2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its subsidiary, Advance Biofactures Corp., a New York corporation (“ABC-NY”). All intercompany balances and transactions have been eliminated.

Reclassification

Certain reclassifications have been made to prior year balances to conform to the current year’s presentation.

Critical Accounting Policies, Estimates and Assumptions

The preparation of consolidated financial statements in conformity with U.S. Generally Accepted Accounting Principles (“GAAP”) requires the use of management’s estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. The Company makes certain assumptions and estimates for its deferred tax assets and deferred royalty buy-down. For further details see footnote “Provision for Income Taxes and Third Party Royalties and Royalty Buy-Down”. Actual results could differ from those estimates.

Cash, Cash Equivalents and Investments

Cash equivalents include only securities having a maturity of three months or less at the time of purchase. Investments are stated on an amortized cost basis. The Company limits its credit risk associated with cash, cash equivalents and investments by placing its investments with banks it believes are highly creditworthy and with highly rated money market funds, certificates of deposit, pre-refunded municipal bonds, municipal bonds and corporate bonds. All investments are classified as held to maturity. As of December 31, 2015 and 2014, the aggregate fair value of these investments was $31.9 million and $12.2 million, respectively. No unrealized gains or losses were recorded in the balance sheet in either period.

Fair Value Measurements

Management believes that the carrying amounts of the Company’s financial instruments, including cash, cash equivalents, held to maturity investments, accounts receivable, accounts payable and accrued expenses approximate fair value due to the short-term nature of those instruments. As of December 31, 2015 and 2014, there were no recorded unrealized gains or losses on our investments as they are held to maturity. As of December 31, 2015, amortized cost basis of the investments approximate their fair value. In 2015 and 2014, the amortized premium included in interest income was $316,000 and $18,000, respectively.

The schedule of maturities at December 31, 2015 and 2014 are as follows:

	Maturities as of December 31, 2015				Maturities as of December 31, 2014
	1 Year or Less		Greater than 1 Year		1 Year or Less		Greater than 1 Year
Municipal bonds	$	6,461,216	$	155,826	$	2,287,773	$	-
Corporate Bonds		9,882,285		1,597,715		-		-
Certificates of deposit		12,004,041		1,843,000		8,612,664		1,250,000
Total	$	28,347,542	$	3,596,541	$	10,900,437	$	1,250,000

Concentration of Credit Risk and Major Customers

The Company maintains bank account balances, which, at times, may exceed insured limits. The Company has not experienced any losses with these accounts and believes that it is not exposed to any significant credit risk on cash.

The Company maintains its investment in FDIC insured certificates of deposits with several banks, pre-refunded municipal bonds, municipal bonds and corporate bonds.

At December 31, 2015 our accounts receivable balance was $2.5 million and was from one customer, Endo.

At December 31, 2014 our accounts receivable balance was $3.0 million of which $2.9 million was from one customer, Endo.

The Company is currently dependent on one customer, Endo, who generates almost all its revenues. For the years ended December 31, 2015, 2014 and 2013, the licensing, sublicensing, milestones and royalty revenues under the License Agreement with Endo were approximately $22.8 million, $14.0 million and $10.9 million, respectively.

Revenue Recognition

We currently recognize revenues resulting from the licensing and sublicensing of the use of our technology and from services we sometimes perform in connection with the licensed technology under the guidance of Accounting Standards Codification 605, Revenue Recognition (“ASC 605”).

If we determine that separate elements exist in a revenue arrangement under ASC 605, we recognize revenue for delivered elements only when the fair values of undelivered elements are known, when the associated earnings process is complete, when payment is reasonably assured and, to the extent the milestone amount relates to our performance obligation, when our customer confirms that we have met the requirements under the terms of the agreement.

Revenues, and their respective treatment for financial reporting purposes, are as follows:

Royalty / Mark-Up on Cost of Goods Sold / Earn-Out Revenue

For those arrangements for which royalty and mark-up on cost of goods sold information becomes available and collectability is reasonably assured, we recognize revenue during the applicable period in which it is earned. For interim quarterly and year-end reporting purposes, when collectability is reasonably assured, but a reasonable estimate of royalty and mark-up on cost of goods sold cannot be made, the royalty and mark-up on cost of goods sold are generally recognized in the quarter that the applicable licensee provides the written report and related information to us.

Under our Second Amended and Restated Development and Licensing Agreement with Auxilium (the “License Agreement”), which Endo assumed in the Acquisition, we do not participate in the selling, marketing or manufacturing of products for which we receive royalties and a mark-up on the cost of goods sold. The royalty and mark-up on cost of goods sold will generally be recognized in the quarter that Endo provides the written reports and related information to us; that is, royalty and mark-up on cost of goods sold are generally recognized one quarter following the quarter in which the underlying sales by Endo occurred. The royalties payable by Endo to us are subject to set-off for certain patent costs.

