FAIR VALUE

9 Months Ended

Sep. 30, 2020

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs.

•Level 1: Quoted prices in active markets for identical assets or liabilities.

•Level 2: Inputs other than Level 1 that are observable, either directly or indirectly, such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

•Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities.

The following table reflects the Company’s fair value hierarchy for its financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2020 and December 31, 2019 (in thousands):


September 30, 2020	Financial Statement Classification	Level 1		Level 2		Level 3		Total
Assets:
Money market funds	Cash and cash equivalents	$	77	$	—	$	—	$	77
Total		$	77	$	—	$	—	$	77
Liabilities:
Short-term contingent consideration	Contingent consideration, current portion	$	—	$	—	$	6,475	$	6,475
Long-term contingent consideration	Contingent consideration	—		—		35,188		35,188
Total		$	—	$	—	$	41,663	$	41,663


December 31, 2019	Financial Statement Classification	Level 1		Level 2		Level 3		Total
Assets:
Collegium warrants	Investments	$	—	$	9,629	$	—	$	9,629
Total		$	—	$	9,629	$	—	$	9,629
Liabilities:
Contingent consideration	Contingent consideration liability	$	—	$	—	$	168	$	168
Total		$	—	$	—	$	168	$	168

Cash equivalents consisted of money market funds with overnight liquidity and no stated maturities. The Company classified cash equivalents as Level 1, due to their short-term maturity, and measured the fair value based on quoted prices in active markets for identical assets.

Pursuant to the Zyla Merger, the Company assumed a contingent consideration obligation which is measured at fair value. The contingent consideration fair value represents the estimated fair value of the royalty payments (Royalty Consideration) owed by the Company to Iroko. The Company has obligations to make contingent payment consideration for future royalties to Iroko based upon annual INDOCIN product net sales over $20.0 million. The Company recorded the fair value of these contingent liabilities, based on the likelihood of contingent earn-out payments. The earn-out payments are subsequently remeasured to fair value each reporting date. The Company classified the acquisition-related contingent consideration liabilities to be settled in cash as Level 3, due to the lack of relevant observable inputs and market activity. Changes in assumptions described above could have an impact on the payout of contingent consideration. As of September 30, 2020, the balance of assumed contingent consideration from the Zyla Merger was $41.7 million with $6.5 million classified as short-term and $35.2 million classified as long-term Contingent Consideration, respectively, in the Condensed Consolidated Balance Sheet.

The fair value of the contingent consideration at the Zyla Merger date was determined using an option pricing model under the income approach based on estimated INDOCIN product revenues over 10 years, and discounted to present value at a rate of 10.0%. The fair value of the contingent consideration is remeasured each reporting period, with changes in the fair value

resulting from a change in the underlying inputs are recognized in operating expenses until the contingent consideration arrangement is settled. The valuation inputs utilized to estimate the fair value of the contingent consideration as of September 30, 2020 included a weighted average cost of capital of 10.5% and updated projections of future INDOCIN revenues. Changes in the fair value of contingent consideration resulting from the passage of time are recorded within change in fair value of contingent consideration on the Condensed Consolidated Statement of Comprehensive Income, until the contingent consideration is settled.

The fair value of the warrants to purchase Collegium’s common stock was calculated using the Black-Scholes option pricing model. As of the first quarter of 2020, the significant inputs included the fair value of Collegium’s common stock of $16.33, an expected term of 2.61 years and a risk-free rate of 0.27%. The expected term was based on the remaining contractual period of 2.61 years, and the volatility was determined using Collegium’s historical common stock volatility over the expected term.

In May 2020, the Company sold the Collegium warrants for an aggregate purchase price of $6.0 million to Armistice Capital Mater Fund, Ltd. As a result, the Company derecognized the remaining carrying value of $6.5 million of the financial asset and recognized a net loss of approximately $0.5 million, recorded within other gain (loss) on the Condensed Consolidated Statement of Comprehensive Income, in the second quarter of 2020.

The carrying value of the Company’s debt for the period ended September 30, 2020 approximates its fair value. When determining the estimated fair value of the Company’s debt, the Company uses a commonly accepted valuation methodology and market-based risk measurements that are indirectly observable, such as credit risk.

There were no transfers between Level 1, Level 2 or Level 3 of the fair value hierarchy during the three and nine months ended September 30, 2020 and 2019.

- Definition

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

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