The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the accompanying notes included within this Annual Report on Form 10-K. The following discussion may contain forward-looking statements that reflect our plans, estimates and beliefs and involve risks, uncertainties and assumptions. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include those discussed in Item 1A. Risk Factors and "Forward-Looking Statements" included within this Annual Report on Form 10-K.
Overview
We are a global business consisting of multiple wholly owned subsidiaries that develop, manufacture, market and distribute specialty pharmaceutical products and therapies. Areas of focus include autoimmune and rare diseases in specialty areas like neurology, rheumatology, nephrology, pulmonology and ophthalmology; immunotherapy and neonatal respiratory critical care therapies; analgesics and gastrointestinal products. We operate our business in two reportable segments, which are further described below: • Specialty Brands includes innovative specialty pharmaceutical brands; and
• Specialty Generics includes niche specialty generic drugs and API(s).
During fiscal 2019, we experienced a change in our reportable segments, which primarily served to move the results related to Amitiza to the Specialty Brands segment from the Specialty Generics segment. All prior period segment information has been recast to reflect the realignment of our reportable segments on a comparable basis. For further information on our business and products, refer to Item 1. Business included within this Annual Report on Form 10-K. Significant Events Opioid-Related Matters As a result of the greater awareness of the public health issue of opioid abuse, there has been increased scrutiny of, and investigation into, the commercial practices of opioid manufacturers by state and federal agencies. We, along with other opioid manufacturers, have been the subject of federal and state government investigations and enforcement actions, focused on the misuse and abuse of opioid medications in theU.S. Similar investigations may be initiated in the future. During fiscal 2019 and 2018, we incurred$56.2 million and$38.8 million in opioid defense costs, respectively, which are included in SG&A. OnSeptember 30, 2019 , we announced thatMallinckrodt plc , along with its wholly owned subsidiariesMallinckrodt LLC andSpecGx LLC , executed a definitive settlement agreement and release withCuyahoga andSummit Counties inOhio in connection with the MDL Track 1 Cases. The settlement fully resolved the Track 1 Cases against all named Mallinckrodt entities that were scheduled to go to trial inOctober 2019 in the MDL. The Track 1 Cases asserted various claims related to the opioid business operated bySpecGx LLC . Under the agreement, we paid$24.0 million in cash inOctober 2019 . In addition, we will provide$6.0 million in generic products, including addiction treatment products, and will also provide a$0.5 million payment in two years in recognition of the counties' time and expenses. Further, in the event of a comprehensive resolution of government-related opioid claims, we have agreed that the two plaintiff counties will receive the value they would have received under such a resolution, less the payments described above. All named Mallinckrodt entities were dismissed with prejudice from the lawsuit. The value of the settlement should not be extrapolated to any other opioid-related cases or claims. Litigation Settlement OnFebruary 25, 2020 , we, the Specialty Generics Subsidiaries and certain other affiliates announced an agreement in principle on the terms of a global settlement that would resolve all opioid-related claims against us, the Specialty Generics Subsidiaries and our other subsidiaries. The Litigation Settlement has been reached with a court-appointed plaintiffs' executive committee representing the interests of thousands of plaintiffs in the MDL and is supported by a broad-based group of 47 state andU.S. Territory Attorneys General (the "Plaintiffs"). The Litigation Settlement contemplates the filing of voluntary petitions under Chapter 11 by the Specialty Generics Subsidiaries and the establishment of theOpioid Claimant Trust . Under the terms of the proposed settlement, which would become effective upon the Specialty Generics Subsidiaries' emergence from a contemplated Chapter 11 process, subject to court approval and other conditions, we would (1) make cash payments of$1,600.0 million in structured payments over eight years, beginning upon the Specialty Generics Subsidiaries' emergence from the completed Chapter 11 case, the substantial majority of which is expected to be contributed to theOpioid Claimant Trust and (2) issue warrants with an 53 -------------------------------------------------------------------------------- eight year term to theOpioid Claimant Trust exercisable at a strike price of$3.15 per share to purchase our ordinary shares that would represent approximately 19.99% of our fully diluted outstanding shares, including after giving effect to the exercise of the warrants (the "Settlement Warrants"). As a result of the Litigation Settlement, we recorded a charge of$1,643.4 million attributed to the anticipated structured cash payments and the Settlement Warrants to be issued upon effectiveness of the settlement. The court-supervised process is also expected to provide a fair, orderly, efficient and legally binding mechanism to resolve all opioid-related claims against the Company, Specialty Generics, and all of our other subsidiaries and related entities.Mallinckrodt plc and our Specialty Brands-related subsidiaries would not be part of the Chapter 11 filing. It is expected thatMallinckrodt plc would receive the benefit of a "channeling injunction" that would provide for the release of all opioid-related claims that have been or could have been asserted againstMallinckrodt plc or our subsidiaries related to Specialty Generics' manufacture and sale of opioids prior to the time the Specialty Generics Chapter 11 plan becomes effective. All of our subsidiaries, including Specialty Generics, are operating as normal and are expected to continue operating normally throughout the court-supervised process contemplated for Specialty Generics. We currently expect that the Specialty Generics Subsidiaries would continue to be an indirect, wholly owned subsidiary ofMallinckrodt plc during and following emergence from the contemplated court-supervised process. Further discussion of this Litigation Settlement is included in Note 24 of the Notes to Consolidated Financial Statements included within Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
Separation
In fiscal 2016, the Board of Directors began to explore a range of strategic alternatives for our Specialty Generics business. Consistent with that strategy, onDecember 6, 2018 , we announced our plans to spin off to our shareholders a new independent public company that would hold the Specialty Generics business. OnAugust 6, 2019 , based on market conditions and developments, including increasing uncertainties created by the opioid litigation, we announced the suspension of our previously announced plans to spin off the Specialty Generics business. Our long-standing goal remains to be an innovation-driven biopharmaceutical company focused on improving outcomes for underserved patients with severe and critical conditions. We hope that the Litigation Settlement will help resolve opioid uncertainties and we will continue to evaluate strategic options for the Specialty Generics business upon emergence from the contemplated Chapter 11 process. During fiscal 2019 and 2018, we incurred$63.9 million and$6.0 million in separation costs, respectively. These costs, which are included in SG&A expenses, primarily relate to professional fees, incremental costs incurred to build out the corporate infrastructure of the previously planned Specialty Generics business, costs incurred as we work to resolve opioid uncertainties, as well as rebranding initiatives associated with the Specialty Brands ongoing transformation. Silence Therapeutics InJuly 2019 , we entered into a license and collaboration agreement with Silence Therapeutics plc ("Silence") that will allow the companies to develop and commercialize ribonucleic acid interference ("RNAi") drug targets designed to inhibit the complement cascade, a group of proteins that are involved in the immune system and that play a role in the development of inflammation. These proteins are known to contribute to the pathogenesis of many diseases, including autoimmune disease. During fiscal 2019, we paid$20.0 million upfront, which was recorded within R&D expense, and gained an exclusive worldwide license to Silence's C3 complement asset, SLN500, with options to license up to two additional complement-targeted assets in Silence's preclinical complement-directed RNAi development program. The agreement also includes additional payments to Silence of up to$10.0 million in research milestones for SLN500, in addition to funding for Phase 1 clinical development including good manufacturing practices. Silence will be responsible for preclinical activities, and for executing the development program of SLN500 until the end of Phase 1, after which we will assume clinical development and responsibility for global commercialization. If approved, Silence could receive up to$563.0 million in commercial milestone payments and tiered low double-digit to high-teen royalties on net sales for SLN500. In addition to the aforementioned agreement, inJuly 2019 we acquired an equity investment of$5.0 million in Silence, which was valued at$26.2 million and included within other assets in the consolidated balance sheet as ofDecember 27, 2019 . The unrealized gain on this investment of$20.2 million was recognized in the fiscal 2019 consolidated statement of operations. Further information regarding this investment is included in Note 20 of the Notes to Consolidated Financial Statements included within Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
InNovember 2019 , we completed the sale ofBioVectra Inc. ("BioVectra") to an affiliate ofH.I.G. Capital with total consideration of up to$250.0 million including an upfront payment of$135.0 million and contingent consideration of$115.0 54 -------------------------------------------------------------------------------- million based on the long-term performance of the business. During fiscal 2019, the Company recorded a loss on the sale of$33.5 million , which excluded any potential proceeds from future milestones, in the event they are achieved. The financial results ofBioVectra's operations are presented within continuing operations as this divestiture did not meet the criteria for discontinued operations classification. Medicaid Lawsuit InMay 2019 , we filed a lawsuit in federal district court against the HHS and CMS (together with the HHS, the "Agency"). This lawsuit is in response to a decision by CMS to require that we revert to the original base date AMP used to calculate Medicaid drug rebates for Acthar Gel, which has the practical effect of imposing a prospective reduction in Acthar Gel net sales of$90.0 million to$100.0 million , which corresponds with the approximate amount of annualized Medicaid net sales for Acthar Gel. While we believe that our lawsuit has strong factual and legal bases, as ofDecember 27, 2019 , the potential for retroactive non-recurring charges could range from zero to approximately$630.0 million . Further discussion of this matter is included in Note 19 to the Noted to Consolidated Financial Statements included within Item 8. Financial Statements and Supplementary Data of this Annual report on Form 10-K. Tax Matters OnAugust 5, 2019 , theIRS proposed an adjustment to the taxable income ofMallinckrodt Hospital Products Inc. ("MHP") as a result of its findings in the audit of MHP's tax year endedSeptember 26, 2014 . MHP, formerly known asCadence Pharmaceuticals, Inc. ("Cadence"), was acquired as aU.S. subsidiary onMarch 19, 2014 . Following the acquisition of Cadence, we transferred certain rights and risks in Ofirmev® intellectual property ("Transferred IP") to one of our wholly owned non-U.S. subsidiaries. The transfer occurred at a price ("Transfer Price") determined in conjunction with our external advisors, in accordance with applicable Treasury Regulations and with reference to the$1,329.0 million taxable consideration we paid to the shareholders of Cadence. TheIRS asserts the value of the Transferred IP exceeds the value of the acquired Cadence shares and, further, partially disallows our control premium subtraction. The proposed adjustment to taxable income of$871.0 million , excluding potential associated interest and penalties, is proposed as a multi-year adjustment and may result in a non-cash reduction of ourU.S. Federal net operating loss carryforward of$782.0 million . We strongly disagree with the proposed increase to the Transfer Price and intend to contest it through all available administrative and judicial remedies, which may take a number of years to conclude. The final outcome cannot be reasonably quantified at this time, however, the proposed adjustment may be material. We believe our reserve for income tax contingencies is adequate. Reorganization of Intercompany Financing and Legal Entity Ownership During fiscal 2019, we completed a reorganization of our intercompany financing and associated legal entity ownership in response to the changing global tax environment. As a result, during fiscal 2019, we recognized current income tax expense of$26.2 million and a deferred income tax benefit of$239.0 million with a corresponding reduction to net deferred tax liabilities. The reduction in net deferred tax liabilities was comprised of a decrease in interest-bearing deferred tax obligations, which resulted in the elimination of theDecember 28, 2018 balance of$227.5 million , a$29.7 million increase in various other net deferred tax liabilities, a$28.7 million increase to a deferred tax asset related to excess interest carryforwards and a$12.5 million increase to a deferred tax asset related to tax loss and credit carryforwards net of valuation allowances. The elimination of the interest-bearing deferred tax obligation also eliminated the annual Internal Revenue Code section 453A interest expense. The reorganization involved the interpretation of multi-jurisdictional tax laws and regulations, supported by third party opinions. Interpretation of tax laws can be inherently uncertain and can be subject to potential challenges by the relevant tax authorities, both of which were considered in assessing our reserves for uncertain tax positions.
