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Financial Instruments and Fair Value Measurements

3 Months Ended

Mar. 27, 2020

Financial Instruments and Fair Value Measurements



12.	Financial Instruments and Fair Value Measurements

Fair value is defined as the exit price that would be received from the sale of an asset or paid to transfer a liability, using assumptions that market participants would use in pricing an asset or liability. The fair value guidance establishes a three-level fair value hierarchy, which maximizes the use of observable inputs and minimizes the use of unobservable inputs used in measuring fair value. The levels within the hierarchy are as follows:

Level 1— observable inputs such as quoted prices in active markets for identical assets or liabilities;

Level 2— significant other observable inputs that are observable either directly or indirectly; and

Level 3— significant unobservable inputs in which there is little or no market data, which requires the Company to develop its own assumptions.

The following tables provide a summary of the significant assets and liabilities that are measured at fair value on a recurring basis at the end of each period:



	March 27, 2020		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Debt and equity securities held in rabbi trusts	$	28.6	$	19.3	$	9.3	$	—
Equity securities	29.2		29.2		—		—
	$	57.8	$	48.5	$	9.3	$	—

Liabilities:
Deferred compensation liabilities	$	27.5	$	—	$	27.5	$	—
Contingent consideration and acquired contingent liabilities	68.8		—		—		68.8
Settlement Warrants	26.6		—		—		26.6
	$	122.9	$	—	$	27.5	$	95.4



	December 27, 2019		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Assets:
Debt and equity securities held in rabbi trusts	$	30.6	$	21.0	$	9.6	$	—
Equity securities	26.2		26.2		—		—
	$	56.8	$	47.2	$	9.6	$	—

Liabilities:
Deferred compensation liabilities	$	39.2	$	—	$	39.2	$	—
Contingent consideration and acquired contingent liabilities	69.3		—		—		69.3
Settlement Warrants	43.4		—		—		43.4
	$	151.9	$	—	$	39.2	$	112.7

Debt and equity securities held in rabbi trusts. Debt securities held in rabbi trusts primarily consist of U.S. government and agency securities and corporate bonds. When quoted prices are available in an active market, the investments are classified as level 1. When quoted market prices for a security are not available in an active market, they are classified as level 2. Equity securities held in rabbi trusts primarily consist of U.S. common stocks, which are valued using quoted market prices reported on nationally recognized securities exchanges.

Equity securities. Equity securities consist of shares in Silence Therapeutics plc, for which quoted prices are available in an active market; therefore, the investment is classified as level 1 and is valued based on quoted market prices reported on an internationally recognized securities exchange.

Deferred compensation liabilities. The Company maintains a non-qualified deferred compensation plan in the U.S., which permits eligible employees of the Company to defer a portion of their compensation. A recordkeeping account is set up for each participant and the participant chooses from a variety of funds for the deemed investment of their accounts. The recordkeeping accounts generally correspond to the funds offered in the Company's U.S. tax-qualified defined contribution retirement plan and the account balance fluctuates with the investment returns on those funds.

Contingent consideration and acquired contingent liabilities. As of March 27, 2020, the Company maintains various contingent consideration and acquired contingent liabilities associated with the acquisitions of Questcor, Stratatech Corporation ("Stratatech"), and Ocera Therapeutics, Inc. ("Ocera").

The contingent liability associated with the acquisition of Questcor pertains to the Company's license agreement with Novartis AG and Novartis Pharma AG (collectively "Novartis") related to Synacthen, otherwise known as the Company's development

product MNK-1411. The fair value of the remaining contingent payments expected to be transferred was measured based on the net present value of a probability-weighted assessment. The Company determined the fair value of the contingent consideration associated with the acquisition of Questcor to be $24.8 million and $24.5 million as of March 27, 2020 and December 27, 2019, respectively.

As part of the acquisition of Stratatech, the Company provided contingent consideration to the prior shareholders of Stratatech, primarily in the form of regulatory filing and approval milestones associated with the deep partial thickness and full thickness indications associated with StrataGraft^®. The Company assesses the likelihood and timing of making such payments at each balance sheet date. The fair value of the contingent payments was measured based on the net present value of a probability-weighted assessment. The Company determined the fair value of the contingent consideration associated with the acquisition of Stratatech to be $31.4 million and $29.0 million as of March 27, 2020 and December 27, 2019, respectively.

As part of the acquisition of Ocera, the Company provided contingent consideration to the prior shareholders of Ocera in the form of both patient enrollment clinical study milestones and sales-based milestones associated with MNK-6105 and MNK-6106. The Company determined the fair value of the contingent consideration based on an option pricing model to be $12.6 million and $15.8 million as of March 27, 2020 and December 27, 2019, respectively.

Of the total fair value of the contingent consideration of $68.8 million, $62.1 million was classified as current and $6.7 million was classified as non-current in the unaudited condensed consolidated balance sheet as of March 27, 2020. The following table summarizes the activity for contingent consideration:



Balance as of December 27, 2019	$	69.3
Accretion expense	0.3
Fair value adjustments	(0.8		)
Balance as of March 27, 2020	$	68.8

Settlement Warrants. As a result of the Litigation Settlement, the Company is to issue Settlement Warrants upon emergence from the contemplated Chapter 11 process to the Opioid Claimant Trust to purchase ordinary shares of the Company with an eight year term at a strike price of $3.15 per ordinary share that would represent approximately 19.99% of the Company's fully diluted outstanding shares, including after giving effect to the exercise of the warrants, provided that such warrants may not be exercised during any calendar quarter in a quantity that would exceed 5.0% of the number of shares outstanding.

The fair value of the Settlement Warrants has been estimated using the Black-Scholes pricing model. Use of a valuation model requires management to make certain assumptions with respect to selected model inputs. The expected volatility assumption is based on the historical and implied volatility of the Company's peer group with similar business models. The expected term assumption is based on the contractual term of the Settlement Warrants, including the maximum exercise restriction of 5.0% per calendar quarter, which resulted in the valuation of four separate tranches. The expected annual dividend per share is based on the Company's current intentions regarding payment of cash dividends. The risk-free interest rate is based on U.S. Treasury zero-coupon issues with a remaining term equal to the expected term assumed. The estimated fair value for the Settlement Warrants will be subject to revaluation at each balance sheet date with any changes in fair value recorded as a non-cash gain or (loss) in the consolidated statements of operations until the Settlement Warrants are issued, at which point they will be recorded as equity or as a liability based upon the facts and circumstances at the time of issuance.

The key assumptions used to estimate the fair value of the Settlement Warrants were as follows:



	March 27, 2020			December 27, 2019
Expected share price volatility	64.1		%	54.4		%
Weighted-average risk-free rate	0.6		%	1.8		%
Expected annual dividend per share	—		%	—		%
Weighted-average expected term (in years)	7.6			7.6
Share price	$	2.23		$	3.45

Financial Instruments Not Measured at Fair Value

The following methods and assumptions were used by the Company in estimating fair values for financial instruments not measured at fair value as of March 27, 2020 and December 27, 2019:


•	The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and the majority of other current assets and liabilities approximate fair value because of their short-term nature. The Company classifies cash on hand and deposits in banks, including commercial paper, money market accounts and other investments it may hold from

time to time, with an original maturity of three months or less, as cash and cash equivalents (level 1). The fair value of restricted cash was equivalent to its carrying value of $41.2 million and $31.7 million as of March 27, 2020 and December 27, 2019, (level 1), respectively, which was included in other assets on the unaudited condensed consolidated balance sheets.

•

The Company has received a portion of consideration as part of contingent earn-out payments related to the sale of the Nuclear Imaging business in the form of preferred equity certificates. These securities are classified as held-to-maturity and are carried at amortized cost, which approximates fair value (level 3), of $29.8 million and $18.9 million as of March 27, 2020 and December 27, 2019, respectively. These securities are included in other assets on the unaudited condensed consolidated balance sheets.

•

The Company's life insurance contracts are carried at cash surrender value, which is based on the present value of future cash flows under the terms of the contracts (level 3). Significant assumptions used in determining the cash surrender value include the amount and timing of future cash flows, interest rates and mortality charges. The fair value of these contracts approximates the carrying value of $51.0 million and $51.1 million as of March 27, 2020 and December 27, 2019, respectively. These contracts are included in other assets on the unaudited condensed consolidated balance sheets.

•

The carrying value of the Company's revolving credit facility approximates the fair value due to the short-term nature of this instrument, and is therefore classified as level 1. The Company's 4.875%, 5.75%, 4.75%, 5.625%, 5.50% and 10.00% senior notes are classified as level 1, as quoted prices are available in an active market for these notes. Since the quoted market prices for the Company's term loans and 9.50% and 8.00% debentures are not available in an active market, they are classified as level 2 for purposes of developing an estimate of fair value. The following table presents the carrying values and estimated fair values of the Company's debt as of the end of each period:



	March 27, 2020				December 27, 2019
	Carrying Value		Fair Value		Carrying Value		Fair Value
Level 1:
4.875% senior notes due April 2020	$	614.8	$	408.9	$	614.8	$	480.0
5.75% senior notes due August 2022	610.3		283.3		610.3		251.0
4.75% senior notes due April 2023	133.7		28.8		133.7		53.7
5.625% senior notes due October 2023	514.7		131.2		514.7		193.2
5.50% senior notes due April 2025	387.2		76.1		387.2		135.5
10.00% second lien senior notes due April 2025	322.9		221.9		322.9		253.8
Revolving credit facility	900.0		900.0		900.0		900.0
Level 2:
9.50% debentures due May 2022	10.4		5.2		10.4		5.4
8.00% debentures due March 2023	4.4		1.6		4.4		2.0
Term loan due September 2024	1,516.9		1,026.3		1,520.8		1,240.0
Term loan due February 2025	402.6		270.2		403.6		326.2
Total Debt	$	5,417.9	$	3,353.5	$	5,422.8	$	3,840.8

Concentration of Credit and Other Risks

Financial instruments that potentially subject the Company to concentrations of credit risk primarily consist of accounts receivable. The Company generally does not require collateral from customers. A portion of the Company's accounts receivable outside the U.S. includes sales to government-owned or supported healthcare systems in several countries, which are subject to payment delays. Payment is dependent upon the financial stability and creditworthiness of those countries' national economies.

The following table shows net sales attributable to distributors that accounted for 10.0% or more of the Company's total net sales:



	Three Months Ended
	March 27, 2020		March 29, 2019
CuraScript, Inc.	24.6	%	27.5	%

The following table shows accounts receivable attributable to distributors that accounted for 10.0% or more of the Company's gross accounts receivable at the end of each period:



	March 27, 2020		December 27, 2019
AmerisourceBergen Corporation	31.1	%	31.3	%
McKesson Corporation	18.5		15.3
CuraScript, Inc.	*		12.1

*Accounts receivable attributable to this distributor were less than 10.0% of total gross accounts receivable during the respective period presented above.

The following table shows net sales attributable to products that accounted for 10.0% or more of the Company's total net sales:



	Three Months Ended
	March 27, 2020		March 29, 2019
Acthar Gel	25.2	%	28.3	%
INOmax	21.3		19.1
Ofirmev	11.3		12.1

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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