AVITA Medical, Inc. (RCEL) FY 2022 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS
Objective
The purpose of this Management's Discussion and Analysis is to better allow our investors to understand and view our company from management's perspective. We are providing an overview of our business and strategy including a discussion of our financial condition and results of operations. The following discussion and analysis of our financial condition and results of operations for the year-ended December 31, 2022 and 2021, should be read in conjunction with our consolidated financial statements and related notes included in this Annual Report.
Overview
AVITA Medical, Inc. is a regenerative medicine company leading the development and commercialization of devices and autologous cellular therapies for skin restoration. Our patented and proprietary RECELL® System technology platform harnesses the regenerative properties of a patient’s own skin to create Spray-On Skin™ Cells, an autologous skin cell suspension that is sprayed onto the patient to regenerate natural healthy skin.
Our objective is to become the leading provider of regenerative medicine addressing unmet medical needs in burn injuries, trauma injuries, and in dermatological and aesthetics indications, such as vitiligo. To achieve this objective, we intend to:
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| • | Become the standard of care in the U.S. burns industry by increasing RECELL System penetration in burn centers and with burn physicians |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| • | Commercialize the RECELL System in the U.S. for use in soft tissue repair following approval of our pending PMA supplement, which was submitted to the FDA in December 2022. Following anticipated FDA approval for soft tissue repair, we plan to commence a full commercial launch in July 2023 with both inpatient and outpatient reimbursement in place |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| • | Commercialize the RECELL System in the U.S. for use in treatment of vitiligo following approval of our pending PMA application, which was submitted to the FDA in December 2022. Subsequent to FDA approval for vitiligo, we will commence a full commercial launch following receipt of in-office reimbursement, which we anticipate will occur by January 2025 |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| • | Evaluate potential commercialization applications for the RECELL System related to skin rejuvenation and Epidermolysis Bullosa indications |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| • | Further invest in our RECELL System platform to automate and improve workflow, speed, and ease of use as it relates to specific indications, as well as to build upon our intellectual property estate |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| • | Continue to build upon commercial activities in Japan through our partnership with COSMOTEC Company, Ltd with our current PMDA approval for RECELL with an indication in burns |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| • | Develop and pursue viable commercial activities outside of the U.S. and Japan once we have received FDA approval with RECELL System indications in soft tissue and vitiligo |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| • | Pursue business development opportunities that are complementary to our core RECELL System indications and/or our targeted markets |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| • | Improve our margins and profitability by leveraging our current team and infrastructure across an expanding base of business in burns and in future indications |
Business Environment and Current Trends
The outbreak of the global pandemic and the associated response measures implemented by governments and businesses around the world, as well as subsequent accelerated and robust recovery in global business activity, have increased uncertainty in the business environment. These macroeconomic environment implications, including supply chain shortages, increased cost of healthcare, increased inflation rates, competitive and tight labor market, and other related global economic conditions and geopolitical conditions, remain unknown. Additionally, there have been various economic indicators that the United States economy may be entering a recession in upcoming quarters.
Changes in reimbursement rates by third party payors, may place additional financial pressure on hospitals and the broader healthcare system. Healthcare institutions may take actions to mitigate any persistent pressures on their budgets and such actions could impact the future demand for our products. Geopolitical conditions may also impact our operations. Although we do not have operations in Russia or Ukraine, the continuation of the Russia-Ukraine military conflict and/or an escalation of the conflict beyond its current scope may further weaken the global economy and could result in additional inflationary pressures and supply chain constraints.
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Although we do not believe that these trends have had a material effect on our business, financial condition or results of operations, it may in the future. If these conditions continue or worsen, they could adversely impact our future operating results. An economic recession could potentially impact the general business environment and the capital markets, which may have a material negative impact on our financial results.
