Perrigo Company plc (formerly known as Perrigo Company Limited, and prior thereto,
Blisfont Limited) ("Perrigo" or "the Company"), was incorporated under the laws of Irelandon June 28, 2013, and became the successor registrant of Perrigo Company on December 18, 2013in connection with the consummation of the acquisition of Elan Corporation, plc ("Elan"), which is discussed further in Note 2 to the Notes to the Consolidated Statements. From its beginnings as a small local proprietor selling medicinals to regional grocers in 1887, Perrigo has evolved into a leading global pharmaceutical company that manufactures and distributes more than 47 billion oral solid doses and more than two billion liquid doses, as well as dozens of other product dosage forms, each year. The Company's mission is to offer "Quality Affordable Healthcare Products®", and it does so across a wide variety of product categories primarily in the U.S., United Kingdom, Mexico, Israeland Australia, as well as many other key markets worldwide, including Canada, Chinaand Latin America. The Company's fiscal year is a 52- or 53-week period, which ends the Saturday on or about June 30. An extra week is required approximately every six years in order to re-align the Company's fiscal reporting dates with the actual calendar months. Fiscal years 2014 and 2013 were comprised of 52 weeks and ended on June 28, 2014and June 29, 2013, respectively. Fiscal year 2012 was 53 weeks and ended June 30, 2012. Using a weekly average, the extra week of operations in fiscal 2012 is estimated to have contributed approximately 2% in net sales. This factor should be considered when comparing the Company's fiscal 2014 and 2013 financial results with the Company's fiscal 2012 financial results. Segments - The Company has five reportable segments, aligned primarily by type of product: Consumer Healthcare, Nutritionals, Rx Pharmaceuticals, API, and Specialty Sciences. In addition, the Company has an Other category that consists of the Israel Pharmaceutical and Diagnostic Products operating segment, which does not individually meet the quantitative thresholds required to be a separately reportable segment.
marketer and manufacturer of over-the-counter ("OTC") pharmaceutical
products. Major product categories include analgesics,
cough/cold/allergy/sinus, gastrointestinal, smoking cessation, animal
health, and secondary product categories include feminine hygiene, diabetes care and dermatological care. The CHC business markets products that are comparable in quality and effectiveness to national brand products. The cost to the retailer of a store brand product is significantly lower than that of a comparable nationally advertised brand-name product. Generally, the retailers' dollar profit per unit of store brand product is greater than the dollar profit per unit of the comparable national brand product. The retailer, 57 -------------------------------------------------------------------------------- therefore, can price a store brand product below the competing national brand product and realize a greater profit margin. The consumer benefits by receiving a high quality product at a price below the comparable national brand product. Therefore, the Company's business model saves consumers on their healthcare spending. The Company, one of the original architects of private label pharmaceuticals, is the market leader for consumer healthcare products in many of the geographies where it currently competes - the U.S.,
U.K., and Mexico- and is developing its position in Australia. The Company's market share of OTC store brand products has grown in recent years as new products, retailer efforts to increase consumer education and awareness, and economic conditions have directed consumers to the value of store brand product offerings.
• The Nutritionals segment develops, manufactures, markets and distributes
store brand infant and toddler formula products, infant and toddler foods,
and vitamin, mineral and dietary supplement ("VMS") products to retailers,
distributors and consumers primarily in the U.S.,
store brand products that are comparable in quality and formulation to the
national brand products. The cost to the retailer of a store brand product
is significantly lower than that of a comparable nationally advertised
brand-name product. The retailer, therefore, can price a store brand
product below the competing national brand product yet realize a greater
profit margin. All infant formulas sold in the U.S. are subject to the
same regulations governing manufacturing and ingredients under the Infant
Formula Act of 1980, as amended. Store brands, which offer substantial
savings to consumers, must meet the same
("FDA") requirements as the national brands. Substantially all products
are developed using ingredients and formulas comparable to those of
national brand products. In most instances, packaging is designed to
increase visibility of store brand products and to invite and reinforce
comparison to national brand products in order to communicate store brand value to the consumer. •
The Rx Pharmaceuticalssegment develops, manufactures and markets a portfolio of generic prescription ("Rx") drugs primarily for the U.S.
market. The Company defines this portfolio as predominantly "extended
topical" and "specialty" as it encompasses a broad array of topical dosage
forms such as creams, ointments, lotions, gels, shampoos, foams, suppositories, sprays, liquids, suspensions, solutions and powders. The portfolio also includes select controlled substances, injectables, hormones, oral solid dosage forms and oral liquid formulations. The
strategy in the
with those new products that are exposed to less competition because they
have formulations that are more difficult and costly to develop and launch
(e.g., extended topicals, specialty solutions or products containing
controlled substances). In addition, the
OTC products through the prescription channel (referred to as "ORx®"
marketing). ORx® products are OTC products available for pharmacy
fulfillment and healthcare reimbursement when prescribed by a physician.
The Company offers over 100 ORx® products that are reimbursable through
many health plans and
• The API segment develops, manufactures and markets active pharmaceutical
ingredients ("API") used worldwide by the generic drug industry and
branded pharmaceutical companies. The API business identifies APIs
critical to its pharmaceutical customers' future product launches and then
works closely with these customers on the development processes. API development is focused on the synthesis of less common molecules for the U.S., European and other international markets. The Company is also
focusing development activities on the synthesis of molecules for use in
its own OTC and Rx pipeline products. This segment is undergoing a
strategic platform transformation, moving certain production from
to the acquired API manufacturing facility in
cost production and to create space for other, more complex production in
• As a result of the Elan acquisition, the Company expanded its operating
segments to include the Specialty Sciences segment, which is comprised of
assets focused on the treatment of Multiple Sclerosis (Tysabri®). The
Company is entitled to royalty payments from Biogen Idec Inc. ("Biogen")
based on its Tysabri® revenues in all indications and geographies.
In addition to general management and strategic leadership, each business segment has its own sales and marketing teams focused on servicing the specific requirements of its customer base. Each of these business segments share Research & Development, Supply Chain, Information Technology, Finance, Human Resources, Legal and Quality services. 58 -------------------------------------------------------------------------------- Principles of Consolidation - The consolidated financial statements include the accounts of the Company and all majority-owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation.
Fiscal Year Ended Percentage Change ($ in millions) June 28, 2014 June 29, 2013 June 30, 2012 2014/2013 2013/2012 Net sales
$ 4,060.8 $ 3,539.8 $ 3,173.215 % 12 % Gross profit $ 1,447.7 $ 1,280.0 $ 1,095.613 % 17 % Gross profit % 35.7 % 36.2 % 34.5 % Operating expenses $ 880.7 $ 600.9 $ 526.447 % 14 % Operating expenses % 21.7 % 17.0 % 16.6 % Operating income $ 567.0 $ 679.1 $ 569.2(17 )% 19 % Operating income % 14.0 % 19.2 % 17.9 % Interest and other, net $ 294.4$ 71.4 $ 57.2 312 % 25 % Income taxes $ 67.3 $ 165.8 $ 119.0(59 )% 39 % Income from continuing operations $ 205.3 $ 441.9 $ 393.0(54 )% 12 % Net income $ 205.3 $ 441.9 $ 401.6(54 )% 10 %
Net sales • Fiscal 2014 net sales increased
new product sales of
$231.4 million. • Fiscal 2013 net sales increased $366.6 millionover fiscal 2012 due
new product sales of
Gross profit • Fiscal 2014 gross profit increased
with the net sales increase. As a percent of sales, gross profit decreased
due primarily to increased amortization expense associated with the Tysabri® intangible asset acquired during fiscal 2014.
• Fiscal 2013 gross profit increased
with the net sales increase. Fiscal 2013 gross profit was negatively
impacted by charges of
inventory acquired and sold during the year in connection with acquisitions.
Operating expenses • Fiscal 2014 operating expenses increased over fiscal 2013 due primarily to
$108.9 millionof transaction costs incurred in connection with the Elan acquisition, $47.0 millionof restructuring expense and an increase of $37.3 millionrelated to research and development expenses incurred in accordance with the Company's strategy. • Fiscal 2013 operating expenses increased over fiscal 2012 due to incremental expenses attributable to acquisitions, charges of $12.4 millionrelated to acquisition and other integration-related costs, and a $9.0 millionimpairment charge related to an in-process research and development asset ("IPR&D"). Interest and other, net • Fiscal 2014 interest and other, net increased over fiscal 2013 due
primarily to the
former debt arrangements and issuing new debt. • Fiscal 2013 interest and other, net increased over fiscal 2012 due to
incremental interest expense on new debt issuances and a
on the sale of investment securities.
