1.	Nature of business and summary of significant accounting policies:

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 drug delivery technologies, including the 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 addiction. 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

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.

Significant accounting policies:

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.

Reclassification

Idle Equipment previously classified separately in the accompanying balance sheets has been reclassified to Property and Equipment, net as of December 31, 2013 to conform to the current year presentation. In addition certain amounts within cash flows from operating activities in the Statements of Cash Flows for the year ended December 31, 2013 were reclassified to conform to the current year presentation. These reclassifications had no effect on the previous reported total assets, net cash flows from operations, activities or net losses.

Certain Risks, Concentrations and Uncertainties

The Company relies on certain materials used in its development and third-party manufacturing processes, most of which are procured from two contract manufacturers and two active pharmaceutical ingredient (“API”) suppliers for BUNAVAIL^®. The Company purchases its pharmaceutical ingredients pursuant to long-term supply agreements with a limited number of suppliers. The failure of a supplier, including a subcontractor, to deliver on schedule could delay or interrupt the development or commercialization process and thereby adversely affect the Company’s operating results. In addition, a disruption in the commercial supply of or a significant increase in the cost of the API from any of these sources could have a material adverse effect on the Company’s BUNAVAIL^® business, which would affect the Company’s financial position and results of operations.

In addition, the Company utilizes only one contract manufacturer to create the BUNAVAIL^® laminate and only one contract manufacturer to package the laminate into final product. Although the Company has long term supply agreements with these two vendors, any problems or regulatory issues at either of these vendors could create significant BUNAVAIL^® supply delays. Payments to the Company’s two contract manufacturers represented over 90% of the Company’s total inventory on-hand for the year ended December 31, 2014. Amounts due to these vendors represented approximately 12.3% of total accounts payable as of December 31, 2014.

Key components used in the manufacture of ONSOLIS^® are currently provided by 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 certain supply agreements. This could delay timely commercialization efforts causing our obligations to not be fulfilled

The Company sells its products primarily to large national wholesalers, which in turn may resell the products to smaller or regional wholesalers, retail pharmacies, chain drug stores, government agencies and other third parties. The following table lists the Company’s customers that individually comprise greater than 10% of total accounts receivable:


	December 31,
Customer	2014			2013
Customer A		28	%		—
Customer B		24	%		—
Customer C		20	%		—
Customer D		14	%		—
Customer E		—			100	%

Total		86	%		100	%

Cash

The Company places cash and cash equivalents on deposit with financial institutions in the United States. The Federal Deposit Insurance Corporation covers $0.25 million for substantially all depository accounts. The Company may from time to time have amounts on deposit in excess of the insured limits. As of December 31, 2014, the Company had approximately $70.2 million, which exceeded these insured limits.

Accounts Receivable

The Company typically requires its customers to remit payments within the first 30 to 37 days, depending on the customer and the products purchased. In addition, the Company offers wholesale distributors a prompt payment discount if they make payments within these deadlines. This discount is generally 2%, but may be higher in some instances due to product launches or customer and/or industry expectations. Because the Company’s wholesale distributors typically take the prompt payment discount, the Company accrues 100% of the prompt payment discounts, based on the gross amount of each invoice, at the time of sale, and the Company applies earned discounts at the time of payment. The allowance for prompt payment discounts was $0.05 million and $0 as of December 31, 2014 and 2013, respectively.

The Company performs ongoing credit evaluations and does not require collateral. As appropriate, the Company establishes provisions for potential credit losses. In the opinion of management, no allowance for doubtful accounts was necessary as of December 31, 2014 or 2013. The Company writes off accounts receivable when management determines they are uncollectible and credits payments subsequently received on such receivables to bad debt expense in the period received. There were no write-offs during the years ending December 31, 2014, 2013, or 2012.

Inventory

Inventories are stated at the lower of cost or market value with costs determined for each batch under the first-in, first-out method and specifically allocated to remaining inventory. Inventory consists of raw materials, work in process and finished goods. Raw materials include API for a product to be manufactured, work in process includes the bulk inventory of laminate prior to being packaged for sale, and finished goods include pharmaceutical products ready for commercial sale.

On a quarterly basis, the Company analyzes its inventory levels and records allowances for inventory that has become obsolete, inventory that has a cost basis in excess of the expected net realizable value and inventory that is in excess of expected demand based upon projected product sales. There were no allowances recorded at December 31, 2014.

Inventory is composed of the following at December 31:


	2014		2013
Raw Materials & Supplies		544		—
Work-in-process		523		—
Finished Goods		761		—

Total Inventories		1,828		—

Property and Equipment

The Company records property and equipment at cost less accumulated depreciation, which is computed on a straight-line basis over its estimated useful lives, generally 3 to ten years.

