2. Summary of Significant Accounting Policies and Select Balance Sheet Information

Cash, restricted cash and cash equivalents consist of financial instruments with maturities of three months or less at the Company’s acquisition date of the security and are stated at cost which approximates fair value and may include money market instruments, certificates of deposit, repurchase agreements and commercial paper instruments. Restricted cash represents cash balances restricted pursuant to the terms of a real estate lease .

Investments consisted principally of commercial paper and corporate bond securities and are classified as available-for-sale as of September 30, 2018 and 2017. Available-for-sale securities are reported at fair value with unrealized gains and losses, net of tax, excluded from the consolidated statements of operations and reported in the consolidated statements of comprehensive (loss) income as well as a separate component of stockholders’ equity in the consolidated balance sheets, except for other-than-temporary impairments, which are reported as a charge to current earnings. A loss would be recognized when there is an other-than-temporary impairment in the fair value of any individual security classified as available-for-sale, with the associated net unrealized loss reclassified out of accumulated other comprehensive income with a corresponding adjustment to other income (loss). This adjustment would result in a new cost basis for the investment. No such adjustments occurred during the years ended September 30, 2018, 2017 or 2016. Interest earned on debt securities, including amortization of premiums and accretion of discounts, is included in other income (loss). Realized gains and losses from the sales of available-for-sale debt securities, which are included in other income (loss), are determined using the specific identification method.

The amortized cost, unrealized holding gains and losses, and fair value of available-for-sale securities as of September 30, 2018 and 2017 were as follows (in thousands):

	September 30, 2018
(Dollars in thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
Commercial paper and corporate bonds	$	41,403	$	—	$	(51	)	$	41,352
Total	$	41,403	$	—	$	(51	)	$	41,352

	September 30, 2017
(Dollars in thousands)	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value
Commercial paper and corporate bonds	$	31,817	$	—	$	(15	)	$	31,802
Total	$	31,817	$	—	$	(15	)	$	31,802

There were no held-to-maturity debt securities as of September 30, 2018 or 2017 and no realized gains or losses on sales of available-for-sale securities for the years ended September 30, 2018, 2017 or 2016.

Inventories are principally stated at the lower of cost or market using the specific identification method and include direct labor, materials and overhead. Inventories consisted of the following components as of September 30 (in thousands):

Property and equipment are stated at cost, less any impairment, and are depreciated using the straight-line method over the estimated useful lives of the assets. The Company recorded depreciation expense of $3.7 million, $3.0 million and $2.3 million for the years ended September 30, 2018, 2017 and 2016, respectively.

The September 30, 2018 and 2017 balances in construction-in-progress include the cost of enhancing the capabilities of the Company’s Ballinasloe, Ireland and Eden Prairie, Minnesota facilities. As assets are placed in service, construction-in-progress is transferred to the specific property and equipment categories and depreciated over the estimated useful lives of the assets. Leasehold improvements are amortized over the shorter of the term of the lease or the estimated useful life of the asset. Expenditures for maintenance and repairs and minor renewals and betterments that do not extend or improve the life of the respective assets are expensed as incurred.

Property and equipment consisted of the following components as of September 30 (in thousands):

	Useful Life	2018			2017
	(In years)
Land	N/A	$	4,420		$	4,420
Laboratory fixtures and equipment	3 to 10		22,024			19,491
Buildings and improvements	3 to 20		21,717			21,924
Leasehold improvements	10		4,836			—
Office furniture and equipment	3 to 10		5,824			4,541
Construction-in-progress			4,834			2,493
Less accumulated depreciation			(33,512	)		(29,927	)
Property and equipment, net		$	30,143		$	22,942

Other assets consist principally of the following as of September 30 (in thousands):

Intangible assets consist principally of acquired patents and technology, customer lists and relationships, licenses and trademarks. The Company recorded amortization expense of $2.7 million, $2.6 million and $2.4 million for the years ended September 30, 2018, 2017 and 2016, respectively.

