The following discussion and analysis should be read in conjunction with the audited annual consolidated financial statements and the related notes thereto included elsewhere in this Annual Report on Form 10-K. This discussion contains forward-looking statements reflecting our current expectations that involve risks and uncertainties. Actual results may differ materially from those discussed in these forward-looking statements due to a number of factors, including those set forth in the section entitled "Risk Factors" and elsewhere in this Annual Report on Form 10-K. For further information regarding forward-looking statements, please refer to the special note regarding forward-looking statements at the beginning of this Annual Report on Form 10-K. Throughout this discussion, unless the context specifies or implies otherwise, the terms "Company," "we," "us" and "our" refer toOmeros Corporation and our wholly owned subsidiaries. Overview
We are a commercial-stage biopharmaceutical company committed to discovering, developing and commercializing small-molecule and protein therapeutics for large-market as well as orphan indications targeting inflammation, complement-mediated diseases, disorders of the central nervous system, and immune-related diseases, including cancers.
Our drug product OMIDRIA® is marketed inthe United States for use during cataract surgery or intraocular lens replacement for adult and pediatric patients. Our drug candidate narsoplimab is the subject of a rolling biologics license application ("BLA") under priority review by theU.S. Food and Drug Administration ("FDA") for the treatment of hematopoietic stem cell transplant-associated thrombotic microangiopathy ("HSCT-TMA"). We also have multiple Phase 3 and Phase 2 clinical-stage development programs in our pipeline, which are focused on: complement-mediated disorders, including immunoglobulin A ("IgA") nephropathy, atypical hemolytic uremic syndrome ("aHUS"), and COVID-19. We have also initiated a Phase 1 clinical program for our MASP-3 inhibitor OMS906 targeting the alternative pathway of complement and have successfully completed a Phase 1 study in our phosphodiesterase 7 ("PDE7") program focused on addiction. In addition, we have a diverse group of preclinical programs, including GPR174, a novel target in immuno-oncology that modulates a new cancer immunity axis that we discovered. Small-molecule and antibody inhibitors of GPR174 are part of our proprietary G protein-coupled receptor ("GPCR") platform through which we control 54 GPCR drug targets and their corresponding compounds. We also possess a proprietary-asset-enabled antibody-generating technology. We have retained control of all commercial rights for OMIDRIA and each of our product candidates and programs.
Financial Summary
We recognized net losses of
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respectively. Historically, OMIDRIA revenues were impacted by the reimbursement status for OMIDRIA under Medicare Part B, as well as the COVID-19 pandemic.
[[Image Removed: Graphic]] * Fiscal quarters without pass-through reimbursement ** Fiscal quarters with reduced cataract procedures due to COVID-19 *** Pass-through reimbursement expired onOctober 1, 2020 . InDecember 2020 , separate payment was confirmed for OMIDRIA, effective retroactively as ofOctober 1, 2020 . During the period fromJanuary 1, 2018 toSeptember 30, 2018 , OMIDRIA was not reimbursed separately when used for procedures involving patients covered by Medicare Part B, and our revenues decreased significantly. After reinstatement of pass-through reimbursement for OMIDRIA in the fourth quarter of 2018, our revenues quickly returned to levels seen in prior periods during which pass-through reimbursement was available and subsequent quarter-over-quarter revenue growth approximated historical rates. Pass-through status for OMIDRIA allowed for separate reimbursement payment (i.e., outside the packaged procedural payment) to ASCs and hospitals using OMIDRIA in procedures involving patients covered by Medicare PartB. Pass -through reimbursement for OMIDRIA under Medicare Part B expired onOctober 1, 2020 , and consequently, our net revenues for September and the fourth quarter of 2020 were significantly reduced. InDecember 2020 , theCenters for Medicare & Medicaid Services ("CMS") confirmed that OMIDRIA, as an otherwise policy packaged drug following OMIDRIA's expiration of pass-through status onOctober 1, 2020 , qualifies for separate payment when used on Medicare Part B patients in the ambulatory surgery center ("ASC") setting under CMS' policy for non-opioid pain management surgical drugs. CMS made separate payment for OMIDRIA under this policy effective retroactively as ofOctober 1, 2020 . CMS' non-opioid separate payment policy and, as a result, separate payment for OMIDRIA thereunder, like other CMS policies in the OPPS and ASC systems, can be changed by CMS through its annual rulemaking and comment process for its outpatient prospective payment and ASC payment systems. We believe that CMS will continue its separate payment policy for non-opioid pain management surgical drugs, which has been in effect since 2019, and that OMIDRIA will continue to be separately reimbursed when used in the ASC setting.
