5. Financial assets and liabilities

This note provides information about the Group's financial instruments, including:

•

an overview of all financial instruments held by the Group;

•

specific information about each type of financial instrument;

•

accounting policies; and

•

information used to determine the fair value of the instruments, including judgments and estimation uncertainty involved.

The Group holds the following financial instruments:

Financial assets (in U.S. dollars, in thousands)	Notes	Assets at FVOCI⁽¹⁾		Assets at FVTPL⁽²⁾		Assets at amortized cost		Total
As of June 30, 2018
Cash & cash equivalents	5(a)		—		—		37,763		37,763
Trade & other receivables	5(b)		—		—		50,366		50,366
Available-for-sale financial asset	5(c)		2,321		—		—		2,321
Other non-current assets	5(d)		—		—		3,361		3,361
			2,321		—		91,490		93,811
As of June 30, 2017
Cash & cash equivalents	5(a)		—		—		45,761		45,761
Trade & other receivables	5(b)		—		—		3,743		3,743
Available-for-sale financial asset	5(c)		1,997		—		—		1,997
Other non-current assets	5(d)		—		—		1,916		1,916
			1,997		—		51,420		53,417

(1)	Fair value through other comprehensive income

(2)	Fair value through profit or loss

Financial liabilities (in U.S. dollars, in thousands)	Notes	Liabilities at FVOCI⁽¹⁾		Liabilities at FVTPL⁽²⁾		Liabilities at amortized cost		Total
As of June 30, 2018
Trade and other payables	5(e)		—		—		18,921		18,921
Borrowings	5(f)		—		—		59,397		59,397
Contingent considerations	5(g)(iii)		—		42,070		—		42,070
			—		42,070		78,318		120,388
As of June 30, 2017
Trade and other payables	5(e)		—		—		21,805		21,805
Contingent considerations	5(g)(iii)		—		63,595		—		63,595
			—		63,595		21,805		85,400

(1)	Fair value through other comprehensive income

(2)	Fair value through profit or loss

The Group’s exposure to various risks associated with the financial instruments is discussed in Note 10. The maximum exposure to credit risk at the end of the reporting period is the carrying amount of each class of financial assets mentioned above.

a.	Cash and cash equivalents


	As of June 30,
(in U.S. dollars, in thousands)	2018		2017
Cash at bank		37,221		7,722
Deposits at call⁽¹⁾		542		38,039
		37,763		45,761

(1)	As of June 30, 2018 and June 30, 2017, interest-bearing deposits at call include amounts of $0.4 million and $0.5 million, respectively, held as security and are restricted for use.

(i)	Classification as cash equivalents

Term deposits are presented as cash equivalents if they have a maturity of three months or less from the date of acquisition.

b.	Trade and other receivables and prepayments

(i)	Trade receivables

	As of June 30,
(in U.S. dollars, in thousands)	2018		2017
Trade debtors		6,630		474
Funds receivable from debt financing and unissued capital⁽¹⁾		38,950		—
Income tax and tax incentives recoverable		3,305		1,631
Other receivables		615		698
Foreign withholding tax recoverable		471		471
Security deposit		250		250
Sundry debtors		81		120
Other recoverable taxes (Goods and services tax and value-added tax)		53		87
Interest receivables		11		12
Trade and other receivables		50,366		3,743

(1)

On July 2, 2018, the Group announced that the Group had entered into a financing agreement with NovaQuest on June 29, 2018 to develop and commercialize its allogeneic product candidate MSC-100-IV for pediatric patients with acute Graft versus Host Disease ("aGVHD”). The contractual terms of the agreement pertaining to the receipt of funds were binding and therefore the Group recognized a receivable of $39.0 million at June 30, 2018. On July 10, 2018 the net proceeds from the financing facility of $39.0 million were received and recognized in cash and cash equivalents.