Under the DFB Agreement, pursuant to which we sold our topical collagenase business to an affiliate of DFB, we had the right to receive earn-out payments based on sales of certain products. This right to receive payments on Santyl sales expired in August 2013. Generally, under the DFB Agreement we received payments and a report within ninety (90) days from the end of each calendar year after DFB sold the royalty-bearing product. DFB provided us earn-out reports on a quarterly basis. BioSpecifics has now recognized all income from the Santyl sales under the DFB Agreement, and received the corresponding cash payment in March 2014, the income recognized in 2013.

Licensing Revenue

We include revenue recognized from upfront licensing, sublicensing and milestone payments in “License Revenues” in our consolidated statements of income in this Report.

Upfront License and Sublicensing Fees

We generally recognize revenue from upfront licensing and sublicensing fees when the agreement is signed, we have completed the earnings process and we have no ongoing performance obligation with respect to the arrangement. Nonrefundable upfront technology license for product candidates for which we are providing continuing services related to product development are deferred and recognized as revenue over the development period.

Milestones

Milestones, in the form of additional license fees, typically represent nonrefundable payments to be received in conjunction with the achievement of a specific event identified in the contract, such as completion of specified development activities and/or regulatory submissions and/or approvals. We believe that a milestone represents the culmination of a distinct earnings process when it is not associated with ongoing research, development or other performance on our part. We recognize such milestones as revenue when they become due and collection is reasonably assured. When a milestone does not represent the culmination of a distinct earnings process, we recognize revenue in a manner similar to that of an upfront license fee.

The timing and amount of revenue that we recognize from licenses of technology, either from upfront fees or milestones where we are providing continuing services related to product development, is primarily dependent upon our estimates of the development period. We define the development period as the point from which research activities commence up to regulatory approval of either our, or our partners’, submission assuming no further research is necessary. As product candidates move through the development process, it is necessary to revise these estimates to consider changes to the product development cycle, such as changes in the clinical development plan, regulatory requirements, or various other factors, many of which may be outside of our control. Should the FDA or other regulatory agencies require additional data or information, we would adjust our development period estimates accordingly. The impact on revenue of changes in our estimates and the timing thereof is recognized prospectively over the remaining estimated product development period.

Treasury Stock

The Company accounts for treasury stock under the cost method and includes treasury stock as a component of stockholders’ equity. For the year ended December 31, 2015, we repurchased 40,001 shares at an average price of $45.06 as compared to 30,848 shares at an average price of $26.89 in the 2014 period. In the 2013 period, we purchased 40,107 shares at an average price of $16.83.

Receivables

Trade accounts receivable are stated at the amount the Company expects to collect. We may maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We consider the following factors when determining the collectability of specific customer accounts: customer credit-worthiness, past transaction history with the customer, current economic industry trends, and changes in customer payment terms. Our accounts receivable balance is typically due from Endo, our one large specialty pharmaceutical customer. Endo has historically paid timely and has been a financially stable organization. Due to the nature of the accounts receivable balance, we believe the risk of doubtful accounts is minimal. If the financial condition of our customer were to deteriorate, adversely affecting its ability to make payments, additional allowances would be required. We may provide for estimated uncollectible amounts through a charge to earnings and a credit to a valuation allowance. Balances that remain outstanding after we have used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to accounts receivable.

At December 31, 2015 our accounts receivable balance was $2.5 was from one customer, Endo. At December 31, 2014 our accounts receivable balance was $3.0 million of which $2.9 million was from one customer, Auxilium.

Deferred Revenue

Nonrefundable upfront product license fees, for product candidates for which we are providing continuing services related to product development, are deferred and recognized as revenue over the development period. In addition in 2015, we deferred the recognition of a $100,000 which remains uncollected, related to a milestone payment received from Endo due to a foreign tax withholding. Currently, the Company expects to recover the full amount. For the years ended December 2015, 2014 and 2013, we recognized deferred revenue of $49,378, $59,255 and $133,524, respectively. At December 31, 2015 and 2014, our remaining deferred revenue balances were $198,757 and $148,135, respectively.

Reimbursable Third Party Development Costs

We accrued patent expenses for R&D that are reimbursable by us under the License Agreement. We capitalize certain patent costs related to estimated third party development costs that are reimbursable under the License Agreement. As of December 31, 2015 and 2014 our net reimbursable third party patent expense accrual was approximately $20,000 and $34,000, respectively.

