Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our 2015 Annual Report on Form 10-K, filed with the Securities and Exchange Commission, or the SEC, on March 15, 2016.

Forward Looking Statements

This Quarterly Report on Form 10-Q contains “forward-looking statements” that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements.  The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended or the Exchange Act.  Forward-looking statements are often identified by the use of words such as, but not limited to, “anticipate,” “believe,” “can,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “will,” “plan,” “project,” “seek,” “should,” “target,” “will,” “would,” and similar expressions or variations intended to identify forward-looking statements.  These statements are based on the beliefs and assumptions of our management based on information currently available to management.  Such forward-looking statements are subject to risks, uncertainties and other important factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by such forward-looking statements.  Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” included in our most recent annual report on Form 10-K, as well as any amendments thereto, as filed with the SEC and which are incorporated herein by reference.  Furthermore, such forward-looking statements speak only as of the date of this report.  Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

Overview

CorMedix Inc. and Subsidiary (referred to herein as “we,” “us,” “our” and the “Company”), is a commercial pharmaceutical and medical device company.  We in-license, develop and commercialize prophylactic and therapeutic products for the prevention and treatment of infectious and inflammatory diseases.  We have in-licensed the worldwide rights to develop and commercialize our product CRMD003 (Neutrolin ® ), which we believe addresses potentially large market opportunities in the instances in which a central venous catheter is used, such as hemodialysis, intensive care units, oncology and total parenteral nutrition, IV hydration, and/or IV medications.

Neutrolin is an anti-infective solution for the prevention of catheter-related infections and thrombosis in the central venous catheter markets such as dialysis, critical care, and oncology. Catheter related blood stream infections cause extensive morbidity and mortality, prolonged hospital stays and cost the U.S. healthcare system over $11 billion per year. Neutrolin is a novel formulation of taurolidine, citrate and heparin 1000 u/ml that provides a combination preventative solution to decrease the development of biofilm in order to reduce infection and thrombosis and thereby keep catheters operating optimally in clinical settings in hemodialysis, critical care/intensive care and oncology.  Our initial target market for Neutrolin was hemodialysis using a tunneled central vein catheter, and we launched Neutrolin as a medical device in our first geographical market, Germany, in December 2013.

In July 2013, we received CE Mark approval for Neutrolin. As a result, in December 2013, we began the commercial launch of Neutrolin in Germany for the prevention of catheter-related bloodstream infections (“CRBSI”), and maintenance of catheter patency in hemodialysis patients using a tunneled, cuffed central venous catheter for vascular access.  To date, Neutrolin is registered and may be sold in Austria, Germany, Italy, Malta, Saudi Arabia, Bahrain, Qatar, Kuwait, United Arab Emirates and The Netherlands for such treatment.

 

In September 2014, the TUV-SUD and The Medicines Evaluation Board of the Netherlands granted a label expansion for Neutrolin for these same expanded indications for the European Union (“EU”).  In December 2014, we received approval from the Hessian District President in Germany to expand the label to include use in oncology patients receiving chemotherapy, IV hydration and IV medications via central venous catheters. The expansion also adds patients receiving medication and IV fluids via central venous catheters in intensive or critical care units (cardiac care unit, surgical care unit, neonatal critical care unit, and urgent care centers). An indication for use in total parenteral nutrition was also approved.  

In late 2013, we met with the U.S. Food and Drug Administration (the “FDA”) to determine the pathway for U.S. approval of Neutrolin.  Based on our discussions with the FDA, we plan to conduct at least one Phase 3 clinical trial in hemodialysis catheters, which began in December 2015, and one Phase 3 clinical trial in oncology/total parenteral nutrition.  We have worked with the FDA to design the protocol for a planned Phase 3 clinical trial in hemodialysis patients with a central venous catheter; this protocol was accepted in August 2014 and we filed an investigational new drug application (“IND”) in September 2014.  In October 2014, the FDA informed us that it had determined that the IND is not subject to a clinical hold, and the Phase 3 clinical trial in hemodialysis patients was initiated in the U.S. in December 2015.