Business Factors Influencing the Results of Operations
Specialty Brands Net sales of Acthar Gel for fiscal 2019 decreased$157.4 million , or 14.2%, to$952.7 million driven primarily by continued reimbursement challenges impacting new and returning patients and continued payer scrutiny on overall specialty pharmaceutical spending. This was partially offset by continued strength in Ofirmev, INOmax andTherakos and an increase in net sales related to Amitiza, which was acquired in the first quarter of 2018. 55 -------------------------------------------------------------------------------- Research and Development We devote significant resources to R&D of products and proprietary drug technologies. During fiscal 2019, we incurred R&D expenses of$349.4 million . We expect to continue to pursue targeted investments in R&D activities, both for existing products and the development of new portfolio assets. We intend to focus our R&D investments in the specialty pharmaceuticals areas, specifically investments to support our Specialty Brands portfolio, where we believe there is the greatest opportunity for growth and profitability. We have completed the Phase 3 clinical studies for two of our development programs, terlipressin for the treatment of HRS type 1 and StrataGraft for the treatment of deep partial thickness burns, both of which had positive top line results. We expect to submit to the FDA the NDA filing for terlipressin and the BLA filing for StrataGraft in the first half of 2020. Upon approval we would be responsible for a one-time milestone payment related to terlipressin of$12.5 million . As part of the contingent consideration included in our acquisition of StrataGraft, we are responsible for a$20.0 million payment upon submission and another$20.0 million upon approval. Non-restructuring Impairment Charges During the three months endedJune 28, 2019 , we recognized a full impairment on our in-process research and development ("IPR&D") asset related to stannsoporfin of$113.5 million as we are no longer pursuing this development product. During the three months endedDecember 27, 2019 , we recognized a full impairment on our IPR&D asset related to VTS-270 of$274.5 million , primarily driven by continued regulatory challenges. The Company will continue to engage with the FDA and assess future opportunities for the development program. Specialty Generics After experiencing contraction over the last several years, the Specialty Generics business returned to growth in fiscal 2019, as compared to 2018, primarily driven by share recapture in specialty generic products, partially offset by opioid market contraction. Net sales from the Specialty Generics segment were$738.7 million for fiscal 2019 compared to$718.9 million for fiscal 2018. Results of Operations Fiscal Year EndedDecember 27, 2019 Compared with Fiscal Year EndedDecember 28, 2018 Net Sales Net sales by geographic area are as follows (dollars in millions): Fiscal Year Percentage 2019 2018 Change U.S.$ 2,765.6 $ 2,834.5 (2.4 )% Europe, Middle East and Africa 281.8 256.8 9.7 Other 115.1 124.3 (7.4 ) Net sales$ 3,162.5 $ 3,215.6 (1.7 ) Net sales in fiscal 2019 decreased$53.1 million , or 1.7%, to$3,162.5 million , compared with$3,215.6 million in fiscal 2018. This decrease was driven by our Specialty Brands segment primarily due to Acthar Gel, as the brand continues to face reimbursement challenges impacting new and returning patients while navigating continued payer scrutiny on overall specialty pharmaceutical spending. In addition, we experienced lower net sales in Other branded products primarily due to the sale of Recothrom during the first quarter of 2018, as well as a decrease in net sales fromBioVectra largely driven by the sale of this business inNovember 2019 . These decreases were partially offset by continued strength in Ofirmev, INOmax andTherakos and the increase in net sales related to Amitiza, which was acquired in the first quarter of 2018. In addition, we continue to experience increased net sales in the Specialty Generics segment due to share recapture in specialty generic products, partially offset by opioid market contraction. For further information on changes in our net sales, refer to "Business Segment Results" within this Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. Operating Loss Gross profit. Gross profit for fiscal 2019 decreased$49.8 million , or 3.4%, to$1,421.4 million , compared with$1,471.2 million in fiscal 2018, due in part to the$53.1 million decrease in net sales, as discussed above. Gross profit margin was 44.9% for 56 -------------------------------------------------------------------------------- fiscal 2019, compared with 45.8% in fiscal 2018. The decrease in gross profit and gross profit margin was primarily attributable to a change in product mix driven by the decrease in Acthar Gel net sales and an additional$107.3 million of amortization for the Ofirmev intangible asset resulting from a change in amortization method on day 1 of fiscal 2019, as discussed further in Note 13 of the Notes to the Consolidated Financial Statements included within Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. The additional amortization was partially offset by a decrease in the amortization of the inventory fair value adjustment related to Amitiza, which was fully amortized during the first quarter of 2019. Selling, general and administrative expenses. SG&A expenses for fiscal 2019 were$831.0 million , compared with$834.1 million for fiscal 2018, a decrease of$3.1 million , or 0.4%. This decrease is attributable to cost benefits gained from restructuring actions, including lower employee compensation costs and a$60.2 million decrease in the fair value of our contingent consideration liabilities in fiscal 2019, compared to a$50.2 million decrease in fiscal 2018. These decreases were partially offset by a$57.9 million increase in separation costs, an increase in legal expense, primarily related to opioid defense costs, and an increase in legal settlements driven by the$28.2 million charge associated with the settlement of the MDL Track 1 Cases during fiscal 2019. As a percentage of our net sales, SG&A expenses were 26.3% and 25.9% in fiscal 2019 and 2018, respectively. Research and development expenses. R&D expenses decreased$11.7 million , or 3.2%, to$349.4 million in fiscal 2019, compared with$361.1 million in fiscal 2018. This decrease was driven by the completion of certain development programs, partially offset by the$20.0 million upfront payment made to Silence during fiscal 2019. The Company continues to focus current R&D activities on performing clinical studies and publishing clinical and non-clinical experiences and evidence that support health economic activities and patient outcomes. As a percentage of our net sales, R&D expenses were 11.0% and 11.2% in fiscal 2019 and 2018, respectively. Restructuring and related charges, net. During fiscal 2019, we recognized a net benefit of$1.7 million of restructuring and related charges, net. During fiscal 2019, we finalized the settlement of the contract termination costs related to the production of Raplixa resulting in a$14.1 million reversal of the associated restructuring reserve that was previously established in fiscal 2018. This was partially offset by restructuring charges related to employee severance and benefits. During fiscal 2018, we recorded$108.2 million of restructuring and related charges, net, of which$5.2 million related to accelerated depreciation and was included in cost of sales. The remaining$103.0 million primarily related to the estimated contract termination costs related to the production of Raplixa, exiting certain facilities and employee severance and benefits. Non-restructuring impairment charges. Non-restructuring impairment charges were$388.0 million for fiscal 2019 resulting from the$274.5 million full impairment related to our VTS-270 intangible asset and the$113.5 million full impairment related to our stannsoporfin intangible asset, both as previously discussed. Non-restructuring impairment charges were$3,893.1 million for fiscal 2018 primarily related to the$3,672.8 million full goodwill impairment and the$218.3 million full impairment related to our MNK-1411 intangible asset. Losses on divestiture. During fiscal 2019, we completed the sale ofBioVectra for a loss of$33.5 million . During fiscal 2018, we sold a portion of our Hemostasis business, inclusive of our PreveLeak and Recothrom products. As a result of this sale, we recorded a loss of$0.8 million . Opioid-related litigation settlement charge. During fiscal 2019, we recorded a charge of$1,643.4 million attributed to the anticipated structured cash payments and the Settlement Warrants to be issued upon effectiveness of the settlement. For further information, refer to Note 24 of the Notes to the Consolidated Financial Statements included within Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. Non-Operating Items Interest expense and interest income. During fiscal 2019 and fiscal 2018, net interest expense was$299.5 million and$362.0 million , respectively. This$62.5 million decrease was attributable to a lower average outstanding debt balance during fiscal 2019 that yielded a decrease in interest expense of$26.6 million , a$23.7 million decrease in interest accrued on deferred tax liabilities associated with our previously outstanding installment notes and the recognition of an$8.6 million benefit to interest expense during fiscal 2019 due to a lapse of certain statute of limitations. For further information, refer to Note 19 of the Notes to the Consolidated Financial Statements included within Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. Additionally, non-cash interest expense decreased by$2.4 million over the comparable period. Interest income increased to$9.5 million during fiscal 2019, compared to$8.2 million during fiscal 2018, primarily related to interest on preferred equity certificates received as contingent consideration associated with the sale of the Nuclear Imaging business. Gains on debt extinguishment, net. During fiscal 2019 and 2018, we recorded gains on debt extinguishment, net, of$466.6 million and$8.5 million , respectively. During fiscal 2019 we completed a private exchange of our senior unsecured notes resulting in a gain of$377.4 million , net of the write-off of associated deferred financing fees of$4.9 million . For further information, refer to Note 14 of the Notes to the Consolidated Financial Statements included within Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. Fiscal 2019 also included a gain of$98.6 million on debt repurchases that aggregated to a total principal amount of$492.1 million , partially offset by the write-off of associated deferred financing fees of$9.4 million . 57 -------------------------------------------------------------------------------- Fiscal 2018 included a gain of$12.7 million on debt repurchases that aggregated to a total principal amount of$81.8 million , partially offset by the write-off of associated deferred financing fees of$4.2 million . Other income, net. During fiscal 2019 and 2018, we recorded other income, net, of$63.6 million and$22.4 million , respectively. This was primarily driven by a$23.5 million increase in royalty income related to our license agreement withAdvanced Accelerator Applications ("AAA") for net sales of their Lutathera product. In addition, we recorded an unrealized gain on investment of$20.2 million related to our equity investment in Silence. The remaining amounts in both fiscal years represented non-service pension expense and other items, including gains and losses on intercompany financing, foreign currency transactions and related hedging instruments. Benefit from income taxes. During fiscal 2019, we recognized an income tax benefit of$584.3 million on a loss from continuing operations before income taxes of$1,591.5 million . The fiscal 2019 income tax benefit was comprised of$21.8 million of current tax expense and$606.1 million of deferred tax benefit, which was predominantly related to previously acquired intangibles, the opioid-related litigation settlement charge, the generation of tax loss and credit carryforwards net of valuation allowances, the non-restructuring impairment charge, as well as the reorganization of our intercompany financing and associated legal entity ownership, which eliminated the interest-bearing deferred tax obligation. During fiscal 2018, we recognized an income tax benefit of$430.1 million on a loss from continuing operations before income taxes of$4,052.0 million . The fiscal 2018 income tax benefit was comprised of$112.8 million of current tax expense and$542.9 million of deferred tax benefit, which was predominantly related to the reorganization of our intercompany financing and