Third Party Royalties and Royalty Buy-Down

We have entered into licensing and royalty agreements with third parties and agreed to pay certain royalties on net sales of products for specific indications. The royalty rates differ from agreement to agreement and in certain cases have been redacted with the permission of the SEC. No assumptions should be made that the disclosed royalty rates payable to a particular third party is the same or similar with respect to the royalty rates payable to other third parties. We accrue third party royalty expenses on net sales reported to us by Endo. Third party royalty costs are generally expensed in the quarter that Endo provides the written reports and related information to us, that is, generally one quarter following the quarter in which the underlying sales by Endo occurred. For the years ended December 31, 2015, 2014 and 2013, third party royalty expenses was $1.4 million, $0.8 million and $0.4 million, respectively. We expect our third party royalty expense under general and administrative expenses will continue to increase as net sales by Endo for XIAFLEX increase and potential new indications for CCH are approved.

On March 31, 2012, we entered into an amendment to our existing agreement with Dr. Martin K. Gelbard, dated August 27, 2008, related to our future royalty obligations for Peyronie’s disease. The amendment enables us to buy down a portion of our future royalty obligations in exchange for an initial cash payment of $1.5 million and five additional cash payments of $0.6 million, three of which have been paid as of December 31, 2015. We are currently making the payments to buy down the future royalty obligations, which royalty obligations terminate 5 years after first commercial sale. The Company amortizes long-term contracts with finite lives in a manner that reflects the pattern in which the economic benefits of the assets are consumed or otherwise used up. Dr. Gelbard’s agreement is amortized based on an income forecast method by estimating sales of XIAFLEX for Peyronie’s disease on an annual basis as measured by the proportion to the total estimated sales over the five year period. For the year ended December 31, 2015, we amortized approximately $0.6 million and $0.1 million in the 2014 period related to this agreement. For the year ended December 31, 2013, there was no amortization related to this agreement, as XIAFLEX for the treatment of Peyronie’s disease was not approved for sale until December 2013 and the resulting royalty revenues were recognized in accordance with our royalty revenue recognition policy. As of December 31, 2015 and 2014, the remaining capitalized balances were approximately $3.9 million and $3.8 million, respectively. We perform an evaluation of the recoverability of the carrying value to determine if facts and circumstances indicate that the carrying value of the assets may be impaired and if any adjustment is warranted. As of December 31, 2015, there was no indicator that an impairment existed.

Research and Development Expenses

R&D expenses include, but are not limited to, internal costs, such as salaries and benefits, costs of materials, lab expense, facility costs and overhead. R&D expenses also consist of third party costs, such as medical professional fees, product costs used in clinical trials, consulting fees and costs associated with clinical study arrangements. We may fund R&D at medical research institutions under agreements that are generally cancelable. All of these costs are charged to R&D as incurred, which may be measured by percentage of completion, contract milestones, patient enrollment, or the passage of time.

Clinical Trial Expenses

Our cost accruals for clinical trials are based on estimates of the services received and efforts expended pursuant to contracts with various clinical trial centers and clinical research organizations. In the normal course of business we contract with third parties to perform various clinical trial activities in the ongoing development of potential drugs. The financial terms of these agreements are subject to negotiation and vary from contract to contract and may result in uneven payment flows. Payments under the contracts depend on factors such as the achievement of certain events, the successful enrollment of patients, the completion of portions of the clinical trial, or similar conditions. The objective of our accrual policy is to match the recording of expenses in our financial statements to the actual cost of services received and efforts expended. As such, expenses related to each patient enrolled in a clinical trial are recognized ratably beginning upon entry into the trial and over the course of the patient’s continued participation in the trial. In the event of early termination of a clinical trial, we accrue an amount based on our estimate of the remaining non-cancelable obligations associated with the winding down of the clinical trial. Our estimates and assumptions could differ significantly from the amounts that may actually be incurred.

Income Taxes

Deferred tax assets and liabilities are recognized based on the expected future tax consequences, using current tax rates, of temporary differences between the financial statement carrying amounts and the income tax basis of assets and liabilities. A valuation allowance is applied against any net deferred tax asset if, based on the weighted available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized.

We use the asset and liability method of accounting for income taxes, as set forth in Accounting Standards Codification 740-10-25-2. Under this method, deferred income taxes, when required, are provided on the basis of the difference between the financial reporting and income tax basis of assets and liabilities at the statutory rates enacted for future periods. In accordance with Accounting Standards Codification 740-10-45-25, Income Statement Classification of Interest and Penalties, we classify interest associated with income taxes under interest expense and tax penalties under other.

The Company recognizes a tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by taxing authorities, based on the technical merits of the position. The tax benefit recognized in the consolidated financial statements from such position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon the ultimate settlement. As of December 31, 2015 and 2014, the Company has not recorded any unrecognized tax benefits.

Stock-Based Compensation

The Company has one stock-based compensation plans in effect which is described more fully in Note 10. Accounting Standards Codification 718, Compensation - Stock Compensation (“ASC 718”) requires the recognition of compensation expense, using a fair-value based method, for costs related to all share-based awards including stock options and common stock issued to our employees and directors under our stock plans. It requires companies to estimate the fair value of share-based awards on the date of grant using an option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense on a straight-line basis over the requisite service periods in our consolidated statements of income.