In June 2015, we received guidance from the FDA on the acceptable design of the second planned pivotal Phase 3 trial in oncology/total parenteral nutrition patients and are working with the FDA to finalize the details. We plan to initiate the Phase 3 trial in oncology/total parenteral nutrition in the first quarter of 2017, depending on our ability to raise additional capital and our ability to complete the hemodialysis catheters trial within our expected budget, although we also plan to continue to seek one or more strategic partners or other sources of capital to complete the development of Neutrolin in the U.S.

We are evaluating opportunities for the possible expansion of indications for taurolidine.  Provisional patents have been submitted in four areas, antimicrobial sutures, nanofiber webs, wound management, and osteoarthritis and visco-supplementation.   There exists a need to control and protect against surgical site infections upon closure with sutures.  We believe taurolidine could offer benefits not currently available in marketed antimicrobial sutures.  We also believe that the nanofiber webs used for absorbable meshes could benefit from taurolidine’s minimal inflammatory response and infection control.  Taurolidine incorporated into webs or hydrogels could also be used for wound management especially wounds in less sterile environments and burn patients.  Lastly, incorporating taurolidine into formulations for osteoarthritis and visco-supplementation may benefit from taurolidine’s anti-inflammatory and anti-infection properties.

In March 2015, we commenced a process to evaluate our strategic alternatives in order to accelerate the global development of Neutrolin and maximize shareholder value.   We engaged investment bank Evercore Group L.L.C. to provide financial advice and assist us with our evaluation process.  After the process with Evercore, we announced in July 2015 that we expect to continue to pursue product development and commercialization opportunities as we move forward with the planned Phase 3 clinical trials, rather than pursuing a possible sale of our company as this time.  We continue to retain Evercore and will work with them as potential opportunities are presented to us.

Since our inception, we have not generated enough revenue from product sales to be profitable.  Our operations to date have been primarily limited to licensing product candidates, developing clinical trials for our product candidates, establishing manufacturing for our product candidates, performing business and financial planning, performing research and development, seeking regulatory approval for our products, initial commercialization activities for Neutrolin, and maintaining and improving our patent portfolio.  We have funded our operations primarily with debt and equity financings.  We have generated significant losses to date, and we expect to incur increases in our cash used in operations as we continue to market Neutrolin in Europe and other markets, prepare for and undertake our ongoing and planned Phase 3 clinical trials, pursue business development activities, incur additional legal costs to defend our intellectual property, and seek FDA approval of Neutrolin in the U.S.  As of March 31, 2016, we had an accumulated deficit of approximately $98.6 million.  We are unable to predict the extent of any future losses or when we will become profitable, if at all.

 

Financial Operations Overview

Revenue

We recognize revenue in accordance with SEC Staff Accounting Bulletin (SAB) No. 101, Revenue Recognition in Financial Statements (SAB 101), as amended by SAB No. 104, Revenue Recognition (SAB 104) and Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) 605, Revenue Recognition (ASC 605) .

Our product shipments to dialysis centers began in December 2013.  Orders are processed through a distributor.  The distributor remits payment to us upon collection from the customer. We recognize net sales upon shipment of product to the dialysis centers.

Deferred Revenue

In August 2014, we entered into an exclusive distribution agreement (the “Agreement”) with Wonik Corporation, a South Korean company, to market, sell and distribute Neutrolin for hemodialysis and oncolytic patients upon receipt of regulatory approval in Korea.  Upon execution of the Agreement, Wonik paid us a non-refundable $50,000 payment and will pay an additional $50,000 upon receipt of the product registration necessary to sell Neutrolin in the Republic of Korea (the “Territory”).  The term of the agreement commenced on August 8, 2014 and will continue for three years after the first commercial sale of Neutrolin in the Territory.  The non-refundable up-front payment has been recorded as deferred revenue and will be recognized as revenue on a straight-line basis over the contractual term of the Agreement.

