REVENUE RECOGNITION

On January 1, 2018, we adopted ASC 606 applying the modified retrospective transition method to all contracts that were not completed as of January 1, 2018. Results for reporting periods beginning after January 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported under the accounting standards in effect for prior periods. We recorded a net increase to opening stockholders' equity of $1.1 million as of January 1, 2018, reflecting the cumulative impact of adopting ASC 606 primarily related to the capitalization of incremental direct costs of obtaining a contract, which consisted of sales commissions related to the CBR Services. There was no impact to revenue for the three months ended March 31, 2018.

Under ASC 606, we recognize revenue when our customer obtains control of promised goods or services in an amount that reflects the consideration which we expect to receive in exchange for those goods or services. To determine revenue recognition for arrangements that we determine are within the scope of ASC 606, we perform the following five steps:

a.Identify the contract(s) with a customer;

b.Identify the performance obligations in the contract;

c.Determine the transaction price;

d.Allocate the transaction price to the performance obligations in the contract; and

e.Recognize revenue when (or as) the performance obligations are satisfied.

We only apply the five-step model to contracts when it is probable that we will collect the consideration we are entitled to in exchange for the goods or services we transfer to the customer. At contract inception, if the contract is determined to be within the scope of ASC 606, we assess the goods or services promised within each contract, determine those that are performance obligations, and assess whether each promised good or service is distinct. We then recognize as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied.

Our major sources of revenue during the reporting periods were: (a) product revenues from Makena and Feraheme; and (b) service revenues associated with the CBR Services. The adoption of ASC 606 did not have an impact on our product or service revenue.

Revenue and Allowances

The following table provides information about disaggregated revenue by products and services (in thousands):



	Three Months Ended March 31,
	2018		2017
Product sales, net
Makena	$	89,983	$	86,455
Feraheme	25,135		25,922
Intrarosa	2,165		—
MuGard	65		140
Total	$	117,348	$	112,517
Service revenues, net	$	28,969	$	26,931

Total gross product sales were offset by product sales allowances and accruals for the three months ended March 31, 2018 and 2017 as follows (in thousands, except for percentages):



	Three Months Ended March 31,
	2018		Percent of gross product sales		2017		Percent of gross product sales
Gross product sales	$	239,870			$	206,724
Provision for product sales allowances and accruals:
Contractual adjustments	86,144		36	%	69,829		34	%
Governmental rebates	36,378		15	%	24,378		12	%
Total	122,522		51	%	94,207		46	%
Product sales, net	$	117,348			$	112,517

The following table summarizes the product revenue allowance and accrual activity for the three months ended March 31, 2018 (in thousands):



	Contractual			Governmental
	Adjustments			Rebates			Total
Balance at December 31, 2017	$	62,164		$	50,598		$	112,762
Provisions related to current period sales	85,308			31,028			116,336
Adjustments related to prior period sales	836			5,350			6,186
Payments/returns relating to current period sales	(44,633		)	—			(44,633		)
Payments/returns relating to prior period sales	(39,441		)	(25,149		)	(64,590		)
Balance at March 31, 2018	$	64,234		$	61,827		$	126,061

The following table provides information about assets and liabilities from contracts with customers (in thousands):



	March 31, 2018		At Adoption
Short-term contract assets (sales commissions)	$	97	$	79
Long-term contract assets (sales commissions)	$	1,700	$	1,400
Short-term contract liabilities (deferred revenue)	$	42,510	$	42,494
Long-term contract liabilities (deferred revenue)	$	27,398	$	24,387

We receive payments from customers based upon contractual billing schedules; accounts receivable are recorded when the right to consideration becomes unconditional. Contract assets include deferred contract acquisition costs, which will be amortized along with the associated revenue. Contract liabilities include payments received in advance of performance under the contract, and are realized with the associated revenue recognized under the contract. We had no asset impairment charges related to contract assets in the three months ended March 31, 2018.

The following table presents changes in the Company’s contract assets and liabilities during the three months ended March 31, 2018 (in thousands):



	Balance at January 1, 2018		Additions		Deductions			Balance at March 31, 2018
Contract assets (sales commissions)	$	1,479	$	340	$	(22	)	$	1,797
Contract liabilities (deferred revenue)	$	66,881	$	21,727	$	(18,700	)	$	69,908

Performance Obligations

At contract inception, we assess the goods and services promised in our contracts with customers and identify a performance obligation for each promise to transfer to the customer a good or service (or bundle of goods or services) that is distinct. To identify the performance obligations, we consider all of the goods or services promised in the contract regardless of whether they are explicitly stated or are implied by customary business practices. We determined that the following distinct goods and services represent separate performance obligations:

•Supply of Makena product

•Supply of Feraheme product

•Supply of Intrarosa product

•CBR collection and processing services

•CBR storage services

Product Revenue

For performance obligations related to products (i.e. Makena, Feraheme and Intrarosa), we principally sell our products to wholesalers, specialty distributors, specialty pharmacies and other customers (collectively, “Customers”), who purchase products directly from us. Our Customers subsequently resell the products to healthcare providers and patients. In addition to distribution agreements with Customers, we enter into arrangements with healthcare providers and payers that provide for government-mandated and/or privately-negotiated rebates, chargebacks and discounts with respect to the purchase of our products.

For the majority of our Customers, we transfer control at the point in time when the goods are delivered. In instances when we perform shipping and handling activities, these are considered fulfillment activities, and accordingly, the costs are accrued when the related revenue is recognized. Taxes collected from Customers and remitted to governmental authorities are excluded from revenues.

Variable Consideration

Under ASC 606, we are required to make estimates of the net sales price, including estimates of variable consideration (such as rebates, chargebacks, discounts, co-pay assistance and other deductions), and recognize the estimated amount as revenue, when we transfer control of the product to our customers. Variable consideration must be determined using either an “expected value” or a “most likely amount” method.

We record product revenues net of certain allowances and accruals in our condensed consolidated statements of operations. Product sales allowances and accruals are primarily comprised of both direct and indirect fees, discounts and rebates and provisions for estimated product returns. Direct fees, discounts and rebates are contractual fees and price adjustments payable to Customers that purchase products directly from us. Indirect fees, discounts and rebates are contractual price adjustments payable to healthcare providers and organizations, such as certain physicians, clinics, hospitals, group purchasing organizations (“GPOs”), and dialysis organizations that typically do not purchase products directly from us but rather from wholesalers and specialty distributors. Consideration payable to a Customer, or other parties that purchase goods from the Customer, are considered to be a reduction of the transaction price, and therefore, of revenue.

Product sales allowances and accruals are based on definitive contractual agreements or legal requirements (such as Medicaid laws and regulations) related to the purchase and/or utilization of the product by these entities and are recorded in the same period that the related revenue is recognized. We use the expected value method for estimating variable consideration. We estimate product sales allowances and accruals using either historical, actual and/or other data, including estimated patient usage, applicable contractual rebate rates, contract performance by the benefit providers, other current contractual and statutory requirements, historical market data based upon experience of our products and other products similar to them, specific known market events and trends such as competitive pricing and new product introductions, current and forecasted Customer buying patterns and inventory levels, and the shelf life of our products. As part of this evaluation, we also review changes to federal and other legislation, changes to rebate contracts, changes in the level of discounts, and changes in product sales trends. Although allowances and accruals are recorded at the time of product sale, rebates are typically paid out in arrears, one to three months after the sale.

The estimate of variable consideration, which is included in the transaction price, may be constrained and is included in the net sales price only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is subsequently resolved in a future period. Estimating variable consideration and the related constraint requires the use of significant management judgment and actual amounts of consideration ultimately received may differ from our estimates. If actual results in the future vary from our estimates, we will adjust these estimates, which would affect net product revenue and earnings in the period such variances become known. No amounts were constrained as of March 31, 2018.

Discounts

We typically offer a 2% prompt payment discount to certain customers as an incentive to remit payment in accordance with the stated terms of the invoice, generally 30 days. Because we anticipate that those customers who are offered this discount will take advantage of the discount, 100% of the prompt payment discount at the time of sale are accrued, based on the gross amount of each invoice. We adjust the accrual quarterly to reflect actual experience.

Chargebacks

Chargeback reserves represent the estimated obligations resulting from the difference between the prices at which we sell our products to wholesalers and the sales price ultimately paid to wholesalers under fixed price contracts by third-party payers, including governmental agencies. The chargeback estimates are determined based on actual product sales data and forecasted customer buying patterns. Actual chargeback amounts are determined at the time of resale to the qualified healthcare provider, and we generally issue credits for such amounts within several weeks of receiving notification from the wholesaler. Estimated chargeback amounts are recorded at the time of sale and adjusted quarterly to reflect actual experience.

Distributor/Wholesaler and Group Purchasing Organization Fees

Fees under the arrangements with distributors and wholesalers are usually based upon units of product purchased during the prior month or quarter and are usually paid by us within several weeks of the receipt of an invoice from the wholesaler or distributor, as the case may be. Fees under the arrangements with GPOs are usually based upon member purchases during the prior quarter and are generally billed by the GPO within 30 days after period end. In accordance with ASC 606, since the consideration given to the Customer is not for a distinct good or service, the consideration is a reduction of the transaction price of the vendor’s products or services. We have included these fees in contractual adjustments in the table above. We generally pay such amounts within several weeks of the receipt of an invoice from the distributor, wholesaler or GPO. Accordingly, we accrue the estimated fee due at the time of sale, based on the contracted price invoiced to the Customer. We adjust the accrual quarterly to reflect actual experience.

Product Returns

Consistent with industry practice, we generally offer wholesalers, specialty distributors and other customers a limited right to return our products based on the product’s expiration date. Currently the expiration dates for Feraheme, Makena and Intrarosa have a range of three to five years. Product returns are estimated based on the historical return patterns and known or expected changes in the marketplace. We track actual returns by individual production lots. Returns on lots eligible for credits under our returned goods policy are monitored and compared with historical return trends and rates. We expect that wholesalers and healthcare providers will not stock significant inventory due to the cost of the product, the expense to store our products, and/or that our products are readily available for distribution. We record an estimate of returns at the time of sale. If necessary, our estimated rate of returns may be adjusted for actual return experience as it becomes available and for known or expected changes in the marketplace. We did not significantly adjust our reserve for product returns during the three months ended March 31, 2018. To date, our product returns have been relatively limited; however, returns experience may change over time. We may be required to make future adjustments to our product returns estimate, which would result in a corresponding change to our net product sales in the period of adjustment and could be significant.

Sales Rebates

We contract with various private payer organizations, primarily pharmacy benefit managers, for the payment of rebates with respect to utilization of our products. We determine our estimates for rebates, if applicable, based on actual product sales data and our historical product claims experience. Rebate amounts generally are invoiced quarterly and are paid in arrears, and we expect to pay such amounts within several weeks of notification by the provider. We regularly assess our reserve balance and the rate at which we accrue for claims against product sales. If we determine in future periods that our actual rebate experience is not indicative of expected claims, if actual claims experience changes, or if other factors affect estimated claims rates, we may be required to adjust our current accumulated reserve estimate, which would affect net product sales in the period of the adjustment and could be significant.

Governmental Rebates

Governmental rebate reserves relate to our reimbursement arrangements with state Medicaid programs. We determine our estimates for Medicaid rebates, if applicable, based on actual product sales data and our historical product claims experience. In estimating these reserves, we provide for a Medicaid rebate associated with both those expected instances where Medicaid will act as the primary insurer as well as in those instances where we expect Medicaid will act as the secondary insurer. Rebate amounts generally are invoiced quarterly and are paid in arrears, and we expect to pay such amounts within several weeks of notification by the Medicaid or provider entity. We regularly assess our Medicaid reserve balance and the rate at which we accrue for claims against product sales. If we determine in future periods that our actual rebate experience is not indicative of expected claims, if actual claims experience changes, or if other factors affect estimated claims rates, we may be required to adjust our current Medicaid accumulated reserve estimate, which would affect net product sales in the period of the adjustment and could be significant.

Other Incentives

Other incentives which we offer include voluntary patient assistance programs, such as co-pay assistance programs, which are intended to provide financial assistance to qualified commercially insured patients with prescription drug co-payments required by payers. The calculation of the accrual for co-pay assistance is based on an estimate of claims and the cost per claim that we expect to receive associated with product that has been recognized as revenue.

Service Revenue

The CBR Services include the collection, processing, and storage of both umbilical cord blood and cord tissue. We market and sell the CBR Services directly to consumers at the prices that are known at contract inception. The discounts offered to the customer are known at the time of enrollment and thereby do not result in variable consideration. CBR Services include the following two performance obligations: collection and processing and storage services, further described below.

Collection and Processing Services

Enrollment services, including the provision of a collection kit and cord blood and cord tissue unit processing, are delivered at the beginning of the relationship. The revenue for this performance obligation is recognized at the point in time after the collection and successful processing of the cord blood and cord tissue.

When purchasing collection and processing services, the customer can (a) pay for the service upfront, when the service is provided; (b) finance the processing fee with us over six or twelve months; or (c) finance the processing fee through a third-party provider, and therefore not finance the arrangement with us. We elected to apply the practical expedient and therefore we have not adjusted the promised consideration for the effects of financing for either the six or twelve month payment plans.

Storage Services

Payment options for storage services of newborn cord blood and cord tissue units include either (a) an annual fee or (b) a prepayment of 18 years or for the lifetime of the newborn donor (the “lifetime option”). The revenue for this performance obligation is recognized ratably over the storage period on a straight-line basis, which is consistent with how the services are provided. For the lifetime option, storage fees are not charged during the lifetime of the newborn donor. However, revenue is recognized based on the average of male and female life expectancies using lifetime actuarial tables published by the Social Security Administration in effect at the time of the newborn’s birth. We determined that the 18 year and lifetime prepayment options do not include a significant financing component as the payment terms were structured primarily for reasons other than for the provision of financing and to maximize profitability.

As of March 31, 2018, the total aggregate transaction price allocated to the unsatisfied performance obligations was recorded as deferred revenue, which will be recognized ratably on a straight-line basis over the contractual period, as described above, of which $42.5 million will be recognized over the next twelve months.

Allocation of Transaction Price

We have selected an adjusted market assessment approach to estimate the stand-alone selling prices of the collection and processing services and storage services and concluded that the published list price is the price that a customer in that market would be willing to pay for those goods or services. We also considered the fact that all customers are charged the list prices current at the time of their enrollment where we have separately stated list prices for processing and storage. The discounts provided to the customers at the time of entering into the contract are allocated proportionally to both performance obligations (i.e. processing and storage).

Cost to Obtain a Contract

We pay commissions to internal sales representatives as compensation for obtaining contract enrollments for the CBR Services. We capitalize commissions that are incremental as a result of obtaining customer contracts and costs incurred to fulfill a customer contract if those costs are not within the scope of another topic within the accounting literature and meet the specified criteria. These costs are deferred in other current or long-term assets and are expensed to selling, general and administrative expenses as we satisfy the performance obligations by transferring the service to the customer. These assets will be periodically assessed for impairment.

As of January 1, 2018, the date we adopted ASC 606, we capitalized $1.5 million in incremental contract acquisition costs related to contracts that were not completed. In the three months ended March 31, 2018 we amortized an immaterial amount of these acquisition costs, and did not record any impairment losses in relation to costs capitalized.