Under ASC 718, we estimate the fair value of our employee stock awards at the date of grant using the Black-Scholes option-pricing model, which requires the use of certain subjective assumptions. The most significant of these assumptions are our estimates of the expected volatility of the market price of our stock and the expected term of an award. When establishing an estimate of the expected term of an award, we consider the vesting period for the award, our recent historical experience of employee stock option exercises (including forfeitures) and the expected volatility. When there is uncertainty in the factors used to determine the expected term of an award, we use the simplified method. As required under the accounting rules, we review our valuation assumptions at each grant date and, as a result, our valuation assumptions used to value employee stock-based awards granted in future periods may change.

We account for stock options granted to persons other than employees or directors at fair value using the Black-Scholes option-pricing model in accordance with Accounting Standards Codification 505-50, Equity Based Payments to Non-Employees (“ASC 505-50”). Stock options granted to such persons and stock options that are modified and continue to vest when an employee has a change in employment status are subject to periodic revaluation over their vesting terms. We recognize the resulting stock-based compensation expense during the service period over which the non-employee provides services to us.

Patent Costs

We amortize intangible assets with definite lives on a straight-line basis over their remaining estimated useful lives, ranging from 1 to 13 years, and review for impairment on an annual basis and when events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. As of December 31, 2015, there was no indicator that an impairment existed.

For the year ended December 31, 2015, we capitalized patent costs related to patent prosecution and maintenance of approximately $26,000 based on the most current information reported to us by Endo. As of December 31, 2015, the Company’s estimated costs related to certain patent costs are approximately $20,000, which are reimbursable to Endo under the License Agreement. These patent costs are creditable against future royalty revenues. For each period presented below net patent costs consisted of:

	December 31,
	2015			2014
Patents	$	697,260		$	671,326
Accumulated Amortization		(422,054	)		(376,296	)
Net Patent Costs	$	275,206		$	295,030

The amortization expense for patents for the years ended December 31, 2015, 2014 and 2013 were $45,758, $119,920 and $64,323, respectively. The estimated aggregate amortization expense for each of the next five years is approximately as follows:

2016	$	38,000
2017		38,000
2018		38,000
2019		38,000
2020		26,000

New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board, or FASB, issued a new revenue recognition standard which amends revenue recognition principles and provides a single, comprehensive set of criteria for revenue recognition within and across all industries. The new standard provides a five step framework whereby revenue is recognized when promised goods or services are transferred to a customer at an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The standard also requires enhanced disclosures pertaining to revenue recognition in both interim and annual periods. In August 2015, the FASB deferred the effective date of the new revenue standard from January 1, 2017 to January 1, 2018. Early adoption is permitted any time after the original effective date, which for us is January 1, 2017. The standard allows for adoption using a full retrospective method or a modified retrospective method. We are currently evaluating the timing, method of adoption and the expected impact that the standard could have on our consolidated financial statements and related disclosures. We expect to complete our analysis by December 31, 2016.

In November 2015, the FASB issued final guidance that requires companies to classify all deferred tax assets and liabilities as noncurrent on the balance sheet instead of separating deferred taxes into current and noncurrent amounts. This guidance allows for adoption on either a prospective or retrospective basis. This guidance will be effective on January 1, 2017. Early adoption is permitted and can be applied prospectively or retrospectively. We do not expect the adoption to have an impact on our consolidated financial statements.

In January 2016, the FASB issued new guidance on recognition and measurement of financial assets and financial liabilities. The new guidance will impact the accounting for equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. All equity investments in unconsolidated entities (other than those accounted for under the equity method of accounting) will generally be measured at fair value with changes in fair value recognized through earnings. There will no longer be an available-for-sale classification (changes in fair value reported in other comprehensive income (loss)) for equity securities with readily determinable fair values. In addition, the FASB clarified the need for a valuation allowance on deferred tax assets resulting from unrealized losses on available-for-sale debt securities. In general, the new guidance will require modified retrospective application to all outstanding instruments, with a cumulative effect adjustment recorded to opening retained earnings. This guidance will be effective for us on January 1, 2018. We are currently evaluating the expected impact that the standard could have on our consolidated financial statements and related disclosures.

In February 2016, FASB issued Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842). Under the new guidance, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: a lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and a right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged. Certain targeted improvements were made to align, where necessary, lessor accounting with the lessee accounting model and Topic 606, Revenue from Contracts with Customers. The new lease guidance simplified the accounting for sale and leaseback transactions primarily because lessees must recognize lease assets and lease liabilities. Lessees will no longer be provided with a source of off-balance sheet financing. Public business entities should apply the amendments in ASU 2016-02 for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years (i.e., January 1, 2019, for a calendar year entity). Early application is permitted. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees and lessors may not apply a full retrospective transition approach.