Due to the postponement of the U.S. re-launch of ONSOLIS^® (note 6), related manufacturing equipment, net, totaling $2.4 million has been deemed idle. The Company evaluates the carrying value of the idle equipment when events or changes in circumstances indicate the related carrying amount may not be recoverable. The Company has recorded an impairment of certain equipment during the year ended December 31, 2014 that cannot be used to manufacture BUNAVAIL^®, totaling $0.3 million and is recorded as an impairment loss in other (expenses) income, net in the accompanying consolidated statements of operations. The remaining idle equipment is being re-tooled and prepared to manufacture BUNAVAIL^® to meet product demand in 2015.

Intangibles and Goodwill

The Company reviews intangible assets with finite lives (“other intangible assets”) 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 other intangible 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.

There were no impairment charges recognized on finite lived intangibles in 2014, 2013 or 2012.

Intangible assets with finite useful lives are amortized over the estimated useful lives as follows:


		Estimated Useful Lives
Licenses		14 years
U.S. Product rights		10-12 years
EU Product rights		11 years

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. In the course of the evaluation of the potential impairment of Goodwill, either a qualitative or a quantitative assessment may be performed. If a qualitative evaluation determines that no impairment exists, then no further analysis is performed. If a qualitative evaluation is unable to determine whether impairment has occurred, a quantitative evaluation is performed. The quantitative 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 2014, 2013 or 2012.

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.

The Company is also deferring its sales of BUNAVAIL^® and recognizes these revenues as product is sold through to the end user based on prescriptions filled.

Revenue recognition

Net Product Sales

Product Sales- The Company recognizes revenue from its product sales upon transfer of title, which occurs when product is received by its customers. The Company sells its products primarily to large national wholesalers, which have the right to return the products they purchase. The Company is required to reasonably estimate the amount of future returns at the time of revenue recognition. The Company recognizes product sales net of estimated allowances for, rebates, price adjustments, chargebacks, and prompt payment and other discounts. When the Company cannot reasonably estimate the amount of future product returns, it defers revenues until the risk of product return has been substantially eliminated.

As of December 31, 2014 and 2013, the Company had $0.8 million and $0 million of deferred revenue related to sales to wholesalers for which future returns could not be reasonably estimated at the time of sale. Deferred revenue is recognized when the product is sold to the end user, based upon prescriptions filled. To estimate product sold to end users, the Company relies on third-party information, including prescription data and information obtained from significant distributors with respect to their inventory levels and sales to customers. Deferred revenue is recorded net of estimated allowances for rebates, price adjustments, chargebacks, prompt payment and other discounts. Estimated allowances are recorded and classified as accrued expenses in the accompanying balance sheets as of December 31, 2014 (Note 3).

Product Returns- Consistent with industry practice, the Company offers contractual return rights that allow its customers to return the products within an 18-month period that begins six months prior to and ends twelve months subsequent to expiration of the products. The Company does not believe it has sufficient experience with BUNAVAIL^® to estimate its returns at time of exfactory sales. When the Company cannot reasonably estimate the amount of future product returns, it records revenues when the risk of product return has been substantially eliminated which is at the time the product is sold through to the end user.

Rebates- The liability for government program rebates is calculated based on historical and current rebate redemption and utilization rates contractually submitted by each program’s administrator.

Price Adjustments and Chargebacks- The Company’s estimates of price adjustments and chargebacks are based on its estimated mix of sales to various third-party payers, which are entitled either contractually or statutorily to discounts from the Company’s listed prices of its products. In the event that the sales mix to third-party payers are different from the Company’s estimates, the Company may be required to pay higher or lower total price adjustments and/or chargebacks than it had estimated and such differences may be significant.

The Company, from time to time, offers certain promotional product-related incentives to its customers. These programs include certain product incentives to pharmacy customers and other sales stocking allowances. The Company has voucher programs for BUNAVAIL^® whereby the Company offers a point-of-sale subsidy to retail consumers. The Company estimates its liabilities for these voucher programs based on the historical redemption rates for similar completed programs used by other pharmaceutical companies as reported to the Company by a third-party claims processing organization and actual redemption rates for the Company’s completed programs. The Company accounts for the costs of these special promotional programs as price adjustments, which are a reduction of gross revenue.

Prompt Payment Discounts- The Company typically offers its wholesale customers a prompt payment discount of 2% as an incentive to remit payments within the first 30 to 37 days after the invoice date depending on the customer and the products purchased.

License and Development agreements

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 upfront payments, milestone payments and other forms of payment. The Company currently has multiple license and development agreements that are described in notes 6, 7 and 8. Depending on the nature of the contract these revenues are classified as research revenue, research and development reimbursements or contract revenue.

Deferred Cost of Sales

The Company defers its cost of sales in connection with BUNAVAIL^® sales at time of exfactory sales. These costs are recognized when the product is sold through to the end user. At December 31, 2014, the Company has $0.7 million of deferred costs of sales which are included in other current assets in the accompanying balance sheet.

Cost of Sales

The cost of sales includes the direct costs attributable to the production of ONSOLIS^® and BREAKYL™. It includes all costs related to creating the product at the Company’s contract manufacturing locations in the U.S. and Germany. The Company’s contract manufacturers bill the Company for the final product, which includes materials, direct labor costs, and certain overhead costs as outlined in applicable supply agreements. Cost of sales also includes royalty expenses that the Company owes to third parties.

For BUNAVAIL^®, cost of sales includes raw materials, production costs at our two contract manufacturing sites, quality testing directly related to the product, and depreciation on equipment that we have purchased to produce BUNAVAIL^®. It also includes any batches not meeting specifications and raw material yield loss. Yield losses and batches not meeting specifications are expensed as incurred. Cost of sales is recognized as actual product is sold through to the end user.

Research and Development Expenses

Research and development expenses consist of product development expenses incurred in identifying, developing and testing product candidates. Product development expenses consist primarily of labor, benefits and related employee expenses for personnel directly involved in product development activities; fees paid to professional service providers for monitoring and analyzing clinical trials; expenses incurred under joint development agreements; regulatory costs; costs of contract research and manufacturing of inventory used in testing and clinical trials; and the cost of facilities used by the Company’s product development personnel.

Product development expenses are expensed as incurred and reflect costs directly attributable to product candidates in development during the applicable period and to product candidates for which the Company has discontinued development. Additionally, product development expenses include the cost of qualifying new current Good Manufacturing Practice (“cGMP”) third-party manufacturers for the Company’s product candidates, including expenses associated with any related technology transfer. All indirect costs (such as salaries, benefits or other costs related to the Company’s accounting, legal, human resources, purchasing, information technology and other general corporate functions) associated with individual product candidates are included in general and administrative expenses.

Advertising

Advertising costs, which include promotional expenses and the cost of placebo samples, are expensed as incurred. Advertising expenses were $4.8 million, $0 and $0 for the years ended December 31, 2014, 2013 and 2012, respectively, and are included in selling, general and administrative expenses in the accompanying consolidated statements of operations.

Shipping and Handling Costs

Shipping and handling costs are included in selling, general and administrative expenses and totaled $0.06 million for the year ended December 31, 2014. There were no shipping costs for the years ended December 31, 2013 or 2012.

Net (loss) income per common share

The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per common share computations for the years ended December 31:


	2014			2013			2012
	(U.S. dollars, in thousands, except share and per share amounts)
Basic:
Net (loss) income attributable to common stockholders	$	(54,218	)	$	(57,394	)	$	1,652
Weighted average common shares outstanding		48,355,200			37,941,044			30,546,581

Basic earnings per common share	$	(1.12	)	$	(1.51	)	$	0.05

Diluted:
Effect of dilutive securities:
Net (loss) income attributable to common stockholders		(54,218	)		(57,394	)		1,652
Adjustments to income for dilutive options and warrants		—			—			—

		(54,218	)		(57,394	)		1,652
Weighted average common shares outstanding		48,355,200			37,941,044			30,546,581
Effect of dilutive options and warrants		—			—			142,654

Diluted weighted average common shares outstanding		48,355,200			37,941,044			30,689,235

Diluted earnings per common share	$	(1.12	)	$	(1.51	)	$	0.05

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, 2014, 2013 and 2012, outstanding stock options and warrants totaling 3,196,384, 6,549,719 and 5,509,075, 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

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 and warrant 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.

In applying the Black-Scholes options-pricing model, assumptions are as follows:


	2014	2013	2012
Expected price volatility	73.00%-78.05%	77.59%-81.65%	81.96%-83.69%
Risk-free interest rate	1.58%-1.70%	0.70%-1.60%	0.62%-1.02%
Weighted average expected life in years	6 years	5-6 years	5-6 years
Dividend yield	—	—	—

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

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 operating results will reflect the volatility in these estimate and assumption changes.

Recent accounting pronouncements

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update 2014-09, “Revenue from Contracts with Customers,” which supersedes the revenue recognition requirements of Accounting Standards Codification (“ASC”) Topic 605, “Revenue Recognition” and most industry-specific guidance on revenue recognition throughout the ASC. The new standard is principles-based and provides a five step model to determine when and how revenue is recognized. The core principle of the new standard is that revenue should be recognized when a company transfers promised goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. The new standard also requires disclosure of qualitative and quantitative information surrounding the amount, nature, timing and uncertainty of revenues and cash flows arising from contracts with customers. The new standard will be effective for the Company in the first quarter of the year ending December 31, 2017 and can be applied either retrospectively to all periods presented or as a cumulative-effect adjustment as of the date of adoption. Early adoption is not permitted. The Company is currently evaluating the impact of adoption of the new standard on its consolidated financial statements.