(ii)	Prepayments

	As of June 30,
(in U.S. dollars, in thousands)	2018		2017
Clinical trial research and development expenditure		12,042		13,571
Other		759		340
Prepaid insurance and subscriptions		141		194
Prepayments		12,942		14,105

(iii) Classification as trade and other receivables

Interest receivables are amounts due at maturity of term deposits. All trade and other receivable balances are within their due dates and none are considered to be impaired as of June 30, 2018 and June 30, 2017.

(iv) Other receivables

These amounts generally arise from transactions outside the usual operating activities of the Group.

(v) Fair values of trade and other receivables

Due to the short-term nature of the current receivables, their carrying amount is assumed to be the same as their fair value.

(vi) Impairment and risk exposure

Information about the impairment of trade and other receivables, their credit quality and the Group’s exposure to credit risk, foreign currency risk and interest rate risk can be found in Note 10(a) and (b).

c.	Available-for-sale financial assets

Available-for-sale financial assets include the following classes of financial assets:

	As of June 30,
(in U.S. dollars, in thousands)	2018		2017
Unlisted securities:
Equity securities		2,321		1,997
		2,321		1,997

(i) Classification of financial assets as available-for-sale

Investments are designated as available-for-sale financial assets if they do not have fixed maturities and fixed or determinable payments, and management intends to hold them for the medium to long-term. Financial assets that are not classified into any of the other categories (at FVTPL, loans and receivables or held-to-maturity investments) are also included in the available-for-sale category.

The financial assets are presented as non-current assets unless they mature, or management intends to dispose of them within 12 months of the end of the reporting period.

(ii) Impairment indicators for available-for-sale financial assets

A security is considered to be impaired if there has been a significant or prolonged decline in the fair value below its cost. See Note 22(l)(v) for further details about the Group’s impairment policies for financial assets.

(iii) Amounts recognized in other comprehensive income

For the years ended June 30, 2018, 2017 and 2016, the Group recognized in statement of comprehensive income a gain of $0.3 million, a gain of $Nil and a loss of $0.3 million respectively, for change in fair value of the available-for-sale financial assets.

(iv) Fair value, impairment and risk exposure

Information about the methods and assumptions used in determining fair value is provided in Note 5(g). None of the available-for-sale financial assets are either past due or impaired.

All available-for-sale financial assets are denominated in USD.

d.	Other non-current assets

	As of June 30,
(in U.S. dollars, in thousands)	2018		2017
Bank Guarantee		710		738
Letter of Credit		1,178		1,178
U.S. Tax credits		1,473		—
		3,361		1,916

(i) Classification of financial assets as other non-current assets

Bank guarantee

These funds are held in an account named Mesoblast Limited at National Australia Bank according to the terms of a Bank Guarantee which is security for the sublease agreement for our occupancy of Level 38, 55 Collins Street, Melbourne, Victoria, Australia. The Bank Guarantee is security for the full and faithful performance and observance by the subtenant of the terms, covenants and conditions of the sublease. The Bank Guarantee continues in force until it is released by the lessor.

Letter of credit

These funds held in an account named Mesoblast, Inc. at the Bank of America according to the terms of an irrevocable standby letter of credit which is security for the sublease agreement for our occupancy of 505 Fifth Avenue, New York, New York, United States of America. The letter of credit is security for the full and faithful performance and observance by the subtenant of the terms, covenants and conditions of the sublease. The letter of credit is deemed to automatically extend without amendment for a period of one year at each anniversary but will not automatically extend beyond the final expiration of July 31, 2021.

U.S. Tax credits

These funds are receivable from the Internal Revenue Service (“IRS”) as a result of the changes in the U.S. corporate income tax legislation with the Tax Act which was signed into law in December 2017. Tax credits arising from the Alternative Minimum Tax (“AMT”) regime have become refundable in 2021.

(ii) Impairment and risk exposure

No other non-current assets are either past due or impaired.

e.	Trade and other payables

	As of June 30,
(in U.S. dollars, in thousands)	2018		2017
Trade payables and other payables		18,921		21,805
Trade and other payables		18,921		21,805

The carrying amounts of trade and other payables are assumed to be the same as their fair values, due to their short-term nature.

f.Borrowings

	As of June 30,
(in U.S. dollars, in thousands)	2018			2017
Current
Secured liabilities:
Borrowing arrangements		—			—
		—			—

Non-current
Secured liabilities:
Borrowing arrangements		65,000			—
Less: transaction costs		(6,328	)		—
Amortization of transaction costs		725			—
		59,397			—

(i) Borrowing arrangements

Hercules Capital, Inc.

On March 6, 2018, the Group drew the first tranche of $35.0 million of the principal amount from the $75.0 million 9.45% floating rate loan with Hercules. An additional $40.0 million may be drawn as certain milestones are met. The loan matures in March 2022 with principal repayments commencing in October 2019 with the ability to defer the commencement of principal repayments up to October 2020 if certain milestones are met. Interest on the loan is payable monthly in arrears on the 1^st day of the month. At closing date, the interest rate was 9.45%. On March 22, 2018 and June 14, 2018, in line with the increases in the U.S. prime rate, the interest rate on the loan increased to 9.70% and 9.95%, respectively.

The carrying amount of the non-current loan is secured by a first charge over the assets of the Group, excluding $0.7 million of bank guarantees and $1.2 million of letters of credit included in other non-current assets (refer to Note 5(d)), $0.5 million of interest-bearing deposits at call included in cash and cash equivalents (refer to Note 5(a)) and $0.2 million of cash held as security included in trade and other receivables (refer to Note 5(b)). These items have been used to secure liabilities other than the non-current loan.

NovaQuest Capital Management, L.L.C.

On June 29, 2018, we drew the first tranche of $30.0 million of the principal amount from the $40.0 million secured loan with NovaQuest. There is a four-year interest only period, until July 2022, with the principal repayable in equal quarterly instalments over the remaining period of the loan. The loan matures in July 2026. Interest on the loan will accrue at a fixed rate of 15% per annum.

All interest and principal payments will be deferred until after the first commercial sale of our allogeneic product candidate MSC-100-IV in pediatric patients with steroid refractory aGVHD, in the United States and other geographies excluding Asia (“pediatric aGVHD”). We can elect to prepay all outstanding amounts owing at any time prior to maturity, subject to a prepayment charge, and may decide to do so if net sales of pediatric aGVHD are significantly higher than current forecasts.

If there are no net sales of pediatric aGVHD, the loan is only repayable on maturity in 2026. If in any annual period 25% of net sales of pediatric aGVHD exceed the amount of accrued interest owing and, from 2022, principal and accrued interest owing (“the payment cap”), Mesoblast will pay the payment cap and an additional portion of excess sales which may be used for early prepayment of the loan. If in any annual period 25% of net sales of pediatric aGVHD is less than the payment cap, then the payment is limited to 25% of net sales of pediatric aGVHD. Any unpaid interest will be added to the principal amounts owing and shall accrue further interest. At maturity date, any unpaid loan balances are repaid.

Because of this relationship of net sales and repayments, changes in our estimated net sales may trigger an adjustment of the carrying amount of the financial liability to reflect the revised estimated cash flows. The carrying amount adjustment is recalculated by computing the present value of the revised estimated future cash flows at the financial instrument’s original effective interest rate. The adjustment is recognized in the Income Statement in the period the revision is made.

The carrying amount of the loan is subordinated to the senior creditor, Hercules.

(ii) Compliance with loan covenants

The Group has complied with the financial covenants of its borrowing facilities during the year ended June 30, 2018. There were no borrowings during the year ended June 30, 2017.

(iii) Net debt reconciliation

(in U.S. dollars, in thousands)	Current borrowings		Non-current borrowings			Total
As of June 30, 2017		—		—			—
Changes from financing cash flows
Proceeds from debt		—		31,704			31,704
Payment of transaction costs		—		(392	)		(392	)
Repayment of loans		—		—			—
Movement in short-term borrowings		—		—			—
Total changes in liabilities arising on financing cash flows		—		31,312			31,312
Non-cash changes
Funds receivable from debt financing		—		28,950			28,950
Accrued transaction costs		—		(1,590	)		(1,590	)
Amortization of transaction costs		—		725			725
As of June 30, 2018		—		59,397			59,397

(iv) Fair values of borrowing arrangements

The carrying amount of the borrowings at amortized cost in accordance with our accounting policy is a reasonable approximation of fair value.

g.Recognized fair value measurements

(i) Fair value hierarchy

The following table presents the Group's financial assets and financial liabilities measured and recognized at fair value as of June 30, 2018 and June 30, 2017 on a recurring basis, categorized by level according to the significance of the inputs used in making the measurements:

As of June 30, 2017
(in U.S. dollars, in thousands)	Notes	Level 1		Level 2		Level 3		Total
Financial Assets
Available-for-sale financial assets:
Equity securities - biotech sector	5(c)		—		—		1,997		1,997
Total Financial Assets			—		—		1,997		1,997

Financial Liabilities
Financial liabilities at fair value through profit or loss:
Contingent consideration	6(d)		—		—		63,595		63,595
Total Financial Liabilities			—		—		63,595		63,595

As of June 30, 2018
(in U.S. dollars, in thousands)	Notes	Level 1		Level 2		Level 3		Total
Financial Assets
Available-for-sale financial assets:
Equity securities - biotech sector	5(c)		—		—		2,321		2,321
Total Financial Assets			—		—		2,321		2,321

Financial Liabilities
Financial liabilities at fair value through profit or loss:
Contingent consideration	6(d)		—		—		42,070		42,070
Total Financial Liabilities			—		—		42,070		42,070

There were no transfers between any of the levels for recurring fair value measurements during the period.

The Group’s policy is to recognize transfers into and transfers out of fair value hierarchy levels as at the end of the reporting period.

Level 1: The fair value of financial instruments traded in active markets (such as publicly traded derivatives, and trading and available-for-sale securities) is based on quoted market prices at the end of the reporting period. The quoted market price used for financial assets held by the Group is the current bid price. These instruments are included in level 1.

Level 2: The fair value of financial instruments that are not traded in an active market (for example, foreign exchange contracts) is determined using valuation techniques which maximize the use of observable market data and rely as little as possible on entity-specific estimates. If all significant inputs required to fair value an instrument are observable, the instrument is included in level 2.

Level 3: If one or more of the significant inputs is not based on observable market data, the instrument is included in level 3. This is the case for provisions (contingent consideration) and equity securities (unlisted).

(ii) Valuation techniques used.

The Group used the discounted cash flow analysis to determine the fair value measurements of level 3 instruments.

(iii) Fair value measurements using significant unobservable inputs (level 3)

The following table presents the changes in level 3 instruments for the years ended June 30, 2018 and June 30, 2017:

(in U.S. dollars, in thousands)	Contingent consideration provision
Opening balance - July 1, 2016		63,716
Amount used during the year		(251	)
Charged/(credited) to consolidated income statement:
Remeasurement⁽¹⁾		130
Closing balance - June 30, 2017		63,595

Opening balance - July 1, 2017		63,595
Amount used during the year		(10,984	)
Charged/(credited) to consolidated income statement:
Remeasurement⁽²⁾		(10,541	)
Closing balance - June 30, 2018		42,070

(1)

In the year ended June 30, 2017 a loss of $0.1 million was recognized on the remeasurement of contingent consideration pertaining to the acquisition of assets from Osiris. This loss is a net result of changes to the key assumptions of the contingent consideration valuation such as developmental timelines, probability of success, market penetration, market population and the increase in valuation as the time period shortens between the valuation date and the potential settlement dates of contingent consideration.

(2)

In the year ended June 30, 2018 a gain of $10.5 million was recognized on the remeasurement of contingent consideration pertaining to the acquisition of assets from Osiris. This gain is a net result of changes to the key assumptions of the contingent consideration valuation such as developmental timelines, product pricing, market population, market penetration and the increase in valuation as the time period shortens between the valuation date and the potential settlement dates of contingent consideration.

(iv) Valuation inputs and relationship to fair value

The following table summarizes the quantitative information about the significant unobservable inputs used in level 3 fair value measurements:

Range of inputs

(weighted average)

(in U.S. dollars, in thousands, except percent data)

Fair value as of

June 30,

Valuation

Unobservable

Year Ended

June 30,

Relationship of

unobservable inputs to

Description

2018

2017

technique

inputs⁽¹⁾

2018

2017

fair value

Contingent consideration provision

42,070

63,595

Discounted cash flows

Risk adjusted

discount rate

11%-13%

(12.5%)

11%-13%

(12.5%)

Year ended June 30, 2018: A change in the discount rate by 0.5% would increase/decrease the fair value by 1%.

Year ended June 30, 2017: A change in the discount rate by 0.5% would increase/decrease the fair value by 1%.

Expected unit

revenues

n/a

Year ended June 30, 2018: A 10% increase/decrease in the price assumptions adopted would increase/decrease the fair value by 4%.

Year ended June 30, 2017: A 10% increase/decrease in the price assumptions adopted would increase/decrease the fair value by 5%.

Expected sales volumes

n/a

Year ended June 30, 2018: A 10% increase/decrease in sales volume assumptions adopted would increase/decrease the fair value by 4%.

Year ended June 30, 2017: A 10% increase/decrease in sales volume assumptions adopted would increase/decrease the fair value by 5%.

(1)	There were no significant inter-relationships between unobservable inputs that materially affect fair values.

(v) Valuation processes

In connection with the Osiris acquisition, on October 11, 2013 (the “acquisition date”), an independent valuation of the contingent consideration was carried out by an independent valuer.

For the years ended June 30, 2018 and 2017, the Group has adopted a process to value contingent consideration internally. This valuation has been completed by the Group’s internal valuation team and reviewed by the Chief Financial Officer (the "CFO"). The valuation team is responsible for the valuation model. The valuation team also manages a process to continually refine the key assumptions within the model. This is done with input from the relevant business units. The key assumptions in the model have been clearly defined and the responsibility for refining those assumptions has been assigned to the most relevant business units. The remeasurement charged to the consolidated income statement was a net result of changes to key assumptions such as developmental timelines, product pricing, market population, market penetration, probability of success and the increase in valuation as the time period shortens between the valuation date and the potential settlement dates of contingent consideration.

The fair value of contingent consideration	As of June 30,
(in U.S. dollars, in thousands)	2018		2017
Fair value of cash or stock payable, dependent on achievement of future late-stage clinical or regulatory targets		23,674		34,501
Fair value of royalty payments from commercialization of the intellectual property acquired		18,396		29,094
		42,070		63,595

The main level 3 inputs used by the Group are evaluated as follows:

Risk adjusted discount rate:

The discount rate used in the valuation has been determined based on required rates of returns of listed companies in the biotechnology industry (having regards to their stage of development, their size and number of projects) and the indicative rates of return required by suppliers of venture capital for investments with similar technical and commercial risks. This assumption is reviewed as part of the valuation process outlined above.

Expected unit revenues:

Expected market sale price of the most comparable products currently available in the market place. This assumption is reviewed as part of the valuation process outlined above.

Expected sales volumes: Expected sales volumes of the most comparable products currently available in the market place. This assumption is reviewed as part of the valuation process outlined above.