2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

The accompanying consolidated financial statements reflect the accounts of Sarepta Therapeutics, Inc. and its wholly-owned subsidiaries. All inter-company transactions between and among its consolidated subsidiaries have been eliminated. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). Management has determined that the Company operates in one segment: the development of pharmaceutical products on its own behalf or in collaboration with others.

Estimates and Uncertainties

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Significant items subject to such estimates and assumptions include the valuation of stock-based awards and liability classified warrants, research and development expenses, and revenue recognition.

Cash and Cash Equivalents

The Company considers all highly liquid investments with an original maturity of 90 days or less from the date of purchase to be cash equivalents.

Accounts Receivable

Accounts receivable are generally stated at invoiced amount and do not bear interest. Because the accounts receivable are primarily from the U.S. government and historically no amounts have been written off, an allowance for doubtful accounts receivable is not considered necessary. The accounts receivable balance included $2.4 million and $3.2 million of receivables from the U.S. government that were unbilled at December 31, 2013 and 2012, respectively.

Property and Equipment

Property and equipment are carried at cost, subject to review for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. The cost of normal, recurring, or periodic repairs and maintenance activities related to property and equipment are expensed as incurred. The cost for planned major maintenance activities, including the related acquisition or construction of assets, is capitalized if the repair will result in future economic benefits.

The Company generally depreciates the cost of its property and equipment using the straight-line method over the estimated useful lives of the respective assets, which are summarized as follows:


Asset Category		Useful lives
Lab equipment		5 years
Office equipment		5 years
Leasehold improvements		Lesser of the useful life or the term of the respective lease
Building		30 years
Construction in Progress		Not depreciated until put into service

Amounts included in property and equipment are as follows:


	As of December 31,
	2013			2012
	(in thousands)
Lab equipment	$	7,728		$	6,890
Office equipment		1,432			1,301
Leasehold improvements		10,058			10,058
Building		1,856			1,856
Construction in progress		11,303			—


Property and equipment, gross		32,377			20,105

Less accumulated depreciation		(17,328	)		(16,708	)


Property and equipment, net	$	15,049		$	3,397

At December 31, 2013, the Company recorded construction in progress related to the Cambridge headquarters lease totaling $11.3 million, of which $6.2 million was paid by the landlord as part of a tenant improvement allowance which is recorded in other long-term liabilities. These assets will be placed into service during the first quarter of fiscal 2014.

In 2009, the Company listed for sale the industrial property it owns in Corvallis, Oregon. In connection with this decision, the Company classified the property as “Property held for sale” and ceased depreciating the property. While the property was held for sale, the Company, with the assistance of independent appraisals, periodically estimated the fair market value less the costs to sell the property and in 2011 and 2010, recorded impairment charges of $0.1 million and $0.4 million, respectively. In November 2011, the Company leased approximately 70% of the building to a third party through March 31, 2017 at rates ranging from $14,500 per month to $15,500 per month. Under the terms of the agreement, the third party can terminate the lease in November 2014 upon proper notice and delivery of a termination fee. In addition, the third party has the option to purchase the building for prices ranging from $2.0 million to $2.2 million during the initial lease term. Upon entering into the lease agreement, the Company reclassified the $1.9 million carrying value of the building from “Property held for sale” to “Property and equipment” and began depreciating the building over 30 years which is the remaining term of the ground lease. Rent earned on the building is recorded as “Interest income and other, net” and was $0.2 million and $0.1 million in 2013 and 2012, respectively.

Depreciation expense was $0.8 million in 2013, $1.0 million in 2012, and $0.8 million in 2011.

Patent Costs

Patent costs consist primarily of external legal costs, filing fees incurred to file patent applications and renewal fees on proprietary technology developed or licensed by the Company. Patent costs associated with applying for a patent, being issued a patent and annual renewal fees are capitalized. Costs to defend a patent and costs to invalidate a competitor’s patent or patent application are expensed as incurred. Patent costs are amortized on a straight-line basis over the shorter of the estimated economic lives or the initial term of the patents, generally 20 years. Patent amortization expense was $0.4 million, $0.6 million and $0.5 million for the years ended December 31, 2013, 2012 and 2011, respectively. The Company also expensed the remaining net book value of previously capitalized patents that were later abandoned of $0.5 million, $0.4 million and $0.2 million in 2013, 2012 and 2011, respectively. The Company expects to incur amortization expense of approximately $0.5 million per year over the next five years based on the unamortized patent costs as of December 31, 2013.

Revenue Recognition

Government Research Contract Revenue. Substantially all of the Company’s revenue is generated from U.S. government research contracts and grants. See “Note 6—Government Contracts.” The Company’s contracts with the U.S. government are cost plus contracts providing for reimbursed costs which include overhead and general and administrative costs and a target fee. The Company recognizes revenue from U.S. government research contracts during the period in which the related expenses are incurred and presents such revenues and related expenses gross in the consolidated financial statements.

License Arrangements. License arrangements may consist of non-refundable upfront license fees, data transfer fees, research reimbursement payments, exclusive licensed rights to patented or patent pending compounds, technology access fees, various performance or sales milestones and future product royalty payments. Some of these arrangements are multiple element arrangements. The Company defers recognition of non-refundable upfront fees if it has continuing performance obligations without which the technology, right, product or service conveyed in conjunction with the non-refundable fee has no utility to the licensee that is separate and independent of Company performance under the other elements of the arrangement. In addition, if the Company has continuing involvement through research and development services that are required because of its know-how and expertise related to the technology that is proprietary to the Company, or can only be performed by the Company, then such up-front fees are deferred and recognized over the period of continuing involvement.

Research and Development

Research and development costs are expensed as incurred.