Results of Operations
Year-Ended December 31, 2022, compared to the Year-Ended December 31, 2021
The table below summarizes the results of our continuing operations for each of the periods presented (in thousands).
| Year-Ended | Year-Ended | $ | % | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Statement of Operations Data: | December 31, 2022 | December 31, 2021 | Change | Change | ||||||||||||
| Revenues | $ | 34,421 | $ | 33,025 | $ | 1,396 | 4 | % | ||||||||
| Cost of sales | (6,041 | ) | (6,104 | ) | 63 | 1 | % | |||||||||
| Gross profit | 28,380 | 26,921 | 1,459 | 5 | % | |||||||||||
| BARDA income | 3,215 | 1,590 | 1,625 | 102 | % | |||||||||||
| Operating Expenses: | ||||||||||||||||
| Sales and marketing expenses | (21,913 | ) | (16,267 | ) | (5,646 | ) | (35 | )% | ||||||||
| General and administrative expenses | (23,330 | ) | (21,693 | ) | (1,637 | ) | (8 | )% | ||||||||
| Research and development expenses | (13,857 | ) | (15,669 | ) | 1,812 | 12 | % | |||||||||
| Total operating expenses | (59,100 | ) | (53,629 | ) | (5,471 | ) | (10 | )% | ||||||||
| Operating loss | (27,505 | ) | (25,118 | ) | (2,387 | ) | (10 | )% | ||||||||
| Interest expense | (16 | ) | (29 | ) | 13 | 45 | % | |||||||||
| Other income | 892 | 47 | 845 | nm* | ||||||||||||
| Loss before income taxes | (26,629 | ) | (25,100 | ) | (1,529 | ) | (6 | )% | ||||||||
| Provision for income tax | (36 | ) | (42 | ) | 6 | 14 | % | |||||||||
| Net loss | $ | (26,665 | ) | $ | (25,142 | ) | (1,523 | ) | (6 | )% |
*not meaningful
Total net revenue increased 4% or $1.4 million to $34.4 million, compared to $33.0 million in the corresponding period in the prior year which included $7.9 million from our delivery of units to managed inventory for the Biomedical Advanced Research and Development Authority (“BARDA”) (of the Office for the Assistant Secretary for Preparedness and Response) for emergency response preparedness. Total commercial revenue, which excludes BARDA revenue, increased by 36% or $9.0 million to $34.0 million in the full year-ended December 31, 2022, compared to $25.1 million in the corresponding period in the prior year. The growth in commercial revenues was largely driven by deeper penetration within individual customer accounts along with the commencement of commercial sales with our partner COSMOTEC in Japan.
Gross profit margin was 82% and relatively flat compared to the corresponding period in the prior year.
BARDA income consisted of funding from BARDA, under the Assistant Secretary for Preparedness and Response, within the U.S. Department of Health and Human Services, under ongoing USG Contract No. HHSO100201500028C. Under the BARDA contract, income of $3.2 million was recognized during the year-ended December 31, 2022, compared to income of $1.6 million for the same period in the prior year. BARDA income increased as a result of funding by BARDA for the pivotal trial for use of the RECELL System for soft tissue repair.
Total operating expenses increased 10% or $5.5 million to $59.1 million, compared to $53.6 million in the corresponding period in the prior year.
Sales and marketing expenses increased 35%, or $5.6 million, to $21.9 million, compared to $16.3 million recognized in the corresponding period in the prior year. Increased costs in the current year were primarily driven by higher selling costs, pre-commercialization costs and higher salaries and benefits. Higher selling costs are attributable to increased commissions due to increased revenue and higher costs for travel, hands-on professional education, and training. Increased pre-commercialization costs are driven by activities related to future RECELL launches in soft tissue repair and vitiligo. Higher salaries and benefits were primarily due to additional field personnel added to deepen penetration within individual customer accounts.
General and administrative expenses increased 8%, or $1.6 million, to $23.3 million, compared to $21.7 million recognized in the corresponding period in the prior year. The increase was primarily driven by higher salaries and benefits and share-based
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compensation expenses. Higher salaries and benefits costs were due to the expansion of our workforce to support overall operations along with severance costs associated with the termination of a former executive officer. Higher share-based compensation expense was due to the new equity grants in the current period, partially offset by the reversal of expense for unvested awards related to the termination of a former executive officer in the current year.
