Nature of Business and Summary of Significant Accounting Policies (Policies)

12 Months Ended

Dec. 31, 2012

Nature of Business and Summary of Significant Accounting Policies [Abstract]

Organization

Organization:

BioDelivery Sciences International, Inc. (the “Company”) was incorporated in the State of Indiana on January 6, 1997 and reincorporated as a Delaware corporation in 2002. The Company and its subsidiaries (Arius Pharmaceuticals, Inc., a Delaware corporation (“Arius One”) and Arius Two, Inc., a Delaware corporation (“Arius Two”), each of which are wholly-owned, and its majority-owned subsidiary, Bioral Nutrient Delivery, LLC, a Delaware limited liability company (“BND”) are collectively referred herein to as the “Company.”

The Company is a specialty pharmaceutical company that is leveraging its novel, proprietary and patented BioErodible MucoAdhesive (“BEMA^®”) drug delivery technology to develop and commercialize, either on its own or in partnerships with third parties, new applications of proven therapeutics, primarily in the areas of pain management and oncology supportive care. The Company’s development strategy focuses on utilization of the U.S. Food and Drug Administration’s (“FDA”) 505(b)(2) approval process to obtain more timely and efficient approval of new formulations of previously approved therapeutics.

As used herein, the Company’s common stock, par value $.001 per share, is referred to as the “Common Stock”.

Principles of consolidation

Principles of consolidation:

The consolidated financial statements include the accounts of the Company, Arius One, Arius Two and BND. BND is currently and has for several years been an inactive subsidiary. All significant inter-company balances and transactions have been eliminated.

Cash and cash equivalents

Cash and cash equivalents:

Cash and cash equivalents include all highly liquid investments with an original maturity of three months or less. The Company’s cash equivalents include Ultra Short Term Government Funds. Because of the short-term maturities of the Company’s cash and cash equivalents, the Company does not believe that an increase in market rates would have a significant impact on the realized value of its investments. The Company places cash and cash equivalents on deposit with financial institutions in the United States. The Federal Deposit Insurance Corporation (“FDIC”) covers $250,000 for substantially all depository accounts. In addition, the FDIC provided unlimited coverage for certain qualifying and participating non-interest bearing transaction accounts through December 31, 2012; however, effective January 1, 2013 the FDIC discontinued the additional unlimited coverage. The Company may from time to time have amounts on deposit in excess of the insured limits. As of December 31, 2012, the Company had approximately $24.2 million which exceed these insured limits.

Revenue recognition

Revenue recognition:

The Company periodically enters into license and development agreements to develop and commercialize its products. The arrangements typically are multi-deliverable arrangements that are funded through up-front payments, milestone payments and other forms of payment. The Company currently has two major license and development agreements that are described in notes 5 and 6. The Company adopted the milestone method of accounting in 2010.

Meda License, Development and Supply Agreement:

General

The Company entered into license, development and supply agreements (collectively, the “Meda Agreements”) with Meda AB, a Swedish company (“Meda”), in September 2007 (covering the United States, Canada and Mexico) and August 2006 (covering certain countries in Europe) to develop and commercialize the Company’s sole FDA-approved and marketed product, ONSOLIS ^® (fentanyl buccal soluble film), a treatment with an initial indication for “breakthrough” cancer pain. ONSOLIS ^® is a product consisting of the narcotic fentanyl formulated with the Company’s patented BEMA ^® technology. The Company’s deliverables under the Meda Agreements, including the Company’s related rights and obligations, contractual cash flows and performance periods, are more fully described in note 5.

License and product development research and development services revenue

Based on the Company’s assessment of each arrangement, all deliverables under the Meda Agreements have been accounted for as one combined unit of accounting and, as such, all cash payments from Meda (upfront payments and product development research and development services revenue) related to these deliverables were recorded as deferred revenue. Upon delivery of the license rights to Meda in October 2009, the Company recognized revenue associated with the license and the research and development services rendered related to development of the ONSOLIS^® product through the date of FDA and other governmental approval. A portion of the upfront payments have been attributed to the Company’s continuing obligation to participate in joint committees with Meda and to provide certain other specified services and this revenue will be recognized as services are provided through expiration of the license agreements.

