RECRO PHARMA, INC. Management’s Discussion and Analysis of Financial Position and Operating Results (Form 10-Q)


You should read the following discussion and analysis of our financial condition
and results of operations together with our unaudited consolidated financial
statements and notes thereto in Part I, Item 1 of this Quarterly Report on Form
10-Q, or Quarterly Report, and the audited consolidated financial statements and
notes thereto for the year ended December 31, 2020 and the related Management's
Discussion and Analysis of Financial Condition and Results of Operations, both
of which are contained in our Annual Report on Form 10-K for the year ended
December 31, 2020 filed with the SEC on February 26, 2021, or Annual Report.

In addition to historical information, this discussion and analysis contains
forward-looking statements that involve risks, uncertainties and assumptions and
other factors that could cause actual results to differ materially from those
made, projected or implied in the forward-looking statements. Our actual results
may differ materially from those discussed below. Please see "Forward-Looking
Statements" and "Risk Factors" included in Part I, Item 1A of our Annual Report
for factors that could cause or contribute to such differences.

Caution Regarding Forward-Looking Statements

This Quarterly Report contains forward-looking statements that involve
substantial risks and uncertainties. All statements, other than statements of
historical facts, included in this Quarterly Report regarding our strategy,
future operations, future financial position, future revenues, projected costs,
prospects, plans and objectives of management are forward-looking statements.
The words "anticipate," "believe," "estimate," "expect," "intend," "may,"
"plan," "predict," "project," "will," "would" "could," "should," "potential,"
"seek," "evaluate," "pursue," "continue," "design," "impact," "affect,"
"forecast," "target," "outlook," "initiative," "objective," "designed,"
"priorities," "goal," or the negative of such terms and similar expressions are
intended to identify forward-looking statements, although not all
forward-looking statements contain these identifying words. Such statements are
based on assumptions and expectations that may not be realized and are
inherently

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subject to risks, uncertainties and other factors, many of which cannot be predicted with precision and some of which may not even be anticipated.

Forward-looking statements contained in this quarterly report include, among others, statements regarding:

?
our estimates regarding expenses, future revenue, cash flow, capital
requirements and timing and availability of and the need for additional
financing;
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our ability to maintain or expand our relationships, profitability and contracts
with our key commercial partners, including the impact of changes in consumer
demand for the products we manufacture for our commercial partners;
?
our ability to grow and diversify our business with new customers, including our
ability to meet desired project outcomes with development customers;
?
the extent to which the ongoing COVID-19 pandemic continues to disrupt our
business operations and financial condition and the business operations and
financial condition of our customers and suppliers, including our ability to
initiate and continue relationships with third-party clinical research
organizations and manufacturers and third-party logistics providers given recent
supply chain challenges;
?
our ability to operate under increased leverage and associated lending
covenants; to pay existing required interest and principal amortization payments
when due; and/or to obtain acceptable refinancing alternatives;
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the performance of third-party suppliers upon which we depend for Active
Pharmaceutical Ingredients, or APIs, excipients, capsules, reagents, etc., and
other third parties involved with maintenance of our facilities and equipment;
?
our ability to obtain and maintain patent protection for applicable products and
defend our intellectual property rights against third-parties;
?
pharmaceutical industry market forces that may impact our commercial customers'
success and continued demand for the products we produce;
?
our ability to recruit and retain key scientific, technical, business
development, and management personnel and our executive officers, including as a
result of our enforcement of state and federal vaccine mandates;
?
our ability to comply with stringent U.S. and foreign government regulation in
the manufacture of pharmaceutical products, including Good Manufacturing
Practice, or cGMP, compliance and U.S. Drug Enforcement Agency, or DEA,
compliance and other relevant regulatory authorities applicable to our business;
and
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our ability to integrate the IriSys business successfully and the risk that we
may not realize the expected benefits of such acquisition.