Research and development expenses decreased 12%, or $1.8 million, to $13.9 million, compared to $15.7 million recognized in the corresponding period in the prior year. Research and development costs were lower due to the following: pediatric burn study was closed for enrollment, soft tissue repair and vitiligo trial participants were in less costly follow-up phases this period compared to more costly recruitment and treatment phases in the prior period, and lower expense for sponsored research toward pipeline development in the current period. This is partially offset by higher development expenses in the current year from ongoing development of next generation devices for an automated preparation of Spray-On Skin™ Cells as compared to the prior year due to early prototype development and testing.
Net loss increased 6%, or $1.5 million, to $26.7 million, over the $25.1 million recognized in the corresponding period in the prior year. The increase in net loss was driven by higher operating expenses as described above, partially offset by higher revenue.
Transition Period Ended December 31, 2021, compared to the Six Months Ended December 31, 2020
The table below summarizes the results of our continuing operations for each of the periods presented (in thousands).
| Transition Period | Six Months Ended | $ | % | |||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Statement of Operations Data: | July 1 - December 31, 2021 | December 31, 2020 | Change | Change | ||||||||||||
| Revenues | $ | 13,956 | $ | 10,163 | 3,793 | 37 | % | |||||||||
| Cost of sales | (1,905 | ) | (1,750 | ) | (155 | ) | 9 | % | ||||||||
| Gross profit | 12,051 | 8,413 | 3,638 | 43 | % | |||||||||||
| BARDA income | 580 | 1,045 | (465 | ) | (44 | )% | ||||||||||
| Operating Expenses: | ||||||||||||||||
| Sales and marketing expenses | (8,472 | ) | (6,865 | ) | (1,607 | ) | 23 | % | ||||||||
| General and administrative expenses | (10,996 | ) | (11,703 | ) | 707 | (6 | )% | |||||||||
| Research and development expenses | (7,586 | ) | (6,735 | ) | (851 | ) | 13 | % | ||||||||
| Total operating expenses | (27,054 | ) | (25,303 | ) | (1,751 | ) | 7 | % | ||||||||
| Operating loss | (14,423 | ) | (15,845 | ) | 1,422 | (9 | )% | |||||||||
| Interest expense | (17 | ) | (10 | ) | (7 | ) | 70 | % | ||||||||
| Other income | 38 | 8 | 30 | 375 | % | |||||||||||
| Loss before income taxes | (14,402 | ) | (15,847 | ) | 1,445 | (9 | )% | |||||||||
| Income tax benefit (expense) | (25 | ) | (21 | ) | (4 | ) | 19 | % | ||||||||
| Net loss | $ | (14,427 | ) | $ | (15,868 | ) | 1,441 | (9 | )% |
Total net revenue increased 37% to $14.0 million, compared to $10.2 million in the corresponding period in the prior year. RECELL® commercial revenues were $13.8 million, while RECELL revenues associated with the U.S. Department of Health and Human Services’ Biomedical Advanced Research and Development Authority within the Office of the Assistant Secretary for Preparedness and Response (“BARDA”) were $0.2 million. Revenues associated with BARDA were attributable to the vendor managed inventory associated with the purchase of RECELL units for emergency preparedness by BARDA.
Gross profit margin was 86% compared with 83% in the corresponding period in the prior year, driven largely by the extension of our shelf-life and lower shipping costs.
BARDA income consisted of funding from BARDA, under the Assistant Secretary for Preparedness and Response, within the U.S. Department of Health and Human Services, under ongoing USG Contract No. HHSO100201500028C. Under the BARDA contract, income of $0.6 million was recognized during the transition period ended December 31, 2021, compared to income of $1.0 million for the same period in the prior year. BARDA income declined as a result of wind-down of certain activities associated with continued pivotal trials for the treatment of pediatric scald injuries.
Total operating expenses increased 7% to $27.1 million, compared to $25.3 million in the corresponding period in the prior year.
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Sales and marketing expenses increased 23%, or $1.6 million, to $8.5 million, compared to $6.9 million recognized in the corresponding period in the prior year. Increased costs in the current year are driven primarily by pre-commercialization planning for RECELL launches in soft tissue repair and vitiligo as well higher travel costs and increased hands-on professional education and training events. Higher travel costs along with professional and training events in the current period are driven by fewer COVID-19 related travel restrictions.