	2018
	Weighted Average Original Life (Years)		Gross Carrying Amount		Accumulated Amortization			Net
Definite-lived intangible assets:
Customer lists and relationships		8.9	$	18,086	$	(9,377	)	$	8,709
Developed technology		11.5		9,656		(2,361	)		7,295
Non-compete		5.0		230		(150	)		80
Patents and other		16.5		2,321		(1,569	)		752
Subtotal				30,293		(13,457	)		16,836
Unamortized intangible assets:
In-process research and development				267		—			267
Trademarks and trade names				580		—			580
Total			$	31,140	$	(13,457	)	$	17,683

	2017
	Weighted Average Original Life (Years)		Gross Carrying Amount		Accumulated Amortization			Net
Definite-lived intangible assets:
Customer lists and relationships		8.9	$	18,293	$	(7,834	)	$	10,459
Developed technology		11.7		9,297		(1,478	)		7,819
Non-compete		5.0		230		(103	)		127
Patents and other		16.5		2,321		(1,423	)		898
Subtotal				30,141		(10,838	)		19,303
Unamortized intangible assets:
In-process research and development				679		—			679
Trademarks and trade names				580		—			580
Total			$	31,400	$	(10,838	)	$	20,562

Based on the intangible assets in service, excluding any possible future amortization associated with acquired in process research and development (“IPR&D”), which has not met technological feasibility as of September 30, 2018, estimated amortization expense for each of the next five fiscal years is as follows (in thousands):

2019	$	2,690
2020		2,514
2021		2,375
2022		2,336
2023		1,737

Future amortization amounts presented above are estimates. Actual future amortization expense may be different as a result of future acquisitions, impairments, completion or abandonment of IPR&D intangible assets, changes in amortization periods, foreign currency exchange rates or other factors.

The Company defines IPR&D as the value of technology acquired for which the related projects have substance and are incomplete. IPR&D acquired in a business acquisition is recognized at fair value and is capitalized as an indefinite-lived intangible asset until completion or abandonment of the IPR&D project. Upon completion of the development project (generally when regulatory approval to market the product is obtained), an impairment assessment is performed prior to amortizing the asset over its estimated useful life. If the IPR&D projects were abandoned, the related IPR&D assets would be written off. The Company assesses indefinite-lived assets for impairment annually in the fourth quarter and whenever an event occurs or circumstances change that would indicate that the carrying amount may be impaired. Similar to the goodwill impairment test, the indefinite-lived assets impairment test requires the Company to make several estimates about fair value, most of which are based on projected future cash flows.

The Company performed its annual impairment analysis as of August 31, 2018 and did not record any impairment charges in fiscal 2018 as there were no indicators of impairment associated with the indefinite-lived intangible assets. As a result of the August 31, 2017 impairment analysis, impairment losses on indefinite-lived intangible assets of $0.3 million and $0.1 million were recorded in research and development and selling, general and administrative expenses, respectively, in the consolidated statements of operations for fiscal 2017. No other impairment losses were identified during the annual impairment analyses in fiscal 2018 or 2017. The valuation methodology for determining the decline in value of the indefinite-lived intangible assets was based on inputs that require management judgment and are Level 3 inputs, as discussed in Note 5 to the consolidated financial statements.

Goodwill represents the excess of the purchase price of an acquired business over the fair value assigned to the assets purchased and liabilities assumed. Goodwill is not amortized but is subject, at a minimum, to annual tests for impairment in accordance with accounting guidance for goodwill. The carrying amount of goodwill is evaluated annually, and between annual evaluations if events occur or circumstances change indicating that it is more likely than not that the fair value of a reporting unit is less than its carrying amount.

The Company’s reporting units are the In Vitro Diagnostics and Medical Device operating segments. Inherent in the determination of fair value of the reporting units are certain estimates and judgments, including the interpretation of current economic indicators and market valuations as well as the Company’s strategic plans with regard to its operations.