See Part 1, Item 1, "Business-Commercial Product-OMIDRIA" for additional details regarding the pass-through reimbursement status for OMIDRIA.
We expect our net losses will continue until such time as we derive sufficient revenues from sales of OMIDRIA and/or other sources, such as licensing, product sales and other revenues from our product candidates, that are sufficient to cover our operating expenses and debt service obligations. As ofDecember 31, 2020 , we had$135.0 million in cash and cash equivalents and short-term investments available for general corporate use and$3.8 million
in accounts receivable, net. 50 Table of Contents Results of Operations Revenue
Our revenue consists of OMIDRIA product sales to ASCs, and hospitals in the
Year Ended December 31, 2020 2019 2018 (In thousands) Product sales, net$ 73,813 $ 111,805 $ 29,868
We launched OMIDRIA in the
In 2020, OMIDRIA revenue decreased$38.0 million , or 34%, as compared to the year endedDecember 31, 2019 . The decrease in revenue during 2020 compared to 2019 was due to COVID-19-related reductions in the number of elective cataract procedures frommid-March 2020 through lateJune 2020 . The additional decrease in revenue during 2020 compared to 2019 was due to a slowdown in orders from wholesalers during September and the fourth quarter following expiration of pass-through reimbursement for OMIDRIA onOctober 1, 2020 . InDecember 2020 , CMS confirmed that OMIDRIA qualifies for separate payment when used in the ASC setting. In 2019, OMIDRIA revenue increased$81.9 million , or 274%, as compared to the year endedDecember 31, 2018 . The increase in revenue in 2019 compared to 2018 was due to significantly increased demand for OMIDRIA by ASCs and hospitals following the reinstatement of pass-through reimbursement status for OMIDRIA onOctober 1, 2018 .
During the nine-month period from
Given the uncertainty and local variances in the severity and response to the COVID-19 pandemic across theU.S. , and whether CMS will continue its separate payment policy for non-opioid pain management surgical drugs, which has been in effect since 2019, we may experience significant fluctuations in period-over-period OMIDRIA revenues.
Gross-to-Net Deductions
We record OMIDRIA product sales net of estimated chargebacks, rebates, distribution fees and product returns. These deductions are generally referred to as gross-to-net deductions. Our total gross-to-net provisions for the years endedDecember 31, 2020 , 2019 and 2018 were 31.2%, 27.7% and 28.1%, respectively, of gross OMIDRIA product sales.
Our gross-to-net provision and payments for the years ended
Distribution Fees and Product Chargebacks Return and Rebates Allowances Total (In thousands) Balance as of December 31, 2017$ 5,724 $ 3,373 $ 9,097 Provisions 10,341 1,309 11,650 Payments (9,050) (3,197) (12,247)
Balance as of December 31, 2018 7,015 1,485
8,500 Provisions 37,232 5,387 42,619 Payments (34,007) (4,635) (38,642) Balance as of December 31, 2019 10,240 2,237 12,477 Provisions 25,639 7,764 33,403 Payments (32,139) (9,053) (41,192) Balance as of December 31, 2020$ 3,740 $ 948$ 4,688 51 Table of Contents Chargebacks and Rebates
We record a provision for estimated chargebacks and rebates at the time we recognize OMIDRIA product sales revenue and reduce the accrual when payments are made or credits are granted. Our chargebacks are related to a pharmaceutical pricing agreement, a federal supply schedule agreement, a 340B prime vendor agreement, a Medicaid drug rebate agreement and an off-invoice discount to our customers. We also record a provision for our OMIDRIAssure® patient assistance and reimbursement services program and our rebates under our purchase volume-discount programs.