In October 2015, we shipped product with less than 75% of its remaining shelf life to a customer and issued a guarantee that the specific product shipped would be replaced by us if the customer was not able to sell the product before it expired.  As a result of this warranty, we may have an additional performance obligation (i.e. accept returned product and deliver new product to the customer) if the customer is unable to sell the short-dated product.  Due to limited sales experience with the customer, we are unable to estimate the amount of the warranty obligation that may be incurred as a result of this shipment.  Therefore, we deferred the revenue and related cost of sales associated with the shipment of this product.  Since we will be unable to resell the expired product if returned by the customer, the deferred revenue and related cost of sales is presented net as Deferred Revenue on the condensed consolidated balance sheet.

Research and Development Expense

Research and development, or R&D, expense consists of: (i) internal costs associated with our development activities; (ii) payments we make to third party contract research organizations, contract manufacturers, investigative sites, and consultants; (iii) technology and intellectual property license costs; (iv) manufacturing development costs; (v) personnel related expenses, including salaries, stock–based compensation expense, benefits, travel and related costs for the personnel involved in drug development; (vi) activities relating to regulatory filings and the advancement of our product candidates through preclinical studies and clinical trials; and (vii) facilities and other allocated expenses, which include direct and allocated expenses for rent, facility maintenance, as well as laboratory and other supplies.  All R&D is expensed as incurred.

Conducting a significant amount of development is central to our business model.  Product candidates in later-stage clinical development generally have higher development costs than those in earlier stages of development, primarily due to the significantly increased size and duration of the clinical trials.  We plan to increase our R&D expenses for the foreseeable future in order to complete development of Neutrolin in the U.S.

 

The process of conducting pre-clinical studies and clinical trials necessary to obtain regulatory approval is costly and time consuming.  The probability of success for each product candidate and clinical trial may be affected by a variety of factors, including, among others, the quality of the product candidate’s early clinical data, investment in the program, competition, manufacturing capabilities and commercial viability.  As a result of the uncertainties associated with clinical trial enrollments and the risks inherent in the development process, we are unable to determine the duration and completion costs of current or future clinical stages of our product candidates or when, or to what extent, we will generate revenues from the commercialization and sale of any of our product candidates.

Development timelines, probability of success and development costs vary widely.  Our current focus is on clinical development efforts in the U.S.  Based on our discussions with the FDA, we initiated the Phase 3 clinical trial in hemodialysis catheters in December 2015 and subject to finalization of the protocol, we plan to initiate the Phase 3 trial in oncology/total parenteral nutrition in the first quarter of 2017, depending on our ability to raise additional capital and our ability to complete the hemodialysis catheters trial within our expected budget.  We expect that the ongoing Phase 3 trial for hemodialysis catheters will cost approximately $26 million to $30 million and will take 18 months to complete after initiation.  We are still finalizing the details of the protocol for the planned second Phase 3 trial for oncology/total parenteral nutrition and are unable to provide a cost estimate at this time .   We are seeking one or more strategic partners or other sources of capital to complete the development of Neutrolin in the U.S.

Selling, General and Administrative Expense

Selling, general and administrative, or SG&A, expense includes costs related to commercial personnel, medical education professionals, marketing and advertising, salaries and other related costs, including stock-based compensation expense, for persons serving in our executive, sales, finance and accounting functions.  Other SG&A expense includes facility-related costs not included in R&D expense, promotional expenses, costs associated with industry and trade shows, and professional fees for legal services and accounting services.  We expect that our SG&A expenses will increase due to marketing of our Neutrolin product in Europe and other markets in which it may be approved.

Foreign Currency Exchange Transaction Gain (Loss)

Foreign currency exchange transaction gain (loss) is the result of re-measuring transactions denominated in a currency other than our functional currency and is reported in the consolidated statement of operations as a separate line item within other income (expense).  Foreign currency exchange transaction gain (loss) consists of foreign exchange transaction gains and losses on intercompany loans that are in place between our company, which is based in New Jersey and our German subsidiary.  The intercompany loans outstanding are not expected to be repaid in the foreseeable future and unrealized foreign exchange movements related to long-term intercompany loans are recorded in other comprehensive income (loss).

