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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA The following table sets forth selected financial data for each of the five years in the period ended December 31, 2015 (in thousands, except share and per share amounts). This financial data should be read together with our consolidated financial statements and related notes, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and other financial data appearing elsewhere in this report. ITEM 7.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with our audited annual consolidated financial statements and the related notes that appear elsewhere in this annual report on Form 10-K. This discussion contains forward-looking statements reflecting our current expectations that involve risks and uncertainties. Actual results may differ materially from those discussed in these forward-looking statements due to a number of factors, including those set forth in the section entitled “Risk Factors” and elsewhere in this annual report on Form 10-K. For further information regarding forward-looking statements, please refer to the “Special Note Regarding Forward-Looking Statements and Projections” at the beginning of Part I of this annual report on Form 10-K. Overview Alimera Sciences, Inc., and its subsidiaries (we, Alimera or the Company) is a pharmaceutical company that specializes in the research, development and commercialization of prescription ophthalmic pharmaceuticals. We are presently focused on diseases affecting the back of the eye, or retina, because we believe these diseases are not well treated with current therapies and represent a significant market opportunity. Our only commercial product is ILUVIEN®, which has been developed to treat diabetic macular edema (DME). DME is a disease of the retina that affects individuals with diabetes and can lead to severe vision loss and blindness. ILUVIEN has received marketing authorization in the United States (U.S.), Austria, Belgium, the Czech Republic, Denmark, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Norway, Poland, Portugal, Spain, Sweden, and the United Kingdom. In the U.S., ILUVIEN is indicated for the treatment of DME in patients who have been previously treated with a course of corticosteroids and did not have a clinically significant rise in intraocular pressure (IOP). In the European Economic Area (EEA) countries in which ILUVIEN has received marketing authorization, it is indicated for the treatment of vision impairment associated with DME considered insufficiently responsive to available therapies. As part of the approval process in the EEA, we have committed to conduct a five-year, post-authorization, open label registry study in 800 patients treated with ILUVIEN. We launched ILUVIEN in Germany and the United Kingdom in the second quarter of 2013 and in the U.S. and Portugal in the first quarter of 2015. In addition, we have entered into various agreements under which distributors will provide regulatory, reimbursement or sales and marketing support for future commercialization of ILUVIEN in numerous countries in the Middle East, Canada, Italy and Australia. We commenced operations in June 2003. Since our inception we have incurred significant losses. As of December 31, 2015, we have accumulated a deficit of $343.9 million. We expect to incur substantial losses through the continued commercialization of ILUVIEN as we: • continue the commercialization of ILUVIEN in the U.S. and EEA; • continue to seek regulatory approval of ILUVIEN in other jurisdictions; • evaluate the use of ILUVIEN for the treatment of other diseases; and • advance the clinical development of any future products or product candidates either currently in our pipeline, or that we may license or acquire in the future. As of December 31, 2015, we had approximately $31.1 million in cash and cash equivalents. We launched ILUVIEN in Germany and the United Kingdom, in the second quarter of 2013 and in the U.S. and Portugal in the first quarter of 2015. We do not expect to have positive cash flow from operations until 2017, if at all. Due to the limited revenue generated by ILUVIEN to date, we may have to raise additional capital to fund the continued commercialization of ILUVIEN. If we are unable to raise additional financing, we will need to adjust our commercial plans so that we can continue to operate with our existing cash resources or there may be substantial doubt about our ability to continue as a going concern. Further, in January 2016, we did not meet a revenue threshold under the covenants of our loan and security agreement (Term Loan Agreement) with Hercules Technology Growth Capital, Inc. (Hercules). While this violation was subsequently waived by Hercules, our current financial forecast for 2016 projects that we must obtain additional or alternative financing or it is probable that we will not be able to comply with our liquidity covenant under the Term Loan Agreement. We are currently pursuing alternative or additional debt financing and have an at-the-market offering in place under which we may sell up to approximately $34.2 million of our common stock. If we are not successful in obtaining additional or alternative financing, we would default under the Term Loan Agreement. In an event of default under our Term Loan Agreement, Hercules may call the Term Loan, and there would be substantial doubt about our ability to continue as a going concern. Our Agreement with pSivida US, Inc. We entered into an agreement with pSivida US, Inc. (pSivida) for the use of fluocinolone acetonide (FAc) in pSivida’s proprietary delivery device in February 2005, which was subsequently amended and restated in 2008. pSivida is a global drug delivery company committed to the biomedical sector and the development of drug delivery products. Our agreement with pSivida provides us with a worldwide exclusive license to develop and sell ILUVIEN, which consists of a tiny polyimide tube with a permeable membrane cap on one end and an impermeable silicone cap on the other end that is filled with FAc in a polyvinyl alcohol matrix for delivery to the back of the eye for the treatment and prevention of eye diseases in humans (other than uveitis). This agreement also provides us with a worldwide non-exclusive license to develop and sell pSivida’s proprietary delivery device to deliver other corticosteroids to the back of the eye for the treatment and prevention of eye diseases in humans (other than uveitis) or to treat DME by delivering a compound to the back of the eye through a direct delivery method through an incision required for a 25-gauge or larger needle. We do not have the right to develop and sell pSivida’s proprietary delivery device in connection with indications for diseases outside of the eye or for the treatment of uveitis. Further, our agreement with pSivida permits pSivida to grant to any other party the right to use its intellectual property (i) to treat DME through an incision smaller than that required for a 25-gauge needle, unless using a corticosteroid delivered to the back of the eye, (ii) to deliver any compound outside the back of the eye unless it is to treat DME through an incision required for a 25-gauge or larger needle, or (iii) to deliver non-corticosteroids to the back of the eye, unless it is to treat DME through an incision required for a 25-gauge or larger needle. The agreement provides that after commercialization of ILUVIEN, pSivida will be entitled to 20% of the net profits, as defined in the amended and restated agreement. In connection with this arrangement we are entitled to recover 20% of commercialization costs of ILUVIEN, as defined in the agreement, incurred prior to product profitability out of pSivida’s share of net profits. As of December 31, 2015 and 2014, pSivida owed us $21.6 million and $13.0 million, respectively, in commercialization costs. Due to the uncertainty of future profits from ILUVIEN, we have fully reserved these amounts in the accompanying consolidated financial statements. As a result of the Food and Drug Administration’s (FDA) approval of ILUVIEN in September 2014, we paid pSivida a milestone payment of $25.0 million (the pSivida Milestone Payment) in October 2014. Our Credit Facility 2013 Loan Agreement In May 2013, Alimera Sciences Limited (Limited), our subsidiary, entered into a loan and security agreement (2013 Loan Agreement) with Silicon Valley Bank (SVB) to provide Limited with additional working capital for general corporate purposes. Under the 2013 Loan Agreement, SVB made a term loan (2013 Term Loan) in the principal amount of $5.0 million to Limited and agreed to provide up to an additional $15.0 million to Limited under a working capital line of credit (2013 Line of Credit). No advances were made at closing under the 2013 Line of Credit and no amounts were outstanding as of December 31, 2013. As a result of entering into the 2013 Loan Agreement, in May 2013, we repaid all amounts owed to lenders under our previous term loan and we recognized a loss on early extinguishment of debt of $153,000 associated with the remaining unamortized deferred financing costs, unamortized discount, the final interest payment, the prepayment penalty and a lender fee. In April 2014, the 2013 Term Loan was repaid and the 2013 Line of Credit was terminated in connection with the 2014 Loan Agreement described below. Upon repayment of the 2013 Term Loan in April 2014, Limited paid SVB an outstanding loan balance prepayment penalty of $133,000, and an early termination fee of $113,000 in connection with the termination of the 2013 Line of Credit in April 2014. In addition, in accordance with the Financial Accounting Standards Board (FASB)Accounting Standards Codification (ASC) 470-50-40-17, the Company expensed the facility fee and incremental value of the warrants associated with the 2013 Term Loan as part of the loss on early extinguishment. 2014 Loan Agreement, 2015 Loan Amendment and 2016 Loan Amendment In April 2014, Limited entered into a loan and security agreement (2014 Loan Agreement) with Hercules, which Limited and Hercules later amended in November 2015 (the 2015 Loan Amendment and, together with the 2014 Loan Agreement, the Term Loan Agreement). Under the 2014 Loan Agreement, Hercules made an advance in the initial principal amount of $10.0 million to Limited at closing to provide Limited with additional working capital for general corporate purposes and to repay the 2013 Term Loan. Hercules made an additional advance of $25.0 million to Limited in September 2014 following the approval of ILUVIEN by the FDA to fund the pSivida Milestone Payment. The Term Loan provided for interest only payments through November 2015. The 2015 Loan Amendment extended the interest only payments through May 2017. Interest on the Term Loan accrues at a floating per annum rate equal to the greater of (i) 10.90%, or (ii) the sum of (A) 7.65%, plus (B) the prime rate. Beginning in June 2017, Limited will make eleven equal monthly payments of principal and interest based upon a 30-month amortization schedule followed by a final payment of all remaining outstanding principal and interest in May 2018. In connection with the initial advance under the Term Loan, Limited paid to Hercules a facility charge of $262,500 and incurred legal and other fees of approximately $383,000. Limited incurred $375,000 in additional fees in connection with the second advance. If Limited repays the Term Loan, as amended, prior to maturity, it will pay Hercules a prepayment penalty of 1.25% of the total principal amount repaid. In connection with the 2015 Loan Amendment, Limited paid to Hercules an amendment fee of $262,500 and agreed to make an additional payment of $1,050,000 equal to 3% of the Term Loan at the time of the final payment in May 2018 (End of Term Payment). We also agreed to customary affirmative and negative covenants and events of default in connection with these arrangements, including revenue requirements and minimum cash balances. The occurrence of an event of default could result in the acceleration of Limited’s obligations under the Term Loan Agreement and an increase to the applicable interest rate, and would permit Hercules to exercise remedies with respect to the collateral under the Term Loan Agreement. In connection with the amendment, Limited agreed to covenants regarding certain revenue thresholds and liquidity. As of December 31, 2015, we, on a consolidated basis with our subsidiaries, were in compliance with the covenants of the Term Loan Agreement. In January 2016, we did not meet the revenue threshold covenant. As a result, on March 14, 2016, Limited entered into a second amendment to the Term Loan Agreement (the 2016 Loan Amendment) with Hercules, which waived the covenant violation and amended certain terms of the Term Loan Agreement. The 2016 Loan Amendment amends the revenue covenant to a rolling three month calculation to first be measured for the three months ending May 31, 2016 and increases the liquidity covenant. The amended liquidity covenant requires us to keep at least $25.0 million in liquidity, with a minimum of $17.5 million in cash. Additionally, in any month in which we have $25.0 million in cash, the revenue requirement will be waived. Upon execution of the 2016 Loan Amendment, Limited paid Hercules an amendment fee of $350,000 and agreed to increase the End of Term Payment to $1,400,000 from $1,050,000, which is payable on the date that the Term Loan Agreement is paid in full. Our current financial forecast for 2016 projects that we must obtain alternative or additional financing or it is probable that we will not be able to comply with the liquidity covenant. While Hercules may waive financial covenant requirements in the future, there can be no certainty that this will be the case. We are currently pursuing alternatives with various lenders and have an at-the-market offering in place under which we can sell up to approximately $34.2 million of our common stock, however, the avoidance of noncompliance with the liquidity covenant cannot be assured. If we do not maintain compliance with any of its covenants, Hercules could demand immediate repayment in full of the $35.0 million note payable and the End of Term Payment. As a result, the full amount of the related long-term note payable and the End of Term Payment have been classified as current liabilities in the accompanying Balance Sheet at December 31, 2015. Regardless of the noncompliance with financial covenants, we have made every scheduled payment required under the terms of the Term Loan Agreement. Limited’s obligations to Hercules are secured by a first priority security interest in substantially all of Limited’s assets, excluding intellectual property. Hercules does, however, maintain a negative pledge on Limited’s intellectual property requiring Hercules’ consent prior to the sale of such intellectual property. We and certain of our subsidiaries are guarantors of the obligations of Limited to Hercules under the Term Loan Agreement pursuant to separate guaranty agreements between Hercules and each of Limited and such subsidiaries (Guaranties). Pursuant to the Guaranties, we and these subsidiaries granted Hercules a first priority security interest in substantially all of their respective assets excluding intellectual property. In connection with Limited entering into the 2014 Loan Agreement, we entered into a warrant agreement with Hercules to purchase up to 285,016 shares of our common stock at an exercise price of $6.14 per share. Sixty percent of the warrants were exercisable at the closing in April 2014 and the remaining forty percent became exercisable upon the funding of the additional $25.0 million to Limited in September 2014. Further, we agreed to amend the warrant agreement in connection with the 2015 Loan Amendment to increase the number of shares issuable upon exercise to 660,377 and decrease the exercise price to $2.65 per share. We recorded the incremental fair value of these warrants as a discount of $1.3 million which is being amortized to interest expense using the effective interest method. The weighted average interest rates of our notes payable approximate the rate at which we could obtain alternative financing; therefore, the carrying amount of the notes approximated their fair value at December 31, 2015 and 2014, respectively. Financial Operations Overview We began generating revenue from ILUVIEN in the second quarter of 2013, but do not expect positive cash flow from operations until late 2017, if at all. In addition to generating revenue from product sales, we intend to seek to generate revenue from other sources such as upfront fees, milestone payments in connection with collaborative or strategic relationships, and royalties resulting from the licensing of ILUVIEN or any future product candidates and other intellectual property. We expect any revenue we generate will fluctuate from quarter to quarter as a result of the nature, timing and amount of any milestone payments we may receive from potential collaborative and strategic relationships, as well as revenue we may receive upon the sale of our products to the extent any are successfully commercialized. Research, Development and Medical Affairs Expenses Substantially all of our research, development and medical affairs expenses incurred to date related to our continuing operations have been related to the development of ILUVIEN. We anticipate that we will incur additional research, development and medical affairs expenses in the future as we evaluate and possibly pursue the regulatory approval of ILUVIEN in additional jurisdictions, the development of ILUVIEN for additional indications, or develop additional products or product candidates. We recognize research, development and medical affairs expenses as they are incurred. Our research, development and medical affairs expenses consist primarily of: • salaries and related expenses for personnel, including medical sales liaisons; • fees paid to consultants and contract research organizations (CRO) in conjunction with independently monitoring clinical trials and acquiring and evaluating data in conjunction with clinical trials, including all related fees such as investigator grants, patient screening, lab work and data compilation and statistical analysis; • costs incurred with third parties related to the establishment of a commercially viable manufacturing process for products or product candidates; • costs related to production of clinical materials, including fees paid to contract manufacturers; • costs related to post marketing authorization studies; • costs related to the provision of medical affairs support, including symposia development for physician education; • costs related to compliance with FDA, EEA or other regulatory requirements; • consulting fees paid to third-parties involved in research and development activities; and • costs related to stock options or other stock-based compensation granted to personnel in development functions. We expense both internal and external development costs as they are incurred. We expect that a large percentage of our research, development and medical affairs expenses in the future will be incurred in support of our current and future technical, preclinical and clinical development programs. These expenditures are subject to numerous uncertainties in terms of both their timing and total cost to completion. We expect to continue to develop stable formulations of ILUVIEN or any future products or product candidates, test such formulations in preclinical studies for toxicology, safety and efficacy and to conduct clinical trials for each future product candidate. We anticipate funding clinical trials ourselves, but we may engage collaboration partners at certain stages of clinical development. As we obtain results from clinical trials, we may elect to discontinue or delay clinical trials for certain products or product candidates or programs in order to focus our resources on more promising products or product candidates or programs. Completion of clinical trials by us or our future collaborators may take several years or more, the length of time generally varying with the type, complexity, novelty and intended use of a product candidate. Our only commercial product is ILUVIEN, which has received marketing authorization in the U.S., Austria, Belgium, the Czech Republic, Denmark, Finland, Germany, France, Ireland, Italy, Luxembourg, the Netherlands, Norway, Poland, Portugal, Spain, Sweden and the United Kingdom. In the U.S., ILUVIEN is indicated for the treatment of DME in patients who have been previously treated with a course of corticosteroids and did not have a clinically significant rise in IOP. In the EEA countries in which ILUVIEN has received marketing authorization, it is indicated for the treatment of vision impairment associated with chronic DME considered insufficiently responsive to available therapies. ILUVIEN has not been approved in any jurisdiction other than as set forth above. In order to grant marketing approval, a health authority such as the FDA or foreign regulatory agencies must conclude that clinical and preclinical data establish the safety and efficacy of ILUVIEN or any future products or product candidates with an appropriate benefit to risk profile relevant to a particular indication and that the product can be manufactured under current Good Manufacturing Practice (cGMP) in a reproducible manner to deliver the product’s intended performance in terms of its stability, quality, purity and potency. Until our submissions are reviewed by health authorities, there is no way to predict the outcome of their review. Even if the clinical studies meet their predetermined primary endpoints and a registration dossier is accepted for filing, a health authority could still determine that an appropriate benefit to risk relationship does not exist for the indication that we are seeking. We cannot forecast with any degree of certainty whether ILUVIEN or any future products or product candidates will be subject to future collaborations or how such arrangements would affect our development plan or capital requirements. As a result of the uncertainties discussed above, we are unable to determine the duration and completion costs of our development projects or when and to what extent we will receive cash inflows from the commercialization and sale of an approved product candidate. Within the Operating expenses section of our Consolidated Statements of Operations, we reclassified certain medical affairs support expenses of $448,000 and $429,000 for the year ended December 31, 2014 and 2013, respectively, from sales and marketing expenses to research, development and medical affairs expenses. General and Administrative Expenses General and administrative expenses consist primarily of compensation for employees in executive and administrative functions, including finance, accounting, information technology and human resources. Other significant costs include facilities costs and professional fees for accounting and legal services, including legal services associated with obtaining and maintaining patents. We expect to continue to incur significant costs to comply with the corporate governance, internal control and similar requirements applicable to public companies. Within the Operating expenses section of our Consolidated Statements of Operations for the year ended December 31, 2013, we reclassified depreciation expense of $138,000 from general and administrative expenses to depreciation and amortization to conform to the current year presentation. Sales and Marketing Expenses Sales and marketing expenses consist primarily of professional fees and compensation for employees for the commercial promotion, the assessment of the commercial opportunity of, the development of market awareness for, the pursuit of market reimbursement and the execution of launch plans for ILUVIEN. Other costs include professional fees associated with developing plans for ILUVIEN or any future products or product candidates and maintaining public relations. We launched ILUVIEN in Germany and the United Kingdom, in the second quarter of 2013 and the U.S. and Portugal in the first quarter of 2015. We expect significant increases in our sales and marketing expenses as we continue the commercialization of ILUVIEN in these countries. In November 2012, we entered into a master services agreement with Quintiles Commercial Europe Limited. Under the agreement, Quintiles Commercial Europe Limited and its affiliates (collectively, Quintiles Commercial) provided certain services to us in relation to the commercialization of ILUVIEN, in France, Germany and the United Kingdom. In December 2013 and January 2014, respectively, we transitioned our German and United Kingdom country manager positions in-house. In April 2015, we terminated the project orders associated with France and Germany and transitioned the persons employed by Quintiles Commercial to our payroll. In July 2015, we terminated the project orders associated with the United Kingdom and transitioned the covered positions employed by Quintiles Commercial to our payroll. As of December 31, 2015, we have a European management team, local management teams and commercial personnel in France, Germany, Portugal and the United Kingdom totaling 31 persons, of which five are consultants. In the fourth quarter of 2014, following the FDA approval of ILUVIEN in the U.S., we began establishing the infrastructure to support the anticipated commercial launch of ILUVIEN in the U.S. in the first quarter of 2015 with the addition of regional sales directors, reimbursement specialists and payor relations directors. We hired additional sales and marketing personnel through the first quarter of 2015 for the launch of ILUVIEN and as of December 31, 2015, had a field force of approximately 49 people, including sales personnel, reimbursement specialists and payor relations directors. Interest Expense and Other Interest expense consists primarily of interest and amortization of deferred financing costs and debt discounts associated with an earlier term loan entered into in 2010, the 2013 Term Loan and our current Term Loan Agreement. Interest income consists primarily of interest earned on our cash, cash equivalents and investments. Change in Fair Value of Derivative Warrant Liability Warrants to purchase our Series A Convertible Preferred Stock or common stock that do not meet the requirements for classification as equity, in accordance with the Derivatives and Hedging Topic of the FASB ASC, are classified as liabilities. We record these derivative financial instruments as liabilities in our balance sheet measured at their fair value. We record the changes in fair value of such instruments as non-cash gains or losses in the consolidated statements of operations. Basic and Diluted Net Loss Applicable to Common Stockholders per Share of Common Stock We calculated net loss per share in accordance with ASC 260, Earning Per Share. We had a net loss for all periods presented; accordingly, the inclusion of common stock options and warrants would be anti-dilutive. Dilutive common stock equivalents would include the dilutive effect of convertible securities, common stock options, warrants for convertible securities and warrants for common stock equivalents. Common stock equivalent securities that would potentially dilute basic EPS in the future, but were not included in the computation of diluted EPS because to do so would have been anti-dilutive, totaled approximately 32,164,307, 29,994,312 and 27,225,082 for the years ended December 31, 2015, 2014 and 2013, respectively. Potentially dilutive common stock equivalents were excluded from the diluted earnings per share denominator for all periods of net loss because of their anti-dilutive effect. Therefore, for the years ended December 31, 2015, 2014 and 2013, the weighted average shares used to calculate both basic and diluted loss per share are the same. Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. On an ongoing basis, we evaluate these estimates and judgments, including those described below. We base our estimates on 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. 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 consolidated financial statements. Revenue Recognition - U.S. Product Sales Product sales consist of U.S. sales of ILUVIEN. In the U.S., we sell ILUVIEN to a limited number of pharmaceutical distributors who in turn sell the product downstream to pharmacies and physician practices. Revenue from product sales is recognized when persuasive evidence of an arrangement exists, title to product and associated risk of loss have passed to the customer, the price is fixed or determinable, collection from the customer is reasonably assured, we have no further performance obligations and returns can be reasonably estimated. We record revenue from product sales upon delivery to our pharmaceutical distributors. Revenue from U.S. product sales is recorded net of applicable provisions for rebates and chargebacks under governmental programs, such as Medicaid and Veterans’ Administration (VA), distribution-related fees and other sales-related deductions. We estimate reductions to product sales based upon contracts with customers and government agencies, statutorily-defined discounts applicable to government-funded programs, estimated payer mix, inventory levels, shelf life of the product and other relevant factors. Calculating these provisions involves management’s estimates and judgments. We review our estimates of rebates, chargebacks and other applicable provisions each period and record any necessary adjustments in the current period’s net product sales. We estimate reductions to product sales for Medicaid and VA programs and for certain other qualifying federal and state government programs. Based upon our contracts with government agencies, statutorily-defined discounts applicable to government-funded programs, historical experience and estimated payer mix, we estimate and record an allowance for rebates and chargebacks. Our liability for Medicaid rebates consists of estimates for claims that a state will make for a current quarter, claims for prior quarters that have been estimated for which an invoice has not been received and invoices received for claims from prior quarters that have not been paid. Our reserves related to discounted pricing to VA, Public Health Services and other institutions (collectively qualified healthcare providers) represent our estimated obligations resulting from contractual commitments to sell products to qualified healthcare providers at prices lower than the list prices we charge to our customers (i.e., pharmaceutical distributors). Our customers charge us for the difference between what they pay for the products and the ultimate selling price to the qualified healthcare providers. Our reserve for this discounted pricing is based on expected sales to qualified healthcare providers and the chargebacks that customers have already claimed. We have written contracts with our customers that include terms for distribution-related fees. We estimate and record distribution and related fees due to its customers based on gross sales. Consistent with industry practice, we offer our customers a limited right to return product purchased directly from us, which is principally based upon the product’s expiration date. We will accept returns for three months prior to and up to nine months after the product expiration date. Depending on the circumstances, we may provide replacement products or cash credit for returns. Product returned is generally not resalable given the nature of our products and method of administration. We develop estimates for product returns based upon historical experience, inventory levels, shelf life of the product and other relevant factors. We monitor product supply levels in the distribution channel, as well as sales by its customers to healthcare providers using product-specific data provided by its customers. If necessary, our estimates of product returns may be adjusted in the future based on actual returns experience, known or expected changes in the marketplace, or other factors. Research and Development Costs Research and development expenditures are expensed as incurred, pursuant to ASC 730, Research and Development. Costs to license technology to be used in our research and development that have not reached technological feasibility, defined as regulatory approval for ILUVIEN or any future products or product candidates, and have no alternative future use are expensed when incurred. Payments to licensors that relate to the achievement of preapproval development milestones are recorded as research and development expense when incurred. Clinical Trial Prepaid and Accrued Expenses We record prepaid assets and accrued liabilities related to clinical trials associated with CROs, clinical trial investigators and other vendors based upon amounts paid and the estimated amount of work completed on each clinical trial. The financial terms of agreements vary from vendor to vendor and may result in uneven payment flows. As such, if we have advanced funds exceeding our estimate of the work completed, we record a prepaid asset. If our estimate of the work completed exceeds the amount paid, an accrued liability is recorded. All such costs are charged to research and development expenses based on these estimates. Our estimates may or may not match the actual services performed by the organizations as determined by patient enrollment levels and related activities. We monitor patient enrollment levels and related activities to the extent possible through internal reviews, correspondence and discussions with our CROs and review of contractual terms. However, if we have incomplete or inaccurate information, we may underestimate or overestimate activity levels associated with various clinical trials at a given point in time. In this event, we could record significant research and development expenses in future periods when the actual level of activities becomes known. To date, we have not experienced material changes in these estimates. Additionally, we do not expect material adjustments to research and development expenses to result from changes in the nature and level of clinical trial activity and related expenses that are currently subject to estimation. In the future, as we expand our clinical trial activities, we expect to have increased levels of research and development costs that will be subject to estimation. Stock-Based Compensation We have stock option plans which provide for grants of stock options to employees, directors and consultants or other service providers to purchase shares of our common stock at exercise prices generally equal to the fair values of such stock at the dates of grant. Compensation cost is recognized for all stock-based awards based on the grant date fair value in accordance with the provisions of ASC 718, Compensation - Stock Compensation. We recognize the grant date fair value as compensation cost of employee stock-based awards using the straight-line method over the actual vesting period, adjusted for our estimates of forfeiture. Typically, we grant stock options with a requisite service period of four years from the grant date. We have elected to use the Black-Scholes option pricing model to determine the fair value of stock-based awards. We concluded that this was the most appropriate method by which to value our share-based payment arrangements, but if any share-based payment instruments should be granted for which the Black-Scholes method does not meet the measurement objective as stated within ASC 718, we will utilize a more appropriate method for valuing that instrument. However, we do not believe that any instruments granted to date and accounted for under ASC 718 would require a method other than the Black-Scholes method. Our determination of the fair market value of share-based payment awards on the grant date using option valuation models requires the input of highly subjective assumptions, including the expected price volatility and option life. Changes in these input variables would affect the amount of expense associated with equity-based compensation. Expected volatility is based on the historical volatility of our common stock over the expected term of the stock option grant. To estimate the expected term, we utilize the “simplified” method for “plain vanilla” options as discussed within the Securities and Exchange Commission’s (SEC) Statement of Accounting Bulletin (SAB) 107. We believe that all factors listed within SAB 107 as pre-requisites for utilizing the simplified method are true for us and for our share-based payment arrangements. We intend to utilize the simplified method for the foreseeable future until more detailed information about exercise behavior will be more widely available. The risk-free interest rate is based on U.S. Treasury Daily Treasury Yield Curve Rates corresponding to the expected life assumed at the date of grant. Dividend yield is zero as there are no payments of dividends made or expected. Income Taxes We recognize deferred tax assets and liabilities for temporary differences between the financial reporting basis and the tax basis of our assets and liabilities in accordance with ASC 740, Income Taxes. We evaluate the positive and negative evidence bearing upon the realizability of our deferred tax assets on an annual basis. Significant management judgment is involved in determining the provision for income taxes, deferred tax assets and liabilities, and any valuation allowance recorded against net deferred tax assets. Due to uncertainties with respect to the realization of our U.S. deferred tax assets due to our history of operating losses, a valuation allowance has been established against our U.S. deferred tax asset balances to reduce the net carrying value to an amount that is more likely than not to be realized. As a result we have fully reserved against the U.S. deferred tax asset balances. The valuation allowances are based on our estimates of taxable income in the jurisdictions in which we operate and the period over which deferred tax assets will be recoverable. In the event that actual results differ from these estimates or we adjust these estimates in future periods, a change in the valuation allowance may be needed, which could materially impact our financial position and results of operations. Our deferred tax assets primarily consist of net operating loss (NOL) carry-forwards. At December 31, 2015 we had federal NOL carry-forwards of approximately $100.8 million and state NOL carry-forwards of approximately $84.3 million, respectively, that are available to reduce future income otherwise taxable. If not utilized, the federal NOL carry-forwards will expire at various dates between 2029 and 2035 and the state NOL carry-forwards will expire at various dates between 2020 and 2035. We periodically evaluate our NOL carry-forwards and whether certain changes in ownership have occurred that would limit our ability to utilize a portion of our NOL carry-forwards. If it is determined that significant ownership changes have occurred since these NOLs were generated, we may be subject to annual limitations on the use of these NOLs under Internal Revenue Code (IRC) Section 382 (or comparable provisions of state law). The issuance of the Series A Convertible Preferred Stock on October 2, 2012 constituted such a change in ownership. As a result of this change in ownership, we performed a formal analysis in connection with IRC Section 382 and determined that approximately $13.7 million of our NOLs generated prior to the change in ownership could not be utilized in the future. Our remaining NOLs remain subject to future limitation under IRC Section 382. In the event that we were to determine that we are able to realize any of our net deferred tax assets in the future, an adjustment to the valuation allowance would increase net income in the period such determination was made. We believe that the most significant uncertainty that will impact the determination of our valuation allowance will be our estimation of the extent and timing of future net income, if any. We considered our income tax positions for uncertainty in accordance with ASC 740. We believe our income tax filing positions and deductions are more likely than not of being sustained on audit and do not anticipate any adjustments that will result in a material change to our financial position; therefore, we have not recorded ASC 740 liabilities. We recognize accrued interest and penalties related to unrecognized tax benefits as interest expense and income tax expense, respectively, in our statements of operations. Our tax years since 2003 remain subject to examination in Georgia, Tennessee, and on the federal level. We do not anticipate any material changes to our uncertain tax positions within the next 12 months. Foreign Currency Translation The U.S. dollar is the functional currency of Alimera Sciences, Inc. The Euro is the functional currency for the majority of our subsidiaries operating outside of the U.S. Our foreign currency assets and liabilities are remeasured into U.S. dollars at end-of-period exchange rates, except for nonmonetary balance sheet accounts, which are remeasured at historical exchange rates. Revenue and expenses are remeasured at average exchange rates in effect during each period, except for those expenses related to the non-monetary balance sheet amounts, which are remeasured at historical exchange rates. Gains or losses from foreign currency remeasurement are included in income. The financial statements of the foreign subsidiaries whose functional currency is not the U.S. dollar have been translated into U.S. Dollars in accordance with ASC 830-30, Translation of Financial Statements. For the subsidiaries operating outside of the U.S. that are denominated in the Euro, assets and liabilities are translated at end-of-period rates while revenues and expenses are translated at average rates in effect during the period in which the activity took place. Equity is translated at historical rates and the resulting cumulative translation adjustments are included as a component of accumulated other comprehensive income. Results of Operations - Segment Review The following selected unaudited financial and operating data are derived from our consolidated financial statements and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations" and our consolidated financial statements. The results and discussions that follow are reflective of how executive management monitors the performance of our reporting segments. Certain operating expenses are allocated between our reporting segments based on activity-based costing methods. These activity-based costing methods require us to make estimates that impact the amount of each expense category that is attributed to each segment. Changes in these estimates will directly impact the amount of expense allocated to each segment and therefore the operating profit of each reporting segment. There were no significant changes in our expense allocation methodology during 2015, 2014 or 2013. However, in 2015, as a result of the FDA approval of ILUVIEN in the U.S. in late 2014, there was a shift in allocation of research, development and medical affairs costs between segments to more accurately reflect the benefit of those costs on future revenue streams. In addition, there was a shift in sales and marketing and general and administrative activity between segments in late 2014 and 2015 in anticipation and as a result of the commercial launch of ILUVIEN in the U.S. U.S. Segment Year ended December 31, 2015 compared to the year ended December 31, 2014 Net Revenue. Net revenue of approximately $15.2 million for the year ended December 31, 2015, was recognized as a result of the U.S. commercial launch of ILUVIEN in the first quarter of 2015. Net revenue of $17,000 was recognized during the year ended December 31, 2014 as a result of sales of ILUVIEN in the U.S. prior to the commercial launch. Cost of goods sold, excluding depreciation and amortization. Cost of goods sold, excluding depreciation and amortization of approximately $790,000 was recognized for the year ended December 31, 2015, as a result of the U.S. commercial launch of ILUVIEN in the first quarter of 2015. Cost of goods sold, excluding depreciation and amortization of approximately $1,000 was recognized for the for the year ended December 31, 2014, as a result of sales of ILUVIEN prior to the U.S. commercial launch of ILUVIEN in the first quarter of 2015. Research, development and medical affairs expenses. Research, development and medical affairs expenses increased by approximately $4.3 million, or 80%, to approximately $9.7 million for the year ended December 31, 2015, compared to approximately $5.4 million for the year ended December 31, 2014. The increase was primarily attributable to the costs of approximately $2.6 million associated with U.S based research and development in 2015 that in previous years would have been allocated to the International segment and increases of $1.4 million in costs incurred with third parties related to product life cycle management, $1.2 million in scientific communications costs, $890,000 in personnel and related costs associated with our medical science liaison team engaging physicians in the study of ILUVIEN and $570,000 in ongoing post marketing scientific studies of ILUVIEN. These costs were offset by a decrease of approximately $2.4 million in costs incurred in 2014 related to the use of a consultant to assist with the approval of ILUVIEN in the U.S., which included a milestone payment of $2.0 million payable upon FDA approval of ILUVIEN in September 2014. General and administrative expenses. General and administrative expenses increased by approximately $700,000, or 9%, to approximately $8.2 million for the year ended December 31, 2015, compared to approximately $7.5 million for the year ended December 31, 2014. The increase was primarily attributable to increases of approximately $680,000 in personnel and related costs and $170,000 in office expenses due to our growth to support the launch and commercialization of ILUVIEN in the U.S. These costs were offset by a decrease of $220,000 in professional and legal fees. Sales and marketing expenses. Sales and marketing expenses increased by approximately $15.1 million, or 321%, to approximately $19.8 million for the year ended December 31, 2015, compared to approximately $4.7 million for the year ended December 31, 2014. The increase was primarily attributable to increases of approximately $11.2 million in personnel and travel costs associated with the commercial team hired for the launch of ILUVIEN in the U.S. in the first quarter of 2015, $2.4 million in media and promotional costs incurred to support the launch and commercialization of ILUVIEN in the U.S. and $1.2 million in costs associated with establishing reimbursement in the U.S. Depreciation and amortization. Depreciation and amortization increased by approximately $1.8 million, or 273%, to approximately $2.5 million for the year ended December 31, 2015, compared to approximately $660,000 for the year ended December 31, 2014. The increase was primarily attributable to an increase in amortization of $1.4 million associated with an intangible asset which was capitalized in connection with a required payment to pSivida upon FDA approval of ILUVIEN in September 2014. Additional increases in depreciation were primarily attributable to increases as a result of capital leases associated with automobile leases for the U.S. commercialization team. Year ended December 31, 2014 compared to the year ended December 31, 2013 Net Revenue. Net revenue of approximately $17,000 was recognized for the year ended December 31, 2014, as a result of sales of ILUVIEN prior to the U.S. commercial launch of ILUVIEN in the first quarter of 2015. No U.S. revenue was recognized during the year ended December 31, 2013. Cost of goods sold, excluding depreciation and amortization. Cost of goods sold, excluding depreciation and amortization of approximately $1,000 was recognized for the for the year ended December 31, 2014, as a result of sales of ILUVIEN prior to the U.S. commercial launch of ILUVIEN in the first quarter of 2015. No U.S. cost of goods sold was recognized during the year ended December 31, 2013. Research, development and medical affairs expenses. Research, development and medical affairs expenses increased by approximately $1.3 million, or 31%, to approximately $5.4 million for the year ended December 31, 2014, compared to approximately $4.1 million for the year ended December 31, 2013. The increase was primarily attributable to increases of $990,000 in payroll and related costs for clinical personnel and medical science liaisons hired in the second half of 2014 to support the U.S. launch of ILUVIEN in the first quarter of 2015, $780,000 related to a consultant that was engaged to assist with the pursuit of FDA approval of ILUVIEN in the U.S., $410,000 related to scientific communications in preparation for the commercial launch in the U.S. The increase was offset by a decrease of $1.1 million in costs related to our domestic ancillary clinical studies including the physician utilization study which was completed in the fourth quarter of 2013. General and administrative expenses. General and administrative expenses increased by approximately $2.5 million, or 50%, to approximately $7.5 million for the year ended December 31, 2014, compared to approximately $5.0 million for the year ended December 31, 2013. The increase was primarily attributable to an increases of approximately $970,000 in personnel and related costs associated with U.S. based employees shifting focus from the International segment to support the U.S. expansion and launch efforts, $510,000 in stock based compensation incurred in connection with the additional hires and contingent options that vested as a result of the FDA approval of ILUVIEN in 2014, $440,000 in personnel costs associated with increased headcount, $380,000 in legal fees and $310,000 in professional fees associated with internal controls compliance and attestation, as our independent auditors were required to opine on our internal controls for the first time for the year ended December 31, 2014. Sales and marketing expenses. Sales and marketing expenses increased by approximately $3.8 million, or 427%, to approximately $4.7 million for the year ended December 31, 2014, compared to approximately $890,000 for the year ended December 31, 2013. The increase was primarily attributable to increases of $2.7 million in U.S. marketing cost incurred in preparation for the U.S. launch of ILUVIEN, $650,000 in personnel costs associated with U.S. based employees shifting focus to the U.S. sales and marketing effort in late 2014 and $450,000 in payroll and related costs for additional sales and marketing personnel hired in 2014 in preparation for the U.S. launch of ILUVIEN in the first quarter of 2015. Depreciation and amortization. Depreciation and amortization increased by approximately $520,000, or 371%, to approximately $660,000 for the year ended December 31, 2014, compared to approximately $140,000 for the year ended December 31, 2013. The increase was primarily attributable to amortization of $510,000 associated with an intangible asset which was capitalized in connection with a required payment to pSivida upon FDA approval of ILUVIEN in September 2014. International Segment Year ended December 31, 2015 compared to the year ended December 31, 2014 Net Revenue. Net revenue decreased by approximately $1.1 million, or 13%, to approximately $7.3 million for the year ended December 31, 2015, compared to approximately $8.4 million for the year ended December 31, 2014. The decrease was primarily attributable to decreases in the value of the British pound sterling and the Euro which impacted reported revenue by $1.2 million offset by incremental sales associated with the commercial launch of ILUVIEN in Portugal in 2015. Cost of goods sold, excluding depreciation and amortization. Cost of goods sold, excluding depreciation and amortization decreased by approximately $430,000, or 31%, to approximately $970,000 for the year ended December 31, 2015, compared to approximately $1.4 million for the year ended December 31, 2014. The decrease was primarily attributable to decreases in charges for expiring inventory. In 2015, we recognized approximately $450,000 in invetory reserves as a result of pricing delays in France as compared to $860,000 recorded in 2014 primarily as a result of lower than expected sales in Germany. Research, development and medical affairs expenses. Research, development and medical affairs expenses decreased by approximately $1.3 million, or 20%, to approximately $5.1 million for the year ended December 31, 2015, compared to approximately $6.4 million for the year ended December 31, 2014. The decrease was primarily attributable to a reduction of allocated costs of approximately $2.6 million associated with U.S. based research and development in 2015 that in previous years would have been allocated to the International segment. The decrease was offset by increases of approximately $670,000 in ongoing post marketing scientific studies of ILUVIEN, $300,000 in scientific communications costs and $250,000 in pharmacovigilence costs. General and administrative expenses. General and administrative expenses increased by approximately $1.0 million, or 20%, to approximately $5.9 million for the year ended December 31, 2015, compared to approximately $4.9 million for the year ended December 31, 2014. The increase was primarily attributable to an increase of approximately $480,000 in payroll and related costs due to an increase in our EEA employee headcount and $420,000 in U.S. corporate overhead allocated to the international segment as we grew our infrastructure to support our global business. Sales and marketing expenses. Sales and marketing expenses decreased by approximately $2.1 million, or 20%, to approximately $8.3 million for the year ended December 31, 2015, compared to approximately $10.4 million for the year ended December 31, 2014. The decrease was primarily attributable to a decrease of approximately $3.3 million associated with the transition of management and market access roles that were contracted from Quintiles Commercial in 2014 and brought in-house in 2015 and a reallocation of corporate resources to the U.S. following FDA approval of ILUVIEN in September 2014, offset by increases of approximately $690,000 for congresses and marketing costs and $370,000 in costs associated with outside consultants. Year ended December 31, 2014 compared to the year ended December 31, 2013 Net Revenue. Net revenue increased by approximately $6.5 million, or 342%, to approximately $8.4 million for the year ended December 31, 2014, compared to approximately $1.9 million for the year ended December 31, 2013. We initiated the commercial launch of ILUVIEN in Germany and the United Kingdom in the second quarter of 2013 and began recognizing revenue at that time. The increase was primarily due to revenue growth in the United Kingdom following the implementation of NICE guidance for the reimbursement of ILUVIEN in early 2014 as well as continued growth in Germany. No customer accounted for more than 10% of revenue during the year ended December 31, 2014. For the year ended December 31, 2013 two pharmacy customers in Europe accounted for approximately 23% of our total consolidated revenues. Cost of goods sold, excluding depreciation and amortization. Cost of goods sold, excluding depreciation and amortization decreased by approximately $500,000, or 26%, to approximately $1.4 million for the year ended December 31, 2014, compared to approximately $1.9 million for the year ended December 31, 2013. We initiated the commercial launch of ILUVIEN in Germany and the United Kingdom in the second quarter of 2013 and began recognizing cost of goods sold at that time. Cost of goods sold was impacted by two items during the year ended December 31, 2013. During a routine manufacturing inspection, we identified a quality issue related to one of our suppliers that affected certain batches of work in process which resulted in a write-off of $1.4 million. Additionally, we reserved approximately $400,000 for potential United Kingdom inventory expiration as a result of delays in receiving the NICE guidance. For the year ended December 31, 2014, we reserved approximately $860,000 primarily for potential German inventory expiration, as a result of lower than expected sales in Germany. Research, development and medical affairs expenses. Research, development and medical affairs expenses increased by approximately $1.7 million, or 36%, to approximately $6.4 million for the year ended December 31, 2014, compared to approximately $4.7 million for the year ended December 31, 2013. The increase was primarily attributable to increases of $880,000 in additional payroll and related costs associated with additional medical and clinical personnel hired during 2013 to support the commercialization of ILUVIEN in Europe being employed for the full year ended 2014, $370,000 in scientific study costs for an ongoing open label registry study in the EEA, $160,000 in costs associated with maintaining regulatory compliance within EEA jurisdictions in which ILUVIEN has received marketing authorization and $150,000 in medical affairs costs to increase ILUVIEN awareness among doctors in Germany. General and administrative expenses. General and administrative expenses increased by approximately $500,000, or 11%, to approximately $4.9 million for the year ended December 31, 2014, compared to approximately $4.4 million for the year ended December 31, 2013. The increase was primarily attributable to an increase of approximately $410,000 in European payroll and related costs due to an increase in employee headcount and a shift away from U.S. based employees management and oversight of the international entities. Additionally, there was an increase of approximately $260,000 in general office related expense in establishing new facilities in each of the respective countries. The increase was offset by a reduction of approximately $230,000 in professional fees and insurance expenses. Sales and marketing expenses. Sales and marketing expenses decreased by approximately $4.7 million, or 31%, to approximately $10.4 million for the year ended December 31, 2014, compared to approximately $15.1 million for the year ended December 31, 2013. The decrease was primarily attributable to a decreases of approximately $1.9 million in costs incurred with Quintiles Commercial for market access assistance in the United Kingdom in 2013 in preparation for the implementation of the NICE guidance for reimbursement, $1.6 million in costs associated with one time launch costs incurred in 2013 for the launch of ILUVIEN in Germany and the United Kingdom, $650,000 in personnel costs associated with U.S. based employees shifting focus to the U.S. sales and marketing effort in late 2014 and $480,000 associated with Quintiles Commercial as certain positions were transitioned to us over the course of 2014. Consolidated other income and expense The following selected unaudited financial and operating data are derived from our consolidated financial statements and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements. Year ended December 31, 2015 compared to the year ended December 31, 2014 Interest expense and other. Interest expense and other increased by approximately $2.6 million, or 124%, to approximately $4.7 million for the year ended December 31, 2015, compared to approximately $2.1 million for the year ended December 31, 2014. The increase was primarily attributable to higher principal balances for the year ended December 31, 2015 as a result of the increase in the average principal year over year under the Term Loan Agreement,under which we borrowed an additional $25.0 million in September 2014. Unrealized foreign currency (loss) gain, net. Unrealized foreign currency (loss) gain, net was a loss of approximately $110,000 for the year ended December 31, 2015, compared to a loss of approximately $540,000 for the year ended December 31, 2014. The 2015 and 2014 unrealized foreign currency losses were primarily attributable to the weakening of the Euro during the period and the revaluation of Limited’s U.S. dollar denominated liabilities. Change in fair value of derivative warrant liability. During the year ended December 31, 2015, we recognized a gain of approximately $13.3 million related to the decrease in the fair value of our derivative warrant liability. During the year ended December 31, 2014, we recognized a gain of approximately $280,000 related to the decrease in the fair value of our derivative warrant liability. The change in fair value was primarily due to a decrease in the fair market value of our underlying common stock during the years ended December 31, 2015 and 2014. Year ended December 31, 2014 compared to the year ended December 31, 2013 Interest expense and other. Interest expense and other increased by approximately $1.6 million, or 302%, to approximately $2.1 million for the year ended December 31, 2014, compared to approximately $530,000 for the year ended December 31, 2013. Interest expense for the year ended December 31, 2014 was primarily interest expense incurred in connection with our 2013 Term Loan and 2014 Loan Agreement. Interest expense for the year ended December 31, 2013 was primarily interest expense incurred in connection with our 2010 Term Loan and our 2013 Term Loan. The increase was primarily attributable to higher principal balances for the year ended December 31, 2014 as a result of the 2014 Loan Agreement. Unrealized foreign currency (loss) gain, net. Unrealized foreign currency (loss) gain, net was a loss of approximately $540,000 for the year ended December 31, 2014, compared to a gain of approximately $830,000 for the year ended December 31, 2013. The 2014 unrealized foreign currency loss was primarily attributable to the weakening of the Euro during 2014 and the revaluation of Alimera Sciences Limited’s U.S. dollar denominated liabilities. The 2013 unrealized foreign currency gain was primarily attributable to the strengthening of the Euro during 2013 and the revaluation of Alimera Sciences Limited’s U.S. dollar denominated liabilities. Change in fair value of derivative warrant liability. During the year ended December 31, 2014, we recognized a gain of approximately $280,000 related to the decrease in the fair value of our derivative warrant liability. The change in fair value was primarily due to a decrease in the fair market value of our underlying common stock during the year ended December 31, 2014. During the year ended December 31, 2013, we recognized a loss of approximately $12.0 million related to the increase in the fair value of our derivative warrant liability. The change in fair value was primarily due to an increase in the fair market value of our underlying common stock during the year ended December 31, 2013. Liquidity and Capital Resources Since inception, we have incurred recurring losses, negative cash flow from operations and have accumulated a deficit of $343.9 million from our inception through December 31, 2015. We have funded our operations through the public and private placement of common stock, convertible preferred stock, warrants, the sale of certain assets of the non-prescription business in which we were previously engaged and certain debt facilities. In September 2014, we entered into a sales agreement with Cowen and Company, LLC (Cowen) to offer shares of our common stock, $0.01 par value per share, from time to time through Cowen, as our sales agent for the offer and sale of the shares up to an aggregate offering price of $35.0 million. We pay a commission equal to 3% of the gross proceeds from the sale of shares of our common stock under the sales agreement. We intended to use the net proceeds from this offering for general corporate purposes, including capital expenditures, debt repayments and working capital. In 2015, we sold a total of 268,978 shares of common stock at a weighted average price of $3.07 per share through our at-the-market offering, for total net proceeds of approximately $800,000, further reduced by approximately $79,000 of related issuance costs and placement agent fees. As of December 31, 2015, we had approximately $31.1 million in cash and cash equivalents. We launched ILUVIEN in Germany and the United Kingdom in the second quarter of 2013 and in the U.S. and Portugal in the first quarter of 2015. Due to the limited revenue generated by ILUVIEN to date, we may have to raise additional capital to fund the continued commercialization of ILUVIEN. If we are unable to raise additional financing, we will need to adjust our commercial plans so that we can continue to operate with our existing cash resources. The actual amount of funds that we will need will be determined by many factors, some of which are beyond our control and we may need funds sooner than currently anticipated. In January 2016, we did not meet a revenue threshold under the covenants of the Term Loan Agreement. Limited entered into the 2016 Loan Amendment, which waived the covenant violation and amended certain terms of the Term Loan Agreement. The 2016 Loan Amendment amends the revenue covenant to a rolling three month calculation to first be measured for the three months ending May 31, 2016 and increases the liquidity covenant. The amended liquidity covenant requires us to keep at least $25.0 million in liquidity, with a minimum of $17.5 million in cash. Additionally, in any month in which we have $25.0 million in cash, the revenue requirement will be waived. Our current financial forecasts for 2016 project that we must obtain alternative or additional financing otherwise it is probable that we will not be able to comply with the liquidity covenant. We are currently pursuing alternative or additional debt financing and have an at-the-market offering in place under which we may sell up to approximately $34.2 million of our common stock. If we are not successful, we will be in default of the Term Loan Agreement. In an event of default under our Term Loan Agreement, Hercules may call the Term Loan. We cannot be sure that alternative or additional financing will be available when needed or that, if available, the additional financing will be obtained on terms favorable to us or our stockholders especially in light of the current difficult financial environment. If we raise additional funds by issuing equity securities, substantial dilution to existing stockholders would likely result and the terms of any new equity securities may have a preference over our common stock. If we attempt to raise additional funds through strategic collaboration agreements and debt financing, we may not be successful in obtaining collaboration agreements, or in receiving milestone or royalty payments under those agreements, or the terms of the debt may involve significant cash payment obligations as well as covenants and specific financial ratios that may restrict our ability to commercialize ILUVIEN or any future products or product candidates or operate our business. For the twelve months ended December 31, 2015, cash used in our operations of $45.4 million was primarily due to our net loss of $30.6 million, which is subject to further adjustment for non-cash items. These items included approximately$13.3 million for a non-cash gain for the change in our derivative warrant liability, charges of approximately $5.0 million for stock compensation expense, $2.6 million of depreciation and amortization expense, $840,000 of amortization of our debt discount, $450,000 in inventory reserves and $110,000 for unrealized foreign currency transactions losses. Further impacting cash from operations was an increase in accounts receivable of $8.9 million, decrease in accounts payable, accrued expenses and other current liabilities of $1.9 million and increase in inventory of $390,000. Accounts receivable increased primarily due to the U.S. launch of ILUVIEN during the first quarter of 2015. Accounts payable, accrued expenses and other current liabilities decreased primarily due to the milestone payment of $2.0 million paid to a consultant that was engaged to assist with the pursuit of approval of ILUVIEN in the U.S. and a decrease of $1.2 million in amounts payable to Quintiles Commercial, offset by increases of $460,000 in accruals associated with accrued rebate, chargeback and other revenue reserves, $450,000 in clinical studies accruals and $300,000 in commissions payable to our U.S. sales force. For the twelve months ended December 31, 2014, cash used in our operations of $24.3 million was primarily due to our net loss of $35.9 million, increased by $280,000 for a non-cash gain for the change in our derivative warrant liability and offset by non-cash charges of approximately $3.9 million for stock compensation expense, $660,000 of depreciation and amortization expense, $540,000 for unrealized foreign currency transactions, $460,000 amortization of deferred financing costs and debt discount and $440,000 for the loss from early extinguishment of debt. Further impacting cash from operations was an increase in accounts payable, accrued expenses and other current liabilities of $6.1 million and increase in accounts receivable of $440,000. The increase in accounts payable, accrued expenses and other current liabilities of $6.1 million was primarily due to increases of $2.6 million of amounts payable to Quintiles Commercial and $2.0 million for a milestone payment payable to a consultant that was engaged to assist with the pursuit of approval of ILUVIEN in the U.S. For the twelve months ended December 31, 2013, cash used in our operations of $37.8 million was primarily due to our net loss of $46.2 million, offset by a non-cash loss of $12.0 million for a change in derivative warrant liability and by non-cash charges of $2.5 million for stock compensation expense, and increased by a non-cash gain of $830,000 for unrealized foreign currency transactions. Further decreasing cash was a decrease in accounts payable, accrued expenses and other current liabilities of $2.6 million and increases in prepaid expenses and other current assets of $1.4 million, inventory of $1.4 million and accounts receivable of $480,000. The decrease in accounts payable, accrued expenses and other current liabilities of $2.6 million was primarily due to decreases of $2.0 million in amounts paid to Quintiles Commercial. The increase in prepaid expense and other current assets of $1.4 million was primarily due to increases of $1.3 million in advances to Quintiles Commercial during the fourth quarter of 2013. For the year ended December 31, 2015, net cash used in our investing activities was approximately $450,000, which was primarily due to the purchase of drug safety management software. For the year ended December 31, 2014, net cash used in our investing activities was approximately $25.8 million, which was primarily due to the payment of a $25.0 million milestone payment to pSivida which was payable upon the FDA’s approval of ILUVIEN in September 2014. For the year ended December 31, 2013, net cash used in our investing activities was approximately $970,000, which was primarily due to the purchase of back-up manufacturing equipment for ILUVIEN. For the year ended December 31, 2015, net cash provided by our financing activities was approximately $630,000. During the fourth quarter of 2015 we sold 268,978 shares of common stock at a weighted average price of $3.07 per share for proceeds of approximately $800,000 excluding approximately $79,000 of related issuance costs and placement agent fees. Further increasing cash from our financing activities was $570,000 from the proceeds from exercises of stock options. These increases were offset by decreases due to the payment of issuance costs of approximately $330,000 in January 2015 associated with the sale of our Series B Convertible Preferred Stock in December 2014, $290,000 in payments on capital leases and $260,000 in fees to modify our Term Loan Agreement. For the year ended December 31, 2014, net cash provided by our financing activities was approximately $114.7 million. In January 2014, we entered into a securities purchase agreement with investors pursuant to which we sold an aggregate of 6,250,000 shares of our common stock at a purchase price of $6.00 per share. Gross proceeds from the offering were $37.5 million prior to the payment of approximately $2.4 million of related issuance costs. In April 2014, we entered into a term loan agreement with Hercules, which resulted in proceeds of $10.0 million in April of 2014 and $25.0 million in September of 2014 prior to the payment of approximately $1.0 million in related costs, and $4.9 million used to prepay and terminate our 2013 Term Loan. Further increasing cash from our financing activities was $770,000 from the proceeds from exercises of stock options. In December 2014, we closed a preferred stock financing in which we sold 8,416.251 shares of Series B Convertible Preferred Stock for gross proceeds of $50.0 million, prior to the payment of approximately $430,000 of related issuance costs. For the year ended December 31, 2013, net cash provided by our financing activities was approximately $1.7 million, which was primarily due to proceeds from the 2013 Term Loan of $5.0 million offset by the use of approximately $3.2 million to repay the 2010 Term Loan. Contractual Obligations and Commitments The following table summarizes our contractual obligations and commitments as of December 31, 2015: (1) Amounts do not include interest on our note payable which accrues at a floating per annum rate equal to the greater of (i) 10.90%, or (ii) the sum of (A) 7.65%, plus (B) the prime rate. In addition, amounts do not include a required $1.05 million payment at the termination of the note. Amounts are considered payable in less than 1 year due as our current financial forecasts for 2016 project that we must obtain alternative or additional financing or it is probable that we will not be in compliance with the liquidity covenant, as discussed above. The following has not been included in the table above as the timing of the payments is uncertain: In May 2013, we entered into an agreement with the first of two CROs for clinical and data management services to be performed in connection with the five-year, post-authorization, open label registry study of 800 patients treated with ILUVIEN per the labeled indication in the EEA. Since May of 2013 eight additional agreements have been entered into for work with these CROs. For the years ended December 31, 2015, 2014 and 2013, we incurred $591,000, $346,000 and $222,000, respectively, of expense associated with these agreements. At December 31, 2015, $150,000 is recorded in outsourced services payable. As of December 31, 2015 we expect to incur an additional $810,000 of expense associated with these agreements through December 31, 2019. Off-Balance Sheet Arrangements We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, that would have been established for the purpose of facilitating off-balance sheet arrangements (as that term is defined in Item 303(a)(4)(ii) of Regulation S-K) or other contractually narrow or limited purposes. As such, we are not exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in those types of relationships. We enter into guarantees in the ordinary course of business related to the guarantee of our own performance and the performance of our subsidiaries. New Accounting Pronouncements From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board, or FASB, or other standard setting bodies that are adopted by us as of the specified effective date. Unless otherwise discussed, we believe that the impact of recently issued standards that are not yet effective will not have a material impact on our financial position or results of operations upon adoption. Adoption of New Accounting Standards In April 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2015-03, Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. ASU 2015-03 is intended to simplify the presentation of debt issuance costs. These amendments require 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. The recognition and measurement guidance for debt issuance costs are not affected by the amendments in this ASU. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted and the standard is to be retrospectively applied to all periods presented upon adoption. We elected to early adopt ASU 2015-03 effective December 31, 2015, and as a result reclassified $629,000 and $754,000 from deferred financing costs to note payable, net of discount in our Consolidated Balance Sheet as of December 31, 2015 and 2014, respectively. In November 2015, the FASB issued ASU 2015-17, Balance Sheet Classification of Deferred Taxes, which simplifies the presentation of deferred income taxes. This ASU requires that deferred tax assets and liabilities be classified as non-current in a statement of financial position. We elected to early adopt ASU 2015-17 effective December 31, 2015 on a prospective basis. Adoption of this ASU resulted in a reclassification of our net current deferred tax asset to the net non-current deferred tax asset in our Consolidated Balance Sheet as of December 31, 2015. No prior periods were retrospectively adjusted. Accounting Standards Issued But Not Yet Effective In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 provides a single, comprehensive revenue recognition model for all contracts with customers. The revenue guidance contains principles that an entity will apply to determine the measurement of revenue and timing of when it is recognized. The underlying principle is that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. The standard will be effective for the first interim period within annual reporting periods beginning after December 15, 2017 for public entities, with early adoption permitted in the annual reporting period beginning after December 15, 2016. Our management is still evaluating the potential impact of adopting this guidance on our financial statements. In June 2014, the FASB issued ASU 2014-12, Compensation Stock - Compensation (Topic 718). ASU 2014-12 applies to all reporting entities that grant their employees share-based payments in which the terms of the award provide that a performance target that affects vesting could be achieved after the requisite service period. It requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition and follows existing accounting guidance for the treatment of performance conditions. The standard will be effective for annual periods and interim periods within those annual periods beginning after December 15, 2015, with early adoption permitted. Our management does not expect there to be a material impact upon adopting this guidance in our financial statements. In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements-Going Concern. ASU 2014-15 provides guidance around management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and to provide related footnote disclosures. For each reporting period, management will be required to evaluate whether there are conditions or events that raise substantial doubt about a company’s ability to continue as a going concern within one year from the date the financial statements are issued. The new standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2016. Early adoption is permitted. Our management does not expect there to be a material impact upon adopting this guidance in our financial statements. ITEM 7A.