associated legal entity ownership and generation of net operating losses. Our effective tax rate was 36.7% and 10.6% for fiscal 2019 and 2018, respectively. Our effective tax rate for fiscal 2019 was most significantly impacted by the recognition of$212.8 million tax benefit associated with the reorganization of our intercompany financing and associated legal entity ownership. Further impacts include receiving$211.9 million of tax benefit associated with the$1,643.4 million opioid-related litigation settlement charge,$71.9 million of tax benefit associated with the$386.3 million of restructuring costs and non-restructuring impairment charges,$18.7 million of tax benefit associated with accrued income tax liabilities and uncertain tax positions,$13.5 million of tax benefit primarily associated withU.S. tax credits,$11.4 million of tax benefit associated with separation costs of$63.9 million ,$10.2 million of tax expense associated with a gain on debt extinguishment of$466.6 million ,$8.0 million of tax benefit associated with a legal settlement charge of$28.2 million ,$7.6 million of tax expense associated with$60.2 million of income from the decrease in the fair value of contingent consideration liabilities and zero tax impact associated with a$33.5 million loss associated with the sale ofBioVectra . Any remaining impacts were related to the impact of recent acquisitions. Our effective tax rate for fiscal 2018 was most significantly impacted by the recognition of$256.0 million tax benefit associated with the reorganization of our intercompany financing and associated legal entity ownership; partially offset by a decrease to tax benefit of$73.2 million associated with accrued income tax liabilities and uncertain tax positions. Further impacts include receiving$60.9 million of tax benefit associated with the$4,001.3 million of restructuring costs and non-restructuring impairment charges,$25.9 million of tax benefit primarily associated withU.S. tax credits,$2.7 million of tax benefit associated with a$0.8 million loss associated with the sale of our PreveLeak and Recothrom assets, and$2.2 million of tax expense associated with$50.2 million of income from the decrease in the fair value of contingent consideration liabilities. Any remaining impacts were related to the impact of recent acquisitions and the reduction in theU.S. federal corporate statutory rate fromU.S. Tax Reform. Income from discontinued operations, net of income taxes. We recorded income of$10.7 million and$14.9 million on discontinued operations, net of income taxes, during fiscal 2019 and 2018, respectively. During fiscal 2019 and 2018, the income from discontinued operations included$9.0 million and$13.6 million of income, net of tax, respectively, from the receipt of contingent consideration related to the sale of the Nuclear Imaging business. The remaining amounts in both periods represented various post-sale adjustments associated with our previous divestitures. Fiscal Year EndedDecember 28, 2018 Compared with Fiscal Year EndedDecember 29, 2017 Net Sales Net sales by geographic area are as follows (dollars in millions): Fiscal Year Percentage 2018 2017 Change U.S.$ 2,834.5 $ 2,899.0 (2.2 )% Europe, Middle East and Africa 256.8 242.3 6.0 Other 124.3 80.3 54.8 Net sales$ 3,215.6 $ 3,221.6 (0.2 ) 58
-------------------------------------------------------------------------------- Net sales in fiscal 2018 decreased$6.0 million , or 0.2%, to$3,215.6 million , compared with$3,221.6 million in fiscal 2017. This decrease was driven by our Specialty Brands segment primarily due to Acthar Gel as the brand continued to face reimbursement challenges impacting new and returning patients while navigating growing payer scrutiny on overall specialty pharmaceutical spending. In addition, we experienced lower net sales in Other branded products primarily due to the sale of Recothrom during the first quarter of 2018. These decreases were partially offset by the strength in Ofirmev, INOmax andTherakos and the acquisition of the Amitiza product in the first quarter of 2018. The Specialty Generics segment experienced increased competition and customer consolidation, which resulted in downward pricing pressure. For further information on changes in our net sales, refer to "Business Segment Results" within this Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. Operating (Loss) Income Gross profit. Gross profit for fiscal 2018 decreased$186.3 million , or 11.2%, to$1,471.2 million , compared with$1,657.5 million in fiscal 2017. Gross profit margin was 45.8% for fiscal 2018, compared with 51.4% in fiscal 2017. The decrease in gross profit and gross profit margin was primarily attributable to the amortization of the Amitiza intangible asset and expense recognition of the inventory fair value adjustment associated with the product. Selling, general and administrative expenses. SG&A expenses for fiscal 2018 were$834.1 million , compared with$849.7 million for fiscal 2017, a decrease of$15.6 million , or 1.8%. Fiscal 2018 included a$49.9 million decrease in fair value of the contingent consideration liabilities related to stannsoporfin and MNK-1411 and cost benefits gained from restructuring actions, including lower employee compensation costs. These decreases were partially offset by increased legal fees and provisions for settlement agreements. As a percentage of our net sales, SG&A expenses were 25.9% and 26.4% of net sales for fiscal 2018 and 2017, respectively. Research and development expenses. R&D expenses increased$84.2 million , or 30.4%, to$361.1 million in fiscal 2018, compared with$276.9 million in fiscal 2017. The increase was attributable to higher spend in the Specialty Brands segment, where our pipeline products are concentrated. This increase was partially offset by lower spend in the Specialty Generics segment. R&D activities focused on performing clinical studies and publishing clinical and non-clinical experiences and evidence to support health economic and patient outcomes. As a percentage of our net sales, R&D expenses were 11.2% and 8.6% in fiscal 2018 and 2017, respectively. Restructuring and related charges, net. During fiscal 2018, we recorded$108.2 million of restructuring and related charges, net, of which$5.2 million related to accelerated depreciation and was included in cost of sales and SG&A. The remaining$103.0 million was primarily attributable to the estimated contract termination costs related to the production of Raplixa, exiting certain facilities and employee severance and benefits. During fiscal 2017, we recorded$36.4 million of restructuring and related charges, net, of which$5.2 million related to accelerated depreciation and was included in cost of sales. The remaining$31.2 million primarily related to exiting certain facilities and employee severance and benefits. Non-restructuring impairment charges. Non-restructuring impairment charges were$3,893.1 million for fiscal 2018 primarily related to the$3,672.8 million full goodwill impairment and the$218.3 million full impairment related to our MNK-1411 intangible asset, both as previously discussed. Non-restructuring impairment charges were$63.7 million for fiscal 2017 related to the Raplixa intangible asset. Losses (gains) on divestiture. During fiscal 2018, we sold a portion of our Hemostasis business, inclusive of our PreveLeak and Recothrom products. As a result of this sale, we recorded a loss of$0.8 million . In fiscal 2017, we recorded a$56.6 million gain associated with the sale of our Intrathecal Therapy business. Non-Operating Items Interest expense and interest income. During fiscal 2018 and fiscal 2017, net interest expense was$362.0 million and$364.5 million , respectively. This decrease was primarily driven by a$3.6 million increase in interest income related to higher interest earned on our money market funds. This increase was partially offset by the$1.1 million increase in interest expense which included an increase of$48.1 million due to our higher average outstanding debt balance in fiscal 2018 following the close of theSucampo Pharmaceuticals Inc. ("Sucampo") acquisition compared to fiscal 2017, partially offset by a$45.6 million decrease in interest accrued on deferred tax liabilities associated with outstanding installment notes primarily due to the reorganization of our legal entity ownership and the Tax Cut and Jobs Act of 2017 ("TCJA") that reduced the interest-bearingU.S. deferred tax liabilities balance during late fiscal 2017. Gains on debt extinguishment, net. During fiscal 2018 we recorded an$8.5 million gain consisting of a$12.7 million gain on debt repurchases that aggregated to a total principal amount of$81.8 million , partially offset by a$4.2 million write-off of associated deferred financing fees. During fiscal 2017 we recorded a gain of$8.3 million consisting of a$9.4 million gain on debt 59 -------------------------------------------------------------------------------- repurchases that aggregated to a total principal amount of$66.9 million , partially offset by a$1.1 million write-off of associated deferred financing fees. Other income (expense), net. During fiscal 2018 and 2017, we recorded other income, net, of$22.4 million and other expense, net, of$75.1 million , respectively. Fiscal 2018 included royalty income of$15.5 million and fiscal 2017 included a$70.5 million charge from recognition of previously deferred losses on the settlement of obligations associated with the termination of six defined benefit pension plans and a$10.0 million charge associated with the refinancing of our term loan. The remaining amounts in both fiscal years represented non-service pension expense and other items, including gains and losses on intercompany financing, foreign currency transactions and related hedging instruments. Benefit from income taxes. In fiscal 2018, we recognized an income tax benefit of$430.1 million on a loss from continuing operations before income taxes of$4,052.0 million . The fiscal 2018 income tax benefit was comprised of$112.8 million of current tax expense and$542.9 million of deferred tax benefit which was predominantly related to the reorganization of our intercompany financing and associated legal entity ownership and generation of net operating losses. In fiscal 2017, income tax benefit was$1,709.6 million on income from continuing operations before income taxes of$61.6 million . The fiscal 2017 income tax benefit was comprised of$38.1 million of current tax expense and$1,747.7 million of deferred tax benefit which was predominantly related to the reorganization of our legal entity ownership, TCJA and acquired intangibles. Our effective tax rate was 10.6% and negative 2,775.3% for fiscal 2018 and 2017, respectively. Our effective tax rate for fiscal 2018 was most significantly impacted by the recognition of$256.0 million tax benefit associated with the reorganization of our intercompany financing and associated legal entity ownership; partially offset by a decrease to tax benefit of$73.2 million associated with accrued income tax liabilities and uncertain tax positions. Further impacts include receiving$60.9 million of tax benefit associated with the$4,001.3 million of restructuring costs and non-restructuring impairment charges,$25.9 million of tax benefit primarily associated withU.S. tax credits,$2.7 million of tax benefit associated with a$0.8 million loss associated with the sale of our PreveLeak and Recothrom assets, and$2.2 million of tax expense associated with$50.2 million of income from the decrease in the fair value of contingent consideration liabilities. Any remaining impacts were related to the impact of recent acquisitions and the reduction in theU.S. federal corporate statutory rate fromU.S. Tax Reform. Our effective tax rate for fiscal 2017 was most significantly impacted by the recognition of$1,054.8 million tax benefit associated with the reorganization of our legal entity ownership and$456.9 million of tax benefit associated with the TCJA. Further impacts included receiving$5.5 million of tax benefit associated with$100.1 million of restructuring costs and non-restructuring impairment charges,$0.7 million of tax expense associated with$41.4 million of income from the decrease in the fair value of contingent consideration liabilities,$28.3 million of tax benefit associated with$70.5 million from the termination and settlement of our fundedU.S. pension plans,$38.9 million of tax expense associated with a$56.6 million gain associated with the sale of our Intrathecal Therapy business and$13.8 million of tax benefit primarily associated withU.S. tax credits. Income from discontinued operations, net of income taxes. We recorded income of$14.9 million and$363.2 million on discontinued operations, net of income taxes, during fiscal 2018 and 2017, respectively. During fiscal 2018, the income from discontinued operations included$13.6 million of income, net of tax, from the receipt of contingent consideration related to the sale of the Nuclear Imaging business. During fiscal 2017, the income from discontinued operations included a$361.7 million gain on divestiture and$4.1 million of income from operating results, both net of tax, associated with the Nuclear Imaging business. The remaining amounts in both periods represented various post-sale adjustments associated with our previous divestitures. Business Segment Results Management measures and evaluates our operating segments based on segment net sales and operating income. Management excludes corporate expenses from segment operating income. In addition, certain amounts that management considers to be non-recurring or non-operational are excluded from segment operating income because management evaluates the operating results of the segments excluding such items. These items include, but are not limited to, intangible asset amortization, net restructuring and related charges, non-restructuring impairments and separation costs. Although these amounts are excluded from segment operating income, as applicable, they are included in reported consolidated operating (loss) income and in the reconciliations presented below. Selected information by business segment is as follows: 60 --------------------------------------------------------------------------------