We may not achieve the plans, intentions or expectations disclosed in our
forward-looking statements, and you should not place undue reliance on our
forward-looking statements. Actual results or events could differ materially
from the plans, intentions and expectations disclosed in the forward-looking
statements we make. We have included important factors in the Annual Report,
particularly under "Risk Factors," that we believe could cause actual results or
events to differ materially from the forward-looking statements that we make.
Our forward-looking statements do not reflect the potential impact of any future
acquisitions, mergers, dispositions, joint ventures, collaborations or
investments we may make. You should read this Quarterly Report and the documents
that we incorporate by reference herein completely and with the understanding
that our actual future results may be materially different from what we expect.
We do not assume any obligation to update any forward-looking statements.

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Overview

We are a dedicated contract development and manufacturing organization, or CDMO,
dedicated to solving complex formulation and manufacturing challenges primarily
in small molecule therapeutic development. We leverage our formulation and
development expertise to develop and manufacture pharmaceutical products using
proprietary delivery technologies and know-how for partners who develop and
commercialize or plan to commercialize these products. In 2020, we launched our
clinical trials support services capabilities, which includes preparation of
clinical trial supplies, as well as specialized services dedicated to the
development and Good Manufacturing Practices, or GMP, of high-potency products.
In August 2021, we acquired IriSys, a San Diego-based CDMO that possesses
capabilities that complement and expand those of Recro. We operate a 97,000
square foot, DEA-licensed manufacturing facility in Gainesville, Georgia, a
24,000 square foot development, high-potency product and clinical packaging
facility in Gainesville, Georgia that we opened in October 2018, and a 24,500
square foot development and cGMP facility in San Diego, California that was part
of the IriSys acquisition. We currently develop and/or manufacture the following
key products with our key commercial partners: Ritalin LA®, Focalin XR®, Verelan
PM®, Verelan SR®, Verapamil PM, Verapamil SR, and Donnatal®, as well as
supporting development stage products.

Our manufacturing and development capabilities include formulation, product
development from formulation through clinical trial and commercial
manufacturing, and specialized capabilities for solid oral dosage forms,
extended release and controlled substance manufacturing, as well as high potency
development and manufacturing. With the acquisition of IriSys, our capabilities
have been expanded beyond oral solid dose to include sterile injectables oral
liquids, tablets, topicals, liquid/powder filled capsules, ophthalmic droppers,
liposomes and nano/microparticles. In addition, the acquisition adds new
capabilities in the areas of aseptic fill/finish and lyophilization and
established bi-coastal footprint from which to better serve clients within the
U.S., as well as globally. In a typical collaboration, we work with our partners
to develop product candidates, or new formulations of existing product
candidates, and may license certain intellectual property to such partners. We
also typically exclusively manufacture and supply clinical and commercial
supplies of these proprietary products and product candidates.

We have used cash flow generated by our business primarily to fund the growth of
our CDMO business, to fund a historical acute care research and development
business that was spun off in 2019, and to make payments under our credit
facility. We believe our business will continue to contribute cash to fund our
growth, make payments under our credit facility and other general corporate
purposes.

COVID-19[female[feminine

We continue to closely monitor developments related to the COVID-19 pandemic,
which continues to have adverse effects on the U.S. and world economies,
including the commercial activities of our customers and their peers. While we
are committed to continue providing essential pharmaceutical products to our
customers, we are also taking all necessary measures to protect the health and
safety of our employees. These developments include:

Operations. We are continuing to follow appropriate safety protocols including
strict social distancing and other protective measures for employees supporting
essential operations at our plant. We are also supporting continued remote work
arrangements for other personnel not required to work on site.

Business development. We continue to experience lower than expected growth in
our development business, which we believe is partially attributable to
COVID-19. We have responded to these challenges by adopting new methods for
meeting and contacting customers. Meanwhile, some customers have begun easing
restrictions, but these measures vary among customers and from state to state.
Other customers continue to delay their development plans for a variety of
reasons such as concerns about the timing of clinical trials.