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2015

ITEM 6. SELECTED FINANCIAL DATA Disclosure under this item is not required of a smaller reporting company. ITEM 7.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Plan of Operation In March 2016, HPC acquired distribution rights to natural agrochemicals manufactured by ECOWIN, state permits related to those products, a trademark, and cash to commence the business of selling Vegalab products, as described under “Item 1. Business,” above. HPC has no customers and no employees, so this endeavor represents the start of a new venture with the assets described above. We believe the most effective way to establish a foothold in the agriculture industry for our products is to pursue acceptance by one or more of the major United States agricultural businesses. This approach is based, in part, on the resources these businesses have available to test, or try-out, new product offerings and the resulting “cachet” that can attach to products once they have been accepted by these businesses. To that end our executive officers will pursue discussions with large distributors of fertilizers and pesticides, and large farming operations to invite them to perform field tests with sample product. Preliminary discussions and information provided on the Vegalab technology have been well-received, so HPC expects to focus its efforts initially on pursuing testing programs with the major distributors and producers to advance the opportunity for acceptance and then purchase of the products. We believe the spring and early summer of 2016 will be a period of high activity for testing and promoting the products with the major distributors and producers. The large distributors and farming operations is not a large group and we are focused on approximately 15 of these businesses. This targeted approach will enable us to limit the cost of promoting our products during this initial phase of the marketing effort, so we believe we have the financial resources to do so without additional capital. To the extent we are successful in converting a major distributor or farming operation to a customer, we will need to be able obtain and deliver product, which means we will need to finance inventory. We expect to purchase inventory in April 2016, so that there is product on-hand for testing by prospective customers and sales of “starter” purchases to try the products out in a typical crop setting. We estimate the total amount we will spend on inventory in the first and second quarters of calendar year 2016 will be approximately $1,300,000. Inventory purchases after that will depend on how successful we are with our marketing efforts and our ability to finance such purchases. During the second the third quarters of calendar year 2016, we expect to establish an e-commerce presence. One of the items we acquired is the US trademark “Vegalab™.” Our marketing efforts will incorporate this brand name, which is approved by ECOWIN. Our intention is to establish a website around this trademark and build a brand by promoting the efficacy and environmental safety of the Vegalab products. Assuming we have some success with our targeted initial marketing strategy described above, we intend to use that to attract other potential users to the products we offer through our website and by employing sales representatives with experience in agriculture to promote our products to other distributors and large scale users. If we are successful in gaining acceptance and initial orders for our product, we expect we will develop two sales channels. The first is establishing sub-distributors made up of well-established distributors of fertilizers and pesticides. Second is direct sales to farm operations through farm coops and retailers. As this is a new venture we cannot predict whether or to what extent we will be successful in establishing and managing these sales channels. Once we become more established, we will actively pursue other marketing and promotional activities, such as participation in trade shows and developing plans for expanding marketing outside the Unites States. To summarize, by the end of the first calendar quarter of 2017, we hope to have: ·Several major agrichemical product distributors or farming operation established as customers; ·A well-developed Internet presence and brand for our products; ·Sales representatives promoting our products; and ·Growing revenue from sales of our products. Our plan of operation notwithstanding, our business is a new venture with all of the risks and uncertainties associated with such ventures. We do not have customers or a history of sales from which you can evaluate or predict out ability to gain customers and grow the business. We do not have inventory on hand, so if we acquire customers, we will need to obtain financing to meet our inventory purchase requirements. We have a limited amount of capital for inventory purchases, but the establishment of customers for our products will require capital for inventory that we have not yet obtained, or purchases of inventory under credit arrangements we have not arranged. We do not have established market acceptance of our products, so we are a new entrant in a well-established market for agrochemicals in which our competitors have well-known products and much more substantial financial, managerial, and promotional resources than we do. As product sales increase, we will need to employ people to support that growth, and there is no assurance that we will be able to attract and engage employees with the skills needed to facilitate the development of our business. Liquidity and Capital Resources At December 31, 2015 and 2014, the Company had a working capital deficit of approximately $(166,000) and $(213,500), respectively; inclusive of stockholder debt and accrued interest of approximately $111,800 and $103,500, respectively. On March 8, 2016, we raised $303,100, from the sale of 12,011,000 shares of common stock to David D. Selakovic. The shares offered will not be registered under the Securities Act of 1933, as amended (the “Securities Act”), and may not be offered or sold in the United States absent registration under the Securities Act or an applicable exemption from such registration requirements. Of this amount $294,423 was applied to payment of notes payable, accrued expenses, and professional fees. We intend to apply the remaining $8,677 to fund the initial marketing efforts described above that we are beginning in March 2016, and continuing through the second and third calendar quarters of this year. The Company is making an additional private offering of 1,000,000 shares of common stock for $500,000 in cash. The shares offered will not be registered under the Securities Act, and may not be offered or sold in the United States absent registration under the Securities Act or an applicable exemption from such registration requirements. These shares are offered solely to “accredited investors,” as defined in Rule 501 of Regulation D adopted under the Securities Act, and in reliance on the exemption from registration set forth in Section 4(a)(2) of the Securities Act and Rule 506(b) of Regulation D. As of March 22, 2016, we completed the sale of 760,000 shares of common stock in the private offering at a total sale price of $380,000. We intend to apply $300,000 to the purchase of initial inventory we can make available for testing and initial sales to prospective customers. The remainder will be held and applied for general corporate purposes that facilitate the development of our business and administrative costs. We believe our current funding is sufficient to meet our needs described above over the next 9 - 12 months. Nevertheless, our goal is to begin and then increase product sales as quickly as we can within the constraints of our managerial and financial resources. If sales opportunities exceed our expectations, we will need additional debt or equity financing to seize these opportunities and there is no assurance financing will be available or available at terms we would find acceptable. If we are unable to raise additional capital at a level adequate to support our sales opportunities, we would need to curtail marketing efforts, which would adversely affect growth and results of operations and could prevent us from succeeding in implementing its new operating business. Results of Operations Prior to 2016, the Company was a “shell company” seeking a business venture to pursue. Accordingly, the Company had no operating revenue for either of the years ended December 31, 2015 or 2014. General and administrative expenses for each of the years ended December 31, 2015 and 2014 were approximately $37,600 and $119,700, respectively. During the fourth quarter of Calendar 2014, the Company’s management spent in excess of $100,000 in performing due diligence tasks related to various proposed acquisition or combination transactions, which did not result in a transaction with the Company. All other expenditures were directly related to the maintenance of the corporate entity and the preparation and filing of periodic reports with the SEC pursuant to the Exchange Act. Earnings per share for the respective years ended December 31, 2015 and 2014 were $(0.01) and $(0.02) based on the weighted-average shares issued and outstanding at the end of each respective period. Critical Accounting Policies Our financial statements and related public financial information are based on the application of accounting principles generally accepted in the United States (“GAAP”). GAAP requires the use of estimates; assumptions, judgments and subjective interpretations of accounting principles that have an impact on the assets, liabilities, revenue and expense amounts reported. These estimates can also affect supplemental information contained in our external disclosures including information regarding contingencies, risk and financial condition. We believe our use of estimates and underlying accounting assumptions adhere to GAAP and are consistently and conservatively applied. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances. Actual results may differ materially from these estimates under different assumptions or conditions. We continue to monitor significant estimates made during the preparation of our financial statements. Our significant accounting policies are summarized in Note D of our financial statements. While all these significant accounting policies impact our financial condition and results of operations, we view certain of these policies as critical. Policies determined to be critical are those policies that have the most significant impact on our financial statements and require management to use a greater degree of judgment and estimates. Actual results may differ from those estimates. Our management believes that given current facts and circumstances, it is unlikely that applying any other reasonable judgments or estimate methodologies would cause effect on our results of operations, financial position or liquidity for the periods presented in this report. ITEM 7A.

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2015

ITEM 6. SELECTED FINANCIAL DATA The Company, as a “smaller reporting company” (as defined by §229.10(f)(1)), is not required to provide the information required by this Item. ITEM 7.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read the following plan of operation together with our financial statements and related notes appearing elsewhere in this annual report. This plan of operation contains forward-looking statements that involve risks, uncertainties, and assumptions. The actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors. Overview We are a development stage company. We were incorporated in Delaware on August 29, 2012. We are focused on developing novel neurological therapies to be directly delivered into specific regions of the brain. As our first development program, we are developing our ACX-31 program to deliver two chemotherapy drugs, temozolomide in combination with BCNU, locally to brain tumor sites. Our ACX-31 program is based on an issued patent licensed from Accelerating Combination Therapies LLC which is co-owned by Dr. Henry Brem, Director of the Neurosurgery Department at Johns Hopkins University (“ACL License”). We are collaborating in the development of our ACX-31 program with Dr. Henry Brem who built one of the largest brain tumor research and treatment centers in the world at Johns Hopkins University. Dr. Robert Langer, who is the David H. Koch Institute Professor at MIT and the most cited engineer in history, is also advising us in the development of our ACX-31 program. Both Dr. Brem and Dr. Langer are pioneers in the development of local drug delivery treatments, and invented and developed Gliadel® which is a FDA approved, local chemotherapy for the treatment of glioblastoma multiforme. We entered into an agreement with the Yissum Research Development Company of The Hebrew University of Jerusalem Ltd. (“Yissum”) to develop and supply a polymeric formulation of a combination of temozolomide and BCNU. Professor Avi Domb of The Hebrew University of Jerusalem had previously worked with Dr. Langer on the formulation of Gliadel® and leads the development efforts provided by Yissum. As our second development program, we are developing our BranchPoint device that can potentially deliver therapeutics through the radial deployment of a flexible delivery catheter to large and anatomically complex brain targets through a single initial brain penetration. Our BranchPoint device was originally developed at the University of California, San Francisco (UCSF) with $1.8 million in funding from the California Institute for Regenerative Medicine (CIRM). It is based on a neurosurgical delivery platform that we have exclusively licensed from UCSF. It can potentially enable new approaches to neurological therapy and be modified for the delivery of a broad range of novel therapeutics, such as stem cells to treat neurodegenerative diseases, chemotherapeutics to brain tumors and gene therapy vectors. A 510(k) application was submitted to the FDA on June 15, 2015. Furthermore, UCSF requested a pre-IND meeting with the FDA on November 4, 2015 to discuss a collaborative program between UCSF and us to evaluate a combined stem cell/gene transfer candidate therapeutic CNS10-NPC GDNF for the treatment of Parkinson's Disease using our BranchPoint delivery device. UCSF received a written response from the FDA on March 21, 2016 which provided guidance on the non-clinical activities that are necessary to enable the filing of a future potential IND application. CNS10-NPC are human fetal neural stem cells that express Glial-Derived Neurotrophic Factor (GDNF) in the treatment of Parkinson's Disease, and are expected to be supplied by the Cedars-Sinai Regenerative Medicine Institute in support of IND (Investigational New Drug) enabling studies. We cannot assure you that we will be successful with our development activities. Recent Developments On August 11, 2015 (“Effective Date”), we entered into an exclusive license agreement (“ACL License”) with Accelerating Combination Therapies LLC (“ACL”) in regards to the exclusive licensing of the issued U.S. Patent No. 8,895,597 B2 Combination of Local Temozolomide with Local BCNU (“Patent Rights”). ACL is beneficially owned by the original Patent Rights holders and Inventors Violette Renard Recinos, Betty Tyler, Sarah Brem Sunshine and Henry Brem (“Inventors”) who assigned the Patent Rights to ACL. Henry Brem is the Harvey Cushing Professor of Neurosurgery, Director of the Department of Neurosurgery, and Neurosurgeon-in-Chief at The Johns Hopkins University, and invented and developed Gliadel® wafers to deliver local chemotherapy to brain tumors. Betty Tyler is Associate Professor of Neurosurgery at Johns Hopkins University. Violette Renard Recinos is a Neurosurgeon at the Cleveland Clinic. The Patent Rights relate to formulations for chemotherapy, especially of brain tumors such as gliomas. They claim a composition for treating an individual with a solid tumor comprising a combination of BCNU and temozolomide in a pharmaceutically acceptable polymeric carrier for sustained local administration of an effective amount of BCNU and temozolomide to reduce tumor size or prolong survival of the individual with greater efficacy or reduced systemic side effects as compared to administration of either BCNU or temozolomide systemically (“Invention”). Under the ACL License, we obtained rights to develop and commercialize the Patent Rights, and have been granted the right to sublicense to third parties. The ACL License requires us to initiate a first human clinical trial within 30 months and to pay ACL royalties and other consideration which includes (i) a license issue fee of 1,000,000 shares of the Company’s common stock to be issued within 6 months after the Effective Date; (ii) reimbursement of past patent expenses of $19,392; (iii) license maintenance fees of $8,000 annually until the first commercial sale; (iv) running royalties of 4% of net sales; and (v) certain minimum annual royalties and milestone payments. The ACL License remains in effect from the Effective Date until expiration of the Patent Rights. For a full description of payment obligations and the ACL License itself, the license agreement is filed and can be reviewed as an exhibit to the Form 8-K as filed on August 12, 2015. On August 18, 2015, we executed a License Termination Agreement (“Termination Agreement”) with the Board of Trustees of the University of Arkansas (“UofA”) acting for and on behalf of the University of Arkansas for Medical Sciences (“UAMS”) under which both parties terminated the UAMS License and Research Agreement in order to be relieved of all liability for future payments of any consideration due under Article 6.1 of the UAMS License and Article 1 of the Research Agreement, and the UofA has agreed to terminate the UAMS License and Research Agreement and release us in accordance with the terms thereof. For a full description of the Termination Agreement, a copy of which is filed and can be reviewed as Exhibit 10.18 to the Form 8-K as filed on August 20, 2015. On November 1, 2015, we entered into a service agreement (“Agreement”) with the Yissum Research Development Company of The Hebrew University of Jerusalem Ltd. (“Yissum”) to develop and supply a polymeric formulation of a combination of carmustine and temozolomide for sustained local administration to a solid tumor (the “Services”). Under the Agreement we will retain ownership of all intellectual property rights that are discovered or developed during the course of the provision of the Services. Professor Avi Domb of The Hebrew University of Jerusalem leads the development efforts provided by Yissum. For a full description, a Form of the Agreement is filed and can be reviewed as an exhibit 10.19 to the Form 8-K as filed on November 2, 2015. Plan of Operations As a development stage company, we are focused on developing novel neurological therapies to be directly delivered into specific regions of the brain. We are currently developing two programs in our pipeline. 1. We are developing our ACX-31 program to deliver two chemotherapy drugs, temozolomide in combination with BCNU, locally to brain tumor sites. Temozolomide is a generic, approved chemotherapy drug that is indicated for the treatment of adult patients with newly diagnosed glioblastoma multiforme concomitantly with radiotherapy and then as maintenance treatment. Local delivery of temozolomide has been demonstrated to be superior to oral administration in an animal model. In the scientific publication at Johns Hopkins University Brem S, Tyler BM, Li K, Pradilla G, Legnani F, Caplan J, et al. Local delivery of temozolomide by biodegradable polymers is superior to oral administration in a rodent glioma model. Cancer Chemother Pharmacol 2007;60:643-50, it was demonstrated that that intracranial concentrations of temozolomide increased threefold compared with orally delivered temozolomide. In a rodent glioma model, animals treated with a single temozolomide polymer (50% w/w) had a median survival of 28 days (P < 0.001 vs. controls, P < 0.001 vs. oral treatment), whereas animals treated with oral temozolomide had a median survival of 22 days compared to control animals (median survival of 13 days). Animals treated with two temozolomide polymers (50% w/w) had a median survival of 92 days (P < 0.001 vs. controls, P < 0.001 vs. oral treatment). The percentage of long-term survivors (LTS) for groups receiving intracranial temozolomide ranged from 25 to 37.5%; there were no LTS with oral temozolomide treatment. Animals treated with radiation therapy (XRT) and intracranial temozolomide (median survival not reached, LTS = 87.5%) demonstrated improved survival compared to those with intracranial temozolomide alone (median survival, 41 days; LTS = 37.5%), or oral temozolomide and XRT (median survival, 43 days, LTS = 38.9%). BCNU (carmustine) is a chemotherapy drug that is contained in Gliadel®, a biodegradable polymer that is implanted locally into the resection cavity after surgical removal of a brain tumor and is indicated for the treatment of newly diagnosed and recurrent glioblastoma multiforme. In another scientific publication at Johns Hopkins University Renard Recinos V, Tyler BM, Brem H, et al. Combination of intracranial temozolomide with intracranial carmustine improves survival when compared with either treatment alone in a rodent glioma model. Neurosurgery 2010; 66:530-537, it was shown that the additive effect of combined delivery of local temozolomide with local BCNU, especially in combination with radiotherapy, was significantly more effective than delivery of either drug alone or one systemically and one locally, either with or without radiation. Groups treated with combination of local temozolomide, local BCNU and radiation therapy had 75% long-term survivors. 2. We are developing our BranchPoint device that can potentially deliver therapeutics through the radial deployment of a flexible delivery catheter to large and anatomically complex brain targets through a single initial brain penetration. It can potentially enable new approaches to neurological therapy and be modified for the delivery of a broad range of novel therapeutics, such as stem cells to treat neurodegenerative diseases, chemotherapeutics to brain tumors and gene therapy vectors. A 510(k) application was submitted to the FDA on June 15, 2015. Furthermore, UCSF requested a pre-IND meeting with the FDA on November 4, 2015 to discuss a collaborative program between UCSF and us to evaluate a combined stem cell/gene transfer candidate therapeutic CNS10-NPC GDNF for the treatment of Parkinson's Disease using our BranchPoint delivery device. UCSF received a written response from the FDA on March 21, 2016 which provided guidance on the non-clinical activities that are necessary to enable the filing of a future potential IND application. CNS10-NPC are human fetal neural stem cells that express Glial-Derived Neurotrophic Factor (GDNF) in the treatment of Parkinson's Disease, and are expected to be supplied by the Cedars-Sinai Regenerative Medicine Institute in support of IND enabling studies. The development of our programs is estimated to cost approximately $5-7 million over 4-5 years as a standalone company. However, we may seek to pursue a strategic collaboration partnership which may accelerate the development timeline, share expenses, and also provide access to ex-US markets. The development of our programs may also cost substantially more than $5-7 million and may require a substantially longer development timeline than 4-5 years. Higher development expenses and delays may be caused by but are not limited to sub-optimal product performance and continued product optimization cycles, adverse clinical results and repeat of clinical trials, or delays of an FDA approval. In such a scenario, we may not be able to secure sufficient funding or a strategic collaboration partnership and could cease operations under such circumstances. Need for Additional Capital As we continue the development of our pipeline programs, we are actively seeking to raise additional capital. If we are unable to raise additional capital to develop our development pipeline and business, we might have to suspend or cease operations and our investors may lose their investment. We have no assurance that future financings will be available to us on acceptable terms. If financing is not available on satisfactory terms, we may be unable to continue, develop, or expand our operations. Equity financing could result in additional dilution to existing shareholders. Liquidity and Capital Resources The reader is referred to our financial statements included elsewhere herein. As of December 31, 2015, we had $2,011,777 cash, cash equivalents and marketable securities on hand. We are actively seeking additional capital investment as the total required capital for our product development over the next four to five years is estimated to be from $5 million to $7 million as a standalone company. We cannot assure you that we will have access to the funding required for our product development or that if available it will be available on terms that are not dilutive to our present shareholders. If the funding is not available, we may have to severely curtail or cease operations. We believe that our OTCQB listing will assist us in our funding efforts. Most of the funds we raise will be applied directly towards continued development of our pipeline programs. Results of Operations for the Twelve Months ended December 31, 2015 Revenues We had no revenues as a development stage company for the twelve months ended December 31, 2015 and 2014, respectively. Operating Expenses Depreciation and Amortization Expenses: Depreciation and Amortization expenses were $42,276 and $94,298 for the twelve months ended December 31, 2015 and 2014, respectively. The decrease was due to the termination of the UAMS License and end of associated patent amortization. Impairment Loss: Impairment losses were $0 and $4,304,927 for the twelve months ended December 31, 2015 and 2014, respectively. The decrease was due to the termination of the UAMS License and end of associated write-offs of the licensing fees. Research and Development: Research and development expenses were $1,638,868 and $177,414 for the twelve months ended December 31, 2015 and 2014, respectively. The increase was due to the development efforts and formulation work associated with our ACX-31 program and BranchPoint device. General and Administrative: General and administrative expenses were $956,482 and $123,127 for the twelve months ended December 31, 2015 and 2014, respectively. The increase was primarily caused by the share issuances in connection with investor relations and media consulting agreements. Net Loss We had a net loss of $2,564,597 and $4,737,670 for the twelve months ended December 31, 2015 and 2014, respectively. The decrease was due to the end of impairment losses caused by write-offs. Off-Balance Sheet Arrangements We do not have any off balance sheet arrangements that are reasonably likely to have a current or future effect on our financial condition, revenues, and results of operations, liquidity or capital expenditures. CRITICAL ACCOUNTING POLICIES AND USE OF ESTIMATES We prepare our financial statements in accordance with generally accepted accounting principles in the United States of America. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and related disclosures of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Significant accounting policies and methods used in preparation of the financial statements are described in Note 1 to our financial statements included in this Form 10-k. We evaluate our estimates and assumptions on a regular basis, based on historical experience and other relevant factors. Actual results could differ materially from these estimates and assumptions. The following critical accounting policies are impacted by judgments, assumptions and estimates used in preparation of our financial statements included in this registration statement. Prepaid Assets On January 12, 2015, we and the Lim Development Group (“Consultant”) entered into a consulting agreement (“Agreement”) under which the Consultant provides scientific advisory to us in the development, partnering and commercialization of the “Microinjection Brain Catheter” (a.k.a. BranchPoint device) that we exclusively licensed from the University of California San Francisco (“UCSF”) on September 16, 2014. As consideration for provided services, we issued a promissory note (“Note”) in the amount of $200,000 at an interest rate of 5.00% per annum to the Consultant. The principal amount of the Note is amortized on a straight-line basis over the 24-month term of the Agreement. On February 18, 2015, we entered into a consulting agreement (“Agreement”) with the Capital Communications Group (“Consultant”) under which the Consultant assists us in our efforts to gain greater recognition and awareness among relevant investors in the public capital markets on a non-exclusive basis. In connection with the Agreement, we issued a four-year Warrant (“Warrant”) to the Consultant under which the Consultant is entitled to purchase from us up to 200,000 shares of our Company’s Common Stock (“Warrant Shares”) at an exercise price of $0.50 per Share (“Exercise Price”). The Warrant is exercisable, in whole or in part, during the term commencing on the issuance date of the Warrant on February 18, 2015 and ending on February 18, 2019 (the “Exercise Period”). The 200,000 Warrant Shares are valued at $527,500 based on the Black-Scholes formula and are amortized on a straight-line basis over the 24-month term of the Agreement. On February 4, 2015, we issued 57,000 shares of our common stock to a consultant to provide investor relations services over 3 months per its consulting agreement. The 57,000 issued shares of common stock are valued at $2 per share, equal to the price per share paid by an investor in a prior sale of our Company’s shares of common stock on July 15, 2014, and are capitalized in the amount of $114,000 and amortized over the 3-month term of the consulting agreement. On February 10, 2015, we issued 150,000 shares of our common stock to a consultant to provide media services over 6 months per its consulting agreement. The 150,000 issued shares of common stock are valued at $2 per share, equal to the price per share paid by an investor in a prior sale of our Company’s shares of common stock on July 15, 2014, and are capitalized in the amount of $300,000 and amortized over the 6-month term of the consulting agreement. On March 17, 2015, we issued 20,000 shares of our common stock to a consultant to provide investor relations services over 6 months per its consulting agreement. The 20,000 issued shares of common stock are valued at $2 per share, equal to the price per share paid by an investor a prior sale of our Company’s shares of common stock on July 15, 2014, and are capitalized in the amount of $40,000 and amortized over the 6-month term of the consulting agreement. On August 11, 2015 (“Effective Date”), we entered into an exclusive license agreement (“ACL License”) with Accelerating Combination Therapies LLC (“ACL”) in regards to the exclusive licensing of the issued U.S. Patent No. 8,895,597 B2 Combination of Local Temozolomide with Local BCNU (“Patent Rights”). Under the ACL License, we are required to pay ACL a license issue fee of 1,000,000 shares of our Company’s common stock to be issued within 6 months after the Effective Date. The 1,000,000 shares of common stock are valued at $1.13 per share, equal to the publicly traded share price on the Effective Date, are capitalized in the amount of $1,130,000 and amortized over an expected patent life of 15 years. Fixed Assets We have purchased equipment to support the development of our prototype device which are capitalized in the amount of $166,119 as fixed assets on our Company’s balance sheet as of December 31, 2015. The equipment is amortized on a straight-line basis over 5 years. Research and Development Expenses We expense all of our research and development expenses in the period in which they are incurred. At such time as our products are determined to be commercially available, we will capitalize those development expenditures that are related to the maintenance of the commercial products, and amortize these capitalized expenditures over the estimated life of the commercial product. The estimated life of the commercial product will be based on management’s estimates, including estimates of current and future industry conditions. A significant change to these assumptions could impact the estimated useful life of our commercial products resulting in a change to amortization expense and impairment charges. Impact of New Accounting Standards The Company does not expect the adoption of recently issued accounting pronouncements to have a significant impact on the Company's results of operations, financial position, or cash flow. ITEM 7A.

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2015

ITEM 6. SELECTED FINANCIAL DATA Basis of Presentation The selected consolidated financial data for the five years from 2011 to 2015 are derived from our audited consolidated financial statements included in our Annual Reports on Form 10-K or Form 10-K/A. The following financial data should be read in conjunction with the consolidated financial statements and notes thereto and with Item 7