Further details related to current year results, including results by segment, are included below under Results of Operations.
Performance Evaluation Criteria
The Company's management evaluates business performance using a Return on
Invested Capital("ROIC") metric. This includes evaluating performance of business segments, manufacturing locations, product categories and capital projects. Business segment performance is expected to meet or exceed the Company's weighted average cost of capital ("WACC") each year. Capital expenditures and large projects are required to demonstrate that they will contribute positively to ROIC in excess of the Company's WACC. Likewise, potential acquisition targets are evaluated on whether they have the capacity to deliver a ROIC in excess of 200 basis points over the Company's WACC within three years. In addition, improvement in return on capital is incorporated into management's Long-Term Incentive ("LTI") Plan. In order to make the overall ROIC metric more actionable for the broader operating management team, the metric used in the LTI award calculation is based on Return on Tangible Capital, which eliminates the direct effect of goodwill and acquired intangibles, and to incentivize management to focus on the critical business elements that they can directly impact. Both management and the Board of Directors regularly review corporate and business segment ROIC calculations as well as the return on tangible capital performance by segment and product category to track year-over year-improvements and/or the actions to achieve performance at or better than the required threshold.
Growth Strategy and Strategic Evaluation
Over recent years, the Company has been executing a strategy designed to expand its product offerings through both R&D and acquisitions and to reach new healthcare consumers through entry into new markets. This strategy is accomplished by investing in and continually improving all aspects of the Company's five strategic pillars: high quality, superior customer service, leading innovation, best cost and empowered people. The concentration of common shared service activities around the world and development of centers of excellence in R&D have played an important role in ensuring the consistency and quality of the Company's five strategic pillars. Management plans to continue on its strategic path of growing the Company organically as well as inorganically. The Company continually reinvests in its own R&D pipeline and at the same time also works with partners as necessary to strive to be first to market with new products. In recent years, the Company has grown organically by launching a series of successful new products in the
Consumer Healthcare and Rx Pharmaceuticalssegments. Management expects to continue to grow inorganically through continued expansion into adjacent products, product categories and channels, as well as new geographic markets. Acquisition opportunities are evaluated on the basis of their ability to deliver long-term ROIC for the Company.
During fiscal 2014, the Company continued its strategic growth through the following product line expansions and acquisitions:
Product Launches: • In partnership with Teva Pharmaceutical Industries Ltd., U.S. launch of
temozolomide, generic equivalent of Temodar® in
• Nitroglycerin lingual spray, 400 mcg/spray, the generic equivalent to
Nitrolingual® pumpspray in
• Fluocinonide cream 0.1%, the generic equivalent to Vanos® cream 0.1% in
• Repaglinide tablets 1 mg and 2 mg, the generic equivalent to Prandin®
January 2014. • Sergeant's SENTRY Clean Up™ stain and odor remover product line in February 2014.
• Calcipotriene 0.005% / betamethasone dipropionate 0.064%, the authorized
generic version of Taclonex® ointment in
April 2014. • Azelastine hydrochloride nasal spray (0.15%), the generic version of Astepro® nasal spray in May 2014.
• Acquisition in
The acquisition provides the Company with assets focused on the treatment
of Multiple Sclerosis (Tysabri®).
• Acquisition in
the marketing and sale of methazolomide from
Fera Pharmaceuticals, LLC("Fera").
• Acquisition in
Australia and New Zealandfrom Aspen Global Inc.("Aspen"). The acquisition of this product portfolio broadens the Company's product 60
Capital and Liquidity
The Company's goal in managing its capital structure is to provide sufficient liquidity to enable it to pursue its business goals and objectives while optimizing long-term flexibility. Over its recent history, the Company has increasingly focused on the importance of funding a majority of its core organic objectives through cash flows from operations. Management is incented to achieve improved cash flows from operations through individual segment operating income and working capital targets and strives to achieve annual cash flows from operations greater than net income. Capital expenditures for the last three fiscal years were at higher levels to allow for capacity expansion, quality and technology investments, API strategic transformations and integration of acquisitions. Capital expenditures for fiscal 2015 are expected to be at or slightly above fiscal 2014 levels to allow for continued manufacturing productivity and capacity projects, quality and technology investments and investments at newly acquired entities. To support its inorganic acquisition strategies, the Company seeks to maintain access to a broad range of debt capital markets to optimize cost, flexibility and liquidity. The Company has historically provided shareholder return of capital through its dividend policy, payments under which have increased steadily over recent years. Share repurchases authorized by the Company's Board of Directors are evaluated against alternative uses of cash, such as acquisitions and debt repayments, and when approved are typically made at levels to help offset the dilutive effects of share-based compensation awards. Refer to the Financial Condition, Liquidity and Capital Resources and Results of Operations sections below for a more detailed discussion of the Company's capital and liquidity.
Events Impacting Future Results
As discussed in Note 2 of the Notes to the Consolidated Financial Statements, the Company's subsidiary Elan has the rights to receive royalties from Biogen Idec Inc. The amount of royalties received under this agreement is expected to be material to the future results of operations and cash flows. For the six-month period ending
June 28, 2014, Elan recorded $146.7 millionin royalties associated with this agreement. Further, Elan incurs costs associated with the ongoing business operations, and, as outlined in Note 5 of the Notes to the Consolidated Financial Statements, maintains investments in various equity interests. In addition, the Company expects to realize approximately $291.1 millionof amortization expense annually associated with the intangible assets acquired with the acquisition of Elan discussed in Note 2 of the Notes to the Consolidated Financial Statements. The Company expects to realize recurring annual operating expense and tax savings associated with the acquisition of Elan. Certain of these savings result from the elimination of redundant public company costs while optimizing back-office support. Additionally, in fiscal 2015, the Company expects to have a lower annual effective tax rate due to changes to the estimated jurisdictional mix of income and the new corporate structure attributable to the acquisition of Elan. The Company is in the process of transitioning its long-term strategy for its API business from primarily third-party to a dual focus on third-party business, including products to be manufactured in India, and vertical integration of high value and more difficult-to-manufacture inputs to the Consumer Healthcareand Rx businesses in an effort to gain efficiencies and lower costs, thus increasing margins. With a limited pipeline of products in development for future third-party customer new product introductions, the API segment revenues will likely decrease in the future, while intercompany vertical integration revenues (which will be eliminated in consolidation) will potentially increase. The Company plans to continue to seek and execute upon niche, complex differentiated new product APIs opportunistically for its overall portfolio, commence production in the Company's new API site in India, and strive to develop unique collaborations and profit sharing agreements between the Company's API business and pharmaceutical companies globally. Beginning in the third quarter of fiscal 2010, a branded competitor in the OTC market began to experience periodic interruptions of distribution of certain of its products in the adult and pediatric analgesic categories. These interruptions have included periods of time where supply of certain products has been suspended altogether. Due to this situation, which continued through fiscal 2013, the Company experienced an increase in demand for certain adult and pediatric analgesic products. This increased demand has generally had a positive impact on the Consumer Healthcaresegment's net sales over that period of time. At present, the branded competitor continues its progress to re-enter the market, and the Company believes that this re-entry should largely be complete over the 61 -------------------------------------------------------------------------------- next six to 12 months. The Company is considering the impact of this ongoing development in its forward-looking sales forecast, but it cannot fully predict the extent of consumers' re-acceptance of the branded products, the full extent of the branded competitor's marketing activities or the ultimate market share this competitor can be expected to achieve.