Fiscal Year Ended
Net Sales Net sales by segment are shown in the following table (dollars in millions): Fiscal Year Percentage 2019 2018 Change Specialty Brands$ 2,423.8 $ 2,496.7 (2.9 )% Specialty Generics 738.7 718.9 2.8 Net sales$ 3,162.5 $ 3,215.6 (1.7 ) Specialty Brands. Net sales for fiscal 2019 decreased$72.9 million , or 2.9%, to$2,423.8 million , compared with$2,496.7 million for fiscal 2018. This decrease was primarily driven by a$157.4 million , or 14.2%, decrease in Acthar Gel net sales driven primarily by continued reimbursement challenges impacting new and returning patients and continued payer scrutiny on overall specialty pharmaceutical spending, a$13.7 million , or 40.4%, decrease in Other product sales primarily attributable to the sale of Recothrom during the first quarter of 2018 and a$13.0 million or 24.5% decrease in net sales related toBioVectra , which was sold inNovember 2019 . These decreases were partially offset by continued strength in Ofirmev, INOmax, andTherakos , as well as an increase in net sales related to Amitiza, which was acquired in the first quarter of 2018. Net sales for Specialty Brands by geography are as follows (dollars in millions): Fiscal Year Percentage 2019 2018 Change U.S.$ 2,164.3 $ 2,246.7 (3.7 )%
98.1 105.8 (7.3 ) Net sales$ 2,423.8 $ 2,496.7 (2.9 ) Net sales for Specialty Brands by key products are as follows (dollars in millions): Fiscal Year 2019 2018 Percentage Change Acthar Gel$ 952.7 $ 1,110.1 (14.2 )% INOmax 571.4 542.7 5.3 Ofirmev 384.0 341.9 12.3 Therakos 246.9 231.2 6.8 Amitiza 208.5 183.8 13.4 BioVectra 40.1 53.1 (24.5 ) Other 20.2 33.9 (40.4 ) Specialty Brands$ 2,423.8 $ 2,496.7 (2.9 ) Specialty Generics. Net sales for fiscal 2019 increased$19.8 million , or 2.8%, to$738.7 million , compared to$718.9 million for fiscal 2018. The increase in net sales was driven by increased net sales of$10.4 million or 15.8% and$8.8 million or 13.3% for hydrocodone-related products and oxycodone-related products, respectively, along with an increase of$8.7 million or 2.5% related to net sales of other controlled substances. These increases were partially offset by decreased net sales of$5.3 million or 10.5% related to other product net sales primarily due to decreases from our supply agreement with the acquirer of our contrast media and delivery systems ("CMDS") business. 61 -------------------------------------------------------------------------------- Net sales for Specialty Generics by geography are as follows (dollars in millions): Fiscal Year Percentage 2019 2018 Change U.S.$ 601.3 $ 587.8 2.3 %
17.0 18.5 (8.1 ) Net sales$ 738.7 $ 718.9 2.8
Net sales for Specialty Generics by key products are as follows (dollars in millions):
Fiscal Year 2019 2018
Percentage Change
Hydrocodone (API) and hydrocodone-containing tablets
15.8 % Oxycodone (API) and oxycodone-containing tablets 74.9 66.1 13.3 Acetaminophen (API) 189.9 192.7 (1.5 ) Other controlled substances 352.5 343.8 2.5 Other 45.1 50.4 (10.5 ) Specialty Generics$ 738.7 $ 718.9 2.8 Operating (Loss) Income Operating income by segment and as a percentage of segment net sales for fiscal 2019 and 2018 is shown in the following table (dollars in millions): Fiscal Year 2019 2018 Specialty Brands (1)$ 1,174.5 48.5 %$ 1,093.1 43.8 % Specialty Generics 108.1 14.6 89.3 12.4 Segment operating income 1,282.6 40.6 1,182.4 36.8 Unallocated amounts: Corporate and allocated expenses (137.8 ) (155.8 ) Intangible asset amortization (853.4 ) (740.2 ) Restructuring and related charges, net (2) 1.7 (108.2 ) Non-restructuring impairment charges (388.0 ) (3,893.1 ) Separation costs (63.9 ) (6.0 ) R&D upfront payment (3) (20.0 ) - Opioid-related litigation settlement charge (4) (1,643.4 ) - Total operating loss$ (1,822.2 ) $ (3,720.9 ) (1) Includes$10.0 million and$118.8 million of inventory fair-value step up expense, primarily related to Amitiza during fiscal 2019 and 2018, respectively.
(2) Includes restructuring-related accelerated depreciation.
(3) Represents R&D expense incurred related to an upfront payment made to
Silence in connection with the license and collaboration agreement
entered into inJuly 2019 . (4) For further information, refer to Note 24 of the Notes to the
Consolidated Financial Statements included within Item 8. Financial
Statements and Supplementary Data of this Annual Report on Form 10-K.
Specialty Brands. Operating income for fiscal 2019 increased$81.4 million to$1,174.5 million , compared with$1,093.1 million for fiscal 2018. Operating margin increased to 48.5% for fiscal 2019, compared with 43.8% for fiscal 2018. The increase in operating income and margin includes a$39.4 million increase in gross profit primarily driven by an additional$110.8 million of expense recorded during fiscal 2018 related to the inventory fair value adjustment for Amitiza, which was fully amortized in the first quarter of 2019. The increase in operating income and margin was also attributable to a$19.4 million decrease in R&D spending and a$23.3 million decrease in SG&A expenses compared to fiscal 2018, primarily due to cost benefits gained from restructuring actions, including lower employee compensation costs. These changes were partially offset by changes in product mix, primarily driven by the decrease in Acthar Gel net sales. 62 -------------------------------------------------------------------------------- Specialty Generics. Operating income for fiscal 2019 increased$18.8 million to$108.1 million , compared with$89.3 million for fiscal 2018. Operating margin increased to 14.6% for fiscal 2019, compared with 12.4% for fiscal 2018. The increase in operating income and margin was impacted by a$21.2 million increase in gross profit primarily due to product mix as well as a$13.2 million decrease in R&D spending, partially offset by a$15.6 million increase in SG&A primarily due to higher legal expense related to opioid litigation defense costs and increased consulting and professional fees. Corporate and allocated expenses. Corporate and allocated expenses were$137.8 million and$155.8 million for fiscal 2019 and 2018, respectively. Fiscal 2019 included a$33.5 million loss on the divestiture ofBioVectra and a$28.2 million charge associated with the settlement of the MDL Track 1 Cases, partially offset by a$60.2 million decrease in the fair value of our contingent consideration liabilities. Fiscal 2018 included a$50.2 million decrease in the fair value of our contingent consideration liabilities, as well as an$11.8 million reduction in the accrual associated with ourLower Passaic River ,New Jersey environmental remediation liability. The remaining decrease was primarily driven by cost benefits gained from restructuring actions, including lower employee compensation costs, partially offset by increased professional fees. Fiscal Year EndedDecember 28, 2018 Compared with Fiscal Year EndedDecember 29, 2017 Net Sales Net sales by segment are shown in the following table (dollars in millions): Fiscal Year Percentage 2018 2017 Change Specialty Brands$ 2,496.7 $ 2,352.0 6.2 % Specialty Generics 718.9 869.6 (17.3 ) Net sales$ 3,215.6 $ 3,221.6 (0.2 ) Specialty Brands. Net sales for fiscal 2018 increased$144.7 million , or 6.2%, to$2,496.7 million , compared with$2,352.0 million for fiscal 2017. This increase was primarily driven by net sales of$183.8 million from Amitiza acquired in the first quarter of fiscal 2018 coupled with increases of$39.4 million , or 13.0%,$37.5 million , or 7.4%, and$16.3 million , or 7.6%, in net sales of Ofirmev, INOmax andTherakos , respectively, driven by increased demand during the year. These increases were partially offset by a decrease in Acthar Gel net sales of$85.0 million , or 7.1%, driven by the residual impact of previously reported patient withdrawal issues from fiscal 2017 while navigating growing payer scrutiny on overall specialty pharmaceutical spending and a decrease of$45.7 million , or 57.4%, in sales of Other products. The decrease in Other product sales was primarily attributable to a$42.9 million decrease in net sales related to the sale of Recothrom during the first quarter of 2018 and a$7.8 million decrease in net sales related to the sale of the Intrathecal Therapy business during the first quarter of 2017. Net sales for Specialty Brands by geography are as follows (dollars in millions): Fiscal Year Percentage 2018 2017 Change U.S.$ 2,246.7 $ 2,216.9 1.3 % Europe, Middle East and Africa 144.2 73.0 97.5 Other 105.8 62.1 70.4 Net sales$ 2,496.7 $ 2,352.0 6.2 63
-------------------------------------------------------------------------------- Net sales for Specialty Brands by key products are as follows (dollars in millions): Fiscal Year 2018 2017 Percentage Change Acthar Gel$ 1,110.1 $ 1,195.1 (7.1 )% INOmax 542.7 505.2 7.4 Ofirmev 341.9 302.5 13.0 Therakos 231.2 214.9 7.6 Amitiza 183.8 - - BioVectra 53.1 54.7 (2.9 ) Other 33.9 79.6 (57.4 ) Specialty Brands$ 2,496.7 $ 2,352.0 6.2 Specialty Generics. Net sales for fiscal 2018 decreased$150.7 million , or 17.3%, to$718.9 million , compared with$869.6 million for fiscal 2017. The decrease in net sales was driven by decreases of$21.9 million , or 24.9%, and$19.4 million , or 22.7%, in net sales of oxycodone-related products and hydrocodone-related products, respectively. These decreases were due to increased competition and customer consolidation, which resulted in downward pricing pressure. Other controlled substances products also decreased by$68.2 million , or 16.6%, primarily attributable to a$31.2 million decrease in Methylphenidate ER due to theFDA's 2014 reclassification of these products to therapeutically inequivalent status. Other products also decreased$48.4 million , or 49.0%, primarily due to a$33.8 million decrease from our supply agreement with the acquirer of our CMDS business. These decreases were partially offset by an increase of$7.2 million in net sales of acetaminophen products compared to fiscal 2017. Net sales for Specialty Generics by geography are as follows (dollars in millions): Fiscal Year Percentage 2018 2017 Change U.S.$ 587.8 $ 682.1 (13.8 )%
18.5 18.2 1.6 Net sales$ 718.9 $ 869.6 (17.3 )
Net sales for Specialty Generics by key products are as follows (dollars in millions):
Fiscal Year 2018 2017
Percentage Change
Hydrocodone (API) and hydrocodone-containing tablets
(22.7 )% Oxycodone (API) and oxycodone-containing tablets 66.1 88.0 (24.9 ) Acetaminophen (API) 192.7 185.5 3.9 Other controlled substances 343.8 412.0 (16.6 ) Other 50.4 98.8 (49.0 ) Specialty Generics$ 718.9 $ 869.6 (17.3 ) 64
-------------------------------------------------------------------------------- Operating (Loss) Income Operating income by segment and as a percentage of segment net sales for fiscal 2018 and 2017 is shown in the following table (dollars in millions): Fiscal Year 2018 2017 Specialty Brands (1)$ 1,093.1 43.8 %$ 1,146.3 48.7 % Specialty Generics 89.3 12.4 266.4 30.6 Segment operating income 1,182.4 36.8 1,412.7 43.9 Unallocated amounts: Corporate and allocated expenses (155.8 ) (125.2 ) Intangible asset amortization (740.2 ) (694.5 ) Restructuring and related charges, net (2) (108.2 ) (36.4 ) Non-restructuring impairment charges (3,893.1 ) (63.7 ) Separation costs (6.0 ) - Total operating (loss) income$ (3,720.9 ) $ 492.9 (1) Includes$118.8 million of inventory fair-value step up expense, primarily related to Amitiza during fiscal 2018.