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of financial condition, results of operations, liquidity and capital resources should be read in conjunction with the accompanying audited consolidated financial statements and notes thereto that are included under Part II, Item 8, of this Form 10-K. Also refer to “Special Note Regarding Forward-Looking Statements,” which is included after Table of Contents in this Form 10-K. Our Business Core-Mark is one of the largest marketers of fresh and broad-line supply solutions to the convenience retail industry in North America. We offer a full range of products, marketing programs and technology solutions to approximately 36,500 customer locations in the U.S. and Canada. Our customers include traditional convenience stores, drug stores, grocery stores, liquor stores and other specialty and small format stores that carry convenience products. Our product offering includes cigarettes, other tobacco products (OTP), candy, snacks, fast food, groceries, fresh products, dairy, bread, beverages, general merchandise and health and beauty care products. We operate a network of 28 distribution centers in the U.S. and Canada (excluding two distribution facilities we operate as a third party logistics provider). Our core business objective is to help our customers increase their sales and profitability. Overview of 2015 Results In 2015, we continued to grow market share and increase our food/non-food sales and gross profit by leveraging our “Fresh” product solutions, driving our Vendor Consolidation Initiative (VCI) and providing category management expertise in order to make our customers more relevant and profitable. In addition, during 2015 we secured supply agreements with two significant customers and several other regional customers which we will begin servicing in 2016. Net sales in 2015 increased 7.7% or $789.3 million, to $11,069.4 million compared to $10,280.1 million for 2014. Excluding the effects of foreign currency fluctuations and one additional selling day in 2015, net sales increased by approximately 9.1% driven primarily by market share gains, including the acquisition of Karrys Bros., Limited (Karrys Bros.), and sales growth from existing customers. We believe lower fuel prices contributed to higher sales in the convenience industry during 2015. Cigarette sales, which increased 8.4%, benefitted from market share gains and cigarette price inflation, whereas the success of our core strategies continued to drive the increase in our food/non-food sales, which increased 6.1% in 2015 compared to the same period in 2014. However, we believe that the growth in our food/non-food sales during 2015 was impacted by a shift in consumer spending preferences away from certain traditional product categories, such as candy and grocery, and the effects of foreign currency changes. Gross profit in 2015 increased $64.2 million, or 11.2%, to $637.9 million from $573.7 million during 2014, driven primarily by an increase in food/non-food sales and gross margins. LIFO expense decreased $14.4 million in 2015 compared to 2014, due primarily to a decrease in the Producer Price Index (PPI) for certain product categories. Since we value our inventory in the U.S. on a LIFO basis, our gross profit can be positively or negatively impacted depending on the relative level of price inflation or deflation in manufacturer prices. Remaining gross profit(1), which excludes LIFO expense, inventory holding gains and OTP tax refunds, increased $51.6 million, or 9.1%, in 2015. Operating expenses increased $45.8 million, or 9.1%, in 2015 to $551.2 million from $505.4 million in 2014. This increase includes $15.9 million in incremental expenses, primarily for our Ohio division and Karrys Bros. In addition, we saw a 5.9% increase in the amount of cubic feet of product handled and a 9.4% increase in the number of customer deliveries. We also incurred approximately $6.0 million in costs associated with infrastructure, people and systems to support future growth and $1.1 million related to on-boarding our new customers we began servicing in the first quarter of 2016. Net income was $51.5 million in 2015 compared to $42.7 million in 2014. Net income excluding LIFO expense(1) was $52.7 million for both 2015 and 2014. Pre-tax income for 2015 includes incremental inventory holding gains of $4.4 million, offset by a reduction in pre-tax income from OTP tax refunds of $5.8 million, net of fees, compared with 2014. In addition, pre-tax income for 2015 includes incremental start-up and integration costs and additional investment spending to support our growth, as discussed above, and a $1.7 million increase in foreign currency transaction losses. In addition our provision for income taxes was higher in 2015, stemming primarily from lower LIFO expense compared to 2014. Adjusted EBITDA(1) increased $12.5 million, or 10.2%, to $135.2 million in 2015 from $122.7 million in 2014. ________________________________________ (1) Remaining gross profit, net income excluding LIFO expense and Adjusted EBITDA are non-GAAP financial measures and should be considered as a supplement to, and not as a substitute for, or superior to, financial measures calculated in accordance with generally accepted accounting principles in the United States of America (GAAP) (see the calculation of Remaining Gross Profit in "Results of Operations" and Adjusted EBITDA in “Liquidity and Capital Resources” below). Net income excluding LIFO expense represents FIFO net income adjusted for related tax expense effects. Business and Supply Expansion We continue to benefit from the expansion of our business and the execution of our core strategies, focused primarily on enhancing our fresh product offering, leveraging VCI and providing category management expertise to our customers. Our strategies take costs and inefficiencies out of the supply chain, bringing our customers a supply channel to offer high quality fresh foods and optimize their consumer product offering. We believe each of these strategies, when adopted, will increase the retailers’ profits. Some of our more recent expansion activities include: • In October 2015, we signed a five year agreement with Murphy USA to be the primary wholesale distributor to over 1,300 stores located in 23 states across the southwest, southeast and midwest United States. Services under this contract began in the first quarter of 2016 and are expected to create efficiencies and a strategic supply chain relationship for Murphy USA. • In October 2015, we signed a five year supply agreement with 7-Eleven, Inc. to service approximately 900 stores in three western regions. Core-Mark will be the primary wholesale distributor delivering a wide range of products to these stores out of three of our divisions - Las Vegas, Nevada; Salt Lake City, Utah; and Sacramento, California. • In July 2015, we amended our contract with Rite Aid to expand our service to include other product categories in addition to the frozen, refrigerated, bakery and fresh food categories, which we began delivering in June 2014. We are committed to our long-term partnership with Rite Aid to help them maximize supply chain efficiencies and optimize product sales to meet the needs of their customers. • In February 2015, we acquired substantially all the assets of Karrys Bros., a regional distributor servicing customers in Ontario, Canada, and the surrounding provinces. The acquisition of Karrys Bros. has provided the opportunity to expand our market share in eastern Canada and is expected to contribute to the leverage of fixed costs and improved profitability in our Toronto division. • In September 2014, we opened a new distribution facility in Glenwillow, Ohio to support customer growth in this region. This facility currently services approximately 800 Rite Aid stores, 500 stores transferred from other Core-Mark distribution centers to gain transportation efficiencies and approximately 100 new customer locations. During 2015, we continued to grow sales and margins in our “Fresh” categories resulting from improving our customers’ product assortment and in-store marketing efforts. Sales of our fresh categories grew approximately 17% in 2015 compared to the same period in 2014. We continue to focus on fresh and healthy offerings because we believe that over the long-term, the trend is for the convenience consumer to shift buying preferences to these types of items. We benefit from this shift due to the higher margins of these products compared to the other merchandise we distribute. Industry experts have indicated that consumers are making more shopping trips related to fresh food and that perishable foods will serve a more important role in the convenience retail channel in the future. We believe our strategies have helped position us and our customers to benefit from these trends. Other Business Developments Dividends The Board of Directors approved the following cash dividends in 2015 (in millions, except per share data) ______________________________________________ (1) Includes cash payments on declared dividends and payments made on RSUs vested subsequent to the payment date. We paid dividends of $12.8 million and $10.7 million in 2015 and 2014, respectively. Share Repurchase Program In May 2013, our Board of Directors authorized a $30 million increase to our stock repurchase plan. At the time of increase, we had $2.3 million remaining under our stock repurchase plan that was then in place. In 2015, we repurchased 151,183 shares of common stock at an average price of $60.70 compared to repurchases of 175,917 shares of common stock at an average price of $45.49 in 2014. As of December 31, 2015 and 2014, we had $11.5 million and $20.7 million, respectively, available for future share repurchases under the program. Results of Operations Comparison of 2015 and 2014 (in millions) (1): ______________________________________________ (1) Amounts and percentages have been rounded for presentation purposes and might differ from unrounded results. (2) Net sales, less excise taxes is a non-GAAP financial measure which we provide to separate the increase in sales due to product sales growth and increases in state, local and provincial excise taxes which we are responsible for collecting and remitting. Federal excise taxes are levied on the manufacturers who pass the taxes on to us as part of the product cost and thus are not a component of our excise taxes. Although increases in cigarette excise taxes result in higher net sales, our overall gross profit percentage may be reduced; however we do not expect increases in excise taxes to negatively impact gross profit per carton (see Comparison of Sales and Gross Profit by Product Category). (3) Gross profit may not be comparable to those of other entities because warehousing and distribution expenses are not included as a component of our cost of goods sold. (4) Adjusted EBITDA is a non-GAAP financial measure and should be considered as a supplement to, and not as a substitute for, or superior to, financial measures calculated in accordance with GAAP (see calculation of Adjusted EBITDA in “Liquidity and Capital Resources”). Net Sales. Net sales for 2015 increased by $789.3 million, or 7.7%, to $11,069.4 million from $10,280.1 million in 2014. Excluding the effects of foreign currency fluctuations and one additional selling day, net sales increased approximately 9.1%, due primarily to a 6.6% increase in cigarette carton sales, an increase in the average sales price per carton, and incremental food/non- food sales driven primarily by the continued success of our core strategies. In addition, net sales in 2015 benefited from lower fuel prices, which we believe contributed to higher sales in the convenience industry. Net Sales of Cigarettes. Net sales of cigarettes for 2015 increased by $586.5 million, or 8.4%, to $7,528.5 million from $6,942.0 million in 2014. Excluding the effects of foreign currency fluctuations and one additional selling day, cigarette sales increased by approximately 9.9% driven primarily by a 6.6% increase in carton sales and a 3.5% increase in the average sales price per carton due primarily to increases in manufacturers' prices. Cigarette carton sales increased by 6.4% in the U.S. and by 9.1% in Canada. The increase in cigarette carton sales was due primarily to market share gains, including the acquisition of Karrys Bros. in Canada, and an increase in cartons sold to existing customers. Total net cigarette sales as a percentage of total net sales were 68.0% in 2015 compared to 67.5% for 2014. Despite recent increases in our cigarette sales, we believe long-term cigarette consumption will continue to be impacted by rising prices, legislative actions, diminishing social acceptance and sales through illicit markets. We expect cigarette manufacturers will raise prices as carton sales decline in order to maintain or enhance their overall profitability, thus mitigating the effects of the decline to the distributor. In addition, industry data indicates that convenience retailers are more than offsetting cigarette volume profit declines through higher sales of food/non-food products. We expect this trend to continue as the convenience industry adjusts to consumer demands. Net Sales of Food/Non-food Products. Net sales of food/non-food products for 2015 increased $202.8 million, or 6.1%, to $3,540.9 million from $3,338.1 million in 2014. The following table provides net sales by product category for our food/non-food products (in millions)(1): ______________________________________________ (1) Amounts and percentages have been rounded for presentation purposes and might differ from unrounded results. Excluding the effects of foreign currency fluctuations and one additional selling day, food/non-food sales for 2015 increased by approximately 7.5%, driven primarily by incremental sales to existing customers and market share gains including the acquisition of Karrys Bros. Sales generated from VCI, Fresh and Focused Marketing Initiatives (FMI) were the primary drivers of the increase in net sales to existing customers. Net sales in our Food category, which increased 8.5% for 2015, contributed over 60% of the 6.1% increase in food/non-food sales. In addition, sales of smokeless tobacco products continue to be the primary driver of the increase in sales in our OTP category. We believe the overall trend toward the increased use of smokeless tobacco products will continue and will help offset the impact of the expected continued decline in cigarette consumption over the long term. This shift could potentially result in improved profitability over time due to the profit margins associated with smokeless tobacco products, which are generally higher than those we earn on cigarette sales. Total net food/non-food product sales as a percentage of total net sales decreased to 32.0% in 2015 compared to 32.5% in 2014. Gross Profit. Gross profit represents the amount of profit after deducting cost of goods sold from net sales during the period. Inventory holding gains represent incremental revenues whereas vendor incentives, OTP tax refunds and changes in LIFO reserves are components of cost of goods sold and therefore part of our gross profit. Gross profit in 2015 increased by $64.2 million, or 11.2% to $637.9 million from $573.7 million for 2014 due primarily to increases in sales and gross margins in our food/non-food category. Gross profit for 2015 also benefitted from a $14.4 million decrease in LIFO expense, cigarette tax stamp inventory holding gains of approximately $9.0 million related to increases in excise taxes by certain jurisdictions in the third quarter this year and $1.8 million in refunds of excise taxes on OTP from prior years. The decrease in LIFO expense was due primarily to a decrease in the PPI for certain product categories we use to measure food/non-food LIFO expense as published by the Bureau of Labor Statistics. Since we value our inventory in the U.S. on a LIFO basis, our gross profit can be positively or negatively impacted depending on the relative level of price inflation or deflation in manufacturer prices as reported in the Bureau of Labor Statistics PPI used to estimate and record our book LIFO expense (see Note 2 - Summary of Significant Accounting Policies to our consolidated financial statements). In 2014, gross profit included $8.5 million in OTP tax refunds, net of tax assessments, and $6.0 million of candy inventory holding gains. Gross profit margin was 5.76% and 5.58% of total net sales for 2015 and 2014, respectively. Distributors such as Core-Mark may, from time to time, earn higher gross profits on inventory and excise tax stamp quantities on hand at the time manufacturers' increase their prices or when states, localities or provinces increase their excise taxes. Such increases are reflected in customer pricing for all subsequent sales, including sales of inventory on hand at the time of the increase. The higher gross profits are referred to as inventory holding gains. However, significant increases in cigarette product costs and cigarette excise taxes adversely impact our gross profit as a percentage of net sales, because we are paid on a cents per carton basis for cigarette sales. Conversely, we generally benefit from food/non-food price increases, because product prices for these categories are usually determined using a percentage markup on cost of goods sold. Our cigarette and cigarette tax stamp inventory holding gains were $19.1 million, or 3.0%, of our gross profit for 2015 compared to $8.2 million, or 1.4%, of our gross profit for 2014. We expect cigarette manufacturers will continue to raise prices as carton sales decline in order to maintain or enhance their overall profitability and the various taxing jurisdictions will raise excise taxes to make up for lost tax dollars related to consumption declines. In addition, in 2014, we recognized $6.0 million, or 1.1%, of our gross profit for candy inventory holding gains resulting from manufacturer price increases. These gains were recognized as the inventory was sold. Although we have realized significant candy inventory holding gains in two of the last five years, this income is not predictable and is dependent on inventory levels and the timing of manufacturer price increases. The following table provides the components comprising the change in gross profit as a percentage of net sales for 2015 and 2014 (in millions)(1): ______________________________________________ (1) Amounts and percentages have been rounded for presentation purposes and might differ from unrounded results. (2) Net sales, less excise taxes is a non-GAAP financial measure which we provide to separate the increase in sales due to product sales growth and increases in state, local and provincial excise taxes which we are responsible for collecting and remitting. Federal excise taxes are levied on the manufacturers who pass the tax on to us as part of the product cost and thus are not a component of our excise taxes. Although increases in cigarette excise taxes result in higher net sales, our overall gross profit percentage may be reduced; however we do not expect increases in excise taxes to negatively impact gross profit per carton (see Comparison of Sales and Gross Profit by Product Category). (3) The amount of cigarette inventory holding gains attributable to the U.S. and Canada were $8.7 million and $1.4 million, respectively, for 2015, compared to $7.2 million and $1.0 million, respectively, for 2014. (4) For 2014, we recognized approximately $6.0 million in candy inventory holding gains resulting from manufacturer price increases. The amount of candy inventory holding gains attributable to the U.S. and Canada for 2014 were $5.4 million and $0.6 million, respectively. (5) For 2015, we recognized cigarette tax stamp inventory holding gains in the U.S. of $9.0 million, resulting from the increase in the excise tax rates of certain jurisdictions. (6) For 2015, we received OTP tax refunds of $1.8 million related to prior years’ taxes. For 2014, we received OTP tax refunds of $9.0 million related to prior years’ taxes, offset by an OTP tax assessment of $0.5 million. (7) The decrease in LIFO expense was due primarily to a decrease in the PPI for certain product categories we use to measure food/non-food LIFO expense as published by the Bureau of Labor Statistics. Since we value our inventory in the U.S. on a LIFO basis, our gross profit can be positively or negatively impacted depending on the relative level of price inflation or deflation in manufacturer prices as reported in the Bureau of Labor Statistics PPI used to estimate and record our book LIFO expense (see Note 2 - Summary of Significant Accounting Policies to our consolidated financial statements). (8) Remaining gross profit is a non-GAAP financial measure which we provide to segregate the effects of LIFO expense, cigarette inventory holding gains and other items that significantly affect the comparability of gross profit. Remaining gross profit increased $51.6 million, or 9.1%, to $618.9 million for 2015 from $567.3 million for 2014. In 2015, remaining gross profit margin was 5.59% of total net sales compared to 5.52% in 2014. The seven basis points increase in remaining gross profit margin was driven primarily by an increase in food/non-food margins, resulting largely from the continued success of our marketing strategies, which improved overall margins by 10 basis points, together with an increase in cigarette margins, which contributed two basis points and offset by five basis points related primarily to increases in cigarette manufacturers' prices. Cigarette remaining gross profit per carton increased by 2.5% in 2015 compared to 2014 due primarily to a shift in carton sales to more profitable geographies and higher manufacturers’ discounts earned as a result of price increases, offset partially by the unfavorable impact of foreign currency fluctuations. Food/non-food remaining gross profit increased $36.5 million, or 8.9% in 2015 compared to 2014. Food/non-food remaining gross profit margin increased 33 basis points to 12.61% in 2015 compared with 12.28% for the same period in 2014 driven primarily by sales growth in our Food category and a sales shift towards higher margin items. Our remaining gross profit for food/non-food products was approximately 72% of our total remaining gross profit for both 2015 and 2014. To the extent we capture large chain business, our gross profit margins may be negatively impacted. Although our gross profit margins in 2015 were not negatively impacted on a comparable basis due to large chain customer additions, we do expect our gross profit margins to be negatively impacted in 2016 due to large chain customer additions. However, large chain customers generally require less working capital, allowing us, in most cases, to offer lower prices to achieve a favorable return on our investment. Our focus is to strike a balance between large chain business, which generally has lower gross profit margins, and independently-owned convenience stores, which comprise approximately 67% of the overall convenience store market and generally have higher gross profit margins. Operating Expenses. Our operating expenses include costs related to Warehousing and Distribution, Selling, General and Administrative and Amortization of Intangible Assets. In 2015, operating expenses increased by $45.8 million, or 9.1%, to $551.2 million from $505.4 million in 2014. As a percentage of net sales, total operating expenses were 5.0% in 2015 compared to 4.9% in 2014. Operating expenses for 2015 include approximately $15.9 million in incremental expenses for our new Ohio division and the addition of the Karrys Bros. operations. In addition, increases in the amount of cubic feet of product handled, incremental customer deliveries, approximately $6.0 million of additional costs associated with information technology, infrastructure and people to support future growth, and $1.1 million of identifiable costs related to the on-boarding of new customers in the first quarter of 2016, contributed to higher operating costs in 2015. Warehousing and Distribution Expenses. Warehousing and distribution expenses increased by $34.2 million, or 10.7%, to $352.6 million in 2015 from $318.4 million in 2014. As a percentage of total net sales, warehousing and distribution expenses were 3.2% for 2015 compared with 3.1% for 2014. The increase in warehouse and distribution expenses was primarily attributable to a 5.9% increase in comparable cubic feet of product sold driven largely by our food/non-food category, a 9.4% increase in deliveries to customers, and approximately $11.8 million in incremental expenses for our new Ohio division and the addition of the Karrys Bros. operations. In addition, workers’ compensation costs increased $2.5 million, and we incurred $1.1 million of identifiable costs related to the on-boarding of new customers in the first quarter of 2016. These increases were offset partially by a $7.7 million decrease in net fuel costs. The increase in workers’ compensation costs related primarily to the adverse development of certain claims from prior years. The decrease in our fuel costs was driven by lower diesel fuel prices and in part by our conversion to vehicles that use compressed natural gas (CNG), offset by an increase in miles driven. As of December 31, 2015, we had converted approximately 24% of our fleet to CNG tractors. Future increases or decreases in fuel costs and fuel surcharges we collect from our customers may materially impact our financial results depending on the extent and timing of these changes. Selling, General and Administrative (SG&A) Expenses. SG&A expenses increased by $11.6 million, or 6.3% in 2015 to $196.0 million from $184.4 million in 2014. SG&A expenses for 2015 included approximately $4.1 million of incremental expenses for our new Ohio division and the addition of the Karrys Bros. operations, a $2.8 million increase in employee bonus and stock compensation expense, $1.6 million related to the lump sum settlement of pension liabilities and approximately $6.0 million of additional costs associated with information technology, infrastructure and people to support future growth. SG&A expenses for 2014 included $1.5 million for a product liability settlement and related legal expenses and $1.0 million in professional fees associated with the collection of the OTP tax refunds in 2014. As a percentage of net sales, SG&A expenses were 1.8% for both 2015 and 2014. Interest Expense. Interest expense includes both interest and loan amortization fees related to borrowings and facility fees and interest on capital lease obligations. Interest expense was $2.5 million and $2.4 million in 2015 and 2014, respectively. Average borrowings were $39.6 million and $14.8 million in 2015 and 2014, respectively, with an average interest rate of 1.6% for both years. Foreign Currency Transaction Losses, Net. Foreign currency transaction losses were $1.8 million in 2015 compared to $0.1 million in 2014. The change was due primarily to the fluctuation in the Canadian/U.S. dollar exchange rate. During times of a strengthening U.S. dollar, we will record transaction losses from our Canadian operations. Conversely we will record transaction gains during times of a weakening U.S. dollar. Income Taxes. Our effective tax rate was 37.9% for 2015 compared to 35.7% for 2014. The provision for income taxes for 2015 included a net benefit of $0.3 million, compared to a net benefit of $1.8 million in 2014, related primarily to adjustments of prior years' estimates and the expiration of statute of limitations for uncertain tax positions which reduced our effective tax rates by approximately 0.4% and 2.7%, respectively. Results of Operations Comparison of 2014 and 2013 (in millions) (1): ______________________________________________ (1) Amounts and percentages have been rounded for presentation purposes and might differ from unrounded results. (2) Net sales, less excise taxes is a non-GAAP financial measure which we provide to separate the increase in sales due to product sales growth and increases in state, local and provincial excise taxes which we are responsible for collecting and remitting. Federal excise taxes are levied on the manufacturers who pass the taxes on to us as part of the product cost and thus are not a component of our excise taxes. Although increases in cigarette excise taxes result in higher net sales, our overall gross profit percentage may be reduced; however we do not expect increases in excise taxes to negatively impact gross profit per carton (see Comparison of Sales and Gross Profit by Product Category). (3) Gross profit may not be comparable to those of other entities because warehousing and distribution expenses are not included as a component of our cost of goods sold. (4) Adjusted EBITDA is a non-GAAP financial measure and should be considered as a supplement to, and not as a substitute for, or superior to, financial measures calculated in accordance with GAAP (see calculation of Adjusted EBITDA in “Liquidity and Capital Resources”). Net Sales. Net sales for 2014 increased by $512.5 million, or 5.2%, to $10,280.1 million from $9,767.6 million in 2013. Excluding the effects of foreign currency fluctuations, net sales increased approximately 6.2%, due primarily to market share gains, incremental food/non-food sales to existing customers and an increase in the average price per carton of cigarettes, offset by a modest decline in carton sales, excluding market share gains. The incremental food/non-food sales to existing customers was driven primarily by the continued success of our core strategies. The increase in the average price per carton of cigarettes was related mainly to increases in manufacturers’ prices. Net sales in our Food category, which increased 8.9% in 2014, contributed over half of the 6.8% increase in food/non-food sales. Net Sales of Cigarettes. Net sales of cigarettes for 2014 increased by $300.0 million, or 4.5%, to $6,942.0 million from $6,642.0 million in 2013. The increase in net cigarette sales was driven primarily by a 3.0% increase in the average price per carton and the addition of two major customers in the second half of 2013, offset by a decline of 0.8% in carton sales for the remainder of the business. Excluding the two major customers, cigarette cartons decreased by 1.1% in the U.S. and increased by 2.0% in Canada, driven primarily by market share gains. Total net cigarette sales as a percentage of total net sales were 67.5% in 2014 compared to 68.0% for 2013. We believe long-term cigarette consumption will be negatively impacted by rising prices, legislative actions, tobacco alternatives, including electronic cigarettes, diminishing social acceptance and sales through illicit markets. We expect cigarette manufacturers will raise prices as carton sales decline in order to maintain or enhance their overall profitability, thus mitigating the effects of the decline to the distributor. In addition, industry data indicates that convenience retailers are more than offsetting cigarette volume profit declines through higher sales of food/non-food products. We expect this trend to continue as the convenience industry adjusts to consumer demands. Net Sales of Food/Non-food Products. Net sales of food/non-food products for 2014 increased $212.5 million, or 6.8%, to $3,338.1 million from $3,125.6 million in 2013. The following table provides net sales by product category for our food/non-food products (in millions)(1): ______________________________________________ (1) Amounts and percentages have been rounded for presentation purposes and might differ from unrounded results. (2) In 2014, certain products were moved from the Candy category to the Health, beauty & general category to align them with the industry classifications used by NACS. The 2013 presentation has been realigned to reflect these changes. Without the changes, net sales for Candy would have been $527.2 million for the year ended December 31, 2013. Net sales for Health, beauty & general products would have been $327.3 million for the year ended December 31, 2013. The increase in food/non-food sales was driven by incremental sales to existing customers, market share gains and price inflation, offset partially by the impact of a weaker Canadian dollar in 2014. Sales generated from VCI, Fresh and FMI contributed to this improvement in net sales. In addition, we also continued to see higher sales of smokeless tobacco products in our OTP category. We believe the overall trend toward increased use of smokeless tobacco products will continue and will help offset the impact of expected continued declines in cigarette consumption. This shift could potentially result in improved profitability over time due to the profit margins associated with smokeless tobacco products, which are generally higher than those we earn on cigarette carton sales. Total net sales of food/non-food products as a percentage of total net sales increased to 32.5% in 2014 compared to 32.0% in 2013. Gross Profit. Gross profit represents the amount of profit after deducting cost of goods sold from net sales during the period. Inventory holding gains represent incremental revenues whereas vendor incentives, OTP tax refunds and changes in LIFO reserves are components of cost of goods sold and therefore part of our gross profit. Gross profit in 2014 increased by $36.6 million, or 6.8% to $573.7 million from $537.1 million for 2013 due primarily to increases in sales and profit margins in our food/non-food category. This increase includes $8.5 million in refunds, net of tax assessments, related primarily to the over payment of excise taxes on OTP from prior years. Gross profit in 2014 also benefitted from candy inventory holding gains of $6.0 million, offset by a $7.6 million increase in LIFO expense, driven largely by inflation in the cigarette, confection and grocery categories as measured by the PPI published by the Bureau of Labor Statistics. Gross profit margin was 5.58% and 5.50% of total net sales for 2014 and 2013, respectively. Distributors such as Core-Mark may, from time to time, earn higher gross profits on inventory and excise tax stamp quantities on hand at the time manufacturers' increase their prices or when states, localities or provinces increase their excise taxes. Such increases are reflected in customer pricing for all subsequent sales, including sales of inventory on hand at the time of the increase. The higher gross profits are referred to as inventory holding gains. However, significant increases in cigarette product costs and cigarette excise taxes adversely impact our gross profit as a percentage of net sales, because we are paid on a cents per carton basis for cigarette sales. Conversely, we generally benefit from food/non-food price increases, because product costs for these categories are usually marked up using a percentage of cost of goods sold. Our cigarette inventory holding gains were $8.2 million, or 1.4%, of our gross profit for 2014, $9.0 million, or 1.7%, of our gross profit for 2013. In addition, we recognized $6.0 million, or 1.1%, of our gross profit for 2014, for candy inventory holding gains resulting from manufacturer price increases. These gains were recognized as the inventory was sold. Lastly, since we value our inventory in the U.S. on a LIFO basis, our gross profit can be positively or negatively impacted depending on the relative level of price inflation or deflation in manufacturer prices as reported in the Bureau of Labor Statistics Producer Price Index used to estimate and accrue for our book LIFO expense (see Note 2 - Summary of Significant Accounting Policies to our consolidated financial statements). The following table provides the components comprising the change in gross profit as a percentage of net sales for 2014 and 2013 (in millions)(1): ______________________________________________ (1) Amounts and percentages have been rounded for presentation purposes and might differ from unrounded results. (2) Net sales, less excise taxes is a non-GAAP financial measure which we provide to separate the increase in sales due to product sales growth and increases in state, local and provincial excise taxes which we are responsible for collecting and remitting. Federal excise taxes are levied on the manufacturers who pass the tax on to us as part of the product cost and thus are not a component of our excise taxes. Although increases in cigarette excise taxes result in higher net sales, our overall gross profit percentage may be reduced; however we do not expect increases in excise taxes to negatively impact gross profit per carton (see Comparison of Sales and Gross Profit by Product Category). (3) The amount of cigarette inventory holding gains attributable to the U.S. and Canada were $7.2 million and $1.0 million, respectively, for 2014, compared to $8.3 million and $0.7 million, respectively, for 2013. (4) For 2014, we recognized approximately $6.0 million in candy inventory holding gains resulting from manufacturer price increases. The amount of candy inventory holding gains attributable to the U.S. and Canada for 2014 were $5.4 million and $0.6 million, respectively. (5) For 2014, we received OTP tax refunds of $9.0 million related to prior years’ taxes, offset by an OTP tax assessment of $0.5 million. (6) The increase in LIFO expense was driven largely by inflation in the cigarette, confection and grocery categories as measured by the PPI published by the Bureau of Labor Statistics. We value our inventory in the U.S. on a LIFO basis, therefore our gross profit can be positively or negatively impacted depending on the relative level of price inflation or deflation in manufacturer prices as reported in the Bureau of Labor Statistics Producer Price Index used to estimate and accrue for our book LIFO expense (see Note 2 - Summary of Significant Accounting Policies to our consolidated financial statements). (7) Remaining gross profit is a non-GAAP financial measure which we provide to segregate the effects of LIFO expense, cigarette inventory holding gains and other items that significantly affect the comparability of gross profit. Remaining gross profit increased $30.5 million, or 5.7%, to $567.3 million for 2014 from $536.8 million for 2013. In 2014, remaining gross profit margin was 5.52% of total net sales compared to 5.50% in 2013. The shift in sales mix towards higher margin food/non-food items increased overall remaining gross profit margin by 13 basis points, offset by the addition of two new major customers in 2013, which reduced margins by six basis points. In addition, increases in cigarette manufacturers’ prices compressed remaining gross profit margin by approximately six basis points in 2014. Cigarette remaining gross profit per carton decreased by 0.8% in 2014 compared to 2013 due primarily to the compressing impact of the two major customers gained during 2013. Food/non-food remaining gross profit increased $30.2 million, or 8.0% in 2014 compared to 2013. Food/non-food remaining gross profit margin increased 13 basis points to 12.28% in 2014 compared with 12.15% in 2013. Excluding the two new major customers, food/non-food remaining gross profit margin increased by 20 basis points driven by sales growth in our Food category and the shift toward higher margin items primarily as a result of the continued success of our marketing programs, offset by OTP, which had higher sales in 2014 but lower gross profit margins relative to other food/non-food products. To the extent we capture large chain business, our gross profit margins may be negatively impacted. However, large chain customers generally require less working capital, allowing us, in most cases, to offer lower prices to achieve a favorable return on our investment. Our focus is to strike a balance between large chain business, which generally has lower gross profit margins, and independently-owned convenience stores, which comprise approximately 67% of the overall convenience store market and generally have higher gross profit margins. Operating Expenses. Our operating expenses include costs related to Warehousing and Distribution, Selling, General and Administrative and Amortization of Intangible Assets. In 2014, operating expenses increased by $37.3 million, or 8.0%, to $505.4 million from $468.1 million in 2013. As a percentage of net sales, total operating expenses were 4.9% in 2014 compared to 4.8% in 2013. Increases in the amount of cubic feet of product handled in the warehouse and by our drivers, contributed to higher operating costs. In addition, we continue to see upward pressure on operating expenses as a percentage of net sales due to a shift in sales to food/non-food categories. This is due, in part, to the lower selling price point for these categories, compared to cigarettes. The shift in sales to food/non-food products increased operating expenses as a percentage of net sales by approximately 14 basis points in 2014 compared to 2013. Warehousing and Distribution Expenses. Warehousing and distribution expenses increased by $21.3 million, or 7.2%, to $318.4 million in 2014 from $297.1 million in 2013. The increase in warehousing and distribution expenses was due primarily to a 7.2% increase in comparable cubic feet of product sold driven largely by our food/non-food category. In addition, we experienced higher delivery salaries and healthcare costs, offset partially by a decrease in fuel costs. Delivery salaries increased approximately 11% driven primarily by the increase in cubic feet of product shipped, a 6.1% increase in miles driven and higher costs resulting from the continued tightness of the driver labor pool in certain markets, consistent with national trucking industry trends. Fuel costs decreased $1.2 million, or 5.6%, due primarily to lower diesel fuel prices and in part our conversion to vehicles that use compressed natural gas (CNG). As of December 31, 2014, we had converted approximately 20% of our fleet to CNG. As a percentage of total net sales, warehousing and distribution expenses were 3.1% for both 2014 and 2013. The shift in sales to food/non-food products increased warehouse and delivery expenses as a percentage of net sales by approximately nine basis points in 2014 compared to 2013, since food/non-food products have lower sales price points than the cigarette category. Selling, General and Administrative (SG&A) Expenses. SG&A expenses increased by $16.1 million, or 9.6% in 2014 to $184.4 million from $168.3 million in 2013. SG&A expenses in 2014 included a $4.5 million increase for employee bonus and stock-based compensation expense, a $1.9 million increase in employee healthcare costs, $1.5 million for a product liability settlement and related legal expenses, $1.4 million of transitional expenses related to our business expansion activities and $1.0 million in professional fees associated with the collection of the OTP tax refunds in 2014. SG&A expenses in 2013 included $2.5 million of integration and other expenses related to our business expansion activities. As a percentage of net sales, SG&A expenses were 1.8% in 2014 compared to 1.7% for 2013. Excluding the aforementioned items, SG&A expenses as a percentage of sales were 1.5% for both 2014 and 2013. The shift in sales to food/non-food products increased SG&A expenses as a percentage of net sales by approximately five basis points in 2014 compared to 2013. Interest Expense. Interest expense includes both interest and loan amortization fees related to borrowings and facility fees and interest on capital lease obligations. Interest expense was $2.4 million and $2.7 million in 2014 and 2013, respectively. Average borrowings in 2014 were $14.8 million with an average interest rate of 1.6%, compared to average borrowings of $35.3 million and an average interest rate of 1.8% in 2013. Lower average borrowings and interest rates for 2014 were offset by an increase in interest expense related to capital lease arrangements. Foreign Currency Transaction Losses, Net. Foreign currency transaction losses were $0.1 million in 2014 compared to $0.8 million in 2013. The change was due primarily to the fluctuation in the Canadian/U.S. dollar exchange rate. Income Taxes. Our effective tax rate was 35.7% for 2014 compared to 37.0% for 2013. The provision for income taxes for 2014 included a net benefit of $1.8 million, compared to a net benefit of $0.9 million in 2013, related primarily to adjustments of prior years' estimates and the expiration of statute of limitations for uncertain tax positions which reduced our effective tax rates by approximately 2.7% and 1.4%, respectively. Comparison of Sales and Gross Profit by Product Category The following table summarizes our cigarette and food/non-food product sales, LIFO expense, gross profit and other relevant financial data for 2015, 2014 and 2013 (in millions)(1): ______________________________________________ (1) Amounts and percentages have been rounded for presentation purposes and might differ from unrounded results. (2) Excise taxes included in our net sales consist of state, local and provincial excise taxes which we are responsible for collecting and remitting. Federal excise taxes are levied on the manufacturers who pass the tax on to us as part of the product cost and thus are not a component of our excise taxes. Although increases in cigarette excise taxes result in higher net sales, our overall gross profit percentage may be reduced since gross profit dollars generally remain the same. (3) Net sales, less excise taxes is a non-GAAP financial measure which we provide to separate the increase in sales due to product sales growth and increases in excise taxes. (4) LIFO expense decreased $14.4 million in 2015 compared to 2014, due primarily to a decrease in the PPI for certain product categories we use to measure food/non-food LIFO expense as published by the Bureau of Labor Statistics. Since we value our inventory in the U.S. on a LIFO basis, our gross profit can be positively or negatively impacted depending on the relative level of price inflation or deflation in manufacturer prices as reported in the Bureau of Labor Statistics PPI used to estimate and record our book LIFO expense (see Note 2 - Summary of Significant Accounting Policies to our consolidated financial statements). (5) Cigarette gross profit includes (i) cigarette inventory holding gains related to manufacturer price increases, (ii) increases in state, local and provincial excise taxes and (iii) LIFO effects. Cigarette inventory holding gains for the years 2015, 2014 and 2013 were $10.1 million, $8.2 million and $9.0 million, respectively. For 2015, we recognized cigarette tax stamp inventory holding gains in the U.S. of $9.0 million, resulting from the increase in the excise tax rates of certain jurisdictions. (6) Food/non-food gross profit includes (i) inventory holding gains related to manufacturer price increases, (ii) increases in state, local and provincial excise taxes, (iii) LIFO effects, (iv) OTP tax refunds of $1.8 million in 2015 and $8.5 million in 2014, net of an OTP tax assessment of $0.5 million, related to prior years’ taxes and (v) a $6.0 million net candy holding gain in 2014. (7) Remaining gross profit is a non-GAAP financial measure which we provide to segregate the effects of LIFO expense, cigarette inventory holding gains and other items that significantly affect the comparability of gross profit. Liquidity and Capital Resources Our cash and cash equivalents as of December 31, 2015 were $12.5 million compared to $14.4 million at December 31, 2014. Our restricted cash at December 31, 2015 was $8.5 million compared to $13.0 million at December 31, 2014. Restricted cash represents primarily funds that have been set aside in trust as required by one of the Canadian provincial taxing authorities to secure amounts payable for cigarette and tobacco excise taxes. Our liquidity requirements arise primarily from the funding of our working capital, capital expenditures, debt service requirements of our Credit Facility, income taxes, repurchases of common stock and dividend payments. We have historically funded our liquidity requirements through our cash flows from operations and external borrowings. For the year ended December 31, 2015, our cash flows from operating activities provided $77.2 million and at December 31, 2015, we had $123.9 million of borrowing capacity available under our Credit Facility. Based on our anticipated cash needs, availability under our Credit Facility and the scheduled maturity of our debt, we expect that our current liquidity will be sufficient to meet all of our anticipated operating needs during the next twelve months. Cash flows from operating activities Year ended December 31, 2015 Net cash provided by operating activities increased by $10.7 million to $77.2 million for the year ended December 31, 2015 compared to $66.5 million for the same period in 2014. This increase was due primarily to an increase of $17.6 million in net income adjusted for non-cash items, offset by an increase in cash used in working capital of $6.9 million. The increase in cash used in working capital was due primarily to an increase in receivables resulting primarily from higher sales and the timing of inventory purchases including prepayments to certain vendors. Year ended December 31, 2014 Net cash provided by operating activities increased by $7.4 million to $66.5 million for the year ended December 31, 2014 compared to $59.1 million for the same period in 2013. This increase was due primarily to an increase of $7.9 million in net income adjusted for non-cash items, offset by an increase in cash used in working capital of $0.5 million. The slight increase in working capital was due primarily to an increase in inventory related to year-end LIFO purchases, which were higher than 2013, offset by a decline in prepayments, driven primarily by the timing of certain cigarette manufacturer prepayments and a lesser increase in cigarette and tobacco taxes payable in 2014 compared to 2013 due to timing of year-end stamp purchases. Cash flows from investing activities Year ended December 31, 2015 Net cash used in investing activities decreased by $17.9 million to $43.2 million for the year ended December 31, 2015 compared to $61.1 million for the same period in 2014. The reduction in cash used was due primarily to a decrease in capital expenditures of approximately $23.6 million and a decrease in restricted cash of $5.4 million, offset by $8.0 million used for the acquisition of Karrys Bros. The decrease in capital expenditures is attributable primarily to higher spending in 2014 discussed below. We expect capital expenditures for 2016 to be approximately $50 million, primarily for expansion projects, including a new building in Las Vegas, and maintenance investments. Year ended December 31, 2014 Net cash used in investing activities increased by $37.1 million to $61.1 million for the year ended December 31, 2014 compared to $24.0 million for the same period in 2013. This increase was due primarily to an increase in capital expenditures, which increased by approximately $35.9 million to $53.9 million in 2014 compared to $18.0 million in 2013. The increase in capital expenditures is attributable primarily to certain projects which were postponed in 2013, our new distribution center in Ohio, and an investment in advanced ordering technology for customers. Cash flows from financing activities Year ended December 31, 2015 Net cash used in financing activities increased by $32.8 million to $34.2 million for the year ended December 31, 2015 compared to $1.4 million for the same period in 2014. This increase was due primarily to net repayments on our Credit Facility of $9.3 million in 2015 compared to net borrowings of $9.6 million in 2014, a decrease in book overdrafts of $6.1 million caused by the level of cash on hand in relation to the timing of vendor payments and outstanding checks, and an increase of $3.3 million for dividends and stock repurchases. Year ended December 31, 2014 Net cash used in financing activities decreased by $42.1 million to $1.4 million for the year ended December 31, 2014 compared to $43.5 million for the same period in 2013. This decrease was due primarily to net borrowings of $9.6 million in 2014 compared to net repayments of $27.3 million in 2013 and an increase in book overdrafts of $8.0 million caused by the level of cash on hand in relation to the timing of vendor payments and outstanding checks. Adjusted EBITDA Adjusted EBITDA is a measure used by management to measure operating performance. We believe Adjusted EBITDA provides meaningful supplemental information for investors regarding the performance of our business and allows investors to view results in a manner similar to the method used by our management. Adjusted EBITDA is also among the primary measures used externally by our investors, analysts and peers in our industry for purposes of valuation and comparing our results to other companies in our industry. Adjusted EBITDA is not defined by GAAP and the discussion of Adjusted EBITDA should be considered as a supplement to, and not as a substitute for, or superior to, financial measures calculated in accordance with GAAP. We may define Adjusted EBITDA differently than other companies and therefore such measures may not be comparable to ours. The following table provides the components of Adjusted EBITDA for years ended December 31, 2015, 2014 and 2013 (in millions): ______________________________________________ (1) Interest expense, net, is reported net of interest income. Adjusted EBITDA for 2015 increased 10.2% to $135.2 million compared to $122.7 million for 2014. The increase in Adjusted EBITDA was driven primarily by an increase in gross profit. Our Credit Facility We have a revolving credit facility (Credit Facility) with a capacity of $200 million as of December 31, 2015, which can be increased up to an additional $100 million, limited by a borrowing base primarily consisting of eligible accounts receivable and inventories. All obligations under the Credit Facility are secured by first priority liens on substantially all of our present and future assets. The terms of the Credit Facility permit prepayment without penalty at any time (subject to customary breakage costs with respect to London Interbank Offer Rate (LIBOR) or Canadian Dollar Offer Rate (CDOR) based loans prepaid prior to the end of an interest period). On January 11, 2016, we entered into a seventh amendment to the Credit Facility (Seventh Amendment), which increased our Credit Facility from $200 million to $300 million. The Seventh Amendment also includes an expansion feature that gives us the option to increase the size of the Credit Facility to a total of $400 million, if exercised. On May 21, 2015, we entered into a sixth amendment to the Credit Facility (Sixth Amendment), which extended the term of the Credit Facility from May 2018 to May 2020, among other changes. The Credit Facility contains restrictive covenants, including among others, limitations on dividends and other restricted payments, other indebtedness, liens, investments and acquisitions and certain asset sales. We identified that the total amount of our capital lease obligations exceeded the maximum specified in the agreement’s restrictive covenant for capital leases as of December 31, 2015. The Seventh Amendment resolved this by waiving the prior technical default and increasing the limit on the restrictive covenant for capital leases. We were in compliance with all other covenants under the Credit Facility as of December 31, 2015. See Note 8 - Long-Term Debt to our consolidated financial statements included in this Form 10-K for additional details on the Credit Facility. Amounts borrowed, outstanding letters of credit and amounts available to borrow, net of certain reserves required under the Credit Facility, were as follows (in millions): ______________________________________________ (1) Excluding $100 million expansion feature. Average borrowings during the years ended December 31, 2015 and 2014 were $39.6 million and $14.8 million, respectively, with amounts borrowed at any one time during the years then ended ranging from zero to $120.9 million and zero to $80.3 million, respectively. Contractual Obligations and Commitments Contractual Obligations. The following table presents information regarding our contractual obligations that existed as of December 31, 2015 (in millions): ______________________________________________ (1) Represents amounts borrowed under our Credit Facility and does not include interest costs associated with the Credit Facility. (2) Our purchase obligations at December 31, 2015 were related primarily to purchases of compressed natural gas for our trucking fleet, delivery and warehouse equipment and computer software and services (see Note 9 - Commitments and Contingencies to our consolidated financial statements). (3) Represents net future minimum lease payments for warehouse facility, refrigeration and other office and warehouse equipment. Current maturities of capital leases are included in accrued liabilities, and non-current maturities are included in long-term debt. Interest costs associated with the capitalized leases are included in the table above. (4) We have not included in the table above claims liabilities of $38.5 million, which includes health and welfare, workers’ compensation and general and auto liabilities because it does not have a definite payout by year. Claims liabilities are discussed in Note 2 - Summary of Significant Accounting Policies to our consolidated financial statements. (5) As discussed in Note 11 - Employee Benefit Plans to our consolidated financial statements, we have a $4.7 million and a $3.0 million long-term obligation arising from an underfunded pension plan and other post-retirement benefit plan, respectively. Future minimum pension funding requirements are not included in the schedule above as they are not available for all periods presented. (6) The table excludes unrecognized tax liabilities of $0.4 million because a reasonable and reliable estimate of the timing of future tax payments or settlements, if any, cannot be determined (see Note 10 - Income Taxes to our consolidated financial statements). Off-Balance Sheet Arrangements Letter of Credit Commitments. As of December 31, 2015, our standby letters of credit issued under our Credit Facility were $18.5 million related primarily to casualty insurance. The majority of the standby letters of credit mature in one year. However, in the ordinary course of our business, we will continue to renew or modify the terms of the letters of credit to support business requirements. The liabilities underlying the letters of credit are reflected on our consolidated balance sheets. Operating Leases. The majority of our sales offices, warehouse facilities and trucks are subject to lease agreements which expire at various dates through 2029, excluding renewal options. These leases generally require us to maintain, insure and pay any related taxes. In most instances, we expect the leases that expire will be renewed or replaced in the normal course of our business. Critical Accounting Policies and Estimates This Management’s Discussion and Analysis of our Financial Condition and Results of Operations is based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the U.S. The preparation of our consolidated financial statements requires estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and the reported amounts of net sales and expenses during the reporting period. The critical accounting polices used in the preparation of the consolidated financial statements are those that are important both to the presentation of financial condition and results of operations and require significant judgments with regards to estimates. We base our estimates on historical experience and on various assumptions we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. We believe the current assumptions and other considerations used to estimate amounts reflected in our financial statements are appropriate; however, actual results could differ from these estimates. We consider the allowance for doubtful accounts, vendor rebates and promotional allowances, claims liabilities and insurance recoverables, valuation of pension assets and obligations, valuation of long-lived assets and goodwill, realizability of deferred income taxes and uncertain tax positions to be those estimates which involve a higher degree of judgment and complexity. We believe that the following represent the more critical accounting policies, which are subject to estimates and assumptions used in the preparation of our financial statements. Allowance for Doubtful Accounts We maintain an allowance for doubtful accounts for losses we estimate will arise from our trade customers’ inability to make required payments. We evaluate the collectability of accounts receivable and determine the appropriate allowance for doubtful accounts based on historical experience and a review of specific customer accounts. In determining the adequacy of allowances for customer receivables, we analyze factors such as the value of any collateral, customer financial statements, historical collection experience, aging of receivables, general economic conditions and other factors. It is possible that the accuracy of the estimation process could be materially affected by different judgments as to the collectability based on information considered and further deterioration of accounts. If circumstances change (i.e., further evidence of material adverse creditworthiness, additional accounts become credit risks, store closures or deterioration in general economic conditions), our estimates of the recoverability of amounts due us could be reduced by a material amount. The allowance for doubtful accounts at December 31, 2015 and 2014 amounted to 3.9% and 4.2%, respectively, of gross trade accounts receivable. Bad debt expense associated with our trade customer receivables was $1.3 million, $2.2 million and $1.1 million in 2015, 2014 and 2013, respectively. As a percentage of net sales, our bad debt expense was less than 0.1% for 2015, 2014 and 2013. Vendor Rebates and Promotional Allowances Periodic payments from vendors in various forms including rebates, promotional allowances and volume discounts are reflected in the carrying value of the related inventory when earned and as cost of goods sold as the related merchandise is sold. Up-front consideration received from vendors linked to purchase or other commitments is initially deferred and amortized ratably to cost of goods sold as the performance of the activities specified by the vendor to earn the fee is completed. Cooperative marketing incentives from suppliers are recorded as reductions to cost of goods sold to the extent the vendor considerations exceed the costs relating to the programs. These amounts are recorded in the period the related promotional or merchandising programs are provided. Certain vendor incentive promotions require that we make assumptions and judgments regarding, for example, the likelihood of achieving market share levels or attaining specified levels of purchases. Vendor incentives are at the discretion of our vendors and can fluctuate due to changes in vendor strategies and market requirements. Claims Liabilities and Insurance Recoverables We maintain reserves related to workers’ compensation, general and auto liability and health and welfare programs that are principally self-insured. Our workers’ compensation, general and auto liability insurance policies currently include a deductible of $500,000 per occurrence and we maintain excess loss insurance that covers any health and welfare costs in excess of $250,000 per person per year. Our reserves for workers’ compensation, general and auto insurance liabilities are estimated based on applying an actuarially derived loss development factor to our incurred losses, including losses for claims incurred but not yet reported. Actuarial projections of losses concerning workers’ compensation, general and auto insurance liabilities are subject to a high degree of variability. Among the causes of this variability are unpredictable external factors affecting future inflation rates, health care costs, litigation trends, legal interpretations, legislative reforms, benefit level changes and claim settlement patterns. Our reserve for health and welfare claims includes an estimate of claims incurred but not yet reported, which is derived primarily from historical experience. Our claim liabilities and the related recoverables from insurance carriers for estimated claims in excess of the deductible and other insured events are presented in their gross amounts because there is no right of offset. The following is a summary of our net reserves as of December 31, 2015 and 2014 (in millions): ______________________________________________ The increase in these reserves for 2015 was due primarily to a higher number of claims and reported losses for our workers compensation, general and auto insurance liability. A 10% change in our incurred but not reported estimates would increase or decrease the estimated reserves for our workers’ compensation liability, general and auto insurance liability and health and welfare liability as of December 31, 2015 by $0.9 million, $0.2 million and $0.3 million, respectively. Valuation of Pension Assets and Obligations We sponsored a qualified defined-benefit pension plan and a post-retirement benefit plan (collectively, Pension Plans) for employees hired before September 1986 and certain employees of Fleming, our former parent company. As discussed in Note 11 - Employee Benefit Plans to our consolidated financial statements, our qualified defined-benefit pension plan was underfunded by $4.7 million and $3.2 million at December 31, 2015 and 2014, respectively. There have been no new entrants to the pension or non-pension post-retirement benefit plans after those benefit plans were frozen on September 30, 1989. The determination of the obligation and expense associated with our Pension Plans are dependent, in part, on our selection of certain assumptions used by our independent actuaries in calculating these amounts. These assumptions are disclosed in Note 11 to the consolidated financial statements and include, among other things, the weighted-average discount rate and the expected weighted-average long-term rate of return on plan assets. Actual results in any given year will often differ from actuarial assumptions because of economic and other factors. In accordance with U.S. GAAP, actual results that differ from the actuarial assumptions are accumulated and amortized over future periods and, therefore, affect recognized expense and the recorded obligation in such future periods. While we believe our assumptions are appropriate, significant differences in actual results or changes in our assumptions may materially affect our pension and other post-retirement obligations and the future expense. We select the weighted-average discount rates for each benefit plan as the rate at which the benefits could be effectively settled as of the measurement date. In selecting an appropriate weighted-average discount rate we use a yield curve methodology, matching the expected benefits at each duration to the available high quality yields at that duration and calculating an equivalent yield, which is the ultimate discount rate used. The weighted-average discount rate used to determine the pension obligation and pension expense was 4.32% and 4.05%, respectively, for 2015 and 4.00% and 4.60%, respectively, for 2014. A lower weighted-average discount rate increases the present value of benefit obligations and increases pension expense. In addition, we adopted the Society of Actuaries RP-2014 mortality table with MP-2015 projection in 2015. Expected return on pension plan assets is based on historical experience of our portfolio and the review of projected returns by asset class on broad, publicly traded equity and fixed-income indices, as well as target asset allocation. Our target asset allocation mix is designed to meet our long-term pension and post-retirement benefit plan requirements. Our assumed weighted-average rate of return on our assets was 6.0% and 6.55% for 2015 and 2014, respectively. Sensitivity to changes in the major assumptions for our pension plans as of December 31, 2015 is as follows (in millions): Valuation of Long-Lived Assets We review our long-lived assets for indicators of impairment whenever events or changes in circumstances indicate that the carrying amounts of such assets may not be recoverable. Long-lived assets consist primarily of land, buildings, delivery, warehouse and office equipment, leasehold improvements and definite-lived assets. An impairment of long-lived assets exists when the carrying amount of a long-lived asset, or asset group, exceeds its fair value. Impairment losses are recorded when the carrying amount of the impaired asset is not recoverable. Recoverability is determined by comparing the carrying amount of the asset (or asset group) to the undiscounted cash flows which are expected to be generated from its use. Our estimates of future cash flows are based on historical experience and management’s expectations of relevant customers and markets and other operational factors. These estimates project future cash flows several years into the future and can be affected by factors such as competition, inflation and other economic conditions. In 2015, we assessed our asset groups and determined we have six asset groups. This change resulted from a reassessment of independently identifiable cash flows within the Company given the organic growth in the business as well as the addition of national chain customers. We did not record impairment losses related to long-lived assets in any of the years ended December 31, 2015, 2014 and 2013. Valuation of Goodwill Goodwill represents the excess of the purchase consideration of an acquired business over the fair value of the identifiable tangible and intangible assets acquired and liabilities assumed in a business combination. Goodwill is not subject to amortization but must be evaluated for impairment. We test goodwill for impairment annually as of October 1 or whenever events or circumstances indicate that it is more likely than not that the fair value of a reporting unit is below its carrying amount. The Company’s reporting units, which are the United States and Canada, also represent the Company’s operating segments. Whenever events or circumstances change, we assess the related qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. The tests to evaluate goodwill for impairment are performed at the reporting unit level. In the first step of the quantitative impairment test, we compare the fair value of the reporting unit to its carrying value. If the fair value of the reporting unit is less than its carrying value, we perform a second step to determine the implied fair value of goodwill associated with the reporting unit. If the carrying value of goodwill exceeds the implied fair value of goodwill, such excess represents the amount of goodwill impairment for which an impairment loss would be recorded. Determining the fair value of a reporting unit involves the use of significant estimates and assumptions. The estimated fair value of each reporting unit is based on the discounted cash flow method, which is based on historical and forecasted amounts specific to each reporting unit and considers sales, gross profit, operating profit and cash flows and general economic and market conditions, as well as the impact of planned business and operational strategies and other estimates and assumptions for future growth rates, working capital and capital expenditures. We base our fair value estimates on assumptions we believe to be reasonable at the time, but such assumptions are subject to inherent uncertainty. We did not record any impairment charges related to goodwill during the years ended December 31, 2015, 2014 and 2013. In connection with our annual goodwill impairment testing performed during 2015, the first step of the test indicated that the fair values of the applicable reporting units significantly exceeded their carrying values, and accordingly, no further testing of goodwill was required. However, changes in the judgments and estimates underlying our analysis of goodwill for possible impairment, including expected future cash flows and discount rate, could result in a significantly different estimate of the fair value of the reporting units in the future and could result in impairment of goodwill. ITEM 7A.

1318084

2015

Item 6. Selected Financial Data. Not applicable because the Company is a smaller reporting company. Item 7.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion of our financial condition and results of operations should be read in conjunction with the audited financial statements and notes thereto for the fiscal year ended November 30, 2015, found in this report. In addition to historical information, the following discussion contains forward-looking statements that involve risks, uncertainties and assumptions. Where possible, we have tried to identify these forward looking statements by using words such as “anticipate,” “believe,” “intends,” or similar expressions. Our actual results could differ materially from those anticipated by the forward-looking statements due to important factors and risks including, but not limited to, those set forth under “Risk Factors” in Part I, Item 1A of this report. Company Overview Exceed World, Inc., formerly known as Brilliant Acquisition, Inc., (the “Company”) was incorporated under the laws of the State of Delaware on November 25, 2014, with an objective to acquire, or merge with, an operating business. Recent Developments: None. Critical Accounting Policies We prepare our financial statements in conformity with GAAP, which requires management to make certain estimates and assumptions and apply judgments. We base our estimates and judgments on historical experience, current trends and other factors that management believes to be important at the time the financial statements are prepared and actual results could differ from our estimates and such differences could be material. We have identified below the critical accounting policies which are assumptions made by management about matters that are highly uncertain and that are of critical importance in the presentation of our financial position, results of operations and cash flows. On a regular basis, we review our accounting policies and how they are applied and disclosed in our financial statements. Use of Estimates The preparation of financial statements in conformity with U.S. generally accepted accounting principles (GAAP) requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Estimates are based on historical experience, management expectations for future performance, and other assumptions as appropriate. Key areas affected by estimates include the assessment of the recoverability of long-lived assets, which is based on such factors as estimated future cash flows. We re-evaluate estimates on an ongoing basis; therefore, actual results may vary from those estimates. Fair Values of Financial Instruments The carrying values of cash, accounts receivable, accounts payable and accrued expenses approximate the fair values of these instruments due to their short-term nature. The carrying amount for borrowings under the financing agreement approximates fair value because of the variable market interest rates charged for these borrowings. Off Balance Sheet Arrangements There are no off balance sheet arrangements. Capital Resources. We had no material commitments for capital expenditures as of November 30, 2015 and 2014. Results of Operations for the years ended November 30, 2015 and for the period from November 25, 2014 (inception) through November 30, 2014 For the year ended November 30, 2015 and the period from November 25, 2014 (inception) through November 30, 2014 we did not generate any revenues. For both fiscal year ends we also did not have any cash or cash equivalents. For the year ended November 30, 2015 we had total general and administrative expenses in the amount of $8,746 compared to total general & administrative expenses of $4,148 for the period from November 25, 2014 (inception) through November 30, 2014. Our general and administrative expenses made up the entirety of our net loss for both fiscal year ends respectively. The variance in net loss is due to increased professional fees for the year ended November 30, 2015. Item 7A.

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2015

Item 6. Selected Financial Data You should read the following selected consolidated financial data together with the information under “Item 7.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with the attached financial statements and notes thereto. This Annual Report on Form 10-K, including the following sections, contains forward-looking statements within the meaning of the federal securities laws. These statements are subject to risks and uncertainties that could cause actual results and events to differ materially from those expressed or implied by such forward-looking statements. For a detailed discussion of these risks and uncertainties, see the “Risk Factors” section in Item 1A of this Annual Report on Form 10-K. We caution the reader not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date of this Form 10-K. We undertake no obligation to update forward-looking statements, which reflect events or circumstances occurring after the date of this Form 10-K. Overview We are a late-stage clinical biologics platform company focused on the global biosimilar market. Biosimilars are an emerging class of protein-based therapeutics with high similarity to approved originator products on the basis of various physicochemical and structural properties, as well as in terms of safety, purity and potency. Our goal is to become a global leader in the biosimilar market by leveraging our team’s collective expertise in key areas such as process science, analytical characterization, protein production and clinical-regulatory development. Our clinical-stage biosimilar pipeline includes the following three product candidates: · CHS-1701 (our pegfilgrastim (Neulasta) biosimilar candidate). Our long-acting G-CSF product candidate, CHS-1701, is being developed as a pegfilgrastim (Neulasta) biosimilar. In October 2015, we completed a pivotal pharmacokinetic (PK) and pharmacodynamics (PD) study for CHS-1701 in the United States (U.S.). Although it did not meet the PK AUC bioequivalence endpoint due to low, anomalous PK profile in the Neulasta first period group, we believe this study will support the planned filing of a biologics license application (BLA) in the U.S. as it met all the other co-primary endpoints including the PD endpoints. An immunogenicity study in healthy volunteers pursuant to this BLA met its primary endpoints. In February 2016, we initiated a follow-on PK/PD study, which is expected to read-out late in the first half of 2016. We expect to file a BLA in the United States directly thereafter. · CHS-0214 (our etanercept (Enbrel) biosimilar candidate). CHS-0214 is a product candidate for which we have partnered with Baxalta Incorporated, Baxalta US Inc., and Baxalta GmbH, (collectively “Baxalta”) and Daiichi Sankyo Company, Limited (“Daiichi Sankyo”), to develop and commercialize in key markets outside of the United States. In October 2015, we completed part 1 of a Phase 3 clinical study in psoriasis comparing CHS-0214 to Enbrel. This study is on-going but has met all its primary efficacy endpoints at 12 weeks. There were no clinically important safety issues noted in either treatment group. We are currently conducting a Phase 3 clinical study in rheumatoid arthritis. This study met the primary endpoint at 24 weeks. We expect that results from these studies, combined with data from our Phase 1 studies will support the expected filing of a marketing application in Europe and Japan in 2016. We have retained the development and commercial rights to this product in the U.S. However, the therapeutic protein in etanercept is subject to certain originator-controlled U.S. patents expiring in 2028 and 2029. Assuming these patents are valid and enforceable, and that we would be unable to obtain a license to them, we do not expect to commercialize CHS-0214 in the U.S. prior to their expiration. · CHS-1420 (our adalimumab (Humira) biosimilar candidate). Our second anti-TNF product candidate, CHS-1420, is being developed as an adalimumab (Humira) biosimilar. This product successfully completed a pivotal Phase 1 PK study in August 2014 by meeting the primary PK bioequivalence endpoint. We initiated a Phase 3 study in psoriasis in August 2015 to support the planned filing of a marketing application in the U.S. in 2016 and the E.U. in 2017. We initiated a bridging PK study comparing the Phase 3 CHS-1420 material to U.S. manufactured adalimumab (Humira) during the first quarter of 2016 and we plan to initiate a bridging PK study comparing the Phase 3 CHS-1420 material to E.U. manufactured adalimumab (Humira) in mid-2016. Our revenue to date has been generated primarily from collaboration and license payments pursuant to our license agreements with Daiichi Sankyo and Baxalta. We have not generated any commercial product revenue. We have incurred significant losses in the past and expect to incur significant and increasing losses in the foreseeable future as we advance our product candidates into later stages of development and, if approved, commercialization. Our net losses were $223.9 million, $87.2 million and $53.6 million for the years ended December 31, 2015, 2014 and 2013, respectively. As of December 31, 2015, we had an accumulated deficit of $410.0 million. In March 2015, our registration statement on Form S-1 (File No. 333-202936) relating to the follow-on offering of our common stock was declared effective by the SEC. The price of the shares sold in the follow-on offering was $29.00 per share. The follow-on offering closed on April 7, 2015, pursuant to which we sold 4,137,931 shares of common stock. We received total gross proceeds from the offering of $120.0 million. After deducting underwriting discounts and commissions of $7.2 million and offering expenses of $0.6 million, the net proceeds were $112.2 million. In April 2015, we entered into a second amendment to the license agreement with Baxalta. Under the terms of the second amendment, a revised milestone payment structure totaling $130.0 million replaced certain existing milestone and funding obligations under the license agreement as originally executed. Therefore, we are eligible to receive up to $335.3 million in contingent payments comprised of $215.3 million in clinical development payments, and $120.0 million in regulatory milestone payments. Pursuant to the second amendment, we received a total of $100.0 million in milestone payments in 2015 which are subject to the 50% claw-back feature. We lease office spaces for our corporate headquarters in Redwood City, California and for laboratory facilities in Camarillo, California under operating lease agreements. In July 2015, we entered into a new office lease with Hudson 333 Twin Dolphin Plaza, LLC to lease approximately 27,532 square feet of office space located in Redwood City, California for our new corporate headquarters. The New Lease commenced and we moved into the new facility in December 2015. In September 2015, we completed a private placement with Baxalta, in which we sold an aggregate of 390,167 shares of common stock for aggregate gross proceeds of approximately $10.0 million. In December 2015, we filed our registration statement on Form S-3 (File No. 333-208625) relating to the private placement of our common stock and was declared effective by the SEC on January 21, 2016. In February 2016, we issued and sold $100.0 million aggregate principal amount of our 8.2% senior convertible notes due 2022 (“the Notes”). These Notes require quarterly interest distributions at a fixed coupon rate of 8.2% until maturity, redemption or conversion, which will be no later than March 31, 2022. The Notes are convertible into shares of common stock at an initial conversion rate of 44.7387 shares of common stock per $1,000 principal amount of the Notes (equivalent to a conversion price of approximately $22.35 per share of common stock, representing a 60% premium over the average last reported sale price of our common stock over the 15 trading days preceding the date the notes were issued), subject to adjustment in certain events. After March 31, 2020, the full amount of the Notes not previously converted are redeemable for cash at our option if the last reported sale price per share of our common stock exceeds 160% of the conversion price on 20 or more trading days during the 30 consecutive trading days preceding the date on which we send notice of such redemption to the holders of the Notes. Upon conversion of the Notes by a holder, the holder will receive shares of our common stock, together, if applicable, with cash in lieu of any fractional share. At maturity or redemption, if not earlier converted, we will pay 109% of the par value of the Notes, together with accrued and unpaid interest, in cash. The holders of the Notes are Healthcare Royalty Partners III, L.P., which holds $75.0 million in aggregate principal amount, and three related party investors, KKR Biosimilar L.P., which holds $20.0 million, MX II Associates LLC, which holds $4.0 million, and KMG Capital Partners, LLC, which holds $1.0 million. Financial Operations Overview Revenue We have not generated any revenue from commercial product sales to date. Our revenue has been generated from license and collaboration agreements, which is composed of license payments and milestone and other contingent payments under our license agreements. Research and Development Expenses Research and development expenses represent costs incurred to conduct research, such as the discovery and development of our product candidates. We recognize all research and development costs as they are incurred. We currently track only the external research and development costs incurred for each of our product candidates. Our external research and development expenses consist primarily of: · expenses incurred under agreements with consultants, third-party contract research organizations, or CROs, and investigative sites where a substantial portion of our preclinical studies and all of our clinical trials are conducted; · costs of acquiring originator comparator materials and manufacturing preclinical study and clinical trial supplies and other materials from contract manufacturing organizations, or CMOs, and related costs associated with release and stability testing; and · costs associated with manufacturing process development activities. Internal costs are associated with activities performed by our research and development organization and generally benefit multiple programs. These costs are not separately allocated by product candidate. Unallocated, internal research and development costs consist primarily of: · personnel-related expenses, which include salaries, benefits and stock-based compensation; and · facilities and other allocated expenses, which include direct and allocated expenses for rent and maintenance of facilities, depreciation and amortization of leasehold improvements and equipment and laboratory and other supplies. The largest component of our total operating expenses has historically been our investment in research and development activities, including the clinical development of our product candidates. We expect these expenses to increase in absolute dollars in the future as we continue to invest in research and development activities related to our product candidates. The process of conducting the necessary clinical research to obtain regulatory approval is costly and time consuming. Furthermore, in the past we have entered into collaborations with third parties to participate in the development and commercialization of our product candidates, and we may enter into additional collaborations in the future. In situations in which third parties have substantial influence over the development activities for product candidates, the estimated completion dates are not fully under our control. For example, pursuant to our collaboration agreements with respect to CHS-0214, our partners in licensed territories may exert considerable influence on the regulatory filing process globally. Therefore, we cannot forecast with any degree of certainty the duration and completion costs of these or other current or future clinical trials of our product candidates. We may never succeed in achieving regulatory approval for any of our product candidates. In addition, we may enter into other collaboration arrangements for our other product candidates, which could affect our development plans or capital requirements. The following table summarizes our research and development expenses incurred during the respective periods: (1) CHS-0214 entered into Phase 3 clinical trials in June and July 2014. (2) CHS-1420 initiated a Phase 3 study in psoriasis in August 2015 to support the planned filing of a marketing application in the U.S. in 2016 and in the E.U. in 2017. We initiated a bridging PK study comparing the Phase 3 CHS-1420 material to U.S. manufactured adalimumab (Humira) during the first quarter of 2016 and we plan to initiate a bridging PK study comparing the Phase 3 CHS-1420 material to E.U. manufactured adalimumab (Humira) in mid-2016. (3) We met with the FDA on October 9, 2014 and informed the agency of our decision to transition from a 351(a) (novel biologic) approval pathway to a 351(k) (biosimilar) approval pathway. In March 2015, we received written feedback from the FDA on our development plan for CHS-1701 and we initiated a pivotal pharmacokinetic and pharmacodynamic study for CHS-1701inhealthy volunteers, and an additional immunogenicity study in healthy volunteers in May 2015, both pursuant to this BLA. We continue to believe it may be possible to advance CHS-1701 to a 351(k) (biosimilar) approval application without a collaboration or licensing partner. (4) CHS-131 (previously designated as INT-131, a small molecule PPARgamma partial agonist) currently in a Phase 2 trial in multiple sclerosis in Russia. (5) Amount consists of costs for other pipeline candidates. (6) Our research and development expenses have been reduced by reimbursements of certain research and development expenses pursuant to the cost-sharing provision of our licensing agreement with Daiichi Sankyo. Reimbursement of research and development expenses under the Baxalta licensing agreement was recognized as revenue pursuant to the revenue recognition accounting policy applicable to that agreement. General and Administrative Expenses General and administrative expenses consist primarily of personnel costs, allocated facilities costs and other expenses for outside professional services, including legal, human resources, audit and accounting services. Personnel costs consist of salaries, benefits and stock-based compensation. We incurred increased expenses in 2015 and expect future expenses to increase as a result of operating as a public company, including expenses related to compliance with the rules and regulations of the Securities and Exchange Commission, or SEC, or The NASDAQ Global Market, or NASDAQ, additional insurance expenses, investor relations activities and other administration and professional services. Interest Expense Interest expense consists primarily of interest incurred on our outstanding indebtedness and non-cash interest related to the amortization of debt discount associated with our various debt agreements outstanding during the years ended December 31, 2014 and 2013. The convertible notes issued in 2013 were converted into shares of our Series C convertible preferred stock in May 2014. Other Expense, Net Other income (expense), net for the year ended December 31, 2015 consists primarily of losses resulting from the remeasurement of our contingent consideration and foreign exchange gains and losses resulting from currency fluctuations. Additionally, for the year ended December 31, 2014, other income (expense), net includes gains and losses resulting from the remeasurement of the fair value of our convertible preferred stock warrant liability, derivative liability associated with our convertible notes, and the gain on the extinguishment of our convertible notes issued in 2013. In November 2014, in connection with the closing of our IPO all of our outstanding warrants for convertible preferred stock were exercised, for cash or on a net basis, and the convertible preferred stock warrant liability was reclassified to equity. As such, we no longer record adjustments to reflect the remeasurement of the fair values. In March 2015, the contingent consideration related to the Earn-Out Payment was settled for shares and cash, and the contingent liability related to the Earn-Out Payment was reclassified to equity. As such, we ceased recording adjustments to reflect the remeasurement of the Earn-Out Payment to fair value. We will still continue to record adjustments to the estimated fair value of our contingent consideration related to the Compound Transaction Payment until the contingency settles or expires. Critical Accounting Policies and Estimates Our management’s discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with United States generally accepted accounting principles, or GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, as well as the reported revenue generated and expenses incurred during the reporting periods. On an on-going basis, we evaluate our critical accounting policies and estimates. Our estimates are based on our historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. Revenue Recognition We recognize revenue when persuasive evidence of an arrangement exists; transfer of technology has been completed, services have been performed or products have been delivered; the fee is fixed and determinable; and collection is reasonably assured. Our collaboration and license agreements may provide for reimbursement by our collaborators of a portion of our research and development expenses, and we make judgments that affect how these reimbursements are recorded. In collaborations where we and our partner are actively and jointly engaged in the research activities and for which both parties are sharing costs, amounts reimbursed by our partner are recognized as a reduction of research and development expense. For example, Daiichi Sankyo reimburses certain of our research and development costs in quarterly advance payments pursuant to the cost-sharing provision of our collaboration and license agreement with them. Because Daiichi Sankyo is an active participant in the research and development activities, we account for these reimbursements as reductions in our research and development expense when the applicable research and development activity has been performed. Under our collaboration agreement with (Baxalta Incorporated, Baxalta US Inc., and Baxalta GmbH (collectively “Baxalta”), on the other hand, we recognize reimbursement of our research and development expenses thereunder as revenue because Baxalta is not actively participating in research and development activities. For revenue agreements with multiple-elements, we identify the deliverables included within the agreement and evaluate which deliverables represent separate units of accounting based on the achievement of certain criteria including whether the deliverable has stand-alone value to the collaborator. Upfront payments received in connection with licenses of our technology rights are deferred if facts and circumstances dictate that the license does not have stand-alone value and are recognized as license revenue over the estimated period of performance that is generally consistent with the terms of the research and development obligations contained in the specific collaboration and license agreement. We periodically review our estimated periods of performance based on the progress under each arrangement and account for the impact of any changes in estimated periods of performance on a prospective basis. At the inception of each agreement that includes milestone payments, we evaluate whether each milestone is substantive and at risk to both parties on the basis of the contingent nature of the milestone. We evaluate factors such as the scientific, regulatory, commercial and other risks that must be overcome to achieve the respective milestone, the level of effort and investment required to achieve the respective milestone and whether the milestone consideration is reasonable relative to all deliverables and payment terms in the arrangement in making this assessment. Non-refundable payments that are contingent upon achievement of a substantive milestone are recognized in their entirety in the period in which the milestone is achieved, assuming all other revenue recognition criteria are met. Other contingent payments in which a portion of the milestone consideration is refundable or adjusts based on future performance or non-performance (e.g., through a penalty or claw-back provision) are not considered to relate solely to past performance, and therefore, not considered substantive. Amounts that are not recognized as revenue due to the uncertainty as to whether they will be retained or because they are expected to be refunded are recorded as a liability. We recognize non-substantive milestone payments over the remaining estimated period of performance once the milestone is achieved. Contingent payments associated with the achievement of specific objectives in certain contracts that are not considered substantive because we do not contribute effort to the achievement of such milestones are recognized as revenue upon achievement of the objective, as long as there are no undelivered elements remaining and no continuing performance obligations by us, assuming all other revenue recognition criteria are met. Contingent payments associated with the achievement of specific objectives in certain contracts that are not considered substantive because we do not contribute effort to the achievement of such milestones are recognized as revenue upon achievement of the objective, as long as there are no undelivered elements remaining and no continuing performance obligations by us, assuming all other revenue recognition criteria are met. We also generate revenue from a Russian government contract. The government contract is an agreement that provides us with payments for certain types of expenditures in return for research and development activities over a contractually defined period. Revenue from the government contract is recognized as other revenue in the consolidated statement of operations in the period during which the related costs are incurred and the related services are rendered, provided that the funds received are not refundable and applicable conditions under the government contract have been met. Funds received in advance are recorded as deferred revenue. Accrued Research and Development Expenses As part of the process of preparing financial statements, we are required to estimate and accrue expenses, the largest of which are research and development expenses. This process involves the following: · communicating with appropriate internal personnel to identify services that have been performed on our behalf and estimating the level of service performed and the associated cost incurred for the service when we have not yet been invoiced or otherwise notified of actual cost; · estimating and accruing expenses in our consolidated financial statements as of each balance sheet date based on facts and circumstances known to us at the time; and · periodically confirming the accuracy of our estimates with service providers and making adjustments, if necessary. Examples of estimated research and development expenses that we accrue include: · fees paid to CROs in connection with preclinical and toxicology studies and clinical trials; · fees paid to investigative sites in connection with clinical trials; · fees paid to CMOs in connection with the production of clinical trial materials; and · professional service fees for consulting and related services. We base our expense accruals related to clinical trials on our estimates of the services received and efforts expended pursuant to contracts with multiple research institutions and CROs that conduct and manage clinical trials on our behalf. The financial terms of these agreements vary from contract to contract and may result in uneven payment flows. Payments under some of these contracts depend on factors, such as the successful enrollment of patients and the completion of clinical trial milestones. In accruing service fees, we estimate the time period over which services will be performed and the level of effort to be expended in each period. If we do not identify costs that we have begun to incur or if we underestimate or overestimate the level of services performed or the costs of these services, our actual expenses could differ from our estimates. Due to the nature of these estimates, we cannot assure you that we will not make changes to our estimates in the future as we become aware of additional information about the status or conduct of our clinical trials and other research activities. Derivative Liabilities There were two contingent payments associated with the acquisition of InteKrin: (i) the completion of the first dosing of a human subject in the first Phase 2 clinical trial for InteKrin, or the Earn-Out Payment and (ii) upon the execution of any license, sublicense, development, collaboration, joint venture, partnering or similar agreement between us and the third-party, or the Compound Transaction Payment. The contingent consideration is accounted for as a liability and remeasured to estimated fair value as of each balance sheet date and the related remeasurement adjustment is recognized as other income (expense), net in the consolidated statement of operations. We determined the fair value of the two contingent consideration scenarios (the Earn-Out Payment and the Compound Transaction Payment) using a probability-weighted discounted cash flow approach. A probability-weighted value was determined by summing the probability of achieving a contingent payment threshold by the respective contingent payment. The expected cash flows were discounted at a rate selected to capture the risk of achieving the contingent payment thresholds and earning the contingent payment. This risk is comprised of InteKrin’s continued development, a specific risk factor associated with meeting the contingent consideration threshold and related payout and counterparty risk associated with the payment of the contingent consideration. Stock-Based Compensation Common Stock Options Stock-based compensation expense related to stock options granted to employees is measured at the date of grant, based on the estimated fair value of the award and recognized as an expense over the employee’s requisite service period on a straight-line basis. We estimate the grant date fair value and the resulting stock-based compensation expense using the Black-Scholes option-pricing model. We account for stock-based compensation arrangements with non-employees using a fair value approach. The fair value of these options is measured using the Black-Scholes option pricing model reflecting the same assumptions as applied to employee options in each of the reported periods, other than the expected life, which is assumed to be the remaining contractual life of the option. The fair value of the unvested options under these arrangements is subject to remeasurement over the vesting terms as earned. We recorded non-cash stock-based compensation expense related to options granted to employees and non-employees of $16.7 million, $6.8 million and $764,000 for the years ended December 31, 2015, 2014 and 2013, respectively. The Black-Scholes option-pricing model requires the use of highly subjective assumptions which determine the fair value of stock-based awards. These assumptions include: · Expected term. The expected term represents the period that stock-based awards are expected to be outstanding and is based on the options’ vesting term, contractual term and industry peers. We do not have sufficient historical information to develop reasonable expectations about future exercise patterns and post-vesting employment termination behavior. · Expected volatility. We use an average historical stock price volatility of industry peers to be representative of future stock price volatility as we do not have any trading history for our common stock. · Risk-free interest rate. The risk free interest rate is based on the U.S. Treasury constant maturity rate in effect at the time of the grant for periods corresponding with the expected term. · Expected dividends. We have not paid and do not anticipate paying any dividends in the near future, and therefore we used an expected dividend yield of zero in the valuation model. In addition to the Black-Scholes assumptions, we estimate our forfeiture rate based on an analysis of our actual forfeitures and will continue to evaluate the adequacy of the forfeiture rate based on actual forfeiture experience, analysis of employee turnover behavior and other factors. The impact from any forfeiture rate adjustment would be recognized in full in the period of adjustment and if the actual number of future forfeitures differs from our estimates, we might be required to record adjustments to stock-based compensation in future periods. Historically, for all periods prior to our IPO, the fair values of the shares of common stock underlying our share-based awards were estimated on each grant date by our board of directors. In order to determine the fair value of our common stock underlying option grants, our board of directors considered, among other things, valuations of our common stock prepared by an unrelated third-party valuation firm in accordance with the guidance provided by the American Institute of Certified Public Accountants Practice Guide, Valuation of Privately-Held-Company Equity Securities Issued as Compensation. Given the absence of a public trading market for our common stock, our board of directors exercised reasonable judgment and considered a number of objective and subjective factors to determine the best estimate of the fair value of our common stock, including our stage of development; progress of our research and development efforts; the rights, preferences and privileges of our preferred stock relative to those of our common stock; equity market conditions affecting comparable public companies; and the lack of marketability of our common stock. Founders’ Shares In October 2010 and January 2011, we issued 4,130,173 shares and 968,804 shares of common stock, respectively, at $0.0083 per share to our founders under the founder stock agreements. These founders’ shares are subject to a repurchase option in our favor that lapses over time subject to continued service. As such, we recorded stock-based compensation based on the fair value of the common stock on the date of issuance. One of the holders of the founders’ shares is a consultant, therefore the fair value of the consultant’s founder shares is measured using the Black-Scholes option-pricing model reflecting the same assumptions as applied to employee options in each of the reported years, other than the expected life, which is assumed to be the remaining contractual life of the vesting period. We recorded non-cash stock-based compensation expense related to the founders’ shares of $9,000, $1.6 million and $1.3 million for the years ended December 31, 2015, 2014 and 2013, respectively. As of December 31, 2015, there were no shares subject to repurchase. Common Stock Warrants In March 2014, we issued warrants to purchase 553,274 shares of common stock with an exercise price of $1.667 per share to two employees and a member of our board of directors in his capacity as a consultant to us for past services. We valued the warrants at $2.7 million using the Black-Scholes option-pricing model on the date of grant. Due to the immediate exercisability of the warrants upon issuance, we immediately recognized $1.3 million and $1.4 million in research and development expense and general and administrative expense, respectively, in the consolidated statement of operations. In connection with the closing of our IPO, all outstanding warrants for common stock were exercised on a net basis into 491,580 shares of common stock. Income Taxes We file U.S. federal and state income tax with varying statutes of limitations. The tax years from 2011 forward remain open to examination due to the carryover of unused net operating losses and tax credits. To date, we have not been audited by the Internal Revenue Service or any state income tax authority. We use the liability method of accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial reporting and the tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. We assess the likelihood that the resulting deferred tax assets will be realized. A valuation allowance is provided when it is more likely than not that some portion or all of a deferred tax asset will not be realized. As of December 31, 2015, our total net deferred tax assets, net of gross deferred tax liabilities, were $134.8 million. Due to our lack of earnings history, the net deferred tax assets have been fully offset by a valuation allowance. The deferred tax assets were primarily comprised of federal and state tax net operating losses and tax credit carryforwards. Utilization of the net operating loss and tax credit carryforwards may be subject to an annual limitation due to historical or future ownership percentage change rules provided by the Internal Review Code of 1986, and similar state provisions. The annual limitation may result in the expiration of certain net operating loss and tax credit carryforwards before their utilization. Recent Accounting Pronouncements In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which converges the FASB and the International Accounting Standards Board standards on revenue recognition. Areas of revenue recognition that will be affected include, but are not limited to, transfer of control, variable consideration, allocation of transfer pricing, licenses, time value of money, contract costs and disclosures. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date (“ASU 2015-14”). Under the amendments in ASU 2015-14, the FASB deferred the effective date of this standards update to fiscal years beginning after December 15, 2017, including interim reporting periods within that reporting period, with early adoption permitted on the original effective date of fiscal years beginning after December 15, 2016. We are currently evaluating the impact that the adoption of ASU 2014-09 will have on our consolidated financial statements and related disclosures. In August 2014, the FASB issued ASU No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. ASU 2014-15 is effective for our annual reporting period ending December 31, 2016 and all annual and interim reporting periods thereafter, with early adoption permitted. We elected to not early adopt this standard. When adopted, ASU 2014-15 will require management to evaluate whether there is substantial doubt about our ability to continue as a going concern for at least 12 months from the issuance date of the financial statements and to provide related footnote disclosures. In November 2015, the FASB issued ASU No. 2015-17, Balance Sheet Classification of Deferred Taxes. To simplify the presentation of deferred income taxes, the amendments in ASU 2015-17 requires that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. ASU 2015-17 is effective for our interim and annual reporting periods during the year ending December 31, 2017 and all annual and interim reporting periods thereafter, with early adoption permitted. We have elected to early adopt ASU 2015-17 prospectively. Such adoption did not have a material impact on our consolidated balance sheet and related disclosures as of December 31, 2015, and did not adjust prior periods presented. In January 2016, the FASB issued ASU No. 2016-1, Recognition and Measurement of Financial Assets and Financial Liabilities. ASU 2016-1 makes amendments to the classification and measurement of financial instruments and revises the accounting related to: (1) the classification and measurement of investments in equity securities, and (2) the presentation of certain fair value changes for financial liabilities measured at fair value. In addition, the update also amends certain disclosure requirements associated with the fair value of financial instruments. ASU 2016-1 is effective for our interim and annual reporting periods during the year ending December 31, 2018, and all annual and interim reporting periods thereafter. Early adoptions of certain amendments within the update are permitted. We are currently evaluating the impact that the adoption of ASU 2016-1 will have on our consolidated financial statements and related disclosures. In February 2016, the FASB issued ASU No. 2016-2, Leases. ASU 2016-2 is aimed at making leasing activities more transparent and comparable, and requires substantially all leases be recognized by lessees on their balance sheet as a right-of-use asset and corresponding lease liability, including leases currently accounted for as operating leases. ASU 2016-2 is effective for our interim and annual reporting periods during the year ending December 31, 2019, and all annual and interim reporting periods thereafter. Early adoption is permitted. We are currently evaluating the impact that the adoption of ASU 2016-2 will have on our consolidated financial statements and related disclosures. We have reviewed other recent accounting pronouncements and concluded they are either not applicable to the business or no material effect is expected on the consolidated financial statements as a result of future adoptions. Comparison of Years Ended December 31, 2015 and 2014 Revenue (1) Represents revenue from Daiichi Sankyo through November 12, 2014 as a related party, a holder of more than 10% of our common stock until the closing of our IPO. Total revenue for the year ended December 31, 2015 was $30.0 million compared to $31.1 million for the same period in 2014, a decrease of $1.1 million. The decrease was primarily due to the $10.0 million receipt received for the achievement of a substantive milestone in the third quarter of 2014 under our license agreement with Baxalta. The decrease was partially offset by increased revenue recognized in connection with the amortization of deferred revenue under our license agreement with Baxalta. Research and Development Expenses Research and development expenses for the year ended December 31, 2015 was $213.1 million compared to $78.2 million for the same period in 2014, an increase of $134.8 million. The increase in research and development expenses was primarily due to: · an increase of $47.7 million in costs incurred for CHS-0214 due to the fully enrolling and completing Phase 3 clinical studies, which is net of an increase of $9.0 million in cost reimbursements from Daiichi Sankyo that were recognized as a reduction of research and development expense; · an increase of $38.4 million related to initiating and completing two BLA-enabling studies for CHS-1701; · an increase of $25.0 million to start and enroll subjects into a Phase 3 clinical study in psoriasis for CHS-1420; · an increase of $9.8 million in personnel, consulting and other related expenses and $2.4 million in stock-based compensation due to a net increase of approximately 31 employees, annual salaries increases and additional stock options granted during 2015, partially offset by common stock warrant issued during 2014 and none in 2015, and higher stock-based compensation expense related to consultants during 2014 than during 2015; · an increase of $4.8 million in facilities, supplies and materials and other infrastructure to support our research and development growth; · an increase of $4.4 million to advance other product candidates in our pipeline; and · an increase of $2.3 million to initiate and enroll a proof-of concept Phase 2 clinical study for CHS-131 (formerly INT-131). General and Administrative Expenses General and administrative expenses for year ended December 31, 2015 was $36.0 million compared to $17.6 million for the same period in 2014, an increase of $18.5 million. The increase was primarily due to an increase of $6.9 million in personnel, consulting and other related expenses and $3.2 million in stock-based compensation as a result of an increase in headcount, annual salaries increases, and costs associated with stock options granted in 2015. The increase in stock-based compensation was driven primarily from additional stock options granted during 2015, partially offset by common stock warrants issued during 2014. In addition, the increase in general and administrative expenses was due to an increase of $6.7 million in legal, accounting, recruiting and other professional services and $1.7 million in facilities, supplies and materials to support our growing infrastructure as we expanded our operations as a public company. Interest Expense Interest expense for the year ended December 31, 2015 was $33,000, compared to $3.9 million for the same period in 2014, a decrease of $3.9 million. The decrease was due to the conversion of our 2013 convertible notes into shares of our Series C convertible preferred stock in May 2014 resulting in no interest expense during 2015 related to this debt compared to the recognition of non-cash interest expense and amortization of the debt discount during 2014. Other Expense, Net Other expense, net for the year ended December 31, 2015 was $4.8 million compared to $18.6 million for the same period in 2014, a decrease of $13.8 million. The decrease is primarily due to the change of $15.9 million in fair value of our convertible preferred stock warrant liability during 2014 which converted into equity contemporaneously with the closing of our IPO on November 12, 2014, therefore no remeasurement expense in 2015 and a decrease in the change in fair value of our contingent consideration related to the InteKrin acquisition of $0.6 million during 2015 when compared to 2014 as the fair value of the Earn-Out Payment portion of the contingent consideration was settled in May 2015. The decrease was partially offset by the gain on extinguishment of our convertible notes issued in 2013 of $2.0 million in May 2014 and the net expense increase of $1.1 million during 2015 when compared to 2014 due to foreign exchange fluctuations. Comparison of Years Ended December 31, 2014 and 2013 Collaboration and License Revenue (1) Represents revenue from Daiichi Sankyo, a holder of more than 10% of our common stock for the periods presented until the closing of our IPO on November 12, 2014. Collaboration and license revenue for the year ended December 31, 2014 was $30.4 million, compared to $2.8 million for the same period in 2013, an increase of $27.6 million. The increase was primarily due to $20.3 million of revenue recognized in connection with the amortization of deferred revenue and a$10.0 million receipt for achievement of a substantive milestone in the third quarter of 2014 under our license agreement with Baxalta, which we entered into in August 2013. Other revenue for the year ended December 31, 2014 was $0.7 million. The other revenue is related to the government contract received from the Russian government in connection with the clinical development of the CHS-131 drug candidate. Research and Development Expenses Research and development expenses for the year ended December 31, 2014 was $78.2 million compared to $31.3 million for the same period in 2013, an increase of $46.9 million. The increase in research and development expenses was primarily due to the following: · an increase of $25.6 million in costs incurred for CHS-0214 due to the ongoing Phase 3 clinical trial, which is net of an increase of $5.8 million in cost reimbursements from Daiichi Sankyo that was recognized as a reduction of research and development expense; · an increase of $6.0 million to complete CHS-1420 to a Phase 1 study and to advance to Phase 3 clinical trial; · an increase of $3.5 million to advance CHS-1701 to a 351 (k) approval pathway; · an increase of $1.7 million to advance CHS-131 to a Phase 2 clinical trial; · an increase of $9.9 million in personnel and consulting related expenses due to an increase in stock-based compensation expense related to common stock warrants and options granted in 2014, and an increase of 21 employees; and · an increase of $1.6 million in facilities, supplies and materials and other infrastructure to support our research and development growth. These increases were partly offset by a decrease of $1.4 million in costs for other pipeline biosimilars. General and Administrative Expenses General and administrative expenses for the year ended December 31, 2014 was $17.6 million compared to $7.5 million for the same period in 2013, an increase of $10.1 million. The increase was primarily due to a $7.2 million increase in personnel and consulting related expenses associated with an increase in stock-based compensation related to the common stock warrants and options granted in 2014, and an increase of nine employees. Additionally, the increase was due to increased costs of $2.3 million in legal, accounting and recruiting services, and increased costs of $0.7 million in insurance and facilities to support our growing infrastructure and our operations as a public company. Interest Expense Interest expense for the year ended December 31, 2014 was $3.9 million compared to $5.3 million for the same period in 2013, a decrease of $1.4 million. The decrease of $0.9 million was due to the recognition of approximately four months in 2014 compared to approximately five months in 2013 of non-cash amortization of the debt discount and interest expense related to our convertible notes entered into during the third quarter of 2013 which converted into shares of our series C convertible preferred stock in May 2014. The additional $0.5 million decrease was due to the extended payment arrangement with one of our vendors in 2013. Other Expense, Net Other expense, net for the year ended December 31, 2014 was $18.6 million compared to $12.3 million for the same period in 2013, an increase of $6.2 million. The increase is primarily due to a change in the fair value of our convertible preferred stock warrant liability of $3.3 million when compared to 2013 and the change in fair value of our contingent consideration of $5.2 million related to and as a result of the acquisition of InteKrin in February 2014. The increase was partly offset by the gain on extinguishment of our convertible notes issued in 2013 of $2.0 million in May 2014 and foreign currency gain of $0.7 million primarily due to the increase in the exchange rate of the U.S. Dollar against the Russian Ruble on U.S. Dollar denominated cash accounts held by InteKrin Russia whose functional currency is the Ruble. Liquidity and Capital Resources Due to our significant research and development expenditures, we have generated significant operating losses since our inception. We have funded our operations primarily through the issuance of debt, equity financing, sales of our convertible preferred stock and payments received under our collaboration and license agreements. In May 2014, we completed our Series C convertible preferred stock financing, which resulted in aggregate net cash proceeds of $54.7 million. In addition, our outstanding convertible notes and accrued interest of $10.6 million were contemporaneously converted into shares of our Series C convertible preferred stock. In November 2014, we completed our IPO and raised net proceeds of $80.2 million, after deducting underwriting discounts and commissions and offering expenses. In April 2015, we completed a follow-on offering of common stock and raised net proceeds of $112.2 million, after deducting underwriting discounts and commissions and offering expenses. Additionally, in September 2015 we completed a private placement with Baxalta which raised net proceeds of approximately $10.0 million. In February 2016, we issued and sold $100.0 million aggregate principal amount of 8.2% senior convertible notes due March 31, 2022. As of December 31, 2015, we had an accumulated deficit of $410.0 million and cash and cash equivalents of $158.2 million. We believe that our current available cash and cash equivalents, together with the proceeds from the Notes issued in February 2016 and funding we expect to receive under our license agreement with Daiichi Sankyo and Baxalta, will be sufficient to fund our planned expenditures and meet our obligations through at least the next twelve months. We will need to raise additional funds in the future; however, there can be no assurance that such efforts will be successful or that, in the event that they are successful, the terms and conditions of such financing will be favorable. Summary Statement of Cash Flows The following table summarizes our cash flows for the periods presented: Net cash provided by (used in) operating activities Cash used in operating activities was $108.0 million for the year ended December 31, 2015, reflecting a net loss of $223.9 million and an increase in prepaid and other assets of $15.9 million as a result of initiating clinical activities and timing of vendor payments. Cash used in operating activities was partially offset by non-cash charges of $4.6 million for the remeasurement of our contingent consideration obligations, $16.7 million for stock-based compensation, $2.3 million for depreciation and amortization and impairment of property and equipment, and $1.3 million related to a reserve for other receivables. Cash used in operating activities was also offset by an increase of $32.8 million in accounts payable, accounts payable-related parties, and accrued liabilities as a result of the increase in clinical activities and timing of vendor payments, an increase of $32.3 million in deferred revenue and $38.6 million in contingent liability to collaborator both related to $100.0 million milestone payments received from Baxalta under our license agreement, a decrease of $1.9 million in notes receivable as it was settled, and a decrease of $0.9 million in receivables from collaboration and license agreements. Cash used in operating activities was $23.9 million for the year ended December 31, 2014 reflecting a net loss of $87.2 million, an increase in prepaid assets of $14.7 million as a result of the increase in clinical activities and expenses associated with becoming a public company, an increase in receivable from collaboration and license agreement of $2.1 million with Daiichi Sankyo, an increase in notes receivable of $1.8 million, and an increase in other assets of $2.1 million. The cash used in operating activities was partly offset by non-cash charges of $15.9 million for the remeasurement of our convertible preferred stock warrant liability and embedded derivative liabilities, $5.2 million for remeasurement of our contingent consideration obligations, $3.9 million of non-cash interest expense and amortization of debt discount, $11.1 million for stock-based compensation and $0.7 million for depreciation and amortization, partially offset by the gain on the extinguishment of our convertible notes issued in 2013 of $2.0 million. Cash used in operating activities was also offset by an increase in deferred revenue of $19.8 million and an increase in contingent liability to collaborator of $20.2 million both related to the additional payments received from Baxalta under our license agreement. In addition, accounts payable and accounts payable-related parties increased by $5.3 million, and accrued liabilities increased by $3.9 million as a result of the increase in clinical activities and timing of vendor payments. Cash provided by operating activities was $15.4 million for the year ended December 31, 2013 reflecting non-cash charges of $7.6 million in preferred stock issued in exchange for services received, $7.8 million for the fair value of warrants and embedded derivatives issued in excess of debt proceeds, $5.3 million of non-cash interest expense, $2.0 million for stock-based compensation, $0.4 million for depreciation and amortization and a non-cash gain of $4.6 million for the remeasurement of our convertible preferred stock warrant liability and embedded derivatives. Cash provided by operating activities also reflected an increase in deferred revenue of $34.7 million, an increase in contingent liability to collaborator of $7.5 million both related to the payments received from Baxalta and an increase in accrued liabilities of $2.8 million related to an increase in the accrual for clinical development activities. The cash provided by operating activities were partially offset by a net loss of $53.6 million, and an increase in prepaid and other current assets of $3.2 million related to an increase in prepaid clinical, material and manufacturing costs. Net cash used in investing activities Cash used in investing activities of $6.9 million for the year ended December 31, 2015 was due primarily to the purchase of capital equipment and leasehold improvements of $6.2 million, and an increase in restricted cash of $0.8 million as a result of the new headquarters lease requirement. Cash used in investing activities of $525,000 for the year ended December 31, 2014 was due primarily to the purchases of capital equipment and leasehold improvements of $2.8 million, partially offset by the net cash acquired from the acquisition of InteKrin in February 2014 of $2.3 million. Cash used in investing activities of $0.4 million for the year ended December 31, 2013 was related to capital equipment purchases. Net cash provided by financing activities Cash provided by financing activities of $122.7 million for the year ended December 31, 2015 was primarily related to the net proceeds of $112.8 million from the issuance of our common stock in connection with our follow-on offering, net proceeds of approximately $10.0 million from the private placement with Baxalta, and proceeds from the exercise of stock options of $1.4 million, partially offset by our payments of IPO and follow-on offering costs of $1.5 million. Cash provided by financing activities of $136.0 million for the year ended December 31, 2014 was primarily related to the net proceeds from the issuance of our Series C convertible preferred stock of $54.7 million and the completion of our IPO in November 2014 resulting in net proceeds of $80.2 million. Cash provided by financing activities of $10.0 million for the year ended December 31, 2013 was primarily related to proceeds from the issuance of convertible notes. Funding Requirements We believe that our current available cash and cash equivalents, together with the proceeds from the Notes issued in February 2016 and funding we expect to receive under our license agreements with Daiichi Sankyo and Baxalta, will be sufficient to fund our planned expenditures under our 2016 budget and meet our obligations through at least December 31, 2016. We have based this estimate on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect. Further, our operating plan may change, and we may need additional funds to meet operational needs and capital requirements for product development and commercialization sooner than planned. We currently have no credit facility or committed sources of capital although we may receive milestone and other contingent payments under our current license and collaboration agreements. Because of the numerous risks and uncertainties associated with the development and commercialization of our product candidates and the extent to which we may enter into additional agreements with third parties to participate in their development and commercialization, we are unable to estimate the amounts of increased capital outlays and operating expenditures associated with our current and anticipated clinical trials. Our future funding requirements will depend on many factors, including the following: · the scope, rate of progress, results and cost of our clinical trials, preclinical testing and other related activities; · the cost of manufacturing clinical supplies and establishing commercial supplies of our product candidates and any products that we may develop; · the costs of acquiring originator comparator materials and manufacturing preclinical study and clinical trial supplies and other materials from CMOs and related costs associated with release and stability testing; · the receipt of any collaboration payments; · the number and characteristics of product candidates that we pursue; · the cost, timing and outcomes of regulatory approvals; · the terms and timing of any other collaborative, licensing and other arrangements that we may establish; · the timing, receipt and amount of sales, profit sharing or royalties, if any, from our potential products; · the cost of preparing, filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; and · the extent to which we acquire or invest in businesses, products or technologies. We will need to raise additional capital to fund our operations in the near future. Funding may not be available to us on acceptable terms, or at all. If we are unable to obtain adequate financing when needed, we may have to delay, reduce the scope of or suspend one or more of our clinical trials, research and development programs or commercialization efforts. We may seek to raise any necessary additional capital through a combination of public or private equity offerings, debt financings, collaborations, strategic alliances, licensing arrangements and other marketing and distribution arrangements. We anticipate receiving up to $62 million in 2016 under our collaborations, and we will seek to enter into strategic partnerships to commercialize our biosimilar candidates in ex-US territories or globally for certain therapeutic areas. To the extent that we raise additional capital through marketing and distribution arrangements or other collaborations, strategic alliances or licensing arrangements with third parties, we may have to relinquish valuable rights to our product candidates, future revenue streams, research programs or product candidates or to grant licenses on terms that may not be favorable to us. If we do raise additional capital through public or private equity offerings, the ownership interest of our existing stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect our stockholders’ rights. If we raise additional capital through debt financing, we may be subject to covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. Off-Balance Sheet Arrangements Since our inception, we have not engaged in any off-balance sheet arrangements, as defined in the rules and regulations of the SEC. Contractual Obligations Our future contractual obligations as of December 31, 2015 were as follows: We enter into contracts in the normal course of business with contract research organizations, or CROs, for preclinical studies and clinical trials and contract manufacturing organizations, or CMOs, for the manufacture of clinical trial materials. As of December 31, 2015, we had commitments of $14.5 million with CMOs for the manufacture of clinical trial material due within a year. We also have an agreement with a CRO vendor which provides for a minimum fee commitment of $35.0 million for clinical trial services. As of December 31, 2015, we have fulfilled the minimum fee commitment related to this agreement. Item 7A.

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ITEM 6: SELECTED FINANCIAL DATA As a “smaller reporting company,” as defined in Rule 12b-2 of the Exchange Act, we are not required to provide the information called for by this Item. ITEM 7:

ITEM 7: MANAGEMENT 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 financial statements and related notes included elsewhere in this report. This report contains forward looking statements relating to our Company's future economic performance, plans and objectives of management for future operations, projections of revenue mix and other financial items that are based on the beliefs of, as well as assumptions made by and information currently known to, our management. The words "expects”, “intends”, “believes”, “anticipates”, “may”, “could”, “should" and similar expressions and variations thereof are intended to identify forward-looking statements. The cautionary statements set forth in this section are intended to emphasize that actual results may differ materially from those contained in any forward looking statement. Our auditor’s report on our March 31, 2015 financial statements expresses an opinion that substantial doubt exists as to whether we can continue as an ongoing business. We believe that if we do not raise additional capital over the next 12 months, we may be required to suspend or cease our business. As of March 31, 2015, we had $0 cash on hand or in the bank. This amount will not satisfy our cash requirements for the next twelve months. We plan to satisfy our future cash requirements - primarily legal and accounting fees - by additional equity financing. This will likely be in the form of private placements of common stock. Additional equity financing may not be available to us on acceptable terms or at all, and thus we could fail to satisfy our future cash requirements. If we are unsuccessful in raising the additional proceeds through a private placement offering, we will then have to seek additional funds through debt financing, which would be highly difficult for a shell company to secure. Therefore, we depend upon the success of the any private placement offering and failure thereof would result in our having to seek capital from other sources such as debt financing, which may not even be available to us. However, if such financing were available, because we are a shell company, we would likely have to pay additional costs associated with high risk loans and be subject to an above market interest rate. At such time these funds are required, management would evaluate the terms of such debt financing and determine whether the business could manage the debt load. If we cannot raise additional proceeds via a private placement of our common stock or secure debt financing we would be required to cease as a business. As a result, investors in our common stock would lose all of their investment. We did not generate any revenue during the fiscal years ended March 31, 2014 and 2015. We incurred operating expenses in the amount of $25,322 in the fiscal year ended March 31, 2015. These operating expenses were comprised of professional fees and office and general expenses. We have no current agreements to merge with any other entity. As of the date of this Annual Report, the current funds available to the Company will not be sufficient to continue operations. The cost of maintaining our reporting status for the next twelve months is estimated to be $30,000. RESULTS OF OPERATIONS Our expenses decreased to $25,322 for the twelve months ended March 31, 2015 from $86,850 in the twelve months ended March 31, 2014. This decrease was the result of a decrease in management fees to $0 from $55,000 between the two periods partially offset by an increase in professional fees to $25,101 from $15,068 between the two periods. As we had no revenues or additional losses in either period, our net losses were the same as our total expenses. OFF BALANCE SHEET ARRANGEMENTS As of the date of this Annual Report, the current funds available to the Company will not be sufficient to continue operations. The cost to of maintaining our reporting status for the next twelve months is estimated to be $30,000 over this same period. Management believes that if the Company cannot raise sufficient revenues or maintain its reporting status with the SEC it will have to cease all efforts directed towards the Company. As such, any investment previously made would be lost in its entirety. The Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors. ITEM 7A:

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2015

ITEM 6. SELECTED FINANCIAL DATA (All dollar [$] amounts shown in thousands.) The following selected consolidated financial data should be read together with our consolidated financial statements and accompanying notes and “Management Discussion and Analysis of Financial Condition and Results of Operations” appearing elsewhere in this document. The selected consolidated financial data in this section is not intended to replace our consolidated financial statements and the accompanying notes. Our historical results and information are not necessarily indicative of our future results. The summary consolidated financial data as of and for the fiscal years ended December 31, 2015, and 2014 is derived from our audited consolidated financial statements included elsewhere in this document. The summary consolidated financial data as of and for the fiscal years ended December 31, 2013, 2012 and 2011 is derived from our audited consolidated financial statements not included in this document. As of, and for, the years ended December 31, (1) Fiscal 2011 includes in this amount ($250) for the redemption of the ownership interests of two of our former members; ($383) was a return of capital to certain of the remaining members; and ($322) was earnings distributed to the members. ITEM 7.

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (All dollar [$] amounts shown in thousands.) The following Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our consolidated financial statements and the notes thereto contained elsewhere in this report. See also “Cautionary Note Regarding Forward-Looking Statements” preceding Part I. Overview We were organized in the Commonwealth of Pennsylvania in 2007 under the name 84 RE Partners, LLC and changed our name to Shepherd’s Finance, LLC on December 2, 2011. We converted to a Delaware limited liability company on March 29, 2012. Our business is focused on commercial lending to participants in the residential construction and development industry. We believe this market is underserved because of the lack of traditional lenders currently participating in the market. We are located in Jacksonville, Florida. Our operations are governed pursuant to our operating agreement. From 2007 through the majority of 2011, we were the lessor in three commercial real estate leases with a then affiliate, 84 Lumber Company. Beginning in late 2011, we began commercial lending to residential homebuilders. Our current loan portfolio is described more fully in this section under the sub heading “Commercial Construction and Development Loans.” We have a limited operating history as a finance company. We currently have four paid employees, including our Executive Vice President of Operations. We currently use our CEO to originate most of our new loans, and augment that with several people to whom we pay consulting fees. Our Board of Managers is comprised of Mr. Wallach and three independent Managers - Bill Myrick, Eric Rauscher, and Kenneth R. Summers. Our officers are responsible for our day-to-day operations, while the Board of Managers is responsible for overseeing our business. The commercial loans we extend are secured by mortgages on the underlying real estate. We extend and service commercial loans to small-to-medium sized homebuilders for the purchase of lots and/or the construction of homes thereon. We also extend and service loans for the purchase of undeveloped land and the development of that land into residential building lots. In addition, we may, depending on our cash position and the opportunities available to us, do none, any or all of the following: purchase defaulted unsecured debt from suppliers to homebuilders at a discount (and then secure that debt with real estate or other collateral), purchase defaulted secured debt from financial institutions at a discount, and purchase real estate in which we will operate our business. Our Chief Executive Officer, Daniel M. Wallach, has been in the housing industry since 1985. He was the CFO of a multi-billion dollar supplier of building materials to home builders for 11 years. He also was responsible for that company’s lending business for 20 years. During those years, he was responsible for the creation and implementation of many secured lending programs to builders. Some of these were performed fully by that company, and some were performed in partnership with banks. In general, the creation of all loans, and the resolution of defaulted loans, was his responsibility, whether the loans were company loans or loans in partnership with banks. Through these programs, he was responsible for the creation of approximately $2,000,000 in loans which generated interest spread of $50,000, after deducting for loan losses. Through the years, he managed the development of systems for reducing and managing the risks and losses on defaulted loans. Mr. Wallach also was responsible for that company’s unsecured debt to builders, which reached over $300,000 at its peak. He also gained experience in securing defaulted unsecured debt. We had $14,060 and $8,097 in loan assets as of December 31, 2015 and 2014, respectively. Loan assets increased at an annualized rate of 74% and equity increased 7% during the same period. Loan assets increased 100% and equity increased 61% from December 31, 2013 to December 31, 2014. As of December 31, 2015, we have a limited number of construction loans in nine states with fourteen borrowers, and have three development loans in Pittsburgh, Pennsylvania. At the end of 2014 and again in April 2015, we entered into purchase and sale agreements for portions of our loans. The first loan portions sold under the program took place during the first quarter of 2015 and it has allowed us to increase our loan balances and commitments significantly in 2015. We currently have six sources of capital: Certain features of the purchase and sale agreement have added liquidity and flexibility, which have lessened the need for the lines of credit from affiliates. Eventually, the Company intends to permanently replace the lines of credit to affiliates with a secured line of credit from a bank or through other liquidity. Economic and Industry Dynamics Demand for residential construction loans was negatively impacted by the net decrease in housing starts (a key driver relative to commercial lending to residential homebuilders) in the past nine years. The housing market started to decline in 2006, reached its bottom in 2008, and is not back to historical norms as of December 31, 2015. See “Inflation, Interest Rates, and Housing Starts” later in this section. This decrease followed 15 years of increases in housing starts. Home values also decreased during the housing start decline, but have returned to average numbers. The combination of these events, along with others, presented significant hurdles to residential homebuilders. Due to the need to fund either part or all of the costs of their construction projects, homebuilders often have to work with lending institutions. The normal lending institutions (banks, S&L, credit unions, etc.) have all been negatively impacted by these same recent trends, which have raised default rates and losses related to commercial lending loans issued to residential homebuilders. In fact, many state and federal regulators are discouraging community banks and lending institutions from lending to residential homebuilders. We believe all the factors above present three significant opportunities. The first opportunity, and our primary focus, is to become the lender of choice or secondary lender to residential homebuilders during the absence of lending at the homebuilder’s local financial institution or community bank. Another is to purchase and securitize the loans made by building supply companies to those homebuilders. Finally, we may acquire deeply discounted defaulted debt from other financial institutions. While we have not entered into any transactions related to the final two opportunities, we will remain mindful of those opportunities to generate a return from such transactions. Perceived Challenges and Anticipated Responses The following is not intended to represent a comprehensive list or description of the risks or challenges facing the Company. Currently, our management is most focused on the following challenges along with the corresponding actions to address those challenges: Perceived Challenges and Risks Anticipated Management Actions/Response Concentration of loan portfolio (i.e., how many of the loans are of one type, with any particular customer, or within any particular geography) 37% and 60% of our loan commitments as of December 31, 2015 and 2014, respectively, were to one builder in one market (Pittsburgh, Pennsylvania). As of December 31, 2015 and 2014, we have loans in 9 and 7 states to 14 and 10 builders, respectively. As of December 31, 2015, our next two largest customers make up 22% and 6% respectively of our loan commitments, with loans in Sarasota, Florida and Columbia, South Carolina, respectively. As of December 31, 2014, our next two largest customers made up 9% and 8% respectively of our loan commitments, with loans in New Orleans, Louisiana and Charleston, South Carolina. In the upcoming years, we plan on increasing our geographic and builder diversity while continuing to focus on residential homebuilder customers. Potential loan value-to-collateral value issues (i.e., being underwater on particular loans) We manage this challenge by risk-rating both the geographic region and the builder, then adjusting the loan-to-value (i.e., the loan amount versus the value of the collateral) based on risk assessments. Additionally, for construction loans, we collect a deposit up-front. Potential increases in interest rates, which would reduce operating income We offer variable rate loans that incorporate a spread (i.e., profit) above the Company’s costs of funds to insulate it against this risk. A more detailed description is included in Interest Spread below. Liquidity As in every financial institution, we manage our loan balances to builders with our capital structure in mind. We have six sources of capital: ● Secured lines of credit from our members; ● Purchase and sale agreements which are treated like a secured borrowing; ● Our Notes offering; ● Other unsecured debt; ● Preferred equity; and ● Common equity. We make decisions as to: ● What loans and to what customer(s) to make loan(s); ● What portions of loans to sell (under our purchase and sale agreements); and ● What interest rates and terms to offer to prospective Note holders. These decisions are based on: ● Expected customer payoffs and borrowings; ● Expected Note redemptions; ● Expected new Note proceeds; ● Availability on our lines of credit; ● Unfunded commitments; and ● Loans we have agreed to make which have not closed yet. Opportunities Although we can give no assurance as to our success in our efforts, in the future, our management will focus its efforts on the following opportunities: ● receiving money from the Notes and other sources of capital, sufficient to operate our business and allow for growth and diversification in our loan portfolio; ● growing loan assets and the staffing and operations to handle it. We hire office staff as loan volume grows, and hire the origination staff, which is field based, as our liquidity allows for new loan originations. The goal for the field staff is to have a geographic coverage that eventually covers most of the continental U.S.; ● replacing our existing lines of credit from our affiliates with lines of credit from financial institutions. We would like the maximum amount (the credit limit) to be 20% of our asset size, and our outstanding amounts to average 10% of our asset size. Certain features of the purchase and sale agreements have added liquidity and flexibility, which have lessened the need for the lines of credit; ● producing a profit, and making distributions to our members to cover their tax burden from our operations, and, if possible, to give them a return on their investment; and ● retaining earnings to grow the equity of the Company. Understanding and Evaluating Our Operating Results Our results of operations are driven by three major factors - interest spread, loan losses, and selling, general and administrative (SG&A) expenses. Interest Spread Interest spread is generally made up of the following three components: ● Difference between the interest rate received (on our loan assets) and the interest rate paid (on our borrowings). ● Fee income. This fee is generally recognized over the life of the loan, based on the maximum allowed loan balance over the expected life of the loan. The amount of interest spread on these loans will depend on the life of the loans, as well as the fee percentage. As more competition comes into the residential construction lending market, we expect this portion of spread income to decrease as a percentage of assets. ● Amount of nonperforming assets. Since we are paying interest on all money we borrow, any asset created or funded with borrowed funds that does not have an interest return costs us money. There is an interest expense for us, with no interest income to offset it. Generally there are two types of nonperforming assets. The first is nonperforming loans and related foreclosed assets held, which do not generate interest income unless actually received in cash. The second nonperforming asset type is money borrowed which is not invested in loans. To mitigate the negative spread on unused borrowed funds (idle cash), we use our line of credit to handle daily liquidity. We would like to maintain a secured line of credit with a credit limit of 20% of our loan assets, and generally carry a balance of 10% of our loan assets on that line. This way, as money comes in from Notes or loan payoffs, it can be used to pay down the line, and as money goes out for Note redemptions and new loans created, money can be drawn on the line. This will help reduce any negative spread on idle cash. We calculate interest spread by taking the difference between interest income and expense, and, when we express it as a percentage, by dividing it by our weighted average outstanding loan balance. Loan Losses The second major factor in determining our profitability is loan losses. Losses on loans occur with nonperforming loans (i.e., when customers are unable to repay their interest and/or principal). Normally, the loss in this situation is the difference between the collateral value and the loan value, less any costs of disposal. Homes which were constructed in the mid 2000’s created significant losses because many homes were worth less when completed than the appraised value at the time the loan was created. Losses also occur in loans when homes are partly built at the point of default, or never built. Generally, a declining real estate market will be the primary driver for loan losses. We believe that while current values may fall in some real estate markets, in general, values are low and represent a lower risk than at many other times over the last eight years, and that over the last several years in general, values have been rising. SG&A Expenses SG&A expenses for us are almost all of the expenses that are not interest and loan losses. In 2015 we increased SG&A as compared to 2014 due to increases in the number of employees and board members, loan and foreclosed asset expenses, and advertising. Foreclosed asset expeneses generally include subdivsision HOA expenses, taxes, and legal expenses. We anticipate SG&A expenses increasing as our loan balance increases, and because we are paying our CEO effective January 1, 2016. Critical Accounting Estimates To assist in evaluating our consolidated financial statements, we describe below the critical accounting estimates that we use. We consider an accounting estimate to be critical if: (1) the accounting estimate requires us to make assumptions about matters that were highly uncertain at the time the accounting estimate was made, and (2) changes in the estimate that are reasonably likely to occur from period to period, or use of different estimates that we reasonably could have used, would have a material impact on our consolidated financial condition or results of operations. Loan Losses Nature of estimates required Loan losses, as applicable, are accounted for both on the consolidated balance sheets and the consolidated statements of operations. On the consolidated statements of operations, management estimates the amount of losses to capture during the current year. This current period amount incurred is referred to as the loan loss provision. The calculation of our allowance for loan losses, which appears on our consolidated balance sheets, requires us to compile relevant data for use in a systematic approach to assess and estimate the amount of probable losses inherent in our commercial lending operations and to reflect that estimated risk in our allowance calculations. We use the policy summarized as follows: We establish a collective reserve for all loans which are not more than 60 days past due at the end of a quarter. This collective reserve takes into account both historical information and a qualitative analysis of housing and other economic factors that may impact our future realized losses. For loans to one borrower with committed balances less than 10% of our total committed balances on all loans extended to all customers, we individually analyze for impairment all loans which are more than 60 days past due at the end of a quarter. For loans to one borrower with committed balances equal to or greater than 10% of our total committed balances on all loans extended to all customers, we individually analyze all loans for potential impairment. The analysis of loans, if required, includes a comparison of estimated collateral value to the principal amount of the loan. For impaired loans, if the value determined is less than the principal amount due (less any builder deposit), then the difference is included in the allowance for loan loss. As values change, estimated loan losses may be provided for more or less than the previous period, and some loans may not need a loss provision based on payment history. For homes which are partially complete, we appraise on an as-is and completed basis, and use the one that more closely aligns with our planned method of disposal for the property. For loans greater than 12 months in age that are individually evaluated for impairment, appraisals have been prepared within the last 13 months. For all loans individually evaluated for impairment, there is also a broker’s opinions of value (“BOV”) prepared, if the appraisal is more than six months old. The lower of any BOV prepared in the last six months, or the most recent appraisal, is used, unless we determine a BOV to be invalid based on the comparable sales used. If we determine a BOV to be invalid, we will use the appraised value. Appraised values are adjusted down for estimated costs associated with asset disposal. Broker’s opinion of selling price, currently valid sales contracts on the subject property, or representative recent actual closings by the builder on similar properties may be used in place of a broker’s opinion of value. Appraisers are state certified, and are selected by first attempting to utilize the appraiser who completed the original appraisal report. If that appraiser is unavailable or not affordable, we use another appraiser who appraises routinely in that geographic area. BOVs are created by real estate agents. We try to first select an agent we have worked with, and then, if that fails, we select another agent who works in that geographic area. Loan losses are also impacted when a loan asset is taken through foreclosure or similar means and changed from a loan to a foreclosed asset. The valuation for foreclosed assets does not include future value, as it does while the asset is a loan, and therefore the calculation can have a different result. Also as market values of foreclosed assets reduce, losses are added to loan loss. Gains on loan assets as they become foreclosed assets, and as foreclosed assets are liquidiated, are reflected in non-interest income, gain on foreclosed assets. Fair Value Nature of estimates required Currently, fair value of collateral has the potential to impact the calculation of the loan loss provision most heavily. Specifically relevant to the allowance for loan loss reserve is the fair value of the underlying collateral supporting the outstanding loan balances. Also the fair value of real estate will effect our foreclosed asset value (which is booked at 100% of fair value (after selling cost are deducted). Fair value measurements are an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Due to a rapidly changing economic market, an erratic housing market, the various methods that could be used to develop fair value estimates, and the various assumptions that could be used, determining the collateral’s fair value requires significant judgment. Sensitivity analysis * Increases in the fair value of the real estate collateral do not impact the loan loss provision, as the value generally is not “written up.” **If the loans were nonperforming, assuming a book amount of the loans outstanding of $14,060 and the fair value of the real estate collateral on all outstanding loans was reduced by 30%, an addition to the loan loss provision of $33 would be required. * Increases in the fair value of the foreclosed assets do not impact the carrying value, as the value generally is not “written up.” Those gains would be recognized at the sale of the asset. Amortization of Deferred Financing Costs We amortize our deferred financing costs based on the effective interest method. As such, we make estimates for the duration of the future investment proceeds we anticipate receiving from our Notes offering. If this estimate is determined to be incorrect in the future, the rate at which we are amortizing the deferred financing costs as interest expense would be adjusted. Currently we anticipate a consistent average duration of 21 months for the Notes. An increasing average duration over the remaining anticipated length of the Notes offering would decrease the amount of amortization reflected in interest expense for 2015, and a decreasing average duration of investments over the remaining anticipated length would increase the amount reflected in interest expense for 2015. Sensitivity analysis for average duration Other Loss Contingencies Other loss contingencies are recorded as liabilities when it is probable that a liability has been incurred and the amount of the loss is reasonably estimable. Disclosure is required when there is a reasonable possibility that the ultimate loss will exceed the recorded provision. Contingent liabilities are often resolved over long time periods. Estimating probable losses requires analysis of multiple forecasts that often depend on judgments about potential actions by third parties such as courts, arbitrators, juries, or regulators. Accounting and Auditing Standards Applicable to “Emerging Growth Companies” We are an “emerging growth company” under the recently enacted JOBS Act. For as long as we are an “emerging growth company,” we are not required to: (1) comply with any new or revised financial accounting standards that have different effective dates for public and private companies until those standards would otherwise apply to private companies, (2) provide an auditor’s attestation report on management’s assessment of the effectiveness of internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act, (3) comply with any new requirements adopted by the Public Company Accounting Oversight Board, or the PCAOB, requiring mandatory audit firm rotation or a supplement to the auditor’s report in which the auditor would be required to provide additional information about the audit and the financial statements of the issuer or (4) comply with any new audit rules adopted by the PCAOB after April 5, 2012, unless the SEC determines otherwise. We intend to take advantage of such extended transition period. Since we will not be required to comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies, our consolidated financial statements may not be comparable to the financial statements of companies that comply with public company effective dates. If we were to subsequently elect to instead comply with these public company effective dates, such election would be irrevocable pursuant to Section 107 of the JOBS Act. Other Significant Accounting Policies Other significant accounting policies, not involving the same level of measurement uncertainties as those discussed above, are nevertheless important to an understanding of the consolidated financial statements. Policies related to credit quality information, fair value measurements, offsetting assets and liabilities, related party transactions and revenue recognition require difficult judgments on complex matters that are often subject to multiple and recent changes in the authoritative guidance. Certain of these matters are among topics currently under reexamination or have recently been addressed by accounting standard setters and regulators. Specific conclusions have not been reached by these standard setters, and outcomes cannot be predicted with confidence. Also, see Notes 1 and 2 to our consolidated financial statements, as they discuss accounting policies that we have selected from acceptable alternatives. Consolidated Results of Operations Key financial and operating data for the years ended December 31, 2015 and 2014 are set forth below. For a more complete understanding of our industry, the drivers of our business, and our current period results, this discussion should be read in conjunction with our consolidated financial statements, including the related notes and the other information contained in this document. Accounting principles generally accepted in the United States of America (U.S. GAAP) require that we report financial and descriptive information about reportable segments and how these segments were determined. Our management determines the allocation and performance of resources based on operating income, net income and operating cash flows. Segments are identified and aggregated based on the products sold or services provided and the market(s) they serve. Based on these factors, management has determined that our ongoing operations are in one segment, commercial lending. Below is a summary of our income statement for the following periods for the years ended December 31, 2015 and 2014: Interest Spread The following table displays a comparison of our interest income, expense, fees and spread: ____________ *annualized amount as percentage of weighted average outstanding gross loan balance There are three main components that can impact our interest spread: ● Difference between the interest rate received (on our loan assets) and the interest rate paid (on our borrowings). The loans we have originated have interest rates which are based on our cost of funds, with a minimum cost of funds of 5%. The margin is fixed at 2%. Future loans are anticipated to be originated at approximately the same 2% margin. This component is also impacted by the lending of money with no interest cost (our equity). Our interest income was 12% and 9% for the years ended December 31, 2015 and 2014, respectively. Our interest cost (expressed as a percentage of our loan assets) was 9% and 6% for the years ended December 31, 2015 and 2014, respectively. These amounts are less than our actual borrowing rate, as some of the funds we lend are funded by equity that has no borrowing cost. The difference was 3% for both of those periods. Our interest expense increased in 2015 as we sought to increase our loan balances and found that we were able to so by raising the interest rates we paid to our lenders, including the Notes program. It also increased due to the extinguishment of the SF Loan which had a 5% interest rate. We expect the relationship between interest income and expense for the first half of 2016 to be generally consistent with 2015. We expect an increase in the spread for the second half of 2016, as discussed in the next paragraph. ● Fee income. Fee income is displayed in the table above. The two loans originated in December 2011 had a net origination fee of $924. This fee is being recognized over the life of the loans. In both 2015 and 2014, this fee was 4% of the average outstanding balance on those loans. All of our construction loans have a 5% fee on the amount we commit to lend, which is amortized over the expected life of each of those loans. In both 2015 and 2014, this fee was 12% of the average outstanding balance on those loans. In the future, we anticipate creating loans with fees ranging between 4 and 5% of the maximum loan amount, and we anticipate that our fee percentage in 2016 vs. 2015 will be slightly higher due to construction loans being a higher portion of our balances in 2015, and slightly lower due to the 2011 loans only having fee income through July 2016. After July 2016, the interest rate on those loans increases to offset the decrease in fee income, but that amount will be reflected in the difference between the interest rate received and the interest rate paid amounts described in the previous paragraph. ● Amount of nonperforming assets. We had no nonperforming loan assets at December 31, 2015 and 2014, however during 2015 we had loans which did not perform (pay interest). Those loans were foreclosed or acquired in lieu of foreclosure and taken into foreclosed assets during 2015. On December 31, 2015 and 2014, we carried cash balances of $1,341 and $558, respectively. We would like to have a secured line of credit with a credit limit of 20% of our loan assets, and generally carry a balance of 10% of our loan assets on that line. This way, as money comes in from Notes or loan payoffs, it can be used to pay down the line, and as money goes out for Note redemptions and new loans created, money can be drawn on the line. This would help reduce any negative spread on idle cash. Certain features of the purchase and sale agreement with the Loan Purchaser have added liquidity and flexibility, which have lessened the need for the lines of credit from affiliates. We have unfunded loan commitments outstanding as of December 31, 2015 and 2014 of $7,332 and $1,745, respectively. We do not anticipate having the secured line of credit mentioned above during 2016, and we expect to continue to carry cash balances as a result. Loan Loss Provision Prior to a foreclosure sale in July 2015, at which we took the properties into foreclosed assets, we had three nonperforming loans to one borrower. (Foreclosure started in February 2015). The loans were collateralized by lots that were intended for construction, but construction did not commence. We recorded no income from these loans in 2015 and reserved $42 in our loan loss provision for these loans in 2015. We recorded $17 and $22 in the years 2015 and 2014, respectively, in loss reserve related to our collective reserve (loans not individually impaired). We anticipate that the collective reserve will increase as our balances rise throughout 2016. SG&A Expenses The following table displays our SG&A expenses for the years ended December 31, 2015 and 2014: Salaries and related expenses increased in 2015 due to increasing our staff size. We anticipate adding more staff in 2016, and we will begin paying a salary to our CEO effective January 1, 2016. Board related expenses increased due to the addition of a board member. Advertising increased due to expenses related to both investor retention and new builder efforts. Loan and foreclosed asset expenses increased due to expenses related to having real estate which we foreclosed on. We anticipate additional travel and advertising expenses in 2016 due to having a field staff, the first of which was hired in December of 2015. Consolidated Financial Position Cash and Cash Equivalents We try to not borrow on our line of credit from affiliates. To accomplish this, we must carry some cash for liquidity. This amount generally grows as our company grows. At December 31, 2015 and 2014, we had $1,341 and $558, respectively, in cash. When we create new loans, they typically do not have significant outstanding loan balances for several months. We anticipate loan production to increase in 2016, therefore increasing the average amount of cash we may hold, unless we obtain a line of credit from a financial institution. Deferred Financing Costs, Net Gross deferred financing costs were $935 and $737 as of December 31, 2015 and 2014, respectively. The accumulated amortization of those costs was $336 and $107 as of the same dates. We expect that the gross deferred financing amount will continue to increase over time as more of the anticipated financing costs are deferred when paid, and expensed over the life of the debt associated with the financing using the effective interest method. We also expect that the amortization expense and the accumulated amortization will increase in 2016. The following is a roll forward of deferred financing costs for the years ended December 31, 2015 and 2014: The following is a roll forward of the accumulated amortization of deferred financing costs for the years ended December 31, 2015 and 2014: Loans Receivable In December 2011, we originated two new loans and assumed a lender’s position on a third loan, which, net of unearned loan fees, had total balances of $6,004 and $4,435 as of December 31, 2015 and 2014, respectively (these amounts do not include the construction loans mentioned below). These loans were all to borrowers that are affiliated with each other, and are cross-collateralized. Collectively, the development loans and home construction loans to the borrower are referred to herein as the “Pennsylvania Loans.” No individual impairment has been deemed necessary for these loans. The purpose of the loans was to develop two subdivisions in a suburb of Pittsburgh, Pennsylvania. The Hamlets subdivision is a five phase subdivision of 81 lots, of which 48 have been developed and sold, 11 are developed and not sold, 7 are under development, and 15 are undeveloped as of December 31, 2015. The Tuscany subdivision is a single phase 18 lot subdivision, with 8 lots remaining as of December 31, 2015. A portion of the collateral of the Pennsylvania Loans is preferred equity interests in us (see Risk Factor “Currently, we are reliant on a single developer and homebuilder, the Hoskins Group, for a significant portion of our revenues and a portion of our capital.”). In April, July, September and December 2013, in March and December 2014, and in March, June and December of 2015, we entered into amendments to the Pennsylvania Loans. As a result of these amendments, BMH was allowed to borrow for the construction of homes on lots 204, 205, and 206 of the Hamlets subdivision and lots 2 and 5 of the Tuscany subdivision, both located in a suburb of Pittsburgh, Pennsylvania, and to borrow for the purchase of lot 5 of the Hamlets subdivision. As of December 31, 2015, all of the construction loans for homes extended by amendment to the credit agreement have been repaid. The lot loan for lot 5 in the Hamlets subdivision is still outstanding. As a result of these amendments to the Credit Agreement, we converted $1,000 of the SF Loan from debt to preferred equity. The new preferred equity serves as collateral for the Pennsylvania Loans. There is no liquid market for the preferred equity instrument, so we can give no assurance as to our ability to generate any amount of proceeds from that collateral. We also reduced the balance of the SF Loan by $125, which was added to the Interest Escrow, and repaid the remaining $375 with cash. The interest rate on the Existing IMA Loan was raised to match the New IMA Loan. As of December 2015, the Hoskins Group invests in our preferred equity an amount equal to $10 per closing of a lot payoff in the Hamlets or Tuscany subdivisions. Also as a result of these amendments to the Credit Agreement, we funded an additional $500 of interest escrow, we issued a letters of credit to a sewer authority relating to BMH Loan which totaled $68 and $155 as of December 31, 2015 and 2014, respectively (the “Letter of Credit”), and we issued cash bonds for development with $257 and $0 outstanding on December 31, 2015 and 2014, respectively. We also allowed a fully funded mortgage in the amount of $1,146 to be placed in superior position to our mortgage, with the $1,146 proceeds being used to reduce the balance of BMH’s outstanding loan with us. The terms and conditions of the Pennsylvania Loans are set forth in further detail below. We have other borrowers, all of whom borrow money for the purpose of building new homes. Commercial Loans - Real Estate Development Loan Portfolio Summary The following is a summary of our loan portfolio to builders for land development as of December 31, 2015. The Pennsylvania loans below are included as part of the Pennsylvania Loans discussed above. (1) The value is determined by the appraised value adjusted for remaining costs to be paid and third party mortgage balances. Part of this collateral is $1,010 of preferred equity in our Company. In the event of a foreclosure on the property securing certain of our loans, a portion of our collateral is preferred equity in our Company, which might be difficult to sell, which could impact our ability to eliminate the loan balance. (2) The loan to value ratio is calculated by taking the outstanding amount and dividing by the appraised value. (3) The commitment amount includes letters of credit and cash bonds. The following is a summary of our loan portfolio to builders for land development as of December 31, 2014. The Pennsylvania loans below are included as part of the Pennsylvania Loans discussed above. (1) The value is determined by the appraised value adjusted for remaining costs to be paid and third party mortgage balances. Part of this collateral is $1,000 of preferred equity in our Company. In the event of a foreclosure on the property securing certain of our loans, a portion of our collateral is preferred equity in our Company, which might be difficult to sell, which could impact our ability to eliminate the loan balance. (2) The loan to value ratio is calculated by taking the outstanding amount and dividing by the appraised value. (3) The commitment amount includes a portion of the letter of credit which, when added to the current outstanding balance, is greater than the $4,750 maximum commitment amount per the Credit Agreement. Commercial Loans - Construction Loan Portfolio Summary The following is a summary of our loan portfolio to builders for home construction loans as of December 31, 2015. (1) The value is determined by the appraised value. (2) The loan to value ratio is calculated by taking the commitment amount and dividing by the appraised value. (3) Represents the weighted average loan to value ratio of the loans. The following is a summary of our loan portfolio to builders for home construction loans as of December 31, 2014. Some of the Pennsylvania loans are included as part of the Pennsylvania Loans discussed above. (1) The value is determined by the appraised value. (2) The loan to value ratio is calculated by taking the commitment amount and dividing by the appraised value. (3) Represents the weighted average loan to value ratio of the loans. Financing receivables are comprised of the following as of December 31, 2015 and 2014: Roll forward of commercial loans for the years ended December 31, 2015 and 2014: Finance Receivables - Method of impairment calculation: Below is an aging schedule of loans receivable as of December 31, 2015, on a recency basis: Below is an aging schedule of loans receivable as of December 31, 2015, on a contractual basis: Below is an aging schedule of loans receivable as of December 31, 2014, on a recency basis: Below is an aging schedule of loans receivable as of December 31, 2014, on a contractual basis: Customer Interest Escrow The Pennsylvania Loans called for a funded Interest Escrow account which was funded with proceeds from the Pennsylvania Loans. The initial funding on that Interest Escrow was $450. The balance as of December 31, 2015 and 2014 was $267 and $249, respectively. To the extent the balance is available in the Interest Escrow, interest due on certain loans is deducted from the Interest Escrow on the date due. The Interest Escrow is increased by 10% of lot payoffs on the same loans, and by interest and/or distributions on the SF Loan and Hoskins Group preferred equity. All of these transactions are noncash to the extent that the total escrow amount does not need additional funding. The Interest Escrow is also used to contribute to the reduction of the $400 subordinated mortgage upon certain lot sales of the collateral of that loan. Ten and nine other loans active as of December 31, 2015 and 2014 also have interest escrows. The cumulative balance of all interest escrows other than the Pennsylvania Loans was $231 and $69 as of December 31, 2015 and 2014, respectively. Roll forward of interest escrow for the years ended December 31, 2015 and 2014: Notes Payable Unsecured At the same time that we extended the Pennsylvania Loans in December 2011, we assumed a note payable to our borrowing customer for $1,500, which was the balance until December 2014. This loan was unsecured and had the same priority as the Notes. It was also collateral for the loans we extended to this customer. In December 2014, we converted $1,000 of this note payable to preferred equity and moved $125 of the note payable to the interest escrow. In January 2015, we repaid the remaining $375 to the borrower. In addition, we owed $8,496 and $5,427 in Notes payable under our Notes offering December 31, 2015 and 2014, respectively. In August 2015, we borrowed $500 through a note with Seven Kings Holdings, Inc. (“7Kings”), which is due in February of 2016. We also have a note to a third party for $100 which is due in June 2017. We expect our Notes payable unsecured balance to increase as we raise funds in our Notes offering. Notes Payable Related Party We have two lines of credit from affiliates, which had a combined, outstanding balance of $0 as of both December 31, 2015 and 2014. We had $1,500 available to us on the affiliate lines as of both December 31, 2015 and 2014, although there is no obligation of the affiliates to lend money up to the note amount. We intend to have a line of credit or multiple lines of credit in the future, and intend to eventually replace these lines from affiliates with lines from unrelated financial institutions. However, we can make no assurance that we will obtain a line of credit with an unrelated financial institution on favorable terms or at all. Certain features of the purchase and sale agreement with the Loan Purchaser have added liquidity and flexibility, which have lessened the need for the lines of credit from affiliates. 7Kings owns 4% of our common equity. 7Kings also: ● Is an investor in our notes program for $500 ● Is a buyer in a purchase and sale agreement where we are the seller ● Has a $500 unsecured note due from us Purchase and Sale Agreements In December 2014, the Company entered into a purchase and sale agreement with 1st Financial Bank USA whereby the purchaser may buy loans offered to it by us, and we may be obligated to offer certain loans to purchaser. Purchaser is buying senior positions in the loans they purchase, generally 50% of each loan. Purchaser generally receives the interest rate we charge the borrower (with a floor of 10%) on their portion of the loan balance, and we receive the rest of the interest and all of the loan fee. We service the loans. There is an unlimited right for us to call any loan sold, however in any case of such call, a minimum of 4% of the commitment amount of purchaser must have been received by purchaser in interest, or we must make up the difference. Also, the purchaser has a put option, which is limited to 10% of the funding made by purchaser under all loans purchased in the trailing 12 months. In April 2015, the Company entered into a purchase and sale agreement with Seven Kings Holdings, Inc. (“7Kings”) as purchaser and the Company as seller, whereby 7Kings buys loans offered to it by us, providing that their portions of the loans always total less than $1,500. 7Kings may adjust the $1,500 with notice, but such change will not cause a buyback by us. 7Kings is buying pari-passu positions in the loans they purchase, generally 50% of each loan. 7Kings generally receives a 9% interest rate on its portion of the loan balance, and we receive the rest of the interest and all of the loan fees. We service the loans. There is an unlimited right for us to call any loan sold. This transaction is accounted for as a secured line of credit. In the fourth quarter of 2015, we entered into a modification of our agreement with 7Kings whereby purchaser agreed to buy priority interests of $1,000 each in two large loans we originated. The interest rate for those two loans is 9.5% to 7Kings. On December 31, 2015, 7Kings and its affiliates purchased 4% of our common equity from the Wallach family. The purchase and sale agreements are recorded as secured borrowings in our financial statements. The purchase and sale agreements are detailed below: Contractual Obligations We currently have four notes outstanding outside of the public offering. Two notes to affiliates are demand notes established on December 30, 2011, with balances of $0 as of both December 31, 2015 and 2014. We also have an unsecured note from 7Kings for $500 due in 2016 and one from an unrelated third party for $100 due in 2017. We have secured debt as well, which is due when the loan collateral is repaid by the borrower. Their maturities are estimated in the table below. As of December 31, 2015, we have contractual obligations with maturity dates of: We are obligated to lend money to customers based on agreements we have with them. We do not always have the maximum amount obligated outstanding at any given time. The amount we have not loaned, but are obligated to lend, under certain conditions is a potential liquidity use. This amount was $7,332 as of December 31, 2015 and $1,745 as of December 31, 2014. See Note 9 of our consolidated 2015 financial statements for more information regarding contractual obligations. Liquidity and Capital Resources Our operations are subject to certain risks and uncertainties, particularly related to the concentration of our current operations, a significant portion of which are to a single customer and geographic region, as well as the evolution of the current economic environment and its impact on the United States real estate and housing markets. Both the concentration of risk and the economic environment could directly or indirectly cause or magnify losses related to certain transactions and access to and cost of adequate financing. The Company’s anticipated primary sources of liquidity going forward are: ● The purchase and sale agreements, which are allowing for a significant increase in loan balances; ● The continued issuance of Notes to the general public through our second public Notes offering, which was declared effective by the SEC on September 29, 2015, and has been registered and declared effective in 37 states as of December 31, 2015. We began to advertise for our Notes offerings in March 2013 and received an aggregate of approximately $8,496 and $5,427 in Notes proceeds as December 31, 2015 and 2014, respectively (net of redemptions). We anticipate continuing our capital raising efforts in 2016, focusing on the efforts that have proven fruitful; ● Interest income and/or principal repayments related to the loans. The Company’s ability to fund its operations remains dependent upon the ability of our largest borrower, whose loan commitments represented 37% and 60% of our total outstanding loan commitments as of December 31, 2015 and 2014, respectively, to continue paying interest and/or principal. The risk of our largest customer not paying interest is mitigated in the short term by having an interest escrow, which had a balance of $267 and $249 as of December 31, 2015 and 2014, respectively. While a default by this large customer could impact our cash flow and/or profitability in the long term, we believe that, in the short term, a default might impact profitability, but not liquidity, as we are generally not receiving interest payments from the customer while he is performing (interest is being credited from his interest escrow); As of December 31, 2015, our next two largest customers make up 22% and 6% respectively of our loan commitments, with loans in Sarasota, Florida and Columbia, South Carolina, respectively. As of December 31, 2014, our next two largest customers made up 9% and 8% respectively of our loan commitments, with loans in New Orleans, Louisiana and Charleston, South Carolina. ● Funds borrowed from affiliated creditors. We generated net income of $498 and $293 for the years ended December 31, 2015 and 2014, respectively and cash flow from operations of $1,322 and $297 for the same periods. At December 31, 2015 and 2014, we had cash on hand of $1,341 and $558, respectively, and our outstanding debt totaled $12,779 and $5,802, respectively, of which $3,683 and $0 was secured, respectively. The secured amount is from our purchase and sale agreements, which add liquidity and allow us to expand our business. As of December 31, 2015 and 2014, the amount that we have not loaned, but are obligated to potentially lend to our customers based on our agreements with them, was $7,332 and $1,745, respectively. Our availability on our line of credit from our members was $1,500 at both December 31, 2015 and 2014. Our members are not obligated to fund requests under our line of credit. Our current plan is to expand the commercial lending program by using current liquidity and available funding (including funding from our Notes program). We have anticipated the costs of this expansion and the continuing costs of maintaining our public company status, and we anticipate generating, through normal operations, the cash flows and liquidity necessary to meet our operating, investing, and financing requirements. As noted above, the three most significant factors driving our current plans are the purchase and sale agreements, continued payments of principal and/or interest by our largest borrower, and the public offering of Notes. If actual results differ materially from our current plan or if expected financing is not available, we believe we have the ability and intent to obtain funding and generate net worth through additional debt or equity infusions of cash, if needed. There can be no assurance, however, that we will be able to implement our strategies or obtain additional financing under favorable terms, if at all. Our business of borrowing money and re-lending it to generate interest spread is our primary use of capital resources. There are several risks in any financing company of this nature, and we will discuss significant risks here and how they relate to our Company and what, if any, mitigation techniques we have or may employ. First, any financial institution needs to match the maturities of its borrowings with the maturities of its assets. The bulk of most financial institutions’ borrowings are in the form of public investments or deposits. These generally have maturities that are either set periods of time, or upon the demand of the investor/depositor. The risk is that either obligations come due before funds are available to be paid out (a shortage of liquidity) or that funds are repaid before the obligation comes due (idle cash, as described herein). To mitigate these risks, we are not offering demand deposits (for instance, a checking account). Instead, we are offering Notes with varying maturities between one and four years, which we believe will be longer than the average life of the loans we will extend. However, we have the option to repay the Notes early, if we wish, without penalty. These items protect us against this risk of matching of debt and asset maturity. Second, financial institutions must have daily liquidity on their debt side, to offset variations in loan balances on a daily basis. Borrowers can repay their Notes at any time, and they will request draws as they are ready for them. Further, construction loans are not funded 100% initially, so there are contractual obligations on the lender’s part to fund loans in the future. Most financial institutions mitigate this risk by having a secured line of credit from the Federal Reserve Bank. We have the same risk from customer repayments and draws as banks, and we intend to mitigate this risk by obtaining a secured line of credit with a bank. Our current debt financing consists of the two demand loans from our members, our purchase and sale agreement, two unsecured notes, and our unsecured Notes from the public offering. The loan balance from our members on both December 31, 2015 and 2014 was $0. We had balances on our purchase and sale agreements (which are treated like secured lines of credit in our consolidated financial statements) of $3,683 and $0 on December 31, 2015 and 2014, respectively. The loan balance on all unsecured notes not part of the Notes program was $600 and $375 on December 31, 2015 and 2014, respectively. The balance of debt from the Notes offering was $8,496 and $5,427 as of December 31, 2015 and 2014, respectively. If we are able to refinance the demand loans with a bank line of credit, we intend to maintain the outstanding balance on the line at approximately 10% of our committed loan amount. Failure to refinance the demand loans in the future with a larger bank line of credit may result in a lack of liquidity, or low loan production. Future lines of credit from banks will have expiration dates or be demand loans, which will have risks associated with those maturities. Third, financial institutions have the risk of swings in market rates on borrowing and lending, which can make borrowing money to fund loans to their customers or fund their operations costly. The rates at which institutions can borrow are not necessarily tied to the rates at which they can lend. In our case, we are lending to customers using a rate which varies monthly with our cost of funds. So while we somewhat mitigate this risk, we are still open to the problem of, at the time of originating loans, wanting to originate new loans at a rate that would be profitable, but that rate not being competitive in the market. Lack of lending may cause us to repay Notes early and lose interest spread dollars, hurting our profitability and ability to repay. We currently generate liquidity (or may in the future) from: ● borrowings in the form of the demand loans from our members; ● proceeds from our purchase and sales agreement; ● proceeds from the Notes; ● repayments of loan receivables; ● interest and fee income; ● borrowings from lines of credit with banks (not in place yet); ● sale of property obtained through foreclosure (none to date); and ● other sources as we determine in the future. We currently (or may in the future) use liquidity to: ● make payments on other borrowings, including loans from affiliates; ● pay Notes on their scheduled due date and Notes that we are required to redeem early; ● make interest payments on the Notes; and ● to the extent we have remaining net proceeds and adequate cash on hand, fund any one or more of the following activities: ○ to extend commercial construction loans to homebuilders to build single or multi-family homes or develop lots; ○ to make distributions to equity owners, including the preferred equity; ○ for working capital and other corporate purposes; ○ to purchase defaulted secured debt from financial institutions at a discount; ○ to purchase defaulted unsecured debt from suppliers to homebuilders at a discount and then secure it with real estate or other collateral; ○ to purchase real estate, in which we will operate our business; and ○ to redeem Notes which we have decided to redeem prior to maturity. The Company’s anticipated primary sources of liquidity going forward are the purchase and sale agreement, continued extension of Notes to the general public, interest income and principal repayments related to loans it extends, as well as funds borrowed from affiliated creditors. Therefore, the Company’s ability to fund its operations is dependent upon these sources of liquidity. Inflation, Interest Rates, and Housing Starts Since we are in the housing industry, we are affected by factors that impact that industry. Housing starts impact our customers’ ability to sell their homes. Faster sales mean higher effective interest rates for us, as the recognition of fees we charge is spread over a shorter period. Slower sales mean lower effective interest rates for us. Slower sales are likely to increase the default rate we experience. Housing inflation has a positive impact on our operations. When we lend initially, we are lending a percentage of a home’s expected value, based on historical sales. If those estimates prove to be low (in an inflationary market), the percentage we loaned of the value actually decreases, reducing potential losses on defaulted loans. The opposite is true in a deflationary housing price market. It is our opinion that values are average in many of the housing markets in the U.S. today, and our lending against these values is safer than loans made by financial institutions in 2006 to 2008. Interest rates have several impacts on our business. First, rates affect housing (starts, home size, etc.). High long term interest rates may decrease housing starts, having the effects listed above. Higher interest rates will also affect our investors. We believe that there will be a spread between the rate our Notes yield to our investors and the rates the same investors could get on deposits at FDIC insured institutions. We also believe that the spread may need to widen if these rates rise. For instance, if we pay 7% above average CD rates when CDs are paying 0.5%, when CDs are paying 3%, we may have to have a larger than 7% difference. This may cause our lending rates, which are based on our cost of funds, to be uncompetitive. High interest rates may also increase builder defaults, as interest payments may become a higher portion of operating costs for the builder. Below is a chart showing average CD rates as reported by the Federal Reserve Board. The Board stopped issuing this information in 2014, as rates are so low. We will monitor and update once the Federal Reserve Board begins to update again. Short term interest rates were raised slightly at the end of 2015. Certificates of Deposit Index Source: Derivation of Rates Reported by Federal Reserve Board-Copyright 2014 MoneyCafe.com (01/2002-06/2013) and Mortgage-X (07/2013 -12/2013). Housing prices are also generally correlated with housing starts, so that increases in housing starts usually coincide with increases in housing values, and the reverse is generally true. Below is a graph showing single family housing starts from 2000 through today. Source: U.S. Census Bureau To date, changes in housing starts, CD rates, and inflation have not had a material impact on our business. Off-Balance Sheet Arrangements As of December 31, 2015, we had no off-balance sheet transactions, nor do we currently have any such arrangements or obligations Recent Accounting Pronouncements See Note 2 to our consolidated financial statements for a description of new or recent accounting pronouncements. Subsequent Events See Note 12 to our consolidated financial statements for subsequent events. ITEM 7A.