General and administrative expenses decreased 6%, or $0.7 million, to $11.0 million, compared to $11.7 million recognized in the corresponding period in the prior year. The decrease was driven by certain one-time professional services costs incurred in the prior period with establishing the Company as a domestic filer with the SEC following completion of the Redomiciliation, and severance costs associated with a former executive employee in the prior year.
Research and development expenses increased 13%, or $0.9 million, to $7.6 million, compared to $6.7 million recognized in the corresponding period in the prior year. The increase was primarily attributed to ongoing development of a next generation device for more automated preparation of Spray-On Skin™ Cells for vitiligo. In addition, we had higher costs associated with an increased rate of enrollment into our soft tissue repair clinical trial, as well as other research and development costs associated with furthering the Company’s pipeline.
Net loss decreased 9%, or $1.4 million, to $14.4 million, over the $15.9 million recognized in the corresponding period in the prior year. The decrease in net loss was driven by higher revenue during the year, partially offset by higher operating expenses as described above.
Liquidity and Capital Resources
Overview
We expect to utilize cash reserves until U.S. sales of our products reach a level sufficient to fund ongoing operations. AVITA Medical has historically funded its research and development activities, and more recently its substantial investment in sales and marketing activities, through raising capital by issuing securities, and it is expected that similar funding will be obtained to provide working capital if and when required. As of December 31, 2022, the Company had approximately $18.2 million in cash and cash equivalents and $68.1 million in marketable securities and believes it has sufficient cash reserves to fund operations for the next 12-months. If the Company is unable to raise capital in the future, the Company may need to curtail expenditures by scaling back certain research and development or other programs.
Financing Activities
On March 1, 2021, the Company issued 3,214,250 shares of common stock at an offering price of $21.50 per share in a registered underwritten offering. The gross proceeds from the offering were approximately $69.1 million.
AVITA Medical also benefits from cash inflows from the BARDA contract (discussed earlier in this Annual Report). We entered into the contract on September 29, 2015, and the scope has expanded through a number of amendments to the contract. The current contract period continues to December 31, 2023, with the option by BARDA to terminate earlier. The contract provided funding for the development of the RECELL System. The contract will continue to provide funding for future use of the product as a medical countermeasure to assist disaster preparedness and response in the U.S. for mass casualty events involving burn injuries.
Under the contract, BARDA has provided funding and technical support for the development of the RECELL System. BARDA funded the completion of two randomized, controlled pivotal clinical trials, as well as Compassionate Use and Continued Access programs, and development of the health economic model demonstrating the cost savings associated with the RECELL System. BARDA exercised a contract option to fund a randomized, controlled clinical trial for a pediatric early intervention study which commenced enrollment in March 2020, and closed to enrollment in June 2021, subsequent to FDA-approval of an expanded RECELL indication for use that includes treatment of pediatric patients. Currently, the BARDA contract is supporting the Company’s clinical trial in soft-tissue repair. Also included in the BARDA contract was a provision for procurement of the RECELL System under a vendor-managed inventory system to bolster emergency preparedness in the amount of $7.6 million. Further, BARDA expanded the awarded contract to provide supplemental funding of $1.6 million to support the logistics of emergency deployment of RECELL Systems for use in mass casualty or other emergency situations. We are contracted to manage this inventory of product until the federal government requests shipment or at contract termination on December 31, 2023. As of December 31, 2022, we had received cumulative payments of $37.9 million under the BARDA contract. For the year-ended December 31, 2022, we recognized $370,000 of revenue related to BARDA services provided to BARDA for emergency preparedness.
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Given the above, we believe there is presently sufficient working capital to support our committed research and development programs and other activities over the next twelve months and the Company believes it has the ability to realize its assets and pay its liabilities and commitments in the normal course of business.