RESULTS OF OPERATIONS
The Company's consolidated statements of income, expressed as a percent of net sales, are presented below: Fiscal Year Ended June 28, 2014 June 29, 2013 June 30, 2012 Net sales 100.0 % 100.0 % 100.0 % Cost of sales 64.3 63.8 65.5 Gross profit 35.7 36.2 34.5 Operating expenses Distribution 1.4 1.3 1.2 Research and development 3.8 3.3 3.3 Selling 5.1 5.3 4.7 Administration 10.1 6.8 7.1 Write-off of in-process research and development 0.1 0.3 - Restructuring 1.2 0.1 0.3 Total 21.7 17.0 16.6 Operating income 14.0 19.2 17.9 Interest, net 2.5 1.9 1.9 Other expense (income), net 0.3 - (0.1 ) Loss on sales of investments 0.3 0.1 - Loss on extinguishment of debt 4.1 - -
Income from continuing operations before income taxes 6.7
17.2 16.1 Income tax expense 1.7 4.7 3.8 Income from continuing operations 5.1 12.5 12.4 Income from discontinued operations, net of tax - - 0.3 Net income 5.1 % 12.5 % 12.7 % Consumer Healthcare Fiscal Year Percentage Change ($ in millions) 2014 2013 2012 2014/2013 2013/2012 Net sales
$ 2,219.0 $ 2,089.0 $ 1,815.86 % 15 % Gross profit $ 719.8 $ 683.8 $ 571.85 % 20 % Gross profit % 32.4 % 32.7 % 31.5 % Operating expenses $ 351.2 $ 320.6 $ 256.510 % 25 % Operating expenses % 15.8 % 15.3 % 14.1 % Operating income $ 368.6 $ 363.2 $ 315.31 % 15 % Operating income % 16.6 % 17.4 % 17.4 % Net Sales Fiscal 2014 net sales increased $130.0 millioncompared to fiscal 2013. The increase was due primarily to new product sales of $60.9 million, $57.6 millionof net sales attributable to the Sergeant's, Velcera, and Aspenacquisitions, and an increase in sales volumes of existing products of $99.6 million, primarily in the smoking cessation, gastrointestinal, and dermalogic categories. These increases were partially offset by a decline of 62 -------------------------------------------------------------------------------- $87.3 millionin sales of existing products, primarily in the contract manufacturing category, due to certain national brands re-entering the retail marketplace, as further described above in "Events Impacting Future Results", along with $6.2 millionof discontinued products. New product sales were led by the cough and cold category, as well as the smoking cessation and animal health categories. Fiscal 2013 net sales increased $273.2 millioncompared to fiscal 2012. The increase was due primarily to an increase in U.S. sales of existing products of $110.6 million, primarily in the contract manufacturing, smoking cessation and cough/cold categories, $141.5 millionof net sales attributable to the Sergeant's, Velcera, and CanAm acquisitions and new product sales of $53.0 million, mainly in the cough/cold, smoking cessation and gastrointestinal product categories. The Company's international locations, primarily the U.K., also experienced an increase of $18.0 millionin their existing product sales due primarily to smoking cessation and contract manufacturing sales growth in European markets. These increases were partially offset by a decline of $32.2 millionin sales of existing products, primarily in the gastrointestinal and analgesics product categories and $16.0 millionin discontinued products.
Fiscal 2014 gross profit increased
$36.0 millioncompared to fiscal 2013 consistent with the increase in net sales. The increase was due primarily to incremental gross profit attributable to the Sergeant's, Velcera, and Aspenacquisitions and gross profit contribution from new product sales, partially offset by the net decrease in sales of the contract manufacturing category. The largest contributors to the increase in gross profit were products in the smoking cessation and gastrointestinal product categories. The gross profit percentage for fiscal 2014 fell slightly compared to fiscal 2013 due to under-absorption of fixed production costs relative to increased capacity, particularly due to the reduction in contract manufacturing and a soft cough/cold season. Fiscal 2013 gross profit increased $112.1 millioncompared to fiscal 2012. The increase was due primarily to gross profit attributable to the net increase in sales of existing products, incremental gross profit attributable to the Sergeant's, Velcera, and CanAm acquisitions and contribution from new product sales. These increases were partially offset by a one-time charge of $7.7 millionto cost of sales as a result of the step-up of inventory acquired and sold during fiscal 2013 related to the Sergeant's acquisition. This one-time charge also negatively impacted the gross profit percentage for fiscal 2013, but was entirely offset by favorable product mix. Operating Expenses Fiscal 2014 operating expenses increased $30.6 millioncompared to fiscal 2013 due primarily to $22.8 millionof incremental operating expenses from the Sergeant's, Velcera, and Aspenacquisitions. In addition, research and development expenses increased $6.4 milliondue primarily to higher spending on new product development projects than in the prior year. Fiscal 2013 operating expenses increased $64.1 millioncompared to fiscal 2012 due primarily to $54.1 millionof incremental operating expenses from the acquisitions of Sergeant's, Velcera, and CanAm. In addition to the increase due to acquisitions, selling and distribution expenses increased $8.7 millionon higher sales volume. Nutritionals Fiscal Year Percentage Change ($ in millions) 2014 2013 2012 2014/2013 2013/2012 Net sales $ 551.7 $ 508.4 $ 501.09 % 1 % Gross profit $ 141.6 $ 127.1 $ 125.311 %
1 % Gross profit % 25.7 % 25.0 % 25.0 % Operating expenses
(8 )% Operating expenses % 18.3 % 18.1 % 19.9 % Operating income
39 % Operating income % 7.3 % 6.9 % 5.1 % 63 --------------------------------------------------------------------------------
Fiscal 2014 net sales increased
$43.3 millioncompared to fiscal 2013 due primarily to a net increase in sales of existing products of $23.0 millionacross all major product categories and new product sales of $22.5 million. The increase in new product sales was primarily led by sales of Insync® probiotic. Sales in the infant nutritionals category increased due primarily to higher infant formula sales as compared to last year. Fiscal 2013 infant formula sales were negatively impacted by a production conversion and ramp up at the Company's Vermontmanufacturing facility following the installation of a new plastic container powder infant formula packaging line. As of June 2013, the Company had successfully transitioned 100% of its core items at U.S. retailer customers to the new plastic container. Fiscal 2013 net sales increased $7.4 millioncompared to fiscal 2012 due primarily to new product sales of $18.6 millionand a $4.0 millionincrease in existing product sales within the VMS product category. These increases were partially offset by a decline in sales of existing products of $15.0 million, primarily in the infant formula category. As noted above, fiscal 2013 infant formula sales were negatively impacted by the product conversion at the Company's Vermontmanufacturing facility. In the fourth quarter of fiscal 2012, retailers increased purchases in advance of the installation of the new plastic container packaging line and the conversion of the Company's ERP system on July 1, 2012. Gross Profit Fiscal 2014 gross profit increased $14.5 millioncompared to fiscal 2013 due primarily to the increase in sales of existing products, mainly in the infant formula category, and contribution from new product sales, primarily Insync® probiotic. The increase in the gross profit percentage for fiscal 2014 was due to improved operational efficiencies compared to last year.
Fiscal 2013 gross profit increased
Fiscal 2014 operating expenses increased
$9.2 millioncompared to fiscal 2013 due primarily to higher distribution and selling expenses as a result of higher sales volume, as well as higher selling expenses related to the marketing of Insync® probiotic as a branded product. Fiscal 2013 operating expenses decreased $8.0 millioncompared to fiscal 2012 due primarily to the absence of $7.1 millionof restructuring charges incurred in fiscal 2012 related to the closure of the Company's Floridalocation.
Fiscal Year Percentage Change ($ in millions) 2014 2013 2012 2014/2013 2013/2012 Net sales
$ 927.1 $ 709.5 $ 617.431 % 15 % Gross profit $ 489.9 $ 361.5 $ 288.636 %
25 % Gross profit % 52.8 % 51.0 % 46.7 % Operating expenses
31 % Operating expenses % 15.1 % 13.9 % 12.2 % Operating income
23 % Operating income % 37.7 % 37.1 % 34.6 %
Fiscal 2014 net sales increased
sales of existing products. New product sales were led by sales of Fenofibrate, Fluocinonide cream, Nitroglycerine spray, Repaglinide, and Azelastine nasal spray.
Fiscal 2013 net sales increased
$92.2 millioncompared to fiscal 2012. The increase was due primarily to new product sales of $48.6 million, $24.1 millionof net sales attributable to the Rosemont and Feraacquisitions, an additional month of net sales of $19.1 millionfrom the July 26, 2011Paddock acquisition and improved pricing on select products as compared to the prior year. These increases were partially offset by decreased volume in existing products and decreased pricing on one particular product.
Fiscal 2014 gross profit increased
$128.4 millioncompared to fiscal 2013 due primarily to incremental gross profit attributable to the Rosemont and Feraacquisitions, gross profit contribution from new products, and product mix for sales of existing products. Gross profit as a percent of sales increased due to the Rosemont and Feraacquisitions, as well as favorable pricing dynamics. Fiscal 2013 gross profit increased $72.9 millioncompared to fiscal 2012. The increase was due primarily to the absence of the one-time charge of $27.2 millionto cost of sales as a result of the step-up of inventory acquired and sold during the first quarter of fiscal 2012 related to the Paddock acquisition, partially offset by the charge of $3.2 millionto cost of sales as a result of the step-up of inventory acquired and sold during the last half of fiscal 2013 related to the Rosemont acquisition. The fiscal 2013 gross profit increase was also due to an additional month of gross profit contribution from the Paddock acquisition, gross profit from new product sales, incremental gross profit attributable to the Rosemont and Feraacquisitions, and favorable pricing dynamics on select products as compared to the prior year. These increases were partially offset by lower gross profit contribution due to decreased volume and pricing on certain existing products. The fiscal 2013 gross profit percentage increase was due primarily to gross profit from new product sales and the absence of the inventory step-up charge related to the Paddock acquisition discussed above.
Fiscal 2014 operating expenses increased
$41.8 millioncompared to fiscal 2013 due primarily to $15.1 millionof incremental operating expenses from the Rosemont and Feraacquisitions, including $3.0 millionfor the start up of a branded ophthalmic sales force; a $15.0 millionloss accrual related to the Texas Medicaid contingency discussed in Note 14 of the Notes to the Consolidated Financial Statements; and a $6.0 millioncharge related to the write-off of IPR&D acquired through the Rosemont and Paddock acquisitions. We expect certain sales force related operating expenses to continue to increase as the Company pursues a strategy of further expanding its specialty brand. Fiscal 2013 operating expenses increased $23.2 millioncompared to fiscal 2012 due primarily to $6.8 millionof incremental operating expenses from the Rosemont acquisition and an additional month of operating expenses of $2.8 millionattributable to the Paddock acquisition. The Company also recorded a $9.0 millionimpairment charge related to the write-off of certain IPR&D intangible assets that were acquired as part of the Paddock acquisition due to changes in the projected development and regulatory timelines for various projects. API Fiscal Year Percentage Change ($ in millions) 2014 2013 2012 2014/2013 2013/2012 Net sales $ 137.6 $ 159.3 $ 165.8(14 )% (4 )% Gross profit $ 77.1 $ 83.8 $ 86.1(8 )% (3 )% Gross profit % 56.0 % 52.6 % 51.9 % Operating expenses $ 31.0 $ 35.0 $ 32.2(11 )% 9 % Operating expenses % 22.5 % 22.0 % 19.4 % Operating income $ 46.1 $ 48.9 $ 53.9(6 )% (9 )% Operating income % 33.5 % 30.7 % 32.5 % 65 --------------------------------------------------------------------------------
Net sales for fiscal 2014 decreased
$21.7 millioncompared to fiscal 2013 due primarily to a decrease in sales of existing products of $63.6 million, partially offset by $39.6 millionof new product sales, which relates primarily to the U.S. launch of temozolomide, and $2.4 milliondue to favorable changes in foreign currency exchange rates. The decrease in existing product sales was due primarily to increased competition on certain products, along with lower sales related to the post-exclusivity status of a customer's generic finished dosage pharmaceutical product ("API Agreement"). The Company's customer launched its product with 180-day exclusivity status in the fourth quarter of fiscal 2012. Net sales for fiscal 2013 decreased $6.5 millioncompared to fiscal 2012. This decrease was due primarily to a decrease of sales of existing products of $20.0 million, along with a $1.2 milliondecrease related to unfavorable changes in foreign currency exchange rates, partially offset by an increase of $15.0 millionover fiscal 2012 related to the API Agreement.
Gross profit for fiscal 2014 decreased
$6.7 millioncompared to fiscal 2013 due to the decrease in the sales of existing products discussed above, partially offset by the favorable contribution from the U.S. launch of temozolomide. The gross profit percentage for fiscal 2014 increased due primarily to the U.S. launch of temozolomide as well as favorable vertical integration activity, partially offset by operational inefficiencies experienced during the year. Gross profit for fiscal 2013 decreased $2.3 millioncompared to fiscal 2012. This decrease was due primarily to decreased profit of $5.7 millionrelated to the demand in the U.S. for one specific product, along with decreased profit related to the decrease in sales of other existing products, partially offset by an increase of $7.7 millionfrom the API Agreement over fiscal 2012. The increase in the gross profit percentage was due primarily to the API Agreement.
Operating expenses for fiscal 2014 decreased
$4.0 millioncompared to fiscal 2013 due primarily to lower administrative costs driven by lower legal expenses and lower employee-related expenses.
Operating expenses for fiscal 2013 increased
($ in millions) Fiscal 2014(1) Net sales
$ 146.7Gross profit $ (6.1 )Gross profit % (4.1 )% Operating expenses $ 62.5Operating expenses % 42.6 % Operating loss $ (68.6 )Operating loss % (46.7 )%
(1) Includes operations from
66 -------------------------------------------------------------------------------- In fiscal 2014, the Company recognized revenue of
$146.7 millionrelated to royalties received from Biogen Idec Inc.'s global sales of the Multiple Sclerosis drug Tysabri®, which is manufactured and distributed by Biogen Idec Inc. The Company recognized intangible asset amortization of $152.8 millionfor fiscal 2014. Fiscal 2014 operating expenses included $38.7 millionof restructuring charges related primarily to employee termination benefits. See Note 16 of the Notes to the Consolidated Financial Statements for additional information on these restructuring charges. Operating expenses also included $10.4 millionof research and development expenses, which related to the ELND005 Phase 2 clinical program in collaboration with Transition. As mentioned in Note 5 of the Notes to the Consolidated Financial Statements, the Company ended its collaboration with Transition during the third quarter of fiscal 2014. Transition is now solely responsible for all ongoing development activities and costs associated with ELND005.
The Other category consists of the Company's Israel Pharmaceutical and Diagnostic Products operating segment, which does not individually meet the quantitative thresholds required to be a reportable segment.
Fiscal Year Percentage Change ($ in millions) 2014 2013 2012 2014/2013 2013/2012 Net sales
$ 78.7 $ 73.6 $ 73.37 % - % Gross profit $ 25.4 $ 23.8 $ 23.87 %
- % Gross profit % 32.4 % 32.3 % 32.5 % Operating expenses
(6 )% Operating expenses % 27.2 % 27.6 % 29.6 % Operating income
69 % Operating income % 5.2 % 4.6 % 2.7 %
Fiscal 2014 net sales increased
Fiscal 2013 net sales were relatively flat compared to fiscal 2012. The slight increase was due to new product sales of
$2.1 million, offset by unfavorable changes of $1.6 millionin foreign currency exchange rates.
Fiscal 2014 gross profit dollars increased in line with the increase in net sales. Gross profit as a percent of sales was relatively flat as compared to fiscal 2013.
Fiscal 2013 gross profit was flat compared to fiscal 2012 and as a percent of sales decreased slightly.
Fiscal 2014 operating expenses increased
Fiscal 2013 operating expenses decreased
Unallocated expenses were comprised of certain corporate services that were not allocated to the segments. Fiscal 2014 unallocated expenses were
$173.4 millioncompared to $34.7 millionin fiscal 2013, an increase of $138.7 milliondue primarily to acquisition-related costs incurred in connection with the Elan transaction. Acquisition-related costs consist primarily of general transaction costs (legal, banking, and other professional fees), 67 --------------------------------------------------------------------------------
financing fees, and debt extinguishment. See Note 2 of the Notes to the Consolidated Financial Statements for details by line item on the Consolidated Statements of Operations.
Fiscal 2013 unallocated expenses were
$34.7 millioncompared to $40.9 millionin fiscal 2012, a decrease of $6.2 millionor 15% due primarily to lower corporate development and variable incentive-related expenses.