Manufacturing demand. We believe that there continues to be lower end-user
demand for some of the commercial products we manufacture as compared to periods
prior to the onset of the COVID-19 pandemic. Third party national data
demonstrates that there was a meaningful impact of COVID-19 on the reduction of
total prescriptions filled by patients across most therapeutic areas, including
chronic cardiovascular and pediatric medications.

Logistics challenges. As global logistics and supply chain issues continue to
present obstacles to the U.S. economy and our business, we will continue to work
to overcome these challenges. We also expect to continue facing inflationary
pressure on raw materials, labor and logistics. During the three months ended
September 30, 2021, we experienced minimal supply chain disruption.

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Our sales and manufacturing operations for the nine months ended September 30,
2021 were disrupted as a result of the pandemic because of production slowdowns,
stoppages and decreased demand for the products we manufacture. While we are not
currently expecting that future results will be materially impacted by the
pandemic, there can be no assurance that such future results will not be
impacted. While vaccines have proven effective in reducing the severity and
mortality of COVID-19, including the variants that have evolved to date, the
overall vaccination rate in the United States has not reached the level required
for herd immunity. Certain variants of COVID-19, such as the delta variant, are
proving to be more easily spread than earlier variants. We may also be adversely
impacted by broader economic effects associated with the pandemic such as
inflation, changes in laws and general volatility in the markets. The continued
low vaccination rate, and the emergence of new variants, which could prove
resistant to existing vaccines, could again result in major disruptions to
businesses and markets worldwide and our business, results of operations and
financial condition could be materially and adversely affected. We will continue
to closely monitor any developments.

Financial overview

Income

We recognize three types of income: manufacturing, profit sharing, and research and development.

Manufacturing

We recognize manufacturing revenue from the sale of products we manufacture for
our commercial partners. Manufacturing revenues are recognized upon transfer of
control of a product to a customer, generally upon shipment, based on a
transaction price that reflects the consideration we expect to be entitled to as
specified in the agreement with the commercial partner, which could include
pricing and volume-based adjustments.

Profit sharing

We recognize profit-sharing or royalty revenue, collectively referred to as
profit-sharing revenue, related to the sale of products by our commercial
partners that incorporate our technologies. Profit-sharing revenues are
generally recognized under the terms of the applicable license, development
and/or supply agreement. For arrangements that include sales-based
profit-sharing and the license is deemed to be the predominant item to which the
profit-sharing relates, we recognize revenue when the related sales occur by the
commercial partner. For arrangements that include sales-based profit-sharing and
the license is not deemed to be the predominant item to which the profit-sharing
relates, we recognize revenue when the performance obligation to which the
profit-sharing has been allocated has been satisfied, which is upon transfer of
control of a product to a customer. In these cases, significant judgment is
required to calculate the estimated variable consideration from such
profit-sharing using the expected value method based on historical commercial
partner pricing and deductions. Estimated variable consideration is partially
constrained due to the uncertainty of price adjustments made by our commercial
partners, which are outside of our control. Factors causing price adjustments by
our commercial partners include increased competition in the products' markets,
mix of volume between the commercial partners' customers, and changes in
government pricing.

Research and development

Research and development revenue includes services associated with formulation,
process development, clinical trial material and clinical trial support
services, as well as custom development of manufacturing processes and
analytical methods for a customer's non-clinical, clinical and commercial
products. Such revenues are recognized at a point in time or over time depending
on the nature and particular facts and circumstances associated with the
contract terms.

In contracts that specify milestones, we evaluate whether the milestones are
considered probable of being achieved and estimate the amount to be included in
the transaction price using the most likely amount method. Milestone payments
related to arrangements under which we have continuing performance obligations
are deferred and recognized over the period of performance. Milestone payments
that are not within our control, such as submission for approval to regulators
by a commercial partner or approvals from regulators, are not considered
probable of being achieved until those submissions are submitted by the customer
or approvals are received.

