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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 _________________________________
FORM 10-Q
 _________________________________
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 28, 2018
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 

Commission File Number : 001-35803
 _________________________________
Mallinckrodt plc
(Exact name of registrant as specified in its charter)
 _________________________________
Ireland
 
98-1088325
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
3 Lotus Park, The Causeway, Staines-Upon-Thames,
Surrey TW18 3AG, United Kingdom
(Address of principal executive offices) (Zip Code)

Telephone: +44 017 8463 6700
(Registrant's telephone number, including area code)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x     No  o

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  x     No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and "emerging growth company" in Rule 12b-2 of the Exchange Act:
 
Large accelerated filer
 
x
 
 
Accelerated filer
 
o
Non-accelerated filer
 
o
 
 
Smaller reporting company
 
o
 
 
 
 
 
Emerging growth company
 
o

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes o      No  x

Indicate number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:
Ordinary shares, $0.20 par value - 83,313,240 shares as of November 2, 2018





MALLINCKRODT PLC
INDEX
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 









PART I. FINANCIAL INFORMATION
 
Item 1.
Financial Statements.

MALLINCKRODT PLC
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(unaudited, in millions, except per share data)

 
Three Months Ended
 
Nine Months Ended
 
September 28,
2018
 
September 29,
2017
 
September 28,
2018
 
September 29,
2017
Net sales
$
640.0

 
$
600.6

 
$
1,844.3

 
$
1,760.7

Cost of sales
326.2

 
268.0

 
936.7

 
808.3

Gross profit
313.8

 
332.6

 
907.6

 
952.4

 
 
 
 
 
 
 
 
Selling, general and administrative expenses
164.0

 
186.3

 
520.7

 
618.5

Research and development expenses
78.5

 
46.9

 
223.9

 
144.2

Restructuring charges, net
14.7

 
15.4

 
96.5

 
26.3

Losses (gains) on divestiture
0.6

 
0.4

 
0.6

 
(56.6
)
Operating income
56.0

 
83.6

 
65.9

 
220.0

 
 
 
 
 
 
 
 
Interest expense
(93.6
)
 
(92.6
)
 
(280.1
)
 
(279.0
)
Interest income
2.0

 
1.3

 
6.6

 
2.8

Other income (expense), net
13.4

 
3.0

 
17.5

 
(70.6
)
Loss from continuing operations before income taxes
(22.2
)
 
(4.7
)
 
(190.1
)
 
(126.8
)
 
 
 
 
 
 
 
 
Income tax benefit
(125.2
)
 
(57.8
)
 
(222.0
)
 
(153.4
)
Income from continuing operations
103.0

 
53.1

 
31.9

 
26.6

 
 
 
 
 
 
 
 
Income from discontinued operations, net of income taxes
10.8

 
10.6

 
79.5

 
499.1

 
 
 
 
 
 
 
 
Net income
$
113.8

 
$
63.7

 
$
111.4

 
$
525.7

 
 
 
 
 
 
 
 
Basic earnings per share (Note 8):
 
 
 
 
 
 
 
Income from continuing operations
$
1.24

 
$
0.55

 
$
0.38

 
$
0.27

Income from discontinued operations
0.13

 
0.11

 
0.94

 
5.02

Net income
$
1.37

 
$
0.66

 
$
1.32

 
$
5.28

 
 
 
 
 
 
 
 
Basic weighted-average shares outstanding
83.2

 
96.7

 
84.2

 
99.5

 
 
 
 
 
 
 
 
Diluted earnings per share (Note 8):
 
 
 
 
 
 
 
Income from continuing operations
$
1.21

 
$
0.55

 
$
0.37

 
$
0.27

Income from discontinued operations
0.13

 
0.11

 
0.93

 
5.00

Net income
$
1.34

 
$
0.66

 
$
1.31

 
$
5.27

 
 
 
 
 
 
 
 
Diluted weighted-average shares outstanding
85.0

 
97.0

 
85.2

 
99.8




See Notes to Condensed Consolidated Financial Statements.



2




MALLINCKRODT PLC
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited, in millions)


 
Three Months Ended
 
Nine Months Ended
 
September 28,
2018
 
September 29,
2017
 
September 28,
2018
 
September 29,
2017
Net income
$
113.8

 
$
63.7

 
$
111.4

 
$
525.7

Other comprehensive income (loss), net of tax:
 
 
 
 
 
 
 
Currency translation adjustments
3.2

 
5.6

 
(4.1
)
 
13.0

Derivatives, net of $-, $-, $- and $0.2 tax
0.2

 
0.3

 
0.7

 
0.9

Benefit plans, net of $-, $-, $- and ($31.4) tax
(0.4
)
 
(0.5
)
 
(0.9
)
 
45.4

Investments, net of $-, $-, $-, and $- tax

 
(10.5
)
 

 
0.1

Total other comprehensive income (loss), net of tax
3.0

 
(5.1
)
 
(4.3
)
 
59.4

Comprehensive income
$
116.8

 
$
58.6

 
$
107.1

 
$
585.1


See Notes to Condensed Consolidated Financial Statements.