The following table summarizes our cash flows for the periods presented:
| Year-Ended | Year-Ended | |||||||
|---|---|---|---|---|---|---|---|---|
| (In Thousands) | December 31, 2022 | December 31, 2021 | ||||||
| Net cash used in operations | $ | (19,090 | ) | $ | (18,024 | ) | ||
| Net cash used in investing activities | (19,332 | ) | (50,208 | ) | ||||
| Net cash provided by financing activities | 900 | 64,065 | ||||||
| Effect of foreign exchange rate on cash and cash equivalents and restricted cash | (26 | ) | (87 | ) | ||||
| Net increase/(decrease) in cash and cash equivalents and restricted cash | (37,548 | ) | (4,254 | ) | ||||
| Cash and cash equivalents and restricted cash at beginning of year | 55,712 | 59,966 | ||||||
| Cash and cash equivalents and restricted cash at end of year | 18,164 | 55,712 |
Net cash used in operating activities was $19.1 million during the year-ended December 31, 2022, and $18.0 million during the year-ended December 31, 2021. The increase was primarily resulted from higher operating costs, partially offset by increased revenues.
Net cash used in investing activities was $19.3 million during the year-ended December 31, 2022 and $50.2 million during the during the year-ended December 31, 2021. Cash flows used for investing activities were primarily attributable to investing excess cash in marketable securities in the prior year.
Net cash provided by financing activities was $0.9 million and $64.1 million for the year-ended December 31, 2022 and 2021 respectively. The decrease in cash provided by financing activities was due to the issuance of common stock during March 2021.
Capital Management and Material Cash Requirements
We aim to manage capital so that the Company continues as a going concern while also maintaining optimal returns to stockholders and benefits for other stakeholders. We also aim to maintain a capital structure that ensures the lowest cost of capital available to the Company. We regularly review the Company’s capital structure and seek to take advantage of available opportunities to improve outcomes for the Company and its stockholders.
For the annual period ended December 31, 2022, there were no dividends paid and we have no plans to commence the payment of dividends. We have no purchase commitments or long-term contractual obligations or purchase commitments, except for lease obligations as of December 31, 2022. Refer to Note 6 of our Consolidated Financial Statements for further details on our lease obligations. In addition, we have no off-balance sheet arrangements (as defined in the rules and regulations of the SEC) that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material investors. We have no committed plans to issue further shares on the market but will continue to assess market conditions and the Company’s cash flow requirements to ensure the Company is appropriately funded in order to pursue its various opportunities.
There is no significant external borrowing at the reporting date. Neither the Company nor any of the subsidiaries are subject to externally imposed capital requirement.
Critical Accounting Policies and Estimates
The SEC defines “critical accounting policies” as those that require the application of management’s most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain and may change in subsequent periods.
The preparation of consolidated financial statements in conformity with U.S. Generally Accepted Accounting Practices, or U.S. GAAP, requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We base those estimates on historical experience and on various assumptions that are believed to be reasonable under the circumstances. Actual results could differ from those estimates.
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The following listing is not intended to be a comprehensive list of all of our accounting policies. Our significant accounting policies are described in Note 2 to our consolidated financial statements contained elsewhere in this Annual Report. In many cases, the accounting treatment of a particular transaction is dictated by U.S. GAAP, with no need for our judgment in its application. There are also areas in which our judgment in selecting an available alternative would not produce a materially different result. We have identified the following as our critical accounting policies.
Revenue Recognition
The Company adopted ASC Topic 606 – Revenue from Contracts with Customers, on July 1, 2018. Under Topic 606, the Company recognizes revenue when its customers obtain control of promised goods or services, in an amount that reflects the consideration which the Company expects to be entitled in exchange for those goods or services.
To determine revenue recognition for arrangements that are within the scope of Topic 606, the Company performs the following five steps:
1.Identify the contract with a customer
2.Identify the performance obligations
3.Determine the transaction price
4.Allocate the transaction price to the performance obligations
5.Recognize revenue when/as performance obligation(s) are satisfied
In order for an arrangement to be considered a contract, it must be probable that the Company will collect the consideration to which it is entitled for goods or services to be transferred. Once the contract is determined to be within the scope of ASC 606, the Company assesses the goods or services promised with each contract, determines whether those are performance obligations and the related transaction price. The Company then recognizes the sale of goods based on the transaction price that is allocated to the respective performance obligation when the performance obligation is satisfied.
