Societal CDMO, Inc. - Quarter Report: 2020 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒ Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended: June 30, 2020

☐ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Commission File Number: 001-36329

Recro Pharma, Inc.

(Exact name of registrant as specified in its charter)

(484) 395-2470

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒   No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes ☒  No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section13(a) of the Exchange Act. ☐  

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐  No ☒

As of August 5, 2020, there were 23,640,494 shares of common stock, par value $0.01 per share, outstanding.

TABLE OF CONTENTS

Index

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RECRO PHARMA, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(Unaudited)

See accompanying notes to consolidated financial statements.

3

RECRO PHARMA, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(Unaudited)

See accompanying notes to consolidated financial statements.

4

RECRO PHARMA, INC. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Deficit

(Unaudited)

See accompanying notes to consolidated financial statements.

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RECRO PHARMA, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(Unaudited)

See accompanying notes to consolidated financial statements.

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RECRO PHARMA, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(amounts in thousands, except share and per share data)

(Unaudited)

Recro Pharma, Inc. (the “Company”) was incorporated in Pennsylvania on November 15, 2007. The Company is a leading contract development and manufacturing organization (“CDMO”) with integrated solutions for the development, formulation, regulatory support, manufacturing, and packaging of oral solid dose drug products. It leverages its formulation and development expertise to develop and manufacture pharmaceutical products using proprietary delivery technologies and know-how for commercial partners who commercialize or plan to commercialize these products. The Company operates in one segment.

In November 2019, the Company’s former Acute Care business, which developed products for hospital and other acute care settings, was spun-out through its former wholly-owned subsidiary, Baudax Bio, Inc. (“Baudax Bio”) when the Company completed a special dividend distribution of all the outstanding shares of common stock of Baudax Bio to its shareholders. See note 3 to the consolidated financial statements for additional information about the spin-off of Baudax Bio.

The Company has incurred net losses since inception and has an accumulated deficit of $220,587 as of June 30, 2020, which is mostly related to activities that are presented as discontinued operations as a result of the spin-off of Baudax Bio. The Company’s future operations are highly dependent on the continued profitability of its manufacturing operations. Management believes that it is probable that the Company will be able to meet its obligations as they become due within one year after the date the financial statements are issued.

The accompanying unaudited consolidated financial statements of the Company and its subsidiaries have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information. In accordance with SEC rules for interim financial statements, certain information required by U.S. GAAP may be condensed or omitted. The Company’s consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated. In the opinion of management, the accompanying consolidated financial statements include all normal and recurring adjustments (which consist primarily of accruals, estimates and assumptions that impact the financial statements) considered necessary to present fairly the Company’s results for the interim periods. Operating results for the three and six months ended June 30, 2020 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2020.

The accompanying unaudited interim consolidated financial statements should be read in conjunction with the annual audited financial statements and related notes included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

The preparation of financial statements and the notes to the financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from such estimates.

Cash and cash equivalents represent cash in banks and highly liquid short-term investments that have maturities of three months or less when acquired. These highly liquid short-term investments are both readily convertible to known amounts of cash and so near to their maturity that they present insignificant risk of changes in value because of the changes in interest rates.

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Property and equipment are recorded at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets, which are as follows: three to ten years for furniture, office and computer equipment; six to ten years for manufacturing equipment; 40 years for buildings; and the shorter of the lease term or useful life for leasehold improvements. Repairs and maintenance costs are expensed as incurred.

Goodwill represents the excess of purchase price over the fair value of net assets acquired by the Company. Goodwill is not amortized but assessed for impairment on an annual basis or more frequently if impairment indicators exist. The impairment model prescribes a one-step method for determining impairment.

The one-step quantitative test calculates the amount of goodwill impairment as the excess of a reporting unit’s carrying amount over its fair value, not to exceed the total amount of goodwill allocated to the reporting unit.

Intangible assets include the Company’s royalties and contract manufacturing relationships assets. The royalties and contract manufacturing relationships intangible asset is considered a definite-lived intangible asset and is amortized on a straight-line basis over a useful life of six years. The Company is required to review the carrying value of definite-lived intangible assets for recoverability whenever events occur or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recoverable.

The Company performs its annual goodwill impairment test as of November 30^th, or whenever an event or change in circumstances occurs that would require reassessment of the recoverability of goodwill. In performing the evaluation, the Company assesses qualitative factors such as overall financial performance, anticipated changes in industry and market conditions, and competitive environments. The Company performed its last annual impairment test as of November 30, 2019.

Since the last annual test, the Company has only identified the ongoing novel strain of coronavirus (“COVID-19”) pandemic as a potential indicator of impairment. The Company has performed periodic interim impairment testing that has resulted in no impairment of goodwill or other assets. The Company continues to monitor the impact of the COVID-19 pandemic.

The Company generates revenues from manufacturing, packaging, research and development and related services for multiple pharmaceutical companies. The agreements that the Company has with its commercial partners provide for manufacturing revenues, sales-based royalties and/or profit-sharing components.

Manufacturing revenue

Manufacturing and other related services revenue is recognized upon transfer of control of a product to a customer, generally upon shipment, based on a transaction price that reflects the consideration the Company expects to be entitled to as specified in the agreement with the commercial partner, which could include pricing and volume-based adjustments.

Royalty Revenue

In addition to manufacturing and packaging revenue, certain customer agreements may have intellectual property sales-based royalties and/or profit-sharing consideration, collectively referred to as royalties, computed on the net product sales of the commercial partner. Royalty revenues are generally recognized under the terms of the applicable license, development and/or supply agreement. For arrangements that include sales-based royalties where the license for intellectual property is deemed to be the predominant item to which the royalties relate, the Company recognizes revenue when the related sales occur by the commercial partner. For arrangements that include sales-based royalties where the license for intellectual property is not deemed to be the predominant item to which the royalties relate, the Company recognizes revenue upon transfer of control of the manufactured product. In these cases, significant judgment is required to calculate this estimated variable consideration using

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the most-likely amount method based on historical customer pricing and deductions and is partially constrained due to items that are outside of the Company’s control including the uncertainty of the timing of future commercial partner sales, mix of volume, customer stocking and ordering patterns, as well as unforeseen price adjustments made by the Company’s commercial partners.

Research and Development

Research and development revenue includes services associated with formulation, process development, CTM 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, the Company evaluates whether the milestones are considered probable of being achieved and estimates 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 would be 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, the Company utilizes 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 the Company’s services and can make changes to its process or specifications upon request.

Financial instruments that potentially subject the Company to significant concentration of credit risk consist primarily of cash, cash equivalents and accounts receivable. The Company manages its cash and cash equivalents based on established guidelines relative to diversification and maturities to maintain safety and liquidity.

The Company’s accounts receivable balances are primarily concentrated among four customers. If any of these customers’ receivable balances should be deemed uncollectible, it could have a material adverse effect on the Company’s results of operations and financial condition.

The Company is dependent on its relationships with a small number of commercial partners, with its four largest customers having generated 95% or more of its revenues for the periods presented. A portion of the Company’s revenues are dependent on U.S. based customers selling to end-users outside the United States.

The Company measures employee stock-based awards at grant-date fair value and recognizes employee compensation expense on a straight-line basis over the vesting period of the award. The Company accounts for forfeitures as they occur.

Determining the appropriate fair value of stock options requires the input of subjective assumptions, including the expected life of the option and expected stock price volatility. The Company uses the Black-Scholes option pricing model to value its stock option awards. The assumptions used in calculating the fair value of stock-based awards represent management’s best estimates and involve inherent uncertainties and the application of management’s judgment. As a result, if factors change and/or management uses different assumptions, stock-based compensation expense could be materially different for future awards.

The expected life of stock options was estimated using the “simplified method,” as the Company has limited historical information to develop reasonable expectations about future stock option exercise patterns, which is

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based on the average of the vesting tranches and the contractual life of each grant. For stock price volatility, the Company uses the historical volatility of its publicly traded stock in order to estimate future stock price trends. The risk-free interest rate is based on U.S. Treasury notes with a term approximating the expected life of the option.

Upon exercise of stock options or vesting of restricted stock units, the holder may elect to cover tax withholdings by forfeiting shares of an equivalent value. In such cases, the Company issues net new shares to the holder, pays the tax withholding on behalf of the participant and presents the payment similar to a capital distribution as both a reduction to additional paid-in-capital and a financing cash outflow in the consolidated financial statements.

For non-employee stock-based awards, the Company recognizes compensation expense on a straight-line basis over the vesting period of each separated vesting tranche of the award, which is known as the accelerated attribution method. The estimation of the number of stock awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from the Company’s current estimates, such amounts are recognized as an adjustment in the period in which estimates are revised.

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis, operating losses and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in operations in the period that includes the enactment date. A valuation allowance is recorded to the extent it is more likely than not that some portion or all of the deferred tax assets will not be realized. A full valuation allowance was recorded as of June 30, 2020 and December 31, 2019.

Unrecognized income tax benefits represent income tax positions taken on income tax returns that have not been recognized in the consolidated financial statements. The Company recognizes the benefit of an income tax position only if it is more likely than not (greater than 50%) that the tax position will be sustained upon tax examination, based solely on the technical merits of the tax position. Otherwise, no benefit is recognized. The tax benefits recognized are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. The Company does not anticipate significant changes in the amount of unrecognized income tax benefits over the next year.

Basic income or loss per common share is determined by dividing net income or loss by the weighted average common shares outstanding during the period.

For purposes of calculating diluted income or loss per common share, the numerator and denominator of basic income or loss per share are adjusted to eliminate the income or loss and the dilutive effects on shares, respectively, caused by outstanding common stock options, warrants and unvested restricted stock units, using the treasury stock method, if the inclusion of such instruments would be dilutive.

There were no differences in the basic and diluted calculations for the three and six months ended June 30, 2020 because the Company reported net losses for those periods. There were also no differences in the income or loss used to calculate basic and diluted per share results in either of the three- or six-month periods ended June 30, 2019.

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The following table presents the reconciliation of weighted average shares outstanding used for basic and diluted per share results for the three and six months ended June 30, 2019:

The following potentially dilutive securities have been excluded from the computations of diluted weighted average shares outstanding, as they would have been anti-dilutive:

Amounts in the table above reflect the common stock equivalents of the noted instruments.

Recently Adopted Accounting Pronouncements

In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement,” or ASU 2018-13. ASU 2018-13 removes, modifies and adds certain disclosure requirements in Topic 820 “Fair Value Measurement”. ASU 2018-13 eliminates certain disclosures related to transfers and the valuations process, clarifies the measurement uncertainty disclosure, and requires additional disclosures for Level 3 fair value measurements, including the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements. ASU 2018-13 is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. On January 1, 2020, the Company adopted this standard which did not have any impact on the Company’s consolidated financial statements or disclosures.

Accounting Pronouncements Not Yet Adopted

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments,” or ASU 2016-13. ASU 2016-13 requires companies to measure credit losses utilizing a methodology that reflects expected credit losses and requires consideration of a range of reasonable information to estimate credit losses on certain types of financial instruments, including trade receivables and available-for-sale debt securities. ASU 2016-13 is effective for fiscal years beginning after December 15, 2022, including those interim periods within those fiscal years. The Company is currently assessing the impact of adopting this standard, but based on a preliminary assessment, does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.

On November 21, 2019 (the “Distribution Date”), the Company completed the separation (the “Separation”) of its former Acute Care business by distributing to the Company’s shareholders on a pro rata basis all of the issued and outstanding common stock of Baudax Bio, the entity the Company incorporated to hold such businesses. To effect the Separation, the Company distributed to its shareholders 1 share of Baudax Bio common stock for every 2.5 shares of the Company’s common stock outstanding as of November 15, 2019, the record date for the distribution. Fractional shares of Baudax Bio common stock that otherwise would have been distributed were aggregated and sold into the public market and the proceeds distributed to the Company’s shareholders. Additionally, in connection with the

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Separation, the Company contributed $19,000 of cash to Baudax Bio, the Company retained significant net operating loss carryforwards, and the Company was released from significant milestone and royalty payment obligations.

The accounting requirements for reporting the Separation of Baudax Bio as a discontinued operation were met when the Separation was completed. Accordingly, the accompanying consolidated financial statements for all periods presented reflect this business as a discontinued operation.

In connection with the Separation, the Company and Baudax Bio entered into various agreements to effect the Separation and provide a framework for their relationship after the Separation, including a transition services agreement, an employee matters agreement, a tax matters agreement and an intellectual property matters agreement. These agreements provide for the allocation between the Company and Baudax Bio of assets, employees, liabilities and obligations (including investments, property and employee benefits and tax-related assets and liabilities) attributable to periods prior to, at, and after Baudax Bio’s separation from the Company and govern certain relationships between the Company and Baudax Bio after the Separation.

The historical consolidated balance sheet and statements of operations of the Company and the related notes to the consolidated financial statements have been presented as discontinued operations in the consolidated financial statements and prior periods have been recast. Discontinued operations include results of the Company’s Acute Care business except for certain corporate overhead costs and certain costs associated with transition services provided by Baudax Bio to the Company, following the Separation, which are included in continuing operations.

The Separation and Distribution Agreement with Baudax Bio sets forth, among other things, the assets that were transferred, the liabilities assumed, and the contracts that were assigned to each of Baudax Bio and the Company as part of the Separation of the Company into two companies, and provided for when and how these transfers, assumptions and assignments were to occur.

The tax matters agreement governs the respective rights, responsibilities and obligations of Baudax Bio and the Company with respect to taxes (including taxes arising in the ordinary course of business and taxes, if any, incurred as a result of any failure of the Distribution and certain related transactions to qualify as tax-free for U.S. federal income tax purposes), tax attributes, uncertain tax positions, tax returns, tax proceedings and certain other tax matters.

The employee matters agreement governs certain compensation and employee benefit obligations and allocates liabilities and responsibilities relating to employment matters, employee compensation and benefit plans and programs and other related matters, including the transfer or assignment of employees from the Company to Baudax Bio.

As of December 31, 2019, certain current liabilities of discontinued operations remained on the Company’s consolidated balance sheet due to timing of payment, which consisted of $22 of accounts payable and $1,150 of accrued expenses, which were paid in the quarter ended March 31, 2020.

The following is a summary of the Acute Care business expenses for the three and six months ended June 30, 2019:

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The Company follows the provisions of FASB ASC Topic 820, “Fair Value Measurements and Disclosures,” for fair value measurement recognition and disclosure purposes for its financial assets and financial liabilities that are remeasured and reported at fair value each reporting period. The Company measures certain financial assets and liabilities at fair value on a recurring basis, including cash equivalents, short-term investments and warrants. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of financial assets and financial liabilities and their placement within the fair value hierarchy. Categorization is based on a three-tier valuation hierarchy, which prioritizes the inputs used in measuring fair value, as follows:

The Company has classified assets and liabilities measured at fair value on a recurring basis as follows:

The Company follows the disclosure provisions of FASB ASC Topic 825, “Financial Instruments” (ASC 825), for disclosure purposes for financial assets and financial liabilities that are not measured at fair value. As of June 30, 2020, the financial assets and liabilities recorded on the Consolidated Balance Sheets that are not measured at fair value on a recurring basis include accounts receivable, accounts payable and accrued expenses and approximate fair value due to the short-term nature of these instruments.

The fair value of long-term debt, where a quoted market price is not available, is evaluated based on, among other factors, interest rates currently available to the Company for debt with similar terms, remaining payments and considerations of the Company’s creditworthiness. The Company determined that the recorded book value of its debt, a level 2 measurement, approximated fair value at June 30, 2020 because (i) the terms of borrowings under the Credit Agreement are equivalent to the terms of other borrowings currently available to the Company; and (ii) the fair value of the PPP Note, which carries a fixed interest rate below market, is not materially different from its carrying value.

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The following is a summary of the Company’s cash equivalents:

Inventory is stated at the lower of cost and net realizable value. Included in inventory are raw materials and work-in-process used in the production of commercial products. Items are issued out of inventory using the first-in, first-out method.

Inventory was as follows:

Adjustments to inventory are determined at the raw materials, work-in-process, and finished good levels to reflect obsolescence or impaired balances. Inventory is primarily ordered to meet specific customer orders and largely reflects demand. Factors influencing inventory obsolescence include changes in demand, product life cycle, product pricing, physical deterioration and quality concerns.

Property, plant and equipment consists of the following:

Depreciation expense for the three months ended June 30, 2020 and 2019 was $1,508 and $1,467, respectively. Depreciation expense for the six months ended June 30, 2020 and 2019 was $3,008 and $2,784, respectively.

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The following table presents the components of our royalties and contract manufacturing relationships asset, which was the only class of intangible asset for the periods presented:

Amortization expense was $646 for the three months ended June 30, 2020 and 2019 and $1,292 for the six months ended June 30, 2020 and 2019.

As of June 30, 2020, future amortization expense is as follows:

Accrued expenses and other current liabilities consist of the following:

The carrying value of debt consists of the following as of June 30, 2020: 

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The following table presents the maturity of debt principal (including exit fee):

Term Loans under Credit Agreement

On November 17, 2017, the Company entered into a $100,000 Credit Agreement (the “Credit Agreement”) with Athyrium Opportunities III Acquisition LP (“Athyrium”). The Credit Agreement provided for a term loan in the original principal amount of $60,000 funded at closing. In December 2018, the Company amended the Credit Agreement (the “First Amendment”). Pursuant to the First Amendment, the $20,000 term B loan and $20,000 term C loan provided for under the Credit Agreement, which were contingent on the Company receiving approval of IV meloxicam (developed by the Company’s Acute Care segment) by December 31, 2018, were restructured into (i) a $10,000 term B-1 loan, funded on December 28, 2018; (ii) a $15,000 term B-2 loan; and (iii) a $15,000 term C loan.

On February 28, 2019, the Company entered into a Second Amendment to Credit Agreement (the “Second Amendment”) with Athyrium. Pursuant to the Second Amendment, (i) the total commitments of the term loan credit facility governed by the Credit Agreement was increased from $100,000 to $125,000, (ii) the $15,000 term B-2 loan and $15,000 term C loan provided for under the Credit Agreement were restructured into a $55,000 term B-2 loan, which was funded on the date of execution of the Second Amendment and (iii) the maturity date was extended to March 31, 2023 (the “Maturity Date”). Beginning on March 31, 2021, the Company must repay the outstanding principal amount in quarterly installments of $3,000 with the outstanding principal balance due on the Maturity Date.

On October 22, 2019, the Company entered into a Third Amendment to Credit Agreement (the “Third Amendment”) with Athyrium. The Third Amendment authorized the release of two of the Company’s subsidiaries, Baudax Bio and Baudax Bio N.A. LLC (formerly known as Recro N.A. LLC) (“Baudax Bio N.A.”), from their respective obligations as guarantors and the release of any liens granted to or held by Athyrium on collateral provided by or equity interests in Baudax Bio and Baudax Bio N.A., including the security interest in Baudax Bio Limited (formerly Recro Ireland Limited) (the “Release”) under the Credit Agreement, as amended. The Release was applicable only to Baudax Bio and Baudax Bio N.A. and did not affect or modify any obligations of the Company or the Guarantors (other than Baudax Bio and Baudax Bio N.A.) under the Credit Agreement, except that it increased the permitted leverage ratio (which is the Company’s indebtedness under the Credit Agreement divided by EBITDA, each as defined) to 5.00:1.00.

The term loans bear interest at a rate equal to the three-month LIBOR rate, with a 1% floor plus 9.75% per annum. In addition, in accordance with the Credit Agreement, as amended (the “Amended Credit Agreement”) the Company will have to pay a 1% exit fee, which is $1,250 at the current outstanding loan balance and is being accreted to the carrying amount of the debt using the effective interest method over the term of the loan. In addition, if there is an early repayment, there is a sliding scale of prepayment penalties beginning with a 10% penalty and including a make-whole interest payment. No prepayment penalties are assessed for payments made after March 31, 2022.

The Amended Credit Agreement contains certain usual and customary affirmative and negative covenants, as well as financial covenants that the Company will need to satisfy on a monthly and quarterly basis. As of June 30, 2020, the Company was in compliance with the covenants.

In connection with the Credit Agreement, the Company issued warrants to each of Athyrium and its affiliate, Athyrium Opportunities II Acquisition LP (“Athyrium II”), to purchase an aggregate of 348,664 shares of the Company’s common stock with an exercise price of $8.6043 per share. In connection with the First Amendment, the warrants were amended to decrease the exercise price to $6.84 per share. See note 12(d) for additional information. The warrants are exercisable through November 17, 2024. The initial fair value of the warrant and revaluation adjustment from the repricing of the warrants of $2,232 was recorded as a debt issuance cost.

In addition, the Company recorded debt issuance costs for the Amended Credit Agreement of $4,439 at original signing, an amendment fee of $500 as well as certain other fees and expenses in December 2018, and recorded debt

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issuance costs for the Second Amendment consisting of a $2,500 amendment fee, $436 closing fee and $11,400 original issue discount which, along with the fair value of warrants, are being amortized using the effective interest method over the term of the Amended Credit Agreement. Debt issuance cost amortization is included in interest expense within the Consolidated Statements of Operations. As of June 30, 2020, the effective interest rate was 15.98%, which takes into consideration the non-cash accretion of the exit fee, the amortization of the debt issuance cost and the original issue discount.

The Company recorded debt issuance cost amortization related to the Amended Credit Agreement of $1,384 for the three months ended June 30, 2020 and 2019 and $2,768 and $2,362 for the six months ended June 30, 2020 and 2019, respectively.

Paycheck Protection Program (“PPP”) Note

On May 12, 2020, the Company entered into a $4,416 promissory note with PNC Bank under the Small Business Administration (“SBA”) Paycheck Protection Program of the Coronavirus Aid, Relief and Economic Security Act of 2020 (the “CARES Act,” collectively the “PPP Note”). The note has a two-year term, matures on May 12, 2022 and bears interest at a stated rate of 1.0% per annum. Monthly principal and interest payments, less the amount of any potential forgiveness (discussed below), will commence on December 15, 2020. The note requires no collateral or guarantees, nor did the Company pay any fees to acquire the note. The note provides for customary events of default, including, among others, failure to make payment, bankruptcy, breaches of representations and material adverse effects. The Company may prepay the principal of the PPP Note at any time without incurring any prepayment charges. On May 18, 2020, which fell within a safe-harbor period established by the SBA, the Company prepaid $1,100 of the note in order to comply with the SBA’s limitations on the amount that could be borrowed at that time. Certifications made with respect to loan amounts repaid during this safe harbor period are deemed to have been made in good faith.

The PPP Note may be partially or fully forgiven if the Company complies with the provisions of the CARES Act, including the use of note proceeds for payroll costs, rent, utilities and other expenses, and at least 60% of the note proceeds must be used for payroll costs as defined by the CARES Act. Any forgiveness of the note will be subject to approval by the SBA and PNC Bank, and will require the Company to apply for such treatment in the future. Should the Company meet the requirements for forgiveness, it would extinguish the note upon receiving legal release from PNC Bank and record a gain on extinguishment in that period.

Litigation

The Company is involved, from time to time, in various claims and legal proceedings arising in the ordinary course of its business. Except as disclosed below, the Company is not currently a party to any such claims or proceedings that, if decided adversely to it, would either individually or in the aggregate have a material adverse effect on its business, financial condition or results of operations.

On May 31, 2018, a securities class action lawsuit (the “Securities Litigation”) was filed against the Company and certain of its officers and directors in the U.S. District Court for the Eastern District of Pennsylvania (Case No. 2:18-cv-02279-MMB) that purported to state a claim for alleged violations of Section 10(b) and 20(a) of the Exchange Act and Rule 10(b)(5) promulgated thereunder, based on statements made by the Company concerning the NDA for IV meloxicam. The complaint seeks unspecified damages, interest, attorneys’ fees and other costs. On December 10, 2018, the lead plaintiff filed an amended complaint that asserted the same claims and sought the same relief but included new allegations and named additional officers as defendants. On February 8, 2019, the Company filed a motion to dismiss the amended complaint in its entirety, which the lead plaintiff opposed on April 9, 2019. On May 9, 2019, the Company filed its response and briefing was completed on the motion to dismiss. In response to questions from the Judge, the parties submitted supplemental briefs with regard to the motion to dismiss the amended complaint during the fall of 2019. On February 18, 2020, the motion to dismiss was granted without prejudice. On April 25, 2020, the plaintiff filed a second amended complaint. The Company filed a motion to dismiss the second amended complaint on June 18, 2020. The plaintiff’s deadline to file an opposition to the Company’s motion to dismiss is August 17, 2020, and the Company will have thirty days from the filing of the plaintiff’s opposition to file a reply in support of the motion to dismiss. In connection with the separation of Baudax Bio, Baudax Bio accepted assignment by the Company of all of its obligations in connection with the Securities Litigation and agreed to indemnify it for all liabilities related to the Securities Litigation. The Company and Baudax Bio believe that the lawsuit is without merit and intend to vigorously defend against it.

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Purchase Commitments

As of June 30, 2020, the Company had outstanding non-cancelable purchase commitments in the aggregate amount of $10,721 related to inventory, capital expenditures, transition services agreement and other goods and services.

The Company is authorized to issue up to 50,000,000 shares of common stock, with a par value of $0.01 per share.

Reflected below are the Company’s capital raises since its initial public offering (“IPO”):

On March 12, 2014, the Company completed an IPO in which the Company sold 4,312,500 shares of common stock at $8.00 per share, resulting in gross proceeds of $34,500. In connection with the IPO, the Company paid $4,244 in underwriting discounts, commissions and offering expenses, resulting in net proceeds of $30,256. Also, in connection with the IPO, all of the outstanding shares of the Company’s Series A Redeemable Convertible Preferred Stock, including accreted dividends, and certain bridge notes, including accrued interest, were converted into common stock.

On July 7, 2015, the Company closed a private placement with certain accredited investors in which the Company sold 1,379,311 shares of common stock at a price of $11.60 per share, for net proceeds of $14,812. The Company paid the placement agents a fee equal to 6.0% of the aggregate gross proceeds from the private placement, plus reimbursement of certain expenses.

On August 19, 2016, the Company closed an underwritten public offering in which the company sold 1,986,666 shares of common stock at a price per share of $7.50, for net proceeds of $13,367 after deducting underwriting discounts, commissions and offering expenses. 

On December 16, 2016, the Company closed an underwritten public offering in which the company sold 6,670,000 shares of common stock at a price per share of $6.00, for net proceeds of $36,888 after deducting underwriting discounts, commissions and offering expenses.

On December 29, 2017, the Company entered into a sales agreement, or the Sales Agreement, with Cowen and Company, LLC, or Cowen, pursuant to which the Company may sell from time to time, at its option, shares of its common stock, $0.01 par value per share, having an aggregate offering price of up to $40,000 through Cowen, as the placement agent. As of June 30, 2020, the Company did not have any sales of common stock under the Sales Agreement. The Sales Agreement will terminate on August 11, 2020.

On March 2, 2018, the Company entered into a Common Stock Purchase Agreement (the “2018 Purchase Agreement”) with Aspire Capital Fund LLC (“Aspire Capital”), which provides that, upon the terms and subject to the conditions and limitations set forth in the 2018 Purchase Agreement, Aspire Capital is committed to purchase, at the Company’s sole election, up to an aggregate of $20,000 of shares of the Company’s common stock over the approximately 30-month term of the 2018 Purchase Agreement. On the execution of the 2018 Purchase Agreement, the Company agreed to issue 33,040 shares of common stock to Aspire Capital as consideration for entering into the 2018 Purchase Agreement. As of June 30, 2020, the Company sold 1,950,000 shares of common stock under the 2018 Purchase Agreement for proceeds of $16,999, at an average per share price of $8.72, all of which transactions occurred during 2018. The Amended Purchase Agreement, as defined below, replaces the 2018 Purchase Agreement.

On February 19, 2019, the Company entered into a common stock purchase agreement (the “2019 Purchase Agreement”) with Aspire Capital, which provides that, upon the terms and subject to the conditions and limitations set forth in the 2019 Purchase Agreement, Aspire Capital is committed to purchase, at the Company’s sole election, up to an aggregate of $20,000 of its shares of common stock over the approximately 30-month term of the 2019 Purchase Agreement. On the execution of the 2019 Purchase Agreement, the Company agreed to issue 34,762 shares of common stock to Aspire Capital as consideration for entering into the 2019 Purchase Agreement. As of June 30, 2020, the Company did not have any sales of common stock under the 2019 Purchase

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Agreement. On August 7, 2020, the Company entered into a First Amendment to the 2019 Purchase Agreement with Aspire Capital (the “Amended Purchase Agreement”) which amended the 2019 Purchase Agreement to, among other things, increase the aggregate amount of shares of common stock Aspire is committed to purchase to $30,000 and extend the term of the 2019 Purchase Agreement to March 20, 2022.

The Company is authorized to issue 10,000,000 shares of preferred stock, with a par value of $0.01 per share. As of June 30, 2020, no preferred stock was issued or outstanding.

As of June 30, 2020, the Company had the following warrants outstanding to purchase shares of the Company’s common stock:

The warrant to purchase 348,664 shares related to Athyrium is equity classified. During March 2019, the warrant to purchase 140,000 shares originally issued to Aegis Capital Corporation, which was equity classified, was forfeited upon expiration.

In November 2019, the warrant to purchase 350,000 shares issued to Alkermes, which was liability classified as it contained a contingent net cash settlement feature, was exercised on a cashless basis, with Alkermes surrendering 165,673 shares to cover the aggregate exercise price, resulting in the issuance of 184,327 shares of common stock based on the closing bid price of the Company’s common stock on November 8, 2019 of $17.45.

In October 2013, the Company established the 2013 Equity Incentive Plan (the “2013 Plan”), which allows for the grant of stock options, stock appreciation rights and stock awards for a total of 600,000 shares of common stock. In June 2015, the Company’s shareholders approved the Amended and Restated Equity Incentive Plan (the “2015 A&R Plan”), which amended and restated the 2013 Plan and increased the aggregate amount of shares available for issuance to 2,000,000. In May 2018, the Company’s shareholders approved the 2018 Amended and Restated Equity Incentive Plan (the “A&R Plan”) which amended and restated the 2015 A&R Plan to increase the aggregate amount of shares available for issuance to 8,119,709. At June 30, 2020, the total number of shares authorized under the A&R Plan was 9,281,402, of which 3,369,127 shares were available for future grants. On December 1^st of each year, pursuant to the “Evergreen” provision of the A&R Plan, the number of shares available under the plan may be increased by the board of directors by an amount equal to 5% of the outstanding common stock on December 1^st of that year.

Stock options

Stock options are exercisable generally for a period of 10 years from the date of grant and generally vest over four years.

The weighted average grant-date fair value of the options awarded to employees during the six months ended June 30, 2020 and 2019 was $8.24 and $5.60, respectively. The fair value of the options was estimated on the date of grant using a Black-Scholes option pricing model with the following assumptions:

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The intrinsic value of options exercised during the six months ended June 30, 2020 and 2019 was $1,058 and $1,033, respectively.

The following table summarizes stock option activity during the six months ended June 30, 2020:

Included in the table above are 438,000 options outstanding as of June 30, 2020 that were granted outside the plan. The grants were made pursuant to the NASDAQ inducement grant exception in accordance with NASDAQ Listing Rule 5635(c)(4).

Restricted stock units

Restricted stock units (“RSUs”) generally vest over four years. The fair value of RSUs on the date of grant is measured as the closing price of our common stock on that date. The weighted average grant-date fair value of RSUs awarded to employees during the six months ended June 30, 2020 and 2019 was $15.11 and $8.12, respectively. The fair value of RSUs vested during the six months ended June 30, 2020 and 2019 was $3,227 and $3,952, respectively.

The following table summarizes RSU activity during the six months ended June 30, 2020:

Included in the table above are 15,000 time-based RSUs outstanding as of June 30, 2020 that were granted outside the plan. The grants were made pursuant to the NASDAQ inducement grant exception in accordance with NASDAQ Listing Rule 5635(c)(4).

Other information

Stock-based compensation expense from continuing operations for the six months ended June 30, 2020 and 2019 was $5,677 and $3,541, respectively. Of these amounts, $1,991 and $845, respectively, were classified as cost of sales and $3,686 and $2,696, respectively, were classified as selling, general and administrative expenses.

For the six months ended June 30, 2020, this represents stock-based compensation expense for the Company’s employees as well as Baudax Bio employees that continue to provide services to the Company through the transition services agreement (See note 3). For the six months ended June 30, 2019, additional stock-based compensation expense of $1,644 is included in amounts presented in the line item “Loss from discontinued operations” on the Company’s Consolidated Statements of Operations.

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In conjunction with the Separation, the employment of certain of the Company’s employees was transferred to Baudax Bio pursuant to the Employee Matters Agreement dated November 20, 2019 by and between the Company and Baudax Bio. In accordance with the terms of the Employee Matters Agreement, the Recro equity grants held by such former employees continue to vest in accordance with their respective vesting schedules. Any stock-based compensation expense with respect to former employees who no longer provide services to the Company is reflected in Baudax Bio’s financial statements.

As of June 30, 2020, there was $11,106 of unrecognized compensation expense related to unvested options and time-based RSUs that are expected to vest and will be expensed over a weighted average period of 2.2 years. As of June 30, 2020, there was $2,707 of unrecognized compensation expense related to unvested performance-based RSUs. The performance-based RSUs will be expensed if the performance criteria are achieved or become probable of being achieved.

Contract assets represent revenue recognized for performance obligations completed before an unconditional right to payment exists, and therefore invoicing or associated reporting from the customer regarding the computation of the net product sales has not yet occurred. Contract assets were $8,911 and $8,851 at June 30, 2020 and December 31, 2019, respectively. Generally, the contract assets balance is impacted by the recognition of additional contract assets, offset by amounts invoiced to customers or actual net product sale amounts reported by the commercial partner for the period.

The following table presents changes in the Company’s contract assets and liabilities for the six months ended June 30, 2020:

The following table disaggregates revenue by timing of revenue recognition:

The Company’s payment terms for manufacturing revenue and development services are typically 30 to 45 days. Royalty revenue is recorded to accounts receivable in the quarter that the product is sold by the commercial partner upon reporting from the commercial partner and payment terms are generally 45 days after quarter end.

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The Company is a party to various operating leases in Georgia for office, manufacturing, chemistry, and manufacturing and controls development space. The Company is also a party to leases for office equipment and storage. Operating lease assets, current lease liabilities and noncurrent lease liabilities are classified as other assets, other current liabilities and other liabilities, respectively, on the Consolidated Balance Sheets.

The Company determines if an arrangement is a lease at inception. The arrangement is a lease if it conveys the right to the Company to control the use of identified property, plant, or equipment for a period of time in exchange for consideration. Lease terms vary based on the nature of operations, however, all leased facilities are classified as operating leases with remaining lease terms between less than one year and 5 years. Most leases contain specific renewal options where notice to renew must be provided in advance of lease expiration or automatic renewals where no advance notice is required. Periods covered by an option to extend the lease were included in the non-cancellable lease term when exercise of the option was determined to be reasonably certain. Costs determined to be variable and not based on an index or rate were not included in the measurement of operating lease liabilities. As most leases do not provide an implicit rate, the Company's incremental borrowing rate was used to discount its lease liabilities.

The Company’s leases with an initial term of 12 months or less that do not have a purchase option or extension that is reasonably certain to be exercised are not included in the right-of-use asset or lease liability. Lease expense is recognized on a straight-line basis over the lease term.

As of June 30, 2020, undiscounted future lease payments for non-cancellable operating leases are as follows:

At June 30, 2020, the weighted average remaining lease term was 5 years and the weighted average discount rate was 16%.

The components of the Company’s lease cost were as follows:

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Baudax Bio is a related party to the Company. As part of the Separation, the Company entered into a transition services agreement with Baudax Bio. Under the transition services agreement, Baudax Bio provides certain services to the Company, each related to corporate functions which are charged to the Company. Additionally, the Company may incur expenses that are directly related to Baudax Bio after the Separation, which are billed to Baudax Bio. Our continuing involvement with Baudax Bio as a result of the transition services agreement is expected to end by late 2020, unless extended. During the three and six months ended June 30, 2020, the Company recorded expense of $516 and $1,032, respectively, related to its transition services agreement with Baudax Bio. These expenses are included in selling, general and administrative expenses on the Company’s Consolidated Statements of Operations. The Company recorded a net receivable of $33 and a net payable of $273 for such activities and other activity with Baudax Bio as of June 30, 2020 and December 31, 2019, respectively.

The Company has a voluntary 401(k) Savings Plan (the 401(k) Plan) in which all employees are eligible to participate. The Company’s policy is to match 100% of the employee contributions up to a maximum of 5% of employee compensation. Total Company contributions to the 401(k) plan for the three months ended June 30, 2020 and 2019 were $223 and $237, respectively. Total Company contributions to the 401(k) plan for the six months ended June 30, 2020 and 2019 were $539 and $528, respectively.

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The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the interim unaudited financial statements contained in Part I, Item 1 of this Quarterly Report, and the audited financial statements and notes thereto for the year ended December 31, 2019 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, 2019 filed with the SEC on March 4, 2020. As used in this report, unless the context suggests otherwise, “we,” “us,” “our,” “the Company” or “Recro” refer to Recro Pharma, Inc. and its consolidated subsidiaries.

Cautionary Note Regarding Forward-Looking Statements

This Quarterly Report on Form 10-Q, or Quarterly Report, contains forward-looking statements. We may, in some cases, use terms such as “may,” “will,” “should,” “expect,” “plan,” “anticipate,” “could,” “intend,” “target,” “project,” “contemplates,” “believes,” “estimates,” “predicts,” “potential,” or “continue,” the negatives thereof and other words that convey uncertainty of future events or outcomes to identify these forward-looking statements.

These forward-looking statements in this Quarterly Report include, among other things, statements about:

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Any forward-looking statements that we make in this Quarterly Report speak only as of the date of such statement, and we undertake no obligation to update such statements to reflect events or circumstances after the date of this Quarterly Report or to reflect the occurrence of unanticipated events. Comparisons of results for current and any prior periods are not intended to express any future trends or indications of future performance, unless expressed as such, and should only be viewed as historical data.

You should also read carefully the factors described in the “Risk Factors” included in Part II, Item 1A of this Quarterly Report, Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019 filed with the SEC on March 4, 2020, or the 2019 Annual Report, and Part II, Item 1A of our Quarterly Report on Form 10-Q for the three months ended March 31, 2020 filed with the SEC on May 11, 2020, or the Q1 Quarterly Report, to better understand significant risks and uncertainties inherent in our business and underlying any forward-looking statements. As a result of these factors, actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements in this report and you should not place undue reliance on any forward-looking statements.

Overview

We are a leading contract development and manufacturing organization, or CDMO, with integrated solutions for the development, formulation, regulatory support, manufacturing and packaging of oral solid dose drug products. We have operated through a single CDMO business segment since the completion of the spin-off of our historical Acute Care business segment, which developed products for hospital and other acute care settings, on November 21, 2019.

We leverage our formulation and development expertise to develop and manufacture pharmaceutical products using proprietary delivery technologies and know-how for commercial partners who develop, commercialize or plan to commercialize these products. These collaborations can result in revenue streams including manufacturing, royalties, profit sharing, and development. We operate a 97,000 square foot, DEA-licensed manufacturing facility in Gainesville, Georgia, as well as a 24,000 square foot development and high potency product facility in Gainesville, Georgia. 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 Zohydro ER®, as well as CDMO services for supporting development stage products.

We have used cash flow generated by our business primarily to fund operations at our Gainesville, Georgia manufacturing facilities, to fund our historical Acute Care business and to make payments under our credit facility. We believe our business will continue to contribute cash for future operations at our Gainesville facilities and other general corporate purposes.

In November 2019, our former Acute Care business was spun-out from us through our former wholly-owned subsidiary, Baudax Bio, Inc., or Baudax Bio, when we completed a special dividend distribution of all the outstanding shares of common stock of Baudax Bio to our shareholders. On November 21, 2019, the distribution date, each of our shareholders received one share of Baudax Bio’s common stock, or the Distribution, for every two and one-half shares of our common stock held of record at the close of business on November 15, 2019, the record date for the Distribution. Additionally, we contributed $19 million of cash to Baudax Bio in connection with the separation, retained significant net operating loss carryforwards, and were released from significant milestone and royalty payment obligations. As a result of the Distribution, Baudax Bio is now an independent public company whose shares of common stock are trading under the symbol “BXRX” on The Nasdaq Capital Market, or Nasdaq.

In the second quarter of 2020, we launched a new clinical trial material offering, or CTM. Our capabilities include on-demand services for innovative trial design and direct-to-patient supply logistics. We also can provide non-clinical formulations, Active Pharmaceutical Ingredient (API) characterization, over-encapsulation and manufacturing, in addition to clinical and commercial packaging services. We also made additional capital improvements to support a new tech transfer project for a commercial product and also believe the equipment will be useful for future commercial projects.

Our consolidated results of operations and financial position included in this Quarterly Report reflect the financial results of Baudax Bio as a discontinued operation for all periods presented. For additional information on the spin-off of Baudax Bio please read note 4, Discontinued Operations, to our consolidated financial statements included in the Company’s 2019 Annual Report.

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COVID-19

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 have instituted protocols to have appropriate personnel work remotely and have implemented strict social distancing and other protective measures for those employees continuing to support essential operations at our work locations in order to ensure the health of our employees while continuing to provide critical products. Our sales, manufacturing and development efforts have continued since the outbreak of the pandemic. Our cost of sales has increased as a percentage of revenues in part due to lower production volumes, resulting in manufacturing variances, and there are some incremental expenses associated with safe practices for our organization due to COVID-19.

Business Development: We successfully launched our new CTM offering in the second quarter and secured new customers. In other sectors, we have experienced lower than expected new development business growth, which we believe is primarily attributable to COVID-19. Concerns surrounding COVID-19 have resulted in our adoption of new methods for meeting and contacting customers, have slowed customer access, and have caused delays in plans for development services by some customers and prospects for a variety of reasons, such as concerns about the timing of clinical trials.

Manufacturing Demand: We believe that there has been lower demand for some of the commercial products we manufacture for our customers due to the effects of COVID-19. Third party national data demonstrates that there has been 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, etc.

Our sales and manufacturing operations could be further disrupted as a result of the pandemic because of production slowdowns, stoppages, or decreased demand for the products we manufacture. Given the uncertain scope and duration of the pandemic, the extent to which the pandemic will continue to impact our financial results remains uncertain in terms of manufacturing volumes and certain profit sharing results, even when our partners have not experienced loss of market share, in part due to reduced total prescription (TRx) rates for many chronic therapeutics. However, we will continue to monitor the situation closely, we have taken steps to reduce costs and drive more new business, and we are actively evaluating various ways to further conserve operational resources.

Financial Overview

Recent Developments

Some recent developments have occurred that have impacted and are expected to continue to impact full year expected results, including:

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As a result of these recent events, we implemented operating improvement initiatives including two separate reduction in force actions during the first half of 2020 as well as other initiatives. We estimate that these initiatives will provide an annual savings of approximately $3.4 million in fiscal year 2021. Additional cost saving measures continue to be assessed.

Revenues

During the periods presented, we recognized revenues from three revenue streams: manufacturing revenue, royalty revenue and development revenue.

Manufacturing Revenue

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.

Royalty Revenue

We recognize royalty or profit-sharing revenue, collectively referred to as royalty revenue, related to the sale of products by our commercial partners that incorporate our technologies. Royalty revenues are generally recognized under the terms of the applicable license, development and/or supply agreement. For arrangements that include sales-based royalties and the license is deemed to be the predominant item to which the royalties relate, we recognize revenue when the related sales occur by the commercial partner. For arrangements that include sales-based royalties and the license is not deemed to be the predominant item to which the royalties relate, we recognize revenue when the performance obligation to which the royalty has been allocated has been satisfied, which is upon transfer of control of a product to a customer. In this case, significant judgment is used in the estimation of these royalties based on historical customer pricing and deductions and is partially constrained due to items that are outside of our control including the uncertainty of the timing of future commercial partner sales, mix of volume, customer stocking and ordering patterns, as well as unforeseen price adjustments made by our commercial partners.

Research and Development Revenue

Research and development revenue includes services associated with formulation, process development, CTM 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 would be 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.

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Selling, General and Administrative Expenses

Selling, general and administrative expenses consist of salaries and related costs for corporate administrative, public company costs, and business development personnel as well as legal, patent-related and consulting fees. Public company costs include compliance, auditing services, tax services, insurance and investor relations. We expect our business development expenses to increase in 2020, compared to prior year, as we continue to expand our sales team in various geographies in support of our new offerings, in anticipation of business growth from new formulation, development and CTM capabilities.

Amortization of Intangible Assets

We recognize amortization expense related to the intangible asset for our contract manufacturing relationships on a straight-line basis over an estimated useful life of six years.

Change in Fair Value of Warrants

We had previously classified as liabilities certain warrants then outstanding that contained a contingent net cash settlement feature, upon a change in control. The fair value of these warrants was remeasured through settlement or expiration with changes in fair value recognized as a period charge within the Consolidated Statements of Operations. There are no remaining liability classified warrants as the last of these warrants were exercised in November 2019. A fair value determination at the time of the exercise occurred and was included in the change in warrant valuation for the year ended December 31, 2019.

Interest Expense

Interest expense for the periods presented primarily includes interest expense incurred on our Athyrium senior secured term loans, the amortization of related financing costs and interest expense on a promissory note with PNC Bank under the Small Business Administration, or “SBA, Paycheck Protection Program of the Coronavirus Aid, Relief and Economic Security Act of 2020, or the CARES Act, and collectively the PPP note.

Net Operating Losses and Tax Carryforwards

As of December 31, 2019, we had approximately $121.6 million of federal net operating loss carryforwards. We also had federal and state research and development tax credit carryforwards of $4.4 million available to offset future taxable income. U.S. tax laws limit the time during which these carryforwards may be utilized against future taxes. With the exception of the 2019 and 2018 federal net operating losses, which have an indefinite carry forward period, these federal and state net operating loss and federal and state tax credit carryforwards 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 deferred tax assets.

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Results of Operations

Comparison of the Three Months Ended June 30, 2020 and 2019