Endo License and Development Agreement:

General

The Company entered into a worldwide license and development agreement (the “Endo Agreement”) with Endo Pharmaceuticals, Inc. (now known as Endo Health Solutions) (“Endo”) in January 2012 to develop and commercialize the Company’s product candidate BEMA^® Buprenorphine. BEMA ^® Buprenorphine is a partial mu-opioid agonist and a potential treatment for moderate to severe chronic pain. The Company’s deliverables under the Endo Agreement, including the Company’s related rights and obligations, contractual cash flows and performance periods, are more fully described in note 6.

License and product development research and development services revenue

Upon delivery of the license rights for BEMA ^® Buprenorphine to Endo in January 2012, the Company recognized revenue of $15.6 million of the $30 million non-refundable up-front license fee, with the balance of $14.4 million recorded as deferred revenue to be recognized as the related research and development services are rendered. Of the amount deferred, the Company recognized $5.2 million as revenue in 2012. In addition, in May 2012 the Company received and recognized $15 million in revenue associated with an intellectual property milestone under the Endo Agreement.

Reimbursement of direct out-of-pocket costs (research revenue)

Reimbursement of direct out-of-pocket costs (research revenue)

The Company pays fees to regulatory agencies and other out-of-pocket costs for which it is reimbursed at cost, without mark-up or profit. The gross amount of these reimbursed research and development costs are reported as research revenue in the consolidated statements of operations. Criteria for qualifying as such are transactions where the Company acts as a principal, has discretion to choose suppliers, bears credit risk and may perform part of the services required in the transactions. The actual expenses creating the reimbursements are reflected as research and development expense.

Contract Revenue

Contract Revenue

The Company earned contract revenue as a result of Meda up-front and milestone payments related to ONSOLIS ^®. Upon FDA approval of ONSOLIS ^® in July 2009, and the subsequent commercial launch of ONSOLIS ^® in October 2009, the Company recognized this contract revenue. The Company also recognized contract revenue as a result of the approval and subsequent launch of BREAKYL™ in the E.U. in 2012.

The Company also earned contract revenue as a result of Endo up-front and milestone payments related to the Company’s BEMA^® Buprenorphine product in 2012. The Company recognized as revenue $15.6 million of the $30 million non-refundable up-front license payment, with the balance of $14.4 million recorded as deferred revenue to be recognized as the related research and development services are rendered. Of the amount deferred, the Company earned $5.2 million in 2012. In addition, in May 2012 the Company received $15 million in revenue associated with an intellectual property milestone.

The Company also earned contract revenue in 2010 related to two similar license, development and supply agreements covering different territories: (i) Kunwha Pharmaceutical Co., Ltd., a Republic of Korea corporation (“Kunwha”), to develop, manufacture, sell and distribute BEMA ^® Fentanyl in the Republic of Korea, and (ii) TTY Biopharm Co., Ltd., a Taiwanese company (“TTY”), to develop, manufacture, sell and distribute the Company’s BEMA ^® Fentanyl product in Taiwan. Upfront payments from Kunwha and TTY are recorded as contract revenue upon receipt. The Company earned contract revenue in 2011 related to a milestone from TTY upon government approval.

Sponsored Research

Sponsored Research

Sponsored research amounts are recognized as revenue when the research underlying such funding has been performed or when the grant funds have otherwise been properly utilized. Grant revenue is recognized to the extent provided for under the related grant or collaborative research agreement. This is shown as sponsored research revenue on the accompanying consolidated statements of operations.

Product Royalties

Product Royalties

The Company earns royalties based on a percentage of net sales revenue of the ONSOLIS ^® product. Product royalty revenues are computed on a quarterly basis when revenues are fixed or determinable, collectability is reasonably assured and all other revenue recognition criteria are met.

Cost of Product Royalties

Cost of Product Royalties

The cost of product royalties includes the direct costs attributable to the production of ONSOLIS ^®. It includes all costs related to creating the product at Aveva Drug Delivery Systems, Inc. (“Aveva”), the Company’s contract manufacturer. Only costs that are directly attributable to the production of the product are considered cost of royalty revenue. Aveva bills the Company for the material cost used in creating the product along with direct labor costs, and certain overhead costs as outlined in the supply agreement. Cost of product royalties also includes royalty expenses owed to third parties. These royalty expenses are directly related to the product sold during the period.

Research and Development Expenses

Research and Development Expenses

Research and development costs are expensed in the period in which they are incurred and include the expenses paid to third parties who conduct research and development activities on behalf of the Company.

Certain Risks, Concentrations and Uncertainties

Certain Risks, Concentrations and Uncertainties

The Company’s product candidates under development require approval from the FDA or other international regulatory agencies prior to commercial sales. For those product candidates that have not yet been so approved, there is a risk that they will not receive necessary approval. If approval is denied or delayed, it may have a material adverse impact on the Company. In addition, the Company’s products compete in rapidly changing, highly competitive markets which are characterized by advances in scientific discovery, changes in customer requirements, evolving regulatory requirements and developing industry standards. Any failure by the Company to anticipate or to respond adequately to scientific developments, changes in customer requirements, changes in regulatory requirements or industry standards, or any significant delays in the development or introduction of products or services could have a material adverse effect on the Company’s business, operating results and future cash flows.

Accounts receivable from one customer (Meda) accounted for 83% and 92% of the Company’s trade accounts receivable at December 31, 2012 and December 31, 2011, respectively. Deferred revenue balances relate to the Meda and Endo Agreements at December 31, 2012 and Meda Agreements only at December 31, 2011. The Company depends significantly upon the collaboration with Meda and Endo, and its activities may be impacted if these relationships are disrupted.

Key components used in the manufacture of ONSOLIS ^® are currently provided by sole or a limited number of suppliers. This could result in the Company’s inability to timely obtain an adequate supply of required components and reduce control over pricing, quality and timely delivery. Also, if the supply of any components is interrupted, components from alternative suppliers may not be available in sufficient volumes within required time frames, if at all, to meet the Company’s obligations under the

Meda supply agreements. This could delay timely commercialization efforts by Meda, causing the Company to lose royalty revenue and potentially harming its reputation.

Deferred revenue

Deferred revenue

Consistent with the Company’s revenue recognition policy, deferred revenue represents cash received in advance for licensing fees, consulting, research and development services and related supply agreements. Such payments are reflected as deferred revenue until recognized under the Company’s revenue recognition policy. Deferred revenue is classified as current if management believes the Company will be able to recognize the deferred amount as revenue within twelve months of the balance sheet date.

Equipment

Equipment

Office and Manufacturing equipment are carried at cost less accumulated depreciation, which is computed on a straight-line basis over their estimated useful lives, generally 5 to ten years.

Intangibles and Goodwill

Intangibles and Goodwill

The Company reviews intangible assets with finite lives for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company uses an estimate of the undiscounted cash flows over the remaining life of its long-lived assets, or related group of assets where applicable, in measuring whether the assets to be held and used will be realizable. In the event of impairment, the Company would discount the future cash flows using its then estimated incremental borrowing rate to estimate the amount of the impairment.

During the twelve months ended December 31, 2010, the Company determined not to pursue the Bioral ^® technology (ote 13). As such, the Company recorded a $0.2 million impairment charge, which removed the remaining intangible asset related to the Company’s Bioral^® cochleate drug delivery technology (a second delivery technology held under license by the Company or its predecessor since 1995). There was no impairment charge recognized on finite lived intangibles in 2011 or 2012.

Goodwill is evaluated for impairment at least annually or more frequently if events or changes in circumstances indicate that the carrying amount may not be recoverable. The impairment analysis involves a two-step process. Step one involves the comparison of the fair value of the reporting unit to which goodwill relates (the Company’s enterprise value) to the carrying value of the reporting unit. If the fair value exceeds the carrying value, there is no impairment. If the carrying value exceeds the fair value of the reporting unit, the Company determines the implied fair value of goodwill and records an impairment charge for any excess of the carrying value of goodwill over its implied fair value. There were no goodwill impairment charges in 2012, 2011 or 2010.

Use of estimates in financial statements

Use of estimates in financial statements:

The preparation of the accompanying consolidated financial statements requires management to make certain estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates and assumptions.

Net Income (loss) per common share

Net Income (loss) per common share:

Basic earnings per common share is calculated using the weighted average shares of Common Stock outstanding during the period. Common equivalent shares from stock options and warrants using the treasury stock method, are also included in the diluted per share calculations unless the effect of inclusion would be antidilutive. During the years ended December 31, 2012, 2011 and 2010, outstanding stock options and warrants of 5,509,072, 7,847,052 and 9,585,460, respectively, were not included in the computation of diluted earnings per common share, because to do so would have had an antidilutive effect because the outstanding exercise prices were greater than the average market price of the common shares during the relevant periods.