The Company’s revenue consists primarily of the sale of the RECELL System to hospitals or other treatment centers, COSMOTEC and to BARDA (collectively, “customers”), predominately in the United States. The Company evaluated the BARDA contract and concluded that a portion of the arrangement, such as the procurement of the RECELL system and the emergency preparedness, represents a transaction with a customer and as such are in the scope of ASC 606. Amounts received from BARDA for the research and development of the Company’s product are classified as BARDA income in the consolidated statement of operations and are accounted for under IAS 20. For further details refer to BARDA Income and Receivables below.
Revenues for commercial customers (COSMOTEC, hospitals and treatment centers) are recognized as control of the product is transferred to customers, at an amount that reflects the consideration expected to be received in exchange for the product. Revenues are recognized net of volume discounts. As such, revenue is recognized only to the extent a significant reversal of revenues is not expected to occur in subsequent periods. For the Company’s contracts that have an original duration of one year or less, the Company used the practical expedient applicable to such contracts and does not consider the time value of money. Further, because of the short duration of these contracts, the Company has not disclosed the transaction price for the remaining performance obligations as of each reporting period or when the Company expects to recognize this revenue. The Company has further applied the practical expedient to exclude sales tax in the transaction price and expense contract fulfilment costs such as commissions and shipping and handling expenses as incurred.
For revenues related to the BARDA contract with-in the scope of ASC 606, the Company identified two performance obligations (i) the procurement of 5,614 RECELL units, (ii) emergency preparedness services. Through this contract the Company promises to procure the product through a vendor management inventory arrangement and to stand ready to provide emergency deployment services related to the product. Emergency preparedness services include procuring necessary storage containers, housing, and maintaining the containers (and product), and providing shipping and handling services in the event of an emergency situation. This stand ready obligation is a series of distinct services that are substantially the same and have the same pattern of transfer to the customer, overtime as services are consumed.
The total transaction price for the portion of the BARDA contract that is with-in the scope of ASC 606, was determined to be $9.2 million. The transaction price was allocated on a stand-alone selling price basis as follows: $7.6 million to the procurement of the RECELL product, which is classified as revenues when recognized in the consolidated statement of operations and $1.6 million to the emergency deployment services is be classified as revenues when recognized in the consolidated statement of operations. The
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$1.6 million for emergency deployment includes variable consideration which is deemed immaterial to the contract as a whole. The Company estimated the stand-alone selling price of the procurement of the RECELL product based on historical pricing of the Company’s product at the initial execution of the contract. The Company estimated the stand-alone selling price of the emergency deployment services performed based on the Company’s projected cost of providing the services plus an applicable profit margin as denoted in the contract.
The Company’s performance obligations are either satisfied at a point in time or over time as services are provided. The product procurement performance obligation is satisfied at a point in time, upon transfer of control of the product. As such, the related revenue for these performance obligations is recognized at a point in time as revenue within the Company’s consolidated statement of operations. In addition to guidance under ASC 606, the Company recognizes revenue from the sales of RECELL product to BARDA for placement into vaccine stockpiles in accordance with Securities and Exchange Commission (SEC) Interpretation, Commission Guidance regarding Accounting for Sale of Vaccines and BioTerror Countermeasures to the Federal Government for Placement into the Pediatric Vaccine Stockpile or the Strategic National Stockpile (SNS). Under this guidance, revenue is recognized when product is placed in the BARDA vendor-managed inventory (“VMI”) as control of the product has been transferred to the customer at the time of delivery to the VMI. RECELL units that have been delivered to BARDA have a product replacement obligation at no cost to BARDA due to product’s limited shelf-life. The estimated cost of the expired inventory over the term of the contract is accrued on a per unit basis at the time of delivery. The liability is released upon replacement of the product along with a corresponding reduction to inventory. The emergency preparedness services performance obligation is satisfied over time. Revenue for the emergency deployment will be recognized on a straight-line basis during the term of the contract as services are consumed over time. Services recognized are included in sales within the consolidated statement of operations. Contract costs to fulfil the performance obligation are incremental and expected to be recovered are capitalized and amortized on a straight-line basis over the term of the contract. Contract costs are included in other long-term assets.
