4. Revenue

Revenue Recognition and Net Product Sales

As disclosed in note 2, the Company recognizes product revenue from sales of MACI Kits, MACI implants and Epicel grafts following the five step model in ASC 606.

MACI Kits

MACI (and previously Carticel) kits are sold directly to hospitals based on contracted rates in the approved contract or sales order. The Company recognizes MACI (or Carticel) kit revenue upon delivery of the biopsy kit at which time the customer (the doctor) is in control of the kit. The kit provides the doctor the ability to biopsy a sampling of cells to provide to the Company that can be used later to manufacture the implant. The ordering of the kit does not obligate the Company to manufacture an implant nor does the receipt of the cell tissue. The customer’s order of an implant is separate from the process of ordering the kit. Therefore, the sale of the kit and any subsequent sale of an implant are distinct contracts and are accounted for separately.

MACI Implants

The Company recognizes product revenues from sales of MACI (and previously Carticel) implants upon delivery at which time the customer is in control of the implant and the claim is billable. Prior authorization or confirmation of coverage level by the patient’s private insurance plan, hospital or government payer is a prerequisite to the shipment of product to a patient. Depending upon the type of contract and whom the payer is for the MACI implant, the Company's net product revenues are based on contracted rates or estimated based on expected payments from the insurance provider, hospital or patient. The estimates of such payment amounts vary by customer and payer and are based on either contracted rates, publicly available rates or past payer precedents. Changes in estimates are recorded through revenue in the period such change occurs. Net product revenues from sales to distributors may include a prompt pay discount.

On July 25, 2018 and August 10, 2018, the Company entered into amendments to its distribution agreement with Orsini Pharmaceutical Services, Inc. (Orsini). The amendments modified certain payment terms for surgeries after June 15, 2018. In addition, under the revised agreement, the parties agreed to eliminate Orsini's right to serve as the Company's exclusive distributor for MACI as the Company moves to a limited expanded network of distributors. Orsini remains the exclusive pharmacy supplying MACI for only an enumerated list of payers. The amended agreement includes a provision whereby the Company retains the credit and collection risk from the end customer on implants after June 15, 2018. Orsini performs the collection activities. The net product revenues for these cases are based on expected payments from the insurance provider, hospital or patient. The estimates of such payment amounts vary by customer and payer and are based on either contracted rates, publicly available rates or past payer precedents. Changes in estimates are recorded through revenue in the period such change occurs. Pursuant to the revised arrangement, the Company pays Orsini a dispensing fee on a per implant basis.

In addition, in consideration of Orsini’s future administrative services related to the amendment, the Company has agreed to pay Orsini an incremental service fee based on a fixed number of MACI cases subsequent to the date of amendment of approximately$1.3 million which is fully expensed as of December 31, 2018.

On July 26, 2018, the Company entered into a Dispensing Agreement (Dispensing Agreement) with AllCare Plus Pharmacy, Inc. (AllCare). Pursuant to the Dispensing Agreement, the Company appoints AllCare as a non-exclusive specialty pharmacy provider of MACI. The Company pays AllCare a fee for each patient to whom MACI is dispensed. Under the Dispensing Agreement, the Company retains the credit and collection risk from the end customer on all implants. The net product revenues for these cases are based on contracted rates stated in the approved contract or other documentation with the insurance provider, hospital or patient.

Epicel

The Company sells Epicel directly to hospitals based on contracted rates stated in the approved contract or purchase order. Similar to MACI, there is no obligation to manufacture skin grafts upon receipt of a skin biopsy, and Vericel has no contractual right to receive payment until the product is delivered to the hospital. The Company recognizes product revenues from sales of Epicel upon delivery to the hospital at which time the customer is in control of the skin grafts and the claim is billable to the hospital.

Revenue by Product and Customer

The following table and description below shows the products from which the Company generated its revenue:



	Year Ended December 31,
Revenue by product (in thousands)	2018			2017			2016
MACI and Carticel implants and kits
Implants - based on contracted rate	$	40,830		$	30,366		$	17,027
Implants - based on third party reimbursement	25,096			12,122			20,299
Biopsy kits - direct bill	1,997			1,764			1,545
Change in estimates related to prior periods	(182		)	(350		)	—
Epicel
Direct bill (hospital)	23,116			18,858			15,512
License Revenue	—			1,164			—
Total revenue	$	90,857		$	63,924		$	54,383

Revenue Recognition for License Grants, Milestone and Royalty Payments

The Company recognizes other revenue from contracts with customers related to license grants, milestone related payments and royalty based payments by following the five step model described above.

On May 10, 2017, the Company announced that it has entered into a License Agreement (License Agreement) with ICT, a leading cell therapy company and developer of CAR-T cell therapy for cancer treatment, for the development, manufacturing and commercialization of the Company's product portfolio in Greater China, South Korea, Singapore, and other countries in Asia. ICT acquired an exclusive license to certain patent rights, know-how and intellectual property relating to Carticel, MACI, ixmyelocel-T, and Epicel for the purpose of developing, manufacturing and commercializing the Company's products in the territory described above. The initiation of the technology transfer, the license grants in the License Agreement and the warrant purchase were contingent upon the Company’s receipt of the upfront payment. ICT will be responsible for funding the development of the programs and manufacturing of the products for commercialization in China and the rest of the territory. On December 21, 2017, the Company received $5.2 million (gross of withholding tax), of which $4.0 million was allocated to the warrant based on the fair value on the date of grant as described in note 12 and the remaining $1.2 million was recognized as described below.

Upon adoption of ASC 606, the Company reassessed the accounting for its license agreement with Innovative Cellular Therapeutics CO., LTD. (ICT). The Company identified its performance obligations under the agreement, which include the license, a training obligation, and supply of certain raw materials for technology transfer. Based on its assessment of this agreement under the new revenue standard the Company determined that the license is distinct and provides ICT with the right to use the Company's technology and accordingly revenue should be recognized at the point in time at which the Company delivered the license (December 2017). This evaluation was based on 1) the rights provided to ICT under the license, including the ability to sublicense, 2) the nature of the technology (primarily rights to technology already commercially approved in the US) and 3) ICT's ability to benefit from the license on its own including using its own existing resources as a manufacturer of autologous cell therapies. The transaction price was determined to be $1.2 million. No milestones or royalties are included in the transaction price as the criteria for including these variable payments have not yet been met. The Company assessed the allocation of arrangement consideration noting no differences in allocation from that determined under ASC 605. The license was delivered in December 2017, and revenue of $1.2 million was recorded in 2017 under the then applicable revenue accounting standard ASC 605. Based upon the Company's evaluation under ASC 606 there was no change in amount or timing of revenue recognized for the agreement, and therefore no cumulative change adjustment was recorded upon adoption of the new revenue standard on January 1, 2018. The Company has no significant performance obligations remaining under the agreement.

The ICT license agreement provides for future milestone payments due to the Company upon the achievement of certain developmental and commercial events. The Company evaluates these milestones under the new revenue recognition standard at contract inception and at each reporting period date. Based on the Company’s evaluations to date, the Company has not included any of the future milestones in its determination of the transaction price because the criteria for including these variable payments have not yet been met. This evaluation was based on 1) the pace and eventual achievement of the milestones are largely dependent on ICT’s performance of its contractual obligations and the Company has no prior experience to determine the likelihood of ICT performing those obligations, and 2) the transfer of the funds for each of the milestone payments by ICT to the Company, if achieved, is subject to approval by the State Administration of Foreign Exchange of the People's Republic of China. The Company does not anticipate receiving any milestone payments in the near-term. Furthermore, there can be no assurance that the Company will receive any such milestone or receive any such transfer of funds from ICT ever.

The ICT license agreement contains future sales-based royalties to the Company in the low-to-mid double digits. These royalties meet the exception for sales-based or usage-based royalties because they predominantly relate to the license and will be recognized when and if the subsequent sales occur. However, there can be no assurance that the Company will receive any such royalties or receive any such transfer of funds from ICT ever.

Concentration of Credit Risk

From July 2016 through June 2017, the Company utilized a direct sales model and contracted with Dohmen Life Science Services, LLC (DLSS) to provide administrative services associated with case management and reimbursement support and to provide billing and collection services for MACI. The Company also utilized Vital Care, Inc. (Vital Care) to provide similar billing and collection services for a subset of insurance payers and patients. In the second quarter of 2017, the Company and DLSS mutually terminated their agreement effective June 30, 2017. On May 15, 2017, the Company entered into a distribution agreement with Orsini Pharmaceutical Services, Inc. as a specialty pharmacy distributor of MACI and has engaged a third party services provider to provide the patient support program previously provided by DLSS and to manage patient cases for MACI. The Company’s receivables risk and credit risk became more concentrated from June 30, 2017 through June 15, 2018 due to the shift from DLSS to Orsini. Beginning June 16, 2018, the concentration of risk decreased because the Company retains the credit and collection risk from the end customer on implants after June 15, 2018. The Company sells Epicel directly to hospitals and not through a distributor.

The Company's total revenue and accounts receivable balances were comprised of the following concentrations from its largest customers of Carticel, MACI and Epicel, as follows:



	Revenue Concentration						Accounts Receivable Concentration
	Year Ended December 31,						December 31,
	2018		2017		2016		2018		2017
Carticel and MACI	16	%	35	%	31	%	2	%	46	%
Epicel	7	%	10	%	11	%	4	%	3	%