| Summary of Significant Accounting Policies | 2. Summary of Significant Accounting Policies
Basis of Presentation and Principles of Consolidation
The accompanying consolidated financial statements of United Therapeutics Corporation and its wholly owned subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States (GAAP). All intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of our consolidated financial statements in accordance with GAAP requires our management to make estimates and assumptions that affect reported amounts of assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. We base our estimates on assumptions regarding historical experience, currently available information and anticipated developments that we believe are reasonable and appropriate. However, because the use of estimates involves an inherent degree of uncertainty, actual results could differ from those estimates. Estimates are used for, but not limited to, revenue recognition, share-based compensation, determining the fair value of assets acquired and liabilities assumed in business combinations, marketable investments, fair value measurements (including those related to contingent consideration), inventory reserves, investments in privately-held companies, income taxes, goodwill and other intangible assets, and obligations related to our Supplemental Executive Retirement Plan.
Fair Value Measurements
Fair value is a market-based measurement, not an entity-specific measurement. The objective of a fair value measurement is to estimate the price to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date under current market conditions. Such transactions to sell an asset or transfer a liability are assumed to occur in the principal market for that asset or liability, or in the absence of the principal market, the most advantageous market for the asset or liability.
Assets and liabilities subject to fair value measurement disclosures are required to be classified according to a three-level fair value hierarchy with respect to the inputs (or assumptions) used to determine fair value. The level in which an asset or liability is disclosed within the fair value hierarchy is based on the lowest level input that is significant to the related fair value measurement in its entirety. The guidance under the fair value measurement framework applies to other existing accounting guidance in the Financial Accounting Standards Board (FASB) codification that requires or permits fair value measurements. Refer to related disclosures in Note 6— Fair Value Measurements .
Fair Value of Financial Instruments
The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, and accrued expenses approximate fair value because of their short maturities. The fair values of our marketable investments and contingent consideration are reported in Note 5 -Investments and Note 6 -Fair Value Measurements , respectively.
Cash Equivalents
Cash equivalents consist of highly liquid investments with maturities of three months or less from the date of acquisition.
Marketable Investments
Our marketable investments are primarily debt securities that we classify as available-for-sale or held-to-maturity. If we have both the positive intent and the ability to hold the securities until maturity, the securities are classified as held-to-maturity. We determine the appropriate classification of the securities at the time they are acquired and evaluate the appropriateness of such classifications at each balance sheet date. Available-for-sale debt securities are recorded at fair value, with unrealized gains and losses included as a component of accumulated other comprehensive income (loss) in stockholders’ equity, until realized. Held-to-maturity debt securities are recorded at amortized cost, adjusted for the amortization of discounts or premiums. Related discounts and premiums are amortized over the term of these securities as an adjustment to the yield using the effective interest method. Marketable investments are classified as either current or non-current assets on our consolidated balance sheets based on their contractual maturity dates.
We monitor our investment portfolio for impairment quarterly or more frequently if circumstances warrant. In the event that the carrying value of a debt security exceeds its fair value and the decline in value is determined to be other‑than‑temporary, we record an impairment charge within earnings attributable to the estimated credit loss. In determining whether a decline in the value of an investment is other‑than‑temporary, we evaluate currently available factors that may include, among others: (1) general market conditions; (2) the duration and extent to which fair value has been less than the carrying value; (3) the investment issuer’s financial condition and business outlook; and (4) our assessment as to whether it is more likely than not that we will be required to sell a security prior to recovery of its amortized cost basis.