The Company performed its annual assessment of goodwill for impairment as of August 31, 2018 and no goodwill impairment charges were recorded as there were no indicators of impairment associated with either of the reporting units. The impairment assessment is reliant on forecasted cash flows, as well as the selected discount rate when a quantitative assessment is necessary, which are inherently subjective and require significant management estimates. Differences in the reporting units’ actual future operating results as compared with these forecasted estimates could materially affect the estimation of the fair value of the reporting units.

The Company did not record any goodwill impairment charges in the years ended September 30, 2018, 2017 or 2016.

Goodwill as of September 30, 2018 and 2017 totaled $27.0 million and $27.3 million, respectively. Goodwill related to the In Vitro Diagnostics reporting unit represents the gross value from the acquisition of BioFX Laboratories, Inc. in 2007. As part of the acquisition of Creagh Medical, Ltd. and NorMedix, Inc. in fiscal 2016 (Note 4), the Medical Device reporting segment added $17.9 million of goodwill during fiscal 2016, $13.4 million of which is denominated in Euros and subject to revaluation due to fluctuations in exchange rates.

The change in the carrying amount of goodwill by segment for the years ended September 30, 2018 and 2017 was as follows (in thousands):

Accounting guidance requires the Company to evaluate periodically whether events and circumstances have occurred that may affect the estimated useful life or the recoverability of the remaining balance of long-lived assets, such as property and equipment and intangibles with finite lives. If such events or circumstances were to indicate that the carrying amount of these assets may not be recoverable, the Company would estimate the future cash flows expected to result from the use of the assets and their eventual disposition. If the sum of the expected future cash flows (undiscounted and without interest charges) were less than the carrying amount of the assets, the Company would recognize an impairment charge to reduce such assets to their fair value. In fiscal 2018, 2017 and 2016, there were no impairment charges relating to the Company’s long-lived assets as there were no events or circumstances that occurred that affected the recoverability of such assets.

Other accrued liabilities consisted of the following as of September 30 (in thousands):

The Company recognizes revenue when all of the following criteria are met: (1) persuasive evidence of an arrangement exists; (2) shipment has occurred or delivery has occurred if the terms specify destination; (3) the sales price is fixed or determinable; and (4) collectability is reasonably assured. When there are additional performance requirements, revenue is recognized when all such requirements have been satisfied. Under revenue arrangements with multiple deliverables, the Company recognizes each separable deliverable as it is earned.

The Company derives its revenue from three primary sources: (1) royalties and license fees from licensing our proprietary surface modification coating, and medical device technologies to customers; (2) product revenue from the sale of reagent chemicals to licensees, the sale of stabilization products, antigens, substrates and surface coatings to the diagnostic and biomedical research markets as well as the sale of medical devices (such as balloons and catheters) and related products to OEM suppliers and distributors; and (3) research and commercial development fees generated on customer projects.

Taxes collected from customers and remitted to governmental authorities are excluded from revenue and amounted to $0.1 million for each of the years ended September 30, 2018, 2017 and 2016.

Royalties and license fees. The Company licenses technology to third parties and collects royalties. Sales-based royalty revenue is generated when a customer sells products incorporating the Company’s licensed technologies. Royalty revenue is recognized as licensees report it to the Company, and payment is typically submitted concurrently with the report. For stand-alone license agreements, up-front license fees are recognized based on the terms of the related licensing agreement, either over the term of the agreement or at the point in time when the earnings process is complete. Minimum royalty fees are recognized in the period earned.

Revenue related to a performance milestone is recognized upon the achievement of the milestone, as defined in the respective agreements and provided the following conditions have been met:

If these conditions have not been met, the milestone payment is deferred and recognized over the term of the agreement.