(2) Includes restructuring-related accelerated depreciation.
Specialty Brands. Operating income for fiscal 2018 decreased$53.2 million to$1,093.1 million , compared with$1,146.3 million for fiscal 2017. Operating margin decreased to 43.8% for fiscal 2018, compared with 48.7% for fiscal 2017. The decrease in operating income was impacted by an increase of$95.7 million in R&D expenses related to the increased investment in our pipeline products. This was partially offset by a decrease of$42.8 million in SG&A expenses as compared to fiscal 2017, primarily due to cost benefits gained from restructuring actions, including lower employee compensation costs and stock compensation expense, lower legal and advertising and promotion fees and various minor increases and decreases. Specialty Generics. Operating income for fiscal 2018 decreased$177.1 million to$89.3 million , compared with$266.4 million for fiscal 2017. Operating margin decreased to 12.4% for fiscal 2018, compared with 30.6% for fiscal 2017. The decrease in operating income was impacted by a$134.4 million decrease in gross profit, primarily due to the previously discussed decrease in net sales of oxycodone-related products, hydrocodone-related products and other controlled substances due to channel consolidation and increased pricing pressure. The decrease in operating income was also impacted by a$51.4 million increase in SG&A expenses, primarily due to higher legal expense related to opioid litigation defense costs and higher professional fees, partially offset by lower employee compensation costs and stock compensation expense. Corporate and allocated expenses. Corporate and allocated expenses were$155.8 million and$125.2 million for fiscal 2018 and 2017, respectively. Fiscal 2018 included$19.7 million of provisions for legal matters, offset by a$50.2 million decrease in the fair value of our contingent consideration liabilities. Fiscal 2017 included a$56.6 million gain associated with the sale of our Intrathecal Therapy business and$54.6 million of income resulting from the decrease in fair value of the contingent liability related to Raplixa. The remaining$50.4 million decrease was primarily attributable to cost benefits gained from restructuring actions, including lower employee compensation costs, lower professional fees and various minor increases and decreases. Liquidity and Capital Resources Significant factors driving our liquidity position include cash flows generated from operating activities, financing transactions, capital expenditures, cash paid in connection with acquisitions and licensing agreements and cash received as a result of our divestitures. We have historically generated and expect to continue to generate positive cash flows from operations. Our ability to fund our capital needs is impacted by our ongoing ability to generate cash from operations and access to capital markets. We believe that our future cash from operations and access to capital markets will provide adequate resources to fund our working capital needs, capital expenditures and strategic investments for the foreseeable future. As previously discussed, onFebruary 25, 2020 , we announced the Litigation Settlement. If the Litigation Settlement is not fully implemented or consummated, we or our subsidiaries may become subject to some or all of the liabilities that would have otherwise been settled, which could have a material and adverse effect on our business, financial condition, results of operations and cash flows. Further information on these risks are described in Part I, Item 1A. "Risk Factors". 65 -------------------------------------------------------------------------------- Furthermore, from time to time, we may seek to enter into certain transactions to extend the maturities of our outstanding indebtedness. For example, onFebruary 25, 2020 , we announced certain financing activities that are aimed at addressing our near-term debt maturities, as discussed further in "Debt and Capitalization" within this Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. In fiscal 2020, we intend to fund capital expenditures with cash generated from operations. AtDecember 27, 2019 , we had capital expenditure commitments of$1.0 million . A summary of our cash flows from operating, investing and financing activities is provided in the following table (dollars in millions): Fiscal
Year
2019 2018
2017
Net cash provided by (used in): Operating activities$ 742.9 $ 665.5 $ 727.3 Investing activities (8.3 ) (480.3 ) 318.4 Financing activities (280.1 ) (1,095.0 ) (130.2 ) Effect of currency exchange rate changes on cash 0.6 (1.8 ) 2.5 Net increase (decrease) in cash, cash equivalents and restricted cash$ 455.1 $ (911.6 ) $ 918.0 Operating Activities Net cash provided by operating activities of$742.9 million for fiscal 2019 included a loss from continuing operations, as adjusted for non-cash items including a$466.6 million gain on debt extinguishment, net and a$388.0 million adjustment for non-cash impairment charges, both as previously discussed. The loss from continuing operations adjusted for non-cash items was offset by a$1,451.6 million inflow from net changes in working capital, primarily driven by the portion of the opioid-related litigation settlement liability related to the structured cash payments of$1,600.0 million with the remaining$43.4 million related to the Settlement Warrants reflected as a non-cash item. This was partially offset by a$161.5 million net outflow from other assets and liabilities primarily driven by cash outflows related to separation costs, one time legal settlement payments of$24.0 million and$15.4 million related to the settlement of the MDL Track 1 Cases and theQuestcor Pharmaceuticals, Inc. ("Questcor") DOJ settlement, respectively, a$26.5 million decrease in accrued restructuring charges, a$16.3 million decrease in payroll related accruals and decreases in other accrual balances attributable to cost benefits gained from restructuring actions. Net cash provided by operating activities of$665.5 million for fiscal 2018 was primarily attributable to income from continuing operations, as adjusted for non-cash items including a$3,893.1 million adjustment for non-cash impairment charges, as previously discussed, and a$46.4 million inflow from net investment in working capital. The working capital inflow was primarily attributable to a$99.0 million cash inflow from net tax related balances, a$63.1 million decrease in inventory balances, a$24.6 million increase in accounts payable, net, and a$5.5 million net inflow related to other assets and liabilities, offset by a$145.8 million increase in accounts receivable, net. Net cash provided by operating activities of$727.3 million for fiscal 2017 was primarily attributable to income from continuing operations, as adjusted for non-cash items including an outflow of$1,744.1 million of deferred income taxes related to the reduction in our deferred tax liabilities primarily as a result of the reorganization of our legal entity ownership and the TCJA. The income from continuing operations, as adjusted for non-cash items, was offset by a$188.8 million outflow from net investment in working capital. The working capital outflow included cash payments of$102.0 million for the settlement with theFTC and the settling states,$35.0 million for settlement of the DEA investigation, a$62.3 million contribution to terminated pension plans that were settled during the period, a$34.2 million outflow from net tax related balances, a$25.8 million decrease in accounts payable, net, and a$70.5 million net inflow related to other assets and liabilities. Investing Activities Net cash used in investing activities of$8.3 million for fiscal 2019 was primarily attributable to capital expenditures of$133.0 million , partially offset by$95.1 million in proceeds received related to the sale ofBioVectra , net of cash, as well as proceeds from other long-term asset disposals. Net cash used in investing activities of$480.3 million for fiscal 2018 was primarily attributable to cash outflows related to the Sucampo acquisition of$698.0 million and capital expenditures of$127.0 million , partially offset by the$159.0 million of proceeds received, net of transaction costs, from the divestiture of a portion of the Hemostasis business, inclusive of the PreveLeak and Recothrom products; proceeds received of$154.0 million related to the note receivable from the purchaser of the Intrathecal Therapy business that was sold during fiscal 2017; and a$25.5 million cash inflow related to the sale of our investment in Mesoblast Limited ("Mesoblast") during fiscal 2018. 66 -------------------------------------------------------------------------------- Net cash provided by investing activities of$318.4 for fiscal 2017 included$576.9 million of proceeds received from the divestiture of the Nuclear Imaging and Intrathecal Therapy businesses during fiscal 2017, partially offset by capital expenditures of$186.1 million ; payments, net of cash acquired, of$36.8 million and$39.5 million related to the acquisitions of InfaCare and Ocera, respectively; and$21.5 million related to the investment in Mesoblast that was made in fiscal 2017. Under our term loan credit agreement, the proceeds from the sale of assets and businesses must be either reinvested into capital expenditures or business development activities within one year of the respective transaction or we are required to make repayments on our term loan. Financing Activities Net cash used in financing activities was$280.1 million for fiscal 2019, compared with$1,095.0 million for fiscal 2018. The$814.9 million decrease was primarily attributable to a$748.5 million decrease in debt repayments and a$54.9 million decrease in shares repurchased. The significant components of our current year debt repayments included aggregate debt repayments of$286.4 million on our variable-rate term loans, open market debt repurchases that aggregated to a total principal amount of$492.1 million and a repayment of$250.0 million on the receivable securitization program. These repayments were partially offset by a net draw of$680.0 million on our revolving credit facility. Net cash used in financing activities was$1,095.0 million for fiscal 2018, compared with$130.2 million for fiscal 2017. The$964.8 million increase in cash outflows was attributable to a$776.4 million increase in debt repayments and$774.7 million less cash provided by issuance of external debt, offset by a$594.2 million decrease in shares repurchased. The significant components of our current year debt repayments included$680.0 million related to our revolving credit facility, a$225.0 million repayment of the variable-rate term loan maturing in 2024, repayment of$366.0 million of assumed debt from the Sucampo acquisition, a$300.0 million repayment of fully matured unsecured fixed rate notes and open market debt repurchases that aggregated to a total principal amount of$81.8 million .