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Item 6. Selected Financial Data Not required for smaller reporting companies. - 14 - Item 7.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Business Operations Meganet is focused on the development of data security solutions for enterprise, large organizations and corporations around the globe, including the U.S. Department of Defense, Military Intelligence and the Federal Government. The Company has developed and does develop products that it believes are attractive and important to these markets. Working with government in a business capacity can be a long and arduous process. Governments and their agencies have constant budget restraints and lengthy product procurement processes. In many if not in most cases, a bidding process is required before an order for goods can be placed with a private supplier. Before products can be sold to the U.S. Government or to any of its agencies, the product and/or its supplier must be certified by the U.S. Government, which certification is not easy to obtain. From the time a product is developed until the time it is actually shipped to an agency in return for payment can be months if not years. The financial statements that form part of this annual report have been prepared on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. Our independent accountants that audited the financial statements observed that the Company requires capital for its contemplated operational and marketing activities and that the Company’s ability to raise additional capital through the future issuances of common stock is unknown and that the obtainment of additional financing, the successful development of the Company’s contemplated plan of operations, and its transition to the attainment of profitable operations are necessary for the Company to continue operations. The independent accountants concluded that the ability to successfully resolve these factors raise substantial doubt about the Company’s ability to continue as a going concern. Our management has been with Meganet from its inception and has in the past shepherded all software products from the development stage through the government procurement process to final delivery and payment. Management believes that despite the Company’s current illiquid position, the Company is in a strong position with respect to the upcoming 18 to 24 months of operations estimating Meganet has more than $200,000,000 of potential product sales in the so-called product pipeline. Being in the pipeline does not mean that product has necessarily been bought, sold or ordered. It does mean that products are somewhere in the bidding and/or procurement process and in management’s opinion have a reasonable chance of becoming orders, having a portion of those orders delivered and thereby producing collected revenues for the Company in material amounts within the next 18 to 24 months. Management reasonably expects 50% of the potential product sales in its pipeline to produce revenue. At the present time Meganet has confirmed sales to two third world countries, one in the amount of $130,000,000 and one in the amount of $85,000,000. However, Meganet has not received the up-front cash deposit for either order that it requires before Meganet will begin filling the order. It is the potential of these two orders that account for much of the $200,000,000 pipeline estimate set forth earlier in this paragraph. These two orders have been delayed due to budgetary issues within the respective countries. - 15 - The cash deposit necessary to begin the implementation of each sale is $50,000,000. With regard to the $130,000,000 sale, the implementation will take 18 months. The product for this sale will not be delivered and accepted until approximately 18 months after Meganet receives the cash deposit to begin work. Accordingly, revenue for this sale will not be booked for 18 months after receipt of the initial deposit. With regard to the $85,000,000 sale, implementation will take approximately 14 months. In this case, product will be produced and delivered from time to time during the 14 month period. The initial product delivery valued at more than $50,000,000 will take place approximately six months after the receipt of the $50,000,000 deposit. Accordingly, the initial deposit of $50,000,000 will be booked as revenue upon the acceptance of that initial product shipment. It should be noted that when the initial deposits are made is under the sole control of the countries to whom the sales have been made. The confirmed sales to the two third world countries are for defense/security type products and were originally slated to be procured by the countries out of their respective defense budgets for the 2015 fiscal year. However, in each case, the 2015 defense funds were spent by the countries on other priorities and the purchase of Meganet’s products have now been delayed until 2016. Meganet has been told by each country that monies allocated in their 2016 defense budgets will be allocated to the purchase and the installation of Meganet’s products. It should be noted that Company management will make every effort to finalize these two sales through and including receipt of all payment and believes based upon information it has at this time that it will be successful. However, until payment is actually received, there can be no guarantee that management will be successful in these efforts. Liquidity At March 31, 2015, the Company had cash in the amount of $94 compared to $929,077 in accounts payable and accrued liabilities. On a monthly basis the Company has fixed expenditures including without limitation rent and salary in the approximate amount of $20,000. This $20,000 includes the $10,000 monthly salary of our CEO which he does not take but rather accrues if money is not available for payment of the salary. Taking this into consideration, the Company needs $15,000 per month which equals $180,000 for 12 months to sustain operations and estimates it will need $180,000 in additional capital to sustain business operations over the next twelve months. Our CEO will lend the full $180,000 to Meganet, if cash is not otherwise available within the Company. Two thirds or 67% of this amount will pay rent, approximately 13% will pay property taxes, approximately 5% will pay utilities, 10% will pay salary and the remaining 5% will pay for maintenance and miscellaneous office expenses such as mail and shipping expense and office supplies. During the fiscal year ended March 31, 2015, our CEO advanced to the Company the net amount of $188,824 to meet the financial needs of the Company. - 16 - It is common for companies to resolve illiquid positions by attempting to raise additional working capital through the sale of equity capital or short term borrowing from third parties. However, our management does not believe this will be necessary. Rather management believes there will be sales sufficient to cover the next 18 to 24 months of cash operating expenses; however, there can be no surety that anticipated sales will materialize. Also, in the event that sales anticipated during the next 18 to 24 months are funded in the later end of the 18 to 24 month period, it will be necessary for the Company to procure additional operating capital during the early months of the next 18 to 24 month period. In order to provide for this potential situation, our CEO has agreed to contribute additional amounts to capital as needed to cover operating expenses. Background to Understanding the Financial Results for the Past Two Years To understand Meganet’s financial results for the past two years, it is necessary to understand its sales cycle which is different from traditional companies that may have sales on a daily, weekly and/or monthly basis. Meganet’s sales cycle is highly sporadic as a result of its product lines and its customer mix. Product Lines Meganet is a technology company supplying world markets with products primarily instrumental in military defense, personal protection, data protection, home land security and other intelligence and counter-intelligence uses. Examples of products for these uses are bomb jammers and cell phone interceptors. This product base lends itself to sporadic sales cycles for the following reasons. In times of war which can come upon a country quickly, a country will have immediate need of products for military defense uses such as bomb jammers. In times of peace, bomb jammers may not be needed for many years. To the contrary, as a country develops and implements a long term homeland security strategy, it may put out bids for certain types of intelligence and counter-intelligence products that it may leave out to bid for one to two years. To participate in such a bidding process, Meganet must maintain protectable state of the art technologies over a lengthy bidding process that it can deliver in quick fashion in the event it is awarded the bid for a particular product. Customer Mix Meganet’s focus is on government and military markets which has advantages and disadvantages. Advantages include the fact that governments have deep pockets and when they really need a product they can procure it and pay for it. Also, when a company such as Meganet has a technology that a government really needs, the product can sustain a large margin in the sales price. In addition, technology is often scalable. Once developed, products based upon a technology can bring close to a 100% return. - 17 - Disadvantages in selling to governments and militaries include the fact that there is fierce competition for these lucrative markets and large suppliers are notorious for using underhanded methods. Also, governments are subject to budgetary issues and budgetary crises and ever changing priorities for fixed budgeted funds. Governments have bidding requirements. This can be good and bad. Bidding does allow for companies such as Meganet to bid against the large suppliers. However, it makes for lengthy and unwieldy sales cycles that make it difficult to predict and sustain cash flow. Examples Illustrative of Meganet’s Sales Cycle A good way to understand Meganet’s sales cycle is to see examples of past sales. Meganet obtained its product base and its business plan from a company called Meganet Corporation, a California corporation (“Meganet California”). In 2002, Meganet California made a sale to the U.S. Department of Labor. After soliciting the U.S. Dept of Labor for over a year, Meganet California received a software order for $4,200,000. Development costs of the software had been expensed as they were incurred and since it was software it had no production cost. Therefore the sale was virtually 100% profit to the company at the time it was realized. However, in the 12 months leading to this sale, total sales were only $100,000. Another example is Meganet California’s sale to the U.S. Department of Transportation (the “DOT”) in 2005. After pursuing a sale for only three months which would typically be just the beginning of a solicitation cycle, an internal security breach at the DOT heightened security concerns and it issued Meganet California a $10,000,000 contract immediately. In the 12 months prior to the sale, Meganet California had sales of under $1,000,000 dollars total. A third example is a sale to the U.S. Department of Veteran Affairs (the “DVA”) in 2007. Meganet California had been soliciting the DVA’s business for three years trying to sell a biometric USB storage device without success. One day without prior notice, Meganet California was selected as the sole source provider of biometric USB storage devices nationwide to over 5,000 facilities. Like before, sales for the prior 12 months had been under $1,000,000. Prior Two Years For the past two years, Meganet has been working hard toward securing some large sales which it believes will materialize in the near future. However, the financial statements included in this annual report show only sales totaling $12,329 for the fiscal year ending March 13, 2015 and $19,481 for the year ending March 31, 2014. However, this pattern of sporadic sales is typical for this Company. Our sporadic sales cycle is not the only reason for the lack of sales in the prior two years. The global economic crisis has made many of our customers put purchases on hold. The U.S. government in particular has had many departments put projects on hold, cancel some existing projects and in many cases simply run out of budget for new products. Also in the private sector, the economic downturn has made the purchase of products like ours not a possibility at this time. - 18 - Meganet is a company that goes from one large sale to the next with low or quite periods in between. Results of Operations for Fiscal Year Ended March 31, 2015 During the fiscal year ended March 31, 2015, Meganet realized gross profit of $6,829. This was offset by operating expenses of $357,374 resulting in a net loss after interest expense of $489,341. However, $46,428 of the operating expense was non-cash depreciation expense. Nevertheless there was an operating cash shortfall during the year. The shortfall was covered by a net increase in officer loans to the Company of $126,167. The Company’s revenue consists primarily of revenue from the sale of jamming and interceptor hardware and data security software. The Company recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed or determinable, and collection is probable. Product is considered delivered to the customer once it has been shipped and title and risk of loss have been transferred. For most of the Company’s product sales, these criteria are met at the time the product is shipped. The Company recognizes revenue from the sale of hardware products (e.g., jammers and cell phone interceptors) and software included with hardware that is essential to the functionality of the hardware, in accordance with general revenue recognition accounting guidance. The software inherent to the functionality of the hardware is inseparable from the hardware component and does not have a standalone fair market value. The Company has no continuing obligations, such as providing software updates, subsequent to the delivery of its products. This is true of software products as well as of hardware products for which software is a component. Accordingly, revenue recognition takes place pursuant to the guidelines in the preceding paragraph without any adjustments that would otherwise be required because of an ongoing obligation to maintain software. In addition to the software essential to the hardware that is sold, the Company sells off the shelf software to customers that is not related to the hardware that is sold. The Company recognizes revenue in accordance with industry specific software accounting guidance for the following types of sales transactions: (i) standalone sales of software and (ii) sales of software upgrades. Generally, the Company requires customers to deposit 50% of the gross sales price upon execution of a formal intent to sell with the remaining 50% due upon delivery of the product. The Company records deferred revenue when it receives payments in advance of the delivery of products. - 19 - Comparison of the Fiscal Years Ended March 31, 2015 and 2014 Operating results for the fiscal years ended March 31, 2015 and 2014 yielded gross profit of $6,829 and $19,244 respectively, operating expenses of $357,374 and $881,712 respectively and net loss of $489,341 and $909,254 respectively. The 59% decrease in operating expenses and the corresponding 46% decrease in net loss is due primarily to a reduction in depreciation expense of $532,439 during the fiscal year ended March 31, 2015 when compared to the prior year. Contractual Obligations The Company has no long-term debt obligations, capital lease obligations, purchase obligations or other long-term liabilities. Off-balance Sheet Arrangements The Company does not have any off-balance sheet arrangements. No Undisclosed Material Trends or Events There are no trends, events or developments that occurred during the fiscal year ended March 31, 2015, or from March 31, 2015 through the date of this annual report that would indicate or would be a material departure from the financial information set forth in this annual report. Furthermore, there are no other undisclosed events or events likely to occur, of which management is aware, that would materially affect the business and/or financial information set forth in this annual report. All forward-looking statements are inherently uncertain as they are based on current expectations and assumptions concerning future events or future performance of the Company. Readers are cautioned not to place undue reliance on these forward-looking statements, which are only predictions and speak only as of the date hereof. Forward-looking statements usually contain the words "estimate," "anticipate," "believe," "expect," or similar expressions, and are subject to numerous known and unknown risks and uncertainties. In evaluating such statements, prospective investors should carefully review various risks and uncertainties identified in this report, including the matters set forth in the Company's other SEC filings. These risks and uncertainties could cause the Company's actual results to differ materially from those indicated in the forward- looking statements. The Company undertakes no obligation to update or publicly announce revisions to any forward-looking statements to reflect future events or developments. Although forward-looking statements in this annual report reflect the good faith judgment of our management, such statements can only be based on facts and factors currently known by us. Consequently, forward-looking statements are inherently subject to risks and uncertainties and actual results and outcomes may differ materially from the results and outcomes discussed in or anticipated by the forward-looking statements. Readers are urged not to place undue reliance on these forward-looking statements, which speak only as of the date of this annual report. We will file reports with the Securities and Exchange Commission ("SEC"). We shall make available, free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports as soon as reasonably practicable after we electronically file such materials with or furnish them to the SEC. You can read and copy any materials we file with the SEC at the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, D.C. 20549. You can obtain additional information about the operation of the Public Reference Room by calling the SEC at 1-800- SEC-0330. In addition, the SEC maintains an Internet site (www.sec.gov) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, including us. We undertake no obligation to revise or update any forward-looking statements in order to reflect any event or circumstance that may arise after the date of this annual filing. Readers are urged to carefully review and consider the various disclosures made throughout the entirety of this annual report, which attempt to advise interested parties of the risks and factors that may affect our business, financial condition, results of operations, and prospects. Item 7A.