3




MALLINCKRODT PLC
CONDENSED CONSOLIDATED BALANCE SHEETS
(unaudited, in millions, except share data)

 
September 28,
2018
 
December 29,
2017
Assets
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
290.7

 
$
1,260.9

Accounts receivable, less allowance for doubtful accounts of $3.4 and $2.8
349.6

 
275.4

Inventories
143.4

 
128.7

Prepaid expenses and other current assets
117.7

 
74.7

Notes receivable

 
154.0

Current assets held for sale
1,136.8

 
391.5

Total current assets
2,038.2

 
2,285.2

Property, plant and equipment, net
439.3

 
413.2

Goodwill
3,675.4

 
3,482.7

Intangible assets, net
8,585.2

 
8,261.0

Long-term assets held for sale

 
742.7

Other assets
170.5

 
156.2

Total Assets
$
14,908.6

 
$
15,341.0

 
 
 
 
Liabilities and Shareholders' Equity
 
 
 
Current Liabilities:
 
 
 
Current maturities of long-term debt
$
16.7

 
$
313.7

Accounts payable
76.6

 
77.3

Accrued payroll and payroll-related costs
89.0

 
78.4

Accrued interest
77.0

 
57.0

Income taxes payable
43.4

 
15.5

Accrued and other current liabilities
437.5

 
368.5

Current liabilities held for sale
182.4

 
140.0

Total current liabilities
922.6

 
1,050.4

Long-term debt
6,174.0

 
6,420.9

Pension and postretirement benefits
65.2

 
67.1

Environmental liabilities
49.8

 
62.8

Deferred income taxes
668.9

 
749.1

Other income tax liabilities
127.6

 
94.1

Long-term liabilities held for sale

 
22.6

Other liabilities
296.9

 
352.0

Total Liabilities
8,305.0

 
8,819.0

Shareholders' Equity:
 
 
 
Preferred shares, $0.20 par value, 500,000,000 authorized; none issued and outstanding

 

Ordinary A shares, €1.00 par value, 40,000 authorized; none issued and outstanding

 

Ordinary shares, $0.20 par value, 500,000,000 authorized; 92,678,152 and 92,196,662 issued;
83,243,748 and 86,336,232 outstanding

18.5

 
18.4

Ordinary shares held in treasury at cost, 9,434,404 and 5,860,430
(1,618.5
)
 
(1,564.7
)
Additional paid-in capital
5,521.3

 
5,492.6

Retained earnings
2,701.0

 
2,588.6

Accumulated other comprehensive loss
(18.7
)
 
(12.9
)
Total Shareholders' Equity
6,603.6

 
6,522.0

Total Liabilities and Shareholders' Equity
$
14,908.6

 
$
15,341.0


See Notes to Condensed Consolidated Financial Statements.


4




MALLINCKRODT PLC
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited, in millions)

 
Nine Months Ended
 
September 28,
2018
 
September 29,
2017
Cash Flows From Operating Activities:
 
 
 
Net income
$
111.4

 
$
525.7

Adjustments to reconcile net cash from operating activities:
 
 
 
Depreciation and amortization
597.0

 
606.5

Share-based compensation
27.9

 
46.1

Deferred income taxes
(232.7
)
 
(128.7
)
Loss (gain) on divestiture
0.6

 
(418.1
)
Other non-cash items
(3.7
)
 
40.8

Changes in assets and liabilities, net of the effects of acquisitions:
 
 
 
Accounts receivable, net
(59.0
)
 
(34.7
)
Inventories
43.1

 
(18.2
)
Accounts payable
(0.1
)
 
(30.2
)
Income taxes
16.7

 
(68.1
)
Other
(20.1
)
 
(72.6
)
Net cash from operating activities
481.1

 
448.5

Cash Flows From Investing Activities:
 
 
 
Capital expenditures
(93.3
)
 
(151.3
)
Acquisitions, net of cash
(699.9
)
 
(35.9
)
Proceeds from divestitures, net of cash
313.2

 
576.9

Other
28.8

 
0.5

Net cash from investing activities
(451.2
)
 
390.2

Cash Flows From Financing Activities:
 
 
 
Issuance of external debt
657.2

 
540.0

Repayment of external debt and capital lease obligation
(1,563.4
)
 
(887.5
)
Debt financing costs
(12.0
)
 
(12.7
)
Proceeds from exercise of share options
1.0

 
4.0

Repurchase of shares
(57.4
)
 
(437.7
)
Other
(24.3
)
 
(18.6
)
Net cash from financing activities
(998.9
)
 
(812.5
)
Effect of currency rate changes on cash
(0.9
)
 
2.7

Net change in cash, cash equivalents and restricted cash
(969.9
)
 
28.9

Cash, cash equivalents and restricted cash at beginning of period
1,279.1

 
361.1

Cash, cash equivalents and restricted cash at end of period
$
309.2

 
$
390.0

 
 
 
 
Cash and cash equivalents at end of period
$
290.7

 
$
371.8

Restricted cash included in other assets at end of period
18.5

 
18.2

Cash, cash equivalents and restricted cash at end of period
$
309.2

 
$
390.0


See Notes to Condensed Consolidated Financial Statements.