Inventories
Inventories are stated at the lower of cost (first-in, first-out method) or net realizable value and consist of the following, net of reserves (in millions):
As of December 31,
2018
2017
Raw materials
$
24.3
$
27.9
Work-in-progress
28.0
24.1
Finished goods
48.7
55.9
Total inventories
$
101.0
$
107.9
Goodwill and Other Intangible Assets
The carrying amount of goodwill is not amortized but is subject to annual impairment testing. We conduct our impairment testing of goodwill annually during the fourth quarter, or more frequently, if impairment indicators exist. Initially, we evaluate various pertinent qualitative factors to assess whether it is more likely than not that the fair value of a reporting unit to which goodwill has been assigned is less than its carrying value. Such qualitative factors can include, among others: (1) industry and market conditions; (2) present and anticipated sales and cost factors; and (3) overall financial performance. If we conclude based on our qualitative assessment that it is more likely than not that the fair value of a reporting unit is less than its carrying value, we then measure the fair value of the reporting unit and compare its fair value to its carrying value (Step 1 of the goodwill impairment test). If the carrying amount of the reporting unit exceeds its fair value, then the amount of an impairment loss, if any, is measured as the excess of the recorded amount of goodwill over its implied fair value (Step 2 of the goodwill impairment test). We used a qualitative assessment for our goodwill impairment testing for 2018 and 2017. Our evaluation of goodwill completed during the years ended December 31, 2018 and 2017, resulted in no impairment losses.
Indefinite-lived intangible assets are not amortized but are evaluated annually or more frequently for impairment if impairment indicators exist. Our indefinite-lived intangible assets include purchased in-process research and development (IPR&D) projects, which were measured at their estimated fair values as of their acquisition dates. We used a qualitative assessment for our indefinite-lived intangible asset impairment testing. Our evaluation of indefinite-lived intangible assets completed during the years ended December 31, 2018 and 2017, resulted in no impairment losses.
Intangible assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an intangible asset may not be recoverable. Impairment losses are measured and recognized to the extent the carrying value of such assets exceeds their fair value. We recorded no impairment losses during the years ended December 31, 2018 and 2017.
Goodwill and other intangible assets consist of the following (in millions):
As of December 31, 2018
As of December 31, 2017
Accumulated
Accumulated
Gross
Amortization
Net
Gross
Amortization
Net
Goodwill
$
31.5
$
—
$
31.5
$
13.7
$
—
$
13.7
Other intangible assets:
Technology, patents and trade names
6.7
(5.1)
1.6
6.5
(5.0)
1.5
In-process research and development
137.7
—
137.7
30.4
—
30.4
Total
$
175.9
$
(5.1)
$
170.8
$
50.6
$
(5.0)
$
45.6
For more information related to changes in the current year, refer to Note 4—Acquisition.
Related amortization expense for the years ended December 31, 2018, 2017 and 2016, was $0.1 million, $0.5 million and $0.6 million, respectively. As of December 31, 2018, aggregate amortization expense related to definite-lived intangible assets for each of the five succeeding years and thereafter is estimated at less than $1.0 million per year.
Property, Plant and Equipment
Property, plant and equipment is recorded at cost and depreciated over its estimated useful life using the straight‑line method. The estimated useful lives of property, plant and equipment by major category are as follows:
Land improvements
15 Years
Buildings
25 - 39 Years
Building improvements
10 - 39 Years
Furniture, equipment and vehicles
3 - 25 Years
Leasehold improvements
Remaining lease term, or the estimated useful life of the improvement, whichever is shorter
Property, plant and equipment consists of the following (in millions):
As of December 31,
2018
2017
Land and land improvements
$
69.0
$
60.5
Buildings, building improvements and leasehold improvements
533.3
408.0
Buildings under construction
126.5
119.8
Furniture, equipment and vehicles
205.5
159.9
934.3
748.2
Less—accumulated depreciation
(234.6)
(202.5)
Property, plant and equipment, net
$
699.7
$
545.7
Depreciation expense for the years ended December 31, 2018, 2017 and 2016, was $35.8 million, $30.5 million and $31.0 million, respectively.
Buildings under construction consists of direct costs related to our construction projects.
Treasury Stock
Repurchased treasury stock is recorded at cost, including commissions and fees. The cost of treasury shares sold or reissued is determined using the first-in, first-out method. Related gains and losses on sales of treasury stock are recognized as adjustments to stockholders’ equity.
