policy that the pre-launch inventory is capitalized if it has a probable future economic benefit. If marketing authorization is received and previously expensed pre-launch inventory is sold, such sales may contribute up to a 100% margin to the Company’s operating results. Pre-launch inventory costs include cost of work in process, materials, and finished drug products. As of December 31, 2020, 2019, and 2018, the Company did not have material capitalized pre-launch inventory.
Financial Instruments
The carrying amounts of cash and cash equivalents, short-term investments, restricted cash and short-term investments, accounts receivable, accounts payable, accrued expenses, and short-term borrowings approximate fair value due to the short maturity of these items. The majority of the Company’s long-term obligations consist of variable rate debt, and their carrying value approximates fair value as the stated borrowing rates are comparable to rates currently offered to the Company for instruments with similar maturities. The Company at times enters into fixed interest rate swap contracts to exchange the variable interest rates for fixed interest rates without the exchange of the underlying notional debt amounts. Such interest rate swap contracts are recorded at their fair values.
Cash and Cash Equivalents
Cash and cash equivalents consist of cash, money market accounts, certificates of deposit and highly liquid investments purchased with original maturities of three months or less.
Short-Term Investments
Short-term investments as of December 31, 2020 and 2019 consisted of certificates of deposit and investment grade corporate bonds with original expiration dates within 12 months.
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AMPHASTAR PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Restricted Cash
Restricted cash is collateral required for the Company to guarantee certain vendor payments in France. As of December 31, 2020 and 2019, the restricted cash balance was $1.9 million.
Restricted Short-Term Investments
Restricted short-term investments consist of certificates of deposit that are collateral for standby letters of credit to qualify for workers’ compensation self-insurance. The certificates of deposit have original maturities greater than three months, but less than one year. As of December 31, 2020 and 2019, the balance of restricted short-term investments was $2.2 million and $2.3 million, respectively.
Allowance for Credit Losses
The Company evaluates the collectability of accounts receivable based on a combination of factors. When the Company is aware of circumstances that may impair a customer’s ability to pay subsequent to the original sale, the Company records a specific allowance to reduce the amounts receivable to the amount that the Company reasonably believes to be collectable. For all other customers, the Company recognizes an allowance for credit losses based on factors that include the length of time the receivables are past due, industry and geographic concentrations, the current economic conditions and historical collection experience. As of December 31, 2020 and 2019, the Company's allowance for credit losses was $1.3 million and $1.1 million, respectively.
Inventories
Inventories consist of currently marketed products and products manufactured under contract. Inventories are stated using the first-in, first-out method, on a consistent basis. The Company states inventory at the lower of cost and net realizable value. Provisions are made for slow-moving, unsellable, or obsolete items. Net realizable value is determined using the estimated selling price, in the ordinary course of business, less estimated costs to complete and dispose.
Property, Plant and Equipment
Property, plant and equipment are stated at cost or, in the case of assets acquired in a business combination, at fair value on the purchase date. Depreciation and amortization expense is computed using the straight-line method over the estimated useful lives of the related assets as follows:
Buildings 20 - 31 years
Machinery and equipment 3 - 12 years
Furniture and fixtures 3 - 7 years
Automobiles 4 - 5 years
Leasehold improvements Lesser of remaining lease term or useful life
Intangible Assets
Intangible assets with finite lives are amortized using the straight-line method over the period the asset is expected to contribute directly or indirectly to the future cash flows of the Company as follows: