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

12 Months Ended

Dec. 31, 2018

Organization

BioDelivery Sciences International, Inc. and subsidiaries (the “Company”) was incorporated in the State of Indiana on January 6, 1997 and reincorporated as a Delaware corporation in 2002. The Company’s subsidiaries are 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”).

The Company is a rapidly growing commercial-stage specialty pharmaceutical company dedicated to patients living with chronic pain. The Company has built a portfolio of products utilizing its novel and proprietary BioErodible MucoAdhesive (BEMA^®) drug-delivery technology, and other drug-delivery technologies to develop and commercialize new applications of proven therapies aimed at addressing important unmet medical needs. The Company now commercializes in the United States using its own sales force while working in partnership with third parties to commercialize its products outside the United States.

The Company’s historical clinical and regulatory development strategy has focused primarily on its ability to use the U.S. Food and Drug Administration’s (“FDA’s”) 505(b)(2) approval process to obtain more timely and efficient approval of new formulations of previously approved, active therapeutics incorporated into the Company’s drug-delivery technology.

As used herein, the Company’s common stock, par value $.001 per share, is referred to as the “Common Stock” and the Company’s preferred stock, par value $0.001 per share, is referred to as the “Preferred Stock”.

Principles of consolidation

Principles of consolidation

The consolidated financial statements include the accounts of the Company, Arius One, Arius Two and BND. For each period presented BND has been an inactive subsidiary. All significant inter-company balances and transactions have been eliminated.

Use of estimates in financial statements

Use of estimates in financial statements

The preparation of the accompanying consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. The Company reviews all significant estimates affecting the consolidated financial statements on a recurring basis and records the effect of any necessary adjustments prior to their issuance. Significant estimates of the Company include: revenue recognition, sales allowances such as returns of product sold, government program rebates, customer coupon redemptions, wholesaler/pharmacy discounts, product service fees, rebates and chargebacks, sales bonuses, stock-based compensation, determination of fair values of assets and liabilities relating to business combinations, and deferred income taxes.

Certain risks, concentrations and uncertainties

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 three contract manufacturers and two active pharmaceutical ingredient (“API”) suppliers for BELBUCA and 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 BELBUCA and BUNAVAIL business, which would affect the Company’s financial position and results of operations.

In addition, the Company utilizes only two contract manufacturers to create the BELBUCA and BUNAVAIL laminates and only one contract manufacturer to package the laminates 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 BELBUCA and BUNAVAIL supply delays. Amounts due to these vendors represented approximately 6.3% and 22.8% of total accounts payable as of December 31, 2018 and 2017, respectively.

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 the Company’s obligations to not be fulfilled.

The Company sells its BELBUCA and BUNAVAIL 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,
Customers	2018			2017
Customer A		47	%		47	%
Customer B		22	%		22	%
Customer C		25	%		26	%

Total		94	%		95	%

These three customers accounted for 92%, 92% and 91% of total annual sales during the years ended December 31, 2018, 2017 and 2016 respectively.

Cash

Cash

The Company places cash on deposit with financial institutions in the United States. The Federal Deposit Insurance Corporation covers $0.25 million for substantially all depository accounts. As of December 31, 2018, the Company had approximately $43.6 million, which exceeded these insured limits. As of December 31, 2017, the Company had approximately $21.2 million, which exceeded these insured limits.

Accounts receivable

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 and agreed upon terms. 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 $0.3 million and $0.2 million as of December 31, 2018 and 2017, respectively.

The Company performs ongoing credit evaluations and does not require collateral. As appropriate, the Company establishes provisions for potential credit losses. There were no allowances for doubtful accounts as of December 31, 2018 or 2017. 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.

Inventory

Inventory

Inventories are stated at the lower of cost or net realizable 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 amounts of active pharmaceutical ingredient for a product to be manufactured, work in process includes the bulk inventory of laminate (the Company’s drug delivery film) 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 more than the expected net realizable value and inventory that is more than expected demand based upon projected product sales. The Company recorded a $0.2 million in reserve for inventory obsolescence as of December 31, 2018, and 2017.

Inventory is composed of the following at December 31:


	2018			2017
Raw Materials & Supplies	$	645		$	1,338
Work-in-process		2,093			3,135
Finished Goods		2,855			1,861
Finished Goods Reserve		(187	)		(243	)

Total Inventories	$	5,406		$	6,091

Property and equipment

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 10 years.

The Company evaluates the carrying value of equipment when events or changes in circumstances indicate the related carrying amount may not be recoverable. The Company has certain manufacturing equipment that isn’t currently in production, which has been deemed idle. There was no impairment of equipment recorded during the year ended December 31, 2018 or 2017.

Intangibles and goodwill

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 2018, 2017 or 2016.

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


		Estimated Useful Lives
Licenses		15 years
BELBUCA license and distribution rights		10 years
U.S. product rights		8-12 years
EU product rights		7-11 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. During the evaluation of the potential impairment of goodwill, either a qualitative or a quantitative assessment may be performed. If a qualitative evaluation determines that it is more likely than not that no impairment exists, then no further analysis is performed. If a qualitative evaluation is unable to determine whether it is more likely than not that impairment has occurred, a quantitative evaluation is performed. If the carrying value exceeds the fair value, an impairment charge is recorded based on that difference. There were no goodwill impairment charges in 2018, 2017 or 2016.

Revenue recognition

Revenue recognition

Product sales

As discussed further below in Note 2, effective January 1, 2018, the Company adopted Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers” (“Topic 606”) and began recognizing revenue under the new accounting guidance on that date. Under the new accounting guidance, the Company recognizes revenue on product sales when control of the promised goods is transferred to its customers in an amount that reflects the consideration expected to be received in exchange for transferring those goods. The Company accounts for a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable. When determining whether the customer has obtained control of the goods, the Company considers any future performance obligations. Generally, there is no post-shipment obligations on product sold.

Performance obligations

A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account in Topic 606. A contract’s transaction price is allocated to each distinct performance obligation and recognized as revenue when, or as, the performance obligation is satisfied. The majority of the Company’s product sales contracts have a single performance obligation as the promise to transfer the individual goods is not separately identifiable from other promises in the contracts and, therefore, not distinct. The Company’s performance obligations are satisfied at a point in time. The multiple performance obligations are not allocated based off of the obligations but based off of standard selling price.

Adjustments to product sales

The Company recognizes product sales net of estimated allowances for rebates, price adjustments, returns, chargebacks and prompt payment discounts. A significant majority of the Company’s adjustments to gross product revenues are the result of accruals for its commercial contracts, retail consumer subsidy programs, and Medicaid rebates.

The Company establishes allowances for estimated rebates, chargebacks and product returns based on numerous qualitative and quantitative factors, including:

•

the number of and specific contractual terms of agreements with customers;

•

estimated levels of inventory in the distribution channel;

•

historical rebates, chargebacks and returns of products;

•

direct communication with customers;

•

anticipated introduction of competitive products or generics;

•

anticipated pricing strategy changes by the Company and/or its competitors;

•

analysis of prescription data gathered by a third-party prescription data provider;

•

the impact of changes in state and federal regulations; and

•

the estimated remaining shelf life of products.

In its analyses, the Company uses prescription data purchased from a third-party data provider to develop estimates of historical inventory channel sell-through. The Company utilizes an internal analysis to compare historical net product shipments to estimated historical prescriptions written. Based on that analysis, management develops an estimate of the quantity of product in the channel which may be subject to various rebate, chargeback and product return exposures. To estimate months of ending inventory in the Company’s distribution channel, the Company divides estimated ending inventory in the distribution channel by the Company’s recent prescription data, not considering any future anticipated demand growth beyond the succeeding quarter. Monthly for each product line, the Company prepares an internal estimate of ending inventory units in the distribution channel by adding estimated inventory in the channel at the beginning of the period, plus net product shipments for the period, less estimated prescriptions written for the period. This is done for each product line by applying a rate of historical activity for rebates, chargebacks and product returns, adjusted for relevant quantitative and qualitative factors discussed above, to the potential exposed product estimated to be in the distribution channel. In addition, the Company receives daily information from the wholesalers regarding their sales and actual on hand inventory levels of the Company’s products. This enables the Company to execute accurate provisioning procedures.

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 after expiration of the products.

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. If the sales mix to third-party payers is 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 BELBUCA and 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 actual redemption rates as reported to the Company by a third-party claims processing organization. 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.

Gross to net accruals-A significant majority of the Company’s gross to net adjustments to gross product revenues are the result of accruals for its voucher program and rebates related to Medicare Part D, Part D Coverage Gap, Medicaid and commercial contracts, with most of those programs having an accrual to payment cycle of anywhere from one to three months. In addition to this relatively short accrual to payment cycle, the Company receives daily information from the wholesalers regarding their sales of the Company’s products and actual on hand inventory levels of its products. This enables the Company to execute accurate provisioning procedures. Consistent with the pharmaceutical industry, the accrual to payment cycle for returns is longer and can take several years depending on the expiration of the related products.

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 7, 9 and 10. Depending on the nature of the contract these revenues are classified as research and development reimbursements or contract revenue.

Cost of sales

Cost of sales

Cost of sales includes the direct costs attributable to the production of BELBUCA and BUNAVAIL. It includes raw materials, production costs at the Company’s three contract manufacturing sites, quality testing directly related to the products, and depreciation on equipment that the Company has purchased to produce BELBUCA and BUNAVAIL. It also includes any batches not meeting specifications and raw material yield losses. Yield losses and batches not meeting specifications are expensed as incurred. Cost of sales is recognized when sold to the wholesaler from our distribution center.

For BREAKYL and PAINKYL (the Company’s out-licensed breakthrough cancer pain therapies), cost of sales includes all costs related to creating the product at the Company’s contract manufacturing location in Germany. The Company’s contract manufacturer bills 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.

Research and development expenses

Research and development expenses

Research and development expenses have historically consisted 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; regulatory costs; costs of contract research and manufacturing of inventory used in testing and clinical trials.

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. 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

Advertising costs, which include promotional expenses and the cost of placebo samples, are expensed as incurred. Advertising expenses were $4.5 million, $3.8 million and $4.2 million for the years ended December 31, 2018, 2017 and 2016, 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

Shipping and handling costs, which include expenses from our wholesalers, are expensed as incurred. Shipping and handling costs were $0.02 million, $0.01 and $0.01 million for the years ended December 31, 2018, 2017 and 2016, respectively, and are included in selling, general and administrative expenses in the accompanying consolidated statements of operations.

Stock-based compensation

Stock-based compensation

The Company has a stock-based compensation plan under which various types of equity-based awards are granted, including stock options, restricted stock units (RSUs) and performance-based RSUs. The fair value of stock option and RSUs, which are subject only to service conditions with graded vesting, are recognized as compensation expense, generally on a straight-line basis over the service period, net of estimated forfeitures. Forfeitures are recognized as they occur. The fair values of performance-based RSUs are recognized as compensation expense from the grant date to the end of the performance period. 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 grant date fair value of an RSU equals the closing price of our common stock on the trading day preceding the grant date. 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:


	2018	2017	2016
Expected price volatility	60.34%-68.77%	68.76%-78.79%	62.65%-80.78%
Risk-free interest rate	2.05%-3.00%	1.77%-2.05%	0.56%-1.70%
Weighted average expected life in years	6 years	6 years	6 years
Dividend yield	—	—	—

Fair Value of Financial Instruments

Fair Value of Financial Instruments

The Company measures the fair value of instruments in accordance with 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)

Recent accounting pronouncements-adopted

Recent accounting pronouncements-adopted

The SEC has released SEC Final Rule Release No. 33-10532 Disclosure Update and Simplification, which adopts amendments to certain disclosure requirements that have become redundant, duplicative, overlapping, outdated, or superseded, in light of other SEC disclosure requirements, GAAP, or changes in the information environment. The amendments also refer certain SEC disclosure requirements that overlap with but require information incremental to GAAP to the Financial Accounting Standards Board (“FASB”) for potential incorporation into GAAP. The amendments are intended to facilitate the disclosure of information to investors and simplify compliance without significantly altering the total mix of information provided to investors. These amendments are part of an initiative by the Division of Corporation Finance to review disclosure requirements applicable to issuers to consider ways to improve the requirements for the benefit of investors and issuers. The amendments became effective on November 5, 2018 and did not have a material impact to the Company.

In the first quarter of 2018, the Company adopted Topic 606. Under the standard, revenue is recognized when a customer obtains control of promised goods or services in an amount that reflects the consideration the entity expects to receive in exchange for those goods or services. In addition, the standard requires disclosure of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. The Company applied the five-step method outlined in the ASU to all revenue streams and elected the modified retrospective implementation method. The additional disclosures required by Topic 606 have been included in Note 2.

Recent accounting pronouncements-issued, not yet adopted

Recent accounting pronouncements-issued, not yet adopted

In November 2018, the FASB issued ASU “Collaborative Arrangements (Topic 808) – Clarifying the Interaction between Topic 808 and Topic 606” (“ASU 2018-18”). The amendments in ASU 2018-18 make targeted improvements to GAAP for collaborative arrangements by clarifying that certain transactions between collaborative arrangement participants should be accounted for as revenue under Topic 606 when the collaborative arrangement participant is a customer in the context of a unit of account. In those situations, all the guidance in Topic 606 should be applied, including recognition, measurement, presentation, and disclosure requirements. In addition, unit-of-account guidance in Topic 808 was aligned with the guidance in Topic 606 (that is, a distinct good or service) when an entity is assessing whether the collaborative arrangement or a part of the arrangement is within the scope of Topic 606. ASU 2018-18 is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted, including adoption in any interim period. The amendments in this Update should be applied retrospectively to the date of initial application of Topic 606. The Company is currently assessing the impact to its consolidated financial statements but believes there to be no material impact.

ASU 2016-02, issued on February 25, 2016, is intended to improve financial reporting about leasing transactions. The ASU affects all companies and other organizations that lease assets such as real estate, airplanes, and manufacturing equipment. The ASU will require organizations that lease assets referred to as “Lessees” to recognize on the balance sheet the assets and liabilities for the rights and obligations created by those leases. An organization is to provide disclosures designed to enable users of financial statements to understand the amount, timing, and uncertainty of cash flows arising from leases. These disclosures include qualitative and quantitative requirements concerning additional information about the amounts recorded in the financial statements. Under the new guidance, a lessee will be required to recognize assets and liabilities for leases; however, the Company has elected the short-term practical expedient which allows us not to recognize assets and liabilities for leases with lease terms of 12 months or less. Consistent with current GAAP, the recognition, measurement, and presentation of expenses and cash flows arising from a lease by a lessee primarily will depend on its classification as a finance or operating lease. The guidance also requires disclosures regarding the amount, timing and uncertainty of cash flows arising from leases. Effects such as changes in the categorization of rental costs, from rent expense to interest and depreciation expense should also be disclosed. Other effects may occur depending on the types of leases and on the specific terms that are utilized by particular lessees.

However, unlike current GAAP which requires only capital leases to be recognized on the balance sheet, the new ASU will require both types of leases (i.e., operating and finance leases) to be recognized on the balance sheet. The FASB lessee accounting model will continue to account for both types of leases. The finance lease will be accounted for in substantially the same manner as capital leases are accounted for under existing GAAP. The operating lease will be accounted for in a manner similar to operating leases under existing GAAP, except that lessees will recognize a lease liability and a right-of-use asset for all of those leases. The new standard requires a modified-retrospective approach to adoption and is effective for interim and annual periods beginning on January 1, 2019 but may be adopted earlier. In addition, the standard will require that the Company update its systems, processes and controls it uses to track, record and account for its lease portfolio.

The Company will adopt and implement this standard on January 1, 2019, using the required modified-retrospective approach as of the effective date. The Company will elect the package of practical expedients permitted under the transition guidance within the new standard, which among other things, allows us to carryforward the historical lease classification. The Company will make an accounting policy election to account for leases with an initial term of 12 months or less similar to existing guidance for operating leases today. The Company will recognize those lease payments in the Consolidated Statements of Operations on a straight-line basis over the lease term. The Company is substantially complete with its implementation to the new leasing standard and believes that the transition will not have a material impact on its consolidated balance sheet. As disclosed in Note 18 – Commitments and Contingencies, the Company has approximately $1.3 million in future minimum lease commitments as of the year ended December 31, 2018. Upon adoption, the Company’s lease liability will generally be based on the present value of such payments and the related right-of-use asset will generally be based on the lease liability.

The Company has estimated the right-of-use lease assets of $0.9 million and liabilities of $1.0 million that will be required to be recorded as an adjustment to retained earnings upon adoption beginning January 1, 2019. The Company does not believe that adoption of the standard will materially affect consolidated net income.