Revenue Recognition
On January 1, 2018, we adopted Topic 606 using the modified retrospective approach applied to those contracts in effect as of January 1, 2018. Under this transition method, results for reporting periods beginning after January 1, 2018 are presented under the new standard, while prior period amounts are not adjusted and continue to be reported in accordance with our historical accounting under Topic 605, Revenue Recognition. See Note 3— Recently Issued Accounting Standards for further discussion of the adoption of Topic 606, including the impact on our 2018 financial statements.
To determine revenue recognition for contractual arrangements that we determine are within the scope of Topic 606, we perform the following five steps: (1) identify each contract with a customer; (2) identify the performance obligations in the contract; (3) determine the transaction price; (4) allocate the transaction price to our performance obligations in the contract; and (5) recognize revenue when (or as) we satisfy the relevant performance obligation. We only apply the five-step model to contracts when it is probable that we will collect the consideration we are entitled to in exchange for the goods or services we transfer to the customer.
We generate revenues from the sale of our five commercially approved products: Remodulin, Tyvaso, Orenitram, Unituxin and Adcirca. We recognize revenue when we transfer control of our products to our distributors, as our contracts have a single performance obligation (delivery of our product). Except for Adcirca sales, the performance obligation is generally satisfied when our products are delivered to the distributor’s designated location. We recognize revenue from Adcirca sales upon shipment from an Eli Lilly and Company (Lilly) distribution center. Future revenue from delivery of our products will be based on purchase orders provided to us by our distributors. We are not required to disclose the value of unsatisfied performance obligations as our contracts have a non-cancelable duration of one year or less.
See Note 15—Segment Information, for information on revenues disaggregated by commercial product, geographic area and customer.
Gross-to-Net Deductions
As is customary in the pharmaceutical industry, our product sales are recorded net of various forms of gross-to-net deductions. These deductions vary the consideration to which we are entitled in exchange for the sale of our products to our distributors, and include reserves for: (1) rebates and chargebacks; (2) prompt payment discounts; (3) allowances for sales returns; and (4) distributor fees and other allowances. We estimate these reserves in the same period that we recognize revenue for product sales to distributors. The net product sales amount recognized represents the amount we believe will not be subject to a significant future reversal of revenue.
Estimating gross-to-net deductions involves the use of significant assumptions and judgments , as well as information obtained from external sources. For our rebate and chargeback liabilities, in particular, the time lag experienced in the payment of the rebate or chargeback may result in revisions of these accruals in future periods. However, based on our significant history and experience estimating these accruals and our development of these accruals based on the expected value method, we do not believe there will be significant changes to our estimates recorded during the period of sale. We recognized an aggregate $8.8 million increase in our net product sales for the year ended December 31, 2018 and an aggregate $13.1 million decrease in our net product sales for the year ended December 31, 2017, related to revenue recognized from product sales in prior periods. In 2018 we recorded a change in estimate that resulted in the reversal of an estimated liability for Medicaid rebates of $13.6 million, which had initially been recorded in 2017. Additional adjustments to accruals for prior periods primarily related to our participation in state Medicaid programs and contracts with commercial payers.
Rebates and chargebacks. Allowances for rebates include mandated discounts due to our participation in various government health care programs and contracted discounts with commercial payers. We estimate our rebate liability on a product-by-product basis, considering actual revenue, contractual discount rates, expected utilization under each contract and historical payment experience. We also consider changes in our product pricing and information regarding changes in program regulations and guidelines. Our chargebacks represent contractual discounts payable to distributors for the difference between the invoice price paid to us by the distributor for a particular product and the contracted price that the distributor’s customer pays for that product. Our chargebacks primarily relate to sales of Adcirca. We estimate our chargeback liability on a product-by-product basis, primarily considering historical payment experience. Although we accrue a liability for rebates and chargebacks in the same period the product is sold, third-party reporting and payment of the rebate or chargeback amount occur on a time lag, with the majority of rebates and chargebacks paid within six months from date of sale. Our liability for rebates and chargebacks is included in accounts payable and accrued expenses on our consolidated balance sheets.
