| Summary of Significant Accounting Policies | 2. Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiary, Osiris Therapeutics International GmbH, which was formed in 2016. All intercompany transactions have been eliminated in consolidation. Osiris Therapeutics International GmbH does not have any operations.
Use of Estimates
We make certain estimates and assumptions in preparing our consolidated financial statements in accordance with generally accepted accounting principles in the United States ("GAAP"). These estimates and assumptions affect the reported amount of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statement and the reported amounts of revenue and expenses for the period presented. Actual results may differ from these estimates.
Cash and Cash Equivalents
Cash and cash equivalents includes all financial instruments purchased with an initial maturity of three months or less when purchased.
Investments
All of the Company's investments are classified as "available-for-sale" and are carried at fair value, with the exception of the Mesoblast Limited common stock, which was classified as a trading security (see Note 4). Securities which have been classified as Level 1 are measured using quoted market prices in active markets for identical assets or liabilities while those which have been classified as Level 2 are measured using quoted prices for identical assets and liabilities in markets that are not active (see Note 4). The Company's policy is to classify all investments with contractual maturities within one year as current. Investment income is recognized when earned and reported net of investment expenses. Net unrealized holding gains or losses are excluded from earnings and are reported as "Accumulated other comprehensive income (loss)" in the accompanying consolidated balance sheets and consolidated statements of comprehensive income (loss) until realized, unless the losses are deemed to be other-than-temporary. Realized gains or losses, including any provision for other-than-temporary declines in value, are included in "Other income (expense)" in the accompanying consolidated statements of comprehensive income (loss).
If a debt security is in an unrealized loss position and the Company has the intent to sell the debt security, or it is more likely than not that the Company will have to sell the debt security before recovery of its amortized cost basis, the decline in value is deemed to be other-than-temporary and is recorded to other-than-temporary impairment losses recognized in income in the consolidated statements of comprehensive income (loss). For impaired debt securities that the Company does not intend to sell or it is more likely than not that the Company will not have to sell such securities, but the Company expects that it will not fully recover the amortized cost basis, the credit component of the other-than-temporary impairment is recognized in other-than-temporary impairment losses recognized in income in the consolidated statements of comprehensive income (loss) and the non-credit component of the other-than-temporary impairment is recognized in other comprehensive income (loss).
The credit component of an other-than-temporary impairment is determined by comparing the net present value of projected future cash flows with the amortized cost basis of the debt security. The net present value is calculated by discounting the best estimate of projected future cash flows at the effective interest rate implicit in the debt security at the date of acquisition. Cash flow estimates are driven by assumptions regarding probability of default, including changes in credit ratings, and estimates regarding timing and amount of recoveries associated with a default. Furthermore, unrealized losses entirely caused by non-credit related factors related to debt securities for which the Company expects to fully recover the amortized cost basis continue to be recognized in accumulated other comprehensive income (loss).
As of December 31, 2015, 2016 and 2017, there were no unrealized losses that the Company believed to be other-than-temporary.
Trade Receivables, net
Trade receivables, net are reported net of an allowance for doubtful accounts. We consider receivables outstanding longer than the time specified in the respective customer's contract to be past due. In making the determination of the appropriate allowance for doubtful accounts, management considers prior experience with customers, analysis of accounts receivable aging reports, changes in customer payment patterns, and historical write-offs.
Inventory, net
Inventory, net consists of raw materials, products in process, finished goods available for sale and products held by customers under consignment sales arrangements. We determine our inventory values using the first-in, first-out method. The Company periodically reviews its quantities of inventories on hand and compares these amounts to the expected usage of each particular product. The Company records as a charge to Cost of revenue any amounts required to reduce the carrying value of inventories to net realizable value. Inventory excludes units that we anticipate distributing for clinical evaluation.
Property and Equipment, net
Property and equipment, net are valued at cost less accumulated depreciation. Depreciation is recognized on a straight-line basis over the estimated useful lives of the related assets and is allocated between cost of sales and selling, general and administrative expenses. Maintenance and repairs, which do not improve or extend the life of the respective assets, are charged to expense as incurred. Assets recorded under capital leases are included in property and equipment and are amortized using the straight-line method over the shorter of the estimated useful lives of the assets or the lease term and is recorded in depreciation expense in the consolidated statements of comprehensive income (loss).
We review long-lived assets, which consist solely of property and equipment, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset or group of assets may not be fully recoverable based on the criteria for accounting for the impairment or disposal of long-lived assets under Accounting Standard Code ("ASC") Topic 360, Property, Plant and Equipment . These events or changes in circumstances may include a significant deterioration of operating results, changes in business plans, or changes in anticipated future cash flows. If an impairment indicator is present, we evaluate recoverability by a comparison of the carrying amount of the assets group to future undiscounted net cash flows expected to be generated by the assets group. Assets are grouped at the lowest level for which there is identifiable cash flows that are largely independent of the cash flows generated by other asset groups. If the total of the expected undiscounted future cash flows is less than the carrying amount of the asset, an impairment loss is recognized for the difference between the fair value and carrying value of assets within the group. Fair value is generally determined by estimates of discounted cash flows. The discount rate used in any estimate of discounted cash flows would be the rate required for a similar investment of like risk. There were no impairment losses recognized during the years ended December 31, 2017, 2016 or 2015.
Accrued liabilities
As of December 31, 2017, 2016 and 2015, accrued liabilities consisted of:
December 31,
(in $000's)
2017
2016
2015
Payroll and related
$
$
$
Commissions
Accounting and audit fees
Lease liabilities
SEC action(1)
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Other
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Total
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(1)
Included as a long-term liability as of December 31, 2015. (See Note 13).
Revenue Recognition
We recognize revenue from sales of our products when title and the risk of loss pass to the customer, persuasive evidence of an arrangement exists, sales amounts are fixed or determinable and collectability is reasonably assured. In situations where collection of receivables is not reasonably assured, we recognize revenue upon the receipt of cash.
Our policy is to recognize revenue when title to the product, ownership and risk of loss transfer to the customer, which is either the date of receipt by the customer or when we receive appropriate notification that the product has been used or implanted. A provision for estimated returns, discounts, rebates and other incentives is recorded as a reduction of revenues in the same period that the revenue is recognized.
We sell our products through our internal direct sales force and our distributor network. Our distributors typically act as our selling agents, selling our products to end-use (clinical provider) customers in exchange for earning sales commissions and administrative support fees. Revenue from sales to distributors who act as agents to Osiris is recorded at the sales price to the end-use customer, and the commission expense and administrative support fees paid to the distributor are recorded as sales and marketing expenses.
At times, we enter into revenue arrangements that include multiple elements, including exclusivity provisions, participation in joint steering committees, as well as sales of our products and provisioning of various other services. We evaluate each deliverable to determine whether it represents a separate unit of accounting based on the following criteria: (i) if the delivered item has value to the customer on a standalone basis, and (ii) if the contract includes a general right of return relative to the delivered item, and delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the vendor. Revenue is then allocated to the units of accounting based on an estimate of each unit's relative selling price and is recognized based on the underlying characteristics of each element.
In December 2014, we entered into exclusive distribution agreements with a subsidiary of Stryker Corporation for the marketing and distribution of BIO 4 , previously branded by the Company as OvationOS, our viable bone matrix allograft. Pursuant to the agreement, Stryker has been granted worldwide distribution rights to the product and any improvements, for all surgical applications. We are responsible for supply, manufacturing, inventory management, shipments to customers, continued research and product improvement activities. We maintain all inventory and collection risk and we control the product. We recognize revenue as principal in the arrangement, for the amounts charged to end-use customers for the allografts. Commissions and administrative support fees paid to Stryker are accounted for as selling expenses, as Stryker is acting as an outside sales and marketing agent for the Company. We received an up-front payment of $5.0 million from Stryker in 2015, related to its initial exclusivity, and are entitled to additional fees upon any exercise by Stryker of its right to extend the initial term, whether on an exclusive or non-exclusive basis. The exclusivity fee is recognized as a reduction of commission expense over the four-year term of the agreement. At December 31, 2017, 2016 and 2015, we had remaining balances of $1.4 million, $2.5 million, and $3.8 million, respectively, related to the exclusivity payment of which $1.25 million was classified as other current liabilities in the consolidated balance sheets at the end of each year. The long-term portion of the exclusivity payment is included in other long-term liabilities in the consolidated balance sheets at the end of each year.
In October 2014, we entered into an exclusive marketing and sales representative agreement for our cartilage product, Cartiform, with Arthrex. The agreement provides Arthrex with exclusive commercial distribution rights to Cartiform beginning in 2015. We are responsible for manufacturing, continued research and product improvement activities. Pursuant to the agreement, Arthrex is entitled to a certain commission on Cartiform sales. We maintain all inventory and collection risk. We recognize revenue as principal in the agreement, for the amounts charged to end-use customers for the allografts. We account for the commission payment to Arthrex as sales and marketing expense, as Arthrex is acting as outside sales and marketing agent for the Company.
Research and Development Costs
R&D expenditures are charged to expense as incurred. R&D expenses include the costs of certain personnel, preclinical studies, clinical trials, regulatory affairs, biostatistical data analysis, and manufacturing costs for development of drug materials for use in clinical trials. We accrue R&D expenses for activity as incurred during the fiscal year and prior to receiving invoices from clinical sites and third party clinical research organizations.
Share-Based Compensation
We account for share-based employee compensation under the fair value recognition and measurement provisions in accordance with applicable accounting standards, which require all share-based payments to employees, including grants of stock options, to be measured based on the grant date fair value of the awards, with the resulting expense generally recognized on an accelerated basis over the period during which the employee is required to perform service in exchange for the award.
Income Taxes
We use the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that such tax rate changes are enacted. The measurement of a deferred tax asset is reduced, if necessary, by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized.
We use a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. We recognize interest and penalties accrued on any unrecognized tax exposures as a component of income tax expense.
On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (the "Tax Act") was enacted into law and the new legislation contains certain key tax provisions that affected the Company, including a reduction of the corporate income tax rate to 21% effective January 1, 2018, the repeal of Alternative Minimum Tax ("AMT") (and changes to the utilization of AMT credit carryforwards that exist at December 31, 2017), among others. We are required to recognize the effect of the tax law changes in the period of enactment, such as re-measuring our U.S. deferred tax assets and liabilities as well as reassessing the net realizability of our deferred tax assets and liabilities. In December 2017, the Securities and Exchange Commission (the "SEC") issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118), which allows us to record provisional amounts during a measurement period not to extend beyond one year of the enactment date. Since the Tax Act was passed late in the fourth quarter of 2017, and ongoing guidance and accounting interpretation is expected over the next 12 months, we consider the deferred tax re-measurements and other items to be incomplete due to the forthcoming guidance and our ongoing analysis of final year-end data and tax positions. We expect to complete our analysis within the measurement period in accordance with SEC Staff Accounting Bulletin No. 118, although we do not expect there to be any adjustment to the income tax expense on our statements of operations during the measurement period. See Note 12 for additional information.
Concentration of Risk
We maintain cash with high credit quality financial institutions and do not believe we are exposed to a significant credit risk, although such balances exceed federally insured limits. We also invest excess cash in investment-grade securities, generally with average maturities of approximately two years.
Accounting Pronouncements Adopted
In August 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-15, " Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern" ("ASU 2014-15"), that requires management to evaluate whether there are conditions and events that raise substantial doubt about the Company's ability to continue as a going concern within one year after the financial statements are issued or available to be issued on both an interim and annual basis. Management is required to provide certain footnote disclosures if it concludes that substantial doubt exists or when its plans alleviate substantial doubt about the Company's ability to continue as a going concern. ASU 2014-15 was effective for all entities for the annual period ending after December 15, 2016, and for annual and interim periods thereafter, with early adoption permitted. We adopted ASU 2014-15 as of the annual period ended December 31, 2016, and its adoption did not have any significant impact on our consolidated financial statements.
In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330), Simplifying the Measurement of Inventory . This standard replaces the lower of cost or market test with a lower of cost or net realizable value test when cost is determined on a first-in, first-out or average cost basis. We adopted this standard in the first quarter of 2017 on a prospective basis. The adoption of this standard did not have a material impact on our consolidated financial statements.
In November 2015, the FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes . The new guidance requires that all deferred taxes be presented as noncurrent, rather than separated into current and noncurrent amounts. We adopted this guidance in the first quarter of fiscal year 2015 on a prospective basis. The adoption of this standard did not have a material impact on our financial position.
In March 2016, the FASB issued ASU 2016-09, " Compensation—Stock Compensation Topic 718: Improvements to Employee Share-Based Payment Accounting" , which is intended to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. We adopted this guidance as of January 1, 2017. From January 1, 2017 onward, in accordance with the new guidance, no excess tax benefits or tax deficiencies will be recognized in additional paid in capital. We presented the impact of classifying excess tax benefits as an operating activity in the consolidated statement of cash flows beginning in 2017 and prior periods were not adjusted. We will continue to estimate forfeitures and recognize expense, net of estimated forfeitures. The adoption of the remaining amendments did not have a material impact on our consolidated financial statements.
Accounting Pronouncements Not Yet Adopted
In May 2014, the FASB issued ASU No. 2014-09, " Revenue from Contracts with Customers (Topic 606)". The ASU outlines a single set of comprehensive principles for recognizing revenue under U.S. GAAP and supersedes existing revenue recognition guidance. The main principle of the ASU is that revenue should be recognized to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The Company will apply the ASU and its related updates on a modified retrospective basis as of January 1, 2018. The Company has completed a comprehensive assessment of customer contracts and evaluated the effect the ASU will have on the Company's financial statements and related disclosures. The Company has concluded that the adoption of the ASU will not have a material impact on the consolidated financial statements. As such, no cumulative catch-up adjustment will be recorded. The primary impact of adoption will be expanded disclosures that will enable users to better understand the nature, amount, timing, and uncertainty of revenues and cash flows arising from contracts with customers. Additionally, the Company has made appropriate revisions to its accounting policies, procedures, and the design of our internal controls, which took effect starting January 1, 2018, to comply with the effective date of the standard.
In January 2016, the FASB issued ASU 2016-01, " Financial Instruments—Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities, " which requires various changes to the measurement and disclosure of equity investments. Among a number of changes, ASU 2016-01 will eliminate the available-for-sale classification for equity securities with readily determinable fair values, and any changes in fair value of those equity securities will be included as an adjustment to earnings, rather than other comprehensive income (loss). The ASU will be adopted by the Company in the first quarter of 2018. As the Company does not hold any equity securities at December 31, 2017, the ASU will not have any impact upon adoption.
In February 2016, the FASB issued ASU No. 2016-02, " Leases (Topic 842)". The ASU requires, among other things, a lessee to recognize assets and liabilities associated with the rights and obligations attributable to most leases but also recognize expenses similar to current lease accounting. The ASU also requires certain qualitative and quantitative disclosures designed to assess the amount, timing and uncertainty of cash flows arising from leases, along with additional key information about leasing arrangements. The guidance is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. The new guidance must be adopted using a modified retrospective transition and provides for certain practical expedients. The Company is in the process of analyzing initial data gathered to evaluate the impact of adopting the ASU on its consolidated financial statements, the related systems required to capture the increased reporting and disclosures associated with the ASU, and its use of practical expedients. The Company will apply the ASU and its related updates on a modified retrospective basis as of January 1, 2019. The adoption of the guidance will likely have a material effect on the consolidated balance sheets, resulting in the recording of an operating lease asset and liability.
In June 2016, the FASB issued ASU 2016-13, " Financial Instruments—Credit Losses Topic 326" . The guidance eliminates the probable initial recognition threshold that was previously required prior to recognizing a credit loss on financial instruments. The credit loss estimate can now reflect an entity's current estimate of all future expected credit losses. Under the previous guidance, an entity only considered past events and current conditions. The guidance is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The adoption of certain amendments of this guidance must be applied on a modified retrospective basis and the adoption of the remaining amendments must be applied on a prospective basis. We currently expect that the adoption of this guidance will likely change the way we assess the collectability of our receivables and recoverability of other financial instruments. We have not yet begun to evaluate the specific impacts of this guidance nor have we determined the manner in which we will adopt this guidance.
In August 2016, the FASB issued ASU No. 2016-15, "Statement of Cash Flows (Topic 203)" . The ASU addresses eight specific cash flow issues and clarifies their presentation and classification in the statement of cash flows. The ASU is effective for fiscal years beginning after December 15, 2017 and is to be applied retrospectively. The Company concluded that the adoption of the ASU will not have a material impact on the consolidated financial statements and will apply the ASU and its related updates beginning in the first quarter of 2018. |
