| 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, 2015 and 2016.
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, 2015 and the notes thereto, which are included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2015.
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, revenues and expenses, other comprehensive income and the related disclosures. On an ongoing basis, management evaluates its estimates, including estimates related to sales of its approved product, 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, product revenue, license, collaboration, and other revenue, and valuation of convertible notes, inventory and intangible assets. 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
Level 2 inputs
Level 3 inputs
The following table presents information about the Company’s financial assets and liabilities that have been measured at fair value as of December 31, 2015 and September 30, 2016 and indicates the fair value hierarchy of the valuation inputs utilized to determine such fair value (in thousands):
December 31, 2015
Description
Balance Sheet Classification
Total
Level 1
Level 2
Level 3
Assets:
Money market funds
Cash and cash equivalents
$
$
$
—
$
—
Total assets
$
$
$
—
$
—
September 30, 2016
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, 2016, the carrying value of the Convertible Notes, net of unamortized discount and debt issuance costs, was $129.0 million and the estimated fair value of the principal amount was $588.7 million. The Convertible Notes are discussed in more detail in Note 5, “Convertible Notes.”
Revenue Recognition
Product Revenue
Revenues from product sales are recognized when persuasive evidence of an arrangement exists, delivery has occurred and title to the product and associated risk of loss has passed to the customer, the price is fixed or determinable, collection from the customer has been reasonably assured, all performance obligations have been met, and returns and allowances can be reasonably estimated. Product revenues are recorded net of estimated rebates, chargebacks, discounts, co-pay assistance and other deductions as well as estimated product returns.
VARUBI is currently distributed in the U.S. principally through a limited number of specialty distributors and to a lesser extent though the specialty pharmacy channel, or collectively, Customers. Customers subsequently resell VARUBI to health care providers and patients.
In addition to distribution agreements with Customers, the Company has entered into arrangements with many health care providers and payers that provide for government-mandated and/or privately-negotiated rebates, chargebacks and discounts with respect to the purchase of VARUBI.
The Company has determined that it does not yet meet the criteria for the recognition of revenue for shipments of VARUBI at the time of shipment to its specialty pharmacy and specialty distributor customers. For shipments of VARUBI from specialty distributors and from specialty pharmacies to providers and patients through September 30, 2016, allowances for rebates, chargebacks, discounts, co-pay assistance and other deductions are known or are estimable because they are based on the actual invoice information, claims data, or other market information and analyses. As a result, the Company has concluded that it can recognize revenue related to such shipments. For units that remained in distribution channel inventories as of September 30, 2016, the Company continues to conclude that it cannot yet reasonably make certain estimates necessary to recognize revenue on such shipments.
During the three and nine months ended September 30, 2016, the Company recognized $2.8 million and $4.4 million in net product revenues, respectively, related to VARUBI sales. No net product revenue was recorded for the three and nine months ended September 30, 2015.
Payments received from Customers in advance of recognition of revenue are recorded as deferred revenue, net of payments made to Customers, providers and payers, on the condensed consolidated balance sheets. The related deferred revenue balance (current) as of September 30, 2016 was $0.4 million. No such amounts were recorded as of December 31, 2015.
License, Collaboration and Other Revenue
Revenues from license arrangements are recognized when persuasive evidence of an arrangement exists, delivery of goods or services has occurred including title to the product and associated risk of loss has passed to the customer, the price is fixed or determinable, collection from the customer has been reasonably assured, all performance obligations have been met, and any associated reductions of revenue can be reasonably estimated. The Company 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
·
delivery or performance of the undelivered item(s) is considered probable and substantially in the control of the Company, and the arrangement includes a general right of return relative to the delivered item(s).
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. The consideration that is fixed or determinable is allocated to the separate units of accounting based on the relative selling prices of each deliverable. The consideration allocated to each unit of accounting is recognized as the related goods and services are delivered. The amount allocable to the delivered units of accounting is limited to the amount that is not contingent upon the delivery of additional items or meeting other specified performance conditions.
