SOCIETAL CDMO, INC. You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and the related notes appearing elsewhere. 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 this Annual Report on Form 10-K for factors that could cause or contribute to such differences.
Overview
We are a bi-coastal contract development and manufacturing organization, or CDMO, with capabilities spanning pre-investigational new drug development to commercial manufacturing and packaging for a wide range of therapeutic dosage forms with a primary focus on small molecules. With an expertise in solving complex manufacturing problems, Societal is a leading CDMO providing development, end-to-end regulatory support, clinical and commercial manufacturing, aseptic fill/finish, lyophilization, packaging and logistics services to the global pharmaceutical market. In addition to our experience in handling DEA-controlled substances and developing and manufacturing modified-release dosage forms, Societal has the expertise to deliver on our clients' pharmaceutical development and manufacturing projects, regardless of complexity level. We do all of this in our state-of-the-art facilities that, in the aggregate, total 145,000 square feet, inGainesville, Georgia andSan Diego, California . 33 --------------------------------------------------------------------------------
We currently manufacture the following key products with our key commercial partners: Ritalin LA®, Focalin XR®, Verelan PM®, Verelan SR®, Verapamil PM, Verapamil SR and Donnatal liquids and tablets. We also support numerous development stage products.
During the third quarter of 2021, we acquiredIriSys, LLC , orIriSys , an independentSan Diego -based CDMO. The acquisition provided us significant new capabilities beyond oral solid dose, including sterile and non-sterile injectables, liquid and powder filled capsules, tablets, oral liquids, liposomes and nano/micro-particles and topical formulations. Our manufacturing and development capabilities include product development from formulation through clinical trial and commercial manufacturing, and specialized capabilities for solid oral dosage forms, with specialization in modified release technologies and facilities to handle high potent compounds and controlled substances, liposomes and nano/microparticles, topicals and oral liquids. InSeptember 2022 , Societal announced a new state of the art, aseptic fill/finish and lyophilization suite in ourSan Diego facility to further our goal of offering end-to-end solutions to our clients. In addition to providing manufacturing capabilities, we offer our customers clinical trial support including over-encapsulation, comparator sourcing, packaging, labeling, storage and distribution. We have a bi-coastal footprint from which to better serve clients within theU.S. , as well as globally. In a typical collaboration between us and our commercial partners, we continue to work with our partners to develop product candidates or new formulations of existing product candidates. We also typically exclusively manufacture and supply clinical and commercial supplies of these proprietary products and product candidates. We use cash flow generated by our business primarily to fund the growth of our CDMO business 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.
Global economic and supply conditions
Global economic conditions, logistics and supply chain issues continue to present obstacles to our business, including challenges related to the COVID-19 pandemic.
We rely on third-party manufacturers to supply our manufacturing components, supplies and related materials, which in some instances are supplied from a single source. Prolonged disruptions in the supply of any of our third-party materials, difficulty implementing new sources of supply or significant price increases could have an adverse effect on our results. While the impact of COVID-19 has lessened in many ways, we are experiencing a higher level of residual supply chain disruptions that we are actively managing to meet our production timelines and that may constrain our ability to capture additional growth opportunities, beyond our established projections, from customers who would otherwise want to increase their safety stock of the products that we produce.
We also continue to closely monitor economic developments related to COVID-19
and other diseases and geopolitical conflicts, such as the conflict between
We continue to anticipate a general slowdown in clinical development activity as a result of clinical failures and/or a lack of adequate funding to go forward. We are making efforts to adapt to these market changes, including a reconfiguration of our business development team to be better positioned in the longer-term by focusing on account management roles and replacing lost positions in strategic focus areas. The anticipated slowdown and/or the reconfiguration may cause a reduction in the number of business development opportunities that we will be able to pursue in 2023. We also expect to face continuing inflationary pressures on raw materials, labor and logistics during 2023. Finally, we were impacted by higher variable base interest rates on our borrowings under credit agreements during the second half of 2022, and while we believe that we have been able to capture overall interest savings as a result of theDecember 2022 refinancing, we expect those improvements could be partially offset by variable base interest rate increases in 2023.
Financial overview
Revenues
We recognize three types of revenue: manufacturing, profit-sharing and research and development.
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--------------------------------------------------------------------------------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
In addition to manufacturing revenue, certain customers who use our technologies are subject to agreements that provide us intellectual property sales-based profit-sharing and/or royalties consideration, collectively referred to as profit-sharing, computed on the net product sales of the commercial partner. Profit-sharing revenues are generally recognized under the terms of the applicable license, development and/or supply agreement. We have determined that in our arrangements, the license for intellectual property is not the predominant item to which the profit-sharing relates, so we recognize revenue upon transfer of control of the manufactured product. 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 trials materials 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. 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 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.
In
For the year endedDecember 31, 2021 , we qualified for approximately$4.4 million of federal employee retention credits, all of which was recognized as an offset to expense. We did not recognize any additional credits during the year endedDecember 31, 2022 , and do not anticipate any additional credits in future periods. 35 --------------------------------------------------------------------------------
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 inApril 2021 . With the acquisition ofIriSys , we are recognizing amortization expense related to acquired customer relationships, backlog and trademarks and trade names on a straight-line basis over estimated useful lives of 7.0, 2.4, and 1.5 years, respectively. Interest expense
Interest expense for the periods presented primarily relates to the
InDecember 2022 , we completed a refinancing that included the repayment of$100.0 million of outstanding term loans with Athyrium funded in part by$36.9 million of new term loan borrowings with Royal Bank of Canada and$39.0 million of gross proceeds from the sale and leaseback of our commercial manufacturing campus inGainesville, Georgia . We expect that future periods will include a lower amount of aggregate interest expense related to these transactions and the amortization of related financing costs due to lower amount of aggregate principal and lower variable interest margins as compared to the Athyrium borrowings.
Net operating losses and tax carryforwards
As ofDecember 31, 2022 , we had federal net operating loss, or NOL, carry forwards of approximately$125.6 million , substantially all of which have an indefinite carry forward period. We also had$135.4 million of state NOL carry forwards available to offset future taxable income that will begin to expire at various dates beginning in 2028 if not utilized. We believe that it is more likely than not that our deferred income tax assets will not be realized, and as such, there is a full valuation allowance.
Key indicators of performance
To evaluate our performance, we monitor a number of industry-standard key indicators such as:
•
Safety and human capital management, as measured by recordable injuries, good saves and employee retention;
•
Operational excellence, as measured by the percentage of our orders that are delivered on-time and in full;
•
New business growth, as measured by value of new contracts signed; and
•
Financial operating results, as measured by revenue and EBITDA, as adjusted.
EBITDA, as adjusted, is a non-GAAP measure that we discuss and reconcile to its
nearest GAAP measure elsewhere in our public financial reporting. We believe
that supplementing our financial results presented in accordance with GAAP with
non-GAAP measures is useful to investors, creditors and others in assessing our
performance. These measurements should not be considered in isolation or as a
substitute for reported GAAP results because they may include or exclude certain
items as compared to similar GAAP-based measurements, and such measurements may
not be comparable to similarly-titled measurements reported by other companies.
Rather, these measurements should be considered as an additional way of viewing
aspects of our operations and gaining an understanding of our business.
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--------------------------------------------------------------------------------Results of operations
Comparison of years ended
Year ended December 31,
(in millions) 2022 2021
Revenue $ 90.2 $ 75.4Operating expenses: Cost of sales (excluding amortization of intangible assets)
67.1 55.6
Selling, general and administrative 21.9
18.4
Amortization of intangible assets 0.9 1.0 Total operating expenses 89.9 75.0 Operating income 0.3 0.4 Interest expense (14.1 ) (15.1 ) (Loss) gain on extinguishment of debt (5.0 ) 3.3 Loss before income taxes (18.8 ) (11.4 ) Income tax expense 1.1 - Net loss$ (19.9 ) $ (11.4 ) Revenue. The increase of$14.8 million was primarily driven by an increase in European Ritalin LA demand from our new customer InfectoPharm, as well as an increase in revenue from our largest commercial customer Teva, correlated with pull through in demand resulting from market share gains against the sole competitor for the Verapamil SR products. In addition, there were higher revenues from our clinical trial materials business as well as a full year of revenue resulting from the acquisition ofIriSys compared to approximately five months of revenue in 2021. The increase in revenue was partially offset by a decline in revenue from Lannett's commercial sales of the Verapamil PM products. Cost of sales. The increase of$11.5 million was primarily due to the acquisition of theSan Diego facility and certain 2021 employment incentive tax credits that were not repeated in 2022 resulting in increased expense in 2022. These increases were partially offset by the reallocation of expenses reflecting the post-acquisition organizational structure. Selling, general and administrative. The increase of$3.5 million was primarily related to costs associated with the debt refinancing in the fourth quarter of 2022 and increased personnel costs tied to the reallocation of expenses. Specifically, effectiveOctober 1, 2021 , certain employees who previously supported the our plant operations now support our multi-site organization structure and operations. Accordingly, expenses associated with these employees have been reclassified from cost of sales to selling, general and administrative expenses. These increases were offset by lowerIriSys acquisition and integration costs. Amortization of intangible assets. The decrease of$0.1 million was primarily the result of amortizing a lower amount ofIriSys intangible assets in 2022 as compared to a higher amount of historical intangible assets in the first part of 2021, partially offset by an approximately four-month period in 2021 prior to theIriSys acquisition when no intangible assets were being amortized. Interest expense. The decrease of$1.0 million was primarily due to the extension of the maturity date of our prior term loans, which deferred a portion of the interest expense from non-cash amortization of financing expenses until they were written off as loss on extinguishment of debt inDecember 2022 (see below), as well as increased capitalized interest. These decreases were partially offset by a full period of interest on the debt portion of theIriSys acquisition purchase price and an increase in the variable LIBOR component of interest on prior term loans with Athyrium. Loss or gain on extinguishment of debt. InDecember 2022 , as a result of fully paying off our loan with Athyrium, we recorded a loss on extinguishment of debt for the write-off of certain deferred financing costs. InJune 2021 , we received forgiveness of principal and interest on a note issued under a Federal COVID-19 relief program and recorded a gain on extinguishment of debt. 37 --------------------------------------------------------------------------------
Comparison of years ended
Year ended December 31,
(in millions) 2021 2020
Revenue $ 75.4 $ 66.5
Operating expenses:
Cost of sales (excluding amortization of intangible assets) 55.6 54.1
Selling, general and administrative 18.4 18.1
Amortization of intangible assets 1.0 2.6
Total operating expenses 75.0 74.8
Operating loss 0.4 (8.3 )
Interest expense (15.1 ) (19.2 )
Gain on extinguishment of debt 3.3 -
Net loss $ (11.4 ) $ (27.5 )
Revenue. The increase of $8.9 million was primarily the result of increases in
revenue due to the acquisition of IriSys as well as higher revenues from our
clinical trial materials business including revenue from a commercial product
tech transfer project. Despite the discontinuation of two commercial product
lines by our commercial partners announced in the first quarter of 2020, our
legacy commercial business has remained relatively flat in 2021 compared to 2020
as our other commercial products saw growth in 2021 compared to 2020 rebounding
from lower volumes in 2020 due to impacts to the market from COVID-19.
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 the prior year reduction in force and certain employment
incentive tax credits in 2021.
Selling, general and administrative. The increase of $0.3 million was primarily
related to deal and integration costs related to the acquisition of IriSys and
administrative expenses associated with the addition of our San Diego team
offset by lower public company costs and stock-based compensation expense.
Specifically, effective October 1, 2021 , certain employees who previously
supported our plant operations now support our multi-site organization structure
and operations. Accordingly, expenses associated with these employees have been
reclassified from cost of sales to selling, general and administrative expenses.
Amortization of intangible assets. The decrease of $1.6 million was the result
of amortizing a lower amount of IriSys intangible assets in 2021, as compared to
a higher amount of historical intangible assets in 2020 and the first part of
2021, as well as an approximately four-month period in 2021 prior to the IriSys
acquisition when no intangible assets were being amortized.
Interest expense. The decrease of $4.1 million was primarily due to reduced term
loan borrowings under the Athyrium Credit Agreement as well as a decrease in the
LIBOR base rate of interest on our term loans under the Athyrium 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 extinguishment of debt. In
Liquidity and capital resources
At
Since our inception, we have financed our operations and capital expenditures
primarily from results of operations, the issuance of equity and debt, and
recently to a lesser extent real estate transactions. During the year ended
InDecember 2022 , we completed a refinancing that included the repayment of$100.0 million of outstanding term loans with Athyrium, funded by entering into three transactions: (i) we raised gross proceeds of$39.0 million through the sale and subsequent leaseback of our commercial manufacturing campus located inGainesville, Georgia (see below); (ii) we raised net proceeds of$32.9 million from the issuance of common and preferred stock; and (iii) we borrowed$36.9 million under a new term loan with Royal Bank of Canada. Among other things, the refinancing has resulted in a reduction to our leverage ratio, a reset of our financial covenants and a reduction in the amount of cash payable for interest in future periods. 38 -------------------------------------------------------------------------------- We are currently party to a credit agreement with Royal Bank of Canada, or the Credit Agreement, for a term loan with a principal amount of$36.9 million . The outstanding principal amount will be repaid in equal quarterly payments totaling$1.8 million in 2023,$2.8 million 2024 and$3.7 million in 2025, with the remaining principal balance dueDecember 16, 2025 . If the Company completes a sale of certain real property byDecember 14, 2023 and makes the$10.0 million principal repayment disclosed below, the quarterly principal payments will be reduced proportionately to the reduction in principal. Subject to certain exceptions, we are required to make mandatory prepayments with the cash proceeds received in respect of asset sales, extraordinary receipts and debt issuances, upon a change of control and specified other events. Additionally, we are obligated to repay$10.0 million of principal byDecember 14, 2023 upon the sale of certain real property adjacent to itsGainesville, Georgia manufacturing campus. If that property is not sold byDecember 14, 2023 , we will be required to pay a fee of$0.4 million and increase each of our quarterly principal payments by$0.2 million until that property is sold and the$10,000 principal payment is made. The Credit Agreement also includes certain financial covenants that the Company will need to satisfy on a quarterly basis, including: (i) maintaining a net leverage ratio less than 3.75:1.00, stepping down to 2.75:1.00 over time; (ii) maintaining a fixed charge coverage ratio greater than 1.15:1.00; and (iii) maintaining no less than$4.0 million cash and cash equivalents on hand, stepping up to$5.0 million over time. InSeptember 2022 , we signed a sales and purchase agreement to sell approximately 121 acres of land adjacent to ourGainesville, Georgia manufacturing campus for expected proceeds of$9.1 million , which we are obligated to use to repay outstanding balances on the Credit Agreement. The land sale is expected to close in the second half of 2023. Until closing, the sale of the land is subject to customary closing conditions for transactions of this type, including completion of title and environmental due diligence and receipt of certain zoning approvals and permits. InAugust 2021 , we acquiredIriSys 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$20.9 million , respectively, to the former equity holders ofIriSys . We may require additional financing or choose to refinance certain of these instruments, which could include strategic development, licensing activities and/or marketing arrangements, public or private sales of equity or debt securities or debt refinancing. Financing may not be available on acceptable terms, or at all, and our failure to raise capital when needed could materially adversely impact our growth plans and our financial condition or results of operations. If and until we are able to obtain shareholder approval to increase the number of shares of common stock authorized under our articles of incorporation, we will be limited in the number of additional shares we will be able to issue in future periods. Further, our ability to access capital market or otherwise raise capital may be adversely impacted by potential worsening global economic conditions and the recent disruptions to, and volatility in, financial markets inthe United States and worldwide resulting from COVID-19 and other diseases and geopolitical conflicts. Additional debt or equity financing, if available, may be dilutive to the holders of our common stock, may involve significant cash payment obligations and covenants that restrict our ability to operate our business or to access capital, and may further restrict dividend payments. Sources and uses of cash Year ended December 31, (amounts in millions) 2022 2021 2020 Net cash (used in) provided by: Operating activities$ (3.6 ) $ 10.9 $ 9.2 Investing activities (8.4 ) (29.3 ) (7.6 ) Financing activities 1.8 19.9 4.1 Total$ (10.2 ) $ 1.5 $ 5.7 39
-------------------------------------------------------------------------------- Cash flows from operating activities represents our net loss as adjusted for stock-based compensation expense, non-cash interest expense, depreciation expense, impairment expense, amortization of intangible assets, deferred income tax expense and gains and losses on extinguishment of debt as well as changes in operating assets and liabilities. The$14.5 million decrease in cash flows from operations in 2022 compared to 2021 was primarily due changes in operating assets and liabilities, including a$4.8 million effect from changes in accrued interest due to the timing of the fourth quarter 2021 interest payment on the prior Athyrium credit agreement that was not paid until 2022. Additionally, we experienced changes to inventory, accrued expenses and accounts receivable collectively resulting in a$10.0 million decrease in cash flows, primarily caused by accrued costs related to theDecember 2022 debt refinancing that will be paid in 2023, growth in our development business and changes to customer ordering patterns. The increase in cash flows from operations in 2021 compared to 2020 was primarily due to the decrease in net loss, net of various non-cash items described above, an increase in accrued interest for the same reasons described above, and an increase in accrued expenses, partially offset by increases in accounts receivable and contract assets.
Net cash used in investing activities for each of the three years includes
capital expenditures to scale and support our expansion of capabilities. In
2021, net cash used in investing activities also included
Net cash provided by financing activities included:
•
During 2022, net proceeds from the issuance of preferred and common stock of$33.0 million ,$36.9 million from the term loan with Royal Bank of Canada, and$37.3 from the sale-leaseback of our commercial manufacturing campus inGainesville, Georgia , partially offset by debt repayments of$103.0 million , financing costs of$2.2 million , and$0.2 million to pay employee tax withholdings upon vesting of equity awards.
•
During 2021, net proceeds from an issuance of common stock of$32.1 million , partially offset by debt repayments of$10.1 million , financing costs of$1.4 million paid in connection with the debt amendments and common stock issuances, and$0.7 million to pay employee tax withholdings upon vesting of equity awards.
•
During 2020, net proceeds of$11.1 million from issuance of common stock in an at-the-market offering and$4.4 million from a note issued under a Federal COVID-19 relief program, partially offset by a$1.1 million repayment of the note,$10.1 million to repay term loans with Athyrium and$1.1 million to pay employee tax withholdings upon vesting of equity awards.
Forward-looking 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
•
our ability to raise additional funds through equity or debt financings or sale of real-estate or other assets;
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the costs of maintaining, enforcing and defending intellectual property claims;
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the extent to which health epidemics and other outbreaks of communicable diseases, including the COVID-19 pandemic, could disrupt our operations or materially and adversely affect our business and financial conditions; and
•
the extent to which inflation, global instability, including political
instability and any resulting sanctions, export controls or other restrictive
actions that may be imposed by the
40
--------------------------------------------------------------------------------or other entities may disrupt our business operations or financial condition or the financial condition of our customers and suppliers.
We might use existing cash and cash equivalents on hand, additional debt, equity financing, sale of real-estate or other 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. If and until we are able to obtain shareholder approval to increase the number of shares of common stock authorized under our articles of incorporation, we will be limited in the number of additional shares we will be able to issue in future periods. If we do issue additional equity in future periods, our shareholders may experience dilution. 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.
Contractual commitments
The table below reflects our contractual commitments as ofDecember 31, 2022 : 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$ 41.3 $ 7.6 $ 33.4 $ 0.1 $ 0.2 Interest 9.9 3.5 6.3 0.1 - Purchase obligations (2) 9.7 9.2 0.5 - - Operating leases (3) 9.4 1.2 2.4 2.2 3.6 Other long-term liabilities (4)(5) 94.5 3.5 7.4 7.8 75.8 Total$ 164.8 $ 25.0 $ 50.0 $ 10.2 $ 79.6 (1) Debt obligations consist of principal and interest on$36.9 million of an outstanding term loan under our credit facility with Royal Bank of Canada,$4.1 million of notes issued to the former members ofIriSys and a small finance lease. Because the Royal Bank of Canada term loan bears interest at a variable rate based on SOFR, we estimated future interest commitments utilizing the SOFR rate as ofDecember 31, 2022 . In accordance withU.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
(3)
We are party to two operating leases for development facilities inCalifornia andGeorgia that end in 2031 and 2025, respectively. The leases each include options to extend at our discretion.
(4)
We are party to a lease for a DEA-licensed facility in
(5)
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$3.8 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.
Critical accounting policies and estimates
This management's discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance withU.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities in our consolidated financial statements. On an ongoing basis, we evaluate our estimates and judgments. We base our estimates on historical experience, known trends and events and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. 41 -------------------------------------------------------------------------------- We have determined that certain accounting policies and estimates are critical to the preparation of the financial statements. We have prepared the following additional disclosures to supplement our summary of significant accounting policies located in note 2 to the consolidated financial statements beginning on page F-1 of this Annual Report on Form 10-K.
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. Although our estimates of fair value are based upon assumptions believed to be reasonable, actual results may differ. See note 15 to the consolidated financial statements beginning on page F-1 of this report for more information related to the acquisition ofIriSys .
Revenue recognition for variable consideration in sales-based profit-sharing arrangements
For sales-based profit-sharing where the license for intellectual property is not deemed to be the predominant item to which the profit-sharing relates, we recognize revenue upon transfer of control of the manufactured product. 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. We are required to exercise significant judgment to estimate the value of the variable consideration, which we partially constrain 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. If we were to increase or decrease the percentage value of the constraint by 5%, we would recognize a corresponding decrease or increase, respectively, to revenue and earnings of$0.5 million . Impairment of goodwill We are required to review, on an annual basis, the carrying value of goodwill to determine whether impairment may exist. The impairment analysis for goodwill consists of an optional qualitative assessment potentially followed by a quantitative analysis. If we determine that the carrying value of our reporting unit exceeds its fair value, an impairment charge to goodwill is recorded for the excess. The critical judgments involved in our annual qualitative test include an assessment of unfavorable events and a judgment whether those events put our goodwill at risk of impairment, which if determined to be at risk would require us to perform a quantitative test. The critical judgments and estimates in our quantitative test include selection and weighting of available valuation methods and the selection of assumptions that may be used in those methods. In 2022, we concluded qualitatively that our goodwill was not at risk of impairment due to the substantial excess of fair value over the carrying value of our reporting unit that we observed in prior period quantitative testing. The carrying value of our goodwill was$41.1 million atDecember 31, 2022 . Any changes to our judgments or estimates could result in a goodwill impairment of up to that amount in a future period.
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