The accompanying unaudited interim condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S.”) (“GAAP”) and, in the opinion of management, reflect all adjustments, consisting of normal recurring adjustments, needed to fairly present the financial results of Surmodics, Inc. and subsidiaries (“Surmodics” or the “Company”) for the periods presented. These financial statements include amounts that are based on management’s best estimates and judgments. These estimates may be adjusted as more information becomes available, and any adjustment could be significant. The impact of any change in estimates is included in the determination of net income (loss) in the period in which the change in estimate is identified. The results of operations for the three and nine months ended June 30, 2019 are not necessarily indicative of the results that may be expected for the entire 2019 fiscal year.

In accordance with the rules and regulations of the U.S. Securities and Exchange Commission (“SEC”), the Company has omitted footnote disclosures that would substantially duplicate the disclosures contained in the audited consolidated financial statements of the Company. These unaudited condensed consolidated financial statements should be read together with the audited consolidated financial statements for the fiscal year ended September 30, 2018, and footnotes thereto included in the Company’s Form 10-K as filed with the SEC on November 30, 2018.

In May 2014, the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) issued Update No. 2014-09, Revenue from Contracts with Customers (“ASC Topic 606”). The core principal of ASC Topic 606 is 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 in exchange for those goods or services. The guidance also requires expanded disclosures relating to the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers, as well as significant judgements and changes in judgements, which are described in Note 2 to the condensed consolidated financial statements. The Company adopted ASC Topic 606 in the first quarter of fiscal year 2019 using the modified retrospective method and applied the new revenue standard to all new customer contracts initiated on or after the effective date and contracts which had remaining performance obligations as of the effective date.

The adoption of ASC Topic 606 resulted in an acceleration of minimum license fees and sales-based royalty revenue earned under the Company’s hydrophilic coating technology license agreements by approximately one quarter. Prior to the adoption of ASC Topic 606, sales-based royalties were recognized in the period the Company’s customers reported the underlying sales, which is generally one quarter after the sales occur. Additionally, minimum royalties were recognized in the period they were contractually owed to the Company. Upon adoption of ASC Topic 606, sales-based royalties are recognized in the period the underlying customer sale occurs, while the minimum royalties are recognized at each renewal of the license contract, which generally occurs on the last day of the quarter for minimum royalties contractually due in the following quarter. The adoption of ASC Topic 606 resulted in cumulative-effect adjustments to opening retained earnings, contract assets, deferred tax assets and income tax receivable.

The impact of the adoption of ASC Topic 606 on the opening consolidated balance sheet as of October 1, 2018, as compared with the consolidated balance sheet previously reported as of September 30, 2018, was as follows:

(Dollars in thousands)	September 30, 2018, As Reported		Adjustments for Adoption of Topic 606			October 1, 2018 Opening Balance
Assets
Contract assets - royalties and license fees	$	—	$	6,904		$	6,904
Deferred income taxes		6,304		(1,215	)		5,089
Income tax receivable		1,152		(390	)		762

Liabilities and Stockholders' Equity
Deferred revenue, current portion		9,646		(18	)		9,628
Deferred revenue, less current portion		11,247		(181	)		11,066
Retained earnings		97,615		5,498			103,113

The impact of adoption of ASC Topic 606 to the Company’s condensed consolidated statements of operations for three and nine months ended June 30, 2019 was an increase of royalty and license fee revenue of $1.2 million and $1.3 million, respectively, as well as reduced income tax benefit of $0.3 million for each period.

Not Yet Adopted

In February 2016, the FASB issued Accounting Standards Update 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 remaining contractual 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 applied using a modified retrospective approach. 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 and expects the impact to be material due to the right of use assets and lease obligations that will be recorded as a result of the adoption, as well as several additional required financial statement footnote disclosures. The Company estimates that a right of use asset totaling approximately $1.7 million and a lease obligation liability totaling approximately $2.9 million will be recorded as a result of the adoption of the new lease accounting standard. Additionally, the deferred rent liability totaling approximately $1.2 million that is currently included in other current and long-term liabilities will be eliminated as it will reduce the amount of the right-of-use asset recorded upon adoption. The Company expects the adoption of the lease standard will not have a significant impact on stockholders’ equity, the consolidated statements of operations, or the consolidated statements of cash flows.

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 2021 (October 1, 2020). Early adoption is permitted and the guidance will be applied using a modified retrospective approach. 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.

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