The Company determines the selling price on the basis of vendor-specific objective evidence, or VSOE, third party evidence, or best estimate of selling price. VSOE is the price charged for a deliverable when it is sold separately. Third party evidence is the price that the Company or vendors charge for a similar deliverable when sold separately. Best estimate is the price at which the Company would sell the deliverable if the deliverable were sold by the Company regularly on a stand-alone basis.
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 timing of the delivery of 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. Nonsubstantive milestone payments that are paid based on the passage of time or as a result of the licensee’s performance are allocated to the units of accounting within the arrangement and recognized as revenue when those deliverables are satisfied. 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.
Commercial milestone and royalty payments received under license agreements will be recognized as license revenue when they are earned.
In July 2015, the Company entered into a license agreement with J iangsu Hengrui Medicine Co., Ltd., or Hengrui, pursuant to which Hengrui has licensed 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 and $0.4 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, 2016, respectively, and recorded $0.4 million as deferred revenue as of September 30, 2016. 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 Hengrui. 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.
In April 2016, the Company entered into a collaboration and license agreement with Janssen Biotech, Inc., or Janssen, under which the Company granted Janssen licenses under certain patent rights and know-how relating to niraparib, for prostate cancer worldwide. See Note 11, “License and Collaboration Arrangements”, for further discussion.
In September 2016, the Company entered into a collaboration, development and license agreement with Zai Lab (Shanghai) Co., Ltd., or Zai Lab, under which the Company granted Zai Lab an exclusive license to develop and commercialize niraparib in China, including Hong Kong and Macao. In addition, the agreement provides the Company with certain negotiation rights with respect to two immuno-oncology assets being developed by Zai Lab, and in return for certain consideration, an option for the Company to co-market niraparib in greater China with Zai Lab. See Note 11, “License and Collaboration Arrangements”, for further discussion.
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, preclinical, discovery and other research 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 condensed consolidated balance sheets as prepaid or accrued research and development expenses. Certain clinical development costs incurred by the Company with respect to its niraparib program are reimbursed as part of a collaborative research agreement with Merck. Cost-sharing amounts received by the Company are recorded as a reduction to 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 pre-commercial milestone payments, are immediately expensed as acquired in-process research and development in the period in which they are incurred, provided that the new drug compound 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. Milestone payments made to third parties subsequent to regulatory approval are capitalized as intangible assets and amortized over the estimated remaining useful life of the related product. Royalties owed on sales of the products licensed pursuant to the agreements are expensed in the period the related revenues are recognized.
Intangible Assets
The Company maintains definite-lived intangible assets related to certain capitalized milestones. These assets are amortized on a straight-line basis over their remaining useful lives, which are estimated to be the remaining patent life. If the Company’s estimate of the product’s useful life is shorter than the remaining patent life, then the shorter period is used. Amortization expense is recorded as a component of cost of sales in the consolidated statements of operations.
The Company assesses its intangible assets for impairment if indicators are present or changes in circumstance suggest that impairment may exist. Events that could result in an impairment, or trigger an interim impairment assessment, include the receipt of additional clinical or nonclinical data regarding one of the Company’s drug candidates or a potentially competitive drug candidate, changes in the clinical development program for a drug candidate or new information regarding potential sales for the drug. If impairment indicators are present or changes in circumstance suggest that impairment may exist, the Company performs a recoverability test by comparing the sum of the estimated undiscounted cash flows of each intangible asset to its carrying value on the consolidated balance sheet. If the undiscounted cash flows used in the recoverability test are less than the carrying value, the Company would determine the fair value of the intangible asset and recognize an impairment loss if the carrying value of the intangible asset exceeds its fair value.
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 closing market price of the Company’s common stock on that date. The value of the award is recognized as expense on a straight-line basis over the requisite service period and is adjusted for pre-vesting forfeitures in the period in which the forfeitures occur. For stock awards that have a performance condition, the Company recognizes compensation expense based on its assessment of the probability that the performance condition will be achieved, using an accelerated attribution model, over the explicit or implicit service period.
Inventory
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 sales. The determination of whether inventory costs will be realizable requires estimates by management. If actual market conditions are less favorable than projected by management, additional write-downs of inventory may be required, which would be recorded as a cost of product sales in the consolidated statements of operations.
New Accounting Pronouncements - Recently Adopted
In June 2014, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or 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 Accounting Standards Codification, or ASC, or 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 adopted this ASU on January 1, 2016, and the adoption of this guidance did not have an impact on the Company’s consolidated financial statements.
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 No. 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 adopted this ASU prospectively on January 1, 2016 and the adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.
In March 2016, the FASB issued ASU No. 2016-09, which simplifies various aspects of accounting for share-based payments to employees. Key provisions of the new standard include requiring excess tax benefits and shortfalls to be recorded as income tax benefit or expense in the income statement, rather than in equity, and permitting an election to record the impact of pre-vesting forfeitures as they occur. The new guidance is effective for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years, with early adoption permitted. The Company elected to early adopt ASU No. 2016-09 during the quarter ended June 30, 2016, retroactive to January 1, 2016.
Impact of Adoption
As a result of adopting ASU No. 2016-09 during 2016, the Company adjusted retained earnings for the impact of its accounting policy election to recognize share-based award forfeitures only as they occur rather than by applying an estimated forfeiture rate as previously required. ASU No. 2016-09 requires that this change be applied using a modified-retrospective transition method by means of a cumulative-effect adjustment to retained earnings as of the beginning of the fiscal year in which the guidance is adopted. The following table summarizes the impact to the Company’s condensed consolidated balance sheet, including the amount charged to retained earnings as of January 1, 2016 (in thousands):
Balance Sheet Classification
Amount
Increase to additional paid-in capital resulting from the Company's election to recognize forfeitures as they occur rather than applying an estimated forfeiture rate
Additional paid-in capital
$ 1,278
Charge to accumulated deficit for cumulative-effect adjustment from adoption of ASU No. 2016-09
Accumulated deficit
$ 1,278
In addition, the Company’s stock-based compensation expense for the three months ended March 31, 2016 and additional-paid in capital as of March 31, 2016 have also been revised to reflect the adoption of ASU No. 2016-09, resulting in increases of approximately $0.2 million to both additional paid-in capital and accumulated deficit, compared to the amounts originally reported.
New Accounting Pronouncements - Recently Issued
In May 2014, the FASB issued ASU No. 2014-09, which amends the guidance for accounting for revenue from contracts with customers. This ASU supersedes the revenue recognition requirements in 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. In August 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. In 2016, the FASB has issued three additional ASUs related to Topic 606: ASU Nos. 2016-08, 2016-10, and 2016-12. These ASUs clarify various aspects of the new revenue guidance, including principal versus agent considerations, identifying performance obligations, and licensing, and include other improvements and practical expedients. The Company plans to early adopt the requirements of this new standard in the first quarter of 2017, using the full retrospective transition method. The Company has not yet completed its assessment of the impact of the adoption of this standard on its consolidated financial statements, but expects that the adoption will at least impact the amount and timing of certain revenues recognized through the periods prior to adoption, and the impact may be material to certain periods.
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 has not yet adopted this standard; however, i f this standard had been adopted as of September 30, 2016, the Company believes that it would have concluded there was not substantial doubt about its ability to continue as a going concern.
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 is currently in the process of evaluating the impact that the adoption of this guidance will have on its consolidated financial statements and related disclosures.
In February 2016, the FASB issued ASU No. 2016-02, a comprehensive new lease accounting standard, which provides revised guidance on accounting for lease arrangements by both lessors and lessees and requires lessees to recognize a lease liability and a right-of-use asset for most leases. The new guidance is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years, with early adoption permitted. The new standard must be applied using a modified retrospective transition method which requires application of the new guidance for all periods presented. The Company is currently in the process of evaluating the impact that the adoption of this guidance will have on its consolidated financial statements and related disclosures.
In August 2016, the FASB issued ASU No. 2016-15, which is intended to simplify and clarify how certain transactions are classified in the statement of cash flows, and to reduce diversity in practice for such transactions. This ASU addresses eight specific issues regarding classification of cash flows. The standard is effective for financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. Early adoption is permitted, provided that all of the amendments are adopted in the same period. The guidance requires application using a retrospective transition method. The Company believes that the adoption of this guidance will not have a significant impact on its consolidated financial statements and related disclosures. |