Inflation
Inflationary pressures have had an adverse effect on us through higher raw material and fuel costs. We have entered into commodity swap contracts in the past to mitigate the impact of rising prices and may do so in the future. If these contracts are not effective or we are not able to achieve price increases on our products, we may continue to be impacted by these increased costs. Concentration of Credit and Other Risks Financial instruments that potentially subject us to concentrations of credit risk primarily consist of accounts receivable. We generally do not require collateral from customers. A portion of our accounts receivable outside theU.S. includes sales to government-owned or supported healthcare systems in several countries, which are subject to payment delays. Payment is dependent upon the financial stability and creditworthiness of those countries' national economies. Debt and Capitalization InNovember 2015 , our Board of Directors authorized us to reduce our outstanding debt at our discretion. As market conditions warrant, we may from time to time repurchase debt securities issued by us, in the open market, in privately negotiated transactions, by tender offer or otherwise. Such repurchases, if any, will depend on prevailing market conditions, our liquidity requirements and other factors. The amounts involved may be material. During fiscal 2019, we repurchased debt that aggregated to a principal amount of$492.1 million . As ofDecember 27, 2019 , total debt principal was$5,422.8 million compared with$6,156.7 million as ofDecember 28, 2018 , with total debt reduction of$733.9 million during fiscal 2019. Total debt principal atDecember 27, 2019 is comprised of the following: December 27, 2019 Variable-rate instruments: Term loan due September 2024 $ 1,520.8 Term loan due February 2025 403.6 Revolving credit facility 900.0 Fixed-rate instruments 2,598.4 Debt principal $ 5,422.8 67
-------------------------------------------------------------------------------- The variable-rate term loan interest rates are based on LIBOR, subject to a minimum LIBOR level of 0.75% with interest payments generally expected to be payable every 90 days, and requires quarterly principal payments equal to 0.25% of the original principal amount. As ofDecember 27, 2019 , our fixed-rate instruments had a weighted-average interest rate of 6.0% and pay interest at various dates throughout the fiscal year. As ofDecember 27, 2019 , we were fully drawn on our$900.0 million revolving credit facility. InDecember 2019 , upon the terms and conditions set forth in a confidential offering memorandum datedNovember 5, 2019 ,Mallinckrodt International Finance S.A. andMallinckrodt CB LLC (the "Issuers") completed private offers to exchange (the "2019 Exchange Offers") (i)$83.2 million 2020 Notes issued by the Issuers for$70.2 million of new 10.00% Second Lien Senior Secured Notes dueApril 2025 to be issued by the Issuers (the "2025 Notes") and (ii)$52.9 million of the 5.75% senior unsecured notes dueAugust 2022 (the "2022 Notes"),$216.4 million of the 4.75% senior unsecured notes dueApril 2023 ,$144.7 million of the 5.625% senior unsecured notes dueOctober 2023 (the "October 2023 Notes") and$208.9 million of the 2025 Notes issued by the Issuers (collectively, and together with the 2020 Notes, the "Existing Notes") for$252.7 million of 2025 Notes. The 2019 Exchange Offers were accounted for as a debt extinguishment, which resulted in the extinguishment of$383.2 million of principal of Existing Notes and the transfer of$322.9 million of Existing Notes to the 2025 Notes. The exchanges also resulted in the capitalization of$10.1 million of deferred financing fees related to the 2025 Notes. In conjunction with the exchanges, we recorded a gain on debt extinguishment of$377.4 million primarily associated with retiring a portion of our Existing Notes at less than face value, net of the write-off of associated deferred financing fees of$4.9 million . As ofDecember 27, 2019 ,$634.5 million of our total debt is classified as current as these payments are due within the next fiscal year, including$614.8 million of the 2020 Notes. OnFebruary 25, 2020 , we announced certain financing activities that are aimed at addressing our near term-debt maturities. We and the Issuers have entered into a support agreement with certain of our existing term lenders, as well as certain of our existing noteholders, as new lenders, relating to an amendment to our existing credit agreement on terms consistent with an agreed term sheet (the "Amendment"), which, if effected on the terms contemplated by the term sheet, will (i) provide for a commitment to provide a new$800.0 million term loan with a four-year term and (ii) implement certain other amendments on the terms described in the term sheet. The proceeds of the new term loan will be used to fund the redemption or repayment of all of our outstanding 2020 Notes, and additionally to partially repay loans and terminate corresponding commitments under the revolving credit facility in respect of revolving lenders who agree to extend their loans and commitments toMarch 2024 . The amendments to the existing credit agreement would provide for, among other things, certain changes to the covenants, including the financial covenant, a rate increase of 100 basis points for existing term loans, and an increase in amortization on the existing term loans. Conditions to the effectiveness of the Amendment, include, among other things, (i) the consent by certain thresholds of the existing term lenders and revolving lenders (which condition has not yet been satisfied as of this date) and (ii) the commencement of an exchange offer with respect to our 2022 Notes pursuant to the Exchange Agreement (as described below). However, we cannot guarantee that we will satisfy the conditions, and in such event, we could experience heightened risks related to short-term liquidity constraints, which could adversely affect our ability to fulfill our other financial obligations and jeopardize the consummation of the Litigation Settlement. We and the Issuers entered into a support and exchange agreement withAurelius Capital Master, Ltd. ,Franklin Advisers, Inc. andCapital Research and Management Company (the "Exchange Agreement") pursuant to which, among other things, the Issuers agreed to use commercially reasonable efforts to commence, by no later thanMarch 20, 2020 , a private offer to exchange any and all of the 2022 Notes held by such noteholders for an equal principal amount of new second lien secured notes (such new notes, the "Exchange Offer Notes" and, such private offer to exchange, the "2022 Exchange Offer") at a rate of$1,000 of Exchange Offer Notes for every$1,000 of 2022 Notes exchanged, subject to the terms and conditions set forth in the Exchange Agreement. Pursuant to the Exchange Agreement, the Issuers also agreed to use commercially reasonable efforts to commence, by no later thanMarch 20, 2020 , a solicitation of consents from holders of the 2022 Notes to certain amendments to eliminate or waive substantially all of the restrictive covenants contained in the 2022 Notes and the applicable indenture, and eliminate certain events of default, modify covenants regarding mergers and the transfer of assets, and modify and eliminate certain other provisions, including covenants regarding future guarantors and certain provisions relating to defeasance (such solicitation of consents, the "2022 Consent Solicitation"). The closing of the 2022 Exchange Offer will be conditioned on, among other things, the absence of events materially and adversely affecting the ability to implement the Litigation Settlement, and the funding of the new term loans and the effectiveness of the Amendment. The noteholders have agreed to tender in the 2022 Exchange Offer all of their 2022 Notes, deliver their consents in the 2022 Consent Solicitation and, if the aggregate principal amount of Exchange Offer Notes issued pursuant to the 2022 Exchange Offer is less than approximately$610.3 million (the "Exchange Cap"), exchange the outstandingOctober 2023 Notes held by the noteholders party to the Exchange Agreement for an amount of Exchange Offer Notes equal to the excess, if any, by which the Exchange Cap exceeds the aggregate principal amount of Exchange Offer Notes to be issued pursuant to the 2022 Exchange Offer, at a rate of$900 of Exchange Offer Notes for every$1,000 ofOctober 2023 Notes exchanged by each noteholder. The noteholders collectively hold approximately$271.0 million aggregate principal amount of the 2022 Notes and approximately$255.0 million aggregate principal amount of theOctober 2023 Notes. Additionally, pursuant to the Exchange Agreement, the noteholders have consented, in their capacity as holders of the 2020 Notes, to the adoption of an amendment to the 2020 Notes and the indenture governing the 2020 Notes to provide for the reduction of the optional redemption notice period from 30 days to three business days. The 2022 Exchange Offer will be subject to 68 -------------------------------------------------------------------------------- the satisfaction or waiver of certain conditions, and the failure to consummate the 2022 Exchange Offer could adversely affect the implementation and consummation of the Litigation Settlement. The risks associated with the failure to consummate the Litigation Settlement are further described in the risk factor "The Litigation Settlement is subject to certain contingencies and may not go into effect in its current form or at all, as a result of which our business prospects may be adversely impacted." in Part I, Item 1A. "Risk Factors." As ofDecember 27, 2019 , we were, and expect to remain, in compliance with the provisions and covenants associated with our debt agreements. For additional information regarding our debt agreements, refer to Note 14 of the Notes to Consolidated Financial Statements included within Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
Capitalization
Shareholders' equity was$1,940.7 million atDecember 27, 2019 compared with$2,887.3 million atDecember 28, 2018 . The decrease in shareholders' equity is primarily attributed to the fiscal 2019 net loss. From time to time, the Company's Board of Directors have authorized share repurchase programs. We did not make any share repurchases during fiscal 2019, compared to$55.2 million in fiscal 2018, due to our shift to debt reduction as one of our primary focuses of our capital allocation strategy for fiscal 2019. For further information, refer to Note 16 of the Notes to the Consolidated Financial Statements included within Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
Dividends
We currently do not anticipate paying any cash dividends for the foreseeable future, as we intend to retain earnings to finance acquisitions, R&D and the operation and expansion of our business, while executing disciplined capital allocation. The recommendation, declaration and payment of dividends in the future by us will be subject to the sole discretion of our Board of Directors and will depend upon many factors, including our financial condition, earnings, capital requirements of our operating subsidiaries, covenants associated with certain of our debt obligations, legal requirements, regulatory constraints and other factors deemed relevant by our Board of Directors. Moreover, if we determine to pay dividends in the future, there can be no assurance that we will continue to pay such dividends. Commitments and Contingencies Contractual Obligations The following table summarizes our contractual obligations as ofDecember 27, 2019 (dollars in millions): Payments Due By Period Less than 1 More than 5 Total year 1 - 3 years 3 - 5 years years Long-term debt obligations$ 5,422.8 $ 634.5 $ 1,560.1 $ 2,135.0 $ 1,093.2 Interest on long-term debt obligations (1) 1,083.2 268.5 483.7 301.6 29.4 Operating lease obligations (2) 104.2 23.5 31.6 21.0 28.1 Purchase obligations (3) 73.4 63.4 3.4 3.3 3.3 Total contractual obligations$ 6,683.6 $ 989.9 $ 2,078.8 $ 2,460.9 $ 1,154.0 (1) Interest on long-term debt obligations are projected for future periods using interest rates in effect as ofDecember 27, 2019 . Certain of these projected interest payments may differ in the future based on changes in market interest rates.
