Amphastar Pharmaceuticals, Inc. (AMPH) FY 2021 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following is a discussion and analysis of the consolidated operating results, financial condition, liquidity and cash flows of our company as of and for the periods presented below. The following discussion and analysis should be read in conjunction with the audited consolidated financial statements and the related notes thereto included in Item 8 under the heading “Financial Statements and Supplementary Data.” This discussion contains forward-looking statements that are based on the beliefs of our management, as well as assumptions made by and information currently available to, our management. Actual results could differ materially from those discussed in or implied by forward-looking statements. These risks, uncertainties and other factors include among others, those identified under the “Special Note About Forward-Looking Statements,” above and described in greater detail elsewhere in this Annual Report on Form 10-K, particularly in Item 1A, “Risk Factors.”

In this section, we generally discuss the results of our operations for the year ended December 31, 2021 compared to the year ended December 31, 2020. For a discussion of the year ended December 31, 2020 to the year ended December 31, 2019, please refer to Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2020, filed with the SEC on March 15, 2021, which discussion is hereby incorporated herein by reference.

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Overview

We are a bio pharmaceutical company that focuses primarily on developing, manufacturing, marketing and selling technically challenging generic and proprietary injectable, inhalation, and intranasal products as well as insulin API products. We currently manufacture and sell over 20 products.

We are currently developing a portfolio of generic abbreviated new drug applications, or ANDAs, biosimilar insulin product candidates, and proprietary product candidates, which are in various stages of development and target a variety of indications. Five of the ANDAs and one NDA are currently on file with the FDA. Additionally, we have one product with tentative FDA approval, Vasopressin, which we plan to launch in the third quarter of 2022, subject to a confidential settlement agreement with the product’s innovator.

Our largest products by net revenues currently include Primatene Mist®, glucagon, epinephrine, enoxaparin sodium injection, lidocaine, naloxone, and phytonadione. In December 2020, the FDA granted approval of our glucagon for injection emergency kit, 1mg, which we launched in February 2021.

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To complement our internal growth and expertise, we have made several strategic acquisitions of companies, products, and technologies. These acquisitions collectively have strengthened our core injectable and inhalation product technology infrastructure by providing additional manufacturing, marketing, and research and development capabilities, including the ability to manufacture raw materials, API, and other components for our products.

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These acquisitions include marketing authorizations for 33 products in the UK, Ireland, Australia, and New Zealand, representing 11 different injectable chemical entities. We are in the process of transferring the manufacturing of these products to our facilities in California. We plan to launch these products in the UK once we receive the required approvals from the UK Medicines and Healthcare products Regulatory Agency.

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In July 2018, our Chinese subsidiary, ANP, completed a private placement of its common equity interest and received approximately $56.3 million of cash proceeds. We retained approximately 58% of the equity interest in ANP following the private placement. During the third quarter of 2021, we restructured the equity ownership of ANP, whereby we repurchased an additional ownership interest in ANP from certain equity holders of ANP (the “Sellers”), and split-off certain subsidiaries of ANP. We paid approximately $29.4 million in cash and contributed approximately 80% of Hanxin Pharmaceutical Technology Co., Ltd, or Hanxin, to the Sellers in exchange for additional ownership interest in ANP, resulting in our ownership of ANP increasing to approximately 85%, while ANP retained approximately 20% of ownership in Hanxin. Hanxin’s wholly-owned subsidiaries, Nanjing Baixin Trading Co., Ltd., and Nanjing Letop Biological Technology Co., Ltd., were included in the split-off of Hanxin.

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In August 2021, we entered into a second Share Purchase Agreement, or Second SPA, with the other remaining equity holder of ANP to acquire the remaining approximately 15% of ownership interest in ANP. The total cash paid for this transaction was approximately $22.5 million. As a result of the transaction, our ownership interest in ANP increased to 100%. The Sellers in both transactions include some of our executive officers, directors and other related parties who participated in the ANP Private Placement in 2018, see Note 3 to the condensed consolidated financial statements.