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In contracts that require revenue recognition over time, we utilize input or
output methods, depending on the specifics of the contract, that compare the
cumulative work-in-process to date to the most current estimates for the entire
performance obligation. Under these contracts, the customer typically owns the
product details and process, which have no alternative use. These projects are
customized to each customer to meet its specifications and typically only one
performance obligation is included. Each project represents a distinct service
that is sold separately and has stand-alone value to the customer. The customer
also retains control of its product as the product is being created or enhanced
by our services and can make changes to its process or specifications upon
request.

Cost of sales and selling, general and administrative expenses

Cost of sales consists of inventory costs, including production wages, material
costs and overhead, and other costs related to the recognition of revenue.
Selling, general and administrative expenses consists of salaries and related
costs for corporate administrative, public company costs, business development
personnel as well as legal, patent-related expenses and consulting fees. Public
company costs include compliance, auditing services, tax services, insurance and
investor relations.

With the August 2021 acquisition of IriSys, we have been integrating and
reorganizing our collective employee base to support a multi-site organization.
As a result, we are reevaluating our expense classification policies which may
result in material reclassification in the fourth quarter of 2021.

We expect our business development expenses to increase during the remainder of
2021 as we continue to expand our sales team in various geographies, in
anticipation of business growth from new formulation and development
capabilities as well as the expansion of the team through the acquisition of
IriSys.

For the first nine months of 2021, we qualified for approximately $4.4 million
of federal employee retention credits. The employee retention credits are
recognized as offsets to our expenses in the same period that the related
employee expenditures are recognized. The expense offset for the three and nine
months ended September 30, 2021 was approximately $1.9 million and $3.6 million,
respectively, and we expect to recognize an additional expense offset of $0.8
million in the fourth quarter of 2021. We do not expect to qualify for any
additional credits based on recent legislative activity.

Amortization of intangible assets

Historically, we recognized amortization expense related to an intangible asset
for our profit-sharing and contract manufacturing relationships on a
straight-line basis over an estimated useful life of six years. Amortization
stopped when the intangible asset reached the end of its useful life in April
2021. With the acquisition of IriSys, we are recognizing amortization expense
related to acquired customer relationships, backlog and trademarks and trade
names on a straight-line basis over an estimated useful life of 12, 2.4, and 1.5
years, respectively.

Interest expense

Interest expense for the periods presented primarily relates to our Athyrium
senior secured term loans and the amortization of related financing costs. In
addition, following the acquisition of IriSys, there is additional interest
expense related to interest on the sellers note which was a component of the
IriSys acquisition purchase price.

Net operating losses and tax deferrals

As of December 31, 2020, we had federal net operating loss, or NOL, carry
forwards of approximately $130.6 million, $122.4 million of which have an
indefinite carry forward period. The remaining $8.2 million of federal NOL carry
forwards, $127.4 million of state NOL carry forwards and federal and state
research and development tax credit carryforwards of $4.4 million are also
available to offset future taxable income, but they will begin to expire at
various dates beginning in 2028 if not utilized. We believe that it is more
likely than not that the deferred income tax assets associated with our U.S.
operations will not be realized, and as such, there is a full valuation
allowance against our U.S. deferred tax assets.

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Results of operations

Comparison of the third quarters 2021 and 2020


                                                         Three months ended September 30,
(in millions)                                              2021                    2020
Revenue                                               $          18.2         $          19.3
Operating expenses:
Cost of sales (excluding amortization of intangible
assets)                                                          13.2                    11.7
Selling, general and administrative                               4.6                     4.4
Amortization of intangible assets                                 0.1                     0.7
Total operating expenses                                         17.9                    16.8
Operating income (loss)                                           0.3                     2.5
Interest expense                                                 (3.8 )                  (4.6 )
Net loss                                              $          (3.5 )       $          (2.1 )

Returned. The decline of $ 1.1 million was mainly the result of lower product sales due to the timing of customer orders. This decrease was partially offset by increases in revenues attributable to the acquisition of IriSys as well as higher revenues from our clinical trial materials business, including revenues from the Otsuka Pharmaceutical Co., Ltd. commercial product technology transfer project.