(2) Refer to Note 12 of the Notes to Consolidated Financial Statements
included within Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K for further information.
(3) Purchase obligations consist of commitments for purchases of goods and
services made in the normal course of business to meet operational and
capital requirements.
The preceding table does not include other liabilities of$2,219.1 million , primarily consisting of the opioid-related litigation settlement liability of$1,643.4 million and obligations under our pension and postretirement benefit plans, unrecognized tax benefits for uncertain tax positions and related accrued interest and penalties, contingent consideration liabilities, environmental liabilities and asset retirement obligations, because the timing of their future cash outflow is uncertain. The most significant of these liabilities, other than the opioid-related settlement liability discussed in Note 24 of the Notes to the Consolidated Financial Statements included within Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K, are discussed below. As part of our acquisitions, we are subject to contractual arrangements to pay contingent consideration to former owners of these businesses. The payment of obligations under these arrangements are uncertain, and even if payments are expected to be made the 69 -------------------------------------------------------------------------------- timing of these payments may be uncertain as well. As ofDecember 27, 2019 , we have accrued$69.3 million for these potential payments, of which$11.5 million is considered to be long-term. For further information on our contingent consideration arrangements, refer to Note 20 of the Notes to Consolidated Financial Statements included within Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. As part of our divestitures and licensing agreements, we have the potential to earn in excess of$250.0 million in milestone payments in the future. During fiscal 2019, we received royalty income of$39.0 million and preferred equity certificates of$9.0 million . During fiscal 2018, we received royalty income of$15.5 million , milestone payments of$6.0 million and preferred equity certificates of$9.0 million . For further information, refer to Notes 5 and 6 of the Notes to Consolidated Financial Statements included within Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. We are obligated to pay royalties under certain agreements with third parties. During fiscal 2019, 2018 and 2017, we made payments under these arrangements of$95.7 million ,$106.4 million and$86.0 million , respectively. The timing and amounts to be paid in future periods are uncertain as they are dependent upon net sales generated in future periods. Non-current income taxes payable, primarily related to unrecognized tax benefits, is included within other income tax liabilities on the consolidated balance sheet and, as ofDecember 27, 2019 , was$227.1 million . Payment of these liabilities is uncertain and, even if payments are determined to be necessary, they are subject to the timing of rulings by the Internal Revenue Service related to tax positions we take. For further information on income tax related matters, refer to Note 8 of the Notes to Consolidated Financial Statements included within Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. As ofDecember 27, 2019 , we had net unfunded pension and postretirement benefit obligations of$27.0 million and$40.5 million , respectively. The timing and amounts of long-term funding requirements for pension and postretirement obligations are uncertain. We do not anticipate making material involuntary contributions in fiscal 2020, but may elect to make voluntary contributions to our defined pension plans or our postretirement benefit plans during fiscal 2020. We settled all outstanding obligations associated with our sixU.S. qualified pension plans during fiscal 2017 and made contributions of$62.3 million associated with the unfunded portion of these obligations. We are involved in various stages of investigation and cleanup related to environmental remediation matters at a number of sites. The ultimate cost of cleanup and timing of future cash outlays is difficult to predict given uncertainties regarding the extent of the required cleanup, the interpretation of applicable laws and regulations and alternative cleanup methods. As ofDecember 27, 2019 , we believe that it is probable that we will incur investigation and remediation costs of approximately$61.9 million , of which$1.9 million is included in accrued and other current liabilities on our consolidated balance sheet atDecember 27, 2019 . Note 19 of the Notes to Consolidated Financial Statements included within Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K provides additional information regarding environmental matters. Legal Proceedings We are subject to various legal proceedings and claims, including present and former operations, including those described in Part I, Item 3. Legal Proceedings and in Note 19 of the Notes to Consolidated Financial Statements included within Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K, which are incorporated by reference into this Part II, Item 7. We believe these legal proceedings and claims likely will be resolved over an extended period of time. Although it is not feasible to predict the outcome of these matters, we believe, unless otherwise indicated, given the information currently available, that their ultimate resolution should not have a material adverse effect on our business, financial condition, results of operations and cash flows.
Guarantees
In disposing of assets or businesses, we have historically provided representations, warranties and indemnities to cover various risks and liabilities, including unknown damage to the assets, environmental risks involved in the sale of real estate, liability to investigate and remediate environmental contamination at waste disposal sites and manufacturing facilities, and unidentified tax liabilities related to periods prior to disposition. We assess the probability of potential liabilities related to such representations, warranties and indemnities and adjust potential liabilities as a result of changes in facts and circumstances. We believe, given the information currently available, that our ultimate resolution will not have a material adverse effect on our financial condition, results of operations and cash flows. These representations, warranties and indemnities are discussed in Note 18 of the Notes to Consolidated Financial Statements included within Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. Off-Balance Sheet Arrangements As ofDecember 27, 2019 , we had various other letters of credit and guarantee and surety bonds totaling$35.2 million and restricted cash of$12.8 million held in segregated accounts primarily to collateralize surety bonds for the Company's environmental liabilities. 70 -------------------------------------------------------------------------------- Critical Accounting Policies and Estimates The consolidated financial statements have been prepared inU.S. dollars and in accordance with GAAP. The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. The following accounting policies are based on, among other things, judgments and assumptions made by management that include inherent risks and uncertainties. Management's estimates are based on the relevant information available at the end of each period. Revenue Recognition Product Sales Revenue We sell products through independent channels, including direct to retail pharmacies, end user customers and through distributors who resell our products to retail pharmacies, institutions and end user customers, while certain products are sold and distributed directly to hospitals. We also enter into arrangements with indirect customers, such as health care providers and payers, wholesalers, government agencies, institutions, managed care organizations and GPOs to establish contract pricing for certain products that provides for government-mandated and/or privately-negotiated rebates, sale incentives, chargebacks, distribution service agreement fees, fees for services and administration fees and discounts with respect to the purchase of our products. Reserve for Variable Considerations Product sales are recorded at the net sales price (transaction price), which includes estimates of variable consideration for which reserves are established. These reserves result from estimated chargebacks, rebates, product returns and other sales deductions that are offered within contracts between us and our customers, health care providers and payers relating to the sale of our products. These reserves are based on the amounts earned or to be claimed on the related sales and are classified as reductions of accounts receivable (if the amount is payable to the customer) or a current liability (if the amount is payable to a party other than a customer). Where appropriate, these estimates take into consideration a range of possible outcomes that are probability-weighted for relevant factors such as our historical experience, estimated future trends, estimated customer inventory levels, current contracted sales terms with customers, level of utilization of our products and other competitive factors. Overall, these reserves reflect our best estimate of the amount of consideration to which we are entitled based on the terms of the contract. The amount of variable consideration that is included in the transaction price may be constrained (reduced), and is included in the net sales price only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue recognized will not occur in a future period. We adjust reserves for chargebacks, rebates, product returns and other sales deductions to reflect differences between estimated and actual experience. Such adjustments impact the amount of net sales recognized in the period of adjustment. The following table reflects activity in our sales reserve accounts (dollars in millions): Rebates and Other Sales Chargebacks Product Returns Deductions Total Balance as of December 30, 2016$ 349.1 $ 31.4$ 10.8 $ 391.3 Provisions 1,897.2 38.7 72.6 2,008.5 Payments or credits (1,918.9 ) (35.6 ) (68.7 ) (2,023.2 ) Balance as of December 29, 2017 327.4 34.5 14.7 376.6 Provisions 2,281.3 39.3 66.9 2,387.5 Payments or credits (2,254.4 ) (39.8 ) (64.5 ) (2,358.7 ) Balance as of December 28, 2018 354.3 34.0 17.1 405.4 Provisions 2,347.3 22.2 68.2 2,437.7 Payments or credits (2,405.8 ) (27.8 ) (72.1 ) (2,505.7 ) Balance as of December 27, 2019$ 295.8 $
28.4
Provisions presented in the table above are recorded as reductions to net sales. For our presentation of net sales by product family, refer to Note 21 of the Notes to Consolidated Financial Statements included within Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K Total provisions for fiscal 2019 increased$50.2 million compared with fiscal 2018. The increase in rebates and chargebacks of$66.0 million primarily related to an increase in$49.3 million in the Specialty Generics segment as our distributors incurred higher chargebacks as compared to our direct customers, coupled with a$16.7 million increase in Specialty Brands. Provisions for returns decreased$17.1 million driven the Specialty Generics segment primarily related to discontinuation of select products in fiscal 2019, and other sales deductions increased by$1.3 million from fiscal 2018 to fiscal 2019. 71 -------------------------------------------------------------------------------- Total provisions for fiscal 2018 increased$379.0 million compared with fiscal 2017. The increase in rebates and chargebacks of$384.1 million primarily related to a$350.4 million increase in the Specialty Generics products as additional indirect customers were added to our distributors' customer base resulting in additional chargebacks, coupled with a$33.7 million increase in Specialty Brands. Provisions for returns increased$0.6 million and other sales deductions decreased by$5.7 million from fiscal 2017 to fiscal 2018, due to increased competition within the Specialty Generics segment. Product sales are recognized when the customer obtains control of our product. Control is transferred either at a point in time, generally upon delivery to the customer site, or in the case of certain of our products, over the period in which the customer has access to the product and related services. Revenue recognized over time is based upon either consumption of the product or passage of time based upon our determination of the measure that best aligns with how the obligation is satisfied. Our considerations of why such measures provide a faithful depiction of the transfer of our products are as follows: For those contracts whereby revenue is recognized over time based upon consumption of the product, we either have: 1. the right to invoice the customer in an amount that
directly
corresponds with the value to the customer of our
performance to