Research and development expense consists of costs associated with research activities as well as costs associated with the Company’s product development efforts, conducting preclinical studies, and clinical trial and manufacturing costs.

Direct research and development expenses associated with the Company’s programs include clinical trial site costs, clinical manufacturing costs, costs incurred for consultants and other outside services, such as data management and statistical analysis support, and materials and supplies used in support of the clinical programs. Indirect costs of the Company’s clinical program include salaries, stock based compensation, and an allocation of the Company’s facility costs. When third-party service providers’ billing terms do not coincide with the Company’s period-end, the Company is required to make estimates of its obligations to those third parties, including clinical trial and pharmaceutical development costs, contractual services costs and costs for supply of its drug candidates, incurred in a given accounting period and record accruals at the end of the period. The Company bases its estimates on its knowledge of the research and development programs, services performed for the period, past history for related activities and the expected duration of the third-party service contract, where applicable.

Stock Compensation

The Company issues stock options, stock appreciation rights, restricted stock and restricted stock units to certain employees, officers and directors. The Company accounts for stock compensation using the fair value method, which results in the recognition of compensation expense over the vesting period of the awards. See “Note 3—Stock Compensation” for additional information.

Income Taxes

The Company follows the asset and liability method of accounting for income taxes. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. It is the intention of the Company to reinvest the earnings of its non-U.S. subsidiaries in those operations and not to repatriate the earnings to the United States. Accordingly, the Company does not provide for deferred taxes on the excess of the financial reporting over the tax basis in its investments in foreign subsidiaries as they are considered permanent in duration. To date, the Company has not had any earnings in its non-U.S. subsidiaries.

Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered and settled. A valuation allowance is recorded to reduce the net deferred tax asset to zero because it is more likely than not that the net deferred tax asset will not be realized. The Company recognizes the effect of income tax positions only if those positions are more likely than not of being sustained upon an examination.

Fair Value of Financial Instruments

The Company measures at fair value certain financial assets and liabilities in accordance with a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. There are three levels of inputs that may be used to measure fair-value:

•

Level 1—quoted prices for identical instruments in active markets;

•

Level 2—quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; and

•

Level 3—valuations derived from valuation techniques in which one or more significant value drivers are unobservable.

The Company’s assets and liabilities measured at fair value on a recurring basis consisted of the following as of the date indicated:


	Fair Value Measurement as of December 31, 2013
	Total		Level 1		Level 2		Level 3
	(in thousands)
Restricted investments, current	$	7,250	$	7,250		$—		$—
Restricted investments, noncurrent		647		647


Total assets	$	7,897	$	7,897		$—		$—


	Fair Value Measurement as of December 31, 2013
	Total		Level 1		Level 2		Level 3
	(in thousands)
Warrants*	$	9,006		$—		$—	$	9,006


Total liabilities	$	9,006		$—		$—	$	9,006


	Fair Value Measurement as of December 31, 2012
	Total		Level 1		Level 2		Level 3
	(in thousands)
Warrants*	$	65,193		$—		$—	$	65,193


Total liabilities	$	65,193		$—		$—	$	65,193

*See “Note 8—Warrants” for additional information related to the determination of fair value of the warrants.

As of December 31, 2012, there were no restricted investments held by the Company. The carrying amounts reported in the consolidated balance sheets for cash and cash equivalents, accounts receivable, and accounts payable approximate fair value because of the immediate or short-term maturity of these financial instruments and carrying amounts reported for long-term debt approximate fair value based on market activity for other debt instruments with similar characteristics and comparable risk.

Rent Expense

The Company’s operating leases for its Cambridge, Massachusetts and Corvallis, Oregon facilities provide for scheduled annual rent increases throughout each lease’s term. The Company recognizes the effects of the scheduled rent increases on a straight-line basis over the full term of the leases, which expire in 2020 for the Cambridge, Massachusetts and Corvallis, Oregon facilities.

Commitments and Contingencies

The Company records liabilities for legal and other contingencies when information available to the Company indicates that it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. Legal costs in connection with legal and other contingencies are expensed as costs are incurred.

Long-Lived Asset Impairment

Long-lived assets held and used by the Company and intangible assets with determinable lives are reviewed for impairment whenever events or circumstances indicate that the carrying amount of assets may not be recoverable. The Company evaluates recoverability of assets to be held and used by comparing the carrying amount of an asset to future net undiscounted cash flows to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amount of the assets exceeds the fair value of the assets. Such reviews assess the fair value of the assets based upon estimates of future cash flows that the assets are expected to generate.

The Company conducts periodic evaluations of the value of its patents. Pursuant to these evaluations, the Company recorded charges of $0.5 million, $0.4 million and $0.2 million in 2013, 2012 and 2011, respectively, for previously capitalized costs related to patents that were abandoned.

Recent Accounting Pronouncements

In February 2013, the Financial Accounting Standards Board (the “FASB”) issued new guidance which requires disclosure of significant amounts reclassified out of accumulated other comprehensive income by component and their corresponding effect on the respective line items of net income. This guidance was adopted by the Company in fiscal year 2013. The adoption of this guidance did not have an impact on the Company’s consolidated financial statements.

In July 2013, the FASB issued new guidance which amends the guidance related to the presentation of unrecognized tax benefits and allows for the reduction of a deferred tax asset for a NOL carryforward whenever the NOL or tax credit carryforward would be available to reduce the additional taxable income or tax due if the tax position is disallowed. The new guidance is effective for annual and interim periods for fiscal years beginning after December 15, 2013, and early adoption is permitted. Since the guidance relates only to the presentation of unrecognized tax benefits, the Company does not expect its adoption in January 2014 will have a material effect on its financial position, results of operations or cash flows.