Distribution Fees and Product Return Allowances
We pay our wholesalers a distribution fee for services they perform for us based on the dollar value of their purchases of OMIDRIA. We record a provision for these charges as a reduction to revenue at the time of sale to the wholesaler and make payments to our wholesalers based on contractual terms. We allow for the return of product up to 12 months past its expiration date, or for product that is damaged or not used by our customers. We record a provision for returns upon sale of OMIDRIA to our wholesaler. When a return or claim is received, we issue a credit memo to the wholesaler against its outstanding receivable to us or we reimburse the customer.
Research and Development Expenses
Our research and development expenses can be divided into three categories: direct external expenses, which include clinical research and development and preclinical research and development activities; internal, overhead and other expenses; and stock-based compensation expense. Direct external expenses consist primarily of expenses incurred pursuant to agreements with third-party manufacturing organizations prior to receiving regulatory approval for a product candidate, contract research organizations ("CROs"), clinical trial sites, collaborators, and licensors and consultants. Costs are reported in preclinical research and development until the program enters the clinic. Internal, overhead and other expenses consist of personnel costs, overhead costs such as rent, utilities and depreciation and other miscellaneous costs. We do not generally allocate our internal resources, employees and infrastructure to any individual research project because we deploy them across multiple clinical and preclinical projects that we are advancing in parallel. The following table illustrates our expenses associated with these activities: Year Ended December 31, 2020 2019 2018 (In thousands) Direct external expenses: Clinical research and development: MASP-2 program - OMS721 (narsoplimab)$ 45,020 $ 49,804 $ 46,383 MASP-3 program - OMS906 7,172 - - OMIDRIA - Ophthalmology 2,053 2,679 2,388 PDE7 - OMS527 1,833 4,066 3,586
Total clinical research and development 56,078 56,549 52,357 Preclinical research and development 10,664 14,410 6,465 Total direct external expenses
66,742 70,959 58,822
Internal, overhead and other expenses 37,744 32,642 26,077 Stock-based compensation expense
6,331 6,095 4,961 Total research and development expenses$ 110,817 $ 109,696 $ 89,860 Clinical research and development expenses decreased by$0.5 million between 2020 and 2019 due to timing of narsoplimab drug manufacturing activities and reduced OMS527 toxicology spending. During 2020, OMS906 clinical research and development expenses were$7.2 million , and embedded within pre-clinical research and development costs 52
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were
The decrease in preclinical research and development expenses in 2020 compared to 2019 is primarily due to the migration of OMS906 from preclinical to clinical research and development beginning in the third quarter of 2020. The increases in internal, overhead and other expenses in all years presented are primarily due to additional employee-related costs and buildout of expanded laboratory facilities in 2020 to support our research and development activities. We expect overall research and development costs to increase in 2021 as we continue our ongoing Phase 3 clinical programs for narsoplimab and manufacture commercial drug substance in anticipation of the drug's FDA approval for the treatment of HSCT-TMA. Our accounting policy is to expense all manufacturing costs incurred until regulatory approval is obtained in either theU.S. orEurope . At this time, we are unable to estimate with certainty the longer-term costs we will incur in the continued development of our product candidates due to the inherently unpredictable nature of our preclinical and clinical development activities as well as the potential impact of the COVID-19 pandemic. Clinical development timelines, the probability of success and development costs can differ materially as new data become available and as expectations change. Our future research and development expenses will depend, in part, on the preclinical or clinical success of each product candidate as well as ongoing assessments of each program's commercial potential. In addition, we cannot forecast with precision which product candidates, if any, may be subject to future collaborations, when such arrangements will be secured, if at all, and to what degree such arrangements would affect our development plans and capital requirements. We are required to expend substantial resources in the development of our product candidates due to the lengthy process of completing clinical trials and seeking regulatory approval. Any failure or delay in completing clinical trials, or in obtaining regulatory approvals, could delay our generation of product revenue and increase our research and development expenses.
Selling, General and Administrative Expenses
Our selling, general and administrative expenses are comprised primarily of salaries, benefits and stock-compensation costs for sales, marketing and other personnel who are not directly engaged in research and development. Costs also include marketing and selling expenses, professional and legal services, general corporate costs and an allocation of our occupancy costs. Year Ended December 31, 2020 2019 2018 (In thousands) Selling, general and administrative expenses, excluding stock-based compensation expense$ 64,101 $ 56,936 $ 44,966 Stock-based compensation expense 8,594 7,690
6,752
Total selling, general and administrative expenses$ 72,695 $ 64,626
The increase in selling, general and administrative expenses, excluding stock-based compensation during both years endedDecember 31, 2020 and 2019 was primarily due to increased pre-commercialization activities for narsoplimab for the treatment of HSCT-TMA. We expect that our selling, general and administrative expenses in 2021 will increase from 2020, primarily due to plannedU.S. commercialization activities related to narsoplimab. 53 Table of Contents Interest Expense Year Ended December 31, 2020 2019 2018 (In thousands) Interest expense$ 26,751 $ 22,657 $ 16,252 Interest expense is primarily comprised of contractual interest and amortization of debt issuance and debt discount related to our 6.25% Convertible Senior Notes (the "2023 Notes") and 5.25% Convertible Senior Notes (the "2026 Notes") as well as interest on our finance leases. Non-cash interest expense for 2020, 2019 and 2018 was$11.6 million ,$9.2 million and$5.6 million , respectively. Interest expense increased for each of these periods due to increases in total debt outstanding for each period. For more information regarding our debt and our unsecured convertible notes, see Part II, Item 8, "Note 7-Debt" and "Note 8-Unsecured Convertible Senior Notes" to our Consolidated Financial Statements in this Annual Report on Form 10-K.
Loss on Early Extinguishment of Debt
Year Ended December 31, 2020 2019 2018 (In thousands)
Loss on early extinguishment of debt
In August and
In
Other Income Year Ended December 31, 2020 2019 2018 (In thousands) Other income$ 654 $ 1,553 $ 1,781 Other income principally includes sublease rental income and interest earned on our cash and investments. The variations between years is primarily due to$0.8 million of expenses incurred in 2020 in connection with terminating the portion of the capped call related to the 2023 Notes that we repurchased. Income Tax Benefit Year Ended December 31, 2020 2019 2018 (In thousands) Income tax benefit$ 12,011 $ -$ 12,929 The income tax benefit in 2020 and 2018 is related to the issuance of the 2026 and 2023 Notes, respectively. See Part II, Item 8, "Note 13-Income Taxes" for additional information. 54 Table of Contents
Financial Condition - Liquidity and Capital Resources
As ofDecember 31, 2020 , we had$135.0 million in cash, cash equivalents and short-term investments available for general corporate use held primarily in money-market accounts as compared to$60.8 million atDecember 31, 2019 . We have historically generated net losses and incurred negative cash flows. For the year endedDecember 31, 2020 , we incurred net losses of$138.1 million and incurred negative cash flows from operations of$100.1 million . The net loss and the negative cash flows from operations were significantly affected by (1) reduced OMIDRIA revenues due to uncertainties regarding the reimbursement status of OMIDRIA following expiration of the drug's pass-through status and associated separate payment by CMS onOctober 1, 2020 and (2) the impact of COVID-19 on the number of cataract surgeries performed nationally. InDecember 2020 , CMS confirmed that OMIDRIA qualifies for separate payment when used in the ASC setting. See Part 1, Item 1, "Business-Commercial Product-OMIDRIA" for additional details regarding the reimbursement status for OMIDRIA. FDA accepted our BLA for narsoplimab in HSCT-TMA for priority review and has indicated a Prescription Drug User Fee Act ("PDUFA") date ofJuly 17, 2021 . We expect to launch narsoplimab commercially for HSCT-TMA in theU.S. very soon following FDA approval, and preparations to execute our sales and marketing strategies for launch are underway. These plans include various milestones at which we commit to incremental activities, such as field sales hiring, and provide for flexibility in the timing of costs incurred should the approval of narsoplimab occur in advance or after the current PDUFA date. If warranted, we will adjust the timing and associated costs of our HSCT-TMA launch activities as we advance through the BLA review and approval process. We plan to continue to fund our operations for at least the next twelve months with our cash and investments on hand, from sales of OMIDRIA and, if FDA approval is granted, from sales of narsoplimab for HSCT-TMA. There