Cost of sales. The increase of $1.5 million was primarily due to costs from the
San Diego facility due to the acquisition of IriSys and is partially offset by
lower costs due to certain employment incentive tax credits in 2021.

Selling, general and administrative. The increase of $0.2 million was primarily
related to deal and integration costs related to the acquisition of IriSys and
business development expenses associated with our San Diego team offset by lower
public company costs and stock-based compensation expense.

Amortization of intangible assets. The decrease of $0.6 million was because the
amortization of CDMO royalties and contract manufacturing relationships acquired
in 2015 ended on April 10, 2021 offset by amortization related to the
acquisition of IriSys for acquired customer relationships, backlog and
trademarks and trade names.

Interest expense. The decrease of $0.8 million was primarily due to reduced term
loan borrowings under the Credit Agreement with Athyrium as well as a decrease
in the LIBOR base rate of interest on our term loans under the Credit Agreement.
This decrease was partially offset by an increase in interest from the sellers
note which was a component of the IriSys acquisition purchase price.

Comparison of the first nine months 2021 and 2020


                                                           Nine months ended September 30,
(in millions)                                               2021                     2020
Revenue                                               $           53.1         $           56.6

Operating expenses: Cost of sales (excluding amortization of intangible assets)

                                                           39.8                     41.6
Selling, general and administrative                               13.1                     14.1
Amortization of intangible assets                                  0.9                      2.0
Total operating expenses                                          53.8                     57.7
Operating loss                                                    (0.7 )                   (1.1 )
Interest expense                                                 (11.7 )                  (14.7 )
Gain on extinguishment of debt                                     3.4                        -
Net loss                                              $           (9.0 )       $          (15.8 )




Revenue. The decrease of $3.5 million was primarily the result of the
discontinuation of two commercial product lines by our commercial partners
announced in the first quarter of 2020 as well as decreased product sales from
one of our commercial partners due to timing of customer orders. During the 2021
period, increased product sales from one of our commercial partners, increased
revenue due to the acquisition of IriSys as well as higher revenues from our
clinical trial materials new business growth activities, have partially offset
the decrease.

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Cost of sales. The decrease of $1.8 million was primarily due to lower
commercial manufacturing volumes and reflects lower costs due to the prior year
reduction in force as well as certain employment incentive tax credits in 2021
offset by costs from the San Diego facility due to the acquisition of IriSys.

Selling, general and administrative. The decrease of $1.0 million was primarily
related to lower public company costs and stock-based compensation expense
offset by expenses related to the acquisition of IriSys and business development
expenses associated with our San Diego team.

Amortization of intangible assets. The decrease of $1.2 million was because the
amortization of CDMO royalties and contract manufacturing relationships acquired
in 2015 ended on April 10, 2021 offset by amortization related to the
acquisition of IriSys for acquired customer relationships, backlog and
trademarks and trade names.

Interest expense. The decrease of $3.0 million was primarily due to reduced term
loan borrowings under the Credit Agreement with Athyrium as well as a decrease
in the LIBOR base rate of interest on our term loans under the Credit Agreement.
This decrease was partially offset by an increase in interest from the sellers
note which was a component of the IriSys acquisition purchase price.

Gain on extinction of debt. In June 2021, the PPP Note and all accrued interest thereon have been canceled.

Liquidity and capital resources

TO September 30, 2021, we have had $ 23.5 million in cash and cash equivalents.

Since our inception, we have financed our operations and capital expenditures
primarily from the issuance of equity and debt. During the nine months ended
September 30, 2021, our capital expenditures were $2.8 million to scale and
support our expansion of capabilities.

We are party to a credit agreement with Athyrium, or the Credit Agreement, which
has been fully drawn. The Credit Agreement requires us to repay the outstanding
principal amount of $100.0 million on December 31, 2023. The Credit Agreement
also includes certain financial covenants that the Company will need to satisfy
on a monthly and quarterly basis, including: 1) maintaining a permitted net
leverage ratio, calculated as our indebtedness, net of cash and cash
equivalents, divided by EBITDA, each as defined in the Credit Agreement; and 2)
a minimum amount of cash and cash equivalents on hand.