Contract Liabilities
The Company receives payments from customers based on contractual terms. Trade receivables are recorded when the right to consideration becomes unconditional. The Company satisfies its performance obligation on product sales when the products are shipped or delivered, depending on the terms of the sale. Payment terms on invoiced amounts are typically 30-90 days, and do not include a financing component. Contract liabilities are recorded when the Company receives payment prior to satisfying its obligation to transfer goods to a customer.
See Note 14 to our Consolidated Financial Statements included in this Annual Report for additional detail on revenue recognition.
Government Grants / BARDA Income and Receivables
AVITA Medical was granted a BARDA contract in September 2015, wherein BARDA provided funding to the AVITA Medical to support the ongoing U.S. clinical regulatory program towards FDA premarket approval, Compassionate Use program, clinical and health economics research, and U.S. pediatric burn programs.
Income under the BARDA contract is earned under a cost-plus-fixed-fee arrangement in which the Company is reimbursed for direct costs incurred plus allowable indirect costs and a fixed-fee earned. Billings under the contracts are based on approved provisional indirect billing rates, which permit recovery of fringe benefits, general and administrative expenses and a fixed fee.
The Company has concluded that grants are not within the scope of ASC 606, as they do not meet the definition of a contract with a “customer”. The Company has further concluded that Subtopic 958-605, Not-for-Profit-Entities-Revenue Recognition also does not apply, as the Company is a business entity, and the grants are with governmental agencies. Government grants and related receivables are recognized when there is reasonable assurance that the grant will be received, and all attaching conditions will be complied with. When the grant relates to an expense item, it is recognized as income over the periods necessary to match the grant on a systematic basis to the costs that it is intended to compensate. When the grant relates to an asset, the fair value is credited to deferred income and is released to the profit or loss over the expected useful life of the relevant asset by equal annual installments.
Share-Based Compensation
The Company records compensation expense for share-based payments to employees, including grants of stock options, restricted stock units and performance-based awards based on the fair market value of the awards on the date of grant. The fair value of share-based compensation awards is amortized over the vesting period of the award. Compensation expense for performance-based awards is measured based on the number of shares ultimately expected to vest, estimated at each reporting date based on management’s expectations regarding the relevant performance criteria.
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The Company estimates the fair value of tenure-based share options using the Black-Scholes option pricing model on the date of grant. The Company estimates the fair value of options with a performance condition and market condition using the Monte-Carlo simulation model. Restricted stock units are valued based on the market price on the grant date.
The following assumptions were used in the valuation of stock options.
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| • | Expected volatility – determined using the average of the historical volatility using daily intervals over the expected term and the derived volatility using the longest term available of 12 months. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| • | Expected dividends – None, based on the fact that the Company has never paid cash dividends and does not expect to pay any cash dividends in the foreseeable future. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| • | Expected term – the expected term of the Company’s stock options for tenure only vesting has been determined utilizing the “simplified” method as described in the SEC’s Staff Accounting Bulletin No. 107 relating to stock-based compensation. The simplified method was chosen because the Company has limited historical option exercise experience due to its short operating history of awards granted, the first plan was established in 2016 and was primarily used for Executives awards. Further, the Company does not have sufficient history of exercises in the U.S. market given the Company’s redomiciliation from Australia to the United States in 2020. The expected term of options with a performance condition or market condition was set to the contractual term of 10 years. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| • | Risk-free interest rate – the risk-free interest rate is based on the U.S. Treasury yield in effect at the time of grant for a period approximately equal to the expected term of the award. |
See Note 15 to our Consolidated Financial Statements included in this Annual Report for additional detail on share-based compensation.
Income Taxes
Income taxes are accounted for using the liability method. 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. 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 or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that a portion of the deferred tax asset will not be realized.
The Company reviews its uncertain tax positions regularly. An uncertain tax position represents the Company’s expected treatment of a tax position taken in a filed return or planned to be taken in a future tax return or claim that has not been reflected in measuring income tax expense for financial reporting purposes. The Company recognizes the tax benefit from an uncertain tax position when it is more-likely-than-not that the position will be sustained upon examination on the basis of the technical merits or the statute of limitations for the relevant taxing authority to examine and challenge the tax position has expired.
See Note 16 to our Consolidated Financial Statements included in this Annual Report for additional detail on income taxes.
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