is also the possibility that narsoplimab will generate revenues in the treatment of COVID-19. In addition, we may utilize funds available under our accounts receivable-based line of credit, which allows us to borrow up to 85% of our available accounts receivable borrowing base less certain reserves or$50.0 million , whichever is less. We may also sell shares of our common stock through our "at the market" equity offering program. For additional information regarding this program, see Part II, Item 9B, "Other Information." Should it be necessary or determined to be strategically advantageous, we also could pursue debt financings, public and private offerings of our equity securities similar to those we have completed previously, or other strategic transactions, which may include licensing all or a portion of any of our existing technologies. Should it be necessary to manage our operating expenses, we would reduce our projected cash requirements through reduction of our expenses by delaying clinical trials, reducing selected research and development efforts, or implementing other restructuring activities. Cash Flow Data Year Ended December 31, 2020 2019 2018 (In thousands) Selected cash flow data Cash provided by (used in): Operating activities$ (100,086) $ (60,073) $ (103,737) Investing activities$ (67,031) $ (3,401) $ 25,151 Financing activities$ 174,534 $ 60,697 $ 81,053 Operating Activities. Net cash used in operating activities increased for the year endedDecember 31, 2020 by$40.0 million compared to the same period in 2019. The difference largely resulted from the$53.6 million increase in our net loss from 2019, a$33.0 million increase in cash used in accounts payable and accrued expense, and a$3.6 million increase in cash used for prepaid and other assets. These uses were partially offset by a$43.7 million increase in cash provided from collections of accounts receivable and an increase in non-cash charges of$5.6 million . 55 Table of Contents
Net cash used in operating activities decreased for the year endedDecember 31, 2019 by$43.7 million as compared to the same period in 2018. The decrease largely resulted from the$42.3 million decrease in our net loss from 2018 due to an increase in OMIDRIA product sales of$81.9 million , partially offset by a$33.1 million increase in total cost and expenses. In addition, increases in non-cash charges of$6.1 million in 2019 compared to 2018 also positively impacted the change in our cash used in operating activities. The net change in operating assets and liabilities of$5.1 million also reduced our net cash used in operations for the year endedDecember 31, 2019 compared to the same period in 2018. Investing Activities. Cash flows from investing activities primarily reflect cash used to purchase short-term investments and proceeds from the sale of short-term investments, thus causing a shift between our cash and cash equivalents and short-term investment balances. Because we manage our cash usage with respect to our cash, cash equivalents and short-term investments, we do not consider the fluctuations in cash flows from investing activities to be important to the understanding of our liquidity and capital resources. Net cash used in investing activities during 2020 was$67.0 million , an increase of$63.6 million from the$3.4 million net cash used in investing activities for the same period in 2019, driven by an increase in purchases of investments of$133.2 million offset by proceeds from sale and maturities of investments of$66.4 million . Net cash used investing activities during 2019 was$3.4 million , a decrease of$28.6 million from the$25.2 million net cash provided by investing activities for the same period in 2018. The net change in our investments sold compared to purchased decreased by$28.8 million providing cash to fund our operations. Financing Activities. Net cash provided by financing activities in the year endedDecember 31, 2020 was$174.5 million , a net increase of$113.8 million over the same period in 2019. The increase compared to the prior year was due to receiving cash proceeds of$76.9 million , net, from the issuance of our 2026 Notes, which includes the payments for partial repurchase of our 2023 Notes, payments for debt issuance costs, proceeds from termination of our 2023 capped call, and purchases of capped calls related to our 2026 Notes. In addition, we received net proceeds of$93.7 million from ourAugust 2020 public offering of our common stock. Net cash provided by financing activities in the year endedDecember 31, 2019 was$60.7 million , a net decrease of$20.4 million over the same period in 2018, InDecember 2019 , we received$54.2 million net proceeds from a public offering of our common stock. Convertible Notes
For more information regarding the 2023 and 2026 Notes, see Part II, Item 8, "Note 8-Unsecured Convertible Senior Notes" to our Consolidated Financial Statements in this Annual Report on Form 10-K.