Product sales. Product sales to third parties consist of OEM and distributor sales and are recognized at the time of shipment. The Company’s sales terms provide no right of return outside of the standard warranty policy. Payment terms are generally set at 30-45 days.

Research and development. The Company performs third-party research and development activities, which are typically provided on a time and materials basis. Generally, revenue for research and development is recorded as performance progresses under the applicable contract, which corresponds with the period the related costs are incurred.

Arrangements with multiple deliverables. Revenue arrangements with multiple deliverables require the Company to:

(i) disclose whether multiple deliverables exist, how the deliverables in an arrangement should be separated, and how the consideration should be allocated;

(ii) allocate revenue in an arrangement using estimated selling prices (“ESP”) of deliverables if a vendor does not have vendor-specific objective evidence of selling price (“VSOE”) or third-party evidence of selling price (“TPE”); and

The Company accounts for revenue using a multiple attribution model in which consideration allocated to research and development activities is recognized as performed, and milestone payments are recognized when the milestone events are achieved, when such activities and milestones are deemed substantive. Accordingly, in situations where a unit of accounting includes both a license and research and development activities, and when a license does not have stand-alone value, the Company applies a multiple attribution model in which consideration allocated to the license is recognized ratably, consideration allocated to research and development activities is recognized as performed and milestone payments are recognized when the milestone events are achieved, when such activities and milestones are deemed substantive.

The Company enters into license and development arrangements that may consist of multiple deliverables which could include license(s) to Surmodics’ technology, research, development and clinical activities, and product sales based on the needs of its customers. For example, a customer may enter into an arrangement to obtain a license to Surmodics’ intellectual property which may also include research, development and clinical activities, as well as supply of products manufactured by Surmodics. For these services provided, Surmodics could receive upfront license fees upon signing of an agreement and granting the license, milestone payments contingent upon advancement of the product through development and clinical stages to successful commercialization, per-unit payments for supply of product, and royalty payments based on customer sales of product incorporating Surmodics’ technology. The Company’s license and development arrangements generally do not have refund provisions if the customer cancels or terminates the agreement. Typically all payments made are non-refundable.

The Company is required to evaluate each deliverable in a multiple element arrangement for separability. The Company is then required to allocate revenue to each separate deliverable using a hierarchy of VSOE, TPE, or ESP. In many instances, the Company is not able to establish VSOE for all deliverables in an arrangement with multiple elements. This may be a result of the Company infrequently selling each element separately or having a limited history with multiple element arrangements. When VSOE cannot be established, the Company attempts to establish a selling price of each element based on TPE. TPE is determined based on competitor prices for similar deliverables when sold separately.

When the Company is unable to establish a selling price using VSOE or TPE, the Company uses ESP in its allocation of arrangement consideration. The objective of ESP is to determine the price at which the Company would transact a sale if the product or service were sold on a stand-alone basis. ESP is generally used for highly customized offerings.

The Company determines ESP for undelivered elements by considering multiple factors including, but not limited to, market conditions, competitive landscape and past pricing arrangements with similar features. The determination of ESP is made through consultation with the Company’s management, taking into consideration the marketing strategies for each business unit.

Amounts received prior to satisfying the above revenue recognition criteria are recorded as deferred revenue in the accompanying consolidated balance sheets, with deferred revenue to be recognized beyond one year being classified as non-current deferred revenue. The Company had deferred revenue of $20.9 million and $0.3 million as of September 30, 2018 and 2017, respectively recorded in current and long-term deferred revenue on the consolidated balance sheets.

The Company has licenses and supply agreements with a diverse base of customers and certain customers have multiple products using the Company’s technology. Medtronic plc (“Medtronic”) is the Company’s largest customer at approximately 16%, 18% and 25% of total consolidated revenue for the years ended September 30, 2018, 2017 and 2016, respectively. Medtronic has several separately-licensed products that generate royalty revenue for Surmodics, none of which represented more than 4% of Surmodics’ total revenue. As discussed in Note 3, the Company entered into an agreement with Abbott Vascular, Inc. (“Abbott”) during the year ended September 30, 2018. As a result of revenue recognized under this and other agreements, revenue from Abbott and its affiliates accounted for 11% of consolidated revenue in the year ended September 30, 2018. No other individual customer constitutes more than 10% of the Company’s total revenue. The loss of Medtronic, Abbott or any of our largest customers, or reductions in business from them, could have a material adverse effect on the Company’s business, financial condition, results of operations, and cash flows from operations.

The Company’s licensing agreements with many of its customers, including most of its significant customers, cover many licensed products that each separately generates royalty revenue. This structure reduces the potential risk to the Company’s operations that may result from reduced sales (or the termination of a license) of a single product for any specific customer.

The Company believes that the credit risk related to marketable securities is limited due to the adherence to an investment policy and that credit risk related to accounts receivable is limited due to a large customer base.

The Company accounts for income taxes under the asset and liability method prescribed in accounting guidance. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. A valuation allowance is provided when it is more likely than not that some portion or all of a deferred tax asset will not be realized. The ultimate realization of deferred tax assets depends on the generation of future taxable income during the period in which related temporary differences become deductible. Management considers the scheduled reversal of deferred tax liabilities, projected future taxable income and tax planning strategies in this assessment. Deferred tax assets and liabilities are measured using the enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in earnings in the period that includes the enactment date of such change.

Research and development (“R&D”) costs are expensed as incurred. Some R&D costs are related to customer contracts, and the related revenue is recognized as described in “Revenue Recognition” above. Costs associated with customer-related R&D include specific project direct labor and material expenses as well as an allocation of overhead costs based on direct labor dollars.

Clinical trial costs. The Company sponsors clinical trials intended to obtain the necessary clinical data required to obtain approval from various regulatory agencies to market medical devices developed by the Company. Costs associated with clinical trials are included within R&D expense and include trial design and management expenses, clinical site reimbursements and third party fees. The Company’s clinical trials are administered by third-party clinical research organizations (“CROs”). These CROs generally bill monthly for certain services performed as well as upon achievement of certain milestones. The Company monitors patient enrollment, the progress of clinical studies and related activities through internal reviews of data reported to the Company by the CROs and correspondence with the CROs. The Company periodically evaluates its estimates to determine if adjustments are necessary or appropriate based on information it receives.

Government funding. The Company is eligible to receive reimbursement for certain qualifying R&D expenditures under a grant from the Industrial Development Agency of Ireland (“IDA”). Reimbursements are recognized as a reduction of R&D expense when there is reasonable assurance that the funding will be received and conditions associated with the funding are met. The Company recorded reimbursements from IDA grants of $0.8 million during each of the years ended September 30, 2018 and 2017 as a reduction of R&D expense. No reimbursements were recorded during fiscal 2016.

The preparation of consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, 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. Ultimate results could differ from those estimates.

Basic (loss) income per common share is calculated based on the weighted average number of common shares outstanding during the period. Diluted income per common share is computed by dividing income by the weighted average number of common and common equivalent shares outstanding during the period. The Company’s potentially dilutive common shares are those that result from dilutive common stock options and non-vested stock relating to restricted stock awards, restricted stock units and performance shares. However, these items have been excluded from the calculation of diluted net loss per share as their effect is antidilutive for the year ended September 30, 2018, as a result of the net loss incurred for that period. Therefore, diluted weighted average number of shares outstanding and diluted net loss per share were the same as basic weighted average number of shares outstanding and net loss per share for the year ended September 30, 2018.

The following table sets forth the denominator for the computation of basic and diluted income per share for each of the years ended September 30 (in thousands):

The Company’s reporting currency is the U.S. Dollar. Assets and liabilities of non-U.S. dollar functional currency subsidiaries are translated into U.S. dollars at the period-end exchange rates, and revenue and expenses are translated at the average quarterly exchange rates during the period. The net effect of these translation adjustments on the consolidated financial statements is recorded as a foreign currency translation adjustment, a component of accumulated other comprehensive income on the consolidated balance sheets. Realized foreign currency transaction gains and losses are included in other, income (loss) net in the consolidated statements of operations.

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (ASC Topic 606). Principles of this guidance require entities to recognize revenue in a manner that depicts the transfer of goods or services to customers in amounts that reflect the consideration an entity expects to be entitled to receive in exchange for those goods or services and the guidance may be adopted through either a full retrospective or modified retrospective approach. The guidance also requires expanded disclosures relating to the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. Additionally, qualitative and quantitative disclosures are required about customer contracts, significant judgments and changes in judgments, and assets recognized from the costs to obtain or fulfill a contract. This accounting standard will be adopted by the Company beginning in the first quarter of fiscal year 2019 (October 1, 2018) using the modified retrospective approach and the impact will be material to the consolidated financial statements due to an anticipated one-quarter acceleration of minimum license fees and sales-based royalty revenue earned under its hydrophilic license agreements. Under the modified retrospective approach, the Company will apply the new revenue standard to all new revenue contracts initiated on or after the effective date, and, for contracts which have remaining obligations as of the effective date, the Company will adjust the beginning balance of retained earnings. These changes will result in an increase of approximately $5.9 million to retained earnings, including establishment of contract assets on the consolidated balance sheets of $7.6 million and a deferred tax liability of $1.7 million upon adoption.

In February 2016, the FASB issued ASU 2016-02, Leases (ASC Topic 842). The new guidance primarily affects lessee accounting, while accounting by lessors will not be significantly impacted by the update. The update maintains two classifications of leases: finance leases, which replace capital leases, and operating leases. Lessees will need to recognize a right-of-use asset and a lease liability on the statement of financial position for those leases previously classified as operating leases under the old guidance. The liability will be equal to the present value of lease payments. The asset will be based on the liability, subject to adjustment, such as for direct costs. The accounting standard will be effective for the Company beginning the first quarter of fiscal year 2020 (October 1, 2019) and will be implemented using a modified retrospective approach, which is one of two allowed adoption methods. While the Company is evaluating the impact of the lease guidance on its consolidated financial statements, the Company anticipates that the impact will be material due to the right-of-use assets and lease liabilities related to existing operating leases that will be recorded on the Company’s consolidated balance sheets upon adoption of the standard.

In June 2016, the FASB issued ASU No 2016-13, Financial Instruments – Credit Losses (ASC Topic 326), Measurement of Credit Losses on Financial Statements. This ASU requires a financial asset (or a group of financial assets) measured at an amortized cost basis to be presented at the net amount expected to be collected. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial asset(s) to present the net carrying value at the amount expected to be collected on the financial asset. The accounting standard will be effective for the Company beginning in the first quarter of fiscal 2020 (October 1, 2019), and early adoption is permitted. The Company is currently evaluating the impact that the adoption of this standard will have on the Company’s results of operations, cash flows and financial position.

In January 2017, the FASB issued ASU No. 2017-01, Clarifying the Definition of a Business. The new guidance changed the definition of a business as it relates to evaluation of transactions under Accounting Standards Codification (“ASC”) Topic 805 Business Combinations, introducing a screen whereby a transaction would not be considered a business combination if substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable assets or group of similar identifiable assets. The accounting standard is effective for fiscal years beginning after December 15, 2017, with early adoption permitted. This accounting guidance was adopted during fiscal 2018, in conjunction with the acquisition of in-process research and development assets from Embolitech, LLC further discussed in Note 11 (the “Embolitech Transaction”). The application of this guidance to the Embolitech Transaction resulted in a determination that the acquired assets did not constitute a business.

No other new accounting pronouncement issued or effective has had, or is expected to have, a material impact on the Company’s consolidated financial statements.