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The reduction of our ownership in Hanxin to 20%, resulted in ANP experiencing a “loss of control” of a subsidiary as defined by generally accepted accounting principles, or GAAP. Loss of control is deemed to have occurred when, among other things, a parent company owns less than a majority of the outstanding common stock in the subsidiary, lacks a controlling financial interest in the subsidiary and, is unable to unilaterally control the subsidiary through other means such as having, or being able to obtain, the power to elect a majority of the subsidiary's board of directors based solely on contractual rights or ownership of shares holding a majority of the voting power of the subsidiary's voting securities. These loss-of-control factors were met with respect to ANP’s ownership interest in Hanxin after the restructuring. Accordingly, we deconsolidated Hanxin and recorded a $13.6 million gain on deconsolidation, which is recognized in other income (expenses), net in the consolidated statement of operations.

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Subsequent to the restructuring, during the third quarter of 2021, Hanxin received additional capital contributions from its equity owners further reducing ANP’s ownership interest to approximately 14%.

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In addition to the retained noncontrolling investment in Hanxin, we maintain a seat on Hanxin’s board of directors. Additionally, Henry Zhang, a relative of Dr. Jack Zhang and Dr. Mary Luo, holds a significant stake in Hanxin and is Hanxin’s General Manager and Chairman of the Board of Directors. As a result, we determined that we have significant influence over Hanxin, and as such, the retained noncontrolling investment in Hanxin is accounted for as an equity method investment. Hanxin continues to be a related party subsequent to the restructuring.

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COVID-19 Pandemic

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We are actively monitoring the COVID-19 pandemic, including the Omicron variant, and its impact globally. Currently, our production facilities in all of our locations continue to operate as they had before the COVID-19 pandemic with few changes, other than for enhanced safety measures intended to prevent the spread of the virus.

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As a result of the COVID-19 pandemic, during the first half of 2020, sales of Primatene Mist® and certain hospital products increased, while sales of certain products frequently used in elective procedures, such as Cortrosyn® and lidocaine products decreased. We saw these trends continue in late 2020 and early 2021 when COVID-19 cases trended higher. The sales of these products, frequently used in elective procedures, returned to their normal level by the second quarter of 2021.

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Some of our ongoing clinical trials experienced short-term interruptions in the recruitment of patients due to the COVID-19 pandemic, as hospitals prioritize their resources towards the COVID-19 pandemic and governments impose travel restrictions. Some clinical trials experienced increased expenses due to new protocols to protect participants from COVID-19. Additionally, certain suppliers had difficulties meeting their delivery commitments.

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It is not possible at this time to estimate the complete impact that COVID-19 could have on our business, including our customers and suppliers, as the effects will depend on future developments, which are highly uncertain and cannot be predicted. Infections may resurge or become more widespread, including due to new variants and the limitation on our ability to travel and timely sell and distribute our products, as well as any closures or supply disruptions, may be prolonged for extended periods, all of which would have a negative impact on our business, financial condition, and operating results.

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Even after the COVID-19 pandemic has subsided, we may continue to experience an adverse impact on our business due to the continued global economic impact of the COVID-19 pandemic. We cannot anticipate all of the ways in which health epidemics such as COVID-19 could adversely impact our business. See Item 1A, “Risk Factors” for further discussion of the possible impact of the COVID-19 pandemic on our business.

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Business Segments

As of December 31, 2021, our performance is assessed and resources are allocated based on the following two reportable segments: (1) finished pharmaceutical products and (2) API products. The finished pharmaceutical products segment manufactures markets and distributes Primatene Mist®, glucagon, enoxaparin, naloxone, phytonadione, lidocaine, as well as various other critical and non-critical care drugs. The API segment manufactures and distributes RHI API and porcine insulin API for external customers and internal product development. Information reported herein is consistent with how it is reviewed and evaluated by our chief operating decision maker. Factors used to identify our segments include markets, customers and products.

For more information regarding our segments, see “Part II – Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Segment Reporting Information.”

Results of Operations

Year ended December 31, 2021 compared to year ended December 31, 2020

Net revenues

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The increase in net revenues of finished pharmaceutical products for 2021 was primarily due to the following changes:

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We launched glucagon for injection emergency kit, 1mg in the first quarter of 2021. The continued growth in sales of Primatene Mist® was due to increased unit volumes, which was primarily a result of the continued success of our advertising campaign. The increase in sales of epinephrine was primarily due to the launch of our epinephrine injection, USP 30mg/30mL multiple dose vial product in the second quarter of 2020, as well as an increase in unit volumes, as a result of higher demand due to a market shortage for pre-filled syringes. The increase in sales of phytonadione was primarily due to higher average selling price. The increase in sales of lidocaine was primarily due to an increase in unit volumes, as a result of a market shortage. Sales of enoxaparin decreased $12.7 million due to a decrease in unit volumes, as well as a lower average selling price as a competitor re-entered the market during the second quarter of 2021. The

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decrease in sales of naloxone was primarily due a decrease in unit volumes as well as lower average selling price as a result of a competitor entering the market. The decrease in other finished pharmaceutical products was primarily due to lower unit volumes as a result of competitors returning to their normal distribution levels during the year after being unable to supply market demands in 2020.

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We anticipate that sales of naloxone and enoxaparin will continue to fluctuate in the future as a result of changing levels of competition.

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Sales of API primarily depend on the timing of customer purchases. In May 2021, we amended the Supply Agreement with MannKind, whereby MannKind’s aggregate total commitment of RHI API under the Supply Agreement was modified and extended for an additional year through 2027, which timeframe would have previously lapsed after calendar year 2026. MannKind has agreed to pay us an amendment fee of $2.0 million. We received the first payment of the amendment fee of $1.0 million in June 2021 which we recognized in net revenues during the year ended December 31, 2021. The remaining $1.0 million of the amendment fee was received in January 2022 and relates to the amendments to the 2022 supply level and will be recognized ratably to net revenues in 2022.

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We anticipate that sales of API will continue to fluctuate and may decrease due to the inherent uncertainties related to sales to MannKind Corporation pursuant to our supply agreement with them. In addition, most of our API sales are denominated in euros, and the fluctuation in the value of euros versus the U.S. dollar has had, and will continue to have, an impact on API sales revenues in the near term.

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Gross Margins

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The increase in sales of Primatene Mist®, the launch of glucagon for injection emergency kit during the first quarter of 2021, and the launch of our epinephrine injection multiple dose vial in the second quarter of 2020, which are all higher-margin products, helped increase our gross margins for the year ended December 31, 2021. These increases in gross margins were partially offset by lower pricing and increased costs for enoxaparin, particularly the cost for heparin raw material, which is used as the starting material for enoxaparin.

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We are experiencing increased costs for labor and certain purchased components. Additionally, the cost of heparin may increase further, putting downward pressure on our gross margins. However, we believe that this trend will be offset by increased sales of our higher-margin products, including Primatene Mist®, glucagon and new products we anticipate launching in 2022.

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Selling, distribution, and marketing, and general and administrative

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The increase in selling, distribution, and marketing expenses was primarily due to marketing and distribution expenses related to Primatene Mist®, including the cost of creating a new commercial for our national digital, television and radio marketing campaign. The increase in general and administrative expense was primarily due to an increase in legal expenses (see Note 20 to the consolidated financial statements for more information regarding litigation matters). This was partially offset by a decrease in compensation expense relating to the separation agreement that we entered into with a former executive during the second quarter of 2020.

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We expect that selling, distribution and marketing expenses will increase due to the increase in marketing expenditures for Primatene Mist®. Legal fees may fluctuate from period to period due to the timing of patent challenges and other litigation matters.

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Research and development

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The decrease in research and development expenses is primarily due to a decrease in clinical trial expense as a result of the completion of one of our clinical trial studies at the end of 2020, and delays in other studies. Additionally, the restructuring of ANP and the deconsolidation of Hanxin and its subsidiaries resulted in a decrease in our testing, operating and lab supplies expenses.

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Research and development costs consist primarily of costs associated with the research and development of our product candidates including the cost of developing APIs. We expense research and development costs as incurred.

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We have made, and expect to continue to make, substantial investments in research and development to expand our product portfolio and grow our business. We expect that research and development expenses will increase on an annual basis due to increased clinical trial costs related to our biosimilar and inhalation product candidates. These expenditures will include costs of APIs developed internally as well as APIs purchased externally, the cost of purchasing reference listed drugs and the costs of performing the clinical trials. As we undertake new and challenging research and development projects, we anticipate that the associated costs will increase significantly over the next several quarters and years. Over the past year, some of our ongoing clinical trials experienced short term interruptions in the recruitment of patients due to the COVID-19 pandemic, as hospitals prioritized their resources towards the COVID-19 pandemic and government imposed travel restrictions. These conditions may in turn delay spending and the results of these trials. Additionally, some clinical trials experienced increased expenses due to new protocols to protect participants from COVID-19.

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Other income (expense), net

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During the third quarter of 2021, we completed the restructuring of ANP, whereby our ownership interest in ANP increased to 100% and ANP’s ownership interest in Hanxin and its subsidiaries was reduced to approximately 14%. As a result of the loss in control over Hanxin, we deconsolidated Hanxin and recorded a $13.6 million gain on deconsolidation. For more information regarding our ANP restructuring, see Note 3 to the consolidated financial statements. We received a settlement payment, net of contingent legal fees, in the amount of $2.7 million. The payment was related to the settlement of a legal dispute and is recorded as other income (expense), see Note 2 to the consolidated financial statements.

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Income tax provision

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Our tax rate is affected by recurring items, such as tax rates in non-U.S. jurisdictions as compared to statutory U.S. federal and state tax rates, and the relative amount of income or loss in those various jurisdictions. It is also impacted by

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certain items that may occur in any given period, but are not consistent from period to period.

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For additional information on our income taxes, including information about the impact of the CARES Act, refer to Note 15 to the consolidated financial statements.

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Liquidity and Capital Resources

Cash Requirements and Sources

We need capital resources to maintain and expand our business. We expect our cash requirements to increase significantly in the foreseeable future as we sponsor clinical trials for, seek regulatory approvals of, and develop, manufacture and market our current development-stage product candidates and pursue strategic acquisitions of businesses or assets. Our future capital expenditures include projects to upgrade, expand, and improve our manufacturing facilities in the United States and China, including a significant increase in capital expenditure in 2022. We plan to fund this facility expansion with cash flows from operations. Our cash obligations include the principal and interest payments due on our existing loans and lease payments, as described below and throughout this Annual Report on Form 10-K.

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As of December 31, 2021, our foreign subsidiaries collectively held $14.7 million in cash and cash equivalents. Cash or cash equivalents held at foreign subsidiaries are not available to fund the parent company’s operations in the United States. We believe that our cash reserves, operating cash flows, and borrowing availability under our credit facilities will be sufficient to fund our operations for at least the next 12 months. We expect additional cash flows to be generated in the longer term from future product introductions, although there can be no assurance as to the receipt of regulatory approval for any product candidates that we are developing or the timing of any product introductions, which could be lengthy or ultimately unsuccessful.

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We maintain a shelf registration statement on Form S-3 pursuant to which we may, from time to time, sell up to an aggregate of $250 million of our common stock, preferred stock, debt securities, depositary shares, warrants, subscription rights, purchase contracts, or units. If we require or elect to seek additional capital through debt or equity financing in the future, we may not be able to raise capital on terms acceptable to us or at all. To the extent we raise additional capital through the sale of equity or convertible debt securities, the issuance of such securities will result in dilution to our stockholders. If we are required and unable to raise additional capital when desired, our business, operating results and financial condition may be adversely affected.

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Working capital increased $46.8 million to $214.3 million at December 31, 2021, compared to $167.5 million at December 31, 2020.

Cash Flows from Operations

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The following table summarizes our cash flows from operating, investing, and financing activities for the years ended December 31, 2021 and 2020.

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Sources and Use of Cash

Operating Activities

Net cash provided by operating activities was $98.0 million for the year ended December 31, 2021, which included net income of $63.3 million. Non-cash items comprised primarily of $26.8 million of depreciation and amortization, $18.7 million of share-based compensation expense and a $13.6 million gain relating to the deconsolidation of Hanxin and its subsidiaries as result of the ANP restructuring during the third quarter of 2021.

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Additionally, for the year ended December 31, 2021, there was a net cash outflow from changes in operating assets and liabilities of $1.9 million, which resulted from an increase in accounts receivable, which was partially offset by a decrease in inventory, as well as an increase in accounts payable and accrued liabilities. Accounts payable and accrued liabilities increased primarily due to the timing of payments. The increase in accounts receivable was due to both increases in sales and the timing of sales.

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Net cash provided by operating activities was $57.3 million for the year ended December 31, 2020, which included net income of $1.1 million. Non-cash items comprised primarily of $25.2 million of depreciation and amortization, and $20.5 million of share-based compensation expense.

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Additionally, for the year ended December 31, 2020, there was a net cash inflow from changes in operating assets and liabilities of $9.1 million, which resulted from an increase in accounts payable and accrued liabilities and a decrease in inventory, which was partially offset by an increase in accounts receivable. Accounts payable and accrued liabilities increased primarily due to the timing of payments. The decrease in inventory was a result of strong sales throughout the year and a decrease in purchases of raw materials of enoxaparin. The increase in accounts receivable was due to the timing of sales.

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Investing Activities

Net cash used in investing activities was $28.7 million for the year ended December 31, 2021, primarily as a result of $27.5 million in purchases of property, plant, and equipment, which included $15.3 million incurred in the United States, $0.8 million in France, and $11.4 million in China.

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Net cash used in investing activities was $36.4 million for the year ended December 31, 2020, primarily as a result of $33.9 million in purchases of property, plant, and equipment, which included $11.5 million incurred in the United States, $2.9 million in France, and $19.5 million in China. Additionally, we purchased $1.1 million in short-term investments in 2020.

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Financing Activities

Net cash used in financing activities was $37.0 million for the year ended December 31, 2021, primarily as a result of $53.6 million in payments relating to the purchase of additional ANP ownership interest in connection with the ANP restructuring completed during the third quarter of 2021 (see Note 3 to the condensed consolidated financial statements). We borrowed $70.0 million in connection with a credit agreement with Capital One N.A., which was partially offset by $37.9 million in principal payments on our long-term debt and lines of credit. We used $28.9 million to purchase treasury stock and received $15.9 million in net proceeds from the settlement of share-based compensation awards under our equity plans.

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Net cash used in financing activities was $2.2 million for the year ended December 31, 2020, primarily as a result of $24.4 million used to purchase treasury stock offset by $23.2 million in net proceeds from the settlement of share-based compensation awards under our equity plans. Additionally, we also made $8.4 million in principal payments on our long-term debt and received $7.5 million from borrowings on our lines of credit, of which $3.1 million was converted into an equipment loan during the year.

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Debt and Borrowing Capacity

Our outstanding debt obligations are summarized as follows:

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As of December 31, 2021, we had $84.6 million in unused borrowing capacity under revolving lines of credit with Capital One N.A. and China Merchant Bank.

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The weighted average interest rates on lines of credit as of December 31, 2021 and 2020 were 1.8% and 3.8%, respectively. For our loans with Capital One N.A. and East West Bank, we have entered into fixed interest rate swap contracts to exchange the variable interests for fixed interest rates.

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For more information regarding our outstanding indebtedness, see “Part II – Item 8. Financial Statements and Supplementary Data – Notes to Consolidated Financial Statements – Debt.”

Operating Lease Obligations

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As discussed in Note 18 to the consolidated financial statements, as of December 31, 2021 we had a total of $34.4 million of minimum rental payments under operating leases. Of that amount, $4.1 million is due within 12 months as of December 31, 2021.

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Purchase obligations

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We have certain purchase obligations under which we are required to make minimum payments for items including, but not limited to, inventory and pharmaceutical manufacturing and laboratory equipment. As of December 31, 2021, we had an aggregate amount of approximately $60.0 million. We anticipate that most of these commitments with a remaining term in excess of one year will be fulfilled by 2023.

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Critical Accounting Policies

We prepare our consolidated financial statements in accordance with accounting principles generally accepted in the United States, or GAAP. The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates. To the extent that there are material differences between these estimates and actual results, our financial condition and results of operations will be affected. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies, which we discuss further below. While our significant accounting policies are more fully described in Note 2 to our audited consolidated financial statements, we believe that the following accounting policies are critical to the process of making significant judgments and estimates in the preparation of our audited consolidated financial statements.

Revenue Recognition

In 2018, we adopted ASC 606, Revenue from Contracts with Customers, or ASC 606, using the modified retrospective transition method. The adoption of ASC 606 did not have a material impact on our revenues recognition or on the consolidated financial statements and related disclosures. According to ASC 606, revenue is recognized at the time that our customers obtain control of the promised goods. Revenues derived from contract manufacturing services are recognized when third-party products are shipped to customers, after customers have accepted test samples of the products to be shipped. The results for the reporting period beginning after January 1, 2018, are presented in accordance

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with the new standard, although comparative information continues to be reported under the accounting standards and policies in effect for those periods.

Our net revenues consist principally of revenues generated from the sale of our pharmaceutical products. We also generate a small amount of revenues from contract manufacturing services. Generally, we recognize revenues at the time of product delivery to our customers. In some cases, revenues are recognized at the time of shipment when stipulated by the terms of the sale agreements. Revenues derived from contract manufacturing services are recognized when third-party products are shipped to customers, after the customer has accepted test samples of the products to be shipped.

The consideration we receive in exchange for our goods or services is only recognized when it is probable that a significant reversal will not occur. The consideration to which we expect to be entitled includes a stated list price, less various forms of variable consideration. We make significant estimates for related variable consideration at the point of sale, including chargebacks, rebates, product returns, other discounts and allowances.

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Provision for estimated chargebacks, rebates, discounts, product returns and credit losses is made at the time of sale and is analyzed and adjusted, if necessary, at each balance sheet date.

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If actual future payments for the discounts, returns, fees, rebates and chargebacks exceed the estimates we made at the time of sale, our financial position, results of operations and cash flows would be negatively impacted. As discussed under “Accrual for Product Returns” below, we are generally obligated to accept from our customers the return of pharmaceuticals that have reached or will soon reach their expiration dates. We establish reserves for such amounts based on historical experience and other information available at the time of sale, but the actual returns will not occur until several years after the sale. Although we believe that our estimates and assumptions are reasonable as of the date when made, actual results may differ significantly from these estimates. Our financial position, results of operations and cash flows may be materially and negatively impacted if actual returns exceed our estimated allowances for returns.

We establish allowances for estimated chargebacks, rebates and product returns based on a number of qualitative and quantitative factors, including:

Service revenues derived from research and development contracts is recognized over time based on progress toward complete satisfaction of the performance obligation. For each performance obligation satisfied over time, we assess the proper method to be used for revenue recognition, either an input method to measure progress toward the satisfaction of services or an output method of determining the progress of completion of performance obligation. Revenue from research and development services at ANP was $5.1 million.

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Provision for Chargebacks and Rebates

The provision for chargebacks and rebates is a significant estimate used in the recognition of revenue. Wholesaler chargebacks relate to sales terms under which we agree to reimburse wholesalers for differences between the gross sales prices at which we sell our products to wholesalers and the actual prices of such products that wholesalers resell them under our various contractual arrangements with third parties such as hospitals and group purchasing organizations in the United States. Rebates include primarily amounts paid to retailers, payers, and providers in the United States, including

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those paid to state Medicaid programs, and are based on contractual arrangements or statutory requirements. We estimate chargebacks and rebates using the expected value method at the time of sale to wholesalers based on wholesaler inventory stocking levels, historic chargeback and rebate rates, and current contract pricing.

The provision for chargebacks and rebates is reflected as a component of net revenues. The following table is an analysis of the chargeback and rebate provision:

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Changes in the chargeback provision from period to period are primarily dependent on our sales to wholesalers, the level of inventory held by wholesalers, and the wholesalers’ customer mix. Changes in the rebate provision from period to period are primarily dependent on retailer’s and other indirect customers’ purchases. The approach that we use to estimate chargebacks and rebates has been consistently applied for all periods presented. Variations in estimates have been historically small. We continually monitor the provision for chargebacks and rebates and make adjustments when we believe that the actual chargebacks and rebates may differ from the estimates. The settlement of chargebacks and rebates generally occurs within 30 days to 60 days after the sale to wholesalers. Accounts receivable and/or accounts payable and accrued liabilities are reduced and/or increased by the chargebacks and rebate amounts depending on whether we have the right to offset with the customer. Of the provision for chargebacks and rebates as of December 31, 2021 and 2020, $15.6 million and $16.4 million were included as a reduction to accounts receivable, net, on the consolidated balance sheets, respectively. The remaining provision as of December 31, 2021 and 2020, was $4.6 million and $4.0 million, which were included in accounts payable and accrued liabilities, respectively.

Accrual for Product Returns

We offer most customers the right to return qualified excess or expired inventory for partial credit; however, API product sales are generally non-returnable. Our product returns primarily consist of the returns of expired products from sales made in prior periods. Returned products cannot be resold. At the time product revenue is recognized, we record an accrual for product returns estimated using the expected value method. The accrual is based, in part, upon the historical relationship of product returns to sales and customer contract terms. We also assess other factors that could affect product returns including market conditions, product obsolescence and the introduction of new competition. Although these factors do not normally give our customers the right to return products outside of the regular return policy, we realize that such factors could ultimately lead to increased returns. We analyze these situations on a case-by-case basis and make adjustments to the product return reserve as appropriate.

The provision for product returns is reflected as a component of net revenues. The following table is an analysis of the product return liability:

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Of the provision for product returns as of December 31, 2021 and 2020, $16.0 million and $10.2 million were included in accounts payable and accrued liabilities on the consolidated balance sheets, respectively. The remaining provision as of December 31, 2021 and 2020, of $5.7 million and $4.0 million were included in other long-term liabilities, respectively. For the years ended December 31, 2021 and 2020, our aggregate product return rate was 1.7% and 1.4% of qualified sales, respectively.

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Inventory

Inventories consist of currently marketed products and products manufactured under contract. Inventories are stated using the first-in, first-out method, on a consistent basis. Inventory is stated at the lower of cost or net realizable value. We adjust inventories to their net realizable value: (i) if a launch of a new product is delayed and inventory may not be fully utilized and could be subject to impairment, (ii) when a product is close to expiration and not expected to be sold, (iii) when a product has reached its expiration date, (iv) when a product is not expected to be sellable, and (v) when the estimated net realizable value is below cost. In determining the estimated net realizable value of an inventory item, we consider factors such as the forecasted average net selling price, the amount of inventory on hand, its remaining shelf life, its regulatory approval status, and current and expected market conditions, including management forecasts and levels of competition.

The largest adjustment to the net realizable value of our inventory has historically been related to enoxaparin. The adjustment of enoxaparin inventory to its net realizable value has been driven primarily by increases in the prices of heparin, the starting material for the production of the API in our enoxaparin product. Other cost increases relate to labor and overhead also impacted the cost of producing enoxaparin. Additionally, fluctuations in the forecasted average net selling price impact this estimate. The average net selling price has fluctuated due to competitor entries and exits from the market.

Impairment of Intangible and Long-Lived Assets

We review long-lived assets and definite-lived identifiable intangible assets or asset groups for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Such events and circumstances include decisions by the FDA regarding evidence of effectiveness of proprietary drug candidates or bioequivalence (sameness) of our generic product candidates as compared to the reference drug, communication with the regulatory agencies regarding the safety and efficacy of our products under review, the use of the asset in current research and development projects, any potential alternative uses of the asset in other research and development projects in the short-to-medium term, clinical trial results and research and development portfolio management options. Determination of recoverability is based on an estimate of undiscounted future cash flows resulting from the use of the asset or asset groups and its eventual disposition. If the sum of the expected future undiscounted cash flows is less than the carrying amount of the asset or asset groups, further impairment analysis is performed. An impairment loss is measured as the amount by which the carrying amount exceeds the fair value of the asset or asset groups (assets to be held and used) or fair value less cost to sell (assets to be disposed of). All of our impairments relate primarily to the isolated write-off of certain manufacturing equipment related to abandoned projects. Since we periodically assess our product candidates and make changes to product development plans, we incur impairment charges from time to time which can fluctuate significantly from period to period.

The indefinite-lived intangible asset, the Primatene® trademark acquired in June 2008, and goodwill are tested for impairment annually, in the fourth quarter, or more frequently if indicators of impairment are present. An impairment loss is recorded if the asset’s fair value is less than its carrying value. We also periodically review the Primatene® trademark to determine if events and circumstances continue to support an indefinite useful life. When we choose to perform a qualitative assessment, we evaluate economic, industry and company-specific factors as an initial step. If we determine it is more likely than not that the Primatene® trademark is impaired or the fair value of a reporting unit is less than its carrying amount, further quantitative impairment process is then performed; otherwise, no further testing is required. If the life is no longer indefinite, the asset is tested for impairment, and the carrying value, after recognition of any impairment loss, is amortized over its remaining useful life. No impairment of indefinite-lived intangible asset and goodwill was recorded during the years ended December 31, 2021, 2020, or 2019, respectively.

Deferred Income Taxes

We utilize the liability method of accounting for income taxes under which deferred taxes are determined based on the temporary differences between the financial statements and the tax basis of assets and liabilities using enacted tax rates. A valuation allowance is recorded when it is more likely than not that the deferred tax assets will not be realized.

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A number of years may elapse before an uncertain tax position for which we have established a tax reserve is audited and finally resolved. The number of years for which we can be subject to audit varies depending on the tax jurisdiction. While it is often difficult to predict the final outcome or the timing of the resolution of an audit, we believe that our

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reserves for uncertain tax benefits reflect the outcome of tax positions that is more likely than not to occur. The resolution of a matter could be recognized as an adjustment to our provision for income taxes and our effective tax rate in the period of resolution, and may also require a use of cash.

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Share-Based Compensation

Options issued under our 2015 Equity Incentive Award Plan, or the 2015 Plan, and our Amended and Restated 2005 Equity Incentive Award Plan, or 2005 Plan, are granted at exercise prices equal to or greater than the fair value of the underlying common shares on the date of grant and vest based on continuous service. There have been no awards with performance conditions and no awards with market conditions. The options have a contractual term of five to ten years and generally vest over a three- to five-year period.

We use the Black-Scholes option pricing model to determine the fair value of options awards. The Black-Scholes option pricing model has various inputs such as the common share price on the date of grant, exercise price, the risk-free interest rate, volatility, expected life and dividend yield, all of which are estimates. We used the risk free rate on U.S. Treasury securities at the time of grant for instruments with maturities commensurate with the expected term of the stock option. Starting in 2020, our volatility estimate was based on the weighted average historical volatility of our stock price since IPO. Prior to 2020, our volatility estimate was based on the weighted average historical volatility of our stock price and the stock price from a set of peer companies, since our shares did not have sufficient trading history. We consider factors such as stage of life cycle, competitors, size, market capitalization and financial leverage in the selection of similar entities. Our dividend yield was assumed to be 0%, because we have no plans to pay dividends. We estimate the expected term of options with consideration of vesting date, contractual term, and historical experience for employee exercise and post-vesting employment termination behavior after our common stock has been publicly traded. The expected term of “plain vanilla” options is estimated based on the midpoint between the vesting date and the end of the contractual term under the simplified method.

The fair value of each share-based compensation award is amortized into compensation expense on a straight-line basis between the grant date for the option and the vesting date net of expected forfeitures. We estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual numbers differ from such estimates. The change of any of these inputs could significantly impact the determination of the fair value of our options as well as significantly impact our results of operations.

Recent Accounting Pronouncements

There have been no recent accounting pronouncements or changes in accounting pronouncements during the year ended December 31, 2021 that could have a material impact on our balance sheets or statement of operations.

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Non-GAAP Financial Measures

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We report our financial results in accordance with accounting principles generally accepted in the United States, or GAAP.

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Off-Balance Sheet Arrangements

We do not have any relationships or financial partnerships with unconsolidated entities, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. In addition, we do not engage in trading activities involving non-exchange traded contracts.

Government Regulation

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Our products and facilities are subject to regulation by a number of federal and state governmental agencies. The FDA in particular, maintains oversight of the formulation, manufacture, distribution, packaging, and labeling of all of our products. The Drug Enforcement Administration, or DEA, maintains oversight over our products that are considered controlled substances.

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From June 14 through June 22, 2021, our Amphastar facility in Rancho Cucamonga, California was subject to a pre-approval inspection by the FDA. The inspection included a review of our corrective actions taken from the previous cGMP inspection in February 2019, as well as review of data to support our pending applications. The inspections resulted in multiple observations on Form 483. We fully responded to those observations on July 14, 2021. We believe that our responses to the observations will satisfy the requirements of the FDA and that no significant further actions will be necessary.

From July 12 through July 16, 2021, our IMS facility in South El Monte, California was subject to a post-approval inspection by the FDA. The inspection included a review progress and updates since the October 2019 pre-approval inspection. The inspection resulted in no Form 483 findings. No further actions will be necessary.

From July 12 through July 14, 2021, our Armstrong facility in Canton, Massachusetts was subject to a routine inspection by the FDA. The inspection included a review of compliance with FDA regulations relating to Good Manufacturing Practices. The inspection resulted in no Form 483 findings. No further actions will be necessary.

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