Interest Income

Interest income consists of interest earned on our cash and cash equivalents.

Interest Expense

Interest expense consists of interest incurred on financing of expenses.

 

Revenue.   Revenue was $41,000 for the three months ended March 31, 2016 compared to $31,000 in the same period last year.  The majority of the revenue is from sales of Neutrolin in Germany and Middle East markets.  In addition, we realized $2,000 associated with the amortization of deferred revenue from a non-refundable payment received from a distribution agreement for the three month periods ended March 31, 2016 and 2015.

Cost of Sales.   Cost of sales was approximately $50,000 for the three months ended March 31, 2016 compared to $17,000 in the same period last year, an increase of $33,000.  The increase was primarily due to the charge of $23,000 for the reserve of raw materials expected to expire before utilization and an increase in direct cost of materials of $20,000 due to the use of new commercial batches as compared to the use of old previously expensed research and development batches last year. These increases were offset by decreases in ongoing stability studies and services performed in the management of manufacturing of $9,000.

Research and Development Expense .  R&D expense was approximately $2,089,000 for the three months ended March 31, 2016, an increase of $854,000, from $1,235,000 for the three months ended March 31, 2015.  The increase was primarily attributable to $981,000 expenses related to Phase 3 clinical trial in hemodialysis catheters in the U.S., higher costs to support the U.S. clinical trial drug supply consisting of manufacturing process development activities of $388,000, consulting fees pertaining mainly to regulatory activities of $101,000, and personnel costs of $61,000.  These increases were offset by decreased pharmacoeconomics, and pricing and market research studies of $306,000 and non-cash stock based compensation of $372,000.

Selling, General and Administrative Expense .  SG&A expense was $2,163,000 for the three months ended March 31, 2016, a decrease of $530,000 from $2,693,000 for the three months ended March 31, 2015.  The decrease was attributable to decreases in costs related to business development activities of $170,000; decrease in selling costs related to commercialization of Neutrolin in the EU of $199,000; and a non-cash charge of $213,000 for stock-based compensation expense.  These decreases, among others of lesser significance, were offset by an increase in legal fees due mainly to ongoing intellectual property and securities litigations, increased SEC and clinical activities of $89,000.

Interest Income .  Interest income was $32,000 for the three months ended March 31, 2016 compared to $500 for the same period last year, an increase of $31,500.  The increase was attributable to having higher average interest-bearing cash balances during the three months ended March 31, 2016 as compared to the same period last year.

 

Other Comprehensive Income (Loss) . Unrealized foreign exchange movements related to long-term intercompany loans and the translation of the foreign affiliate financial statements to U.S. dollars and unrealized movements related to short-term investment are recorded in other comprehensive income totaling a $31,000 and $3,000 gain for the three months ended March 31, 2016 and 2015, respectively.

Liquidity and Capital Resources

Sources of Liquidity

We have not been profitable and have generated operating losses since we were incorporated in July 2006.  During the quarter ended March 31, 2016, we received gross proceeds of $149,300 from the issuance of 74,975 shares of common stock under the at-the-market-issuance sales agreement and $116,700 from the following exercise of stock options:

·	30,000 shares of common stock with an exercise price of $0.29 per share;

·	20,000 shares of common stock with an exercise price of $0.90 per share; and

·	50,000 shares of common stock with an exercise price of $1.80 per share.

Net Cash Used in Operating Activities

Net cash used in operating activities was $5,451,000 for the three months ended March 31, 2016 as compared to approximately $2,348,000 for the same period last year.  The net loss of $4,231,000 for the three months ended March 31, 2016 was lower than cash used in operating activities by $1,220,000.  The difference is primarily attributable to an increase in prepaid expenses of $1,680,000, offset by non-cash stock-based compensation of $442,000.  In comparison for the same period last year, the net loss of $5,498,000 was higher than cash used in operating activities by $3,149,000.  The difference was primarily attributable to a non-cash charge for warrants issued in connection with the backstop agreement of $1,583,000, non-cash stock-based compensation of $1,027,000 and increases in accounts payable and accrued expenses of $546,000 and $197,000, respectively, partially offset by increases in restricted cash and prepaid expenses of $132,000 and $76,000, respectively.