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Item 6. Selected Financial Data The Company, through its wholly-owned subsidiary, Premier GP, holds an approximately 26% controlling general partner interest in, and, as a result, consolidates the financial statements of, Premier LP. The limited partners' approximately 74% ownership of Premier LP is reflected as redeemable limited partners' capital in the Company's consolidated balance sheets, and their proportionate share of income in Premier LP is reflected within net income attributable to noncontrolling interest in Premier LP in the Company's consolidated statements of income and within comprehensive income attributable to noncontrolling interest in the consolidated statements of comprehensive income. After the completion of the Reorganization following the consummation of our IPO, PHSI became our consolidated subsidiary and is considered our predecessor for accounting purposes. Accordingly, PHSI's consolidated financial statements are our historical financial statements, for periods prior to October 1, 2013. The historical consolidated financial statements of PHSI are reflected herein based on PHSI's historical ownership interests of Premier LP and its consolidated subsidiaries. See Note 2 - Initial Public Offering and Reorganization to the audited consolidated financial statements of this Annual Report for further information related to the IPO and the Reorganization. We derived the selected historical consolidated financial data presented below for the years ended June 30, 2015, 2014, 2013, 2012 and 2011 from the audited consolidated financial statements and related notes of Premier, Inc, and PHSI, as applicable, included elsewhere in this Annual Report. You should refer to Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and the notes to the accompanying consolidated financial statements for additional information regarding the financial data presented below, including matters that might cause this data not to be indicative of our future financial position or results of operations. We have reclassified certain prior period amounts to be consistent with the current period presentation. The following tables set forth selected historical consolidated financial and operating data for the five-year period ended June 30, 2015 and should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations, and our audited consolidated financial statements contained elsewhere herein. (1) Amounts include the results of operations of TheraDoc, Inc. ("TheraDoc") and Aperek, Inc. ("Aperek"), both in our performance services segment, from September 1, 2014 and August 29, 2014, respectively, the dates of acquisition of all the outstanding shares of common stock of TheraDoc for $108.6 million and Aperek for $47.4 million. See Note 4 - Business Acquisitions to the audited consolidated financial statements of this Annual Report for further information related to acquisitions completed during the year ended June 30, 2015. (2) Amounts include the results of operations of MEMdata, LLC ("MEMdata"), Meddius, L.L.C. ("Meddius") and SYMMEDRx, LLC ("SYMMEDRx"), all in our performance services segment, from April 7, 2014, October 31, 2013 and July 19, 2013, respectively, the dates of acquisition of all the outstanding shares of common stock of MEMdata for $6.1 million, Meddius for $7.7 million and SYMMEDRx for $28.7 million. See Note 4 - Business Acquisitions to the audited consolidated financial statements of this Annual Report for further information related to acquisitions completed during the year ended June 30, 2014. (3) Amounts include the results of operations of S2S Global in our supply chain services segment from December 6, 2011 the date of acquisition of 60% of the outstanding shares of common stock of S2S Global for $500,000. (4) Amounts include the results of operations of Commcare in our supply chain services segment from November 1, 2010, the date of acquisition of all the outstanding shares of common stock of Commcare for $35.9 million. (5) Following the completion of the Reorganization and IPO, we are contractually required under the GPO participation agreements to pay each member owner revenue share from Premier LP equal to 30% of all gross administrative fees collected by Premier LP based upon purchasing by such member owner's member facilities through our GPO supplier contracts. Prior to the Reorganization and IPO, we did not generally have a contractual requirement to pay revenue share to member owners participating in our GPO programs, but paid semi-annual distributions of partnership income. In addition, certain non-owner members have historically operated under, and, following the Reorganization and IPO, continue to operate under contractual relationships that provide for a specific revenue share that differs from the 30% revenue share that we provide to our member owners under the GPO participation agreements following the Reorganization and IPO. As a result, our revenue share expense as a percentage of gross administrative fees increased for the fiscal years ended June 30, 2015 and 2014 which resulted in a decrease in net administrative fees for the fiscal year ended June 30, 2015 and 2014 when compared to the actual net administrative fees for the prior fiscal years. (6) Other income, net consists primarily of equity in net income of unconsolidated affiliates related to our 50% ownership interest in Innovatix, interest income, net and realized gains and losses on our marketable securities (which represent our interest and investment income, net) and gain or loss on disposal of assets. (7) PSCI currently owns a 100% voting and economic interest in S2S Global as a result of its February 2, 2015 purchase of the remaining noncontrolling interest (40%) in S2S Global. Prior to February 2, 2015, PSCI owned a 60% voting and economic interest in S2S Global. Net loss attributable to noncontrolling interest in S2S Global represents the portion of net loss attributable to the noncontrolling equity holders of S2S Global (40%) prior to the February 2, 2015 purchase. (8) PHSI, through Premier Plans, owned a 1% controlling general partnership interest in Premier LP prior to the Reorganization. Net income attributable to noncontrolling interest in Premier LP represents the portion of net income attributable to the limited partners of Premier LP, which was 78% following the Reorganization and 99% prior to the Reorganization. (9) Working capital represents the excess of total current assets over total current liabilities. (10) Deferred revenue is primarily related to deferred subscription fees and deferred advisory fees in our performance services segment and consists of unrecognized revenue related to advanced member invoicing or member payments received prior to fulfillment of our revenue recognition criteria. (11) Redeemable limited partners' capital consists of the limited partners' approximately 74% ownership of Premier LP after the Reorganization and IPO and subsequent quarterly exchanges pursuant to the Exchange Agreement and 99% ownership of Premier LP prior to the Reorganization and IPO. Pursuant to the terms of the existing limited partnership agreement of Premier LP, Premier LP is required to repurchase a limited partner's interest upon the withdrawal of such limited partner and therefore the interest in Premier LP is classified as temporary equity in the mezzanine section of the consolidated balance sheets. The Company records redeemable limited partners' capital at the greater of the book value or redemption amount per the LP Agreement at the reporting date, with the corresponding offset to additional paid-in-capital and retained earnings (accumulated deficit). Item 7.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion should be read in conjunction with our audited consolidated financial statements and the notes thereto included elsewhere in this Annual Report. This discussion is designed to provide the reader with information that will assist in understanding our consolidated financial statements, the changes in certain key items in those financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles affect our consolidated financial statements. In addition, the following discussion includes certain forward-looking statements. For a discussion of important factors, including the continuing development of our business and other factors which could cause actual results to differ materially from the results referred to in the forward-looking statements, see "Item 1A Risk Factors" and "Cautionary Note Regarding Forward-Looking Statements" contained in this Annual Report. Business Overview Our Business We are a leading healthcare performance improvement company, uniting an alliance of approximately 3,600 U.S. hospitals and 120,000 other providers to transform healthcare. We unite hospitals, health systems, physicians and other healthcare providers with the common goal of improving and innovating in the clinical, financial and operational areas of their business to meet the demands of a rapidly evolving healthcare industry. We deliver value through a comprehensive technology-enabled platform that offers critical supply chain services, clinical, financial, operational and population health SaaS informatics products, advisory services and performance improvement collaborative programs. As of June 30, 2015, we were controlled by 176 U.S. hospitals, health systems and other healthcare organizations that represent approximately 1,300 owned, leased and managed acute care facilities and other non-acute care organizations, through the holdings of Class B common stock, which they received upon the consummation of the Reorganization and IPO on October 1, 2013. As of June 30, 2015, the Class A common stock and Class B common stock represented approximately 26% and 74% of our combined Class A and Class B common stock (the "common stock"). As of June 30, 2015, all of our Class A common stock was held by public investors, which may include member owners that have received shares of our Class A common stock in connection with previous quarterly exchanges pursuant to the Exchange Agreement discussed in Note 2 - Initial Public Offering and Reorganization to the audited consolidated financial statements. We generated net revenue of $1,007.0 million, $910.5 million and $869.3 million, net income of $234.8 million, $332.6 million, and $375.1 million and Adjusted EBITDA of $393.2 million, $392.3 million, and $419.0 million for the fiscal years ended June 30, 2015, 2014, and 2013, respectively. On a non-GAAP pro forma basis, after giving effect to the Reorganization and the IPO, we generated net revenue of $1,007.0 million, $869.3 million and $764.3 million, net income of $234.8 million, $294.6 million and $247.3 million, and Adjusted EBITDA of $393.2 million, $351.0 million, and $314.0 million for the fiscal years ended June 30, 2015, 2014 and 2013, respectively. Non-GAAP pro forma adjustments for the impact of the Reorganization and IPO do not impact operating results for the year ended June 30, 2015. Our Business Segments Our business model and solutions are designed to provide our members access to scale efficiencies, spread the cost of their development, provide actionable intelligence derived from anonymized data in our data warehouse provided by our members, mitigate the risk of innovation and disseminate best practices that will help our member organizations succeed in their transformation to higher quality and more cost-effective healthcare. We deliver our integrated platform of solutions that address the areas of total cost management, quality and safety improvement and population health management through two business segments: supply chain services and performance services. Our supply chain services segment includes one of the largest healthcare GPOs in the United States, serving acute and alternate sites, a specialty pharmacy and our direct sourcing activities. Supply chain services net revenue grew from $678.1 million for fiscal year 2014 to $738.3 million for fiscal year 2015, representing net revenue growth of 9%, and accounted for 73% of our overall net revenue. Supply chain services segment net revenue grew from $664.1 million in fiscal year 2013 to $678.1 million in fiscal year 2014, representing net revenue growth of 2%, and in fiscal year 2014 accounted for 74% of our overall net revenue. We generate revenue in our supply chain services segment from fees received from suppliers based on the total dollar volume of supplies purchased by our members and through product sales in connection with our specialty pharmacy and direct sourcing activities. Our performance services segment includes one of the largest informatics and advisory services businesses in the United States focused on healthcare providers. Performance services net revenue grew from $232.4 million for fiscal year 2014 to $268.8 million for fiscal year 2015, representing revenue growth of 16%, and in fiscal year 2015 accounted for 27% of our overall net revenue. Performance services net revenue grew from $205.2 million in fiscal year 2013 to $232.4 million in fiscal year 2014, representing net revenue growth of 13%, and in fiscal year 2014 accounted for 26% of our overall net revenue. Our SaaS informatics products utilize our comprehensive data set to provide actionable intelligence to our members, enabling them to benchmark, analyze and identify areas of improvement across three main categories: cost management, quality and safety and population health management. This segment also includes our technology-enabled performance improvement collaboratives. Reorganization and IPO On October 1, 2013, we completed our IPO by issuing 32,374,751 shares of our Class A common stock, at a price of $27.00 per share, raising net proceeds of approximately $821.7 million, after underwriting discounts and commissions, but before expenses. In addition, on October 1, 2013, upon the consummation of the IPO, we completed the Reorganization. See Note 2 - Initial Public Offering and Reorganization to the audited consolidated financial statements contained herein for more information. We incurred strategic and financial restructuring expenses in connection with the Reorganization and IPO of approximately $1.4 million, $3.8 million and $5.2 million during fiscal years ended June 30, 2015, 2014 and 2013, respectively. The strategic and financial restructuring expense incurred during fiscal year ended June 30, 2015 is primarily attributable to the company directed offering conducted pursuant to the Registration Rights Agreement discussed in Note 2 - Initial Public Offering and Reorganization to the audited consolidated financial statements. We may incur additional financial and restructuring expenses in connection with future quarterly exchanges pursuant to the Exchange Agreement and company directed offerings pursuant to the Registration Rights Agreement. Acquisitions On February 2, 2015 we purchased the remaining 40% of the outstanding shares of common stock of S2S Global for approximately $14.5 million. In connection with the purchase, we repaid the $14.2 million balance outstanding under the S2S Global line of credit and terminated the line of credit. We utilized available funds on hand to complete the acquisition and pay-off the S2S Global line of credit. On September 1, 2014, we completed the acquisition of TheraDoc, Inc. ("TheraDoc"), a leading provider of clinical surveillance software to healthcare organizations across the country that bring together disparate data from a hospital's source systems and helps alert clinicians to potential risks, for $108.6 million. We utilized available funds on hand to complete the acquisition. The primary reason for our acquisition of TheraDoc was to augment our capabilities across our existing platform and associated applications in an effort to help our hospital and health system members to improve clinical outcomes, lower costs, and strengthen regulatory compliance. On August 29, 2014 we completed the acquisition of Aperek, Inc. ("Aperek"), (formerly Mediclick), a SaaS-based supply chain solutions company focused on purchasing workflow and analytics, for $47.4 million. We utilized available funds on hand to complete the acquisition. The primary reason for our acquisition of Aperek, a business with a track record of analyzing and reducing costs for health systems through the innovative use of data, was to continue to strengthen the Company's ability to drive improvement in member cost savings. See Note 4 - Business Acquisitions and Note 25 - Subsequent Events to the audited consolidated financial statements contained herein for more information regarding our acquisition activities. Market and Industry Trends and Outlook We expect that certain trends and economic or industry-wide factors will continue to affect our business, both in the short-term and long-term. We have based our expectations described below on assumptions made by us and on information currently available to us. To the extent our underlying assumptions about, or interpretation of, available information prove to be incorrect, our actual results may vary materially from our expected results. See "Cautionary Note Regarding Forward-Looking Statements." Trends in the U.S. healthcare market affect our revenues in the supply chain services and performance services segments. The trends we see affecting our current healthcare business include the implementation of healthcare reform legislation, expansion of insurance coverage, intense cost pressure, payment reform, provider consolidation, shift in care to the alternate site market and increased data availability and transparency. To meet the demands of this environment, there will be increased focus on scale and cost containment and healthcare providers will need to measure and report on, and bear financial risk for, outcomes. We believe these trends will result in increased demand for our supply chain services and performance services solutions in the areas of cost management, quality and safety, population health management and PremierConnect® Enterprise, a cloud-based data warehousing, collaboration and content management solution that allows our members to aggregate and share information on one common platform that is both payer and supplier neutral. Key Components of Our Results of Operations Net Revenue Net revenue consists of (i) service revenue, which includes net administrative fees revenue and other services and support revenue and (ii) product revenue. Net administrative fees revenue consists of GPO administrative fees in our supply chain services segment. Other services and support revenue consists primarily of fees generated by our performance services segment in connection with our SaaS informatics products subscriptions, license fees, advisory services and performance improvement collaborative subscriptions. Product revenue consists of specialty pharmacy and direct sourcing product sales, which are included in the supply chain services segment. Supply Chain Services Supply chain services revenue consists of GPO net administrative fees (gross administrative fees received from suppliers, reduced by the amount of any revenue share paid to members), specialty pharmacy revenue and direct sourcing revenue. The success of our supply chain services revenue streams are influenced by the number of members that utilize our GPO supplier contracts and the volume of their purchases, the number of members that utilize our specialty pharmacy, as well as the impact of changes in the defined allowable reimbursement amounts determined by Medicare, Medicaid and other managed care plans, and the number of members that purchase products through our direct sourcing activities and the impact of competitive pricing. Performance Services Performance services revenue consists of SaaS informatics products subscriptions, license fees, performance improvement collaborative and other service subscriptions, professional fees for advisory services, and insurance services management fees and commissions from endorsed commercial insurance programs. Our performance services growth will depend upon the expansion of our SaaS informatics products, performance improvement collaboratives and advisory services to new and existing members, impact of applied research initiatives, renewal of existing subscriptions to our SaaS informatics products and expansion into new markets with potential future acquisitions. Cost of Revenue Cost of service revenue includes expenses related to employees (including compensation and benefits) and outside consultants who directly provide services related to revenue-generating activities, including advisory services to members and implementation services related to SaaS informatics products. Cost of service revenue also includes expenses related to hosting services, related data center capacity costs, third-party product license expenses and amortization of the cost of internal use software. Cost of product revenue consists of purchase and shipment costs for specialty pharmaceuticals and direct sourced medical products. Our cost of product revenue will be influenced by the cost and availability of specialty pharmaceuticals and the manufacturing and transportation costs associated with direct sourced medical products. Operating Expenses Selling, general and administrative expenses consist of expenses directly associated with selling and administrative employees and indirect costs associated with employees that primarily support revenue-generating activities (including compensation and benefits) and travel-related expenses, as well as occupancy and other indirect costs, insurance costs, professional fees, and other general overhead expenses. General and administrative expenses have increased as a result of being a public company, including stock-based compensation expense related to the equity incentive plan established in connection with the Reorganization and IPO. Research and development expenses consist of employee-related compensation and benefits expenses, and third-party consulting fees of technology professionals, incurred to develop, support and maintain our software-related products and services. Amortization of purchased intangible assets includes the amortization of all identified intangible assets resulting from acquisitions. Other Income, Net Other income, net, consists primarily of equity in net income of unconsolidated affiliates that is generated from our 50% ownership interest in Innovatix. A change in the number of, and use by, members that participate in our GPO programs through Innovatix could have a significant effect on the amounts earned from this investment. Other income, net, also includes interest income, net, and realized gains and losses on our marketable securities as well as gains or losses on disposal of assets. Income Tax Expense Income tax expense includes the income tax expense attributable to Premier, PHSI and PSCI. For federal and state income tax purposes, income realized by Premier LP is taxable to its partners. As such, the low effective tax rate is attributable to the flow through of Premier LP income, which is not subject to federal and state income tax at Premier. Net Income Attributable to Noncontrolling Interest As of June 30, 2015, we owned an approximate 26% controlling general partner interest in Premier LP through Premier GP. We owned a 100% voting and economic interest in S2S Global, through our 100% interest in PSCI, as a result of the purchase of the remaining 40% noncontrolling interest on February 2, 2015. Net income attributable to noncontrolling interest represents the portion of net income attributable to the limited partners of Premier LP (approximately 74%) and the portion of net income or loss attributable to the noncontrolling equity holders of S2S Global (40%) prior to the February 2, 2015 purchase. Our noncontrolling interest attributable to limited partners of Premier LP was reduced from 99% to approximately 78% upon the Reorganization, and further reduced to approximately 74%, as of June 30, 2015, as a result of completed quarterly exchanges pursuant to the Exchange Agreement. Other Key Business Metrics The other key business metrics we consider are EBITDA, Adjusted EBITDA, Segment Adjusted EBITDA, Adjusted Fully Distributed Net Income, Adjusted Fully Distributed Earnings Per Share, and Free Cash Flow. We define EBITDA as net income before interest and investment income, net, income tax expense, depreciation and amortization and amortization of purchased intangible assets. We define Adjusted EBITDA as EBITDA before merger and acquisition related expenses and non-recurring, non-cash or non-operating items, and including equity in net income of unconsolidated affiliates. For all non-GAAP financial measures, we consider non-recurring items to be expenses and other items that have not been incurred within the prior two years and are not expected to recur within the next two years. Such expenses include certain strategic and financial restructuring expenses. Non-operating items include gain or loss on disposal of assets. We define Segment Adjusted EBITDA as the segment's net revenue less operating expenses directly attributable to the segment excluding depreciation and amortization, amortization of purchased intangible assets, merger and acquisition related expenses and non-recurring or non-cash items, and including equity in net income of unconsolidated affiliates. Operating expenses directly attributable to the segment include expenses associated with sales and marketing, general and administrative and product development activities specific to the operation of each segment. General and administrative corporate expenses that are not specific to a particular segment are not included in the calculation of Segment Adjusted EBITDA. We define Adjusted Fully Distributed Net Income as net income attributable to Premier (i) excluding income tax expense, (ii) excluding the effect of non-recurring and non-cash items, (iii) assuming the exchange of all the Class B common units into shares of Class A common stock, which results in the elimination of noncontrolling interest in Premier LP and (iv) reflecting an adjustment for income tax expense on non-GAAP pro forma fully distributed net income before income taxes at our estimated effective income tax rate. Adjusted Fully Distributed Net Income is a non-GAAP financial measure because it represents net income attributable to Premier before merger and acquisition related expenses and non-recurring or non-cash items and the effects of noncontrolling interests in Premier LP. We define Adjusted Fully Distributed Earnings Per Share as earnings per share attributable to Premier (i) excluding income tax expense, (ii) excluding impact of adjustment of redeemable limited partners' capital to redemption amount, (iii) excluding the effect of non-recurring and non-cash items, (iv) assuming the exchange of all the Class B common units into shares of Class A common stock, which results in the elimination of noncontrolling interest in Premier LP and (v) reflecting an adjustment for income tax expense on non-GAAP pro forma fully distributed net income before income taxes at our estimated effective income tax rate. Adjusted Fully Distributed Earnings Per Share is a non-GAAP financial measure because it represents earnings per share attributable to Premier before merger and acquisition related expenses and non-recurring or non-cash items, the effects of noncontrolling interests in Premier LP, and the impact of the adjustment of redeemable limited partners' capital to redemption amount. We define Free Cash Flow as net cash provided by operating activities less distributions to limited partners and purchases of property and equipment. Free Cash Flow is a non-GAAP financial measure because it does not represent net cash provided by operating activities alone but takes into consideration the ongoing distributions to limited partners and purchase of property and equipment that are necessary for ongoing business operations and long-term value creation. We believe Free Cash Flow is an important measure because it represents the cash that we generate after payment of tax distributions to limited partners and capital investment to maintain existing products and services as well as development of new and upgraded products and services to support future growth. Free Cash Flow is important because it allows us to enhance shareholder value through acquisitions, partnerships, joint ventures, investments in related business and/or debt reduction. Also, Free Cash Flow does not represent discretionary cash available for spending as it excludes certain contractual obligations such as debt repayment. Adjusted EBITDA and Free Cash Flow are supplemental financial measures used by us and by external users of our financial statements. We consider Adjusted EBITDA and Free Cash Flow to be indicators of the operational strength and performance of our business. Adjusted EBITDA and Free Cash Flow measures allow us to assess our performance without regard to financing methods and capital structure and without the impact of other matters that we do not consider indicative of the operating performance of our business. Segment Adjusted EBITDA is the primary earnings measure we use to evaluate the performance of our business segments. We use Adjusted EBITDA, Segment Adjusted EBITDA, Adjusted Fully Distributed Net Income and Adjusted Fully Distributed Earnings Per Share to facilitate a comparison of our operating performance on a consistent basis from period to period that, when viewed in combination with our results prepared in accordance with GAAP, provides a more complete understanding of factors and trends affecting our business than GAAP measures alone. We believe Adjusted EBITDA and Segment Adjusted EBITDA assist our board of directors, management and investors in comparing our operating performance on a consistent basis from period to period because they remove the impact of our asset base (primarily depreciation and amortization) and items outside the control of our management team (taxes), as well as other non-cash (impairment of intangible assets, purchase accounting adjustments and stock-based compensation) and non-recurring items (strategic and financial restructuring expenses), from our operations. We believe Adjusted Fully Distributed Net Income and Adjusted Fully Distributed Earnings Per Share assist our board of directors, management and investors in comparing our net income and earnings per share on a consistent basis from period to period because it removes non-cash (impairment of intangible assets, purchase accounting adjustments and stock-based compensation) and non-recurring items (strategic and financial restructuring expenses), and eliminates the variability of noncontrolling interest as a result of member owner exchanges of Class B common units into shares of Class A common stock (which exchanges are a member owner’s cumulative right, but not obligation, which began on October 31, 2014, and occur each year thereafter, and are limited to one-seventh of the member owner’s initial allocation of Class B common units). Despite the importance of these non-GAAP financial measures in analyzing our business, determining compliance with certain financial covenants in our new revolving facility, measuring and determining incentive compensation and evaluating our operating performance relative to our competitors, EBITDA, Adjusted EBITDA, Segment Adjusted EBITDA, Adjusted Fully Distributed Net Income, Adjusted Fully Distributed Earnings Per Share and Free Cash Flow are not measurements of financial performance under GAAP, may have limitations as analytical tools and should not be considered in isolation from, or as an alternative to, net income, net cash provided by operating activities, or any other measure of our performance derived in accordance with GAAP. Some of the limitations of EBITDA, Adjusted EBITDA and Segment Adjusted EBITDA include that they do not reflect: our capital expenditures or our future requirements for capital expenditures or contractual commitments; changes in, or cash requirements for, our working capital needs; the interest expense or the cash requirements to service interest or principal payments under our revolving credit facility; income tax payments we are required to make; and any cash requirements for replacements of assets being depreciated or amortized. In addition, EBITDA, Adjusted EBITDA, Segment Adjusted EBITDA and Free Cash Flow are not measures of liquidity under GAAP, or otherwise, and are not alternatives to cash flows from continuing operating activities. Some of the limitations of Adjusted Fully Distributed Net Income and Adjusted Fully Distributed Earnings Per Share are that they do not reflect income tax expense or income tax payments we are required to make. In addition, Adjusted Fully Distributed Net Income and Adjusted Fully Distributed Earnings Per Share are not measures of profitability under GAAP. We also urge you to review the reconciliation of these non-GAAP measures included elsewhere in this Annual Report. To properly and prudently evaluate our business, we encourage you to review the audited consolidated financial statements and related notes included elsewhere in this Annual Report, and to not rely on any single financial measure to evaluate our business. In addition, because EBITDA, Adjusted EBITDA, Segment Adjusted EBITDA, Adjusted Fully Distributed Net Income, Adjusted Fully Distributed Earnings Per Share and Free Cash Flow are susceptible to varying calculations, the EBITDA, Adjusted EBITDA, Segment Adjusted EBITDA, Adjusted Fully Distributed Net Income, Adjusted Fully Distributed Earnings Per Share and Free Cash Flow measures, as presented in this Annual Report, may differ from, and may therefore not be comparable to, similarly titled measures used by other companies. As discussed in more detail below under "Results of Operations," we also use a non-GAAP pro forma presentation in this Annual Report for consolidated operating results prior to October 1, 2013, the effective date of the Reorganization and IPO. We believe this presentation is useful because our consolidated operating results prior to the Reorganization and IPO are not indicative of our results for periods after the Reorganization and IPO. This non-GAAP pro forma presentation is for informational purposes only and does not purport to reflect our historical results or operations or financial position. This non-GAAP pro forma presentation should not be relied upon as being indicative of our financial condition or results of operations had the Reorganization and IPO occurred on the dates assumed. Further, this presentation does not project our results of operations or financial position for any future period or date. You should carefully review our historical actual results presented herein. Results of Operations Our consolidated operating results prior to October 1, 2013 do not reflect (i) the Reorganization, (ii) the IPO and the use of the proceeds from the IPO or (iii) additional expenses we incur as a public company. As a result, our consolidated operating results prior to the Reorganization and IPO are not indicative of what our results of operations are for periods after the Reorganization and IPO. In addition to presenting the historical actual results, we have presented non-GAAP pro forma results reflecting the following for all applicable periods presented, to provide a more indicative comparison between current and prior periods. The non-GAAP pro forma consolidated financial information is included for informational purposes only and does not purport to reflect our results of operations or financial position that would have occurred had we operated as a public company during the applicable periods presented. The non-GAAP pro forma consolidated financial information should not be relied upon as being indicative of our financial condition or results of operations had the Reorganization and IPO occurred on the dates assumed. The non-GAAP pro forma consolidated financial information also does not project our results of operations or financial position for any future period or date. The non-GAAP pro forma results reflect the following for the periods indicated: • The contractual requirement under the GPO participation agreements to pay each member owner revenue share from Premier LP equal to 30% of all gross administrative fees collected by Premier LP based upon purchasing by such member owner's member facilities through Premier LP's GPO supplier contracts. Historically, Premier LP did not generally have a contractual requirement to pay revenue share to member owners participating in its GPO programs, but paid semi-annual distributions of partnership income. • Additional U.S. federal, state and local income taxes with respect to its additional allocable share of any taxable income of Premier LP. • A decrease in noncontrolling interest in Premier LP from 99% to approximately 78%. Years Ended June 30, 2015 and 2014 The following table summarizes our actual consolidated results of operations for the fiscal years ended June 30, 2015 and 2014 and non-GAAP pro forma consolidated results of operations for the fiscal year ended June 30, 2014 (in thousands, except per share data): nm = Not meaningful na = Not Applicable (1) Represents the adjustments related to the Reorganization and IPO described below. (2) Represents the impact related to the change in revenue share described above in "Results of Operations." (3) Represents the income tax impact of the Reorganization and IPO effective October 1, 2013. (4) Represents the decrease in noncontrolling interest in Premier LP from 99% to 78%. (5) The table that follows shows the reconciliation of net income to Adjusted EBITDA and the reconciliation of Segment Adjusted EBITDA to income before income taxes for the periods presented (in thousands): (a) Represents the adjustments related to the Reorganization and IPO described above. (b) Represents interest income and realized gains and losses on our marketable securities. (c) Represents legal, accounting and other expenses related to acquisition activities. (d) Represents legal, accounting and other expenses directly related to strategic and financial restructuring expenses. During the fiscal year ended June 30, 2015, strategic and financial restructuring expenses were incurred in connection with the company directed offering conducted pursuant to the Registration Rights Agreement. During the fiscal year ended June 30, 2014, strategic and financial restructuring expenses were incurred in connection with the Reorganization and IPO. (e) Represents the loss on investment for the fiscal year ended June 30, 2015 and the gain on sale of investment in GHX for the fiscal year ended June 30, 2014. (f) Represents adjustment to tax receivable agreement liability for the Premier LP change in tax accounting method approved by the Internal Revenue Service subsequent to the original recording of the tax receivable agreement liability. (g) Represents gains and losses on investments and other assets. (h) Represents non-cash adjustment to deferred revenue of acquired entities. Business combination accounting rules require us to account for the fair values of software license updates and product support contracts and hardware systems support contracts assumed in connection with our acquisitions. Because these support contracts are typically one year in duration, our GAAP revenues for the one year period subsequent to our acquisition of a business do not reflect the full amount of support revenues on these assumed support contracts that would have otherwise been recorded by the acquired entity. The non-GAAP adjustment to our software license updates and product support revenues is intended to include, and thus reflect, the full amount of such revenues. (i) Corporate consists of general and administrative corporate expenses that are not specific to either of our segments. (6) The table that follows shows the reconciliation of net income attributable to stockholders to non-GAAP pro forma Adjusted Fully Distributed Net Income for the periods presented (in thousands): (a) Represents legal, accounting and other expenses related to acquisition activities. (b) Represents legal, accounting and other expenses directly related to the Reorganization and IPO. During the fiscal year ended June 30, 2015, strategic and financial restructuring expenses were incurred in connection with the company directed offering conducted pursuant to the Registration Rights Agreement. During the fiscal year ended June 30, 2014, strategic and financial restructuring expenses were incurred in connection with the Reorganization and IPO. (c) Represents the loss on investment for the fiscal year ended June 30, 2015 and the gain on sale of investment in GHX for the fiscal year ended June 30, 2014. (d) Represents adjustment to tax receivable agreement liability for the Premier LP change in tax accounting method approved by the Internal Revenue Service subsequent to the original recording of the tax receivable agreement liability. (e) Represents non-cash adjustment to deferred revenue of acquired entities. Business combination accounting rules require us to account for the fair values of software license updates and product support contracts and hardware systems support contracts assumed in connection with our acquisitions. Because these support contracts are typically one year in duration, our GAAP revenues for the one year period subsequent to our acquisition of a business do not reflect the full amount of support revenues on these assumed support contracts that would have otherwise been recorded by the acquired entity. The non-GAAP adjustment to our software license updates and product support revenues is intended to include, and thus reflect, the full amount of such revenues. (f) Reflects the elimination of the noncontrolling interest in Premier LP as if all member owners of Premier LP had fully exchanged their Class B common units for shares of Class A common stock. (g) Reflects income tax expense at an estimated effective income tax rate of 40% of income before income taxes assuming the conversion of all Class B common units into shares of Class A common stock and the tax impact of excluding strategic and financial restructuring expenses. (7) The table that follows shows the reconciliation of (loss) earnings per share attributable to stockholders after adjustment of redeemable limited partners' capital to redemption amount to non-GAAP earnings per share attributable to stockholders: (8) The table that follows shows the reconciliation of the numerator and denominator for (loss) earnings per share attributable to stockholders after adjustment of redeemable limited partners' capital to redemption amount to non-GAAP pro forma Adjusted Fully Distributed Earnings Per Share for the periods presented (in thousands): (a) Represents legal, accounting and other expenses related to acquisition activities. (b) Represents legal, accounting and other expenses directly related to the Reorganization and IPO. During the fiscal year ended June 30, 2015, strategic and financial restructuring expenses were incurred in connection with the company directed offering conducted pursuant to the Registration Rights Agreement. During the fiscal year ended June 30, 2014, strategic and financial restructuring expenses were incurred in connection with the Reorganization and IPO. (c) Represents the loss on investment for the fiscal year ended June 30, 2015 and the gain on sale of investment in GHX for the fiscal year ended June 30, 2014. (d) Represents adjustment to tax receivable agreement liability for the Premier LP change in tax accounting method approved by the Internal Revenue Service subsequent to the original recording of the tax receivable agreement liability. (e) Represents non-cash adjustment to deferred revenue of acquired entities. Business combination accounting rules require us to account for the fair values of software license updates and product support contracts and hardware systems support contracts assumed in connection with our acquisitions. Because these support contracts are typically one year in duration, our GAAP revenues for the one year period subsequent to our acquisition of a business do not reflect the full amount of support revenues on these assumed support contracts that would have otherwise been recorded by the acquired entity. The non-GAAP adjustment to our software license updates and product support revenues is intended to include, and thus reflect, the full amount of such revenues. (f) Reflects the elimination of the noncontrolling interest in Premier LP as if all member owners of Premier LP had fully exchanged their Class B common units for shares of Class A common stock. (g) Reflects income tax expense at an estimated effective income tax rate of 40% of income before income taxes assuming the conversion of all Class B common units into shares of Class A common stock and the tax impact of excluding strategic and financial restructuring expenses. The table that follows shows the reconciliation of (loss) earnings per share attributable to stockholders to non-GAAP pro forma Adjusted Fully Distributed Earnings Per Share for the periods presented: (a) Represents legal, accounting and other expenses related to acquisition activities. (b) Represents legal, accounting and other expenses directly related to the Reorganization and IPO. During the fiscal year ended June 30, 2015, strategic and financial restructuring expenses were incurred in connection with the company directed offering conducted pursuant to the Registration Rights Agreement. During the fiscal year ended June 30, 2014, strategic and financial restructuring expenses were incurred in connection with the Reorganization and IPO. (c) Represents the loss on investment for the fiscal year ended June 30, 2015 and the gain on sale of investment in GHX for the fiscal year ended June 30, 2014. (d) Represents adjustment to tax receivable agreement liability for the Premier LP change in tax accounting method approved by the Internal Revenue Service subsequent to the original recording of the tax receivable agreement liability. (e) Represents non-cash adjustment to deferred revenue of acquired entities. Business combination accounting rules require us to account for the fair values of software license updates and product support contracts and hardware systems support contracts assumed in connection with our acquisitions. Because these support contracts are typically one year in duration, our GAAP revenues for the one year period subsequent to our acquisition of a business do not reflect the full amount of support revenues on these assumed support contracts that would have otherwise been recorded by the acquired entity. The non-GAAP adjustment to our software license updates and product support revenues is intended to include, and thus reflect, the full amount of such revenues. (f) Reflects the elimination of the noncontrolling interest in Premier LP as if all member owners of Premier LP had fully exchanged their Class B common units for shares of Class A common stock. (g) Reflects income tax expense at an estimated effective income tax rate of 40% of income before income taxes assuming the conversion of all Class B common units into shares of Class A common stock and the tax impact of excluding strategic and financial restructuring expenses. (h) Reflects impact of increased share count assuming the conversion of all Class B common units into shares of Class A common stock. Net Revenue The following table summarizes our actual net revenue for the year ended June 30, 2015 and 2014, respectively, and our non-GAAP pro forma net revenue for the year ended June 30, 2014, indicated both in dollars (in thousands) and as a percentage of net revenue: (a) Represents the impact related to the change in revenue share. Total net revenue for the year ended June 30, 2015 was $1,007.0 million, an increase of $96.5 million, or 11%, from total net revenue of $910.5 million for the year ended June 30, 2014 and an increase of $137.7 million, or 16%, from non-GAAP pro forma net revenue of $869.3 million for the year ended June 30, 2014. Supply Chain Services Our supply chain services segment net revenue for the year ended June 30, 2015 was $738.3 million, an increase of $60.2 million, or 9%, from supply chain services segment net revenue of $678.1 million for the year ended June 30, 2014 and an increase of $101.4 million, or 16%, from non-GAAP pro forma supply chain services segment net revenue of $636.9 million for the year ended June 30, 2014. Net administrative fees revenue in our supply chain services segment for the year ended June 30, 2015 was $457.0 million, a decrease of $7.8 million, or 2%, from $464.8 million for the year ended June 30, 2014. The decrease in net administrative fees revenue is primarily due to the increase in revenue share of $43.4 million reflecting the 30% revenue share payable to member owners after the Reorganization on October 1, 2013, offset by further contract penetration of existing members, continuing impact of newer member conversion to our contract portfolio, as well as the impact of increased utilization trends. We may experience quarterly fluctuations in net administrative fees revenue due to periodic variability associated with the receipts of supplier member purchasing reports and administrative fee payments at quarter-end. Net administrative fees revenue for the year ended June 30, 2015 was $457.0 million, an increase of $33.4 million, or 8%, from non-GAAP pro forma net administrative fees revenue of $423.6 million for the year ended June 30, 2014. The increase in net administrative fees revenue was primarily attributable to the impact of further contract penetration of existing members, continuing impact of newer member conversion to our contract portfolio, as well as the impact of increased utilization trends. Product revenue in our supply chain services segment for the year ended June 30, 2015, was $279.3 million, an increase of $66.8 million, or 31%, from $212.5 million for the year ended June 30, 2014. Product revenue in our supply chain services segment increased for the year ended June 30, 2015, due to $37.4 million of increased specialty pharmacy revenue and $30.9 million of increased direct sourcing revenue, as a result of growth in our specialty pharmacy, including member growth as well as access to additional drug therapies entering the market, and ongoing expansion of member support for our direct sourcing offering. We expect our specialty pharmacy and direct sourcing program revenue to continue to grow to the extent we are able to expand our product sales to existing members and additional members begin to utilize our products. Performance Services Other services and support revenue in our performance services segment for the year ended June 30, 2015 was $268.8 million, an increase of $36.4 million, or 16%, from $232.4 million for the year ended June 30, 2014. The increase was primarily the result of growth in our SaaS subscription and license revenue of $31.7 million, primarily related to the acquisitions of TheraDoc and Aperek, growth in advisory services of $12.5 million, primarily from cost management and population health management, offset by decline in performance improvement collaboratives of $8.0 million, primarily related to the termination of Partnership for Patients (PfP) contract in December 2014. We expect to experience quarterly variability in revenues generated from our performance services segment due to the timing of revenue recognition from certain advisory services and performance-based engagements in which our revenue is based on a percentage of identified member savings and recognition occurs upon approval and documentation of savings. Non-GAAP pro forma adjustments do not impact financial results for our performance services segment. Cost of Revenue The following table summarizes our cost of revenue for the periods indicated (in thousands): Cost of revenue for the year ended June 30, 2015 was $396.9 million, an increase of $89.3 million, or 29%, from $307.6 million for the year ended June 30, 2014. Cost of product revenue increased by $61.7 million, which was primarily attributable to the increases in specialty pharmacy and direct sourcing revenue. We expect our cost of product revenue to increase as we enroll additional members into our specialty pharmacy program and sell additional direct-sourced medical products to new and existing members. The increase in specialty pharmacy is also driven by increased cost of revenue related to sales of new hepatitis-C therapies, whose drug acquisition costs are generally higher than traditionally seen across other specialty therapies. Cost of service revenue increased by $27.6 million primarily due to an increase in amortization of internally-developed software applications, expenses related to population health management SaaS informatics products under reseller agreements, and increased salary costs related to advisory services. We expect cost of service revenue to increase to the extent we expand our performance improvement collaboratives and advisory services to members, increase sales of our population health management SaaS informatics products under reseller agreements, and continue to develop new and existing internally-developed software applications. Cost of revenue for the supply chain services segment for the year ended June 30, 2015 was $255.8 million, an increase of $61.1 million, or 31%, from $194.7 million for the year ended June 30, 2014. The increase is primarily attributable to the growth in specialty pharmacy and direct sourcing, which have higher associated cost of revenue as compared to group purchasing. As a result, there is a higher increase in cost of revenue relative to net revenue because product revenue is growing at a higher rate than net administrative fees. Cost of revenue for the performance services segment for the year ended June 30, 2015 was $141.1 million, an increase of $28.2 million, or 25%, from $112.9 million for the year ended June 30, 2014. The increase is primarily attributable to the increase in amortization of internally-developed software applications and expenses related to population health management SaaS informatics products under reseller agreements, as well as increased salary costs related to advisory services. Operating Expenses The following table summarizes our operating expenses for the periods indicated (in thousands): Selling, General and Administrative Selling, general and administrative expenses for the year ended June 30, 2015 were $332.0 million, an increase of $37.6 million, or 13%, from $294.4 million for the year ended June 30, 2014. The increase was attributable to increased salaries and benefits, rent and utilities, and insurance expense due to the acquisitions of TheraDoc and Aperek as well as increased business development expenses related to member meetings and increased hardware and software maintenance costs related to the expansion and growth of SaaS informatics products. The increase is also the result of $9.0 million of increased stock-based compensation expense, as a result of twelve months of stock-based compensation expense for the year ended June 30, 2015 as compared to only nine months of stock-based compensation expense for the year ended June 30, 2014. In addition, increased acquisition-related expenses of $7.0 million were recognized during the year ended June 30, 2015 as compared to the year ended June 30, 2014. Research and Development Research and development expenses for the year ended June 30, 2015 were $2.9 million, a decrease of $0.5 million, or 15%, from $3.4 million for the year ended June 30, 2014. The decrease was primarily a result of a higher level of capitalized expenses in the current fiscal year from software in the development stages of production. We experience fluctuations in our research and development expenditures across reportable periods due to the timing of our software development lifecycles that result in new product features and functionality, new technologies and upgrades to our service offerings. Amortization of Purchased Intangible Assets Amortization of purchased intangible assets for the year ended June 30, 2015 was $9.1 million, an increase of $6.0 million, or 194%, from $3.1 million for the year ended June 30, 2014. The increase was as a result of the additional amortization of purchased intangible assets obtained in the acquisitions of TheraDoc and Aperek. As we execute on our growth strategy and further deploy our available capital, we expect increases in amortization of purchased intangible assets in connection with recent and future potential acquisitions. Other Non-operating Income and Expense Other Income, Net Other income, net, for the year ended June 30, 2015 was $5.1 million, a decrease of $53.2 million from $58.3 million for the year ended June 30, 2014. This decrease is primarily attributable to the $15.2 million loss on disposal of long-lived assets recognized during the year ended June 30, 2015 in connection with our operations integration as a result of the TheraDoc acquisition and the $38.4 million gain recognized in connection with the sale of our 13% equity interest in GHX during the year ended June 30, 2014. Income Tax Expense Income tax expense for the year ended June 30, 2015 was $36.3 million, an increase of $8.6 million from $27.7 million for the year ended June 30, 2014, which is primarily attributable to the establishment of a valuation allowance on the majority of PHSI deferred tax assets due to uncertainties surrounding PHSI's ability to utilize these assets, offset by a reduction in book income in the current year and the recognition of a one-time tax expense of $11.9 million on the sale of the general partner interest during the year ended June 30, 2014. Our effective tax rate was 13.4% and 7.7% for the year ended June 30, 2015 and 2014, respectively. The low effective tax rate compared to the statutory rate for both periods is attributable to the flow through of partnership income which is not subject to federal and state income tax at the Company. Income tax expense for the year ended June 30, 2015 was $36.3 million, an increase of $11.8 million, from $24.5 million of income tax expense on a non-GAAP basis, which reflects the impact of the Reorganization and IPO for the year ended June 30, 2014. The increase in tax expense is primarily due to the establishment of a valuation allowance on the majority of PHSI deferred tax assets offset by lower taxable income within our taxable corporations. Our effective tax rate was 13.4% for the year ended June 30, 2015 and 7.7% on a non-GAAP pro forma basis for the year ended June 30, 2014. The low effective tax rate for both periods is attributable to the flow through of partnership income which is not subject to federal and state income tax at the Company. Net Income Attributable to Noncontrolling Interest Net income attributable to noncontrolling interest for the year ended June 30, 2015 was $196.0 million, a decrease of $108.3 million, or 36%, from $304.3 million for the year ended June 30, 2014, primarily as a result of the gain on sale of investment in GHX of $38.4 million recognized during the year ended June 30, 2014, change in ownership of the limited partners of Premier LP from 99% to approximately 74% in connection with the Reorganization and IPO and subsequent quarterly exchanges pursuant to the Exchange Agreement, and increased revenue share in connection with the Reorganization and IPO. Net income attributable to noncontrolling interest was $196.0 million for the year ended June 30, 2015, a decrease of $50.6 million, or 21%, from $246.6 million on a non-GAAP pro forma basis for the year ended June 30, 2014, primarily due to increased net administrative fee revenue, offset by increased revenue share as a result of the Reorganization and IPO and the gain on sale of investment in GHX of $38.4 million recognized during the year ended June 30, 2014. Non-GAAP Adjusted EBITDA (a) Represents the impact related to the change in revenue share. Adjusted EBITDA for the year ended June 30, 2015 was $393.2 million, an increase of $0.9 million, from $392.3 million for the year ended June 30, 2014. Adjusted EBITDA for the year ended June 30, 2015 was $393.2 million an increase of $42.2 million, or 12%, from non-GAAP pro forma Adjusted EBITDA of $351.0 million for the year ended June 30, 2014. Segment Adjusted EBITDA for the supply chain services segment of $391.2 million for the year ended June 30, 2015 reflects a decrease of $5.3 million, or 1%, compared to $396.5 million for the year ended June 30, 2014, primarily driven by the 30% revenue share payable to member owners after the Reorganization on October 1, 2013. Segment Adjusted EBITDA for the supply chain services segment of $391.2 million for the year ended June 30, 2015 reflects an increase of $36.0 million, or 10%, compared to non-GAAP pro forma Segment Adjusted EBITDA of $355.2 million for the year ended June 30, 2014, primarily as a result of the increased net administrative fees revenue and growth in direct sourcing. Segment Adjusted EBITDA for the performance services segment of $90.2 million for the year ended June 30, 2015 reflects an increase of $16.3 million, or 22%, compared to $73.9 million for the year ended June 30, 2014, as a result of the sale of new SaaS informatics products, effective management of operating expenses, and increased subscription and license revenue, partially offset by increased operating expenses, related to our acquisitions of Aperek and TheraDoc. Years Ended June 30, 2014 and 2013 The following table summarizes our actual consolidated results of operations for the fiscal years ended June 30, 2014 and 2013 (in thousands, except per share data): nm - Not Meaningful na - Not Applicable The following table summarizes our actual and non-GAAP pro forma consolidated results of operations for the fiscal year ended June 30, 2014 (in thousands, except per share data): The following table summarizes our actual and non-GAAP pro forma consolidated results of operations for the fiscal year ended June 30, 2013 (in thousands, except per share data): (1) Represents the adjustments related to the Reorganization and IPO described below. (2) Represents the impact related to the change in revenue share described above in "Results of Operations." (3) Represents the income tax impact of the Reorganization and IPO effective October 1, 2013. (4) Represents the decrease in noncontrolling interest in Premier LP from 99% to 78%. (5) The table that follows shows the reconciliation of net income to Adjusted EBITDA and the reconciliation of Segment Adjusted EBITDA to income before income taxes for the periods presented (in thousands): (a) Represents the adjustments related to the Reorganization and IPO described above. (b) Represents interest income and realized gains and losses on our marketable securities. (c) Represents legal, accounting and other expenses related to acquisition activities. (d) Represents legal, accounting and other expenses directly related to the Reorganization and IPO. (e) Represents the gain on sale of investment in GHX. (f) Represents adjustment to tax receivable agreement liability for the Premier LP change in tax accounting method approved by the Internal Revenue Service subsequent to the original recording of the tax receivable agreement liability. (g) Represents gains and losses on investments and other assets. (h) Corporate consists of general and administrative corporate expenses that are not specific to either of our segments. (6) The table that follows shows the reconciliation of net income attributable to stockholders to Non-GAAP pro forma Adjusted Fully Distributed Net Income for the periods presented (in thousands): (a) Represents legal, accounting and other expenses related to acquisition activities. (b) Represents legal, accounting and other expenses directly related to the Reorganization and IPO. (c) Represents the gain on sale of investment in GHX. (d) Represents adjustment to tax receivable agreement liability for the Premier LP change in tax accounting method approved by the Internal Revenue Service subsequent to the original recording of the tax receivable agreement liability. (e) Reflects the elimination of the noncontrolling interest in Premier LP as if all member owners of Premier LP had fully exchanged their Class B common units for shares of Class A common stock. (f) Reflects income tax expense at an estimated effective income tax rate of 40% of income before income taxes assuming the conversion of all Class B common units into shares of Class A common stock and the tax impact of excluding strategic and financial restructuring expenses. (7) The table that follows shows the reconciliation of (loss) earnings per share attributable to stockholders after adjustment of redeemable limited partners' capital to redemption amount to non-GAAP earnings per share attributable to stockholders: (8) The table that follows shows the reconciliation of the numerator and denominator for (loss) earnings per share attributable to stockholders after adjustment of redeemable limited partners' capital to redemption amount to non-GAAP pro forma Adjusted Fully Distributed Earnings Per Share for the periods presented (in thousands): (a) Represents legal, accounting and other expenses related to acquisition activities. (b) Represents legal, accounting and other expenses directly related to the Reorganization and IPO. (c) Represents the gain on sale of investment in GHX. (d) Represents adjustment to tax receivable agreement liability for the Premier LP change in tax accounting method approved by the Internal Revenue Service subsequent to the original recording of the tax receivable agreement liability. (e) Reflects the elimination of the noncontrolling interest in Premier LP as if all member owners of Premier LP had fully exchanged their Class B common units for shares of Class A common stock. (f) Reflects income tax expense at an estimated effective income tax rate of 40% of income before income taxes assuming the conversion of all Class B common units into shares of Class A common stock and the tax impact of excluding strategic and financial restructuring expenses. The table that follows shows the reconciliation of (loss) earnings per share attributable to stockholders to non-GAAP pro forma Adjusted Fully Distributed Earnings Per Share for the periods presented: (a) Represents legal, accounting and other expenses related to acquisition activities. (b) Represents legal, accounting and other expenses directly related to the Reorganization and IPO. During the fiscal year ended June 30, 2015, strategic and financial restructuring expenses were incurred in connection with the company directed offering conducted pursuant to the Registration Rights Agreement. During the fiscal year ended June 30, 2014, strategic and financial restructuring expenses were incurred in connection with the Reorganization and IPO. (c) Represents the gain on sale of investment in GHX. (d) Represents adjustment to tax receivable agreement liability for the Premier LP change in tax accounting method approved by the Internal Revenue Service subsequent to the original recording of the tax receivable agreement liability. (e) Reflects the elimination of the noncontrolling interest in Premier LP as if all member owners of Premier LP had fully exchanged their Class B common units for shares of Class A common stock. (f) Reflects income tax expense at an estimated effective income tax rate of 40% of income before income taxes assuming the conversion of all Class B common units into shares of Class A common stock and the tax impact of excluding strategic and financial restructuring expenses. (g) Reflects impact of increased share count assuming the conversion of all Class B common units into shares of Class A common stock. Net Revenue The following table summarizes our net revenue for the years ended June 30, 2014, indicated both in dollars (in thousands) and as a percentage of net revenue: (a) Represents the impact related to the change in revenue share. The following table summarizes our net revenue for the year ended June 30, 2013, indicated both in dollars (in thousands) and as a percentage of net revenue: (a) Represents the impact related to the change in revenue share. Total net revenue for the year ended June 30, 2014 was $910.5 million, an increase of $41.2 million, or 5%, from $869.3 million for the year ended June 30, 2013. Total non-GAAP pro forma net revenue for the year ended June 30, 2014 was $869.3 million, and increase of $105.0 million, or 14%, from non-GAAP pro forma net revenue of $764.3 million for the year ended June 30, 2013. Supply Chain Services Our supply chain services segment net revenue for the year ended June 30, 2014 was $678.1 million, an increase of $14.0 million, or 2%, from $664.1 million for the year ended June 30, 2013. Our supply chain services segment non-GAAP pro forma net revenue for the year ended June 30, 2014 was $636.9 million, an increase of $77.8 million, or 14%, from non-GAAP pro forma supply chain services segment net revenue of $559.1 million for the year ended June 30, 2013. Net administrative fees revenue in our supply chain services segment for the year ended June 30, 2014 was $464.8 million, a decrease of $54.4 million, or 10%, from $519.2 million for the year ended June 30, 2013. Revenue share increased $64.5 million, primarily as a result of $128.3 million, which represents the impact of the 30% revenue share to member owners following the Reorganization and IPO on October 1, 2013, offset by a decrease in revenue share of $59.3 million, as a result of the conversion of certain members with higher contractual revenue share agreements to member owners during fiscal year 2013. Non-GAAP pro forma net administrative fees revenue for the year ended June 30, 2014 was $423.6 million, an increase of $9.4 million, or 2%, from non-GAAP pro forma net administrative fees revenue of $414.2 million for the year ended June 30, 2013. Product revenue in our supply chain services segment for the year ended June 30, 2014 was $212.5 million, an increase of $68.1 million, or 47%, from $144.4 million for the year ended June 30, 2013. Product revenue in our supply chain services segment increased for the year ended June 30, 2014, due to increased specialty pharmacy revenue as a result of growth of historical patient prescriptions, the expansion of specialty pharmacy product sales to our members and the availability and associated sales of additional limited-distribution drugs available in the portfolio and increased direct sourcing revenue as a result of growth in our members purchasing our products through our direct souring program. Performance Services Other services and support revenue in our performance services segment for the year ended June 30, 2014 was $232.4 million, an increase of $27.2 million, or 13%, from $205.2 million for the year ended June 30, 2013. The increase was primarily attributable to $12.1 million of new Saas informatics products, including population health management tools, $8.0 million of advisory services, and revenue generated from our performance improvement collaboratives. Pro forma adjustments do not impact financial results for our performances services segment. Cost of Revenue The following table summarizes our cost of revenue for the periods indicated (in thousands): Cost of revenue for the year ended June 30, 2014 was $307.6 million, an increase of $70.2 million, or 30%, from $237.4 million for the year ended June 30, 2013. Cost of product revenue increased by $58.3 million, which was primarily attributable to the increases in specialty pharmacy and direct sourcing revenue. Cost of service revenue increased by $11.9 million primarily due to an increase in amortization of internally-developed software applications and expenses related to population health management SaaS informatics products under reseller agreements. Cost of revenue for the supply chain services segment for the year ended June 30, 2014 was $194.7 million, an increase of $55.9 million, or 40%, from $138.8 million for the year ended June 30, 2013. The increase is primarily attributable to the growth in specialty pharmacy and direct sourcing, which have a higher associated cost of revenue as compared to group purchasing. As a result, there is a higher increase in cost of revenue relative to net revenue because net administrative fees represents the majority of supply chain services net revenue and product revenue from specialty pharmacy and direct sourcing is growing at a higher rate than net administrative fees. Cost of revenue for the performance services segment for the year ended June 30, 2014 was $112.9 million, an increase of $14.3 million, or 15%, from $98.6 million for the year ended June 30, 2013. The increase is primarily attributable to the increase in amortization of internally-developed software applications and expenses related to population health management SaaS informatics products under reseller agreements. Operating Expenses The following table summarizes our operating expenses for the periods indicated (in thousands): Selling, General and Administrative Selling, general and administrative expenses for the year ended June 30, 2014 were $294.4 million, an increase of $46.1 million, or 19%, from $248.3 million for the year ended June 30, 2013. The increase was primarily attributable to $19.5 million of stock-based compensation expense in fiscal year 2014, a $6.2 million adjustment to the tax receivable agreement liability related to a change in tax accounting method approved by the IRS in the fourth quarter of 2014 and $2.0 million of acquisition-related expenses recognized during the year ended June 30, 2014, as well as higher employee-related expenses due to increased selling and service personnel headcount and other general and administrative expenses attributable to operating as a public company. Research and Development Research and development expenses for the year ended June 30, 2014 were $3.4 million, a decrease of $6.0 million, or 64%, from $9.4 million for the year ended June 30, 2013. The decrease was primarily a result of higher level of capitalized expense in the current fiscal year from software in the development stages of production and higher non-capitalizable outside contractor expenses in the prior fiscal year related to the development and testing activities associated with our PremierConnect™ platform and associated applications. We experience fluctuations in our research and development expenditures across reportable periods due to the timing of our software development lifecycles, with new product features and functionality, new technologies and upgrades to our service offerings. Amortization of Purchased Intangible Assets Amortization of purchased intangible assets for the year ended June 30, 2014 was $3.0 million, an increase of $1.5 million, or 100%, from $1.5 million for the year ended June 30, 2013. The increase was as a result of the additional amortization of purchased intangible assets obtained in the acquisition of SYMMDRx in July 2013, Meddius in October 2013 and MEMdata in April 2014. Other Non-operating Income and Expense Other Income, Net Other income, net, for the year ended June 30, 2014 was $58.3 million, an increase of $46.2 million from $12.1 million for the year ended June 30, 2013. This increase is primarily attributable to the $38.4 million gain recognized in connection with the sale of our 13% equity interest in GHX, as well as $5.0 million increase in equity in net income of unconsolidated affiliates that is generated from our 50% ownership interest in Innovatix. Income Tax Expense Income tax expense for the year ended June 30, 2014 was $27.7 million, an increase of $18.0 million from $9.7 million for the year ended June 30, 2013, which is primarily attributable to additional taxable income from the increase in net income attributable to stockholders as a result of the Reorganization and IPO to approximately 22% to 1% for the periods prior to the Reorganization and IPO and a one-time tax expense of $11.9 million on the sale of the general partner interest during the year ended June 30, 2014. Our effective tax rate was 7.7% and 2.5% for the year ended June 30, 2014 and 2013, respectively. The low effective tax rate compared to the statutory rate for both periods is attributable to the flow through of partnership income which is not subject to federal and state income tax at the Company. On a pro forma basis, income tax expense of $24.5 million for the year ended June 30, 2014 reflects the effect of the Reorganization and IPO for the first three months of the year ended June 30, 2014 and represents a decrease of $8.0 million from income tax expense of $32.5 million for the year ended June 30, 2013 which reflects the effect of the Reorganization and IPO for the entire year. The decrease in tax expense is primarily attributable to a one-time tax benefit of $2.4 million recorded in the year ended June 30, 2014, in connection with a Premier LP change in tax accounting method as well as decreases in taxable income in the Company, PHSI and PSCI compared to the prior year. The pro forma effective tax rate was 7.7% and 11.6% for the year ended June 30, 2014 and 2013, respectively. The low effective tax rate compared to the statutory rate for both periods is attributable to the flow through of partnership income which is not subject to federal and state income tax at the Company. Net Income Attributable to Noncontrolling Interest Net income attributable to noncontrolling interest for the year ended June 30, 2014 was $304.3 million, a decrease of $63.4 million, or 17%, from $367.7 million for the year ended June 30, 2013, primarily as a result of the change in ownership of the limited partners of Premier LP from approximately 99% to 78% in connection with the Reorganization. On a non-GAAP pro forma basis, net income attributable to noncontrolling interest was $246.6 million for the year ended June 30, 2014, an increase of $29.6 million, or 14%, from $217.0 million for the year ended June 30, 2013. This increase was attributable to higher income of Premier LP, driven by the $38.4 million gain recognized on the sale of our investment in GHX for the year ended June 30, 2014, of which 78% was allocated to the limited partners of Premier LP. Adjusted EBITDA (a) Represents the impact related to the change in revenue share. (a) Represents the impact related to the change in revenue share. Adjusted EBITDA for the year ended June 30, 2014 was $392.3 million, a decrease of $26.7 million, or 6%, from $419.0 million for the year ended June 30, 2013. Non-GAAP pro forma Adjusted EBITDA for the year ended June 30, 2014 was $351.0 million, an increase of $37.0 million, or 12%, from non-GAAP pro forma Adjusted EBITDA of $314.0 million for the year ended June 30, 2013. Segment Adjusted EBITDA for the supply chain services segment of $396.5 million for the year ended June 30, 2014 reflects a decrease of $35.1 million, or 8%, compared to $431.6 million for the year ended June 30, 2013, primarily driven by the 30% revenue share payable to member owners after the Reorganization on October 1, 2013. Non-GAAP pro forma Adjusted EBITDA for the supply chain services segment of $355.2 million for the year ended June 30, 2014 reflects an increase of $28.6 million, or 9%, compared to non-GAAP pro forma Adjusted EBITDA of $326.6 million for the year ended June 30, 2013, primarily as a result of the growth in direct sourcing, increased net administrative fees revenue and lower operating expenses due to ongoing efforts to control costs. Segment Adjusted EBITDA for the performance services segment of $73.9 million for the year ended June 30, 2014 reflects an increase of $17.4 million, or 31%, compared to $56.5 million for the year ended June 30, 2013, as a result of growth from advisory services engagements, the sale of new SaaS informatics products and performance improvement collaboratives. Off-Balance Sheet Arrangements As of June 30, 2015, we did not have any off-balance sheet arrangements. Emerging Growth Company As of June 30, 2015, we no longer qualify as an "emerging growth company" as defined in Section 2(a)(19) of the Securities Act, as modified by the Jumpstart Our Business Startups Act of 2012 (the "JOBS Act"). Accordingly, we will no longer receive the benefits of such status and expect to incur increased costs of compliance with various additional reporting requirements generally applicable to public companies. Critical Accounting Policies and Estimates Management's Discussion and Analysis of Financial Condition and Results of Operations is based upon our consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of our consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosure of contingent assets and liabilities. Estimates are evaluated on an ongoing basis, including those related to reserves for bad debts, useful lives of property and equipment, value of investments not publicly traded, the valuation allowance on deferred tax assets and the fair value of purchased intangible assets and goodwill. These estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates. We believe that our most critical accounting policies are the following: Business Combinations We account for acquisitions using the acquisition method. All of the assets acquired, liabilities assumed, contractual contingencies, and contingent consideration are recognized at their fair value on the acquisition date. Any excess of the purchase price over the estimated fair values of the net assets acquired is recorded as goodwill. Acquisition-related costs are recorded as expenses in the consolidated financial statements. Several valuation methods may be used to determine the fair value of assets acquired and liabilities assumed. For intangible assets, we typically use the income method. This method starts with a forecast of all of the expected future net cash flows for each asset. These cash flows are then adjusted to present value by applying an appropriate discount rate that reflects the risk factors associated with the cash flow streams. Some of the more significant estimates and assumptions inherent in the income method or other methods include the amount and timing of projected future cash flows, the discount rate selected to measure the risks inherent in the future cash flows and the assessment of the asset's life cycle and the competitive trends impacting the asset, including consideration of any technical, legal, regulatory, or economic barriers to entry. Determining the useful life of an intangible asset also requires judgment as different types of intangible assets will have different useful lives and certain assets may even be considered to have indefinite useful lives. Marketable Securities We invest our excess cash in commercial paper, U.S. government securities, corporate debt securities and other securities with maturities generally ranging from three months to five years from the date of purchase. Marketable securities, classified as available-for-sale, are carried at fair market value, with the unrealized gains and losses on such investments reported in comprehensive income as a separate component of stockholders' (deficit) equity or redeemable limited partners' capital as appropriate. Realized gains and losses, and other-than-temporary declines in investments, are included in other income, net in the accompanying consolidated statements of income. We use the specific-identification method to determine the cost of securities sold. We do not hold publicly traded equity investments. Goodwill Goodwill represents costs in excess of fair values assigned to the underlying net assets of acquired businesses. Goodwill is not amortized, but we evaluate for impairment annually on the first day of the last fiscal quarter of the fiscal year or whenever there is an impairment indicator. Under accounting rules, we can elect to perform a qualitative assessment to determine if an impairment is more likely than not to have occurred. This qualitative assessment requires an evaluation of any excess of fair value over the carrying value for a reporting unit and significant judgment regarding potential changes in valuation inputs, including a review of our most recent long-range projections, analysis of operating results versus the prior year, changes in market values, changes in discount rates and changes in terminal growth rate assumptions. If it is determined that an impairment is more likely than not to exist, then we are required to perform a quantitative assessment to determine whether or not goodwill is impaired and to measure the amount of goodwill impairment, if any. Goodwill impairment is determined using a two-step process. The first step involves a comparison of the estimated fair value of each of our reporting units to its carrying amount, including goodwill. In performing the first step, we determine the fair value of a reporting unit using a discounted cash flow analysis that is corroborated by a market-based approach. Determining fair value requires the exercise of significant judgment, including judgment about appropriate discount rates, perpetual growth rates and the amount and timing of expected future cash flows. The cash flows employed in the discounted cash flow analyses are based on our most recent budget and long-term forecast. The discount rates used in the discounted cash flow analyses are intended to reflect the risks inherent in the future cash flows of the respective reporting units. If the estimated fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not impaired and the second step of the impairment test is not necessary. If the carrying amount of a reporting unit exceeds its estimated fair value, then the second step of the goodwill impairment test must be performed. The second step of the goodwill impairment test compares the implied fair value of the reporting unit's goodwill with its goodwill carrying amount to measure the amount of impairment, if any. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. In other words, the estimated fair value of the reporting unit is allocated to all of the assets and liabilities of that unit (including any unrecognized intangible assets) as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid. If the carrying amount of the reporting unit's goodwill exceeds the implied fair value of that goodwill, an impairment charge is recognized in an amount equal to that excess. Our most recent annual impairment testing, which consisted of a quantitative assessment, did not result in any goodwill impairment charges during the fourth quarter of the fiscal year ended June 30, 2015. Further, the results of our quantitative assessment indicated that the estimated fair value of each reporting unit evaluated substantially exceeded its respective carrying amount. Tax Receivable Agreements We record a liability related to the Tax Receivable Agreements based on 85% of the estimated amount of tax savings we expect to receive, generally over a 15-year period, in connection with the additional tax benefits created in connection with the Reorganization and IPO. Tax payments under the Tax Receivable Agreements will be made to our member owners as we realize tax benefits attributable to the initial purchase of Class B common units from the member owners in the Reorganization and subsequent exchanges of Class B common units into Class A common stock or cash between us and the member owners. Determining the estimated amount of tax savings we expect to receive requires judgment as deductibility of goodwill amortization expense is not assured and the estimate of tax savings is dependent upon the actual realization of the tax benefit and the tax rates in effect at that time. Changes in the estimated tax receivable agreement liability that are the result of a change in tax accounting method are recorded in selling, general and administrative expense in the consolidated statements of income. Changes in the estimated tax receivable agreement liability that are related to new basis changes as a result of the exchange of Class B common units into shares of our Class A common stock or related to departed member owners are recorded as an increase to additional paid-in capital in the consolidated statements of stockholders' (deficit) equity. Revenue Recognition Net Revenue Net revenue consists of (i) service revenue which includes net administrative fees revenue and other services and support revenue and (ii) product revenue. Net administrative fees revenue consists of GPO administrative fees in our supply chain services segment. Other services and support revenue consists primarily of fees generated in our performance services segment in connection with our SaaS informatics products subscriptions, advisory services and performance improvement collaborative subscriptions. Product revenue consists of specialty pharmacy and direct sourcing product sales, which are included in the supply chain segment. We recognize revenue when (i) there is persuasive evidence of an arrangement, (ii) the fee is fixed or determinable, (iii) services have been rendered and payment has been contractually earned, and (iv) collectability is reasonably assured. Net Administrative Fees Revenue Net administrative fees revenue is generated through administrative fees received from suppliers based on the total dollar volume of supplies purchased by our members. Through our group purchasing program, we aggregate the purchasing power of our members to negotiate pricing discounts and improve contract terms with suppliers. Contracted suppliers pay administrative fees to us which generally represent 1% to 3% of the purchase price of goods and services sold to members under the contracts we have negotiated. Administrative fees are recognized as revenue in the period in which the respective supplier reports member purchasing data, usually a month or a quarter in arrears of actual member purchase activity. The supplier report proves that the delivery of product or service has occurred, the administrative fees are fixed and determinable based on reported purchasing volume, and collectability is reasonably assured. Member and supplier contracts substantiate persuasive evidence of an arrangement. We do not take title to the underlying equipment or products purchased by members through our GPO supplier contracts. We partner with certain members, including regional GPOs, to extend our network base to their members and pay a revenue share equal to a percentage of gross administrative fees that we collect based upon purchasing by such members and their member facilities through our GPO supplier contracts. Revenue share is recognized according to the members' contractual agreements with us as the related administrative fees revenue is recognized. Considering GAAP relating to principal agent considerations under revenue recognition, revenue share is recorded as a reduction to gross administrative fees revenue to arrive at net administrative fees revenue in the accompanying consolidated statements of income. Other Services and Support Revenue Other services and support revenue consists of SaaS informatics products subscriptions, performance improvement collaborative and other service subscriptions, professional fees for advisory services, and insurance services management fees and commissions from group-sponsored insurance programs. SaaS informatics products subscriptions include the right to use our proprietary hosted technology on a SaaS basis, training and member support to deliver improvements in cost management, quality and safety, population health management and provider analytics. Pricing varies by subscription and size of the subscriber. Informatics subscriptions are generally three to five year agreements with automatic renewal clauses and annual price escalators that typically do not allow for early termination. These agreements do not allow for physical possession of the software. Subscription fees are typically billed on a monthly basis and revenue is recognized as a single deliverable on a straight-line basis over the remaining contractual period following implementation. Implementation involves the completion of data preparation services that are unique to each member's data set and, in certain cases, the installation of member site-specific software, in order to access and transfer member data into our hosted SaaS informatics products. Implementation is generally 100 to 170 days following contract execution before the SaaS informatics products can be fully utilized by the member. The Company sells certain perpetual and term licenses that include mandatory post-contract customer support in the form of maintenance and support services. Pricing varies by application and size of healthcare system. Fees for the initial period include the license fees, implementation fees and the initial bundled maintenance and support services fees. The fees for the initial period are recognized straight-line over the remaining initial period following implementation. Subsequent renewal maintenance and support services fees are recognized on a straight-line basis over the contractually stated renewal periods. Implementation services are provided to the customer prior to the use of the software and do not involve significant customization or modification. Implementation is generally 300 to 350 days following contract execution before the licensed software products can be fully utilized by the member. Revenue from performance improvement collaboratives and other service subscriptions that support our offerings in cost management, quality and safety and population health management is recognized over the service period, which is generally one year. Professional fees for advisory services are sold under contracts, the terms of which vary based on the nature of the engagement. Fees are billed as stipulated in the contract, and revenue is recognized on a proportional performance method as services are performed and deliverables are provided. In situations where the contracts have significant contract performance guarantees or member acceptance provisions, revenue recognition occurs when the fees are fixed and determinable and all contingencies, including any refund rights, have been satisfied. Our other services and support revenue growth will be dependent upon the expansion of our SaaS informatics products, performance improvement collaboratives and advisory services to new and existing members and the renewal of existing subscriptions to our SaaS informatics products and performance improvement collaboratives. Certain administrative and/or patient management specialty pharmacy services are provided in situations where prescriptions are sent back to member health systems for dispensing. Additionally, we derive revenue from pharmaceutical manufacturers for providing patient education and utilization data. Revenue is recognized as these services are provided. Product Revenue Specialty pharmacy revenue is recognized when a product is accepted and is recorded net of the estimated contractual adjustments under agreements with Medicare, Medicaid and other managed care plans. Payments for the products provided under such agreements are based on defined allowable reimbursements rather than on the basis of standard billing rates. The difference between the standard billing rate and allowable reimbursement rate results in contractual adjustments which are recorded as deductions from net revenue. Direct sourcing revenue is recognized upon delivery of medical products to members once the title and risk of loss have been transferred. Multiple Deliverable Arrangements We occasionally enter into agreements where the individual deliverables discussed above, such as SaaS subscriptions and advisory services, are bundled into a single service arrangement. These agreements are generally provided over a time period ranging from approximately three months to five years after the applicable contract execution date. Revenue is allocated to the individual elements within the arrangement based on their relative selling price using vendor specific objective evidence, or VSOE, third-party evidence, or TPE, or the estimated selling price, or ESP, provided that the total arrangement consideration is fixed and determinable at the inception of the arrangement. We establish VSOE, TPE, or ESP for each element of a service arrangement based on the price charged for a particular element when it is sold separately in a stand-alone arrangement. All deliverables which are fixed and determinable are recognized according to the revenue recognition methodology described above. Certain arrangements include performance targets or other contingent fees that are not fixed and determinable at the inception of the arrangement. If the total arrangement consideration is not fixed and determinable at the inception of the arrangement, we allocate only that portion of the arrangement that is fixed and determinable to each element. As additional consideration becomes fixed, it is similarly allocated based on VSOE, TPE or ESP to each element in the arrangement and recognized in accordance with each element's revenue recognition policy. Performance Guarantees On limited occasions, we may enter into an agreement which provides for guaranteed performance levels to be achieved by the member over the term of the agreement. In situations with significant performance guarantees, we defer revenue recognition until the amount is fixed and determinable and all contingencies, including any refund rights, have been satisfied. In the event that guaranteed savings levels are not achieved, we may have to pay the difference between the savings that were guaranteed and the actual achieved savings. Deferred Revenue Deferred revenue consists of unrecognized revenue related to advanced member invoicing or member payments received prior to fulfillment of the Company's revenue recognition criteria. Substantially all deferred revenue consists of deferred subscription fees and deferred advisory fees. Subscription fees for company-hosted SaaS applications are deferred until the member's unique data records have been incorporated into the underlying software database, or until member site-specific software has been implemented and the member has access to the software. Deferred advisory fees arise when cash is received from members prior to delivery of service. When the fees are contingent upon meeting a performance target that has not yet been achieved, the advisory fees are deferred until the performance target is met. Software Development Costs Costs to develop internal use computer software that are incurred in the preliminary project stage are expensed as incurred. During the development stage, direct consulting costs and payroll and payroll-related costs for employees that are directly associated with each project are capitalized and amortized over the estimated useful life of the software, once it is placed into operation. Capitalized costs are amortized on a straight-line basis over the estimated useful lives of the related software applications of up to five years and amortization is included in depreciation and amortization expense. Replacements and major improvements are capitalized, while maintenance and repairs are expensed as incurred. Some of the more significant estimates and assumptions inherent in this process involve determining the stages of the software development project, the direct costs to capitalize and the estimated useful life of the capitalized software. Income Taxes We account for income taxes under the asset and liability approach. Deferred tax assets or liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities as measured by the enacted tax rates which will be in effect when these differences reverse. We provide a valuation allowance against net deferred tax assets unless, based upon the available evidence, it is more likely than not that the deferred tax assets will be realized. We prepare and file tax returns based on interpretations of tax laws and regulations. In the normal course of business our tax returns are subject to examination by various taxing authorities. Such examinations may result in future tax and interest assessments by these taxing authorities. In determining our tax provision for financial reporting purposes we establish a reserve for uncertain income tax positions unless it is determined to be "more likely than not" that such tax positions would be sustained upon examination, based on their technical merits. That is, for financial reporting purposes, we only recognize tax benefits taken on the tax return if we believe it is "more likely than not" that such tax position would be sustained. There is considerable judgment involved in determining whether it is "more likely than not" that such tax positions would be sustained. We adjust our tax reserve estimates periodically because of ongoing examinations by, and settlements with, varying taxing authorities, as well as changes in tax laws, regulations and interpretations. The consolidated tax provision of any given year includes adjustments to prior year income tax accruals and related estimated interest charges that are considered appropriate. Our policy is to recognize, when applicable, interest and penalties on uncertain income tax positions as part of income tax expense. New Accounting Standards In May 2014, the Financial Accounting Standards Board (the "FASB") issued ASU 2014-09, Revenue from Contracts with Customers, which will supersede nearly all existing revenue recognition guidance under U.S. GAAP. The new standard requires revenue to be recognized when promised goods or services are transferred to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new standard also requires additional disclosures about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. The new standard allows for either full retrospective or modified retrospective adoption. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date, to defer the effective date of the new standard for all entities by one year. The new standard will be effective for fiscal years, and interim periods within those years, beginning after December 15, 2017 and early adoption as of the original effective date for public entities will be permitted. The new standard will be effective for the Company for the fiscal year ending June 30, 2019. The Company is currently evaluating the transition method that will be elected as well as the impact of the adoption of the new standard on its consolidated financial statements and related disclosures. In February 2015, the FASB issued ASU 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis, which effectively eliminates the presumption that a general partner should consolidate a limited partnership, modifies the evaluation of whether limited partnerships and similar legal entities are variable interest entities (VIEs) or voting interest entities, and affects the consolidation analysis of reporting entities that are involved with VIEs (particularly those that have fee arrangements and related party relationships). In some cases, consolidation conclusions will change under the new guidance and, in other cases, a reporting entity will need to provide additional disclosures if an entity that currently is not considered a VIE is considered a VIE under the new guidance. The new standard will be effective for fiscal years, and interim periods within those years, beginning after December 15, 2015 and early adoption is permitted. The new standard allows for either full retrospective or modified retrospective adoption. The new standard will be effective for the Company for the fiscal year ending June 30, 2017. The Company is currently evaluating the impact of the adoption of the new standard on its consolidated financial statements and related disclosures. Liquidity and Capital Resources Our principal source of cash has historically been cash provided by operating activities. From time-to-time we have used, and expect to use in the future, borrowings under our long-term credit facility as a source of liquidity. Our primary cash requirements involve operating expenses, working capital fluctuations, capital expenditures, acquisitions and related business investments. Our capital expenditures typically consist of internally-developed software costs, software purchases and computer hardware purchases. Prior to the Reorganization and IPO, the vast majority of our excess cash has been distributed to our member owners. As of June 30, 2015 and June 30, 2014, we had cash and cash equivalents totaling $146.5 million and $131.8 million, respectively, and marketable securities with maturities ranging from three months to two years totaling $415.4 million and $408.6 million, respectively. For the years ended June 30, 2015 and 2014, we financed our operations primarily through internally generated cash flows. As of June 30, 2015, there were no outstanding borrowings under the Credit Agreement. We funded a portion of the recently announced acquisition of CECity.com, Inc. with $150 million of borrowings under our Credit Agreement. See Note 13 - Lines of Credit and Note 25 - Subsequent Events to the audited consolidated financial statements contained herein for more information regarding our credit facilities. It is our intent to retain a significantly greater portion of our earnings following the Reorganization to provide additional liquidity to fund operations and future growth, including through acquisitions. We expect earnings, remaining proceeds from our IPO and occasional borrowings under our credit facility to provide us with liquidity to fund our working capital requirements, revenue share obligations, tax payments, capital expenditures and growth for the foreseeable future. Our capital requirements depend on numerous factors, including funding requirements for our product and service development and commercialization efforts, our information technology requirements and the amount of cash generated by our operations. We currently believe that we have adequate capital resources at our disposal to fund currently anticipated capital expenditures, business growth and expansion, and current and projected debt service requirements; however, strategic growth initiatives will likely require the use of available cash on hand, cash generated from operations, borrowings under our credit facility and/or potentially, proceeds from the issuance of additional equity or debt securities. Discussion of Cash Flow A summary of net cash flows follows (in thousands): Discussion of cash flows for the years ended June 30, 2015 and 2014 Net cash provided by operating activities was $364.1 million for the year ended June 30, 2015, a decrease of $4.0 million compared to $368.1 million for the year ended June 30, 2014 due primarily to the impact of changes to adjustments to reconcile net income to net cash provided by operating activities and changes in working capital needs, offset by increase in net revenue. Net cash used in investing activities was $231.9 million for the year ended June 30, 2015 compared to net cash used in investing activities of $397.1 million for the year ended June 30, 2014. Our investing activities for the year ended June 30, 2015 primarily consisted of (i) the acquisitions of Aperek and TheraDoc, net of cash acquired, for a total of $156.0 million, (ii) capital expenditures of $70.7 million, (iii) purchase of noncontrolling interest in S2S Global of $14.5 million, (iv) net purchases of marketable securities of $9.5 million, and (v) investment in PharmaPoint, LLC of $5.0 million, partially offset by (i) distributions from Innovatix of $18.9 million and (ii) decrease in restricted cash of $5.0 million. Our investing activities for the year ended June 30, 2014 primarily consisted of (i) the net purchases of marketable securities of $352.8 million due to a decision to invest the proceeds from the IPO in longer term marketable securities, (ii) the acquisitions of SYMMEDRx, Meddius and Memdata, net of cash acquired, for a total of $42.6 million and (iii) capital expenditures of $55.7 million for property and equipment, partially offset by proceeds from the sale of our investment in GHX of $38.4 million and distributions from Innovatix of $15.7 million. Net cash used in financing activities was $117.4 million for the year ended June 30, 2015, compared to $37.5 million for the year ended June 30, 2014. Our financing activities for the year ended June 30, 2015 primarily included (i) net cash payments to Premier LP limited partners of $92.2 million, (ii) payoff of S2S Global's revolving line of credit of $14.7 million, (iii) payments to Premier LP limited partners of $11.5 million under tax receivable agreements, and (iv) payments made on notes payable of $1.4 million, partially offset by proceeds from the exercise of stock options of $1.5 million. Our financing activities for the year ended June 30, 2014 primarily included (i) net proceeds of $277.8 million in connection with the IPO, (ii) proceeds of $66.0 million from withdrawals on our lines of credit and (iii) proceeds from notes receivable from partners of $12.7 million, offset by (i) net cash payments to Premier LP limited partners of $319.7 million, (ii) payments on the line of credit of $60.0 million and (iii) payments made on notes payable of $9.3 million. Discussion of Free Cash Flow A summary of Free Cash Flow and reconciliation to net cash provided by operating activities for the periods presented follows (in thousands): (a) Due to the lack of comparability of Free Cash Flow for the years ended June 30, 2015 and 2014 due to the impact of the Reorganization and IPO, only Free Cash Flow for the three months ended June 30, 2015 and 2014 are reflected above. Free Cash Flow for the three months ended June 30, 2015 was $53.9 million, compared with $42.2 million for the three months ended June 30, 2014. The increase in Free Cash Flow is primarily the result of strong performance in our Supply Chain Services segment, partially offset by an increase in distributions to limited partners and purchases of property and equipment. Contractual Obligations At June 30, 2015, we had material commitments for obligations under notes payable, our non-cancellable office space lease agreements, and estimated payments due to limited partners under Tax Receivable Agreements. Future payments for notes payable, operating lease obligations due under long-term contractual obligations, and estimated payments to limited partners under Tax Receivable Agreements as of June 30, 2015 are as follows: (1) Notes payable represent an aggregate principal amount of $17.9 million owed to departed member owners, payable over five years. (2) Future contractual obligations for leases represent future minimum payments under non-cancellable operating leases primarily for office space. (3) Estimated payments due to limited partners under Tax Receivable Agreements are based on 85% of the estimated amount of tax savings we expect to receive, generally over a 15-year period, in connection with the additional tax benefits created in connection with the Reorganization and IPO. 2014 Credit Agreement On June 24, 2014, we entered into our new Credit Agreement, which was amended on June 4, 2015. The Credit Agreement has a maturity date of June 24, 2019. The Credit Agreement provides for borrowings of up to $750.0 million with (i) a $25.0 million subfacility for standby letters of credit and (ii) a $75.0 million subfacility for swingline loans. At our request, the credit facility may be increased from time to time up to an additional aggregate of $250.0 million, subject to lender approval. The Credit Agreement includes an unconditional and irrevocable guaranty of all obligations under the credit facility by Premier GP, certain domestic subsidiaries of Premier GP and future guarantors, if any. Premier, Inc. is not a guarantor under the Credit Agreement. The Credit Agreement permits us to prepay amounts outstanding without premium or penalty provided, however, we are required to compensate the lenders for losses and expenses incurred as a result of the prepayment of any Eurodollar Rate Loan, as defined in the Credit Agreement. Committed loans may be in the form of Eurodollar Rate Loans or Base Rate Loans, as defined in the Credit Agreement, at our option. Eurodollar Rate Loans bear interest at the Eurodollar Rate (defined as the London Interbank Offer Rate, or LIBOR, plus the Applicable Rate (defined as a margin based on the Consolidated Total Leverage Ratio (as defined in the Credit Agreement)). Base Rate Loans bear interest at the Base Rate (defined as the highest of the prime rate announced by the Administrative Agent, the federal funds effective rate plus 0.50% or the one-month LIBOR plus 1.0%) plus the Applicable Rate. The Applicable Rate ranges from 1.125% to 1.75% for Eurodollar Rate Loans and 0.125% to 0.750% for Base Rate Loans. At June 30, 2015, the interest rate for three-month Eurodollar Rate Loans was 1.41% and the interest rate for Base Rate Loans was 3.375%. We are required to pay a commitment fee ranging from 0.125% to 0.250% per annum on the actual daily unused amount of commitments under the credit facility. At June 30, 2015, the commitment fee was 0.125%. The Credit Agreement contains customary representations and warranties as well as customary affirmative and negative covenants, including, among others, limitations on liens, indebtedness, fundamental changes, dispositions, restricted payments and investments. Under the terms of the Credit Agreement, Premier GP is not permitted to allow its Consolidated Total Leverage Ratio (as defined in the Credit Agreement) to exceed 3.00 to 1.00 for any period of four consecutive fiscal quarters. In addition, Premier GP must maintain a minimum Consolidated Interest Coverage Ratio (as defined in the Credit Agreement) of 3.00 to 1.00 at the end of every fiscal quarter. We were compliance with all such covenants at June 30, 2015. The Credit Agreement also contains customary events of default including, among others, payment defaults, breaches of representations and warranties, covenant defaults, cross-defaults of any indebtedness or guarantees in excess of $30.0 million, bankruptcy and other insolvency events, judgment defaults in excess of $30.0 million, and the occurrence of a change of control (as defined in the Credit Agreement). If any event of default occurs and is continuing, the Administrative Agent under the credit facility may, with the consent, or shall, at the request, of the required lenders, terminate the commitments and declare all of the amounts owed under the credit facility to be immediately due and payable. Proceeds from borrowings under the Credit Agreement may generally be used to finance ongoing working capital requirements, including permitted acquisitions and other general corporate purposes. As of June 30, 2015, we had no outstanding borrowings under the Credit Agreement. The above summary does not purport to be complete, and is subject to, and qualified in its entirety by reference to, the complete text of the Credit Agreement which is filed as an exhibit to this Annual Report. See also, Note 13 - Lines of Credit to our audited consolidated financial statement contained in this Annual Report. S2S Global Revolving Line of Credit On February 2, 2015, we purchased the remaining 40% of the outstanding shares of common stock of S2S Global. In connection with the purchase, we repaid the $14.2 million balance outstanding under the S2S Global line of credit and terminated the S2S Global line of credit prior to its February 16, 2015 maturity date. At June 30, 2014, S2S Global had $13.7 million outstanding on the revolving line of credit. Member-Owner Tax Receivable Agreement In connection with the Reorganization and IPO, we entered into a tax receivable agreement with each of our member owners, pursuant to which we agreed to pay to the member owners, generally over a 15-year period (under current law), 85% of the amount of cash savings, if any, in U.S. federal, foreign, state and local income and franchise tax that we actually realize (or are deemed to realize, in the case of payments required to be made upon certain occurrences under such Tax Receivable Agreements) as a result of the increases in tax basis resulting from the initial sale of Class B common units by the member owners in connection with the Reorganization, as well as subsequent exchanges by such member owners pursuant to the Exchange Agreement, and of certain other tax benefits related to our entering into the Tax Receivable Agreements, including tax benefits attributable to payments under the Tax Receivable Agreements. During the year ended June 30, 2015, we paid $11.5 million to the member owners during the year ended June 30, 2015 in connection with the initial exchanges and reduced the liability by $2.0 million in connection with departed member owners. Additional amounts payable under the tax receivable agreements for subsequent exchanges of Class B common units made by the member owners during the year ended June 30, 2015 are $57.1 million, which resulted in $235.9 million in tax receivable agreement liabilities as of June 30, 2015. We expect to fund our payments under the tax receivable agreements from distributions we receive from Premier LP. Certain Contractual Arrangements with Our Member Owners In connection with the Reorganization, we entered into several agreements to define and regulate the governance and control relationships among us, Premier LP and the member owners. Note 2 - Initial Public Offering and Reorganization to our audited consolidated financial statements contained herein provides a summary of the material provisions of these agreements. These summaries do not purport to be complete, and they are subject to, and qualified in their entirety by reference to, the complete text of the agreements which are filed as exhibits to this Annual Report. These agreements should be carefully read before making any investment decisions regarding our Class A common stock. Item 7A.