date, for which the practical expedient to recognize in proportion to the amount it has the right to invoice has been applied, or 2. the remaining goods and services to which the customer is entitled is diminished upon consumption. For those contracts whereby revenue is recognized over time based upon the passage of time, the benefit that the customer receives from unlimited access to our product does not vary, regardless of consumption. As a result, our obligation diminishes with the passage of time; therefore, ratable recognition of the transaction price over the contract period is the measure that best aligns with how the obligation is satisfied. Costs to obtain a contract As the majority of our contracts are short-term in nature, sales commissions are generally expensed when incurred as the amortization period would have been less than one year. These costs are recorded within SG&A. For contracts that extend beyond one year, the incremental expense recognition matches the recognition of related revenue. Costs to fulfill a contract We capitalize the costs associated with the devices used in our portfolio of drug-device combination products, which are used in satisfaction of future performance obligations. Capital expenditures for these devices represent cash outflows for our cost to produce the asset, which is classified in property, plant and equipment, net on the consolidated balance sheets and expensed to cost of sales over the useful life of the equipment. Product Royalty Revenues We license certain rights to Amitiza to a third party in exchange for royalties on net sales of the product. We recognize such royalty revenue as the related sales occur. Contract Balances Accounts receivable are recorded when the right to consideration becomes unconditional. Payments received from customers are typically based upon payment terms of between 30 to 90 days depending on the customer. We do not maintain contract asset balances aside from the accounts receivable balance as presented on the consolidated balance sheets as costs to obtain a contract are expensed when incurred as the amortization period would have been less than one year. These costs are recorded within SG&A. Contract liabilities are recorded when cash payments are received in advance of our performance, including amounts which are refundable. For additional information, refer to Note 4 of the Notes to Consolidated Financial Statements included within Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. Goodwill and Other Intangible Assets During fiscal 2018, our annual goodwill impairment analysis resulted in the recognition of a full goodwill impairment of$3,672.8 million related to our Specialty Brands reporting unit. As a result, we did not have a goodwill balance during fiscal 2019. Prior to this full impairment, we tested goodwill on the first day of the fourth quarter of each year for impairment or whenever events or changes in circumstances indicated that the carrying value may not be recoverable. In performing goodwill assessments, management relies on a number of factors including operating results, business plans, economic projections, internally developed cash flows, transactions and market place data. There are inherent uncertainties related to these factors and judgment in applying them to the analysis of goodwill impairment. Since judgment is involved in performing goodwill valuation analyses, there is risk that the carrying value of our goodwill may be overstated or understated. The impairment test is comprised of comparing the carrying value of a reporting unit to its estimated fair value. We estimate the fair value of a reporting unit through internal analyses and valuation, utilizing an income 72 -------------------------------------------------------------------------------- approach (a level three measurement technique) based on the present value of future cash flows. This approach incorporates many assumptions including future growth rates, discount factors and income tax rates. The fair value of our reporting units is reconciled to our share price and market capitalization as a corroborative step. If the carrying value of a reporting unit exceeds its fair value, we recognize the excess of the carrying value over the fair value as a goodwill impairment loss. Intangible assets include completed technology, licenses, trademarks and IPR&D. Intangible assets acquired in a business combination are recorded at fair value, while intangible assets acquired in other transactions are recorded at cost. Finite-lived intangible assets are amortized, generally using the straight-line method over five to thirty years. We assess the remaining useful life and the recoverability of finite-lived intangible assets whenever events or circumstances indicate that the carrying value of an asset may not be recoverable. When a triggering event occurs, we evaluate potential impairment of finite-lived intangible assets by first comparing undiscounted cash flows associated with the asset to its carrying value. If the carrying value is greater than the undiscounted cash flows, the amount of potential impairment is measured by comparing the fair value of the assets with their carrying value. Indefinite-lived intangible assets are tested annually for impairment, or whenever events or changes in circumstances indicate that the carrying value may not be recoverable by either a qualitative or income approach. We compare the fair value of the assets with their carrying value and record an impairment when the carrying value exceeds the fair value. The fair value of the intangible asset is estimated using an income approach, using similar assumptions as used in our goodwill valuation. If the fair value is less than the carrying value of the intangible asset, the amount recognized for impairment is equal to the difference between the carrying value of the asset and the present value of future cash flows. Changes in economic and operating conditions impacting these assumptions could result in intangible asset impairment in future periods. For more information on our goodwill and intangible impairment analyses and the results thereof, refer to Notes 2 and 13 of the Notes to Consolidated Financial Statements included within Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
Acquisitions
For acquisitions that meet the criteria for business combination accounting, the amounts paid are allocated to the tangible assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition. We then allocate the purchase price in excess of net tangible assets acquired to identifiable intangible assets, including purchased research and development. The fair value of identifiable intangible assets is based on detailed valuations. These valuations rely on a number of factors including operating results, business plans, economic projections, anticipated future cash flows, transactions and market place data. There are inherent uncertainties related to these factors and judgment in applying them to estimate the fair value of individual assets acquired in a business combination. Due to these inherent uncertainties, there is risk that the carrying value of our recorded intangible assets and goodwill may be overstated, which may result in an increased risk of impairment in future periods. We perform our intangible asset valuations using an income approach based on the present value of future cash flows. This approach incorporates many assumptions including future growth rates, discount factors and income tax rates. Changes in economic and operating conditions impacting these assumptions could result in impairment in future periods. Our purchased research and development represents the estimated fair value as of the acquisition date of in-process projects that have not reached technological feasibility. The primary basis for determining technological feasibility of these projects is obtaining regulatory approval. The fair value of IPR&D is determined using the discounted cash flow method. In determining the fair value of IPR&D, we consider, among other factors, appraisals, the stage of completion of the projects, the technological feasibility of the projects, whether the projects have an alternative future use and the estimated residual cash flows that could be generated from the various projects and technologies over their respective projected economic lives. The discount rate used includes a rate of return that accounts for the time value of money, as well as risk factors that reflect the economic risk that the cash flows projected may not be realized. The fair value attributable to IPR&D projects at the time of acquisition is capitalized as an indefinite-lived intangible asset and tested annually for impairment until the project is completed or abandoned. Upon completion of the project, the indefinite-lived intangible asset is then accounted for as a finite-lived intangible asset and amortized on a straight-line basis over its estimated useful life. If the project is abandoned, the indefinite-lived intangible asset is charged to expense. Certain asset acquisitions or license agreements may not meet the criteria for a business combination. We account for these transactions as an asset acquisition and recognize the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquired entity. Any initial up-front payments incurred in connection with the acquisition or licensing of IPR&D product candidates that do not meet the definition of a business are treated as research and development expense. Contingent Consideration As part of certain acquisitions, we are subject to contractual arrangements to pay contingent consideration to former owners of these businesses. The payment of obligations under these arrangements are uncertain, and even if payments are expected to be made 73 -------------------------------------------------------------------------------- the timing of these payments may be uncertain as well. These contingent consideration obligations are required to be recorded at fair value within the consolidated balance sheet and adjusted at each respective balance sheet date, with changes in the fair value being recognized in the consolidated statement of operations. The determination of fair value is dependent upon a number of factors, which include projections of future revenues, the probability of successfully achieving certain regulatory milestones, competitive entrants into the marketplace, the timing associated with the aforementioned criteria and market place data (e.g., interest rates). Several of these assumptions require projections several years into the future. Due to these inherent uncertainties, there is risk that the contingent consideration liabilities may be overstated or understated. Changes in economic and operating conditions impacting these assumptions are expected to impact future operating results, with the magnitude of the impact tied to the significance in the change in assumptions. For additional information, refer to Note 20 of the Notes to Consolidated Financial Statements included within Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K.
Contingencies
We are involved, either as a plaintiff or a defendant, in various legal proceedings that arise in the ordinary course of business, including, without limitation, patent infringement claims, product liability matters, government investigations, environmental matters, employment disputes, contractual disputes and other commercial disputes, and other legal proceedings as further discussed in Note 19 of Notes to Consolidated Financial Statements included within Item 8. Financial Statements and Supplementary Data of this Annual Report on Form 10-K. Accruals recorded for various contingencies, including legal proceedings, self-insurance and other claims, are based on judgment, the probability of losses and, where applicable, the consideration of opinions of internal and/or external legal counsel, internal and/or external technical consultants and actuarially determined estimates. When a range is established but a best estimate cannot be made, we record the minimum loss contingency amount. These estimates are often initially developed substantially earlier than the ultimate loss is known, and the estimates are reevaluated each accounting period as additional information becomes available. When we are initially unable to develop a best estimate of loss, we record the minimum amount of loss, which could be zero. As information becomes known, additional loss provisions are recorded when either a best estimate can be made or the minimum loss amount is increased. When events result in an expectation of a more favorable outcome than previously expected, our best estimate is changed to a lower amount. We record receivables from third-party insurers up to the amount of the related liability when we have determined that existing insurance policies will provide reimbursement. In making this determination, we consider applicable deductibles, policy limits and the historical payment experience of the insurance carriers. Receivables are not netted against the related liabilities for financial statement presentation. Income Taxes In determining income for financial statement purposes, we must make certain estimates and judgments. These estimates and judgments affect the calculation of certain tax liabilities and the determination of the recoverability of certain of the deferred tax assets, which arise from temporary differences between the tax and financial statement recognition of revenue and expense. Deferred tax assets are reduced by a valuation allowance if, based on the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. In evaluating our ability to recover our deferred tax assets, we consider all available positive and negative evidence including our past operating results, the existence of cumulative losses in the most recent years and our forecast of future taxable income. In estimating future taxable income, we develop assumptions including the amount of future state, federal and international pre-tax operating income, the reversal of temporary differences, and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment about the forecasts of future taxable income and are consistent with the plans and estimates we use to manage the underlying businesses. We believe that we will generate sufficient future taxable income in the appropriate jurisdictions to realize the tax benefits related to the net deferred tax assets on our consolidated balance sheets. However, any reduction in future taxable income, including any future restructuring activities, may require that we record an additional valuation allowance against our deferred tax assets. An increase in the valuation allowance would result in additional income tax expense in such period and could have a significant impact on our future earnings. Our income tax expense recorded in the future may also be reduced to the extent of decreases in our valuation allowances. We determine whether it is more likely than not that a tax position will be sustained upon examination. The tax benefit of any tax position that meets the more-likely-than-not recognition threshold is calculated as the largest amount that is more than 50.0% likely of being realized upon resolution of the uncertainty. To the extent a full benefit is not realized on the uncertain tax position, an income tax liability is established. We adjust these liabilities as a result of changing facts and circumstances; however; due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the tax liabilities. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax regulations in a multitude of jurisdictions across our global operations. Changes in tax laws and rates could affect recorded deferred tax assets and 74 --------------------------------------------------------------------------------
liabilities in the future. Management is not aware of any such changes, however, which would have a material adverse effect on our competitive position, business, financial condition, results of operations and cash flows.
Recently Issued Accounting Standards Refer to Note 3 of Notes to Consolidated Financial Statements included within
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