Interest and Other (Consolidated)
Fiscal 2014 interest expense was
$105.6 millioncompared to $70.0 millionfor fiscal 2013. The increase was due in part to increased borrowings related to the issuance of $600.0 millionof debt in a public offering, which was completed during the fourth quarter of fiscal 2013 and paid off during the second quarter of fiscal 2014 in conjunction with the Elan transaction. Interest expense also increased due to an incremental increase in borrowings resulting from the issuance of $2.3 billionof debt in a private placement to finance the Elan transaction, as well as a new $1.0 billionbank term loan, both of which were completed during the second quarter of fiscal 2014. The Company simultaneously retired its former debt arrangements, resulting in a loss of $165.8 millionduring fiscal 2014, which consisted of make-whole payments, write-off of unamortized discounts, write-off of deferred financing fees, and interest on the bridge agreements. As a result of the debt issuances, the Company expects interest expense to be approximately $100.0 millionon an annual basis based on the current Libor interest rate. Fiscal 2014 interest income was $2.1 millioncompared to $4.2 millionfor fiscal 2013. The Company recognized a loss on sales of investments of $12.7 millionduring fiscal 2014. The loss consisted of $9.9 millionand $2.8 millionon the sales of the Company's investments in Prothena and Janssen AI, respectively. Fiscal 2013 interest expense was $70.0 millioncompared to $64.7 millionfor fiscal 2012. The increase in interest expense was due to a full year of interest on the Company's previous private placement notes and the increased borrowings related to the $600.0 millionpublic offering discussed above. Fiscal 2013 interest income was $4.2 millioncompared to $4.0 millionfor fiscal 2012. During fiscal 2013, in conjunction with the Cobrek acquisition, the Company remeasured the fair value of its 18.5% noncontrolling interest, which was valued at $9.5 million, and recognized a loss of $3.0 millionin other expense (income), net. Also during fiscal 2013, the Company sold its auction rate securities ("ARS") for $8.6 millionand recognized a loss of $1.6 millionin other expense (income), net. Income Taxes (Consolidated) The effective tax rate on continuing operations was 24.7%, 27.3% and 23.2%% for fiscal 2014, 2013 and 2012, respectively. The effective tax rate for fiscal 2014 was impacted by the transaction costs, changes to the estimated jurisdictional mix of income and the new corporate structure attributable to the Elan transaction. Additionally, the effective tax rate for fiscal 2014 was unfavorably impacted by Israeltax rate changes in the amount of $1.8 millionand favorably impacted by United Kingdomtax rate changes in the amount of $4.7 million, as discussed further below. The effective tax rate was favorably affected by a reduction in the reserves for uncertain tax liabilities, recorded in accordance with ASC Topic 740 "Income Taxes", in the amount of $7.5 millionfor fiscal 2013 related to various audit resolutions and statute expirations. In fiscal 2011, Israelenacted new tax legislation that reduced the effective tax rate to 10% for 2011 and 2012, 7% for 2013 and 2014, and 6% thereafter for certain qualifying entities that elect to be taxed under the new legislation. This legislation was rescinded as announced in the Official Gazetteon August 5, 2013.The new legislation enacted a 9% rate for certain qualifying entities that elect to be taxed under the new legislation. The Company has two entities that had previously elected the new tax legislation for years after fiscal 2011. For all other entities that do not qualify for this reduced rate, the tax rate has been increased from 25% to 26.5%. These rates were applicable to Perrigo as of June 30, 2013and have unfavorably impacted the effective tax rate in the amount of $1.8 million. In July 2013, the United Kingdompassed legislation reducing the statutory rate to 21% and 20% effective April 1, 2014and April 1, 2015, respectively. These rates are applicable to Perrigo as of June 30, 2013and have favorably impacted the effective tax rate in the amount of $4.7 million.
Financial Condition, Liquidity and Capital Resources
The Company finances its operations with internally-generated funds, supplemented by credit arrangements with third parties and capital market financing. The Company routinely monitors current and expected operational requirements and financial market conditions to evaluate accessing other available financing sources, including revolving bank credit and securities offerings. Based on the Company's current financial condition and credit relationships, management believes that the Company's operations and borrowing resources are sufficient to provide for the Company's current and foreseeable capital requirements. However, the Company continues to evaluate the impact of commercial and capital market conditions on liquidity and may determine that modifications to the Company's capital structure are appropriate if market conditions deteriorate or if favorable capital market opportunities become available.
Cash and cash equivalents increased
$25.5 millionto $805.4 millionat June 28, 2014from $779.9 millionat June 29, 2013. Working capital, including cash, at June 28, 2014was consistent with June 29, 2013at $1.5 billion. In addition to the cash and cash equivalents balance of $805.4 millionat June 28, 2014, the Company had approximately $600.0 millionavailable under its revolving loan commitment and $200.0 millionavailable under its accounts receivable securitization program described below. Cash, cash equivalents, cash flows from operations and borrowings available under the Company's credit facilities are expected to be sufficient to finance the known and/or foreseeable liquidity, capital expenditures, dividends, acquisitions and, to the extent authorized, share repurchases of the Company. Although the Company's lenders have made commitments to make funds available to it in a timely fashion, if economic conditions worsen or new information becomes publicly available impacting the institutions' credit rating or capital ratios, these lenders may be unable or unwilling to lend money pursuant to the Company's existing credit facilities. Fiscal Year Ended ($ in millions) June 28, 2014 June 29, 2013 June 30, 2012 Net cash from operating activities $ 693.5 $ 553.8$
Net cash for investing activities
Net cash from financing activities
In fiscal 2014, net cash provided from operating activities increased
$139.7 millionor 25% to $693.5 millioncompared to $553.8 millionin fiscal 2013, due primarily to increased earnings. In fiscal 2013, net cash provided from operating activities increased $40.4 millionor 8% to $553.8 millioncompared to $513.4 millionfor fiscal 2012, due primarily to increased earnings for fiscal 2013 compared to fiscal 2012. Net cash used for investing activities increased $757.0 millionto $1.7 billionfor fiscal 2014 compared to $947.8 millionfor fiscal 2013. This increase was due primarily to cash used to acquire Elan as well as increased capital expenditures, partially offset by proceeds from the sale of the Company's investments in Prothena and Janssen AI. Net cash used for investing activities increased $263.6 millionto $947.8 millionfor fiscal 2013 compared to $684.1 millionfor fiscal 2012, due primarily to increased funding used for acquisitions in fiscal 2013 compared to fiscal 2012. Cash used for capital expenditures for facilities and equipment during fiscal 2014 totaled $171.6 million, which includes accounts payable accruals. Capital expenditures were incurred for manufacturing productivity and capacity projects and investments at newly acquired entities. Capital expenditures for fiscal 2015 are anticipated to be between $130 millionto $170 millionrelated primarily to manufacturing productivity capacity and quality/regulatory projects. The Company expects to fund these estimated capital expenditures with funds from operational cash flows or revolving credit facilities. Capital expenditures were $132.2 millionand $120.2 millionfor fiscal 2013 and 2012, respectively. Net cash provided from financing activities was $1.0 billionfor fiscal 2014 compared to $577.2 millionfor fiscal 2013. The increase in cash provided from financing activities was due primarily to net borrowings of long-term 69 --------------------------------------------------------------------------------
debt under the Company's term loan and revolver as well as the issuance of senior unsecured notes associated with the acquisition of Elan.
The Company does not currently have an ordinary share repurchase program, but may repurchase shares in private party transactions from time to time. Private party transactions are shares repurchased in connection with the vesting of restricted stock awards to satisfy employees' minimum statutory tax withholding obligations. During fiscal 2014, the Company repurchased 60 thousand shares of common stock for
$7.5 millionin private party transactions. During fiscal 2013 and 2012, the Company repurchased 112 thousand and 90 thousand shares of common stock for $12.4 millionand $8.2 million, respectively, in private party transactions. All ordinary shares repurchased by the Company will either be canceled or held as treasury shares available for reissuance in the future for general corporate purposes. In January 2003, the Board of Directors adopted a policy of paying quarterly dividends. The Company paid dividends of $46.1 million, $33.0 millionand $29.0 million, or $0.39, $0.35and $0.31per share, during fiscal 2014, 2013 and 2012, respectively. The declaration and payment of dividends and the amount paid, if any, are subject to the discretion of the Board of Directors and depend on the earnings, financial condition, capital and surplus requirements of the Company and other factors the Board of Directors may consider relevant.
Dividends paid for the years ended
Dividend Declared Fiscal 2014 April 28, 2014 May 30, 2014 June 17, 2014 $ 0.105 January 29, 2014 February 28, 2014 March 18, 2014 $ 0.105 November 6, 2013 November 29, 2013 December 17, 2013 $ 0.09 August 14, 2013 August 30, 2013 September 17, 2013 $ 0.09 Fiscal 2013 May 2, 2013 May 31, 2013 June 18, 2013 $ 0.09 January 31, 2013 March 1, 2013 March 19, 2013 $ 0.09 November 6, 2012 November 29, 2012 December 17, 2012 $ 0.09 August 15, 2012 August 31, 2012 September 18, 2012 $ 0.08
Accounts Receivable Securitization
July 23, 2009, the Company entered into an accounts receivable securitization program (the "Securitization Program") with several of its wholly owned subsidiaries and Bank of America Securities, LLC. The program was most recently renewed for one year on June 13, 2014with Wells Fargo Bank, National Association("Wells Fargo") as sole agent. The Securitization Program is a one-year program, expiring June 13, 2015. Under the terms of the Securitization Program, the subsidiaries sell certain eligible trade accounts receivables to a wholly owned bankruptcy-remote special purpose entity ("SPE"), Perrigo Receivables, LLC. The Company has retained servicing responsibility for those receivables. The SPE will then transfer an interest in the receivables to the Committed Investors. Under the terms of the Securitization Program, Wells Fargo has committed $200.0 million, effectively allowing the Company to borrow up to that amount, subject to a Maximum Net Investment calculation as defined in the agreement. At June 28, 2014, the entire $200.0 millioncommitted amount of the Securitization Program was available under this calculation. The annual interest rate on any borrowing is equal to thirty-day LIBOR plus 0.375%. In addition, an annual facility fee of 0.375% is applied to the entire $200.0 millioncommitment whether borrowed or undrawn. Under the terms of the Securitization Program, the Company may elect to have the entire amount or any portion of the facility unutilized. Any borrowing made pursuant to the Securitization Program will be classified as short-term debt in the Company's Consolidated Balance Sheets. The amount of the eligible receivables will vary during the year based on seasonality of the business and could, at times, limit the amount available to the Company from the sale of these 70 --------------------------------------------------------------------------------
Bank Loan Facilities
September 6, 2013, the Company entered into a $1.0 billionTerm Loan Agreement (the "Term Loan") and a $600.0 millionRevolving Credit Agreement (the "Revolver") with Barclays Bank PLC as Administrative Agent, HSBC Bank USA, N.A.as Syndication Agent, Bank of America, N.A., JPMorgan Chase Bank, N.A. and Wells Fargo Bank, N.A.as Documentation Agents and certain other participant banks (together, the "Permanent Credit Agreements"). The Term Loan consists of a $300.0 milliontranche maturing December 18, 2015and a $700.0 milliontranche maturing December 18, 2018. Both tranches were drawn in full on December 18, 2013. No amounts were outstanding under the Revolver as of June 28, 2014. Obligations of the Company under the Permanent Credit Agreements are guaranteed by Perrigo Company plc, certain U.S. subsidiaries of Perrigo Company plc, Elan, and certain Irish subsidiaries of Elan. Amounts outstanding under each of the Permanent Credit Agreements will bear interest at the Company's option (a) at the alternative base rate or (b) the eurodollar rate plus, in either case, applicable margins as set forth in the Permanent Credit Agreements.
November 8, 2013, the Company issued $500.0 millionaggregate principal amount of its 1.30% Senior Notes due 2016 (the "2016 Notes"), $600.0 millionaggregate principal amount of its 2.30% Senior Notes due 2018 (the "2018 Notes"), $800.0 millionaggregate principal amount of its 4.00% Senior Notes due 2023 (the "2023 Notes") and $400.0 millionaggregate principal amount of its 5.30% Senior Notes due 2043 (the "2043 Notes" and, together with the 2016 Notes, the 2018 Notes and the 2023 Notes, the "Bonds") in a private placement with registration rights. Interest on the Bonds is payable semiannually in arrears in May and November of each year, beginning in May 2014. The Bonds are governed by a Base Indenture and a First Supplemental Indenture between the Company and Wells Fargo Bank N.A., as trustee (collectively the "2013 Indenture"). The Bonds are the Company's unsecured and unsubordinated obligations, ranking equally in right of payment to all of the Company's existing and future unsecured and unsubordinated indebtedness and are guaranteed on an unsubordinated, unsecured basis by the Company's subsidiaries that guarantee the Permanent Credit Agreements. The Company received net proceeds of $2.3 billionfrom issuance of the Bonds after deduction of issuance costs of $14.6 millionand a market discount of $6.3 million. The Bonds are not entitled to mandatory redemption or sinking fund payments. The Company may redeem the Bonds in whole or in part at any time and from time to time for cash at the redemption prices described in the 2013 Indenture.
The Company was in compliance with all covenants under its various debt agreements as of
The Company's credit ratings on
Credit rating agencies review their ratings periodically and, therefore, the credit rating assigned to the Company by each agency may be subject to revision at any time. Accordingly, the Company is not able to predict whether current credit ratings will remain as disclosed above. Factors that can affect the Company's credit ratings include changes in operating performance, the economic environment, the Company's financial position, and changes in business strategy. If changes in the Company's credit ratings were to occur, they could impact, among other things, future borrowing costs, access to capital markets, and vendor financing terms.
The Company's enforceable and legally binding obligations as of
June 28, 2014are set forth in the following table. Some of the amounts included in this table are based on management's estimates and assumptions about these obligations, including the duration, the possibility of renewal, anticipated actions by third parties and other factors. Because these estimates and assumptions are necessarily subjective, the enforceable and legally binding obligations actually paid in future periods may vary from the amounts reflected in the table. 71 --------------------------------------------------------------------------------
Payment Due by Period (in millions) 2015 2016-2017 2018-2019 After 2019 Total Short and long-term debt(1)
$ 218.1 $ 1,228.7 $ 935.1 $ 1,857.1 $ 4,239.0Purchase obligations(2) 535.1 2.2 1.0 - 538.3 Operating leases(3) 31.9 39.2 27.0 21.1 119.2 Other non-current contractual liabilities reflected on the consolidated balance sheet: Deferred compensation and benefits(4) - - - 90.7 90.7 Other (5) 36.3 6.7 0.4 - 43.4 Total $ 821.4 $ 1,276.8 $ 963.5 $ 1,968.9 $ 5,030.6
(1) Short and long-term debt includes interest payments, which were calculated
using the effective interest rate at
lease obligations. (2) Consists of commitments for both materials and services.
(3) Used in normal course of business, principally for warehouse facilities
and computer equipment.
(4) Includes amounts associated with non-qualified plans related to deferred
compensation, executive retention and post employment benefits. Of this amount,
$47.8 millionhas been funded by the Company and is recorded in
other non-current assets on the balance sheet. These amounts are assumed
payable after five years, although certain circumstances, such as termination, would require earlier payment. (5) Includes Fera contingent consideration of
$17.4 millionas discussed in Note 4 of the Notes to the Consolidated Financial Statements and contract terminations totaling $4.0 millionas discussed in Note 16 of
the Notes to the Consolidated Financial Statements. Both were recorded in
other current liabilities at
The Company funds its U.S. qualified profit-sharing and investment plan in accordance with the Employee Retirement Income Security Act of 1974 regulations for the minimum annual required contribution and Internal Revenue Service regulations for the maximum annual allowable tax deduction. The Company is committed to making the required minimum contributions, which the Company expects to be approximately
$12.3 millionduring fiscal 2015. Future contributions are dependent upon various factors including employees' eligible compensation, plan participation and changes, if any, to current funding requirements. Therefore, no amounts were included in the Contractual Obligations table above. The Company generally expects to fund all future contributions with cash flows from operating activities. As of June 28, 2014, the Company had approximately $205.4 millionof liabilities for uncertain tax positions. These unrecognized tax benefits have been excluded from the Contractual Obligations table above due to uncertainty as to the amounts and timing of settlement with taxing authorities. Net deferred income tax liabilities were $642.6 millionas of June 28, 2014. This amount is not included in the Contractual Obligations table above because the Company believes this presentation would not be meaningful. Net deferred income tax liabilities are calculated based on temporary differences between the tax basis of assets and liabilities and their book basis, which will result in taxable amounts in future years when the book basis is settled. The results of these calculations do not have a direct connection with the amount of cash taxes to be paid in any future periods. As a result, scheduling net deferred income tax liabilities as payments due by period could be misleading, because this scheduling would not relate to liquidity needs.
Critical Accounting Estimates
Determination of certain amounts in the Company's financial statements requires the use of estimates. These estimates are based upon the Company's historical experiences combined with management's understanding of current facts and circumstances. Although the estimates are considered reasonable, actual results could differ from the estimates. The accounting estimates, discussed below, are considered by management to require the most judgment and are critical in the preparation of the financial statements. These estimates are reviewed by the Audit Committee. Revenue Recognition and Customer-Related Accruals and Allowances - The Company generally records revenues from product sales when the goods are shipped to the customer. For customers with Free on Board ("FOB") destination terms, a provision is recorded to exclude shipments estimated to be in-transit to these customers at the end of the reporting period. A sales allowance is recorded and accounts receivable are reduced as 72 -------------------------------------------------------------------------------- revenues are recognized for estimated losses on credit sales due to customer claims for discounts, price discrepancies, returned goods and other items. Revenue is also reduced for any contractual customer program arrangements and related liabilities are recorded concurrently. The Company maintains customer-related accruals and allowances that consist primarily of chargebacks, rebates, sales returns, shelf stock allowances, administrative fees and other incentive programs. Some of these adjustments relate specifically to the
Rx Pharmaceuticalssegment while others relate only to the Consumer Healthcare("CHC") and Nutritionals segments. Typically, the aggregate gross-to-net adjustments related to Rx Pharmaceuticalscan exceed 50% of the segment's gross sales. In contrast, the aggregate gross-to-net adjustments related to CHC and Nutritionals typically do not exceed 10% of the segment's gross sales. Certain of these accruals and allowances are recorded in the balance sheet as current liabilities and others are recorded as a reduction in accounts receivable. Chargebacks - The Company markets and sells products directly to wholesalers, distributors, warehousing pharmacy chains, and other direct purchasing groups. The Company also markets products indirectly to independent pharmacies, non-warehousing chains, managed care organizations, and group purchasing organizations, collectively referred to as "indirect customers." In addition, the Company enters into agreements with some indirect customers to establish contract pricing for certain products. These indirect customers then independently select a wholesaler from which to purchase the products at these contracted prices. Alternatively, the Company may pre-authorize wholesalers to offer specified contract pricing to other indirect customers. Under either arrangement, the Company provides chargeback credit to the wholesaler for any difference between the contracted price with the indirect customer and the wholesaler's invoice price. The accrual for chargebacks is based on historical chargeback experience and confirmed wholesaler inventory levels, as well as estimated sell-through levels by wholesalers to retailers. We regularly assess current pricing dynamics and wholesaler inventory levels to ensure the liability for future chargebacks is fairly stated. Medicaid Rebates - The Company participates in certain qualifying U.S. federal and state government programs whereby discounts and rebates are provided to participating government entities. Medicaidrebates are amounts owed based upon contractual agreements or legal requirements with public sector ( Medicaid) benefit providers, after the final dispensing of the product by a pharmacy to a benefit plan participant. Medicaidreserves are based on expected payments, which are driven by patient usage, contract performance, as well as field inventory that will be subject to a Medicaidrebate. Medicaidrebates are typically billed up to 180 days after the product is shipped, but can be billed as many as 270 days after the quarter in which the product is dispensed to the Medicaidparticipant. As a result, the Company's Medicaidrebate provision includes an estimate of outstanding claims for end-customer sales that occurred but for which the related claim has not been billed, and an estimate for future claims that will be made when inventory in the distribution channel is sold through to plan participants. The Company's calculation also requires other estimates, such as estimates of sales mix, to determine which sales are subject to rebates and the amount of such rebates. Our rebates are reviewed on a quarterly basis against actual claims data to ensure the liability is fairly stated. Returns and Shelf Stock Allowances - Consistent with industry practice, the Company maintains a return policy that allows its customers to return product within a specified period prior to and subsequent to the expiration date. Generally, product may be returned for a period beginning six months prior to its expiration date to up to one year after its expiration date. The majority of the Company's product returns are the result of product dating, which falls within the range set by the Company's policy, and are settled through the issuance of a credit to the customer. The Company's estimate of the provision for returns is based upon its historical experience with actual returns, which is applied to the level of sales for the period that corresponds to the period during which the Company's customers may return product. This period is known by the Company based on the shelf life of its products at the time of shipment. Additionally, when establishing its reserves, the Company considers factors such as levels of inventory in the distribution channel, product dating and expiration period, size and maturity of the market prior to a product launch, entrance into the market of additional competition and changes in formularies. Shelf stock allowances are credits issued to reflect changes in the selling price of a product and are based upon estimates of the amount of product remaining in a customer's inventory at the time of the anticipated price change. In many cases, the customer is contractually entitled to such a credit. The allowances for shelf stock adjustments are based on specified terms with certain customers, estimated launch dates of competing products and estimated changes in market price. 73
-------------------------------------------------------------------------------- Rx Administrative Fees and Other Rebates - Rebates or administrative fees are offered to certain wholesale customers, group purchasing organizations and end-user customers, consistent with pharmaceutical industry practice. Settlement of rebates and fees may generally occur from one to 15 months from the date of sale. The Company provides a provision for rebates at the time of sale based on contracted rates and historical redemption rates. Assumptions used to establish the provision include level of wholesaler inventories, contract sales volumes and average contract pricing. CHC/Nutritionals Rebates and Other Allowances - In the CHC and Nutritionals segments, the Company offers certain customers a volume incentive rebate if specific levels of product purchases are made during a specified period. The accrual for rebates is based on contractual agreements and estimated levels of purchasing. In addition, the Company has a reserve for product returns, primarily related to damaged and unsaleable products. The Company also has agreements with certain customers to cover promotional activities related to the Company's products. These activities include coupon programs, new store allowances, product displays and other various activities. The accrual for these activities is based on customer agreements and is established at the time product revenue is recognized. Allowances for customer-related programs are generally recorded at the time of sale based on the estimates and methodologies described above. The Company continually monitors product sales provisions and re-evaluates these estimates as additional information becomes available, which includes, among other things, an assessment of current market conditions, trade inventory levels and customer product mix. The Company makes adjustments to these provisions at the end of each reporting period, to reflect any such updates to the relevant facts and circumstances. Current reporting period adjustments to allowance amounts established in prior reporting periods have not historically been material. The following table summarizes activity for the fiscal years ended
June 28, 2014and June 29, 2013in the balance sheet for customer-related accruals and allowances: Customer-Related Accruals and Allowances CHC/Nutritionals/Specialty Rx Pharmaceuticals Sciences Medicaid Returns and Shelf Stock Admin. Fees and Other (in millions) Chargebacks Rebates Allowances Rebates Rebates and Other Allowances
Balance at June 30, 2012 $ 63.5
$ 10.6$ 34.7 $ 17.1 $ 25.0 $ 150.9Balances Acquired in Business Acquisitions - - - 1.0 1.9 2.9 Provisions/Adjustments 591.0 22.0 22.0 93.0 92.5 820.5 Credits/Payments (587.2 ) (23.2 ) (19.5 ) (91.8 ) (81.8 ) (803.5 ) Balance at June 29, 2013 67.4 9.3 37.2 19.3 37.6 170.8 Balances Acquired in Business Acquisitions - - - - 17.1 17.1 Provisions/Adjustments 885.4 52.5 46.9 116.4 117.4 1,218.6 Credits/Payments (804.9 ) (37.4 ) (30.5 ) (110.4 ) (105.3 ) (1,088.5 ) Balance at June 28, 2014 $ 147.9 $ 24.4$ 53.6 $ 25.3 $ 66.8 $ 318.0Revenues from service and royalty arrangements, including revenues from collaborative agreements, consist primarily of royalty payments, payments for research and development services, up-front fees and milestone payments. If an arrangement requires the delivery or performance of multiple deliverables or service elements, the Company determines whether the individual elements represent "separate units of accounting". If the separate elements meet the requirements, the Company recognizes the revenue associated with each element separately and revenue is allocated among elements based on their relative selling prices. If the elements within a multiple deliverable arrangement are not considered separate units of accounting, the delivery of an individual element is considered not to have occurred if there are undelivered elements that are considered essential to the arrangement. To the extent such arrangements contain refund clauses triggered by non-performance or other adverse circumstances, revenue is not recognized until all contractual obligations are satisfied. Non-refundable up-front fees are deferred and amortized to revenue over the related performance period. The Company estimates the performance period based on the specific terms of each collaborative agreement. Revenue associated with research and development services is recognized on a proportional performance basis over the period that the 74 -------------------------------------------------------------------------------- Company performs the related activities under the terms of the agreement. Revenue resulting from the achievement of contingent milestone events stipulated in the agreements is recognized when the milestone is achieved. Milestones are based upon the occurrence of a substantive element specified in the contract. Inventory Reserves - The Company maintains reserves for estimated obsolete or unmarketable inventory based on the difference between the cost of the inventory and its estimated market value. In estimating the reserves, management considers factors such as excess or slow-moving inventories, product expiration dating, products on quality hold, current and future customer demand and market conditions. Changes in these conditions may result in additional reserves. Income Taxes - The Company's tax rate is subject to adjustment over the balance of the fiscal year due to, among other things, income tax rate changes by governments; the jurisdictions in which the Company's profits are determined to be earned and taxed; changes in the valuation of the Company's deferred tax assets and liabilities; adjustments to estimated taxes upon finalization of various tax returns; adjustments to the Company's interpretation of transfer pricing standards, changes in available tax credits, grants and other incentives; changes in stock-based compensation expense; changes in tax laws or the interpretation of such tax laws (for example, proposals for fundamental U.S. international tax reform); changes in U.S. generally accepted accounting principles; expiration or the inability to renew tax rulings or tax holiday incentives; and the repatriation of earnings with respect to which the Company has not previously provided taxes. Although we believe that our tax estimates are reasonable and that we prepare our tax filings in accordance with all applicable tax laws, the final determination with respect to any tax audit, and any related litigation, could be materially different from our estimates or from our historical income tax provisions and accruals. The results of an audit or litigation could have a material effect on operating results and/or cash flows in the periods for which that determination is made. In addition, future period earnings may be adversely impacted by litigation costs, settlements, penalties, and/or interest assessments. Legal Contingencies - The Company is involved in product liability, patent, commercial, regulatory and other legal proceedings that arise in the normal course of business. Refer to Note 14 of the Notes to the Consolidated Financial Statements for further information. The Company records a liability when a loss is considered probable and the amount can be reasonably estimated. If the reasonable estimate of a probable loss is a range and no amount within that range is a better estimate, the minimum amount in the range is accrued. If a loss is not probable or a probable loss cannot be reasonably estimated, no liability is recorded. The Company has established reserves for certain of its legal matters, as described in Note 14 . The Company also separately records any insurance recoveries that are probable of occurring. Acquisition Accounting - The Company accounts for acquired businesses using the acquisition method of accounting, which requires that assets acquired and liabilities assumed be recorded at fair value, with limited exceptions. Any excess of the purchase price over the fair value of the specifically identified net assets acquired is recorded as goodwill. Amounts allocated to acquired IPR&D are recognized at fair value and initially characterized as indefinite-lived intangible assets, irrespective of whether the acquired IPR&D has an alternative future use. If the acquired net assets do not constitute a business, the transaction is accounted for as an asset acquisition and no goodwill is recognized. In an asset acquisition, acquired IPR&D with no alternative future use is charged to expense at the acquisition date. The judgments made by management in determining the estimated fair value assigned to each class of asset acquired and liability assumed can materially impact the Company's results of operations. As part of the valuation procedures, the Company typically consults an independent advisor. There are several methods that can be used to determine fair value. The Company typically uses an income approach for valuing its specifically identifiable intangible assets by employing either a relief from royalty or multi-period excess earnings methodology. The relief from royalty method assumes that, if the acquired company did not own the intangible asset or intellectual property, it would be willing to pay a royalty for its use. The benefit of ownership of the intellectual property is valued as the relief from the royalty expense that would otherwise be incurred. This method is typically used by the Company for valuing readily transferable intangible assets that have licensing appeal, such as trade names and trademarks and certain technology assets. The multi-period excess earnings approach starts with a forecast of the net cash flows expected to be generated by the asset over its estimated useful life. These cash flows are then adjusted to present value by applying an appropriate discount rate that reflects the risk factors associated with the cash flow streams. This method is typically used by the Company for valuing intangible assets such as developed 75 -------------------------------------------------------------------------------- product technology, customer relationships, product formulations and IPR&D. Some of the more significant estimates and assumptions inherent in one or both of these income approaches include: • the amount and timing of projected future cash flows, adjusted for the probability of technical and marketing success; • the amount and timing of projected costs to develop IPR&D into commercially viable products;
• the discount rate selected to measure the risks inherent in the future
• the estimate of an appropriate market royalty rate; and
• an assessment of the asset's life cycle and the competitive trends
impacting the asset, including consideration of any technical, legal,
regulatory, or economic barriers to entry.
The Company believes the fair values assigned to the assets acquired and liabilities assumed are based on reasonable assumptions; however, unanticipated events and circumstances may occur that may affect the accuracy and validity of such assumptions, estimates or actual results. While the Company uses its best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date, the Company's estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, the Company records adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to the Company's consolidated statements of operations. Determining the useful life of an intangible asset also requires judgment, as different types of intangible assets will have different useful lives and certain assets may even be considered to have indefinite useful lives. Useful life is the period over which the intangible asset is expected to contribute directly or indirectly to the company's future cash flows. The Company determines the useful lives of intangible assets based on a number of factors, such as legal, regulatory, or contractual provisions that may limit the useful life, and the effects of obsolescence, anticipated demand, existence or absence of competition, and other economic factors on useful life. Goodwill - Goodwill is tested for impairment annually or more frequently if changes in circumstances or the occurrence of events suggest impairment exists. The test for impairment requires the Company to make several estimates about fair value, most of which are based on projected future cash flows and market valuation multiples. The estimates associated with the goodwill impairment tests are considered critical due to the judgments required in determining fair value amounts, including projected future cash flows. Changes in these estimates may result in the recognition of an impairment loss. The Company performs its annual goodwill and indefinite-lived intangible assets impairment testing for all of its reporting units in the fourth quarter of the fiscal year. Other Intangible Assets - Other intangible assets consist of a portfolio of individual developed product technology/formulation and product rights, distribution and license agreements, customer relationships, non-compete agreements, IPR&D, and trade names and trademarks. The assets categorized as developed product technology/formulation and product rights, certain distribution and license agreements and non-compete agreements are amortized over their estimated useful economic lives using the straight-line method. Customer relationships and certain distribution agreements are amortized on a proportionate basis consistent with the economic benefits derived from those relationships and agreements. Certain trade names and trademarks, as well as IPR&D assets, are determined to have an indefinite useful life and are not subject to amortization. The Company, however, reviews them for impairment on an annual basis, or more frequently if events or changes in circumstances indicate that any individual asset might be impaired, and adjusts the carrying value of the asset as necessary. IPR&D assets are initially recognized at fair value and classified as indefinite-lived assets until the successful completion or abandonment of the associated research and development efforts. For intangible assets subject to amortization, an impairment analysis is performed whenever events or changes in circumstances indicate that the carrying amount of any individual asset may not be recoverable. The carrying amount of an intangible asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. An impairment loss is recognized if the carrying amount of the asset is not recoverable and its carrying amount exceeds its fair value. 76 --------------------------------------------------------------------------------
Recently Issued Accounting Standards
See Note 1 of the Notes to Consolidated Financial Statements for information regarding recently issued accounting standards.