Line of Credit
We have a Line of Credit Agreement, under which we may draw, on a revolving basis, up to the lesser of$50.0 million and 85.0% of our eligible accounts receivable, less certain reserves. The Line of Credit Agreement is secured by all our assets excluding intellectual property and development program inventories and matures onAugust 2, 2022 . As ofDecember 31, 2020 , we had no outstanding borrowings under the Line of Credit Agreement and we were in compliance with all covenants. For more information regarding the Line of Credit Agreement, see Part II, Item 8, "Note 7-Debt" to our Consolidated Financial Statements in this Annual Report on Form 10-K. 56
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Contractual Obligations and Commitments
The following table presents a summary of our contractual obligations and
commitments as of
Payments Due Within More than 1 Year 2-3 Years 4-5 Years 5 Years Total (In thousands) Operating leases$ 6,536 $ 13,501 $ 13,970 $ 12,593 $ 46,600
Finance leases (principal and interest) 1,205 771 30 - 2,006 Unsecured convertible senior notes - 95,000 - 225,030 320,030 Goods & services 11,042 20,979
123 - 32,144 Total$ 18,783 $ 130,251 $ 14,123 $ 237,623 $ 400,780
Operating Leases
We lease our office and laboratory space inThe Omeros Building under a lease agreement with BMR - 201Elliott Avenue LLC . The initial term of the lease ends inNovember 2027 and we have two options to extend the lease term, each by five years. We lease office and laboratory equipment under various operating and finance lease agreements with initial terms of five years or less. As ofDecember 31, 2020 , the remaining aggregate non-cancelable rent payable under the initial term of the lease, excluding common area maintenance and related operating expenses, is$46.6 million .
Convertible Notes
Refer to "Financial Condition-Liquidity and Capital Resources-Convertible Notes" above.
Goods & Services
We have certain non-cancelable obligations under other agreements for the
acquisitions of goods and services associated with the manufacturing of our
product candidates, which contain firm commitments. As of
We may be required, in connection with in-licensing or asset acquisition agreements, to make certain royalty and milestone payments and we cannot, at this time, determine when or if the related milestones will be achieved or whether the events triggering the commencement of payment obligations will occur. Therefore, such payments are not included in the table above. For information regarding agreements that include these royalty and milestone payment obligations, see Part II, Item 8, "Note 10-Commitments and Contingencies" to our Consolidated Financial Statements in this Annual Report on Form 10-K.
Critical Accounting Policies and Significant Judgments and Estimates
The preparation of our consolidated financial statements, in conformity withU.S. generally accepted accounting principles ("GAAP"), requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances; however, actual results could differ from those estimates. An accounting policy is considered critical if it is important to a company's financial condition and results of operations and if it requires the exercise of significant judgment and the use of estimates on the part of management in its application. Although we believe that our judgments and estimates are appropriate, actual results may differ materially from our estimates. For a summary of our critical accounting policies, See Part II, Item 8, "Note 2-Significant Accounting Policies" to our Consolidated Financial Statements in this Annual Report on Form 10-K. 57
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We believe the following to be our critical accounting policies because they are both important to the portrayal of our financial condition and results of operations and they require critical judgment by management and estimates about matters that are uncertain: ? revenue recognition;
? research and development expenses, primarily related to the manufacturing of
drug product;
? accounting for lease agreements, primarily related to our computation of
incremental borrowing rate;
? accounting for convertible debt issuances, primarily related to fair valuing
debt and issuance costs; and
? stock-based compensation, primarily related to our fair value assumptions.
If actual results or events differ materially from those contemplated by us in making these estimates, our reported financial condition and results of operations for future periods could be materially affected.