We are also party to an amended common stock purchase agreement with Aspire
Capital Fund LLC, or Aspire Capital. The amended agreement provides that, upon
the terms and subject to the conditions and limitations set forth in the
agreement, Aspire Capital is committed to purchase, at our sole election, up to
an aggregate value of $41.2 million in shares of common stock. As of September
30, 2021, there is availability to issue up to $30.0 million or 6,199,299 shares
of common stock under the 2019 Common Stock Purchase Agreement.

In August 2021, we acquired IriSys for $50.2 million by paying $24.0 million in
cash, net of cash acquired, and issuing a note and equity with fair values of
$5.3 million and $20.9 million, respectively, to the former equity holders of
IriSys.

We may require additional financing and if we do, we may raise such additional
funds through debt refinancing, bank or other loans, through strategic
development, licensing activities, sale of assets and/or marketing arrangements
or through public or private sales of equity or debt securities from time to
time. Financing may not be available on acceptable terms, or at all, and our
failure to raise capital when needed could materially adversely impact our
growth plans and our financial condition or results of operations. Further, our
ability to access capital market or otherwise raise capital may be adversely
impacted by potential worsening global economic conditions and the recent
disruptions to, and volatility in, financial markets in the United States and
worldwide resulting from the ongoing COVID-19 pandemic. Additional debt or
equity financing, if available, may be dilutive to the holders of our common
stock and may involve significant cash payment obligations and covenants that
restrict our ability to operate our business or to access capital.

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Sources and uses of cash

                                                            Nine months ended September 30,
(amounts in millions)                                         2021                    2020
Net cash provided by (used in) continuing operations:
Operating activities                                    $            6.4         $          6.4
Investing activities                                               (26.8 )                 (5.5 )
Financing activities                                                20.1                    2.6
Net cash (used in) provided by continuing operations    $           (0.3 )  

$ 3.5

Net cash used in discontinued operations                $              -         $         (1.2 )




Cash flows from operating activities represent our net loss as adjusted for
stock-based compensation, depreciation, non-cash interest expense, amortization
of intangibles, a gain on extinguishment of debt and changes in operating assets
and liabilities. Cash flows from operations were relatively flat for the first
nine months of 2021 compared to 2020.

Net cash used in investing activities includes $ 24.0 million paid to acquire
IriSys for the first nine months of 2021 and capital spending in both periods to expand and support our capacity expansion.

The net cash flow generated by financing activities in the first nine months of 2021 mainly includes the net proceeds from an issuance of common shares of $ 32.1 million, partially offset by debt repayments of $ 10.1 million and the financing costs of $ 1.4 million paid in connection with debt modifications and common share issues.

The net cash used in discontinued operations in 2020 was intended to settle outstanding debts related to our former research and development activity in acute care.

Prospective factors

Our future use of operating cash and capital requirements will depend on many forward-looking factors, including the following:

?
the extent to which we in-license, acquire or invest in products, businesses and
technologies;
?
the timing and extent of our manufacturing and capital expenditures;
?
our ability to maintain or expand our relationships and contracts with our
commercial partners;
?
our ability to grow and diversify our business with new customers, including our
ability to meet desired project outcomes with development customers;
?
our ability to regain profitability;
?
our ability to comply with stringent U.S. & foreign government regulation in the
manufacture of pharmaceutical products, including cGMP and U.S. DEA
requirements;
?
our ability to raise additional funds through equity or debt financings or sale
of certain assets;
?
the costs of preparing, submitting and prosecuting patent applications and
maintaining, enforcing and defending intellectual property claims; and
?
the extent to which health epidemics and other outbreaks of communicable
diseases, including the ongoing COVID-19 pandemic, could disrupt our operations
or materially and adversely affect our business and financial conditions.