5




MALLINCKRODT PLC
CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(unaudited, in millions)
 
 
Ordinary Shares
 
Treasury Shares
 
Additional
Paid-In Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Loss
 
Total
Shareholders'
Equity
 
Number
 
Par
 Value
 
Number
 
Amount
 
 
Balance at December 29, 2017
92.2

 
$
18.4

 
5.9

 
$
(1,564.7
)
 
$
5,492.6

 
$
2,588.6

 
$
(12.9
)
 
$
6,522.0

Impact of accounting standard adoptions, net of tax

 

 

 

 

 
2.6

 
(1.5
)
 
1.1

Net income

 

 

 

 

 
111.4

 

 
111.4

Currency translation adjustments

 

 

 

 

 

 
(4.1
)
 
(4.1
)
Change in derivatives, net of tax

 

 

 

 

 

 
0.7

 
0.7

Change in benefit plans, net of tax

 

 

 

 

 

 
(0.9
)
 
(0.9
)
Vesting of restricted shares
0.5

 
0.1

 
0.1

 
(2.2
)
 
0.8

 

 

 
(1.3
)
Share-based compensation

 

 

 

 
27.9

 

 

 
27.9

Reissuance of treasury shares

 

 
(0.2
)
 
3.6

 

 
(1.6
)
 

 
2.0

Repurchase of shares

 

 
3.6

 
(55.2
)
 

 

 

 
(55.2
)
Balance at September 28, 2018
92.7

 
$
18.5

 
9.4

 
$
(1,618.5
)
 
$
5,521.3

 
$
2,701.0

 
$
(18.7
)
 
$
6,603.6

 
See Notes to Condensed Consolidated Financial Statements.


6




MALLINCKRODT PLC
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited, dollars in millions, except share data, per share data and where indicated)

1.
Background and Basis of Presentation
Background
Mallinckrodt plc and its subsidiaries (collectively, "Mallinckrodt" or "the Company") is a global business that develops, manufactures, markets and distributes specialty pharmaceutical products and therapies.
On February 22, 2018, the Company's Board of Directors authorized commencement of a process to dispose of (1) its Specialty Generics business comprised of the previously reported Specialty Generics segment, with the exception of BioVectra, Inc. - a wholly-owned subsidiary of the Company that operates a contract manufacturing business in Canada ("BioVectra"), (2) certain of its non-promoted brands business, which was previously reflected in the Specialty Brands segment; and (3) its ongoing, post-divestiture supply agreement with the acquirer of the contrast media and delivery systems ("CMDS") business, which was previously reflected in the Other non-operating segment (referred to collectively as the "Specialty Generics Disposal Group"). The Company evaluated the criteria prescribed by United States ("U.S.") Generally Accepted Accounting Principles ("GAAP") for recording a disposal group as held for sale and discontinued operations. This criteria was met during the three months ended March 30, 2018, and as a result, prior year balances have been recast to present the financial results of the disposal group as a discontinued operation.
As the Specialty Generics Disposal Group is reported as a discontinued operation, the Company's continuing operations are limited to the results of operations from the Specialty Brands segment. The Specialty Brands segment markets branded pharmaceutical products for autoimmune and rare diseases in the specialty areas of neurology, rheumatology, nephrology, ophthalmology and pulmonology; immunotherapy and neonatal respiratory critical care therapies, analgesics and gastrointestinal products. The Company's diversified, in-line portfolio of both marketed and development products is focused on patients with significant unmet medical needs.
The Company owns or has rights to use the trademarks and trade names that are used in conjunction with the operation of its business. One of the more important trademarks that the Company owns or has rights to use that appears in this Quarterly Report on Form 10-Q is "Mallinckrodt," which is a registered trademark or the subject of pending trademark applications in the U.S. and other jurisdictions. Solely for convenience, the Company only uses the ™ or ® symbols the first time any trademark or trade name is mentioned in the following notes. Such references are not intended to indicate in any way that the Company will not assert, to the fullest extent permitted under applicable law, its rights to its trademarks and trade names. Each trademark or trade name of any other company appearing in the following notes is, to the Company's knowledge, owned by such other company.

Basis of Presentation
The unaudited condensed consolidated financial statements have been prepared in U.S. dollars and in accordance with GAAP. The preparation of the unaudited condensed 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. Actual results may differ from those estimates. The unaudited condensed consolidated financial statements include the accounts of the Company, its wholly-owned subsidiaries and entities in which they own or control more than 50% of the voting shares, or have the ability to control through similar rights. All intercompany balances and transactions have been eliminated in consolidation and all normal recurring adjustments necessary for a fair presentation have been included in the results reported. The results of entities disposed of are included in the unaudited condensed consolidated financial statements up to the date of disposal, and where appropriate, these operations have been reported in discontinued operations. Divestitures of product lines and businesses not meeting the criteria for discontinued operations have been reflected in operating income. The fiscal year end balance sheet data was derived from audited consolidated financial statements, but do not include all of the annual disclosures required by GAAP; accordingly these unaudited condensed consolidated financial statements should be read in conjunction with the Company's audited annual consolidated financial statements included in its Annual Report on Form 10-K for the period ended December 29, 2017 filed with the Securities and Exchange Commission ("SEC") on February 27, 2018.

Fiscal Year
The Company reports its results based on a "52-53 week" year ending on the last Friday of December. Unless otherwise indicated, the three and nine months ended September 28, 2018 refers to the thirteen and thirty-nine week periods ended September 28, 2018 and the three and nine months ended September 29, 2017 refers to the thirteen and thirty-nine week periods ended September 29, 2017.