Revenue Recognition
Product Sales, Net: We typically record revenue from product sales when the product is delivered to our wholesalers which is generally when we satisfy all performance obligations. Product sales are recorded net of wholesaler distribution fees and estimated chargebacks, rebates, returns and purchase-volume discounts. Accruals or allowances are established for these deductions in the same period when revenue is recognized, and actual amounts incurred are offset against the applicable accruals or allowances. We reflect each of these accruals or allowances as either a reduction in the related accounts receivable or as an accrued liability depending on how the amount is expected to be settled. Chargebacks and Rebates: Provisions for chargebacks are determined utilizing historical and projected payer mix and information regarding sell-through and inventory on-hand received directly from wholesalers. Chargebacks are generally settled within four weeks of recording product sales revenue. We provide reimbursement support services and financial assistance in the form of a rebate to patients whose commercial insurance is inadequate to cover the full cost of OMIDRIA. We apply an experience ratio based on historical and projected patient claims. This experience ratio is applied to product sales to determine the patient rebate accrual and is reviewed and updated periodically to reflect actual results. We provide rebate payments for which ASCs qualify by meeting or exceeding purchase volumes of OMIDRIA under our purchase volume-discount program. We calculate rebate payment amounts due under this program based on actual qualifying purchase volumes and apply a contractual discount rate. For purchases of OMIDRIA not yet reported as sold-through to the ASC by our wholesalers, we apply an experience ratio to product sales to determine the rebate accrual. This experience ratio is reviewed and updated periodically to reflect actual results. Distribution Fees and Product Return Allowances: We pay our wholesalers a distribution fee for services that they perform for us based on the wholesaler average cost value of their purchases of OMIDRIA. We record a provision against product sales for these charges at the time of sale to the wholesaler. We allow for the return of product up to 12 months past its expiration date or for product that is damaged. In estimating product returns, we take into consideration our return experience to date, the remaining shelf-life of product we have previously sold, inventory in the wholesale channel and our expectation that product is typically not held by the health care providers based on the frequency of their reorders. 58
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Research and Development Expenses
Research and development costs are comprised primarily of:
? contracted research and manufacturing costs;
? clinical study costs;
? costs of personnel, including salaries, benefits and stock compensation;
? consulting arrangements;
? depreciation and an allocation of our occupancy costs; and
? other expenses incurred to sustain our overall research and development
programs.
Contracted research and manufacturing costs are primarily incurred in the development and production of our drug substance and drug product candidates. Prior to approval, our estimates are based on the timing of services provided. We record accrued expenses equal to our estimated expense in excess of amount invoiced by the suppliers. Clinical trial expenses are estimated on a cost per patient that varies depending on the clinical trial site. As actual costs become known to us, we adjust our estimates; these changes in estimates may result in understated or overstated expenses at any given point in time.
Right-of-Use Assets and Related Lease Liabilities
OnJanuary 1, 2019 , we adopted Accounting Standards Update (ASU) 2016-02, Leases, (Topic 842) using a modified retrospective approach versus recasting the prior periods presented. For a summary of the adoption of this critical accounting policies, See Part II, Item 8, "Note 2-Significant Accounting Policies" to our Consolidated Financial Statements in this Annual Report on Form 10-K. We record operating leases on our Consolidated Balance Sheet as right-of-use assets and recognize the related lease liabilities equal to the fair value of the lease payments using our incremental borrowing rate when the implicit rate in the lease agreement is not readily available. We derived our incremental borrowing rate by assessing rates in recent market transactions, as adjusted for security interests and our credit quality. A change in the calculated incremental borrowing rate of 100 basis points would not be material to our consolidated financial statements.
Stock-Based Compensation
Stock-based compensation expense is recognized for all share-based payments made to employees, directors and non-employees based on estimated fair values. The fair value of our stock options is calculated using the Black-Scholes option valuation model, which requires assumptions, including volatility, forfeiture rates and expected option life. We estimate forfeitures for expense recognition based on our historical experience. Groups of employees that have similar historical forfeiture behavior are considered separately. If any of the assumptions used in the Black-Scholes model change significantly, stock-based compensation expense for new awards may differ materially from that recorded for existing awards and stock-based compensation for non-employees will vary as the awards are re-measured over the vesting term.
Recent Accounting Pronouncements
Please refer to Part II, Item 8, "Note 2--Significant Accounting Policies" to our Consolidated Financial Statements in this Annual Report in Form 10-K for information regarding recent accounting pronouncements. 59
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Off-Balance Sheet Arrangements
We have not engaged in any off-balance sheet arrangements.
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