We might use existing cash and cash equivalents on hand, additional debt, equity
financing, sale of assets or out-licensing revenue or a combination thereof to
fund our operations or acquisitions. If we increase our debt levels, we might be
restricted in our ability to raise additional capital and might be subject to
financial and restrictive covenants. Our shareholders may experience dilution as
a result of the issuance of additional equity or debt securities. This dilution
may be significant depending upon the amount of equity or debt securities that
we issue and the prices at which we issue any securities.

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Contractual commitments

The table below reflects our contractual commitments as of September 30, 2021:

                                                         Payments due by period
                                               Less than                                       More than
(in millions)                     Total         1 year         1-3 years       3-5 years        5 years
Debt obligations (1):
Principal                       $   106.5     $       2.0     $     104.1     $       0.1     $       0.3
Interest                             11.3             5.0             6.1             0.1             0.1
Purchase obligations (2)              4.5             4.0             0.5               -               -
Operating leases (3)                 10.8             1.1             2.3             2.3             5.1
Other long-term liabilities (4)       1.3             1.0             0.3               -               -
Total                           $   134.4     $      13.1     $     113.3     $       2.5     $       5.5


(1)
Debt obligations consist of principal, an exit fee of 1% of that principal, and
interest on $100.0 million of outstanding term loans under our credit facility
with Athyrium, $6.1 million of notes issued to the former members of IriSys and
a small finance lease. Because the Athyrium term loans bear interest at a
variable rate based on LIBOR, we estimated future interest commitments utilizing
the LIBOR rate as of September 30, 2021. In accordance with U.S. GAAP, the
future interest obligations are not recorded on our consolidated balance sheet.
(2)
Purchase obligations consist of cancelable and non-cancelable purchase
commitments related to inventory, capital expenditures and other goods or
services. In accordance with U.S. GAAP, these obligations are not recorded on
our consolidated balance sheets.
(3)
We are party to two operating leases for development facilities in California
and Georgia that end in 2031 and 2025, respectively. The leases each include
options to extend at our discretion.
(4)
We have entered into employment agreements with each of our named executive
officers that provide for, among other things, severance commitments of up to
$1.3 million should we terminate the named executive officers for convenience or
if certain events occur following a change in control. In addition, we would be
subject to other contingencies of up to $3.6 million in the aggregate if certain
events occur following a change in control; because these obligations are
contingent, the amounts are not included in the table above.

Off-balance sheet provisions

We have no off-balance sheet arrangement as defined in Article 303 (a) (4) of Regulation SK.

Critical accounting conventions and estimates

The following complements the accounting policies and critical estimates disclosed in the “Management Commentary and Analysis of the Financial Condition and Results of Operations” section of our Annual Report.

Business combinations

Business acquisitions are accounted for in accordance with Accounting Standards
Codification, or ASC, Topic 805, Business Combinations. In purchase accounting,
identifiable assets acquired and liabilities assumed, are recognized at their
estimated fair values at the acquisition date, and any remaining purchase price
is recorded as goodwill. In determining the fair values of the consideration
transferred, the assets acquired and the liabilities assumed, we make
significant estimates and assumptions, particularly with respect to long-lived
tangible and intangible assets. Critical estimates used in valuing tangible and
intangible assets include, but are not limited to, future expected cash flows,
discount rates, market prices and asset lives.

While we use our best estimates and assumptions as part of the purchase price
allocation process to accurately value assets acquired and liabilities assumed
at the business acquisition date, our estimates and assumptions are inherently
uncertain and subject to refinement. As a result, during the purchase price
allocation period, which is generally one year from the business acquisition
date, we record adjustments to the assets acquired and liabilities assumed, with
the corresponding offset to goodwill. For changes in the valuation of intangible
assets between preliminary and final purchase price allocation, the related
amortization is adjusted in the period it occurs. Subsequent to the purchase
price allocation period any adjustment to assets acquired or liabilities assumed
is included in operating results in the period in which the adjustment is
determined.

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Although our estimates of fair value are based upon assumptions believed to be
reasonable, actual results may differ. See note 3 to the consolidated financial
statements contained in Part I, Item 1 for more information related to the
acquisition of IriSys.

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