7




2.
Recently Issued Accounting Standards
Adopted
The Financial Accounting Standards Board ("FASB") issued Accounting Standard Update ("ASU") 2018-05, "Income Taxes (Topic 740): Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 118 (SEC Update)," in March 2018. This update adds SEC paragraphs pursuant to the SEC's Staff Accounting Bulletin ("SAB") 118, which provides guidance on accounting for the tax effects of the Tax Cuts and Jobs Act ("TCJA") that was enacted in December 2017. SAB 118 provides a measurement period that should not extend beyond one year from the TCJA enactment date for companies to complete their accounting for the tax effects of the TCJA. The amendments are effective upon addition to the FASB Accounting Standards Codification ("ASC"). The Company adopted this guidance in fiscal 2018. See Note 7 for additional details of the Company's assessment of impact of this adoption.
The FASB issued ASU 2017-09, "Compensation - Stock Compensation: Scope of Modification Accounting," in May 2017. Under the new guidance, the effects of a modification should be accounted for unless all of the following are met: (1) the fair value or calculated intrinsic value of the modified award is the same as the fair value of the original award immediately before the original award is modified; (2) the vesting conditions of the modified award are the same as the vesting conditions of the original award immediately before the original award is modified; and (3) the classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified. The Company adopted this standard in fiscal 2018 and will apply this standard to prospective modifications. The adoption of this guidance did not result in any material changes to the unaudited condensed consolidated financial statements.
The FASB issued ASU 2017-07, "Compensation - Retirement Benefits: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Post Retirement Benefit Cost," in March 2017. This update requires that the service cost component be disaggregated from the other components of net benefit cost. Service cost should be reported in the same line item or items as other compensation costs arising from services rendered by pertinent employees during the period. The other components of net benefit cost should be presented in the income statement separately from the service cost component and outside a subtotal of income from operations, if one is presented. The Company adopted this guidance in fiscal 2018 which required retroactive application resulting in the reclassification of $72.4 million of other components of net benefit costs to other income (expense), net for the nine months ended September 29, 2017 from selling, general and administrative expenses ("SG&A") of $70.8 million, cost of sales of $1.2 million, and research and development expenses ("R&D") of $0.4 million. The adoption of this guidance did not result in any material changes to the unaudited condensed consolidated financial statements.
The FASB issued ASU 2017-01, "Business Combinations (Topic 805): Clarifying the Definition of a Business," in January 2017. This update provides a screen to determine whether or not a set of assets is a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset or a group of similar identifiable assets, the set of assets is not a business. If the screen is not met, the amendments in this update require that (1) to be considered a business, a set of assets must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create output and (2) remove the evaluation of whether a market participant could replace missing elements. The Company adopted this guidance in fiscal 2018, which did not have a material impact to the unaudited condensed consolidated financial statements.
The FASB issued ASU 2016-01, "Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities," in January 2016. This update addresses certain aspects of recognition, measurement, presentation and disclosure of financial instruments. Under the new guidance, equity investments, other than equity method investments, are to be measured at fair value with changes in fair value recognized through net income. The Company adopted this guidance in fiscal 2018, resulting in a $1.5 million increase to beginning retained earnings with an offsetting decrease to accumulated other comprehensive loss relating to the unrealized gain on its investment in Mesoblast Limited ("Mesoblast"). The adoption of this standard did not result in any material changes to the unaudited condensed consolidated financial statements.

The FASB issued ASU 2014-09, "Revenue from Contracts with Customers," in May 2014. The issuance of ASU 2014-09 and International Financial Reporting Standards ("IFRS") 15, "Revenue from Contracts with Customers," completes the joint effort by the FASB and the International Accounting Standards Board to clarify the principles for recognizing revenue and develop a common revenue standard for GAAP and IFRS. Under the new guidance, an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services, applying the following steps: (1) identify the contract(s) with a customer; (2) identify the performance obligations in the contract(s); (3) determine the transaction price; (4) allocate the transaction price to the performance obligations in the contract(s); and (5) recognize revenue when (or as) the entity satisfies a performance obligation. The FASB subsequently issued additional ASUs to clarify the guidance in ASU 2014-09. The additional ASUs issued include ASU 2016-08, "Revenue from Contracts with Customers;" ASU 2016-10 "Revenue from Contracts with Customers, Identifying Performance Obligations and Licensing;" and ASU 2016-12, "Narrow-Scope Improvements and Practical Expedients."


8




The Company adopted ASU 2014-09 and its related amendments (collectively known as "ASC 606") effective on December 30, 2017 using the modified retrospective transition approach. The adoption of ASC 606 represents a change in accounting principle that more closely aligns revenue recognition with the delivery of the Company's products and will provide financial statement readers with enhanced disclosures, which have been included in Note 3. The cumulative effect of applying the new standard to contracts not completed at December 30, 2017 was recorded as a $1.1 million increase, net of tax, to beginning retained earnings. The prior periods were not restated. The adoption of this standard did not result in any material changes to the unaudited condensed consolidated financial statements.

Not Yet Adopted
The FASB issued ASU 2018-15, "Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract," in August 2018. This update aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The amendments in this update also require the entity (customer) to expense the capitalized implementation costs of a hosting arrangement that is a service contract over the term of the hosting arrangement. Upon adoption, the update will be applied either retrospectively or prospectively to all implementation costs incurred after the date of adoption. This guidance is effective for the Company in the first quarter of fiscal 2020; however, early adoption is permitted. The Company is currently assessing the impact of this guidance on the unaudited condensed consolidated financial statements.
The FASB issued ASU 2016-02, "Leases," in February 2016. This update was issued to increase transparency and comparability among organizations by recognizing all lease transactions (with terms in excess of 12 months) on the balance sheet as a lease liability and a right-of-use asset (as defined under ASU 2016-02). This guidance is effective for the Company in the first quarter of fiscal 2019. The FASB subsequently issued additional ASUs to clarify the guidance in ASU 2016-02. The ASUs include ASU 2018-10, "Codification Improvements to Topic 842, Leases" and ASU 2018-11 "Leases, (Topic 842), Targeted Improvements." The Company currently expects to utilize the additional transition approach as provided under ASU 2018-11, which allows for the initial application of the new leasing standard at the adoption date (day 1 of fiscal 2019) with a cumulative-effect adjustment to the opening balance of retained earnings. The Company has identified its population of lease agreements and is currently assessing other arrangements such as supply and service agreements for embedded leases. Although the Company is in the process of determining the potential impact on its consolidated financial statements, it anticipates that the most significant change will be related to the Company recording additional assets and corresponding liabilities on the balance sheet for operating leases. The ultimate impact of the new standard will depend on the total amount of the Company's lease commitments as of the adoption date.

3.
Revenue from Contracts with Customers
Product Sales Revenue

The Company sells its products through distributors who resell the products to institutions and end user customers, while certain products are sold and distributed directly to hospitals. The Company also enters into arrangements with indirect customers, such as health care providers and payers, to establish contract pricing for certain products that provide for government-mandated and/or privately-negotiated rebates, chargebacks and discounts with respect to the purchase of the Company's products.
 
Reserves for variable consideration
 
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 the Company and its customers, health care providers and payers relating to the Company's sales of its 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 which are probability-weighted for relevant factors such as the Company's historical experience, estimated future trends, estimated customer inventory levels, current contracted sales terms with customers, level of utilization of the Company's products and other competitive factors. Overall, these reserves reflect the Company's best estimates of the amount of consideration to which it is entitled based on the terms of the contract. The amount of variable consideration 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. The Company adjusts reserves for rebates, chargebacks, 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.  

9





The following table reflects activity in the Company's sales reserve accounts, on a continuing operations basis:
 
Rebates and Chargebacks
 
Product Returns
 
Other Sales Deductions
 
Total
Balance at December 29, 2017
$
60.3

 
$
4.1

 
$
1.1

 
$
65.5

Provisions
221.2

 
6.6

 
7.4

 
235.2

Payments or credits
(205.8
)
 
(5.9
)
 
(7.4
)
 
(219.1
)
Balance at September 28, 2018
$
75.7

 
$
4.8

 
$
1.1

 
$
81.6



 See Note 19 for presentation of the Company's net sales by product family.

Product sales are recognized when the customer obtains control of the Company's product. Control is transferred either at a point in time, generally upon delivery to the customer site, or in the case of certain of the Company's 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 the Company's determination of the measure that best aligns with how the obligation is satisfied. The Company's considerations of why such measures provide a faithful depiction of the transfer of its products are as follows:

For those contracts whereby revenue is recognized over time based upon consumption of the product, the Company either has:
1)
the right to invoice the customer in an amount that directly corresponds with the value to the customer of the Company's performance to date, for which the practical expedient to recognize revenue 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 the Company's product does not vary, regardless of consumption. As a result, the Company's obligation diminishes with the passage of time; therefore, it was determined that ratable recognition of the transaction price over the contract period is the measure that best aligns with how the obligation is satisfied.

Product sales transferred to customers at a point in time and over time are as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 28,
2018
 
September 28,
2018
Product sales transferred at a point in time
78.9
%
 
77.9
%
Product sales transferred over time
21.1
%
 
22.1
%


Transaction price allocated to the remaining performance obligations

The majority of the Company's contracts (as defined under ASC 606) are less than one year; therefore, the related disclosure of the amount of transaction price allocated to the performance obligations that are unsatisfied at period end has been omitted, with the exception of those noted below. The following table includes estimated revenue from certain of the Company's products that are expected to be recognized in the future related to performance obligations that are unsatisfied or partially unsatisfied at September 28, 2018:
Remainder of Fiscal 2018
$
71.7

Fiscal 2019
135.3

Fiscal 2020
118.6

Fiscal 2021
23.9

Thereafter
3.2



Costs to obtain a contract

As the majority of the Company's 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 expenses. For contracts that extend beyond one year, the incremental expense recognition matches the recognition of related revenue and therefore, no costs to obtain a contract were capitalized upon adoption of ASC 606.

10





Costs to fulfill a contract

The Company capitalizes the costs associated with the devices used in the Company's portfolio of drug-device combination products, which are used in satisfaction of future performance obligations. Capital expenditures for these devices represent cash outflows for the Company's cost to produce the asset, which is classified in property, plant and equipment, net on the unaudited condensed consolidated balance sheet and expensed to cost of sales over the useful life of the equipment. As of September 28, 2018, the total net book value of these devices was $27.6 million. The associated depreciation expense recognized during the nine months ended September 28, 2018 was $8.5 million.

Product Royalty Revenues
 
In relation to the Company's acquisition of Sucampo Pharmaceuticals, Inc. on February 13, 2018, as discussed in further detail in Note 5, it acquired an arrangement under which the Company licenses certain rights to Amitiza® (lubiprostone) ("Amitiza") to a third party in exchange for royalties on net sales of the product. The Company recognizes such royalty revenue as the related sales occur. The associated royalty revenue recognized during the three and nine months ended September 28, 2018 was $22.5 million and $52.1 million, respectively.

Contract Balances

Accounts receivable are recorded when the right to consideration becomes unconditional. Payments received from customers are typically based upon payment terms of 30 days. The Company does not maintain contract asset balances aside from the accounts receivable balance presented on the unaudited condensed consolidated balance sheet as costs to obtain a contract are expensed when incurred and the amortization period would have been less than one year. These costs are recorded within SG&A expenses.
Contract liabilities are recorded when cash payments are received in advance of the Company's performance, including amounts which are refundable. Contract liabilities as of September 28, 2018 and December 29, 2017 were as follows:
 
September 28,
2018
 
December 29,
2017
Accrued and other current liabilities
$
21.2

 
$
13.9

Other liabilities
14.0

 
6.3

Contract liabilities
$
35.2

 
$
20.2


Revenue recognized during the nine months ended September 28, 2018 from amounts included in contract liabilities at the beginning of the period was approximately $14.9 million.

4.
Discontinued Operations and Divestitures
Discontinued Operations
Specialty Generics Disposal Group: On February 22, 2018, the Specialty Generics Disposal Group met the criteria for held for sale classification and discontinued operation presentation upon commencement of a process to dispose of the group.

11




The following table summarizes the financial results of the Specialty Generics Disposal Group presented in the unaudited condensed consolidated statements of income:
 
Three Months Ended
 
Nine Months Ended
 
September 28,
2018
 
September 29,
2017
 
September 28,
2018
 
September 29,
2017
Major line items constituting income from discontinued operations:
 
 
 
 
 
 
 
Net sales
$
159.9

 
$
193.3

 
$
536.4

 
$
668.6

Cost of sales
107.3

 
125.3

 
336.1

 
384.5

Selling, general and administrative expenses
29.4

 
19.3

 
73.8

 
56.6

Research and development expenses
7.6

 
12.6

 
36.8

 
46.3

Restructuring charges, net
0.1

 
(1.1
)
 
5.3

 
5.8

Non-restructuring impairment charges
2.0

 

 
2.0

 

Other income, net

 
0.6

 
0.3

 
4.4

Income from discontinued operations
13.5

 
37.8

 
82.7

 
179.8

Income tax expense
2.3

 
26.6

 
18.1

 
42.6

Income from discontinued operations, net of income taxes
$
11.2

 
$
11.2

 
$
64.6

 
$
137.2



The following table summarizes the assets and liabilities of the Specialty Generics Disposal Group that are classified as held for sale on the unaudited condensed consolidated balance sheets:
 
September 28,
2018
 
December 29, 2017
Carrying amounts of major classes of assets included as part of discontinued operations:
 
 
 
Accounts receivable
$
189.0

 
$
170.4

Inventories
205.9

 
211.7

Property, plant and equipment, net
561.7

 
553.6

Intangible assets, net
110.3

 
114.0

Other current and non-current assets
69.9

 
84.5

Total assets classified as held for sale in the balance sheet
$
1,136.8

 
$
1,134.2

 
 
 
 
Carrying amounts of major classes of liabilities included as part of discontinued operations:
 
 
 
Accounts payable
$
39.0

 
$
36.0

Other current and non-current liabilities
143.4

 
126.6

Total liabilities classified as held for sale in the balance sheet
$
182.4

 
$
162.6



The following table summarizes significant cash and non-cash transactions of the Specialty Generics Disposal Group that are included within the unaudited condensed consolidated statements of cash flows for the respective periods:
 
Three Months Ended
 
Nine Months Ended
 
September 28,
2018
 
September 29,
2017
 
September 28,
2018
 
September 29,
2017
Depreciation, including accelerated depreciation
$
0.6

 
$
15.3

 
$
12.1

 
$
45.7

Amortization

 
3.9

 
1.7

 
14.6

Capital expenditures
5.9

 
11.1

 
21.7

 
41.7


All other notes to the unaudited condensed consolidated financial statements that were impacted by this discontinued operation have been reclassified accordingly.

Nuclear Imaging: On January 27, 2017, the Company completed the sale of its Nuclear Imaging business to IBA Molecular ("IBAM") for approximately $690.0 million before tax impacts, including up-front consideration of approximately $574.0 million, up to $77.0 million of contingent consideration and the assumption of certain liabilities. The Company recorded a pre-tax gain on the sale

12




of the Nuclear Imaging business of $362.8 million during the nine months ended September 29, 2017, which excluded any potential proceeds from the contingent consideration and reflects a charge of $0.6 million during the three months ended September 29, 2017 primarily as a result of ongoing working capital adjustments associated with the purchase agreement. During the nine months ended September 28, 2018 the Company received a total of $15.0 million in contingent consideration related to the sale of the Nuclear Imaging business, consisting of a $6.0 million cash payment and the issuance of $9.0 million par value non-voting preferred equity certificates. The preferred equity certificates accrue interest at a rate of 10.0% per annum and are redeemable on the retirement date of July 27, 2025, or earlier if elected by the issuer, for cash at a price equal to the par value and any accrued but unpaid interest. The Company recorded tax expense of $1.5 million associated with the $6.0 million contingent consideration cash payment. The $9.0 million in preferred equity certificates is presented as a non-cash investing activity on the unaudited condensed consolidated statement of cash flows. The $13.5 million of contingent consideration received, net of tax, was recorded as income from discontinued operations.
The following table summarizes the financial results of the Nuclear Imaging business presented in the unaudited condensed consolidated statements of income:
 
Three Months Ended
 
Nine Months Ended
 
September 29,
2017
 
September 29,
2017
Major line items constituting income from discontinued operations:
 
 
 
Net sales
$

 
$
31.6

Cost of sales

 
15.6

Selling, general and administrative expenses

 
7.8

Other

 
(0.2
)
Income from discontinued operations

 
8.4

(Loss) gain on divestiture of discontinued operations
(0.6
)
 
362.8

(Loss) income from discontinued operations, before income taxes
(0.6
)
 
371.2

Income tax (benefit) expense
(0.1
)
 
5.2

(Loss) income from discontinued operations, net of income taxes
$
(0.5
)
 
$
366.0


During the three months ended September 29, 2017, there was income tax benefit of $0.1 million associated with the $0.6 million loss recognized on divestiture. During the nine months ended September 29, 2017, there was income tax expense of $0.9 million associated with the $362.8 million gain on divestiture and a $4.3 million income tax expense associated with the $8.4 million income from discontinued operations. The tax impact of the gain recognized on divestiture was favorably impacted by a benefit from permanently deductible items.
The Company incurred $0.3 million of capital expenditures related to the Nuclear Imaging business that are included within the unaudited condensed consolidated statements of cash flows for the nine months ended September 29, 2017.
All other notes to the unaudited condensed consolidated financial statements that were impacted by this discontinued operation have been reclassified accordingly.

Divestitures
PreveLeak/Recothrom: On March 16, 2018, the Company completed the sale of a portion of its Hemostasis business, inclusive of its PreveLeak™ Surgical Sealant ("PreveLeak") and RECOTHROM® Thrombin topical (Recombinant) ("Recothrom") products to Baxter International, Inc. ("Baxter") for approximately $185.0 million, with a base payment of $153.0 million, inclusive of existing inventory and subject to a closing inventory adjustment, with the remainder in potential future milestones. Baxter assumed other expenses, including contingent liabilities associated with PreveLeak. During the nine months ended September 28, 2018, the Company recorded a pre-tax loss on the sale of $0.6 million, which excluded any potential proceeds from the attainment of future milestones and reflected a post-sale closing inventory adjustment of $13.7 million. The financial results of the PreveLeak and Recothrom operations are presented within continuing operations as this divestiture did not meet the criteria for discontinued operations presentation.
As part of the divestiture and calculation of the gain, the Company wrote off intangible assets of $49.9 million and goodwill of $51.5 million, from the Specialty Brands segment, ascribed to the PreveLeak and Recothrom operations. The remaining items included in the loss calculation are primarily attributable to inventory transferred, contingent consideration transferred and transaction costs incurred by the Company.


13




Intrathecal Therapy: On March 17, 2017, the Company completed the sale of its Intrathecal Therapy business to Piramal Enterprises Limited's subsidiary in the United Kingdom ("U.K."), Piramal Critical Care ("Piramal"), for approximately $203.0 million, including fixed consideration of $171.0 million and contingent consideration of up to $32.0 million. The $171.0 million of fixed consideration consisted of $17.0 million received at closing and a $154.0 million note receivable that was due one year from the transaction closing date. During the nine months ended September 29, 2017, the Company recorded a pre-tax gain on the sale of the business of $56.6 million, which excluded any potential proceeds from the contingent consideration and reflects a post-sale adjustment of $0.4 million during the three months ended September 29, 2017. On February 28, 2018, the Company received $154.0 million from Piramal for the settlement of the aforementioned note receivable. The financial results of the Intrathecal Therapy business are presented within continuing operations as this divestiture did not meet the criteria for discontinued operations presentation.
As part of the divestiture and calculation of the gain, the Company wrote off intangible assets of $48.7 million and goodwill of $49.8 million, from the Specialty Brands segment, ascribed to the Intrathecal Therapy business. The Company is committed to reimburse up to $7.3 million of product development expenses incurred by Piramal, of which $3.1 million was included in accrued and other current liabilities on the unaudited condensed consolidated balance sheet as of September 28, 2018. The remaining items included in the gain calculation are attributable to inventory transferred and transaction costs incurred by the Company.

5.
Acquisitions

Sucampo Pharmaceuticals, Inc.
On February 13, 2018, the Company acquired Sucampo Pharmaceuticals, Inc. ("Sucampo") through the acquisition of all the outstanding common stock of Sucampo. Consideration for the transaction consisted of approximately $1.2 billion, including the assumption of Sucampo's third-party debt ("the Sucampo Acquisition"). The acquisition was funded through the issuance of $600.0 million aggregate principal amount of senior secured notes, a $900.0 million borrowing under the Company's revolving credit facility, as discussed further in Note 12, and cash on hand. Sucampo's commercialized products include Amitiza, a leading global product in the branded constipation market, and Rescula® (unoprostone isopropyl ophthalmic solution) 0.15% ("Rescula"), which is indicated for ocular hypertension and open-angle glaucoma, and marketed solely in Japan. Through this acquisition, the Company acquired VTS-270, a Phase 3 development product for Niemann-Pick Type C, a rare, neurodegenerative and ultimately fatal disease that can present at any age. Also acquired was an option to exercise a collaborative agreement with Cancer Prevention Pharmaceuticals ("CPP") associated with the development of CPP-1X/sulindac, a Phase 3 development product for Familial Adenomatous Polyposis ("FAP").
Upon completion of the Sucampo Acquisition, Sucampo's 3.25% convertible senior notes due 2021 ("the Sucampo Notes") became eligible to receive increased consideration in conjunction with a make-whole fundamental change, such that each $1,000 principal face amount of Sucampo Notes could be converted into $1,221 in cash. As of September 28, 2018, the issued convertible debt of $300.0 million had been converted and paid in full by the Company.

Fair value allocation
The following amounts represent the preliminary allocations of the fair value of the identifiable assets acquired and liabilities assumed for the Sucampo Acquisition, including preliminary goodwill, intangible assets and the related deferred tax balances. The Company expects to complete its valuation analysis and finalize deferred tax balances as of the acquisition date no later than twelve months from the date of the acquisition. The changes in the purchase price allocation and preliminary goodwill based on the final valuation may include, but are not limited to, finalization of working capital settlements, the impact of U.S. state tax rates in determining the deferred tax balances and changes in assumptions utilized in the preliminary valuation report.

14




Cash and cash equivalents
$
149.6

Accounts receivable
35.7

Inventory
153.2

Intangible assets
919.5

Goodwill
244.7

Other current and non-current assets
25.9

Total assets acquired
1,528.6

Current liabilities
108.3

Deferred tax liabilities, net (non-current)
170.2

Debt
366.3

Other noncurrent liabilities
36.2

Total liabilities assumed
681.0

Net assets acquired
$
847.6



The following is a reconciliation of the total consideration to net assets acquired:
Total consideration, net of cash
$
698.0

Plus: cash assumed in acquisition
149.6

Total consideration/net assets acquired
$
847.6



Intangible assets acquired consist of the following:
 
 
Amount
 
Amortization Period
 
Discount Rate
Completed technology - Amitiza
 
$
634.0

 
9 years
 
14.0%
Completed technology - Rescula
 
11.0

 
8 years
 
14.0%
In-process research and development - VTS-270
 
274.5

 
Non-Amortizable
 
15.0%

The fair value of the completed technology and in-process research and development ("IPR&D") was determined using the income approach, which is a valuation technique that provides an estimate of fair value of the assets based on the market participant expectations of cash flows the asset would generate. The cash flows were discounted commensurate with the level of risk associated with each asset or its projected cash flows. The discount rates were developed after assigning a probability of success to achieving the projected cash flows based on the current stage of development, inherent uncertainty in the U.S. Food and Drug Administration ("FDA") approval process and risks associated with commercialization of a new product. Based on the Company's preliminary estimate, the excess of purchase price over net tangible and intangible assets acquired resulted in goodwill, which represents future product development, the assembled workforce, and the tax status of the transaction. The goodwill is not deductible for U.S. income tax purposes. All assets acquired are included within the Company's Specialty Brands segment.

Financial results - The amount of net sales and loss included in the Company's results for the periods presented were as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 28,
2018
 
September 29,
2017
 
September 28,
2018
 
September 29,
2017
Net sales
$
50.7

 
$

 
$
124.5

 
$

Operating loss
(32.2
)
 

 
(99.9
)
 




The following was included within cost of sales for the periods presented:
 
Three Months Ended
 
Nine Months Ended
 
September 28,
2018
 
September 29,
2017
 
September 28,
2018
 
September 29,
2017
Intangible asset amortization
$
18.0

 
$

 
$
45.0

 
$

Inventory fair value step-up expense
31.0

 

 
77.5

 



Acquisition-related costs incurred for the acquisition of $3.2 million were recognized during the nine months ended September 28, 2018.

15





Licenses
On April 5, 2018 (the "Exercise Date"), the Company exercised the option under its collaborative agreement with CPP to negotiate terms of an exclusive license to develop and commercialize CPP-1X/sulindac in North America. In addition, the Company provided CPP with a $10.0 million upfront R&D payment for expenses related to the FAP pivotal trial incurred during the "Negotiation Period," or the period from the Exercise Date through the execution of such license agreement. CPP shall return to the Company any portion of the R&D payment that is not utilized during the Negotiation Period. Of the $10.0 million upfront payment, $7.3 million was utilized during the nine months ended September 28, 2018 and recorded as R&D expense within the condensed consolidated statement of income. The remaining $2.7 million was included in prepaid expenses and other current assets on the unaudited condensed consolidated balance sheet as of September 28, 2018.
On August 4, 2018, the license agreement with CPP was executed and the Company paid $5.0