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2015

Item 6. SELECTED FINANCIAL DATA. Our selected financial data in the table below is derived from our audited financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States (US GAAP) for the fiscal years ended September 30, 2015 and August 31, 2014, 2013, and 2012; and International Financial Reporting Standards (IFRS) for the fiscal year ended August 31, 2011. We adopted IFRS effective September 1, 2010. Our auditors for the fiscal years ended September 30, 2015 and August 31, 2014, Moss Adams LLP, conducted the audit in accordance with United States generally accepted auditing standards, and the standards of the Public Company Accounting Oversight Board. Our auditors for the fiscal years ended August 31, 2013 and 2012, D&H Group LLP, conducted the audits in accordance with Canadian generally accepted auditing standards, and the standards of the Public Company Accounting Oversight Board. You should read these selected financial data together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7

Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. This discussion contains forward-looking statements that involve risks and uncertainties that could cause actual results or events to differ materially from those expressed or implied by such forward-looking statements as a result of many important factors, including those set forth in Part I of this Annual Report on Form 10-K under the caption “Risk Factors.” Please see “Special Note Regarding Forward-Looking Statements” in Part I above. We do not undertake any obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this Annual Report. Change in Fiscal Year End On June 3, 2014, the Company’s Board of Directors approved a change in the Company’s fiscal year end from August 31 to September 30 of each year, with effect from September 1, 2014. As a result, the Company had a one-month transition period from September 1, 2014 to September 30, 2014. Operating and Financial Review and Prospects Overview Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and include the accounts of the Company and our wholly-owned subsidiary, Stellar Biotechnologies, Inc. Since inception, we have primarily financed our activities through the issuance of common shares, exercise of warrants, grant revenues, contract services revenue, and product sales. In September 2013, we closed a private placement with total gross proceeds of $12,000,000. Management believes these financial resources are adequate to support our initiatives at the current level for at least the next 12 months. Management is also continuing the ongoing effort toward expanding the customer base for our currently marketed products, and we may seek additional financing alternatives, including additional equity financing, debt financing, bank loans, or nondilutive financing alternatives including applying for grants and entering into collaboration and/or licensing arrangements. Results of Operations The greatest impact on the comparison of our consolidated statements of operations is from fluctuations in the change in fair value of our warrant liability. As a result of having exercise prices denominated in a currency other than our functional currency, our warrants with Canadian dollar exercise prices meet the definition of derivatives and are therefore classified as derivative liabilities measured at fair value with noncash adjustments to fair value recognized through the consolidated statements of operations. Fair values are based on the Black-Scholes option valuation model. The losses and gains in each year are a reflection of our share price fluctuations with increases in share prices causing greater warrant liability and a resulting loss on fair value of warrant liability, while decreases in share prices cause a resulting gain on fair value of warrant liability. Changes in fair value of warrant liability have no impact on cash flow. If the warrants are exercised, the warrant liability is reclassified to common shares. If the warrants expire, the decrease in warrant liability offsets the changes in fair value. Fiscal Year Ended September 30, 2015 Our net loss for fiscal 2015 was $2,843,029, or ($0.36) per share, as compared to a net loss of $8,439,523, or ($1.11) per share, for fiscal 2014. The decrease in net loss of approximately $5.6 million for fiscal 2015 was primarily due to a significant noncash gain in the fair value of warrant liability, increased sales and decreased research and development expenses. Revenue for fiscal 2015 totaled $758,689, as compared to revenue of $372,132 in fiscal 2014. Revenue for fiscal 2015 included product sales of $563,689, as compared to $143,553 in the prior year. The increase in product sales for fiscal 2015 was due to an increase in the number of customers and greater product sales volume including sales under supply agreements and custom manufactured products. Contract services revenue was $195,000 for fiscal 2015, as compared to $192,000 in the prior year, resulting from the net impact of services performed under a collaboration agreement entered into mid-December 2013 and completion of services in December 2014 related to a supply agreement. There were no grant revenues for fiscal 2015 as compared to $36,579 in the prior year due to completion of work associated with our Phase II/IIB grants from the National Science Foundation (“NSF”) Small Business Innovation Research (“SBIR”) through the Technology Enhancement for Commercial Partnerships program. Expenses for fiscal 2015 decreased to $5,097,281, as compared to $6,090,648 incurred in fiscal 2014. Costs of sales and contract services increased to $580,824 for fiscal 2015, as compared to $469,149 for the prior year, consistent with increased sales and contract services revenue. Also, due to the early stage of our development in fiscal 2014, all manufacturing costs of production were expensed during that period. There were no grant expenses for fiscal 2015 as compared to $36,579 in the prior year due to the close out of NSF Phase II/IIB grants in November 2013. Research and development expense was $1,029,489 for fiscal 2015, as compared to $2,458,934 for the prior year. The decrease was a result of the decreased use of contract research organizations due to a realignment of our focus from internal research and process development to manufacturing our Stellar KLH™ products in response to increased customer demand. General and administration expenses increased to $3,227,545 for fiscal 2015, as compared to $2,871,455 in the prior year. The increase was caused by the net impact of increased corporate expenses, including legal and audit fees related to our transition to reporting as a U.S. domestic issuer rather than a foreign private issuer, our Nasdaq application and listing, and increased business development and investor relations activity, partially offset by decreases in share-based compensation. Share-based compensation is allocated to all expense types but the greatest portion is recorded as general and administration expenses. Share-based compensation was $267,222 for fiscal 2015, which was a decrease from $956,634 recorded in fiscal 2014. The decrease for fiscal 2015 was related to fewer stock options granted, fluctuations in our share price that affect the valuation model and vesting of options granted in prior years. Other income was an overall gain of $1,532,363 in fiscal 2015, as compared to a loss of $2,693,807 in fiscal 2014. The most significant factor in the change for fiscal 2015 as compared to the prior year resulted from the noncash change in fair value of warrant liability, which fluctuated to a gain of $2,131,062 for fiscal 2015 from a loss of $2,533,305 in the prior year. These fair value gains and losses occur in inverse relation to changes in our share price that affect the valuation model. The gain in fiscal 2015 is a reflection of the decrease in our share price from $11.90 to $6.40 compared to the loss in fiscal 2014 as a result of the increase in our share price from $14.00 to $15.90. Also, there were fewer Canadian denominated warrants outstanding than each prior year. The increase in overall gain in fiscal 2015 was offset by an increase in foreign exchange loss to $653,333 over the same period. Our foreign exchange loss in fiscal 2014 was $222,437. The change over the prior year was due to unfavorable exchange rates for our Canadian cash and cash equivalents. The portion of foreign exchange loss realized in cash was $14,995 in fiscal 2015, and $26,778 in the fiscal 2014. Fiscal Year Ended August 31, 2014 Our net loss for fiscal 2014 was $8,439,523, or ($1.11) per share, as compared to a net loss of $14,495,779, or ($2.81) per share, for the fiscal 2013. The decrease in net loss of approximately $6 million for fiscal 2014 was primarily due to a large change in the fair value of warrant liability. Revenue for fiscal 2014 totaled $372,132, as compared to revenue of $545,469 in fiscal 2013. As expected during this early stage of our development, our revenues have high volatility as we establish a market for our products and services. Revenue for fiscal 2014 included product sales of $143,553, as compared to $76,055 in the prior year. The increase in revenue for fiscal 2014 was due to greater product sales volume. Grant revenue for fiscal 2014 decreased to $36,579, as compared to $409,414 in the prior year due to close out of our work associated with the NSF Phase II/IIB grant in November 2013. Contract services revenue was $192,000 for fiscal 2014, as compared to $60,000 in the prior year. The increase for fiscal 2014 was due to new contract services under a collaboration agreement. Expenses for fiscal 2014 increased to $6,090,648, as compared to $4,393,388 incurred in fiscal 2013. Costs of sales and contract services increased to $469,149 for fiscal 2014, as compared to $57,351 for the prior year, due to the operations department resuming manufacturing activities during fiscal 2014 and greatly reducing the efforts spent on the NSF grant and on other internal research. It should be noted that we did not capitalize the cost of inventory at this early stage of our development, so manufacturing costs of production were expensed, although related product sales normally occur in a later period. Costs of aquaculture increased to $254,531 for fiscal 2014, as compared to $137,450 for the prior year due to significant efforts in aquaculture during fiscal 2013 covered under the NSF grant and recorded as grant costs in the prior year. Grant costs decreased to $36,579 from $409,414 in line with the decrease in grant revenue due to completion of NSF Phase II/IIB in fiscal 2013 with the close out period ended November 2013. Research and development expense was $2,458,934 for fiscal 2014, as compared to $2,018,554 for the prior year, due to preclinical research on C. diff immunotherapy, coupled with a decrease in our other internal research and development activities caused by operations shifting time from process development to manufacturing. General and administration expenses increased to $2,871,455 for fiscal 2014, as compared to $1,770,619 in the prior year, as management executed on strategic initiatives for fiscal 2014, particularly related to corporate development and business development. Share-based compensation is allocated to all expense types but the greatest portion is recorded as general and administration expenses. Share-based compensation was $956,634 for fiscal 2014, which was an increase from $786,585 recorded in fiscal 2013. The increase for fiscal 2014 was related to the timing of granting stock options, increases in our share price that affect the valuation model and the vesting of options granted in prior years. Other income (loss) was an overall loss of $2,693,807 in fiscal 2014, as compared to a loss of $10,647,060 in fiscal 2013. The largest change for fiscal 2014 as compared to the prior year occurred due to a change in fair value of warrant liability, which decreased to a loss of $2,533,305 for fiscal 2014 from a loss of $10,566,208 in the prior year. The loss in fiscal 2014 is a reflection of the increase in our share price from August 31, 2013 to August 31, 2014, but not as much as in the prior year. Our foreign exchange loss in fiscal 2014 was $222,437, as compared to $95,842 in fiscal 2013. The change was due to unfavorable exchange rates for our Canadian cash and cash equivalents in fiscal 2014. Capital Expenditures Our capital expenditures, which primarily consist of scientific, manufacturing, and aquaculture equipment, and facility leasehold improvements for the previous three fiscal years are as follows: Liquidity and Capital Resources Our working capital position at September 30, 2015 was $7,485,971, including cash and cash equivalents of $3,955,503, short-term investments of $5,015,171 and net of $1,550,630 in the noncash current portion of our warrant liability. Management believes the current working capital is sufficient to meet our present requirements, including all contractual obligations and anticipated research and development expenditures for at least the next 12 months. We expect to finance our future expenditures and obligations through revenues from product sales, contract services income, grant revenues, and sales of common shares. We expect to continue incurring losses for the foreseeable future and may need to raise additional capital to pursue our business plan and continue as a going concern. We cannot provide any assurances that we will be able to raise additional capital. Our management believes that we have access to capital resources through possible public or private equity offerings, debt financings, corporate collaborations or other means, if needed; however, we have not secured any commitment for new financing at this time, nor can we provide any assurance that new financing will be available on commercially acceptable terms, if needed. Fiscal Year Ended September 30, 2015 As of September 30, 2015, our working capital position was $7,485,971 compared to working capital of $12,650,004 as of August 31, 2014. Working capital is reduced by the noncash current portion of our warrant liability in the amount of $1,550,630 and $879,040 at September 30, 2015 and August 31, 2014, respectively. Our cash and cash equivalents totaled $3,955,503 at September 30, 2015, as compared to cash and cash equivalents of $8,423,089 at August 31, 2014, which represented a decrease of $4,467,586. Our short-term investments totaled $5,015,171 at September 30, 2015, as compared to short-term investments of $5,462,413 at August 31, 2014, which represented a decrease of $447,242. During fiscal 2015, operating activities used cash of $4,412,395. Items not affecting cash included: depreciation and amortization of $159,521; share-based compensation related to the issuance of stock options of $267,222; unrealized foreign exchange loss of $653,333; and gain in fair value of warrant liability of $2,131,062 due to adjustment to fair value of warrants previously issued as a result in the decrease in the price of our shares. Changes in working capital items include an increase in accounts receivable of $113,917 related mostly to increased revenues; increase in inventory of $522,389 caused by recording inventory beginning in fiscal 2015; increase in prepaid expenses of $45,758; increase in accounts payable and accrued liabilities of $77,018; and increase in deferred revenue of $86,666 related to deposits on custom manufactured products billed in advance. Investing activities provided cash of $122,470. The acquisition of property, plant and equipment used cash of $274,589. Purchase of short-term investments used cash of $13,677. Proceeds on maturities of short-term investments provided cash of $410,736. The effect of exchange rate changes on cash and cash equivalents was a reduction of $629,808. Financing activities provided cash of $106,777 from the proceeds from exercise of warrants and options. During the year 2015, a total of 42,770 common shares were issued upon the exercise of warrants and options, of which: ·4,020 common shares were issued pursuant to the exercise of warrants for gross proceeds of $12,609. ·38,753 common shares were issued pursuant to the exercise of options for proceeds of $94,168. Fiscal Year Ended August 31, 2014 As of August 31, 2014, our working capital position was $12,650,004 compared to working capital of $4,260,364 as of August 31, 2013. Working capital is reduced by the noncash current portion of our warrant liability in the amount of $879,040 and $3,454,745 at August 31, 2014 and 2013, respectively. Our cash and cash equivalents totaled $8,423,089 at August 31, 2014, as compared to cash and cash equivalents of $7,859,889 at August 31, 2013, which represented an increase of $563,200. Our short-term investments totaled $5,462,413 at August 31, 2014, as compared to no short-term investments at August 31, 2013, which represented an increase of $5,462,413. During fiscal 2014 operating activities used cash of $4,266,707. Items not affecting cash included: depreciation and amortization of $158,313; share-based compensation related to the issuance of stock options of $956,634; unrealized foreign exchange loss of $222,437; loss in fair value of warrant liability of $2,533,305 due to adjustment to fair value of warrants previously issued; impairment loss of $90,476 and loss on disposal of property, plant and equipment of $3,670. Changes in non-cash working capital items include a decrease in accounts receivable of $121,075 related mostly to grants; decrease in deferred financing costs related to the private placement of units completed in September 2013 of $60,656; increase in prepaid expenses of $94,974; increase in accounts payable and accrued liabilities of $106,224; and increase in deferred revenue of $15,000 related to contract services billed in advance. Investing activities used cash of $5,745,730. The acquisition of property, plant and equipment used cash of $279,065. Proceeds on sale of property, plant and equipment totaled $2,150. Purchase of short-term investments used cash of $5,468,815. The effect of exchange rate changes on cash and cash equivalents was a reduction of $212,338. Financing activities provided cash of $10,787,975. The proceeds from exercise of warrants and options provided cash of $4,308,878; share subscription proceeds provided cash of $7,000,000; and share issuance costs used cash of $520,903. During the year 2014, a total of 2,032,269 common shares were issued: ·1,142,857 common shares were issued pursuant to private placements for gross proceeds of $12,000,000 (with $5,000,000 of these proceeds received as subscriptions in the prior fiscal year). ·151,515 common shares were issued for performance shares allotted under the 2010 reverse merger transaction. The vested value had been recorded in prior years and there were no proceeds received in fiscal 2014. ·593,730 common shares were issued pursuant to the exercise of warrants for gross proceeds of $3,920,134 (with $155,674 of these proceeds received as subscriptions in the prior fiscal year). ·144,167 common shares were issued pursuant to the exercise of options for proceeds of $544,418. Research and Development Our core business is developing and commercializing Keyhole Limpet Hemocyanin for use in immunotherapy and immunodiagnostic applications. Our internal research includes, among other activities, continual improvement of methods for the culture and growth of Giant Keyhole Limpet, innovations in aquaculture systems and infrastructure, biophysical and biochemical characterization of the KLH molecule, analytical processes to enhance performance of our products, KLH manufacturing process improvements, new KLH formulations, and early development of potential new KLH-based immunotherapies. Research and development costs, including materials and salaries of employees directly involved in research and development efforts, are expensed as incurred. The following table includes our research and development costs for each of the most recent three fiscal years: Disclosure of Contractual Obligations We lease three buildings and facilities used in operations under sublease agreements with the Port Hueneme Surplus Property Authority. In June 2015, we exercised our option to extend these sublease agreements for an additional five-year term beginning in October and November 2015. We also negotiated an option to extend the leases for two additional five-year terms. We lease facilities used for executive offices and laboratories, and we must pay a portion of the common area maintenance. In July 2014, we exercised our option to extend this lease for a two-year term. In June 2015, we leased undeveloped land in Baja California, Mexico to assess its suitability for the long-term development and potential expansion of our production capability. The first two years rent was prepaid in June 2015. The initial term is three years and we may terminate early with 30 days’ notice. If we decide to proceed with development of the site, we have options to extend the lease for 30 years. We have purchase commitments for contract research organizations and consultants. The approximate amounts of our contractual obligations are as follows: Contractual Obligations As of September 30, 2015 Significant Accounting Policies and Estimates Our consolidated financial statements, which are indexed under Item 15 of this Annual Report on Form 10-K, have been prepared in accordance with accounting principles generally accepted in the United States, which require that the management make certain assumptions and estimates and, in connection therewith, adopt certain accounting policies. Our significant accounting policies are set forth in Note 3 in the Notes to Consolidated Financial Statements. Of those policies, we believe that the policies discussed below may involve a higher degree of judgment or may otherwise be more relevant to our financial condition and results of operations. Investments Investments include a mutual fund of short-term fixed, floating and variable rate debt securities with normal weighted average effective maturity of approximately 1 year or less. This mutual fund investment is classified as held-to-maturity and reported at fair value using level 1 inputs. Investments also include Canadian enhanced yield time deposits with an original maturity of 6 months. These enhanced yield time deposits are classified as held-to-maturity and are reported at amortized cost, which approximates fair value. We regularly review our investments in enhanced yield time deposits to determine whether a decline in fair value below the cost basis is other than temporary. If the decline in fair value is determined to be other than temporary, the cost basis of the investment is written down to fair value. Inventory We record inventory at the lower of cost or market, with market not in excess of net realizable value. Raw materials are measured using FIFO (first-in first-out) cost. Work in process and finished goods are measured using average cost. Raw materials include inventory of manufacturing supplies. Work in process includes manufacturing supplies, direct and indirect labor, contracted manufacturing and testing, and allocated manufacturing overhead for inventory in process at the end of the period. Finished goods include products that are complete and available for sale. In fiscal 2015, the Company recorded work in process and finished goods inventory only for those products with recent sales levels to evaluate net realizable value. In fiscal 2014 and prior, the Company recorded inventory only for custom manufacturing of products for specific customers, including manufacturing under supply agreements. Fair Value of Financial Instruments We use the fair value measurement framework for valuing financial assets and liabilities measured on a recurring basis in situations where other accounting pronouncements either permit or require fair value measurements. Fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The carrying value of certain financial instruments such as accounts receivable, accounts payable, accrued liabilities, and deferred revenue approximates fair value due to the short-term nature of such instruments. Canadian enhanced yield time deposits are reported at amortized cost, which approximates fair value. We follow the 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. There are three levels of inputs that may be used to measure fair value: Level 1: Quoted prices in active markets for identical or similar assets and liabilities. Level 2: Quoted prices for identical or similar assets and liabilities in markets that are not active or observable inputs other than quoted prices in active markets for identical or similar assets and liabilities. Level 3: Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. We record our short-term investments in mutual fund debt securities at fair value using Level 1 inputs in the fair value hierarchy. We record our warrant liability at fair value using Level 2 input using the Black-Scholes option valuation model. Warrant Liability Our equity offerings in prior years included the issuance of warrants with exercise prices denominated in Canadian dollars. As a result of having exercise prices denominated in a currency other than our functional currency, our warrants with Canadian dollar exercise prices meet the definition of derivatives and are therefore classified as derivative liabilities measured at fair value with noncash adjustments to fair value recognized through the consolidated statements of operations. Upon exercise of these warrants, the fair value of warrants included in derivative liabilities is reclassified to common shares. If these warrants expire, the related decrease in warrant liability is recognized as gain in fair value of warrant liability. There is no cash flow impact as a result of this accounting treatment. The fair value of the warrants is determined using the Black-Scholes option valuation model at the end of each reporting period. The losses and gains in each year are a reflection of our share price fluctuations with increases in share prices causing greater warrant liability and a resulting loss in fair value of warrant liability, while decreases in share prices cause a resulting gain in fair value of warrant liability. Changes in fair value of warrant liability have no impact on cash flow. Revenue Recognition Contract Services Revenue We recognize contract services revenue when contract services have been performed and reasonable assurance exists regarding measurement and collectability. An appropriate amount will be recognized as revenue in the period that we are assured of fulfilling the contract requirements. Amounts received in advance of performance of contract services are recorded as deferred revenue. Contract services include services performed under collaboration agreements and monthly maintenance of limpet colonies through December 2014 designated to meet the needs of the customer. We also have the right to use raw material produced from designated limpet colonies at no cost to us with prior written consent from the customer. Product Sales We recognize product sales when KLH product is shipped (for which the risk is typically transferred upon delivery to the shipping carrier) and there is persuasive evidence of an arrangement, the fee is fixed or determinable, and collectability is reasonably assured. We document arrangements with customers with purchase orders and sales agreements. Product sales include sales made under supply agreements with customers for a fixed price per gram of KLH products based on quantities ordered, including those produced from a customer’s designated limpet colonies. The supply agreements are on a non-exclusive basis except within that customer’s field of use. Share-Based Compensation We grant options to buy common shares of the Company to our directors, officers, employees and consultants, and grant other equity-based instruments to non-employees. The fair value of share-based compensation is measured on the date of grant, using the Black-Scholes option valuation model and is recognized over the vesting period net of estimated forfeitures for employees or the service period for non-employees. The Black-Scholes option valuation model requires the input of subjective assumptions, including price volatility of the underlying stock, risk-free interest rate, dividend yield, and expected life of the option. Foreign Exchange Items included in the financial statements of our subsidiary are measured using the currency of the primary economic environment in which the entity operates (the “functional currency”). Our functional currency and the functional currency of our subsidiary is the U.S. dollar. Transactions in currencies other than the U.S. dollar are recorded at exchange rates prevailing on the dates of the transactions. Segments We operate in one reportable segment and, accordingly, no segment disclosures have been presented. All equipment, leasehold improvements and other fixed assets owned by us are physically located within the United States (except for insignificant leasehold improvements under evaluation in Baja, Mexico), and all supply, collaboration and licensing agreements are denominated in U.S. dollars. The geographic markets of our customers are principally Europe, the United States and Asia. The geographic breakdown of revenues in fiscal 2015 was 53% Europe, 38% Asia and 9% U.S.; fiscal 2014 was 41% Europe, 40% Asia, 14% U.S., and 6% Canada; and fiscal 2013 was 84% Europe, 12% U.S., 3% South America and 1% Canada. Recent Accounting Pronouncements In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606). ASU 2014-09 creates a new topic in the Accounting Standards Codification (“ASC”) Topic 606 and establishes a new control-based revenue recognition model, changes the basis for deciding when revenue is recognized over time or at a point in time, provides new and more detailed guidance on specific topics, and expands and improves disclosures about revenue. In addition, ASU 2014-09 adds a new Subtopic to the Codification, ASC 340-40, Other Assets and Deferred Costs: Contracts with Customers, to provide guidance on costs related to obtaining a contract with a customer and costs incurred in fulfilling a contract with a customer that are not in the scope of another ASC Topic. The guidance in ASU 2014-09 is effective for public entities for annual reporting periods beginning after December 15, 2017, including interim periods therein. Early application is not permitted. Management is in the process of assessing the impact of ASU 2014-09 on the Company’s consolidated financial statements. In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity's Ability to Continue as a Going Concern. ASU 2014-15 defines management's responsibility to evaluate whether there is substantial doubt about an organization's ability to continue as a going concern and to provide related footnote disclosures. The guidance in ASU 2014-15 is effective for annual reporting periods beginning after December 15, 2016, with early application permitted. Management is in the process of assessing the impact of ASU 2014-15 on the Company’s consolidated financial statements. In July 2015, FASB issued ASU 2015-11, Simplifying the Measurement of Inventory (Topic 330). ASU 2015-11 indicates that an entity should measure inventory at the lower of cost and net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The ASU does not apply to inventory measured using LIFO or the retail inventory method. It does apply to all other inventory, including inventory measured using FIFO or average cost. The guidance in ASU 2015-11 is effective for public entities for annual reporting periods beginning after December 15, 2016, including interim periods therein. The provisions should be applied prospectively with early application permitted. Management is in the process of assessing the impact of ASU 2015-11 on the Company’s consolidated financial statements. CERTAIN INCOME TAX CONSIDERATIONS United States Federal Income Taxation As used below, a “U.S. holder” is a beneficial owner of a common share that is, for U.S. federal income tax purposes, (i) a citizen or resident alien individual of the United States, (ii) a corporation (or an entity treated as a corporation) created or organized under the law of the United States, any State thereof or the District of Columbia, (iii) an estate the income of which is subject to U.S. federal income tax without regard to its source or (iv) a trust if (1) a court within the United States is able to exercise primary supervision over the administration of the trust, and one or more United States persons have the authority to control all substantial decisions of the trust, or (2) the trust has a valid election in effect under applicable U.S. Treasury Regulations to be treated as a United States person. For purposes of this discussion, a “non-U.S. holder” is a beneficial owner of a common share that is (i) a nonresident alien individual, (ii) a corporation (or an entity treated as a corporation) created or organized in or under the law of a country other than the United States or a political subdivision thereof or (iii) an estate or trust that is not a U.S. Holder. If a partnership (including for this purpose any entity treated as a partnership for U.S. federal tax purposes) is a beneficial owner of a common share, the U.S. federal tax treatment of a partner in the partnership generally will depend on the status of the partner and the activities of the partnership. A holder of a common share that is a partnership and partners in that partnership should consult their own tax advisers regarding the U.S. federal income tax consequences of holding and disposing of common shares. We have not sought a ruling from the Internal Revenue Service (“IRS”) or an opinion of counsel as to any U.S. federal income tax consequence described herein. The IRS may disagree with the description herein, and its determination may be upheld by a court. This discussion does not address U.S. federal tax laws other than those pertaining to U.S. federal income taxation (such as estate or gift tax laws), nor does it address any aspects of U.S. state or local or non-U.S. taxation. GIVEN THE COMPLEXITY OF THE TAX LAWS AND BECAUSE THE TAX CONSEQUENCES TO ANY PARTICULAR SHAREHOLDER MAY BE AFFECTED BY MATTERS NOT DISCUSSED HEREIN, SHAREHOLDERS ARE URGED TO CONSULT THEIR OWN TAX ADVISORS WITH RESPECT TO THE SPECIFIC TAX CONSEQUENCES OF THE ACQUISITION, OWNERSHIP AND DISPOSITION OF COMMON SHARES, INCLUDING THE APPLICABILITY AND EFFECT OF STATE, LOCAL AND NON-U.S. TAX LAWS, AS WELL AS U.S. FEDERAL TAX LAWS. Taxation of Dividends U.S. Holders. In general, subject to the passive foreign investment company rules discussed below, a distribution on a common share will constitute a dividend for U.S. federal income tax purposes to the extent that it is made from a corporation’s current or accumulated earnings and profits as determined under U.S. federal income tax principles. If a distribution exceeds the current and accumulated earnings and profits of the distributing corporation, it will generally be treated as a non-taxable reduction of basis to the extent of the U.S. holder’s tax basis in the common share on which it is paid, and to the extent it exceeds that basis it will be treated as capital gain. The Company has not and does not plan to maintain calculations of earnings and profits under U.S. federal income tax principles. Accordingly, it is unlikely that U.S. holders will be able to establish that a distribution by the Company is in excess of its current and accumulated earnings and profits (as computed under U.S. federal income tax principles). Therefore, a U.S. holder should expect that a distribution by the Company will generally be taxable in its entirety as a dividend to U.S. holders for U.S. federal income tax purposes even though the distribution may be treated in whole or in part as a non-taxable distribution for Canadian tax purposes. The gross amount of any dividend on a common share (which will include the amount of any Canadian taxes withheld with respect to such dividend) generally will be subject to U.S. federal income tax as foreign source dividend income, and will not be eligible for the corporate dividends received deduction. The amount of a dividend paid in Canadian dollars will be its value in U.S. dollars based on the prevailing spot market exchange rate in effect on the day the U.S. holder receives the dividend. A U.S. holder will have a tax basis in any distributed Canadian dollars equal to their U.S. dollar value on the date of receipt, and any gain or loss realized on a subsequent conversion or other disposition of such Canadian dollars generally will be treated as U.S. source ordinary income or loss. If dividends paid in Canadian dollars are converted into U.S. dollars on the date they are received by a U.S. holder, the U.S. holder generally should not be required to recognize foreign currency gain or loss in respect of the dividend income. Subject to certain exceptions for short-term and hedged positions, as well as the passive foreign investment rules, a dividend that a non-corporate holder receives on a common share will generally be subject to a maximum federal income tax rate of 20% if the dividend is a “qualified dividend.” A dividend on a common share will be a qualified dividend if (i) either (a) the common shares are readily tradable on an established market in the United States or (b) we are eligible for the benefits of a comprehensive income tax treaty with the United States that the Secretary of the Treasury determines is satisfactory for purposes of these rules and that includes an exchange of information program, and (ii) we were not, in the year prior to the year the dividend was paid, and are not, in the year the dividend is paid, a passive foreign investment company (“PFIC”). The common shares are listed on The Nasdaq Capital Market which should be treated as an established securities market in the United States. In any event, the U.S. Canada Income Convention (the “Treaty”) satisfies the requirements of clause (i)(b), the Company is incorporated in and tax resident of Canada and should be entitled to the benefits of the Treaty. Based on our audited financial statements, income tax returns and relevant market and shareholder data, we believe that we likely will not be classified as a PFIC in the September 30, 2015 or August 31, 2014 taxable years. There can be no assurance, however, that the Company will not be considered to be a PFIC for any particular year in the future because PFIC status is factual in nature, depends upon factors not wholly within the Company’s control, generally cannot be determined until the close of the taxable year in question, and is determined annually. Accordingly, no assurance can be made that a dividend paid, if any, would be a “qualified dividend.” In addition, as described in the section below entitled “Passive Foreign Investment Company Rules,” if we were a PFIC in a year while a U.S. holder held a common share, and if the U.S. holder has not made a qualified electing fund election effective for the first year the U.S. holder held the common share, the common share remains an interest in a PFIC for all future years or until such an election is made. The IRS takes the position that such rule will apply for purposes of determining whether a common share is an interest in a PFIC in the year a dividend is paid or in the prior year, even if we do not satisfy the tests to be a PFIC in either of those years. Even if dividends on the common shares would otherwise be eligible for qualified dividend treatment, in order to qualify for the reduced qualified dividend tax rates, a non-corporate holder must hold the common share on which a dividend is paid for more than 60 days during the 120-day period beginning 60 days before the ex-dividend date, disregarding for this purpose any period during which the non-corporate holder has an option to sell, is under a contractual obligation to sell or has made (and not closed) a short sale of substantially identical stock or securities, is the grantor of an option to buy substantially identical stock or securities or, pursuant to Treasury regulations, has diminished such holder’s risk of loss by holding one or more other positions with respect to substantially similar or related property. In addition, to qualify for the reduced qualified dividend tax rates, the non-corporate holder must not be obligated to make related payments with respect to positions in substantially similar or related property. Payments in lieu of dividends from short sales or other similar transactions will not qualify for the reduced qualified dividend tax rates. A non-corporate holder that receives an extraordinary dividend (generally, any dividend that is in excess of 10% of the holder's adjusted basis in the common share on which the dividend is paid) that is eligible for the reduced qualified dividend rates must treat any loss on the sale of the common share as a long-term capital loss to the extent of the dividend. For purposes of determining the amount of a non-corporate holder’s deductible investment interest expense, a dividend is treated as investment income only if the non-corporate holder elects to treat the dividend as not eligible for the reduced qualified dividend tax rates. Special limitations on foreign tax credits with respect to dividends subject to the reduced qualified dividend tax rates apply to reflect the reduced rates of tax. The U.S. Treasury has announced its intention to promulgate rules pursuant to which non-corporate holders of stock of non-U.S. corporations, and intermediaries through which the stock is held, will be permitted to rely on certifications from issuers to establish that dividends are treated as qualified dividends. Because those procedures have not yet been issued, it is not clear whether we will be able to comply with them. Non-corporate holders of common shares are urged to consult their own tax advisers regarding the availability of the reduced qualified dividend tax rates with respect to dividends, if any, received on the common shares in the light of their own particular circumstances. Any Canadian withholding tax imposed on dividends received with respect to the common shares will be treated as a foreign income tax eligible for credit against a U.S. holder’s U.S. federal income tax liability, subject to generally applicable limitations under U.S. federal income tax law. For purposes of computing those limitations separately under current law for specific categories of income, a dividend generally will constitute foreign source “passive category income” or, in the case of certain holders, “general category income.” A U.S. holder will be denied a foreign tax credit with respect to Canadian income tax withheld from dividends received with respect to the common shares to the extent the U.S. holder has not held the common shares for at least 16 days of the 30-day period beginning on the date which is 15 days before the ex-dividend date or to the extent the U.S. holder is under an obligation to make related payments with respect to substantially similar or related property. Any days during which a U.S. holder has substantially diminished its risk of loss on the common shares are not counted toward meeting the 16-day holding period required by the statute. The rules relating to the determination of the foreign tax credit are complex, and U.S. holders are urged to consult with their own tax advisers to determine whether and to what extent they will be entitled to foreign tax credits as well as with respect to the determination of the foreign tax credit limitation. Alternatively, any Canadian withholding tax may be taken as a deduction against taxable income, provided the U.S. holder takes a deduction and not a credit for all foreign income taxes paid or accrued in the same taxable year. In general, special rules will apply to the calculation of foreign tax credits in respect of dividend income that is subject to preferential rates of U.S. federal income tax. Non-U.S. Holders. A dividend paid to a non-U.S. holder of a common share will generally not be subject to U.S. federal income tax unless the dividend is effectively connected with the conduct of trade or business by the non-U.S. holder within the United States (and is attributable to a permanent establishment or fixed base the non-U.S. holder maintains in the United States if an applicable income tax treaty so requires as a condition for the non-U.S. holder to be subject to U.S. taxation on a net income basis on income from the common share). A non-U.S. holder generally will be subject to tax on an effectively connected dividend in the same manner as a U.S. holder. A corporate non-U.S. holder under certain circumstances may also be subject to an additional “branch profits tax,” the rate of which may be reduced pursuant to an applicable income tax treaty. Taxation of Capital Gains U.S. Holders. Subject to the passive foreign investment company rules discussed below, on a sale or other taxable disposition of a common share, a U.S. holder will recognize capital gain or loss in an amount equal to the difference between the U.S. holder’s adjusted basis in the common share and the amount realized on the sale or other disposition, each determined in U.S. dollars. Such capital gain or loss will be long-term capital gain or loss if at the time of the sale or other taxable disposition the common share has been held for more than one year. In general, any adjusted net capital gain of an individual is subject to a maximum federal income tax rate of 20%. Capital gains recognized by corporate U.S. holders generally are subject to U.S. federal income tax at the same rate as ordinary income. The deductibility of capital losses is subject to limitations. Any gain a U.S. holder recognizes generally will be U.S. source income for U.S. foreign tax credit purposes, and, subject to certain exceptions, any loss will generally be a U.S. source loss. If a Canadian tax is paid on a sale or other disposition of a common share, the amount realized will include the gross amount of the proceeds of that sale or disposition before deduction of the Canadian tax. The generally applicable limitations under U.S. federal income tax law on crediting foreign income taxes may preclude a U.S. holder from obtaining a foreign tax credit for any Canadian tax paid on a sale or other disposition of a common share. The rules relating to the determination of the foreign tax credit are complex, and U.S. holders are urged to consult with their own tax advisers regarding the application of such rules. Alternatively, any Canadian tax paid on the sale or other disposition of a common share may be taken as a deduction against taxable income, provided the U.S. holder takes a deduction and not a credit for all foreign income taxes paid or accrued in the same taxable year. Non-U.S. Holders. A non-U.S. holder will not be subject to U.S. federal income tax on gain recognized on a sale or other disposition of a common share unless (i) the gain is effectively connected with the conduct of trade or business by the non-U.S. holder within the United States (and is attributable to a permanent establishment or fixed base the non-U.S. holder maintains in the United States if an applicable income tax treaty so requires as a condition for the non-U.S. holder to be subject to U.S. taxation on a net income basis on income from the common share), or (ii) in the case of a non-U.S. holder who is an individual, the holder is present in the United States for 183 or more days in the taxable year of the sale or other disposition and certain other conditions apply. Any effectively connected gain of a corporate non-U.S. holder may also be subject under certain circumstances to an additional “branch profits tax,” the rate of which may be reduced pursuant to an applicable income tax treaty. Passive Foreign Investment Company Rules A special set of U.S. federal income tax rules applies to a foreign corporation that is a PFIC for U.S. federal income tax purposes. As noted above, based on our audited financial statements, income tax returns, and relevant market and shareholder data, we believe that we likely will not be classified as a PFIC in the September 30, 2015 or August 31, 2014 taxable years. There can be no assurance, however, that the Company will not be considered to be a PFIC for any particular year in the future because PFIC status is factual in nature, depends upon factors not wholly within the Company’s control, generally cannot be determined until the close of the taxable year in question, and is determined annually. In general, a non-US corporation is a PFIC if in any taxable year either (i) at least 75% of its gross income is “passive income” or (ii) at least 50% of the quarterly average value of its assets is attributable to assets that produce or are held to produce “passive income.” In applying these tests, the Company generally is treated as holding its proportionate share of the assets and receiving its proportionate share of the income of any other corporation in which the Company owns at least 25% by value of the shares. Passive income for this purpose generally includes dividends, interest, royalties, rent and capital gains, but generally does not include certain royalties derived in an active business. Passive assets are those assets that are held for production of passive income or do not produce income at all. Thus cash will be a passive asset. Interest, including interest on working capital, is treated as passive income for purposes of the income test. Without taking into account the value of its goodwill, more than 50% of the Company’s assets by value would be passive so that the Company would be a PFIC under the asset test. Based upon its current operations, its goodwill (the value of which should be based upon the Company’s market capitalization) will likely be attributable to its activities that will generate active income and to such extent, should be treated as an active asset. The determination of whether a foreign corporation is a PFIC is a factual determination made annually and is therefore subject to change. Subject to exceptions pursuant to certain elections that generally require the payment of tax, once stock in a foreign corporation is stock in a PFIC in the hands of a particular shareholder that is a United States person, it remains stock in a PFIC in the hands of that shareholder. If we are treated as a PFIC, contrary to the tax consequences described in “Taxation of Dividends” and “Taxation of Capital Gains” above, a U.S. holder that does not make an election described in the succeeding two paragraphs would be subject to special rules with respect to (i) any gain realized on a sale or other disposition of a common share (for purposes of these rules, a disposition of a common share includes many transactions on which gain or loss is not realized under general U.S. federal income tax rules) and (ii) any “excess distribution” by the Company to the U.S. holder (generally, any distribution during a taxable year in which distributions to the U.S. holder on the common share exceed 125% of the average annual taxable distributions (whether actual or constructive and whether or not out of earnings and profits) the U.S. holder received on the common share during the preceding three taxable years or, if shorter, the U.S. holder’s holding period for the common share). Under those rules, (i) the gain or excess distribution would be allocated ratably over the U.S. holder’s holding period for the common share, (ii) the amount allocated to the taxable year in which the gain or excess distribution is realized would be taxable as ordinary income in its entirety and not as capital gain, would be ineligible for the reduced qualified dividend rates, and could not be offset by any deductions or losses, and (iii) the amount allocated to each prior year, with certain exceptions, would be subject to tax at the highest tax rate in effect for that year, and the interest charge generally applicable to underpayments of tax would be imposed in respect of the tax attributable to each of those years. The special PFIC rules described above will not apply to a U.S. holder if the U.S. holder makes a timely election, which remains in effect, to treat the Company as a “qualified electing fund” (“QEF”) in the first taxable year in which the U.S. holder owns a common share and the Company is a PFIC and if the Company complies with certain requirements. Instead, a shareholder of a QEF generally is currently taxable on a pro rata share of the Company’s ordinary earnings and net capital gain as ordinary income and long-term capital gain, respectively. Neither that ordinary income nor any actual dividend from the Company would qualify for the 20% maximum federal income tax rate on dividends described above if the Company is a PFIC in the taxable year the ordinary income is realized or the dividend is paid or in the preceding taxable year. A QEF election cannot be made unless the Company provides U.S. Holders the information and computations needed to report income and gains pursuant to a QEF election. The Company expects that will not provide this information. It is, therefore, likely that U.S. holders would not be able to make a QEF election in any year we are a PFIC. In lieu of a QEF election, a U.S. holder of stock in a PFIC that is considered marketable stock could elect to mark the stock to market annually, recognizing as ordinary income or loss each year an amount equal to the difference as of the close of the taxable year between the fair market value of the stock and the U.S. holder’s adjusted basis in the stock. Losses would be allowed only to the extent of net mark-to-market gain previously included in income by the U.S. holder under the election for prior taxable years. A U.S. holder’s adjusted basis in the common shares will be adjusted to reflect the amounts included or deducted with respect to the mark-to-market election. If the mark-to-market election were made, the rules set forth in the second preceding paragraph would not apply for periods covered by the election. A mark-to-market election will not apply during any later taxable year in which the Company does not satisfy the tests to be a PFIC. In general, the common shares will be marketable stock if the common shares are traded, other than in de minimis quantities, on at least 15 days during each calendar quarter on a national securities exchange that is registered with the SEC or on a designated national market system or on any exchange or market that the Treasury Department determines to have rules sufficient to ensure that the market price accurately represents the fair market value of the stock. Under current law, the mark-to-market election may be available to U.S. holders of common shares because the common shares are listed on The Nasdaq Capital Market and the TSX Venture Exchange (at least one of which should constitute a qualified exchange for this purpose), although there can be no assurance that the common shares will be “regularly traded” for purposes of the mark-to-market election. If we are treated as a PFIC, each U.S. holder generally will be required to file a separate annual information return with the United States Internal Revenue Service (IRS) with respect to the Company (and any lower-tier PFICs). A failure to file this return will suspend the statute of limitations with respect to any tax return, event, or period to which such report relates (potentially including with respect to items that do not relate to a U.S. holder’s investment in the common shares). Given the complexities of the PFIC rules and their potentially adverse tax consequences, U.S. holders of common shares are urged to consult their tax advisers about the PFIC rules. Medicare Surtax on Net Investment Income Non-corporate U.S. Holders whose income exceeds certain thresholds generally will be subject to 3.8% surtax on their “net investment income” (which generally includes, among other things, dividends on, and capital gain from the sale or other taxable disposition of, the common shares). Absent an election to the contrary, if a QEF election is available and made, QEF inclusions will not be included in net investment income at the time a U.S. Holder includes such amounts in income, but rather will be included at the time distributions are received or gains are recognized. Non-corporate U.S. Holders should consult their own tax advisors regarding the possible effect of such tax on their ownership and disposition of the common shares, in particular the applicability of this surtax with respect to a non-corporate U.S. Holder that makes a QEF or mark-to-market election in respect of their common shares. Information Reporting and Backup Withholding Dividends paid on, and proceeds from the sale or other disposition of, a common share to a U.S. holder generally may be subject to information reporting requirements and may be subject to backup withholding unless the U.S. holder provides an accurate taxpayer identification number or otherwise establishes an exemption. The amount of any backup withholding collected from a payment to a U.S. holder will be allowed as a credit against the U.S. holder’s U.S. federal income tax liability and may entitle the U.S. holder to a refund, provided certain required information is furnished to the Internal Revenue Service. A non-U.S. holder generally will be exempt from these information reporting requirements and backup withholding tax but may be required to comply with certain certification and identification procedures in order to establish its eligibility for exemption. Under U.S. federal income tax law and U.S. Treasury Regulations, certain categories of U.S. holders must file information returns with respect to their investment in, or involvement in, a foreign corporation. U.S. holders are urged to consult with their own tax advisors concerning such reporting requirements. Reporting Obligations of Individual Owners of Foreign Financial Assets Section 6038D of the Code generally requires U.S. individuals (and possibly certain entities that have U.S. individual owners) to file IRS Form 8938 if they hold certain “specified foreign financial assets,” the aggregate value of which exceeds $50,000. The definition of specified foreign financial assets includes not only financial accounts maintained in foreign financial institutions, but also, unless held in accounts maintained by a financial institution, any stock or security issued by a non-US. person, any financial instrument or contract held for investment that has an issuer or counterparty other than a U.S. person and any interest in a foreign entity. Persons who are required to report foreign financial assets and fail to do so may be subject to substantial penalties. Canadian Federal Income Tax Consequences The following summary of the material Canadian federal income tax consequences is stated in general terms and is not intended to be legal or tax advice to any particular shareholder. Each shareholder or prospective shareholder is urged to consult his or her own tax advisor regarding the tax consequences of his or her purchase, ownership and disposition of common shares. The tax consequences to any particular holder of common shares will vary according to the status of that holder as an individual, trust, corporation or member of a partnership, the jurisdiction in which that holder is subject to taxation, the place where that holder is resident and, generally, according to that holder’s particular circumstances. This summary is applicable only to holders who are resident in the United States for income tax purposes, have never been resident in Canada for income tax purposes, deal at arm’s length with the Company, hold their common shares as capital property and who will not use or hold the common shares in carrying on business in Canada. Special rules, which are not discussed in this summary, may apply to a United States holder that is an issuer that carries on business in Canada and elsewhere. This summary is based upon the provisions of the Income Tax Act (Canada) and the regulations thereunder (collectively, the “Tax Act” or “ITA”) and the Canada-United States Tax Convention (the “Tax Convention”) at the date of this Annual Report and the current administrative practices of the Canada Revenue Agency. This summary does not take into account provincial income tax consequences. The comments in this summary that are based on the Tax Convention are applicable to U.S. holders only if they qualify for benefits under the Tax Convention. Management urges each holder to consult his own tax advisor with respect to the income tax consequences applicable to him in his own particular circumstances. Non-Resident Holders The summary below is restricted to the case of a holder (a “Holder”) of one or more common shares who for the purposes of the Tax Act is a non-resident of Canada, holds his common shares as capital property and deals at arm’s length with the Company. Dividends A Holder will be subject to Canadian withholding tax (“Part XIII Tax”) equal to 25%, or such lower rates as may be available under an applicable tax treaty, of the gross amount of any dividend paid or deemed to be paid on his common shares. The Company will be required to withhold the applicable amount of Part XIII Tax from each dividend so paid and remit the withheld amount directly to the Receiver General for Canada for the account of the Holder. Disposition of Common Shares A Holder who disposes of common shares, including by deemed disposition on death, will not be subject to Canadian tax on any capital gain thereby realized unless the common share constituted “taxable Canadian property” as defined by the Tax Act. Generally, a common share of a public corporation will not constitute taxable Canadian property of a Holder unless he held the common share as capital property used by him carrying on a business in Canada, or he, persons with whom he did not deal at arm’s length or (under currently proposed rules) partnerships in which he or persons with whom he did not deal at arm’s length held an interest, alone or together held or held options to acquire, at any time within the 60 months preceding the disposition, 25% or more of the issued shares of any class of the capital stock of the Company and at any time during the 60 months preceding the disposition more than 50% of the value of the common shares is derived from, or from an interest in, Canadian real estate, including Canadian resource or timber resource properties. Holders Resident in the United States A Holder who is a resident of the United States and realizes a capital gain on disposition of common shares that was taxable Canadian property will, if qualified for benefits under the Tax Convention, generally be exempt from Canadian tax thereon unless (a) more than 50% of the value of the common shares is derived from, or from an interest in, Canadian real estate, including Canadian mineral resources properties, (b) the common shares formed part of the business property of a permanent establishment that the Holder has or had in Canada within the 12 months preceding disposition, or (c) the Holder (i) was a resident of Canada at any time within the ten years immediately preceding the disposition, and for a total of 120 months during any period of 20 consecutive years, preceding the disposition, (ii) owned the common shares when he ceased to be resident in Canada, and (iii) the common shares were not subject to a deemed disposition on the Holder’s departure from Canada. Inclusion in Taxable Income A Holder who is subject to Canadian tax in respect of a capital gain realized on disposition of common shares must include one half of the capital gain (“taxable capital gain”) in computing his taxable income earned in Canada. The Holder may, subject to certain limitations, deduct one half of any capital loss (“allowable capital loss”) arising on disposition of taxable Canadian property from taxable capital gains realized in the year of disposition in respect to taxable Canadian property and, to the extent not so deductible, from such taxable capital gains of any of the three preceding years or any subsequent year. Subject to certain exceptions, a non-resident person who disposes of taxable Canadian property must notify the Canada Revenue Agency either before or after the disposition (within ten days of the disposition). Item 7A.

1540159

2015

Item 6. Selected Financial Data The information set forth under “Financial Summary - Five Year Financial Summary,” which appears on page 60 of the Company’s 2015 Annual Report to Shareholders, is incorporated herein by reference. Such information should be read along with the Company’s financial statements and the notes to those financial statements and with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” incorporated by reference elsewhere herein. Item 7.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations The information set forth under “Management’s Discussion and Analysis,” which appears on pages 14 through 32 of the Company’s 2015 Annual Report to Shareholders, is incorporated herein by reference. Item 7A.

933034

2015

Item 6.Selected Financial Data The following table presents selected financial data for the last five years and should be read in conjunction with “Item 7.

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Introduction Management’s discussion and analysis (“MD&A”) should be read in conjunction with Part I of this Form 10-K as well as the consolidated financial statements and related notes included in Item 8 of this Form 10-K. Overview During 2015, we delivered on the strategic objectives we established in the fourth quarter of 2014, which included: (1) focusing on differentiated offerings in our core markets, with emphasis on global sales, commercial rigor and consistent delivery, (2) rebalancing our business portfolio, streamlining operations and reducing costs, (3) continuing in our efforts to proactively resolve legacy disputes and litigation and (4) retaining a strong balance sheet while employing a balanced capital allocation policy. In conjunction with our strategic initiative, effective December 2014, we reorganized our business into three segments, T&C, E&C and GS to focus on our core strengths in global hydrocarbons and international government services. Our corporate expenses and other operations that do not individually meet the criteria for group presentation are now included in our Other business segment, while operations we intend to exit upon completing the existing contracts are in our Non-strategic Business segment. Each business segment, excluding our Other business segment, reflects a reportable segment led by a separate business segment president who reports directly to our chief operating decision maker ("CODM"). See "Item 1. Business" for a description of the business segments. Business Environment Our portfolio includes process technologies, energy project technical consulting, engineering, program management, construction, asset life cycle solutions and other related services. We provide these services to a wide range of customers across the hydrocarbons value chain and to various international and U.S. governmental agencies. The demand for our services depends on the level of capital and operating expenditures of our customers, which is often considered against prevailing market conditions and the availability of resources to support and fund projects. The significant decline in commodity prices has resulted in some of our oil and gas customers taking steps to defer, suspend or terminate capital expenditures. Upstream oil projects have experienced the largest reductions in capital expenditures, as the effect of declining oil prices has been more pronounced in this sector. We continue to see other opportunities in the hydrocarbons market, including midstream gas projects such as LNG to satisfy future demand, and across the downstream sector, which will benefit from low feedstock prices. We believe that success in gas monetization, specifically LNG, is driven by the fundamental economic profile of these types of projects and requires the same focus in the selection of sustainable solutions. To deliver positive outcomes in these areas we collaborate with our customers using integrated teams, from project conceptualization and technical solutions selection through project award and implementation. The current environment of low feedstock and energy prices has created strong downstream infrastructure investment in the U.S. Continued investment in the U.S. downstream market is expected to be supported, under the current market conditions, by international demand for petrochemicals and byproducts, derived from low gas prices. We expect investors to continue to reevaluate international downstream infrastructure investments for opportunities in the U.S. that offer low feedstock (i.e. natural gas) for their projects. We expect continued opportunities within our global GS business as we drive higher value and lower cost solutions to support governments’ increasing training needs, operation, maintenance and sustainment requirements amidst generally lower operating budgets. We believe KBR has a balanced portfolio of upstream, midstream and downstream solutions as well as recurring government services outsourcing opportunities, which together provide us with less exposure to the oil price declines than some of our peers. Overview of Financial Results 2015 was a transformational year on the path towards KBR achieving the strategic objectives outlined during our Analyst Day in New York, NY, on December 11, 2014. In 2015, we successfully restructured our business, refocused the company around our core strengths in the hydrocarbons and international government services businesses, rebalanced our business portfolio through sales of businesses or through formation of strategic partnerships, significantly reduced our overhead costs and deployed a balanced capital allocation strategy while maintaining a strong balance sheet. Exiting 2015, we are well on track to successfully complete our business transformation by the end of 2016. During the year we made significant progress in winding down activities related to our Non-strategic business segment. We completed two of three fixed-price EPC Power projects, with the third EPC power project expected to be completed in 2017. We also completed the sale of our Building Group and Infrastructure Americas businesses. We made strong progress rebalancing our business portfolio to enhance the value creation for certain businesses that were under review by the company. We executed agreements to establish two strategic relationships within our E&C business segment. These relationships allowed us to (1) establish the Brown & Root Industrial Services 50/50 joint venture, where we contributed our Industrial Services Americas business in order to grow this business in North America, and (2) acquired a minority interest in a Gulf Coast pipe fabrication business, where we contributed a majority of our Canadian pipe fabrication and module assembly business. During 2015, we completed the last of the seven loss-making Canadian pipe fabrication and module assembly projects, further reducing the risk in KBR’s portfolio during the year. In our GS business segment, we have been in the process of closeout of the legacy LogCAP III contract with the U.S. government which concluded in 2011. The U.S. government audits through 2011 are now complete with $9 million in questioned costs remaining out of approximately $46 billion in audited, incurred costs through 2011. We expect to conclude discussions regarding the questioned $9 million during 2016. We maintain provisions for all incurred cost audits and believe our settlement amount on the $9 million in disputed costs will fall within our previously provisioned amounts, further reducing risk in our legacy portfolio. However, we still have $173 million subject to issued and outstanding Form 1s. We were also successful in having numerous tort cases against us relating to alleged exposure to sodium dichromate from work performed under the LogCAP III contract dismissed on the merits. Although these cases are being appealed, we believe our risk of loss has been significantly reduced. We made significant progress in reducing our operating expenses against our year-end 2016 strategic target of $200 million in annualized savings. To-date, we have identified and actioned more than $165 million of the $200 million in savings across the company. Our transformation in 2015 has made KBR a leaner, more efficient and more customer-focused organization with improved operational capabilities delivering consistent and improved financial results. Our financial results for the year ended December 31, 2015 were significantly improved from the year ended December 31, 2014. We generated net income in 2015 of $203 million compared to a net loss of $1.3 billion in 2014. Restructuring charges, impairments of goodwill and other assets and tax valuation allowances totaling approximately $1.1 billion were included in the results of 2014. Our E&C business segment, where we execute large EPC projects, generated revenues of $3.5 billion and gross profit of $224 million during 2015. This business segment continues to deliver solid operational performance and successful execution on two mega-LNG projects in Australia. The business segment continues to actively pursue opportunities for LNG, floating LNG ("FLNG”), oil & gas, ammonia and chemicals projects and expects growth in services contracts executed by our Brown & Root Industrial Services joint venture. We have completed work on the seven loss making Canadian pipe fabrication and module assembly projects. The majority of our Canadian pipe fabrication and module assembly business has now been contributed to a separate third party pipe fabrication business as part of our minority ownership in that entity. Our Non-strategic Business segment completed two of three fixed-price EPC Power projects with the remaining project scheduled for completion in 2017. During the year this segment contributed positive earnings of $27 million versus a loss of $227 million in 2014. Our GS business segment decreased its gross loss by $29 million to a $3 million loss in 2015 compared to a $32 million loss in 2014. This segment is experiencing increased activity from new awards and expansions on existing U.S. government contracts, however, it continues to be adversely impacted by legal fees associated with the LogCAP III and Restore Iraqi Oil ("RIO") legacy projects. This segment has secured a major contract to support the U.K. Ministry of Defence ("MoD") Military Flying Training Systems program in January 2016 and is well positioned for a second large-scale contract with the U.K. MoD. Our T&C business segment provides licensed technologies and consulting services to the oil and gas value chain, from wellhead to crude refining and specialty chemicals production. Gross profits increased by $24 million to $77 million in 2015 driven by a profitable mix of projects and cost reductions. The decrease in consolidated revenues in 2015 compared to 2014 was primarily due to reduced activity within our E&C business segment from the substantial completion of one of the major LNG projects in Australia. The decrease in revenues was also attributable to the completion or substantial completion of several projects in the U.S., Middle East and Canada as well as the elimination of $126 million of revenues related to the deconsolidation of our Industrial Services Americas business in the third quarter of 2015. These decreases were partially offset by increased work or ramp up on chemicals and ammonia projects in the U.S. and a new oil and gas project in Europe. Our revenues were also impacted by activity within our Non-strategic Business segment, including the elimination of $141 million of revenues related to the Building Group, which we sold at the end of the second quarter of 2015, and the continued wind-down on two power projects that are nearing completion. In addition, the decline in both proprietary equipment sales and awards of new consulting contracts from upstream oil related projects within our T&C business segment contributed to the decrease. The decrease in consolidated revenues in 2014 compared to 2013 was primarily driven by reduced activity within our E&C business segment resulting from the completion or near completion of EPC projects in our LNG/GTL markets, partially offset by new awards of refining, petrochemicals and chemicals projects. Lower overall volumes associated with our GS business segment's support and logistics activities in Iraq and Afghanistan for the U.S. and U.K. governments, respectively, also contributed to the decline. Additionally, the reduction in revenues was due to completion of several building projects within our Non-strategic Business segment. The increase in consolidated gross profit in 2015 compared to 2014 was primarily due to losses and charges that were recognized during 2014 on projects within our E&C and Non-strategic Business segments that did not recur in 2015. Gross profit was also impacted by the recognition of favorable settlements in the third quarter of 2015 within our Non-strategic Business segment, ongoing execution on base operations and other contracts within our GS business segment and reduced overhead spending within our E&C business segment. This increase was partially offset by reduced activity on the major LNG project discussed above. The decrease in consolidated gross profit in 2014 compared to 2013 was primarily attributable to an increase in estimated costs to complete projects within our Non-strategic Business segment and reduced volumes resulting from completion of our GS contracts discussed above. Within our E&C business segment, reduced volume as we reached peak activity in 2013 on certain EPC projects, higher estimated costs to complete certain projects and the positive impact of a fee negotiation in 2013, which did not recur in 2014, contributed to the reduction in gross profit. The impact of these decreases was partially offset by the reduction in losses within our E&C business segment on our Canadian pipe fabrication and module assembly projects in 2014 compared to 2013. The decrease in equity in earnings of unconsolidated affiliates in 2015 compared to 2014 was primarily due to an insurance recovery and reduced costs on a joint venture project within our GS business segment in 2014 that did not recur in 2015 as well a reduction in volume due to the substantial completion of construction activities on this project during 2015. This decrease was offset by increased earnings on our offshore maintenance joint venture in Mexico in our E&C business segment. The increase in equity in earnings of unconsolidated affiliates in 2014 compared to 2013 was primarily due to increased activity and progress on an LNG project joint venture within our E&C business segment and by an insurance recovery and reduced costs on a joint venture project in our GS business segment, offset by a reduction in volume as we neared completion of construction activities on this project. The decrease in general and administrative expenses in 2015 compared to 2014 was primarily due to lower information technology support costs resulting from the cancellation of our enterprise resource planning ("ERP") implementation project in the fourth quarter of 2014, reduced overhead costs resulting from headcount reductions and other cost savings initiatives implemented at the end of 2014 and during 2015. General and administrative expenses in 2015 included $113 million related to corporate activities and $42 million related to the business segments. The decrease in general and administrative expenses in 2014 compared to 2013 was primarily due to lower information technology support costs and reduced overhead costs resulting from headcount reductions and cost savings initiatives implemented at the end of 2013 and during 2014. Our general and administrative expenses for 2014 and 2013 included $35 million each related to our ERP project. Amortization on the completed phase of the project was $15 million and $7 million for 2014 and 2013, respectively. General and administrative expenses in 2014 included $174 million related to corporate and $65 million related to the business segments. Asset impairment charges in 2015 reflects $22 million of charges within our E&C and Other business segments on the remaining portion of one of our ERP assets, which we abandoned during the year. We also recognized $9 million of impairment on leasehold improvements as a result of early termination of lease arrangements during 2015 related to leases within our E&C and Other business segments. Restructuring charges in 2015 reflects $12 million in charges as a result of early termination of lease arrangements primarily within our E&C and Non-strategic Business segments and severance of $27 million within our E&C and T&C business segments as the result of workforce reduction efforts primarily related to our announcement at the end of 2014. In 2014, we recognized goodwill impairment of $446 million related to the remaining goodwill associated with our Roberts and Schaefer ("R&S") and BE&K, Inc. acquisitions as a result of our decision to exit related businesses and the continued business decline in certain markets. Asset impairment charges in 2014 reflects the impairment of $135 million for a portion of our ERP project we did not expect would provide us any future benefits, the recognition of a $31 million impairment of R&S intangible assets and $5 million of impairment charges related to leasehold improvements on the terminated leases and other properties. Restructuring charges in 2014 reflect $29 million of severance charges as a result of workforce reductions and lease termination charges of $14 million as a result of terminated leases in several locations. See Notes 8 and 9 to our consolidated financial statements for further discussion on our goodwill and asset impairment and restructuring charges. The gain on disposition of assets in 2015 primarily reflects the gain recognized on the sale of our U.K. office location within our E&C business segment and our Infrastructure Americas business within our Non-strategic Business segment. This also includes the gain recognized in our E&C business segment for the deconsolidation and transfer of our Industrial Services business to the Brown & Root Industrial Services joint venture and the sale of our Building Group subsidiary within our Non-strategic Business segment in the second quarter. See Notes 2 and 10 to our consolidated financial statements for additional information. Non-operating income includes interest income, interest expense, foreign exchange gains and losses and other non-operating income or expense items. The decrease in non-operating income in 2015 compared to 2014 was primarily due to the gain on a negotiated settlement with our former parent as well as the reversal of associated interest under a tax sharing agreement recognized in 2014 that did not recur in 2015. Also contributing to operating income were foreign exchange gains of $9 million in 2015 due to the strengthening of the U.S. dollar against the majority of our foreign currencies compared to losses in 2014. The change to non-operating income in 2014 compared to non-operating expense in 2013 was primarily attributable to a $24 million gain related to a negotiated dispute settlement with our former parent in 2014. n/m - not meaningful The decrease in income tax expense in 2015 compared to 2014 was primarily due to the absence of the nondeductible goodwill impairment loss, the increase in our valuation allowance for deferred tax assets and the recognition of taxes on undistributed earnings which impacted 2014 income taxes. The increase in income tax expense in 2014 compared to 2013 was primarily due to the recognition of income tax expense of $421 million in 2014 on our loss before provision for income taxes instead of recognizing a tax benefit primarily as a result of the nondeductible goodwill impairment loss, an increase in our valuation allowance for deferred tax assets and recognition of taxes on undistributed earnings. A reconciliation of our effective tax rates for 2015, 2014 and 2013 to the U.S. statutory federal rate is presented in Note 13 to our consolidated financial statements. The decrease in net income attributable to noncontrolling interests in 2015 compared to 2014 was primarily due to reduced joint venture earnings resulting from the substantial completions of an LNG project joint venture in Australia in our E&C business segment. The decrease in net income attributable to noncontrolling interests in 2014 compared to 2013 is primarily due to earnings from the renegotiation of fees and cost recoveries on a joint venture project which were recognized in our E&C business segment in 2013 but did not recur in 2014. Results of Operations by Business Segment We analyze the financial results for each of our five business segments. The business segments presented are consistent with our reportable segments discussed in Note 2 to our consolidated financial statements. n/m - not meaningful Technology & Consulting T&C revenues decreased by $29 million, or 8%, to $324 million in 2015 compared to $353 million in 2014 due to a decrease in proprietary equipment sales and awards of new consulting contracts from upstream oil projects partially offset by higher technology revenues related to several petrochemicals, ammonia and refining projects. T&C gross profit increased by $24 million, or 45%, to $77 million in 2015 compared to $53 million in 2014 due to higher profitability on the mix of projects executed, a larger number of license milestones achieved and significant overhead reductions during 2015. T&C revenues increased by $23 million, or 7%, to $353 million in 2014 compared to $330 million in 2013 driven largely by an increase in proprietary equipment supply on several ammonia plants and an increase in the number of consulting projects. This improvement was partially offset by a reduction in volume attributable to delays in project awards and a decline in BED activities on several projects. T&C gross profit decreased by $16 million, or 23%, to $53 million in 2014 compared to $69 million in 2013 due primarily to the project delays and decline in BED activities discussed above, offset by the impact to gross profit of the increased revenues from proprietary equipment supply and consulting projects. Engineering & Construction E&C revenues decreased by $1.1 billion, or 25%, to $3.5 billion in 2015 compared to $4.6 billion in 2014. This decrease resulted primarily from reduced activity on a major LNG project in Australia, the completion of Canadian pipe fabrication and module assembly projects which had peak activity in 2014, reduced activity in the construction market and the elimination of revenues resulting from the deconsolidation of our Industrial Services Americas business during the third quarter. E&C gross profit increased by $83 million, or 59%, to $224 million in 2015 compared to $141 million in 2014. This increase was primarily due to Canadian pipe fabrication and module assembly projects, which had profit in 2015 resulting from negotiated settlements and closeout activities compared to recognition of losses in 2014, and reduced overheads in 2015. This increase was partially offset by reduced activity on a major LNG project in Australia. E&C equity in earnings in unconsolidated affiliates increased by $14 million, or 16%, to $104 million in 2015 compared to $90 million in 2014. The increase was primarily attributable to our offshore maintenance joint venture in Mexico, which had increased earnings in 2015 due to the vessels being in dry dock during 2014 and a benefit of $15 million due to an adjustment in the second quarter of 2015 to correct transactions between the unconsolidated affiliates associated with that Mexican joint venture. The increase was partially offset by reduced earnings on an LNG project joint venture in Australia and reduced earnings on our ammonia plant joint venture in Egypt. E&C revenues decreased by $372 million, or 8%, to $4.6 billion in 2014 compared to $5.0 billion in 2013. This decrease was primarily due to lower activity on LNG projects, as they neared completion in 2014, and reduced activity in the Construction market. These decreases were partially offset by increased activity on contracts for downstream projects in the U.S., on several Canadian pipe fabrication, module assembly and construction projects, on an upstream project in Azerbaijan and an increase in KBR services on an LNG project joint venture in Australia. E&C gross profit decreased by $122 million, or 46%, to $141 million in 2014 compared to $263 million in 2013 due to higher activity and incentive fees on an LNG project in Australia in 2013 that did not recur in 2014 and a reduction in gross profit resulting from an increase in estimated costs to complete certain projects. These decreases were partially offset by reduced losses on our Canadian pipe fabrication and module assembly projects, start-up work on an ammonia plant in the U.S. and charges taken on LNG projects in 2013 that did not recur in 2014. E&C equity in earnings in unconsolidated affiliates increased by $14 million, or 18%, to $90 million in 2014 compared to $76 million in 2013 due primarily to increased progress on an LNG project in Australia. This increase was partially offset by reduced earnings on the MMM joint venture in Mexico, as the vessels were out of contract for a significant portion of 2014. Government Services GS revenues increased by $25 million, or 4% to $663 million in 2015 compared to $638 million in 2014. This increase was driven primarily from the expansion of existing U.S. government contracts, partially offset by the effect of reduced troop numbers on services under U.K. MoD and NATO contracts in Afghanistan. Revenues were also positively impacted by favorable settlement of disputes with the U.S. government on some of our legacy projects. GS gross loss decreased by $29 million, or 91% to a loss of $3 million in 2015 compared to a loss of $32 million in 2014. This improvement was driven by increased activity on U.S. government contracts discussed above, partially offset by the reduction in Afghanistan-related support activities. The positive impact of the favorable settlement of disputes with the U.S. government on some of our legacy projects includes the recognition of $18 million in legal fees related to these legacy contracts during 2015. GS equity in earnings in unconsolidated affiliates decreased by $28 million, or 38% to $45 million in 2015 compared to $73 million in 2014. This decrease was driven primarily by an insurance recovery on a joint venture for a U.K. MoD project in 2014 that did not recur in 2015 as well as the impact of reaching substantial completion of construction activities on this project. GS revenues decreased by $293 million, or 31% to $638 million in 2014 compared to $931 million in 2013. This decline was driven by a $246 million reduction in revenues from U.S. government contracts supporting military activities in Iraq in early 2014, and a $45 million reduction in revenues from U.K. MoD and NATO contracts supporting military operations in Afghanistan as a result of gradually reducing troop numbers. These decreases were partially offset by new awards of U.S. government construction and base support contracts in Europe and Africa as well as the award of a long term contract with the U.K. Metropolitan Police. Settlement of outstanding items and adjustments to reserves for questioned costs on our U.S. government legacy contracts, resulted in a $94 million reduction in revenues. GS gross profit decreased by $122 million, or 136% to a gross loss of $32 million in 2014 compared to gross profit of $90 million in 2013. This decline was primarily driven by the completion of the U.S. government contracts in Iraq along with the reduced U.K. MoD and NATO support activities discussed above. Additionally, an increase in our estimate of costs to complete a roads program management contract in Qatar and a construction management contract with the U.S. government in Europe contributed to reduced gross profit. The settlements and reserves for questioned costs on the U.S. government legacy contracts discussed above also reduced gross profit by $66 million. GS equity in earnings in unconsolidated affiliates increased by $12 million, or 20% to $73 million in 2014 compared to $61 million in 2013. This increase was primarily due to an insurance recovery on a joint venture for a U.K. MoD project, offset by a reduction in volume as we near completion of construction activities on this joint venture project. Non-strategic Business Non-strategic Business revenues decreased by $136 million, or 17%, to $655 million in 2015 compared to $791 million in 2014. This decrease was due to the sale of Building Group in the second quarter of 2015 and the near completion of several power and construction projects partially offset by increased activity on power and infrastructure projects that began in the second half of 2014. Non-strategic Business gross profit increased by $254 million to a profit of $27 million in 2015 compared to a loss of $227 million in 2014. This increase was due to the non-recurrence of charges recognized during 2014 on a power project, improved performance and favorable settlements on power projects in the third quarter of 2015 as well as overhead savings resulting from the Building Group sale mentioned above and headcount reductions which began in late 2014. Non-strategic Business revenues decreased by $206 million, or 21%, to $791 million in 2014 compared to $997 million in 2013. This was largely due to the completion or near completion of several building construction projects, partially offset by higher revenues from increased activity on two power projects. Non-strategic Business gross loss increased by $222 million to $227 million in 2014 compared to $5 million in 2013. This increase in gross loss was primarily due to a $173 million impact from an increase in the estimate of costs to complete three power projects, resulting in losses or reduced margins on these projects, a settlement on a minerals project and increased legal reserves on an infrastructure project. Changes in Estimates Information relating to our changes in estimates is discussed in Note 2 to our consolidated financial statements and the information discussed therein is incorporated by reference into this Item 7. Acquisitions, Dispositions and Other Transactions Information relating to various acquisitions, dispositions and other transactions is described in Notes 2, 7 and 10 to our consolidated financial statements and the information discussed therein is incorporated by reference into this Item 7. Backlog of Unfilled Orders Backlog generally represents the dollar amount of revenues we expect to realize in the future as a result of performing work on contracts and our pro-rata share of work to be performed by unconsolidated joint ventures. We generally include total expected revenues in backlog when a contract is awarded under a legally binding commitment. In many instances, arrangements included in backlog are complex, nonrepetitive and may fluctuate depending on estimated revenues and contract duration. Where contract duration is indefinite and clients can terminate for convenience at any time without having to compensate us for periods beyond the date of termination, projects included in backlog are limited to the estimated amount of expected revenues within the following twelve months. Certain contracts provide maximum dollar limits, with actual authorization to perform work under the contract agreed upon on a periodic basis with the customer. In these arrangements, only the amounts authorized are included in backlog. For projects where we act solely in a project management capacity, we only include the value of our services of each project in backlog. Previously, for long term contracts associated with the U.K. government's privately financed initiatives or projects ("PFIs" also "service concession arrangements"), the amount included in backlog was limited to five years. Effective in the second quarter of 2015, we modified our backlog policy and now record the estimated value of all work forecast to be performed under the PFI contracts. The reason for the change is that under these PFI contracts, the client is obligated to pay us certain amounts spanning periods beyond five years even if the client terminates the contracts for convenience. This change only relates to backlog of unfilled orders and does not alter our longstanding policies for revenue recognition; therefore, it has no impact on our financial statements. The $5 billion included in the change in policy column below represents our estimate of revenues related to payment obligations for periods beyond five years. We have included in the table below our proportionate share of unconsolidated joint ventures' estimated revenues. Since these projects are accounted for under the equity method, only our share of future earnings from these projects will be recorded in our results of operations. Our proportionate share of backlog for projects related to unconsolidated joint ventures totaled $8.5 billion including the PFI change discussed above, at December 31, 2015 and $4.3 billion at December 31, 2014. We consolidate joint ventures which are majority-owned and controlled or are variable interest entities ("VIEs") in which we are the primary beneficiary. Our backlog included in the table below for projects related to consolidated joint ventures with noncontrolling interests includes 100% of the backlog associated with those joint ventures and totaled $285 million at December 31, 2015 and $928 million at December 31, 2014. The following table summarizes our backlog by business segment: (a) Change in policy was implemented in the second quarter of 2015. (b) These amounts include adjustments for (i) changes in scope, (ii) effects of changes in foreign exchange rates, (iii) elimination of 50% of backlog associated with our Industrial Services Americas business, which we transferred to the Brown & Root Industrial Services joint venture in the third quarter of 2015 and (iv) elimination of our proportionate share of non-partner costs related to our unconsolidated joint ventures. (c) These amounts include the workoff of our projects as well as our proportionate share of the workoff of our unconsolidated joint ventures' projects. We estimate that as of December 31, 2015, 38% of our backlog will be executed within one year. As of December 31, 2015, 22% of our backlog was attributable to fixed-price contracts, 49% was attributable to service concession arrangements, and 29% of our backlog was attributable to cost-reimbursable contracts. For contracts that contain both fixed-price and cost-reimbursable components, we classify the components as either fixed-price or cost-reimbursable according to the composition of the contract; however, except for smaller contracts, we characterize the entire contract based on the predominant component. Liquidity and Capital Resources Cash and equivalents totaled $883 million at December 31, 2015 and $970 million December 31, 2014 and consisted of the following: Domestic cash relates to cash balances held by U.S. entities and is largely used to support obligations of those businesses as well as general corporate needs such as the payment of dividends to shareholders and potential repurchases of our outstanding common stock. The international cash balances may be available for general corporate purposes but are subject to local restrictions such as capital adequacy requirements and local obligations such as maintaining sufficient cash balances to support our underfunded U.K. pension plan and other obligations incurred in the normal course of business by those foreign entities. Repatriated foreign cash may become subject to U.S. income taxes. Joint venture cash balances reflect the amounts held by joint venture entities that we consolidate for financial reporting purposes. Such amounts are limited to joint venture activities and are not readily available for general corporate purposes but portions of such amounts may become available to us in the future should there be a distribution of dividends to the joint venture partners. We expect that the majority of the joint venture cash balances will be utilized for the corresponding joint venture projects. Cash generated from operations is our primary source of operating liquidity. Our cash balances are held in numerous locations throughout the world. We believe that existing cash balances and internally generated cash flows are sufficient to support our day-to-day domestic and foreign business operations for at least the next 12 months. Our international cash balances are primarily held in Australia and the Netherlands. As part of our cash repatriation strategy, we have provided cumulative income taxes on certain foreign earnings which allow for repatriation of approximately $140 million of international cash without recognizing additional tax expense. See Note 13 to our consolidated financial statements for further discussion on our foreign cash repatriation strategy. Our operating cash flow can vary significantly from year to year and is affected by the mix, terms and percentage of completion of our engineering and construction projects. We sometimes receive cash through billings to our customers on our larger engineering and construction projects and those of our consolidated joint ventures in advance of incurring the related costs. In other projects our net investment in the project costs may be greater than available project cash and we may utilize other cash on hand or availability under our Credit Agreement to satisfy any periodic operating cash requirements. Engineering and construction projects generally require us to provide credit support to our customers in the form of letters of credit, surety bonds or guarantees. Our ability to obtain new project awards in the future may be dependent on our ability to maintain or increase our letter of credit and surety bonding capacity, which may be further dependent on the timely release of existing letters of credit and surety bonds. As the need for credit support arises, letters of credit will be issued under our Credit Agreement or arranged with our banks on a bilateral, syndicated or other basis. We believe we have adequate letter of credit capacity under our existing Credit Agreement and bilateral lines, as well as adequate surety bond capacity under our existing lines to support our operations and current backlog for the next twelve months. As of December 31, 2015, substantially all of our excess cash was held in commercial bank time deposits and money market funds with the primary objectives of preserving capital and maintaining liquidity. Operating activities. Cash provided by operations totaled $47 million in 2015 and was primarily attributable to distributions of earnings received from unconsolidated affiliates of $92 million and fluctuations in our working capital accounts. This increase was partially offset by contributions of approximately $48 million to our pension funds. Cash provided by operations totaled $170 million in 2014 and was primarily attributable to distributions of earnings received from unconsolidated affiliates of $249 million and fluctuations in our working capital accounts. This increase was partially offset by contributions of approximately $48 million to our pension funds. Cash provided by operations totaled $297 million in 2013 and resulted from our earnings, working capital and distributions of earnings received from unconsolidated affiliates of $180 million, partially offset by our payment of $108 million in outstanding performance bonds to PEMEX Exploration and Production ("PEP"), other uses driven by taxes and contributions of approximately $54 million to our pension funds. See Note 15 to our consolidated financial statements for further discussion of the performance bonds. Investing activities. Cash provided by investing activities totaled $101 million in 2015, which was primarily due to $130 million in proceeds from sale of assets or investments. This increase was partially offset by a payment of $19 million to acquire an investment in a partnership. Cash used in investing activities totaled $44 million and $62 million in 2014 and 2013, respectively, which was primarily due to purchases of property, plant and equipment associated with information technology projects which have now largely been cancelled. Financing activities. Cash used in financing activities totaled $192 million in 2015 and included $62 million for the purchase of treasury stock, $40 million for our purchase of a noncontrolling interest in a joint venture, $47 million for dividend payments to common shareholders, $28 million for distributions to noncontrolling interests and $11 million for principal payments on short- and long-term borrowings consisting primarily of nonrecourse debt of our Fasttrax VIE. Cash used in financing activities totaled $210 million in 2014 and included $106 million for the purchase of treasury stock, $47 million for dividend payments to common shareholders, $61 million for distributions to noncontrolling interests and $11 million for principal payments on short- and long-term borrowings consisting primarily of nonrecourse debt of our Fasttrax joint venture. The uses of cash were partially offset by $10 million of investments from noncontrolling interests and $4 million of proceeds from the exercise of stock options. Cash used in financing activities totaled $148 million in 2013 and included $7 million for the purchase of treasury stock, $36 million for dividend payments to common shareholders, $109 million for distributions to noncontrolling interests and $14 million for principal payments on short- and long-term borrowings consisting primarily of nonrecourse debt of our Fasttrax VIE and computer software purchases financed in 2010. The uses of cash were partially offset by $9 million of investments from noncontrolling interests and $6 million of proceeds from the exercise of stock options. Future sources of cash. Future sources of cash include cash flows from operations, cash derived from working capital management, and cash borrowings under our Credit Agreement as well as potential litigation proceeds. Future uses of cash. Future uses of cash will primarily relate to working capital requirements, capital expenditures, dividends, share repurchases and strategic investments. Our capital expenditures will be focused primarily on facilities and equipment to support our businesses. In addition, we will use cash to fund pension obligations, payments under operating leases and various other obligations, including potential litigation payments, as they arise. Other factors potentially affecting liquidity Power project losses. Our reserve for estimated losses on uncompleted contracts included in "other current liabilities" on our consolidated balance sheets includes $47 million at December 31, 2015 related to a power project. These accrued losses will result in future cash expenditures in excess of customer receipts. Based on current contracts and work authorizations, we anticipate completion of this project in 2017. Credit Agreement On September 25, 2015, we entered into a new $1 billion, unsecured revolving credit agreement (the "Credit Agreement") with a syndicate of banks replacing the previous agreement which was scheduled to mature in December 2016. The Credit Agreement is guaranteed by certain of the Company's domestic subsidiaries, matures in September 2020 and is available for cash borrowings and the issuance of letters of credit related to general corporate needs. Subject to certain conditions, we may request (i) that the aggregate commitments under the Credit Agreement be increased by up to an additional $500 million, and (ii) that the maturity date of the Credit Agreement be extended by two additional one-year terms. Amounts drawn under the Credit Agreement will bear interest at variable rates, per annum, based either on (i) the London interbank offered rate ("LIBOR") plus an applicable margin of 1.375% to 1.75%, or (ii) a base rate plus an applicable margin of 0.375% to 0.75%, with the base rate equal to the highest of (a) reference bank’s publicly announced base rate, (b) the Federal Funds Rate plus 0.5%, or (c) LIBOR plus 1%. The amount of the applicable margin to be applied will be determined by the Company’s ratio of consolidated debt to consolidated EBITDA for the prior four fiscal quarters, as defined in the Credit Agreement. The Credit Agreement provides for fees on letters of credit issued under the Credit Agreement at a rate equal to the applicable margin for LIBOR-based loans, except for performance letters of credit, which are priced at 50% of such applicable margin. KBR pays an annual issuance fee of 0.125% of the face amount of a letter of credit and pays a commitment fee of 0.225% to 0.25%, per annum, on any unused portion of the commitment under the Credit Agreement based on the Company's consolidated leverage ratio. As of December 31, 2015, there were $127 million in letters of credit and no cash borrowings outstanding. The Credit Agreement contains customary covenants, as defined by the agreement, which include financial covenants requiring maintenance of a ratio of consolidated debt to consolidated EBITDA not greater than 3.5 to 1 and a minimum consolidated net worth of $1.2 billion plus 50% of consolidated net income for each quarter beginning September 30, 2015 and 100% of any increase in shareholders’ equity attributable to the sale of equity interests, but excluding any adjustments in shareholders' equity attributable to changes in foreign currency translation adjustments. As of December 31, 2015, we were in compliance with our financial covenants. The Credit Agreement contains a number of other covenants restricting, among other things, our ability to incur additional liens and indebtedness, enter into asset sales, repurchase our equity shares and make certain types of investments. Our subsidiaries are restricted from incurring indebtedness, except if such indebtedness relates to purchase money obligations, capitalized leases, refinancing or renewals secured by liens upon or in property acquired, constructed or improved in an aggregate principal amount not to exceed $200 million at any time outstanding. Additionally, our subsidiaries may incur unsecured indebtedness not to exceed $200 million in aggregate outstanding principal amount at any time. We are also permitted to repurchase our equity shares, provided that no such repurchases shall be made from proceeds borrowed under the Credit Agreement, and that the aggregate purchase price and dividends paid after September 25, 2015, does not exceed the Distribution Cap (equal to the sum of $750 million plus the lesser of (1) $400 million and (2) the amount received by us in connection with the arbitration and subsequent litigation of the PEP contracts as discussed in Note 15 to our consolidated financial statements). As of December 31, 2015, the remaining availability under the Distribution Cap was approximately $698 million. Nonrecourse Project Finance Debt Information relating to our nonrecourse project debt is described in Note 12 to our consolidated financial statements and the information discussed therein is incorporated by reference into this Item 7. Off-Balance Sheet Arrangements Letters of credit, surety bonds and guarantees. In connection with certain projects, we are required to provide letters of credit, surety bonds or guarantees to our customers. Letters of credit are provided to certain customers and counterparties in the ordinary course of business as credit support for contractual performance guarantees, advanced payments received from customers and future funding commitments. We have approximately $2.2 billion in committed and uncommitted lines of credit to support the issuance of letters of credit and as of December 31, 2015, we have utilized $593 million of our present capacity under lines of credit. Surety bonds are also posted under the terms of certain contracts to guarantee our performance. The letters of credit outstanding included $127 million issued under our Credit Agreement and $466 million issued under uncommitted bank lines as of December 31, 2015. Of the letters of credit outstanding under our Credit Agreement, there are no letters of credit that have expiry dates beyond the maturity date of the Credit Agreement. Of the total letters of credit outstanding, $236 million relate to our joint venture operations where the letters of credit are posted using our capacity to support our pro-rata share of obligations under various contracts executed by joint ventures of which we are a member. As the need arises, future projects will be supported by letters of credit issued under our Credit Agreement or other lines of credit arranged on a bilateral, syndicated or other basis. We believe we have adequate letter of credit capacity under our Credit Agreement and bilateral lines of credit to support our operations for the next twelve months. Commitments and other contractual obligations. The following table summarizes our significant contractual obligations and other long-term liabilities as of December 31, 2015: (a) Amounts presented are net of subleases. (b) In the ordinary course of business, we enter into commitments for the purchase or lease of software, materials, supplies and similar items. The purchase obligations can span several years depending on the duration of the projects. The purchase obligations disclosed above do not include purchase obligations that we enter into with vendors in the normal course of business that support existing contracting arrangements with our customers. We expect to recover such obligations from our customers. (c) Included in our pension obligations are payments related to our agreement with the trustees of our international plan. The agreement calls for minimum contributions of £28 million in 2016 through 2023. The foreign funding obligations were converted to U.S. dollars using the conversion rate as of December 31, 2015. KBR, Inc. has provided a guarantee for up to £125 million in support of Kellogg Brown & Root (U.K.) Limited's obligation to make payments to the plan in respect of its liability under the U.K. Pensions Act 1995. (d) Not included in the total are uncertain tax positions recorded pursuant to Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 740 - Income Taxes, which totaled $257 million as of December 31, 2015. The ultimate timing of settlement of these obligations cannot be determined with reasonable assurance and have been excluded from the table above. See Note 13 to our consolidated financial statements for further discussion on income taxes. Transactions with Joint Ventures We perform many of our projects through incorporated and unincorporated joint ventures. In addition to participating as a joint venture partner, we often provide engineering, procurement, construction, operations or maintenance services to the joint venture as a subcontractor. Where we provide services to a joint venture that we control and therefore consolidate for financial reporting purposes, we eliminate intercompany revenues and expenses on such transactions. In situations where we account for our interest in the joint venture under the equity method of accounting, we do not eliminate any portion of our revenues or expenses. We recognize the profit on our services provided to joint ventures that we consolidate and joint ventures that we record under the equity method of accounting primarily using the percentage-of-completion method. Recent Accounting Pronouncements Information relating to recent accounting pronouncements is described in Note 21 to our consolidated financial statements and the information discussed therein is incorporated by reference into this Item 7. U.S. Government Matters Information relating to U.S. government matters commitments and contingencies is described in Note 14 to our consolidated financial statements and the information discussed therein is incorporated by reference into this Item 7. Legal Proceedings Information relating to various commitments and contingencies is described in Note 15 to our consolidated financial statements and the information discussed therein is incorporated by reference into this Item 7. Critical Accounting Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States ("U.S. GAAP") requires management to make estimates and judgments that affect the determination of financial positions, cash flows and results of operations. Our critical accounting policies are described below to provide a better understanding of our estimates and assumptions about future events that affect the amounts reported in the financial statements and accompanying notes. Significant accounting estimates are important to the representation of our financial position and results of operations and require our most difficult, subjective or complex judgments. We base our estimates on historical experience and on various other assumptions we believe to be reasonable according to the current facts and circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We believe the following are the critical accounting policies used in the preparation of our consolidated financial statements in accordance with U.S. GAAP, as well as the significant estimates and assumptions affecting the application of these policies. Our accounting policies are more fully described in Note 1 to our consolidated financial statements. Engineering and Construction Contracts. Revenues from the performance of contracts for which specifications are provided by the customer for the construction of facilities, the production of goods or the provision of related services is accounted for using the percentage-of-completion method. These contracts include services essential to the construction or production of tangible property, such as design, EPC and EPC management. We account for these contracts in accordance with ASC 605-35, Revenue Recognition, Construction-Type and Production-Type Contracts. At the outset of each contract, we prepare a detailed analysis of our estimated cost to complete the project. Risks relating to service delivery, usage, productivity and other factors are considered in the estimation process. Our project personnel regularly evaluate the estimated costs, revenues and progress and adjust the estimates accordingly. We measure the progress towards completion of the project to determine the amount of revenues and profit to be recognized in each reporting period. Profit is recorded based upon the product of estimated contract profit-at-completion times the current percentage-complete for the contract. Our progress estimates are based upon estimates of the total cost to complete the project, which considers, among other things, the current project schedule and anticipated completion date, as well as estimates of the extent of progress toward completion. While progress is generally based upon costs incurred in relation to total estimated costs at completion, we also use alternative methods including physical progress, labor hours incurred to total estimated labor hours at completion or others depending on the type of project. Our estimate of total revenues includes estimates of probable liquidated damages and certain probable claims and unapproved change orders. When estimating the amount of total gross profit or loss on a contract, we include certain unapproved change orders or claims to our clients as adjustments to revenues and claims to vendors, subcontractors and others as adjustments to total estimated costs. Claims against others are recorded up to the extent of the lesser of the amounts management expects to recover or to costs incurred and include no profit until such time as they are finalized and approved. See Note 5 to our consolidated financial statements for our discussion on unapproved change orders and claims. At least quarterly, significant projects are reviewed by management. We have a long history of working with multiple types of projects and in preparing cost estimates. However, there are many factors that impact future costs, including but not limited to weather, inflation, labor and community disruptions, timely availability of materials, productivity and other factors as outlined in "Item 1A. Risk Factors". These factors can affect the accuracy of our estimates and materially impact our future reported earnings. For contracts containing multiple deliverables we analyze each activity within the contract to ensure that we adhere to the separation guidelines of ASC 605 - Revenue Recognition and ASC 605-25 - Multiple-Element Arrangements. Estimated Losses on Uncompleted Contracts and Changes in Contract Estimates. We record provisions for total estimated losses on uncompleted contracts in the period in which such losses are identified. The cumulative effects of revisions to contract revenues and estimated completion costs are recorded in the accounting period in which the amounts become evident and can be reasonably estimated. These revisions can include such items as the effects of change orders and claims, warranty claims, liquidated damages or other contractual penalties, adjustments for audit findings on U.S. government contracts and contract closeout settlements. Information relating to our changes in estimates is discussed in Note 2 to our consolidated financial statements and the information discussed therein is incorporated by reference into this Item 7. Accounting for Government Contracts. Some of the services provided to the U.S. government are performed on cost-reimbursable contracts. Generally, these contracts may contain base fees (a fixed profit percentage applied to our actual costs to complete the work). Revenues are recognized at the time services are performed, and such revenues include base fees, estimated direct project costs incurred and an allocation of indirect costs. Indirect costs are applied using rates approved by our government customers. The general, administrative and overhead cost reimbursement rates are estimated periodically in accordance with government contract accounting regulations and may change based on actual costs incurred or based upon the volume of work performed. Revenues are reduced for our estimate of costs that either are in dispute with our customer or have been identified as potentially unallowable pursuant to the terms of the contract or the federal acquisition regulations. Similar to many cost-reimbursable contracts, these government contracts are typically subject to audit and adjustment by our customer. Each contract is unique; therefore, the level of confidence in our estimates for audit adjustments varies depending on how much historical data we have with a particular contract. KBR excludes from billings to the U.S. government costs that are expressly unallowable, or mutually agreed to be unallowable, or not allocable to government contracts based on the applicable regulations. Revenues recorded for government contract work are reduced for our estimate of potentially unallowable costs related to issues that may be categorized as disputed or unallowable as a result of cost overruns or the audit process. Our estimates of potentially unallowable costs are based upon, among other things, our internal analysis of the facts and circumstances, terms of the contracts and the applicable provisions of the FAR, quality of supporting documentation for costs incurred and subcontract terms, as applicable. From time to time, we engage outside counsel to advise us in determining whether certain costs are allowable. We also review our analysis and findings with the administrative contracting officer ("ACO"), as appropriate. In some cases, we may not reach agreement with the DCAA or the ACO regarding potentially unallowable costs which may result in our filing of claims in various courts such as the Armed Services Board of Contract Appeals ("ASBCA") or the COFC. We only include amounts in revenues related to disputed and potentially unallowable costs when we determine it is probable that such costs will result in revenue. We generally do not recognize additional revenues for disputed or potentially unallowable costs for which revenues have been previously reduced until we reach agreement with the DCAA or the ACO that such costs are allowable. Goodwill Impairment Testing. Our October 1, 2015 annual impairment test for goodwill was a quantitative analysis using a two-step process that involves comparing the estimated fair value of each reporting unit to its carrying value, including goodwill. The fair values of reporting units were determined using a combination of two methods, one utilizing market earnings multiples (the market approach) and the other derived from discounted cash flow models with estimated cash flows based on internal forecasts of revenues and expenses over a specified period plus a terminal value (the income approach). Under the market approach, we estimate fair value by applying earnings and revenue market multiples ranging from 4.08 to 13.42 times earnings and 0.3 to 1.3 times revenue. The income approach estimates fair value by discounting each reporting unit’s estimated future cash flows using a weighted-average cost of capital that reflects current market conditions and the risk profile of the reporting unit. To arrive at our future cash flows, we use estimates of economic and market assumptions, including growth rates in revenues, costs, estimates of future expected changes in operating margins, tax rates and cash expenditures. Future revenues are also adjusted to match changes in our business strategy. The risk-adjusted discount rates applied to our future cash flows under the income approach ranged from 12% to 15.4%. We believe these two approaches are appropriate valuation techniques and we generally weight the two resulting values equally as an estimate of a reporting unit's fair value for the purposes of our impairment testing. However, we may weigh one value more heavily than the other when conditions merit doing so. Other significant estimates and assumptions include terminal value growth rates, future estimates of capital expenditures and changes in future working capital requirements. The fair value derived from the weighting of these two methods provides appropriate valuations that, in the aggregate, reasonably reconcile to our market capitalization, taking into account observable control premiums. In addition to the earnings and revenue multiples and the discount rates disclosed above, certain other judgments and estimates are used in our goodwill impairment test. Given this, if market conditions change compared to those used in our market approach, or if actual future results of operations fall below the projections used in the income approach, our goodwill could become impaired in the future. At the annual testing date of October 1, 2015, our market capitalization exceeded the carrying value of our consolidated net assets by $1.7 billion and the fair value of all our reporting units substantially exceeded their respective carrying amounts as of that date. The fair value for two reporting units in our E&C business segment with goodwill of $42 million and $33 million, respectively, exceeded their carrying values by 38% and 26%, respectively, based on projected growth rates and other market inputs that are more sensitive to the risk of future variances due to competitive market conditions and reporting unit project execution. If future variances for these assumptions are negative and significant, the fair value of these reporting units may not substantially exceed their carrying values in future periods. Deferred Taxes and Tax Contingencies. See Note 1 to our consolidated financial statements for discussion on income taxes. Legal and Investigation Matters. As discussed in Notes 14 and 15 to our consolidated financial statements, as of December 31, 2015 and 2014, we have accrued an estimate of the probable and estimable costs for the resolution of some of our legal and investigation matters. For other matters for which the liability is not probable and reasonably estimable, we have not accrued any amounts. Attorneys in our legal department monitor and manage all claims filed against us and review all pending investigations. Generally, the estimate of probable costs related to these matters is developed in consultation with internal and external legal counsel representing us. Our estimates are based upon an analysis of potential results, assuming a combination of litigation and settlement strategies. The precision of these estimates and the likelihood of future changes depend on a number of underlying variables and a range of possible outcomes. We attempt to resolve these matters through settlements, mediation and arbitration proceedings, when possible. If the actual settlement costs, final judgments or fines, differ from our estimates after appeals, our future financial results may be materially and adversely affected. We record adjustments to our initial estimates of these types of contingencies in the periods when the change in estimate is identified. Pensions. Our pension benefit obligations and expenses are calculated using actuarial models and methods. Two of the more critical assumptions and estimates used in the actuarial calculations are the discount rate for determining the current value of benefit obligations and the expected rate of return on plan assets. Other assumptions and estimates used in determining benefit obligations and plan expenses include inflation rates and demographic factors such as retirement age, mortality and turnover. These assumptions and estimates are evaluated periodically and are updated accordingly to reflect our actual experience and expectations. The discount rate used to determine the benefit obligations was computed using a yield curve approach that matches plan specific cash flows to a spot rate yield curve based on high quality corporate bonds. The expected long-term rate of return on assets was determined by a stochastic projection that takes into account asset allocation strategies, historical long-term performance of individual asset classes, an analysis of additional return (net of fees) generated by active management, risks using standard deviations and correlations of returns among the asset classes that comprise the plans' asset mix. Plan assets are comprised primarily of equity securities, fixed income funds and securities, hedge funds, real estate and other funds. As we have both domestic and international plans, these assumptions differ based on varying factors specific to each particular country or economic environment. The discount rate utilized to calculate the projected benefit obligation at the measurement date for our U.S. pension plan increased to 3.42% at December 31, 2015 from 2.89% at December 31, 2014. The discount rate utilized to determine the projected benefit obligation at the measurement date for our U.K. pension plan, which constitutes all of our international plans and 96% of all plans, increased to 3.75% at December 31, 2015 from 3.65% at December 31, 2014. Our expected long-term rates of return on plan assets utilized at the measurement date decreased to 4.81% from 5.28% for our U.S. pension plans and decreased to 6.25% from 6.45% for our U.K. pension plans. The following table illustrates the sensitivity to changes in certain assumptions, holding all other assumptions constant, for our pension plans: Unrecognized actuarial gains and losses are generally recognized using the corridor method over a period of approximately 15 years, which represents a reasonable systematic method for amortizing gains and losses for the employee group. Our unrecognized actuarial gains and losses arise from several factors, including experience and assumption changes in the obligations and the difference between expected returns and actual returns on plan assets. The difference between actual and expected returns is deferred as an unrecognized actuarial gain or loss on our consolidated statement of comprehensive income (loss) and is recognized as a decrease or an increase in future pension expense. Our pretax unrecognized actuarial loss in accumulated other comprehensive loss at December 31, 2015 was $769 million, of which $31 million is expected to be recognized as a component of our expected 2016 pension expense compared to $48 million in 2015. The actuarial assumptions used in determining our pension benefits may differ materially from actual results due to changing market and economic conditions, higher or lower withdrawal rates and longer or shorter life spans of participants. While we believe that the assumptions used are appropriate, differences in actual experience, expectations, or changes in assumptions may materially affect our financial position or results of operations. Our actuarial estimates of pension benefit expense and expected pension returns of plan assets are discussed in Note 11 in the accompanying financial statements. Item 7A.

1357615

2015