Net Cash Used in Investing Activities

Cash used in investing activities for the three months ended March 31, 2016 was $6,548,000, attributable to the purchase of short-term investments as compared to $13,000 for the same period last year due to the purchase of software for our German subsidiary.

 
  Net Cash Provided by Financing Activities

Net cash provided by financing activities was $266,000 for the three months ended March 31, 2016 as compared to $6,828,000 for the same period last year, a decrease of $6,562,000.  During the three months ended March 31, 2016, we received net proceeds of $149,000 from the sale of our common stock in an at-the-market program and $117,000 from the exercise of stock options.  In comparison, for the same period last year, we received net proceeds of approximately $6,702,000 from the exercise of warrants and $126,000 from the exercise of stock options.

Funding Requirements

Our total cash on hand and short-term investments as of March 31, 2016 was $30,229,000 excluding restricted cash of $172,000, compared to $35,386,000 at December 31, 2015.  Because our business has not currently generated positive operating cash flow, we will need to raise additional capital before we exhaust our current cash resources in order to continue to fund our research and development activities and our business development activities, as well as to fund operations generally.  Our continued operations and completion of our ongoing Phase 3 clinical trial for Neutrolin in hemodialysis catheters in the U.S. which was initiated in December 2015 and is expected to take 18 months to complete will depend on whether we are able to raise sufficient additional funds through various potential sources, such as equity, debt financings, and/or strategic relationships.  We also plan to conduct an oncology/total parenteral nutrition patient Phase 3 clinical trial in the U.S. for which additional funds over and above the funds needed for the hemodialysis Phase 3 clinical trial will be required to complete that study.  However, we can provide no assurances that financing or strategic relationships will be available on acceptable terms, or at all.

 

 

We expect to continue to fund operations from cash on hand and through either capital raising sources as previously described, which may be dilutive to existing stockholders, or through generating revenues from the licensing of our products or strategic alliances.  At March 31, 2016, we had approximately $10.4 million available for sale under our at-the market program, however, we may seek to sell additional equity or debt securities, obtain a bank credit facility, or enter into a corporate collaboration or licensing arrangement, but can provide no assurances that any such financing will be available on acceptable terms, or at all.  Moreover, the incurrence of indebtedness in connection with a debt financing would result in increased fixed obligations and could also result in covenants that would restrict our operations.  Raising additional funds through collaboration or licensing arrangements with third parties may require us to relinquish valuable rights to our technologies, future revenue streams, research programs or product candidates, or to grant licenses on terms that may not be favorable to us or our stockholders. Our actual cash requirements may vary materially from those now planned, however, because of a number of factors including any change in the focus and direction of our research and development programs, any acquisition or pursuit of development of new product candidates, competitive and technical advances, costs of commercializing any of our product candidates, and costs of filing, prosecuting, defending and enforcing any patent claims and any other intellectual property rights.

While we expect to grow product sales, we do not anticipate that we will generate significant product sales revenue in the foreseeable future.  In the absence of such revenue, we would experience continuing operating cash flow deficits.  We expect to incur increases in our cash used in operations as we continue to commercialize Neutrolin in Europe and other foreign markets, prepare for and undertake our ongoing and planned Phase 3 clinical trials, pursue business development activities, incur additional legal costs to defend our intellectual property and seek FDA approval of Neutrolin in the U.S.

