Basis of Presentation and Significant Accounting Policies | 2. Basis of Presentation and Significant Accounting Policies Basis of Presentation The accompanying condensed consolidated financial statements are unaudited and have been prepared by TESARO in conformity with accounting principles generally accepted in the United States of America, or GAAP. The Company’s condensed consolidated financial statements reflect the operations of the Company and its wholly-owned subsidiaries . All significant intercompany balances and transactions have been eliminated in consolidation. The Company currently operates in one business segment, which is the identification, acquisition, development and commercialization of oncology therapeutics and supportive care product candidates, and has a single reporting and operating unit structure. Certain information and footnote disclosures normally included in the Company’s annual financial statements have been condensed or omitted. These interim financial statements, in the opinion of management, reflect all normal recurring adjustments necessary for a fair presentation of the Company’s financial position and results of operations for the interim periods ended September 30, 2014 and 2015. The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full fiscal year. These interim financial statements should be read in conjunction with the audited financial statements as of and for the year ended December 31, 2014 and the notes thereto, which are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014. Use of Estimates The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make certain estimates and assumptions that affect the reported amounts of assets, liabilities and expenses, other comprehensive income and the related disclosures. On an ongoing basis, management evaluates its estimates, including estimates related to accrued clinical trial and manufacturing development expenses, which form part of the Company’s research and development expenses, and stock-based compensation expense. Significant estimates in these condensed consolidated financial statements include estimates made in connection with accrued research and development expenses, stock-based compensation expense and valuation of convertible notes. The Company bases its estimates on historical experience, known trends and other market-specific or other relevant factors that it believes to be reasonable under the circumstances. Actual results may differ from those estimates or assumptions. Cash and Cash Equivalents The Company considers all highly-liquid investments with original or remaining maturity from the date of purchase of three months or less to be cash equivalents. Cash and cash equivalents include bank demand deposits and money market funds that invest primarily in certificates of deposit, commercial paper and U.S. government and U.S. government agency obligations. Cash equivalents are reported at fair value. Fair Value of Financial Instruments The Company is required to disclose information on all assets and liabilities reported at fair value that enables an assessment of the inputs used in determining the reported fair values. The fair value hierarchy prioritizes valuation inputs based on the observable nature of those inputs. The fair value hierarchy applies only to the valuation inputs used in determining the reported fair value of the investments and is not a measure of investment credit quality. The hierarchy defines three levels of valuation inputs: Level 1 inputs Quoted prices in active markets for identical assets or liabilities Level 2 inputs Observable inputs other than Level 1 inputs, including quoted prices in active markets for similar assets or liabilities and quoted prices for identical assets or liabilities in markets that are not active Level 3 inputs Unobservable inputs that reflect the Company’s own assumptions about the assumptions market participants would use in pricing the asset or liability The following table presents information about the Company’s financial assets and liabilities that have been measured at fair value as of December 31, 2014 and September 30, 2015 and indicates the fair value hierarchy of the valuation inputs utilized to determine such fair value (in thousands): December 31, 2014 Description Balance Sheet Classification Total Level 1 Level 2 Level 3 Assets: Money market funds Cash and cash equivalents $ $ $ — $ — Total assets $ $ $ — $ — September 30, 2015 Description Balance Sheet Classification Total Level 1 Level 2 Level 3 Assets: Money market funds Cash and cash equivalents $ $ $ — $ — Total assets $ $ $ — $ — The carrying amounts of accounts payable and accrued expenses approximate their fair values due to their short-term maturities. In September 2014, the Company issued $201.3 million aggregate principal amount of 3.00% convertible senior notes due October 1, 2021, or the Convertible Notes. Interest is payable semi-annually in arrears on April 1 and October 1 of each year, beginning on April 1, 2015. As of September 30, 2015, the carrying value of the Convertible Notes, net of unamortized discount, was $121.9 million and the estimated fair value of the Convertible Notes was $273.0 million. The Convertible Notes are discussed in more detail in Note 4, “Convertible Notes . ” Research and Development Expenses Research and development costs are charged to expense as incurred and include: · pre-commercial license fees and milestone payments related to the acquisition of in-licensed product candidates, which are reported on the statements of operations as acquired in-process research and development; · employee-related expenses, including salaries, bonuses, benefits, travel and stock-based compensation expense; · fees and expenses incurred under agreements with contract research organizations, investigative sites, research consortia and other entities in connection with the conduct of clinical trials and preclinical studies and related services, such as data management, laboratory and biostatistics services; · the cost of acquiring, developing and manufacturing active pharmaceutical ingredients for product candidates that have not received regulatory approval, clinical trial materials and other research and development materials; · fees and costs related to regulatory filings and activities; · facilities, depreciation and other expenses, which include direct and allocated expenses for rent, utilities, maintenance of facilities, insurance and other supplies; and · other costs associated with clinical and preclinical activities. Costs for certain development activities, such as clinical trials and manufacturing development activities, are recognized based on an evaluation of the progress to completion of specific tasks using data such as patient enrollment, clinical site activations, or information provided to the Company by its vendors on their actual costs incurred or level of effort expended. Payments for these activities are based on the terms of the individual arrangements, which may differ from the pattern of costs incurred, and are reflected in the consolidated balance sheets as prepaid or accrued research and development expenses. Acquired In-Process Research and Development Expense The Company has acquired the rights to develop and commercialize new product candidates. Up-front payments that relate to the acquisition of a new drug compound, as well as milestone payments, are immediately expensed as acquired in-process research and development in the period in which they are incurred, provided that the acquisition did not also include processes or activities that would constitute a “business,” as defined under GAAP, the drug has not achieved regulatory approval for marketing and, absent obtaining such approval, has no alternative future use. Royalties owed on future sales of the products licensed pursuant to the agreements are expensed in the period the related revenues are recognized. Stock-Based Compensation Expense Stock-based compensation is recognized as expense for each stock-based award based on its estimated fair value. The Company determines the fair value of each stock option award at its grant date using the Black-Scholes option pricing model. The Company determines the fair value of each restricted stock unit at its grant date based on the fair market value of its common stock. The value of the award that is ultimately expected to vest is recognized as expense on a straight-line basis over the requisite service period. The cumulative effect of any changes to the estimated forfeiture rates are accounted for as an adjustment to expense in the period of the change. Inventory Beginning in the third quarter of 2015, the Company began to capitalize inventory costs associated with VARUBI when it was determined that the inventory had a probable future economic benefit. Inventories are stated at the lower of cost or estimated net realizable value, on a first-in, first-out, or FIFO, basis. Prior to the regulatory approval of its product candidates, the Company incurs expenses for the manufacture of drug product that could potentially be available to support the commercial launch of its products. Until the first reporting period when regulatory approval has been received or is otherwise considered probable, the Company records all such costs as research and development expense. The Company periodically analyzes its inventory levels, and writes down inventory that has become obsolete, inventory that has a cost basis in excess of its estimated realizable value and inventory in excess of expected sales requirements as cost of product revenues. Expired inventory would be disposed of and the related costs would be written off as cost of product revenues. License Revenue The Company may enter into arrangements under which it licenses certain rights to its product candidates to third parties. Activities under licensing agreements are evaluated to determine if they represent a multiple element arrangement. The Company identifies the deliverables included within the agreement and evaluates which deliverables represent separate units of accounting. The Company accounts for those components as separate units of accounting if the following two criteria are met: · the delivered item or items have stand-alone value to the customer; and · if the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the Company. Factors considered in this determination include, among other things, whether any other vendors sell the items separately and if the licensee could use the delivered item for its intended purpose without the receipt of the remaining deliverables. When multiple deliverables are combined and accounted for as a single unit of accounting, the Company bases its revenue recognition on the last element to be delivered using the straight-line or proportional performance method depending on the Company’s ability to estimate the performance obligation. Amounts received or recorded as receivable prior to satisfying the associated revenue recognition criteria are recorded as deferred revenue in the condensed consolidated balance sheets. Amounts not expected to be recognized within one year following the balance sheet date are classified as non-current deferred revenue. If a future milestone payment under a license agreement is contingent upon the achievement of a substantive milestone, license revenue is recognized in its entirety in the period in which the milestone is achieved. A milestone is substantive if: · it can only be achieved based in whole or in part on either the Company’s performance or the occurrence of a specific outcome resulting from the Company’s performance; · there is substantive uncertainty at the date an arrangement is entered into that the event will be achieved; and · it would result in additional payments being due to the Company. The commercial milestone payments and royalty payments received under license agreements, if any, will be recognized as license revenue when they are earned. The Company has entered into one license agreement with a third party pursuant to which it has licensed the rights to develop, manufacture and commercialize rolapitant in China, including Hong Kong and Macao. For this arrangement, the Company has determined that there is only one unit of accounting that includes the licensed patents and the licensed know-how, which will be delivered over a period of time. The Company recorded $0.1 million of license revenue related to a $1.0 million up-front payment under this arrangement during the three and nine months ended September 30, 2015, and recorded $0.9 million as deferred revenue as of September 30, 2015. This $1.0 million payment is being recognized as license revenue over the two-year period of performance relating to the Company’s obligations to provide the licensed know-how to the licensee. Under the terms of the agreement, the Company would be entitled to additional payments of up to $2.0 million contingent on the achievement of certain regulatory milestones, as well as royalties on product sales at percentage rates in the low teens. New Accounting Pronouncements - Recently Issued In May 2014, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, No. 2014-09, which amends the guidance for accounting for revenue from contracts with customers. This ASU supersedes the revenue recognition requirements in Accounting Standards Codification, or ASC, Topic 605, Revenue Recognition , and creates a new Topic 606, Revenue from Contracts with Customers . Two adoption methods are permitted: retrospectively to all prior reporting periods presented, with certain practical expedients permitted; or retrospectively with the cumulative effect of initially adopting the ASU recognized at the date of initial application. On August 12, 2015, the FASB issued ASU No. 2015-14, which defers the effective date by one year to December 15, 2017 for annual reporting periods beginning after that date, including interim periods within those periods. The FASB also approved permitting early adoption of the standard, but not before the original effective date of December 15, 2016. The Company has not yet determined which adoption method it will utilize or the effect that the adoption of this guidance will have on its potential future revenue streams and consolidated financial statements. In June 2014, the FASB issued ASU No. 2014-12. The amendments in this ASU apply to reporting entities that grant their employees share-based payments in which the terms of the award provide that a performance target can be achieved after a requisite service period. The amendments require an entity to treat a performance target that affects vesting, and that could be achieved after the requisite service period, as a performance condition. A reporting entity should apply existing guidance in ASC Topic 718 relating to awards with performance conditions that affect vesting to account for such awards. The performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The amendments in this ASU are effective for annual reporting periods and interim periods within those annual reporting periods beginning after December 15, 2015, and early adoption is permitted. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements. In August 2014, the FASB issued ASU No. 2014-15, which is intended to define management’s responsibility to evaluate whether there is substantial doubt about an organization’s ability to continue as a going concern and to provide related footnote disclosures. Substantial doubt about an entity’s ability to continue as a going concern exists when relevant conditions and events, considered in the aggregate, indicate that it is probable that the entity will be unable to meet its obligations as they become due within one year after the date that the financial statements are issued (or are available to be issued). ASU No. 2014-15 provides guidance to an organization’s management, with principles and definitions intended to reduce diversity in the timing and content of disclosures commonly provided by organizations in the footnotes of their financial statements. ASU No. 2014-15 is effective for annual reporting periods ending after December 15, 2016, and for annual and interim periods thereafter. Early adoption is permitted. The Company is currently in the process of evaluating the impact of adoption of this guidance on its consolidated financial statements and related disclosures. In April 2015, the FASB issued ASU No. 2015-03, which amends existing guidance to require the presentation of debt issuance costs in the balance sheet as a deduction from the carrying amount of the related debt liability instead of a deferred charge. ASU No. 2015-03 is effective for annual reporting periods beginning after December 15, 2015, and early adoption is permitted. The amendment must be applied retrospectively such that the balance sheet of each individual period presented is adjusted to reflect the period-specific impact of using the new guidance. Upon transition, a business must adhere to the appropriate disclosures for an adjustment in an accounting principle. Such disclosures include why the change in accounting principle is occurring, the transition method, an explanation of the prior period information that was retrospectively adjusted, and how the change impacts the financial statement line items (i.e., debt issuance cost asset and the debt liability). The Company is currently in the process of evaluating the timing of adoption. If the Company had adopted this guidance as of September 30, 2015, the impact would have been to decrease “Other assets” and “Convertible notes, net” by $3.0 million as of September 30, 2015. In April 2015, the FASB issued ASU No. 2015-05, which provides guidance to customers about whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The guidance will not change GAAP for a customer’s accounting for service contracts. ASU 2015-05 is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2015. Early adoption is permitted. An entity can elect to adopt the amendments either (1) prospectively to all arrangements entered into or materially modified after the effective date, or (2) retrospectively. For prospective transition, the only disclosure requirements at transition are the nature of and reason for the change in accounting principle, the transition method, and a qualitative description of the financial statement line items affected by the change. For retrospective transition, the disclosure requirements at transition include the requirements for prospective transition and quantitative information about the effects of the accounting change. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements. In July 2015, the FASB issued ASU No. 2015-11, which amends existing guidance for measurement of inventory. Current inventory guidance requires an entity to measure inventory at the lower of cost or market. Market could be replacement cost, net realizable value, or net realizable value less an approximately normal profit margin. The amendments do not apply to inventory that is measured using last-in, first-out (LIFO) or the retail inventory method. The amendments apply to all other inventory, which includes inventory that is measured using first-in, first-out or average cost. An entity should measure all inventory to which the amendments apply at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Subsequent measurement is unchanged for inventory measured using LIFO or the retail inventory method. The amendments in this ASU more closely align the measurement of inventory in GAAP with the measurement of inventory in International Financial Reporting Standards. The amendments are effective for fiscal years beginning after December 15, 2016, and interim periods within fiscal years beginning after December 15, 2017. The amendments should be applied prospectively with earlier application permitted as of the beginning of an interim or annual reporting period. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements. |