Stock-based compensation

Stock-based compensation:

The Company uses the fair-value based method to determine compensation for all arrangements under which employees and others receive shares of stock or equity instruments (warrants and options). The fair value of each option award is estimated on the date of grant using the Black-Scholes valuation model that uses assumptions for expected volatility, expected dividends, expected term, and the risk-free interest rate. Expected volatility is based on historical volatility of the Company’s Common Stock and other factors estimated over the expected term of the options. The expected term of options granted is derived using the “simplified method” which computes expected term as the average of the sum of the vesting term plus the contract term. The risk-free rate is based on the U.S. Treasury yield.

Fair Value of Financial Assets and Liabilities

Fair Value of Financial Assets and Liabilities

The Company measures the fair value of financial assets and liabilities in accordance with generally accepted accounting principles of the United States (“GAAP”) which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.

GAAP defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. GAAP also establishes a fair value hierarchy, which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. GAAP describes three levels of inputs that may be used to measure fair value:

Level 1 – quoted prices in active markets for identical assets or liabilities

Level 2 – quoted prices for similar assets and liabilities in active markets or inputs that are observable

Level 3 – inputs that are unobservable (for example cash flow modeling inputs based on assumptions)

Derivative instruments

Derivative instruments:

The Company generally does not use derivative financial instruments to hedge exposures to cash-flow, market or foreign-currency risks. However, the Company has entered into certain other financial instruments and contracts, such as debt financing arrangements and freestanding warrants with features that are either not afforded equity classification, embody risks not clearly and closely related to host contracts, or may be net-cash settled by the counterparty. These instruments are required to be carried as derivative liabilities, at fair value, in the Company’s consolidated financial statements.

The Company estimates fair values of derivative financial instruments using the Black-Scholes option valuation technique because it embodies all of the requisite assumptions (including trading volatility, estimated terms and risk free rates) necessary to fairly value these instruments. Estimating fair values of derivative financial instruments requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. In addition, option-based techniques are highly volatile and sensitive to changes in the Company’s trading market price which has high-historical volatility. Since derivative financial instruments are initially and subsequently carried at fair values, the Company’s income will reflect the volatility in these estimate and assumption changes.

Recent accounting pronouncements

Recent accounting pronouncements:

In May 2011, the FASB issued ASU 2011-04, Fair Value Measurement (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in GAAP and IFRSs (“ASU 2011-04”). ASU 2011-04 is intended to result in convergence between GAAP and International Financial Reporting Standards (“IFRS”) requirements for measurement of and disclosures about fair value. The amendments are not expected to have a significant impact on companies applying GAAP. Key provisions of the amendment include: a prohibition on grouping financial instruments for purposes of determining fair value, except when an entity manages market and credit risks on the basis of the entity’s net exposure to the group; an extension of the prohibition against the use of a blockage factor to all fair value measurements (that prohibition currently applies only to financial instruments with quoted prices in active markets); and a requirement that for recurring Level 3 fair value measurements, entities disclose quantitative information about unobservable inputs, a description of the valuation process used and qualitative details about the sensitivity of the measurements. In addition, for items not carried at fair value but for which fair value is disclosed, entities will be required to disclose the level within the fair value hierarchy that applies to the fair value measurement disclosed. ASU 2011-04 is effective for interim and annual periods beginning after December 15, 2011.

The Company adopted these standards on January 1, 2012. The adoption of this standard had no material impact on the Company’s condensed consolidated financial statements.

In July 2012, the FASB issued ASU 2012-02 – Testing Indefinite-Lived Intangible Assets for Impairment (“ASU 2012-02”) in order to reduce the cost and complexity of performing an impairment test for indefinite-lived intangible assets by simplifying how an entity tests those assets for impairment and to improve consistency in impairment testing guidance. The new guidance allows an entity the option to make a qualitative assessment about the likelihood that an indefinite-lived intangible asset is impaired to determine whether it should perform a quantitative impairment test. ASU 2012-02 is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012 and early adoption is permitted. The Company is currently evaluating ASU 2012-02, but does not expect the adoption of this standard to have a material impact on the Company’s condensed consolidated financial statements.