Based on our cash resources at March 31, 2016, our expectations for sales of Neutrolin in the currently approved markets and the expected cost of the Phase 3 clinical trial in hemodialysis catheters in the U.S., we believe that our existing cash will be sufficient to fund our operations for at least the next twelve months following the balance sheet date.  However, if we are unable to raise additional funds when needed, we may not be able to complete our ongoing and planned Phase 3 clinical trials or market our products and we could be required to delay, scale back or eliminate some or all of our research and development programs.  Each of these alternatives would likely have a material adverse effect on our business.

Critical Accounting Policies

Our management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP.  The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities and expenses.  On an ongoing basis, we evaluate these estimates and judgments, including those described below.  We base our estimates on our historical experience and on various other assumptions that we believe to be reasonable under the circumstances.  These estimates and assumptions form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.  Actual results and experiences may differ materially from these estimates.

 

While our significant accounting policies are more fully described in Note 2 to our financial statements included with this report, we believe that the following accounting policies are the most critical to aid you in fully understanding and evaluating our reported financial results and affect the more significant judgments and estimates that we use in the preparation of our financial statements.

 

 

Stock-Based Compensation

 

We account for stock options according to the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) No. 718, “Compensation — Stock Compensation” (“ASC 718”).  Under ASC 718, share-based compensation cost is measured at grant date, based on the estimated fair value of the award, and is recognized as expense net of expected forfeitures, over the employee’s requisite service period on a straight-line basis.   

We account for stock options granted to non-employees on a fair value basis using the Black-Scholes option pricing model in accordance with ASC 718 and ASC No. 505-50, “Equity-Based Payments to Non-Employees” (“ASC 505”).  For the purpose of valuing options and warrants granted to our directors, officers, employees and consultants, we use the Black-Scholes option pricing model.  The non-cash charge to operations for non-employee options with time based vesting provisions is based on the fair value of the options re-measured each reporting period and amortized to expense over the related vesting period, and the non-cash charge to operations for non-employee options with performance based vesting provisions is recorded when the achievement of the performance condition is probable.

Valuations incorporate several variables, including expected term, expected volatility, expected dividend yield and a risk-free interest rate.  We estimate the expected term of the options granted based on anticipated exercises in future periods.  The expected stock price volatility for our stock options is calculated based on the historical volatility since the initial public offering of our common stock in March 2010.  The expected dividend yield reflects our current and expected future policy for dividends on our common stock.  To determine the risk-free interest rate, we utilize the U.S. Treasury yield curve in effect at the time of grant with a term consistent with the expected term of our awards. 

Stock compensation expense is recognized by applying the expected forfeiture rate during the vesting period to the fair value of the award.  The estimation of the number of stock awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from our current estimates, compensation expense may need to be revised.  We consider many factors when estimating expected forfeitures for stock awards granted to employees, officers and directors, including types of awards, employee class, and an analysis of our historical forfeitures. 

Revenue Recognition

We recognize revenue in accordance with SEC SAB No. 101, “Revenue Recognition in Financial Statements” (“SAB 101”), as amended by SAB No. 104, “Revenue Recognition”   (“SAB 104”) and FASB ASC 605, “Revenue Recognition” (“ASC 605”) .   Our product Neutrolin received its CE Mark in Europe in July 2013 and shipment of product to the dialysis centers began in December 2013.  In accordance with SAB 101 and SAB 104, we recognize revenue from product sales when the following four revenue recognition criteria are met: persuasive evidence of an arrangement exists, delivery has occurred, the selling price is fixed or determinable, and collectability is reasonably assured.  We recognize revenue upon shipment of product to the dialysis centers because the four revenue recognition criteria are met at that time.  For an upfront payment related to an exclusive distribution agreement, we record it as deferred revenue and recognize revenue on a straight-line basis over the contractual term of the agreement

In October 2015, we shipped product with less than 75% of its remaining shelf life to a customer and issued a guarantee that any product shipped with less than 75% of its shelf life remaining would be replaced by us if the customer was not able to sell the product before it expired.  As a result of this warranty, we may have an additional performance obligation (i.e. accept returned product and deliver new product to the customer) if the customer is unable to sell the short-dated product.  Due to limited sales experience with the customer, we are unable to estimate the amount of the warranty obligation that may be incurred as a result of this shipment.  Therefore, we have deferred the revenue and related cost of sales associated with the shipment of this product.  Since we will be unable to resell the expired product if returned by the customer, the deferred revenue and related cost of sales is presented net as “Deferred revenue” on the consolidated balance sheet.  At March 31, 2016, deferred revenue on the condensed consolidated balance sheet amounted to $126,000.