Prompt payment discounts . We offer prompt pay discounts to many of our distributors, typically for payments made within 30 days. Prompt pay discounts are estimated in the period of sale based on our experience with sales to eligible distributors. Our domestic distributors have routinely taken advantage of these discounts and we expect them to continue to do so. Prompt pay discounts are recorded as a deduction to the accounts receivable balance presented on our consolidated balance sheets.
Product returns . The sales terms for Adcirca and Unituxin include return rights that extend throughout the distribution channel. For Adcirca, we recognize an allowance for returns as customers have the right to return expired product for up to 12 months past the product’s expiration date (generally 24 to 36 months after the initial sale). Returned product is destroyed. Regulatory exclusivity for Adcirca expired in May 2018, and a generic version of Adcirca became available for purchase in the third quarter of 2018. Due to the availability of the generic version, we have experienced a significant decline in Adcirca demand, which could result in inventory held by distributors and other downstream customers expiring unsold. As a result, we increased our allowance for product returns for Adcirca from $7.2 million as of December 31, 2017 to $22.4 million as of December 31, 2018. We record our allowance for product returns in other current and non-current liabilities on our consolidated balance sheets. We developed our returns liability as of December 31, 2018, based on our estimate of the amount of Adcirca inventory in the downstream channel and the amount of that inventory that we expect will not be dispensed to patients, using forecasted sales and demand estimates. The estimates were developed using reports from our distributors and third-party data, including the historical impact of generic entrants on other branded products that we deemed comparable to Adcirca.
For Unituxin, we ship product with expiration dates that are generally 9 to 14 months after the initial sale. However,our historical returns have not been material and, therefore, we do not record a returns allowance for Unituxin. For sales of our other commercial products, we do not offer our customers a general right of return.
Distributor fees and other allowances . Distributor fees include distribution and other service fees paid to certain distributors. These fees are based on contractual amounts or rates applied to purchases of our product or units of service provided in a given period. Our liability for distributor fees is included in accounts payable and accrued expenses on our consolidated balance sheets.
Trade Receivables
We invoice and receive payment from our customers after we recognize revenue, resulting in receivables from our customers that are presented as accounts receivable on our consolidated balance sheets. Accounts receivable consist of short-term amounts due from our distributors (generally 30 to 90 days) and are stated at the amount we expect to collect. We establish an allowance for doubtful accounts , if deemed necessary, based on our assessment of the collectability of specific distributor accounts. We did not recognize any impairment losses for accounts receivable for each of the years ending December 31, 2018 and 2017. Changes in accounts receivable are primarily due to the timing and magnitude of orders of our products, the timing of when control of our products is transferred to our distributors and the timing of cash collections.
Adcirca
Adcirca is manufactured for us by Lilly and distributed through its pharmaceutical wholesaler network. Specifically, Lilly handles all of the administrative functions associated with the sale of Adcirca on our behalf, including the receipt and processing of customer purchase orders, shipment to customers, and invoicing and collection of customer payments. We recognize sales of Adcirca on a gross basis (net of reserves for gross-to-net deductions) based on our determination that we are acting as a principal due to our control of the product prior to its transfer to our customers. Our control is evidenced by our substantive ownership of product inventory, the fact that we bear all inventory risks, our primary responsibility for the acceptability of the product to our customers, and our ability to influence net product sales through our contracting decisions with commercial payers and participation in governmental-funded programs.
Research and Development
Research and development costs are expensed as incurred except for refundable payments made in advance of services to be provided to us. Related expenses consist of internal labor and overhead, costs to acquire pharmaceutical products and product rights for development, materials used in clinical trials and amounts paid to third parties for services and materials related to drug development and clinical trials.
As part of our business strategy, we may in-license the rights to develop and commercialize product candidates. For each in-license transaction, we evaluate whether we have acquired processes or activities along with inputs that would be sufficient to constitute a “business” as defined under GAAP. As defined under GAAP , a “business” consists of inputs and processes applied to those inputs that have the ability to create outputs. Although businesses usually have outputs, outputs are not required for an integrated set of activities to qualify as a business. When we determine that we have not acquired sufficient processes or activities to constitute a business, any up-front payments, as well as pre-commercial milestone payments, are immediately expensed as acquired in-process research and development in the period in which they are incurred. Milestone payments made to third parties subsequent to regulatory approval are capitalized as intangible assets and amortized over the estimated remaining useful life of the related product.
We recognize the following as research and development expense in the period related costs are incurred:
·
costs associated with in-house or contracted manufacturing activities prior to receiving FDA approval for such facilities, or for major unproven changes to our manufacturing processes;
·
costs incurred in-licensing the rights to technologies in the research and development stage that have no alternative future use; and
·
up‑front payments made in connection with arrangements to obtain license and distribution rights to pharmaceutical product candidates prior to regulatory approval, absent any alternative future use.
Share‑Based Compensation
Generally, the fair value of a stock option grant is measured on its grant date and related compensation expense is recognized ratably over the requisite service period. We issue new shares of our common stock upon the exercise of stock options. Additionally, certain executives have stock options with performance conditions that have vesting rights tied to achievement of specific targeted criteria. Share-based compensation expense for all awards is recorded ratably over their vesting period, depending on the specific terms of the award and achievement of the specified performance conditions. Refer to Note 10 — Share-Based Compensation.
We measure the fair value of restricted stock units using the stock price on the date of grant and related compensation expense is recognized ratably over the vesting period. Each restricted stock unit entitles the holder to receive one share of our common stock upon vesting. We issue new shares of our common stock upon the vesting of restricted stock units.
Awards under our share tracking awards plans require cash settlement upon exercise and are classified as a liability. Accordingly, the fair value of related cash-settled awards is re-measured at each reporting date until awards are exercised or are otherwise no longer outstanding. Related changes in the fair value of outstanding cash-settled awards at each financial reporting date are recognized as adjustments to share-based compensation expense.
We measure the fair value of stock to be purchased through our employee stock purchase plan at the beginning of an offering period, or grant date, and recognize related compensation expense ratably over the requisite service period (the offering period). We issue new shares of our common stock upon the end of each offering period, or exercise date.
Income Taxes
We account for income taxes in accordance with the asset and liability method. Under this method, we determine deferred tax assets and liabilities based on the difference between the financial statement carrying amounts and the tax bases of assets and liabilities, using enacted tax rates in effect for years in which the temporary differences are expected to reverse. We apply a valuation allowance against any net deferred tax asset if, based on the available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.
We recognize the benefit of an uncertain tax position that has been taken or that we expect to take on income tax returns only if such tax position is more likely than not to be sustained. We recognize the benefit in an amount equal to the largest amount that we determine has a greater than 50 percent likelihood of being realized upon settlement. The ultimate resolution of uncertain tax positions could result in amounts different from those recognized in our consolidated financial statements.
Earnings per Share
Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per common share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period, plus the potential dilutive effect of other securities if such securities were converted or exercised. During periods in which we incur net losses, both basic and diluted loss per share is calculated by dividing the net loss by the weighted average shares outstanding. Potentially dilutive securities are excluded from the calculation because their effect would be anti‑dilutive.
Concentration of Credit Risk
Financial instruments that are exposed to credit risk consist of cash, money market funds, certificates of deposit, marketable debt securities, and trade receivables. We maintain our cash and money market funds with financial institutions that are federally insured. While balances deposited in these institutions often exceed Federal Deposit Insurance Corporation limits, we have not experienced any losses on related accounts to date. Furthermore, we limit our risk exposure by maintaining funds in financial institutions that we believe are creditworthy and financially sound. Our investments in marketable debt securities have been issued by corporate entities and government-sponsored enterprises with high credit ratings. We mitigate investment risks by investing in highly-rated securities with relatively short maturities that we believe do not subject us to undue investment or credit risk. In addition, our investment policy does not provide for investments in complex or structured financial instruments. At any given time, our trade receivables are concentrated among a small number of principal customers. If any of these financial institutions, issuers or customers fail to perform their obligations under the terms of these financial instruments, our maximum exposure to potential losses would be equal to amounts reported on our consolidated balance sheets. |