 

Inventory Valuation

We engage third parties to manufacture and package inventory held for sale and warehouse such goods until packaged for final distribution and sale.  Inventories are stated at the lower of cost or market price with cost determined on a first-in, first-out basis. Inventories are reviewed periodically to identify slow-moving or obsolete inventory based on sales activity, both projected and historical, as well as product shelf-life. In evaluating the recoverability of our inventories, we consider the probability that revenue will be obtained from the future sale of the related inventory and, if required, will write down inventory quantities in excess of expected requirements. Expired inventory is disposed of and the related costs are recognized as cost of product sales in our consolidated statements of operations.

We analyze our inventory levels to identify inventory that may expire prior to sale, inventory that has a cost basis in excess of its estimated realizable value, or inventory in excess of expected sales requirements. Although the manufacturing of our products is subject to strict quality controls, certain batches or units of product may no longer meet quality specifications or may expire, which would require adjustments to our inventory values.

In the future, reduced demand, quality issues or excess supply beyond those anticipated by management may result in an adjustment to inventory levels, which would be recorded as an increase to cost of product sales. The determination of whether or not inventory costs will be realizable requires estimates by our management. A critical input in this determination is future expected inventory requirements based on our internal sales forecasts which we then compare to the expiry dates of inventory on hand. To the extent that inventory is expected to expire prior to being sold, we will write down the value of inventory. If actual results differ from those estimates, additional inventory write-offs may be required.

Short-Term Investments

We determine the appropriate classification of marketable securities at the time of purchase and reevaluate such designation as of each balance sheet date.  Investments in marketable debt and equity securities classified as available-for-sale are reported at fair value.  Fair values of our investments are determined using quoted market prices in active markets for identical assets or liabilities or quoted prices for similar assets or liabilities or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities. Our marketable securities are highly liquid and consist of U.S. government agency securities, high-grade corporate obligations and commercial paper with maturities of more than 90 days but less than 12 months.  Changes in fair value that are considered temporary are reported net of tax in other comprehensive income (loss).    Realized gains and losses, amortization of premiums and discounts and interest and dividends earned are included in income (expense) on the condensed consolidated statements of operations and comprehensive income (loss). The cost of investments for purposes of computing realized and unrealized gains and losses is based on the specific identification method. Investments with maturities beyond one year, if any, are classified as short-term based on management’s intent to fund current operations with these securities or to make them available for current operations. For declines, if any, in the fair value of equity securities that are considered other-than-temporary, impairment losses are charged to other (income) expense, net. We consider available evidence in evaluating potential impairments of our investments, including the duration and extent to which fair value is less than cost and, for equity securities, our ability and intent to hold the investments.

Fair Value Measurements

We categorize our financial instruments into a three-level fair value hierarchy that prioritize the inputs to valuation techniques used to measure fair value.  The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets (Level 1) and the lowest priority to unobservable inputs (Level 3).  If the inputs used to measure fair value fall within different levels of the hierarchy, the category level is based on the lowest priority level input that is significant to the fair value measurement of the instrument.  Financial assets recorded at fair value on our condensed consolidated balance sheets are categorized as follows:

 

•      Level 1 inputs—Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

 

•      Level 2 inputs— Significant other observable inputs (e.g., quoted prices for similar items in active markets, quoted prices for identical or similar items in markets that are not active, inputs other than quoted prices that are observable such as interest rate and yield curves, and market-corroborated inputs).

 

•      Level 3 inputs —Unobservable inputs for the asset or liability, which are supported by little or no market activity and are   valued based on management’s estimates of assumptions that market participants would use in pricing the asset or liability.

Recent Authoritative Pronouncements:

In May 2014, the FASB issued new guidance related to how an entity should recognize revenue. The guidance specifies that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. In addition, the guidance expands the required disclosures related to revenue and cash flows from contracts with customers. The guidance is effective for us beginning in the first quarter of 2017. Early adoption is not permitted and retrospective application is required. We are currently evaluating the impact of adopting this guidance on our consolidated financial statements.

In June 2014, the FASB issued an accounting standard that clarifies the accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period.  The standard requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition.   The amendments are effective for interim and annual reporting periods beginning after December 15, 2015.  This adoption did not have a material impact on our consolidated financial statements.

In April 2015, the FASB issued new guidance which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This guidance requires retrospective adoption and will be effective for us beginning in the first quarter of 2016.  Early adoption is permitted.  This adoption did not have a material impact on our consolidated financial statements.

In July 2015, the FASB issued an accounting standard that requires inventory be measured at the lower of cost and net realizable value and options that currently exist for market value be eliminated. The standard defines net realizable value as estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation and is effective for reporting periods beginning after December 15, 2016 and interim periods within those fiscal years with early adoption permitted. The guidance should be applied prospectively. We are evaluating the impact the adoption of this guidance will have on the determination or reporting of our consolidated financial statements.

In November 2015, the FASB issued guidance that requires that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The current requirement that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is not affected by this amendment. The new guidance is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. Early adoption is permitted and the standard may be applied either retrospectively or on a prospective basis to all deferred tax assets and liabilities. We are evaluating the impact the adoption of this guidance will have on the determination or reporting of our consolidated financial statements.

 

On August 27, 2014 ASU No. 2014-15 – Presentation of Financial Statements, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern was issued. The ASU requires management to evaluate whether there are conditions and events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the financial statements are issued and if management’s plans will alleviate that doubt.  Management will be required to make this evaluation for both annual and interim reporting periods.  The guidance is effective for annual periods ending after December 15, 2016 and interim periods thereafter. Early adoption is permitted.

In January 2016, the FASB issued a new standard that modifies certain aspects of the recognition, measurement, presentation, and disclosure of financial instruments. The accounting standard update is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is permitted.  We are currently assessing the impact that adopting this new accounting guidance will have on our consolidated financial statements.

In February 2016, the FASB issued new guidance related to how an entity should lease assets and lease liabilities. The guidance specifies that an entity who is a lessee under lease agreements should recognize lease assets and lease liabilities for those leases classified as operating leases under previous FASB guidance. Accounting for leases by lessors is largely unchanged under the new guidance. The guidance is effective for us beginning in the first quarter of 2019. Early adoption is permitted.  In transition, lessees and lessors are required to recognize and measure leases at the beginning of the earliest period presented using a modified retrospective approach. We are evaluating the impact of adopting this guidance on our consolidated financial statements.

In March 2016, the FASB issued new guidance which clarifies the implementation guidance on principal versus agent considerations when reporting revenue gross versus net.  The amendments in this update do not change the core principle of the new revenue guidance.  The guidance is effective for us beginning in the first quarter of 2017.  Early adoption is not permitted and retrospective application is required.  We are currently evaluating the impact of adopting this guidance on our consolidated financial statements.

 

In March 2016, the FASB issued new guidance which simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows.  The guidance is effective for us beginning in the first quarter of fiscal year 2017.  Early adoption is permitted. We are evaluating the impact of adopting this guidance on our consolidated financial statements. 

In April 2016, the FASB issued an update which clarifies two aspects of the new revenue guidance by providing guidance on how to identify performance obligations and providing implementation guidance surrounding licensing.  The amendments in this update do not change the core principle of the new revenue guidance.  The guidance is effective for us beginning in the first quarter of 2017.  Early adoption is not permitted and retrospective application is required.  We are currently evaluating the impact of adopting this guidance on our consolidated financial statements.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements.